SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ending October 3, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File number 1-3834 CONTINENTAL MATERIALS CORPORATION (Exact name of registrant as specified in its charter) Delaware 36-2274391 (State or other jurisdiction (I.R.S. Employer of Identification No.) incorporation or organization) 225 West Wacker Drive, Chicago, Illinois 60606 (Address of principal executive office) (Zip Code) (312) 541-7200 (Registrant's telephone number, including area code) (Former name, former address and former year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Number of common shares outstanding at November 6, 1998 1,072,371 PART I - FINANCIAL INFORMATION Item 1. Financial Statements CONTINENTAL MATERIALS CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS OCTOBER 3, 1998 and JANUARY 3, 1998 (Unaudited) (000's omitted except share data) OCTOBER 3, JANUARY 3, 1998 1998 ASSETS Current assets: Cash and cash equivalents $ 2,877 $ 1,524 Receivables, net 16,705 13,882 Inventories: Finished goods 7,213 8,562 Work in process 1,452 1,471 Raw materials and supplies 4,475 4,260 Prepaid expenses 2,590 2,343 Total current assets 35,312 32,042 Property, plant and equipment, net 21,175 19,581 Other assets: Investment in mining partnership 600 600 Other 2,273 2,132 $ 59,360 $ 54,355 LIABILITIES Current liabilities: Current portion of long-term debt $ 950 $ 1,900 Accounts payable and accrued expenses 14,271 11,327 Income taxes 892 222 Total current liabilities 16,113 13,449 Long-term debt 5,450 6,400 Deferred income taxes 1,722 1,722 Other long-term liabilities 959 926 SHAREHOLDERS' EQUITY Common shares, $0.50 par value; authorized 3,000,000; issued 1,326,588 663 663 Capital in excess of par value 3,484 3,484 Retained earnings 34,779 31,283 Treasury shares, 254,217 and 246,187, at cost (3,810) (3,572) 35,116 31,858 $ 59,360 $ 54,355 See accompanying notes 2 CONTINENTAL MATERIALS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS FOR THE THREE MONTHS ENDED OCTOBER 3, 1998 AND SEPTEMBER 27, 1997 (Unaudited) (000's omitted except per share amounts) OCTOBER 3, SEPTEMBER 27, 1998 1997 Net sales $ 29,069 $ 25,612 Costs and expenses: Cost of sales (exclusive of depreciation, depletion and amortization) 21,642 19,677 Depreciation, depletion and amortization 1,045 881 Selling and administrative 3,817 3,214 26,504 23,772 Operating income 2,565 1,840 Interest expense, net (154) (244) Equity loss from mining partnership (7) (30) Other income, net 189 209 Income before income taxes 2,593 1,775 Provision for income taxes 908 622 Net income 1,685 1,153 Retained earnings, beginning of period 33,094 29,151 Retained earnings, end of period $ 34,779 $ 30,304 Basic earnings per share $ 1.57 $ 1.05 Average shares outstanding 1,072 1,103 Diluted earnings per share $ 1.54 $ 1.03 Average shares outstanding 1,097 1,122 See accompanying notes 3 CONTINENTAL MATERIALS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS FOR THE NINE MONTHS ENDED OCTOBER 3, 1998 AND SEPTEMBER 27, 1997 (Unaudited) (000's omitted except per share amounts) OCTOBER 3, SEPTEMBER 27, 1998 1997 Net sales $ 80,810 $ 74,508 Costs and expenses: Cost of sales (exclusive of depreciation, depletion and amortization) 61,088 57,749 Depreciation, depletion and amortization 3,094 2,636 Selling and administrative 11,026 10,503 75,208 70,888 Operating income 5,602 3,620 Interest expense, net (538) (748) Equity loss from mining partnership (45) (87) Other income, net 360 494 Income before income taxes 5,379 3,279 Provision for income taxes 1,883 1,148 Net income 3,496 2,131 Retained earnings, beginning of period 31,283 28,173 Retained earnings, end of period $ 34,779 $ 30,304 Basic earnings per share $ 3.26 $ 1.93 Average shares outstanding 1,074 1,103 Diluted earnings per share $ 3.18 $ 1.90 Average shares outstanding 1,098 1,122 See accompanying notes 4 CONTINENTAL MATERIALS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED OCTOBER 3, 1998 AND SEPTEMBER 27, 1997 (Unaudited) (000's omitted) OCTOBER 3, SEPTEMBER 27, 1998 1997 Net cash provided by operating activities $ 8,135 $ 848 Investing activities: Capital expenditures (4,636) (2,157) Proceeds from sale of property and equipment 37 9 Investment in mining partnership (45) (87) Net cash used in investing activities (4,644) (2,235) Financing activities: Borrowings under revolving credit facility -- 600 Long-term borrowings -- 2,000 Repayment of long-term debt (1,900) (750) Payment to acquire treasury stock (238) -- Net cash (used) provided by financing activities (2,138) 1,850 Net increase in cash and cash equivalents 1,353 463 Cash and cash equivalents: Beginning of year 1,524 379 End of period $ 2,877 $ 842 Supplemental disclosures of cash flow items: Cash paid during the nine months for: Interest $ 543 $ 834 Income taxes 1,218 893 See accompanying notes 5 CONTINENTAL MATERIALS CORPORATION SECURITIES AND EXCHANGE COMMISSION FORM 10-Q NOTES TO THE QUARTERLY CONSOLIDATED FINANCIAL STATEMENTS QUARTER ENDED OCTOBER 3, 1998 (Unaudited) 1.The unaudited interim consolidated financial statements included herein are prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and footnote disclosures normally accompanying the annual financial statements have been omitted. The interim financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's latest annual report on Form 10-K. In the opinion of management, the consolidated financial statements include all adjustments (none of which were other than normal recurring adjustments) necessary for a fair statement of the results for the interim periods. 