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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2002
 
OR
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                          to                         
 
Commission File No. 0-28582
 
 
CHANNELL COMMERCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
 
Delaware
(State or other jurisdiction of incorporation or organization)
 
95-2453261
(I.R.S. Employer Identification No.)
 
26040 Ynez Road, Temecula, California
(Address of principal executive offices)
 
92591
(Zip Code)
 
(909) 719-2600
(Registrant’s telephone number, including area code)
 
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter 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 x  No ¨
 
9,024,993 shares of common stock of the Registrant were outstanding at June 30, 2002.
 

 
CHANNELL COMMERCIAL CORPORATION
 
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(amounts in thousands, except per share data)
 
    
Six months ended
June 30,
     
Three months ended
June 30,
  
    
2002
     
2001
     
2002
     
2001
  
Net sales
   
$
45,664
 
   
$
47,729
 
   
$
25,823
 
   
$
25,762
 
Cost of goods sold
   
 
29,194
 
   
 
32,834
 
   
 
15,835
 
   
 
17,379
 
    
  
  
  
Gross profit
   
 
16,470
 
   
 
14,895
 
   
 
9,988
 
   
 
8,383
 
    
  
  
  
Operating expenses
                                    
Selling
   
 
4,961
 
   
 
7,102
 
   
 
2,792
 
   
 
3,368
 
General and administrative
   
 
6,655
 
   
 
5,967
 
   
 
4,654
 
   
 
2,905
 
Research and development
   
 
838
 
   
 
1,253
 
   
 
446
 
   
 
635
 
    
  
  
  
    
 
12,454
 
   
 
14,322
 
   
 
7,892
 
   
 
6,908
 
    
  
  
  
Income from operations
   
 
4,016
 
   
 
573
 
   
 
2,096
 
   
 
1,475
 
Interest expense, net
   
 
(1,321
)
   
 
(1,713
)
   
 
(551
)
   
 
(896
)
    
  
  
  
Income (loss) before income taxes
   
 
2,695
 
   
 
(1,140
)
   
 
1,545
 
   
 
579
 
Income taxes (benefit)
   
 
1,379
 
   
 
(221
)
   
 
725
 
   
 
227
 
    
  
  
  
Net income (loss)
   
$
1,316
 
   
$
(919
)
   
$
820
 
   
$
352
 
    
  
  
  
Net income (loss) per share
                                    
Basic
   
$
0.15
 
   
$
(0.10
)
   
$
0.09
 
   
$
0.04
 
    
  
  
  
Diluted
   
$
0.14
 
   
$
(0.10
)
   
$
0.09
 
   
$
0.04
 
    
  
  
  
Net income (loss)
   
$
1,316
 
   
$
(919
)
   
$
820
 
   
$
352
 
Other comprehensive income (loss), net of tax
                                    
Foreign currency translation adjustments
   
 
615
 
   
 
(1,712
)
   
 
681
 
   
 
333
 
    
  
  
  
Comprehensive net income (loss)
   
$
1,931
 
   
$
(2,631
)
   
$
1,501
 
   
$
685
 
    
  
  
  

1

 
CHANNELL COMMERCIAL CORPORATION
 
CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except per share data)
 
    
June 30, 2002
     
Dec. 31, 2001
  
    
(Unaudited)
         
ASSETS
                  
Current assets
                  
Cash and cash equivalents
   
$
9,875
 
   
$
8,762
 
Accounts receivable, net
   
 
11,378
 
   
 
13,301
 
Inventories
   
 
8,788
 
   
 
9,776
 
Deferred income taxes
   
 
803
 
   
 
1,473
 
Prepaid expenses and misc. receivables
   
 
676
 
   
 
1,238
 
Income taxes receivable
   
 
—  
 
   
 
5,076
 
    
  
Total current assets
   
 
31,520
 
   
 
39,626
 
Property and equipment at cost, net
   
 
30,953
 
   
 
38,718
 
Deferred income taxes
   
 
5,478
 
   
 
5,509
 
Intangible assets, net
   
 
1,463
 
   
 
1,463
 
Other assets
   
 
571
 
   
 
446
 
    
  
    
$
69,985
 
   
$
85,762
 
    
  
LIABILITIES AND STOCKHOLDERS’ EQUITY
                  
Current liabilities
                  
Accounts payable
   
$
4,603
 
   
$
5,090
 
Income taxes payable
   
 
750
 
   
 
—  
 
Short term debt (including current maturities of long term debt)
   
 
17,130
 
   
 
30,228
 
Current maturities of capital lease obligations
   
 
1,154
 
   
 
1,983
 
Accrued restructuring liability
   
 
1,535
 
   
 
2,420
 
Accrued expenses
   
 
4,542
 
   
 
3,939
 
    
  
Total current liabilities
   
 
29,714
 
   
 
43,660
 
    
  
Long term debt, less current maturities
   
 
—  
 
   
 
3,991
 
Deferred gain on sale leaseback transaction
   
 
604
 
   
 
—  
 
Capital lease obligations, less current maturities
   
 
239
 
   
 
614
 
Commitments and contingencies
   
 
—  
 
   
 
—  
 
Stockholders’ equity
                  
Preferred stock
   
 
—  
 
   
 
