UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the Quarterly Period Ended June 26, 2004

OR

COMMISSION FILE NUMBER 0-13198

MORTON INDUSTRIAL GROUP, INC.

1021 W. Birchwood, Morton, Illinois 61550
(Address of principal executive offices)

(309) 266-7176
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o No x

     The aggregate market value of the common stock held by non-affiliates of the registrant (based upon the last reported sale price on the OTC Market) on the last business day of the registrant’s most recently completed second fiscal quarter was approximately $6,700,000.

ITEM 1. FINANCIAL STATEMENTS

MORTON INDUSTRIAL GROUP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
For the Three and Six Months Ended June 26, 2004 and June 28, 2003
(Dollars in thousands, except per share data)
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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Table of Contents

MORTON INDUSTRIAL GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
June 26, 2004 and December 31, 2003
(Dollars in thousands)

See accompanying notes to condensed consolidated financial statements.

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MORTON INDUSTRIAL GROUP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
For the Six Months Ended June 26, 2004 and June 28, 2003
(Dollars in thousands)
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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MORTON INDUSTRIAL GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statement of Stockholders’ Equity (Deficit)
For the Six Months Ended June 26, 2004
(Dollars in thousands)
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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MORTON INDUSTRIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Six Months Ended June 26, 2004 and June 28, 2003
(Unaudited)

(1) Nature of Business

     Through our operating subsidiaries, we are a contract manufacturer and supplier of high-quality fabricated sheet metal components and subassemblies for construction, industrial and agricultural original equipment manufacturers located primarily in the Midwestern and Southeastern United States.

(2) Interim Financial Data

     The Condensed Consolidated Financial Statements at June 26, 2004, and for the three and six months ended June 26, 2004 and June 28, 2003, are unaudited and reflect all adjustments, consisting of normal recurring accruals and other adjustments which, in the opinion of our management, are necessary for a fair presentation of the financial position, operating results, and cash flows for the interim periods indicated. Our fiscal quarters end on a Saturday (nearest to a quarter end) except for the fourth quarter which ends on December 31. For both the quarters ended June 26, 2004 and June 28, 2003 there were 64 shipping days. For the six months ended June 26, 2004, there were 124 shipping days, and for the six months ended June 28, 2003, there were 126 shipping days. Results of operations for interim periods are not necessarily indicative of the results of operations for the full fiscal year. You should read the condensed consolidated financial statements in connection with the consolidated financial statements and notes thereto, together with management’s discussion and analysis of financial condition and results of operations of Morton Industrial Group, Inc. contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, as filed on March 30, 2004.

(3) Discontinued Operations

     The results from discontinued operations for the three and six months ended June 28, 2003 reflect the results of Mid-Central Plastics, Inc., which we sold on June 20, 2003.

     Resulting from that sale is a note receivable of $1,100,000 due June 20, 2006 which bears interest at 15% per annum. Interest for the period of June 20, 2003 through June 20, 2004 was 15% payment-in-kind, with interest payable monthly in cash beginning in July, 2004. The note receivable, due from the buyer, is subordinate to required payments due by the buyer to its senior secured lender. Payments received by the Company are assigned to Harris Trust and Savings Bank, As Agent, the Company’s senior secured lender.

(4) Inventories

     The Company’s inventories, in thousands of dollars, at June 26, 2004, and December 31, 2003, are summarized as follows:

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(5) Earnings Per Share

     The following reflects the reconciliation of the components of the basic and diluted earnings per common share computations:

     For the quarter and six months ended June 28, 2003, options and warrants aggregating 1,053,915 and 1,058,634 shares, respectively, were excluded from the computation of diluted earnings per share due to their anti-dilutive effect. No options or warrants were excluded from the computation of diluted earnings for the quarter and six months ended June 26, 2004.

(6) Segment Reporting

     Following the June 20, 2003 sale of Mid-Central Plastics, Inc., we have only one remaining segment — the contract metals fabrication segment.

