**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-K**

 
| **ý** | ** ** | **Annual  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**      |
|------------|------------|------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                           |
| ** ** | ** ** | **for the fiscal year ended  December 31, 2004;**                                               |
| ** ** | ** ** | ** **                                                                                           |
| ** ** | ** ** | **or**                                                                                               |
| ** ** | ** ** | ** **                                                                                           |
| **o**      | ** ** | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934.** |

 

**Commission File Number 0-28582**

** **

**CHANNELL COMMERCIAL CORPORATION**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                                    | ** ** | **95-2453261**                     |
|-------------------------------------------------|------------|------------------------------------|
| (State or  other jurisdiction of incorporation) |       | (IRS  Employer Identification No.) |

 

**26040 YnezRoad**

**Temecula,CA  92591**

(Address of principal executiveoffices, including zip code)

 

| Registrant’s telephone number, including  area code: **(951) 719-2600** |
|------------------------------------------------------------------------------|
|                                                                         |
| Securities registered pursuant to Section 12(b)  of the Act:            |
|                                                                         |
| **None**                                                                     |
|                                                                         |
| Securities registered pursuant to Section 12(g)  of the Act:            |
|                                                                         |
|                                                                         | **Title of Class** |   |
| **Common  Stock, $0.01 Par Value**                                           |

 

 

 

Indicate by check mark whether the Registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.  Yes **ý   **Noo

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of the Registrant’s knowledge,in definitive proxy or information statements incorporated by reference in PartIII of this Form 10-K or any amendment to this Form 10-K. **ý**

 

On March 11, 2005, the Registrant had9,383,942 shares of Common Stock outstanding with a par value of $.01 pershare.  The aggregate market value of the4,454,412 shares held by non-affiliates of the Registrant was $19,153,972computed by reference to the price at which the shares were last sold, as ofthe last business day of the Registrant’s most recently completed second fiscalquarter.  Shares of Common Stock held byeach officer and director and by each person who may be deemed to be anaffiliate have been excluded.

 

Indicate by check mark whether the Registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2). Yes o   No **ý**

 

DOCUMENTS INCORPORATED BYREFERENCE

 

Part III of this Form 10-K incorporates byreference certain information from the Registrant’s definitive proxy statement(the “Proxy Statement”) for its annual meeting of stockholders to be held onMay 12, 2005.

 

 

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**TABLE OFCONTENTS**

 
| **PART I**               |                                                                                                |
|--------------------------|-----------------------------------------------------------------------------------------------------|
|                     |                                                                                                |   |
| **Item 1.**              | **Business**                                                                                        |   |
|                     |                                                                                                |   |
| **Item 2.**              | **Properties**                                                                                      |   |
|                     |                                                                                                |   |
| **Item 3.**              | **Legal Proceedings**                                                                               |   |
|                     |                                                                                                |   |
| **Item 4.**              | **Submission of Matters to a Vote of Security  Holders**                                            |   |
|                     |                                                                                                |   |
| **PART II**              |                                                                                                |
|                     |                                                                                                |   |
| **Item 5.**              | **Market for Registrant’s Common Equity and  Related Shareholder Matters**                     |   |
|                     |                                                                                                |   |
| **Item 6.**              | **Selected Financial Data**                                                                         |   |
|                     |                                                                                                |   |
| **Item 7.**              | **Management’s Discussion and Analysis of  Financial Condition and Results of Operations**     | ** ** |
|                     |                                                                                                |   |
| **Item 7a.**             | **Quantitative and Qualitative Disclosures  about Market Risk**                                     |   |
|                     |                                                                                                |   |
| **Item 8.**              | **Financial Statements and Supplementary Data**                                                     |   |
|                     |                                                                                                |   |
| **Item 9.**              | **Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure**           | ** ** |
|                     |                                                                                                |   |
| **Item 9a.**             | **Controls and Procedures**                                                                         |   |
|                     |                                                                                                |   |
| **Item 9b.**             | **Other Information**                                                                               |   |
|                     |                                                                                                |   |
| **PART III**             |                                                                                                |
|                     |                                                                                                |   |
| **Item 10.**             | **Executive Officers and Directors of the  Registrant**                                             |   |
|                     |                                                                                                |   |
| **Item 11.**             | **Executive Compensation**                                                                          |   |
|                     |                                                                                                |   |
| **Item 12.**             | **Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters** | ** ** |
|                     |                                                                                                |   |
| **Item 13.**             | **Certain Relationships and Related  Transactions**                                                 |   |
|                     |                                                                                                |   |
| **Item 14.**             | **Principal Accounting Fees and Services**                                                          |   |
|                     |                                                                                                |   |
| **PART IV**              |                                                                                                |   |
|                     |                                                                                                |   |
| **Item 15.**             | **Exhibits, Financial Statement Schedules and  Reports on Form 8-K**                                |   |
|                     |                                                                                                |   |
| **FINANCIAL STATEMENTS** |                                                                                                |
|                     |                                                                                                |   |
| **GLOSSARY  OF TERMS**   |                                                                                                |

 

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** **

**PARTI**

** **

**Item 1. Business**

 

### **Background**

### ** **

Channell Commercial Corporation (the “Company”)was incorporated in Delaware on April 23, 1996, as the successor toChannell Commercial Corporation, a California corporation.  The Company’s executive offices are locatedat 26040 Ynez Road, Temecula, California 92591, and its telephone number atthat address is (951) 719-2600.

 

### **General**

### ** **

The Company is a designer and manufacturer oftelecommunications equipment supplied to broadband and telephone networkproviders worldwide.  Major product linesinclude a complete line of thermoplastic and metal fabricated enclosures,advanced copper termination and connectorization products, fiber optic cablemanagement systems for fiber to the premise (“FTTP”) networks, and heat shrinkproducts.  The Company’s enclosureproducts house, protect and provide access to advanced telecommunicationshardware, including both radio frequency (“RF”) electronics and photonics, andtransmission media, including coaxial cable, copper wire and optical fibers,used in the delivery of voice, video and data services.  The enclosure products are deployed withinthe access portion of the local signal delivery network, commonly known as the “outsideplant”, “local loop” or “last mile”, that connects the network provider’ssignal origination point or local office with its residential and businesscustomers.  The Company’s connectivityproducts provide critical network connection points between cables or networktransmission devices.

 

The Company also designs, manufactures andmarkets polyethylene water tanks for rural and residential markets inAustralia.  The Company’s primary productline of rotational molded tanks is used in the agricultural sector where watershortages require storage of rain and ground water.  The Company also markets a range of waterstorage tanks for use in residential and rural-residential markets.  The Company operates out of four leasedfacilities in Australia.  The facilitiesare located in Dalby, Orange, Terang, and Adelaide.

 

The Company entered the Australian waterstorage tank market in August 2004 with the acquisition of BushmanTanks.  Bushman Tanks is Australia’slargest manufacturer and distributor of rotational molded polyethylene waterstorage tanks.

 

The Company’s enclosure product lineaccounted for 78%, 79% and 59% of the Company’s net sales in 2002, 2003 and2004, respectively.  The Company hasrecently diversified a portion of its business with the acquisition of BushmanTanks.  The Company’s water relatedproducts product line accounted for 30% of the Company’s net sales in2004.  The Company has long-lived assetsin Australia of $2.6 million, $2.4 million and $5.5 million in 2002, 2003 and2004, respectively.

 

### **Industry**

### ** **

The Company operates primarily in twoindustries, the telecommunications industry and the Australian water storagetank industry.

 

In the telecommunications industry, broadbandand local telephone operators are building, rebuilding or upgrading signaldelivery networks around the world. These networks are designed to deliver video, voice and/or datatransmissions to individual residences and businesses.  Operators deploy a variety of networktechnologies and architectures, such as HFC, VoIP, DLC, ADSL and FTTP (see “Glossaryof Terms”) to carry broadband and narrowband signals.  These architectures are constructed ofelectronic hardware connected via coaxial cables, copper wires and/or opticalfibers, including various access devices, amplifiers, nodes, hubs and othersignal transmission and powering electronics. Many of these devices in the outside plant require housing in secure,protective enclosures and cable management connectivity systems, such as thosemanufactured by the Company.

 

As critical components of the outside plant,enclosure products provide (i) protection against weather and vandalism, (ii)ready access for technicians who maintain and manage the outside plant and,(iii) in some cases, provide dissipation of heat generated by the activeelectronic hardware.  Broadband and localtelephone network operators place great reliance on manufacturers of protectiveenclosures because any material damage to the signal delivery networks islikely to disrupt communications services. Connectivity products provide critical data-rated connection pointswhich support cost effective service deployment and ensure signal integrity ismaintained throughout the network.

 

The primary drivers of demand for enclosuresin the communications industry are the construction, rebuilding, upgrading andmaintenance of signal delivery networks by broadband operators and localtelephone companies.  For example,

 

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broadband networks are being upgraded and prepared for advanced two-wayservices such as high-speed Internet access via cable modems, telephony and PCStransport. Local telephone service providers are employing advancedtechnologies, such as a variety of digital subscriber line (“DSL”)technologies, which utilize installed copper wires for broadband services.  These “local loop” copper wire systems oftenrequire significant upgrading and maintenance to provide the optimal throughputnecessary to carry high-speed broadband signals, increasing the need for fullysealed outside plant facilities in order to sustain network reliability andlongevity.   Local telephone serviceproviders are also employing various fiber to the premise (FTTP) technologiesto deliver higher bandwidth services to customers.  FTTP utilizes outside plant enclosures toprotect the networks as well as fiber cable management devices that are bothmanufactured by the Company.

 

In the Australian water storage tankindustry, consumers utilize plastic, steel or concrete tanks for the storage ofwater.  Australia is an arid climate withlimited water resources.  The combinationof a growing population, a movement of people away from urban areas and limitedrainfall has resulted in water shortages in most geographic areas.  Water storage tanks are used to store rainand ground water in residential and commercial properties.  The water is used for outside the homepurposes such as gardening, pumped into the home for non potable uses such aswashing machines and toilets and may often be used as a source of drinkingwater.  Local, state and nationalgovernments have implemented several regulations intended to conservewater.  These include restrictions on theuse of potable water and requirements to install water storage tanks or otherconservancy products in new residential dwellings in selected areas.

 

### **BusinessStrategy**

### ** **

The Company’s strategy is to capitalize onits core strengths in the design and manufacture of thermoplastic products,metal products and connectivity products and to use these strengths to be aleading company in the markets it operates in as well as to enter new markets.

 

The Company pursues opportunities in**the global communications industry by providing enclosures,connectivity products and other complementary components to meet the evolvingneeds of its customers’ communications networks.  The Company’s wide range of products,manufacturing expertise, application-based sales and marketing approach andreputation for high quality products address key requirements of its customers.

 

In addition to the communications industry,the Company seeks to leverage its expertise in plastics and metal manufacturingtechnologies to diversify into other industries.  The Company’s acquisition of the BushmanTanks business is an example of this diversification.  Bushman Tanks utilizes plastic rotationalmolding technology to produce water tanks, a process similar to that used bythe Company to manufacture thermoplastic enclosures for the communicationsindustry.  The Company believes it canapply its advanced rotational manufacturing technologies to the Bushman Tanksoperations to improve performance.

 

Principal elements of the Company’s strategyinclude the following:

 

***Focus on CoreTelecommunications Business.**** *The Company will continue to seekto capitalize on its position as a leading designer, manufacturer and marketerof enclosures and copper wire connectors for the broadband/CATV and localtelephone industries in the North America, Europe, Middle East, Africa,Australia and Asia markets through new product development.  The Company believes it currently supplies asubstantial portion of the enclosure product requirements of a number of majorbroadband operators.

 

The Company has invested in the developmentof a broad range of products designed specifically for telecom applications.These include connectivity and enclosure products for DSL and FTTP basednetworks.  The Company has successfullymarketed its traditional broadband products to local telephone companies thathave been designing and deploying broadband networks to deliver competitive videoand data services.  The Company willcontinue to target this market for growth, both with telephone networkoperators and with major system OEMs.

 

***Expand International Presencein Communications Industry.***  Management believes international markets offersignificant opportunities for increased sales to both broadband and telephonecompanies. The Company’s principal international markets currently includeCanada, Mexico, Asia, the Pacific Rim, the Middle East, Africa and Europe.  Trends expected to result in internationalgrowth opportunities include the on-going deregulation and privatization oftelecommunications in many nations around the world and the focus of numerouscountries on building, expanding and enhancing their communications systems todeliver broadband services in order to participate fully in theinformation-based global economy.  TheCompany will concentrate on expansion in international markets that arecharacterized by deregulation or privatization of telecommunications and by theavailability of capital for the construction of signal delivery networks.

 

***Develop New Products and EnterNew Markets.**** *The Company continues to leverageits core capabilities in developing innovative products that meet the evolvingneeds of its customers.  Innovativeproducts offered by the Company include its MAH SeriesTM free-breathingtelephony enclosures, GLMTM sub surface enclosures, the Mini-RockerTMinsulation

 

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displacement copper connectivity products, and a range of RhinoTM metalfabricated enclosures.  The Companycontinually invests in ongoing improvement and enhancement projects for theexisting products developed by the Company, several of which have received U.S.patent protection.  The Company’s productsare designed to improve the performance of its customers’ outside plantsystems.  The Company has a proven recordin designing, developing and manufacturing “next generation” products thatprovide solutions for its customers and offer advantages over those offered byother suppliers to the industry.  TheCompany also believes its core capabilities are applicable to markets outsidethe telecommunications industry.

 

The Company is expanding its product offeringof water storage tanks to include underground tanks and related productsprimarily for the residential markets in Australia.  The Company’s principal customers arecurrently in rural areas.  The Companycontinues to develop innovative products to expand its presence in theresidential and rural-residential markets of Australia.  The Company may also pursue water storagetank markets beyond Australia in the future.

 

***Concentrate on CoreCapabilities to Diversify into Other Industries***.  The Company believes its core competenciesare in the design and manufacture of plastic and metal infrastructureproducts.  The Company is pursuing astrategy to utilize these core competencies to diversify into other industriesto profitably grow.  Relevant industriesthat the Company may pursue include water, irrigation, power utility and otheroutside plant infrastructure products. The acquisition of Bushman Tanks to operate in the water industry is anexample of this diversification strategy.

 

**Products**

 

The Company currently markets over 60 productfamilies, with several thousand optional product configurations.  The primary functions of the Company’sproducts designed for the telecommunications industry are cable routing andmanagement, equipment access, heat dissipation and security.   The Company believes that it offers one ofthe most complete lines of outside plant infrastructure products in thetelecommunications industry. The primary functions of the Company’s productsdesigned for the water industry are the filtration, storage and pumping ofwater for both outside and inside the home usage.

 

***Enclosures. ***The Companymanufactures precision-molded, highly engineered and application-specificthermoplastic and metal fabricated enclosures for the communications industrythat are considered state-of-the-industry for many applications, having beenfield tested and received approvals and standardization certifications frommajor broadband and telephone company operators.  Most of the Company’s products are designedfor buried and underground network applications.  The Company’s enclosure products providetechnicians access to network equipment for maintenance, upgrades andinstallation of new services.  Buried andunderground networks and enclosures are generally preferred by broadband operatorsfor increased network reliability, lower maintenance, improved security,reduced utility right-of-way conflicts, and aesthetic appeal. The enclosureproducts, particularly the thermoplastic versions, must provide advanced heatdissipation characteristics increasingly required for the protection of activeelectronics in many network installations. The Company is also a designer and manufacturer of metal fabricatedenclosures that house advanced electronics, fiber optic cable and power systemsfor broadband telecommunications networks (branded as “Rhino EnclosuresTM”).  The Company designs and manufactures a seriesof termination blocks, brackets and cable management devices for mountinginside its enclosure products.  Toposition itself as a full-line product supplier, the Company also offers a varietyof complementary products, including thermoplastic and composite grade levelboxes for sub surface network applications.. These products are typically purchased by customers as part of a systempackage and are marketed by the Company through its direct sales force to itscustomer base.  The Company is recognizedin the industry for its differentiated product designs and the functionality,field performance and service life of its products.

 

***Copper Connectivity. ***The Company is adesigner and manufacturer of innovative telephone connectivity devices.  The Company’s Insulation DisplacementConnector (“IDC”) technology provides advanced “tool-less” termination systemsfor copper wires, the predominant medium used in the “Last Mile” for telephoneservices worldwide.  These proprietaryIDC products environmentally seal network termination points with a high levelof reliability.  The Company’s DSLink TMmodular terminal block offers telephone service providers a Category 5 (“Cat-5”) solution to the rising costs of DSL deployment in the local loop. TheCompany’s Mini-RockerTM line of copper connectivity modules, blocks andaccessories offer environmentally sealed and Cat-5 data rated IDC tool-lesscircuit installation and have been accepted as a universal connectivityplatform for network applications worldwide, including xDSL and VoIP services.

 

***Fiber Optic Products.***  The Company offers a range of fiber opticcable management products designed for use in telephone and broadband networks.  These products are particularly well suitedfor fiber to the premises (FTTP) network architectures.  Fiber optic electronic enclosures houseoptical electronics, power supplies and cables. The Company’s fiber optic splice cases are used for organizing, managingand protecting the connection points between separate lengths of fiber opticcable in the outside plant network. Fiber optic cable assemblies and interconnect hardware are used toconnect fiber optic electronics and fiber optic cables primarily forin-building applications.  All of theseproducts are designed and manufactured by the Company and marketed worldwide.

 

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***OEM Programs.***  The Company has OEM marketing programsthrough which other manufacturers incorporate the Company’s products ascomponents of their telecommunications systems. These OEM programs generally include exchanges of technical informationthat the Company can use in developing new products and improvements andenhancements to existing designs.  TheCompany has established additional relationships with systems integrators andinnovative end users that provide valuable product improvement information.

 

***Water Products***.  The Company offers a range of water tankproducts for the storage of potable and non potable water.  These products typically store rain watercollected from the roofs of homes or other buildings or water pumped fromunderground wells.  These products areprimarily used by residential homes, agricultural properties and commercialbuildings.  Accessory products for thesewater tanks include filtration systems, connection devises and pumps.

 

In addition to water storage tanks, theCompany’s water product line includes applications for the communicationsindustry.  Below ground enclosuresprotect networks from water and other damage.

 

**Marketing and Sales**

 

The Company markets its products primarilythrough a direct sales force of technically trained salespeople. The Companyemploys an application-specific, systems approach to marketing its products,offering the customer a complete, cost-effective system solution to meet itsoutside plant requirements.  All salespersonnel have technical expertise in the products they market and aresupported by the Company’s engineering and technical marketing staff.

 

Internal sales/customer service departmentsadminister and schedule incoming orders, handle requests for productenhancements and service inquiries and support the Company’s direct salesforce. This department maintains direct communications with customers and theCompany’s field sales and operations personnel.

 

By engaging in public relations activities,product literature development, market research and advertising, the marketingdepartment also promotes and positions the Company within both domestic andinternational markets.  The Companyregularly attends, participates and exhibits its products at industry tradeshows and conferences within domestic and international markets throughout theyear.

 

Specific to the Company’s water tankproducts, a network of agents and distributors are utilized to market theCompany’s products in addition to the use of a direct sales force.

 

The Company participates in agriculturalfield days in Australia to market water storage products.  Agricultural field days are held in mostrural areas once or twice per year and are used by rural customers to purchasea variety of hardware products by attending a single event.  The Company uses radio and televisionadvertising to promote its water storage tank products throughout Australia.

 

**Manufacturing Operations**

 

The Company’s vertically integratedmanufacturing operations enable the Company to control each step in themanufacturing process, including product design and engineering; design andproduction of many of its own dies, tools, molds and fixtures.  This vertically integrated manufacturingstrategy applies to both the communications equipment and water product lines.

 

The Company’s manufacturing expertise enablesit to modify its product lines to meet changing market demands, rapidly andefficiently produce large volumes of products, control expenses and ensureproduct quality.  Management considersthe Company’s manufacturing expertise a distinct and significant competitiveadvantage, providing it with the ability to satisfy the requirements of majorcustomers with relatively short lead-times by promptly booking and shippingorders.

 

The Company owns a majority of itsmanufacturing equipment.  Manufacturingprocesses are performed by trained Company personnel.  These manufacturing processes includeinjection molding, structural foam molding, rotational molding, metalfabrication, automated discrete connector fabrication, rubber injection,transfer and compression molding, and termination block fabrication.  The Company has implemented severalcomprehensive process and quality assurance programs, including continuousmonitoring of key processes, regular product inspections and comprehensivetesting.

 

The Company’s manufacturing and distributionfacilities as of December 31, 2004, include approximately 367,000 squarefeet in Temecula, California; 7,000 square feet in Mississauga, Ontario,Canada; 34,000 square feet in Sydney, 43,000 square feet in Dalby, 22,000square feet in Orange, 16,000 square feet in Terang, and 13,000 square feet inAdelaide.  The manufacturing operationsin the United Kingdom were closed in June, 2004. 

 

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**Product Development andEngineering**

 

The Company’s product development andengineering staff has designed and tested the Company’s products and hasdeveloped core competencies in telecommunications outside plant and waterstorage products. As a direct result, the Company has been able to develop abroad series of superior products designed to meet the specific needs ofcustomers.  Distinguishingcharacteristics of the Company’s products include:

 

•                  Advancedmechanical innovations providing unique application specific performance andfeature sets;

•                  Sub-surfacenetwork access systems;

•                  Modular metalfabricated enclosure product line covering multiple applications;

•                  Effective heatdissipation qualities for enclosure products;

•                  Advanced copperIDC connectivity products;

•                  A superiorenvironmental sealing and protection system in enclosure products that, unlikemany competitors’ products, does not require gels, compounds or other methodsto maintain the required seal;

•                  Product designsallowing communications equipment technicians easy access through covers thatcan be removed to fully expose the enclosed electronics;

•                  Compatibilitywith a variety of communications equipment signal delivery networkarchitectures;

•                  Versatility ofdesign to accommodate communications network growth through custom hardware anduniversal mounting systems that adapt to a variety of new electronic hardware;

•                  Excellentprotection and management of optical fibers and cables;

•                  ThermoplasticLaminated Coating (TLC®) that bonds directly to metal hardware andprotects against rust and deterioration;

•                  High strengthand UV protected water storage products;

•                  Undergroundwater storage products; and

•                  A complete lineof water storage accessories products including filtration, pumps andconnection devices.

 

The Company’s product development approach isapplications-based and customer driven.  A team comprised of engineering, marketing,manufacturing and direct sales personnel work together to define, develop anddeliver comprehensive systems solutions to customers, focusing on the completedesign cycle from product concept through tooling and high-volumemanufacturing.  The Company is equippedto conduct many of its own product testing requirements for performancequalification purposes, enabling it to accelerate the product developmentprocess.  The Company spent $1.6 millionin 2002, $1.9 million in 2003, and $2.3 million in 2004 on research anddevelopment.

 

**Customers**

 

The Company sells its telecommunicationsrelated products directly to broadband operators and telephone companiesthroughout the world, principally within developed nations.  The Company sells its products to OEMs on aglobal basis.  The Company sells itswater storage products in Australia directly to end users as well as toretailers, wholesalers, distributors and agents.  During 2004, the Company’s five largestcustomers accounted for 48.7% of total net sales.  In 2004, the Company’s five largest customersby sales in the United States were Verizon, Comcast, Cox, Time Warner andBright House Networks. Verizon and Comcast accounted for 21.7% and 14.6%,respectively, of the Company’s net sales in 2004.  In international markets, the Company’s fivelargest customers in 2004 by sales were Telstra (Australia), Rogers (Canada),Shaw (Canada), Uni Telco (Malaysia) and Eircom (Ireland).

 

The Company has historically operated with arelatively small backlog. Sales and operating results in any quarter areprimarily dependent upon orders booked and products shipped in thequarter.  The Company’s customersgenerally do not enter into long-term supply contracts providing for futurepurchase commitments of the Company’s products. Rather, the Company believes that many of its customers periodicallyreview their supply relationships and adjust buying patterns based upon theircurrent assessment of the products and pricing available in the marketplace.  From fiscal period to fiscal period,significant changes in the level of purchases of the Company’s products byspecific customers can and do result from this periodic assessment.  Customers of water products in Australia aretypically individual users that may keep their product for several years beforea repeat purchase, in addition to the distributors that are used to market theCompany’s products.

 

**Intellectual Property**

 

The Company owns substantially all of thepatents and other technology employed by it in the manufacture and design ofits products.  The Company’s patents,which expire through the year 2010, cover various aspects of the Company’sproducts.  In addition, the Company hascertain trade secrets, know-how and trademarks related to its technology andproducts.

 

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Management does not believe any single patentor other intellectual property right is material to the Company’s success as awhole.  The Company maintains anintellectual property protection program designed to preserve its intellectualproperty assets.

 

**Competition**

 

The telecommunications industry is highlycompetitive.  The Company’s competitorsinclude companies that are much larger than the Company, such as Tyco, 3M,Emerson, Arris and Corning in addition to competitors similar in size to theCompany such as Carson Industries.  TheCompany believes its competitive advantages include its ability to servicenational and multi-national customers, its direct sales force, its specializedengineering resources and its vertically integrated manufacturing operations.

 

Management believes the principal competitivefactors in the telecommunications equipment market are customer service, newproduct capabilities, price, product availability, and product performance.

 

Competitive price pressures are common in theindustry.  In the past, the Company hasresponded effectively to competition with cost controls through verticalintegration utilizing advanced manufacturing techniques, cost-effective productdesigns and material selection, and an aggressive procurement approach.

 

In the past, certain of the Company’stelecommunications customers have required relatively lengthy field testing ofnew products prior to purchasing such products in quantity.  While field testing can delay theintroduction of new products, it can also act as a competitive advantage forthose products tested and approved because to a certain extent it creates abarrier to new product introduction and sales by competitors.

 

The water storage products industry inAustralia is characterized by a few large competitors, including ARI Industriesand Clark Tanks, and a high number of smaller, regional competitors.  The Company believes its competitiveadvantages include its low cost structure, manufacturing expertise, productdesign, marketing and sales expertise and its nationwide coverage.  The Company is the only nationwidemanufacturer of water storage tanks in Australia.

 

Management believes that the principlecompetitive factors in the water storage industry are product quality,manufacturing capacity, and geographic location for logistics support,technical support and customer service. The multiple manufacturing plant locations provide nationwide marketcoverage in the industry which is not presently offered by any currentcompetitors.

 

Competitive price pressures are prevalent inthis industry.  The Company has respondedto these with ongoing process improvements, design optimization and targetedprocurement programs.

 

The existing customer base is widelydispersed throughout the rural market areas. Promotion and awareness of the Company’s products and services isstrongly reinforced.  Long term directmarketing programs including media advertising, radio and television, and highprofile promotion at exhibitions have been developed by the Company over manyyears.  These marketing programs haveestablished strong brand equity which creates a competitive advantage/barrierto entry for other suppliers in several significant market areas.

 

**Raw Materials; Availability ofComplementary Products**

 

The principal raw materials used by theCompany are thermoplastic resins, neoprene rubbers, hot and cold rolled steel,stainless steel, copper and brass.  TheCompany also uses certain other raw materials, such as fasteners, packagingmaterials and communications cable. Management believes the Company has adequate sources of supply for theraw materials used in its manufacturing processes and it attempts to developand maintain multiple sources of supply in order to extend the availability andencourage competitive pricing of these materials.

 

Most plastic resins are purchased underannual or multi-year purchase agreements to stabilize costs and improvesupplier delivery performance.  Neoprenerubbers are manufactured using the Company’s proprietary formulas.  Metal products are supplied in standard stockshapes, coils and custom roll forms.

 

The Company also relies on certain othermanufacturers to supply products that complement the Company’s own productline, such as grade level boxes.  TheCompany believes there are multiple sources of supply for these products.

 

**Employees**

 

As of December 31, 2004, the Companyemployed 592 people, of whom 70 were in sales, 431 were in manufacturing operations,32 were in research and development and 59 were in administration.  The Company considers its employee

 

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relations to be good and recognizes its ability to attract and retainqualified employees is an important factor in its growth and development.  None of the Company’s employees is subject toa collective bargaining agreement, and the Company has not experienced anybusiness interruption as a result of labor disputes within the past five years.

 

**Regulation**

 

The telecommunications industry is subject toregulations in the United States and other countries.  Federal and state regulatory agenciesregulate most of the Company’s domestic customers.  On February 1, 1996, the United StatesCongress passed the Telecommunications Act of 1996 that the President signedinto law on February 8, 1996.  TheTelecommunications Act lifted certain restrictions on the ability of companies,including RBOCs and other customers of the Company, to compete with one anotherand generally reduced the regulation of the communications industry.

 

The Company is also subject to a wide varietyof federal, state and local environmental laws and regulations.  The Company utilizes, principally inconnection with its thermoplastic manufacturing processes, a limited number ofchemicals or similar substances that are classified as hazardous.  It is difficult to predict what impact theseenvironmental laws and regulations may have on the Company in the future.  Restrictions on chemical uses or certainmanufacturing processes could restrict the ability of the Company to operate inthe manner that it currently operates or is permitted to operate.  Management believes that the Company’soperations are in compliance in all material respects with currentenvironmental laws and regulations. Nevertheless, it is possible that the Company may experience releases ofcertain chemicals to environmental media which could constitute violations ofenvironmental law (and have an impact on its operations) or which could causethe Company to incur material cleanup costs or other damages.  For these reasons, the Company might becomeinvolved in legal proceedings involving exposure to chemicals or theremediation of environmental contamination from past or presentoperations.   Because certainenvironmental laws impose strict joint and several retrospective liability uponcurrent owners or operators of facilities from which there have been releasesof hazardous substances, the Company could be held liable for remedial measuresor other damages (such as liability in personal injury actions) at propertiesit owns or utilizes in its operations, even if the contamination were notcaused by the Company’s operations.

 

The water storage products industry inAustralia is also subject to regulation. Federal, state and local regulatory agencies regulate and in some casesmandate the use of water storage products to conserve water usage.  Examples include restrictions on the use ofpotable water for gardening, the washing of cars and other non-essentialuses.  In addition, several agencies haveoffered rebates to those who purchase water storage products to conservewater.  Most recently, governmentagencies have mandated that new residential dwellings in the states of New SouthWales and Victoria require a water conservation device such as water storagetanks.  The city of Sydney is located inNew South Wales and the city of Melbourne is located in Victoria.  The affect of these regulations has been toincrease the demand for water storage tanks in Australia.  There can be no guarantee that theseregulations and rebates will remain in existence.

 

**Available Information**

 

The Company’s Annual Report on Form 10-K,Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments tothose reports are available as soon as reasonably practicable after they arefiled or furnished to the Securities and Exchange Commission (“SEC”), throughour Internet website, www.channellcomm.com. Company filings are also available through a database maintained by theSEC at www.sec.gov.

