Notes to Consolidated Financial Statements
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 experienced various changes in 2019 with the sale of substantially all assets of its ready-mix concrete and Daniels Sand operations in the first quarter of 2019, the acquisition of four new operating businesses in the second quarter of 2019 and the cessation of mining at Pikeview quarry in the third quarter of 2019. In conjunction with this activity, management reviewed its operating and reporting structure and made adjustments to align the structure with how operations will be measured and evaluated going forward including revisions to the Company’s reporting segments. Segment information for prior periods has been reclassified to conform to current segment reporting structure. The Company operates primarily in the Building Products industry group. Within this industry group the Company has identified three reportable segments: the HVAC segment, the Door segment and the Construction Materials segment.
The HVAC segment produces and sells a variety of products including wall furnaces, fan coils, evaporative coolers, boiler room equipment and dryer boxes and related accessories from the Company’s wholly-owned subsidiaries, Williams Furnace Co. (WFC) of Colton, California, Phoenix Manufacturing, Inc. (PMI) of Phoenix, Arizona, Global Flow Products /American HVAC (GFP) of Broken Arrow, Oklahoma, and InOvate Dryer Technologies (InOvate) of Jupiter, Florida. Sales of this segment are nationwide although WFC and PMI sales are more concentrated in the southwestern United States. The Door segment sells hollow metal and wood doors, door frames and related hardware, sliding door systems and electronic access and security systems from the Company’s wholly-owned subsidiaries: McKinney Door and Hardware, Inc. (MDHI), Fastrac Building Supply (Fastrac) and Serenity Sliding Door Systems (Serenity), which operate out of facilities in Pueblo and Colorado Springs, Colorado. Sales of this segment are concentrated in Colorado, California and the Northwestern United States although door sales are also made throughout the United States. The Construction Materials segment offers construction supplies from locations along the Southern Front Range of Colorado operated by the Company’s wholly-owned subsidiaries, Castle Aggregates and Castle Rebar & Supply of Colorado Springs, and TMOP Legacy Company (formerly Transit Mix of Pueblo, Inc.) of Pueblo, Colorado (the three companies collectively are referred to as the Castle Companies).
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. Intercompany transactions and balances have been eliminated. All subsidiaries of the Company are wholly-owned.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350), which removed the requirement to compare the implied fair value of goodwill with its carrying amount as part of Step 2 of the goodwill impairment test. As a result, under the ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying value and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. However, the impairment loss should not exceed the total amount of goodwill allocated to that reporting unit. The pronouncement was adopted by the Company in the fourth quarter of 2017 in connection with annual impairment testing. No impairment charges resulted from our impairment testing.
Effective December 31, 2017 (the beginning of fiscal 2018), the Company adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606) and related amendments, which created a single source of
revenue guidance for all companies in all industries and is more principles-based than previous revenue guidance. The Company adopted the standard using the modified retrospective approach. The adoption of this standard did not result in significant changes to the Company’s accounting policies, business processes, systems or controls, or have a material impact on its financial position, consolidated results of operations or consolidated cash flows. As such, prior period financial statements were not recast and there was no cumulative effect adjustment upon adoption.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230), requiring that the statement of cash flows explain the change in total cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. This standard was adopted by the Company in the first quarter of 2018 and did not have a material impact to the consolidated statement of cash flows.
Effective December 30, 2018 (the beginning of fiscal 2019) the Company adopted ASU No. 2016-02, Leases (Topic 842), which superseded Topic 840, “Leases”. As allowed under the new accounting standard, the Company elected to apply practical expedients to carry forward the original lease determinations, lease classifications and accounting of initial direct costs for all asset classes at the time of adoption. The Company also elected not to separate lease components from non-lease components for asset categories, except office space, and to exclude short-term leases from its Consolidated Balance Sheet. For the office space lease category the election was made to report lease and non-lease components separately as the non-lease components are billed and paid separately and are not a fixed amount over the lease term. The implicit discount rate of leases is used to calculate present values when available. When an implicit discount rate is not readily available an incremental borrowing rate is used to calculate present values.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with Generally Accepted Accounting Principles (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 28, 2019 and December 29, 2018 and the reported amounts of revenues and expenses during both of the two fiscal years in the period ended December 28, 2019. 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.
Revolving Bank Loan Payable: 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 the Revolving Bank Loan Payable 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.
Lease liabilities: 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 the Lease liabilities represents a reasonable estimate of the corresponding fair value and was valued as Level 2.
Phantom equity and phantom equity appreciation liability awards: Fair value is estimated based on the use of a Black-Scholes option pricing model based on publicly available inputs. The carrying amount of the liability represents a reasonable estimate of the vested portion of the corresponding fair value of the awards granted and was valued as Level 3.
Contingent consideration: Fair value is estimated based on the use of a Monte Carlo Simulation model based on significant inputs that are not observable in the market, which are considered Level 3 inputs in accordance with ASC Topic 820.
ARO liability: Fair value is estimated using an expected present value technique using estimated cash flows over a period of time and then discounting the expected cash flows using a credit-adjusted risk-free interest rate using significant inputs that are not observable in the market, which are considered Level 3 inputs in accordance with ASC Topic 820.
ARO for asset impairment: Fair value is estimated using an expected present value technique using estimated cash flows over a period of time and then discounting the expected cash flows using a credit-adjusted risk-free interest rate using significant inputs that are not observable in the market, which are considered Level 3 inputs in accordance with ASC Topic 820.
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 net realizable value and are reviewed periodically for excess or obsolete stock with a provision recorded, where appropriate. Cost for certain inventory at WFC and PMI is determined using the last-in, first-out (LIFO) method. These inventories represent approximately 71% of total inventories at December 28, 2019 and 65% at December 29, 2018. 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 and steel have experienced significant fluctuations in recent years which is principally relevant to the four 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. Due to the nature of our products, obsolescence is not typically a significant exposure, however certain HVAC businesses will from time to time contend with some slow-moving inventories or parts that are no longer used due to engineering changes. At December 28, 2019 and December 29, 2018, inventory reserves were approximately 6.8% 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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The cost of property sold or retired and the related accumulated depreciation 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 accordance with ASU 2017-04, the fair value of each reporting unit is compared to its carrying value. Impairment expense would be recognized, limited to the value of the reporting unit’s goodwill, should carrying value exceed fair value. In addition to annual assessment, 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.
The Company had previously paid $2,500,000 related to an aggregate property near Colorado Springs. During fiscal year 2019, the Company decided to cease negotiations with the State of Colorado to obtain mining permits for the property. The amount, less $325,000 that was not expected to be recovered, was included in other current assets as of December 28, 2019.
Intangible assets with definite lives include trade names, intellectual property, and customer relationships. These intangible assets are amortized on a straight-line basis over their estimated useful lives. Amortizable intangible assets are tested for impairment whenever events or changes in circumstances indicate that the carrying value may be greater than the fair value.
RETIREMENT PLANS
The Company and its subsidiaries have a contributory profit sharing retirement plan for specific employees. The plan allows 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 was 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 are eligible to participate in an unfunded Deferred Compensation Plan. This plan accrues an amount equal to the difference between the amount the person would have received as Company contributions to his/her account under the 401(k) plan had there been no limitations and the amount the person would receive under the 401(k) plan giving effect to the limitations. Costs under the plans are charged to operations as incurred. As of December 28, 2019 and December 29, 2018, the unfunded liabilities related to the Deferred Compensation Plan were $1,250,000 and $1,001,000 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 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 28, 2019 and December 29, 2018 was $911,000 and $874,000, respectively.
