UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

ý		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the fiscal year ended January 1, 2005
		OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from                                   to
		Commission file number 1-3834

 

Continental Materials Corporation

(Exact name of registrant as specified in its charter)

 

Delaware		36-2274391
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
200 South Wacker Drive, Suite 4000 Chicago, Illinois		60606
(Address of principal executive offices)		(Zip Code)

 

Registrant’s telephone number, including area code 312-541-7200

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class		Name of each exchange on which registered
Common Stock - $.25 par value		American Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: NONE

 

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   ý  No   o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.  o

 

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

Yes o            No   ý

 

The aggregate market value (based on July 3, 2004 closing price) of voting stock held by non-affiliates of registrant: Approximately $22,517,000.

 

Number of common shares outstanding at March 29, 2005: 1,647,914.

 

Incorporation by reference: Portions of registrant’s definitive proxy statement for the 2004 Annual meeting of stockholders to be held on May 25, 2005 into Part III of this Form 10-K.  (The definitive proxy statement is expected to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year covered by this Form 10-K.)

 

 

PART I

 

Item 1.

BUSINESS

 

Continental Materials Corporation is a Delaware corporation, incorporated in 1954. There have been no significant changes in the Company’s line of business during the past five years other than the acquisition of all of the stock of McKinney Door and Hardware, Inc. (MDHI), a refabricator and distributor of metal doors, wood doors and related hardware in Pueblo, Colorado on April 1, 2002 for $2,125,000, net of cash received, and the purchase of all of the stock of Rocky Mountain Ready Mix Concrete, Inc. (RMRM), a ready-mix concrete producer in the metropolitan Denver, Colorado area, on December 31, 2000 for $11,263,000, net of cash received. Accordingly, results for 2002 and on include the activity of RMRM for the entire year and the activity of MDHI since April 1, 2002. The activities of both companies are included in the construction materials segment.

 

The Company operates primarily in two industry segments, the heating and air conditioning segment and the construction materials segment. The heating and air conditioning segment produces and sells gas-fired wall furnaces and console heaters, evaporative coolers and fan coils, which are manufactured by the Company’s wholly-owned subsidiaries, Phoenix Manufacturing, Inc. (PMI) of Phoenix, Arizona and Williams Furnace Co. (WFC) of Colton, California. The principal products of the construction materials segment are ready mix concrete, construction aggregates, building supplies and doors which are offered by the Company’s wholly-owned subsidiaries, Castle Concrete Company and Transit Mix Concrete Co., in Colorado Springs, Colorado and Transit Mix of Pueblo, Inc. (the three companies are collectively referred to as “TMC”) and MDHI, in Pueblo, Colorado. Currently, the Company’s wholly-owned subsidiary, RMRM of Denver, Colorado, only offers ready mix concrete.

 

In addition to the above operating segments, an “Other” classification is used to report a small real estate operation. The expenses of the corporate office, which provides treasury, insurance and tax services as well as strategic business planning and general management services, are not allocated to the segments. Expenses related to the Management Information Systems group are allocated to all locations, including the corporate office.

 

Financial information relating to industry segments appears in Note 11 on pages 29 and 30 of this Form 10-K. References to a “Note” are to the “Notes to Consolidated Financial Statements” included on pages 22 through 31 of this Annual Report on Form 10-K.

 

MARKETING

 

The heating and air conditioning segment markets its products throughout the United States through plumbing, heating and air conditioning wholesale distributors as well as directly to some major retail home-centers and other retail outlets. Fan coils are also sold to HVAC (Heating, Ventilation and Air Conditioning) installing contractors and equipment manufacturers for commercial applications. The Company contracts independent manufacturers’ representatives for all of its products while also employing and utilizing a staff of sales and sales support personnel. Sales in this segment are predominantly in the United States and are concentrated in the Western and Southwestern states. Sales of furnaces and console heaters usually increase in the months of August through January. Sales of evaporative coolers usually increase in the months of March through July. Sales of the fan coil product line are more evenly distributed throughout the year although the highest volume typically occurs during the late spring and summer.  In order to enhance sales of wall furnaces and evaporative coolers during the off season, extended payment terms are offered to some customers.

 

The construction materials segment markets its products primarily through its own direct sales personnel and, except for MDHI, confines its sales to the Front Range area in Colorado. Sales are primarily made to general and sub-contractors, government entities and individuals. Sales are affected by the general economic conditions and weather conditions in the areas serviced

 

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(as it relates to construction). Revenues usually decline in the winter months as the pace of construction slows. MDHI sells throughout the United States although sales are primarily within Colorado and adjacent states.

 

During 2004, no customer in either segment accounted for 10% or more of the total sales of the Company.

 

CUSTOMER SERVICE AND SUPPORT

 

The heating and air conditioning segment offers parts departments and help lines to assist contractors, distributors and end users in servicing the products. The Company does not perform installation services, nor are maintenance or service contracts offered. In addition, training and product information sessions for the furnace, cooler and fan coil product lines are offered at our plants and other sites for distributors, contractors, utility company employees and other customers. This segment does not derive any revenue from after-sales service and support other than from parts sales. The personnel in the construction materials segment routinely take a leadership role in formulation of the products to meet the specifications of the customers.

 

BACKLOG

 

At January 1, 2005, the heating and air conditioning segment had a backlog of approximately $778,000 ($1,268,000 at January 3, 2004) primarily relating to orders that are expected to be filled during the first quarter of 2005. The decline is due to the timing of an order from a large evaporative cooler customer which was placed after January 1, 2005.

 

At January 1, 2005, the construction materials segment had a backlog of approximately $14,219,000 ($6,642,000 at January 3, 2004) primarily relating to construction contracts awarded and expected to be filled during the first half of 2005.

 

Management does not believe that any of the above backlogs represent a trend but rather are indicative only of the timing of orders received or contracts awarded.

 

RESEARCH AND DEVELOPMENT/PATENTS

 

In general, the Company relies upon, and intends to continue to rely upon, unpatented proprietary technology and information. However, research and development activities in the heating and air conditioning segment have resulted in a patent being issued to PMI related to the Power Cleaning System (expiring January 2014) used in evaporative coolers and a patent issued to WFC entitled “Wall Furnace With Side Vented Draft Hood” (expiring November 2011) for a process that increased the heat transference efficiency in our furnaces above that previously offered by the Company and its competitors. The amounts expended on research and development are not material and are expensed as incurred. The Company believes its interests in its patents, as well as its proprietary knowledge, are sufficient for its businesses as currently conducted.

 

MANUFACTURING

 

The Company conducts its manufacturing operations through a number of facilities as more completely described in Item 2, Properties, below.

 

Due to the seasonality of the businesses, furnaces and evaporative coolers build inventory during their off seasons in order to have adequate supplies to sell during the season. Although sales are made throughout the year, sales volume is generally higher from August through January for furnaces while sales volume of evaporative coolers is generally higher from March through July.