 

**Item 2.  Properties**

 

The Company’s facilities approximate 504,000square feet, of which approximately 63%, 22% and 15% were used formanufacturing, warehouse and office space, respectively.  In Temecula, California, 261,000 square feetof the total 367,000 square feet are leased from William H. Channell, Sr., theCompany’s Chairman of the Board.  (See “CertainRelationships and Related Transactions”, Item 13.)  The Company also leases an aggregate ofapproximately 137,000 square feet of manufacturing, warehouse and office spacein Canada, Australia and the United Kingdom. In Australia, 94,000 square feetof manufacturing and distribution space in Orange, Dalby, Terang and Adelaideare leased from the former owners of Bushman Tanks (See “Certain Relationshipsand Related Transactions”, Item 13).  InDecember, 2002, the Company announced steps to rationalize internationalmanufacturing operations to consolidate operations.  The Company has completed the facilitiesreduction program.  In 2002, the Companycompleted a sale and leaseback of approximately 103,000 square feet ofmanufacturing, warehouse and office space in Temecula, California.  The Company sold approximately 43,000 squarefeet of manufacturing, warehouse and office space in the United Kingdom inJanuary, 2003.  In the fourth quarter of2003, the Company further evaluated International operations to improveprofitability.  A manufacturing facilityin the United Kingdom was closed in June 2004.   The Company considers its currentfacilities, and its facilities following the completion of the foregoingrestructuring activities, to be adequate for its operations.

 

7

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**Item 3.  Legal Proceedings**

 

The Company is from time to time involved inordinary routine litigation incidental to the conduct of its business.  The Company regularly reviews all pendinglitigation matters in which it is involved and establishes reserves deemedappropriate for such litigation matters. Management believes that no presently pending litigation matters willhave a material adverse effect on its business or on its results of operations.

 

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

 

No matters were submitted to a vote ofsecurity holders during the fourth quarter of the fiscal year covered by thisreport.

 

**PART II**

 

**Item 5.  Market for Registrant’sCommon Equity and Related Shareholder Matters**

 

The following table sets forth, for theperiods indicated, the high and low sale prices for the Company’s Common Stock,as reported on the NASDAQ National Market.

 
| ** **                              | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------------------------|------------|----------|------------|---------|------------|
| **Year  Ended December 31, 2003:** |       |     |       |    |       |
| First  Quarter                          |       | $        | 5.46       |    | $          | 3.00 |   |
| Second  Quarter                         |       | 6.42     |       | 3.60    |       |
| Third  Quarter                          |       | 6.00     |       | 4.31    |       |
| Fourth  Quarter                         |       | 5.10     |       | 2.10    |       |
|                                    |       |     |       |    |       |
| **Year  Ended December 31, 2004:** |       |     |       |    |       |
| First  Quarter                          |       | $        | 5.38       |    | $          | 3.85 |   |
| Second  Quarter                         |       | 4.58     |       | 3.60    |       |
| Third  Quarter                          |       | 4.50     |       | 2.90    |       |
| Fourth  Quarter                         |       | 8.50     |       | 3.55    |       |

 

The Company has not declared any dividendssubsequent to its initial public offering in July 1996.

 

The Company currently anticipates it willretain all available funds to finance its business.  The Company does not intend to pay cashdividends in the foreseeable future. Under the terms of the Company’s Loan and Security Agreement, theCompany has agreed not to pay any dividends.

 

As of March 2, 2005, the Company had9,383,942 shares of its Common Stock outstanding, held by approximately 1,050shareholders of record.

 

8

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**Item 6.  Selected FinancialData**

 

The selected consolidated financial datapresented below for each of the five years in the period ended December 31,2004, have been derived from audited consolidated financial statements, whichfor the most recent three years appear elsewhere herein. The data should beread in conjunction with the financial statements, related notes and otherfinancial information included therein (amounts in thousands, except per sharedata).

 
| ** **                                               | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                               | ** ** | **2000**                         | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| **OPERATING  DATA:**                                     |       |                             |       |   |   |   |   |   |   |   |   |
| Net sales                                                |       | $                                | 128,179    |   | $ | 88,698 |   | $ | 84,785 |   | $ | 76,537 |   | $ | 100,134 |   |
| Cost of  goods sold                                      |       | 81,108                           |       | 69,892 |   | 57,450 |   | 53,960 |   | 72,151 |   |
|                                                     |       |                             |       |   |   |   |   |   |   |   |   |
| Gross profit                                             |       | 47,071                           |       | 18,806 |   | 27,335 |   | 22,577 |   | 27,983 |   |
|                                                     |       |                             |       |   |   |   |   |   |   |   |   |
| Operating  expenses                                      |       |                             |       |   |   |   |   |   |   |   |   |
| Selling                                                  |       | 15,484                           |       | 12,789 |   | 9,246 |   | 9,465 |   | 14,279 |   |
| General and  administrative                              |       | 14,231                           |       | 14,124 |   | 11,452 |   | 7,710 |   | 8,584 |   |
| Research and  development                                |       | 2,771                            |       | 2,331 |   | 1,619 |   | 1,902 |   | 2,336 |   |
| Restructuring  charge                                    |       | 1,513                            |       | 2,999 |   | 1,228 |   | 1,565 |   | (690 | ) |
| Asset  impairment charge                                 |       | 4,569                            |       | 4,322 |   | 2,154 |   | 1,238 |   | — |   |
| Goodwill  impairment charge                              |       | —                           |       | 11,772 |   | 966 |   | — |   | — |   |
|                                                     |       | 38,568                           |       | 48,337 |   | 26,665 |   | 21,880 |   | 24,509 |   |
|                                                     |       |                             |       |   |   |   |   |   |   |   |   |
| Income  (loss) from operations                           |       | 8,503                            |       | (29,531 | ) | 670 |   | 697 |   | 3,474 |   |
| Interest  income (expense), net                          |       | (2,859                           | )          | (3,874 | ) | (1,999 | ) | (571 | ) | (489 | ) |
| Income  (loss) before income taxes                       |       | 5,644                            |       | (33,405 | ) | (1,329 | ) | 126 |   | 2,985 |   |
| Income taxes  (benefit)                                  |       | 2,076                            |       | (8,207 | ) | 1,737 |   | 212 |   | (678 | ) |
| Net income  (loss) before minority interest              |       | 3,568                            |       | (25,198 | ) | (3,066 | ) | (86 | ) | 3,663 |   |
| Minority  interest                                       |       | —                           |       | — |   | — |   | — |   | 167 |   |
|                                                     |       |                             |       |   |   |   |   |   |   |   |   |
| Net income  (loss)                                       |       | $                                | 3,568      |   | $ | (25,198 | ) | $ | (3,066 | ) | $ | (86 | ) | $ | 3,496 |   |
|                                                     |       |                             |       |   |   |   |   |   |   |   |   |
| **NET  INCOME (LOSS) PER SHARE:**                        |       |                             |       |   |   |   |   |   |   |   |   |
| Basic                                                    |       | $                                | 0.39       |   | $ | (2.78 | ) | $ | (0.34 | ) | $ | (0.01 | ) | $ | 0.38 |   |
| Diluted                                                  |       | $                                | 0.39       |   | $ | (2.78 | ) | $ | (0.34 | ) | $ | (0.01 | ) | $ | 0.38 |   |
|                                                     |       |                             |       |   |   |   |   |   |   |   |   |
| **WEIGHTED  AVERAGE NUMBER OF SHARES OUTSTANDING:**      |       |                             |       |   |   |   |   |   |   |   |   |
| Basic                                                    |       | 9,091                            |       | 9,050 |   | 9,048 |   | 9,126 |   | 9,203 |   |
| Diluted                                                  |       | 9,126                            |       | 9,050 |   | 9,048 |   | 9,126 |   | 9,223 |   |
|                                                     |       |                             |       |   |   |   |   |   |   |   |   |
| **BALANCE  SHEET DATA:**                                 |       |                             |       |   |   |   |   |   |   |   |   |
| Current  assets                                          |       | $                                | 51,531     |   | $ | 39,626 |   | $ | 23,449 |   | $ | 30,407 |   | $ | 37,686 |   |
| Total assets                                             |       | 116,748                          |       | 85,377 |   | 54,163 |   | 53,965 |   | 78,898 |   |
| Long-term  obligations (including current maturities)(3) |       | 40,364                           |       | 36,816 |   | 6,548 |   | 3,906 |   | 8,840 |   |
| Stockholders’  equity                               |       | 63,927                           |       | 37,497 |   | 35,441 |   | 37,346 |   | 42,901 |   |
|                                                     |       |                             |       |   |   |   |   |   |   |   |   |
| **OTHER  DATA:**                                         |       |                             |       |   |   |   |   |   |   |   |   |
| Gross  margin(1)                                         |       | 36.7                             | %          | 21.2 | % | 32.2 | % | 29.5 | % | 27.9 | % |
| Operating  margin(2)                                     |       | 6.6                              |       | (33.3 | ) | 0.8 |   | 0.9 |   | 3.5 |   |
| Capital  expenditures (excluding capital leases)         |       | 11,606                           |       | 3,153 |   | 1,886 |   | 1,203 |   | 3,281 |   |
| Cash  provided by (used in):                             |       |                             |       |   |   |   |   |   |   |   |   |
| Operating  activities                                    |       | 8,352                            |       | 13,964 |   | 19,767 |   | 7,127 |   | 9,228 |   |
| Investing  activities                                    |       | (11,857                          | )          | (3,153 | ) | 4,346 |   | 1,154 |   | (20,025 | ) |
| Financing  activities                                    |       | 1,876                            |       | (2,927 | ) | (29,832 | ) | (2,662 | ) | 7,550 |   |

 

----

(1)                                  Gross margin is gross profit as a percentageof net sales.

(2)                                  Operating margin is income (loss) fromoperations as a percentage of net sales.

(3)                                  Includes all interest bearing debt and capitallease obligations.

 

9

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**Item7.  Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

### **General**

### ** **

The Company is a designer and manufacturer oftelecommunications equipment supplied to telephone and broadband networkproviders worldwide and of water storage products marketed primarily inAustralia.  In addition to Companymanufactured products, the Company markets complementary products manufacturedby third parties. The Company sells products directly to broadband operatorsand telephone companies throughout the United States, Canada, Australia, Asia,Europe, the Middle East and Africa and certain other international markets,principally within developed nations. The Company’s customers of water storage products in Australia aretypically individual users whom will keep the product for several years withouta repeat purchase.  The Company believesthat many of its customers periodically review their supply relationships andconsequently the Company can experience significant changes in buying patternsfrom specific customers between fiscal periods. The Company has historicallyoperated with a relatively small backlog with sales and operating results inany quarter principally dependent upon orders booked and products shipped inthat quarter.  The Company’s customersgenerally do not enter into long-term supply contracts providing for futurepurchase commitments for the Company’s products. These factors, when combinedwith the Company’s operating leverage and the need to incur certain capitalexpenditures and expenses in part based upon the expectation of future sales,causes the Company’s operating results to be at risk to changing customerbuying patterns.  If sales levels in aparticular period do not meet the Company’s expectations, operating results forthat period may be materially and adversely affected.

 

The Company uses numerous raw materials inits manufacturing processes.  Althoughmanagement believes that the Company has adequate sources of supply for suchraw materials, increases in the market prices of the Company’s raw materialscould significantly increase the Company’s cost of goods sold and materiallyadversely affect the Company’s profitability. The Company’s profitability may also be materially and adverselyaffected by decreases in its sales volume because many of the costs associatedwith the Company’s facilities, product development, engineering, tooling andother manufacturing processes are essentially fixed in nature and must bespread over its sales base in order to maintain historical levels ofprofitability.

 

**Critical Accounting Policies**

 

The consolidatedfinancial statements have been prepared in conformity with accountingprinciples generally accepted in the United States of America. The preparationof these financial statements requires management to make estimates andassumptions that affect the amounts reported in the financial statements and accompanying notes. Managementbases its estimates on historical experience and on assumptions that arebelieved to be reasonable under the circumstances and revises its estimates, asappropriate, when changes in events or circumstances indicate that revisionsmay be necessary. Although these estimates are based on management’s knowledgeof and experience with past and current events and on management’s assumptionsabout future events, it is possible that they may ultimately differ materiallyfrom actual results.

 

The criticalaccounting policies requiring estimates and assumptions that managementbelieves have the most significant impact on the Company’s consolidated financial statements are:

 

•                  Accounts receivables reserves

•                  Allowances for excess and obsolete inventory

•                  Valuation of goodwill and long-lived assets

•                  Restructuring costs

•                  Accounting for income taxes

•                  Foreign currency translation

 

***Accountsreceivable Reserves and estimated sales returns.*** Allowancesfor doubtful accounts are maintained for estimated losses expected to resultfrom the inability of our customers to make required payments.  Provisions for uncollectible accounts aremade based on the Company’s specific assessment of the collectability of allpast due accounts.   An adverse change infinancial condition of a significant customer or group of customers couldmaterially affect management’s estimates related to doubtful accounts.  Provisions for sales returns are made based on historical experience.

 

***Allowancesfor excess and obsolete inventory.*** Theestimates of excess and obsolete inventory are based on management’sassumptions about and analysis of relevant factors including historical salesand usage of items in inventory, current levels of orders and backlog,forecasted demand, product life cycle and market conditions.  If actual market conditions become lessfavorable than anticipated bymanagement, additional allowances for excess and obsolete inventory could berequired.  In the event management adjustsestimates such as forecasted sales or expected product lifecycles, the value ofthe Company’s inventory may become understated or overstated and recognition ofsuch understatement or

 

10

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overstatement will affect cost of sales in afuture period, which could materially affect the Company’s operating resultsand financial position.

 

***Valuationof goodwill and long-lived assets***. Management reviews goodwill and long-lived assets for impairment whenevents or changes in circumstances indicate the carrying values may not befully recoverable. Management assesses potential impairment of the carryingvalues of these assets based on market prices, if available, and/or assumptionsabout and estimates of future cash flows expected to be generated from theseassets. Future cash flows may be adversely impacted by operating performance,market conditions and other factors.  Animpairment charge would be based on the amount by which the carrying valueexceeds fair value.  Fair value isestimated by management based on market prices, if available, and/or forecasteddiscounted cash flows, using a discount rate commensurate with the risksinvolved. Assumptions related to future cash flows and discount rates involvemanagement judgment and are subject to significant uncertainty. If future cashflows, discount rates and other assumptions used in the assessment andmeasurement of impairment differ from management’s estimates and forecasts,additional impairment charges could be required.

 

***Restructuringcosts***.  Restructuring costs are recorded inaccordance with FASB Statement 146, Accounting for Costs Associated With Exitor Disposal Activities.  One-timeseverance benefits for employees terminated are recorded at the time managementcommits to the plan to reduce the work force, knows the amount of thetermination benefit, is unlikely to change the plan and has communicated toemployees the intended work force reduction. Liabilities for costs that will continue to be incurred under a contractfor its remaining term without an economic benefit, such as for facility leasepayments for premises vacated, are recorded when the Company ceases to use theright conveyed by the contract.  In the caseof vacated leased facilities, the liability is based on the future leasepayments required under the contract less the estimated future rental incomethe Company may earn by subletting the facilities or estimates of costsincurred to terminate a lease with a landlord. These estimates of future sublet income are based on current economicconditions, current condition of the local leasing market, past experience andjudgments supplied by professionals in the local real estate market.  These estimates are subject to significantuncertainty and may change.  Additionalcharges could be required as a result in the changes in estimates.

 

***Accountingfor income taxes***.  Income taxes are recorded foreach of the jurisdictions in which the Company operates. Management records theactual current income tax payable and assesses the temporary differencesresulting from differing treatment of items, such as reserves and accruals, fortax and accounting purposes. These differences result in deferred tax assetsand liabilities which are included within the consolidated balance sheet.  In assessing the realizability of deferredtax assets, management considers whether it is more likely than not that someportion or all of the deferred tax assets will not be realized. The ultimaterealization of deferred tax assets is dependent upon the generation of futuretaxable income during periods in which those temporary differences becomedeductible.  In addition, the realizationof deferred tax assets is also dependent upon audits by tax authorities of taxfilings which may result in a revision to previous amounts claimed.  Significant management judgment is involvedin assessing the Company’s ability to realize any future benefit from deferredtax assets. In the event that actual results differ from management estimatesand management adjusts these estimates in future periods, the Company’soperating results and financial position could be materially affected.

 

***Foreigncurrency translation. ***The Company has foreign subsidiaries thattogether accounted for 31.5 % of the Company’s net revenues and 48.8% of theCompany’s assets as of and for the year ended December 31, 2004. Inpreparing the Company’s consolidated financial statements, the Company isrequired to translate the financial statements of its foreign subsidiaries fromthe currencies in which they keep their accounting records into United Statesdollars. This process results in exchange gains and losses which, underrelevant accounting guidance, are either included within the Company’sstatement of operations or as a separate part of the Company’s net equity underthe caption “cumulative translation adjustment.”

 

Under relevantaccounting guidance, the treatment of these translation gains or losses dependsupon management’s determination of the functional currency of each subsidiary.This determination involves consideration of relevant economic facts andcircumstances affecting the subsidiary. Generally, the currency in which thesubsidiary transacts a majority of its transactions, including billings,financing, payroll and other expenditures, would be considered the functionalcurrency. However, management must also consider any dependency of thesubsidiary upon the parent and the nature of the subsidiary’s operations.

 

If managementdeems any subsidiary’s functional currency to be its local currency, then anygain or loss associated with the translation of that subsidiary’s financialstatements is included in a cumulative translation adjustment. However, ifmanagement deems the functional currency to be United States dollars, then anygain or loss associated with the translation of these financial statementswould be included within the Company’s statement of operations.

 

If the Companydisposes of any of its subsidiaries, any cumulative translation gains or losseswould be realized into the Company’s statement of operations. If managementdetermines that there has been a change in the functional currency of asubsidiary to United States dollars, then any translation gains or lossesarising after the date of the change would be included within the Company’sstatement of operations.

 

11

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Based onmanagement’s assessment of the factors discussed above, the Company considersthe functional currency of each of its international subsidiaries to be eachsubsidiary’s local currency. Accordingly, the Company had cumulativetranslation gains of ($1.0) million that were included as part of accumulatedother comprehensive loss within the Company’s balance sheet at December 31,2004. During the year ended December 31, 2004, the Company includedtranslation adjustments of a gain of approximately ($1.1) million underaccumulated other comprehensive income and loss.

 

If the Companyhad determined that the functional currency of its subsidiaries was UnitedStates dollars, these gains or losses would have decreased or increased theCompany’s loss for the year ended December 31, 2004. The magnitude ofthese gains or losses depends upon movements in the exchange rates of theforeign currencies in which the Company transacted business as compared to thevalue of the United States dollar.  Thesecurrencies include the British pound, the Canadian dollar and the Australiandollar. Any future translation gains or losses could be significantly higherthan those the Company recorded for the year ended December 31, 2004.

 

**New Accounting Pronouncements**

*** ***

***Recent AccountingPronouncements.***  In November 2004, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter4.”  SFAS No. 151 retains the generalprinciple of ARB No.43, Chapter 4, “Inventory Pricing,” that inventories arepresumed to be stated at cost; however, it amends ARB No. 43 to clarify that abnormalamounts of idle facilities, freight, handling costs and spoilage should berecognized as current period expenses. Also, SFAS No. 151 requires fixed overhead costs be allocated toinventories based on normal production capacity.  The guidance in SAFS No. 151 is effective forinventory costs incurred during fiscal years beginning after June 15,2005.  The Company believes thatimplementing SFAS No. 151 should not have a material impact on its financialcondition or results of operations.

 

In December 2004, the FASB issued Statement 123 (revised2004), *Share-Based**Payment*(Statement123(R)).  This Statement is a revision toStatement 123, *Accounting for Stock-Based Compensation*,and supersedes Opinion 25, *Accounting for StockIssued to Employees*. Statement 123(R) requires the measurement of the cost of employeeservices received in exchange for an award of equity instruments based on thegrant-date fair value of the award.  Thecost will be recognized over the period during which an employee is required toprovide service in exchange for the award. No compensation cost is recognized for equity instruments for whichemployees do not render service.  TheCompany will adopt Statement 123(R) on July 1, 2005, requiring compensationcost to be recognized as expense for the portion of outstanding unvestedawards, based on the grant-date fair value of those awards calculated using theBlack-Scholes option pricing model under Statement 123 for pro formadisclosures.  The effect of adoptingStatement 123(R)  will decrease the Company’s pretax net income byapproximately $400 during 2005.

 

**Results of Operations**

 

The following table sets forth the Company’soperating results for the periods indicated expressed as a percentage of netsales.

 
| ** **                                  | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **2002**                         | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                        |       |                             |       |   |   |   |   |
| Net Sales                                   |       | 100.0                            | %          | 100.0 | % | 100.0 | % |
| Cost of  Sales                              |       | 67.8                             |       | 70.5 |   | 72.1 |   |
|                                        |       |                             |       |   |   |   |   |
| Gross Profit                                |       | 32.2                             |       | 29.5 |   | 27.9 |   |
|                                        |       |                             |       |   |   |   |   |
| Selling                                     |       | 10.9                             |       | 12.4 |   | 14.2 |   |
| General and  administrative                 |       | 13.5                             |       | 10.1 |   | 8.6 |   |
| Research and  development                   |       | 1.9                              |       | 2.5 |   | 2.3 |   |
| Restructuring  charge                       |       | 1.4                              |       | 2.0 |   | (0.7 | ) |
| Asset  impairment charge                    |       | 2.5                              |       | 1.6 |   | — |   |
| Goodwill  impairment charge                 |       | 1.2                              |       | — |   | — |   |
|                                        |       |                             |       |   |   |   |   |
| Income  (loss) from operations              |       | 0.8                              |       | 0.9 |   | 3.5 |   |
|                                        |       |                             |       |   |   |   |   |
| Interest  income (expense), net             |       | (2.4                             | )          | (0.7 | ) | (0.5 | ) |
|                                        |       |                             |       |   |   |   |   |
| Income  (loss) before income taxes          |       | (1.6                             | )          | 0.2 |   | 3.0 |   |
| Income taxes  (benefit)                     |       | 2.0                              |       | 0.3 |   | (0.7 | ) |
| Net income  (loss) before minority interest |       | (3.6                             | )          | (0.1 | ) | 3.7 |   |
| Minority  interest                          |       | —                           |       | — |   | 0.2 |   |
|                                        |       |                             |       |   |   |   |   |
| Net income  (loss)                          |       | (3.6                             | )%         | (0.1 | )% | 3.5 | % |

 

12

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# **Comparisonof Year Ended December 31, 2004 with Year Ended December 31, 2003**

# ** **

In August of 2004 the Company acquired75% of the Bushman Tanks business (the “acquired company”).  Bushman Tanks is Australia’s largestmanufacturer of plastic water storage tanks. The Bushman Tanks financial results have been consolidated in theCompany’s financial statements for the twelve months ended December 31,2004.  The consolidated results includefive months of business activity of Bushman Tanks.  A minority interest has been recorded for the25% equity owned by ANZ Private Equity, a unit of Australia and New ZealandBanking Group Ltd.

 

***Net Sales***.  Net sales increased $23.6 million or 30.8%from $76.5 million in 2003 to $100.1 million in 2004.   The increase was due to the addition of theacquired business and growth in both the core Americas and Internationalsegments.

 

Americas net sales increased $7.6 million or11.7% from $64.8 million to $72.4 million. The increase was due to higher sales to a major telephone customer anddue to growth in connectivity and metal enclosure sales.  The major telephone customer purchasedplastic enclosures for a construction project to install fiber communicationlines to customer premises.

 

Internationalnet sales increased $16.0 million or 136.3% from $11.7 million to $27.7million.  The increase was primarily dueto sales of the acquired company.  Inaddition, higher sales to telephone customers in the Asian market contributed tothe sales growth.

 

Sales to Verizon of $21.8 million in 2004represented 21.7% of Company sales in the period.  Sales to Verizon in 2003 were $8.0 millionrepresenting 10.5% of the Company sales in the period.  The second largest customer in 2004 was Comcastwith sales of $14.6 million representing 14.6% of the total.  Sales to Comcast in 2003 were $20.7 millionrepresenting 27.1% of the Company sales in the period.

 

***Gross Profit***.  Gross profit increased $5.4 million from$22.6 million in 2003 to $28.0 million in 2004. The increase was primarily dueto the addition of gross profit earned by the acquired company.  Gross profit dollars in the Americas segmentdecreased due to higher raw material costs for plastic and steel.  Gross profit dollars in the Internationalsegment increased due to the addition of the acquired company and the closureof a manufacturing facility in the United Kingdom.  The closure of the United Kingdom facilitylowered the overhead cost structure of International operations primarily dueto the elimination of facility lease costs, middle management and indirectsupport costs.

 

As a percentage of net sales, gross profitdecreased from 29.5% in 2003 to 27.9% in 2004. The decline is due primarily to increased raw material costs for plasticand steel in the Americas segment.  Grossprofit as a percentage of net sales increased in the international segment dueto the addition of the acquired company which has a higher gross profitpercentage than the other Channell businesses and savings associated with theclosure of the manufacturing facility in the United Kingdom.

 

***Selling. ***Selling expensesincreased $4.8 million or 50.9% from $9.5 million in 2003 to $14.3 million in2004.  The increase is due to theaddition of selling expenses of the acquired company and higher commissions andfreight costs as a result of the increased sales level.  The freight cost increase is also due to anincrease in full truckload shipments to customers in which the Company pays thefreight cost.

 

As a percentage of net sales, selling expenseincreased from 12.4% in the 2003 period to 14.3% in the 2004 period.  The higher percentage is primarily due to theincrease in freight costs and the addition of selling expenses for the acquiredcompany.  The acquired company has ahigher percentage of selling expense to net sales than the other Channellbusinesses primarily due to the freight costs incurred to transport waterstorage tanks to customers.

 

***Generaland Administrative*.**  General and administrativeexpenses increased $0.9 million or 11.3% from $7.7 million in 2003 to $8.6million in 2004.   The increase is due tothe addition of the acquired company partially offset by lower general andadministrative expense in the Americas segment. In December of 2004 the Company sold its receivable owed fromAdelphia at a discount for $1.4 million. The receivable had previously been written off and thus the $1.4 millionproceeds were recorded as a reduction to general and administrative expenses inthe Americas segment in 2004.  Partiallyoffsetting this credit to expense in the fourth quarter of 2004 were additionalaccruals and charges for management incentive bonus $0.5 million, state salestax $0.4 million, expenses to evaluate an acquisition candidate that theCompany decided not to further pursue $0.2 million and audit and consultingfees mostly related to the worthless stock deduction associated with the UnitedKingdom operations and costs associated with review and modification ofinternal controls in response to the disclosure requirements of the SarbanesOxley Act $0.1 million.

 

## ***As a percentage of net sales, general and administrativeexpenses decreased from 10.1% in the 2003 period to 8.6% in***the 2004 period.  The decrease is due to the lower costs in theAmericas segment as well as the increased sales level without a correspondingincrease in general and administrative costs.

 

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***Research and Development***.  Research and development expenses increased$0.4 million or 22.8% from $1.9 million in 2003 to $2.3 million in 2004.  The increase is due to spending on newproduct development programs, primarily for telephone connectivity products andthermoplastic enclosures for both telephone and cable customers.

 

As a percentage of net sales, research anddevelopment expenses decreased from 2.5% to 2.3% due to the addition of theacquired company which has a lower level of research and development spendingas compared to the other Channell businesses.

 

***Restructuring charge***.  Restructuring charges of ($0.7) million in2004 compare to $1.6 million in 2003.

 

In 2003, the Company evaluated Internationaloperations to improve profitability.  Aplan was developed to close a manufacturing facility in Internationaloperations by mid-year 2004.  Additionalrestructuring charges of $1.6 million were recorded in the fourth quarter of2003 for employee severance and facility closure cost.

 

In 2004, a credit to restructuring charge of($0.7) million was recorded primarily due to the subletting of a vacatedfacility in the United Kingdom at a cost less than previously estimated bymanagement.

 

***Impairment of Fixed Assets***.  In 2003, an asset impairment charge of $1.2million was recorded for production equipment in International operations aspart of the closure of a manufacturing facility.  There was no impairment of fixed assets in2004.

 

***Income from Operations****. *As a result of theitems discussed above, income from operations increased $2.8 million or 398.4%from $0.7 million in 2003 to $3.5 million in 2004.  Operating margin as a percent of salesincreased from 0.9% to 3.5%.

 

***Interest Expense, Net****.*  Net interestexpense decreased from $0.6 million in 2003 to $0.5 million in 2004.  The decrease was attributable to loweramortization of prepaid bank origination fees in 2004.  Total debt and interest expense increased in August dueto the acquisition of Bushman Tanks.

 

# ***Income Taxes***.  Income tax expense decreased from $0.2million in 2003 to ($0.7) million in 2004. The effective tax rate of 168.3% in 2003 compares to (22.7%) in 2004. The decline is due to an ordinary worthless stockdeduction in 2004 offset by an increase in the valuation allowance.  The worthless stock deduction is associatedwith the United Kingdom operations.  As aresult of the decision to close the manufacturing facility in the UnitedKingdom, an independent party was commissioned to appraise the value of thelegal entity.  The appraisal concludedthat the entity was financially insolvent. Being insolvent, the entity therefore met the requirements for aworthless stock deduction.

# ** **

# **Comparisonof Year Ended December 31, 2003 with Year Ended December 31, 2002**

# ** **

The Company implemented actions in 2002 and 2003 torestructure the Company due to decreased demand in the telecommunications industry.  These actions resulted in a lower coststructure, a return to a positive income from operations, lower debt and anincrease in the Company’s cash balance.  Shown below are the sales, income from operations, loss per share, debtand cash balance for 2001, 2002 and 2003:

 
| ** **                                                              | ** ** | **Year Ended December 31,**                | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                              | ** ** | **2001**                                        | ** ** | **2002** | ** ** | **2003** | ** ** |
| * *                                                                | * *   | **(amounts in million, except loss per share)** | * *   |
| Net Sales                                                               |       | $                                               | 88.7       |   | $ | 84.8 |   | $ | 76.5 |   |
|                                                                    |       |                                            |       |   |   |   |   |
| Income  (loss) from operations                                          |       | $                                               | (29.5      | ) | $ | 0.7 |   | $ | 0.7 |   |
|                                                                    |       |                                            |       |   |   |   |   |
| Loss per  share                                                         |       | $                                               | (2.78      | ) | $ | (0.34 | ) | $ | (0.01 | ) |
|                                                                    |       |                                            |       |   |   |   |   |
| Total debt  as of December 31 (loans, capital leases and mortgage) |       | $                                               | 36.8       |   | $ | 6.5 |   | $ | 3.9 |   |
|                                                                    |       |                                            |       |   |   |   |   |
| Cash and  cash equivalents                                              |       | $                                               | 8.8        |   | $ | 3.2 |   | $ | 9.5 |   |

 

In the fourth quarter of 2003, the Company further evaluatedInternational operations to improve profitability.  A plan was developed to close a manufacturingfacility in International operations by mid-year 2004.  Additional non-recurring charges wererecorded in 2003 as a result of these actions including employee severancebenefits, inventory reserves, impairment of assets and facility closurecost.  The facility closure cost chargeis a revision to restructuring costs recorded in the third

 

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quarter of 2001 and the fourth quarter of 2002.  The revision is due to a change in theestimated sublease income from vacated facilities based on management’s latestestimate.