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 had recorded asset retirement obligations (ARO) and offsetting assets 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 properties. The assessment of the reclamation liability may be done more frequently if events or circumstances arise that may indicate a change in estimated costs. The Company has engaged an independent specialist to assist in evaluating the estimates of the cost of reclamation. Prior to the current fiscal year, the reclamation of mining properties was performed concurrently with mining or soon after each section of the deposit was mined. In the current year, in connection with the decision to cease mining operations at its Pikeview quarry and purchase of formerly leased mining property in Pueblo, the Company was able to reasonably estimate the cost of final reclamation of these properties and has recorded ARO liabilities of $27,913,000 at December 28, 2019. Reclamation liabilities were estimated at $6,269,000 as of December 29, 2018. The Company classifies a portion of the reserve as a current liability, specifically $4,200,000 at December 28, 2019 and $1,017,000 at December 29, 2018 based upon anticipated reclamation timeframe. See Note 2 for discussion of acquisition of Pueblo property and Note 20 for additional discussion of AROs.
TREASURY STOCK
Treasury stock is valued at the aggregated average cost that the Company paid for each transaction.
REVENUE RECOGNITION
Effective December 31, 2017, the Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606) and related amendments, which creates a single source of revenue guidance for all companies in all industries and is more principles-based than previous revenue guidance. The Company adopted the standard using the modified retrospective approach. The adoption of this standard did not result in significant changes to the Company’s accounting policies, business processes, systems or controls, or have a material impact on its financial position, consolidated results of operations or consolidated cash flows. As such, prior period financial statements were not recast and there was no cumulative effect adjustment upon adoption.
The Company is applying Topic 606 to the customer contracts in each industry segment to provide assurance of compliance. Using the five-step model the customer contracts in each segment were evaluated on critical aspects of how revenue is reported and recognized in the financial statements i.e. 1) Identify the contract(s) with the customer; 2) Identify the performance obligations; 3) Determine the transaction price; 4) Allocate the transaction price to the performance obligations; and 5) Recognize revenue as each performance obligation is satisfied. In applying the model to each reporting segment level, the Company is using a portfolio approach which is acceptable because the contracts within each segment are similar with respect to contract attributes, performance obligations, and revenue recognition.
Sales are recognized when control of the promised goods or services transfers to the Company’s customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The
Company’s payment terms generally range between 30 to 90 days after invoice is billed to the customer. Sales are reported net of sales tax. Shipping and other transportation costs paid by the Company and rebilled to the buyer are recorded gross (as both sales and cost of sales). The Company generally recognizes revenue from the sale of products at the time the products are shipped.
While the return of products is generally not allowed, some large customers have been granted the right to return a certain amount at the end of the normal selling season for seasonal products. Sales returns and allowances are estimated based on current program terms and historical experience. Provisions for estimated returns, discounts, volume rebates and other price adjustments are provided for in the same period the related revenues are recognized and are netted against revenues.
The Company is responsible for warranties related to the manufacture of its HVAC products and estimates the future warranty claims based upon historical experience and management estimates. The Company reviews warranty and related claims activities and records provisions, as necessary. Changes in the aggregated product warranty liability for the fiscal years 2019 and 2018 were as follows (amounts in thousands):
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2019
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2018
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Beginning balance
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$
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104
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$
|
132
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Warranty related expenditures
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(148)
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(148)
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Warranty expense accrued
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120
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|
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120
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Ending balance
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$
|
76
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$
|
104
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|
The majority of sales within the Door division do not include extended installation components. Most of the sales of MDHI that contain installation are completed within 30 days and contain two specific components, the product and the installation service. The transaction price for these contracts is allocated to each performance obligation based on its stated stand-alone price. Revenue is recognized at a point in time as each performance obligation is completed. The Company does not offer maintenance or service contracts. The acquisition of Fastrac and Serenity in mid-2019 expanded the type of contracts that require analysis under Topic 606 guidelines as these operations may include extended installation services within the contracts. The company negotiates the terms of the contract and prepares a detailed project quote that might include number and type of doors, number and style of hardware, locks, electronic items and estimated installation cost. Contract price for each item of the quote is negotiated and stated in the contract. Modifications are treated as adjustments to an existing contract and are part of the changes in billing invoices. Revenue is recognized as performance obligations, per the contract agreement, are completed. Revenue for product is recognized as shipped. Revenue for installation services is recognized on a percentage of completion method with costs in excess of billings and/or billings in excess of costs being recorded as an asset or liability until recognized. Costs in excess of billings, of approximately $420,000, are included in Prepaid expenses and retainage on contracts of approximately $345,000 is included in Receivables on the Consolidated Balance Sheet as of December 28, 2019.
SHARE-BASED COMPENSATION
Share-based compensation expense is recognized using the fair value method of accounting. Share-based awards are recognized ratably over the requisite service period.
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 2017 Tax Cuts and Jobs Act (Tax Act) repealed the corporate alternative minimum tax (AMT) and allows for all existing credit carryforwards to be used to offset regular tax liability for tax years beginning after December 31, 2017.
Additionally, for tax years 2018, 2019 and 2020, to the extent that the AMT credit carryover exceeds the regular tax liability, 50% of the excess AMT credit is refundable. Any remaining credits will be fully refundable in 2021. For state tax purposes, net operating losses can be carried forward for various periods 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. The Company has established a valuation reserve related to a portion of the California Enterprise Zone credit not expected to be utilized prior to expiration.
The Company’s 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. The Company did not identify any such uncertain tax positions as of December 28, 2019 or December 29, 2018.
CONCENTRATIONS
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of trade receivables and temporary cash investments. The Company did not have any temporary cash investments in either fiscal 2019 or 2018.
The Company performs ongoing credit evaluations of its customers and generally does not require collateral. In some Door segment and HVAC segment (as it relates to the fan coil product line) transactions, 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 2019 or 2018. One customer in the HVAC segment accounted for 15.9% and 16.1% of consolidated accounts receivable at December 28, 2019 and at December 29, 2018, respectively.
Substantially all of the HVAC 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, 2022. The Company considers relations with its employees and with their union to be good.
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 fair value is required. In the fiscal quarters ended March 31, 2018 and June 30, 2018 the Company wrote off a total of $6,840,000 of deferred development related to a granite mining property south of Colorado Springs. See Note 16 for additional discussion.
In the third quarter of 2019 the Company made a strategic decision to cease mining operations at its Pikeview quarry in Colorado Springs, Colorado as it was no longer in the best economic interest of the consolidated portfolio to continue operations. The Company recorded an ARO liability and offsetting asset of $20,715,000 which represented the estimated fair value of the total reclamation costs. The related ARO asset was considered fully impaired as the total future estimated cash flows exceeded the carrying value. Therefore, the Company also recorded an impairment charge of $20,217,000 related to the asset. In the fourth quarter of 2019, the Pikeview ARO was increased by a $45,000 change in estimate. The related ARO asset was considered fully impaired due to the same reason noted in the third quarter of 2019. Additionally in the fourth quarter, the Company purchased formerly leased mining property in Pueblo, Colorado as part of a legal settlement. See Note 2. With no intention to resume mining of this property, the Company was able to reasonably estimate the cost of final reclamation and recorded an ARO liability and offsetting asset of $6,660,000 related to this property. The related mining asset was considered fully impaired as total estimated cash flows exceeded the
carrying value. Therefore, the Company recorded a net impairment charge, related to the Pueblo property, of $2,230,000 for the year ended December 28, 2019. See Note 20.
