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CUO > SEC Filings for CUO > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for CONTINENTAL MATERIALS CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for CONTINENTAL MATERIALS CORP


13-Nov-2012

Quarterly Report


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

Company Overview

See Note 7 for an overview of the Company.

Liquidity and Capital Resources

As noted above, various factors affect the sales of the Company's products. Historically, the Company has experienced operating losses during the first quarter except when construction activity is strong along the Southern Front Range of Colorado and the weather is mild. Operating results typically improve in the second and third quarters, reflecting more favorable weather conditions in Colorado and the seasonal sales of the 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. While the CACS segment experienced increased demand in September and October, weather conditions can slow the pace of construction activity for November and the winter season.

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, if any. 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 during the first nine months of 2012.

Cash provided by operations was $1,554,000 during the first nine months of 2012 compared to the $547,000 of cash provided by operations during the first nine months of 2011. The Company's operating cash flow was positive despite the operating loss primarily due to a net reduction in working capital during the first nine months of 2012.

During the nine months ended September 29, 2012, investing activities used $1,457,000 of cash compared to the $1,425,000 of cash used in the prior year's period. The Company continued to closely monitor capital expenditures during the first nine months of 2012 despite the growth in sales volume. Capital purchases during the 2012 period were made by all reporting segments and related primarily to routine replacements in the HVAC companies and permits and development costs in the CACS segment. As discussed in Note 7, during the 2011 period the Company also made a loan to an officer of one of the Company's subsidiaries in conjunction with his relocation.

Financing activities during the first nine months of 2012 used $260,000. During the first quarter of 2012, the Company provided a bank letter of credit to replace the $4,340,000 of cash deposited with the Company's casualty insurance provider for self-insured claims. The returned cash was used to reduce the outstanding revolving bank loan. The third quarter payment of $125,000 due September 30, 2012 on the long-term debt was not taken by the bank until October 1, 2012, after the close of the Company's fiscal third quarter. Financing activities provided $1,025,000 during the first nine months of 2011 through borrowings of $1,400,000 against the revolving credit facility as well as receipt of $500,000 resulting from the reduction of the amount deposited with our insurance carrier to secure the Company's self-insured claims under its casualty insurance program. All scheduled term debt payments were made during the 2011 period. During the first nine months of 2012, the highest amount of Company borrowings outstanding under the revolving credit line was $8,150,000 and the average amount outstanding was $4,179,000.


The Company believes that its existing cash balance, anticipated cash flow from operations and borrowings available under its credit agreement will be sufficient to cover expected cash needs, including servicing debt and planned capital expenditures for the next 12 months. The Company was in compliance with all loan covenants as of the fiscal quarter ended September 29, 2012. The Company has begun discussions with the bank to amend the Company's credit agreement principally as it relates to covenants which will commence during 2013. The bank has indicated that it is willing to accommodate the Company and the amendment is expected to be in place prior to the end of the fiscal year.

Results of Operations - Comparison of Quarter Ended September 29, 2012 to Quarter Ended October 1, 2011

In the ensuing discussions of the results of operations the term gross profit means the amount determined by deducting cost of sales (exclusive of depreciation, depletion and amortization) from sales. The gross profit ratio is gross profit divided by sales.

Consolidated sales in the third quarter of 2012 were $29,166,000, an increase of $3,665,000 (14.4%) compared to the third quarter of 2011. Sales in the Concrete, Aggregates and Construction Supplies ("CACS") segment increased by $4,393,000 (53.1%) as the construction markets in southern Colorado are beginning to show some signs of recovery from the very depressed conditions that prevailed over the past three years. Net sales in the Company's Heating & Cooling segment declined by $742,000 (8.8%) as furnace shipments in September, generally the beginning of the furnace selling season, got off to a slow start due to very warm weather in California and the Southwest. Sales in the Door and Evaporative Cooling segment were substantially the same as the year ago quarter. The consolidated gross profit ratio declined from 21.8% in the third quarter of 2011 to 19.0% in the current year quarter. The CACS segment experienced the most significant decline in the gross profit ratio due to stagnant prices for ready-mix concrete coupled with higher cement and fuel prices. In addition, higher costs and an unfavorable shift to lower priced products in the aggregates division contributed to the diminished gross profit rate. Depreciation expense was $825,000 in the third quarter of 2012 compared to $1,012,000 in the prior year third quarter. The lower expense reflects the reduced capital spending in the past few years throughout the Company. Consolidated selling and administrative expenses were $63,000 lower in the 2012 third quarter compared to the third quarter in 2011. Litigation expenses associated with the Pikeview Quarry insurance claim were $241,000 lower in the third quarter of 2012 compared to the prior year. Selling and administrative expenses in the other segments and the corporate office were moderately higher in 2012. Consolidated selling and administrative expenses as a percentage of consolidated sales decreased from 19.4% to 16.7%. The Company incurred an operating loss of $165,000 in the third quarter of 2012 compared to a $363,000 operating loss in the third quarter of 2011.

