Item 1. BUSINESS
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, and 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. Accordingly, results for 2002 include the activity of RMRM for the entire year and the activity of MDHI since April 1, 2002. Results for 2001 include the activity of RMRM for the entire year.
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. of Phoenix, Arizona and Williams Furnace Co. 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. and MDHI, in Pueblo, Colorado. Currently, the Company’s wholly-owned subsidiary, Rocky Mountain Ready Mix Concrete, Inc. 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 and the holding costs for certain mining interests that remain from the period the Company maintained significant interests in mining operations. 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 27 and 28 of this Form 10-K. References to a “Note” are to the “Notes to Consolidated Financial Statements” included on pages 20 through 28 of this Annual Report on Form 10-K.
MARKETING, SALES AND SUPPORT
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 typically are offered to 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 (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 2003, 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
The order backlog at January 3, 2004 and December 28, 2002 for the heating and air conditioning segment were as follows:
The above backlogs are expected to be substantially filled during the first quarter of 2004.
At January 3, 2004, the construction materials segment had a backlog of approximately $6,642,000 ($5,327,000 at December 28, 2002) primarily relating to construction contracts awarded and expected to be filled during the first half of 2004.
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. However, as noted below in the discussion of operations in Item 7, the construction materials segment has experienced a decline in sales volume reflecting decreased construction along the Front Range of Colorado and the fan coil product line has experienced a decline in sales volume reflecting the nationwide slump in commercial construction.
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 Phoenix Manufacturing, Inc. related to the Power Cleaning System (expiring January 2014) used in evaporative coolers and a patent issued to Williams Furnace Co. entitled “Wall Furnace With Side Vented Draft Hood” (expiring November 2011) which has 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.
In general, raw materials required by our companies’ 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. These companies have, on past occasion, experienced some difficulty in obtaining the required volume of cement from this single supplier; however, they were able to acquire sufficient quantities from non-traditional sources, which are expected to remain available in the future, to satisfy their needs. The Company has no long-term supply contracts and does not consider itself 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. 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 goodwill purposes.
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 fourteen companies producing ready mix concrete in the Denver area. Although we are the largest producer in the Colorado Springs and Pueblo markets served, the other competitors in these areas compete aggressively on the basis of price, service and product features. In Denver, two of the producers are significantly larger than RMRM. This market also experiences aggressive competition based on price and service.
The Company is one of five producers of aggregates in the Colorado Springs and Pueblo marketing areas. All producers compete aggressively 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, sand and aggregates from us whereas our competitors for these particular product lines do not offer concrete, sand 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 717 people as of January 3, 2004. 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:
The factory employees at the Colton, California plant are represented by the Carpenters Local 721 Union under a contract that expires in April 2005. The Company considers relations with its employees and with its union to be good.
Item 2.
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. Productive 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 Company serves the Colorado ready-mix concrete market from ten owned batch plants. In addition, the Company currently operates aggregate processing facilities on three owned and three leased mining properties. These facilities are, in the opinion of management, in good condition and sufficient for the Company’s current needs. The Company also owns or leases other aggregate deposits not currently in production. In 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.
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.
The corporate office operates out of leased office space in Chicago, Illinois.
Item 3.
Item 3. LEGAL PROCEEDINGS
See Management’s Discussion and Analysis of Financial Condition and Results of Operations on pages 9 through 14 and Note 4 on page 25 of this Annual Report on Form 10-K.
Item 4.
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 2003.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Continental Materials Corporation shares are traded on the American Stock Exchange under the symbol CUO. Market prices for the past two years are:
At March 19, 2004, the Company had approximately 349 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.
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 3, 2004:
EQUITY COMPENSATION PLAN INFORMATION
Item 6.
Item 6. Selected Financial Data
(Amounts in thousands, except per share amounts)
Item 7.
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 2003 was modestly lower than the prior year’s level; however margins improved, rising slightly from the prior year.
Fan coil sales deteriorated to a level not experienced since 1994. The depressed commercial construction market was the primary cause for the falloff. Hotel construction has been particularly hard hit, reflecting the overall depressed state of the travel and leisure industry.
Evaporative cooler sales volume grew 10% largely due to expanded sales to a large retail customer during the year. Hot, dry weather that persisted later in the year than normal fueled the demand at the consumer level. Wholesale trade remained static. Margins registered slight improvement reflecting the increased volume.
Selling, general and administrative costs were closely monitored and reduced where possible. These savings, however, were largely offset by unusually high legal costs related to product liability claims and a suit filed to ensure the continued supply of a key purchased component for our evaporative cooler product line.
