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 September 30, 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 October 31, 2006
----------------------------- --------------------------------
Class A Common Stock 3,663,390
Class B Common Stock 4,608,945
1
CONGOLEUM CORPORATION
Index
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of September 30, 2006
(unaudited) and December 31, 2005.................................. 4
Condensed Consolidated Statements of Operations for the three
and nine months ended September 30, 2006 and 2005 (unaudited)...... 5
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 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.......................................... 34
Item 3. Quantitative and Qualitative Disclosures About Market Risk......... 44
Item 4. Controls and Procedures............................................ 44
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 45
Item 1A. Risk Factors....................................................... 45
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........ 53
Item 3. Defaults Upon Senior Securities.................................... 53
Item 4. Submission of Matters to a Vote of Security Holders................ 53
Item 5. Other Information.................................................. 53
Item 6. Exhibits .......................................................... 54
Signatures .................................................................. 55
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)
September 30,
2006 December 31,
(Unaudited) 2005
----------------------------
ASSETS
Current assets:
Cash and cash equivalents ................................................................ $ 19,722 $ 24,511
Restricted cash .......................................................................... 10,220 11,644
Accounts receivable, less allowances of $1,420 and $1,142 as of
September 30, 2006 and December 31, 2005, respectively ................................ 26,731 17,092
Inventories .............................................................................. 34,062 34,607
Prepaid expenses and other current assets ................................................ 23,555 20,139
Deferred income taxes .................................................................... 16,735 16,735
--------- ---------
Total current assets ................................................................ 131,025 124,728
Property, plant and equipment, net ....................................................... 68,002 73,207
Other assets, net ........................................................................ 10,515 9,412
--------- ---------
Total assets ........................................................................ $ 209,542 $ 207,347
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ......................................................................... $ 14,295 $ 11,769
Accrued liabilities ...................................................................... 23,739 23,072
Asbestos-related liabilities ............................................................. 16,635 28,369
Revolving credit loan .................................................................... 14,286 9,404
Accrued taxes ............................................................................ 109 107
Liabilities subject to compromise - current ................................................ 31,965 23,990
--------- ---------
Total current liabilities ........................................................... 101,029 96,711
Deferred income taxes ...................................................................... 16,735 16,735
Liabilities subject to compromise - long term .............................................. 136,156 138,861
--------- ---------
Total liabilities ................................................................... 253,920 252,307
--------- ---------
STOCKHOLDERS' EQUITY (DEFICIT)
Class A common stock, par value $0.01; 20,000,000 shares authorized;
4,736,950 shares issued and 3,663,390 shares outstanding as of September 30, 2006 and
4,736,950 shares issued and 3,662,790 shares outstanding as of December 31, 2005,
respectively ........................................................................... 47 47
Class B common stock, par value $0.01; 4,608,945 shares authorized, issued and
outstanding at September 30, 2006 and December 31, 2005, respectively .................. 46 46
Additional paid-in capital ................................................................. 49,294 49,126
Retained deficit ........................................................................... (64,991) (65,405)
Accumulated other comprehensive loss ....................................................... (20,961) (20,961)
--------- ---------
(36,565) (37,147)
Less Class A common stock held in treasury, at cost; 1,073,960 shares at
September 30, 2006 and 1,074,560 shares at December 31, 2005 respectively ............. 7,813 7,813
--------- ---------
Total stockholders' equity (deficit) .................................................. (44,378) (44,960)
--------- ---------
Total liabilities and stockholders' equity (deficit) .................................. $ 209,542 $ 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 Nine Months Ended
September 30, September 30,
------------------------------------------------
2006 2005 2006 2005
(In thousands, except per share amounts)
Net sales ........................................ $ 57,460 $ 60,507 $ 173,440 $ 176,245
Cost of sales .................................... 44,562 47,270 133,661 135,577
Selling, general and administrative expenses ..... 10,681 10,556 31,338 32,962
Asbestos-related reorganization charges .......... -- -- -- 15,454
-------- -------- --------- ---------
Income (loss) from operations .................... 2,217 2,681 8,441 (7,748)
Other income (expense):
Interest income .............................. 104 91 387 273
Interest expense ............................. (2,916) (2,670) (8,517) (7,788)
Other income ................................. 77 223 124 638
-------- -------- --------- ---------