 

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In general, raw materials required by our subsidiaries’ operations in both segments can be obtained from various sources in the quantities desired. The Company’s construction materials subsidiaries in Colorado Springs and Pueblo have historically purchased most of their cement requirements from a single supplier in order to obtain favorable volume rates. On past occasions, the ready mix industry in Colorado has experienced cement shortages. However, our subsidiaries were able to acquire sufficient quantities from their sources. The Company expects that there will be a sufficient supply of cement for the foreseeable future. The Company has no long-term supply contracts and does not consider itself to be dependent on any individual supplier.

 

In connection with permits to mine properties in Colorado, the Company is obligated to reclaim the mined areas. Although the conditions vary by permit, in general the reclamation requirements call for the stabilization of the mined area. These requirements are similar in nature to those included in the mining permits of our competitors. In recent years, reclamation costs have had a more significant effect on the results of operations compared to prior years as the Company has engaged in enhanced reclamation projects that exceed the stated requirements. The augmented reclamation efforts are being performed, in part, for purposes of community goodwill. The Company performs the majority of the reclamation work using existing production employees and equipment primarily at times when production is curtailed due to weather or demand. Consequently, the reclamation work has little impact on capital expenditures.

 

COMPETITIVE CONDITIONS

 

Heating and Air Conditioning – The Company is one of three principal companies producing wall furnaces (excluding units sold to the recreational vehicle industry) and gas fired console heaters. The wall furnace and console heater markets are only a small component of the heating industry. The Company serves these market areas from a plant in Colton, California.  The sales force consists of in-house sales personnel and independent manufacturers’ representatives. The entire heating industry is dominated by manufacturers (most of which are substantially larger than the Company) selling diversified lines of heating and air conditioning units directed primarily toward central heating and cooling systems. All of the producers, including the Company, compete primarily on a basis of price, service and timeliness of delivery.

 

Fan coils are also produced at the Colton plant. The Company generally obtains contracts for larger jobs based upon a competitive bidding process. The contracts are typically awarded based upon the competitive factors noted below. International Environmental Corp., a subsidiary of LSB Industries, Inc., a manufacturer of a diversified line of commercial and industrial products, is the largest manufacturer and competitor in this market. There are also a number of other companies that produce fan coils. All of the producers compete primarily on the basis of price, ability to meet customers’ specific requirements and timeliness of delivery.

 

The Company manufactures evaporative air coolers at a plant in Phoenix, Arizona. The cooler market is dominated by Adobe Air. The other principal competitor is Champion/Essick. All producers of evaporative air coolers typically compete aggressively on the basis of price, product features and service.

 

Construction Materials – The Company is one of five companies producing ready mix concrete in the Colorado Springs area, one of three companies producing ready mix concrete in the Pueblo area and one of eleven companies producing ready mix concrete in the Denver area, other than construction companies that maintain small operations to supply their own needs. Although we are the largest producer in the Colorado Springs and Pueblo markets served, the other competitors in these areas compete on the basis of price, service and product features. In Denver, three of the producers are significantly larger than RMRM. This market experiences aggressive competition based on price and service.

 

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The Company is one of eight producers of aggregates in the Colorado Springs and Pueblo marketing areas. All producers compete on the basis of price, quality of material and service.

 

The Company’s sales of metal doors and door frames, rebar reinforcement and other building materials in the Colorado Springs and Pueblo metropolitan areas are subject to intense competition from two larger companies from Denver, two large companies in Colorado Springs and a number of small local competitors. However, the Company believes it has a slight competitive advantage in that many of our customers also purchase concrete and aggregates from us whereas our competitors for these particular product lines do not offer concrete or aggregates. In addition, the Company believes its Pueblo location has a slight competitive advantage with respect to the two Denver companies based upon delivery costs.

 

EMPLOYEES

 

The Company employed 650 people as of January 1, 2005. Employment varies throughout the year due to the seasonal nature of the businesses. A breakdown of the prior three years employment at year-end by segment was:

 

		2004		2003		2002
Heating and Air Conditioning		277		327		356
Construction Materials		360		377		399
Corporate Office		13		13		14
Total		650		717		769

 

The reduction in the heating and air conditioning segment represents the combination of a lower direct labor force as a result of reduced sales and a reduction in office staff. The reduction in the construction materials segment similarly reflects a small reduction in direct labor and a small reduction in office personnel as some functions have been centralized in the Colorado Springs office. The factory employees at the Colton, California plant are represented by the Carpenters Local 721 Union under a contract that expires in April 2005. Negotiations have begun and the Company does not anticipate a work stoppage. The Company considers relations with its employees and with their union to be good. There are no unions at any of the Company’s other operations.

 

Item 2.

PROPERTIES

 

The heating and air conditioning segment operates out of one owned (Colton, California) and one leased (Phoenix, Arizona) facility. Both manufacturing facilities utilized by this segment are, in the opinion of management, in good condition and sufficient for the Company’s current needs. Production capacity exists at the locations such that the Company could exceed the highest volumes achieved in prior years or expected in the foreseeable future and maintain timely delivery.

 

The construction materials segment serves the Colorado ready-mix concrete market from eleven owned batch plants. In addition, the Company currently operates aggregate processing facilities on three owned and three leased mining properties. In general, the leased mining properties are on long-term leases with payment based upon the number of tons mined. The lease of an aggregates property in Pueblo, Colorado also requires minimum royalty payments when a specified number of tons are not mined during a calendar year. See Note 7 on page 28 for the schedule of future minimum payments. The door and supply division operates out of three owned and one leased facility. All of the construction materials segment’s facilities are located along the Front Range in Colorado and, in the opinion of management, are in good condition and sufficient for the Company’s current needs. The Company also leases or owns other aggregate deposits along the Front Range that are not currently in production. In

 

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the opinion of management, the owned and leased properties contain permitted and minable reserves sufficient to service customers’ and our own sand, rock and gravel requirements for the foreseeable future.

 

The corporate office operates out of leased office space in Chicago, Illinois.

 

Product volumes at all of the facilities of the Company are subject to seasonal fluctuations, but in the opinion of management, the facilities are generally well utilized.

 

Item 3.

LEGAL PROCEEDINGS

 

The Company is involved in litigation matters related to its continuing business, principally product liability matters related to the gas-fired heating products. In the Company’s opinion, none of these proceedings, when concluded, will have a material adverse effect on the Company’s results of operations or financial position as the Company has established adequate reserves for known occurrences. See Management’s Discussion and Analysis of Financial Condition and Results of Operations on pages 9 through 15 and Note 4 on page 27 of this Annual Report on Form 10-K.

 

 

Item 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

There were no matters submitted to a vote of security holders during the fourth quarter of fiscal 2004.