2.The provision for income taxes is based upon the estimated effective tax rate for the year. 3.Operating results for the first nine months of 1998 are not necessarily indicative of performance for the entire year. Historically, sales of construction materials are higher in the second and third quarters. The sales and gross margins of the heating and air-conditioning segment, affected by weather and a changing product mix, have not produced a consistent pattern in recent years. (See Note 12 of Notes to Consolidated Financial Statements in the Company's 1997 Annual Report.) 4.The following is a reconciliation of the calculation of basic and diluted earnings per share (EPS) for the three and nine months ended October 3, 1998 and September 27, 1997. Three months ended Nine months ended Per- Per- share share Income Shares earnings Income Shares earnings October 3, 1998 Basic EPS $1,685 1,072 $ 1.57 $3,496 1,074 $ 3.26 Effect of dilutive options -- 25 -- 24 Diluted EPS $1,685 1,097 $ 1.54 $3,496 1,098 $ 3.18 September 27, 1997 Basic EPS $1,153 1,103 $ 1.05 $2,131 1,103 $ 1.93 Effect of dilutive options -- 19 -- 19 Diluted EPS $1,153 1,122 $ 1.03 $2,131 1,122 $ 1.90 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation The following discussion provides information which management believes is relevant to an assessment and understanding of the Company's results of operation and financial condition. The discussion should be read in conjunction with the Company's unaudited consolidated interim financial statements and notes thereto and the Company's Annual Report on Form 10-K. This report contains certain statements of a forward-looking nature relating to future events or the future financial performance of the Company. Investors are cautioned that such statements are only predictions and that actual events or results may differ materially. In evaluating such statements, investors should carefully consider the various factors identified in this report, which could cause actual results to differ materially from those indicated from such forward-looking statements. Financial Condition (See pages 2 and 5) Operations for the first nine months of 1998 provided $8,135,000 of cash compared to $848,000 in 1997. A reduction in inventory levels and an increase in payables and accrued expenses combined with higher income to generate the significant increase in cash. The Company estimates that its short-term line of credit (none of which was outstanding at October 3, 1998) will be adequate to meet its cash requirements for the foreseeable future. Historically, the Company's borrowings against the short-term line peak during the second quarter and decline over the remainder of the year. In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. In February 1998, the FASB issued SFAS No. 132, Employers' Disclosure about Pensions and Other Postretirement Benefits. In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The Company has not yet adopted these pronouncements, but does not expect that they will have a material impact on the Company's financial position or results of operations. Operations - Comparison of Quarter Ended October 3, 1998 to Quarter Ended September 27, 1997 (See page 3) Consolidated net sales increased $3,457,000 (13.5%). The construction materials segment reported sales up $675,000 (4.5%), as construction activity along the Front Range in southern Colorado remained strong. The heating and air- conditioning segment sales increased $2,782,000 (26.4%) as hot July weather in the Southwest spurred evaporative cooler sales making up some revenues foregone during the adverse effect of El Nino in the second quarter. The fan coil line also recorded sales gains. Consolidated cost of sales (exclusive of depreciation, depletion and amortization) as a percentage of sales decreased from 76.8% to 74.5%. The decrease was due to improved margins in the fan coil product line of the heating and air- conditioning segment and an increase in sales in the construction materials segment. Depreciation, depletion and amortization increased 18.6% ($164,000) due to increased capital expenditures. Interest expense declined 36.9% ($90,000) due to lower levels of outstanding debt. 7 Operations - Comparison of Nine Months Ended October 3, 1998 to Nine Months September 27, 1997 (See page 4) Net sales rose $6,302,000 (8.5%). The increases in the construction materials segment $5,778,000 (14.9%), and the heating and air-conditioning segment $524,000 (1.5%), were due to the reasons noted above. Consolidated cost of sales (exclusive of depreciation, depletion and amortization) as a percentage of sales decreased from 77.5% to 75.6% due to the reasons noted above. Depreciation, depletion