Cash flow from this segment approximated earnings. Depreciation exceeded capital expenditures; however, this was offset by an increase in furnace inventories from an all-time low level at the end of 2002.
Construction Materials Segment
Despite their proximity, Denver, Colorado Springs and Pueblo have distinct competitive and economic conditions. Concrete sales volumes declined in all three markets compared to last year. The per-yard price of concrete reflected the diversity of the three markets. While Pueblo prices remained fairly constant, Colorado Springs prices declined over 4% and Denver’s prices fell over 7%. The average pricing in Denver would have suffered more but for the effect of fixed priced contracts in the opening backlog of RMRM.
The sales volume of construction aggregates increased modestly from the 2002 level, however, gross profits declined. The learning curve on the two new aggregates plants, one at the Colorado Springs sand operation and the other on the east side of Pueblo, was longer than we expected. Progress was made during the year, though, and costs were reduced.
The Door and Supply divisions, together with MDHI, experienced the same drop in sales reflecting the construction slump. Sales for this group increased slightly only because of the inclusion of MDHI for the full year compared to the nine months included in 2002 after the April 1 purchase of MDHI. Profit margins were steady for the door products but declined for building supplies largely due to very competitive price bidding for reinforced steel bar (rebar) projects.
The construction materials segment typically requires large capital investments, particularly when volume is strong. Reflecting the more modest demand, capital spending in 2003 was held to approximately $2,520,000 as the new batch plant in Brighton, Colorado was brought online and a new maintenance facility in Pueblo was built to complement the move of mining and ready mix concrete batching to the east side of Pueblo. Other expenditures were primarily routine replacements and upgrades.
Cash flow surpassed earnings. Depreciation and amortization exceeded capital expenditures; however, an increase in receivables consumed cash.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $4,609,000 at the end of 2003 compared to $3,536,000 at the prior year-end. Operations in 2003 provided $7,778,000 of cash compared to $9,753,000 in 2002 and $13,219,000 generated in 2001. 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 $687,000 in 2003 compared to an increase of only $122,000 in 2002. The decrease in net cash generated by operating activities in 2002 compared to 2001 was chiefly due to the decreased earnings. Increases in the Company’s working capital needs also consumed approximately $122,000 during 2002 compared to providing approximately $1,073,000 of cash during 2001.
Net cash used in investing activities was $2,535,000 in 2003, $9,547,000 in 2002 and $19,215,000 in 2001. Capital expenditures for 2003, 2002 and 2001 were $2,880,000, $7,561,000 and $9,213,000, respectively. 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. During 2001, work was performed on the aforementioned projects and the Company also invested approximately $1,800,000 for a new office building in Colton. On April 1, 2002, $2,125,000 was expended to purchase McKinney Door and Hardware, Inc. (MDHI). During fiscal year 2001, $11,263,000 was used to purchase Rocky Mountain Ready Mix Concrete, Inc. (RMRM) on December 31, 2000.
Budgeted capital expenditures for 2004 are approximately $3,840,000 (including $2,550,000 for the construction materials segment and $1,280,000 for the heating and air conditioning segment), which is approximately $1,875,000 less than planned depreciation. The expenditures are primarily for routine replacement and upgrades. The Company expects that the 2004 expenditures will be funded from existing cash balances and operating cash flow.
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. Scheduled long-term debt repayments of $3,620,000 were made during the year including $620,000 against capital lease obligations. Cash of $604,000 was used to acquire 22,599 shares of treasury stock. During
2001, cash of $7,359,000 was provided by financing activities. The Company increased its term debt by $12,000,000 for the acquisition of RMRM. Scheduled long-term debt repayments of $3,526,000 were made during the year including $526,000 against capital lease obligations. Cash of $600,000 was used to acquire 33,127 shares of treasury stock partially offset by proceeds of $39,000 from the exercise of stock options.
Capital Resources, Obligations and Commitments, and Off-Balance Sheet Arrangements
Revolving Credit and Term Loan Agreement
The Company signed a new Revolving Credit and Term Loan Agreement (the Credit Agreement”) with two banks in September 2003. The 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 3, 2004, $10,750,000 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) in order to fix the floating interest rate characteristic of most of the Company’s term loan borrowings. The Company’s current interest rate under the Swap is 5.88%. 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 3, 2004.
Payments Due by Period as of January 3, 2004 (amounts in thousands)
Amounts of Commitment Expiration per Period as of January 3, 2004 (amounts in thousands)
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.