—  
 
Common stock, par value $.01 per share, authorized—19,000 shares; issued—9,269 shares; outstanding—9,025 shares in June 30, 2002 and 9,025 in December 31, 2001
   
 
93
 
   
 
93
 
Additional paid-in capital
   
 
28,334
 
   
 
28,334
 
Treasury stock—244 shares
   
 
(1,871
)
   
 
(1,871
)
Retained earnings
   
 
14,938
 
   
 
13,622
 
Accumulated other comprehensive (loss)—Foreign currency translation
   
 
(2,066
)
   
 
(2,681
)
    
  
Total stockholders’ equity
   
 
39,428
 
   
 
37,497
 
    
  
Total liabilities and stockholders’ equity
   
$
69,985
 
   
$
85,762
 
    
  

2

 
CHANNELL COMMERCIAL CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(amounts in thousands)
 
    
Six months ended
June 30,
  
    
2002
     
2001
  
Cash flows from operating activities:
                  
Net income (loss)
   
$
1,316
 
   
$
(919
)
Depreciation and amortization
   
 
3,673
 
   
 
4,391
 
Deferred income taxes
   
 
670
 
   
 
(389
)
Loss on disposal of fixed assets
   
 
41
 
   
 
33
 
Foreign currency transaction gain
   
 
—  
 
   
 
(369
)
Change in assets and liabilities:
                  
(Increase) decrease in assets:
                  
Accounts receivable
   
 
2,263
 
   
 
3,828
 
Inventories
   
 
1,274
 
   
 
511
 
Income taxes receivable
   
 
5,076
 
   
 
—  
 
Prepaid expenses
   
 
480
 
   
 
(530
)
Other assets
   
 
(100
)
   
 
42
 
Increase (decrease) in liabilities:
                  
Accounts payable
   
 
(677
)
   
 
(754
)
Accrued expenses
   
 
301
 
   
 
(1,988
)
Accrued restructuring
   
 
(942
)
   
 
—  
 
Income taxes payable
   
 
742
 
   
 
(1,105
)
    
  
Net cash provided by operating activities
   
 
14,117
 
   
 
2,751
 
    
  
Cash flows from investing activities:
                  
Acquisition of property and equipment
   
 
(1,401
)
   
 
(936
)
Proceeds from the sale of a building
   
 
6,614
 
   
 
—  
 
    
  
Net cash provided by (used in) investing activities
   
 
5,213
 
   
 
(936
)
    
  
Cash flows from financing activities:
                  
Repayment of debt
   
 
(17,089
)
   
 
(1,044
)
Proceeds from issuance of long term debt
   
 
—  
 
   
 
2,500
 
Repayment of obligations under capital lease
   
 
(1,215
)
   
 
(1,390
)
Purchase of treasury stock
   
 
—  
 
   
 
(147
)
    
  
Net cash used in financing activities
   
 
(18,304
)
   
 
(81
)
    
  
Effect of exchange rates on cash
   
 
87
 
   
 
(37
)
    
  
Increase in cash and cash equivalents
   
 
1,113
 
   
 
1,697
 
Cash and cash equivalents, beginning of period
   
 
8,762
 
   
 
913
 
    
  
Cash and cash equivalents, end of period
   
$
9,875
 
   
$
2,610
 
    
  
Cash paid during the period for:
                  
Interest
   
$
1,126
 
   
$
1,665
 
    
  
Income taxes
   
$
244
 
   
$
548
 
    
  

3

CHANNELL COMMERCIAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 2002 and 2001
(amounts in thousands, except per share data)
 
1.  Unaudited financial statements:    In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the consolidated financial position of Channell Commercial Corporation (the “Company”) as of June 30, 2002 and the results of its operations for the three months and six months ended June 30, 2002 and June 30, 2001 and its cash flows for the six months ended June 30, 2002 and 2001. The results of operations and cash flows for the six months ended June 30, 2002, are not necessarily indicative of the results to be expected for any other interim period or the full year. These consolidated financial statements should be read in combination with the audited consolidated financial statements and notes thereto for the year ended December 31, 2001.
 
2.  Inventories:    Inventories stated at the lower of cost (first-in, first-out method) or market are summarized as follows:
 
    
June 30,
2002
   
December 31,
2001
Raw Materials
   
$
3,415
   
$
4,738
Work-in-Process
   
 
2,712
   
 
2,605
Finished Goods
   
 
2,661
   
 
2,433
    
  
    
$
8,788
   
$
9,776
    
  
 
3.  Income (loss) per share:    Basic income (loss) per share excludes dilution and is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding for the six month period and the three month period ended June 30, 2002. Diluted income per share reflects the potential dilution that could occur if dilutive options to acquire common stock were exercised. Options to acquire the Company’s common stock were not included in the computation of diluted loss per share for the six months ended June 30, 2001 because they are anti-dilutive. The following is a reconciliation of the number of shares (denominator) used in the basic and diluted income (loss) per share computations for the six months ended June 30 and the three months ended June 30 (shares in thousands):
 
    
Six months ended June 30,
  
    
2002
     
2001
  
    
Shares
   
Per
Share
Amount
     
Shares
   
Per
Share
Amount
  
Basic income (loss) per Share
   
9,025
   
$
0.15
 
   
9,057
   
$
(0.10
)
Effect of dilutive Stock options
   
61
   
$
(0.01
)
   