FISCAL YEAR END
The Company’s fiscal year-end is the Saturday nearest December 31. Fiscal 2019 and fiscal 2018 each consisted of 52 weeks.
2. CESSATION OF MINING AT LEASED PUEBLO GRAVEL SITE
Subsequent to the end of the third quarter, on October 9, 2019, the Company and Valco filed a Joint Notice of Settlement 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 Settlement stated that the parties had reached a settlement agreement resolving all claims. Trial had previously been scheduled for October 21, 2019. On October 16, 2019, the Company and Valco filed a Stipulated Motion for Dismissal with Prejudice which stated: the parties “agree that this matter, including all claims and counterclaims, dismissed with prejudice and without costs, each party to bear its own attorneys’ fees.” The Court entered the Order of Dismissal with Prejudice on October 16, 2019.
As part of the Settlement, the Company agreed to pay Valco $9,000,000, which included purchase of previously leased land. There is no intention to resume mining of the property that ceased several years prior when litigation began. As the litigation claim was a known event prior to the third quarter balance sheet date, the Company recognized the portion of the agreement related to the legal settlement in its financial statements for the period ended September 28, 2019. Since the asset purchase agreement was not a known event prior to the balance sheet date it was not recorded in the financial statements for the period ended September 28, 2019. The Company used its best estimate, based on currently available information, to record an estimated loss on litigation settlement of $6,400,000 for the third quarter of 2019. During the fourth quarter of 2019, a third-party appraisal of the property was obtained which valued the land at $2,200,000. Using this valuation, the Company recorded the property purchase in the fourth quarter and revised the loss on litigation settlement to $6,800,000 for the year-ended December 28, 2019. See Note 20 for discussion of asset retirement obligation and related asset impairment related to the purchased property.
3. INVENTORIES
Inventories consisted of the following (amounts in thousands):
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December 28, 2019
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December 29, 2018
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Finished goods
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$
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6,419
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$
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5,448
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Work in process
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1,061
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|
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1,365
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|
Raw materials and supplies
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6,473
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|
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7,993
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$
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13,953
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$
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14,806
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If inventories valued on the LIFO basis were valued at current costs, inventories would be higher by $6,618,000 and $7,176,000 at December 28, 2019 and December 29, 2018, respectively. Reductions in inventories during 2018 resulted in liquidations of LIFO quantities by charging cost of goods sold with LIFO costs significantly below current costs. By matching these older costs with current revenues, 2018 net loss decreased by approximately $968,000, net of tax. There was not a similar significant reduction in inventory levels in 2019.
Inventory valuation reserves at December 28, 2019 and December 29, 2018 were $1,023,000 and $1,747,000, respectively. The decrease between years is due to progress made in streamlining products sold reducing the risk of excess and obsolete inventory.
4. GOODWILL AND AMORTIZABLE INTANGIBLE ASSETS
As of December 29, 2018 the Company had recorded $1,000,000 of goodwill, not including discontinued operations goodwill of $6,229,000 that was eliminated with the sale of the ready-mix and Daniels Sand operations, related to the Door segment. During the second quarter of 2019, the Company recorded approximately $4,932,000 of goodwill related to the acquisitions of four operating businesses. See Note 18. As of December 28, 2019, the Company has recorded $5,932,000 of goodwill comprised of $3,198,000 or 54% related to the Door segment and $2,734,000 or 46% related to the HVAC segment. The Company assesses goodwill for potential impairment at the end of each year. The Company prepared a discounted cash flow analysis, based on a third party valuation of the Company’s operating units, to estimate the fair value of each reporting unit. The fair value was compared to the carrying value for each reporting unit. There was no goodwill impairment recorded, for any of the periods reported, as fair value exceeded carrying cost for each unit. If events occur or circumstances change in the relevant reporting segments or in their industries, the Company will reassess the recorded goodwill to determine if impairment has occurred. 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.
Intangible assets with definite lives include trade names, intellectual property, and customer relationships. These intangible assets are amortized on a straight-line basis over their estimated useful lives. Amortizable intangible assets are tested for impairment whenever events or changes in circumstances indicate that the carrying value may be greater than the fair value. There were no amortizable intangible assets as of December 29, 2018. See Note 18 for additional discussion of intangible assets acquired during the current fiscal year. Amortizable intangible assets on the Consolidated Balance Sheet as of December 28, 2019 were as follows (amounts in thousands):
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Gross
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Carrying
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Accumulated
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Amount
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Amortization
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Useful Life
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Trade names
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$
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3,590
|
|
|
119
|
|
|
15 years
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|
Intellectual property
|
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|
1,449
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|
|
102
|
|
|
11.5 and 12.5 years
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Customer related intangible
|
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7,769
|
|
|
150
|
|
|
10.5 and 30.5 years
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|
|
|
$
|
12,808
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|
$
|
371
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|
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Amortization Expense for the fiscal year ended December 28, 2019 was $371,000. The estimated amortization expense for each of the next five years is $664,000.
5. REVOLVING BANK LOAN
The Company entered into an Amended and Restated Credit Agreement (the “Credit Agreement”) effective March 16 2020. 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) 85% of eligible accounts receivable, (b) the lesser of 60% of eligible inventories and $8,500,000.
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·
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Financial Covenants include:
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o
|
|
Minimum EBITDA for the three months ending March 31, 2020 must exceed $(525,000)
|
|
|
o
|
|
Minimum EBITDA for the three months ending June 30, 2020 must exceed $265,000
|
|
|
o
|
|
The Minimum Fixed Charge Coverage Ratio is not permitted to be below 1.06 to 1.0 for each computation period measured at the end of each fiscal quarter, provided that the Fixed Charge Coverage Ratio shall not be tested if the average daily Excess Availability during the Fiscal Quarter exceeds $5,000,000. A computation period is the nine months ending September 30, 2020 or twelve months for all subsequent fiscal quarters.
|
|
|
·
|
|
The maturity date of the credit facility is May 1, 2023.
|
|
|
·
|
|
Interest rate pricing for the revolving credit facility is currently LIBOR plus 2.0% or the prime rate.
|
Definitions under the Credit Agreement as amended are as follows:
|
|
·
|
|
Fixed Charge Coverage Ratio means, for any Computation Period, the ratio of (a) the sum (without duplication) for such period of (i) EBITDA, minus (ii) income taxes paid in cash by the Loan Parties, minus (iii) all unfinanced Capital Expenditures, minus (iv) all amounts paid in cash in respect of any Permitted Capital Securities Repurchase, to (b) the sum for such period of (i) cash Interest Expense, plus (ii) scheduled payments of principal of Funded Debt (excluding the Revolving Loans), plus (iii) cash payments made in respect of Capital Leases, plus (iv) the amount by which reclamation or similar costs paid in such period exceed the cash proceeds received from the sale of quarry assets and cash refunds of escrow balances; provided, however that for purposes hereof, to the extent during any period there are excess cash proceeds from the sale of quarry assets after netting such proceeds against the reclamation or similar costs in such period, such excess cash proceeds may be carried forward and netted against the reclamation or similar costs in a later period, plus (v) all amounts paid in respect of any earnout or other deferred payment in connection with any Permitted Acquisition.
|
|
|
·
|
|
EBITDA means, for any Computation Period (or another time period to the extent expressly provided herein), the sum of the following with respect to the Company and its Subsidiaries each as determined in accordance with GAAP:
|
|
|
·
|
|
Consolidated Net Income, plus (without duplication) each of the following items to the extent deducted in determining such Consolidated Net Income:
|
|
|
i.