 

PART II

 

Item 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Continental Materials Corporation shares are traded on the American Stock Exchange under the symbol CUO. Market sales prices for the fiscal quarters of the past two years are:

 

				High			Low
2004		Fourth Quarter		$	28.70		$	26.40
		Third Quarter		29.25			27.80
		Second Quarter		29.40			28.35
		First Quarter		29.40			27.40
2003		Fourth Quarter		$	29.10		$	23.25
		Third Quarter		23.40			23.00
		Second Quarter		26.45			20.15
		First Quarter		27.30			26.45

 

At March 24, 2005, the Company had approximately 317 shareholders of record (including non-objecting beneficial owners).

 

The Company has never paid, nor does it currently intend to declare, any dividends. The Company’s policy of reinvesting earnings from operations is reviewed periodically by the Board of Directors.

 

6

 

The following table presents information with respect to purchases made by the Company of its common stock to become treasury stock for the period October 3, 2004 through January 1, 2005:

 

Issuer Purchases of Equity Securities
Period		(a) Total Number of Shares Purchased		(b) Average Price Paid per Share			(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum Dollar Value of shares that May Yet Be Purchased Under the Plans or Programs
October 3 – October 30, 2004		—		$	—		—		$	1,665,658
October 31- November 27, 2004		—		—			—		1,665,658
November 28 – January 1, 2005		6,013		26.56			6,013		1,505,938
Total		6,013		$	26.56		6,013		$	1,505,938

 

On January 19, 1999, the Company initiated purchases under the current open-ended program to repurchase its common stock. Purchases are made on the open market or in block trades at the discretion of management. The dollar amount authorized for the program has been periodically increased by the Board of Directors and approved by the Company’s two banks as required by the Company’s Revolving Credit and Term Loan Agreement. Effective May 29, 2004, the Board increased the permitted amount to a total not to exceed $2,750,000 for purchases on or after May 29, 2004.

 

Under the Company’s Stock Option Plan (the Plan), officers and key employees may be granted options to purchase the Company’s common stock at option prices established by the Compensation Committee of the Board of Directors provided the option price is not less than the fair market value at the date of the grant. The following is a summary of equity compensation plan information as of January 1, 2005:

 

EQUITY COMPENSATION PLAN INFORMATION

 

		Number of securities to be					Number of securities remaining available for
		issued upon exercise of		Weighted-average exercise			future issuance under equity compensation
		outstanding options,		price of outstanding options,			plans (excluding securities reflected in
Plan Category		warrants and rights		warrants and rights			column (a))
		(a)		(b)			(c)
Equity compensation plans approved by security holders		73,400		$	6.56		227,600
Equity compensation plans not approved by security holders		0		0			0
Total		73,400		$	6.56		227,600

 

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Item 6.

Selected Financial Data (See note below chart)

(Amounts in thousands, except per share amounts)

 

		2004			2003			2002			2001			2000
SUMMARY OF OPERATIONS
Sales		$	126,940		$	120,165		$	128,301		$	130,211		$	116,002
Net income from continuing operations		$	2,373		$	2,349		$	3,275		$	6,438		$	5,335
PER SHARE DATA
Basic earnings per share		$	1.41		$	1.34		$	1.83		$	3.55		$	2.86
Weighted average shares outstanding		1,681			1,754			1,794			1,812			1,869
Diluted earnings per share		$	1.38		$	1.31		$	1.79		$	3.49		$	2.81
Weighted average shares outstanding		1,725			1,791			1,830			1,845			1,901
Cash dividends declared per common share		$	0		$	0		$	0		$	0		$	0
FINANCIAL CONDITION
Current ratio		2.1:1			2.5:1			2.3:1			2.2:1			2.4:1
Total assets		$	85,883		$	81,826		$	82,634		$	86,063		$	68,250
Long-term debt, including current portion		9,000			10,970			13,520			17,140			7,305
Shareholders’ equity		51,448			50,857			49,989			47,722			41,813
Long-term debt to net worth ratio		.17:1			.22:1			.27:1			.36:1			.18:1
Book value per diluted share		$	31.09		$	29.52		$	28.01		$	26.40		$	22.78
(Equity adjusted for exercise of options using end of year stock price and shares outstanding)
Tangible book value per diluted share		$	26.15		$	24.65		$	23.19		$	22.13		$	22.62
(Same as above calculation with Equity less unamortized Goodwill and Non-compete covenants)
CASH FLOWS
Net cash provided by (used in):
Operating activities		$	5,519		$	7,778		$	9,753		$	13,219		$	10,021
Investing activities		(3,350		)	(2,535		)	(9,547		)	(19,215		)	(2,662		)
Financing activities		(3,950		)	(4,170		)	(4,249		)	7,359			(1,490		)
Net (decrease) increase in cash and cash equivalents		$	(1,781	)	$	1,073		$	(4,043	)	$	1,363		$	5,869

 

Note: Above figures include the activity of RMRM for the entire fiscal 2001 year (purchased on December 31, 2000) and on and the activity of MDHI since April 1, 2002, the date it was acquired.

 

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Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

(References to a “Note” are to the Notes to Consolidated Financial Statements contained elsewhere in this report)

 

COMPANY OVERVIEW

 

The Company operates primarily in two industry segments, the heating and air conditioning segment and the construction materials segment. The primary products manufactured by the heating and air conditioning segment are gas fired wall furnaces, console heaters, evaporative coolers and fan coils. Gas-fired wall furnaces, console heaters and fan coil products are manufactured at Williams Furnace Co., headquartered in Colton, California. Evaporative coolers are manufactured at Phoenix Manufacturing, Inc., headquartered in Phoenix, Arizona. The primary products of the construction materials segment are ready mix concrete, construction aggregates, building supplies and doors which are offered by Transit Mix Concrete Co. and Castle Concrete Company in Colorado Springs, Colorado and Transit Mix of Pueblo, Inc. and McKinney Door and Hardware, Inc. (MDHI) in Pueblo, Colorado. Currently, Rocky Mountain Ready Mix Concrete, Inc. (RMRM) of Denver, Colorado, only offers ready mix concrete.

 

Heating and Air Conditioning Segment

Furnace and console heater sales volume in 2004 was steady compared to the prior year’s level; however, margins declined as a result of the increased steel prices.

 

Fan coil sales increased as a result of a modest increase in industry-wide demand. Margins were similarly affected by increased raw material prices and price competition.

 

Evaporative cooler sales volume declined primarily due to the loss of a portion of the evaporative cooler business at a national home center account. As with the furnace product line, margins declined as steel prices increased.

 

Selling, general and administrative expenses were lower due to a reduction in office personnel and reduced legal costs. Sales commissions were lower as a result of the decline in evaporative cooler sales.

 

This segment’s pre-tax earnings exceeded its cash flow by approximately $860,000. A decrease in payables and accrued expenses accounted for most of the reduced cash flow. Capital expenditures modestly exceeded depreciation. Capital expenditures included the replacement of certain equipment at PMI to improve safety and the purchase of a finishing system at WFC for certain wall furnace components.