(7) Debt and Warrants

     On March 26, 2004, the Company entered into a Second Amended and Restated Credit Agreement with a syndicate of banks led by Harris Trust and Savings Bank, As Agent, and also on March 26, 2004, entered into a Note and Warrant Purchase Agreement with BMO Nesbitt Burns Capital (U.S.) Inc., As Agent. These agreements were effective on March 26, 2004, and provided financing to replace the revolving credit facility and term note payable previously due to Harris Trust and Savings Bank, As Agent. In connection with this transaction, the 238,584 warrants to purchase Class A Common Stock were surrendered by the holders; as described below, new warrants were issued on March 26, 2004.

     On June 23, 2004, the Company entered into the First Amendment to the Second Amended and Restated Credit Agreement and also on June 23, 2004, entered into an Amended and Restated Note and Warrant Purchase Agreement with BMO Nesbitt Burns Capital (U.S.) Inc., As Agent. The effect of the June 23, 2004 amendments was to increase the amount due to BMO Nesbitt Burns Capital (U.S.) Inc., As Agent, by $2,000,000, reduce the four-year secured term loan described below by $1,000,000 and reduce the secured revolving credit facility described below by $1,000,000.

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     Under the terms of the new agreements and amendments, at June 26, 2004 the Company has:

     1) A four-year secured term loan in the amount of $21 million with variable rate interest; principal payments are due in quarterly installments of $500,000 beginning June 30, 2004 through March 31, 2005 and due in quarterly installments of $750,000 beginning June 30, 2005 through December 31, 2007 with the balance of $10,750,000 due on March 31, 2008.

     2) A secured revolving credit facility with a limit of $18 million, with variable rate interest, and with an initial revolving credit balance of $8.7 million, and with initial availability of $5.4 million as of March 26, 2004. At June 26, 2004, the Company has a revolving credit balance of $13.9 million and availability of $4.1 million (based on an $18 million limit). The balance is due March 31, 2008. The amount available under the revolving credit facility is limited to 85% of eligible accounts receivable and 60% of eligible inventory. The facility requires a commitment fee of 0.50% per annum on the unused portion of the facility.

     At the Company’s option, for both the secured term loan and the secured revolving credit facility, interest will be at either a bank base rate plus applicable margin, or an adjusted LIBOR plus a LIBOR margin. At inception, the bank rate plus applicable margin is 6.75% and the adjusted LIBOR plus a LIBOR margin is 5.35%. At June 26, 2004, and in connection with the June 23, 2004 amendments, those rates are the same as at inception.

     3) A senior secured subordinated note in the amount of $12 million bearing cash interest of 12% and payment-in-kind interest of 4% with no principal amortization, and the balance due March 26, 2009. This debt is subordinated to the secured term loan and the revolving credit facility with respect to both payment and lien priority.

     Related to the senior secured subordinated note, on March 26, 2004 the Company issued 545,467 warrants to purchase shares of its Class A Common Stock for $0.02 per share; these warrants expire March 26, 2014. The warrant holder may exercise the warrants at any time. The warrants may be put to the Company, at the then fair market value, at the earlier of: a) five years from the date of issue; b) a change of control; c) a default on the senior secured subordinated loan; d) a prepayment of 75% or more of the original principal balance of the senior secured subordinated loan.

     The Company has estimated the fair value of the warrants at the date of issue, and at June 26, 2004, to be $1.5 million, and has reported that amount as warrants payable and as debt discount in the accompanying Condensed Consolidated Balance Sheets. The debt discount is being amortized using the effective yield method over 5 years, the term of the related senior secured subordinated note. The Company will update, on a quarterly basis, the fair value of the warrants and record changes in the fair value, if any, as interest expense.