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 September 29, 2012 and October 1, 2011 (amounts in thousands):



                                             Concrete,
                                          Aggregates and
                                           Construction
                                             Supplies         Doors
Quarter ended September 29, 2012
Revenues from external customers          $        12,659    $ 3,083
Gross profit                                        1,475        653
Gross profit as a percent of sales                   11.7 %     21.2 %
Segment operating income                             (187 )       88
Operating income as a percent of sales               (1.5 )%     2.9 %
Segment assets as of September 29, 2012   $        34,762    $ 5,999
Return on assets                                     (0.5 )%     1.5 %

Quarter ended October 1, 2011
Net sales to external customers           $         8,266    $ 3,161
Gross profit                                        1,311        599
Gross profit as a percent of sales                   15.9 %     18.9 %
Segment operating income                             (780 )       72
Operating income as a percent of sales               (9.4 )%     2.3 %
Segment assets as of October 1, 2011      $        33,568    $ 6,224
Return on assets                                     (2.3 )%     1.2 %


Concrete, Aggregates and Construction Supplies Segment

As discussed above there was some increase in the level of construction activity in the southern Colorado markets, particularly in Colorado Springs during the third quarter of 2012. Concrete yardage and tons of aggregate sold or consumed internally were 35.2% and 80.9% higher, respectively, compared to the third quarter of 2011. The aggregate sales volume was assisted by a crushed concrete job serviced by the Company in the third quarter of 2012. Selling prices for concrete declined compared to the prior year while cement prices, a key ingredient of ready-mix concrete, rose. A shift in product mix at some of the aggregate operations to lower priced secondary products and some higher costs also contributed to the reduced gross profit rate in the CACS segment. The gross profit rate for the CACS segment as a whole was 11.7% in the third quarter of 2012 compared to 15.9% in the prior year third quarter. Depreciation expenses fell by $227,000 reflecting the reduced level of capital spending over the last few years. Selling and administrative expenses for this segment declined by approximately $229,000 due to the litigation expenses related to the Pikeview Quarry insurance claim.

Door Segment

Sales during the third quarter of 2012 in the Door segment were only $78,000 (2.5%) lower than in the third quarter of 2011. The gross profit percentage in 2012 improved reflecting higher prices and product mix factors.

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
September 29, 2012 and October 1, 2011 (amounts in thousands):



                                           Heating and     Evaporative
                                             Cooling         Cooling
Quarter ended September 29, 2012
Net sales to external customers           $       7,672   $       5,662
Gross profit                                      2,147           1,224
Gross profit as a percent of sales                 28.0 %          21.6 %
Segment operating income                            258             394
Operating income as a percent of sales              3.4 %           7.0 %
Segment assets as of September 29, 2012   $      18,039   $      10,335
Return on assets                                    1.4 %           3.8 %

Quarter ended October 1, 2011
Net sales to external customers           $       8,414   $       5,570
Gross profit                                      2,449           1,166
Gross profit as a percent of sales                 29.1 %          20.9 %
Segment operating income                            586             373
Operating income as a percent of sales              7.0 %           6.7 %
Segment assets as of October 1, 2011      $      19,411   $      10,094
Return on assets                                    3.0 %           3.7 %

Heating and Cooling Segment

Sales in the Heating and Cooling segment decreased $742,000 (8.8%) in the third quarter of 2012 from the 2011third quarter. Sales of furnaces were lower in 2012 due to weak sales in September when California and other principal markets experienced unusually high temperatures. Fan coil sales improved from rather weak market conditions in 2011. The gross profit ratio for this segment declined from 29.1% to 28.0% due to product sales mix and a lower level of furnace production. Selling and administrative expenses were substantially unchanged.

Evaporative Cooling Segment

Sales in the Evaporative Cooling segment were just $92,000 (1.7%) higher in the third quarter of 2012 compared to the prior year quarter. The gross profit ratio improved from 20.9% to 21.6% primarily due to increased selling prices which made up some of the erosion in the gross profit rate that occurred in the prior year.

Operations - Comparison of Nine Months Ended September 29, 2012 to Nine Months Ended October 1, 2011

In the ensuing discussions of the results of operations the term gross profit means the amount determined by deducting cost of sales (exclusive of depreciation, depletion and amortization) from sales. The gross profit ratio is gross profit divided by sales.


