Notes to Consolidated Financial Statement
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1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Continental Materials Corporation (the Company) is a Delaware corporation, incorporated in 1954. The Company operates primarily within two industry groups, Heating, Ventilation and Air Conditioning (HVAC) and Construction Products. The Company has identified two reportable segments in each of the two industry groups: the Heating and Cooling segment and the Evaporative Cooling segment in the HVAC industry group and the Concrete, Aggregates and Construction Supplies (CACS) segment and the Door segment in the Construction Products industry group.
The Heating and Cooling segment primarily produces and sells gas-fired wall furnaces, console heaters and fan coils from the Company’s wholly-owned subsidiary, Williams Furnace Co. (WFC) of Colton, California. The Evaporative Cooling segment produces and sells evaporative coolers from the Company’s wholly-owned subsidiary, Phoenix Manufacturing, Inc. (PMI) of Phoenix, Arizona. Concrete, aggregates and construction supplies (CACS) are offered from numerous locations along the Southern Front Range of Colorado operated by the Company’s wholly-owned subsidiaries Castle Concrete Company and Transit Mix Concrete Co., of Colorado Springs and Transit Mix of Pueblo, Inc. of Pueblo (the three companies collectively referred to as TMC). The Door segment sells hollow metal and wood doors, door frames and related hardware, lavatory fixtures and electronic access and security systems from the Company’s wholly-owned subsidiary, McKinney Door and Hardware, Inc. (MDHI), which operates out of facilities in Pueblo and Colorado Springs, Colorado.
In addition to the above reporting segments, an “Unallocated Corporate” classification is used to report the unallocated expenses of the corporate office which provides treasury, insurance and tax services as well as strategic business planning and general management services. Expenses related to the corporate information technology group are allocated to all locations, including the corporate office.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include Continental Materials Corporation and all of its subsidiaries (the Company). Intercompany transactions and balances have been eliminated. All subsidiaries of the Company are wholly-owned.
RECLASSIFICATIONS
Certain reclassifications have been made to the fiscal 2015 Consolidated Balance Sheet and Consolidated Statement of Cash Flows to conform to the 2016 financial statement presentation. These reclassifications had no effect on total assets, liabilities or shareholders’ equity.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In the first quarter of 2016, the Company implemented ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, which changes how deferred taxes are classified on organizations’ balance sheets. The change has been applied retrospectively for all periods presented. The effect of implementation is to report a consolidated non-current net asset of $1,616,000 and $3,149,000 in the consolidated balance sheets as of December 31, 2016 and January 2, 2016, respectively. Adoption of this update resulted in reclassifying current deferred income tax assets of $1,078,000 to non-current deferred income tax assets in the consolidated balance sheet as of January 2, 2016.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606).
This new revenue standard creates a single source of revenue guidance for all companies in all industries and is more principles-based than current revenue guidance
. Subsequently, the FASB has issued various ASUs to provide further clarification around certain aspects of ASC 606. This standard will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and the Company will adopt the standard on January 1,
2018. While the Company has not completed its analysis of the impact of the provisions of this standard, we do not expect a significant impact to the consolidated financial statements or disclosure.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This new standard supersedes existing lease guidance to require lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by long-term leases and to disclose additional quantitative and qualitative information about leasing arrangements. The standard will be effective for the Company in the first quarter of 2019 and will be adopted using a modified retrospective approach. While we anticipate the adoption of ASU 2016-02 may have a significant impact on our consolidated balance sheets, consolidated statements of income and disclosures, we are unable to quantify the financial statement impact at this time.
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 December 31, 2016 and January 2, 2016 and the reported amounts of revenues and expenses during both of the two years in the period ended December 31, 2016. 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. The carrying amount of cash and cash equivalents approximates fair value. The Company has reclassified negative cash balances to Accounts Payable.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:
Level 1 Quoted prices in active markets for identical assets or liabilities.
Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 Unobservable inputs supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect the assumptions that market participants would use when pricing the asset or liability including assumptions about risk.
The following methods were used to estimate the fair value of the financial instruments recognized in the accompanying balance sheet.
Cash and Cash Equivalents: The carrying amount approximates fair value and was valued as Level 1.
Debt: Fair value was estimated based on the borrowing rates then available to the Company for bank loans with similar terms and maturities and determined through the use of a discounted cash flow model. The carrying amount of debt represents a reasonable estimate of the corresponding fair value as the Company’s debt is held at variable interest rates and was valued as Level 2.
There were no transfers between fair value measurement levels of any financial instruments in the current year.
INVENTORIES
Inventories are valued at the lower of cost or market and are reviewed periodically for excess or obsolete stock with a provision recorded, where appropriate. Cost for inventory in the HVAC industry group is determined using the last-in, first-out (LIFO) method. These inventories represent approximately 79% of total inventories at December 31, 2016 and 82% at January 2, 2016. The cost of all other inventory is determined by the first-in, first-out (FIFO) or average cost methods. Some commodity prices such as copper, steel, cement and diesel fuel have experienced significant fluctuations in recent years. Cement and diesel fuel prices are principally relevant to the CACS segment while steel prices and copper prices are principally relevant to our two HVAC businesses. The general effect of using LIFO is that higher prices are not reflected in the inventory carrying value. Current costs are reflected in the cost of sales. The inventories of the businesses using either FIFO or an average costing method for valuing inventories turn over frequently and at any point in time the amount of cement or fuel inventory is not significant. As a result of these circumstances, the commodity fluctuations have primarily affected the cost of sales with little effect on the valuation of inventory. Due to the nature of our products, obsolescence is not typically a significant exposure, however our HVAC businesses will from time to time contend with some slow-moving inventories or parts that are no longer used due to engineering changes. We believe that our inventory valuation reserves are not material. At December 31, 2016, inventory reserves were approximately 1.4% of the total FIFO inventory value.