 

Construction Materials Segment

Despite their proximity, Denver, Colorado Springs and Pueblo have distinct competitive and economic conditions. Concrete sales volumes improved in all three markets compared to last year reflecting a modest improvement in construction activity along the Front Range in Colorado. The price of concrete, however, illustrated the diversity of the three markets. While increases in cement and fuel prices were able to be substantially recovered through increased selling prices in the Pueblo and Colorado Springs markets, average selling prices in Denver actually declined reflecting the intensely competitive market.

 

The sales volume of construction aggregates decreased modestly from the 2003 level; however, gross profits rose as a result of improved operations at the two recently added aggregates plants, one at the Colorado Springs sand operation and the other at our Pueblo gravel operation.

 

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Sales of doors and supplies increased over 25% from the prior year. While steel prices also affected these operations, gross profits improved because of well-timed inventory purchases that enabled the division to satisfy customers’ demands for reinforced steel bar (rebar) when much of the competition could not acquire adequate supplies.

 

The construction materials segment typically requires large capital investments, particularly when volume is strong. Capital spending increased slightly during 2004 to $3,017,000 mirroring the modest increase in demand for concrete. A new batch plant in Pueblo West was added as well as a truck tracking system. Other expenditures were primarily routine replacements and upgrades.

 

Cash flow from this segment was less than pre-tax earnings by approximately $745,000. An increase in receivables, reflecting the improved sales volume, temporarily reduced cash flow.

 

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

 

Cash and cash equivalents were $2,828,000 at the end of 2004 compared to $4,609,000 at the prior year-end. Operations in 2004 provided $5,519,000 of cash compared to $7,778,000 in 2003 and $9,753,000 generated in 2002. The decrease in net cash generated by operating activities in 2004 compared to 2003 was largely due to a lower level of earnings before non-cash charges and gains on sale of property and equipment. Net working capital increased by $1,467,000 compared to an increase of $595,000 in 2003. The decrease in net cash generated by operating activities in 2003 compared to 2002 was primarily due to the decreased earnings. Net working capital increased by $595,000 in 2003 compared to an increase of only $122,000 in 2002.

 

Net cash used in investing activities was $3,350,000 in 2004, $2,535,000 in 2003 and $9,547,000 in 2002. Capital expenditures for 2004, 2003 and 2002 were $4,267,000, $2,880,000 and $7,561,000, respectively. The capital expenditures in 2004 included a new batch plant in Pueblo West and a truck tracking system. The capital expenditures in 2003 included the construction of a maintenance facility in Pueblo and completion of the Brighton batch plant begun in 2002. The expenditures in 2002 included the completion of three large projects that were begun in 2001: a new state-of-the-art sand processing plant was completed in Colorado Springs during the third quarter, a new aggregate processing plant in Pueblo was completed in June and a new central mix batch plant was added in Colorado Springs. In addition, a new batch plant was purchased to replace the existing facility in Brighton, Colorado. As noted above, the new plant became operational in 2003. Proceeds from the sale of property and equipment were $917,000, $345,000 and $139,000 during 2004, 2003 and 2002, respectively. Sales of two parcels of real estate generated $695,000 of the 2004 amount. On April 1, 2002, $2,125,000, net of cash received, was expended to purchase McKinney Door and Hardware, Inc. (MDHI).

 

Budgeted capital expenditures for 2005 are approximately $4,265,000 (including $3,240,000 for the construction materials segment and $925,000 for the heating and air conditioning segment), which is approximately $1,470,000 less than planned depreciation, depletion and amortization. The expenditures are primarily for routine replacement and upgrades. The Company expects that the 2005 expenditures will be funded from existing cash balances and operating cash flow.

 

During 2004, cash of $3,950,000 was used in financing activities. Scheduled long-term payments of $1,970,000 were made during the year including the final $220,000 due on capital lease obligations. Under the Company’s ongoing share repurchase program, cash of $1,980,000 was used to acquire 69,949 shares during 2004. During 2003, cash of $4,170,000 was used in financing activities. Scheduled long-term debt payments of $2,550,000 were made during the year including $300,000 against capital lease obligations. Cash of $1,620,000 was used to acquire 63,135 shares of treasury stock. During 2002, cash of $4,249,000 was used in financing activities repaying scheduled long-term debt of $3,620,000 which included $620,000

 

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against capital lease obligations. An additional $604,000 was used to acquire 22,599 shares of treasury stock.

 

Capital Resources, Obligations and Commitments, and Off-Balance Sheet Arrangements

 

Revolving Credit and Term Loan Agreement

The Company signed a Revolving Credit and Term Loan Agreement (Credit Agreement) with two banks in September 2003. The Credit Agreement provides for a revolving credit facility of $10,000,000 and a term loan facility in the original amount of $11,500,000. Both facilities are unsecured and bear interest at prime or a performance-based LIBOR rate. The term loan is payable in escalating quarterly installments with final payment of all then unpaid principal on June 30, 2008. At January 1, 2005, $9,000,000 was outstanding on the term loan while there was no balance outstanding on the revolving credit facility. The revolving credit facility is available for seasonal needs including the funding of seasonal sales programs related to the furnace and evaporative cooler product lines. The line is also used for stand-by letters of credit to insurance carriers in support of self-insured amounts under the Company’s risk management program. Currently, such performance-based rate is LIBOR plus 1.50% for the term loan and LIBOR plus 1.25% for borrowings under the revolving credit facility. Effective December 17, 2001, the Company entered into an interest rate swap agreement (Swap Agreement) in order to minimize the adverse impact of the floating interest rate characteristic of most of the Company’s term loan borrowings. The Company’s current effective interest rate on the outstanding term loan is 5.88% after giving effect to the Swap Agreement. Such rate is subject to adjustment depending upon the Company’s performance. The Company concluded that it was appropriate to take advantage of the interest rate environment and fix the interest rate at a relatively low level for a five-year period.

 

Obligations and Commitments

The following tables represent our obligations and commitments to make future payments under contracts, such as debt and lease agreements, and under contingent commitments, such as debt guarantees, as of January 1, 2005.

 

Payments Due by Period as of January 1, 2005 (amounts in thousands)

 

		Payments due by period
Contractual Obligations		Total			Less than 1 year			1 – 3 years			3 – 5 years			More than 5 years
Long-term debt including interest (See Note 3)		$	9,868		$	2,427		$	7,441		$	—		$	—
Operating leases (See Note 7)		8,664			1,473			3,973			1,708			1,510
Minimum royalty agreement (See Note 7)		20,859			386			1,159			773			18,541
Total contractual obligations		$	39,391		$	4,286		$	12,573		$	2,481		$	20,051

 

Interest on long-term debt is computed using the interest rate in effect at January 1, 2005 and gives effect to the Swap Agreement. The interest amounts do not include estimated interest payments due under our revolving credit facility because future borrowings under this facility are unknown at this time.