Consolidated sales in the first nine months of 2012 increased $5,065,000 (6.5%) compared to the first nine months of 2011. Most of the increase in sales took place in the CACS segment. The Door and Evaporative Cooling segment posted modestly higher sales. The Heating and Cooling segment experienced just a $375,000 (1.6%) decline in sales. The consolidated gross profit ratio was 19.0% in the first nine months of 2012 compared to 20.4% for the same period in 2011. All but the Heating and Cooling segment experienced some reduction in their gross profit ratio. Depreciation expense decreased by $255,000 reflecting the reduced capital spending in the years since the economic recession and financial crisis of 2008/2009. Consolidated selling and administrative expenses were $438,000 higher in the first nine months of 2012 compared to the comparable period in the prior year. The reduced expenses related to the Pikeview litigation were more than offset by increased spending in the other segments including new product research and development efforts at the Company's HVAC businesses. The first of the new products is expected to be ready for sale during the second quarter of 2013. Product liability defense costs were also higher in the Heating and Cooling segment. Selling and administrative expenses as a percentage of net sales dropped from 18.9% from 18.3%.

The operating loss for the first nine months of 2012 was $2,329,000 compared to a $1,901,000 operating loss in the comparable period in 2011. The operating loss for the first nine months of 2012 includes $21,000 in gains from the sale of equipment compared to gains of $169,000 in the prior year period.

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 nine months
ended September 29, 2012 and October 1, 2011 (amounts in thousands):



                                                   Concrete,
                                                Aggregates and
                                                 Construction
                                                   Supplies         Doors
Nine Months ended September 29, 2012
Net sales to external customers                 $        29,332    $ 9,535
Gross profit                                              2,059      2,123
Gross profit as a percent of sales                          7.0 %     22.3 %
Segment operating (loss) income                          (3,208 )      427
Operating (loss) income as a percent of sales             (10.9 )%     4.5 %
Segment assets as of September 29, 2012         $        34,762    $ 5,999
Return on assets                                           (9.2 )%     7.1 %

Nine Months ended October 1, 2011
Net sales to external customers                 $        24,719    $ 9,164
Gross profit                                              2,386      2,206
Gross profit as a percent of sales                          9.7 %     24.1 %
Segment operating (loss) income                          (3,500 )      556
Operating (loss) income as a percent of sales             (14.2 )%     6.1 %
Segment assets as of October 1, 2011            $        33,568    $ 6,224
Return on assets                                          (10.4 )%     8.9 %

Concrete, Aggregates and Construction Supplies Segment

Sales in the CACS segment increased by $4,613,000 (18.7%) in the first nine months of 2012 compared to the first nine months of 2011. The level of construction activity along the Front Range in southern Colorado has shown some improvement compared to very low levels in 2011. The increase in construction was especially evident beginning in the third quarter of 2012. The increase in sales in 2012 includes approximately $1,057,000 of revenues associated with two projects that are not typically part of our core business. One of the jobs involved supplying flow fill material for a water pipeline being installed between Pueblo and Colorado Springs. The other project was a supply contract for crushed concrete. The concrete is being crushed by a third party contractor. Concrete yardages, excluding a job to supply flow fill material, increased by 4.6% compared to the first nine months of 2011. The average price of ready-mixed concrete remained virtually unchanged from the previous year. Cement prices were higher in 2012. Sales of aggregates (sand, crushed limestone and gravel), including those used internally and the crushed concrete, were approximately 17.9% higher in the first nine months of 2012 compared to the same period in 2011. The overall gross profit rate for the CACS segment decreased from 9.7% for the first nine months of 2011 to 7.0% in the comparable period of the current year. The lower gross profit rate is attributable to some higher costs and a shift in product mix at certain aggregate operations. Depreciation charges for this segment were $283,000 lower in 2012 for the reasons cited in the discussion on the third quarter results. Selling and administrative expenses were $487,000 lower in 2012. Nearly all of the reduction is related to the Pikeview insurance claim litigation.


Door Segment

Sales during the first nine months of 2012 in the Door segment increased $371,000 or 4.0% from the comparable 2011 period. Sales in 2011 were depressed due to weak construction markets. The gross profit ratio in 2012 declined from 24.1% for the first nine months of 2011 to 22.3% due to more competitive pricing especially on jobs serviced in the first part of 2012.