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:
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Land improvements
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5 to 31 years
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Buildings and improvements
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10 to 31 years
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Leasehold improvements
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Shorter of the term of the lease or useful life
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Machinery and equipment
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3 to 20 years
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Depletion of rock and sand deposits and amortization of deferred development costs are computed by the units-of-production method based upon estimated recoverable quantities of rock and sand. The estimated recoverable quantities are periodically reassessed.
The cost of property sold or retired and the related accumulated depreciation, depletion and amortization are removed from the accounts and the resulting gain or loss is reflected in operating income. Maintenance and repairs are charged to expense as incurred. Major renewals and betterments are capitalized and depreciated over their estimated useful lives.
OTHER ASSETS
The Company annually assesses goodwill for potential impairment at the end of each year. In addition, the Company will reassess the recorded goodwill to determine if impairment has occurred if events arise or circumstances change in the relevant reporting segments or in their industries. No goodwill impairment was recognized for any of the periods presented.
Amortizable intangible assets consist of a restrictive land covenant and customer relationships related to the Company’s acquisition of the assets of a ready-mix concrete business in 2006. The restrictive land covenant was being amortized on a straight-line basis over its estimated life of ten years. The customer relationships amount was amortized over its estimated life of ten years using the sum-of-the-years digits method. Both of these intangible assets were fully amortized as of December 31, 2016.
During the fourth quarter of 2016 the Company paid $2,500,000 related to an aggregate property near Colorado Springs. As the Company negotiates with the State of Colorado to obtain the necessary mining permits the amount is being held in an escrow account and is included in other assets as of December 31, 2016.
The Company is party to three aggregate property leases which require royalty payments. The leased gravel operation in Pueblo Colorado is currently the subject of litigation as the Company seeks, among other things, to rescind the lease and to recover overpayment of approximately $627,000 of royalties. This overpayment is included in the other long-term assets category. See Note 2.
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 may make annual contributions, at its discretion, based primarily on profitability. In addition, any individuals whose compensation is in excess of the amount eligible for the Company matching contribution to the 401(k) plan as established by Section 401 of the Internal Revenue Code, participate in an unfunded Supplemental Profit Sharing Plan. This plan accrues an amount equal to the difference between the amount the person would have received as Company contributions to his account under the 401(k) plan had there been no limitations and the amount the person will receive under the 401(k) plan giving effect to the limitations. Costs under the plans are charged to operations as incurred. As of December 31, 2016 and January 2, 2016, the unfunded liabilities related to the Supplemental Profit Sharing Plan were $854,000 and $901,000, respectively.
RESERVE FOR SELF-INSURED AND INSURED LOSSES
The Company’s risk management program provides for certain levels of loss retention for workers’ compensation, automobile liability, healthcare plan coverage and general and product liability claims. The components of the reserve for self-insured losses have been recorded in accordance with Generally Accepted Accounting Principles (GAAP) requirements that an estimated loss from a loss contingency shall be accrued if information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated. The recorded reserve represents management’s best estimate of the future liability related to these claims up to the associated deductible.
GAAP also requires an entity to accrue the gross amount of a loss even if the entity has purchased insurance to cover the loss. Therefore the Company has recorded losses for workers’ compensation, automobile liability, medical plan coverage and general and product liability claims in excess of the deductible amounts, i.e., amounts covered by insurance contracts, in “Liability for unpaid claims covered by insurance” with a corresponding “Receivable for insured losses” on the balance sheet. The components of the liability represent both unpaid settlements and management’s best estimate of the future liability related to open claims. Management has evaluated the creditworthiness of our insurance carriers and determined that recovery of the recorded losses is probable and, therefore, the receivable from insurance has been recorded for the full amount of the insured losses. The amount of claims and related insured losses at December 31, 2016 was $32,000. There were no such claims and related insured losses at January 2, 2016.
RECLAMATION
In connection with permits to mine properties in Colorado, the Company is obligated to reclaim the mined areas whether the property is owned or leased. The Company records a reserve for future reclamation work to be performed at its various aggregate operations based upon an estimate of the total expense that would be paid to a third party to reclaim the disturbed areas. Reclamation expense is determined during the interim periods using the units-of-production method. At each fiscal year-end, a more formal and complete analysis is performed and the expense and reserve is adjusted to reflect the estimated cost to reclaim the then disturbed and unreclaimed areas. The assessment of the reclamation liability may be done more frequently if events or circumstances arise that may indicate a change in estimated costs, recoverable material or period of mining activity. As part of the year-end analysis, the Company engages an independent specialist to assist in reevaluating the estimates of both the quantities of recoverable material and the cost of reclamation. Most of the reclamation on any mining property is generally performed concurrent with mining or soon after each section of the deposit is mined. The Company’s reserve for reclamation activities was $5,940,000 at December 31, 2016 and $5,675,000 at January 2, 2016. The Company classifies a portion of the reserve as a current liability, $748,000 at December 31, 2016 and $695,000 at January 2, 2016 based upon historical expenditures and the anticipated reclamation timeframe for the Pueblo aggregate operation which is still under litigation as discussed in Note 2.