 

***NetSales***.  Net salesdecreased $8.3 million or 9.7% from $84.8 million in 2002 to $76.5 million in2003.  The decrease resulted from aslowdown in equipment purchases by telecommunications service providers in boththe Americas and International operations.

 

Americas net sales decreased $5.2 million or7.4% from $70.0 million to $64.8 million.  In 2003, two major broadband operators reducedpurchases compared to 2002.  One customerreduced purchases as a result of substantially completing its network upgradeprogram.  The second customer reducedpurchases in the first half of 2003 due to deterioration in its financialcondition and the need to reduce spending. The second customer resumed purchases at a higher level in the secondhalf of 2003.  The declines from 

broadband customers were partially offset by a 16.6%increase in sales from the Company’s largest telephone customer, Verizon.  In addition, the Americas segment sold $1.5million of slow moving inventory in 2002 as part of the Company’s debtreduction program which also contributed to the period over period salesdecline.  There were no material sales ofslow moving inventory in 2003.

 

International net sales decreased $3.1 million or20.8% from $14.8 million to $11.7 million. The decrease in International sales was due to generally depressedindustry conditions and lower sales of products discontinued as part of theCompany’s restructuring program.

 

Sales to Comcast of $20.7 million in 2003represented 27.1% of Company sales in the period.  Comcast acquired AT&T’s broadbandbusiness in the fourth quarter of 2002 thereby increasing its purchases fromthe Company. The second largest customer in 2003 was Verizon with sales of $8.0million representing 10.5% of the total. Sales to AT&T of $20.2 million in 2002 represented 23.8% of Companysales for the period. Combined AT&T and Comcast sales for the 2002 periodwere $23.7 million or 28.0% of the Company’s sales in the period.  Sales to Time Warner of $8.3 million in 2002represented 9.8% of Company sales.

 

***Gross Profit***.  Gross profit decreased $4.7 million from$27.3 million in 2002 to $22.6 million in 2003. The decrease is mainly due to the lower sales volume, which resulted inlower manufacturing production rates and higher unabsorbed overhead.  A secondary factor was product mix,predominately in the Americas.  Thechange in product mix was due to:  1) ahigher percentage of products purchased externally for resale that the Companysells as a package with core product lines that have a lower gross profit thanenclosures that are manufactured internally, and, 2) a higher percentage ofconnectivity products that had a lower gross profit than thermoplasticenclosures.  The gross profit ofconnectivity products was affected by sales of new products whose manufactureis still in the start up phase and thus current product costs are higher thanthose anticipated during full scale production.

 

In 2002, gross profit was reduced by $0.4million of special charges in the fourth quarter to write down inventory ofdiscontinued products.  In 2003, grossprofit was reduced by $0.1 million of special charges to write down inventoryas part of the closure of an International manufacturing facility.  Excluding the special charges in both years,gross profit decreased $5.0 million from $27.7 million in 2002 to $22.7 millionin 2003.

 

As a percentage of net sales, gross profitdecreased from 32.2% in 2002 to 29.5% in 2003. Excluding the special charges recorded in both years, gross profit as apercentage of net sales decreased from 32.7% in 2002 to 29.7% in 2003.  The reasons for the decrease are the same asthose noted above for gross profit dollars.

 

***Selling. ***Selling expensesincreased $0.2 million or 2.4% from $9.3 million in 2002 to $9.5 million in2003.  The increase is primarily infreight costs due to higher fuel prices and an increase in full truckload shipmentsto customers in which the Company pays the freight costs.

 

As a percentage of net sales, selling expenseincreased from 10.9% in 2002 to 12.4% in 2003. The higher percentage is primarily due to the reasons noted above.

 

***General and Administrative***.  General and administrative expenses decreased$3.7 million or 32.7% from $11.4 million in 2002 to $7.7 million in 2003.   The year 2002 included a $2.0 million chargeto increase the allowance for bad debt primarily as a result of the Chapter 11bankruptcy filing of a major broadband customer.  Excluding the charge, general andadministrative expense decreased by $1.7 million or 18.4%.  The decrease is due to cost reductions inadministrative functions primarily within the Americas operations.

 

As a percentage of net sales, general andadministrative expenses decreased from 13.5% in the 2002 period to 10.1% in the2003 period.  Excluding the charge forbad debt, general and administrative expenses as a percentage of net sales were11.1% in the 2002 period and 10.1% in the 2003 period.

 

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***Research and Development***.  Research and development expenses increased$0.3 million or 17.5% from $1.6 million in 2002 to $1.9 million in 2003.  The increase is due to spending on projectsfor new product development in connectivity and thermoplastic enclosure productlines.  As a percentage of net sales,research and development expenses increased from 1.9% in 2002 to 2.5% in 2003.

 

***Restructuring charge.***  In the fourth quarter of 2002, the Companyinitiated actions to improve profitability in International operations.  The actions taken included head count andfacility square footage reductions in International operations.  In addition, the management of Internationaloperations was consolidated under one management team.  Restructuring charges of $1.2 million wererecorded in 2002 as a result of these actions.

 

***Impairment of Fixed Assets***.  In 2002, an asset impairment charge of $2.2million was recorded for production equipment in International operations aspart of the rationalization and downsizing of International manufacturingoperations and for tooling associated with products discontinued in theAmericas.

 

In 2003, an asset impairment charge of $1.2million was recorded for production equipment in International operations aspart of the closure of a manufacturing facility.

 

***Impairment of Goodwill. ***In 2002, agoodwill impairment charge in the International segment was recorded for $1.0million.  This impairment charge resultedin the full amortization of the goodwill associated with the A.C. Egertonacquisition.

 

There were no goodwill impairment charges in2003.

 

***Income(Loss) from Operations****. *As a result of the items discussedabove, income from operations was unchanged at $0.7 million in both 2002 and2003.  Operating margin as a percent ofsales increased from 0.8% to 0.9%.

 

***InterestExpense, Net****.*  Net interest expense decreased from $2.0million in 2002 to $0.6 million in 2003. The decrease was attributable to the lower level of debt in 2003.

 

***Income Taxes***.  Income tax expense decreased from $1.7million in 2002 to $0.2 million in 2003. The effective tax rate of 130.7% in 2002 compares to 168.3% in 2003.   The higher tax expense in 2002 was primarilyattributable to an increase in the valuation allowance for deferred tax assetsrelated to net operating loss carry forwards of foreign subsidiaries.  The increase in valuation allowance was dueto the uncertainty of future taxable income in these subsidiaries.  In both years, the Company recorded a taxexpense for income earned in the Americas. In both years, a tax benefit was not recorded for foreign operatinglosses in International operations due to the uncertainty of the realization ofthe tax loss carry forwards.

 

**Liquidity and Capital Resources**

 

Cash and cash equivalents on December 31,2004 were $5.5 million, a decrease of $4.1 million from the December 31,2003 balance of $9.5 million.  Thedecrease was due to cash used for the acquisition of the Bushman Tanks businesspartially offset by cash generated from on going operations and a decrease inworking capital primarily due to a larger accounts payable balance.

 

Net cash used by investing activities was($20.7) million in 2004 as compared to net cash provided by investingactivities of $1.2 million in 2003.  Inthe 2004 period, the Company acquired the Bushman Tanks business.  Capital expenditures for property andequipment were higher in the 2004 period due to equipment required torefacilitate manufacturing facilities in the Americas as part of the transferof operations previously performed in Europe. In the 2003 period, the Company sold a building in the U.K. for $2.2million.

 

Net cash provided by financing activities in2004 was $8.3 million compared to net cash used of ($2.7) million in 2003.  In the 2004 period, the Company acquired theBushman Tank business and financed the purchase with a term loan from TheNational Australia Bank Ltd. and equity provided by ANZ Private Equity.  In the 2003 period, the Company repaid debt.

 

Accounts receivable increased from $10.1million at December 31, 2003 to $13.9 million at December 31, 2004primarily to due the addition of the acquired company and the higher level ofsales.  In terms of days salesoutstanding, accounts receivable decreased from 44 days at December 31,2003 to 37 days at December 31, 2004.

 

Inventories increased from $8.9 million at December 31,2003, to $14.2 million at December 31, 2004.  The increase is due to the addition of theacquired company and due to additional inventory necessary to meet the highersales demand.  Days inventory on handdecreased from 55 days at December 31, 2003 to 52 days at December 31,2004.

 

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Accounts payable increased from $5.1 millionat December 31, 2003 to $16.1 million at December 31, 2004.  Days payables increased from 32 days to 59days, respectively.  The increase is dueto the addition of the acquired company in the consolidated financialstatements, a higher percentage of product being purchased versus produced inhouse, higher inventory purchases to meet sales demand and the extension ofvendor payment terms.

 

The Company and its subsidiaries have enteredinto the following financing arrangements:

 

1.                    On September 25,2002, the Company entered into a three-year Loan and Security Agreement with anasset-based lender in the United States. The Loan and Security Agreement’sinitial term loan balance of $4.7 million and initial revolver balance of $2.1million as well as $9.6 million in cash were used to repay in full the priorCredit Agreement.  The three-year term loan is repayable in quarterlypayments based on a five-year amortization schedule with a balloonrepayment at maturity.  At December 31,2004, the outstanding balance of the term loan was $2.8 million, with nooutstanding balance in the revolver.

 

Under the Loanand Security Agreement, the outstanding balance bears interest payable monthlyat a variable rate based on either LIBOR or the lender’s base rate.  The weighted average interest rate under theLoan and Security Agreement at December 31, 2004 was 4.41%.

 

The Loan andSecurity Agreement contains various financial and operating covenants thatimpose limitations on the Company’s ability, among other things, to incuradditional indebtedness, merge or consolidate, sell assets except in theordinary course of business, make certain investments, enter into leases andpay dividends.  The Company is also required to comply with a fixed chargecoverage ratio financial covenant among others.  The Company was incompliance as of December 31, 2004 with the covenants of the Loan andSecurity Agreement.

 

2.               In July 2004,a subsidiary of the Company located in Australia, Channell Pty Ltd., enteredinto a one-year Loan and Security Agreement with a commercial bank inAustralia.  The Loan and SecurityAgreement contains a revolver line of credit for working capital needs.  The agreement is reviewed annually with thebank for yearly renewals.  At December 31,2004 the outstanding balance of the facility was $0.2 million.

 

Under the Loanand Security Agreement, the balance bears interest payable monthly at avariable rate based on the lender’s base rate. The weighted average interest rate at December 31, 2004 was 6.75%.

 

The Loan andSecurity Agreement contains various financial and operating covenants thatimpose limitations on Channell Pty Ltd.’s ability, among other things, to incuradditional indebtedness, merge or consolidate and sell assets except in theordinary course of business.  Channell Pty Ltd. is also required to complywith an interest coverage ratio.  Channell Pty Ltd. was in compliance asof December 31, 2004 with the covenants of the Loan and SecurityAgreement.

 

3.               On August 2,2004, a subsidiary of the Company, Channell Bushman Pty Ltd., entered into afive-year Loan and Security Agreement with a commercial bank in Australia.  Channell Bushman Pty Ltd. is the holdingcompany established to acquire the Bushman Tanks business.  The Loan and Security Agreement’s initialterm loan balance of $5.8 million was used as part of the consideration paid toacquire the Bushman Tanks business.  The five-year term loan is repayablein quarterly payments based on a five-year amortization schedule.  The loan and security agreement also includesa revolving credit facility, reviewed annually, for working capital needs inthe amount of $1.4 million, a capital expenditure line of credit in the amountof $4.2 million and a $1.2 million facility to fund future “earn out” paymentsto the seller if the Bushman Tanks business achieves specified performancetargets in 2005 and 2006.  The Loan andSecurity Agreement is guaranteed by Channell Pty Ltd., a subsidiary of theCompany in Australia.  At December 31,2004, the outstanding balance of the term loan was $5.6 million and $0.0million on the revolving line of credit. There were no advances on either the capital expenditure line of creditor the earn line credit facility.

 

Under the Loanand Security Agreement, the outstanding balance bears interest payable monthlyat a variable rate based on the lender’s base rate.  The weighted average interest rate under theLoan and Security Agreement at December 31, 2004 was 5.75%.

 

The Loan and SecurityAgreement contains various financial and operating covenants that imposelimitations on Channell Bushman Pty Ltd.’s ability, among other things, toincur additional indebtedness, merge or consolidate, sell assets except in theordinary course of business, make certain investments, enter into leases andpay dividends.  Channell Bushman Pty Ltd. is also required to comply witha Debt/EBIT ratio, capital adequacy ratio, debit service coverage ratio andinterest coverage ratio.  ChannellBushman Pty Ltd. was in compliance as of December 31, 2004 with thecovenants of the Loan and Security Agreement.

 

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

 

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

 

Contractual obligations, consistingprincipally of payment for noncancellable operating lease obligations, longterm debt and capital leases.  Futurepayments required under these contractual obligations have been summarized inthe notes to the Consolidated Financial Statements as follows: (i) leasecommitments –Note M, (ii) long term debt – Note F, and (iii) capital leaseobligations – Note G.

 

The Company believes that cash flow fromoperations should be sufficient to fund the Company’s capital expenditure andworking capital requirements through 2005.

 

**Contractual Obligations and Other Commitments**

 

The following table summarizes the Company’scontractual obligations and other commitments as of December 31, 2004:

 
| **(amounts in thousands)**       | ** ** | **2005** | ** ** | **2006 to  2007** | ** ** | **2007 to  2008** | ** ** | **2009 and  Thereafter** | ** ** | **Total** | ** ** |
|----------------------------------|------------|----------|------------|-------------------|------------|-------------------|------------|--------------------------|------------|-----------|------------|
| Contractual  Obligations         |       |     |       |              |       |              |       |                     |       |      |       |
| Long Term  Debt (1)              |       | $        | 5,334      |              | $          | 2,873             |       | $                        | 1,998      |      | $          | — |   | $ | 10,205 |   |
| Capital  Lease Obligations       |       | 36       |       | 104               |       | —            |       | —                   |       | 140       |       |
| Operating  Lease Obligations (2) |       | 2,676    |       | 2,165             |       | 2,147             |       | 1,912                    |       | 8,900     |       |
| Employment  Contracts (3)        |       | 796      |       | 1,512             |       | 683               |       | —                   |       | 2,991     |       |
| Purchase  Obligations (4)        |       | 12,370   |       | —            |       | —            |       | —                   |       | 12,370    |       |
|                             |       | $        | 21,212     |              | $          | 6,654             |       | $                        | 4,828      |      | $          | 1,912 |   | $ | 34,606 |   |

 

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(1)   The Company entered into a three-year Loan andSecurity Agreement which includes a term loan and revolver line of credit withan asset-based lender in the United States on September 25, 2002.  The Company entered into a one-year Loan andSecurity Agreement which includes a revolver line of credit with a commercialbank in Australia in July 2004.  TheCompany also entered into a five-year Loan and Security Agreement whichincludes a term loan and revolver line of credit with a commercial bank inAustralia in August 2004. See Note F to the Consolidated FinancialStatements.

(2)   The Company leases manufacturing and officespace and machinery & equipment under several operating leases expiringthrough 2012.  See Note M to theConsolidated Financial Statements.

(3)   The Company has employment agreements with itsChairman of the Board expiring July 7, 2006 and its President and ChiefExecutive Officer expiring December 8, 2008.  Both contracts are renewable every 5years.  The Chairman of the Board’ssalary is set at $50,000 per annum for the remainder of the term.  The President and Chief Executive Officer’sbase salary is $745,616 per year effective July 2004, and is subject to anannual cost of living increase based on the consumer price index.  Base salary may also be increased based onthe discretion of the Board of Directors. In the event the President and Chief Executive Officer is terminated theCompany will be obligated to make a lump sum severance payment equal to threetimes his then current base salary.

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

 

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**Off-BalanceSheet Arrangements**

 

Our off-balance sheet arrangements consist ofoperating leases, employment contracts and purchase obligations as describedabove.  In addition, as discussed in NoteL to the Consolidated Financial Statements, the Company guaranteed debt of theCompany’s principal stockholder and Chairman of the Board of approximately $0.8million in 1997.  The guaranteed debt wasincurred in connection with construction of the facilities leased to theCompany and is collateralized by said facilities.  The loan amount subject to the unsecuredguarantee is expected to decline before expiring in 2017.  It is not practicable to estimate the fairvalue of the guarantee; however, the Company does not anticipate that it willincur losses as a result of this guarantee. The Company has not recorded a liability for this guarantee.  If the principal stockholder were to defaulton the outstanding loan balance, the Company may be required to repay theremaining principal balance.  The maximumpotential amount the Company would be required to pay is equal to theoutstanding principal and interest balance of the loan to the stockholder.  At December 31, 2004, the outstandingloan balance subject to the guarantee totaled $0.6 million.

 

**Forward-Looking Statements and Risk Factors**

 

Certain statements contained in this AnnualReport on Form 10-K are “forward-looking” statements within the meaning of thePrivate Securities Litigation Reform Act of 1995 (the “Act”), which providescertain “safe harbor” provisions for forward-looking statements.  All forward-looking statements made in thisAnnual Report on Form 10-K are made pursuant to the Act.  Forward-looking statements include statementswhich are predictive in nature; which depend upon or refer to future events orconditions; or which include words such as “expects,” “anticipates,” “intends,”“plans,” “believes,” “estimates,” or variations or negatives thereof or bysimilar or comparable words or phrases. In addition, any statement concerning future financial performance,ongoing business strategies or prospects, and possible future Company actionsthat may be provided by management are also forward-looking statements asdefined by the Act.  Forward-lookingstatements are based on current expectations and projections about futureevents and are subject to risks, uncertainties, and assumptions about theCompany; and economic and market factors in the countries in which the Companydoes business, among other things.  Thesestatements are not guarantees of future performance, and the Company has nospecific intentions to update these statements.

 

Actual events and results may differmaterially from those expressed or forecasted in forward-looking statements dueto a number of factors.  The principalimportant risk factors that could cause the Company’s actual performance andfuture events and actions to differ materially from such forward-lookingstatements include, but are not limited to, the risk factors discussed below.

 

***Obsolescence and TechnologicalChange.* **Thecommunications industry is in a state of rapid technological change.  The introduction of new technologies, networkarchitectures or changes in industry standards can render the Company’sexisting products or products under development obsolete or unmarketable.  For example, satellite, wireless and othercommunication technologies under development or currently being deployed mayrepresent a threat to copper, coaxial and fiber optic-based systems by reducingthe need for wire-line networks. Further, while management anticipates that a number of factors,including network capacity requirements, existing investments in wire-linenetworks, security and long-term cost effectiveness, will result in growth ofwire-line networks, there can be no assurance that future advances or furtherdevelopment of these or other new technologies will not have a material adverseeffect on the Company’s business.  The Company’sgrowth strategies are designed, in part, to take advantage of opportunitiesthat the Company believes are emerging as a result of the development ofenhanced voice, video, data and other transmission networks, and high-speedInternet access in the telecommunications industry.  There can be no assurance that demandresulting from these emerging trends will continue or that the Company’sproducts will be met with market acceptance.

 

***Importanceof New Product Development to Growth.*** A significant factor in the Company’s abilityto grow and remain competitive will be its ability to anticipate changes intechnology, industry standards and customer preferences, and to successfullydevelop and introduce new products on a timely basis.  New product development often requireslong-term forecasting of market trends, development and implementation of newdesigns and processes, and substantial capital commitment.  Trends toward consolidation of thecommunications industry and convergence of technologies may require the Companyto quickly adapt to rapidly changing market conditions and customerrequirements.  Trends in consumerpreferences in Australia for the aesthetic design of water storage tanks mayrequire the Company to redesign or develop new water tanks and accessoryproducts.

 

The Company’smanufacturing and marketing expertise has enabled it to successfully developand market new products in the past. However, any failure by the Company to anticipate or respond in acost-effective and timely manner to technological developments or changes inindustry standards or customer requirements, or any significant delays inproduct development or introduction, could have a material adverse effect onthe Company’s business, operating results and financial condition.

 

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***Concentrationof Customers.*** Thetelecommunications industry is the largest industry the Company operates in andis highly concentrated. A relatively small number of customers account for alarge percentage of the Company’s available market.  Consequently, the Company’s five largestcustomers accounted for 57.7% and 48.7% of the Company’s total net sales in2003 and 2004, respectively.  Verizonaccounted for 21.7% of the Company’s total net sales in 2004 and 10.5% of theCompany’s net sales in 2003.  Comcastaccounted for 14.6% of the Company’s total net sales in 2004 and 27.1% of theCompany’s net sales in 2003.  Mergers andacquisitions in the telecommunications industry, which are expected tocontinue, not only increase the concentration of the industry and of theCompany’s customer base but also from time to time delay customers’ capitalexpenditures as newly merged service providers consolidate operations.  In the event one of the Company’s major customerswere to terminate purchases of the Company’s products, the Company’s operatingresults would be adversely affected.

 

***Dependenceon the Telecommunications Industry.*** Although the Company has recently diversifieda portion of its business with the acquisition of Bushman Tanks, a manufacturerof water storage tanks, the Company expects that sales to thetelecommunications industry will continue to represent a substantial portion ofits total sales.  Demand for productswithin this industry depends primarily on capital spending by service providersfor constructing, rebuilding, maintaining or upgrading their systems.  The amount of capital spending and,therefore, the Company’s sales and profitability, are affected by a variety offactors, including general economic conditions, access by service providers tofinancing, government regulation of service providers, demand for services andtechnological developments in the telecommunications technology.  While the industry generally experiencedabove average growth in the late 1990’s, since 2001 the telecommunicationsequipment industry has been materially adversely affected by service providers’reductions of their capital expenditures.

 

The Company’s success isdependent upon continued demand by the communications industry for productsused in signal transmission systems which may be affected by factors beyond theCompany’s control, including the convergence of video, voice, and datatransmission systems occurring within the broadband and telephone markets, continuingconsolidation of companies within those markets and the provision of Internetaccess by broadband operators and local telephone companies.

 

***LimitedBacklog***.  TheCompany’s customers typically require prompt shipment of the Company’s productswithin a narrow timeframe.  As a result,the Company has historically operated with a relatively small backlog.  Sales and operating results in any quarterare principally dependent upon orders booked and products shipped in thatquarter.  Further, the Company’s customersgenerally do not enter into long-term supply contracts providing for futurepurchase commitments for the Company’s products.  These factors, when combined with the Company’soperating leverage (see “Operating Leverage” below) and the need to incurcertain capital expenditures and expenses in part based upon the expectation offuture sales, may place the Company’s operating results at risk to changingcustomer buying patterns.  If saleslevels in a particular period do not coincide with the Company’s expectations,operating results for that period may be materially and adversely affected.

 

***PriceFluctuations of Raw Materials; Availability of Complementary Products.*** The Company’s cost of sales may be materiallyaffected by increases in the market prices of the raw materials, includingresins, used in the Company’s manufacturing processes.  The Company does not engage in hedgingtransactions for such materials, although it periodically enters into purchaseagreements for certain raw materials for as much as one year or more.  There can be no assurance that priceincreases in raw materials can be passed on to the Company’s customers throughincreases in product prices.  Inaddition, in order to position itself as a full-line product supplier, theCompany relies on certain manufacturers to supply products, including gradelevel boxes that complement the products manufactured by the Company.  Although the Company believes there aremultiple sources of supply for these products, disruptions or delays in thesupply of such products could have a material adverse effect on sales of theCompany’s own products.

 

***EnergyCosts and Availability*.** The Company’s cost of sales may be materially affected by increases inthe market prices of electricity, natural gas and water used in the Company’smanufacturing processes. California is the site of the Company’s largestmanufacturing operation.  The energycosts of California manufacturing firms may increase.  There exists the possibility ofinterruption(s) in the supply of energy to California’s manufacturingfirms.  There can be no assurance thatthe Company’s energy costs can be passed on to the Company’s customers throughincreases in product prices.  Further,disruptions or delays in the supply of electricity, natural gas and water tothe Company could have a material adverse effect on sales of the Company’sproducts.

 

***Acquisitionsand Failure to Integrate Acquired Businesses*.** In the event of any acquisition by theCompany, there can be no assurance that the Company will be able to identifyand acquire attractive acquisition candidates, profitably manage any suchacquired businesses or successfully integrate such acquired businesses into theCompany without substantial costs, delays or other problems.  Acquisitions involve a number of specialrisks, including, but not limited to, adverse short-term effects on the Company’sreported financial condition or results of operations, diversion of management’sattention, dependence on retention, hiring and training of key personnel, risksassociated with unanticipated problems or liabilities and amortization ofacquired intangible assets, some or all of which could have a material adverseeffect on the Company’s business, financial condition or results of operations.

 

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The Company acquiredBushman Tanks in August 2004.  Thesuccessful integration of this business into Channell requires among otherthings the retention of key personnel, the implementation of the Oracleinformation system used by all Channell businesses, the implementation offinancial accounting and internal controls required by all U.S. publicly ownedcorporations, the time and attention of Channell executive management, theintegration of management styles and culture as well as the hiring of peoplenecessary to implement the aforementioned items and to expand the business

 

In addition, there can beno assurance that any businesses acquired in the future will be profitable atthe time of acquisition or will achieve sales and profitability justifying theCompany’s investment therein or that the Company will realize the synergiesexpected from such acquisitions.

 

The failure to obtain anyor all of the desired results from acquisitions could have a material adverseeffect on the Company’s business, financial condition and results ofoperations.

 

***OperatingLeverage.*** Becausethe fixed costs of facilities, product development, engineering, tooling andmanufacturing are a relatively high percentage of total costs, the Company’sability to operate profitably is dependent on generating a sufficient volume ofproduct sales, thereby spreading fixed costs over the sales base.  Due to this “operating leverage”, a reductionin sales or the rate of sales growth has had in the past and could have in thefuture a disproportionately adverse effect on the Company’s financial results.

 

***Seasonalityand Fluctuations in Operating Results. ***TheCompany’s business is seasonal in nature, with the first and fourth quartersgenerally reflecting lower sales due to the impact of adverse weatherconditions on construction projects that may alter or postpone the needs ofcustomers for delivery of the Company’s telecommunications products.  In addition, first quarter sales may alsoreflect telecommunication customer delays in implementation of their annualcapital expenditure plans.  The waterstorage tank business in Australia is traditionally slow during the fourthquarter due to holidays and restrictions on the number of days in which largetrucks can utilize major roads to deliver water storage tanks tocustomers.  The Company’s operatingresults may also fluctuate significantly from quarter to quarter due to severalother factors, including the volume and timing of orders from and shipments tomajor customers, the timing of new product introductions and deployment as wellas the availability of products by the Company or its competitors, weatherconditions in Australia which may affect the sales of water storage tanks as alarge percentage of sales occur at outdoor agricultural farm fairs, the overalllevel of capital expenditures by broadband operators and telephone companies,market acceptance of new and enhanced versions of the Company’s products,variations in the mix of products the Company sells, and the availability andcosts of raw materials.

 

***RisksAssociated with International Operations*.** International sales, including export salesfrom U.S. operations, accounted for 23.8%, 21.2% and 33.9% of the Company’s netsales in 2002, 2003 and 2004, respectively. The percentage of international sales to total Company sales hasincreased with the acquisition of the Bushman Tanks business.  Due to its international sales, the Companyis subject to the risks of conducting business internationally, includingunexpected changes in or impositions of legislative or regulatory requirements,fluctuations in the U.S. dollar which could materially adversely affect U.S.dollar revenues or operating expenses, tariffs and other barriers andrestrictions, longer collection cycles, greater difficulty in accountsreceivable collection, potentially adverse taxes and the burdens of complyingwith a variety of international laws and communications standards.  The Company is also subject to generalgeopolitical risks, such as political and economic instability and changes indiplomatic and trade relationships, in connection with its Internationaloperations.  There can be no assurancethat these risks of conducting business internationally will not have amaterial adverse effect on the Company’s business.

 

***Competition. ***The industries in whichthe Company operates are highly competitive. The level and intensity of competition may increase in the future.  The Company’s competitors in thetelecommunications industry include companies that are much larger than theCompany, such as Tyco, 3M, Marconi, Arris and Corning.  The Company’s business strategy includesincreased focus on telephone connectivity. There can be no assurance that the Company will be able to competesuccessfully against its competitors, most of whom have access to greaterfinancial resources than the Company. The Company’s competitors in the Australian water storage tank businessincludes Nylex which is much larger than the Company as well as smaller companiesthat have market position in specific geographic regions.  There can be no assurances that the Companywill be able to successfully compete against these competitors or increase itssales by obtaining a higher market share.

 

***Disruptionsat the Company’s Manufacturing Facility; Lease with Related Party*.**  The majority of the Company’s manufacturingoperations are currently located at the Company’s facilities in Temecula,California, which also includes the Company’s principal warehouse and corporateoffice operations.  The Company’s successdepends in large part on the orderly operation of these facilities.  Because the Company’s manufacturingoperations and administrative departments are concentrated at this facility, afire, earthquake, power interruption or other disaster at this facility couldmaterially and adversely affect its business and results of operations.  The Company maintains property insurance onthis facility as well as business interruption insurance.

 

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The Company currentlyleases a portion of its Temecula facilities from William H. Channell, Sr., aprincipal stockholder and Chairman of the Board of the Company.  The Company believes the terms of theseleases are no less favorable than would be available from an unrelated thirdparty after arm’s length negotiations. Although the Company has renewal options through the year 2015 underthese leases, there can be no assurance that the Company and Mr. Channell, Sr.will be able to agree on additional renewal terms for the properties currentlyleased by the Company.  The failure ofthe Company to renew the leases would require the Company to relocate itsexisting facilities, which could have a material adverse effect on the Company’sbusiness, financial condition or results of operations.

 

The Company currentlyleases four facilities in Australia from the former owners of BushmanTanks.  Although the Company believesthese leases are in total in excess of fair market value by $27,000 per year,the Company does not believe that amount is significant compared to totalmanufacturing costs and thus does not place it in a competitive disadvantage. Althoughthe Company also has renewal options through the year 2015 under these leases,there can be no assurance that the Company and then former owners will be ableto agree on additional renewal terms for the properties currently leased by theCompany.  The failure of the Company torenew the leases would require the Company to relocate its existing facilities,which could have a material adverse effect on the Company’s business, financialcondition or results of operations.

 

***Dependenceon Key Personnel*.** The future success of the Company depends in part on its ability toattract and retain key executive, engineering, marketing and salespersonnel.  Key personnel of the Companyinclude William H. Channell, Sr., Chairman of the Board, William H. Channell,Jr., President and Chief Executive Officer and the other executive officers ofthe Company.  The market for qualifiedpersonnel in the communications industry is competitive and the loss of certainkey personnel could have a material adverse effect on the Company.  The Company has employment contracts withWilliam H. Channell, Jr. and William H. Channell, Sr.

