UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to _________
Commission File Number 1-13612
CONGOLEUM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 02-0398678
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3500 Quakerbridge Road
P.O. Box 3127
Mercerville, NJ 08619-0127
(Address of principal executive offices, including zip code)
(609) 584-3000
(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 |_|
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES |_| NO |X|
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at April 30, 2006
-------------------------- -----------------------------
Class A Common Stock 3,663,390
Class B Common Stock 4,608,945
CONGOLEUM CORPORATION
Index
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of March 31, 2006
(unaudited) and December 31, 2005.....................................4
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2006 and 2005 (unaudited)......................5
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2006 and 2005 (unaudited)................6
Notes to Unaudited Condensed Consolidated Financial Statements
(unaudited)...........................................................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................28
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........36
Item 4. Controls and Procedures..............................................36
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................36
Item 1A. Risk Factors.........................................................37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........44
Item 3. Defaults Upon Senior Securities......................................44
Item 4. Submission of Matters to a Vote of Security Holders..................45
Item 5. Other Information....................................................45
Item 6. Exhibits.............................................................45
Signatures....................................................................46
2
FORWARD LOOKING STATEMENTS
Some of the information presented in or incorporated by reference in this
report constitutes "forward-looking statements," within the meaning of the
Private Securities Litigation Reform Act of 1995, that involve risks,
uncertainties and assumptions. These statements can be identified by the use of
the words such as "anticipate," "believe," "estimate," "expect," "intend,"
"plan," "project" and other words of similar meaning. In particular, these
include statements relating to intentions, beliefs or current expectations
concerning, among other things, future performance, results of operations, the
outcome of contingencies such as bankruptcy and other legal proceedings, and
financial conditions. These statements do not relate strictly to historical or
current facts. These forward-looking statements are based on the Company's
expectations, as of the date of this report, of future events, and the Company
undertakes no obligation to update any of these forward-looking statements.
Although the Company believes that these expectations are based on reasonable
assumptions, within the bounds of its knowledge of its business and operations,
there can be no assurance that actual results will not differ materially from
its expectations. Readers are cautioned not to place undue reliance on any
forward-looking statements. Any or all of these statements may turn out to be
incorrect. By their nature, forward-looking statements involve risks and
uncertainties because they relate to events and depend on circumstances that may
or may not occur in the future. Any forward-looking statements made in this
report speak only as of the date of such statement. It is not possible to
predict or identify all factors that could potentially cause actual results to
differ materially from expected and historical results. Factors that could cause
or contribute to the Company's actual results differing from its expectations
include those factors discussed in Item 1A of Part II of this Quarterly Report
on Form 10-Q and in the Company's other filings with the Securities and Exchange
Commission.
3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONGOLEUM CORPORATION
CONSOLIDATED BALANCE SHEEETS
(In thousands, except per share amounts)
March 31,
2006 December 31,
(Unaudited) 2005
--------------------------
ASSETS
Current assets:
Cash and cash equivalents ........................................................ $ 14,659 $ 24,511
Restricted cash .................................................................. 12,118 11,644
Accounts receivable, less allowances of $1,326 and $1,142 as of
March 31, 2006 and December 31, 2005, respectively ............................ 22,837 17,092
Inventories ...................................................................... 38,501 34,607
Prepaid expenses and other current assets ........................................ 22,474 20,139
Deferred income taxes ............................................................ 16,735 16,735
--------- ---------
Total current assets ......................................................... 127,324 124,728
Property, plant and equipment, net ............................................... 71,144 73,207
Other assets, net ................................................................ 9,328 9,412
--------- ---------
Total assets ................................................................ $ 207,796 $ 207,347
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ................................................................. $ 11,670 $ 11,769
Accrued liabilities .............................................................. 21,163 23,072
Asbestos-related liabilities ..................................................... 26,386 28,369
Revolving credit loan ............................................................ 11,290 9,404
Accrued taxes .................................................................... 170 107
Liabilities subject to compromise - current ........................................ 26,660 23,990
--------- ---------
Total current liabilities ................................................... 97,339 96,711
Deferred income taxes .............................................................. 16,735 16,735
Liabilities subject to compromise - long term ...................................... 138,416 138,861
--------- ---------
Total liabilities ........................................................... 252,490 252,307
--------- ---------
STOCKHOLDERS' EQUITY (DEFICIT)
Class A common stock, par value $0.01; 20,000,000 shares authorized; 4,736,950
shares issued and 3,662,790 shares outstanding as of March 31, 2006 and
December 31, 2005, respectively ................................................ 47 47
Class B common stock, par value $0.01; 4,608,945 shares authorized, issued and
outstanding at March 31, 2006 and December 31, 2005, respectively .............. 46 46
Additional paid-in capital ......................................................... 49,181 49,126
Retained deficit ................................................................... (65,194) (65,405)
Accumulated other comprehensive loss ............................................... (20,961) (20,961)
--------- ---------
(36,881) (37,147)
Less Class A common stock held in treasury, at cost; 1,074,560 shares at
March 31, 2006 and December 31, 2005, respectively ............................. 7,813 7,813
--------- ---------
Total stockholders' equity (deficit) .......................................... (44,694) (44,960)
--------- ---------
Total liabilities and stockholders' equity (deficit) .......................... $ 207,796 $ 207,347
========= =========
The accompanying notes are an integral part
of the condensed consolidated financial statements.
4
CONGOLEUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
March 31,
---------------------
2006 2005
(In thousands, except per share amounts)
Net sales ............................................ $ 57,237 $ 57,630
Cost of sales ........................................ 43,960 43,969
Selling, general and administrative expenses ...... 10,396 11,733
-------- --------
Income from operations ............................... 2,881 1,928
Other income (expense):
Interest income .................................. 157 98
Interest expense ................................. (2,734) (2,500)
Other income ..................................... (42) 122
-------- --------
Income (loss) before taxes ........................... 262 (352)
Provision for income taxes ........................... 51 --
-------- --------
Net income (loss) .................................... $ 211 $ (352)
======== ========
Net income (loss) per common share, basic ....... $ 0.03 $ (0.04)
======== ========
Net income (loss) per common share, diluted ..... $ 0.03 $ (0.04)
======== ========
Weighted average number of common shares
outstanding, basic ........................... 8,271 8,261
======== ========
Weighted average number of common shares
outstanding, diluted ......................... 8,321 8,261
======== ========
The accompanying notes are an integral part
of the condensed consolidated financial statements.
5
CONGOLEUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
----------------------
2006 2005
(In thousands)
Cash flows from operating activities:
Net income (loss) .................................................... $ 211 $ (352)
Adjustments to reconcile net loss to net cash (used in) provided by
Operating activities:
Depreciation ..................................................... 2,565 2,749
Amortization ..................................................... 96 96
Stock-based compensation expense ................................. 55 --
Changes in certain assets and liabilities:
Accounts and notes receivable ............................... (5,745) (8,634)
Inventories ................................................. (3,894) (743)
Prepaid expenses and other assets ........................... 1,257 841
Accounts payable ............................................ (99) 3,655
Accrued liabilities ......................................... 1,027 (2,261)
Asbestos-related liabilities ................................ (5,853) (4,263)
Other liabilities ........................................... (382) (415)
-------- --------
Net cash used in operating activities ................. (10,762) (9,327)
Cash flows from investing activities:
Capital expenditures ............................................. (502) (854)
-------- --------
Net cash used in investing activities ................. (502) (854)
Cash flows from financing activities:
Net short-term borrowings ........................................ 1,886 2,910
Net change in restricted cash .................................... (474) (877)
-------- --------
Net cash provided by financing activities ............. 1,412 2,033
-------- --------
Net decrease in cash and cash equivalents ................................ (9,852) (8,148)
Cash and cash equivalents:
Beginning of period .............................................. 24,511 29,710
-------- --------
End of period .................................................... $ 14,659 $ 21,562
======== ========
The accompanying notes are an integral part
of the condensed consolidated financial statements.
6
CONGOLEUM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and with Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements. In the opinion of management, all
adjustments (consisting of normal and recurring adjustments) considered
necessary for a fair presentation of Congoleum Corporation's (the "Company" or
"Congoleum") condensed consolidated financial position, results of operations
and cash flows have been included. Operating results for the three month period
ended March 31, 2006 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2006. For further information, refer
to the consolidated financial statements and related footnotes included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2005.
Based upon the nature of the Company's operations, facilities and
management structure, the Company considers its business to constitute a single
segment for financial reporting purposes.
Certain amounts appearing in the prior period's condensed consolidated
financial statements have been reclassified to conform to the current period's
presentation.
The financial statements of Congoleum have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. Accordingly, the financial
statements do not include any adjustments that might be necessary should the
Company be unable to continue as a going concern. As described more fully below
and in Note 6, there is substantial doubt about the Company's ability to
continue as a going concern unless it obtains relief from its substantial
asbestos liabilities through a successful reorganization under Chapter 11 of the
United States Bankruptcy Code (the "Bankruptcy Code").
During 2003, Congoleum obtained the requisite votes of asbestos personal
injury claimants necessary to seek approval of a proposed, pre-packaged Chapter
11 plan of reorganization. On December 31, 2003, Congoleum filed a voluntary
petition with the United States Bankruptcy Court for the District of New Jersey
(the "Bankruptcy Court") (Case No. 03-51524) seeking relief under Chapter 11 of
the Bankruptcy Code as a means to resolve claims asserted against it related to
the use of asbestos in its products decades ago. In January 2004, the Company
filed its proposed plan of reorganization and disclosure statement with the
Bankruptcy Court. In November 2004, Congoleum filed a modified plan of
reorganization and related documents with the Bankruptcy Court (the "Fourth
Plan") reflecting the result of further negotiations with representatives of the
Asbestos Claimants' Committee, the Future Claimants' Representative and other
asbestos claimant representatives. The Bankruptcy Court approved the disclosure
statement and plan voting procedures in December 2004 and Congoleum obtained the
requisite votes of asbestos personal injury claimants necessary to seek approval
of the Fourth Plan. In April 2005, Congoleum announced that it had reached an
agreement in principle with representatives of the Asbestos Claimants' Committee
and the Future Claimants' Representative to make certain modifications to its
7
proposed plan of reorganization and related documents governing the settlement
and payment of asbestos-related claims against Congoleum. Under the agreed-upon
modifications, asbestos claimants with claims settled under Congoleum's
pre-petition settlement agreements would agree to forbear from exercising the
security interest they were granted and share on a pari passu basis with all
other present and future asbestos claimants in insurance proceeds and other
assets of the trust to be formed upon confirmation of the plan under Section
524(g) of the Bankruptcy Code (the "Plan Trust") to pay asbestos claims against
Congoleum. In July 2005, Congoleum filed an amended plan of reorganization (the
"Sixth Plan") and related documents with the Bankruptcy Court which reflected
the result of these negotiations, as well as other technical modifications. The
Bankruptcy Court approved the disclosure statement and voting procedures and
Congoleum commenced solicitation of acceptances of the Sixth Plan in August
2005. In September 2005, Congoleum learned that certain asbestos claimants were
unwilling to agree to forbear from exercising their security interest as
contemplated by the Sixth Plan and the Sixth Plan was subsequently withdrawn. In
November 2005, the Bankruptcy Court denied a request to extend Congoleum's
exclusive right to file a plan of reorganization and solicit acceptances
thereof. In February 2006, Congoleum filed a new amended plan of reorganization
(the "Seventh Plan"). On February 27, 2006, the Company announced its intention
to make additional changes to its plan of reorganization, and on March 17, 2006
it filed a new amended plan (the "Eighth Plan"). In addition, an insurance
company has filed a plan of reorganization (the "CNA Plan") and the Official
Committee of Bondholders has also filed a plan (the "Bondholder Plan"). The
Bankruptcy Court has scheduled a hearing to consider the adequacy of the
disclosure statements with respect to these plans for June 8, 2006.
There can be no assurance that the Company will not amend the Eighth Plan,
that the Company will obtain approval to solicit acceptances of its plan of
reorganization, that the Company will receive the acceptances necessary for
confirmation of its plan of reorganization, that its plan will not be modified
further, that its plan will receive necessary court approvals from the
Bankruptcy Court or the Federal District Court, or that such approvals will be
received in a timely fashion, that its plan will be confirmed, or that its plan,
if confirmed, will become effective. It is unclear whether the Bankruptcy Court
will approve the CNA Plan or the Bondholder Plan or whether such plans, if
confirmed, would be feasible. Moreover, it is unclear whether any other person
will attempt to propose a plan or what any such plan would provide or propose,
and whether the Bankruptcy Court would approve a plan other than Congoleum's
proposed plan.
Congoleum is presently involved in litigation with certain insurance
carriers related to disputed insurance coverage for asbestos related
liabilities, and certain insurance carriers filed various objections to
Congoleum's previously proposed plans of reorganization and related matters and
are expected to file objections to the Eighth Plan. Certain other parties have
also filed various objections to Congoleum's previously proposed plans of
reorganization and may file objections to the Eighth Plan.
8
The Company expects that the terms of the Eighth Plan may be amended or
modified as a result of further negotiations with various parties. The terms of
the CNA Plan and the Bondholder Plan are materially different from the terms of
the Eighth Plan, and these plans may also be amended or modified or may be
withdrawn. There can be no assurance that the terms of the reorganization plan
that is ultimately confirmed, if any, will not materially differ from the terms
of the Eighth Plan. The Company expects that it will take until some time in the
fourth quarter of 2006 at the earliest to obtain confirmation of any plan of
reorganization.