—  
   
 
—  
 
    
  
  
  
Diluted income (loss) per Share
   
9,086
   
$
0.14
 
   
9,057
   
$
(0.10
)
    
  
  
  

4

 
    
Three months ended June 30,
    
2002
   
2001
    
Shares
   
Per
Share
Amount
   
Shares
   
Per
Share
Amount
Basic income per Share
   
9,025
   
$
0.09
   
9,056
   
$
0.04
Effect of dilutive Stock options
   
76
   
 
0.00
   
—  
   
 
—  
    
  
  
  
Diluted income per Share
   
9,101
   
$
0.09
   
9,056
   
$
0.04
    
  
  
  
 
The following options were not included in the computation of diluted income (loss) per share due to their anti-dilutive effect:
 
    
June 30,
2002
   
June 30,
2001
Options to purchase shares of common stock
   
866
   
931
Exercise prices
   
$6.50-$13.75
   
$6.50-$13.75
Expiration dates
   
July 2006-May 2012
   
July 2006-May 2011
 
4.  Segments:    The Company’s predominant business is the manufacturing and distribution of telecommunications equipment. Currently, the Company is organized into four geographic regions: the United States, Europe / Middle East, Canada and Australia / Asia. The following tables summarize segment information for the six months ended June 30, 2002 and 2001 and the three months ended June 30, 2002 and 2001 (in thousands):
 
    
Six Months Ended
June 30,
    
2002
   
2001
Revenues from unrelated entitites(1):
              
United States
   
$
35,106
   
$
35,385
Europe/Middle East
   
 
4,208
   
 
6,708
Canada
   
 
3,004
   
 
1,863
Australia/Asia
   
 
3,346
   
 
3,773
    
  
    
$
45,664
   
$
47,729
    
  

5

 
    
Six Months Ended
June 30,
  
    
2002
     
2001
  
Income (loss) from operations:
                  
United States
   
$
4,536
 
   
$
4,246
 
Europe/Middle East
   
 
(877
)
   
 
(2,575
)
Canada
   
 
463
 
   
 
85
 
Australia/Asia
   
 
(106
)
   
 
(1,183
)
    
  
    
$
4,016
 
   
$
573
 
    
  
 
Interest expense, net:
                
United States
   
$
1,055
   
$
1,583
 
Europe/Middle East
   
 
136
   
 
143
 
Canada
   
 
38
   
 
(10
)
Australia/Asia
   
 
92
   
 
(3
)
    
  
    
$
1,321
   
$
1,713
 
    
  
 
    
Three Months Ended
June 30,
    
2002
   
2001
Revenues from unrelated entitites (1):
              
United States
   
$
19,927
   
$
18,397
Europe/Middle East
   
 
2,360
   
 
4,330
Canada
   
 
1,684
   
 
804
Australia/Asia
   
 
1,852
   
 
2,231
    
  
    
$
25,823
   
$
25,762
    
  
 
Income (loss) from operations:
                  
United States
   
$
2,215
 
   
$
2,543
 
Europe/Middle East
   
 
(396
)
   
 
(910
)
Canada
   
 
277
 
   
 
40
 
Australia/Asia
   
 
—  
 
   
 
(198
)
    
  
    
$
2,096
 
   
$
1,475
 
    
  
Interest expense, net:
                  
United States
   
$
425
 
   
$
835
 
Europe/Middle East
   
 
70
 
   
 
64
 
Canada
   
 
19
 
   
 
(2
)
Australia/Asia
   
 
37
 
   
 
(1
)
    
  
    
$
551
 
   
$
896
 
    
  
(1)
 
Note: Revenues from any individual foreign country did not exceed 10% of total revenues for the period.

6

 
The Company has revenues from external customers from the following product lines:
 
    
Six Months Ended
June 30,
    
2002
   
2001
Enclosures
   
$
35,689
   
$
36,623
Connectivity
   
 
6,311
   
 
7,578
Other
   
 
3,664
   
 
3,528
    
  
    
$
45,664
   
$
47,729
    
  
 
    
Three Months Ended
June 30,
    
2002
   
2001
Enclosures
   
$
20,017
   
$
18,987
Connectivity
   
 
3,714
   
 
4,491
Other
   
 
2,092
   
 
2,284
    
  
    
$
25,823
   
$
25,762
    
  
 
The Company has identifiable assets in the following geographic regions:
 
    
June 30,
2002
   
December 31,
2001
    
(Unaudited)
     
Identifiable Assets:
              
United States
   
$
48,742
   
$
60,211
Europe/Middle East
   
 
11,347
   
 
15,489
Canada
   
 
2,190
   
 
2,123
Australia/Asia
   
 
7,706
   
 
7,939
    
  
    
$
69,985
   
$
85,762
    
  
 