Income (loss) before taxes ....................... (518) 325 435 (14,625)
Provision (benefit) for income taxes ............. (94) -- 22 --
-------- -------- --------- ---------
Net income (loss) ................................ $ (424) $ 325 $ 413 $ (14,625)
======== ======== ========= =========
Net income (loss) per common share, basic .... $ (0.05) $ 0.04 $ 0.05 $ (1.77)
======== ======== ========= =========
Net income (loss) per common share, diluted .. $ (0.05) $ 0.04 $ 0.05 $ (1.77)
======== ======== ========= =========
Weighted average number of common shares
outstanding, basic ..................... 8,280 8,261 8,317 8,261
======== ======== ========= =========
Weighted average number of common shares
outstanding, diluted ................... 8,280 8,642 8,329 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)
Nine Months Ended
September 30,
---------------------
2006 2005
(In thousands)
Cash flows from operating activities:
Net income (loss) ......................................................... $ 413 $(14,625)
Adjustments to reconcile net income (loss) to net cash used in Operating
activities:
Depreciation ....................................................... 7,742 8,083
Amortization ....................................................... 289 288
Asbestos-related charge ............................................ -- 15,454
Stock-based compensation expense ................................... 169 --
Changes in certain assets and liabilities:
Accounts and notes receivable ............................... (9,639) (8,538)
Inventories ................................................. 545 2,558
Prepaid expenses and other assets ........................... 479 577
Accounts payable ............................................ 2,526 (712)
Accrued liabilities ......................................... 5,689 3,415
Asbestos-related liabilities ................................ (17,752) (20,819)
Asbestos-related expense reimbursements from
insurance settlement .................................... 3,684 6,091
Other liabilities ........................................... (2,703) (1,838)
-------- --------
Net cash used in operating activities ................... (8,558) (10,066)
Cash flows from investing activities:
Capital expenditures ............................................... (2,537) (3,640)
-------- --------
Net cash used in investing activities ................... (2,537) (3,640)
-------- --------
Cash flows from financing activities:
Net short-term borrowings .......................................... 4,882 3,095
Net change in restricted cash ...................................... 1,424 (1,441)
-------- --------
Net cash provided by financing activities ............... 6,306 1,654
-------- --------
Net decrease in cash and cash equivalents ....................................... (4,789) (12,052)
Cash and cash equivalents:
Beginning of period ................................................ 24,511 29,710
-------- --------
End of period ...................................................... $ 19,722 $ 17,658
======== ========
The accompanying notes are an integral part of the
condensed consolidated financial statements.
6
CONGOLEUM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 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 nine month period
ended September 30, 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 as a means to resolve claims asserted against it
related to the use of asbestos in its products decades ago. 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. 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 "ACC"), the Future
Claimants' Representative (the "FCR") 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 ACC and the FCR to make certain
7
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 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 March 2006, Congoleum filed a
new amended plan of reorganization (the "Eighth Plan"). In addition, an
insurance company, Continental Casualty Company, and its affiliate, Continental
Insurance Company (collectively, "CNA"), filed a plan of reorganization and the
Official Committee of Bondholders (the "Bondholders' Committee") (representing
holders of the Company's 8 5/8% Senior Notes due August 1, 2008 (the "Senior
Notes")) also filed a plan of reorganization. In May 2006, the Bankruptcy Court
ordered all parties in interest in Congoleum's reorganization proceedings to
participate in global mediation discussions. Several mediation sessions took
place from June through September 2006. During the initial mediation
negotiations, Congoleum reached an agreement in principle, subject to mutually
agreeable definitive documentation, with the ACC, the FCR and the Company's
controlling shareholder, American Biltrite, Inc. ("ABI"), on certain terms of an
amended plan of reorganization (the "Ninth Plan"), which Congoleum filed and
proposed jointly with the ACC on August 11, 2006. CNA and the Bondholders'
Committee jointly filed a new, competing plan on August 18, 2006 and each
withdrew its prior plan of reorganization. Following further mediated
negotiations, Congoleum, the ACC, the FCR, ABI and the Bondholders' Committee
reached agreement on terms of a new amended plan (the "Tenth Plan"), which
Congoleum filed jointly with the ACC on September 15, 2006. Following the
Bondholders' Committee's withdrawal of support for CNA's plan, CNA filed an
amended plan of reorganization (the "CNA Plan"). On October 23, 2006, Congoleum
and the ACC jointly filed a revised version of the Tenth Plan (the "Eleventh
Plan") which reflected minor technical changes agreed to by the various parties
supporting Congoleum's plan. On October 26, 2006, the Bankruptcy Court held a
hearing to consider the adequacy of the disclosure statements with respect to
the Tenth Plan and the CNA Plan and to hear arguments on respective summary
judgment motions that the Tenth Plan and the CNA Plan are not confirmable as a
matter of law. The Bankruptcy Court provisionally approved the disclosure
statements for both the Tenth Plan and the CNA Plan subject to the Bankruptcy
Court's ruling on the respective summary judgment motions which are pending.
