UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

(Mark One)

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended July 1, 2006
		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)

 (312) 541-7200
(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       

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

Large accelerated filer ___                 Accelerated filer ___                           Non-accelerated filer  X 

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

Yes                         No   X

Number of common shares outstanding at August 8, 2006

1,605,461

 

 

PART I — FINANCIAL INFORMATION

Item 1.    Financial Statements

CONTINENTAL MATERIALS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
JULY 1, 2006 and DECEMBER 31, 2005
(Unaudited)
 (000’s omitted except share data)

 

		JULY 1,			DECEMBER 31,
ASSETS		2006			2005
Current assets:
Cash and cash equivalents		$	4,251		$	6,829
Receivables, net		25,123			17,678
Receivable for insured losses		1,672			1,718
Inventories:
Finished goods		7,478			7,650
Work in process		1,438			1,907
Raw materials and supplies		9,821			7,898
Prepaid expenses		3,536			3,910
Total current assets		53,319			47,590
Property, plant and equipment, net		31,905			28,844
Goodwill		8,439			7,374
Non-compete agreements		1,104			728
Other assets		2,267			2,524
		$	97,034		$	87,060
LIABILITIES
Current liabilities:
Bank loan payable		$	1,000		$	—
Current portion of long-term debt		2,000			2,000
Accounts payable and accrued expenses		19,022			15,748
Liability for unpaid claims covered by insurance		1,672			1,718
Income taxes		707			342
Total current liabilities		24,401			19,808
Long-term debt		14,500			10,000
Deferred income taxes		3,681			3,681
Other long-term liabilities		2,014			2,264
SHAREHOLDERS’ EQUITY
Common shares, $0.25 par value; authorized 3,000,000 shares; issued 2,574,264 shares		643			643
Capital in excess of par value		1,830			1,830
Retained earnings		66,460			65,331
Accumulated other comprehensive gains net of tax of $3 and $3 (interest rate swap adjustments)		8			6
Treasury shares, 968,803, at cost		(16,503		)	(16,503		)
		52,438			51,307
		$	97,034		$	87,060

 

See accompanying notes

2

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CONTINENTAL MATERIALS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS, RETAINED EARNINGS
AND COMPREHENSIVE INCOME (LOSS)
FOR THE THREE MONTHS ENDED JULY 1, 2006 AND JULY 2, 2005
(Unaudited)
(000’s omitted except per-share amounts)

		JULY 1,			JULY 2,
		2006			2005
Sales		$	43,704		$	38,273
Costs and expenses:
Cost of sales (exclusive of depreciation, depletion and amortization)		34,957			30,578
Depreciation, depletion and amortization		1,249			1,215
Selling and administrative		5,194			5,226
Gain on disposition of property and equipment		72			48
		41,328			36,971
Operating income		2,376			1,302
Interest		(202		)	(159		)
Other (expense) income, net		(9		)	24
Income before income taxes		2,165			1,167
Provision for income taxes		735			222
Net income		1,430			945
Retained earnings, beginning of period		65,030			62,285
Retained earnings, end of period		$	66,460		$	63,230
Basic earnings per share		$	.89		$	.59
Average shares outstanding		1,605			1,592
Diluted earnings per share		$	.89		$	.58
Average shares outstanding		1,605			1,633
Comprehensive income:
Net income		$	1,430		$	945
Comprehensive (loss) income from interest rate swap, net of tax of $0 and $2		(1		)	4
		$	1,429		$	949

 

See accompanying notes

 

3

CONTINENTAL MATERIALS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
AND COMPREHENSIVE INCOME (LOSS)
FOR THE SIX MONTHS ENDED JULY 1, 2006 AND JULY 2, 2005
(Unaudited)
(000’s omitted except per-share amounts)

		JULY 1,			JULY 2,
		2006			2005
Sales		$	77,388		$	68,030
Costs and expenses:
Cost of sales (exclusive of depreciation, depletion and amortization)		62,938			55,343
Depreciation, depletion and amortization		2,439			2,431
Selling and administrative		10,201			9,407
Gain on disposition of property and equipment		146			115
		75,432			67,066
Operating income		1,956			964
Interest		(298		)	(290		)
Other income, net		52			70
Income before income taxes		1,710			744
Provision for income taxes		581			87
Net income		1,129			657
Retained earnings, beginning of period		65,331			62,573
Retained earnings, end of period		$	66,460		$	63,230
Basic earnings per share		$	.70		$	.41
Average shares outstanding		1,605			1,620
Diluted earnings per share		$	.70		$	.40
Average shares outstanding		1,605			1,660
Comprehensive income:
Net income		$	1,129		$	657
Comprehensive income from interest rate swap, net of tax of $1 and $28		2			47
		$	1,131		$	704

 

See accompanying notes

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CONTINENTAL MATERIALS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JULY 1, 2006 AND JULY 2, 2005
(Unaudited)
(000’s omitted)