|
|
federal, state and other income taxes deducted in the determination of Consolidated Net Income;
|
|
|
ii.
|
|
Interest Expense deducted in the determination of Consolidated Net Income;
|
|
|
iii.
|
|
depreciation, depletion and amortization expense deducted in the determination of Consolidated Net Income;
|
|
|
iv.
|
|
non-recurring fees and costs paid by the Company and its Subsidiaries in respect of the following: (i) fees, expenses (including legal fees and expenses) and due diligence costs associated with Permitted Acquisitions, whether or not consummated; (ii) legal fees and costs associated with the Valco trial preparation; (iii) fees, costs and expenses (including legal fees and expenses) in connection with the amendment and restatement of this agreement and all matters reasonably related thereto; (iv) fees, costs and expenses (including legal fees and expenses) in connection with the purchase of Capital Securities of the Company by Bee Street Holdings LLC or a Subsidiary thereof and transactions and other matters reasonably related thereto; (v) additional fees and costs associated with the exploration of the Hitch Rack Ranch facility in Colorado Springs, Colorado to determine the sustainability for mining and the pursuit of mining permits; and (vi) fees, costs and expenses in connection with reclamation or similar transactions related to the sale of quarry assets;
|
|
|
v.
|
|
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); and
|
|
|
vi.
|
|
the amount of any earnout or other deferred payment paid in connection with any Permitted Acquisition; minus
|
|
|
·
|
|
any gains from Asset Dispositions, any extraordinary gains and any gains from discontinued operations included in the determination of Consolidated Net Income
|
Outstanding funded revolving debt was $800,000 as of December 28, 2019 compared to $2,200,000 as of December 29, 2018. The highest balance outstanding during 2019 and 2018 was $3,700,000 and $9,800,000 respectively. Average outstanding funded debt was $313,000 and $6,058,000 for 2019 and 2018, respectively. At
December 28, 2019, the Company had outstanding letters of credit (LOC) totaling $5,620,000. At all times since the inception of the Credit Agreement, the Company has had sufficient qualifying and eligible assets such that the available borrowing capacity exceeded the cash needs of the Company and this situation is expected to continue for the foreseeable future. The Company was not in compliance with the Fixed Coverage Charge Ratio as of December 28, 2019. The lender provided a waiver of the covenant violation for the period ended December 28, 2019.
The Company believes that its existing cash balance, anticipated cash flow from operations and borrowings available under the Credit Agreement will be sufficient to cover expected cash needs, including planned capital expenditures, for the next twelve months. The Company expects to be in compliance with all debt covenants, as amended, throughout the facility’s remaining term.
6. COMMITMENTS AND CONTINGENCIES
The Company is involved in litigation matters related to its business. In the Company’s opinion, none of these proceedings, when concluded, will have a material adverse effect on the Company’s consolidated results of operations, cash flows or financial condition as the Company has established adequate accruals for matters that are probable and estimable. The Company does not accrue estimated future legal costs related to the defense of these matters but rather expenses legal costs as incurred. Also see Note 2 for discussion of litigation settlement regarding the Pueblo sand and gravel lease.
7. SHAREHOLDERS’ EQUITY
Four hundred thousand shares of preferred stock ($.50 par value) are authorized and unissued.
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 16,998 shares to the six eligible board members effective December 13, 2019 as partial payment for their 2020 retainer fee. The Company issued a total of 21,000 shares to the seven eligible board members effective February 7, 2019 as full payment for their 2019 retainer fee. The Company issued a total of 16,000 shares to the eight eligible board members effective January 16, 2018 as full payment for their 2018 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 reported fiscal years 2019 or 2018.
9. RENTAL EXPENSE, LEASES AND COMMITMENTS
The Company adopted ASU No. 2016-02 Leases (Topic 842) on December 30, 2018 (the beginning of fiscal 2019), resulting in the recognition of operating right-of-use assets of $5,353,000 and operating lease liabilities of $5,427,000. The Company has entered into lease arrangements for office space, manufacturing facilities, water rights and certain equipment. A number of the leases include one or more options to renew the lease terms, purchase the leased property or terminate the lease. The exercise of these options is at the Company’s discretion and is therefore recognized on the balance sheet when it is reasonably certain the Company will exercise such options.
Substantially all of the Company’s leases are considered operating leases. Finance leases were not material as of December 28, 2019 or for the year ended December 28, 2019. The following table displays the undiscounted cash flows
related to operating leases as of December 28, 2019, along with a reconciliation to the discounted amount recorded on the December 28, 2019 Consolidated Balance Sheet (amounts in thousands):
|
|
|
|
|
|
|
|
|
OPERATING
|
|
|
|
|
LEASE
|
|
|
|
|
LIABILITIES
|
|
|
2020
|
|
$
|
1,402
|
|
|
2021
|
|
|
1,389
|
|
|
2022
|
|
|
1,307
|
|
|
2023
|
|
|
761
|
|
|
2024
|
|
|
255
|
|
|
Thereafter
|
|
|
655
|
|
|
Total lease payments
|
|
|
5,769
|
|
|
Less: interest
|
|
|
(608)
|
|
|
Present value of operating lease liabilities
|
|
$
|
5,161
|
|
Short-term lease cost represents the Company’s cost with respect to leases with a duration of 12 months or less and are not reflected on the Company’s Consolidated Balance Sheet. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. For the year ended December 28, 2019 operating lease cost was $1,979,000, including $623,000 of short-term lease costs.
New leases entered into during the year ended December 28, 2019 resulted in the recognition of operating right-of-use assets and lease liabilities of $665,000 and $572,000, respectively. At December 28, 2019 the weighted-average remaining lease term and discount rate for operating leases was 4.65 years and 6.02%, respectively.
The commitments include amounts expected to be reimbursed to the Company by related party tenants as discussed in Note 13. These related party amounts for 2020 through 2024 are as follows: 2020 – $67,000; 2021 – $68,000; 2022 – $69,000; 2023 – $70,000 and 2024 - $71,000.
10. RETIREMENT PLANS
As discussed in Note 1, the Company maintains a defined contribution retirement benefit plan for eligible employees. Total plan expenses charged to continuing operations were $945,000 and $951,000 in 2019 and 2018, respectively.
11. CURRENT ECONOMIC CONDITIONS
The markets for products manufactured or fabricated by the HVAC and Door segments are expected to remain fairly constant compared with the 2019 levels although sales of fan coils in the HVAC segment are anticipated to grow as construction spending continues to increase during 2020. While general economic indicators are favorable for growth there are significant uncertainties around global trade and public health, particularly with COVID-19 impact uncertainties, which may adversely impact 2020 sales.
As has historically been the case, sales of all segments, other than the Door segment, are influenced by weather conditions.
12. INCOME TAXES
Income taxes are accounted for under the asset and liability method which 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 (benefit) provision for income taxes is summarized as follows (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Federal: Current
|
|
$
|
(66)
|
|
$
|
(387)
|
|
|
Deferred
|
|
|
(3,449)
|
|
|
(1,454)
|
|
|
State: Current
|
|
|
3
|
|
|
1
|
|
|
Deferred
|
|
|
(804)
|
|
|
(345)
|
|
|
|
|
$
|
(4,316)
|
|
$
|
(2,185)
|
|
The benefit for income taxes for 2019 and 2018 included a benefit of $5,396,000 and $2,500,000 for continuing operations and a provision of $1,080,000 and $315,000, respectively, for discontinued operations.