 

Amounts of Commitment Expiration per Period as of January 1, 2005 (amounts in thousands)

 

Other Commercial Commitments		Total			Less than 1 year			1 – 3 years			3 – 5 years			More than 5 years
Standby letters of credit		$	2,010		$	2,010		$	—		$	—		$	—

 

Other than the anticipated funds to be provided to fund the tender offer discussed in Note 12, we believe that existing cash balances and anticipated cash flow, supplemented by seasonal borrowings against the revolving line of credit, will be sufficient to cover expected cash needs, including servicing debt and planned capital expenditures for at least the next twelve months.

 

Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements that would be likely to have a material current or future effect on our financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.

 

11

 

Operations:  Fiscal 2004 vs. 2003

 

Consolidated sales, at $126,940,000 in 2004, were $6,775,000, or 5.6%, higher than in 2003. The increase was realized by the construction materials segment where sales reached $80,398,000, 12.5% above the 2003 amount. Concrete volumes grew in all locations as construction activity along the Front Range in Colorado improved modestly. Prices improved in the Colorado Springs and Pueblo markets in response to increased cement and fuel costs. The Denver market remained highly competitive resulting in lower ready mix concrete prices in spite of the higher cement and fuel costs. Sales of construction aggregates declined slightly. Sales in the supply and door divisions were strong and exceeded the 2003 level by over 25%. Sales in the heating and air conditioning segment decreased $2,146,000 (4.4%). The decline was primarily due to lower evaporative cooler sales as a result of losing the window unit business at a large national home center account. Furnace sales were approximately the same as the prior year. Fan coil sales improved in a still weak market.

 

The Company experienced a high level of price competition in all of its product lines during 2004, especially in the Denver ready mix concrete market. During 2004, steel and fuel prices dramatically outpaced the general rate of inflation. The Company was able to recover a portion of the cost increases through higher selling prices. The rate of increase in health care costs subsided in 2004 compared to the prior year.

 

Cost of sales (exclusive of depreciation, depletion and amortization), as a percent of sales, increased from 78.0% to 81.4%. The decline in the heating and air conditioning segment was primarily due to increased steel costs during the year, an increase in workers’ compensation claims and the write-off of the remaining inventories associated with a product manufactured at our Phoenix plant. The decline in the construction materials segment was primarily in the Denver market due to lower prices for ready mix concrete exacerbated by higher cement and fuel costs and an increase in workers’ compensation claims.

 

Selling and administrative expenses decreased in 2004 despite the increase in sales. The decrease occurred in the heating and air conditioning segment as a result of a reduction in office staff, and reduced legal expenses. Commissions declined reflecting the decrease in evaporative cooler sales. The decrease in the heating and air conditioning segment was partially offset in the construction materials segment where selling and administrative expenses increased in response to the improved sales.

 

Depreciation, depletion and amortization declined reflecting the effect of reduced capital spending in recent years.

 

The gain on disposition of property and equipment increased due to the sales of two parcels of real estate in Colorado which generated gains of $489,000 in 2004.

 

The decline in operating income from $3,810,000 to $3,504,000 is primarily due to the increased raw material costs and lower evaporative cooler sales in the air conditioning segment partially offset by the increased sales, lower depreciation expense and the gain on sale of property in the construction materials segment.

 

Other income declined as a result of $176,000 of gain realized during 2003 on the settlement of property tax bills related to the Oracle Ridge Mining Partners property.

 

The Company’s 2004 effective income tax rate (24.0%) reflects federal and state statutory rates adjusted for non-deductible and other tax items. The effective rate in 2004 was reduced by 5.5% due to earned Colorado and California Enterprise Zone credits that resulted in either a refund of prior years’ taxes or that will benefit future tax years. A deduction for percentage depletion, the donation of appreciated property and the release of tax contingencies also reduced the tax rate by 3.1%, 1.3% and 4.2%, respectively. See Note 9.

 

12

 

Operations:  Fiscal 2003 vs. 2002

 

Consolidated sales in 2003 declined $8,136,000, or 6.3%, to $120,165,000. Sales declined $4,399,000 (5.8%) in the construction materials segment. The reduced level of construction activity along the Front Range in Colorado led to lower volumes and increased price competition resulting in lower ready mix concrete prices, most notably in the Denver metropolitan area. The reduced volume combined with the lower prices account for the diminished sales level. Sales in the heating and air conditioning segment decreased $3,919,000 (7.5%). Fan coil sales continue to reflect the nationwide slump in commercial construction, particularly hotel construction. The sharp decline in fan coil sales was only partially offset by improved evaporative cooler sales. The improved evaporative cooler sales were primarily driven by hot, dry weather that persisted later in the year than normal.

 

The Company experienced a high level of price competition in all of its product lines during 2003, especially in the Denver ready mix concrete market. During 2003, inflation was not a significant factor at any of the operations except that employee health care costs and general business insurance premiums again dramatically outpaced the rate of inflation.

 

Cost of sales (exclusive of depreciation, depletion and amortization), as a percent of sales, decreased from 78.3% to 78.0%. The improvement realized in the heating and air conditioning segment was primarily due to a $662,000 write-down in 2002 of inventories and other costs associated with a product manufactured at our Phoenix plant. A very slight improvement was experienced in the construction materials segment due to the inclusion of MDHI for the full year in 2003. The further decline in construction activity along the Front Range in Colorado had the effect of increasing price competition resulting in lower prices for ready mix concrete. The effect of lower concrete prices on 2003 profit margins was largely offset by lower costs and operating improvement at the various aggregates locations.

 

Selling and administrative expenses increased in 2003 despite the decline in sales. The increase was due to higher legal costs related to product liability claims and a dispute with a supplier concerning the continued availability of a key purchased component for our evaporative cooler product line.

 

Gain on disposition of property and equipment increased in 2003 due to $155,000 realized from the sale of a not exploitable aggregate property in Colorado.

 

The decline in operating income from $5,766,000 to $3,810,000 is primarily due to the decreased sales, the heightened competition in Colorado and the aforementioned increased legal costs.

 

Other income increased in 2003 as a result of $176,000 of gain realized on the settlement of property tax bills related to the Oracle Ridge Mining Partners property.

 

The Company’s 2003 effective income tax rate (31.9%) reflects federal and state statutory rates adjusted for non-deductible and other tax items. The effective rate in 2003 was reduced by 5.3% due to earned California Enterprise Zone credits that will benefit future tax years. See Note 9.

 

CRITICAL ACCOUNTING POLICIES

 

Financial Reporting Release No. 60, issued by the Securities and Exchange Commission, requires all registrants, including the Company, to include a discussion of “critical” accounting policies or methods used in the preparation of financial statements. We believe the following are our critical accounting policies and methods.

 

13

 

Inventories

 

Inventories are priced at the lower of cost (76% at January 1, 2005 at last-in, first-out, with the remainder at first-in, first-out) or market. Inventories are reviewed annually for excess or obsolete stock with a provision recorded, where appropriate.