In anticipation of Congoleum's commencement of the Chapter 11 cases,
Congoleum entered into a settlement agreement with various asbestos personal
injury claimants (the "Claimant Agreement"), which provides for an aggregate
settlement value of at least $466 million as well as an additional number of
individually negotiated trial listed settlements with an aggregate value of
approximately $25 million, for total settlements in excess of $491 million. As
contemplated by the Claimant Agreement, Congoleum also entered into agreements
establishing a pre-petition trust (the "Collateral Trust") to distribute funds
in accordance with the terms of the Claimant Agreement and granting the
Collateral Trust a security interest in Congoleum's rights under its applicable
insurance coverage and payments from Congoleum's insurers for asbestos claims.
In December 2005, Congoleum commenced an omnibus avoidance action and a sealed
avoidance action (collectively, the "Avoidance Actions") seeking to void the
security interest granted to the Collateral Trust and such settlements. In March
2006, Congoleum filed a motion for summary judgment in the Avoidance Actions
seeking to avoid the Claimant Agreement settlements and liens under various
bankruptcy theories. Under the terms of the Eighth Plan, asbestos personal
injury claimants voting to accept the plan would irrevocably consent or would be
deemed to have irrevocably consented to the forbearance of any claim and lien
rights under the Claimant Agreement and related agreements. Under the terms of
the Eighth Plan, after the establishment of the Plan Trust, the assets in the
Collateral Trust would be transferred to the Plan Trust and any asbestos claims
would be paid in accordance with the terms of the Eighth Plan. Settlement values
under the Eighth Plan may differ from values under the Sixth Plan and the
Claimant Agreement, which, together with the outcome of the Avoidance Actions,
may materially affect the liability associated with the asbestos personal injury
claims against Congoleum. As a result of tabulating ballots on the Fourth Plan,
the Company is also aware of claims by claimants whose claims were not
determined under the Claimant Agreement but who have submitted claims with a
value of approximately $512 million based on the settlement values applicable in
the Sixth Plan. Based on the Eighth Plan, the Company has made provision in its
financial statements for the minimum amount of the range of estimates for its
contribution to effect its plan to settle asbestos liabilities through the Plan
Trust. The Company recorded charges aggregating approximately $51.3 million in
prior years, and is not yet able to determine the amount of the additional cost
that will be required to complete its reorganization. Actual amounts that will
be contributed to the Plan Trust and costs for pursuing and implementing the
Eighth Plan or any other plan of reorganization could be materially higher than
currently recorded. The Company may record significant additional charges should
the minimum estimated cost increase. Delays in proposing, filing or obtaining
approval of the Eighth Plan or any new amended plan of reorganization, or the
continued pursuit of the CNA Plan or the Bondholder Plan by the proponents of
such plans, or the proposal of additional plans by other parties could result in
a proceeding that takes longer and is more costly than the Company has
estimated.
9
For more information regarding the Company's asbestos liability and plan
for resolving that liability, please refer to Note 6 of the Notes to Unaudited
Condensed Consolidated Financial Statements.
AICPA Statement of Position 90-7, "Financial Reporting by Entities in
Reorganization under the Bankruptcy Code" ("SOP 90-7") provides financial
reporting guidance for entities that are reorganizing under the Bankruptcy Code.
The Company implemented this guidance in consolidated financial statements for
periods after December 31, 2003.
Pursuant to SOP 90-7, companies are required to segregate pre-petition
liabilities that are subject to compromise and report them separately on the
balance sheet. Liabilities that may be affected by a plan of reorganization are
recorded at the amount of the expected allowed claims, even if they may be
settled for lesser amounts. Substantially all of the Company's liabilities at
December 31, 2003 have been reclassified as liabilities subject to compromise.
Obligations arising post-petition, and pre-petition obligations that are
secured, are not classified as liabilities subject to compromise.
Additional pre-petition claims (liabilities subject to compromise) may
arise due to the rejection of executory contracts or unexpired leases, or as a
result of the allowance of contingent or disputed claims.
2. Recent Accounting Principles:
Share Based Payment
On December 16, 2004, the Financial Accounting Standards Board ("FASB")
issued Statement No. 123 (revised 2004), Share-Based Payment ("SFAS 123R"), a
revision of FASB Statement No. 123, Accounting for Stock-Based Compensation
("SFAS 123"). SFAS 123R supersedes Accounting Principles Board ("APB") Opinion
No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95,
Statement of Cash Flows. Generally, the approach in SFAS 123R is similar to the
approach described in SFAS 123. However, SFAS 123R requires all share-based
payments to employees, including grants of employee stock options, to be
recognized in the income statement based on their fair values at the date of
grant. Pro forma disclosure is no longer permitted.
Effective January 1, 2006, the Company adopted SFAS 123R using the
modified prospective method as permitted under SFAS 123R. Under this transition
method, compensation cost recognized in the first quarter of fiscal 2006
includes: (a) compensation cost for all share-based payments granted prior to
but not yet vested as of December 31, 2005, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123, and (b) compensation
cost for all share-based payments granted subsequent to December 31, 2005, based
on the grant-date fair value estimated in accordance with the provisions of SFAS
123R. In accordance with the modified prospective method of adoption, the
Company's results of operations and financial position for prior periods have
not been restated. Prior to the adoption of SFAS 123R, the Company accounted for
stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock
Issued to Employees" (the intrinsic value method) and, accordingly, recognized
no compensation expense for stock option grants if the intrinsic value of a
grant was zero or less.
10
As a result of adopting SFAS 123R effective January 1, 2006, our income
before taxes, net income and basic and diluted earnings per share for the three
months ended March 31, 2006 were $54.6 thousand, $43.9 thousand, $0.01 per share
and $0.01 per share lower, respectively, than if we had continued to account for
stock-based compensation under APB Opinion No. 25 for our stock option grants.
The following table details the effect on net income and earnings per
share had stock-based compensation expense been recorded for the first three
months of fiscal year 2005 based on the fair-value method under SFAS 123. The
reported and pro forma net income and earnings per share for the first quarter
of fiscal year 2006 are the same since stock-based compensation expense was
calculated under the provisions of SFAS 123R.
Three Months Ended
March 31,
2005
------------------
Net income (loss):
As reported $ (352)
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects 60
-------
Pro forma $ (412)
=======
Net income (loss) per share:
As reported basic and diluted $ (0.04)
Pro forma compensation expense (0.01)
-------
Pro forma basic and diluted $ (0.05)
=======
The Company has elected to continue to use the Black-Scholes option
pricing model to estimate the fair value of stock-based awards. The use of a
Black-Scholes option pricing model requires the input of assumptions determined
by management of the company at the measurement date. These assumptions include
the risk-free interest rate, expected dividend yield, volatility factor of the
expected market price of the Company's common stock and the expected life of
stock option grants.
During the three months ended March 31, 2006 and 2005, the Company did not
grant any stock-based awards. Stock compensation expense recognized in the first
quarter of 2006 represents the vesting of options previously granted. The fair
values of these options were estimated on the dates of grant using the
Black-Scholes model and assumptions determined on the grant dates.
At March 31, 2006, there was $0.3 million of unrecognized compensation
expense related to share-based payments, which is expected to be recognized over
a weighted-average period of 1.6 years.
The Company currently grants stock options under the Company's 1995 Stock
Option Plan (the "1995 Plan") and its 1999 Stock Option Plan for Non-Employee
Directors (the "1999 Plan"). Under the 1995 Plan, options to purchase up to
800,000 shares of the Company's Class A common stock may be issued to officers
and key employees. Such options may be either incentive stock options or
11
nonqualified stock options, and the options' exercise price must be at least
equal to the fair value of the Company's Class A common stock on the date of
grant. All options granted under the 1995 Plan have ten-year terms and vest over
five years at the rate of 20% per year beginning on the first anniversary of the
date of grant
Under the 1999 Plan, non-employee directors may be granted options to
purchase up to 50,000 shares of the Company's Class A common stock. Options
granted under the 1999 Plan have ten-year terms and vest six months from the
grant date.
The following table presents stock option activity for the three months
ended March 31, 2006:
Weighted-
Weighted- Average
Average Remaining
Stock Exercise Contractual
Options Price Term
------- ----- ----
1995 Plan:
Outstanding at December 31, 2005 672,000 $2.03 6.65 years
Forfeited/Cancelled (4,500) $2.05 6.66 years
Exercised --
--------
Outstanding at March 31, 2006 667,500 $2.03 6.40 years
========
Exercisable at March 31, 2006 385,500 $2.02 6.40 years
Weighted-
Weighted- Average
Average Remaining
Stock Exercise Contractual
Options Price Term
------- ----- ----
1999 Plan:
Outstanding at December 31, 2005 21,500 $2.40 6.68 years
Forfeited/Cancelled --
Exercised --
--------
Outstanding at March 31, 2006 21,500 $2.40 7.29 years
========
Exercisable at March 31, 2006 19,500 $2.19 7.29 years
Shares available for future share-based grants to employees and directors
under existing plans were 147,400 at March 31, 2006. At March 31, 2006, the
aggregate intrinsic value of options on outstanding shares was $170,872, and the
aggregate intrinsic value of options exercisable was $104,895. The total
intrinsic value of options vested during the three months ended March 31, 2006
was $4,977.
12
The following table summarizes our non-vested stock option activity for
the three months ended March 31, 2006:
Weighted-Average
Number of Grant-Date
Shares Fair Value
------ ----------
1995 Plan:
Non-vested stock options at January 1, 2006 288,400 $1.63
Granted --
Forfeited (1,000) $1.65
Vested (5,400) $1.10
--------
Non-vested stock options at March 31, 2006 282,000 $1.64
========
Weighted-Average
Number of Grant-Date
Shares Fair Value
------ ----------
1999 Plan:
Non-vested stock options at January 1, 2006 4,500 $4.14
Granted --
Forfeited --
Vested (2,500) $3.91
--------
Non-vested stock options at March 31, 2006 2,000 $4.43
========
3. Inventories
A summary of the major components of inventories is as follows (in
thousands):
March 31, December 31,
2006 2005
-------------------------
Finished goods $29,258 $25,548
Work-in-process 2,072 1,497
Raw materials and supplies 7,171 7,562
------- -------
Total inventories $38,501 $34,607
======= =======
13
4. Income (Loss) Per Share
Basic net income (loss) per share is calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted net income per share is calculated by dividing net income by the
weighted average number of shares of common stock and common stock equivalents
outstanding during the period, unless their effect is anti-dilutive.
5. Environmental and Other Liabilities
The Company records a liability for environmental remediation claims when
a cleanup program or claim payment becomes probable and the costs can be
reasonably estimated. As assessments and cleanup programs progress, these
liabilities are adjusted based upon the progress in determining the timing and
extent of remedial actions and the related costs and damages. The recorded
liabilities, totaling $4.3 million at March 31, 2006 and December 31, 2005,
respectively, are not reduced by the amount of insurance recoveries. Such
estimated insurance recoveries approximated $1.9 million at March 31, 2006 and
December 31, 2005, respectively, and are reflected in other non-current assets.
Receivables for expected insurance recoveries are recorded if the related
carriers are solvent and paying claims under a reservation of rights or under an
obligation pursuant to coverage in place or a settlement agreement.
Substantially all of Congoleum's recorded insurance asset for environmental
matters is collectible from a single carrier.
The Company is named, together with a large number (in most cases,
hundreds) of other companies, as a potentially responsible party ("PRP") in
pending proceedings under the federal Comprehensive Environmental Response,
Compensation and Liability Act, as amended ("CERCLA"), and similar state laws.
In addition, in four other instances, although not named as a PRP, the Company
has received a request for information. The pending proceedings relate to eight
disposal sites in New Jersey, Pennsylvania, and Maryland in which recovery from
generators of hazardous substances is sought for the cost of cleaning up the
contaminated waste sites. The Company's ultimate liability and funding
obligations in connection with those sites depends on many factors, including
the volume of material contributed to the site, the number of other PRPs and
their financial viability, the remediation methods and technology to be used and
the extent to which costs may be recoverable from insurance. However, under
CERCLA and certain other laws, the Company, as a PRP, can be held jointly and
severally liable for all environmental costs associated with a site.
The most significant exposure for which the Company has been named a PRP
relates to a recycling facility site in Elkton, Maryland. The PRP group at this
site is made up of 81 companies, substantially all of which are large
financially solvent entities. Two removal actions were substantially complete as
of December 31, 1998 and a groundwater treatment system was installed
thereafter. The Environmental Protection Agency ("EPA") has selected a remedy
for the soil and shallow groundwater; however, the remedial
investigation/feasibility study related to the deep groundwater has not been
completed. The PRP group estimates that future costs of the remedy selected by
EPA based on engineering estimates would be approximately $11 million.
Congoleum's proportionate share, based on waste disposed at the site, is
estimated to be approximately 5.7%, or $0.7 million. The majority of Congoleum's
share of costs is presently being paid by one of its insurance carriers, whose
remaining policy limits for this claim will cover approximately half this
amount. Congoleum expects the balance to be funded by other insurance carriers
and the Company.