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:
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Statutory tax rate
|
|
(21.0)
|
%
|
(21.0)
|
%
|
|
Percentage depletion
|
|
—
|
|
(0.9)
|
|
|
Non-deductible expenses
|
|
0.1
|
|
0.4
|
|
|
Valuation allowance for tax assets
|
|
0.5
|
|
1.2
|
|
|
State income taxes, net of federal benefit
|
|
(4.5)
|
|
(4.5)
|
|
|
Other
|
|
1.2
|
|
(2.4)
|
|
|
|
|
(23.7)
|
%
|
(27.2)
|
%
|
For financial statement purposes, deferred tax assets and liabilities are recorded at 25.74%, which represents a blend of the current statutory federal and states’ tax rates. The principal temporary differences and their related deferred taxes are as follows (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Deferred tax assets
|
|
|
|
|
|
|
|
|
Reserves for self-insured losses
|
|
$
|
417
|
|
$
|
466
|
|
|
Accrued reclamation
|
|
|
1,972
|
|
|
1,445
|
|
|
Unfunded supplemental profit sharing plan liability
|
|
|
431
|
|
|
263
|
|
|
Asset valuation reserves
|
|
|
439
|
|
|
685
|
|
|
Future state tax credits
|
|
|
833
|
|
|
833
|
|
|
Net state operating loss carryforwards
|
|
|
812
|
|
|
226
|
|
|
Federal AMT carryforward
|
|
|
116
|
|
|
387
|
|
|
Federal NOL carryforward
|
|
|
3,226
|
|
|
468
|
|
|
Other
|
|
|
939
|
|
|
700
|
|
|
|
|
|
9,185
|
|
|
5,473
|
|
|
Deferred tax liabilities
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
833
|
|
|
1,200
|
|
|
Deferred development
|
|
|
—
|
|
|
116
|
|
|
Other
|
|
|
285
|
|
|
443
|
|
|
|
|
|
1,118
|
|
|
1,759
|
|
|
Net deferred tax asset before valuation allowance
|
|
|
8,067
|
|
|
3,714
|
|
|
Valuation allowance
|
|
|
|
|
|
|
|
|
Beginning balance
|
|
|
(300)
|
|
|
(200)
|
|
|
(Increase) decrease during the period
|
|
|
(100)
|
|
|
(100)
|
|
|
Ending Balance
|
|
|
(400)
|
|
|
(300)
|
|
|
Net deferred tax asset
|
|
$
|
7,667
|
|
$
|
3,414
|
|
The deduction of charitable contributions made during 2019 and 2018 was limited by the level of taxable income; however, no valuation reserve was established for the amount carried forward as the Company expects to be able to utilize these deductions in future years. The Tax Act repealed AMT and allows any existing AMT credit carryforwards to be used to offset regular tax obligations for a three year period beginning in 2018. Any AMT credit carryforwards that are not utilized to offset regular tax obligations will be 100 percent refundable by 2021. For State purposes, net operating losses can be carried forward for various periods for the states that the Company is required to file in. Of the $833,000 of state tax credits recorded by the Company at December 28, 2019 and December 29, 2018, $797,000 relates to California Enterprise Zone hiring credits earned in prior years. California has repealed the credit and limited its use to tax years through 2023. At December 28, 2019 and December 29, 2018 the Company carried a valuation reserve of $556,000 ($400,000 tax effected) and $430,000 ($300,000 tax effected), respectively, related to the carry forward 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, if any, 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 ability to realize our deferred tax assets as of December 28, 2019, 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 were no unrecognized tax benefits at either December 28, 2019 or December 29, 2018.
We file income tax returns in the United States at the Federal level and with various state jurisdictions. Federal and state income tax returns are subject to examination based upon the statute of limitations in effect for the various jurisdictions.
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 which settled in October 2019. See Note 2. For the year ending December 28, 2019 the Company paid the director’s firm $826,000 for services rendered. During fiscal 2018 the same director’s firm was paid $474,000 for services rendered.
The corporate office leases space in Chicago, Illinois that is shared with another organization 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 certain insurance 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 related organizations at December 28, 2019 and December 29, 2018 were $13,000 and $28,000, respectively.
14. UNAUDITED QUARTERLY FINANCIAL DATA
The following table and footnotes provide summarized unaudited fiscal quarterly financial data for 2019 and 2018 (amounts in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
First
|
|
Second
|
|
Third
|
|
Fourth
|
|
|
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
22,528
|
|
$
|
25,257
|
|
$
|
31,987
|
|
$
|
33,504
|
|
|
Gross profit
|
|
|
4,681
|
|
|
3,722
|
|
|
7,535
|
|
|
8,615
|
|
|
Depreciation, depletion and amortization
|
|
|
519
|
|
|
254
|
|
|
597
|
|
|
592
|
|
|
Net income (loss)
|
|
|
13,322
|
|
|
(4,836)
|
|
|
(20,284)
|
|
|
(2,100)
|
|
|
Basic and diluted income (loss) per share
|
|
|
7.80
|
|
|
(2.82)
|
|
|
(11.85)
|
|
|
(1.23)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
First
|
|
Second
|
|
Third
|
|
Fourth
|
|
|
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
23,410
|
|
$
|
25,557
|
|
$
|
23,965
|
|
$
|
27,955
|
|
|
Gross profit
|
|
|
5,006
|
|
|
5,974
|
|
|
5,225
|
|
|
6,649
|
|
|
Depreciation, depletion and amortization
|
|
|
405
|
|
|
405
|
|
|
393
|
|
|
269
|
|
|
Net (loss) income
|
|
|
(6,193)
|
|
|
2,113
|
|
|
(1,236)
|
|
|
(540)
|
|
|
Basic and diluted (loss) income per share
|
|
|
(3.65)
|
|
|
1.24
|
|
|
(0.73)
|
|
|
(0.32)
|
|
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 INFORMATION
In the first quarter of 2019, the Company reviewed its reporting structure in connection with the sale of the TMC ready-mix and Daniels Sand operating assets. Reporting segments were modified to conform to the way management measures and evaluates Company performance post-sale. The Company operates primarily in the Building Supplies industry group and has identified three reporting segments within this industry group. The HVAC segment produces and sells a variety of products including wall furnaces, fan coils, evaporative coolers, boiler room equipment and dryer boxes and related accessories from the Company’s wholly-owned subsidiaries, Williams Furnace Co. (WFC) of Colton, California, Phoenix Manufacturing, Inc. (PMI) of Phoenix, Arizona, Global Flow Products /American HVAC (GFP) of Broken Arrow, Oklahoma, and InOvate Dryer Technologies (InOvate) of Jupiter, Florida. Sales of this segment are nationwide although WFC and PMI sales are more concentrated in the southwestern United States. The Door segment sells hollow metal and wood doors, door frames and related hardware, sliding door systems and electronic access and security systems from the Company’s wholly-owned subsidiaries, McKinney Door and Hardware, Inc. (MDHI), Fastrac Building Supply (Fastrac) and Serenity Sliding Door Systems (Serenity), which operate out of facilities in Pueblo and Colorado Springs, Colorado. Sales of this segment are concentrated in Colorado, California and the Northwestern United States although door sales are also made throughout the United States. The Construction Materials segment offers construction supplies from locations along the Southern Front Range of Colorado operated by the Company’s wholly-owned subsidiaries, Castle Aggregates and Castle Rebar & Supply of Colorado Springs, and TMOP Legacy Company (formerly Transit Mix of Pueblo, Inc.) of Pueblo, Colorado (the three companies collectively are referred to as the Castle Companies). During the quarter ended September 28, 2019 the Company determined to cease mining operations at its Pikeview aggregates quarry, which is part of the Construction Materials segment, as continuing mining operations was no longer in the best interest of the consolidated portfolio. During the fourth quarter of 2019, the Company purchased a formerly leased mining property in Pueblo, Colorado as part of a legal settlement. See Note 2 for further discussion of the legal settlement. In conjunction with both of these events, the Company recognized charges to record additional asset retirement liabilities and impairment of related assets associated with the properties. See Note 20 for further discussion. The Company expects an outside party to complete most of the remaining reclamation over approximately the next five years.