 

***ChangingRegulatory Environment.**** *The communications industry issubject to regulation in the United States and other countries.  Federal and state agencies regulate most ofthe Company’s domestic customers. Changes in current or future laws orregulations, in the United States or elsewhere, could materially adverselyaffect the Company’s business. Government regulation in Australia has increased demand for waterstorage tanks through the offering of rebates to those whom purchase watertanks and by requiring the installation of water storage tanks or other waterconservation products in new homes built in selected regions.  There can be no assurances that theseregulations will remain in affect.  Alessening of these regulations most likely would lead to lower demand for waterstorage products and thus negatively affect the Company’s sales.

 

***UncertainAbility to Manage Industry Volatility*.**  The Company’s business has required and isexpected to continue to require significant Company resources in terms ofpersonnel, management and other infrastructure. The Company’s ability to manage effectively the volatility of thetelecommunications industry requires it to attract, train, motivate and managenew employees successfully, to integrate new employees into its overall operationsand to continue to improve its operational, financial and managementinformation systems.

 

***Environmental Matters.*** The Company is subject to a wide variety offederal, state and local environmental laws and regulations and uses a limitednumber of chemicals that are classified or could be classified as hazardous orsimilar substances.  Although managementbelieves that the Company’s operations are in compliance in all materialrespects with current environmental laws and regulations, the Company’s failureto comply with such laws and regulations could have a material adverse effecton the Company.

 

***Weather Matters***.  The Company business may be affected byadverse changes in weather patterns in Australia that may affect the demand forwater storage tanks.  Australia iscurrently experiencing a severe water shortage due to less rainfall, inadequatenational infrastructure to store water for use during drought periods and thegrowth in population in non urban areas. A change in the weather pattern which provides additional rainfall andlessens the affect of the drought could have a negative impact on the demandfor water storage tanks.

 

**Selected Quarterly Financial Data**

 

Set forth below is certain unaudited quarterlyfinancial information. (See also Note P to the Consolidated FinancialStatements included elsewhere herein.) The Company believes that all necessary adjustments, consisting only ofnormal recurring adjustments, have been included in the amounts stated below topresent fairly, and in accordance with generally accepted accountingprinciples, the selected quarterly information when read in conjunction withthe Financial Statements.

 
| ** **                        | ** ** | **December 31,2003**       | ** ** | **December 31,2004**       | ** ** |
|-----------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                        | ** ** | **(amounts in thousands)** | ** ** | **(amounts in thousands)** | ** ** |
| ** **                        | ** ** | **1st  Quarter**           | ** ** | **2nd  Quarter**           | ** ** | **3rd  Quarter** | ** ** | **4th  Quarter** | ** ** | **1st  Quarter** | ** ** | **2nd  Quarter** | ** ** | **3rd  Quarter** | ** ** | **4th  Quarter** | ** ** |
| Net sales                         |       | $                          | 16,218     |                       | $          | 20,285 |   | $ | 19,434 |   | $ | 20,600 |   | $ | 17,720 |   | $ | 21,303 |   | $ | 27,615 |   | $ | 33,496 |   |
| Gross profit                      |       | 4,482                      |       | 6,449                      |       | 5,515 |   | 6,131 |   | 5,344 |   | 5,928 |   | 7,896 |   | 8,815 |   |
| Income (loss) from operations     |       | (67                        | )          | 1,838                      |       | 712 |   | (1,786 | ) | 151 |   | 930 |   | 1,784 |   | 609 |   |
| Income (loss) before income taxes |       | (188                       | )          | 1,699                      |       | 534 |   | (1,919 | ) | 90 |   | 841 |   | 1,614 |   | 440 |   |
|                                   |            |                            |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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### **Item 7a.** Quantitativeand Qualitative Disclosures about Market Risk

### ** **

The marketrisk inherent in the Company’s market risk sensitivity instruments is thepotential loss arising from adverse changes in interest rates and foreigncurrency exchange rates.  All financialinstruments held by the Company and described below are held for purposes otherthan trading.

 

### **Market Risk**

### ** **

The Companyand its subsidiaries have entered into three financing agreements.  In September 2002, the Company entered into athree-year Loan and Security Agreement with an asset based lender in the UnitedStates.  The agreement contains a termloan and a revolver line of credit.  InJuly 2004, the Company entered into a one-year Loan and Security Agreementwhich contains a revolver line of credit with a commercial bank inAustralia.  In August 2004, the Companyentered into a five-year Loan and Security Agreement which contains a term loanand revolver line of credit with a commercial bank in Australia.  The loan and security agreements allow forthe outstanding balance to bear interest at a variable rate based on the lender’sbase rate.  The credit facility exposesoperations to changes in short-term interest rates since the interest rates onthe credit facility are variable.

 

If the variable rates on the Company’s loan andsecurity agreements were to increase by 1% from the rate at December 31, 2004,and if the Company had borrowed during all of fiscal 2004 the maximum amount(approximately $39 million) at any time in 2004 under its credit facility at theincreased interest rate, the Company’s interest expense would have increased,and net income would have decreased by $0.2 million.  A marginal income tax rate of 38.0% was usedin this analysis.  This analysis does notconsider the effects of economic activity on the Company’s sales andprofitability in such an environment.

 

### **Foreign ExchangeRisk**

### ** **

TheCompany has assets and liabilities outside the United States that are subjectto fluctuations in foreign currency exchange rates.  Assets and liabilities outside the UnitedStates are primarily located in the United Kingdom, Australia and Canada.  The Company’s investment in foreignsubsidiaries with a functional currency other than the U.S. dollar aregenerally considered long-term. Accordingly, the Company does not hedge these net investments.  The Company also purchases a limited portionof its raw materials from foreign countries. These purchases are generally denominated in U.S. dollars and areaccordingly not subject to exchange rate fluctuations.  The Company has not engaged in forwardforeign exchange and other similar contracts to reduce its economic exposure tochanges in exchange rates because the associated risk is not consideredsignificant.

 

**Item 8.**** Financial Statements andSupplementary Data**

 
| Consolidated Financial Statements of Channell Commercial Corporation  are as follows:       |   |
|---------------------------------------------------------------------------------------------|--------|
|                                                                                        |   |
| Report of Independent Registered Public  Accounting Firm                                    |   |
| Consolidated Balance Sheets as of December 31, 2003 and December 31,  2004             |   |
| Consolidated Statements of Operations and  Comprehensive Income (Loss) for the years ended  |   |
| December 31, 2002, December 31, 2003, and  December 31, 2004                           |   |
| Consolidated Statement of Stockholders’  Equity for the years ended December 31, 2002, |   |
| December 31, 2003, and December 31, 2004                                                    |   |
| Consolidated Statements of Cash Flows for  the years ended December 31, 2002,               |   |
| December 31, 2003, and December 31, 2004                                                    |   |
| Notes to Consolidated Financial Statements                                             |   |
|                                                                                        |   |
| Financial statement schedules are as follows:                                               |   |
|                                                                                        |   |
| Schedule II - Valuation and Qualifying  Accounts                                            |   |

 

All remaining schedules are omitted because they are not applicable, orthe required information is included in the financial statements or the notesthereto.

 

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### **Item 9.** Changesin and Disagreements with Accountants on Accounting and Financial Disclosure

### ** **

There has beenno change of accountants or disagreements on any matter of accountingprinciple, practice, financial statement disclosure or auditing scope orprocedure during the period covered by this report.

 

### **Item 9A**.  Controlsand Procedures

### ** **

Based on their evaluation as of December 31, 2004 (the “Evaluation Date”),the Company’s principal executive officer and principal financial officer haveconcluded that, as of the Evaluation Date, the Company’s disclosure controlsand procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended) are effective to ensure thatmaterial information relating to the Company and its consolidated subsidiariesis recorded, processed, summarized, reported and made known to the Company’smanagement, including the Company’s principal executive and financial officers,on a timely basis by others within the Company and its consolidatedsubsidiaries.

 

To satisfy their responsibility for financial reporting, the Company’sCEO and CFO have established internal controls for financial reporting whichthey believe are adequate to provide reasonable assurance that the Company’sassets are protected from loss. These internal controls are reviewed by theCompany’s management in order to ensure compliance.  In addition, the Company’s Audit Committeemeets regularly with management and the independent accountants to reviewaccounting, auditing and financial matters. The Audit Committee and the independent accountants have free access toeach other, with or without management being present.

 

The Bushman Tanks business was acquired in August of 2004.  The Company has implemented a number ofactions to ensure the accuracy of financial reporting and adequacy of internalcontrols.  These actions include a reviewof the Bushman Tanks accounting operations and systems during the acquisitiondue diligence, an audit of the Bushman Tanks financial records for the twelvemonths ended June 30, 2004, the hiring of a Finance Director for theAustralia/Asia region of Channell which includes Bushman Tanks, the hiring ofan independent accounting firm to assist with the preparation of financialstatements for each of the five months from August to December 2004, and the monthlyreview of Bushman Tanks financial statements by the Company’s Chief FinancialOfficer. The Company initiated a project in December of 2004 to implement inBushman Tanks the Oracle information system used in all of Channell operationsand to transfer the accounting operations to its Sydney finance and accountingstaff.

 

There has been no change in the Company’s internal control overfinancial reporting during the three months ended December 31, 2004 that hasmaterially affected, or is reasonably likely to materially affect, internalcontrol over financial reporting.

 

The Company initiated a project in December 2004 to review its internalcontrol structure in relation to the requirements of the Sarbanes OxleyAct.   The Company hired an independentconsulting firm experienced in these requirements to assist in itsefforts.  The Company has identified anumber of areas where segregation of duties and evidence of review procedureswill need to be changed.  In addition,the procedures of Bushman Tanks are mostly manual.  The Company’s Oracle information system isbeing implemented in Bushman Tanks in 2005, with the financial modules beingthe initial task.  It is anticipated thatseveral remediation steps will be implemented to improve Bushman Tanks’ internalcontrols.

 

### **Item 9B**.  OtherInformation

### ** **

There were no events required to be reported on Form 8-K during thefourth quarter of 2004 that were not so reported**.**

 

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**PART III**

 

### **Item 10.**  ExecutiveOfficers and Directors of the Registrant

### ** **

The following table sets forth information with respect to the Company’sexecutive officers and directors and their ages as of March 4, 2005.

 
| **Name**                   | ** ** | **Age** | ** ** | **Positions**                                            |
|----------------------------|------------|---------|------------|----------------------------------------------------------|
|                       |       |    |       |                                                     |
| William H. Channell, Sr.   |       | 77      |       | Chairman of the Board and Director                       |
|                       |       |    |       |                                                     |
| William H. Channell, Jr.   |       | 47      |       | President, Chief Executive Officer and Director          |
|                       |       |    |       |                                                     |
| Jacqueline M. Channell     |       | 73      |       | Secretary and Director                                   |
|                       |       |    |       |                                                     |
| David Iannini(1)  (2) |       | 45      |       | Director                                                 |
|                       |       |    |       |                                                     |
| Guy Marge(1)  (2)     |       | 61      |       | Director                                                 |
|                       |       |    |       |                                                     |
| Dana Brenner(1)            |       | 62      |       | Director                                                 |
|                       |       |    |       |                                                     |
| Stephen Gill  (2)     |       | 62      |       | Director                                                 |
|                       |       |    |       |                                                     |
| Edward J. Burke            |       | 49      |       | Vice President, Corporate Engineering                    |
|                       |       |    |       |                                                     |
| Timothy Hankinson          |       | 52      |       | Managing Director, International                         |
|                       |       |    |       |                                                     |
| John B. Kaiser             |       | 53      |       | Vice President, North American Sales                     |
|                       |       |    |       |                                                     |
| Scott Kiefer               |       | 45      |       | Corporate Controller and Interim Chief Financial Officer |
|                       |       |    |       |                                                     |
| Andrew M. Zogby            |       | 44      |       | Vice President, Corporate Marketing                      |

 

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(1)   Audit Committee Member

(2)   Compensation Committee Member

 

The Company’s Board of Directors was comprised of seven members atMarch 4, 2005.  The directors of theCompany are staggered into three classes, with the directors in a single classelected at each annual meeting of stockholders to serve for a term of threeyears or until their successors have been elected and qualified. The authorizednumber of members of the Board of Directors is currently seven. The executiveofficers of the Company serve at the pleasure of the Board of Directors.

 

William H. Channell, Sr., the son of the Company’s founder, James W.Channell, has been the Chairman of the Board since July, 1996. From 1966 toNovember, 2001 and from July, 2002 to December, 2003 Mr. Channell, Sr. wasChief Executive Officer.  Mr. Channell,Sr. is a co-trustee of the Channell Family Trust, which is a principal stockholderof the Company, and is the husband of Jacqueline M. Channell and the father ofWilliam H. Channell, Jr. His term as a Director expires in 2005.

 

William H. Channell, Jr. has been President and Chief Executive Officersince December, 2003.  He was Presidentand Chief Operating Officer of the Company from 1996 to December, 2003.  He has been a Director of the Company since1984. Since joining the Company in 1979, Mr. Channell, Jr. has held thepositions of Executive Vice President, Director of Marketing and National SalesManager. Mr. Channell, Jr. is a principal stockholder of the Company and is theson of William H. Channell, Sr. and Jacqueline M. Channell. His term as aDirector expires in 2006.

 

Jacqueline M. Channell is Secretary and has been a Director since 1966except for approximately three months in 2001. She is a co-trustee of theChannell Family Trust, which is a principal stockholder of the Company, and isthe wife of William H. Channell, Sr. and the mother of William H. Channell, Jr.  Mrs. Channell’s term as a Director expires in2006.

 

Guy Marge became a Director of the Company in August, 2002.  Mr. Marge is President and Chief ExecutiveOfficer of Western Brass Industries, Inc. and Storm Industries, Inc.  From 1988 to 2001, Mr. Marge was ChiefExecutive Officer of the Milhous Group, Inc., a manufacturer of plastic,metal-formed and pre-cast concrete products. From 1978 to 1988, Mr. Marge held executive management positions withKearney-National, Inc., The United Groups, Inc., and Uniroyal TechnologyCorporation.  Mr. Marge’s term as aDirector expires in 2007.

 

Dana Brenner became a Director of the Company in March, 2003.  Mr. Brenner is the managing partner ofBrenner, Bigler & Associates, an accounting firm with offices in Woodland Hillsand Blythe, California, focused on medium and small businesses as well asindividuals.  Mr. Brenner has over 35years of public accounting experience with companies in 

 

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various industries including manufacturing, construction, real estate,mortgage banking and credit unions.  Mr.Brenner’s term as a Director expires in 2005.

 

David Iannini became a Director of the Company in May, 2004.  Mr. Iannini is President of MAR &Associates. MAR & Associates provides strategic and investment bankingservices to public and private companies. Mr. Iannini served as Chief FinancialOfficer of YP.Net, Inc., from 2002 to 2004. From 1999 to 2002, Mr. Iannini was Treasurer and Vice President ofCorporate Development of Viad Corp.  Mr.Iannini was an investment banker primarily with Salomon Brothers from 1986 to1999. Mr. Iannini’s term as a director expires in 2007.

 

Stephen Gill became a Director of the Company in May, 2004.  Mr. Gill has spent 35 years in the aerospacecomposites manufacturing industry with M.C. Gill Corporation, serving asPresident and CEO from 1991 to 2001.  Mr.Gill has also served on the boards of M. C. Gill Corp, Spaulding Composites andSIR Worldwide, Inc.  Mr. Gill’s term as adirector expires in 2007.

 

Edward J. Burke has been the Company’s Vice President, CorporateEngineering since May, 1996 and has served in various similar capacities withthe Company since 1984. Mr. Burke has held various technical positions in thethermoplastic product engineering and tooling design field since 1978.

 

Timothy Hankinson joined the Company in 1998 as Managing Director,Australia and Asia as a result of the acquisition of A.C. Egerton PLC.  Mr. Hankinson had been Managing Director ofA.C. Egerton PLC since 1991.  Prior to1991, Mr. Hankinson had served as General Manager of an Australian aircraftmanufacturer.  Mr. Hankinson becameManaging Director, International in December, 2002.

 

John B. Kaiser has been the Company’s Vice President, North AmericanSales since 1999.  He held the positionof Director of Marketing for the Company from 1987 to 1991 and he was VicePresident, Broadband Division from 1995 through 1998. Between 1991 and 1995,Mr. Kaiser held the position of District Manager, Southern California, for theGeneral Polymers Division of Ashland Chemical, a thermoplastics distributor,where his responsibilities included general management of district operations,including sales, warehousing, procurement and logistics.

 

Scott Kiefer has been the Company’s Corporate Controller since 2002 andwas named interim Chief Financial Officer in February of 2005.  Mr. Kiefer joined the Company as Manager ofCost Accounting in 2001.  From 2000 to2001 Mr. Kiefer was Chief Accounting Officer of Imaging Technologies Corporation.  From 1996 to 2000, Mr. Kiefer was U.S.Controller for Flowserve.  From 1992 to1996 Mr. Kiefer was North American Finance Manager for Flowserve.  He has over 20 years of financial, accountingand management experience.

 

Andrew M. Zogby has been the Company’s Vice President, CorporateMarketing since March, 1996. Prior to joining the Company, Mr. Zogby wasDirector of Strategic Marketing, Broadband Connectivity Group for ADCTelecommunications, a publicly traded telecommunications equipment supplier toboth telephone and broadband network providers worldwide. He had been with ADCTelecommunications since 1990. Mr. Zogby has held various technical marketingpositions in the telecommunications equipment industry since 1984.

 

### **Compensation ofDirectors**

### ** **

Directors who are alsoofficers of the Company (except as indicated below) receive no additionalcompensation for their services as directors. Prior to 2003, the Company’s non-management directors receivedcompensation consisting of an annual retainer fee of $25,000 plus $1,000 forattendance at any meeting of the Board of Directors or any committee thereof,plus direct out-of-pocket costs related to such attendance.  Effective January 2003, the fee for committeemeetings was reduced to $500.  In November2004, the Board of Directors approved increasing the annual retainer fee to$50,000 for the Chair of the Audit Committee and to $30,000 for non-Chairmembers of the Audit Committee.  Theseincreases are effective January 2005. The Board of Directors also approved an additional payment of $10,000 tothe Chair of Audit Committee for 2004.  Mrs. Channell also receives non-management director retainer andattendance fees. In addition, pursuant to the Company’s 1996 Incentive StockPlan (as described below), each non-management director (including Mrs.Channell) received options to acquire 1,000 shares of the Company’s CommonStock with an exercise price equal to $11.00 per share,  and on the date of each of the Company’sannual stockholder meetings after the initial public offering, eachnon-management director (including non-executive officers who serve asdirectors) serving on the Board of Directors immediately following such meetingare to receive options to acquire an additional 1,000 shares of the Company’sCommon Stock with an exercise price equal to the market value of the CommonStock on the date such options are granted. These options will becomeexercisable at a rate of 33 1/3% per year commencing on the first anniversaryof the date of issuance and will have a term of 10 years.

 

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**Audit Committee Financial Expert**

 

The Board of Directors has determined that Mr. Dana Brenner qualifiesas a “financial expert” within the meaning of SEC rules.  Mr. Brenner isthe managing partner of Brenner, Bigler & Associates, an accounting firmwith offices in Woodland Hills and Blythe, California.  Mr. Brenner hasover 35 years of public accounting experience with companies in variousindustries, including manufacturing, construction, real estate, mortgagebanking and credit unions. Mr. Brenner is independent as defined by SEC andNASD rules.

 

**Code of Ethics**

 

The Company has adopted a Code of Ethics within themeaning of Item 406(b) of Regulation S-K. This Code of Ethics applies to allemployees, including its principal executive officer, principal financialofficer and principal accounting officer. This Code of Ethics has been filed asExhibit 14 to the 2003 Annual Report on Form 10-K.  If the Company makes substantive amendmentsto this Code of Ethics or grants any waiver, including any implicit waiver, theCompany will disclose the nature of such amendment or waiver on its web sitewithin five days of such amendment or waiver.

 

**Section 16(a) Beneficial Ownership Reporting Compliance**

 

Information required by Item 405 of Regulation S-K is incorporated byreference to the Company’s Proxy Statement relating to its 2004 annual meetingof stockholders.

 

### **Item 11**.  ExecutiveCompensation

### ** **

Summary Compensation Table

 

The following table sets forth the annual and long-term compensation ofthe Company’s Chief Executive Officer and the four additional most highlycompensated executive officers for the years ended December 31, 2002, 2003 and2004 (collectively, the “Named Officers”).

 
| **Name and  Positions**      | ** ** | ** ** | ** ** | **Annual Compensation** | ** ** | **Other Annual****Compensation** | ** ** | **Restricted****Stock Awards** | ** ** | **Underlying****Options/** | ** ** | **LTIP****Payouts** | ** ** | **All Other****Compensation** | ** ** |
|------------------------------|------------|------------|------------|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|----------------------------|------------|---------------------|------------|-------------------------------|------------|
| **Held with  the Company**   | ** ** | **Years**  | ** ** | **Salary ($)**          | ** ** | **Bonus ($)**                    | ** ** | **($)(1)**                     | ** ** | **($)**                    | ** ** | **SARs(#)**         | ** ** | **($)**                       | ** ** | **($)** | ** ** |
|                         |       |       |       |                    |       |                             |       |                           |       |                       |       |                |       |                          |       |   |   |
| **William H. Channell, Jr.** | ** ** | **2004**   | ** ** | **730,603**             | ** ** | **1,060,000**                    | **(7)**    | **—**                     | ** ** | **—**                 | ** ** | **150,000**         | ** ** | **—**                    | ** ** | **20,858** | **(5)** |
| **President and Chief**      | ** ** | **2003**   | ** ** | **656,109**             | ** ** | **261,206**                      | ** ** | **—**                     | ** ** | **—**                 | ** ** | **1,267,800**       | **(6)**    | **—**                    | ** ** | **23,260** | **(5)** |
| **Executive Officer**        | ** ** | **2002**   | ** ** | **508,300**             | ** ** | **447,500**                      | **(2)**    | **—**                     | ** ** | **—**                 | ** ** | **—**          | ** ** | **—**                    | ** ** | **20,916** | **(5)** |
|                         |       |       |       |                    |       |                             |       |                           |       |                       |       |                |       |                          |       |   |   |
| **Thomas Liguori (8)**       | ** ** | **2004**   | ** ** | **221,379**             | ** ** | **88,950**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **—**          | ** ** | ** **                    | ** ** | **19,517** | **(3)** |
| **Chief Financial Officer**  | ** ** | **2003**   | ** ** | **197,925**             | ** ** | **80,340**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **50,000**          | ** ** | **—**                    | ** ** | **18,638** | **(3)** |
| ** **                   | ** ** | **2002**   | ** ** | **185,250**             | ** ** | **60,060**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **—**          | ** ** | **—**                    | ** ** | **8,079** | **(9)** |
|                         |       |       |       |                    |       |                             |       |                           |       |                       |       |                |       |                          |       |   |   |
| **John B. Kaiser**           | ** ** | **2004**   | ** ** | **172,359**             | ** ** | **55,443**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **—**          | ** ** | ** **                    | ** ** | **21,244** | **(4)** |
| **Vice President,**          | ** ** | **2003**   | ** ** | **161,200**             | ** ** | **66,960**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **145,270**         | **(6)**    | **—**                    | ** ** | **19,498** | **(4)** |
| **North American Sales**     | ** ** | **2002**   | ** ** | **147,250**             | ** ** | **47,740**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **—**          | ** ** | **—**                    | ** ** | **3,996** | **(5)** |
|                         |       |       |       |                    |       |                             |       |                           |       |                       |       |                |       |                          |       |   |   |
| **Andrew M. Zogby**          | ** ** | **2004**   | ** ** | **190,501**             | ** ** | **75,126**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **—**          | ** ** | ** **                    | ** ** | **20,535** | **(4)** |
| **Vice President,**          | ** ** | **2003**   | ** ** | **179,777**             | ** ** | **21,100**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **150,060**         | **(6)**    | **—**                    | ** ** | **18,959** | **(4)** |
| **Corporate Marketing**      | ** ** | **2002**   | ** ** | **164,305**             | ** ** | **53,269**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **—**          | ** ** | **—**                    | ** ** | **2,546** | **(5)** |
|                         |       |       |       |                    |       |                             |       |                           |       |                       |       |                |       |                          |       |   |   |
| **Edward J. Burke**          | ** ** | **2004**   | ** ** | **171,247**             | ** ** | **70,000**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **—**          | ** ** | ** **                    | ** ** | **17,392** | **(4)** |
| **Vice President,**          | ** ** | **2003**   | ** ** | **148,412**             | ** ** | **60,242**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **148,550**         | **(6)**    | **—**                    | ** ** | **16,371** | **(4)** |
| **Corporate Engineering**    | ** ** | **2002**   | ** ** | **138,908**             | ** ** | **45,035**                       | ** ** | **—**                     | ** ** | **—**                 | ** ** | **—**          | ** ** | **—**                    | ** ** | **749** | **(10)** |

 

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(1)   For each individual named, compensationexcludes perquisites and other personal benefits that did not exceed the lesserof $50,000 or 10% of the total annual salary and bonus reported for suchindividual.

(2)   The bonus of William H. Channell, Jr. shown in2002 is based on Company performance in 2001 and 2002.

(3)   Company contributions to the 401(k) Plan andCompany paid auto lease.

(4)   Company paid premiums for life insurance,Company contributions to the 401(k) Plan and Company paid auto lease.

(5)   Company paid premiums for life insurance andCompany paid auto lease.

(6)   In February, 2003, the Company offered currentemployees and non-employee directors an opportunity to exchange their outstandingoptions granted under the 1996 Stock Plan. The tender offer expired March 20, 2003. Outstanding options were cancelled for those employees and non-employeedirectors who tendered their shares.  OnSeptember 24, 2003 new options were exchanged for the options cancelled inMarch, 2003.  Included in the 2003Underlying Options/SARs (#) are new options that were exchanged:  Mr. Channell, Jr.: 596,400; Mr. Kaiser:95,270; Mr. Zogby: 100,060; and Mr. Burke: 98,550.

(7)   Includes $0.5 million accrued bonus forestimated long term incentive plan. Payment based on the increase in the Company’s market capitalization.  The $0.5 million is earned in 2004 withpayment expected in 2005.

(8)   Mr. Liguori resigned as Chief FinancialOfficer in February, 2005.

(9)   Company paid auto lease.

(10)Company paid life insurance.

 

27

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***1996Incentive Stock Plan***

* *

The Company’s 1996Incentive Stock Plan (the “1996 Stock Plan”) currently permits the granting tothe Company’s key employees, Directors and other service providers of (i)options to purchase shares of the Company’s Common Stock and (ii) shares of theCompany’s Common Stock that are subject to certain vesting and otherrestrictions (“Restricted Stock”). Initially, a maximum of 750,000 shares of Common Stock were reserved forissuance under the 1996 Stock Plan.  In1999, the 1996 Stock Plan was amended to allow a maximum of 1,500,000 shares tobe issued under the 1996 Stock Plan.

 

The 1996 Stock Plan isadministered by the Compensation Committee of the Board of Directors.  The aggregate number of stock options orshares of Restricted Stock that may be granted to any single participant underthe 1996 Stock Plan during any fiscal year of the Company is 100,000.  The purpose of the 1996 Stock Plan is tosecure for the Company and its stockholders the benefits arising from stockownership by key employees, directors and other service providers selected bythe Compensation Committee.

 

All options granted underthe 1996 Stock Plan are non-transferable and exercisable in installmentsdetermined by the Compensation Committee, except that each option is to beexercisable in minimum annual installments of 20% commencing with the firstanniversary of the option’s grant date. Each option granted has a termspecified in the option agreement, but all options expire no later than tenyears from the date of grant. Options under the 1996 Stock Plan may bedesignated as “incentive stock options” for federal income tax purposes or asoptions which are not qualified for such treatment, or “non-qualified stockoptions”.  In the case of incentive stockoptions, the exercise price must be at least equal to the fair market value ofthe stock on the date the option is granted. The exercise price of anon-qualified option need not be equal to the fair market value of the stock atthe date of grant, but may be granted with any exercise price which is not lessthan 85% of the fair market value at the time the option is granted, as theCompensation Committee may determine. The aggregate fair market value(determined at the time the options are granted) of the shares covered byincentive stock options granted to any employee under the 1996 Stock Plan (orany other plan of the Company) which may become exercisable for the first timein any one calendar year may not exceed $100,000.

 

Upon exercise of anyoption, the purchase price must generally be paid in full either in cash or bycertified or cashier’s check. However, in the discretion of the CompensationCommittee, the terms of a stock option grant may permit payment of the purchaseprice by means of (i) cancellation of indebtedness owed by the Company, (ii)delivery of shares of Common Stock already owned by the optionee (valued atfair market value as of the date of exercise), (iii) delivery of a promissorynote secured by the shares issued, (iv) delivery of a portion of the sharesissuable upon exercise (i.e., exercise for the “spread” on the option payablein shares), or (v) any combination of the foregoing or any other meanspermitted by the Compensation Committee.

 

Any grants of restrictedstock will be made pursuant to Restricted Stock Agreements, which will providefor vesting of shares at a rate to be determined by the Compensation Committeewith respect to each grant of restricted stock. Until vested, shares of restricted stock are generally non-transferableand are forfeited upon termination of employment.  The Company has not made any grants ofrestricted stock.

 

In January, 2003, the Board of Directors approved anoffer allowing current employees and non-employee directors to exchange all oftheir outstanding options granted under the 1996 Stock Plan for new options tobe granted under the 2003 Stock Plan or any other stock option plan that may beadopted by the Company.  At the time theBoard approved the offer, certain employees’ and non-employee directors’outstanding options had exercise prices that were significantly higher than thecurrent market price of the Company’s common stock.  The Board of Directors made the offer inorder to provide these option holders with the benefit of owning options that,over time, may have a greater potential to increase in value.  The Board of Directors believes that thiswill create better performance incentives for these option holders.  The offer expired on March 20, 2003.  A total of 1,326,890 options to purchaseshares of the Company were accepted for exchange and cancelled on March 20,2003.  The 2003 Incentive Stock Plan wasapproved at the Annual Meeting of Stockholders on April 25, 2003.  On September 24, 2003, a total of 1,324,090new options were exchanged for options cancelled in March, 2003.

 

Eligible option holderswho participated in the offer received a new option on the new grant date inexchange for each old option that was validly tendered and accepted forexchange.  The number of shares coveredby each new option was equal to the number of shares covered by the oldoptions, and the vested status and vesting schedule of the old options waspreserved and continued.  The exerciseprice of the new options was equal to the closing sale price of the Company’scommon stock as reported on the Nasdaq National Market on the grant date of thenew options.

 

28

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***2003Incentive Stock Plan***

* *

The Company’s 2003 Incentive Stock Plan (the “2003Stock Plan”) currently permits the granting of (i) incentive stock options topurchase shares of the Company’s Common Stock to employees of the Company andthe Company’s subsidiaries and (ii) nonqualified stock options to purchaseshares of the Company’s Common Stock to employees, Directors and consultants ofthe Company and the Company’s subsidiaries. The 2003 Stock Plan also permits the granting of shares of the Company’sCommon Stock (“Stock Awards”) that are subject to vesting restrictions based oncontinued employment or attainment of performance goals (“Restricted Stock”) toemployees, Directors and consultants of the Company and the Company’ssubsidiaries.  Incentive stock optionsand nonqualified stock options are granted subject to the terms of a stock optionagreement entered into between the participant and the Company.  A maximum of 3,100,000 shares of CompanyCommon Stock are reserved for issuance under the 2003 Stock Plan.