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%). A sharp decline in fan coil sales was only partially offset by improved evaporative cooler sales. Fan coil sales continue to reflect the nationwide slump in commercial construction, particularly hotel construction. 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. The Company does not expect any appreciable change in market conditions in Denver during 2004. 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. In addition, producers of flat rolled steel products, key raw materials in our heating and air conditioning products, recently announced significant nationwide price increases. Phoenix Manufacturing has sufficient steel inventory to cover cooler production for the remainder of the current cooling season. Our steel suppliers will honor quoted prices on orders already placed. However, it can be expected that prices on future steel orders will be substantially higher. Williams Furnace will incur a small surcharge for April and May deliveries of steel before paying the increased prices beginning in June. While we would seek to increase the selling price of our products to recover the higher steel costs, there is no assurance that we would be able to do so due to the competitive conditions in our particular markets.
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.
The decline in operating income from $5,711,000 to $3,607,000 is primarily due to the decreased sales, the heightened competition in Colorado and the aforementioned increased legal costs.
Other income increased $276,000 as a result of $176,000 of gain realized on the settlement of property tax bills related to the Oracle Ridge Mining Partners property. In addition $155,000 was realized during 2003 from the sale of a not exploitable aggregate property in Colorado.
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.
Operations Fiscal 2002 vs. 2001
Consolidated sales in 2002 declined $1,910,000, or 1.5%, to $128,301,000. Excluding the sales of MDHI, acquired on April 1, 2002, the sales decline would have been approximately 6%. The sales of the construction materials segment declined $2,917,000 (4%) while sales of the heating and air conditioning segment increased $1,007,000 (2%), compared to the previous year. The reduction in the construction materials segment was across the three main markets in Colorado as construction continued to decline along the Front Range of Colorado. The modest increase in the heating and air conditioning segment was the result of strong evaporative cooler sales and slightly improved furnace sales offset by reduced sales of fan coils. The increase in evaporative cooler sales was primarily due to the addition of a large new retail customer. Fan coil sales declined reflecting the nationwide slump in commercial construction, notably hotel construction.
The Company experienced a high level of price competition throughout both 2002 and 2001 in all of its product lines. Inflation was not a significant factor at any of the operations during either 2002 or 2001, except that employee health care costs and general business insurance premiums dramatically outpaced the rate of inflation for the 2002 period.
Cost of sales (exclusive of depreciation, depletion and amortization), as a percent of sales, increased from 75.8% to 78.3%. The increase was primarily experienced in the construction materials segment. The declining construction activity along the Front Range in Colorado had the effect of increasing price competition resulting in lower prices per yard. Some of the aggregates operations experienced increased costs as well. Higher costs were incurred in the Pueblo gravel operation as a now depleted gravel site was closed and start-up costs at the new site exceeded expectations. In addition, initial yields of primary products at the new Pueblo gravel site were less than that experienced at the Company’s other gravel operations. Additional costs were also incurred in dismantling the old aggregates plant. Finally, a plant breakdown at one of the aggregates operations during the first quarter of 2002 and a brief shut-down prior to bringing the new sand plant on-line in Colorado Springs added to the increased costs. The increase in the heating and air conditioning segment is due to a change in product mix and the $662,000 write-down of inventories and other costs associated with a product manufactured at our Phoenix plant.
Selling and administrative expenses remained relatively constant at $16,033,000. As a percentage of sales, selling and administrative expenses increased slightly to 12.5%.
The decline in operating income from $9,154,000 to $5,711,000 is primarily due to the decreased sales, the heightened competition in Colorado, the aforementioned increased costs at three of the construction aggregate operations and the inventory write-down.
The $635,000 decrease in other income is primarily the result of $851,000 of gains realized on sales of depleted or not exploitable aggregate properties in Colorado during 2001 compared to $79,000 of gains on sales during 2002.
The Company’s 2002 effective income tax rate (34.8%) reflects federal and state statutory rates adjusted for non-deductible and other tax items. The lower effective rate in 2001 was due to the benefit of California Enterprise Zone credits as discussed below. Also see Note 9.
RELATED PARTY TRANSACTIONS
The Company purchases insurance coverage for workers’ compensation, general and product liability together with another company controlled by the Company’s principal shareholders to minimize insurance costs and to obtain other more favorable terms. Allocation of the expense of the program is either provided by the underwriter or based upon a formula that considers,
among other things, sales levels, loss exposure and claim experience. Claims under the self-insured portion of the policies are charged directly to the incurring party.