		JULY 1, 2006			JULY 2, 2005
Net cash used in operating activities		$	(2,183	)	$	(2,568	)
Investing activities:
Cash paid for acquisitions of assets of certain businesses		(2,452		)	—
Capital expenditures		(3,609		)	(1,946		)
Proceeds from sale of property and equipment		166			127
Net cash used in investing activities		(5,895		)	(1,819		)
Financing activities:
Borrowings under revolving credit facility		1,000			1,300
Long-term borrowings		5,000			5,000
Repayment of long-term debt		(500		)	(1,000		)
Payment to acquire treasury stock		—			(3,707		)
Net cash provided by financing activities		5,500			1,593
Net decrease in cash and cash equivalents		(2,578		)	(2,794		)
Cash and cash equivalents:
Beginning of period		6,829			2,828
End of period		$	4,251		$	34
Supplemental disclosures of cash flow items:
Cash paid during the six months for:
Interest		$	237		$	406
Income taxes		215			575
Supplemental disclosures of noncash investing and financing activities
Note issued as partial consideration for asset purchase		$	1,000		—

 

See accompanying notes

 

5

 

CONTINENTAL MATERIALS CORPORATION
SECURITIES AND EXCHANGE COMMISSION FORM 10-Q
NOTES TO THE QUARTERLY CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTER ENDED JULY 1, 2006
(Unaudited)

1.               The unaudited interim condensed consolidated financial statements included herein are prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and footnote disclosures normally accompanying the annual consolidated financial statements have been omitted. The interim condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s latest annual report on Form 10-K. For reasons more fully discussed in Note 6, the segment information for the second quarter of 2005 has been restated. In the opinion of management, the condensed consolidated financial statements includes all adjustments (none of which were other than normal recurring adjustments) necessary for a fair statement of the results for the interim periods.

2.               The provision for income taxes for the quarter ended July 1, 2006 of 34% is the same as that used for the quarter ended April 1, 2006 and the estimated effective rate of 34% for the year.

3.               Operating results for the first six months of 2006 are not necessarily indicative of performance for the entire year. Historically, sales of the Evaporative Cooling segment are higher in the first and second quarters, sales of the Concrete, Aggregates and Construction Supplies segment are higher in the second and third quarters and sales of the Heating and Cooling segment are higher in the third and fourth quarters. Sales of the Door segment have not shown strong seasonal fluctuations in recent years.

4.               The following is a reconciliation of the calculation of basic and diluted earnings per share (EPS) for the three and six months ended July 1, 2006 and July 2, 2005 (amounts in thousands except per-share data).

 

5.               On June 8, 2006, the Company entered into the Fourth Amendment to Revolving Credit and Term Loan Agreement amending the Company’s existing Credit Agreement. The Fourth Amendment increases the principal amount of the term loan portion of the Credit Agreement by $5,000,000 and increases the revolving credit facility by $5,000,000. With the increase in the term loan and revolving credit amounts, the total loan commitment, at the time of the signing, was $31,500,000. At the filing date of this Form 10-Q, the commitment had been reduced to $31,000,000 due to a term loan repayment of $500,000, as scheduled.

The additional $5,000,000 proceeds of the term loan facility were drawn at the close of business, June 30, 2006 in conjunction with the acquisition discussed in Note 7. The amount available under the revolving credit facility of the Credit Agreement was increased primarily due to increased stand-by letters of credit requirements to insurance carriers in support of self-insured amounts under the Company’s risk management program and to provide additional liquidity. All other material terms of the Credit Agreement remain in force, except to the extent they have been modified by the Fourth Amendment as described in this paragraph.

6.               The Company operates primarily in two industry groups, HVAC and Construction Products. Prior to the 2005 fiscal year, the Company reported its financial results in two reportable segments, essentially along the lines of these two industry groups. The reporting segments were titled the Heating and Air Conditioning segment and the Construction Materials segment. Prior to filing the annual report on Form 10-K for the 2005 fiscal year, management determined that its segment disclosures did not comply with Statement of Financial Accounting

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Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information.” As a result, the financial information presented for 2005 in the table below has been restated.

Prior to filing the annual report on Form 10-K for the 2005 fiscal year, management concluded that there are four reportable segments within its two principal industry groups; the Heating and Cooling segment and the Evaporative Cooling segment in the HVAC industry group and the Concrete, Aggregates and Construction Supplies segment and the Door segment in the Construction Products industry group. The Heating and Cooling segment produces and sells gas-fired wall furnaces, console heaters and fan coils from the Company’s wholly-owned subsidiary, Williams Furnace Co. of Colton, California. The Evaporative Cooling segment produces and sells evaporative coolers from the Company’s wholly-owned subsidiary, Phoenix Manufacturing, Inc. of Phoenix, Arizona. The operations of these two segments were previously combined and reported as the Heating and Air Conditioning segment. Sales of these two segments are nationwide, but are concentrated in the southwestern United States. Concrete, Aggregates and Construction Supplies are offered from numerous locations along the Front Range of Colorado operated by the Company’s wholly-owned subsidiaries Castle Concrete Company and Transit Mix Concrete Co. (TMC), of Colorado Springs, Transit Mix of Pueblo, Inc. of Pueblo and Rocky Mountain Ready Mix Concrete, Inc. of Denver. Doors are fabricated and sold along with the related hardware from the Company’s wholly-owned subsidiary, McKinney Door and Hardware, Inc. (MDHI) of Pueblo, Colorado. The operations of these two segments were previously combined and reported as the Construction Materials segment.  Sales of these two segments are highly concentrated in the Front Range area in Colorado although door sales are also made throughout the United States.