HVAC Products



The table below presents a summary of operating information for the two
reportable segments within the HVAC products group for the nine months ended
September 29, 2012 and October 1, 2011 (amounts in thousands):



                                           Heating and     Evaporative
                                             Cooling         Cooling
Nine Months ended September 29, 2012
Net sales to external customers           $      22,545   $      21,628
Gross profit                                      6,582           4,987
Gross profit as a percent of sales                 29.2 %          23.1 %
Segment operating income                            466           2,101
Operating income as a percent of sales              2.1 %           9.7 %
Segment assets as of September 29, 2012   $      18,039   $      10,335
Return on assets                                    2.6 %          20.3 %

Nine Months ended October 1, 2011
Net sales to external customers           $      22,920   $      21,173
Gross profit                                      6,290           4,965
Gross profit as a percent of sales                 27.4 %          23.4 %
Segment operating income                            750           2,290
Operating income as a percent of sales              3.3 %          10.8 %
Segment assets as of October 1, 2011      $      19,411   $      10,094
Return on assets                                    3.9 %          22.7 %

Heating and Cooling Segment

Sales in the Heating and Cooling segment decreased by a mere $375,000 (1.6%) in the first nine month of 2012 from the comparable period in 2011. Furnace and heater sales were down 13.8% due to high temperatures in September in southern California and other principal market areas. Also, in 2011 the Heating and Cooling segment supplied furnaces for some rehabilitation projects at multifamily dwellings. We have not had a similar project yet this year. Fan coil sales increased 38.5% from a depressed level of commercial construction in 2011. The gross profit ratio for this segment improved by 1.8 points reflecting better margins on fan coils primarily related to the improved fan coil market and a more selective bidding process. Selling and administrative expenses increased by $575,000 due primarily to new product development efforts, higher product liability defense expenses and incentive bonus provisions. Also, in 2011 the selling and administrative expenses were reduced by approximately $85,000 due to a reversal of a loss contingency.

Evaporative Cooling Segment

Sales in the Evaporative Cooling segment increased $455,000 or 2.1% in the first nine months of 2012 compared to the comparable period in 2011. The additional revenues reflect an increase in selling prices. The gross profit ratio decreased by only three tenths of a point. Production volume was 6.4 % lower in the first three quarters of 2012 compared to the prior year. Selling and administrative expenses were $202,000 higher in the 2012 period due to increased salaries, sales promotion expenses and new product development efforts. As a percentage of net sales these expenses were 12.0% in the first nine months of 2012 compared to 11.3% for the first nine months of 2011.

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 September 29, 2012 and December 31, 2011 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, 2011.

OUTLOOK

The level of construction activity in southern Colorado has increased in recent months. As a result, the level of business in the CACS segment has substantially improved in September and October, 2012. The apparent recovery is exhibiting more strength in the Colorado Springs area than in Pueblo. The economy in Pueblo is still weak. Housing starts in Colorado Springs are expected to increase further in 2013 in part due to the replacement of homes destroyed by last summer's Waldo Canyon fire. Economic forecasts indicate that the level of commercial construction is expected to be meaningfully higher in 2013 compared to 2012. However, winter weather conditions that typically prevail along the Front Range in southern Colorado from November to March slow the pace of construction regardless of the underlying strength of the construction market. Three of the five Colorado Springs ready-mix producers, including the Company, have announced a general price increase for ready-mix concrete effective January 1, 2013. Two other two ready-mix producers have yet to make any announcement. Bid prices on larger jobs remains sharply competitive.

The Door segment's sales are also, to a significant degree, reliant on new construction. The sales backlog of the Door segment at the end of September 2012 is the highest it has been since January of 2009.

We are in the midst of the selling season for wall furnaces and heaters. Warm weather in southern California and in other principal market areas had a negative influence on furnace sales in September and October. Furnace sales for the remainder of the year and winter season will be largely weather dependent. After strengthening some earlier in the year fan coil orders have recently slowed somewhat. Some industry sources opine that bidding opportunities will increase after the November 6 election.

Sales of evaporative coolers during the fourth quarter are preseason orders and are highly dependent upon when these orders are placed by our customers. In-season sales are substantially influenced by temperatures in the Southwest.

The Company's HVAC businesses are in the process of developing new products. The first of the new products is expected to be ready for sale during the second quarter of 2013, however, at this point it is too early to know if these efforts will be successful.

RECENTLY ISSUED ACCOUNTING STANDARDS

See Note 4 for a discussion of recently issued accounting standards.

MATERIAL CHANGES TO CONTRACTUAL OBLIGATIONS

There were no material changes to contractual obligations that occurred during the quarter ended September 29, 2012.

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, competitive forces and changes in governmental regulations and policies. Some of these factors are discussed in more detail in the Company's 2011 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.

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