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.
Inventories
Inventories are priced at the lower of cost (76% at January 3, 2004 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
Goodwill was amortized using a 40-year life through the 2001 year. In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” goodwill is no longer amortized as a charge to earnings. As a result of this new standard, amortization expense was reduced by approximately $188,000 in 2003 and 2002. 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
The “Recently Issued Accounting Pronouncement” section of Note 1 discusses new accounting policies adopted by us during 2003 and the expected impact of accounting pronouncements recently issued but not yet required to be adopted. To the extent the adoption of new accounting standards materially affects financial condition, results of operations or liquidity, the impacts are discussed in the applicable notes to the consolidated financial statements.
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.
Item 7A.
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 swap agreement to offset the majority of the floating interest rate characteristic of the Company’s term loan borrowings. See paragraph below. At January 3, 2004, the notional amount subject to this agreement is $10,500,000. See above discussion under Financial Condition, Liquidity and Capital Resources. The cash payments or receipts associated with this agreement are reflected in interest expense.
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 $10,750,000 at January 3, 2004. In addition, the Company is party to various capital lease agreements with fixed interest rates and original maturity dates ranging up to 60 months. As the latest of the leases matures in early 2004, and the total long-term portion of all leases is $220,000, the book and fair value was considered to be approximately the same. See Note 3.
Commodities
The Company purchases commodities, such as steel, copper, aluminum, cement and cardboard for packaging, at market prices and does not currently use financial instruments to hedge commodity prices.
These statements and other information in this section constitute forward-looking statements.
Item 8.
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 2003, 2002 and 2001
Consolidated statements of cash flows for fiscal years ended 2003, 2002 and 2001
Consolidated balance sheets as of January 3, 2004 and December 28, 2002
Consolidated statements of shareholders’ equity for fiscal years ended 2003, 2002 and 2001
Notes to consolidated financial statements
Report of Independent Auditors
Continental Materials Corporation
Consolidated Statements of Operations and Comprehensive Income
For Fiscal Years 2003, 2002 and 2001
(Amounts in thousands, except per share data)
The accompanying notes are an integral part of the financial statements.
Continental Materials Corporation Consolidated Statements of Cash Flows For Fiscal Years 2003, 2002 and 2001
(Amounts in thousands)
The accompanying notes are an integral part of the financial statements.
Continental Materials Corporation
Consolidated Balance Sheets as of January 3, 2004 and December 28, 2002
(Amounts in thousands except share data)
The accompanying notes are an integral part of the financial statements.
Continental Materials Corporation
Consolidated Statements of Shareholders’ Equity
For Fiscal Years 2003, 2002 and
(Amounts in thousands except share data)
The accompanying notes are an integral part of the financial statements.
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 purchase 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):
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.
Certain prior years’ amounts have been reclassified to conform to the current presentation.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has recently issued the following statements and interpretations:
SFAS No. 143, “Accounting for Obligations Associated with the Retirement of Long-Lived Assets,” was issued in June 2001 and was adopted by the Company on December 29, 2002. This standard requires recording the fair value of a liability for an asset retirement obligation in the period in which it is incurred. In connection with permits to mine aggregate deposits 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 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. Reclamation costs are charged to operations as the properties are mined. 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 with the assistance of an independent professional. Reclamation on any mining property is generally performed soon after each section of the deposit is mined. Reclamation is substantially complete by the time the entire deposit is depleted. The Company believes that this approach, which had been previously used to establish the annual expense and the reserve recorded for future reclamation obligations, continues to provide the best estimate of the fair value of these obligations. Therefore the adoption of SFAS No. 143 did not have an impact on the Company’s consolidated balance sheet or consolidated statement of operations as of December 30, 2002. If the provisions of Statement 143 had been adopted effective December 30, 2001, there would have been no impact on earnings per share, net of income tax effect. Since a change in earnings per share would not have occurred, pro forma earnings per share disclosures are not presented.
SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure,” was issued in December 2002. This standard provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and disclosure requirements of SFAS No. 148 are effective for fiscal years ending after and interim periods beginning after December 15, 2002. As the Company did not have any transactions or circumstances addressed by this pronouncement during the past three years, this statement did not have a material impact on the Company’s results of operations, financial position or liquidity.
SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 84 and Amendment of FASB No. 13 and Technical Corrections as of April 2002;” SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities;” SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity;” Interpretation 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness of Others;” and Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” were also recently issued. The Company does not currently have any transactions or circumstances that are addressed by these pronouncements, therefore adoption of these statements and interpretations did not have a material impact on the Company’s results of operations, financial position or liquidity.