Because the Tenth Plan and Eleventh Plan are substantially identical, the
Company believes rulings issued with respect to the Tenth Plan will also apply
to the Eleventh Plan.
There can be no assurance that the Company will not amend the Eleventh
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 and the Federal District Court, or that such approvals will be
received in a timely fashion, that its plan will be confirmed, that its plan, if
8
confirmed, will become effective, or that there will be sufficient funds to pay
for continued protracted litigation over its plan of reorganization. It is
unclear whether the Bankruptcy Court will approve the CNA Plan or whether the
CNA Plan, 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 Eleventh Plan. Certain other parties have
also filed various objections to Congoleum's previously proposed plans of
reorganization and may file objections to the Eleventh Plan. Furthermore, an ad
hoc committee of noteholders claiming to hold 44.96% of the Senior Notes has
threatened to vote against the Eleventh Plan. While Congoleum intends to seek to
obtain the required acceptances of the Eleventh Plan from all necessary classes
of creditors (if the summary judgment motion regarding the Tenth Plan is
denied), the Eleventh Plan provides an alternative treatment for holders of the
Senior Notes and stockholders, in the event sufficient noteholders do not
consent to the plan, which will materially affect the recoveries of these
classes. In the event that the holders of the Senior Notes do not vote to accept
the Eleventh Plan by the requisite number and amount required by the Bankruptcy
Code, then Plan confirmation shall be sought in accordance with the cram down
provisions of the Bankruptcy Code (the "Cramdown Treatment"). Pursuant to the
Cramdown Treatment, the Senior Notes and existing Class A and Class B Common
Stock would be cancelled and the Senior Note holders would receive their pro
rata share, with the Plan Trust, of Common Stock of Congoleum, as determined by
the Bankruptcy Court in the Confirmation Order.
The terms of the Eleventh Plan could be amended or modified as a result of
further negotiations with various parties. The terms of the CNA Plan are
materially different from the terms of the Eleventh Plan, and the CNA Plan 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 Eleventh Plan. The Company expects
that it will take until some time in the first quarter of 2007 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, which motion was denied in June 2006 and the Avoidance
9
Actions remain pending. The Eleventh Plan incorporates a compromise and
settlement of the asbestos personal injury claims that were settled prior to the
petition date under the Claimant Agreement and other pre-petition settlement
agreements. Under the terms of the Eleventh 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
Eleventh Plan. Settlement values under the Eleventh Plan differ from values
under previous plans, the Claimant Agreement, and other pre-petition settlement
agreements. As a result of such differences, the liability associated with the
asbestos personal injury claims against Congoleum may be materially different
than the present estimates of such items. 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 as based on the Eleventh Plan. Actual
amounts that will be contributed to the Plan Trust and costs for pursuing and
implementing the Eleventh 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 Eleventh Plan or any new amended
plan of reorganization or the proposal or solicitation of additional plans by
other parties could result in a proceeding that takes longer and is more costly
than the Company has estimated.
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.
10
2. Recent Accounting Principles:
Pension and Other Postretirement Plans
In September 2006, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans ("SFAS No. 158"), which amends SFAS No. 87, Employers
Accounting for Pensions, SFAS No. 88, Employers' Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination Benefits, SFAS
No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions,
and SFAS No. 132R, Employers' Disclosures about Pensions and Other
Postretirement Benefits (revised 2003). SFAS No. 158 requires companies to
recognize an asset or liability for the overfunded or underfunded status of
their benefit plans in their financial statements. SFAS No. 158 also requires
the measurement date for plan assets and liabilities to coincide with the
sponsor's year end. This standard provides two transition alternatives related
to the change in measurement date provisions. The recognition of an asset and
liability related to the funded status provision is effective for fiscal years
ending after December 15, 2006, and the change in measurement date provisions is
effective for fiscal years ending after December 15, 2008. Based on the funded
status of the Company's pension plans as of December 31, 2005 and assuming the
same December 31, 2005 actuarial assumptions, such as discount rates and asset
returns, and plan experience, the Company estimates that the impact due to the
recognition at December 31, 2006 of previously unrecognized amounts would reduce
shareholders' equity by approximately $2.0 million, before the recognition of
any tax effect, which the Company believes is not material. The actual impact of
the recognition provisions of SFAS No. 158 will not be known until year-end
valuations are available. Actuarial assumptions used for valuations of the
Company's pension and other postretirement plan liabilities as of December 31,
2006 may differ from actuarial assumptions used as of December 31, 2005.