5.  Credit Agreement:    The Company has a Credit Agreement with two banks. The Credit Agreement contains various financial and operating covenants, which among other things, impose limitations on the Company’s ability to incur additional indebtedness, merge or consolidate, sell assets except in the ordinary course of business, make certain investments, enter into leases and pay dividends. The Company is also required to comply with covenants related to minimum net worth and other financial ratios. The Company was in compliance as of June 30, 2002 with the covenants of the Credit Agreement. The Company made principal payments of $13,000 in the six months ended June 30, 2002. The outstanding balance under the Credit Agreement is due and payable in full on December 31, 2002. The Company will pay an extension fee to the banks on September 30, 2002 in the event there is an outstanding balance under the Credit Agreement. The Company is involved in discussions with several financial institutions and believes it should be able to obtain financing to repay in full the outstanding balance under the Credit Agreement on or before December 31, 2002. In the event the Company obtains financing to repay the outstanding balance under the Credit Agreement it expects to incur refinancing closing costs of no less than $250 but does not expect at this time any material

7

increase in the interest rate charged by the new lenders. In the event the Company does not obtain refinancing of the Credit Agreement by December 31, 2002, and if the banks were to agree to extend the maturity date of the Credit Agreement, the Company would expect the banks to impose requirements such as an extension fee and additional principal payments.
 
6.  Recent Accounting Pronouncements:    In June 2001, the FASB issued Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS 143), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and associated asset retirement costs. The new rules apply to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) normal operation of a long-lived asset. SFAS 143 is effective for the Company at the beginning of fiscal 2003. The Company believes the adoption of SFAS 143 will not have a material impact on its consolidated financial position or results of operations.
 
7.  Goodwill:    In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Intangible Assets which supersedes APB Opinion No. 17, Intangible Assets. SFAS 142 eliminates the current requirement to amortize goodwill and indefinite-lived intangible assets, addresses the amortization of intangible assets with a defined life and addresses the impairment testing and recognition for goodwill and intangible assets. The Company has adopted this Standard as of January 1, 2002. In applying SFAS 142, the Company has performed the transitional reassessment and impairment tests required as of January 1, 2002, and determined that there is no impairment of goodwill. The Company discontinued amortizing goodwill on January 1, 2002. At the time of adoption, the Company had accumulated amortization pertaining to goodwill of $3,057. Below are the calculations of reported net income (loss) and reported basic and diluted net income (loss) per share adjusted for the effect of amortization expense for the June 30, 2001 period:
 
    
Six Months Ended June 30,
  
    
2002
   
2001
  
Reported net income (loss)
   
$
1,316
   
$
(919
)
Effect of amortization expense of goodwill
   
 
—  
   
 
426
 
    
  
Adjusted net income (loss)
   
$
1,316
   
$
(493
)
    
  
Basic income (loss) per share:
                
Reported net income (loss) per share
   
$
0.15
   
$
(0.10
)
Effect of amortization expense of goodwill
   
 
—  
   
 
0.05
 
    
  
Adjusted net income (loss)
   
$
0.15
   
$
(0.05
)
    
  
Diluted income (loss) per share:
                
Reported net income (loss) per share
   
$
0.14
   
$
(0.10
)
Effect of amortization expense of goodwill
   
 
—  
   
 
0.05
 
    
  
Adjusted net income (loss)
   
$
0.14
   
$
(0.05
)
    
  

8

 
    
Three Months Ended
June 30,
    
2002
   
2001
Reported net income
   
$
820
   
$
352
Effect of amortization expense of goodwill
   
 
—  
   
 
191
    
  
Adjusted net income
   
$
820
   
$
543
    
  
Basic income per share:
              
Reported net income per share
   
$
0.09
   
$
0.04
Effect of amortization expense of goodwill
   
 
—  
   
 
0.02
    
  
Adjusted net income
   
$
0.09
   
$
0.06
    
  
Diluted income per share:
              
Reported net income per share
   
$
0.09
   
$
0.04
Effect of amortization expense of goodwill
   
 
—  
   
 
0.02
    
  
Adjusted net income
   
$
0.09
   
$
0.06
    
  
 
8.  Restructuring Charge:    In the fourth quarter of 2000, in connection with management’s plan to reduce costs and improve operating efficiencies, the Company recorded a restructuring charge of $1,513. The principal actions of the restructuring plan involved the closure of facilities and consolidation of support infrastructure. Most of the reductions occurred in the international operations.
 
In the third quarter of 2001, due to a continued slowdown in the telecommunications industry, the Company announced an additional restructuring plan in an effort to further reduce costs and align headcount and facilities with expected business levels in all regions. The additional restructuring charge totaled $2,999. The principal actions in the restructuring plan involved the closure of facilities and a reduction of headcount.
 
The restructuring charges were determined based on formal plans approved by the Company’s management using the best information available to it at the time. The amounts the Company may ultimately incur could differ materially as the restructuring initiative is executed. The changes in the accrual for restructuring charges during 2002 are summarized in the table below:
 
    
Facilities
     
Workforce Reduction
   
Total
  
Restructuring accrual balance at January 1, 2002
   
$
2,344
 
   
$
76
   
$
2,420
 
Costs incurred in the six months ended June 30, 2002
   
 
(885
)
   
 
—  
   
 
(885
)
    
  
  
Restructuring accrual balance at June 30, 2002
   
$
1,459
 
   
$
76
   
$
1,535
 
    
  
  

9

 
9.  Sale Leaseback Arrangement:    In June 2002, the Company entered into a sale and leaseback agreement for a warehouse facility located in Temecula, California. The proceeds from the sale totaled $6,614 and resulted in a pretax deferred gain of $604. The resulting lease is being accounted for as an operating lease. The lease base term is ten years with two five-year options at rental amounts to be adjusted to the fair market rental value at the end of the base term. A portion of the proceeds from the sale was used to pay the outstanding mortgage balance on the facility of $4,036.
 