14
The Company also accrues remediation costs for certain of the Company's
owned facilities on an undiscounted basis. The Company has entered into an
administrative consent order with the New Jersey Department of Environmental
Protection and has established a remediation trust fund of $100 thousand as
financial assurance for certain remediation funding obligations. Estimated total
cleanup costs of $1.6 million, including capital outlays and future maintenance
costs for soil and groundwater remediation, are primarily based on engineering
studies. Of this amount, $0.3 million is included in current liabilities subject
to compromise and $1.3 million is included in non-current liabilities subject to
compromise.
The Company anticipates that these matters will be resolved over a period
of years and that after application of expected insurance recoveries, funding
the costs will not have a material adverse impact on the Company's liquidity or
financial position. However, unfavorable developments in these matters could
result in significant expenses or judgments that could have a material adverse
effect on the financial position of the Company.
6. Asbestos Liabilities
Claims Settlement and Chapter 11 Reorganization
In early 2003, the Company announced a strategy for resolving current and
future asbestos claims liability through confirmation of a pre-packaged plan of
reorganization under Chapter 11 of the Bankruptcy Code. Later in 2003, the
Company entered into the Claimant Agreement, a settlement agreement with various
asbestos personal injury claimants. As contemplated by the Claimant Agreement,
the Company also entered into agreements establishing the Collateral Trust to
distribute funds in accordance with the terms of the Claimant Agreement and
granting the Collateral Trust a security interest in the Company's rights under
its applicable insurance coverage and payments from the Company's insurers for
asbestos claims.
The Claimant Agreement established a compensable disease valuation matrix
(the "Matrix") and allowed claimants who qualified to participate in the
Claimant Agreement (the "Qualifying Claimants") to settle their claims for the
Matrix value, secured in part (75%) by a security interest in the collateral
granted to the Collateral Trust. The Collateral Trust provides for distribution
of trust assets according to various requirements that give priority (subject to
aggregate distribution limits) to participating claimants who had pre-existing
unfunded settlement agreements ("Pre-Existing Settlement Agreements") with the
Company and participating claimants who qualified for payment under unfunded
settlement agreements entered into by the Company with plaintiffs that had
asbestos claims pending against the Company and which claims were scheduled for
trial after the effective date of the Claimant Agreement but prior to the
commencement of the Company's anticipated Chapter 11 reorganization case
("Trial-Listed Settlement Agreements").
15
The Claimant Agreement incorporated Pre-Existing Settlement Agreements and
the settlement of certain Trial-Listed Settlement Agreement claims for a fully
secured claim against the Collateral Trust, and it settled all other claims for
a secured claim against the Collateral Trust equal to 75% of the claim value and
an unsecured claim for the remaining 25%. In December 2005, the Company
commenced the Avoidance Actions seeking to void the security interest granted to
the Collateral Trust and such settlements. In March 2006, Congoleum filed a
motion for summary judgment in the Avoidance Actions seeking to avoid the
Claimant Agreement settlements and liens under various bankruptcy theories.
In October 2003, the Company began soliciting acceptances for its proposed
pre-packaged plan of reorganization and the Company received the votes necessary
for acceptance of the plan in late December 2003. On December 31, 2003,
Congoleum filed a voluntary petition with the Bankruptcy Court (Case No.
03-51524) seeking relief under Chapter 11 of the Bankruptcy Code. In January
2004, the Company filed its proposed plan of reorganization and disclosure
statement with the Bankruptcy Court.
In November 2004, Congoleum filed the Fourth Plan with the Bankruptcy
Court reflecting the result of further negotiations with representatives of the
Asbestos Claimants' Committee, the Future Claimants' Representative and other
asbestos claimant representatives. The Bankruptcy Court approved the disclosure
statement and plan voting procedures in December 2004 and Congoleum obtained the
requisite votes of asbestos personal injury claimants necessary to seek approval
of the Fourth Plan.
In April 2005, Congoleum announced that it had reached an agreement in
principle with representatives of the Asbestos Claimants' Committee and the
Future Claimants' Representative to make certain modifications to its proposed
plan of reorganization and related documents governing the settlement and
payment of asbestos-related claims against Congoleum. Under the agreed-upon
modifications, asbestos claimants with claims settled under Congoleum's
pre-petition settlement agreements would agree to forbear from exercising the
security interest they were granted and share on a pari passu basis with all
other present and future asbestos claimants in insurance proceeds and other
assets of the Plan Trust.
In July 2005, Congoleum filed the Sixth Plan and related documents with
the Bankruptcy Court which reflected the result of these negotiations, as well
as other technical modifications. The Bankruptcy Court approved the disclosure
statement and voting procedures and Congoleum commenced solicitation of
acceptances of the Sixth Plan in August 2005. In September 2005, Congoleum
learned that certain asbestos claimants were unwilling to agree to forbear from
exercising their security interest as contemplated by the Sixth Plan and
subsequently withdrew the Sixth Plan.
In November 2005, the Bankruptcy Court denied a request to extend
Congoleum's exclusive right to file a plan of reorganization and solicit
acceptances thereof. In February 2006, Congoleum filed the Seventh Plan. On
February 27, 2006, the Company announced its intention to make additional
changes to its plan of reorganization, and on March 17, 2006 it filed the Eighth
Plan. In addition, an insurance company has filed the CNA Plan and the Official
Committee of Bondholders has filed the Bondholder Plan. The Bankruptcy Court has
scheduled a hearing to consider the adequacy of the disclosure statements with
respect to these plans for June 8, 2006.
16
Under the terms of the Eighth Plan, asbestos personal injury claimants
voting to accept the plan would irrevocably consent or would be deemed to have
irrevocably consented to the forbearance of any claim and lien rights under the
Claimant Agreement and related agreements.
Under the terms of the Eighth Plan, after the establishment of the Plan
Trust, the assets in the Collateral Trust would be transferred to the Plan Trust
and any asbestos claims would be channeled to the Plan Trust and paid in
accordance with the terms of the Eighth Plan.
There can be no assurance that the Company will not amend the Eighth Plan,
that the Company will obtain approval to solicit acceptances of its plan of
reorganization, that the Company will receive the acceptances necessary for
confirmation of its plan, that its plan will not be modified further, that its
plan will receive necessary court approvals from the Bankruptcy Court or the
Federal District Court, or that such approvals will be received in a timely
fashion, that its plan will be confirmed, or that its plan, if confirmed, will
become effective. It is unclear whether the Bankruptcy Court will approve the
CNA Plan or the Bondholder Plan or whether either of such plans, if confirmed,
would be feasible. Moreover, it is unclear whether any other person will attempt
to propose a plan or what any such plan would provide or propose, and whether
the Bankruptcy Court would approve a plan other than Congoleum's proposed plan.
Congoleum is presently involved in litigation with certain insurance
carriers related to disputed insurance coverage for asbestos related
liabilities, and certain insurance carriers filed various objections to
Congoleum's previously proposed plans of reorganization and related matters and
are expected to file objections to the Eighth Plan. Certain other parties have
also filed various objections to Congoleum's previously proposed plans of
reorganization and may file objections to the Eighth Plan.
During 2005 and 2006 the Company has entered into a number of settlement
agreements with excess insurance carriers over coverage for asbestos-related
claims. In May 2005, certain AIG companies agreed to pay approximately $103
million over ten years to the Plan Trust. This settlement resolves coverage
obligations of policies with a total of $114 million in liability limits for
asbestos bodily injury claims. Payment is subject to various conditions,
including without limitation, the effectiveness of a plan of reorganization that
provides AIG with certain specified relief including a channeling injunction
pursuant to Section 524(g) of the Bankruptcy Code. An insurer has appealed the
approval order granted by the Bankruptcy Court to the U.S. District Court, where
it is pending. In June 2005, the Company entered into a settlement agreement
with certain underwriters at Lloyd's, London, pursuant to which the certain
underwriters paid approximately $20 million into an escrow account in exchange
for a release of insurance coverage obligations. The escrow agent will transfer
the funds to the Plan Trust once a plan of reorganization with the Section
524(g) protection specified in the settlement agreement goes effective and the
Bankruptcy Court approves the transfer of the funds. In August 2005, the Company
entered into a settlement agreement with Federal Insurance Company pursuant to
which Federal will pay $4 million to the Plan Trust, subject to certain
adjustments, once a plan of reorganization with the Section 524(g) protection
specified in the settlement agreement goes effective and the Bankruptcy Court
approves the transfer of the funds. The Future Claimants' Representative has
appealed the approval order granted by the Bankruptcy Court to the U.S. District
Court, where it is pending. In October 2005, Congoleum entered into a settlement
agreement with Mt. McKinley Insurance Company and Everest Reinsurance Company
pursuant to which Mt. McKinley and Everest have paid $21.5 million into an
escrow account. The escrow agent will transfer the funds to the Plan Trust once
a plan of reorganization with the Section 524(g) protection specified in the
17
settlement agreement goes effective and the Bankruptcy Court approves the
transfer of the funds. An insurer and the Future Claimants' Representative have
appealed the approval order granted by the Bankruptcy Court to the U.S. District
Court, where it is pending. In March 2006, Congoleum entered into a settlement
agreement with Harper Insurance Limited. Under the terms of this settlement,
Harper will pay $1.4 million to Congoleum or the Plan Trust once certain
conditions are satisfied, including the effectiveness of a plan of
reorganization containing the Section 524(g) protection specified in the
settlement agreement. The Bankruptcy Court approved this settlement in April
2006. In April 2006, Congoleum entered into a settlement agreement with
Travelers Casualty and Surety Company and St. Paul Fire and Marine Insurance
Company ("Travelers"), collectively. Under the terms of this settlement,
Travelers will pay $25 million in two installments over thirteen months to the
Plan Trust once a plan of reorganization with the Section 524(g) protection
specified in the settlement agreement goes effective and the Bankruptcy Court
approves the transfer of the funds. A motion for Bankruptcy Court approval of
this settlement is pending. In April 2006, Congoleum also entered into a
settlement agreement with Fireman's Fund Insurance Company. Under the terms of
this settlement, Fireman's Fund will pay $1 million to the Plan Trust once a
plan of reorganization with the Section 524(g) protection specified in the
settlement agreement goes effective and the Bankruptcy Court approves the
transfer of the funds. A motion for Bankruptcy Court approval of this settlement
is pending. It is possible that any of the settling insurers may argue that the
Eighth Plan is not substantially similar to relevant provisions of earlier plans
referenced in its respective settlement agreement and therefore is relieved of
its settlement obligation.
The Company expects that it will take until some time in the fourth
quarter of 2006 at the earliest to obtain confirmation of the Eighth Plan.
Under the Eighth Plan, Congoleum's assignment of insurance recoveries to
the Plan Trust is net of costs incurred by Congoleum in connection with
insurance coverage litigation. Congoleum is entitled to withhold from
recoveries, or seek reimbursement from the Plan Trust, for coverage litigation
costs incurred after January 1, 2003. Congoleum also paid $1.3 million in claims
processing fees in connection with claims settled under the Claimant Agreement.
Under the Eighth Plan, Congoleum is entitled to withhold from recoveries, or
seek reimbursement from the Plan Trust, for the $1.3 million claims processing
fee. There can be no assurance that any future plan will provide for Congoleum
to recover any coverage litigation costs or claims processing fees. The Eighth
Plan provides for the channeling of asbestos property damage claims in addition
to asbestos personal injury claims to the Plan Trust. There were no asbestos
related property damage claims asserted against the Company at the time of its
bankruptcy filing. The Bankruptcy Court approved an order establishing a bar
date of May 3, 2004 for the filing of asbestos property damage claims. The
claims agent appointed in the Company's bankruptcy proceeding advised the
Company that, as of the bar date, it received 35 timely filed asbestos property
damage claims asserting liquidated damages in the amount of approximately $0.8
million plus additional unspecified amounts. The Company objected to certain
claims on various grounds, and the Bankruptcy Court ultimately allowed 19 claims
valued at $133 thousand. The Eighth Plan will pay those claims in full from
certain insurance proceeds.
18
The Eighth Plan provides that on the effective date of the Eighth Plan,
Congoleum will issue a new security (the "New Convertible Security") in the form
of either shares of preferred stock or convertible promissory notes and
contribute it to the Plan Trust on the effective date of its plan of
reorganization in satisfaction of section 524(g) of the Bankruptcy Code. If the
New Convertible Security is to be shares of preferred stock of reorganized
Congoleum, it will have the following terms: (i) an initial liquidation
preference equal to $2,738,234.75 in the aggregate, such amount being subject to
increase in the amount (the "Market Reset Obligation"), if any, by which 36% of
reorganized Congoleum's market capitalization based on average trading prices
for reorganized Congoleum's Class A common stock at the close of trading for the
90 consecutive trading days beginning on the one year anniversary of the
effective date of its plan of reorganization, exceeds such initial liquidation
preference; (ii) an initial dividend rate equal to 9% of the liquidation
preference per annum, payable semi-annually in arrears, with such dividend rate
to reset at the rate of 5% of the liquidation preference per annum on the tenth
anniversary of such effective date and payable at such reset dividend rate per
annum unless and until redeemed; (iii) redeemable for the liquidation preference
at the option of the Plan Trust or reorganized Congoleum following the tenth
anniversary of such effective date; (iv) a mandatory redemption on the fifteenth
anniversary of such effective date if not redeemed earlier; (v) convertible into
5,700,000 shares of Class A Common Stock (or the equivalent thereof on a fully
diluted basis) upon a specified default of the obligation to pay dividends and a
failure to cure such default within any cure period, which, when combined with
the 3.8 million newly issued shares of Class A Common Stock to be contributed to
the Plan Trust, will result in the Plan Trust owning 51% of the voting common
shares of reorganized Congoleum on a fully diluted basis; and (vi) no voting
rights, except upon conversion. If the New Convertible Security is convertible
promissory notes, such notes will be on economic terms substantially equivalent
to provisions (i) and (v) of the preferred stock described herein, with other
terms substantially the same as the Promissory Note described in the Sixth Plan.