Share Based Payment
On December 16, 2004, the 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 nine months 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
11
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.
As a result of adopting SFAS 123R effective January 1, 2006, income before
taxes, net income and basic and diluted earnings per share for the nine months
ended September 30, 2006 were $169 thousand and $0.02 per share lower,
respectively, than if The Company 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 nine
months of fiscal year 2005 based on the fair-value method under SFAS 123.
For the Nine
Months Ended
September 30,
2005
------------
Net (loss):
As reported $ (14,625)
Deduct: Total stock-based employee
compensation
expense determined under fair value based
method
for all awards, net of related tax effects 173
----------
Pro forma $ (14,798)
==========
Net income (loss) per share:
As reported basic and diluted $ (1.77)
Pro forma compensation expense (0.02)
----------
Pro forma basic and diluted $ (1.79)
==========
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.
At September 30, 2006, there was $0.1 million of unrecognized compensation
expense related to share-based payments, which is expected to be recognized over
a weighted-average period of 1.2 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
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
12
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.
On July 1, 2006, the Company issued 2,500 options under the 1999 Plan at an
exercise price of $2.11 per share. 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.
The fair value for these options granted was estimated at the date of grant
using a Black-Scholes option pricing model. A summary of the assumptions used
for stock option grants are as follows:
For Year Ended December 31,
---------------------------------
1999 Stock Option Plan 2006 2005 2004
---------------------------------
Dividend yield 0.00% 0.00% 0.00%
Expected volatility 88.37% 92.00% 92.00%
Option forfeiture rate 10.00% 10.00% 10.00%
Risk free interest rate 4.94% 4.76% 5.02%
Expected lives 7.0 years 7.0 years 7.0 years
The following table presents stock option activity for the nine months
ended September 30, 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 (32,400) $2.03 6.53 years
Exercised 600 $0.36
--------
Outstanding at September 30, 2006 639,000 $2.03 5.91 years
========
Exercisable at September 30, 2006 490,000 $2.03 5.91 years
13
Weighted-
Weighted- Average
Average Remaining
Stock Exercise Contractual
Options Price Term
---------- ----------- -------------
1999 Plan:
Outstanding at December 31, 2005 21,500 $ 2.40 7.54 years
Forfeited/Cancelled --
Exercised --
Granted 2,500 $ 2.11 9.75 years
---------
Outstanding at September 30, 2006 24,000 $ 2.37 7.10 years
=========
Exercisable at September 30, 2006 21,500 $ 2.40 7.10 years
Shares available for future share-based grants to employees and directors
under existing plans were 172,800 at September 30, 2006. At September 30, 2006,
the aggregate intrinsic value of options on outstanding shares was $35 thousand,
and the aggregate intrinsic value of options exercisable was $23 thousand. The
total intrinsic value of options vested during the nine months ended September
30, 2006 was $7 thousand.
The following table summarizes our non-vested stock option activity for the
nine months ended September 30, 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 (3,400) $1.85
Vested (136,000) $2.02
-----------
Non-vested stock options at September 30, 2006 149,000 $2.04
===========
Weighted-Average
Number of Grant-Date
Shares Fair Value
----------- ----------------
1999 Plan:
Non-vested stock options at January 1, 2006 4,500 $4.14
Granted 2,500 $2.11
Forfeited --
Vested (4,500) $4.14
------------
Non-vested stock options at September 30, 2006 2,500 $2.11
============
14
3. Inventories
A summary of the major components of inventories is as follows (in
thousands):
September 30, December 31,
2006 2005
-----------------------------
Finished goods $ 25,479 $ 25,548
Work-in-process 2,857 1,497
Raw materials and supplies 5,726 7,562
---------- ----------
Total inventories $ 34,062 $ 34,607
========== ==========
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 $4.8 million at September 30, 2006 and $4.3 million at
December 31, 2005, respectively, are not reduced by the amount of insurance
recoveries. Such estimated insurance recoveries approximated $2.1 million at
September 30, 2006 and $1.9 million at 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
15
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 "Galaxy/Spectron
Superfund Site"). 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 ("Operable
Unit 1" or OU-1); however, the remedial investigation/feasibility study related
to the deep groundwater (OU-2) has not been completed. The PRP group, of which
the Company is a part, has entered into a Consent Decree to perform the remedy
for OU-1 and resolve natural resource damage claims. The Consent Decree also
requires the PRPs to perform the OU-2 remedy, assuming that the estimated cost
of the remedy is not more than $10 million. If the estimated cost of the OU-2
remedy is more than $10 million, the PRPs may decline to perform it or they may
elect to perform anyway. Cost estimates for the OU-1 and OU-2 work combined
(including natural resource damages) range between $22 million and $34 million,
with the Company's share ranging between approximately $1.0 million and $1.6
million. This assumes that all parties participate and that none cash-out and
pay a premium; those two factors may account for some fluctuation in the
Company's share. Fifty percent (50%) of Congoleum's share of the costs is
presently being paid by one of its insurance carriers, Liberty Mutual Insurance
Company, whose remaining policy limits for this claim are expected to cover
approximately $0.3 million in additional costs. Congoleum expects to fund the
balance to the extent further insurance coverage is not available.