In March 2003, the SEC issued Regulation G, “Conditions for Use of Non-GAAP Financial Measures.” As defined in Regulation G, a non-GAAP financial measure is a numerical measure of a company’s historical or future performance, financial position or cash flow that excludes or includes amounts or adjustments that are included or excluded in the most directly comparable measure calculated in accordance with accounting principles generally accepted in the United States of America (GAAP). Companies that present non-GAAP financial measures must disclose a numerical reconciliation to the most directly comparable measurement using GAAP. Management does not believe it has used any non-GAAP financial measure in this report.
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 3, 2004 and December 28, 2002 and the reported amounts of revenues and expenses during each of the three years in the period ended January 3, 2004. 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 3, 2004 (77% at December 28, 2002). 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:
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 other income. Maintenance and repairs are charged to expense as incurred. Major renewals and betterments are capitalized and depreciated over their estimated useful lives.
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):
Amortization of non-compete 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, $213,000 and $175,000 for 2003, 2002 and 2001, respectively. The estimated amortization expense for the five subsequent fiscal years is as follows: 2004 - $225,000; 2005 - $225,000; 2006 - $216,000; 2007 - $137,000 and 2008 - $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 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 have been recorded in accordance with the requirements of SFAS No. 5, “Accounting for Contingencies,” and represent management’s best estimate of future liability.
RECLAMATION
In connection with permits to mine properties in Colorado, the Company is obligated to reclaim the mined areas. Reclamation costs are calculated using a rate based on the total estimated reclamation costs, units-of-production and estimates of recoverable reserves. Reclamation costs are charged to operations as the properties are mined.
REVENUE RECOGNITION
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 program terms and historical experience. The changes in the aggregated product warranty liability for the year 2003, all of which is associated with the heating and air conditioning segment, were as follows (amounts in thousands):
Income Taxes
Income taxes are reported consistent with SFAS No. 109, “Accounting for Income Taxes.” Deferred taxes reflect the future tax consequences associated with the differences between financial accounting and tax bases of assets and liabilities.
Concentration of Credit Risk
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of trade receivables and temporary cash investments. The Company invests its excess cash in commercial paper of companies with strong credit ratings and government securities. The Company has not experienced any losses on these investments.
The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses and such losses have been within management’s expectations. See Note 11 for a description of the Company’s customer base and geographical location by segment.
Impairment of Long-lived Assets
In the event that facts and circumstances indicate that the cost of any long-lived assets may be impaired, an evaluation of recoverability would be performed. If an evaluation were required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset’s carrying amount to determine if a write-down to market value or discounted cash flow value is required.
Fiscal Year End
The Company’s fiscal year end is the Saturday nearest December 31. Fiscal 2003 consists of 53 weeks. Fiscal 2002 and 2001 each consist of 52 weeks.
2. Inventories
Inventories consisted of the following (amounts in thousands):
If inventories valued on the LIFO basis were valued at current costs, inventories would be higher as follows: 2003 - $2,126,000, 2002 - $2,052,000, and 2001 - $1,842,000.
Reductions in inventory quantities during 2002 at two locations resulted in liquidation of LIFO inventory layers carried at costs that were lower than the costs of current purchases. The effect was immaterial in both years.
3. LONG-TERM DEBT
Long-term debt consisted of the following (amounts in thousands):
The Company signed a new Revolving Credit and Term Loan Agreement (the Credit Agreement”) with two banks in September 2003. The unsecured term loan is payable to two banks in escalating quarterly installments with final payment of all then unpaid principal on June 30, 2008. The loan, at the Company’s option, bears interest at either prime or an adjusted LIBOR rate. The Credit Agreement requires the Company to maintain certain levels of consolidated tangible net worth, to attain certain levels of cash flow (as defined) on a rolling four-quarter basis, and to maintain certain ratios including consolidated debt to cash flow (as defined). Additional borrowings, acquisition of stock of other companies, purchase of treasury shares and payment of cash dividends are either limited or require prior approval by the lenders.
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 (Agreement) in order to fix the floating interest rate characteristic of most of the Company’s term loan borrowings. The Company’s current interest rate on the term loan giving effect to the 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. During 2003 and 2002, the fixed rate under the Agreement exceeded the floating rate on the term loan. The effect on operations was to reduce net income by $257,000 and $239,000 for 2003 and 2002, respectively. The fair value of the Agreement is recorded on the balance sheet with subsequent changes recorded as a separate component of shareholders’ equity. At January 3, 2004, the amount subject to this Agreement is $10,500,000 which amount decreases by $1,500,000 each September and March, terminating on December 18, 2006.