Under the Eighth Plan and related documents, ABI has agreed to make a cash
contribution in the amount of $250 thousand to the Plan Trust upon the formation
of the Plan Trust. Under the Eighth Plan, ABI would receive certain relief as
may be afforded under Section 524(g)(4) of the Bankruptcy Code from asbestos
claims that derive from claims made against the Company, which claims are
expected to be channeled to the Plan Trust. However, the Eighth Plan does not
provide that any other asbestos claims that may be asserted against ABI would be
channeled to the Plan Trust.
There are sufficient risks and uncertainties related to Congoleum's
efforts to confirm a plan of reorganization such that no assurances of the
outcome can be given. In addition, the remaining costs to effect the
reorganization process, consisting principally of legal and advisory fees and
contributions to the Plan Trust, are expected to be approximately $17.2 million
at a minimum, not including any Market Reset Obligation arising from revaluation
of the New Convertible Security, and could be materially higher.
Based on the Eighth Plan, the Company has made provision in its financial
statements for the minimum amount of the range of estimates for its contribution
to effect its plan to settle asbestos liabilities through the Plan Trust. The
Company recorded charges aggregating approximately $51.3 million in prior years,
and is not yet able to determine the amount of the additional cost that will be
required to complete its reorganization as based on the Eighth Plan. The Company
is not yet able to determine the additional costs that may be required to effect
the Eighth Plan or any other plan, and actual amounts that will be contributed
to the Plan Trust and costs for pursuing and implementing any plan of
reorganization could be materially higher than currently recorded. Delays in
19
proposing, filing or obtaining approval of the Eighth Plan or any new amended
plan of reorganization, or the continued pursuit of the CNA Plan or the
Bondholder Plan by the proponents of such plans, or the proposal of additional
plans by other parties could result in a proceeding that takes longer and is
more costly than the Company has estimated. The Company may record significant
additional charges should the minimum estimated cost increase.
Pending Asbestos Claims
In 2003, the Company was one of many defendants in approximately 22
thousand pending lawsuits (including workers' compensation cases) involving
approximately 106 thousand individuals, alleging personal injury or death from
exposure to asbestos or asbestos-containing products. Claims involving
approximately 80 thousand individuals have been settled pursuant to the Claimant
Agreement and litigation related to unsettled or new claims is presently stayed
by the Bankruptcy Code. The Company expects unsettled and future claims to be
handled in accordance with the terms of a plan of reorganization and the Plan
Trust. In December 2005, the Company commenced the Avoidance Actions seeking to
void the security interest granted to the Collateral Trust and such settlements.
Nearly all asbestos-related claims that have been brought against the
Company to date allege that various diseases were caused by exposure to
asbestos-containing products, including resilient sheet vinyl and tile
manufactured by the Company (or, in the workers' compensation cases, exposure to
asbestos in the course of employment with the Company). The Company discontinued
the manufacture of asbestos-containing sheet products in 1983 and
asbestos-containing tile products in 1974. In general, governmental authorities
have determined that asbestos-containing sheet and tile products are non-friable
(i.e., cannot be crumbled by hand pressure) because the asbestos was
encapsulated in the products during the manufacturing process. Thus,
governmental authorities have concluded that these products do not pose a health
risk when they are properly maintained in place or properly removed so that they
remain non-friable. The Company has issued warnings not to remove
asbestos-containing flooring by sanding or other methods that may cause the
product to become friable.
Status of Insurance Coverage
During the period that Congoleum produced asbestos-containing products,
the Company purchased primary and excess insurance policies providing in excess
of $1 billion of coverage for general and product liability claims. Through
August 2002, substantially all asbestos-related claims and defense costs were
paid through primary insurance coverage. In August 2002, the Company received
notice that its primary insurance limits had been paid in full. The payment of
limits in full by one of the primary insurance companies was based on its
contention that limits in successive policies were not cumulative for asbestos
claims and that Congoleum was limited to only one policy limit for multiple
years of coverage. Certain excess insurance carriers claimed that the
non-cumulation provisions of the primary policies were not binding on them and
that there remained an additional $13 million in primary insurance limits plus
related defense costs before their policies were implicated. There is insurance
coverage litigation currently pending between Congoleum and its excess insurance
carriers, and the guaranty funds and associations for the State of New Jersey.
The litigation was initiated in September 2001, by one of Congoleum's excess
insurers (the "Coverage Action"). In April 2003, the New Jersey Supreme Court
ruled in another case involving the same non-cumulation provisions as in the
Congoleum primary policies (the "Spaulding Case") that the non-cumulation
20
provisions are invalid under New Jersey law and that the primary policies
provide coverage for the full amount of their annual limits for all successive
policies. Congoleum has reached a settlement agreement (the "Insurance
Settlement") with the insurance carrier whose policies contained the
non-cumulation provisions, pursuant to which the insurance carrier will pay
Congoleum $15.4 million in full satisfaction of the applicable policy limits, of
which $14.5 million has been paid to date. Pursuant to the terms of the Security
Agreement, the Company is obligated to pay any insurance proceeds it receives
under the Insurance Settlement, net of any fees and expenses it may be entitled
to deduct, to the Collateral Trust. Payment of such fees and expenses are
subject to Bankruptcy Court order or approval. The Company does not expect the
Insurance Settlement to have a material effect on its financial condition or
results of operations. As of December 31, 2002, the Company had entered into
additional settlement agreements with asbestos claimants exceeding the amount of
previously disputed coverage. The excess carriers have objected to the
reasonableness of several of these settlements, and Congoleum believes that they
will continue to dispute the reasonableness of the settlements and contend that
their policies still are not implicated and will dispute their coverage for that
and other various reasons in ongoing coverage litigation. The excess insurance
carriers have also raised various objections to the Company's previously
proposed plans of reorganization and may raise objections to any new amended
plan that is proposed.
The excess insurance carriers have objected to the global settlement of
the asbestos claims currently pending against Congoleum as contemplated by the
Claimant Agreement on the grounds that, among other things, the negotiations
leading to the settlement and the Claimant Agreement violate provisions in their
insurance policies, including but not limited to the carriers' right to
associate in the defense of the asbestos cases, the duty of Congoleum to
cooperate with the carriers and the right of the carriers to consent to any
settlement. The excess insurance carriers also contend the Claimant Agreement is
not fair, reasonable or in good faith. Additionally, certain insurers have
argued that Congoleum's entering into the Claimant Agreement voids the insurance
for the underlying claims in their entirety. Certain insurers also have claimed
that the Claimant Agreement voids their entire policy obligations. Congoleum has
disputed the allegations and contentions of the excess insurance carriers. In
November 2003, the Court denied a motion for summary judgment by the excess
insurance carriers that the Claimant Agreement was not fair, reasonable or in
good faith, ruling that material facts concerning these issues were in dispute.
In April 2004, the Court denied motions for summary judgment by the excess
carriers that the Claimant Agreement was not binding on them because Congoleum
had breached the consent and cooperation clauses of their insurance policies by,
among other things, entering into the Claimant Agreement without their consent.
Congoleum has argued, among other things, that it was entitled to enter into the
Claimant Agreement and/or the Claimant Agreement was binding on the excess
insurance carriers because they were in breach of their policies and/or had
denied coverage and/or had created a conflict with Congoleum by reserving rights
to deny coverage and/or the Claimant Agreement was fair, reasonable and in good
faith and/or there was and is no prejudice to the excess insurance carriers from
the Claimant Agreement and/or the excess insurance carriers had breached their
duties of good faith and fair dealing.
In August 2004, the Court entered a case management order that divided the
trial into three phases. A new judge was assigned to the case in February 2005
and the schedule was modified as a result.
21
In February 2005, the Court ruled on a series of summary judgment motions
filed by various insurers. The Court denied a motion for summary judgment filed
by certain insurers, holding that there were disputed issues of fact regarding
whether the Claimant Agreement and other settlement agreements between Congoleum
and the claimants had released Congoleum and the insurers from any liability for
the asbestos bodily injury claims of the claimants who signed the Claimant
Agreement and the other settlement agreements.
The Court also denied another motion for summary judgment filed by various
insurers who argued that they did not have to cover the liability arising from
the Claimant Agreement because they had not consented to it.
The Court granted summary judgment regarding Congoleum's bad faith claims
against excess insurers (other than first-layer excess insurers), holding that
the refusal of these excess insurers to cover the Claimant Agreement was at
least fairly debatable and therefore not in bad faith.
The first phase of the trial began in August 2005 and is addressing all
issues and claims relating to whether the insurers are obligated to provide
coverage under the policies at issue in this litigation for the global Claimant
Agreement entered into by Congoleum, including but not limited to all issues and
claims relating to both Congoleum's decision and conduct in entering into the
Claimant Agreement and filing a pre-packaged bankruptcy and the insurance
company defendants' decisions and conduct in opposing the Claimant Agreement and
Congoleum's pre-packaged bankruptcy, the reasonableness and good faith of the
Claimant Agreement, whether the Claimant Agreement breached any insurance
policies and, if so, whether the insurance companies suffered any prejudice, and
whether the insurance companies' opposition to the Claimant Agreement and
bankruptcy and various other conduct by the insurers has breached their duties
of good faith and fair dealing such that they are precluded from asserting that
Congoleum's decision to enter into the Claimant Agreement constitutes any
breach(es) on the part of Congoleum. The Company believes, however, that even if
the insurers were to succeed in the first phase of the Coverage Action, such
result would not deprive individual claimants of the right to seek payment from
the insurers who issued the affected insurance policies. Additionally, Congoleum
could negotiate settlements with some or all of the signatories to the Claimant
Agreement and seek payment from its insurers for such settlements. Such result
would not preclude the Company from attempting to amend the Claimant Agreement
and thereafter seek recovery under the Claimant Agreement as amended; moreover,
the Company does not believe that it would be deprived of coverage-in-place
insurance for future obligations of or demands upon the insurers under the
applicable insurance policies. However, there can be no assurances of the
outcome of these matters or their potential effect on the Company's ability to
obtain approval of its plan of reorganization.
The second phase of the trial will address all coverage issues, including
but not limited to trigger and allocation. The final phase of the trial will
address bad faith punitive damages, if appropriate.
In March 2005, the Company filed a motion in the Bankruptcy Court asking
the Bankruptcy Court to vacate its prior order lifting the automatic stay in
bankruptcy to permit the Coverage Action to proceed. The Company requested that
the Coverage Action proceedings be stayed until the Company has completed its
plan confirmation process in the Bankruptcy Court. A hearing on the Company's
motion was held in April 2005 and the motion was denied.
22
In October 2005, a federal appeals court ruled that the law firm of
Gilbert Heintz & Randolph, which had been acting as the Company's insurance
co-counsel in the Coverage Action, had other representations which were in
conflict with its representation of Congoleum. As a result of this ruling, with
Bankruptcy Court approval, Congoleum retained the firm of Covington & Burling to
represent it as co-counsel with Dughi & Hewit in the insurance coverage
litigation and insurance settlement matters previously handled by Gilbert Heintz
& Randolph.
In or about mid-November 2005, and in early December 2005, certain
insurers filed motions for summary judgment on the grounds, inter alia, that the
decision of the United States Court of Appeals for the Third Circuit reversing
the Bankruptcy Court's order approving the retention of the Gilbert Heinz &
Randolph firm in In re Congoleum, 426 F.3d 675 (3d Cir. 2005), and/or
Congoleum's filing of the Avoidance Actions in the Bankruptcy Court, entitled
them to judgment as a matter of law on the Phase I issues. Congoleum opposed the
motions. The motions were argued on January 10, 2006, and on March 16, 2006 the
Court denied the motions for summary judgment.
Congoleum completed the presentation of its case on April 28, 2006.
Certain insurers moved for a directed verdict in their favor during the first
week of May 2006. Hearings of arguments on the directed verdict motion are
scheduled to begin June 2, 2006.
Some insurers contend that, if there is a ruling adverse to Congoleum in
the Coverage Litigation, then the insurers will not owe coverage for claims
resolved under the Claimant Agreement and/or under other pre-petition
settlements. Insurers further contend that such result would also deprive
individual claimants who were parties to the Claimant Agreement and other
pre-petition settlements of the right to seek payment from the insurers under
their insurance policies or from negotiating settlements with some or all of the
insurers. Insurers also contend that such result would preclude Congoleum and
claimants from agreeing to forbear under or amending the Claimant Agreement and
other pre-petition settlements and would preclude claimants from seeking
recovery under other claims payment standards, including bankruptcy Trust
Distribution Procedures (TDPs), or under any amended agreements. Congoleum
intends to contest any attempt by the insurers to enlarge or expand upon a Phase
1 ruling that is adverse to Congoleum. However, there can be no assurances of
the outcome of these matters.
The Phase 2 trial will address all remaining coverage issues, including
but not limited to trigger and allocation. Discovery is permitted on all issues,
except for punitive damages. Pre-trial motions and trial dates for the Phase 2
and Phase 3 trials and discovery for the Phase 3 trial will be addressed by the
Court after the Phase 1 trial decision.