The Company filed a motion before the Bankruptcy Court seeking
authorization and approval of the Consent Decree and related settlement
agreements for the Galaxy/Spectron Superfund Site, as well authorization for
Liberty Mutual Insurance Company and the Company to make certain payments that
have been invoiced to the Company with respect to the Consent Decree and related
settlement agreements. An order authorizing and approving the Consent Decree and
related settlement agreements was issued by the Bankruptcy Court in August 2006.
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 $1.3 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 $1.0 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.
16
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").
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,
which motion was denied in June 2006. Settlement values under the Eleventh Plan
differ from values under previous plans, the Claimant Agreement and other
pre-petition settlement agreements. As a result of such differences and the
potential results of the Avoidance Actions, the liability associated with the
asbestos personal injury claims against Congoleum may be materially different
than the present estimates of such items.
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.
17
In November 2004, Congoleum filed the Fourth Plan with the Bankruptcy
Court reflecting the result of further negotiations with representatives of the
ACC, the FCR 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 ACC and the FCR 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 March 2006, Congoleum filed the Eighth Plan. In
addition, CNA filed a plan of reorganization and the Bondholders' Committee also
filed a plan of reorganization. In May 2006, the Bankruptcy Court ordered all
parties in interest in Congoleum's reorganization proceedings to participate in
global mediation discussions. Several mediation sessions took place from June
through September 2006. During the initial mediation negotiations, Congoleum
reached an agreement in principle, subject to mutually agreeable definitive
documentation, with the ACC, the FCR and ABI, on certain terms of the Ninth
Plan, which Congoleum filed and proposed jointly with the ACC on August 11,
2006. CNA and the Bondholders' Committee jointly filed a new, competing plan on
August 18, 2006 and each withdrew its prior plan of reorganization. Following
further mediated negotiations, Congoleum, the ACC, the FCR, ABI and the
Bondholders' Committee reached agreement on terms of the Tenth Plan, which
Congoleum filed jointly with the ACC on September 15, 2006. Following the
Bondholders' Committee's withdrawal of support for CNA's plan, CNA filed the CNA
Plan. On October 23, 2006, Congoleum and the ACC jointly filed a revised version
of the Tenth Plan (the Eleventh Plan) which reflected minor technical changes
agreed to by the various parties supporting Congoleum's plan. On October 26,
2006, the Bankruptcy Court held a hearing to consider the adequacy of the
disclosure statements with respect to the Tenth Plan and the CNA Plan and to
hear arguments on respective summary judgment motions that the Tenth Plan and
the CNA Plan are not confirmable as a matter of law. The Bankruptcy Court
provisionally approved the disclosure statements for both the Tenth Plan and the
CNA Plan subject to the Bankruptcy Court's ruling on the respective summary
judgment motions which are pending. Because the Tenth and Eleventh Plans are
substantially identical, the Company believes rulings issued with respect to the
Tenth Plan will also apply to the Eleventh Plan.
18
The Eleventh Plan incorporates a compromise and settlement of the asbestos
personal injury claims that were settled prior to the petition date under the
Claimant Agreement and other pre-petition settlement agreements. Settlement
values under the Eleventh Plan differ from the values under previous plans, the
Claimant Agreement and other pre-petition settlement agreements. Under the terms
of the Eleventh 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 Eleventh Plan.