10.  Allowance for Doubtful Accounts:    A $2,000 reserve was recorded in the allowance for doubtful accounts in June 2002. A major customer of the Company, Adelphia Communications, filed for Chapter 11 bankruptcy protection. The Company has reserved all of the open receivables with Adelphia.
 
11.  Income Taxes:    The effective tax rate of 51% for the six month period ended June 30, 2002 differed from the statutory rate of 37% primarily due to certain foreign operating losses incurred without a tax benefit recorded.
 
The Federal income taxes of the Company for the years ended December 31,1998 and 1999 are currently under examination by the Internal Revenue Service (IRS). On November 5, 2001, the IRS issued a report assessing penalties of $240 for failure to file certain information with the 1998 and 1999 income tax returns with respect to its foreign subsidiaries. In December 2001, the Company reached a settlement in which the IRS agreed to reduce the penalty assessment to $40. The Company recorded a charge in the fourth quarter of 2001 for the settlement amount and the amount was paid in February 2002. The Company believes that any amount in excess of its recorded liability, if any, will not be significant.
 
12.  Commitments and Contingencies:    In 2001, the State of Texas issued a report assessing the Company additional sales and use tax of $1,600, including interest. The Company has appealed the assessment and is currently providing the State of Texas with documentation to support the Company’s contention that the transactions did not require the Company to remit sales and use tax to the State of Texas. The State of Texas has agreed to a reduction of the amount owed to $644. The Company believes that they have meritorious defenses to the remaining claim of $644 and intends to vigorously defend its position. The Company does not believe that the ultimate outcome of this examination will result in a material impact on the Company’s consolidated results of operations or financial position.
 
13.  Related Party Transactions:    In May 2002 the Company sold its RF line of passive electronic devices to RMS Communications, Inc. which is owned by Gary Napolitano, a former officer of the company. A sale in the amount of $800 was recorded. Mr. Napolitano gave the Company $125 in cash at the time of sale, and the remaining $675 is payable in monthly installments through June 30, 2003, bearing interest at 7%. The amount due from the former officer is included in accounts receivable at June 30, 2002.

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PART I—FINANCIAL INFORMATION
 
Item 2—Management’s Discussion and Analysis of Results of Operations and Financial Condition
 
Results of Operations
 
Comparison of the Six Months Ended June 30, 2002 With the Six Months Ended June 30, 2001
 
The Company earned net income of $1.3 million in the first six months of 2002 compared to a net loss of $(0.9) million in the first six months of 2001. The improvement in earnings is primarily the result of the restructuring and debt reduction program that began in the third quarter of 2001.
 
The restructuring program included a significant reduction in head count, a reduction in the square footage of facilities utilized and exiting certain product lines with the objective of reducing costs in line with anticipated levels of business. The Company also initiated a number of actions to reduce debt including the sale of excess inventory, improved receivables management, the sale and leaseback of a building and improved cash flow from operations. The reduction in debt reduced interest expense. The actions included in the restructuring and debt reduction plan have been substantially completed as of June 30, 2002.
 
The effect of the restructuring and debt reduction plan on each line item in the Consolidated Statement of operations are included in the following analysis.
 
Net Sales.    Net sales in the first six months of 2002 were $45.7 million, a decrease of $2.0 million or 4.2% compared with the first six months of 2001. The decrease resulted from a slowdown in equipment purchases by telecommunications service providers in Europe and lower sales of the RF product line. Sales of RF product declined from $3.5 million in the first six months of 2001 to $1.9 million in the first six months of 2002, for a total decrease of $1.6 million. The RF product line was sold in the second quarter of 2002 (see Note 13).
 
Domestic net sales were $35.1 million in the first six months of 2002, a decrease of $0.3 million or 0.8% compared with the first six months of 2001.
 
International net sales were $10.6 million in the first six months of 2002, a decrease of $1.7 million or 13.8% compared with the first six months of 2001. Sales in Europe / Middle East decreased 37.3% to $4.2 million. Approximately one half of the decline was related to RF product and the remainder due to a continued slow down in the telecommunications industry. Australia/Asia sales declined 13.2% to $3.3 million due to lower equipment purchases from two major telecommunications customers. Sales in Canada increased 57.9% to $3.0 million due to a strong housing market, which stimulated network building by CATV customers, and favorable weather conditions which allowed outside plant construction during winter months.
 
Gross Profit.    Gross profit in the first six months of 2002 was $16.5 million, an increase of $1.6 million compared to the first six months of 2001. Although sales declined, gross profit dollars increased due to manufacturing cost reductions that were

11

implemented as part of the Company’s restructuring program announced in the third quarter of 2001. The cost reductions were predominately in head count and facilities costs.
 
As a percentage of net sales, gross profits increased from 31.2% in the first six months of 2001 to 36.1% in the first six months of 2002. The improvement is due to the head count and facility cost reductions.
 
Selling.    Selling expenses were $5.0 million in the first six months of 2002, a decrease of $2.1 million or 29.6% from the first six months of 2001. The decrease is due to head count reductions in selling administrative functions and marketing, and lower spending on marketing programs.
 