The capital leases are payable in monthly installments over varying periods, the latest of which ends in April 2004. The leases bear interest at various rates based upon the prevailing interest rates at the inception of the respective leases.
Aggregate long-term debt matures as follows (amounts in thousands):
During 2003 and 2002, the Company had an unsecured revolving line of credit of $10,000,000. The line is used for short-term cash needs and standby letters of credit. Interest was charged at
prime or adjusted LIBOR rates on cash borrowings during both years. The weighted average interest rate for all debt was 5.6% for fiscal 2003 and 5.4% for fiscal 2002. There was no balance outstanding against the line as of either January 3, 2004 or December 28, 2002.
At January 3, 2004, the Company had letters of credit outstanding totaling approximately $1,990,000 that collateralize the self-insured losses.
4. COMMITMENTS AND CONTINGENCIES
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.
5. SHAREHOLDERS’ EQUITY
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 no less than the fair market value at the date of the grant. At January 3, 2004, there remained 227,600 shares available for future issuance under the Plan (excluding the 73,400 shares associated with options outstanding).
During 2001, options for 6,000 shares were exercised. No options were exercised during either 2003 or 2002. At January 3, 2004, there remain 73,400 options (all fully vested with an exercise price of $6.56) which will expire on September 25, 2005.
The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its Plan. Accordingly, no compensation expense was recognized for its stock-based compensation Plan.
Four hundred thousand shares of preferred stock ($.50 par value) are authorized and unissued.
6. EARNINGS PER SHARE
The Company computes earnings per share (EPS) in accordance with SFAS No. 128, “Earnings Per Share.” The following is a reconciliation of the calculation of basic and diluted EPS for the years-ended 2003, 2002 and 2001 (dollars in thousands except per-share data).
7. Rental Expense, Leases and Commitments
The Company leases certain of its facilities and equipment and is required to pay the related taxes, insurance and certain other expenses. Rental expense was $2,922,000, $3,737,000 and $3,282,000 for 2003, 2002 and 2001, respectively.
Future minimum rental commitments under non-cancelable operating leases for 2004 and thereafter are as follows: 2004 - $1,966,000; 2005 - $1,541,000; 2006 - $1,401,000; 2007 - $1,377,000; 2008 - $1,268,000 and thereafter - $21,509,000. Included in these amounts is $399,000 per year and approximately $19,000,000 in the “thereafter” amount related to an aggregates lease in conjunction with the Pueblo, Colorado operation. Also included in these amounts is $235,000 per year and approximately $647,000 in the “thereafter” amount related to a ground lease upon which the Company owns a building leased to a third party for approximately $344,000 per year. The ground lease runs through October 1, 2016 and contains a renewal clause. The building lease runs through January 31, 2013.
8. Retirement Plans
As discussed in Note 1, the Company maintains retirement benefit plans for eligible employees. Total plan expenses charged to operations were $1,644,000, $1,523,000 and $2,464,000 in 2003, 2002 and 2001, respectively.
9. Income Taxes
The provision (benefit) for income taxes is summarized as follows (amounts in thousands):
The difference between the tax rate on income for financial statement purposes and the federal statutory tax rate was as follows:
For financial statement purposes, deferred tax assets and liabilities are recorded at a blend of the current statutory federal and states’ tax rates - 38%. The principal temporary differences and their related deferred taxes are as follows (amounts in thousands):
The net current deferred tax assets are $1,803,000 and $1,705,000 at year-end 2003 and 2002, respectively, and are included with “Prepaid expenses” on the Consolidated Balance Sheets.
10. UNAUDITED QUARTERLY FINANCIAL DATA
The following table provides summarized unaudited fiscal quarterly financial data for 2003 and 2002 (amounts in thousands, except per share amounts):
Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share may not equal the total for the year.
11. INDUSTRY SEGMENT INFORMATION
The Company reports its segments in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The Company is organized along its two principal product lines. Wall furnaces, console heaters, evaporative coolers and fan coils have been aggregated into the heating and air conditioning segment. Ready mix concrete, construction aggregates, building supplies and doors are combined to form the construction materials segment. The heating and air conditioning segment produces heating and cooling equipment for residential applications which is sold primarily to wholesale distributors and retail home centers. Fan coils are also sold to HVAC installing contractors and equipment manufacturers for commercial applications. A significant portion of fan coil revenues is dependent upon new hotel construction. Sales are nationwide, but are concentrated in the southwestern U.S. The construction materials segment is involved in the production and sale of concrete and other building materials and the exploration, extraction and sales of construction aggregates. Sales of this segment are highly concentrated in the Front Range area in Colorado.