REVENUE RECOGNITION
The Company recognizes revenue as products are shipped to customers. Sales are recorded net of sales tax and applicable provisions for discounts, volume incentives, returns and allowances. At the time of revenue recognition, the Company also provides an estimate of potential bad debt and warranty expense as well as an amount anticipated to be granted to customers under cooperative advertising programs based upon current program terms and historical experience. In addition, the revenues received for shipping and handling are included in sales while the costs associated with shipping and handling are reported as cost of sales.
The Company is responsible for warranty related to the manufacture of its HVAC products. The Company does not perform installation services except for installation of electronic access and security systems in the Door segment, nor are maintenance or service contracts offered. Changes in the aggregated product warranty liability for the fiscal years 2016 and 2015 were as follows (amounts in thousands):
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2016
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2015
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Beginning balance
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$
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121
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$
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109
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Warranty related expenditures
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(120)
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(150)
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Warranty expense accrued
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117
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162
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Ending balance
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$
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118
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$
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121
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INCOME TAXES
Income taxes are accounted for under the asset and liability method that requires deferred income taxes to reflect the future tax consequences attributable to differences between the tax and financial reporting bases of assets and liabilities. Deferred tax assets and liabilities recognized are based on the tax rates in effect in the year in which differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance when, based on available positive and negative evidence, it is “more likely than not” (greater than a 50% likelihood) that some or all of the net deferred tax assets will not be realized.
The Company has established a valuation reserve related to the carry-forward of all charitable contributions deductions arising from prior years. For Federal tax purposes, net operating losses can be carried forward for a period of 20 years while alternative minimum tax credits can be carried forward indefinitely. For state tax purposes, net operating losses can be carried forward for periods ranging from 5 to 20 years for the states that the Company is required to file in. California Enterprise Zone credits can be used through 2023 while Colorado credits can be carried forward for 7 years.
Income tax returns are subject to audit by the Internal Revenue Service (IRS) and state tax authorities. The amounts recorded for income taxes reflect the Company’s tax positions based on research and interpretations of complex laws and regulations. The Company accrues liabilities related to uncertain tax positions taken or expected to be taken in its tax returns.
CONCENTRATIONS
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of trade receivables and temporary cash investments. The Company may invest its excess cash in commercial paper of companies with strong credit ratings. 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. In many instances in the Concrete, Aggregates and Construction Supplies segment and in the Heating and Cooling segment (as it relates to the fan coil product line), the Company retains lien rights on the properties served until the receivable is collected. The Company writes off accounts when all efforts to collect the receivable have been exhausted. The Company maintains allowances for potential credit losses based upon the aging of accounts receivable, management’s assessment of individual accounts and historical experience. Such losses have been within management’s expectations. See Note 15 for a description of the Company’s customer base.
All long-lived assets are in the United States. No customer accounted for 10% or more of total sales of the Company in fiscal 2016 or 2015.
Substantially all of the Heating and Cooling Segment’s factory employees are covered by a collective bargaining agreement through the Carpenters Local 721 Union under a contract that expires on December 31, 2018.
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. In the fiscal quarter ended October 1, 2016 the Company wrote off $632,000 of prepaid royalties related to the leased gravel operation in Pueblo, Colorado. See Note 2.
FISCAL YEAR END
The Company’s fiscal year-end is the Saturday nearest December 31. Fiscal 2016 and fiscal 2015 each consisted of 52 weeks.
2. CESSATION OF MINING AT LEASED PUEBLO GRAVEL SITE
On September 15, 2016 a Partial Summary Judgment Order was issued regarding the Company’s previously disclosed litigation, Continental Materials Corporation v. Valco, Inc., Civil Action No. 2014-cv-2510, filed in the United States District Court for the District of Colorado. The suit regards a sand and gravel lease between the Company and Valco, Inc. (“Valco”) that calls for the payment of royalties over the life of the lease on an agreed 50,000,000 tons of sand and gravel reserves. In the suit the Company sought, among other things, to reform the sand and gravel lease in regard to the agreed amount of sand and gravel reserves and to recover approximately $1,282,000 of royalty overpayments included in other long-term assets. The Partial Summary Judgment Order resolved many of the Company’s claims in Valco’s favor, but the Company’s claim for the return of royalty overpayments made during the statutorily allowed period is still pending. During the third quarter of 2016, the Company recorded a $632,000 write-down representing the portion of the royalty overpayment paid prior to the statutorily allowed period because of litigation risk attendant to recovering that amount. On September 30, 2016 Valco filed a motion seeking to add three counterclaims alleging damages in excess of $5,900,000. The Company opposed Valco’s motion and on December 9, 2016, Valco withdrew its motion to add counterclaims. The Company has asserted partial failure of consideration as a defense to Valco’s counterclaims for unpaid royalties because the consideration for the promise to pay royalties was the 50,000,000 tons of sand and gravel reserves that do not exist. The Company sought certification of the Partial Summary Judgment Order because it and its legal counsel believe the court improperly resolved factual issues in its Partial Summary Judgment Order that should have been decided by a jury. The Company and its legal counsel believe there is a likelihood that some, or all, of the issues resolved by the Partial Summary Judgment Order may be reversed on appeal and remanded for trial by jury although there can be no assurance that an appeal will result in reversal. The Company paid royalties on approximately 17,700,000 tons, including the overpayments, of the 50,000,000 tons of sand and gravel reserves through the end of the third quarter of 2014. The impact of these proceedings could have a material financial effect on the Company; however, the Company does not believe that there is a reasonable basis for estimating the financial impact, if any, of the final outcome of these proceedings and accordingly no accrual or reserve has been recorded in compliance with accounting principles generally accepted in the United States of America. On February 23, 2017, the Partial Summary Judgment Order was certified for immediate appeal, and all other claims, counterclaims and defenses were stayed pending the resolution of that appeal. The Company filed a notice of appeal on March 24, 2017. The appeal is currently pending.