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 2019 and 2018 along with the items necessary to reconcile the segment information to the totals reported in the financial statements (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Construction
|
|
Unallocated
|
|
Held for
|
|
|
|
|
Year Ended December 28, 2019
|
|
HVAC
|
|
Doors
|
|
Materials
|
|
Corporate (a)
|
|
Sale
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from external customers
|
|
$
|
82,149
|
|
$
|
24,369
|
|
$
|
6,751
|
|
$
|
7
|
|
|
|
|
$
|
113,276
|
|
|
Depreciation, depletion and amortization
|
|
|
1,272
|
|
|
285
|
|
|
321
|
|
|
84
|
|
|
|
|
|
1,962
|
|
|
Operating income (loss)
|
|
|
948
|
|
|
2,174
|
|
|
(18,492)
|
|
|
(7,475)
|
|
|
|
|
|
(22,845)
|
|
|
Segment assets
|
|
|
50,822
|
|
|
14,248
|
|
|
10,463
|
|
|
13,554
|
|
|
896
|
|
|
89,983
|
|
|
Capital expenditures
|
|
|
342
|
|
|
79
|
|
|
2,257
|
|
|
15
|
|
|
|
|
|
2,693
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Construction
|
|
Unallocated
|
|
Held for
|
|
|
|
|
Year Ended December 29, 2018
|
|
HVAC
|
|
Doors
|
|
Materials
|
|
Corporate (a)
|
|
Sale
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from external customers
|
|
$
|
73,478
|
|
$
|
20,158
|
|
$
|
7,150
|
|
$
|
101
|
|
|
|
|
$
|
100,887
|
|
|
Depreciation, depletion and amortization
|
|
|
949
|
|
|
171
|
|
|
301
|
|
|
51
|
|
|
|
|
|
1,472
|
|
|
Operating income (loss)
|
|
|
931
|
|
|
2,233
|
|
|
(7,878)
|
|
|
(4,050)
|
|
|
|
|
|
(8,764)
|
|
|
Segment assets
|
|
|
29,003
|
|
|
8,003
|
|
|
11,315
|
|
|
3,346
|
|
|
24,036
|
|
|
75,703
|
|
|
Capital expenditures
|
|
|
1,064
|
|
|
119
|
|
|
181
|
|
|
45
|
|
|
|
|
|
1,409
|
|
|
|
(a)
|
|
Includes unallocated corporate office expenses and assets which consist primarily of cash and cash equivalents, prepaid expenses, property, plant and equipment.
|
16. WRITE OFF OF DEFERRED DEVELOPMENT
During July 2015, TMC began development of a granite mining property south of Colorado Springs. Prior to beginning the development process, the Company deposited $2,500,000 in an escrow account per agreement with the land owner. This amount was previously included in Other long-term assets on the Consolidated Balance Sheet. The development costs included drilling the property to ascertain its suitability for mining, engineering studies and legal expenses related to the preparation of an application to obtain the required mining permits from the State of Colorado and El Paso County.
TMC made its initial application for a mining permit from the state of Colorado in 2016. TMC filed its second application to the state in November 2017, which was rejected on April 26, 2018. The Company wrote off all capitalized costs associated with the permit application in the first half of 2018, a total of $6,840,000.
As of December 28, 2019 and December 29, 2018 the escrow balance mentioned above was included in Other current assets as the Company has begun the process to settle the account and recover the funds.
17. SETTLEMENT RECEIPT
As previously disclosed, on January 15, 2019, the Company reached an amicable resolution to a business dispute by way of a settlement agreement. Pursuant to the settlement agreement, the Company received $15,000,000. The other party and the Company further agreed to set up a joint escrow account to support certain conditions in the agreement. The Company’s contribution to the escrow account was $218,000. The Settlement Agreement does not contain any admission of liability, wrongdoing, or responsibility by any of the parties.
18. ACQUISITIONS
During the year ended December 28, 2019 the Company completed three different asset purchase transactions, acquiring the assets of four operating businesses. On May 20, 2019 the Company acquired the assets of Serenity and Fastrac, both based in Colorado Springs, Colorado, using available cash reserves. Serenity is a proprietary sliding door system providing superior sound attenuation, sold primarily into healthcare markets across the country. Fastrac is a leading supplier of commercial doors and hardware to healthcare and hospitality customers across the country. Serenity continues to operate as a stand-alone business while Fastrac operations were consolidated with the Company’s existing portfolio company, McKinney Door and Hardware, which has similar operations. The results of the acquisition of Serenity and Fastrac are included in the Company’s Consolidated Financial Statements from the date of acquisition. Both companies are included in the Door segment for reporting purposes.
On June 3, 2019 the Company acquired the assets of American Wheatley HVAC and Global Flow Products (together “GFP”), based in Broken Arrow, Oklahoma using available cash reserves. GFP sells American Wheatley HVAC branded products, including a broad line of ASME pressure vessels, custom fabricated products, valves, strainers and other hydronic accessories to commercial HVAC customers. The results of the acquisition of GFP are included in the Company’s Consolidated Financial Statements from the date of acquisition. GFP is included in the HVAC segment for reporting purposes.
These two transactions are not considered material individually. However, they are considered material in the aggregate. The total purchase price paid for these transactions was $12,855,000, which included a traditional post-closing working capital adjustment for $608,000, with approximately $12,163,000 paid in cash at closing. The Company will pay additional contingent consideration, if earned, in the form of an earn out amount pursuant to the terms of earn out agreements in amounts of up to $4,300,000, the payment of which is subject to certain conditions and the successful achievement of gross profit growth targets for the acquired businesses following the closing of the transactions over a period of twenty-four (24) to thirty-six (36) months. Approximately $1,300,000 has been accrued based on estimated fair values of these earn out agreements. We acquired trade receivables of $1,916,000, inventory of $1,745,000, property and equipment of $2,530,000, other assets of $256,000, intangibles of $4,000,000 and goodwill of $3,614,000 and retained liabilities of $1,205,000. The current value assigned to trade receivables represents fair market value. The working capital adjustment has been finalized on both transactions and final valuation of the fair value of assets and liabilities including receivables, inventory, fixed assets, intangibles, goodwill and accounts payable has been recorded as of December 28, 2019. Transaction costs included in Selling and administrative expenses on the Consolidated Statements of Operations for the year ended December 28, 2019 was $1,229,000.
On June 17, 2019 the Company acquired the assets of InOvate, a supplier of commercial and residential dryer and HVAC venting systems and components. The total purchase price for the net assets acquired was $11,206,000, including a post-closing working capital adjustment of $84,000, with approximately $11,050,000 paid in cash at closing, using available cash reserves. The Company will pay additional contingent consideration, if earned, in the form of an earn out amount pursuant to the terms of an earn out agreement in an amount of up to $1,250,000, the payment of which is subject to certain conditions and the successful achievement of gross profit growth targets for the acquired business following the closing of the transaction over a period of twelve (12) months. Approximately $240,000 has been accrued based on an estimated fair value of this earn out agreement. The results of the acquisition of InOvate are included in the Company’s Consolidated Financial Statements from the date of acquisition. Transaction costs included in Selling and administrative expense on the Consolidated Statement of Operations for the year ended December 28, 2019 were $536,000.
