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:


Land improvements		5 to 31 years
Buildings and improvements		10 to 31 years
Leasehold improvements		Shorter of the term of the lease or useful life
Machinery and equipment		3 to 20 years

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):


	2019		2018
Beginning balance	$	104	$	132
Warranty related expenditures		(148)		(148)
Warranty expense accrued		120		120
Ending balance	$	76	$	104

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.