There can be no assurance that the Company will not amend the Eleventh
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 and the
Federal District Court, or that such approvals will be received in a timely
fashion, that its plan will be confirmed, that its plan, if confirmed, will
become effective, or that there will be sufficient funds to pay for continued
protracted litigation over its plan of reorganization. It is unclear whether the
Bankruptcy Court will approve the CNA Plan or whether the CNA Plan, 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 Eleventh Plan. Certain other parties have
also filed various objections to Congoleum's previously proposed plans of
reorganization and may file objections to the Eleventh Plan. Furthermore, an ad
hoc committee of noteholders holding 44.96% of the Senior Notes has threatened
to vote against the Eleventh Plan. While Congoleum intends to seek to obtain the
required acceptances of the Eleventh Plan from all necessary classes of
creditors (if the summary judgment motion regarding the Tenth Plan is denied),
the Eleventh Plan provides an alternative treatment for holders of the Senior
Notes and stockholders, in the event sufficient noteholders do not consent to
the plan, which will materially affect the recoveries of these classes. In the
event that the holders of the Senior Notes do not vote to accept the Eleventh
Plan by the requisite number and amount required by the Bankruptcy Code, then
Plan confirmation shall be sought in accordance with the Cramdown Treatment.
Pursuant to the Cramdown Treatment, the Senior Notes and existing Class A and
Class B Common Stock would be cancelled and the Senior Note holders would
receive their pro rata share, with the Plan Trust, of Common Stock of Congoleum,
as determined by the Bankruptcy Court in the Confirmation Order.
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 appealed the
approval order granted by the Bankruptcy Court to the U.S. District Court. The
19
District Court, however, entered an order on September 8, 2006 that
administratively terminated the appeal. AIG has recently reserved the right to
argue that the Plan, if confirmed, could lead to the possibility that the AIG
settlement may be declared void; for its part, the Company has reserved its
rights to oppose any such argument. The AIG settlement further provides that any
party may declare that the settlement agreement is null and void if the
Confirmation Order fails to become a final order by May 10, 2007. 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 FCR has appealed the approval order granted by the Bankruptcy Court
to the U.S. District Court, where it is pending. The FCR, Federal and the
Company have reached an agreement to resolve the appeal pursuant to which the
Federal settlement agreement will be amended to fix the settlement amount
payable by Federal at $2.1 million and to delete from the settlement agreement
the adjustment mechanism, which operated under certain circumstances to reduce
the settlement amount. 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 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 settlement
agreement goes effective and the Bankruptcy Court approves the transfer of the
funds. An insurer and the FCR 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 (collectively, "Travelers"). 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. The FCR sought, and was
granted, limited discovery with respect to the Travelers settlement. A hearing
to consider the Travelers settlement has been adjourned until such time that
such discovery can be reasonably completed. 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. The settlement was approved by the Bankruptcy Court in
September 2006. In August 2006, Congoleum entered into a settlement agreement
with Century Indemnity Company and its affiliates ("Century"). Under the terms
of this settlement, Century will pay $16.95 million to the Plan Trust in four
installments over a three-year period commencing 60 days after all conditions to
the agreement have been satisfied. The Bankruptcy Court approved this settlement
20
in September 2006. Certain insurance companies have appealed the Bankruptcy
Court approval order to the U.S. District Court, where it is pending. It is
possible that one or more of the settling insurers may argue temporal,
Plan-related, and other conditions to payment have not been satisfied and
therefore such insurer is relieved of certain of its settlement obligations.
The Company expects that it will take until some time in the first quarter
of 2007 at the earliest to obtain confirmation of the Eleventh Plan.
Under previous plans, Congoleum's assignment of insurance recoveries to
the Plan Trust was net of costs incurred by Congoleum in connection with
insurance coverage litigation, and Congoleum was entitled to withhold from
recoveries, or seek reimbursement from the Plan Trust, for coverage litigation
costs incurred after January 1, 2003 and for $1.3 million in claims processing
fees paid in connection with claims settled under the Claimant Agreement. A
receivable was recorded for these costs as they were paid. Under the Eleventh
Plan, Congoleum would be entitled to reimbursement of only the $1.3 million in
claims processing costs and would not collect the balance of these receivables
($18.8 million at September 30, 2006). The write-off, as well as forgiveness of
indebtedness income pursuant to the Eleventh Plan and any other applicable
charges or credits are expected to be recorded at a future date, the net effect
of which cannot be determined.
The Eleventh 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 Eleventh Plan will
provide for payment of those claims in full from certain insurance proceeds.
Under the terms of the Eleventh Plan, on the effective date of the
Eleventh Plan (the "Effective Date"), the Plan Trust will provide a loan to
Congoleum, which loan is intended, when combined with cash on hand and available
drawings under the revolving credit facility, to provide Congoleum with $18
million of total liquidity, on a pro forma basis as of December 31, 2006 (the
"Plan Trust Note"). If the Effective Date occurs after December 31, 2006, the
total liquidity required by Congoleum, and thus the amount of the Plan Trust
Note, will be as mutually agreed among the ACC, the FCR, the Claimants'
Representative and Congoleum. The proceeds of the Plan Trust Note will only be
used for working capital and general corporate purposes. The Plan Trust Note
will be due and payable on December 31, 2011, shall bear interest at 10% per
annum payable semi-annually until the maturity date, and will contain such
covenants, warranties, and representations as agreed among Congoleum, the ACC,
the FCR and the Claimants' Representative. The principal amount of the Plan
Trust Note, which is subject to review and approval by the FCR and the ACC, may
not exceed $14 million unless both the FCR and ACC agree. There can be no
assurance either or both would agree to any such request from Congoleum, or that
Congoleum would obtain any other consents that might be necessary to increase
the amount of the Plan Trust Note.