 

The 2003 Stock Plan is administered by theCompensation Committee of the Board of Directors.  The aggregate number of stock options thatmay be granted to any single participant under the 2003 Stock Plan during anyfiscal year of the Company is 1,000,000. The purpose of the 2003 Stock Plan is to secure for the Company and itsstockholders the benefits arising from stock ownership by employees, directorsand consultants selected by the Compensation Committee.

 

Options granted under the 2003 Stock Plan arenon-transferable other than by will or by the laws of descent or distributionand exercisable, during the lifetime of the participant, only by theparticipant at times and under conditions determined by the CompensationCommittee.  Each option granted has aterm specified in the stock option agreement, but all options expire no laterthan ten years from the date of grant. Options under the 2003 Stock Plan may be designated as “incentive stockoptions” for federal income tax purposes or as “nonqualified stock options.”  In the case of incentive stock options, theexercise price must be at least equal to the fair market value of the share ofCompany Common Stock on the date the option is granted.  The exercise price of a nonqualified stockoption need not be equal to the fair market value of the share of CompanyCommon Stock on the date of grant, but may be granted, at the discretion of theCompensation Committee, at any exercise price which is not less than 85% of thefair market value at the time the option is granted.  The aggregate fair market value (determinedat the time the options are granted) of the shares of Company Common Stockcovered by incentive stock options granted to any employee under the 2003 StockPlan (or any other plan of the Company) which may become exercisable for thefirst time in any one calendar year may not exceed $100,000.

 

Upon exercise of an option, the purchase price mustgenerally be paid in full in cash or by cashiers check.  However, at the discretion of theCompensation Committee, the terms of a stock option agreement may permit paymentof the purchase price by means of (i) delivery of shares of Common Stockalready owned by the participant (valued at fair market value as of the date ofexercise), (ii) to the extent permitted by applicable law, delivery of apromissory note secured by the shares issued, (iii) delivery of a portion ofthe shares issuable upon exercise (i.e., exercise for the “spread” on theoption payable in shares), or (iv) any combination of the foregoing or anyother means permitted by the Compensation Committee.

 

Grants of Stock Awards are made pursuant to arestricted stock agreement entered into between the Company and theparticipant.  A stock agreement provides(i) the rate at which shares of Restricted Stock will vest and (ii) any otherterms and restrictions deemed appropriate by the Compensation Committee.  Until vested, shares of Restricted Stock aregenerally non-transferable and forfeitable upon termination of employment.

 

In the event of a merger, reorganization or sale ofsubstantially all of the assets of the Company, the Compensation Committee,may, in its discretion, do one or more of the following: (i) shorten the periodduring which options are exercisable, (ii) accelerate any vesting schedule towhich an option or Stock Award is subject; (iii) arrange to have the survivingor successor entity assume the Stock Awards and the options or grantreplacement options or (iv) cancel options or Stock Awards upon payment to theparticipants in cash, with respect to each option or Stock Award to the extentthen exercisable or vested, of an amount that is equal to the excess of thefair market value of the Company’s Common Stock (at the effective time of themerger, reorganization, sale or other event) over (in the case of options) theexercise price of the option.

 

The Board of Directors may at any time amend, alter orsuspend or terminate the 2003 Stock Plan. No amendment, alteration or suspension or termination of the 2003 StockPlan may impair the rights of a participant, unless mutually agreed to by theCompany and the participant.

 

29

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**Options/SAR Grants Table**

 

The following table setsforth the stock options granted to the Named Officers for the year endedDecember 31, 2004.

 

 
| **Name**                     | ** ** | **Number of  Securities  Underlying  Options/SARs  Granted** | ** ** | **% of Total  Options/SARs  Granted to  Employees  in Fiscal Year  2004** | ** ** | **Exercise  On Base  Price  ($/Sh)** | ** ** | **Expiration Date** | ** **        | **Potential Realized  Value at  Assumed Annual  Rates of Stock Price  Appreciation of  Option Term (1)** | ** ** |
|------------------------------|------------|--------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|--------------------------------------|------------|---------------------|-------------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                   | ** ** | ** **                                                   | ** ** | ** **                                                                | ** ** | ** **                           | ** ** | ** **          | ** **        | **5**                                                                                                    | **%**      | **10** | % |
| **William H. Channell, Jr.** | ** ** | **150,000**                                                  | ** ** | **71**                                                                    | **%**      | **$**                                | **4.81**   | ** **          | **November 2014** | ** **                                                                                               | **$**      | **453,747** | ** ** | **$** | **1,149,885** | ** ** |
|                              |            |                                                              |            |                                                                           |            |                                      |            |                     |                   |                                                                                                          |            |  |  |  |  |  |

 

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(1)   The calculation of potential realizable valueassumes annual growth rates for each of the grants shown over their 10-yearoption term.  For example, a $4.81 pershare price with a 5% annual growth rate results in a stock price of $7.83 pershare and a 10% rate results in a stock price of $12.48 per share.  Actual gains, if any, on exercised stockoptions are dependent on the future performance of the stock.

 

**Aggregated Option/SAR Exercises in Last Fiscal Year and December 31,2004 Option/SAR Values**

 

The following table sets forth the number and value of outstandingstock options at December 31, 2004.

No options were exercised in 2004.

 
| ** **                   | ** ** | **Shares  Acquired  On** | ** ** | **Value**    | ** ** | **Number of Shares  Underlying Unexercised  Options/SARs  at December 31, 2004** | ** ** | **Value of Unexercised In-the-  Money Options/SARs  at December 31, 2004** | ** ** |
|------------------------------|------------|--------------------------|------------|--------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **Name**                     | ** ** | **Exercise**             | ** ** | **Realized** | ** ** | **Exercisable**                                                                  | ** ** | **Unexerciseable**                                                         | ** ** | **Exercisable** | ** ** | **Unexerciseable** | ** ** |
|                         |       |                     |       |         |       |                                                                             |       |                                                                       |       |   |   |   |   |
| **William H. Channell, Jr.** | ** ** | **0**                    | ** ** | **0**        | ** ** | **498,801**                                                                      | ** ** | **597,599**                                                                | ** ** | **$** | **1,826,304** | ** ** | **$** | **2,257,096** | ** ** |
|                         |       |                     |       |         |       |                                                                             |       |                                                                       |       |   |   |   |   |
| **Thomas Liguori**           | ** ** | **0**                    | ** ** | **0**        | ** ** | **85,807**                                                                       | ** ** | **33,333**                                                                 | ** ** | **$** | **254,257** | ** ** | **$** | **119,665** | ** ** |
|                         |       |                     |       |         |       |                                                                             |       |                                                                       |       |   |   |   |   |
| **John B. Kaiser**           | ** ** | **0**                    | ** ** | **0**        | ** ** | **61,937**                                                                       | ** ** | **33,333**                                                                 | ** ** | **$** | **216,780** | ** ** | **$** | **116,666** | ** ** |
|                         |       |                     |       |         |       |                                                                             |       |                                                                       |       |   |   |   |   |
| **Andrew M. Zogby**          | ** ** | **0**                    | ** ** | **0**        | ** ** | **66,727**                                                                       | ** ** | **33,333**                                                                 | ** ** | **$** | **233,545** | ** ** | **$** | **116,666** | ** ** |
|                         |       |                     |       |         |       |                                                                             |       |                                                                       |       |   |   |   |   |
| **Edward J. Burke**          | ** ** | **0**                    | ** ** | **0**        | ** ** | **65,217**                                                                       | ** ** | **33,333**                                                                 | ** ** | **$** | **228,260** | ** ** | **$** | **116,666** | ** ** |

 

### **Profit Sharing andSavings Plans**

### ** **

The Company maintains a plan, established in 1993, in accordance withSection 401(k) of the Internal Revenue Code. Under the terms of this plan, eligible employees may make voluntarycontributions to the extent allowable by law. Employees of the Company are eligible to participate in the plan after90 days of employment.  Matchingcontributions by the Company to this plan are discretionary and will not exceedthat allowable for Federal income tax purposes. The Company’s contributions are vested over five years in annualincrements.

 

**Employment Contracts**

 

The Company in December,2003 entered into a five-year employment agreement, renewable every five years,with William H. Channell, Jr.   Mr.Channell, Jr.’s annual salary is $745,616 effective July 2004, subject to anannual cost of living adjustment.  Mr.Channell, Jr. is entitled to participate in the Stock Plan, the 401(k) Plan andthe Incentive Compensation Plan. Additionally, the employment agreementprovides for incentive compensation to Mr. Channell, Jr., based upon personalperformance objectives and increases in the Company’s market capitalizationover a three-year period.  Mr. Channell,Jr. is also entitled to certain other benefits paid for by the Company,including an automobile allowance, health insurance and sick leave, in accordancewith the Company’s customary practices for senior executive officers.  In the event that the Company were toterminate Mr. Channell, Jr. without cause (as defined in the agreement), or Mr.Channell, Jr. were to terminate his employment for good reason (also as definedin the agreement and including, without limitation, a change of control of theCompany), then Mr. Channell, Jr. would be entitled to a lump sum payment equalto three times his then current base salary, all health and life insurancebenefits for three years, and accelerated vesting of any stock options orrestricted stock granted to him.

 

30

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The Company amended in December, 2003 the employment agreement with Mr.Channell, Sr. originally entered into in July, 1996.  Mr. Channell, Sr.’s annual salary starting inDecember, 2003 is $50,000.  Mr. Channell,Sr.’s benefits include (i)  during theterm of the agreement, the payment of premiums for a term disability policyproviding for $250,000 in annual benefits in the case of his temporary orpermanent disability, (ii) during the lifetime of Mr. Channell, Sr. and hiswife, Jacqueline M. Channell, medical insurance for each of Mr. and Mrs.Channell comparable to that provided to the Company’s senior executiveofficers,  (iii) during Mr. Channell, Sr.’slifetime, a portion of the premiums on a $1,500,000 life insurance policy ownedby Mr. Channell, Sr., under which Mrs. Channell is the beneficiary, and (iv) anautomobile allowance.

 

Effectivebeginning in the Company’s 1996 fiscal year, the Board of Directors adopted theCompany’s 1996 Performance-Based Annual Incentive Compensation Plan (the “IncentivePlan”). Eligible participants consist of key employees of the Company. TheIncentive Plan is administered by the Compensation Committee of the Board ofDirectors. The amount of awards granted under the Incentive Plan is determinedbased on an objective computation of the actual performance of the Companyrelative to pre-established performance goals. Measures of performance mayinclude level of sales, EBITDA, net income, income from operations, earningsper share, return on sales, expense reductions, return on capital, stockappreciation, return on equity, invention, design or development of proprietaryproducts or improvements thereto (patented or otherwise), or sales of suchproprietary products or improvements or profitability achieved from sales ofproprietary products or improvements. Awards under the Incentive Plan arepayable in cash or, at the election of the Compensation Committee, Common Stockof the Company. Mr. William H. Channell, Jr., the Company’s President and ChiefExecutive Officer, receives a bonus based on the factors above. The bonus wasearned and payable based on continued service in subsequent years for fiscalyear 2001 and prior.  In 2002, theCompensation Committee changed the bonus to be earned and payable in thecurrent year.  The Compensation Committeemay establish a bonus pool from which all awards under the Incentive Plan maybe granted as well as individual, non-bonus pool awards.

 

The Company’sexecutive compensation program is administered by the Compensation Committee ofthe Board of Directors.  As of March 4,2005, the members of this Committee included Mr. Guy Marge, as Chairperson, Mr.David Iannini and Mr. Stephen Gill. It is the responsibility of the Committeeto review and approve the Company’s executive compensation plans and policiesand to monitor these compensation programs in relation to the performance ofthe particular executive and the overall performance of the Company.

 

In February2003, the Company offered current employees and non-employee directors anopportunity to exchange their outstanding options granted under the 1996 StockPlan.  The tender offer expired on March20, 2003.  Pursuant to the offer, a totalof 1,326,890 options were cancelled on March 20, 2003.  On September 24, 2003, a total of 1,324,090new options were exchanged for options cancelled in March 2003.  (See “Executive Compensation—1996 IncentiveStock Plan”,Item 11.)

 

31

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The followingis a line graph presentation comparing the Company’s cumulative total returnfrom December 31, 1999 to December 31, 2004 with the performance of the NASDAQmarket, the S & P Industrials and a similar Industry Index for the sameperiod.

 

 

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* $100 invested on 12/31/99 in stock or index-including reinvestment ofdividends.  Fiscal year ending December31.

 

Copyright © 2002, Standard & Poor's, a division of The McGraw-HillCompanies, Inc. All rights reserved.www.researchdatagroup.com/S&P.htm

 

**Board Meetings and Committees**

 

The Board ofDirectors held 11 meetings during the fiscal year ending December 31, 2004. TheBoard has two standing committees: the Audit Committee and the CompensationCommittee; both established in June 1996. The Board does not have a Nominating Committee.  The Audit Committee recommends engagement ofthe Company’s independent accountants, approves the services performed by suchaccountants and reviews and evaluates the Company’s accounting systems and itssystem of internal accounting controls. All members of the Audit Committee are independent as defined by NASDrule 4200(a)(14).  Mr. Brenner is the managingpartner of Brenner, Bigler & Associates, an accounting firm with offices inWoodland Hills and Blythe, California.  Mr. Brenner has over 35 years ofpublic accounting experience with companies in various industries, includingmanufacturing, construction, real estate, mortgage banking and credit unions.    The Board has adopted a written charter forthe Audit Committee.  The CompensationCommittee makes recommendations to the full Board of Directors regarding levelsand types of compensation of the Company’s executive officers and administersthe 1996 Stock Plan, the 2003 Stock Plan and the Incentive CompensationPlan.  See “Executive Compensation” and “Descriptionof Certain Plans”.  In 2004, the AuditCommittee met 7 times and the Compensation Committee met 2 times in performingtheir responsibilities.  In 2004, nodirector failed to attend at least 75% of the aggregate number of Board andCommittee meetings during the period of his or her service.

 

**Compensation Committee Interlocks and Insider Participation inCompensation Decisions**

 

During 2004,members of the Company’s Compensation Committee consisted of Messrs. Guy Margeas Chairman, David Iannini and Stephen Gill. No additional information concerning the Compensation Committee or theCompany’s executive officers is required by Item 402 of Regulation S-K.

 

32

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**Compensation Committee Report**

 

The Compensation Committee Report required by Item 402(k) ofRegulations S-K is incorporated by reference to the Company’s Proxy Statementrelating to the 2005 Annual Meeting of Stockholders.

 

**Item 12.****     SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters**

 

Information required by Item 201(d) of Regulation S-Kis incorporated by reference to the Company’s Proxy Statement relating to the2005 Annual Meeting of Stockholders.

 

The followingtable sets forth certain information concerning those persons who are known bymanagement of the Company to be beneficial owners of more than 5% of theCompany’s outstanding common stock (as provided to the Company by such personsor the record holder of such shares).

 
| ** **                                                                                               | ** ** | **Amount and Nature of Beneficial Ownership** | ** ** | ** **                     |       |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------|------------|
| **Name and  Address****of Beneficial Owner**                                                             | ** ** | **No. of Shares****Owned**                    | ** ** | **Exercisable****Options (1)** | ** ** | **Total** | ** ** | **Percent****of Class** |   |
|                                                                                                     |       |                                          |       |                           |       |   |   |   |   |
| William H. Channell, Sr. and                                                                             |       | 3,250,830                                     |       | 7,334                          |       | 3,258,164 |   | 34.7 | % |
| Jacqueline M. Channell, as co-trustees  of the Channell Family Trust  26040 Ynez Rd.  Temecula, CA 92591 |       |                                          |       |                           |       |   |   |   |   |
|                                                                                                     |       |                                          |       |                           |       |   |   |   |   |
| William H. Channell, Jr.                                                                                 |       | 715,250                                       |       | 605,934                        |       | 1,321,184 |   | 13.2 | % |
| 26040 Ynez Rd.  Temecula, CA 92591                                                                       |       |                                          |       |                           |       |   |   |   |   |
|                                                                                                     |       |                                          |       |                           |       |   |   |   |   |
| Rutabaga Capital Management, LLC  (2)                                                                    |       | 897,252                                       |       | —                         |       | 897,252 |   | 9.6 | % |
| 64 Broad Street  Boston, MA 02109                                                                        |       |                                          |       |                           |       |   |   |   |   |
|                                                                                                     |       |                                          |       |                           |       |   |   |   |   |
| State of Wisconsin Investment  Board (3)                                                                 |       | 651,300                                       |       | —                         |       | 651,300 |   | 6.9 | % |
| P.O. Box 7842  Madison, WI 53707                                                                         |       |                                          |       |                           |       |   |   |   |   |
|                                                                                                     |       |                                          |       |                           |       |   |   |   |   |
| The Taylor Family Trust                                                                                  |       | 469,960                                       |       | —                         |       | 469,960 |   | 5.0 | % |
| 1450 Ravenswood Lane  Riverside, CA 92506                                                                |       |                                          |       |                           |       |   |   |   |   |
|                                                                                                     |       |                                          |       |                           |       |   |   |   |   |
| Carrie S. Channell                                                                                       |       | 450,000                                       |       | —                         |       | 450,000 |   | 4.8 | % |
| 18 Buena Vista Avenue  Mill Valley, CA 94941                                                             |       |                                          |       |                           |       |   |   |   |   |

 

----

(1)           Refers tothe number of shares covered by options exercisable within 60 days of March 11,2005.

(2)           Informationprovided by Schedule 13G filing with the SEC in January 2005. Sole Voting Power405,250 shares.  Shared Voting Power492,002. Sole Dispositive Power 897,252.

(3)           Information provided by Schedule13G filing with the SEC in February 2005.

 

33

----

 

**Security Ownership of Management**

 

The followingtable sets forth certain information, as of March 11, 2005, concerning thebeneficial ownership of common stock by the Company’s directors and NamedOfficers, and all directors and executive officers of the Company as a group. 

 
| ** **                                                              | ** ** | **Amount and Nature of Beneficial Ownership** | ** ** | ** **                   | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------|------------|
| **Name of  Beneficial Owner**                                           | ** ** | **No. of Shares  Owned**                      | ** ** | **Exercisable  Options (1)** | ** ** | **Total** | ** ** | **Percent  of Class** | ** ** |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| William H. Channell, Sr.                                                |       | 3,250,830                                     |       | 667                          |       | 3,251,497 |   | 34.6 | % |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| Jacqueline M. Channell                                                  |       | —                                        |       | 6,667                        |       | 6,667 |   | 0.1 | % |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| William H. Channell, Jr.                                                |       | 715,250                                       |       | 605,934                      |       | 1,321,184 |   | 13.2 | % |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| Thomas Liguori                                                          |       | 31,300                                        |       | 102,474                      |       | 133,774 |   | 1.4 | % |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| Guy Marge                                                               |       | 9,000                                         |       | 667                          |       | 9,667 |   |   | * |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| Dana Brenner                                                            |       | —                                        |       | 667                          |       | 667 |   |   | * |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| David Iannini                                                           |       | —                                        |       | —                       |       | — |   | 0.0 | % |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| Stephen Gill                                                            |       | 1,000                                         |       | —                       |       | 1,000 |   |   | * |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| Edward J. Burke                                                         |       | 1,000                                         |       | 81,884                       |       | 82,884 |   |   | * |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| Andrew M. Zogby                                                         |       | 300                                           |       | 83,394                       |       | 83,694 |   |   | * |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| John B. Kaiser                                                          |       | 890                                           |       | 78,604                       |       | 79,494 |   |   | * |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| Total Listed                                                            |       | 4,009,570                                     |       | 960,958                      |       | 4,970,528 |   | 48.0 | % |
|                                                                    |       |                                          |       |                         |       |   |   |   |   |
| All present directors and  executive officers as a group (11 in number) |       | 4,009,570                                     |       | 1,005,792                    |       | 5,015,362 |   | 48.3 | % |

 

----

*              Lessthan 1%

(1)           Refersto the number of shares coverd by options exercisable within 60 days of March11, 2005.

 

**Item 13.****Certain Relationships and Related Transactions**

 

The Companyhas two leases for approximately 261,000 square feet of manufacturing,warehouse and office space in Temecula, California, with William H. Channell,Sr., a principal stockholder and Chairman of the Board of the Company. The termof the first lease is through December 31, 2005, with two five-year renewaloptions. Additionally, an adjacent 100,000 square foot building was constructedand completed in 1996. Subsequent to December 31, 1996, the Company guaranteeddebt of Mr. Channell, Sr. of approximately $0.8 million incurred in connectionwith construction of the building. The loan amount subject to the guarantee isexpected to decline before expiring in 2017. At December 31, 2004, theoutstanding loan balance subject to the guarantee totaled $0.6 million. It isnot practicable to estimate the fair value of the guarantee; however, theCompany does not anticipate that it will incur losses as a result of thisguarantee. This building is also being leased from Mr. Channell, Sr. through2005, with two five-year renewal options. Both leases provide for payments ofinsurance, repairs, maintenance and property taxes. Rent expense paid under theleases was $1.3 million, $1.3 million and $1.3 million for the years endedDecember 31, 2002, 2003 and 2004, respectively. The Company believes that theterms of these leases are no less favorable to the Company than could beobtained from an independent third party.

 

In May, 2002,the Company sold its 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 $800,000 was recorded. RMS Communications,Inc. paid the Company $125,000 in cash at the time of sale, and the remaining$675,000 is payable in 

 

34

----

 

monthly installments throughJune 30, 2003, bearing interest at 7% per annum. The account is currently inarrears. The amount due from RMS Communications, Inc. included in accountsreceivable at December 31, 2004 is $251,000. The Company has security interestin the inventory and a personal guarantee from Mr. Napolitano and believes theamount will be paid in full. The Company continues to purchase RF devices fromMr. Napolitano and from other sources depending on price and supply of product.The RF devices purchased from Mr. Napolitano’s firm in 2004 approximated$100,000 and were used as components in the Company’s product lines. Thepurchases in 2004 did not result in a cash payment to Mr. Napolitano as theamounts owed were used to offset the accounts receivable. 

 

The Companypaid $72,912 and $75,829 in 2003 and 2004, respectively, to Carolyn Channellfor consulting services.   Mrs. Channell is the wife of William H.Channell, Jr., the Company’s President and Chief Executive Officer.  Mrs.Channell consults on insurance coverage matters for the Company.

 

The Companyhas facilities in Orange, Dalby, Terang and Adelaide Australia that are leasedfrom shareholders of the Company. These shareholders are former owners ofBushman Tanks. The facilities comprise 94,000 square feet of manufacturing,warehouse and office space. The rent expense paid in the five months of Augustto December 2004 was $135,720. The Company hired an independent firm toappraise the market lease rates for theses facilities and it was determinedthat the existing leases are in excess of fair market value by approximately$27,000 per year.

 

**Item 14.****Principal Accounting Fees and Services**

 

Theinformation required by Item 14 of Form 10-K is incorporated by reference tothe Company’s definitive proxy statement for the 2005 Annual Meeting ofStockholders. 

 

35

----

 

**PART IV**

 

**Item 15.**** Exhibits, Financial StatementSchedules and Reports**

 

(a)   The following financial statements and schedules arefiled as a part of this report:

(1)   Consolidated Financial Statements

See index included in Part II, Item 8.

(1)   ConsolidatedFinancial Statement Schedules

Schedule II – Valuation and Qualifying Accounts

All remaining schedules are omitted because they are not applicable, orthe required information

is included in the financial statements or notes thereto.

 

(a)(3) and (c).  The following exhibits are filed herewith:

 
| **Exhibit  Number** | ** ** | **Description** |
|---------------------|------------|-----------------|
| ** **          | ** ** | ** **      |
| 3.1                 |       |            | Restated  Certificate of Incorporation of the Company (1) |
| 3.2                 |       |            | Bylaws of  the Company (1) |
| 4                   |       |            | Form of  Common Stock Certificate (1) |
| 10.1                |       |            | Tax  Agreement between the Company and the Existing Stockholders (1) |
| 10.2.1*             |       |            | Channell  Commercial Corporation 1996 Incentive Stock Plan (including forms of Stock  Option Agreements and Restricted Stock Agreement) (1) |
| 10.2.2*             |       |            | Channell  Commercial Corporation 2003 Incentive Stock Plan (including forms of Stock  Option Agreement and Restricted Stock Agreement) (8) |
| 10.3                |       |            | Loan and  Security Agreement dated as of September 25, 2002 by and among the Company, Channell  Commercial Canada Inc., Fleet Capital Corporation, Fleet Capital Canada  Corporation and, under the circumstances set forth therein, Fleet National  Bank, London U.K. Branch, trading as Fleet Boston Financial, and the U.K.  Borrowers (as defined therein, if any) (6) |
| 10.3.1              |       |            | Loan and  Security Agreement dated October 24, 2003 by and among Channell Pty Ltd and  National Australia Bank Ltd (10) |
| 10.3.2              |       |            | Loan and  Security Agreement dated August 2, 2004 by and among Channell Bushman Pty Ltd  and National Australia Bank Ltd (10) |
| 10.3.3              |       |            | Loan and  Security Agreement dated August 2, 2004 by and among Channell Pty Ltd and  National Australia Bank Ltd (10) |
| 10.3.4              |       |            | Investment  and Shareholders Agreement dated August 2, 2004 by and among Channell Bushman  Pty Ltd and Australia and New Zealand Banking Group Ltd (10) |
| 10.4*               |       |            | Employment  Agreement between the Company and William H. Channell, Sr.,dated July 8,  1996. (1) |
| 10.6*               |       |            | Channell  Commercial Corporation 1996 Performance-Based Annual Incentive Compensation  Plan (1) |
| 10.7                |       |            | Lease dated  December 22, 1989 between the Company and William H. Channell, Sr., as  amended (1) |
| 10.8                |       |            | Lease dated  May 29, 1996 between the Company and the Channell Family Trust (1) |
| 10.9                |       |            | Lease dated  October 26, 2000 between the Company and Belston Developments Inc. (4) |
| 10.10               |       |            | Lease  Agreement dated as of March 1, 1996 between Winthrop Resources Corp. and the  Company (1) |
| 10.11               |       |            | Form of  Indemnity Agreement (1) |
| 10.12               |       |            | Form of  Agreement Regarding Intellectual Property (1) |
| 10.13               |       |            | 401(k) Plan  of the Company (3) |
| 10.14               |       |            | A.C. Egerton  (Holdings) PLC Share Purchase Agreement (2) |
| 10.15*              |       |            | Amendment to  Employment Agreement between the Company and William H. Channell, Jr., dated  December 31, 1998 (3) |
| 10.17               |       |            | Lease dated  June 27, 2002 between the Company and Ynez Street, Ltd (5) |
| 10.18               |       |            | Mutual  Specific and General Release between the Company and Richard A. Cude, dated  August 2, 2002 (7) |
| 10.19*              |       |            | Amendment to  Employment Agreement between the Company and William H. Channell, Sr., dated  December 9, 2003 (9) |
| 10.20*              |       |            | Employment  Agreement between the Company and William H. Channell, Jr., dated December 9,  2003 (9) |
| 10.21               |       |            | Share and  Asset Purchase Agreement dated as of July 14, 2004 by and among Australia’s  Bushman Tanks Pty Ltd., Douglas Robin Young, Richard James Young, Lokan  Nominees Pty Ltd and Lenbridge Grange Pty Ltd,  Belsiasun Pty Ltd and Elcarva Pty Ltd, the  holders of all the outstanding shares of Bushmans Group Pty Ltd, Hold-On  Industries Australia Pty Ltd, Australian Bushman Tanks Pty Ltd., and Polyrib  Tanks Pty Ltd, on the one hand, and Channell Commercial Corporation and Channell  Bushman Pty Limited, on the other hand(11) |

 

36

----

 
| 14   |   | Channell  Commercial Corporation Code of Business Conduct and Ethics (9)                                                                                                                       |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 21   |   | Subsidiaries  of the Company(12)                                                                                                                                                               |
| 23   |   | Consent of  Certified Public Accountants (12)                                                                                                                                                  |
| 31.1 |   | Certification  of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) under  the Securities and Exchange Act of 1934. (12)                                                       |
| 31.2 |   | Certification  of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) under  the Securities and Exchange Act of 1934. (12)                                                       |
| 32.1 |   | Certification  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 by William H. Channell, Jr., CEO; and Scott  Kiefer, Interim CFO. (12) |

 

----

* Management contract or, compensatory plan orarrangement.

 

(1)     Incorporated by reference to the indicated exhibits filed in connectionwith the Company’s Registration Statement on Form S-1 (File No. 333-3621).

(2)     Incorporated by reference to the indicated exhibits filed in connectionwith the Company’s Form 8-K on May 18, 1998.

(3)     Incorporated by reference to the indicated exhibits filed in connectionwith the Company’s Form 10-K on March 31, 1999.

(4)     Incorporated by reference to the indicated exhibits filed in connectionwith the Company’s Form 10-K on April 2, 2001.

(5)     Incorporated by reference to the indicated exhibits filed in connectionwith the Company’s Form 10-Q on August 9, 2002.

(6)     Incorporated by reference to the indicated exhibits filed in connectionwith the Company’s Form 8-K dated September 25, 2002.

(7)     Incorporated by reference to the indicated exhibits filed in connectionwith the Company’s Form 10-Q on November 12, 2002.

(8)     Incorporated by reference to Appendix B filed in connection with theCompany’s Definitive Proxy Statement on March 26, 2003.

(9)     Incorporated by reference to the indicated exhibits filed in connectionwith the Company’s Form 10-K dated March 4, 2004.

(10)   Incorporated by reference to the indicated exhibits filed in connectionwith the Company’s Form 10-Q dated November 5, 2004.

(11)   Incorporated by reference to the indicated exhibits filed in connectionwith the Company’s Form 8-K on August 3, 2004.

(12)   Filed herewith.

 

37

----

 

**REPORT OFINDEPEND****ENT REGISTERED PUBLICACCOUNTING FIRM**

 

 

Board of Directors andStockholders

Channell Commercial Corporation

 

We haveaudited the consolidated balance sheets of Channell Commercial Corporation asof December 31, 2003 and 2004, and the related consolidated statements ofoperations and comprehensive income (loss), stockholders’ equity, and cashflows for each of the three years in the period ended December 31, 2004.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  The Company isnot required to have, nor were we engaged to perform an audit of its internalcontrol over financial reporting.  Ouraudit included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Channell CommercialCorporation as of December 31, 2003 and 2004, and the consolidated results oftheir operations and their consolidated cash flows for each of the three yearsin the period ended December 31, 2004, in conformity with accounting principlesgenerally accepted in the United States of America.

 

We have alsoaudited Schedule II of Channell Commercial Corporation for each of the threeyears in the period ended December 31, 2004. In our opinion, this schedule presents fairly, in all material respects,the information required to be set forth therein.