Given the actions of its excess insurance carriers, the Company believes
it likely that it would currently have to fund any asbestos-related expenses for
defense expense and indemnity itself. However, litigation by asbestos claimants
against the Company is stayed pursuant to the Company's bankruptcy proceedings,
and the Company does not anticipate its future expenditures for defense and
indemnity of asbestos-related claims, other than expenditures pursuant to a plan
of reorganization, will be significant.
23
Accounting for Asbestos-Related Claims
Under the terms of the Claimant Agreement, the Company's claims processing
agent processed 79,630 claims meeting the requirements of the Claimant Agreement
with a settlement value in excess of $466 million. In addition, Pre-Existing
Settlement Agreements and Trial-Listed Settlement Agreements with claims secured
by the Collateral Trust total approximately $25 million. As a result of
tabulating ballots on its Fourth Plan, the Company is also aware of claims by
claimants whose claims were not determined under the Claimant Agreement but who
have submitted claims with a value of approximately $512 million based on the
settlement values applicable in the Sixth Plan.
The Company's gross liability of in excess of $491 million for these
settlements and contingent liability for the additional approximately $512
million in unsettled claims is substantially in excess of the total assets of
the Company. The Company believes that it does not have the necessary financial
resources to litigate and/or fund judgments and/or settlements of the asbestos
claims in the ordinary course of business. Therefore, the Company believes the
most meaningful measure of its probable loss due to asbestos litigation is the
amount it will have to contribute to the Plan Trust plus the costs to effect its
reorganization under Chapter 11. At March 31, 2006, the Company estimates it
will spend a further $17.2 million at a minimum in fees, expenses, and trust
contributions in connection with obtaining confirmation of its plan of
reorganization, which amount is recorded in its reserve for asbestos-related
liabilities (in addition to the $9.4 million insurance settlement being held as
restricted cash). It also expects to spend a further $7.9 million at a minimum
in connection with insurance coverage litigation costs, for which it expects to
be reimbursed as discussed above. Required expenditures could be materially
higher than these estimates. The Company currently holds $3.7 million in
restricted cash that may be available to offset future costs incurred pursuing
insurance coverage, subject to approval by the Bankruptcy Court. In February
2006, the Bankruptcy Court ordered Gilbert, Heintz & Randolph, a law firm
formerly representing Congoleum, to disgorge all fees and certain expenses it
was paid by Congoleum. The law firm has appealed this ruling. The amount of the
disgorgement is approximately $9.6 million. Pursuant to the terms of the Eighth
Plan, holders of the Company's 8-5/8% Senior Notes due 2008 (the "Senior Notes")
would forego $10 million in interest accrued during the post-petition period and
would receive the right to any funds (net of related expenses) from the fee
disgorgement and other causes of action against the law firm and one of its
service providers, subject to a maximum of $10 million plus interest at 8.625%
from the effective date of the plan until the time such payment is made (the
"Maximum Additional Bondholder Recovery"). Any net recoveries in excess of the
Maximum Additional Bondholder Recovery would be paid to the Plan Trust.
The Company recorded charges aggregating approximately $51.3 million in
prior years, and is not yet able to determine the amount of the additional cost
that will be required to complete its reorganization. Additional charges may be
required in the future should the minimum estimated cost increase. The maximum
amount of the range of possible asbestos-related losses is limited to the going
concern or liquidation value of the Company, an amount which the Company
believes is substantially less than the minimum gross liability for the known
claims against it.
24
The Company has not attempted to make an estimate of its probable
insurance recoveries for financial statement purposes given the accounting for
its estimate of future asbestos-related costs. Substantially all future
insurance recoveries have been assigned to the Collateral Trust or Plan Trust.
Amounts Recorded in Financial Statements
The table below provides an analysis of changes in the Company's asbestos
reserves and related receivables from December 31, 2005 to March 31, 2006:
Balance at Reserve Balance at
(in thousands) 12/31/05 Spending Addition 3/31/06
---------------------------------------------------
Reserves
Current $ 19,469 $(2,261) $ -- $ 17,208
Long-Term -- -- -- --
Receivables
Current (14,793) (3,592) -- (18,385)
Long-Term -- -- -- --
-------- ------- ---- --------
Net Asbestos Liability $ 4,676 $(5,853) $ -- $ (1,177)
======== ======= ==== ========
Restricted Cash
Insurance Proceeds $ 8,901 $ -- $534 $ 9,435
Balance at Reserve Balance at
(in thousands) 12/31/04 Spending Addition 3/31/05
---------------------------------------------------
Reserves
Current $ 6,550 $(2,387) $-- $ 4,163
Long-Term 2,738 -- -- 2,738
Receivables
Current (1,509) (1,958) -- (3,467)
Long-Term (7,300) -- -- (7,300)
-------- ------- --- --------
Net Asbestos Liability $ 479 $(4,345) $-- $ (3,866)
======== ======= === ========
Restricted Cash
Insurance Proceeds $ 14,526 $ -- $85 $ 14,611
25
7. Product Warranties
The Company provides product warranties for specific product lines and
accrues for estimated future warranty cost in the period in which the revenue is
recognized. The following table sets forth activity in the Company's warranty
reserves (in millions):
Three Months Ended Three Months Ended
March 31, March 31,
2006 2005
---- ----
Beginning balance $ 2.1 $ 2.7
Accruals 1.0 1.0
Charges (1.0) (1.0)
----- -----
Ending balance $ 2.1 $ 2.7
===== =====
8. Liabilities Subject to Compromise
As a result of the Company's Chapter 11 filing (see Notes 1 and 6),
pursuant to SOP 90-7, the Company is required to segregate pre-petition
liabilities that are subject to compromise and report them separately on the
consolidated balance sheet. Liabilities that may be affected by a plan of
reorganization are recorded at the amount of the expected allowed claims, even
if they may be settled for lesser amounts. Substantially all of the Company's
pre-petition debt is recorded at face value and is classified within liabilities
subject to compromise. In addition, the Company's accrued interest expense on
its Senior Notes is also recorded in liabilities subject to compromise.
Liabilities subject to compromise at March 31, 2006 and December 31, 2005
are as follows:
(In thousands)
March 31, December 31,
2006 2005
---- ----
Current
Pre-petition other payables and accrued interest $ 26,660 $ 23,990
Non-current
Debt (at face value) 100,000 100,000
Pension liability 16,552 16,871
Other post-retirement benefit obligation 8,330 8,407
Pre-petition other liabilities 13,534 13,583
-------- --------
Non-current 138,416 138,861
-------- --------
Total liabilities subject to compromise $165,076 $162,851
======== ========
26
Additional pre-petition claims (liabilities subject to compromise) may
arise due to the rejection of executory contracts or unexpired leases, or as a
result of the allowance of contingent or disputed claims.
9. Accrued Liabilities
A summary of the significant components of accrued liabilities consists of
the following:
(In thousands)
March 31, December 31,
2006 2005
---- ----
Accrued warranty, marketing and sales promotion $17,554 $19,129
Employee compensation and related benefits 3,609 3,674
Other -- 269
------- -------
Total accrued liabilities $21,163 $23,072
======= =======
As a result of the Company's Chapter 11 bankruptcy filing and in
accordance with SOP 90-7, certain liabilities are included in liabilities
subject to compromise on the balance sheet as of March 31, 2006 (see Note 8).
10. Pensions and Other Postretirement Plans
The Company sponsors several non-contributory defined benefit pension
plans covering most of the Company's employees. Benefits under the plans are
based on years of service and employee compensation. Amounts funded annually by
the Company are actuarially determined using the projected unit credit and unit
credit methods and are equal to or exceed the minimum required by government
regulations. The Company also maintains health and life insurance programs for
retirees (reflected in the table below in "Other Benefits").
The following summarizes the components of the net periodic benefit cost
for the Pension and Other Benefit Plans for the three months ended March 31,
2006 and 2005:
(In thousands)
Three Months Ended Three Months Ended
March 31, 2006 March 31, 2005
-------------- --------------
Other Other
Pension Benefits Pension Benefits
------- -------- ------- --------
Components of Net Periodic Benefit Cost:
Service cost $ 361 $ 48 $ 355 $ 46
Interest cost 1,113 132 1,094 130
Expected return on plan assets (997) -- (881) --
Recognized net actuarial loss 365 16 385 15
Amortization of transition obligation -- -- (18) --
Amortization of prior service cost (54) 9 (72) (47)
------- ---- ------- -----
Net periodic benefit cost $ 788 $205 $ 863 $ 144
======= ==== ======= =====
27
The weighted average assumptions used to determine net periodic benefit
cost were as follows:
March 31, 2006 March 31, 2005
-------------- --------------
Other Other
Pension Benefits Pension Benefits
------- -------- ------- --------
Discount rate 6.00% 6.00% 6.25% 6.25%
Expected long-term return on plan assets 7.00% -- 7.00% --
Rate of compensation increase 4.00% -- 4.00% --
Income from operations 5.50% 5.50%
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Unaudited
Condensed Consolidated Financial Statements and notes thereto contained in Item
1 of this Quarterly Report on Form 10-Q.
Results of Operations
The Company's business is cyclical and is affected by the same economic
factors that affect the remodeling and housing industries in general, including
the availability of credit, consumer confidence, changes in interest rates,
market demand and general economic conditions.
In addition to external economic factors, the Company's results are
sensitive to sales and manufacturing volume, competitors' pricing, consumer
preferences for flooring products, raw material costs and the mix of products
sold. The manufacturing process is capital intensive and requires substantial
investment in facilities and equipment. The cost of operating these facilities
generally does not vary in direct proportion to production volume and,
consequently, operating results fluctuate disproportionately with changes in
sales volume.
On December 31, 2003, Congoleum filed a voluntary petition with the
Bankruptcy Court seeking relief under Chapter 11 of the Bankruptcy Code as a
means to resolve claims asserted against it related to the use of asbestos in
its products decades ago. During 2003, Congoleum obtained the requisite votes of
asbestos personal injury claimants necessary to seek approval of a proposed,
pre-packaged Chapter 11 plan of reorganization. In January 2004, the Company
filed its proposed plan of reorganization and disclosure statement with the
Bankruptcy Court. In November 2004, Congoleum filed the Fourth Plan with the
Bankruptcy Court reflecting the result of further negotiations with
representatives of the Asbestos Claimants' Committee, the Future Claimants'
Representative and other asbestos claimant representatives. The Bankruptcy Court
approved the disclosure statement and plan voting procedures in December 2004
and Congoleum obtained the requisite votes of asbestos personal injury claimants
necessary to seek approval of the Fourth Plan. In April 2005, Congoleum
announced that it had reached an agreement in principle with representatives of
the Asbestos Claimants' Committee and the Future Claimants' Representative to
make certain modifications to its proposed plan of reorganization and related
documents governing the settlement and payment of asbestos-related claims
against Congoleum. Under the agreed-upon modifications, asbestos claimants with
claims settled under Congoleum's pre-petition settlement agreements would agree
28
to forbear from exercising the security interest they were granted and share on
a pari passu basis with all other present and future asbestos claimants in
insurance proceeds and other assets of the Plan Trust. In July 2005, Congoleum
filed the Sixth Plan and related documents with the Bankruptcy Court which
reflected the result of these negotiations as well as other technical
modifications. The Bankruptcy Court approved the disclosure statement and voting
procedures and Congoleum commenced solicitation of acceptances of the Sixth Plan
in August 2005. In September 2005, Congoleum learned that certain asbestos
claimants were unwilling to agree to forbear from exercising their security
interest as contemplated by the Sixth Plan and the Sixth Plan was subsequently
withdrawn. In November 2005, the Bankruptcy Court denied a request to extend
Congoleum's exclusive right to file a plan of reorganization and solicit
acceptances thereof. In February 2006, Congoleum filed the Seventh Plan. On
February 27, 2006, the Company announced its intention to make additional
changes to its plan of reorganization, and on March 17, 2006 it filed the Eighth
Plan. In addition, an insurance company has filed the CNA Plan and the Official
Committee of Bondholders has filed the Bondholder Plan. The Bankruptcy Court has
scheduled a hearing to consider the adequacy of the disclosure statements with
respect to these plans for June 8, 2006.
There can be no assurance that the Company will not amend the Eighth Plan,
that the Company will obtain approval to solicit acceptances of its plan of
reorganization, that the Company will receive the acceptances necessary for
confirmation of its plan of reorganization, that its plan will not be modified
further, that its plan will receive necessary court approvals from the
Bankruptcy Court or the Federal District Court, or that such approvals will be
received in a timely fashion, that its plan will be confirmed, or that its plan,
if confirmed, will become effective. It is unclear whether the Bankruptcy Court
will approve the CNA Plan or the Bondholder Plan or whether either of such
plans, if confirmed, would be feasible. Moreover, it is unclear whether any
other person will attempt to propose a plan or what any such plan would provide
or propose, and whether the Bankruptcy Court would approve a plan other than
Congoleum's proposed plan.
Congoleum is presently involved in litigation with certain insurance
carriers related to disputed insurance coverage for asbestos related
liabilities, and certain insurance carriers filed various objections to
Congoleum's previously proposed plans of reorganization and related matters and
are expected to file objections to the Eighth Plan. Certain other parties have
also filed various objections to Congoleum's previously proposed plans of
reorganization and may file objections to the Eighth Plan.