3. INVENTORIES
Inventories consisted of the following (amounts in thousands):
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December 31, 2016
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January 2, 2016
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Finished goods
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$
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8,077
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$
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7,446
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Work in process
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1,433
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1,459
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Raw materials and supplies
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11,135
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10,741
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$
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20,645
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$
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19,646
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If inventories valued on the LIFO basis were valued at current costs, inventories would be higher by $5,731,000 and $5,748,000 at December 31, 2016 and January 2, 2016, respectively.
4. GOODWILL AND AMORTIZABLE INTANGIBLE ASSETS
As of December 31, 2016 the Company has recorded $7,229,000 of goodwill consisting of $6,229,000 related to the CACS segment and $1,000,000 related to the Door segment. The Company assesses goodwill for potential impairment at the end of each year. For the CACS segment, the Company engages the services of an investment banking firm to assist management in determining the fair value of the reporting unit. For the Door segment, the Company prepares a discounted cash flow analysis to estimate the fair value of the reporting unit. In addition, if events occur or circumstances change in the relevant reporting segments or in their industries the Company will then reassess the recorded goodwill to determine if impairment has occurred. No goodwill impairment was recognized for any of the periods presented. The valuation of goodwill and other intangibles is considered a significant estimate. Future economic conditions could negatively impact the value of the business which could trigger an impairment that would materially impact earnings.
There were no changes in recorded goodwill for either of the years ended December 31, 2016 or January 2, 2016.
Identifiable intangible assets consist of the following (amounts in thousands):
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December 31, 2016
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January 2, 2016
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Gross
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Gross
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carrying
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Accumulated
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carrying
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Accumulated
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amount
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amortization
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amount
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amortization
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Amortized intangible assets:
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Restrictive land covenant
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$
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350
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$
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350
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$
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350
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$
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332
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Customer relationships
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370
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370
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370
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367
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$
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720
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$
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720
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$
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720
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$
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699
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Amortization expense of intangible assets was $21,000 for 2016 and $45,000 for 2015. All intangible assets are fully amortized as of December 31, 2016; therefore, future amortization expense is $0.
5. REVOLVING BANK LOAN
The Company entered into an Amended and Restated Credit Agreement (the “Credit Agreement”) effective November 18, 2011. The Company entered into the Fifth Amendment to Credit Agreement effective March 20, 2015 and the Sixth Amendment to Credit Agreement effective August 10, 2015. Effective March 24, 2016, the Company entered into the Seventh Amendment to Credit Agreement. The Company had previously entered into four separate amendments to the Credit Agreement. Cumulatively, the amendments were entered into by the Company to, among other things, (i) modify certain of the financial covenants, (ii) adjust the amount of the Revolving Commitment, (iii) terminate the Term Loan Commitment upon the repayment in full of the outstanding principal balance (and accrued interest thereon) of the Term Loan, (iv) modify the Borrowing Base calculation to provide for borrowing availability in respect of new Capital Expenditures, (v) decrease the interest rates on the Revolving Loans and (vi) extend the maturity date. Borrowings under the Credit Agreement are secured by the Company’s accounts receivable, inventories, machinery, equipment, vehicles, certain real estate and the common stock of all of the Company’s subsidiaries. Borrowings under the Credit Agreement bear interest based on a London Interbank Offered Rate (LIBOR) or prime rate based option.
The Credit Agreement either limits or requires prior approval by the lender of additional borrowings, acquisition of stock of other companies, purchase of treasury shares and payment of cash dividends. Payment of accrued interest is due monthly or at the end of the applicable LIBOR period.
The Credit Agreement as amended provides for the following:
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·
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The Revolving Commitment is $20,000,000.
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·
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Borrowings under the Revolving Commitment are limited to (a) 80% of eligible accounts receivable, (b) the lesser of 50% of eligible inventories and $8,500,000 plus (c) 80% of new Capital Expenditures not to exceed $5,500,000 with respect to each of Fiscal Years 2016 and 2017.
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·
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The Minimum Fixed Charge Coverage Ratio is not permitted to be below 1.15 to 1.0 for each trailing twelve month period measured at the end of each Fiscal Quarter.