The Company evaluates the performance of its segments and allocates resources to them based on a number of criteria including operating income, return on investment and other strategic objectives. Operating income is determined by deducting operating expenses from all revenues. In computing operating income, none of the following has been added or deducted: unallocated corporate expenses, interest, other income or loss or income taxes.

In addition to the above reporting segments, an “Unallocated Corporate” classification is used to report the unallocated expenses of the corporate office which provides treasury, insurance and tax services as well as strategic business planning and general management services and an “Other” classification is used to report a small real estate operation. Expenses related to the corporate information technology group are allocated to all locations, including the corporate office.

The following table presents information about reported segments for the six month and three month periods ended July 1, 2006 and July 2, 2005 along with the items necessary to reconcile the segment information to the totals reported in the financial statements (amounts in thousands except in footnotes):

 

		Construction Products									HVAC Products
		Concrete, Aggregates & Construction Supplies			Doors			Combined Construction  Products			Heating and  Cooling			Evaporative Cooling			Combined HVAC  Products			Unallocated Corporate			Other			Total
2006
Six Months
Revenues from external customers		$	47,206		$	4,417		$	51,623		$	11,631		$	13,959		$	25,590		$	3		$	172		$	77,388
Depreciation, depletion and amortization		1,836			67			1,903			198			300			498			38			—			2,439
Operating income (loss)		3,110			295			3,405			(149		)	331			182			(1,685		)	54			1,956
Segment assets		56,857			3,507			60,364			17,418			14,563			31,981			4,685			4			97,034
Capital expenditures (a)		5,067			65			5,132			102			162			264			2			—			5,398
Three Months
Revenues from external customers		$	27,121		$	2,278		$	29,399		$	5,045		$	9,171		$	14,216		$	3		$	86		$	43,704
Depreciation, depletion and amortization		946			33			979			100			150			250			20			—			1,249
Operating income (loss)		3,035			157			3,192			(354		)	358			4			(847		)	27			2,376
Segment assets		56,857			3,507			60,364			17,418			14,563			31,981			4,685			4			97,034
Capital expenditures (a)		3,799			—			3,799			97			37			134			—			—			3,933

 

(a)          Capital expenditures for the Concrete, Aggregates and Construction Supplies segment include $1.735 million purchased on June 30, 2006 as part of the purchase of certain assets of a concrete producer in Colorado Springs. Capital expenditures for the Door segment include $54 thousand purchased on January 1, 2006 as part of the purchase of the assets of Colorado State Safe & Lock Co. (CSSL). Also see Note 7.

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		Construction Products									HVAC Products
		Concrete, Aggregates & Construction Supplies			Doors			Combined Construction Products (a)			Heating and Cooling			Evaporative Cooling			Combined HVAC Products (a)			Unallocated Corporate			Other			Total
2005
Six Months as restated
Revenues from external customers		$	39,681		$	3,672		$	43,353		$	11,473		$	13,032		$	24,505		$	—		$	172		$	68,030
Depreciation, depletion and amortization		1,807			44			1,851			249			288			537			43			—			2,431
Operating income (loss)		1,471			260			1,731			722			310			1,032			(1,842		)	43			964
Segment assets (b)		47,180			2,914			50,094			16,986			12,544			29,530			7,373			63			87,060
Capital expenditures		1,240			29			1,269			87			298			385			292			—			1,946
Three Months as restated
Revenues from external customers		$	22,671		$	1,704		$	24,375		$	5,236		$	8,576		$	13,812		$	—		$	86		$	38,273
Depreciation, depletion and amortization		901			22			923			124			144			268			24			—			1,215
Operating income (loss)		1,836			31			1,867			120			318			438			(1,030		)	27			1,302
Segment assets (b)		47,180			2,914			50,094			16,986			12,544			29,530			7,373			63			87,060
Capital expenditures		353			4			357			34			173			207			8			—			572

 

(a)          Columns for 2005 represent the segments as reported in the July 2, 2005 Form 10-Q.

(b)         Segment assets are as of December 31, 2005.

There are no differences in the basis of segmentation or in the basis of measurement of segment profit or loss from the last annual report.