In accordance with GAAP, the total purchase price has been allocated to the tangible and intangible net assets acquired based on their fair values. The working capital adjustment was finalized in the fourth quarter of 2019. The condensed balance sheet of InOvate at the acquisition date was as follows:
|
|
|
|
|
|
Purchase price
|
|
$
|
11,206
|
|
|
|
|
|
|
Accounts receivable, net
|
|
|
1,448
|
|
Other tangible assets
|
|
|
984
|
|
Intangible assets
|
|
|
8,808
|
|
Right of use asset
|
|
|
387
|
|
Accounts payable and accrued expenses
|
|
|
(1,353)
|
|
Right of use liability
|
|
|
(387)
|
|
Total identifiable net assets
|
|
|
9,887
|
|
Goodwill
|
|
$
|
1,319
|
Accounts receivable are valued at anticipated fair market value and are not materially different from contracted value.
The following table presents selected unaudited pro forma information for the Company assuming the acquisition of InOvate had occurred as of December 31, 2017. This pro forma information does not purport to represent what the Company’s actual results would have been if the acquisition had occurred as of the date indicated or what such results would be for any future periods.
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
DECEMBER 28,
|
|
DECEMBER 29,
|
|
|
|
2019
|
|
2018
|
|
Revenue
|
|
$
|
120,439
|
|
$
|
114,535
|
|
Pre-tax loss from continuing operations
|
|
$
|
(21,505)
|
|
$
|
(7,127)
|
|
Basic and diluted loss per share:
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
$
|
(9.59)
|
|
$
|
(3.04)
|
|
Average shares outstanding
|
|
|
1,711
|
|
|
1,697
|
Per ASC 805, the chart below summarizes the comparative financial statements for revenue and earnings as if all the acquisitions occurred at the beginning of the respective period.
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
DECEMBER 28,
|
|
DECEMBER 29,
|
|
|
|
2019
|
|
2018
|
|
Revenue
|
|
$
|
129,615
|
|
$
|
126,613
|
|
Pre-tax loss from continuing operations
|
|
$
|
(19,325)
|
|
$
|
(4,838)
|
Revenue of the acquired companies’ increased total revenue by 18.5% for the year ended 2019. The impact of the acquired companies on earnings for the current year was not material. Total goodwill added to the Consolidated Balance Sheet due to acquisition activity during fiscal 2019 was $4,932,000. The goodwill is attributable to the skills and technical talent of the established work force at each of the acquired businesses and synergies expected to be achieved from integrating the individual acquired business operations in to the Company’s existing consolidated business portfolio. This amount is attributable to the HVAC and Door segments in the amounts of $2,734,000 and $2,198,000, respectively. Goodwill that is deductible for tax purposes, over the next fifteen years, is $3,092,000. The goodwill amounts were finalized in the fourth quarter of 2019.
19. DISPOSITIONS OF ASSETS
On February 1, 2019, the Company and certain of its subsidiaries sold substantially all of the real property, tangible personal property and executory contracts of TMC’s ready-mix business and the operations of Daniels Sand Company (Daniels) to Aggregate Industries — WCR, Inc. (the Buyer), a Colorado corporation, for $27,129,000. The purchase price was paid to the Company on February 1, 2019 less certain amounts to be held in escrow, as provided in the Asset Purchase Agreement among the Company parties and the Buyer (Purchase Agreement), to secure the Company’s obligations to pay its working capital adjustment and indemnification obligations under the Purchase Agreement. The escrow also retained amounts to be held pending the subdivision of certain real property to be sold to the Buyer at a subsequent date as included in the Purchase Agreement. Combined escrow amounts of $2,049,000 were included in Other current assets in the Consolidated Balance Sheet at December 28, 2019.
The Company retained the aggregates operations and retail building materials business of TMC and all related assets and liabilities. These operations include the Pikeview quarry business located in Colorado Springs (see Note 20), the aggregates mining business located in Pueblo, the sand and gravel mining business located in Fremont County, and the retail building materials business at sites located in Colorado Springs and Pueblo.
In the quarter ended March 30, 2019, the Company recorded a $6,508,000 pre-tax gain on the sale of TMC assets. During the quarter ending June 29, 2019 the working capital adjustment was finalized and resulted in the Company paying a net $1,248,000 to the Buyer. This adjustment, plus an adjustment to transaction fees, reduced the pre-tax gain on the sale to $5,283,000. The operations of the ready-mix and Daniels Sand businesses were classified as discontinued
operations and assets held for sale for all periods presented. General corporate overhead charges were not allocated to discontinued operations. Revenue, expenses and pre-tax income reclassified to discontinued operations were as follows (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
DECEMBER 28,
|
|
DECEMBER 29,
|
|
|
|
2019
|
|
2018
|
|
|
Revenue
|
$
|
4,058
|
|
$
|
63,096
|
|
|
Costs and expenses
|
|
3,900
|
|
|
58,143
|
|
|
Depreciation, depletion and amortization
|
|
578
|
|
|
1,161
|
|
|
Selling and administrative
|
|
304
|
|
|
3,550
|
|
|
Gain on sales of equipment
|
|
-
|
|
|
919
|
|
|
Gain on sale of assets
|
|
5,283
|
|
|
-
|
|
|
Pre-tax income
|
$
|
4,559
|
|
$
|
1,161
|
|
The results of discontinued operations are summarized as follows:
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
DECEMBER 28,
|
|
DECEMBER 29,
|
|
|
2019
|
|
2018
|
|
Operating (loss) income
|
$
|
(724)
|
|
$
|
1,161
|
|
Gain on sale of assets
|
|
5,283
|
|
|
—
|
|
Income tax provision
|
|
(1,080)
|
|
|
(315)
|
|
Income from discontinued operations
|
$
|
3,479
|
|
$
|
846
|
The assets and liabilities held for sale related to TMC’s ready-mix and Daniels Sand businesses were as follows:
|
|
|
|
|
|
|
|
|
|
DECEMBER 28,
|
|
DECEMBER 29,
|
|
|
|
2019
|
|
2018
|
|
|
Accounts receivable, net
|
$
|
—
|
|
$
|
9,054
|
|
|
Inventory
|
|
—
|
|
|
1,914
|
|
|
Property, plant and equipment, net
|
|
—
|
|
|
6,741
|
|
|
Other assets
|
|
—
|
|
|
6,327
|
|
|
Total assets held for sale
|
$
|
—
|
|
$
|
24,036
|
|
|
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses
|
$
|
|
|
$
|
3,800
|
|
|
Other long-term liabilities
|
|
—
|
|
|
292
|
|
|
Total liabilities held for sale
|
$
|
—
|
|
$
|
4,092
|
|
20. ARO ASSET/LIABILITY
During the third quarter of fiscal year ended December 28, 2019, the Company made a strategic decision to cease mining operations at its Pikeview quarry in Colorado Springs, Colorado, as it was no longer in the best economic interest of the consolidated portfolio to continue operations. The Company has a legal obligation to complete reclamation of the property as required by its mining permits with the State of Colorado. GAAP requires the recognition of a liability in the period in which it is incurred if a reasonable estimate of fair value can be made. Prior to the cessation of mining operations, reclamation was performed concurrently by backfilling mined areas with overfill from current mining. The reclamation costs were reported as operating expense as the Company could not reasonably estimate the ultimate liability of final reclamation. Once the Company ceased mining operations and could reasonably estimate the cost of final reclamation, an asset retirement obligation (ARO), was recorded as of September 29, 2019 and revised at December 28, 2019. The ARO liability of $20,804,000 represents the estimated fair value of total reclamation costs using Level 3 inputs. The fair value of the liability was calculated by applying an expected present value technique using estimated cash flows over a period of time and then discounting the expected cash flows using a credit-adjusted risk-free interest rate. The related ARO asset was considered 100% impaired as total carrying value including future costs to maintain and dispose of the asset will exceed the fair value. Therefore, the Company also recorded an impairment charge of $20,217,000 related to the asset.