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·
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The Company must not permit Tangible Net Worth as of the last day of any future Computation Period to be less than $31,000,000 (provided that the required amount of Tangible Net Worth shall increase (but not decrease) by an amount equal to 50% of the Consolidated Net Income for the immediately preceding Fiscal Year).
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·
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The Balance Sheet Leverage Ratio as of the last day of any Computation Period may not exceed 1.00 to 1.00.
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·
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The maturity date of the credit facility is May 1, 2018.
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·
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Interest rate pricing for the revolving credit facility is currently LIBOR plus 2.50% or the prime rate plus 0.25%.
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Definitions under the Credit Agreement as amended are as follows:
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·
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Tangible Net Worth is defined as net worth plus subordinated debt, minus intangible assets (goodwill, intellectual property, prepaid expenses, deposits and deferred charges), minus all obligations owed to the Company or any of its subsidiaries by any affiliate or any or its subsidiaries and minus all loans owed by its officers, stockholders, subsidiaries or employees.
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·
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Fixed Charge Coverage Ratio is defined as, for any computation period, the ratio of (a) the sum for such period of (i) EBITDA, as defined, minus (ii) the sum of income taxes paid in cash and all unfinanced capital expenditures to (b) the sum for such period of interest expense.
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·
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Balance Sheet Leverage Ratio is defined as the ratio of Total Debt to Tangible Net Worth.
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·
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EBITDA means for any Computation Period (or another time period to the extent expressly provided for in the Credit Agreement) the sum of the following with respect to the Company and its Subsidiaries each as determined in accordance with GAAP: (a) Consolidated Net Income, plus (b) federal, state and other income taxes deducted in the determination of Consolidated Net Income, plus (c) Interest Expense deducted in the determination of Consolidated Net Income, plus (d) depreciation, depletion and amortization expense deducted in the determination of Consolidated Net Income, plus (e) for 2014, charges directly related to the closing and reclamation of the Pueblo aggregates mining site, plus (f) any other non-cash charges and any extraordinary charges deducted in the determination of Consolidated Net Income, including any asset impairment charges (including write downs of goodwill), minus (g) any gains from Asset Dispositions, any extraordinary gains and any gains from discontinued operations included in the determination of Consolidated Net Income.
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Outstanding funded revolving debt was $2,000,000 as of December 31, 2016 compared to $6,200,000 as of January 2, 2016. The highest balance outstanding during 2016 and 2015 was $7,500,000 and $7,400,000 respectively. Average outstanding funded debt was $3,712,000 and $5,205,000 for 2016 and 2015, respectively. At December 31, 2016, the Company had outstanding letters of credit totaling $5,415,000. At all times since the inception of the Credit Agreement, the Company has had sufficient qualifying and eligible assets such that the available borrowing capacity exceeded the cash needs of the Company and this situation is expected to continue for the foreseeable future.
The Company believes that its existing cash balance, anticipated cash flow from operations and borrowings available under the Credit Agreement will be sufficient to cover expected cash needs, including planned capital expenditures, for the next twelve months except for the expenditures related to the acquisition of the necessary equipment needed to begin
mining an aggregates property near Colorado Springs should TMC succeed in obtaining the required mining permits from the State of Colorado and El Paso County. As of December 31, 2016 the Company has invested and capitalized approximately $2,884,000 of deferred development expenditures related to this aggregates property. The Company expects to arrange for term or mortgage financing to fund the acquisition of the necessary equipment needed to begin mining the property should the permits be granted. The Company expects to be in compliance with all debt covenants, as amended, throughout the facility’s remaining term.
6. COMMITMENTS AND CONTINGENCIES
The Company is involved in litigation matters related to its business, principally product liability matters related to the gas-fired heating products and fan coil products in the Heating and Cooling segment. In the Company’s opinion, none of these proceedings, when concluded, will have a material adverse effect on the Company’s consolidated results of operations, cash flows or financial condition as the Company has established adequate accruals for matters that are probable and estimable. The Company does not accrue estimated future legal costs related to the defense of these matters but rather expenses legal costs as incurred. Also see Note 2 for discussion of litigation regarding the Pueblo sand and gravel lease.
7. SHAREHOLDERS’ EQUITY
Four hundred thousand shares of preferred stock ($.50 par value) are authorized and unissued.
The Company purchased 2,000 shares and 1,000 shares of its common stock from a former employee to become treasury stock during fiscal 2016 and fiscal 2015, respectively. Under the 2010 Non-Employee Directors Stock Plan (the “Plan”) the Company reserved 150,000 treasury shares representing the maximum number of shares allowed to be granted to non-employee directors in lieu of the base director retainer fee. The Company issued a total of 12,000 shares to the eight eligible board members effective April 6, 2016 as full payment for their 2016 retainer fee. The Company issued a total of 12,000 shares to the eight eligible board members effective January 15, 2015 as full payment for their 2015 retainer fee.
8. EARNINGS PER SHARE
The Company does not have any common stock equivalents, warrants or other convertible securities outstanding, therefore there are no differences between the calculation of basic and diluted EPS for the fiscal years 2016 or 2015.
9. 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 $4,595,000 and $3,429,000 for 2016 and 2015, respectively.