7.               On January 1, 2006 the Company purchased the assets of Colorado State Safe & Lock Co. (CSSL), a company in Colorado Springs offering electronic access and locking capabilities, for $352,000. The assets were acquired by MDHI in the Door segment. The preliminary purchase price allocation included $100,000 of goodwill and $100,000 for a non-compete agreement. The non-compete agreement is being amortized over its four year term.

On June 30, 2006 the Company purchased certain assets of a concrete producer in Colorado Springs for $2,100,000 of cash and a $1,000,000 Note. The assets were acquired by TMC in the Concrete, Aggregates and Construction Supplies segment. The preliminary purchase price allocation included $1,735,000 of plant and equipment, $965,000 of goodwill, $300,000 for a non-compete agreement and $100,000 for a restriction of use agreement. The non-compete and the restriction of use agreements are being amortized over their terms of five years and ten year, respectively.

Both purchases were accounted for as acquisitions of a business under SFAS No. 141, “Standards of Accounting for Business Combinations.” The goodwill related to the above two purchases represents the only changes to the Company’s recorded goodwill during the first and second fiscal quarters of 2006.

The following unaudited pro forma summary financial information summarizes the estimated combined results of operations of the Company, ASCI and CSSL assuming that the acquisitions of ASCI and CSSL had taken place on January 2, 2005. The unaudited pro forma combined results of operations were prepared on the basis of information provided to the Company by the former management of ASCI and CSSL and no representation is made by the Company with respect to the accuracy of such information. The pro forma combined results of operations reflect adjustments for interest expense, additional depreciation based on the fair market value of plant and equipment, amortization of identifiable intangibles and income tax expense.

The pro forma financial information presented below for the year ended December 31, 2005 includes the full year results for ASCI and CSSL, as adjusted for the items noted above. The pro forma financial information for the six months ended July 1, 2006 includes the results of ASCI from January 1, 2006 through April 30, 2006, as adjusted for the items noted above. Interim financial information for the six month periods ended July 1, 2006 and July 2, 2005 was not made available to the Company. Amounts are in thousands except per share amounts.

 

The unaudited pro forma combined results of operations are not necessarily indicative of, and do not purport to represent, what the Company’s results of operations or financial condition actually would have been had the acquisitions been made as of January 2, 2005. Due to competitive conditions, the Company does not expect to retain all of the concrete volume or market share previously attained by ASCI.

8.               Identifiable intangible assets as of July 1, 2006 consisted of five amortizable non-compete agreements, including the non-compete agreements related to CSSL acquired during the first fiscal quarter of 2006 and the purchase of certain assets of a concrete producer in Colorado Springs during the second fiscal quarter of 2006 (see Note 7). The non-compete agreements were carried at $1,104,000, net of $1,396,000 accumulated amortization. The pre-tax amortization expense for intangible assets during the quarter ended July 1, 2006 was $63,000. Based upon the intangible assets recorded on the balance sheet at July 1, 2006, amortization expense for the next five years is estimated to be as follows: 2006 — $277,000, 2007 — $233,000, 2008 — $220,000, 2009 — $220,000, and 2010 — $195,000.

9.               The interest rate swap agreement is reported consistent with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and its related amendment, SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities” which require recognition of derivatives as either assets or liabilities and measurement at fair value. The change in accumulated other comprehensive income net of taxes from January 1, 2006 to July 1, 2006 was as follows (amounts in thousands):

 

 

 

8

 

Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis gives effect to the restatement discussed in Note 6.

Company Overview

The Company operates in four reportable segments within its two principal industry groups; the Heating and Cooling segment and the Evaporative Cooling segment in the HVAC industry group and the Concrete, Aggregates and Construction Supplies segment and the Door segment in the Construction Products industry group.

The Heating and Cooling segment produces and sells gas-fired wall furnaces, console heaters and fan coils from the Company’s wholly-owned subsidiary, Williams Furnace Co. of Colton, California. The Evaporative Cooling segment produces and sells evaporative coolers from the Company’s wholly-owned subsidiary, Phoenix Manufacturing, Inc. of Phoenix, Arizona. Concrete, Aggregates and Construction Supplies are offered from numerous locations along the Front Range of Colorado operated by the Company’s wholly-owned subsidiaries Castle Concrete Company and Transit Mix Concrete Co. (TMC), of Colorado Springs, Transit Mix of Pueblo, Inc. of Pueblo and Rocky Mountain Ready Mix Concrete, Inc. of Denver.

Doors are fabricated and sold along with the related hardware from the Company’s wholly-owned subsidiary, McKinney Door and Hardware, Inc. (MDHI) of Pueblo, Colorado.

In addition to the above reporting segments, an “Unallocated Corporate” classification is used to report the unallocated expenses of the corporate office which provides treasury, insurance and tax services as well as strategic business planning and general management services and an “Other” classification is used to report a small real estate operation. Expenses related to the corporate information technology group are allocated to all locations, including the corporate office.