The Company evaluates the performance of its segments and allocates resources to them based on operating income and return on investment. Other factors are also considered. 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, income or loss from unconsolidated investees, other income or loss or income taxes.
The following table presents information about reported segments for the fiscal years 2003, 2002 and 2001 along with the items necessary to reconcile the segment information to the totals reported in the financial statements (amounts in thousands).
(a) The Construction Materials segment information for 2002 includes MDHI reflecting the purchase which was effective April 1, 2002 and 2001 includes RMRM reflecting the purchase which was effective December 31, 2000.
(b) All other represents segments below the quantitative thresholds. The segments include a small real estate operation and the holding costs for certain mining interests that remain from the period the Company maintained significant interests in mining operations.
(c) Corporate assets consist primarily of cash and cash equivalents.
All long-lived assets are in the United States. During 2003, no customer in either segment accounted for 10% or more of total sales of the Company.
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of Continental Materials Corporation
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive income, of shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of Continental Materials Corporation and its subsidiaries at January 3, 2004 and December 28, 2002, and the results of their operations and their cash flows for each of the three years in the period ended January 3, 2004, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Chicago, Illinois
March 12, 2004
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes of accountants and/or disagreements on any matter of accounting principle or financial statement disclosure during fiscal year 2002 or 2003, nor during the subsequent interim period that required a filing under Item 9.
Item 9A.
Item 9A. CONTROLS AND PROCEDURES
Evaluuation of Disclosure Controls and Procedures
James G. Gidwitz, our Chief Executive Officer, and Joseph J. Sum, our Chief Financial Officer, have performed an evaluation of the Company’s disclosure controls and procedures as that term is defined in Rule 13a-14 (c) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), as of January 3, 2004 and each has concluded that such disclosure controls and procedures are effective to ensure that information required to be disclosed in our periodic reports under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the Securities and Exchange Commission’s rules and regulations.
Changes in Internal Controls
No changes in the Company’s internal controls over financial reporting occurred during the quarter ended January 3, 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
PART III
Items 10, 11, 12, 13 and 14 of Part III have been omitted from this 10-K Report since Registrant expects to file, not later than 120 days following the close of its fiscal year ended January 3, 2004, its definitive 2004 proxy statement. The information required by Items 10, 11, 12, 13 and 14 of Part III will be included in that proxy statement and such information is hereby incorporated by reference.
PART IV
Item 15.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1
Financial statements required by Item 15 are included in Item 8 of Part II.
(a) 2
The following is a list of financial statement schedules filed as part of this Report:
Report of Independent Auditors
Schedule II Valuation and Qualifying Accounts & Reserves
For the Fiscal Years 2003, 2002 and 2001
All other schedules are omitted because they are not applicable or the information is shown in the financial statements or notes thereto.
(a) 3
The following is a list of all exhibits filed as part of this Report:
Exhibit 3
Restated Certificate of Incorporation dated May 28, 1975 filed as Exhibit 5 to Form 8-K for the month of May 1975, incorporated herein by reference.
Exhibit 3a
Registrant’s By-laws as amended September 19, 1975 filed as Exhibit 6 to Form 8-K for the month of September 1975, incorporated herein by reference.
Exhibit 3b
Registrant’s Certificate of Amendment of Certificate of Incorporation dated May 24, 1978 filed as Exhibit 1 to Form 10-Q for quarter ended June 30, 1978, incorporated herein by reference.
Exhibit 3c
Registrant’s Certificate of Amendment of Certificate of Incorporation dated May 27, 1987 filed as Exhibit 3c to Form 10-K for the year ended January 1, 1988, incorporated herein by reference.
Exhibit 3d
Registrant’s Certificate of Amendment of Restated Certificate of Incorporation dated June 4, 1999 filed as Exhibit 1 to Form 8-K for the month of June 1999, incorporated herein by reference.
Exhibit 10
Continental Materials Corporation Amended and Restated 1994 Stock Option Plan dated May 25, 1994 filed as Appendix A to the 1994 Proxy Statement, incorporated herein by reference.*
Exhibit 10a
Revolving Credit and Term Loan Agreement between dated as of September 5, 2003, by and among the Company and LaSalle Bank National Association and Fifth Third Bank filed as 10 to Form 10-Q for the quarterly period ending September 27, 2003, incorporated herein by reference.