As a percentage of net sales, selling expense decreased from 14.9% in the 2001 period to 10.9% in the 2002 period due to the cost reductions noted above.
 
General and Administrative.    General and administrative expenses increased $0.8 million or 13.6% from $5.9 million in the first six months of 2001 to $6.7 million in the first six months of 2002. The increase is due to a $2.0 million charge to increase the allowance for bad debts as a result of the Chapter 11 bankruptcy filing of a major U.S. CATV company. Excluding the $2.0 million allowance for bad debts, general and administrative expenses decreased $1.2 million or 20.3%. The primary reasons for the $1.2 million decrease are reduced head count in administrative functions in all regions, lower facilities costs as a result of buildings vacated and spending reductions implemented in the Company’s restructuring program. Goodwill amortization of $0.4 million is included in general and administrative expenses for the first six months of 2001 and is no longer amortized in 2002.
 
As a percentage of net sales, general and administrative expenses increased from 12.4% in the 2001 period to 14.7% in the 2002 period due to the allowance for bad debts charge. Excluding the charge, general and administrative expenses decreased to 10.3% of sales.
 
Research and Development.    Research and development expenses decreased $0.5 million or 38.5% from $1.3 million in the first six months of 2001 to $0.8 million in the same period of 2002. The decrease is the result of moving and consolidating some of the international research and development functions into U.S. operations, which reduced head count and facilities costs. New product development programs were not affected by the change. As a percentage of net sales, research and development expenses decreased from 2.7% in the first six months of 2001 to 1.8% in 2002.
 
Income from Operations.    As a result of the items discussed above, income from operations increased $3.4 million from $0.6 million in the first six months of 2001 to $4.0 million in the first six months of 2002. Income from operations as a percent of sales increased from 1.3% to 8.8%.
 
Interest Expense, Net.    Net interest expense in the first half of 2002 was $1.3 million, a decrease of $0.4 million from the first six months of 2001. The decrease was primarily attributable to a lower average debt level. The Company reduced debt by $18.3 million in the first six months of 2002 and ended June 30, 2002 with a balance of $18.5 million. This compares to the June 30, 2001 balance of $40.1 million.

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Income Taxes.    Income tax expense was $1.4 million in the first six months of 2002 compared to a tax credit of $0.2 million in the first six months ended June 30, 2001. The effective tax rate of 51.2% in the first six months of 2002 differed from the statutory rate of 37% primarily due to foreign operating losses with no benefit provided.

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Comparison of the Three Months Ended June 30, 2002 With the Three Months Ended June 30, 2001
 
Net Sales.    Net sales in the second quarter of 2002 were $25.8 million, the same as the second quarter of 2001.
 
Domestic net sales were $19.9 million in the second quarter of 2002, an increase of $1.5 million or 8.2% compared with the second quarter of 2001. The increase resulted from an unusually strong demand from one CATV customer.
 
International net sales were $5.9 million in the second quarter of 2002, a decrease of $1.5 million or 20.3% compared to the second quarter of 2001. Sales in Europe / Middle East decreased $2.0 million or 46.5% to $2.3 million primarily due to lower sales of the RF product line and a general industry slow down in the region. Australia / Asia sales decreased $0.3 million or 13.6% from the second quarter of 2001 to $1.9 million in the second quarter of 2002 primarily as a result of lower sales to a major Asian telecommunications service provider. Sales in Canada increased from $0.8 million in the second quarter of 2001 to $1.7 million in the current quarter due to favorable weather conditions and a strong housing market which stimulated sales to CATV customers.
 
Gross Profit.    Gross profit in the second quarter of 2002 was $10.0 million, an increase of $1.6 million or 19.0% compared to the second quarter of 2001. The increase was due to manufacturing cost reductions implemented as part of the Company’s restructuring program. The cost reductions were predominately in head count and facilities costs.
 
As a percentage of net sales, gross profit increased from 32.6% in the second quarter of 2001 to 38.8% in the second quarter of 2002. The improvement was due to the head count and facility cost reductions.
 
Selling.    Selling expenses were $2.8 million in the second quarter of 2002, a decrease of $0.6 million or 17.6% from the second quarter of 2001. The decrease is the result of head count reductions in selling administration and marketing functions and lower spending on marketing programs.
 
As a percentage of net sales, selling expense decreased from 13.2% in the 2001 period to 10.9% in the 2002 period due to the cost reductions noted above.
 
General and Administrative.    General and administrative expenses increased $1.8 million or 62.1% from $2.9 million in the second quarter of 2001 to $4.7 million in the second quarter of 2002. The increase is due to a $2.0 million charge to increase the allowance for bad debts as a result of the Chapter 11 bankruptcy filing of a major U.S. CATV company. Excluding the $2.0 million allowance for bad debts, general and administrative expenses decreased $0.2 million or 6.9%. General and administrative costs in the second quarter of 2002 included approximately $500 of non recurring costs. These included severance payments in international operations and professional fees associated with projects in the second quarter. Head count and facilities costs were lower in the second quarter of 2002 compared to the same period in 2001 due to the Company’s restructuring program.

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As a percentage of net sales, general and administrative expenses increased from 11.2% in the 2001 period to 18.2% in the 2002 period due to the allowance for bad debts charge. Excluding the bad debts charge, general and administrative expenses decreased to 10.5% of sales.
 