In the fourth quarter of 2019, the Company settled its litigation with Valco regarding the Transit Mix of Pueblo (TMOP) mining operation. See Note 2 for discussion of the settlement. As part of the settlement agreement, the Company purchased the land it previously leased from Valco. Once the Company took possession of the property with no plan to resume mining it was able to reasonably estimate the final cost of reclamation. A valuation was completed and resulted in the Company recording a $6,660,000 ARO liability and offsetting ARO asset during the fourth quarter of 2019. The asset was considered fully impaired as its carrying value exceeded the estimated undiscounted future cash inflows. The Company had previously recorded a $4,430,000 accrual for reclamation at TMOP which was eliminated. Therefore, the net impact of the impairment on the Consolidated Statement of Operations for the year ended December 28, 2019 was $2,230,000.
The following table details activity related to the Company’s ARO liabilities for fiscal years 2019 and 2018 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
DECEMBER 28,
|
|
DECEMBER 29,
|
|
|
|
2019
|
|
2018
|
|
|
Beginning balance
|
$
|
6,269
|
|
$
|
6,166
|
|
|
Obligations incurred
|
|
21,455
|
|
|
103
|
|
|
Accretion expense
|
|
189
|
|
|
-
|
|
|
Ending balance
|
|
27,913
|
|
|
6,269
|
|
|
Less current portion
|
|
4,200
|
|
|
1,017
|
|
|
Long-term portion
|
$
|
23,713
|
|
$
|
5,252
|
|
In connection with the Company’s decision to cease mining activities, management performed a review of remaining assets to determine which, if any, should be classified as assets held for sale (AHS). Based on this review a total of $896,000, previously reported as Machinery and equipment on the Consolidated Balance Sheet, has been reclassified as AHS as of December 28, 2019. The net book value of the AHS was considered to be at or below fair market value, thus there was no impact to the Consolidated Statement of Operations from the reclassification.
21. VALUE CREATION INCENTIVE PLAN
The Company adopted the Continental Materials Corporation Value Creation Incentive Plan (VCIP) effective July 1, 2019. The VCIP is designed to attract and retain key management personnel by providing an incentive and reward for selected executive officers and employees of the Company. The VCIP involves only the payment of cash, not the issuance of common stock, based on appreciation of Phantom Equity or Phantom Equity Appreciation Rights (PE or PEARs, respectively) of the defined business unit, over a certain period of time. Fair value of the PE or PEAR awards was measured as of the balance sheet date presented. The awards vest over a period of four or five years and are payable over a three-year period following vesting. At December 28, 2019 total future compensation expense related to unvested awards yet to be recognized by the Company was approximately $1,635,000. This expense is expected to be recognized over a weighted-average remaining vesting period of approximately 4.1 years.
The Company used the Black-Scholes option pricing model as its method for determining fair value of the awards. The compensation expense related to the awards is recognized over the vesting period for each award. For the year ended December 28, 2019 the Company’s net loss included $204,000 of stock-based compensation. The total liability related to the PE and PEAR awards was $496,000, which includes $292,000 from an acquisition recorded at the opening balance sheet date, and is included as Long-term compensation on the Consolidated Balance Sheet as of December 28, 2019.
22. FAIR VALUE MEASUREMENT
PE and PEAR awards were recorded at fair value using the Black-Scholes option pricing model. There were no PE or PEAR appreciation awards at December 29, 2018. The following assumptions were used in determining the fair value of the award liability as of December 28, 2019:
|
|
|
|
|
|
|
Risk-free interest rate
|
|
|
1.67%
|
|
|
Dividend rate
|
|
|
0.00%
|
|
|
Volatility range
|
|
|
25% - 37%
|
|
|
Weighted average expected term (years)
|
|
|
4.1
|
|
The following table is a reconciliation for the PE and PEAR liability measured at fair value using Level 3 unobservable inputs (in thousands):
|
|
|
|
|
|
|
Balance at December 29, 2018
|
|
$
|
-
|
|
|
Awards related to acquired companies
|
|
|
300
|
|
|
Change due to vesting of awards granted
|
|
|
331
|
|
|
Change in fair value measurement of liability
|
|
|
(135)
|
|
|
Balance at December 28, 2019
|
|
$
|
496
|
|
Contingent consideration was recorded at fair value using a Monte Carlo Simulation model. There was no contingent consideration liability at December 29, 2018. The following assumptions were used in determining the fair value of contingent consideration at December 28, 2019:
|
|
|
|
|
|
|
Risk-free interest rate
|
|
|
1.6% - 2.3%
|
|
|
Expected term (years)
|
|
|
.4 - 3.2
|
|
The following table is a reconciliation for the contingent consideration liability measured at fair value using Level 3 unobservable inputs (in thousands):
|
|
|
|
|
|
|
Balance at December 29, 2018
|
|
$
|
-
|
|
|
Contingent consideration granted with acquisitions
|
|
|
1,540
|
|
|
Change in fair value measurement of liability
|
|
|
(58)
|
|
|
Balance at December 28, 2019
|
|
$
|
1,482
|
|
The ARO liabilities were recorded at fair value using an expected present value technique. The following assumptions were used in determining the fair value of the ARO liabilities at December 28, 2019:
|
|
|
|
|
|
|
Credit adjusted risk-free interest rate
|
|
|
3.66%
|
|
|
Expected term (years)
|
|
|
4.7
|
|
23. SUBSEQUENT EVENT
On February 18, 2020, Bee Street Holdings LLC (Bee Street), commenced an unsolicited tender offer for all outstanding shares of Common Stock of the Company (Common Stock) not already owned by Bee Street. Bee Street is an entity controlled by James G. Gidwitz, our chairman and Chief Executive Officer, and other members of Mr. Gidwitz’ s family. As of February 17, 2020, Bee Street beneficially owned 1,027,171, or approximately 61.3%, of the outstanding shares of Common Stock. Bee Street is offering to purchase all outstanding shares of Common Stock that Bee Street does not already own for $9.50 per share, net to the seller in cash, without interest, subject to applicable withholding taxes. Additional information about the tender offer is available in Bee Street’s and the Company’s SEC filings, including the Company’s Schedule 14D-9 filed on March 3, 2020. The offer is subject to certain conditions set forth in Bee Street’s tender offer documents. Bee Street has stated that if it purchases shares of Common Stock in the tender offer such that it will own at least 90% of the issued and outstanding Common Stock, Bee Street (or its affiliate), intends to merge with the Company (the “Merger”). As a result of the Merger, each then issued and outstanding share of Common Stock (other than Common Stock held by Bee Street and held by stockholders who validly perfect their dissenters’ rights under the Delaware General Corporation Law) would be cancelled and converted into and represent the right to receive $9.50 per share.