 

Intangibles

 

In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” goodwill is not amortized as a charge to earnings. We annually assess goodwill for potential impairment. This assessment requires us to make significant assumptions and estimates about the extent and timing of future cash flows, discount rates, and growth rates. No impairment was indicated in the current year. If the assessment had indicated that the carrying value of goodwill was impaired, an impairment charge would have been recorded for the amount by which the carrying value of the goodwill exceeded its fair value. Management believes that the assumptions and estimates used to determine the estimated fair values are reasonable; however, changes in different assumptions and estimates could materially affect the estimated fair value.

 

Liabilities

 

The Company purchases insurance coverage for workers’ compensation, general product and automobile liability, retaining certain levels of risk (self-insured portion). Provision for workers’ compensation and automobile claims is estimated based upon information provided by the Company’s independent claims administrator and the Company’s own experience. With regard to product liability, provisions for both claims and unasserted claims that would be covered under the self-insured portion of the policies are recorded in accordance with the requirements of SFAS No. 5, “Accounting for Contingencies,” and are reviewed at least annually for revisions in estimates.

 

The Company records a reserve for future reclamation work to be performed at its various aggregate operations based upon estimates of the recoverable quantities of rock and sand available in each location combined with an estimate of the total expense that will be incurred to reclaim a property. Provision is made based upon the units-of-production method. Actual reclamation costs are charged against the reserve. The adequacy of the recorded reserve is assessed annually. Estimates of both the quantities of recoverable material and the cost of reclamation are periodically updated by an independent professional. In a similar manner, depletion of rock and sand deposits and amortization of deferred development costs are computed by the units-of-production method based upon estimated recoverable quantities of rock and sand.

 

Sales

 

The Company recognizes revenue as products are shipped to customers. The amount is recorded net of applicable provisions for discounts, volume incentives, returns and allowances. At the time of revenue recognition, the Company also provides an estimate of potential bad debt and warranty expense as well as an amount anticipated to be granted to customers under cooperative advertising programs based upon current program terms and historical experience.

 

Recently Issued Accounting Standards and Tax Law Changes

 

The Financial Accounting Standards Board (FASB) has recently issued the following statements and interpretations:

 

In November 2004, Statement of Financial Accounting Standards (SFAS) No. 151, “Inventory Costs - An Amendment of ARB No. 43, Chapter 4,” was issued which amends the guidance in

 

14

 

Accounting Research Bulleting (“ARB”) No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material.  Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight and rehandling costs be recognized as current -period charges regardless of whether they meet the criteria of “so abnormal” as stated in ARB No. 143.  Additionally, SFAS 151 requires the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.  SFAS 151 is effective for fiscal years beginning after June 1, 2005.  The Company is currently evaluating the effect that the adoption of SFAS 151 will have on its consolidated results of operations and financial condition but does not expect SFAS 151 to have a material impact.

 

In December 2004, SFAS No. 123R, “Share-based Payment” was issued and replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees.”  SFAS 123R requires the measurement of all employee share-based payments, including grants of employee stock options, using a fair-value based model.  Deferred compensation calculated under the fair value method would then be amortized into income over the respective vesting period of the stock option. The accounting provisions of SFAS 123R are effective for reporting periods beginning after June 15, 2005. The adoption of SFAS 123R will not have an impact on the Company’s consolidated results of operations and financial condition as all stock options issued under the Company’s stock option plan are fully vested.

 

On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the “Act”). The Act provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. In return, the Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. The Company has not completed its analysis of the possible effect the phase out of the ETI and phase in of this new deduction may have on the Company.

 

Under the guidance in FASB Staff Position No. FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004,” the deduction will be treated as a “special deduction” as described in FASB Statement No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction, if any, will be reported in the period in which the deduction is claimed on the Company’s tax return.

 

FORWARD-LOOKING STATEMENTS

 

This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended. Such forward-looking statements are based on the beliefs of the Company’s management as well as on assumptions made by and information available to the Company at the time such statements were made. When used in this Report, words such as “anticipates,” “believes,” “contemplates,” “estimates,”  “expects,” “plans,” “projects” and similar expressions are intended to identify forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of factors including but not limited to: weather, interest rates, availability of raw materials and their related costs, economic conditions and competitive forces. Changes in accounting pronouncements could also alter projected results. Forward-looking statements speak only as of the date they were made and we undertake no obligation to publicly update them.

 

15

 

Item 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company is exposed to market risks related to commodity prices and interest rates. To manage interest rate risk, the Company has, from time to time, entered into interest rate swaps as cash flow hedges. These swaps are authorized by the Company’s policies and procedures. The Company does not use swaps or hedging instruments for trading purposes, and is not a party to any transaction involving leveraged derivatives. Effective December 17, 2001, the Company entered into an interest rate swap agreement (Swap Agreement) in order to minimize the adverse impact of the floating interest rate characteristic of most of the Company’s term loan borrowings. The Company’s current effective interest rate on the portion of the term loan covered by the Swap Agreement is 5.88%. Such rate is subject to adjustment depending upon the Company’s performance. Cash payments or receipts associated with this agreement are reflected in interest expense. The fixed rate under the Swap Agreement has exceeded the floating rate on the term loan during each of the years. The effect on operations was to reduce net income by $162,000, $257,000 and $239,000 for 2004, 2003 and 2002, respectively. The fair value of the Swap Agreement is recorded on the balance sheet with subsequent changes recorded as a separate component of accumulated other comprehensive income in shareholders’ equity. At January 1, 2005, the amount subject to this Swap Agreement is $7,500,000 which amount decreases by $1,500,000 each September and March, terminating on December 18, 2006. The pre-tax fair value of the Swap Agreement is $39,000 at March 31, 2005. Although the Company will benefit from the Swap Agreement as interest rates increase, the effect is not expected to be material during the either of the remaining two years. See paragraph below and above discussion under Financial Condition, Liquidity and Capital Resources. See Note 3.

 

Interest Rates

 

The Company utilizes revolving credit and term-loan facilities that bear interest at either prime or an adjusted LIBOR rate. The amount outstanding under these facilities aggregated $9,000,000 at January 1, 2005. The Company is not a party to any capital lease agreements as of January 1, 2005. See Note 3.

 

Commodities

 

The Company purchases commodities, such as steel, copper, aluminum, cement, fuel and cardboard for packaging, at market prices and does not currently use financial instruments to hedge commodity prices.