21
On the Effective Date, if the holders of the Senior Note Claims (as a
class) vote to accept the Eleventh Plan, Congoleum will issue and contribute a
convertible promissory note (the "New Convertible Security") to the Plan Trust
in satisfaction of section 524(g) of the Bankruptcy Code. The New Convertible
Security will have the following terms: (i) an initial aggregate principal
amount of $2,738,234.75, such principal amount being subject to increase in the
amount, if any, by which 36% of Congoleum's market capitalization based on
average trading prices for Congoleum's Class A Common Stock at the close of
trading for the 90 consecutive trading days beginning on the one or two-year
anniversary of the Effective Date (depending on the reset date selected by the
Plan Trust), exceeds such initial principal amount; (ii) an initial interest
rate per annum equal to 9% of the principal amount, payable semi-annually in
arrears, with such interest rate per annum to reset to the rate of 5% of the
principal amount on the tenth anniversary of the Effective Date and payable at
such reset interest rate per annum until maturity; (iii) redeemable for the
principal amount at the option of the Plan Trust or Congoleum on or anytime
after the tenth anniversary of the Effective Date; (iv) a maturity date on the
fifteenth anniversary of the Effective Date if not redeemed or otherwise paid
earlier; (v) convertible into the number of shares of Class A Common Stock (on a
fully diluted basis with all Class B Common Stock converted to Class A Common
Stock), when combined with the number of shares of Class A Common Stock held by
the Plan Trust immediately prior to the conversion date, will result in the Plan
Trust owning 51% of the voting common shares outstanding on a fully diluted
basis immediately after the conversion on the conversion date and 51% of the
total economic equity value of Congoleum outstanding on a fully diluted basis
immediately after the conversion on the conversion date, such conversion to take
place at the option of the Plan Trust upon the occurrence and at any time during
the continuance of an event of default of the obligation to pay interest; (vi)
secured only by a first priority lien and security interest, pari passu only
with the security for the Plan Trust Note, on distributions of recoveries from a
law firm that are to be pledged to the Plan Trust; (vii) no voting rights except
upon conversion; and (viii) contractually subordinated in priority and payment
to the New Senior Notes; provided, however, that in the absence of a default
under the New Indenture, payments due under the New Convertible Security will be
made in the ordinary course in accordance with its terms. The principal
adjustment feature could result in the principal amount of the New Convertible
Security increasing materially.
Under the terms of the Eleventh Plan, if holders of the Senior Notes vote
to accept the Plan by the requisite number and amount required by the Bankruptcy
Code, the Senior Notes would be cancelled and Congoleum would issue new notes
(the "New Senior Notes") in the aggregate principal amount of $100 million.
Interest on the Senior Notes would be payable semi-annually at the rate of 10%
per annum until maturity in August, 2011. The New Senior Notes would be secured
by a lien on or security interest in all of Congoleum's assets (subject to
certain limitations), which security interest will be subordinate in priority
only to the security for Congoleum's working capital credit facility. The New
Senior Notes would be contractually senior in priority and right of payment to
the Plan Trust Note and the New Convertible Security, with the exception of
certain litigation recoveries from a law firm that are to be pledged to the Plan
Trust. In addition to the New Senior Notes, holders of the Senior Notes may
receive an additional $5 million from Congoleum, to be paid from insurance
recoveries, contingent upon Congoleum consummating certain insurance recoveries,
which $5 million will be held in escrow and paid to the noteholders if certain
contingencies occur and conditions are met.
22
While Congoleum intends to seek to obtain the required acceptances of the
Eleventh Plan from all necessary classes of creditors (if the summary judgment
motion regarding the Tenth Plan is denied), the Eleventh Plan provides an
alternative treatment for holders of the Senior Notes and stockholders in the
event sufficient noteholders do not consent to the Eleventh Plan. This
alternative treatment will materially affect the recoveries of these classes. In
the event that the holders of the Senior Notes do not vote to accept the
Eleventh Plan by the requisite number and amount required by the Bankruptcy
Code, then Plan confirmation will be sought in accordance with the Cramdown
Treatment. Pursuant to the Cramdown Treatment, the Senior Notes and existing
Class A and Class B Common Stock would be cancelled and the Senior Note holders
would receive their pro rata share of Common Stock with the Plan Trust, as
determined by the Bankruptcy Court in the Confirmation Order.