Financial Condition

Sales of the Company’s HVAC products are seasonal and weather sensitive except for fan coils. Revenues in the Company’s Concrete, Aggregates and Construction Supplies segment are influenced by the level of construction activity and weather conditions along the Front Range of Colorado. Sales for the Door segment are not as strongly seasonal nor are they much affected by weather conditions. Historically, the Company has experienced operating losses during the first quarter except when the weather is mild along the Front Range. Operating results typically improve in the second and third quarters reflecting more favorable weather conditions in Colorado and the seasonal sales of Evaporative Cooling segment. Fourth quarter results can vary based on weather conditions in Colorado as well as in the principal markets for the Company’s heating equipment. The Company typically experiences operating cash flow deficits during the first half of the year reflecting operating results, the use of sales dating programs (extended payment terms) related to the Evaporative Cooling segment and payments of the prior year’s accrued incentive bonuses and Company profit-sharing contributions. As a result, the Company’s borrowings against its revolving credit facility tend to peak during the second quarter and then decline over the remainder of the year. This trend has continued thus far in 2006.

As expected, the Company’s cash flow during the first six months of 2006 was negative due to the seasonality of sales, production schedules and the sales dating programs related to the evaporative cooler product line. Operations used $2,183,000 of cash compared to the $2,568,000 of cash used during the first six months of 2005. The improved cash flow was primarily due to the improved operating income as discussed below. Changes in working capital accounts largely offset each other when comparing the first six months of 2006 to the comparable 2005 period.

On January 1, 2006 the Company purchased the assets of CSSL, a company in Colorado Springs offering electronic access and locking capabilities, for $352,000 in cash. The assets were acquired by MDHI in the Door segment. The preliminary purchase price allocation included $100,000 of goodwill and $100,000 for a non-compete agreement. On June 30, 2006 the Company purchased certain assets of a concrete producer in Colorado Springs for $2,100,000 of cash and a $1,000,000 Note. The assets were acquired by TMC in the Concrete, Aggregates and Construction Supplies segment. The preliminary purchase price allocation included $965,000 of goodwill, $300,000 for a non-compete agreement and $100,000 for a restriction of use agreement. The $3,609,000 of capital expenditures, primarily for the Concrete, Aggregates and Construction Supplies segment, consisted primarily of routine equipment replacements.

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As more fully discussed in Note 5, the principal amount of the term loan was increased by $5 million. Approximately $2.1 million of the proceeds were used to fund the purchase of certain assets of a concrete producer in Colorado Springs discussed above. The balance of the additional term loan proceeds will be used for business expansion. Scheduled debt repayments are automatically withdrawn from our account by the bank. All scheduled debt repayments for the first six months of 2006 and 2005 have been made as of the filing of this report on Form 10-Q, however, the second $500,000 payment for 2006 was not withdrawn from our account until after the close of the Company’s second fiscal quarter.

As expected, the Company continued to borrow against its revolving credit facility during the 2006 second quarter. During the first six months of 2006, the highest amount of Company borrowings outstanding under the revolving credit agreement was $4,500,000 and the average amount outstanding was $1,334,000.

The Company believes that anticipated cash flow from operations, supplemented by seasonal borrowings against the revolving line of credit, (of which $1,000,000 was outstanding at July 1, 2006) will be sufficient to cover expected cash needs, including servicing debt and planned capital expenditures for at least the next twelve months.

Operations — Comparison of Quarter Ended July 1, 2006 to Quarter Ended July 2, 2005

Historically, the Company has experienced improved operating results during the second quarter as sales in the Concrete, Aggregates and Construction Supplies segment increase due to weather more conducive to construction activity. The 2006 operating results were consistent with this trend. Consolidated sales during the second quarter of 2006 were $43,704,000 compared to $38,273,000 in the second quarter of 2005.

All segments except Heating and Cooling reported increased sales for the quarter lead by a 19.6% increase from the Concrete, Aggregates and Construction Supplies segment. Cost of sales as a percentage of sales increased slightly form 79.9% to 80.0% due to narrower margins in the Heating and Cooling segment. Selling and administrative costs decreased both in amount and as a percentage of sales. The reduction was primarily due to the continuing consolidation of functions in the Concrete, Aggregates and Construction Supplies segment into the Colorado Springs office and the timing of some contributions at the Corporate office. The resulting operating income of $2,376,000 exceeded the $1,302,000 reported for the second quarter of 2005.

Interest expense increased from $159,000 for the second quarter of 2005 to $202,000 in the 2006 quarter due to increased average debt and higher interest rates.

A discussion of operations by segment follows.