 

16

 

Item 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Financial Statements and Schedule of Continental Materials Corporation and report thereon:
Consolidated statements of operations and comprehensive income for fiscal years 2004, 2003 and 2002
Consolidated statements of cash flows for fiscal years ended 2004, 2003 and 2002
Consolidated balance sheets as of January 1, 2005 and January 3, 2004
Consolidated statements of shareholders’ equity for fiscal years ended 2004, 2003 and 2002
Notes to consolidated financial statements
Report of Independent Registered Public Accounting Firm

 

17

 

Continental Materials Corporation

Consolidated Statements of Operations and Comprehensive Income

For Fiscal Years 2004, 2003 and 2002

 (Amounts in thousands, except per share data)

 

		2004			2003			2002
Sales		$	126,940		$	120,165		$	128,301
Costs and expenses
Cost of sales (exclusive of depreciation, depletion and amortization)		103,320			93,713			100,477
Depreciation, depletion and amortization		5,027			6,062			6,080
Selling and administrative		15,699			16,783			16,033
Gain on disposition of property and equipment		611			233			79
Operating income		3,505			3,840			5,790
Interest expense		(516		)	(670		)	(922		)
Other income (expense), net		134			279			157
Income before income taxes		3,123			3,449			5,025
Income tax provision		750			1,100			1,750
Net income		$	2,373		$	2,349		$	3,275
Basic earnings per share		$	1.41		$	1.34		$	1.83
Weighted average shares outstanding		1,681			1,754			1,794
Diluted earnings per share		$	1.38		$	1.31		$	1.79
Weighted average shares outstanding		1,725			1,791			1,830
Comprehensive income:
Net income		$	2,373		$	2,349		$	3,275
Comprehensive income (loss) from interest rate swap, net of tax of $83, $90, and $214, respectively		198			139			(404		)
Total comprehensive income		$	2,571		$	2,488		$	2,871

 

The accompanying notes are an integral part of the financial statements.

 

18

 

Continental Materials Corporation Consolidated Statements of Cash Flows

For Fiscal Years 2004, 2003 and 2002

(Amounts in thousands)

 

		2004			2003			2002
Operating activities
Net income		$	2,373		$	2,349		$	3,275
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation, depletion and amortization		5,027			6,062			6,080
Deferred income tax provision		89			83			422
Provision for doubtful accounts		108			112			75
Gain on disposition of property and equipment		(611		)	(233		)	(79		)
Write-off of investment in product line		—			—			102
Changes in operating assets and liabilities
Receivables		(1,472		)	(425		)	2,247
Inventories		(428		)	(1,589		)	2,158
Prepaid expenses		(28		)	(176		)	151
Prepaid royalties		(239		)	3			(257		)
Accounts payable and accrued expenses		735			146			(3,856		)
Income taxes		88			1,132			(339		)
Other		(123		)	314			(226		)
Net cash provided by operating activities		5,519			7,778			9,753
Investing activities
Acquisitions of subsidiaries, net of cash received		—			—			(2,125		)
Capital expenditures		(4,267		)	(2,880		)	(7,561		)
Proceeds from sale of property and equipment		917			345			139
Net cash used in investing activities		(3,350		)	(2,535		)	(9,547		)
Financing activities
Repayment of long-term debt		(1,970		)	(2,550		)	(3,620		)
Payment of amounts due former shareholders		—			—			(25		)
Payments to acquire treasury stock		(1,980		)	(1,620		)	(604		)
Net cash used in financing activities		(3,950		)	(4,170		)	(4,249		)
Net (decrease) increase in cash and cash equivalents		(1,781		)	1,073			(4,043		)
Cash and cash equivalents
Beginning of year		4,609			3,536			7,579
End of year		$	2,828		$	4,609		$	3,536
Supplemental disclosures of cash flow items Cash paid (received) during the year
Interest		$	585		$	799		$	1,084
Income taxes		608			(137		)	1,682

 

The accompanying notes are an integral part of the financial statements.

 

19

 

Continental Materials Corporation

Consolidated Balance Sheets As of January 1, 2005 and January 3, 2004

(Amounts in thousands except share data)

 

		January 1, 2005			January 3, 2004
ASSETS
Current assets
Cash and cash equivalents		$	2,828		$	4,609
Receivables less allowance of $325 and $436		18,418			17,054
Receivable for insured losses		4,466			709
Inventories		16,609			16,181
Prepaid expenses		1,268			1,260
Deferred income taxes		2,291			1,804
Total current assets		45,880			41,617
Property, plant and equipment
Land and improvements		2,776			3,128
Buildings and improvements		19,087			18,219
Machinery and equipment		70,048			69,660
Mining properties		5,250			5,175
Less accumulated depreciation and depletion		(67,128		)	(65,309		)
		30,033			30,873
Other assets
Goodwill		7,374			7,374
Non-compete agreements		953			1,178
Prepaid royalties		1,140			901
Other		503			592
		$	85,883		$	82,535
LIABILITIES
Current liabilities
Current portion of long-term debt		$	2,000		$	1,970
Accounts payable		4,575			4,688
Income taxes		767			700
Accrued expenses
Compensation		2,638			2,101
Reserve for self-insured losses		2,988			1,973
Liability for unpaid claims covered by insurance		4,466			709
Profit sharing		1,942			1,456
Reclamation		384			409
Other		1,712			2,877
Total current liabilities		21,472			16,883
Long-term debt		7,000			9,000
Deferred income taxes		3,796			3,219
Accrued reclamation		1,171			1,291
Other long-term liabilities		996			1,285
Commitments and contingencies (Notes 4 and 7)
SHAREHOLDERS’ EQUITY
Common shares, $.25 par value; authorized 3,000,000 shares; issued 2,574,264 shares		643			643
Capital in excess of par value		1,982			1,982
Retained earnings		62,573			60,200
Accumulated other comprehensive losses (interest rate swap adjustments)		(67		)	(265		)
Treasury shares, at cost		(13,683		)	(11,703		)
		51,448			50,857
		$	85,883		$	82,535

 

The accompanying notes are an integral part of the financial statements.

 

20

 

Continental Materials Corporation

Consolidated Statements of Shareholders’ Equity

For Fiscal Years 2004, 2003 and 2002

 (Amounts in thousands except share data)

 

				Common			Capital						Accum. other					Treasury
		Common		shares			in excess			Retained			comprehensive			Treasury		shares
		shares		amount			of par			earnings			income (loss)			shares		cost
Balance at December 29, 2001		2,574,264		$	643		$	1,982		$	54,576					768,167		$	9,479
Purchase of treasury shares		—		—			—			—						22,599		604
Net income		—		—			—			3,275						—		—
Comprehensive loss from interest rate swap, net of tax of $214		—		—			—			—			$	(404	)	—		—
Balance at December 28, 2002		2,574,264		643			1,982			57,851			(404		)	790,766		10,083
Purchase of treasury shares		—		—			—			—			—			63,135		1,620
Net income		—		—			—			2,349			—			—		—
Comprehensive income from interest rate swap, net of tax of $90		—		—			—			—			139			—		—
Balance at January 3, 2004		2,574,264		643			1,982			60,200			(265		)	853,901		11,703
Purchase of treasury shares		—		—			—			—			—			69,949		1,980
Net income		—		—			—			2,373			—			—		—
Comprehensive income from interest rate swap, net of tax of $83		—		—			—			—			198			—		—
Balance at January 1, 2005		2,574,264		$	643		$	1,982		$	62,573		$	(67	)	923,850		$	13,683

 

The accompanying notes are an integral part of the financial statements.

 

21

 

Notes to Consolidated Financial Statements

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include Continental Materials Corporation and all of its subsidiaries (the Company) including McKinney Door and Hardware, Inc. (MDHI) from April 1, 2002. The acquisition of MDHI was made to complement existing operations and extend the market area served.