 

 
| /s/ Grant  Thornton LLP  |   |
|--------------------------|--------|
| Los Angeles,  California |
| February 21,  2005       |

 

F-1

----

 

**CHANNELL COMMERCIALCORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**December 31,**

*(amounts in thousands)*

 
| ** **                                                                                                                                                                          | ** ** | **2003** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ASSETS                                                                                                                                                                              |       |     |       |     |       |
| Current assets                                                                                                                                                                      |       |     |       |     |       |
| Cash and cash equivalents                                                                                                                                                           |       | $        | 9,527      |     | $          | 5,453 |   |
| Accounts receivable, net                                                                                                                                                            |       | 10,051   |       | 13,936   |       |
| Inventories                                                                                                                                                                         |       | 8,855    |       | 14,164   |       |
| Deferred income taxes                                                                                                                                                               |       | 876      |       | 1,951    |       |
| Prepaid expenses and other  current assets                                                                                                                                          |       | 996      |       | 859      |       |
| Income taxes receivable                                                                                                                                                             |       | 102      |       | 1,323    |       |
| Total current assets                                                                                                                                                                |       | 30,407   |       | 37,686   |       |
|                                                                                                                                                                                |       |     |       |     |       |
| Property and equipment, net                                                                                                                                                         |       | 17,164   |       | 19,301   |       |
| Deferred income taxes                                                                                                                                                               |       | 5,277    |       | 4,460    |       |
| Goodwill                                                                                                                                                                            |       | 613      |       | 14,724   |       |
| Intangible assets, net of  amortization of $45 in 2004                                                                                                                              |       | —   |       | 1,763    |       |
| Other assets                                                                                                                                                                        |       | 504      |       | 964      |       |
|                                                                                                                                                                                |       |     |       |     |       |
|                                                                                                                                                                                |       | $        | 53,965     |     | $          | 78,898 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                           |       |     |       |     |       |
| Current liabilities                                                                                                                                                                 |       |     |       |     |       |
| Accounts payable                                                                                                                                                                    |       | $        | 5,103      |     | $          | 16,111 |   |
| Short term debt (including  current maturities of long term debt)                                                                                                                   |       | 952      |       | 4,332    |       |
| Current maturities of capital  lease obligations                                                                                                                                    |       | 57       |       | 36       |       |
| Accrued restructuring liability                                                                                                                                                     |       | 2,857    |       | 150      |       |
| Accrued expenses                                                                                                                                                                    |       | 4,240    |       | 7,619    |       |
| Total current liabilities                                                                                                                                                           |       | 13,209   |       | 28,248   |       |
|                                                                                                                                                                                |       |     |       |     |       |
| Long-term debt, less current  maturities                                                                                                                                            |       | 2,830    |       | 4,368    |       |
| Capital lease obligations, less  current maturities                                                                                                                                 |       | 67       |       | 104      |       |
| Deferred gain on sale leaseback  transaction                                                                                                                                        |       | 513      |       | 453      |       |
| Commitments and contingencies                                                                                                                                                       |       | —   |       | —   |       |
| Minority interest                                                                                                                                                                   |       | —   |       | 2,824    |       |
|                                                                                                                                                                                |       |     |       |     |       |
| Stockholders’ equity                                                                                                                                                           |       |     |       |     |       |
| Preferred stock, par value $.01  per share, authorized—1,000 shares, none issued and outstanding                                                                               |       | —   |       | —   |       |
| Common stock, par value $.01 per  share, authorized—19,000 shares; issued – 9,372 in 2003 and 9,608 in 2004;  outstanding - 9,128 shares in 2003 and 9,364 shares in 2004 |       | 94       |       | 96       |       |
| Additional paid-in capital                                                                                                                                                          |       | 28,664   |       | 29,671   |       |
| Treasury stock – 244 shares in  2003 and 2004                                                                                                                                  |       | (1,871   | )          | (1,871   | )          |
| Retained earnings                                                                                                                                                                   |       | 10,470   |       | 13,966   |       |
| Accumulated other comprehensive  income (loss) - Foreign currency translation                                                                                                       |       | (11      | )          | 1,039    |       |
| Total stockholders’ equity                                                                                                                                                     |       | 37,346   |       | 42,901   |       |
|                                                                                                                                                                                |       |     |       |     |       |
|                                                                                                                                                                                |       | $        | 53,965     |     | $          | 78,898 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

F-2

----

 

**CHANNELL COMMERCIALCORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVEINCOME (LOSS)**

**Year ended December 31,**

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

 
| ** **                                                                       | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                             |       |     |       |     |       |     |       |
| Net sales                                                                        |       | $        | 84,785     |     | $          | 76,537   |       | $ | 100,134 |   |
| Cost of goods sold                                                               |       | 57,450   |       | 53,960   |       | 72,151   |       |
|                                                                             |       |     |       |     |       |     |       |
| Gross profit                                                                     |       | 27,335   |       | 22,577   |       | 27,983   |       |
|                                                                             |       |     |       |     |       |     |       |
| Operating expenses                                                               |       |     |       |     |       |     |       |
| Selling                                                                          |       | 9,246    |       | 9,465    |       | 14,279   |       |
| General and administrative                                                       |       | 11,452   |       | 7,710    |       | 8,584    |       |
| Research and development                                                         |       | 1,619    |       | 1,902    |       | 2,336    |       |
| Restructuring charge                                                             |       | 1,228    |       | 1,565    |       | (690     | )          |
| Asset impairment charge                                                          |       | 2,154    |       | 1,238    |       | —   |       |
| Goodwill impairment charge                                                       |       | 966      |       | —   |       | —   |       |
|                                                                             |       | 26,665   |       | 21,880   |       | 24,509   |       |
|                                                                             |       |     |       |     |       |     |       |
| Income from operations                                                           |       | 670      |       | 697      |       | 3,474    |       |
|                                                                             |       |     |       |     |       |     |       |
| Interest income                                                                  |       | 89       |       | 122      |       | 129      |       |
| Interest expense                                                                 |       | (2,088   | )          | (693     | )          | (618     | )          |
|                                                                             |       |     |       |     |       |     |       |
| Income (loss) before income tax  expense (benefit)                               |       | (1,329   | )          | 126      |       | 2,985    |       |
|                                                                             |       |     |       |     |       |     |       |
| Income tax expense (benefit)                                                     |       | 1,737    |       | 212      |       | (678     | )          |
|                                                                             |       |     |       |     |       |     |       |
| Net income (loss) before minority  interest                                      |       | (3,066   | )          | (86      | )          | 3,663    |       |
|                                                                             |       |     |       |     |       |     |       |
| Minority interest                                                                |       | —   |       | —   |       | 167      |       |
|                                                                             |       |     |       |     |       |     |       |
| Net income (loss)                                                                |       | $        | (3,066     | )        | $          | (86      | )          | $ | 3,496 |   |
|                                                                             |       |     |       |     |       |     |       |
| Net income (loss) per share                                                      |       |     |       |     |       |     |       |
| Basic                                                                            |       | $        | (0.34      | )        | $          | (0.01    | )          | $ | 0.38 |   |
|                                                                             |       |     |       |     |       |     |       |
| Diluted                                                                          |       | $        | (0.34      | )        | $          | (0.01    | )          | $ | 0.38 |   |
|                                                                             |       |     |       |     |       |     |       |
| Net (loss) income                                                                |       | $        | (3,066     | )        | $          | (86      | )          | $ | 3,496 |   |
|                                                                             |       |     |       |     |       |     |       |
| Other comprehensive income, net  of tax Foreign currency translation adjustments |       | 688      |       | 1,982    |       | 1,050    |       |
|                                                                             |       |     |       |     |       |     |       |
| Comprehensive net (loss) income                                                  |       | $        | (2,378     | )        | $          | 1,896    |       | $ | 4,546 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

F-3

----

 

**CHANNELLCOMMERCIAL CORPORATION**

**CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY**

**Yearsended December 31, 2002, 2003 and 2004**

*(amountsin thousands)*

 
| ** **                          | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**     | ** ** | ** **   | ** ** | ** **        | ** ** | ** **       | ** ** | **Accumulated  other** | ** ** | **Total**  | ** ** |
|-------------------------------------|------------|------------------|------------|-------------|------------|--------------------|------------|--------------|------------|-------------------|------------|------------------|------------|------------------------|------------|------------|------------|
| ** **                          | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **Treasury stock** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | **stockholders** | ** ** |
| ** **                          | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **capital**        | ** ** | **Shares**   | ** ** | **Amount**        | ** ** | **earnings**     | ** ** | **Income (loss)**      | ** ** | **equity** | ** ** |
|                                |       |             |       |        |       |               |       |         |       |              |       |             |       |                   |       |       |       |
| Balance, January 1, 2002            |       | 9,269            |       | $           | 93         |               | $          | 28,334       |       | 244               |       | $                | (1,871     | )                      | $          | 13,622     |       | $ | (2,681 | ) | $ | 37,497 |   |
|                                |       |             |       |        |       |               |       |         |       |              |       |             |       |                   |       |       |       |
| Exercise of employee stock options  |       | 100              |       | 1           |       | 321                |       | —       |       | —            |       | —           |       | —                 |       | 322        |       |
| Foreign currency translation        |       | —           |       | —      |       | —             |       | —       |       | —            |       | —           |       | 688                    |       | 688        |       |
| Net loss for the year               |       | —           |       | —      |       | —             |       | —       |       | —            |       | (3,066           | )          | —                 |       | (3,066     | )          |
|                                |       |             |       |        |       |               |       |         |       |              |       |             |       |                   |       |       |       |
| Balance, December 31, 2002          |       | 9,369            |       | $           | 94         |               | $          | 28,655       |       | 244               |       | $                | (1,871     | )                      | $          | 10,556     |       | $ | (1,993 | ) | $ | 35,441 |   |
|                                |       |             |       |        |       |               |       |         |       |              |       |             |       |                   |       |       |       |
| Exercise of employee stock  options |       | 3                |       | —      |       | 9                  |       | —       |       | —            |       | —           |       | —                 |       | 9          |       |
| Foreign currency translation        |       | —           |       | —      |       | —             |       | —       |       | —            |       | —           |       | 1,982                  |       | 1,982      |       |
| Net loss for the year               |       | —           |       | —      |       | —             |       | —       |       | —            |       | (86              | )          | —                 |       | (86        | )          |
|                                |       |             |       |        |       |               |       |         |       |              |       |             |       |                   |       |       |       |
| Balance, December 31, 2003          |       | 9,372            |       | $           | 94         |               | $          | 28,664       |       | 244               |       | $                | (1,871     | )                      | $          | 10,470     |       | $ | (11 | ) | $ | 37,346 |   |
|                                |       |             |       |        |       |               |       |         |       |              |       |             |       |                   |       |       |       |
| Exercise of employee stock  options |       | 61               |       | 1           |       | 294                |       | —       |       | —            |       | —           |       | —                 |       | 295        |       |
| Shares issued for acquisition       |       | 175              |       | 1           |       | 713                |       | —       |       | —            |       | —           |       | —                 |       | 714        |       |
| Foreign currency translation        |       | —           |       | —      |       | —             |       | —       |       | —            |       | —           |       | 1,050                  |       | 1,050      |       |
| Net earnings for the year           |       | —           |       | —      |       | —             |       | —       |       | —            |       | 3,496            |       | —                 |       | 3,496      |       |
|                                |       |             |       |        |       |               |       |         |       |              |       |             |       |                   |       |       |       |
| Balance, December 31, 2004          |       | 9,608            |       | $           | 96         |               | $          | 29,671       |       | 244               |       | $                | (1,871     | )                      | $          | 13,966     |       | $ | 1,039 |   | $ | 42,901 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

F-4

----

 

**CHANNELLCOMMERCIAL CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**Yearended December 31,**

*(amountsin thousands)*

 
| ** **                                                                                | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cash flows from operating  activities:                                                    |       |     |       |     |       |     |       |
| Net (loss) income                                                                         |       | $        | (3,066     | )        | $          | (86      | )          | $ | 3,496 |   |
| Adjustments to reconcile net (loss) income  to net cash provided by operating activities: |       |     |       |     |       |     |       |
| Depreciation and amortization                                                             |       | 7,785    |       | 6,232    |       | 4,752    |       |
| Asset impairment charge                                                                   |       | 2,154    |       | 1,238    |       | —   |       |
| Goodwill impairment charge                                                                |       | 966      |       | —   |       | —   |       |
| Loss (gain) on disposal of fixed  assets                                                  |       | 348      |       | 108      |       | (22      | )          |
| Amortization of deferred gain on  sale leaseback                                          |       | (30      | )          | (61      | )          | (60      | )          |
| Deferred income taxes                                                                     |       | 1,193    |       | (749     | )          | 222      |       |
| Changes in assets and  liabilities:                                                       |       |     |       |     |       |     |       |
| Accounts receivable                                                                       |       | 3,120    |       | 751      |       | (1,237   | )          |
| Inventories                                                                               |       | 2,182    |       | (374     | )          | (2,394   | )          |
| Prepaid expenses and other  current assets                                                |       | 156      |       | 327      |       | 248      |       |
| Income taxes receivable                                                                   |       | 4,682    |       | 61       |       | (1,238   | )          |
| Other assets                                                                              |       | 32       |       | (90      | )          | (301     | )          |
| Accounts payable                                                                          |       | 562      |       | (1,046   | )          | 7,178    |       |
| Restructuring liability                                                                   |       | (388     | )          | 296      |       | (2,810   | )          |
| Accrued expenses                                                                          |       | 71       |       | 520      |       | 1,394    |       |
|                                                                                      |       |     |       |     |       |     |       |
| Net cash provided by operating  activities                                                |       | 19,767   |       | 7,127    |       | 9,228    |       |
|                                                                                      |       |     |       |     |       |     |       |
| Cash flows from investing  activities:                                                    |       |     |       |     |       |     |       |
| Purchase of property and  equipment                                                       |       | (1,886   | )          | (1,203   | )          | (3,281   | )          |
| Proceeds from sale of property  and equipment                                             |       | 6,232    |       | 2,357    |       | 23       |       |
| Business acquisitions, net of  cash acquired                                              |       | —   |       | —   |       | (16,767  | )          |
|                                                                                      |       |     |       |     |       |     |       |
| Net cash (used in) provided by  investing activities                                      |       | 4,346    |       | 1,154    |       | (20,025  | )          |
|                                                                                      |       |     |       |     |       |     |       |
| Cash flows from financing  activities:                                                    |       |     |       |     |       |     |       |
| Repayment of debt                                                                         |       | $        | (35,133    | )        | $          | (2,047   | )          | $ | (2,669 | ) |
| Proceeds from issuance of  long-term debt                                                 |       | 6,742    |       | —   |       | 7,233    |       |
| Principal borrowings under  capital lease obligations                                     |       | —   |       | —   |       | 40       |       |
| Payment of capital lease  obligations                                                     |       | (1,763   | )          | (624     | )          | (30      | )          |
| Proceeds from minority investor                                                           |       | —   |       | —   |       | 2,681    |       |
| Proceeds from issuance of stock                                                           |       | —   |       | —   |       | 714      |       |
| Exercise of employee stock  options                                                       |       | 322      |       | 9        |       | 295      |       |
|                                                                                      |       |     |       |     |       |     |       |
| Net cash (used in) provided by  financing activities                                      |       | (29,832  | )          | (2,662   | )          | 7,550    |       |
|                                                                                      |       |     |       |     |       |     |       |
| Effect of exchange rates on cash                                                          |       | 119      |       | 746      |       | (827     | )          |
|                                                                                      |       |     |       |     |       |     |       |
| Increase (decrease) in cash and  cash equivalents                                         |       | (5,600   | )          | 6,365    |       | (4,074   | )          |
|                                                                                      |       |     |       |     |       |     |       |
| Cash and cash equivalents,  beginning of year                                             |       | 8,762    |       | 3,162    |       | 9,527    |       |
|                                                                                      |       |     |       |     |       |     |       |
| Cash and cash equivalents, end of  year                                                   |       | $        | 3,162      |     | $          | 9,527    |       | $ | 5,453 |   |
|                                                                                      |       |     |       |     |       |     |       |
| Cash paid during the year for:                                                            |       |     |       |     |       |     |       |
| Interest                                                                                  |       | $        | 1,608      |     | $          | 292      |       | $ | 364 |   |
|                                                                                      |       |     |       |     |       |     |       |
| Income taxes                                                                              |       | $        | 1,122      |     | $          | 749      |       | $ | 809 |   |
|                                                                                      |       |     |       |     |       |     |       |   |   |   |
| Issuance of common stock in  business combination                                         |       | $        | —     |     | $          | —   |       | $ | 714 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

F-5

----

 

**CHANNELL COMMERCIAL CORPORATION**

**NOTESTO CONS****OLIDATEDFINANCIAL STATEMENTS**

**December 31, 2002, 2003 and 2004**

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

 

**NOTEA—DESCRIPTION OF BUSINESS**

 

The Company is adesigner and manufacturer of telecommunications equipment supplied to broadbandand telephone network providers worldwide. Major product lines include a complete line of thermoplastic and metalfabricated enclosures, advanced copper termination and connectorizationproducts, fiber optic cable management systems for fiber to the premise (FTTP)networks, and heat shrink products.   The Company’s enclosure products house, protect and provide access toadvanced telecommunications hardware, including both radio frequency (“RF”)electronics and photonics, and transmission media, including coaxial cable,copper wire and optical fibers, used in the delivery of voice, video and dataservices.  The enclosure products aredeployed within the access portion of the local signal delivery network,commonly known as the “outside plant”, “local loop” or “last mile”, thatconnects the network provider’s signal origination point or local office withits residential and business customers. The Company’s connectivity products provide critical network connectionpoints between cables or network transmission devices.

 

The Companyalso designs, manufactures and markets polyethylene water tanks for rural andresidential markets in Australia.  TheCompany’s primary product line of rotational molded tanks is used in theagricultural sector where water shortages require storage of rain and groundwater.  The Company also markets a rangeof water storage tanks for use in residential and rural-residential markets.

 

**NOTEB—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

*Estimates*—Inpreparing financial statements in conformity with generally accepted accountingprinciples, management is required to make estimates and assumptions that affectthe reported amounts of assets and liabilities, the disclosure of contingentassets and liabilities at the date of the financial statements, and thereported amounts of revenues and expenses during the reporting period.  Significant estimates include accountsreceivables reserves, the inventory valuation reserve, restructuring accrualsassociated with vacated facilities, valuation of goodwill and long lived assetsand the deferred tax asset valuation allowance. Actual results could differ from those estimates and the differencescould be material.

 

*Basis ofConsolidation*—The consolidated financial statementsinclude the accounts of the Company and its subsidiaries.  All significant intercompany transactions andbalances have been eliminated.  Minority interestrepresents a 25% equity interest in Bushman Tanks acquired by ANZ PrivateEquity (See Note Q)

 

*ForeignCurrency Translation*—Assets and liabilities of foreignoperations are translated into U.S. dollars at current exchange rates.  Income and expenses are translated into U.S.dollars at average rates of exchange prevailing during the period.  Adjustments resulting from translatingforeign functional currency financial statements into U.S. dollars are includedin other comprehensive income.  Foreign currencytransaction gains and losses are included in general and administrativeexpenses.  Transactions gains and losseswere not significant in 2002, 2003 and 2004.

 

*Cash andCash Equivalents*—For purposes of reporting cash flows,cash and cash equivalents include cash on hand, cash in banks and short-terminvestments with original maturities of 90 days or less.

 

*Inventories*—Inventoriesare stated at the lower of cost or market. Cost is determined by the first-in,first-out method of accounting.  Costincludes material, direct production costs, and factory overhead costs.  Reserves for excess and obsolete inventoriesare determined by an analysis of relevant factors including historical salesand usage of items in inventory, current levels of orders and backlog,forecasted demand, product life cycle, and market conditions.

 

*Propertyand Equipment*—Property and equipment are stated atcost. Depreciation is computed using the straight-line method over theestimated useful lives of the assets. Capital lease assets are amortized usingthe straight-line method over the useful lives of the assets. Expenditures forall maintenance and repairs are charged against income. Additions, major renewalsand replacements that increase the useful lives of assets are capitalized.Amortization of leasehold improvements is computed using the straight-linemethod over the shorter of the lease term or the estimated useful life of theleasehold improvements.

 

*Impairmentof Long-Lived Assets*—When events or circumstances indicatethe carrying value of a long-lived asset may be impaired, the Company estimatesthe future discounted cash flows to be derived from the asset to assess whetheror not a potential impairment exists.  Ifthe carrying value exceeds the estimate of future discounted cash flows, theimpairment is calculated as the excess of the carrying value of the asset overthe estimate of its fair market value.

 

F-6

----

 

*Goodwilland Other Intangible Assets*—In June 2001, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 142, “Goodwill and Other IntangibleAssets,” which supersedes APB Opinion No. 17, “Intangible Assets.”  SFAS 142 eliminates the requirement toamortize goodwill and indefinite-lived intangible assets, requiring insteadthat those assets be measured for impairment at least annually, and more oftenwhen events indicate that an impairment exists. Intangible assets with finitelives will continue to be amortized over their useful lives.  SFAS 142 applies to goodwill and intangibleassets arising from transactions completed before and after the Statement’seffective date.

 

The Company has adopted SFAS142 as of January 1, 2002.  In applyingSFAS 142, the Company performed the transitional reassessment and impairmenttests required as of January 1, 2002, and determined that the goodwill ofthe Company has indefinite lives and that there was no impairment on theseassets. The Company discontinued amortizing these assets on January 1, 2002. Atthe time of adoption, the Company had accumulated amortization pertaining togoodwill of $10,303.

 

The Company tests the value ofgoodwill for impairment annually (December 31 for the Canadian reporting unitand June 30 for the Bushman’s reporting unit) or whenever events or changes incircumstance indicate that expected future discounted cashflows may beinsufficient to support the carrying amount of the asset.  The test involves significant judgment inestimating projections of fair value generated through future performance ofthe operating segment.  In calculatingthe fair value, the Company relies on factors such as operating results,business plans, economic projections, and anticipated cash flows used indiscounting the cash flows.  Inherentuncertainties exist in determining and applying such factors.

 

In the fourth quarter of 2002, the Company adjusted the carrying value of the goodwill in the Company’s International operations resulting in a non-cash impairment charge of $966.  The impairment charge was the result of restructuring activities that reduced the level of foreign operations and the exit of certain product lines.  There was no impairment to the carrying value of goodwill in 2003 or 2004.

 

On August 2, 2004 the Company,through a majority-owned subsidiary, acquired a controlling interest in BushmanTanks, a manufacturer and distributor of rotational molded plastic(polyethylene) water storage tanks (Note Q). Included in the Share and Asset Purchase Agreement, the sellers ofBushman Tanks agreed to a “non-compete” clause where by the sellers of BushmanTanks would not directly or indirectlycarry on or be engaged or involved in any trade, business or undertaking thatis in competition with the Bushman Tanks business.  The Company performed an evaluation of thenon-compete agreement and determined the fair value to be $1,600.  The non-compete agreement is recorded in thereporting unit of Bushman Tanks, which is part of the International segment, asa separately identifiable intangible asset and is being amortized overthe ten-year contractual term on a straight line basis.  The amount of goodwill recorded in theBushman Tanks acquisition is not deductible for tax purposes.

 

The change in the carryingamount of goodwill and the non-compete agreement for the years ended December31, 2003 and 2004 is summarized as follows:

 
| ** **                                             | ** ** | **Goodwill** | ** ** | **Non-Compete  Agreement** | ** ** |
|--------------------------------------------------------|------------|--------------|------------|----------------------------|------------|
|                                                   |       |         |       |                       |       |
| Balance at January 1, 2003                             |       | $            | 504        |                       | $          | — |   |
|                                                   |       |         |       |                       |       |
| Effect of foreign currency  translation                |       | 109          |       | —                     |       |
|                                                   |       |         |       |                       |       |
| Balance at December 31, 2003                           |       | 613          |       | —                     |       |
|                                                   |       |         |       |                       |       |
| Additions due to business  acquistion                  |       | 12,442       |       | —                     |       |
| Non-compete agreement related to  business acquisition |       | —       |       | 1,600                      |       |
| Amortization of non-compete  agreement                 |       | —       |       | (45                        | )          |
| Effect of foreign currency translation                 |       | 1,669        |       | 208                        |       |
|                                                   |       |         |       |                       |       |
| Balance at December 31, 2004                           |       | $            | 14,724     |                       | $          | 1,763 |   |

 

F-7

----

 

As of December 31, 2004, TheCompany has recorded goodwill of $659 in its Canadian reporting unit which ispart of the Americas segment, and $14,065 of goodwill in its Bushman Tanksreporting unit which is part of the International segment.

 

The estimated amortizationexpense for the next five fiscal years, based on current intangible balances,is $160 a year.

 

*RevenueRecognition and Accounts Receivable Reserves*—Revenuesare recognized when title passes and the risks and rewards of ownership havepassed to the customer, based on the terms of sale.  Title passes generally upon shipment.  Provisions for estimated sales returns arebased on the Company’s historical sales returns experience.  Provisions for sales allowances are based onthe Company’s historical experience for credits issued to customers for suchitems as a pricing error, items damaged during transportation or incorrectitems shipped to the customer. Provisions for uncollectible accounts are based on the Company’sspecific assessment of the collectibility of all past due accounts.

 

In 2002 the Company recorded areserve for a receivable from Adelphia, a major cable operator, in the amountof $1,573.  Adelphia declared bankruptcyand the Company subsequently wrote off the receivable.  In December 2004 the Company sold itsreceivable for cash to a third-party investor for $1,452.  The sale of the receivable resulted in achange in estimate of the Company’s allowance for uncollectible accounts forthe same amount.  The change in estimatewas reflected as a reduction of bad debt expense which is included in generaland administrative expenses.  The changein estimate for uncollectible accounts increased pretax basic and dilutedearnings per share by $0.16.

 

*ShippingCosts*—In accordance with the Emerging Issues TaskForce (“EITF”) Issue No. 00-10 “Accounting for Shipping and Handling Fees andCosts” shipping and handling costs billed to customers are included in salesand the related costs are included in selling expenses.  Shipping and handling costs are charged toexpense as incurred.  Total shippingcosts of $1,170, $1,336 and $4,004 are included in selling expenses for 2002,2003 and 2004, respectively.

 

*Income(loss) per share*—Basic income (loss) per shareexcludes dilution and is computed by dividing net income (loss) available tocommon stockholders by the weighted average number of common shares outstandingfor the period.  Diluted income per sharereflects the potential dilution that could occur if options to acquire commonstock were exercised.

 

The following is areconciliation of the number of shares (denominator) used in the basic anddiluted income (loss) per share computations:

 
| ** **                       | ** ** | **2002**   | ** ** | **2003**               | ** ** | **2004**   | ** ** |
|----------------------------------|------------|------------|------------|------------------------|------------|------------|------------|
|                             |       | **Shares** | ** ** | **Per  Share  Amount** | ** ** | **Shares** | ** ** | **Per  Share  Amount** | ** ** | **Shares** | ** ** | **Per  Share  Amount** |   |
|                             |       |       |       |                   |       |       |       |   |   |   |   |   |   |
| Basic income (loss) per share    |       | 9,048      |       | (0.34                  | )          | 9,126      |       | (0.01 | ) | 9,203 |   | 0.38 |   |
|                             |       |       |       |                   |       |       |       |   |   |   |   |   |   |
| Effect of dilutive stock options |       | —     |       | —                 |       | —     |       | — |   | 20 |   | — |   |
|                             |       |       |       |                   |       |       |       |   |   |   |   |   |   |
| Diluted income (loss) per share  |       | 9,048      |       | (0.34                  | )          | 9,126      |       | (0.01 | ) | 9,223 |   | 0.38 |   |

 

F-8

----

 

The following options were notincluded in the computation of diluted income (loss) per share due to theirantidilutive effect:

 
| ** **                                 | ** ** | **2002**                  | ** ** | **2003**                       | ** ** | **2004**                  | ** ** |
|--------------------------------------------|------------|---------------------------|------------|--------------------------------|------------|---------------------------|------------|
|                                       |       |                      |       |                           |       |                      |       |
| Options to purchase shares of common stock |       | 917                       |       | 1,894                          |       | 97                        |       |
|                                       |       |                      |       |                           |       |                      |       |
| Exercise prices                            |       | $3.05 – $13.75       |       | $3.16 – $13.75            |       | $6.50 – $13.75       |       |
|                                       |       |                      |       |                           |       |                      |       |
| Expiration dates                           |       | July 2006 – May 2012 |       | July 2006 – December 2013 |       | July 2006 – May 2011 |       |

 

*Fair valueof financial instruments*—The carrying amount of cash,accounts receivable, accounts payable, accrued expenses and short-termborrowings approximates fair value because of the short maturity of thesefinancial instruments.  Long-term obligationsare carried at amounts that approximate fair value.  The estimated fair value of the long-termobligations is based on borrowing rates currently available to the Company forloans with similar terms and maturities.

 

*Accountingfor Stock-Based Compensation*—Statement of FinancialAccounting Standards No. 148, *“Accounting for StockBased Compensation***—***Transition and Disclosure on Amendment of SFAS 123”*,encourages, but does not require, companies to record compensation cost forstock-based employee compensation plans at fair value.  The Company has chosen to continue to accountfor stock-based compensation using the intrinsic value method prescribed inpreviously issued standards. Accordingly, compensation cost for stock options is measured as theexcess, if any, of the quoted market price of the Company’s stock at the dateof grant over the amount an employee must pay to acquire the stock.

 

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

 

Participating eligible optionholders were granted a new option for each old cancelled option.  For each new option granted, the vestingstatus and vesting schedule of the old option was preserved. The weightedaverage fair value of the options issued in September 2003 was $1.91.  The weighted average exercise price was$4.84.

 

Had compensation cost for theplan been determined based on the fair value of the options at the grant datesbased on the above method, the Company’s net income (loss) and income (loss)per share would have been:

 
| ** **                                                                       | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Reported net (loss) income                                                       |       | $        | (3,066     | )        | $          | (86      | )          | $ | 3,496 |   |
| Add stock-based compensation expense  reported in net (loss) income              |       | —   |       | —   |       | —   |       |
| Less total stock-based compensation  expense, determined under fair value method |       | (305     | )          | (915     | )          | (449     | )          |
| Proforma net (loss) income                                                       |       | $        | (3,371     | )        | $          | (1,001   | )          | $ | 3,047 |   |
|                                                                             |       |     |       |     |       |     |       |
| Reported basic and diluted net (loss)  income per share                          |       | $        | (0.34      | )        | $          | (0.01    | )          | $ | 0.38 |   |
| Add stock-based compensation expense  reported in net (loss) income              |       | —   |       | —   |       | —   |       |
| Less total stock-based compensation  expense, determined under fair value method |       | (0.03    | )          | (0.10    | )          | (0.05    | )          |
| Proforma basic and diluted net income  (loss) per share                          |       | $        | (0.37      | )        | $          | (0.11    | )          | $ | 0.33 |   |

 

F-9

----

 

The fair value of options atdate of grant was estimated using the Black-Scholes model with the followingweighted average assumptions:

 
| ** **              | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|
|                    |       |     |       |     |       |     |       |
| Expected life (years)   |       | 5 years  |       | 5 years  |       | 5 years  |       |
| Risk-free interest rate |       | 3.0      | %          | 3.0      | %          | 3.5      | %          |
| Expected volatility     |       | 40       | %          | 40       | %          | 40       | %          |
| Expected dividend yield |       | —   |       | —   |       | —   |       |

 

*RecentAccounting Pronouncements.*   In November 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 151, “Inventory Costs, an Amendment ofARB No. 43, Chapter 4.”  SFAS No. 151retains the general principle of ARB No.43, Chapter 4, “Inventory Pricing,”that inventories are presumed to be stated at cost; however, it amends ARB No.43 to clarify that abnormal amounts of idle facilities, freight, handling costsand spoilage should be recognized as current period expenses.  Also, SFAS No. 151 requires fixed overheadcosts be allocated to inventories based on normal production capacity.  The guidance in SAFS No. 151 is effective forinventory costs incurred during fiscal years beginning after June 15,2005.  The Company believes thatimplementing SFAS No. 151 should not have a material impact on its financialcondition or results of operations.