The Company expects that the terms of the Eighth Plan may be amended or
modified as a result of further negotiations with various parties. The terms of
the CNA Plan and the Bondholder Plan are materially different from the terms of
the Eighth Plan, and these plans may also be amended or modified or may be
withdrawn. There can be no assurance that the terms of the reorganization plan
that is ultimately confirmed, if any, will not materially differ from the terms
of the Eighth Plan. The Company expects that it will take until some time in the
fourth quarter of 2006 at the earliest to obtain confirmation of any plan of
reorganization.
29
In anticipation of Congoleum's commencement of the Chapter 11 cases,
Congoleum entered into the Claimant Agreement, which provides for an aggregate
settlement value of at least $466 million as well as an additional number of
individually negotiated trial listed settlements with an aggregate value of
approximately $25 million, for total settlements in excess of $491 million. As
contemplated by the Claimant Agreement, Congoleum also entered into agreements
establishing the Collateral Trust to distribute funds in accordance with the
terms of the Claimant Agreement and granting the Collateral Trust a security
interest in Congoleum's rights under its applicable insurance coverage and
payments from Congoleum's insurers for asbestos claims. In December 2005,
Congoleum commenced the Avoidance Actions seeking to void the security interest
granted to the Collateral Trust and such settlements. In March 2006, Congoleum
filed a motion for summary judgment in the Avoidance Actions seeking to avoid
the Claimant Agreement settlements and liens under various bankruptcy theories.
Under the terms of the Eighth Plan, asbestos personal injury claimants voting to
accept the plan would irrevocably consent or would be deemed to have irrevocably
consented to the forbearance of any claim and lien rights under the Claimant
Agreement and related agreements. Under the terms of the Eighth Plan, after the
establishment of the Plan Trust, the assets in the Collateral Trust would be
transferred to the Plan Trust and any claims subject to the Claimant Agreement
would be channeled to the Plan Trust and paid in accordance with the terms of
the Eighth Plan. Settlement values under the Eighth Plan may differ from values
under the Sixth Plan and the Claimant Agreement, which, together with the
outcome of the Avoidance Actions, may materially affect the liability associated
with the asbestos personal injury claims against Congoleum. As a result of
tabulating ballots on the Fourth Plan, the Company is also aware of claims by
claimants whose claims were not determined under the Claimant Agreement but who
have submitted claims with a value of approximately $512 million based on the
settlement values applicable in the Sixth Plan. Based on the Eighth Plan, the
Company has made provision in its financial statements for the minimum amount of
the range of estimates for its contribution to effect its plan to settle
asbestos liabilities through the Plan Trust. The Company recorded charges
aggregating approximately $51.3 million in prior years and is not yet able to
determine the amount of the additional cost that will be required to complete
its reorganization. Actual amounts that will be contributed to the Plan Trust
and costs for pursuing and implementing the Eighth Plan or any other plan of
reorganization could be materially higher than currently recorded. The Company
may record significant additional charges should the minimum estimated cost
increase. Delays in proposing, filing or obtaining approval of the Eighth Plan
or any new amended plan of reorganization, or the continued pursuit of the CNA
Plan or the Bondholder Plan by the proponents of such plans, or the proposal of
additional plans by other parties could result in a proceeding that takes longer
and is more costly than the Company has estimated.
30
Three months ended March 31, 2006 as compared to three months ended March
31, 2005:
2006 2005
(In thousands of dollars)
Net sales $ 57,237 $ 57,630
Cost of sales 43,960 43,969
-------- --------
Gross profit 13,277 23.2% 13,661 23.7%
Selling, general and administrative
expenses 10,396 18.2% 11,733 20.4%
-------- --------
Operating income (loss) 2,881 1,928
Interest expense, net (2,734) (2,500)
Other income, net 115 220
-------- --------
Income (loss) before taxes 262 (352)
Provision for income taxes 51 --
-------- --------
Net income (loss) $ 211 $ (352)
======== ========
Net sales for the three months ended March 31, 2006 were $57.2 million as
compared to $57.6 million for the three months ended March 31, 2005, a decrease
of $0.4 million or 0.7%. The decrease reflected weaker sales in high-end
resilient sheet products and the impact of a promotional roll sales program in
the first quarter of 2005 which was not repeated in 2006. Offsetting these
declines were the impact of price increases instituted in the second half of
2005 (5.7%) and higher sales in the manufactured housing category.
Gross profit for the three months ended March 31, 2006 totaled $13.3
million, or 23.2% of net sales, compared to $13.7 million, or 23.7% of net
sales, for the same period last year. The major factors leading to the
deterioration in gross margin were the increase in raw material costs and
utility costs experienced during the second half of 2005, which reduced margins
by approximately 4.0% of net sales, and the poorer sales mix which reduced
margins by 2% of net sales. This was partially mitigated by the 5.7% increase in
selling prices.
Selling, general and administrative expenses were $10.4 million for the
three months ended March 31, 2006 as compared to $11.7 million for the three
months ended March 31, 2005, a decrease of $1.3 million. The reduction in
expenses reflects lower merchandising and sales support related costs (down $0.6
million), lower compensation and related benefit costs reflecting workforce
reductions in late 2005 ($0.4 million) and lower depreciation expense ($0.2
million). As a percent of net sales, selling, general and administrative costs
were 18.2% for the three months ended March 31, 2006 compared to 20.4% for the
same period last year.
Income from operations was $2.9 million for the quarter ended March 31,
2006 compared to income of $1.9 million for the quarter ended March 31, 2005.
The improvement in operating income was a result of lower selling, general and
administrative expenses which offset the impact of lower sales and gross
margins.
31
Liquidity and Capital Resources
The Unaudited Condensed Consolidated Financial Statements of the Company
have been prepared on a going concern basis, which contemplates the realization
of assets and the satisfaction of liabilities in the normal course of business.
Accordingly, the Unaudited Condensed Consolidated Financial Statements do not
include any adjustments that might be necessary should the Company be unable to
continue as a going concern. As described more fully in the Notes to the
Unaudited Condensed Consolidated Financial Statements contained in Part I, Item
1 of this Quarterly Report on Form 10-Q, there is substantial doubt about the
Company's ability to continue as a going concern unless it obtains relief from
its substantial asbestos liabilities through a successful reorganization under
Chapter 11 of the Bankruptcy Code.
On December 31, 2003, Congoleum filed a voluntary petition with the
Bankruptcy Court (Case No. 03-51524) seeking relief under the Bankruptcy Code.
See Notes 1 and 17 of the Notes to the Consolidated Financial Statements, which
are contained in Item 8 of the Company's Annual Report on Form 10-K for the year
ended December 31, 2005, for a discussion of the Company's bankruptcy
proceedings. These matters will have a material adverse impact on liquidity and
capital resources. During the first quarter of 2006, the Company paid $5.9
million in fees and expenses related to implementation of its planned
reorganization under Chapter 11 and litigation with certain insurance companies.
Pursuant to terms of the Eighth Plan and related documents, Congoleum is
entitled to reimbursement for certain expenses it incurs for claims processing
costs and expenses in connection with pursuit of insurance coverage. At March
31, 2006, Congoleum recorded $18.4 million as a receivable for such
reimbursements. The amount and timing of reimbursements that will be received
will depend on when Congoleum or the Plan Trust receives funds from insurance
settlements or other sources. There can be no assurances that these
reimbursements will be received, or that the terms providing for such
reimbursements will not be modified. Congoleum expects to spend a further $17.2
million at a minimum in fees, expenses, and trust contributions in connection
with obtaining confirmation of its plan of reorganization, which amount is
recorded in its reserve for asbestos-related liabilities in addition to the $9.4
million insurance settlement being held as restricted cash. It also expects to
spend a further $7.9 million at a minimum in connection with insurance coverage
litigation costs, for which it expects to be reimbursed as discussed above.
Required expenditures could be materially higher than these estimates. The
Company currently holds $3.7 million in restricted cash that may be available to
offset future costs incurred pursuing insurance coverage, subject to approval by
the Bankruptcy Court.
Due to the Chapter 11 proceedings, the Company has been precluded from
making interest payments on its outstanding Senior Notes since January 1, 2004.
The amount of accrued interest that is due but has not been paid on the Senior
Notes during this period is approximately $21.6 million, including interest on
the unpaid interest due. In February 2006, the Bankruptcy Court ordered Gilbert,
Heintz & Randolph, a law firm formerly representing Congoleum, to disgorge all
fees and certain expenses it was paid by Congoleum. The law firm has appealed
this ruling. The amount of the disgorgement is approximately $9.6 million.
Pursuant to the terms of the Eighth Plan, holders of the Senior Notes would
forego $10 million in interest accrued during the post-petition period and would
receive the right to any funds (net of related expenses) from the fee
disgorgement and other causes of action against the law firm and one of its
service providers, subject to a maximum of $10 million plus interest at 8.625%
from the effective date of the plan until the time such payment is made (the
"Maximum Additional Bondholder Recovery"). There can be no assurance that the
Plan, which is ultimately confirmed, will provide for such interest forgiveness.
Any net recoveries in excess of the Maximum Additional Bondholder Recovery would
be paid to the Plan Trust.
32
Pursuant to the terms of the Eighth Plan, Congoleum is to make a cash
contribution of approximately $7.7 million to the Plan Trust when the plan goes
effective. The Eighth Plan also provides that the maturity of the Senior Notes
will be extended by three years from August 2008 to August 2011. There can be no
assurance that the plan which is ultimately confirmed will provide for such
maturity extension.
As part of the Eighth Plan, Congoleum expects that it will issue a
convertible security (the "New Convertible Security") to the Plan Trust. Under
the terms of the Eighth Plan, the New Convertible Security means either shares
of preferred stock or convertible promissory notes to be issued by reorganized
Congoleum and contributed to the Plan Trust on the effective date of the Eighth
Plan in satisfaction of section 524(g) of the Bankruptcy Code. If the New
Convertible Security is to be shares of preferred stock of reorganized
Congoleum, it will have the following terms: (i) an initial liquidation
preference equal to $2,738,234.75 in the aggregate, such amount being subject to
increase in the amount, if any, by which 36% of reorganized Congoleum's market
capitalization based on average trading prices for reorganized Congoleum's Class
A common stock at the close of trading for the 90 consecutive trading days
beginning on the one year anniversary of the effective date of the plan of
reorganization, exceeds such initial liquidation preference; (ii) an initial
dividend rate equal to 9% of the liquidation preference per annum, payable
semi-annually in arrears, with such dividend rate to reset at the rate of 5% of
the liquidation preference per annum on the tenth anniversary of the effective
date of the plan of reorganization and payable at such reset dividend rate per
annum unless and until redeemed; (iii) redeemable for the liquidation preference
at the option of the Plan Trust or reorganized Congoleum following the tenth
anniversary of the effective date of the plan of reorganization; (iv) a
mandatory redemption on the fifteenth anniversary of the effective date of the
plan of reorganization if not redeemed earlier; (v) convertible into 5,700,000
shares of Class A Common Stock (or the equivalent thereof on a fully diluted
basis) upon a specified default of the obligation to pay dividends and a failure
to cure such default within any cure period, which, when combined with the 3.8
million newly issued shares of Class A Common Stock to be contributed to the
Plan Trust, will result in the Plan Trust owning 51% of the voting common shares
of reorganized Congoleum on a fully diluted basis; and (vi) no voting rights,
except upon conversion. If the New Convertible Security is convertible
promissory notes, such notes will be on economic terms substantially equivalent
to provisions (i) and (v) of the preferred stock described herein, with other
terms substantially the same as the Promissory Note described in the Sixth Plan.
Although the earliest redemption or repayment date for the New Convertible
Security does not occur until its tenth anniversary of issuance, this obligation
may affect Congoleum's ability to obtain other sources of financing or refinance
existing obligations. In addition, it is expected that the terms of the New
Convertible Security will require the Company to make regularly scheduled
dividend or interest payments prior to such instrument's redemption or maturity
date.
33
Unrestricted cash and cash equivalents, including short-term investments
at March 31, 2006, were $14.7 million, a decrease of $9.9 million from December
31, 2005. Under the terms of its revolving credit agreement, payments on the
Company's accounts receivable are deposited in an account assigned by the
Company to its lender and the funds in that account are used by the lender to
pay down any loan balance. Funds deposited in this account but not yet applied
to the loan balance, which amounted to $2.7 million and $2.0 million at March
31, 2006 and December 31, 2005, respectively, are recorded as restricted cash.
Additionally, $9.4 million remaining from a $14.5 million settlement received in
August 2004 from an insurance carrier, which is subject to the lien of the
Collateral Trust, is included as restricted cash at March 31, 2006. The Company
expects to contribute these funds, less any amounts withheld pursuant to
reimbursement arrangements, to the Plan Trust. Working capital was $30.0 million
at March 31, 2006, up from $28.0 million at December 31, 2005. The ratio of
current assets to current liabilities at March 31, 2006 was 1.3 to 1.0, which is
unchanged from December 31, 2005. The ratio of debt to total capital at March
31, 2006 was 0.48 to 1.0 which is also unchanged since December 31, 2005. Net
cash used by operations during the first three months of 2006 was $10.8 million,
as compared to net cash used by operations of $9.3 million in the first three
months of 2005. The increase in cash used by operations in the first three
months of 2006 versus the first three months of 2005 was primarily due to higher
working capital requirements and increased reorganization expenditures in 2006.