Construction Products

The table below presents a summary of operating information for the two reportable segments within the Construction Products group for the quarters ended July 1, 2006 and July 2, 2005 (amounts in thousands):

 

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Concrete, Aggregates and Construction Supplies Segment

Sales in the Concrete, Aggregates and Construction Supplies segment for the second quarter of 2006 increased 19.6% over the prior year’s comparable quarter as a result of increased volume and improved pricing. Concrete and aggregates volumes improved as construction activity remained relatively strong along the Front Range of Colorado. The increase in concrete volume was primarily due to two large jobs in the southern section of our service area. Concrete pricing improved during the second quarter of 2006 although the increases were again largely instituted to offset increased cement and fuel costs. Cement supplies remained tight during the second quarter of 2006; however, we were able to obtain sufficient quantities to service our customers. Construction supplies sales volume improved in the second quarter of 2006 compared to the second quarter of 2005.

Operating income improved in the 2006 quarter over the 2005 quarter as a result of the increase in volumes, pricing increases that slightly outpaced increased costs, primarily in the Denver area, and delivery efficiencies on the two large concrete jobs noted above. A reduction in selling and administrative costs during the second quarter of 2006 compared to the 2005 quarter also contributed to the improved operating income. These reductions were achieved through the continuing consolidation of functions into the Colorado Springs office. As a result, both operating income as a percent of sales and return on assets improved in the 2006 quarter over the prior year’s quarter.

Door Segment

Sales during the second quarter of 2006 in the Door segment increased $574,000 over the comparable 2005 quarter. Sales from the recently acquired electronic access product line and some sales price increases contributed to the added sales volume. In addition, last year’s second quarter sales were weakened by customer requests to delay shipment on some jobs until later in the year.

 

Operating income improved from $31,000 during the second quarter of 2005 to $157,000 for the 2006 quarter as a result of the higher sales volume and increased prices. Selling and administrative costs increased during the 2006 quarter but declined as a percentage of sales when compared to the 2005 quarter primarily due to the increased sales in the 2006 quarter and the unusually low sales level of the 2005 quarter as noted above. As a result, both operating income as a percent of sales and return on assets improved in the 2006 quarter from the prior year’s quarter.

 

HVAC Products

The table below presents a summary of operating information for the two reportable segments within the HVAC products group for the quarters ended July 1, 2006 and July 2, 2005 (amounts in thousands):

 

 

Heating and Cooling Segment

Sales in the Heating and Cooling segment were $5,045,000 for the second quarter of 2006, a decrease of $191,000, or 3.6%, from the comparable 2005 quarter. Lower furnace volume was responsible for the decrease as strong sales in March resulted in lower sales volume in April and May. Cost of sales as a percentage of sales increased during the second quarter of 2006 as compared to the comparable quarter of 2005 due to pricing decisions made to retain a national home center account. Fan coil volume improved as the restructured sales representative network began to take hold. Pricing improved slightly primarily in response to higher material costs.

 

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Operating income declined from $120,000 during the second quarter of 2005 to a loss of $354,000 for the 2006 quarter as a result of the lower sales volume, narrower margins and increased selling and administrative expenses. Selling and administrative expenses were higher due to the addition of personnel in the sales and engineering departments and the opening of a sales and service center in Oklahoma City, Oklahoma. As a result, both operating income as a percent of sales and return on assets declined in the 2006 quarter from the prior year’s quarter.

 

Evaporative Cooling Segment

Sales in the Evaporative Cooling segment increased $595,000, or 6.9%, during the second quarter of 2006 over the comparable 2005 quarter. Hot, dry weather in the markets served prompted the improved sales.

 

Operating income improved slightly during the 2006 quarter due to the increased sales volume as cost of sales as a percentage of sales remained relatively constant compared to the 2005 second quarter. Depreciation and amortization and selling and administrative expenses increased modestly during the 2006 quarter but declined as a percentage of sales compared to the first quarter of 2005. As a result, both operating income as a percent of sales and return on assets improved in the 2006 quarter from the prior year’s quarter.

 

Operations — Comparison of Six Months Ended July 1, 2006 to Six Months Ended July 2, 2005

 

Consolidated sales during the first half of 2006 were $77,388,000 compared to $68,030,000 during the first half of 2005. All segments reported increased sales for the six months ended July 1, 2006 compared to the six months ended July 2, 2005 lead by a 19.0% increase from the Concrete, Aggregates and Construction Supplies segment. Cost of sales as a percentage of sales was largely unchanged between the two six month periods. Selling and administrative costs increased, however they declined as a percentage of sales. The resulting operating income of $1,956,000 exceeded the $964,000 reported for the first six months of 2005.

 

A discussion of operations by segment follows.

 

Construction Products

The table below presents a summary of operating information for the two reportable segments within the Construction Products group for the six months ended July 1, 2006 and July 2, 2005 (amounts in thousands):

 

 

Concrete, Aggregates and Construction Supplies Segment

Sales in the Concrete, Aggregates and Construction Supplies segment for the first six months of 2006 increased 19.0% over the prior year’s comparable period due to the reasons noted above and favorable weather during the first quarter of 2006.