Future minimum rental commitments under non-cancelable operating leases for 2017 and thereafter are as follows: 2017 – $1,842,000; 2018 – $1,436,000; 2019 – $803,000; 2020 – $659,000; 2021 – $572,000 and thereafter – $2,234,000. The commitments do not include any amounts related to minimum royalty payments due on an aggregates property lease in conjunction with the Pueblo, Colorado operation as discussed in Note 2. The commitments do include amounts expected to be reimbursed to the Company by related party tenants as discussed in Note 13. These related party amounts for 2017 and thereafter are as follows: 2017 - $166,000; 2018 – $169,000; 2019 – $171,000; 2020 – $174,000; 2021 – $177,000 and thereafter – $1,057,000.
10. RETIREMENT PLANS
As discussed in Note 1, the Company maintains defined contribution retirement benefit plans for eligible employees. Total plan expenses charged to continuing operations were $1,229,000 and $873,000 in 2016 and 2015, respectively.
11. CURRENT ECONOMIC CONDITIONS
Construction activity along the Southern Front Range of Colorado, around Colorado Springs, exhibited modest and thus far sustained improvement over the past two years. Construction activity in the Pueblo market has shown some improvement in the current year as well. Residential construction is expected to remain below prior, more robust periods, however commercial construction is improving. A new street tax passed in Colorado Springs is expected to spur some municipal projects over the next five years. Economic growth in Southern Colorado continues to lag behind the growth experienced in the Denver area. Although pricing improved in the CACS segment during 2016, bidding on jobs has been and is expected to remain highly competitive.
Further improvement in the CACS segment will require sustained improvement in the Colorado Springs and Pueblo construction markets and the ability to maintain or enhance ready-mix concrete prices especially in response to any increases in cement and/or fuel costs that may occur.
The markets for products manufactured or fabricated by the Heating and Cooling segment are expected to remain somewhat strong mainly due to anticipated continuation of construction spending in the lodging industry. The markets for the Evaporative Cooling and Door segments are expected to stay fairly constant. As has historically been the case, sales of all segments, other than the Door segment, are influenced by weather conditions.
12. INCOME TAXES
The provision for income taxes is summarized as follows (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
|
Federal: Current
|
|
$
|
613
|
|
$
|
(71)
|
|
|
Deferred
|
|
|
1,284
|
|
|
737
|
|
|
State: Current
|
|
|
2
|
|
|
2
|
|
|
Deferred
|
|
|
249
|
|
|
113
|
|
|
|
|
$
|
2,148
|
|
$
|
781
|
|
Note that the percentage effect of an item on the statutory tax rate in a given year will fluctuate based upon the magnitude of the pre-tax profit or loss in that year. The difference between the tax rate on income for financial statement purposes and the federal statutory tax rate was as follows:
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
|
Statutory tax rate
|
|
34.0
|
%
|
34.0
|
%
|
|
Percentage depletion
|
|
(1.8)
|
|
(4.0)
|
|
|
Non-deductible expenses
|
|
1.0
|
|
2.0
|
|
|
Valuation allowance for tax assets
|
|
1.0
|
|
(4.9)
|
|
|
State income taxes, net of federal benefit
|
|
4.2
|
|
5.7
|
|
|
Expiring charitable contributions
|
|
—
|
|
2.6
|
|
|
Domestic production deduction
|
|
(0.8)
|
|
—
|
|
|
Other
|
|
(0.8)
|
|
0.2
|
|
|
|
|
36.8
|
%
|
35.6
|
%
|
For financial statement purposes, deferred tax assets and liabilities are recorded at a blend of the current statutory federal and states’ tax rates – 37.96%. The principal temporary differences and their related deferred taxes are as follows (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
|
Deferred tax assets
|
|
|
|
|
|
|
|
|
Reserves for self-insured losses
|
|
$
|
579
|
|
$
|
605
|
|
|
Accrued reclamation
|
|
|
1,945
|
|
|
2,154
|
|
|
Unfunded supplemental profit sharing plan liability
|
|
|
351
|
|
|
379
|
|
|
Asset valuation reserves
|
|
|
267
|
|
|
317
|
|
|
Future state tax credits
|
|
|
789
|
|
|
789
|
|
|
Net state operating loss carryforwards
|
|
|
167
|
|
|
252
|
|
|
Federal AMT carryforward
|
|
|
620
|
|
|
481
|
|
|
Federal NOL carryforward
|
|
|
—
|
|
|
16
|
|
|
Other
|
|
|
873
|
|
|
746
|
|
|
|
|
|
5,591
|
|
|
5,739
|
|
|
Deferred tax liabilities
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
1,013
|
|
|
841
|
|
|
Deferred development
|
|
|
1,057
|
|
|
563
|
|
|
Prepaid royalties
|
|
|
1,187
|
|
|
478
|
|
|
Other
|
|
|
588
|
|
|
635
|
|
|
|
|
|
3,845
|
|
|
2,517
|
|
|
Net deferred tax asset before valuation allowance
|
|
|
1,746
|
|
|
3,222
|
|
|
Valuation allowance
|
|
|
|
|
|
|
|
|
Beginning balance
|
|
|
(73)
|
|
|
(180)
|
|
|
(Increase) decrease during the period
|
|
|
(57)
|
|
|
107
|
|
|
Ending Balance
|
|
|
(130)
|
|
|
(73)
|
|
|
Net deferred tax asset
|
|
$
|
1,616
|
|
$
|
3,149
|
|
At December 31, 2016 the Company carries a valuation reserve of $79,000 ($30,000 tax effected) related to the carry forward of charitable contribution deductions arising in prior years due to the uncertainty that the Company will be able to utilize these deductions prior to the expiration of their carry forward periods. For Federal purposes, Alternative Minimum Tax credits can be carried forward indefinitely. For State purposes, Net Operating Losses can be carried forward for periods ranging from 5 to 20 years for the states that the Company is required to file in. Of the $789,000 of recorded state tax credits, $760,000 relates to California Enterprise Zone hiring credits earned in prior years. California repealed the credit and limited its use to tax years through 2023. The Company established a valuation reserve of $152,000 ( $100,000 tax effected) at the end of the current year related to the carryforward of the California Enterprise Zone hiring credits due to the uncertainty that the Company will be able to utilize the credits prior to their expiration in 2023.