Capital expenditures for the three months ended March 31, 2006 totaled
$0.5 million. The Company is currently planning capital expenditures of
approximately $5 million in 2006 and between $5 million and $7 million in 2007,
primarily for maintenance and improvement of plants and equipment, which it
expects to fund with cash from operations and credit facilities.
In January 2004, the Bankruptcy Court authorized entry of a final order
approving Congoleum's debtor-in-possession financing, which replaced its
pre-petition credit facility on substantially similar terms. The
debtor-in-possession financing agreement (as amended and approved by the
Bankruptcy Court to date) provides a revolving credit facility expiring on
December 31, 2006 with borrowings up to $30 million. Interest is based on 0.75%
above the prime rate. This financing agreement contains certain covenants, which
include the maintenance of minimum earnings before interest, taxes, depreciation
and amortization ("EBITDA"). It also includes restrictions on the incurrence of
additional debt and limitations on capital expenditures. The covenants and
conditions under this financing agreement must be met in order for the Company
to borrow from the facility. The Company was in compliance with these covenants
at March 31, 2006. Borrowings under this facility are collateralized by
inventory and receivables. At March 31, 2006, based on the level of receivables
and inventory, $17.6 million was available under the facility, of which $4.7
million was utilized for outstanding letters of credit and $11.5 million was
utilized by the revolving loan. The Company anticipates that its
debtor-in-possession financing facility will be replaced with a revolving credit
facility on substantially similar terms upon confirmation and effectiveness of
its plan of reorganization. While the Company expects the facilities discussed
above will provide it with sufficient liquidity, there can be no assurances that
it will continue to be in compliance with the required covenants, that the
Company will be able to obtain a similar or sufficient facility upon exit from
bankruptcy, or that the debtor-in-possession facility (as extended) will be
renewed prior to its expiration if the Company's plan of reorganization is not
confirmed before that time.
34
In addition to the provision for asbestos litigation discussed previously,
the Company has also recorded what it believes are adequate provisions for
environmental remediation and product-related liabilities (other than
asbestos-related claims), including provisions for testing for potential
remediation of conditions at its own facilities. The Company is subject to
federal, state and local environmental laws and regulations and certain legal
and administrative claims are pending or have been asserted against the Company.
Among these claims, the Company is a named party in several actions associated
with waste disposal sites (more fully discussed in Note 5 to the Unaudited
Condensed Consolidated Financial Statements contained in Item 1 of this
Quarterly Report on Form 10-Q). These actions include possible obligations to
remove or mitigate the effects on the environment of wastes deposited at various
sites, including Superfund sites and certain of the Company's owned and
previously owned facilities. The contingencies also include claims for personal
injury and/or property damage. The exact amount of such future cost and timing
of payments are indeterminable due to such unknown factors as the magnitude of
cleanup costs, the timing and extent of the remedial actions that may be
required, the determination of the Company's liability in proportion to other
potentially responsible parties, and the extent to which costs may be
recoverable from insurance. The Company has recorded provisions in its financial
statements for the estimated probable loss associated with all known general and
environmental contingencies. While the Company believes its estimate of the
future amount of these liabilities is reasonable, and that they will be paid
over a period of five to ten years, the timing and amount of such payments may
differ significantly from the Company's assumptions. Although the effect of
future government regulation could have a significant effect on the Company's
costs, the Company is not aware of any pending legislation which would
reasonably have such an effect. There can be no assurances that the costs of any
future government regulations could be passed along to its customers. Estimated
insurance recoveries related to these liabilities are reflected in other
non-current assets.
The outcome of these environmental matters could result in significant
expenses incurred by or judgments assessed against the Company.
The Company's principal sources of capital are net cash provided by
operating activities and borrowings under its financing agreement. The Company
has used $10.8 million in cash from operations in the first quarter of 2006 (as
more fully discussed above), which includes the benefit of $2.2 million of
accrued but unpaid interest on long-term debt. The Company believes these
sources will be adequate to fund working capital requirements, debt service
payments, and planned capital expenditures for the foreseeable future. To meet
the funding obligations under the Eighth Plan, the Company anticipates it will
need to obtain the contemplated forgiveness of $10 million of interest on the
Senior Notes and obtain reimbursement for any unreimbursed coverage litigation
costs. Actual sources and uses of funds to consummate the effectiveness of the
Eighth Plan or any other plan may differ from this description, but confirmation
of any plan is dependent on such plan demonstrating it leaves the Company with
sufficient liquidity that further reorganization will not be needed. The
Company's inability to obtain confirmation of the Eighth Plan in a timely manner
would have a material adverse effect on the Company's ability to fund its
operating, investing and financing requirements.
35
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to changes in prevailing market interest rates
affecting the return on its investments but does not consider this risk exposure
to be material to its financial condition or results of operations. The Company
invests primarily in highly liquid debt instruments with strong credit ratings
and short-term (less than one year) maturities. The carrying amount of these
investments approximates fair value due to the short-term maturities. Over 90%
of the Company's outstanding long-term debt as of March 31, 2006 consisted of
indebtedness with a fixed rate of interest which is not subject to change based
upon changes in prevailing market interest rates. Under its current policies,
the Company does not use derivative financial instruments, derivative commodity
instruments or other financial instruments to manage its exposure to changes in
interest rates, foreign currency exchange rates, commodity prices or equity
prices and does not hold any instruments for trading purposes.
Item 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. The Company's
Chief Executive Officer and Chief Financial Officer have evaluated
the effectiveness of the Company's disclosure controls and
procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended, (the
"Exchange Act")) as of the end of the period covered by this
quarterly report (the "Evaluation Date"). Based on this evaluation,
such officers have concluded that, as of the Evaluation Date, the
Company's disclosure controls and procedures are effective in
alerting them on a timely basis to material information relating to
the Company required to be included in the Company's reports filed
or submitted under the Exchange Act.
(b) Changes in Internal Control Over Financial Reporting. There have not
been any changes in the Company's internal controls over financial
reporting during the last quarter covered by this Quarterly Report
that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings: The information contained in Note 5
"Environmental and Other Liabilities" and Note 6 "Asbestos
Liabilities" of the Notes to Unaudited Condensed Consolidated
Financial Statements is incorporated herein by reference.
36
Item 1A. Risk Factors:
The Company has significant asbestos liability and funding
exposure, and its proposed amended plan of reorganization may
not be confirmed.
As more fully set forth in Notes 1 and 6 of the Notes to
Consolidated Financial Statements, which are included in this
Quarterly Unaudited Condensed Report on Form 10-Q, the Company
has significant liability and funding exposure for asbestos
claims. The Company has entered into settlement agreements
with various asbestos claimants totaling in excess of $491
million. Under the terms of the Eighth Plan, asbestos personal
injury claimants voting to accept the plan would irrevocably
consent or would be deemed to have irrevocably consented to
the forbearance of any claim and lien rights under such
settlement agreements. The outcome of the Avoidance Actions
could affect the outcome of plan voting and therefore
confirmation of the Eighth Plan.
There can be no assurance that the Company will not amend the
Eighth Plan, that the Company will obtain approval to solicit
acceptances of its plan of reorganization, that the Company
will receive the acceptances necessary for confirmation of its
plan, that its plan will not be modified further, that its
plan will receive necessary court approvals from the
Bankruptcy Court or the Federal District Court, or that such
approvals will be received in a timely fashion, that its plan
will be confirmed, or that its plan, if confirmed, will become
effective. In November 2005, the Bankruptcy Court denied a
request to extend Congoleum's exclusive right to file a plan
of reorganization and solicit acceptances thereof, and plans
have been filed by an insurance company and the Official
Committee of Bondholders. It is unclear whether any other
person will attempt to propose a plan or what any such plan
would provide or propose, and whether the Bankruptcy Court
would approve a plan other than Congoleum's proposed plan.
The Eighth Plan and any alternative plan of reorganization
pursued by the Company or another plan proponent or confirmed
by the Bankruptcy Court and the Federal District Court could
materially differ from the description of the Eighth Plan
contained in this Quarterly Report on Form 10-Q. Furthermore,
the estimated costs and contributions to effect the Eighth
Plan or an alternative plan could be significantly greater
than currently estimated. Any plan of reorganization pursued
by the Company will be subject to numerous conditions,
approvals and other requirements, including Bankruptcy Court
and Federal District Court approvals, and there can be no
assurance that such conditions, approvals and other
requirements will be satisfied or obtained.
37
Confirmation of a plan of reorganization will depend on the
Company obtaining exit financing to provide it with sufficient
liquidity to fund obligations upon the plan becoming
effective. If the Company's cash flow from operations is
materially less than anticipated, and/or if the costs in
connection with seeking confirmation of the Company's plan of
reorganization or in connection with the Company's New Jersey
state court insurance coverage litigation discussed elsewhere
in this report are materially more than anticipated, or if
sufficient funds from insurance proceeds or other sources are
not available at confirmation to reimburse coverage litigation
costs as expected, the Company may be unable to obtain exit
financing, when combined with net cash provided from operating
activities, that would provide it with sufficient funds, which
would likely result in the Company not being able to confirm
an amended plan of reorganization or have such plan become
effective.
Some additional factors that could cause actual results to
differ from the Company's goals for resolving its asbestos
liability through an amended plan of reorganization include:
(i) the future cost and timing of estimated asbestos
liabilities and payments, (ii) the availability of insurance
coverage and reimbursement from insurance companies that
underwrote the applicable insurance policies for the Company
for asbestos-related claims, (iii) the costs relating to the
execution and implementation of any plan of reorganization
pursued by the Company, (iv) timely reaching agreement with
other creditors, or classes of creditors, that exist or may
emerge, (v) satisfaction of the conditions and obligations
under the Company's outstanding debt instruments, (vi) the
response from time to time of the lenders, customers,
suppliers and other constituencies of the Company and ABI, the
majority stockholder of the Company, to the ongoing process
arising from the Company's strategy to settle its asbestos
liability, (vii) the Company's ability to maintain
debtor-in-possession financing sufficient to provide it with
funding that may be needed during the pendency of its Chapter
11 case and to obtain exit financing sufficient to provide it
with funding that may be needed for its operations after
emerging from the bankruptcy process, in each case, on
reasonable terms, (viii) timely obtaining sufficient creditor
and court approval (including the results of any relevant
appeals) of any reorganization plan pursued by it and the
court overruling any objections to the Company's
reorganization plan that may be filed, (ix) costs of,
developments in and the outcome of insurance coverage
litigation pending in New Jersey state court involving
Congoleum and certain insurers, (x) the extent to which the
Company is able to obtain reimbursement for costs of the
coverage litigation, (xi) compliance with the Bankruptcy Code,
including Section 524(g) and (xii) the possible adoption of
another party's plan of reorganization which may prove to be
unfeasible. In any event, if the Company is not successful in
obtaining sufficient creditor and court approval of its
amended plan of reorganization, such failure would have a
material adverse effect upon its business, results of
operations and financial condition.
38
In addition, there has been federal legislation proposed that,
if adopted, would establish a national trust to provide
compensation to victims of asbestos-related injuries and
channel all current and future asbestos-related personal
injury claims to that trust. Due to the uncertainties involved
with the pending legislation, the Company does not know what
effects any such legislation, if adopted, may have upon its
business, results of operations or financial condition, or
upon any plan of reorganization it may decide to pursue. To
date, the Company has expended significant amounts pursuant to
resolving its asbestos liability relating to its proposed
amended plan of reorganization. To the extent any federal
legislation is enacted, which does not credit the Company for
amounts paid by the Company pursuant to its plan of
reorganization or requires the Company to pay significant
amounts to any national trust or otherwise, such legislation
could have a material adverse effect on the Company's
business, results of operations and financial condition. As a
result of the Company's significant liability and funding
exposure for asbestos claims, there can be no assurance that
if it were to incur any unforecasted or unexpected liability
or disruption to its business or operations it would be able
to withstand that liability or disruption and continue as an
operating company.
For further information regarding the Company's asbestos
liability, insurance coverage and strategy to resolve its
asbestos liability, please see Notes 1 and 17 of Notes to the
Consolidated Financial Statements, which are included in the
Company's 2005 Annual Report on Form 10-K, and Notes 1 and 6
of Notes to the Unaudited Condensed Consolidated Financial
Statements included in this Quarterly Report on Form 10-Q.
The American Stock Exchange has notified Congoleum that it
does not meet the minimum income and stockholders' equity
requirements for continued listing of its Class A Common
Stock.
On April 21, 2006, Congoleum received a letter from the
American Stock Exchange (the "Amex") indicating that Congoleum
is not in compliance with Section 1003(a)(i) of the Amex
Company Guide, with stockholders' equity of less than
$2,000,000 and losses from continuing operations and/or net
losses in two of its three most recent fiscal years; and
Section 1003(a)(ii) of the Amex Company Guide, with
stockholders' equity of less than $4,000,000 and losses from
continuing operations and/or net losses in three of its four
most recent fiscal years. The letter also stated that the
Company must submit a plan by May 22, 2006 advising the Amex
of actions it has taken or will take to achieve compliance
with the continued listing standards within eighteen months of
receipt of the letter, and that this plan must be approved by
the Amex, for Congoleum to maintain its listing. Congoleum
intends to submit a plan seeking to document that it will
achieve compliance with the continued listing standards within
such eighteen-month period. There can be no assurance that
Congoleum will be able to submit such a plan or achieve such
compliance, or that the Amex will accept the Company's plan.