 

Operating income improved to $3,110,000 during the 2006 period from $1,471,000 for the 2005 period due to the improved margins and reduction of selling and administrative costs as a percentage of sales discussed above. As a result, both operating income as a percent of sales and return on assets improved for the six months ended July 1, 2006 compared to the six months ended July 2, 2005.

 

 

 

 

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Door Segment

Sales in the Door segment for the first six months of 2006 increased $745,000 over the comparable 2005 period due to reasons noted above. Sales from the recently acquired electronic access product line contributed to the added sales volume for the entire six month period in 2006.

Operating income improved from $260,000 during the first half of 2005 to $295,000 for the 2006 period chiefly due to the improved results of the second quarter of 2006 over the comparable 2005 quarter as discussed above. The operating income for the first quarter of 2006 lagged the 2005 first quarter results due to tighter margins resulting from pricing decisions made in response to more competitive bidding on available jobs and slight increases in both depreciation and selling and administrative costs. As a result, operating income as a percent of sales declined while the return on assets was unchanged in the six months ended July 1, 2006 compared to the six months ended July 2, 2005.

HVAC Products

The table below presents a summary of operating information for the two reportable segments within the HVAC products group for the six months ended July 1, 2006 and July 2, 2005 (amounts in thousands):

 

Heating and Cooling Segment

Sales in the Heating and Cooling segment increased $158,000, or 1.4%, during the first six months of 2006 over the comparable 2005 period. Furnace volume was slightly higher as first quarter sales remained strong through March then declined resulting in little change for the first six months of 2006 compared to the first six months of 2005. Similarly, lower fan coil volume during the first quarter of 2006 blunted the increased sales of the second quarter resulting in a slight increase in sales for the first six months of 2006 compared to the first six months of 2005. The lower fan coil volume of the first quarter of 2006 was attributed to the restructuring of the sales representative network over the prior six months which caused some short-term disruption in bidding on jobs.

Operating income declined from $722,000 during the first six months of 2005 to a loss of $149,000 for the 2006 period. The decrease was the result of lower margins due to the pricing decisions discussed above and higher material costs not fully recaptured by higher selling prices, and increased selling and administrative expenses.  Selling and administrative costs were higher due to the above noted addition of personnel and opening of a sales and service center in Oklahoma City, Oklahoma. As a result, both operating income as a percent of sales and the return on assets declined for the first six months of 2006 from the prior year’s period.

Evaporative Cooling Segment

Sales in the Evaporative Cooling segment increased $927,000, or 7.1%, during the first six months of 2006 over the comparable 2005 period. Hot, dry weather in the markets served prompted the improved sales.

The operating profit grew modestly from $310,000 during the first six months of 2005 to $331,000 for the first six months of 2006. Cost of sales as a percentage of sales increased slightly in 2006 due to a decrease in labor efficiency, principally the result of the using more temporary workers, and increased supervision and maintenance costs. Depreciation and amortization and selling and administrative expenses, although modestly higher during the first six months of 2006 compared to the 2005 period, declined as a percentage of sales. As a result, operating income as a percent of sales was unchanged. The return on assets improved for the 2006 period largely due to a decrease in segment assets resulting from lower inventory levels at July 1, 2006.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States which require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of July 1, 2006 and December 31, 2005 and affect the reported amounts of revenues and expenses for the periods reported. Actual results could differ from those estimates.

Information with respect to the Company’s critical accounting policies which the Company believes could have the most significant effect on the Company’s reported results and require subjective or complex judgments by management is contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

OUTLOOK

Concrete prices throughout our Colorado markets have improved compared to 2005 although a substantial portion of the price increase was in response to higher prices paid for cement and fuel. We expect the Denver concrete market to remain very competitive and a small new concrete producer in Colorado Springs is pursuing large home-builders with an aggressive pricing strategy. Commercial and industrial construction seems to be improving. There is some concern that new home construction may slow throughout Colorado, in part due to higher mortgage interest rates. The sales volume and backlog for the door segment remains strong.

Sales of the heating and cooling segment and the evaporative cooling segment are not expected to grow significantly and will remain weather sensitive. However, the demand for fan coil products in the heating and cooling segment is expected to show some improvement from the rather depressed levels of recent years.

RECENTLY ISSUED ACCOUNTING STANDARDS

The Company discusses recently issued accounting standards and tax law changes in the Critical Accounting Policies section under Item 7 and in Note 1 to Consolidated Financial Statements in Item 8 of the Company’s Annual Report on Form 10-K for the fiscal year 2005. Other than as discussed in those sections, or as noted below, the Company does not currently have any transactions or circumstances that have been addressed by recently issued accounting pronouncements. Therefore, adoption of any of these statements or pronouncements would not have a material impact on the Company’s results of operations, financial position or liquidity.