 

On April 1, 2002, the Company acquired MDHI for $2,125,000, net of cash received. The acquisition of MDHI has been accounted for as a purchase. The total purchase price and the fair value of liabilities assumed have been allocated to the tangible and intangible assets of MDHI based on respective fair values. The acquisition has resulted in an unallocated excess purchase price over fair value of net assets acquired of $900,000, which has been classified as goodwill.

 

Had the acquisition of MDHI occurred as of December 30, 2001, the unaudited pro forma results of the Company for 2002 would have been as follows (amounts in thousands except per share data):

 

Sales		$	129,401
Net income		$	3,154
Diluted earnings per share		$	1.72

 

These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisition been made at the beginning of the period presented or the results which may occur in the future.

 

The Consolidated Statements of Operations and Comprehensive Income for 2003 and 2002 have been revised to change the classification of gains on disposition of property and equipment from other income to operating income to conform to the current presentation. Certain other amounts have also been reclassified to conform to the current year presentation.

 

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS AND TAX LAW CHANGES

The Financial Accounting Standards Board (FASB) has recently issued the following statements and interpretations:

 

In November 2004, Statement of Financial Accounting Standards (SFAS) No. 151, “Inventory Costs - An Amendment of ARB No. 43, Chapter 4,” was issued which amends the guidance in Accounting Research Bulleting (“ARB”) No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material.  Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight and rehandling costs be recognized as current -period charges regardless of whether they meet the criteria of “so abnormal” as stated in ARB No. 143.  Additionally, SFAS 151 requires the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.  SFAS 151 is effective for fiscal years beginning after June 1, 2005.  The Company is currently evaluating the effect that the adoption of SFAS 151 will have on its consolidated results of operations and financial condition but does not expect SFAS 151 to have a material impact.

 

In December 2004, SFAS No. 123R, “Share-based Payment” was issued and replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees.”  SFAS 123R requires the measurement of all employee share-based payments, including grants of employee stock options, using a fair-value based model.  Deferred compensation calculated under the fair value method would then be amortized into income over the respective vesting

 

22

 

period of the stock option. The accounting provisions of SFAS 123R are effective for reporting periods beginning after June 15, 2005. The adoption of SFAS 123R will not have an impact on the Company’s consolidated results of operations and financial condition as all stock options issued under the Company’s stock option plan are fully vested.

 

On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the “Act”). The Act provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. In return, the Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. The Company has not completed its analysis of the possible effect the phase out of the ETI and phase in of this new deduction may have on the Company.

 

Under the guidance in FASB Staff Position No. FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004,” the deduction will be treated as a “special deduction” as described in FASB Statement No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction, if any, will be reported in the period in which the deduction is claimed on the Company’s tax return.

 

USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of January 1, 2005 and January 3, 2004 and the reported amounts of revenues and expenses during each of the three years in the period ended January 1, 2005. Actual results could differ from those estimates.

 

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.

 

INVENTORIES

Inventories are valued at the lower of cost or market. Cost is determined using the last-in, first-out (LIFO) method for approximately 76% of total inventories at January 1, 2005 (76% at January 3, 2004). The cost of all other inventory is determined by the first-in, first-out (FIFO) method.

 

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are carried at cost. Depreciation is provided over the estimated useful lives of the related assets using the straight-line method as follows:

 

Buildings		10 to 31 years
Leasehold improvements		Shorter of the term of the lease or useful life
Machinery and equipment		3 to 10 years

 

Depletion of rock and sand deposits and amortization of deferred development costs are computed by the units-of-production method based upon estimated recoverable quantities of rock and sand. The estimated recoverable quantities are periodically reassessed.

 

The cost of property sold or retired and the related accumulated depreciation, depletion and amortization are removed from the accounts and the resulting gain or loss is reflected in operating income. Maintenance and repairs are charged to expense as incurred. Major renewals and betterments are capitalized and depreciated over their estimated useful lives.

 

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OTHER ASSETS

 

Goodwill, all of which relates to the construction materials segment, is not amortized but rather assessed annually for impairment.

 

Identifiable intangible assets consist of the following (amounts in thousands):

 

		January 1, 2005						January 3, 2004
		Gross						Gross
		carrying			Accumulated			carrying			Accumulated
		amount			amortization			amount			amortization
Amortized intangible assets:
Pueblo non-compete		$	500		$	409		$	500		$	359
RMRM non-compete		1,250			500			1,250			375
MDHI non-compete		250			138			250			88
		$	2,000		$	1,047		$	2,000		$	822

 

The above non-compete agreements were signed at the time the Company acquired the Pueblo operations (October 21, 1996) and all of the stock of RMRM (December 31, 2000) and MDHI (April 1, 2002). Amortization of the agreements is computed on a straight-line basis over their agreement periods of 5 and 10 years. Amortization expense for these intangible non-compete agreements was $225,000, $225,000 and $213,000 for 2004, 2003 and 2002, respectively. The estimated amortization expense for the five subsequent fiscal years is as follows: 2005 — $225,000; 2006 — $216,000; 2007 — $137,000; 2008 — $125,000 and 2009 — $125,000.

 

RETIREMENT PLANS

The Company and certain subsidiaries have various contributory profit sharing retirement plans for specific employees. The plans allow qualified employees to make tax deferred contributions pursuant to Internal Revenue Code Section 401(k). The Company makes annual contributions, at its discretion, based primarily on profitability. Costs under the plans are charged to operations as incurred.

 

RESERVE FOR SELF-INSURED AND INSURED LOSSES

The Company’s risk management program provides for certain levels of loss retention for workers’ compensation, automobile liability and general and product liability claims. The components of the reserve for self-insured losses have been recorded in accordance with the requirements of SFAS No. 5, “Accounting for Contingencies,” and represent management’s best estimate of the future liability related to these claims up to the associated deductible limit. FASB Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts,” requires an entity to accrue the gross amount of a loss even if the entity has purchased insurance to cover the loss. Therefore the Company has recorded losses for workers’ compensation, automobile liability and general and product liability claims in excess of the deductible amounts, i.e., amounts covered by insurance contracts, in “Liability for unpaid claims covered by insurance” with a corresponding “Receivable for insured losses” on the balance sheet. The Company’s balance sheet as of January 3, 2004 has been reclassified to reflect this presentation. The components of the liability have been recorded in accordance with the requirements of SFAS No. 5, “Accounting for Contingencies,” and represent both unpaid settlements and management’s best estimate of the future liability related to open claims. Management has evaluated the credit worthiness of our insurance carriers and determined that recovery of the recorded losses is probable and, therefore, the receivable from insurance has been recorded for the full amount of the insured losses.

 

RECLAMATION

In connection with permits to mine properties in Colorado, the Company is obligated to reclaim the mined areas. The Company records a reserve for future reclamation work to be performed at its various aggregate operations based upon estimates of the recoverable quantities of rock

 

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