Research and Development.    Research and development expenses of $0.4 million in the second quarter of 2002 compare to $0.6 million in the second quarter of 2001. The decrease is the result of moving and consolidating some of the international research and development functions into U.S. operations, which reduced head count and facilities cost. As a percentage of net sales, research and development expenses decreased from 2.3% in the second quarter of 2001 to 1.6% in the second quarter of 2002.
 
Income from Operations.    As a result of the items discussed above, income from operations increased $0.6 million or 40.0% from $1.5 million in the second quarter of 2001 to $2.1 million in the second quarter of 2002. Income from operations as a percentage of sales increased from 5.8% to 8.1%.
 
Interest Expense, Net.    Net interest expense in the second quarter of 2002 was $0.6 million, a decrease of $0.3 million or 33.3% from the second quarter of 2001. The decrease was primarily attributable to a lower average debt level. The debt level at June 30, 2001 and 2002 was $40.1 million and $18.5 million, respectively. The second quarter of 2002 interest expense includes a $0.1 million fee paid per the terms of the bank credit agreement.
 
Income Taxes.    The effective income tax rate of 46.9% in the second quarter of 2002 compares to 39.3% in the same period of 2001. The effective tax rate of 46.9% differed from the statutory rate of 37% primarily due to foreign operating losses with no benefit provided.
 
Liquidity and Capital Resources
 
Net cash provided by operating activities was $14.1 million for the six months ended June 30, 2002, up from $2.8 million in the same period last year. The increase is due primarily to a federal tax refund of $5.1 million in the six months ended 6/30/02, net income of $1.3 million in the first half of 2002 compared to a net loss of $0.9 million in the same period of 2001 and continued improvement in working capital management.
 
Net cash provided by investing activities was $5.2 million in the first six months of 2002 while net cash used in investing activities was $0.9 million in the first half of 2001. The Company completed a real estate sale/leaseback of $6.6 million in the first six months of 2002.
 
Net cash used in financing activities was $18.3 million in the first six months of 2002 compared to $0.1 million in the first half of 2001. In the first six months of 2002 debt was reduced by $18.3 million and there were no draw downs under the bank credit facility. In the first six months of 2001, the Company repaid $2.4 million of debt and drew down $2.5 million under the bank facility.

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As a result of the above, the cash and cash equivalents balance increased from $8.8 million at December 31, 2001 to $9.9 million at June 30, 2002.
 
Accounts receivable decreased from $13.3 million at December 31, 2001 to $11.4 million at June 30, 2002. Days sales outstanding decreased from 64 days at December 31, 2001 to 40 days at June 30, 2002.
 
Inventories decreased from $9.8 million at December 31, 2001 to $8.8 million at June 30, 2002. Days inventory declined from 68 days at December 31, 2001 to 50 days at June 30, 2002. The sale of excess inventory contributed to the decline.
 
Accounts payable decreased from $5.1 million at December 31, 2001 to $4.6 million at June 30, 2002. Days payables decreased from 35 days at December 31, 2002 to 26 days at June 30, 2002.
 
The Company has a Credit Agreement with two banks that provides funds for working capital and equipment acquisition purposes. As of June 30, 2002, the credit facility was in the amount of $17.1 million, all of which had been drawn down. The outstanding balance bears interest payable monthly, at a variable rate based on the bank’s base rate. The weighted average interest rate was 7.25% for the first six months of 2002. The loan is collateralized by substantially all of the Company’s tangible and intangible assets and up to 65% of the capital stock of the Company’s subsidiaries.
 
The Credit Agreement contains various financial and operating covenants, which among other things, impose limitations on the Company’s ability to incur additional indebtedness, merge or consolidate, sell assets except in the ordinary course of business, make certain investments, enter into leases and pay dividends. The Company is also required to comply with covenants related to minimum net worth and other financial ratios. The Company was in compliance as of June 30, 2002 with the covenants of the Credit Agreement. The Company made principal payments of $13,000 in the first six months of 2002. The outstanding balance under the Credit Agreement is due and payable in full on December 31, 2002. The Company will pay an extension fee to the banks on September 30, 2002 in the event there is an outstanding balance under the Credit Agreement. The Company is involved in discussions with several financial institutions and believes it should be able to obtain financing to repay in full the outstanding balance under the Credit Agreement on or before December 31, 2002. In the event the Company obtains financing to repay the outstanding balance under the Credit Agreement it expects to incur refinancing closing costs of no less than $250 but does not expect at this time any material increase in the interest rate charged by the new lender(s). In the event the Company does not obtain refinancing of the Credit Agreement by December 31, 2002, and if the banks were to agree to extend the maturity date of the Credit Agreement, the Company would expect the banks to impose requirements such as an extension fee and additional principal payments.
 
The Company believes that cash flow from operations coupled with bank borrowings will be sufficient to fund the Company’s capital expenditure and working capital requirements through 2002.
 
Forward-looking statements contained within this 10-Q are subject to many uncertainties in the Company’s operations and business environments. Examples of such uncertainties include customer demand, low material costs, integration of acquired

16

businesses and worldwide economic conditions among others. Such uncertainties are discussed further in the Company’s annual report and S-1 and other reports filed with the Securities and Exchange Commission.