The realization of the deferred tax assets is subject to our ability to generate sufficient taxable income during the periods in which the temporary differences become realizable. In evaluating whether a valuation allowance is required, we consider all available positive and negative evidence, including prior operating results, the nature and reason of any losses, our forecast of future taxable income and the dates on which any deferred tax assets are expected to expire. These assumptions require a significant amount of judgment, including estimates of future taxable income. The estimates are based on our best judgment at the time made based on current and projected circumstances and conditions.
As a result of the evaluation of the realizability of our deferred tax assets as of December 31, 2016, we concluded that it was more likely than not that all of our deferred tax assets would be realized to the extent not reserved for by a valuation allowance.
The Company accounts for uncertainty in income taxes recognized in its financial statements by applying GAAP’s recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The financial statement effects of a tax position are initially
recognized when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. A tax position that meets the more-likely-than-not recognition threshold should initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon effective settlement with a taxing authority. There was no gross amount of unrecognized tax benefits at either December 31, 2016 or January 2, 2016.
We file income tax returns in the United States Federal and various state jurisdictions. Federal tax years 2013 and on remain subject to examination. Various state income tax returns also remain subject to examination.
13. RELATED PARTY TRANSACTIONS
A director of the Company is a partner in a law firm engaged to represent the Company in various legal matters including the lawsuit filed by the Company related to the sand and gravel lease discussed in Note 2. For the year ending December 31, 2016 the Company has paid the director’s firm $522,000 for services rendered. During fiscal 2015 the same director’s firm was paid $494,000.
The corporate office leases space in Chicago, Illinois that is shared with three organizations related to the Company’s principal shareholders. Each of the organizations pays its pro-rata share of rent and other expenses based on a square footage allocation. See Note 9 for additional discussion. Furthermore, the Company purchases insurance coverage for workers’ compensation, general and umbrella liability together with another company controlled by the Company’s principal shareholders to minimize insurance costs. 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. Amounts receivable from these organizations at December 31, 2016 and January 2, 2016 were $213,000 and $89,000, respectively.
14. UNAUDITED QUARTERLY FINANCIAL DATA
The following table and footnotes provide summarized unaudited fiscal quarterly financial data for 2016 and 2015 (amounts in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
Second
|
|
Third
|
|
Fourth
|
|
|
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
34,228
|
|
$
|
42,721
|
|
$
|
37,647
|
|
$
|
36,996
|
|
|
Gross profit
|
|
|
7,019
|
|
|
9,640
|
|
|
8,038
|
|
|
6,734
|
|
|
Depreciation, depletion and amortization
|
|
|
639
|
|
|
651
|
|
|
607
|
|
|
539
|
|
|
Net income
|
|
|
508
|
|
|
1,801
|
|
|
1,042
|
|
|
335
|
|
|
Basic and Diluted income per share
|
|
|
0.31
|
|
|
1.08
|
|
|
0.62
|
|
|
0.20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
Second
|
|
Third
|
|
Fourth
|
|
|
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
30,685
|
|
$
|
34,865
|
|
$
|
36,165
|
|
$
|
35,120
|
|
|
Gross profit
|
|
|
5,498
|
|
|
6,689
|
|
|
6,908
|
|
|
6,483
|
|
|
Depreciation, depletion and amortization
|
|
|
646
|
|
|
651
|
|
|
640
|
|
|
484
|
|
|
Net (loss) income
|
|
|
(196)
|
|
|
346
|
|
|
562
|
|
|
701
|
|
|
Basic and Diluted (loss) income per share
|
|
|
(0.12)
|
|
|
0.21
|
|
|
0.34
|
|
|
0.42
|
|
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.