     The stock purchase warrant includes provisions that will reduce the 545,467 warrants that can be put to the Company if a) a change of control occurs prior to 5 years from the date of issue and the Company achieves specified net equity levels; or b) if a change of control has not occurred prior to 5 years from the date of issue and the Company achieves specified EBITDA (earnings before interest, taxes, depreciation and amortization) levels. The number of warrants could be reduced to several levels, but no lower than 290,278.

     In connection with these loans, the Company has granted the lenders a lien on all of the Company’s accounts receivable, inventory, equipment, land and buildings, and various other assets. These agreements contain restrictions on capital expenditures, additional debt or liens, investments, mergers and acquisitions, asset sales and payments such as dividends or stock repurchases. These agreements also impose various financial covenants, including financial performance ratios. Fees associated with the March 26, 2004 and June 23, 2004 transactions, including underwriting and legal fees, were approximately $1.75 million, paid at the respective closings.

(8) Stock Option Plan

     The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, the Company records compensation expense on the date of grant only if the current market price of the underlying stock exceeds the exercise price. The Company issues options at the current market price on the date of issuance and, accordingly, has not recognized any stock-based employee compensation cost for stock options in the financial statements.

     The per share weighted-average fair value of stock options granted during the six months ended June 28, 2003 was $0.13 at the date of grant based on the Black Scholes option-pricing model with the following weighted-average assumptions: expected dividend

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yield of 0%, risk-free interest rate of 6%, volatility of 91%, and an expected life of 10 years. No options were granted during the six months ended June 26, 2004.

     Had we determined compensation cost based on the fair value at the grant date for our stock options under SFAS No. 123, Accounting for Stock-Based Compensation, our net earnings, in thousands of dollars, would have been reduced to the pro forma amounts indicated below:

(9) Impact of Recently Issued Accounting Standards

     FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (FIN 46R or the Interpretation), addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. The Interpretation was issued on December 24, 2003, and replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities, which was issued on January 17, 2003. The Company has adopted Interpretation 46 with no impact on its financial statements.

     The FASB issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS 150), which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. FASB Staff Position Financial Accounting Standard 150-3, Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable

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     Noncontrolling Interest under FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, defers the effective date of Statement 150 for certain mandatorily redeemable noncontrolling interests of all entities. The Company adopted SFAS 150 as of July 1, 2003.

(10) Redeemable Preferred Stock

     Pursuant to a 1999 agreement to purchase certain assets of Worthington Custom Plastics, Inc. (“Worthington”), the Company issued 10,000 shares of its preferred stock, without par value, to Worthington. The preferred stock was mandatorily redeemable on April 15, 2004 at $1,000 per share. The preferred stock was valued at $4,250,000 at the time of the acquisition and the discount was being accreted over a five-year period using the effective yield method. The period of accretion was completed in April, 2004.

     The Company and Worthington entered into a stock redemption agreement, dated December 23, 2003, that provides for 30 monthly redemption payments of $50,000 each over a three-year period (10 payments each year in 2004, 2005 and 2006) to redeem all of the preferred stock. Each payment will redeem 333 (or 334) shares of the 10,000 shares outstanding and will result in a gain on redemption of $283,000. Redemption payments made each month during the three and six months ended June 26, 2004 resulted in the “gain on redemption of redeemable preferred stock” of $850,000 and $1,700,000, respectively, which is reported in the accompanying condensed consolidated statements of operations. If shares are not redeemed in accordance with the provisions of this agreement, the redemption price remains at $1,000 per share. As part of this agreement, all litigation between the Company and Worthington was settled and dismissed.

(11) Unbilled Receivables

     During the six months ended June 26, 2004, the Company incurred increased costs for the purchase of raw materials as a result of dynamic changes in the U.S. steel markets. The Company’s supplier agreements with key customers allow surcharges for the passthrough of the additional raw material costs. The Company has recognized as net sales, and also recognized an identical amount as cost of sales, surcharge amounts of approximately $7 million for the six months ended June 26, 2004. The Company has classified unbilled surcharges in accompanying balance sheet as “unbilled receivables”. The surcharges are generally invoiced to the Company’s customers within weeks following the month end in which those surcharges are identified.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion and analysis describes changes in the Company’s financial condition since December 31, 2003. The analysis of results of operations compares the quarters and six months ended June 26, 2004 and June 28, 2003. Any references to December 31, 2003 relate to data found in Form 10-K as filed with the Securities and Exchange Commission on March 30, 2004.