17

 
PART II—OTHER INFORMATION
 
Item 1.    Legal Proceedings
 
The Company is from time to time involved in ordinary routine litigation incidental to the conduct of its business. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate for such litigation matters. Management believes that no presently pending litigation matters will have a material adverse effect on the Company’s financial statements taken as a whole or on its results of operations.
 
Item 2.    Changes in Securities
 
None
 
Item 3.    Defaults Upon Senior Securities
 
None
 
Item 4.    Submission of Matters to a Vote of Security Holders
 
At the Annual Meeting of Shareholders of the Company held on May 20, 2002 in Temecula, California, 9,024,993 shares of the Company’s stock were present either in person or by proxies solicited by management to Regulation 14A under the Securities Exchange Act of 1934.
 
The Shareholders voted on the following matter:
 
To elect two directors to serve on the Company’s Board of Directors:
 
    
Number of
Shares For
   
Number of
Shares
Withheld
William H. Channell, Sr.
   
7,829,318
   
231,285
Eugene R. Schutt, Jr.
   
7,906,203
   
154,400
 
Item 5.    Other Information
 
None
 
Item 6.    Exhibits and Reports on Form 8-K
 
None
 
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
   
Channell Commercial Corporation 1996 Incentive Stock Plan (including form of Stock Option Agreements and Restricted Stock Agreement)(1)
      
  10.3
   
Senior Revolving Loan Agreement dated as of May 1, 1998, between the Company and Fleet National Bank(3)

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Exhibit
Number
   
Description
10.4
   
Second Amendment to Credit Agreement and Consent dated December 29, 1999, between the Company and Fleet National Bank(6)
      
10.5
   
Second Amendment to Security Agreement dated February 1, 2000, between the Company and Fleet National Bank(6)
      
10.6
   
Third Amendment to Credit Agreement and accompanying Notes dated July 20, 2000, between the Company and Fleet National Bank(6)
      
10.7
   
Fourth Amendment to Credit Agreement dated May 31, 2001, between the Company and Fleet National Bank(7)
      
10.8
   
Employment Agreement between the Company and William H. Channell, Sr.(1)
      
10.9
   
Employment Agreement between the Company and William H. Channell, Jr.(1)
      
10.10
   
Channell Commercial Corporation 1996 Performance-Based Annual Incentive Compensation Plan(1)
      
10.11
   
Lease dated December 22, 1989 between the Company and William H. Channell, Sr., as amended(1)
      
10.12
   
Lease dated May 29, 1996 between the Company and the Channell Family Trust(1)
      
10.14
   
Lease dated September 24, 1997 between the Company and SCI North Carolina Limited Partnership(4)
      
10.15
   
Lease dated October 26, 2000 between the Company and Belston Developments Inc.(6)
      
10.16
   
Lease Agreement dated as of March 1, 1996 between Winthrop Resources Corp. and the Company(1)
      
10.17
   
Form of Indemnity Agreement(1)
      
10.18
   
Form of Agreement Regarding Intellectual Property(1)
      
10.19
   
401(k) Plan of the Company(5)
      
10.22
   
A.C.   Egerton (Holdings) PLC Share Purchase Agreement(3)
      
10.23
   
Amendment to Employment Agreement, William H. Channell Jr., dated December 31, 1998(5)
      
10.24
   
Agreement dated November 7, 2001 between the Company and Fleet Bank, as Administrative Agent(8)
      
10.25
   
Employment Agreement between the Company and Richard A. Cude.(9)
      
10.26
   
Fifth Amendment, dated December 17, 2001, to the Credit Agreement between the Company and Fleet National Bank, as Administrative Agent for the lenders.(9)
      
10.27
   
Sixth Amendment, dated March 21, 2002, to the Credit Agreement between the Company and Fleet National Bank, as Administrative Agent for the lenders.(9)
      
10.28
   
Further Amendment to Employment Agreement between the Company and William H. Channell, Jr., dated July 15, 2002(10)
      
10.29
   
Lease dated June 27, 2002 between the Company and Ynez Street, Ltd(10)
      
99.1
   
Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sabanes-Oxley Act of 2002 by William H. Channell, Sr., CEO.(10)
      
99.2
   
Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sabanes-Oxley Act of 2002 by Thomas Liguori, CFO.(10)
 
(b)  Reports on Form 8-K
 
No reports on Form 8-K were filed during the quarter ended June 30, 2002.
  (1)
 
Incorporated by reference to the indicated exhibits filed in connection with the Company’s Registration Statement on Form S-1 (File No. 333-3621).
  (2)
 
Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-K on March 31, 1997.
  (3)
 
Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 8-K on May 18, 1998.
  (4)
 
Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-Q on May 6, 1998.
  (5)
 
Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-K on March 31, 1999.
  (6)
 
Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-K on April 2, 2001.

19

  (7)
 
Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-Q on August 14, 2001.
  (8)
 
Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-Q on November 14, 2001.
  (9)
 
Incorporated by reference to the indicated exhibits filed in connection with the Company’s Form 10-K on March 26, 2002.
(10)
 
Filed herewith.

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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
CHANNELL COMMERCIAL CORPORATION
    (Registrant)
By:
  
/s/    THOMAS LIGUORI        
   
Thomas Liguori
Chief Financial Officer
 
Dated:  August 9, 2002

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