In November 2004, SFAS No. 151, “Inventory Costs—An Amendment of ARB No. 43, Chapter 4,” was issued which amends the guidance in Accounting Research Bulletin (“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. 43.  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 adopted this standard in the first quarter of fiscal 2006 and such adoption did not have a material impact on its consolidated results of operations, cash flows or financial condition.

In March 2005, the Emerging Issues Task Force reached a consensus on Issue 04-6, “Accounting for Stripping Costs in the Mining Industry” (EITF 04-6) which became effective on January 1, 2006. EITF 04-6 states that stripping costs incurred after the first saleable minerals are extracted from the mine (i.e. post-production stripping costs) should be considered costs of the extracted minerals and recognized as a component of inventory to be recognized in costs of sales in the same period as the revenue from the sale of the inventory. As disclosed in the Company’s 2005 Annual Report on Form 10-K, the Company has historically treated post-production stripping costs in the manner prescribed by EITF 04-6 and, therefore, adoption of EITF 04-6 in the first quarter of fiscal 2006 did not have a material impact on the Company’s consolidated results of operations, cash flows or financial condition.

In June 2006 FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” was issued which clarifies the application of SFAS No. 109, “Accounting for Income Taxes” by establishing a threshold condition that a tax position must meet for any part of the benefit of that position to be recognized in financial statements. In addition to recognition, Interpretation No. 48 provides guidance on measurement, derecognition, classification and disclosure of tax positions. Interpretation No. 48 is effective for fiscal years beginning after

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December 15, 2006, with earlier adoption permitted as of the beginning of a fiscal year for which annual or interim financial statements have not yet been issued. The Company has not had sufficient time to evaluate what impact Interpretation No. 48 might have on the Company’s consolidated results of operations or financial condition.

The Company has determined that it qualifies for certain deductions that the American Jobs Creation Act of 2004 provides for income from qualified domestic production activities. Although the effect of the deduction is not expected to have a material effect on the tax provision for 2006, a preliminary estimate of the deduction was included in the determination of the tax provision.

FORWARD-LOOKING STATEMENTS

The foregoing discussion 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, national and local economic conditions and competitive forces. Some of these factors are discussed in more detail in the Company’s 2005 Annual Report on Form 10-K. Changes in accounting pronouncements could also alter projected results. Forward-looking statements speak only as of the date they were made, and the Company undertakes no obligation to publicly update them.

Item 3.                          Quantitative And Qualitative Disclosures About Market Risk

There have been no material changes in the market risks that the Company is exposed to since those discussed in the Company’s 2005 Annual Report on Form 10-K. At July 1, 2006, the amount subject to the interest rate swap agreement was $3,000,000. Also see Note 9 to the quarterly financial statements above.

Item 4.                          Controls and Procedures

(a)  Disclosure Controls and Procedures.

The Company’s Chief Executive Officer and Chief Financial Officer, with the participation of management, have evaluated the effectiveness of the Company’s “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of July 1, 2006. Based on that evaluation, they have concluded that the Company’s disclosure controls and procedures as of such date are effective and are reasonably designed to ensure that all material information relating to the Company (including its subsidiaries) required to be disclosed in this quarterly report is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

(b)  Changes in Internal Control Over Financial Reporting.

As of July 1, 2006, the Company has corrected the material weakness disclosed in its Form 10-K for the fiscal year ended December 31, 2005, regarding the Company’s design of internal control over financial reporting with respect to its lack of a process to evaluate all relevant information specified in Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” (SFAS 131) to ensure that its segment reporting included in the Notes to the Consolidated Financial Statements is presented in accordance with SFAS 131. To address this material weakness, the Company designed and implemented a process during the second quarter in which the Company’s Chief Financial Officer and Chief Accounting Officer discuss, evaluate and analyze changes in internal management reporting, economic characteristics and other factors specified in SFAS 131 as they occur to determine whether any of the changes affect segment reporting on a quarterly basis in accordance with SFAS 131. There have been no other significant changes in the Company’s internal control over financial reporting identified in connection with the evaluation of such internal control that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting, except as described above.

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PART II—OTHER INFORMATION

Item 2.        Unregistered Sales of Equity Securities and Use of Proceeds

There were no purchases made by the Company of its common stock to become treasury stock for the period April 2 through July 1, 2006.

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. The June 28, 2005 amendment to the Loan Agreement provides that the Company may make purchases of its own stock in an amount not to exceed $1,438,000, separate from purchases made in connection with the 2005 tender offer and the exercise of cash-less stock options. At July 1, 2006, the maximum dollar value of shares that may yet be purchased under the program was $1,418,942.

Item 6. Exhibits

	Exhibits   Exhibit No.		Description
	31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) and Rule 13a-14(d)/15d-14(d) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) and Rule 13a-14(d)/15d-14(d) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

SIGNATURE

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.

				CONTINENTAL MATERIALS CORPORATION
Date:		August 15, 2005		By:		/s/ Joseph J. Sum
						Joseph J. Sum, Vice President and Chief Financial Officer

 

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