 

In December 2004, the FASB issued Statement 123(revised 2004), *Share-Based**Payment*(Statement123(R)).  This Statement is a revision toStatement 123, *Accounting for Stock-Based Compensation*,and supersedes Opinion 25, *Accounting for StockIssued to Employees*. Statement 123(R) requires the measurement of the cost of employeeservices received in exchange for an award of equity instruments based on thegrant-date fair value of the award.  Thecost will be recognized over the period during which an employee is required toprovide service in exchange for the award. No compensation cost is recognized for equity instruments for whichemployees do not render service.  TheCompany will adopt Statement 123(R) on July 1, 2005, requiring compensationcost to be recognized as expense for the portion of outstanding unvestedawards, based on the grant-date fair value of those awards calculated using theBlack-Scholes option pricing model under Statement 123 for pro formadisclosures.  Based on the number ofoptions currently outstanding, the effect of adopting Statement 123(R) willdecrease the Company’s pretax net income by approximately $400 during 2005.  This estimate would change if the Companywere to issue additional equity instruments.

 

*Reclassifications*—Certainprior period amounts have been reclassified for comparison with 2004presentation.

 

**NOTEC—INVENTORIES**

 

Inventoriesare summarized as follows:

 
| ** **      | ** ** | **2003** | ** ** | **2004** | ** ** |
|-----------------|------------|----------|------------|----------|------------|
|            |       |     |       |     |       |
| Raw materials   |       | $        | 2,895      |     | $          | 4,777 |   |
| Work-in-process |       | 2,468    |       | 3,050    |       |
| Finished goods  |       | 3,492    |       | 6,337    |       |
|            |       |     |       |     |       |
|            |       | $        | 8,855      |     | $          | 14,164 |   |

 

F-10

----

 

**NOTED—PROPERTY AND EQUIPMENT**

 

Property and equipment aresummarized as follows:

 
| ** **                                      | ** ** | **2003** | ** ** | **2004** | ** ** | **Estimated  useful lives** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|-----------------------------|------------|
|                                            |       |     |       |     |       |                        |       |
| Machinery and equipment                         |       | $        | 58,719     |     | $          | 59,799                      |       | 3-10 years |   |
| Office furniture and equipment                  |       | 3,145    |       | 2,752    |       | 3-7 years                   |       |
| Leasehold improvements                          |       | 2,929    |       | 3,221    |       | 10-20 years                 |       |
|                                            |       | 64,793   |       | 65,772   |       |                        |       |
| Less accumulated depreciation and  amortization |       | (47,629  | )          | (46,471  | )          |                        |       |
|                                            |       | $        | 17,164     |     | $          | 19,301                      |       |   |   |

 

Included in machinery andequipment is $174 and $165 of equipment under capital lease at December 31,2003 and 2004.  Accumulated amortizationof assets under capital lease totaled $51 and $28 at December 31, 2003 and2004, respectively.

 

As a result of therestructuring activities in the fourth quarter of 2002 to rationalizeInternational operations and reduce manufacturing costs, certain productionequipment, tooling and leasehold improvements were idled or sold.  An impairment review of these assets wasconducted.  In the fourth quarter of2002, the Company adjusted the carrying value of their production equipment andtooling and leasehold improvements, resulting in a non-cash impairment chargeof $2,154.  The 2002 impairment chargeincludes approximately $1,665 for equipment in the International operations and$489 for production tooling in the Americas.

 

In the fourth quarter of 2003,a plan was developed to close an additional manufacturing facility in theInternational operations by mid-year 2004. An impairment review of the assets located in the facility was conducted.  In the fourth quarter of 2003, the Companyadjusted the carrying value of production equipment, tooling and leaseholdimprovements resulting in a non cash impairment charge of $1,238 for equipmentin International operations.

 

In January 2003, the Companyentered into a sale of a facility in International operations located inOrpington, Kent, United Kingdom. The proceeds from the sale totaled $2,441 andresulted in a pretax loss of $110 which is included in general andadministrative expense.  Terms of thesale included a provision for the Company to lease back the facility for oneyear at no charge. Included in the proceeds was prepaid rent for one year whichtotaled $213.  The resulting lease wasaccounted for as an operating lease in fiscal 2003.

 

F-11

----

 

**NOTEE—ACCRUED EXPENSES**

 

Accrued expenses consist of thefollowing:

 
| ** **       | ** ** | **2003** | ** ** | **2004** | ** ** |
|------------------|------------|----------|------------|----------|------------|
|             |       |     |       |     |       |
| Accrued vacation |       | $        | 841        |     | $          | 1,024 |   |
| Accrued bonus    |       | 229      |       | 546      |       |
| Other            |       | 3,170    |       | 6,049    |       |
|             |       | $        | 4,240      |     | $          | 7,619 |   |

 

The Company provides a warrantyfor the replacement and repair of a defective product.  Historically, theCompany has not experienced significant warranty costs or returns.  The Company acquired Bushman Tanks (see NoteQ) in August 2004.  Associated with theacquisition of Bushman Tanks was the assumption of warranties related toBushman Tanks polyethylene water tanks. The typical warranty period for water tanks is 25 years which managementbelieves is the industry standard.

 

Warranty expense is estimatedby management at the time of the sale based on historical warranty costs andanalysis of defects that have occurred in field installations.  The change in the Company’s warrantyliability in 2002 and 2003 was not significant. The change in the Company’s warranty liability (included in other above)for the year ended December 31, 2004 is summarized as follows:

 
| Balance, January 1, 2004                                       |   | $      | (50    | ) |
|----------------------------------------------------------------|--------|--------|--------|---|
| Expense for new warranties                                     |   | (192   | )      |
| Product warranty accrual assumed in Bushman  Tanks acquisition |   | (1,092 | )      |
| Warranty claims                                                |   | 169    |   |
| Balance, December 31, 2004                                     |   | $      | (1,165 | ) |

 

F-12

----

 

**NOTEF—DEBT**

 

The Company’s debt consists ofthe following:

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | ** ** | **2003** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| The Company  entered into a Loan and Security Agreement with an asset-based lender in the  United States in September 2002. The Loan and Security Agreement contains a  revolving credit facility. Amounts borrowed under this facility bear interest  at a variable rate based on either the lender’s Base Rate or LIBOR. There was  no balance outstanding under the revolving line of credit at December 31,  2003, or 2004.                                                                                                                                                                                                                                                                           |       | $        | —     |     | $          | — |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |     |       |     |       |
| The Company  entered into a Loan and Security Agreement with an asset-based lender in the  United States in September 2002. The Loan and Security Agreement contains a  three-year term loan and is repayable in equal quarterly payments based on a  five-year amortization schedule with a balloon payment at maturity. Amounts  borrowed under this facility bear interest at a variable rate based on either  the lender’s Base Rate or LIBOR. The weighted average interest rate under the  term loan was 3.02% and 4.41% at December 31, 2003 and 2004, respectively.                                                                                                                               |       | 3,770    |       | 2,828    |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |     |       |     |       |
| Automobile  loan payable in monthly principal and interest installments of $1 through  April, 2005. The note is non-interest bearing and is collateralized by the  automobile.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |       | 12       |       | 2        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |     |       |     |       |
| A subsidiary  of the Company, Channell Pty Ltd., entered into a one-year Loan and Security  Agreement with a commercial bank in Australia in July 2004. The Loan and  Security Agreement contains a revolving line of credit. Amounts borrowed  under this facility bear interest payable monthly at a variable rate based on  the lender’s Base Rate. The weighted average interest rate at December 31,  2004 was 6.75%                                                                                                                                                                                                                                                                                 |       | —   |       | 234      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |     |       |     |       |
| A subsidiary  of the Company, Channell Bushman Pty Ltd., entered into a five-year Loan and  Security Agreement with a commercial bank in Australia in August 2004. The  Loan and Security Agreement contains a five-year term loan that is repayable  in quarterly payments based on a five-year amortization schedule. Under the  Loan and Security Agreement, the outstanding balance bears interest payable  monthly at a variable rate based on the lender’s Base Rate. The weighted  average interest rate under the Loan and Security Agreement at December 31,  2004 was 5.75%                                                                                                                     |       | —   |       | 5,636    |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |     |       |     |       |
| A subsidiary  of the Company, Channell Bushman Pty Ltd., entered into a five-year Loan and  Security Agreement with a commercial bank in Australia in August 2004. The  Loan and Security Agreement contains a revolving credit facility, a facility  to fund future “earn-out” payments to the sellers of Bushman Tanks, and a  capital expenditure facility. Under the Loan and Security Agreement, the  outstanding balance bears interest payable monthly at a variable rate based  on the lender’s Base Rate. There was no balance outstanding under the  revolving line of credit facility, the “earn-out” facility, or the capital  expenditure facility at December 31, 2004. |       | —   |       | —   |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       | 3,782    |       | 8,700    |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |     |       |     |       |
| Less current maturities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |       | 952      |       | 4,332    |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |     |       |     |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       | $        | 2,830      |     | $          | 4,368 |   |

 

The Company entered into athree-year Loan and Security Agreement with an asset-based lender in the UnitedStates in September 2002.  Maximumborrowings available under this facility total $25,000.  The Agreement has a $1,000 sub-limit forletters of credit.  As of December 31,2004, outstanding letters of credit totaled $986.  The Agreement contains various

 

F-13

----

 

financial and operatingcovenants that impose limitations on the Company’s ability, among other things,to incur additional indebtedness, merge or consolidate, sell assets except inthe ordinary course of business, make certain investments, enter into leases andpay dividends.  The Company is alsorequired to comply with a fixed charge coverage ratio and other financialcovenants.  The Agreement requires theCompany to maintain a lockbox on the revolving credit facility.  The lockbox receipts automatically reduce theoutstanding balance of the revolving credit balance, if any.  The Agreement also contains a subjectiveacceleration clause should the Company come into a default which allows theasset-based lender to terminate the facility and require that any outstandingobligation to be repaid.  There was nobalance outstanding under the revolving line of credit at December 31,2004.  The Company was in compliance asof December 31, 2004 with the covenants of the Loan and Security Agreement.

 

Channell Pty Ltd, a subsidiaryof the Company, entered into a one-year Loan and Security Agreement with acommercial bank in Australia in July 2004. The loan contains a revolving line of credit for working capital needswith a maximum available borrowing of Australia dollars $1,200, whichtranslated at December 31, 2004 exchange rates is approximately $940 USdollars.  The Company is required tocomply with an interest coverage ratio. The agreement is reviewed annually with the bank for annualrenewals.  The Agreement contractuallyobligates the Company to repay the revolving credit facility as the Companyreceives payments from its customers. The Agreement also contains a subjective acceleration clause should theCompany come into a default which allows the bank to terminate the facility andrequire any outstanding obligation to be repaid.  The revolving line of credit due to itsone-year term is classified as a short term debt.  The Company was in compliance as of December31, 2004 with the covenants of the Loan and Security Agreement.

 

Channell Bushman Pty Ltd, asubsidiary of the Company, entered into a five-year Loan and Security Agreementwith a commercial bank in Australia in August 2004.  The loan contains a five-year term loan withmaximum borrowings of Australia dollars $8,000 that expires in July 2009, arevolving credit facility with maximum borrowings of Australia dollars $2,000,a facility to fund future “earn-out” payments to the sellers of Bushman Tankswith maximum borrowings of Australia dollars $1,750, and a capital expenditurefacility with maximum borrowings of Australia dollars $6,000.  Translated into US dollars at December 31,2004 exchange rates, the maximum borrowings are:  five-year term loan $6,240, revolving creditfacility $1,560, “earn-out” facility $1,365, capital expenditure facility$4,680.  The Agreement contains variousfinancial and operating covenants that impose limitations on the Company’sability, among other things, to merge or consolidate, sell assets except in theordinary course of business, and pay dividends. The Company is required to comply with an interest cover ratio and otherfinancial covenants.  The Agreementcontractually obligates the Company to repay the revolving credit facility asthe Company receives payments from its customers.  The Agreement also contains a subjectiveacceleration clause should the Company come into a default which allows thebank to terminate the facility and require any outstanding obligation to berepaid.  There was no balance outstandingunder the revolving line of credit, “earn-out” facility, or capital expenditurefacility at December 31, 2004.  TheCompany was in compliance as of December 31, 2004 with the covenants of theLoan and Security Agreement.

 

The Company’s debt at December31, 2004 is scheduled to mature as follows:

 
| **Year**   | ** ** | **Amount** | ** ** |
|------------|------------|------------|------------|
| 2005       |       | $          | 4,332      |   |
| 2006       |       | 1,248      |       |
| 2007       |       | 1,248      |       |
| 2008       |       | 1,248      |       |
| 2009       |       | 624        |       |
| Thereafter |       | —     |       |
|       |       | $          | 8,700      |   |

 

F-14

----

 

## ***NOTE G—CAPITAL LEASE OBLIGATIONS***

 

The Company leases certainmachinery and equipment under various agreements which are classified ascapital leases.  The leases expire onvarious dates through December 2006. Future minimum payments, by year, are as follows:

 
| **Year**                          | ** ** | **Amount** | ** ** |
|-----------------------------------|------------|------------|------------|
| 2005                              |       | $          | 39         |   |
| 2006                              |       | 116        |       |
|                              |       | 155        |       |
|                              |       |       |       |
| Less amount representing interest |       | 15         |       |
|                              |       | 140        |       |
| Less current maturities           |       | 36         |       |
|                              |       | $          | 104        |   |

 

**NOTEH—RESTRUCTURING CHARGES**

 

**2002 Restructuring Charge**

 

In the fourth quarter of 2002, the Company announced a restructuring plan to rationalize International manufacturing operations.  As part of the plan, various manufacturing operations in the International segment were either consolidated or outsourced.  The management of all International operations was consolidated under the Managing Director, International.  The restructuring charge totaled $1,228.  The major components of the 2002 restructuring charge are as follows:

 
| Employee severance and related benefit cost |   | $     | 163    |   |
|---------------------------------------------|--------|-------|--------|--------|
| Cost associated with vacated facilities     |   | 1,065 |   |
|                                        |   | $     | 1,228  |   |

 

*Severance*—The Company had a reduction of employees in the International operations.  The reduction was associated with the reduced level of manufacturing operations in the International operation going forward.

 

*Cost Associated with Vacated Facilities*—The Company has accrued $1,065 consisting principally of the costs of the remaining payments on leased facilities vacated less anticipated future income from sublease.  All of the facilities are located in the United Kingdom.  The accrual represents additional amounts the Company anticipated to be incurred in addition to those originally accrued in the 2000 and 2001 restructuring.  The additional accrual was necessary due to market conditions in the United Kingdom which made it difficult to sublet the properties.

 

**2003 Restructuring Charge**

 

In the fourth quarter of 2003, the Company further evaluated International operations to improve profitability.  A plan was developed to close a manufacturing facility in International operations by mid-year 2004.  As part of the plan, there is a reduction in the number of employees in the International operations.  The restructuring charge totaled $1,565.  The major components of the 2003 restructuring charge are as follows:

 
| Employee severance and related benefit cost |   | $     | 209    |   |
|---------------------------------------------|--------|-------|--------|--------|
| Cost associated with vacated facilities     |   | 1,356 |   |
|                                        |   | $     | 1,565  |   |

 

*Severance*—The Company had a reduction of 39 employees in the International operations as a result of the decision to consolidate manufacturing operations.

 

F-15

 

*Cost Associated with Vacated Facilities*—The Company has accrued $1,356 consisting principally of the costs to terminate an existing lease agreement and the costs of the remaining payments on a second vacated leased facility less anticipated future income from sublease.  The facilities are located in the United Kingdom.  The accrual represents additional amounts the Company anticipated to be incurred in addition to those originally accrued in the 2000, 2001 and 2002 restructurings.  The additional accrual is necessary due to market conditions in the United Kingdom which have made it difficult to sublet the properties and terminate leases.

 

The restructuring charges weredetermined based on formal plans approved by the Company’s management using thebest information available to it at the time. The amounts the Company may ultimately incur could differ materially asthe restructuring initiative is executed. The changes in the accrual for restructuring charges during 2001, 2002and 2003 are summarized in the table below:

 
| ** **                                                      | ** ** | **Facilities** | ** ** | **Workforce  Reduction** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------------|------------|----------------|------------|--------------------------|------------|-----------|------------|
|                                                            |       |           |       |                     |       |      |       |
| **Restructuring accrual balance at January 1,  2002**           |       | $              | 2,344      |                     | $          | 76        |       | $ | 2,420 |   |
|                                                            |       |           |       |                     |       |      |       |
| Charges to operations in twelve months  ended December 31, 2002 |       | 1,065          |       | 163                      |       | 1,228     |       |
|                                                            |       |           |       |                     |       |      |       |
| Costs incurred in twelve months ended  December 31, 2002        |       | (1,314         | )          | (179                     | )          | (1,493    | )          |
|                                                            |       |           |       |                     |       |      |       |
| **Restructuring accrual balance at December  31, 2002**         |       | $              | 2,095      |                     | $          | 60        |       | $ | 2,155 |   |
|                                                            |       |           |       |                     |       |      |       |
| Charges to operations in twelve months  ended December 31, 2003 |       | 1,356          |       | 209                      |       | 1,565     |       |
|                                                            |       |           |       |                     |       |      |       |
| Costs incurred in twelve months ended  December 31, 2003        |       | (810           | )          | (53                      | )          | (863      | )          |
|                                                            |       |           |       |                     |       |      |       |
| **Restructuring accrual balance at December  31, 2003**         |       | $              | 2,641      |                     | $          | 216       |       | $ | 2,857 |   |
|                                                            |       |           |       |                     |       |      |       |
| Costs incurred in twelve months ended December  31, 2004        |       | (1,804         | )          | (213                     | )          | (2,017    | )          |
|                                                            |       |           |       |                     |       |      |       |
| Adjustment to restructuring accrual  recorded 2004              |       | (690           | )          | —                   |       | (690      | )          |
|                                                            |       |           |       |                     |       |      |       |
| **Restructuring accrual balance at December  31, 2004**         |       | $              | 147        |                     | $          | 3         |       | $ | 150 |   |

 

A credit to restructuringcharge of $690 was recorded in the third quarter of 2004 primarily due to theassignment of the lease of a vacated facility in the United Kingdom at a costless than previously estimated by management. The facility closure costs were originally estimated in the third quarterof 2001.  Due to difficulties innegotiating a lease termination or subletting of the facility, the estimate forthe facility closure costs was subsequently increased in the fourth quarter of2002 and further increased in the fourth quarter of 2003.  In July 2004, the lease on the facility wasassigned for the remaining lease term on more favorable terms than managementhad estimated.

 

F-16

----

 

**NOTEI—INCOME TAXES**

 

The components of income taxexpense (benefit) are as follows:

 
| ** **                         | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current                            |       |     |       |     |       |     |       |
| Federal                            |       | $        | 347        |     | $          | 834      |       | $ | (1,225 | ) |
| State                              |       | 92       |       | 95       |       | 1        |       |
| Foreign                            |       | 105      |       | 32       |       | 324      |       |
|                               |       | 544      |       | 961      |       | (900     | )          |
| Deferred                           |       |     |       |     |       |     |       |
| Federal                            |       | 1,158    |       | (594     | )          | (531     | )     |
| State                              |       | (857     | )          | (155     | )          | 783      |       |
| Foreign                            |       | 892      |       | —   |       | (30      | )          |
|                               |       |     |       |     |       |     |       |
|                               |       | 1,193    |       | (749     | )          | 222      |       |
|                               |       |     |       |     |       |     |       |
| Total income tax expense (benefit) |       | $        | 1,737      |     | $          | 212      |       | $ | (678 | ) |

 

The components of income (loss)before income tax expense were as follows:

 
| ** **    | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|---------------|------------|----------|------------|----------|------------|----------|------------|
| United States |       | $        | 5,146      |     | $          | 4,609    |       | $ | 3,472 |   |
| Foreign       |       | (6,475   | )          | (4,483   | )          | (487     | )          |
|          |       | $        | (1,329     | )        | $          | 126      |       | $ | 2,985 |   |

 

Areconciliation from the U.S. Federal statutory income tax rate to the effectiveincome tax rate for the years ended December 31, is as follows:

 
| ** **                                                          | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                |       |     |       |     |       |     |       |
| U.S. Federal statutory rate                                         |       | (34      | )%         | (34      | )%         | (34      | )%         |
| State income taxes, net of federal tax  benefit                     |       | (5       | )          | (5       | )          | (5       | )          |
| Tax settlement (Note M)                                             |       | —   |       | 15       |       | —   |       |
| Worthless stock deduction                                           |       | —   |       | —   |       | (102     | )          |
| Research and development tax credit                                 |       | —   |       | (360     | )          | —   |       |
| Change in valuation allowance                                       |       | —   |       | —   |       | 4        |       |
| Nondeductible expenses                                              |       | 1        |       | 61       |       | 5        |       |
| Foreign operating losses with no benefit  provided                  |       | 164      |       | 398      |       | —   |       |
| Effect of subsidiaries taxes at other than  the U.S. statutory rate |       | 5        |       | 93       |       | 109      |       |
|                                                                |       | 131      | %          | 168      | %          | (23      | )%         |

 

F-17

----

 

In the second quarter of fiscal2004, the Company commissioned an independent appraisal of a subsidiary in theUnited Kingdom.  This appraisal followsthe Company’s announcement in February 2004 to close the European manufacturingoperations.  Based on the independentappraisal, the Company concluded that the subsidiary was insolvent as of June30, 2004 and therefore met the requirements of an ordinary worthless stockdeduction under the Internal Revenue Code. The amount of the worthless stock deduction is approximately $9,000 witha corresponding federal income tax benefit of approximately $3,000.

 

Significant components of theCompany’s deferred tax assets and liabilities are as follows: 

 
| ** **                                 | ** ** | **2003** | ** ** | **2004** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Assets                                     |       |     |       |     |       |
| Patents                                    |       | $        | 498        |     | $          | 360 |   |
| Allowance for bad debts                    |       | 105      |       | 124      |       |
| Inventory capitalization                   |       | 83       |       | 107      |       |
| Vacation pay                               |       | 360      |       | 408      |       |
| Accrued liabilities and reserves           |       | 238      |       | 634      |       |
| Deferred gain on sale leaseback            |       | 220      |       | 180      |       |
| Restructuring charge                       |       | 1,179    |       | 24       |       |
| Impairment charge                          |       | 4,551    |       | 3,173    |       |
| State tax credits and loss carryforwards   |       | 734      |       | 563      |       |
| Federal tax credits and loss carryforwards |       | —   |       | 1,593    |       |
| Inventory reserves                         |       | —   |       | 351      |       |
| Warranty                                   |       | —   |       | 328      |       |
| Foreign tax credit and loss carryforwards  |       | 5,888    |       | 617      |       |
| Valuation allowance                        |       | (5,888   | )          | (732     | )          |
|                                       |       | 7,968    |       | 7,730    |       |
|                                       |       |     |       |     |       |
| Liabilities                                |       |     |       |     |       |
| State taxes                                |       | 794      |       | —   |       |
| Accelerated depreciation                   |       | 1,021    |       | 1,319    |       |
|                                       |       | 1,815    |       | 1,319    |       |
| Net deferred tax asset                     |       | $        | 6,153      |     | $          | 6,411 |   |

 

The classification of the netdeferred tax asset between current and non-current is as follows:

 
| ** **             | ** ** | **2003** | ** ** | **2004** | ** ** |
|------------------------|------------|----------|------------|----------|------------|
|                   |       |     |       |     |       |
| Net current assets     |       | $        | 876        |     | $          | 1,951 |   |
| Net long-term asset    |       | 5,277    |       | 4,460    |       |
| Net deferred tax asset |       | $        | 6,153      |     | $          | 6,411 |   |

 

At December 31,2004, the Company had approximately $2,058 of international operating loss carryforwards(primarily in Australia and Malaysia) with a potential tax benefit of $617.  These loss carryforwards do not expire.  The Australia and Malaysia operations havehighly concentrated customers in the telecommunications industry.  The telecommunications industry in thisgeographic region has been depressed since 2001.  Management evaluated the customer base and stateof the telecommunications industry and concluded that there was significantuncertainty regarding realization of a tax benefit.  The Company has recorded a 100 % valuationallowance at December 31, 2003 and 2004 on the deferred tax asset relating tothe foreign net

 

F-18

----

 

operating losscarryforwards because of uncertainty regarding its realization.  The ultimate realization of the remainingdeferred tax assets is dependent upon the generation of future taxable incomeduring the periods in which those temporary differences become deductible.  Management considers projected future taxableincome and tax planning strategies in making this assessment.  Based on the historical domestic taxableincome and projections for future taxable income over periods that the deferredassets are deductible, management believes it is more likely than not that theCompany will realize the benefits of these deductible differences, net ofvaluation allowances as of December 31, 2004. The amount of the deferred tax assets considered realizable, however,could materially change in the near future if estimates of future taxableincome during the carryforward period are changed.

 

**NOTEJ—STOCKHOLDERS’ EQUITY**

 

In July 1996, the Companyadopted the 1996 Incentive Stock Plan (the 1996 Stock Plan), under which it wasauthorized to issue non-qualified stock options and incentive stock options tokey employees, directors and consultants to purchase up to an aggregate of 750shares of the Company’s common stock. The options have a term of ten years and generally become fully vestedby the end of the third year.  In May1999, the 1996 Stock Plan was amended to increase the authorized number ofshares to 1,500.

 

In January, 2003, the Board of Directors approved anoffer allowing current employees and non-employee directors to exchange all oftheir outstanding options granted under the 1996 Stock Plan for new options tobe granted under the 2003 Stock Plan or any other stock option plan that may beadopted by the Company. The 2003 Incentive Stock Plan was approved at theAnnual Meeting of Stockholders on April 25, 2003.  The authorized shares under the 2003Incentive Stock Plan are 3,100.

 

A total of 1,327 options to purchase shares of theCompany were accepted for exchange and cancelled on March 20, 2003.  On September 24, 2003, a total of 1,324 newoptions were exchanged for options cancelled in March, 2003.

 

Eligible optionholders who participated in the offer received a new option on the new grantdate in exchange for each old option that was validly tendered and accepted forexchange.  The number of shares coveredby each new option was equal to the number of shares covered by the oldoptions, and the vested status and vesting schedule of the old options waspreserved and continued.  The exerciseprice of the new options was equal to the closing sale price of the Company’scommon stock as reported on the Nasdaq National Market on the grant date of thenew options.

 

Plan transactions are asfollows:

 
| ** **                                  | ** ** | **2002**   | ** ** | **2003**                               | ** ** | **2004**   | ** ** |
|---------------------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **Shares** | ** ** | **Weighted  average  exercise  price** | ** ** | **Shares** | ** ** | **Weighted  average  exercise  price** | ** ** | **Shares** | ** ** | **Weighted  average  exercise  price** | ** ** |
|                                        |       |       |       |                                   |       |       |       |   |   |   |   |   |   |
| Options outstanding January 1,              |       | 1,092      |       | $                                      | 9.78       |       | 917        |   | $ | 10.24 |   | 1,894 |   | $ | 4.95 |   |
| Granted                                     |       | 28         |       | 4.09                                   |       | 2,336      |       | 4.71 |   | 213 |   | 4.80 |   |
| Exercised                                   |       | (100       | )          | 3.22                                   |       | (3         | )          | 3.28 |   | (61 | ) | 4.84 |   |
| Cancelled                                   |       | (103       | )          | 10.47                                  |       | (1,356     | )          | 8.12 |   | (19 | ) | 4.96 |   |
| Options outstanding December 31,            |       | 917        |       | $                                      | 10.24      |       | 1,894      |   | $ | 4.95 |   | 2,027 |   | $ | 4.94 |   |
|                                        |       |       |       |                                   |       |       |       |   |   |   |   |   |   |
| Options available for grant at December 31, |       | 451        |       |                                   |       | 2,571      |       |   |   | 2,377 |   |   |   |

 

F-19

----

 

Weighted average fair values ofoptions granted during the years are as follows:

 
| ** **                                             | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                   |       |     |       |     |       |     |       |
| Exercise price is below market price at  date of grant |       | —   |       | —   |       | —   |       |
| Exercise price equals market price at date  of grant   |       | $        | 4.09       |     | $          | 4.71     |       | $ | 4.80 |   |
|                                                        |            |          |            |          |            |          |            |  |  |  |

 

The following informationapplies to options outstanding at December 31, 2004:

 
| **Range of exercise prices** | ** ** | **Number  outstanding** | ** ** | **Weighted  average  remaining  contractual  life (years)** | ** ** | **Weighted  average  exercise  price** | ** ** |
|------------------------------|------------|-------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------|------------|
| $3.16 - $3.60                |       | 60                      |       | 7                                                           |       | $                                      | 3.33       |   |
| $4.15 -  $4.86               | 1,870      |                    | 9          |                                                        | 4.70       |                                   |
| $6.50 - $13.75               |       | 97                      |       | 5                                                           |       | 10.45                                  |       |
|                         |       | 2,027                   |       | 9                                                           |       | $                                      | 4.94       |   |

 

At December 31, 2004, 1,136 ofthe 2,027 options outstanding were exercisable by the optionee.

At December 31, 2003, 815 ofthe 1,894 options outstanding were exercisable by the optionee.

 

**NOTEK—RETIREMENT PLAN**

 

The Company established aretirement plan in accordance with section 401(k) of the Internal Revenue Code.Under the terms of this plan, eligible employees may make voluntarycontributions to the extent allowable by law. Employees of the Company are eligible after 90 days of employment.  Matching contributions by the Company to thisplan are discretionary and will not exceed that allowable for Federal incometax purposes.  The Company’scontributions are vested over five years in equal increments.  The accompanying statements of operationsinclude contribution expense of $0, $134 and $181 for the years ended December31, 2002, 2003 and 2004, respectively.