and amortization increased 17.4% ($458,000) due to increased capital expenditures. Interest expense declined 28.1% ($210,000) due to the reason noted above. Historically, the Company has experienced operating losses during the first quarter while subsequent quarters have improved over the first quarter's operating results. This historical trend of first quarter operating losses has not occurred in the past three years due to mild weather and a strong construction market in the area served by the construction materials segment. The historical trend is expected to resume at some point in time as sales of construction materials are generally higher in the second through fourth quarters. Sales and gross margins in the heating and air-conditioning segment, affected by weather and a changing product mix, have not produced a consistent pattern in recent years. Year 2000 Compliance The Year 2000 issue relates to the way computer hardware and software define calendar dates; many use only two digits to represent the year which could cause failures or miscalculations. In addition, many systems and equipment that are not typically thought of as computer-related (referred to as non-IT) contain imbedded hardware or software that may include a time element. The Year 2000 issue can arise at any point in the Company's supply, manufacturing, processing, distribution and financial chains. As a result, the Company is at risk of disruptions to its business operations from possible miscalculations or system failures occurring not only in its own equipment and software, but those occurring in any business or governmental entity that the Company relies on for goods or services. The Company has completed a study, with the assistance of external consultants, to evaluate the Company's current internal information and financial systems. The Company concluded that the majority of the existing systems were not Year 2000 compliant. We have therefore undertaken to implement a Year 2000 compliant enterprise resource planning (ERP) system to replace all non-compliant systems as well as to modernize and integrate all of the Company's systems. The majority of the hardware utilized by the Company, including all that may be Year 2000 non-compliant, is also being replaced. Work on the project began in the second quarter of 1998 and is expected to be completed during the second quarter of 1999. The cost of the entire project is currently estimated at $3,000,000 including hardware, software, consulting fees and other out-of-pocket expenses. Approximately $1,300,000 has been incurred to date. Funding will be furnished by a lease of approximately $1,500,000 with the balance provided by operating cash flow. The cost of the project is not expected to have a significant negative impact on the Company's future financial results. A review has been undertaken, or is in process, to assess and correct Year 2000 issues affecting both our products and the non-IT systems and equipment used in our businesses. At the present time, the Company has not identified any products which would be Year 2000 non-compliant. One phone system has been identified as Year 2000 non-compliant and a resolution is being pursued. 8 We rely on third party suppliers for raw materials, water, utilities, transportation and other key services. Interruption to any of their operations due to Year 2000 issues could affect the operations of our Company. We have initiated efforts to ascertain the level of preparedness of this group. We have found some of these entities less willing to provide information concerning their state of readiness. Alternative sources of raw materials and certain other services have been identified, where possible, to help mitigate any impact due to disruptions at any of our key suppliers. While we believe that the steps we have taken should reduce the adverse effect on our Company of any such disruptions, the interdependent nature of the Company and its suppliers, service providers, utilities and governmental agencies is such that a disruption at one or more suppliers could have material adverse consequences. We are also dependent upon our customers for sales and cash flow. Year 2000 interruptions in our customers' operations could result in reduced sales, increased inventory or receivable levels and cash flow reductions. While these events are possible, we believe our customer base is broad enough to minimize the affects to our Company of system disruptions at some customers' operations. We are, however, taking steps to contact and monitor the status of our larger customers as a means of determining risks and alternatives. At this time, we have not learned of any potential exposures from external, non-compliant third party suppliers or customers. PART II Other Information - Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: Exhibit 27: Financial data schedule (b) Registrant filed no reports on Form 8-K during the quarter ended October 3, 1998. SIGNATURE Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CONTINENTAL MATERIALS CORPORATION Date: November 9, 1998 By: /S/ Joseph J. Sum Joseph J. Sum, Vice President and Chief Financial Officer 9