Exhibit 10b
Acquisition Agreement Between Valco Properties, Ltd. And Continental Materials Corporation filed as Exhibit 2A to Form 8-K for the month October 1996, incorporated herein by reference.
Exhibit 10c
Non-Competition and Non-Disclosure Agreement by Valco, Inc. And Thomas E. Brubaker in favor of Continental Materials Corporation filed as Exhibit 2B to Form 8-K for the month of October 1996, incorporated herein by reference.
Exhibit 10d
Fee Sand and Gravel Lease Between Valco, Inc. And Continental Materials Corporation filed as Exhibit 2C to Form 8-K for the month of October 1996, incorporated herein by reference.
Exhibit 10e
Form of Supplemental Deferred Compensation Agreement filed as Exhibit 10 to Form 10-Q for the quarter ended July 1, 1983, incorporated herein by reference.*
Exhibit 10f
Stock Purchase Agreement By and Among Continental Materials Corporation, Rocky Mountain Ready Mix Concrete, Inc. and The Shareholders of Rocky Mountain Ready Mix Concrete, Inc. Filed as Exhibit 2A to Form 8-K for the month of December 2000, incorporated herein by reference.
Exhibit 10g
Continental Materials Corporation Employee Profit Sharing Retirement Plan Amended and Restated Generally Effective October 1, 1997 filed as Exhibit 99a to Form 10-K for the year ended January 1, 2000, incorporated herein by reference.*
Exhibit 21
Subsidiaries of Registrant (filed herewith).
Exhibit 23
Consent of Independent Accountants (filed herewith).
Exhibit 31.1
Rule 15d-14(a) Certification of Chief Executive Officer (filed herewith).
Exhibit 31.2
Rule 15d-14(a) Certification of Chief Financial Officer (filed herewith).
Exhibit 32.1
Section 1350 Certification of Chief Executive Officer (filed herewith).
Exhibit 32.2
Section 1350 Certification of Chief Financial Officer (filed herewith).
* - Compensatory plan or arrangement
(b) Reports on Form 8-K:
Registrant filed one report on Form 8-K during the quarter ended January 3, 2004. The report, dated November 6, 2003, related to the press release disclosing the results of the registrant’s operations for the third quarter of 2003 issued November 5, 2003. In addition, one report on Form 8-K was filed after January 3, 2004 but prior to the date of this Form 10-K filing. The report, dated March 17, 2004, related to the press release disclosing the results of the registrant’s operations for the 2003 fourth quarter and full year issued March 15, 2004.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE
CAPACITY(IES)
DATE
/S/ James G. Gidwitz
Chief Executive Officer
James G. Gidwitz
And a Director
April 1, 2004
/S/ Joseph J. Sum
Vice President
Joseph J. Sum
And a Director
April 1, 2004
/S/ Mark S. Nichter
Mark S. Nichter
Secretary and Controller
April 1, 2004
/S/ Thomas H. Carmody
Thomas H. Carmody
Director
April 1, 2004
/S/ Betsy R. Gidwitz
Betsy R. Gidwitz
Director
April 1, 2004
/S/ Ralph W. Gidwitz
Ralph W. Gidwitz
Director
April 1, 2004
/S/ Ronald J. Gidwitz
Ronald J. Gidwitz
Director
April 1, 2004
/S/ Theodore R. Tetzlaff
Theodore R. Tetzlaff
Director
April 1, 2004
/S/ Peter E. Thieriot
Peter E. Thieriot
Director
April 1, 2004
/S/ Darrell M. Trent
Darrell M. Trent
Director
April 1, 2004
REPORT OF INDEPENDENT AUDITORS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Shareholders of Continental Materials Corporation
Our audits of the consolidated financial statements referred to in our report dated March 12, 2004 appearing in the 2003 Annual Report to Shareholders of Continental Materials Corporation also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP
Chicago, Illinois
March 12,
CONTINENTAL MATERIALS CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (c) (d)
for the fiscal years 2003, 2002 and 2001
Notes:
(a) Accounts written off, net of recoveries.
(d) Column C(2) has been omitted as the answer would be “none”.
(b) Amounts written off upon disposal of assets.
(e) Beginning balance has been adjusted to reflect RMRM reserve on purchase date.
(c) Reserve deducted in the balance sheet from the asset to which it applies.
(f) Beginning balance has been adjusted to reflect MDHI reserve on purchase date.