GENERAL

     We are a contract manufacturer of highly engineered metal components and subassemblies for construction, industrial and agricultural original equipment manufacturers. Our largest customers, Caterpillar Inc. and Deere & Co., accounted for approximately 85% of our net sales for the quarter and six months ended June 26, 2004, and accounted for approximately 88% and 87% of our net sales in 2003 and 2002, respectively.

     Historically, the Company has been a fabricator of sheet metal products. Subsequent to a merger in January, 1998, when the Company became a publicly-traded entity, the Company acquired six facilities that fabricated either injection molded or thermoformed plastic components. We acquired two of the plastics fabrication facilities separately in 1998 and four together in 1999. We sold one of the plastics fabrication facilities acquired in 1998 at the end of 1999. The four plastics fabrication facilities acquired together in 1999 were sold in December, 2002. These four facilities, operating as Morton Custom Plastics, LLC, were incurring significant losses and filed for protection as debtor-in-possession under Chapter 11 of the United States Bankruptcy Code. At the time of the sale of Morton Custom Plastics, LLC, the Company determined that is was appropriate to focus solely on its core competency, sheet metal fabrication, and offered for sale its remaining plastics fabrication facility, which we sold in June, 2003. In the Company’s accompanying financial statements, all of the plastics fabrication operating results are reported as discontinued operations.

     As a part of the 1999 plastics facilities acquisition, the Company issued $10 million of redeemable preferred stock with a maturity date of April 2004. The Company negotiated a settlement in December 2003 with the holder of the preferred stock, and began making

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redemption payments in January, 2004. If the redemption payments are paid according to the terms of the settlement agreement, the payments will aggregate $1.5 million over a three-year period ending in 2006.

     Since June, 2003, the Company has focused solely on its core business, sheet metal fabrication (the Company’s continuing operations). The Company recognized earnings of over $1.2 million from its continuing operations in 2003, but had incurred losses from its continuing operations in 2001 and 2002 when demand by the Company’s customers was depressed. These losses from continuing operations as well as the acquisition and subsequent disposition of certain plastics facilities created pressure on our liquidity.

     To take advantage of the potential for growth in 2004 and beyond, and to be able to effectively serve our customers, we must be able to ensure an adequate flow of raw materials into our production processes, be able to hire and train additional employees and be able to fund our need for new manufacturing equipment and meet our other working capital needs. Accordingly, the Company entered into a new credit facility in March, 2004, and an amendment to that facility in June, 2004, that are described below. The new credit facility (March, 2004) provided additional availability at the closing of approximately $5 million. Management believes that the new credit facility will permit the Company to meet its liquidity requirements driven by raw material, manpower and capital expenditure requirements through the term of the facility, which matures in March, 2008.

     As noted above, two customers account for a significant portion of our net sales. Caterpillar Inc. and Deere & Co. are both forecasting greater orders for fabricated parts supplied by Morton Industrial Group, Inc. for 2004. We believe that this demand is being fueled by the improved economic conditions in the United States. The Company is responding by hiring additional manpower, adding capital equipment as necessary and increasing the flow of purchased raw materials in a difficult steel market. The U.S. steel industry has restructured, consolidated and is challenged to meet growing domestic and international demand. The steel industry has been impacted by China’s growing consumption of scrap steel and coke, a raw material used in processing steel. Cosmetically sensitive sheet steel, our core commodity, is on allocation and has correspondingly seen inflationary pricing; most inflationary steel pricing becomes the responsibility of the Company’s customers.