If Congoleum's Class A common stock is delisted on the Amex,
it may have an adverse impact on the price and liquidity of
the Company's Class A common stock.
39
The Company may incur substantial liability for environmental,
product and general liability claims in addition to
asbestos-related claims, and its insurance coverage and its
likely recoverable insurance proceeds may be substantially
less than the liability incurred by the Company for these
claims.
Environmental Liabilities. Due to the nature of the Company's
business and certain of the substances which are or have been
used, produced or discharged by the Company, the Company's
operations are subject to extensive federal, state and local
laws and regulations relating to the generation, storage,
disposal, handling, emission, transportation and discharge
into the environment of hazardous substances. The Company has
historically expended substantial amounts for compliance with
existing environmental laws or regulations, including
environmental remediation costs at both third-party sites and
Company-owned sites. The Company will continue to be required
to expend amounts in the future for costs related to prior
activities at its facilities and third party sites, and for
ongoing costs to comply with existing environmental laws; such
amounts may be substantial. There is no certainty that these
amounts will not have a material adverse effect on its
business, results of operations and financial condition
because, as a result of environmental requirements becoming
increasingly strict, the Company is unable to determine the
ultimate cost of compliance with environmental laws and
enforcement policies. Moreover, in addition to potentially
having to pay substantial amounts for compliance, future
environmental laws or regulations may require or cause the
Company to modify or curtail its operations, which could have
a material adverse effect on the Company's business, results
of operations and financial condition.
Product and General Liabilities. In the ordinary course of its
business, the Company becomes involved in lawsuits,
administrative proceedings, product liability claims (in
addition to asbestos-related claims) and other matters. In
some of these proceedings, plaintiffs may seek to recover
large and sometimes unspecified amounts and the matters may
remain unresolved for several years. These matters could have
a material adverse effect on the Company's business, results
of operations and financial condition if the Company is unable
to successfully defend against or settle these matters, its
insurance coverage is insufficient to satisfy unfavorable
judgments or settlements relating to these matters, or the
Company is unable to collect insurance proceeds relating to
these matters.
The Company is dependent upon a continuous supply of raw
materials from third party suppliers and would be harmed if
there were a significant, prolonged disruption in supply or
increase in its raw material costs.
40
The Company's business is dependent upon a continuous supply
of raw materials from third party suppliers. The principal raw
materials used by the Company in its manufacture of sheet and
tile flooring are vinyl resins, plasticizers, latex,
limestone, stabilizers, cellulose paper fibers, urethane and
transfer print film. The Company purchases most of these raw
materials from multiple sources. Although the Company has
generally not had difficulty in obtaining its requirements for
these materials, it has occasionally experienced significant
price increases for some of these materials. Raw material
prices in 2004 and 2005 increased significantly. During that
period, there was a tight supply of specialty resins used in
flooring, despite significant price increases, due to several
factors, including an explosion at a large resin plant in 2004
that destroyed the plant, the decision by another major
supplier to exit the business, and the effect of hurricanes in
2005. Although the Company has been able to obtain sufficient
supplies of specialty resin and other raw materials, there can
be no assurances that it may not experience difficulty in the
future, particularly if global supply conditions deteriorate,
which could have a material adverse effect on profit margins.
The Company believes that suitable alternative suppliers are
generally available for substantially all of its raw material
requirements, although quantities of certain materials
available from alternative suppliers may be in limited supply
and production trials may be required to qualify new materials
for use. The Company does not have readily available
alternative sources of supply for specific designs of transfer
print film, which are produced utilizing print cylinders
engraved to the Company's specifications. Although no loss of
this source of supply is anticipated, replacement could take a
considerable period of time and interrupt production of some
of the Company's products. In an attempt to protect against
this risk of loss of supply, the Company maintains a raw
material inventory and continually seeks to develop new
sources which will provide continuity of supply for its raw
material requirements. However, there is no certainty that the
Company's maintenance of its raw material inventory or its
ongoing efforts to develop new sources of supply would be
successful in avoiding a material adverse effect on its
business, results of operations and financial condition if it
were to realize an extended interruption in the supply of its
raw materials.
In addition, the Company could incur significant increases in
the costs of its raw materials. Although the Company generally
attempts to pass on increases in the costs of its raw
materials to its customers, the Company's ability to do so is,
to a large extent, dependent upon the rate and magnitude of
any increase, competitive pressures and market conditions for
its products. There have been in the past, and may be in the
future, periods of time during which increases in these costs
cannot be recovered. During those periods of time, there could
be a material adverse effect on the Company's business,
results of operations and financial condition.
41
The Company operates in a highly competitive flooring industry
and some of its competitors have greater resources and broader
distribution channels than the Company.
The market for the Company's products is highly competitive.
The Company encounters competition from three other
manufacturers in North America and, to a lesser extent,
foreign manufacturers. Some of the Company's competitors have
greater financial and other resources and access to capital
than the Company. Furthermore, like the Company, one of the
Company's major competitors has sought protection under
Chapter 11 of the Bankruptcy Code. When such competitor
emerges from bankruptcy as a continuing operating company it
may have shed much of its pre-filing liabilities and have a
competitive cost advantage over the Company as a result of
having shed those liabilities. In addition, in order to
maintain its competitive position, the Company may need to
make substantial investments in its business, including its
product development, manufacturing facilities, distribution
network and sales and marketing activities. Competitive
pressures may also result in decreased demand for the
Company's products and in the loss of the Company's market
share for its products. Moreover, due to the competitive
nature of the Company's industry, the Company may be
commercially restricted from raising or even maintaining the
sales prices of its products, which could result in the
Company incurring significant operating losses if its expenses
were to increase or otherwise represent an increased
percentage of the Company's sales.
The Company's business is subject to general economic
conditions and conditions specific to the remodeling and
housing industries.
The Company is subject to the effects of general economic
conditions. A sustained general economic slowdown could have
serious negative consequences for the Company's business,
results of operations and financial condition. Moreover, the
Company's business is cyclical and is affected by the economic
factors that affect the remodeling and housing industries in
general and the manufactured housing industry specifically,
including the availability of credit, consumer confidence,
changes in interest rates, market demand and general economic
conditions.
The Company could realize shipment delays, depletion of
inventory and increased production costs resulting from
unexpected disruptions of operations at any of the Company's
facilities.
42
The Company's business depends upon its ability to timely
manufacture and deliver products that meet the needs of its
customers and the end users of the Company's products. If the
Company were to realize an unexpected, significant and
prolonged disruption of its operations at any of its
facilities, including disruptions in its manufacturing
operations, it could result in shipment delays of its
products, depletion of its inventory as a result of reduced
production and increased production costs as a result of
taking actions in an attempt to cure the disruption or carry
on its business while the disruption remains. Any resulting
delay, depletion or increased production cost could result in
increased costs, lower revenues and damaged customer and
product end user relations, which could have a material
adverse effect on the Company's business, results of
operations and financial condition.
The Company offers limited warranties on its products which
could result in the Company incurring significant costs as a
result of warranty claims.
The Company offers a limited warranty on all of its products
against manufacturing defects. In addition, as a part of its
efforts to differentiate mid- and high-end products through
color, design and other attributes, the Company offers
enhanced warranties with respect to wear, moisture
discoloration and other performance characteristics, which
generally increase with the price of such products. If the
Company were to incur a significant number of warranty claims,
the resulting warranty costs could be substantial.
The Company is heavily dependent upon its distributors to sell
the Company's products and the loss of a major distributor of
the Company could have a material adverse effect on the
Company's business, results of operations and financial
condition.
The Company currently sells its products through approximately
15 distributors providing approximately 86 distribution points
in the United States and Canada, as well as directly to a
limited number of mass market retailers. The Company considers
its distribution network very important to maintaining its
competitive position. Although the Company has more than one
distributor in some of its distribution territories and
actively manages its credit exposure to its distributors, the
loss of a major distributor could have a materially adverse
impact on the Company's business, results of operations and
financial condition. The Company derives a significant
percentage of its sales from two of its distributors,
LaSalle-Bristol Corporation and Mohawk Industries, Inc.
LaSalle-Bristol Corporation serves as the Company's
manufactured housing market distributor and Mohawk Industries,
Inc. serves as its retail market distributor. These two
distributors accounted for 67% of the Company's net sales for
the year ended December 31, 2005 and 70% of the Company's net
sales for the year ended December 31, 2004.
43
Stockholder votes are controlled by ABI; Congoleum's interests
may not be the same as ABI's interests.
ABI owns a majority (approximately 55% as of December 31,
2005) of the outstanding shares of the Company's common stock,
representing a 68.3% voting interest. As a result, ABI can
elect all of the Company's directors and can control the vote
on all matters, including determinations such as: approval of
mergers or other business combinations, sales of all or
substantially all of the Company's assets, any matters
submitted to a vote of the Company's stockholders, issuance of
any additional common stock or other equity securities,
incurrence of debt other than in the ordinary course of
business, the selection and tenure of the Company's Chief
Executive Officer, payment of dividends with respect to common
stock or other equity securities and other matters that might
be favorable to ABI. ABI's ability to prevent an unsolicited
bid for us or any other change in control could have an
adverse effect on the market price for the Company's common
stock. In addition, certain officers of Congoleum are officers
of ABI and members of the family group that owns a controlling
interest in ABI.
Possible future sales of shares by ABI could adversely affect
the market for Congoleum's stock.
ABI may sell shares of the Company's common stock in
compliance with the federal securities laws. By virtue of
ABI's current control of Congoleum, ABI could sell large
amounts of shares of the Company's common stock by causing the
Company to file a registration statement that would allow them
to sell shares more easily. In addition, ABI could sell shares
of the Company's common stock without registration. Although
the Company can make no prediction as to the effect, if any,
that such sales would have on the market price of the
Company's common stock, sales of substantial amounts of the
Company's common stock, or the perception that such sales
could occur, could adversely affect the market price of the
Company's common stock. If ABI sells or transfers shares of
the Company's common stock as a block, another person or
entity could become the Company's controlling stockholder.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds:
None
Item 3. Defaults Upon Senior Securities: The commencement of the
Chapter 11 proceedings constituted an event of default under
the indenture governing the Company's 8 5/8% Senior Notes. In
addition, due to the Chapter 11 proceedings, the Company was
precluded from making the interest payments due February 1,
2004, August 1, 2004, February 1, 2005, August 1, 2005 and
February 1, 2006, on the Senior Notes. The aggregate amount of
accrued interest that was not paid on the Senior Notes on
those dates is approximately $21.6 million. As of March 31,
2006, the principal amount of the Senior Notes, net of
unamortized original issue discount, was $99.8 million. These
amounts, plus $2.2 million of accrued interest on the interest
due but not paid from February 1, 2004, August 1, 2004,
44
February 1, 2005, August 1, 2005 and February 1, 2006, are
included in "Liabilities Subject to Compromise." (See Note 8
"Liabilities Subject to Compromise" of the Notes to Unaudited
Condensed Consolidated Financial Statements.)
Item 4. Submission of Matters to a Vote of Security Holders: None
Item 5. Other Information: None
Item 6. Exhibits:
(a) Exhibits
Exhibit
Number Exhibits
------ --------
3.1 Amended Certificate of Incorporation of the Company
3.2 Amended and Restated Bylaws of the Company
31.1 Rule 13a-14(a) Certification of Chief Executive
Officer
31.2 Rule 13a-14(a) Certification of Chief Financial
Officer
32.1 Section 1350 Certification of the Chief Executive
Officer.
32.2 Section 1350 Certification of the Chief Financial
Officer.
99.1 Settlement Agreement and Release by and between
Congoleum Corporation and Harper Insurance Limited,
formerly known as Turegum Insurance Company.
99.2 Settlement and Policy Buyback Agreement and Release
by and among Congoleum Corporation, the Plan Trust,
American Biltrite Inc. and Travelers Casualty and
Surety Co., formerly known as The Aetna Casualty and
Surety Company, and St. Paul Fire and Marine
Insurance Company.
99.3 Settlement Agreement, made as of April 27, 2006, by
and between Congoleum Corporation and Fireman's Fund
Insurance Company.
45
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONGOLEUM CORPORATION
(Registrant)
Date: May 12, 2006 By: /s/ Howard N. Feist III
-------------------------
Howard N. Feist III
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial & Accounting Officer)
46
Exhibit Index
Exhibit
Number Exhibits
------ --------
3.1 Amended Certificate of Incorporation of the Company (1)
3.2 Amended and Restated Bylaws of the Company (1)
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certification of the Chief Executive
Officer.
32.2 Section 1350 Certification of the Chief Financial
Officer.
99.1 Settlement Agreement and Release by and between
Congoleum Corporation and Harper Insurance Limited,
formerly known as Turegum Insurance Company.
99.2 Settlement and Policy Buyback Agreement and Release by
and among Congoleum Corporation, the Plan Trust,
American Biltrite Inc. and Travelers Casualty and
Surety Co., formerly known as The Aetna Casualty and
Surety Company, and St. Paul Fire and Marine Insurance
Company.
99.3 Settlement Agreement, made as of April 27, 2006, by
and between Congoleum Corporation and Fireman's Fund
Insurance Company.
(1) Incorporated by reference to the exhibit bearing the same description
filed with the Company's Quarterly Report on Form 10-Q for the period
ended June 30, 1996.
47