 

**NOTEL—RELATED PARTY TRANSACTIONS**

 

TheCompany has two leases for approximately 261,000 square feet of manufacturing,warehouse and office space in Temecula, California, with William H. Channell,Sr., a principal stockholder and Chairman of the Board of the Company. The termof the first lease is through December 31, 2005, with two five-year renewaloptions. Additionally, an adjacent 100,000 square foot building was constructedand completed in 1996. Subsequent to December 31, 1996, the Company guaranteeddebt of Mr. Channell, Sr. of approximately $754 incurred in connection withconstruction of the building.  The loanamount subject to the guarantee is expected to decline before expiring in 2017.  At December 31, 2004, the outstanding loanbalance subject to the guarantee totaled $583. It is not practicable to estimate the fair value of the guarantee;however, the Company does not anticipate that it will incur losses as a resultof this guarantee. This building is also being leased from Mr. Channell, Sr.through 2005, with two five-year renewal options. Both leases provide forpayments of insurance, repairs, maintenance and property taxes.  Rent expense paid under the leases was$1,253, $1,284 and $1,305 for the years ended

 

F-20

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December31, 2002, 2003 and 2004, respectively. The Company believes that at the time the leases were consummated, theterms of these leases were no less favorable to the Company than could havebeen obtained from an independent third party.

 

If the principal stockholderwere to default on the outstanding loan balance, the Company may 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 stockholder. At December 31, 2004, the outstanding loan balance subject to theguarantee totaled $583.

 

In January, 2001,the Company guaranteed personal debt of William H. Channell, Jr., the Company’sPresident and Chief Operating Officer of $650. The guarantee was terminated in March 2002.  In connection with this guarantee, William H.Channell, Jr. paid the Company a fee equal to 1% of the loan balance andprovided as collateral to the Company 300,000 shares of Company stock.

 

The Companypurchased insurance through Talbot Agency Inc. in 2002, 2003, and 2004.  Roy H. Taylor, President of Talbot AgencyInc. is a co-trustee of the Taylor Family Trust, a beneficial owner of morethan 5% of the Company’s outstanding stock. The total premiums and fees paid for insurance obtained through theTalbot Agency for the years ended December 31, 2002, 2003 and 2004 was $253,$45 and $44 respectively, which included commissions earned.

 

In May, 2002, the Company soldits RF line of passive electronic devices to RMS Communications, Inc., which isowned by Gary Napolitano, a former officer of the Company.  A sale in the amount of $800 was recorded.RMS Communications, Inc. paid the Company $125 in cash at the time of sale, andthe remaining $675 is payable in monthly installments through June 30, 2003,bearing interest at 7% per annum.  Theaccount is currently in arrears.  Theamount due from RMS Communications, Inc. included in accounts receivable atDecember 31, 2004 is $251.  The Companyhas security interest in the inventory and a personal guarantee from Mr.Napolitano and believes the amount will be paid in full.  The Company continues to purchase RF devicesfrom Mr. Napolitano and from other sources depending on price and supply ofproduct.  The RF devices purchased fromMr. Napolitano’s firm in 2004 approximated $87 and were used as components inthe Company’s product lines.  The purchasesin 2004 did not result in a cash payment to Mr. Napolitano as the amounts owedwere used to offset the accounts receivable.

 

The Company paid $73 and $76 in2003 and 2004, respectively, to Carolyn Channell for consulting services.  Mrs. Channell is the wife of William H. Channell, Jr., the Company’sPresident and Chief Executive Officer.  Mrs. Channell consults on insurance coverage matters for the Company.

 

TheCompany has facilities in Orange, Dalby, Terang and Adelaide Australia that areleased from shareholders of the Company. These shareholders are former owners of Bushman Tanks.  The facilities comprise 94,000 square feet ofmanufacturing, warehouse and office space. The rent expense paid in the five months of August to December 2004 was$136.  The Company hired an independentfirm to appraise the market lease rates for these facilities and it wasdetermined that the existing leases are in excess of fair market value byapproximately $27 per year.  Included inthe liabilities assumed in the Bushman Tanks acquisition is $215 related tothese unfavorable leases (Note Q).

 

F-21

----

 

### **NOTE M—COMMITMENTS AND CONTINGENCIES**

### ** **

*Leases**—***The Company leases manufacturingand office space and machinery & equipment under several operating leasesexpiring through 2012.  Rent expenseunder all operating leases amounted to $2,325, $2,212, and $2,685 for the yearsended December 31, 2002, 2003 and 2004, respectively.  Total future minimum rental payments undernoncancellable operating leases as of December 31, 2004, including theoperating leases with the related parties discussed in Note L are as follows:

 
| **Year**   | ** ** | **Amount** | ** ** |
|------------|------------|------------|------------|
|       |       |       |       |
| 2005       |       | $          | 2,676      |   |
| 2006       |       | 1,108      |       |
| 2007       |       | 1,057      |       |
| 2008       |       | 1,073      |       |
| 2009       |       | 1,073      |       |
| Thereafter |       | 1,913      |       |
|       |       | $          | 8,900      |   |

 

In addition to these minimumrental commitments, certain of these operating leases provide for payments ofinsurance, repairs and maintenance and property taxes.

 

In June, 2002, the Companyentered into a sale and leaseback agreement for a warehouse facility located inTemecula, California.  The proceeds fromthe sale totaled approximately $6,200 and resulted in a pretax deferred gain of$604.  The resulting lease is beingaccounted for as an operating lease.  Thelease base term is ten years with two five-year options at rental amounts to beadjusted to the fair market rental value at the end of the base term.  A portion of the proceeds from the sale wasused to pay the outstanding mortgage balance on the facility of $4,036.  In fiscal 2002, the Company recorded incomeof $30 related to the amortization of the deferred gain leaving an unamortizedbalance of $574 at December 31, 2002.  In2003, the Company recorded income of $61 related to the amortization of thedeferred gain leaving an unamortized balance is $513 at December 31, 2003.  In 2004, the Company recorded income of $60related to the amortization of the deferred gain leaving an unamortized balanceof $453 at December 31, 2004.

 

*Employment Agreements****—***The Company in December, 2003 enteredinto a five year employment agreement, renewable every five years, with WilliamH. Channell, Jr.   Mr. Channell, Jr.’sannual salary is $746 effective July 2004, subject to an annual cost of livingadjustment.  Mr. Channell, Jr. isentitled to participate in the Stock Plan, the 401(k) Plan and the IncentiveCompensation Plan.  Mr. Channell, Jr. isalso entitled to certain other benefits paid for by the Company, including anautomobile allowance, health insurance and sick leave, in accordance with theCompany’s customary practices for senior executive officers.    In the event that the Company were toterminate Mr. Channell, Jr. without cause (as defined in the agreement), or Mr.Channell, Jr. were to terminate his employment for good reason (also as definedin the agreement and including, without limitation, a change of control of theCompany), then Mr. Channell, Jr. would be entitled to a lump sum payment equalto three times his then current base salary, all health and life insurancebenefits for three years, and accelerated vesting of any stock options orrestricted stock granted to him.

 

The Company amended in December, 2003 the employmentagreement with Mr. Channell, Sr. originally entered into in July, 1996.  Mr. Channell, Sr.’s annual salary starting inDecember, 2003 is $50.  Mr. Channell,Sr.’s benefits include (i)  during theterm of the agreement, the payment of premiums for a term disability policyproviding for $250 in annual benefits in the case of his temporary or permanentdisability, (ii) during the lifetime of Mr. Channell, Sr. and his wife,Jacqueline M. Channell, medical insurance for each of Mr. and Mrs. Channellcomparable to that provided to the Company’s senior executive officers,  (iii) during Mr. Channell, Sr.’s lifetime, aportion of the premiums on a $1,500 life insurance policy owned by Mr.Channell, Sr., under which Mrs. Channell is the beneficiary, and (iv) anautomobile allowance.

 

F-22

----

 

*Taxes**—***TheFederal income taxes of the Company for the years ended December 31, 1997,1998, 2000, and 2001 are currently under examination by the Internal RevenueService (IRS).  In July 2002, the IRSissued the proposed result of their examination for the years ended December31, 1997 and 1998, which increases the 1997 income tax amount due by $315related to transfer pricing for sales to the Company’s Canadiansubsidiary.  In November 2003, the IRSagreed to reduce the transfer pricing assessment for the 1997 and 1998 taxyears to $19 which was accrued at December 31, 2003.  Management believes that the ultimate outcomeof IRS audits for the years ended 2000 and 2001 will not have a materialadverse impact on the Company’s consolidated results of operations or financialposition.

 

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

 

**NOTEN—CREDIT CONCENTRATIONS AND MAJOR CUSTOMERS**

 

The Company maintains cashbalances in financial institutions located in the United States, Canada,Australia and the United Kingdom.  Cashbalances held in financial institutions in the U.K. totaled $343 and $122 atDecember 31, 2003 and 2004, respectively. Cash balances held in financial institutions in Australia totaled $2,539and $3,168 at December 31, 2003 and 2004, respectively.  Cash balances held in financial institutionsin Canada was not significant at December 31, 2003 and 2004.  Cash balances held in financial institutionslocated in the United States may, at times, exceed federally insuredlimits.  The Company has not experiencedany losses in such accounts and believes it is not exposed to any significantcredit risk on cash and cash equivalents.

 

The telecommunications industryis the largest industry the Company operates in and is highlyconcentrated.  A relatively small numberof customers account for a large percentage of the Company’s available market.  Consequently, the Company’s five largestcustomers accounted for 57.2%, 57.7% and 48.7% of the Company’s total net salesin 2002, 2003, and 2004, respectively. Verizon accounted for 21.7% of the Company’s total net sales in 2004 and10.5% of the Company’s net sales in 2003. Comcast accounted for 14.6% of the Company’s net sales in 2004.  Mergers and acquisitions in thetelecommunications industry, which are expected to continue, not only increasethe concentration of the industry and of the Company’s customer base, but alsofrom time to time delay customers’ capital expenditures as newly mergedservices providers consolidate their operations.  In the event one of the Company’s majorcustomers were to terminate purchases of the Company’s products, the Company’soperating results would be adversely affected.

 

F-23

----

 

**NOTEO—SEGMENT AND GEOGRAPHIC INFORMATION**

 

There are two segments:  Americas and International.  Americas includes the United States, Centraland South America and Canada.  The followingtables summarize segment information:

 
| ** **                           | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenues from unrelated entities(1): |       |     |       |     |       |     |       |
| Americas(2)                          |       | $        | 69,963     |     | $          | 64,793   |       | $ | 72,379 |   |
| International                        |       | 14,822   |       | 11,744   |       | 27,755   |       |
|                                 |       | $        | 84,785     |     | $          | 76,537   |       | $ | 100,134 |   |
| Income (loss) from operations:       |       |     |       |     |       |     |       |
| Americas                             |       | $        | 6,995      |     | $          | 4,570    |       | $ | 3,517 |   |
| International                        |       | (6,325   | )          | (3,873   | )          | (43      | )          |
|                                 |       | $        | 670        |     | $          | 697      |       | $ | 3,474 |   |
| Interest income:                     |       |     |       |     |       |     |       |
| Americas                             |       | $        | 89         |     | $          | 18       |       | $ | 13 |   |
| International                        |       | —   |       | 104      |       | 116      |       |
|                                 |       | $        | 89         |     | $          | 122      |       | $ | 129 |   |
|                                 |       |     |       |     |       |     |       |
| Interest expense:                    |       |     |       |     |       |     |       |
| Americas                             |       | $        | 1,663      |     | $          | 111      |       | $ | 225 |   |
| International                        |       | 425      |       | 582      |       | 393      |       |
|                                 |       | $        | 2,088      |     | $          | 693      |       | $ | 618 |   |

 
| Income tax expense (benefit):     |   |   |   |   |   |   |   |
|-----------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Americas                          |   | $      | 1,737  |   | $      | 214    |   | $ | (1,012 | ) |
| International                     |   | — |   | (2     | )      | 334    |   |
|                              |   | $      | 1,737  |   | $      | 212    |   | $ | (678 | ) |
|                              |   |   |   |   |   |   |   |
| Identifiable assets:              |   |   |   |   |   |   |   |
| Americas(6)                       |   | $      | 40,060 |   | $      | 40,949 |   | $ | 43,335 |   |
| International(3)(4)(5)            |   | 14,103 |   | 13,016 |   | 35,563 |   |
|                              |   | $      | 54,163 |   | $      | 53,965 |   | $ | 78,898 |   |
|                              |   |   |   |   |   |   |   |
| International change in goodwill: |   |   |   |   |   |   |   |
| Balance January 1,                |   | $      | 966    |   | $      | — |   | $ | — |   |
| Goodwill acquired                 |   | — |   | — |   | 12,442 |   |
| Impairment charge                 |   | (966   | )      | — |   | — |   |
| Foreign currency translation      |   | — |   | — |   | 1,623  |   |
| Balance December 31,              |   | $      | — |   | $      | — |   | $ | 14,065 |   |
|                              |   |   |   |   |   |   |   |
| Depreciation and amortization:    |   |   |   |   |   |   |   |
| Americas                          |   | $      | 6,011  |   | $      | 4,958  |   | $ | 3,738 |   |
| International                     |   | 1,774  |   | 1,274  |   | 1,014  |   |
|                              |   | $      | 7,785  |   | $      | 6,232  |   | $ | 4,752 |   |
|                              |   |   |   |   |   |   |   |
| Capital expenditures:             |   |   |   |   |   |   |   |
| Americas                          |   | $      | 1,346  |   | $      | 790    |   | $ | 2,865 |   |
| International                     |   | 540    |   | 413    |   | 416    |   |
|                              |   | $      | 1,886  |   | $      | 1,203  |   | $ | 3,281 |   |
|                                   |        |        |        |        |        |        |        |  |  |  |  |  |  |

 

F-24

----

 

----

(1)          Inter-geographic revenues were not significant.  Revenues from external customers from anyindividual foreign country did not exceed 10% of total revenue.

(2)          Includes export sales from the United States of approximately $1,476,$611 and $1,963 in 2002, 2003 and 2004, respectively.

(3)          Includes long-lived assets in the United Kingdom of $5,582, $2,520 and$5 in 2002, 2003 and 2004, respectively.

(4)          Includes long-lived assets in Australia of $2,581, $2,419 and $5,513 in2002, 2003 and 2004, respectively.

(5)          Includes goodwill of $14,065 and non-compete agreement of $1,763 in2004.

(6)          Includes goodwill of $504, $613, and $659 in 2002, 2003 and 2004,respectively.  The change in goodwillrelates to foreign currency translation adjustment.

 

The Company had revenues fromexternal customers from the following product lines:

 
| ** **             | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|------------------------|------------|----------|------------|----------|------------|----------|------------|
|                   |       |     |       |     |       |     |       |
| Enclosures             |       | $        | 65,748     |     | $          | 60,308   |       | $ | 58,748 |   |
| Water related products |       | 7,035    |       | 6,986    |       | 30,203   |       |
| Connectivity           |       | 10,525   |       | 8,169    |       | 9,797    |       |
| Other                  |       | 1,477    |       | 1,074    |       | 1,386    |       |
|                   |       |     |       |     |       |     |       |
| Total                  |       | $        | 84,785     |     | $          | 76,537   |       | $ | 100,134 |   |
|                        |            |          |            |          |            |          |            |  |  |  |  |

 

F-25

----

 

**NOTEP—QUARTERLY FINANCIAL DATA (Unaudited)**

 

Summarized quarterly financialdata for 2002, 2003 and 2004 follows:

 
| ** **                 | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|----------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| 2002                       |       |               |       |                |       |               |       |                |       |
| Net sales                  |       | $                  | 19,841     |                | $          | 25,823             |       | $                   | 19,401     |   | $ | 19,720 |   |
| Gross profit               |       | 6,482              |       | 9,988               |       | 5,435              |       | 5,430               |       |
| Net income (loss)(1)       |       | 496                |       | 820                 |       | 150                |       | (4,532              | )          |
| Income (loss) per share(1) |       |               |       |                |       |               |       |                |       |
| Basic                      |       | 0.05               |       | 0.09                |       | 0.02               |       | (0.50               | )          |
| Diluted                    |       | 0.05               |       | 0.09                |       | 0.02               |       | (0.50               | )          |
|                            |            |                    |            |                     |            |                    |            |                     |            |  |  |  |  |

 
| ** **                 | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|----------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| 2003                       |       |               |       |                |       |               |       |                |       |
| Net sales                  |       | $                  | 16,218     |                | $          | 20,285             |       | $                   | 19,434     |   | $ | 20,600 |   |
| Gross profit               |       | 4,482              |       | 6,449               |       | 5,515              |       | 6,131               |       |
| Net income (loss)(2)       |       | (288               | )          | 1,068               |       | 535                |       | (1,401              | )          |
| Income (loss) per share(2) |       |               |       |                |       |               |       |                |       |
| Basic                      |       | (0.03              | )          | 0.12                |       | 0.06               |       | (0.15               | )          |
| Diluted                    |       | (0.03              | )          | 0.12                |       | 0.06               |       | (0.15               | )          |
|                            |            |                    |            |                     |            |                    |            |                     |            |  |  |  |  |

 
| ** **       | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| 2004             |       |               |       |                |       |               |       |                |       |
| Net sales        |       | $                  | 17,720     |                | $          | 21,303             |       | $                   | 27,615     |   | $ | 33,496 |   |
| Gross profit     |       | 5,344              |       | 5,928               |       | 7,896              |       | 8,815               |       |
| Net income       |       | 14                 |       | 917                 |       | 2,218              |       | 347                 |       |
| Income per share |       |               |       |                |       |               |       |                |       |
| Basic            |       | 0.00               |       | 0.10                |       | 0.24               |       | 0.04                |       |
| Diluted          |       | 0.00               |       | 0.10                |       | 0.24               |       | 0.04                |       |
|                  |            |                    |            |                     |            |                    |            |                     |            |  |  |  |  |

 

----

(1)          In the fourth quarter of 2002, the Companyrecorded a restructuring charge of $1,228 (see Note H). The Company alsorecorded asset impairment charges totaling $1,665 (see Note D), a charge forproduction tooling of $489 (see Note D), and a charge for goodwill impairmenttotaling $966 (see Note B).

(2)          In the fourth quarter of 2003, the Companyrecorded a restructuring charge of $1,565 (see Note H). The Company alsorecorded asset impairment charges totaling $1,238 (see Note D).

 

**NOTEQ—ACQUISITION**

 

On August 2, 2004, the Company,through a majority-owned subsidiary, acquired a controlling interest in BushmanTanks, a manufacturer and distributor of rotational molded plastic(polyethylene) water storage tanks.  BushmanTanks operates out of four leased facilities in Australia, located in Dalby,Orange, Terang, and Adelaide.  Thepurchase price was $16,838.  Theagreement provides for contingent consideration of $2,800.  If paid, the contingent consideration shallresult in an additional element of cost of the acquired entity.  In the event that the Bushman Tanks businessachieves specified sales targets in 2005 and 2006, $1,400 is payable to thesellers. In addition, $1,400 may be paid to the sellers if certain cost reductiontargets are achieved.  The sellers willreceive one-half of the amounts of

 

F-26

----

 

the cost reductions in thespecified cost items that are achieved between 2005 through 2009.  In the event that the cost incurred for theseitems exceeded a predetermined threshold, the seller would be liable to theCompany for the amount of the cost exceeding the threshold.  The purchase agreement includes a workingcapital adjustment based on the April 30, 2004 working capital amounts. Theamount of the adjustment at present is not finalized. The working capitaladjustment as presently estimated by management has been included in the$16,838 purchase price. The final working capital adjustment will result in achange to goodwill and the amount of consideration to the sellers.

 

Consideration for theacquisition of $16,838 consisted of $8,016 in cash contributed by the Company,175,113 shares of the Company’s common stock valued at $714, a $5,520 term loanfrom The National Australia Bank Ltd, and $2,588 in cash contributed by ANZPrivate Equity, a unit of Australia and New Zealand Banking Group Ltd. As aresult of the transaction, the Company acquired a 75% equity interest inBushman Tanks, and ANZ Private Equity acquired the remaining 25%. In addition,the Company incurred direct acquisition costs of $758.

 

The Bushman Tanks acquisitionhas been accounted for using the purchase method of accounting and,accordingly, the assets acquired and liabilities assumed have been recorded attheir estimated fair values based upon preliminary estimates as of theacquisition date. Further adjustments to the acquired assets and assumedliabilities will be made following more detailed reviews by management oftangible assets acquired and liabilities assumed. Changes in the estimated fairvalue of acquired assets and assumed liabilities will be reflected as a changein the allocated fair value of the identifiable tangible and intangible assetsand liabilities and goodwill in the period in which this determination is made,which management expects to be by March 31, 2005.  The results of operations of Bushman Tanksare included in the Consolidated Statement of Operations from the date ofacquisition (August 2, 2004).

 

The following table summarizesthe estimated fair value of the assets acquired and liabilities assumed in theBushman Tanks acquisition at August 2, 2004:

 
| ** **                          | ** ** | **Allocated  Purchase  Price** | ** ** |
|-------------------------------------|------------|--------------------------------|------------|
| Acquired assets:                    |       |                           |       |
| Cash                                |       | $                              | 99         |   |
| Receivables, net                    |       | 2,211                          |       |
| Inventories                         |       | 2,399                          |       |
| Other assets                        |       | 88                             |       |
| Deferred taxes                      |       | 401                            |       |
| Property, plant, and equipment, net |       | 3,089                          |       |
| Goodwill                            |       | 12,442                         |       |
| Intangible non-compete              |       | 1,600                          |       |
| Total Assets                        |       | 22,329                         |       |
|                                |       |                           |       |
| Assumed liabilities:                |       |                           |       |
| Accounts payable                    |       | 3,109                          |       |
| Short term debt                     |       | 35                             |       |
| Accrued liabilities                 |       | 1,589                          |       |
| Total liabilities                   |       | 4,733                          |       |
|                                |       |                           |       |
| Purchase price                      |       | 16,838                         |       |
| Direct cost of acquisition          |       | 758                            |       |
| Net assets acquired                 |       | $                              | 17,596     |   |

 

F-27

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The followingunaudited pro forma financial information reflects the consolidated results ofoperations of the Company as if the acquisition of Bushman Tanks had takenplace on January 1, 2003.  The pro formainformation includes the historical operations of the Company and Bushman Tanks(translated at the average currency exchange rate for the applicable period)and gives effect to the acquisition as if it had occurred at the beginning ofthe applicable period.  The pro formafinancial information is based upon available information and assumptions andadjustment that the Company believes are reasonable.  The pro forma financial information does notpurport to represent what our results of operations actually would have beenhad the transaction been effected on the assumed date.

 

***Amounts in thousands, except per share data***

 
| ** **           | ** ** | **2003  Pro Forma** | ** ** | **2004  Pro Forma** | ** ** |
|----------------------|------------|---------------------|------------|---------------------|------------|
|                 |       |                |       |                |       |
| Net Sales            |       | $                   | 103,866    |                | $          | 117,567 |   |
|                 |       |                |       |                |       |
| Net income           |       | $                   | 680        |                | $          | 3,198 |   |
|                 |       |                |       |                |       |
| Net income per share |       |                |       |                |       |
| Basic                |       | $                   | 0.07       |                | $          | 0.34 |   |
|                 |       |                |       |                |       |
| Diluted              |       | $                   | 0.07       |                | $          | 0.34 |   |
|                      |            |                     |            |                     |            |  |  |  |

 

F-28

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**CHANNELL COMMERCIAL CORPORATION**

 

**SCHEDULEII**

 

**VALUATION AND QUALIFYING ACCOUNTS**

 

*(Amounts in thousands)*

 
| **Column A**                  | ** ** | **Column B**                         | ** ** | **Column C**                       | ** ** | ** **                      | ** ** | ** **                          | ** ** |
|-------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                    | ** ** | ** **                           | ** ** | **Additions**                      | ** ** | **Column D**                    | ** ** | **Column E**                        | ** ** |
| ** **                    | ** ** | **Balance at  Beginning of  Period** | ** ** | **Charged to  Cost and  Expenses** | ** ** | **Charged to  Other  Accounts** | ** ** | **Write-offs and  Deductions, Net** | ** ** | **Balance at  End of  Period** | ** ** |
|                          |       |                                 |       |                               |       |                            |       |                                |       |   |   |   |   |
| Accounts receivables reserves |       | (2004)                               |       | $                                  | 356        |                            | $          | 1,542                               |       | $ | 65 |   | $ | (1,523 | ) | $ | 440 |   |
|                          |       | (2003)                               |       | 623                                |       | (232                            | )          | —                              |       | (35 | ) | 356 |   |
|                          |       | (2002)                               |       | 102                                |       | 2,065                           |       | —                              |       | (1,544 | ) | 623 |   |
|                          |       |                                 |       |                               |       |                            |       |                                |       |   |   |   |   |
| Inventory valuation reserve   |       | (2004)                               |       | $                                  | 836        |                            | $          | 735                                 |       | $ | 89 |   | $ | (409 | ) | $ | 1,251 |   |
|                          |       | (2003)                               |       | 340                                |       | 569                             |       | —                              |       | 73 |   | 836 |   |
|                          |       | (2002)                               |       | 38                                 |       | 302                             |       | —                              |       | — |   | 340 |   |

 

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**GLOSSARYOF TERMS**

 

*ADSL (Asymmetric Digital Subscriber Line): *A standard allowingdigital broadband signals and standard telephone service to be transmitted upto 12,000 feet over a twisted copper pair.

 

*Broadband: *Transmissionrates in excess of 1.544 mega bits per second typically deployed for deliveryof high-speed data, video and voice services. Also, a system for distributingtelevision programming by a cable network rather than by broadcastingelectromagnetic radiation.

 

*Cat-5* (*Category 5*):  Network cabling that consists of four twistedpairs of copper wire terminated by data rated connectors.  Cat-5 cabling supports frequencies up to 100MHz and speeds up to 1000 Mbps.

 

*Cable Modem:* Electronic transmission device placed on the broadband network, locatedat end user locations, providing two-way, high-speed data service capability,including internet access for subscribers.

 

*Coaxial Cable:* The most commonly used means of transmitting cable televisionsignals.  It consists of a cylindricalouter conductor (shield) surrounding a center conductor held concentrically inplace by an insulating material.

 

*DLC (Digital Loop Carrier):*  Telecommunications transmission technologywhich multiplexes multiple individual voice circuits onto copper or fibercables.

 

*DSL (Digital Subscriber Line):* Genericdescriptor covering various versions of DSL services delivered over copperwires.  Included are HDSL and ADSLservices.

 

*Fiber Node:* Refers to the equipment that terminates the fiber cables originatingfrom the host digital terminal.  Thisnetwork element converts the optical signals to their coax electrical, RFequivalents.  Synonymous with opticalnetwork interface (ONI).

 

*Fiber Optics:* The process of transmitting infrared and visible light frequenciesthrough a low-loss glass fiber with a transmitting laser or LED and a photodiode receiver.

 

*FTTC (Fiber-To-The-Curb):*  In a long distance network consisting offiber optics, fiber-to-the-curb refers to the fiber optics running from thedistribution plant to the curb, at which point copper is used for the curb-to-homeconnection.

 

*FTTP (Fiber-To-The-Premise):*  In a long distance network consisting offiber optics, fiber-to-the-curb refers to the fiber optics running from thedistribution plant to the customer premise, which may be the curb or theoutside wall of the premise, at which point copper is used for the remainingconnection.

 

*HDSL (High bit rate Digital Subscriber Line):*  By using sophisticated coding techniques, alarge amount of information may be transmitted over copper.  The HDSL scheme uses such coding over fourcopper wires and is primarily intended for high capacity bi-directionalbusiness services.

 

*Headend:* The primary transmission point in a cable system supplying the hubs andtrunk cables.

 

*HFC (Hybrid Fiber Coax):*  A type of distribution plant that utilizesfiber optics to carry service from a CO to the carrier serving area, thencoaxial cable within the CSA to or close to the individual residences.

 

*ONU (Optical Network Unit):*  The curb mounted electronics device whichconverts fiber optic signals to electrical for service delivery or copperwires.

 

*PCS (Personal Communications Services):*  Any service offered on a personalcommunications network.  These includebasic telephone, voice mail, paging and others. Personal communications networks operate in the 1800-2000 mHz range,utilizing low power cells compared to traditional cellular technology.

 

*RBOC (Regional Bell Operating Company):*  A term for the regional holding companiescreated when AT&T divested the Bell operating companies.

 

*RF (Radio Frequency):*  An electromagnetic wave frequencyintermediate between audio frequencies and infrared frequencies used especiallyin wireless telecommunications and broadband transmission.

 

*VoIP (Voice over Internet Protocol):*Atechnology that allows you to make telephone calls using a broadband Internetconnection instead of a regular (or analog) phone line.

 

G-1

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this Form 10-K Annual Report to be signed on its behalf by theundersigned, thereunto duly authorized, in the City of Temecula, State ofCalifornia, on March 18, 2005.

 
|   | CHANNELL  COMMERCIAL CORPORATION |
|--------|----------------------------------|
|   |                             | a Delaware corporation |
|   |                             |   |
|   |                             |   |
|   | By                               |   /s/ William  H. Channell, Sr. |   |
|   |                             | William H. Channell, Sr. |
|   |                             | Chairman of the Board |

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, this Form 10-K AnnualReport has been signed by the following persons in the capacities indicated belowas of March 18, 2005.

 

 
| **Signature**                            |   |   | **Capacity  in Which Signed**                                   |
|------------------------------------------|--------|--------|-----------------------------------------------------------------|
|                                     |   |   |                                                            |
|                                     |   |   |                                                            |
|  /s/ William  H. Channell, Sr. |   |   | Chairman of  the Board and Director                             |
| William H.  Channell, Sr.                |   |   |                                                            |
|                                     |   |   |                                                            |
|                                     |   |   |                                                            |
|  /s/ William H. Channell, Jr.  |   |   | President  and Chief Executive Officer and Director             |
| William H.  Channell, Jr.                |   |   | (Principal  Executive Officer)                                  |
|                                     |   |   |                                                            |
|                                     |   |   |                                                            |
|  /s/ Jacqueline  M. Channell   |   |   | Secretary  and Director                                         |
| Jacqueline  M. Channell                  |   |   |                                                            |
|                                     |   |   |                                                            |
|                                     |   |   |                                                            |
|  /s/ Guy  Marge                |   |   | Director                                                        |
| Guy Marge                                |   |   |                                                            |
|                                     |   |   |                                                            |
|                                     |   |   |                                                            |
|  /s/ Dana  Brenner             |   |   | Director                                                        |
| Dana Brenner                             |   |   |                                                            |
|                                     |   |   |                                                            |
|                                     |   |   |                                                            |
|  /s/ David  Iannini            |   |   | Director                                                        |
| David  Iannini                           |   |   |                                                            |
|                                     |   |   |                                                            |
|                                     |   |   |                                                            |
|  /s/ Stephen  Gill             |   |   | Director                                                        |
| Stephen Gill                             |   |   |                                                            |
|                                     |   |   |                                                            |
|                                     |   |   |                                                            |
|  /s/ Scott  Kiefer             |   |   | Corporate  Controller and interim Chief Financial Officer       |
| Scott Kiefer                             |   |   | (Principal  Financial Officer and Principal Accounting Officer) |

 

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