15. INDUSTRY SEGMENT INFORMATIO
N
The Company operates primarily in two industry groups, HVAC and Construction Products. The Company has identified two reportable segments in each of the two industry groups: the Heating and Cooling segment and the Evaporative
Cooling segment in the HVAC industry group and the CACS segment and the Door segment in the Construction Products industry group. The Heating and Cooling segment primarily produces and sells gas-fired wall furnaces, console heaters and fan coils from the Company’s wholly-owned subsidiary, WFC of Colton, California. The Evaporative Cooling segment primarily produces and sells evaporative coolers from the Company’s wholly-owned subsidiary, PMI of Phoenix, Arizona. Sales of these two segments are nationwide, but are concentrated in the southwestern United States. Concrete, aggregates and construction supplies are offered by the CACS segment from numerous locations along the Southern portion of the Front Range of Colorado operated by the Company’s wholly-owned subsidiaries collectively referred to as TMC. The Door segment sells hollow metal and wood doors, door frames and related hardwares, lavatory fixtures and electronic access and security systems from the Company’s wholly-owned subsidiary, MDHI, which operates out of facilities in Pueblo and Colorado Springs, Colorado. Sales of these latter two segments are highly concentrated in the Southern Front Range area in Colorado although door sales are also made throughout the United States.
The Company evaluates the performance of its segments and allocates resources to them based on a number of criteria including operating income, return on investment and other strategic objectives. Operating income is determined by deducting operating expenses from all revenues. In computing operating income, none of the following has been added or deducted: unallocated corporate expenses, interest, other income or loss or income taxes.
In addition to the above reporting segments, an “Unallocated Corporate” classification is used to report the unallocated expenses of the corporate office which provides treasury, insurance and tax services as well as strategic business planning and general management services. Expenses related to the corporate information technology group are allocated to all locations, including the corporate office.
The following table presents information about reported segments for the fiscal years 2016 and 2015 along with the items necessary to reconcile the segment information to the totals reported in the financial statements (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Construction Products Industry
|
|
HVAC Industry
|
|
|
|
|
|
|
|
|
Concrete,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Aggregates &
|
|
|
|
Combined
|
|
Heating
|
|
|
|
|
|
Unallocated
|
|
|
|
|
|
|
Construction
|
|
|
|
Construction
|
|
and
|
|
Evaporative
|
|
Combined
|
|
Corporate
|
|
|
|
|
|
|
Supplies
|
|
Doors
|
|
Products
|
|
Cooling
|
|
Cooling
|
|
HVAC
|
|
(a)
|
|
Total
|
|
|
Year Ended December 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from external customers
|
|
$
|
67,091
|
|
$
|
16,990
|
|
$
|
84,081
|
|
$
|
41,853
|
|
$
|
25,642
|
|
$
|
67,495
|
|
$
|
16
|
|
$
|
151,592
|
|
|
Depreciation, depletion and amortization
|
|
|
1,340
|
|
|
134
|
|
|
1,474
|
|
|
526
|
|
|
413
|
|
|
939
|
|
|
23
|
|
|
2,436
|
|
|
Operating income (loss)
|
|
|
3,433
|
|
|
1,563
|
|
|
4,996
|
|
|
3,046
|
|
|
1,413
|
|
|
4,459
|
|
|
(3,614)
|
|
|
5,841
|
|
|
Segment assets
|
|
|
33,518
|
|
|
6,173
|
|
|
39,691
|
|
|
22,381
|
|
|
12,283
|
|
|
34,664
|
|
|
3,653
|
|
|
78,008
|
|
|
Capital expenditures
|
|
|
3,296
|
|
|
110
|
|
|
3,406
|
|
|
655
|
|
|
182
|
|
|
837
|
|
|
162
|
|
|
4,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Construction Products Industry
|
|
HVAC Industry
|
|
|
|
|
|
|
|
|
Concrete,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Aggregates &
|
|
|
|
Combined
|
|
Heating
|
|
|
|
|
|
Unallocated
|
|
|
|
|
|
|
Construction
|
|
|
|
Construction
|
|
and
|
|
Evaporative
|
|
Combined
|
|
Corporate
|
|
|
|
|
|
|
Supplies
|
|
Doors
|
|
Products
|
|
Cooling
|
|
Cooling
|
|
HVAC
|
|
(a)
|
|
Total
|
|
|
Year Ended January 2, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from external customers
|
|
$
|
55,319
|
|
$
|
16,981
|
|
$
|
72,300
|
|
$
|
39,498
|
|
$
|
25,022
|
|
$
|
64,520
|
|
$
|
15
|
|
$
|
136,835
|
|
|
Depreciation, depletion and amortization
|
|
|
1,364
|
|
|
128
|
|
|
1,492
|
|
|
504
|
|
|
399
|
|
|
903
|
|
|
26
|
|
|
2,421
|
|
|
Operating (loss) income
|
|
|
(256)
|
|
|
1,280
|
|
|
1,024
|
|
|
3,371
|
|
|
1,135
|
|
|
4,506
|
|
|
(3,014)
|
|
|
2,516
|
|
|
Segment assets
|
|
|
31,791
|
|
|
6,471
|
|
|
38,262
|
|
|
22,628
|
|
|
12,730
|
|
|
35,358
|
|
|
2,135
|
|
|
75,755
|
|
|
Capital expenditures
|
|
|
1,539
|
|
|
31
|
|
|
1,570
|
|
|
494
|
|
|
239
|
|
|
733
|
|
|
—
|
|
|
2,303
|
|
|
|
(a)
|
|
Includes unallocated corporate office expenses and assets which consist primarily of cash and cash equivalents, prepaid expenses, property, plant and equipment.
|
There are no differences in the basis of segmentation or in the basis of measurement of segment profit or loss from the last annual report.