As part of the Eleventh Plan, Congoleum has agreed to indemnify
representatives of holders of pre-petition secured asbestos claims (the
"Claimants' Representative") and the trustee of the Collateral Trust in
connection with the negotiation and implementation of modifications to the Plan
documents contemplated by the Ninth Plan, the Tenth Plan and the Eleventh Plan,
for claims and costs, including attorneys' fees, up to a maximum of $3 million.
Under the Eleventh 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 and to forego certain indemnification rights it has
from Congoleum for asbestos claims. Under the Eleventh 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 Eleventh
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 $19.2 million
at a minimum, not including any Additional Principal Amount arising from
revaluation of the New Convertible Security or the principal amount of the Plan
Trust Note, 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 Eleventh Plan. The
Company is not yet able to determine the additional costs that may be required
to effect the Eleventh 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
proposing, filing or obtaining approval of the Eleventh Plan or any new amended
plan of reorganization, or the proposal or solicitation 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.
23
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
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 "Liberty
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
24
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 Liberty Settlement, net of any fees and expenses it may be entitled to
deduct, to the Collateral or Plan Trust. Payment of such fees and expenses are
subject to Bankruptcy Court order or approval. 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 the Eleventh Plan.
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.
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.
25
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.
In October 2005, a federal appeals court ruled that the law firm of
Gilbert Heintz & Randolph ("GHR"), 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 GHR.
26
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 in January 2006, and in March 2006 the Court
denied the motions for summary judgment.
Congoleum completed the presentation of its case in April 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 took place in
June 2006. In July 2006 the Court denied the motion for a directed verdict. The
trial resumed in September 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 based on the anticipated channeling injunction in the Eleventh Plan, 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.
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
27
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 September 30, 2006, the Company estimates it
will spend a further $19.2 million at a minimum in fees, expenses, and trust
contributions in connection with obtaining confirmation of its plan of
reorganization (in addition to the $6.0 million insurance settlement being held
as restricted cash). It also expects to spend a further $4.4 million at a
minimum in connection with insurance coverage litigation costs. Required
expenditures could be materially higher than these estimates.
In February 2006, the Bankruptcy Court ordered GHR to disgorge all fees
and certain expenses it was paid by Congoleum. The amount of the disgorgement is
approximately $9.6 million. In October 2006, Congoleum and GHR entered into a
settlement agreement (the "GHR Settlement") under which GHR would pay Congoleum
approximately $9.2 million in full satisfaction of the disgorgement order. The
payment would be made over time according to a formula based on GHR's earnings.
Congoleum has filed a motion seeking Bankruptcy Court approval of the GHR
Settlement which is pending. Pursuant to the terms of the Eleventh Plan, the net
proceeds of the GHR Settlement would be used to reduce the obligations of
Congoleum to the Plan Trust by first being applied to reduce or satisfy
principal and accrued interest under the Plan Trust Note and thereafter to
reduce or satisfy principal and accrued interest under the New Convertible
Security.
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.
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 will be assigned to the Collateral Trust or Plan Trust.
28
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 September 30, 2006:
Reimbursement
Balance at Reserve from Insurance Balance at
(in thousands) 12/31/05 Spending Addition Settlement 9/30/06
-----------------------------------------------------------------------------
Reserves
Current $ 19,469 $ (8,818) $ -- $ -- $ 10,651
Long-Term -- -- -- --
Receivables
Current (14,793) (8,934) 3,684 (20,043)
Long-Term -- -- -- -- --
-------- -------- ------- ------- --------
Net Asbestos Liability $ 4,676 $(17,752) $ -- $ 3,684 $ (9,392)
======== ======== ======= ======= ========
Restricted Cash
Insurance Proceeds $ 8,901 $ (3,684) $ 768 $ -- $ 5,985
Reimbursement
Balance at Reserve from Insurance Balance at
(in thousands) 12/31/04 Spending Addition Settlement 9/30/05
-----------------------------------------------------------------------------
Reserves
Current $ 6,550 $ (9,610) $13,092 $ -- $ 10,032
Long-Term 2,738 -- -- 2,738
Receivables
Current (1,509) (11,209) 2,362 6,091 (4,265)
Long-Term (7,300) -- -- -- (7,300)
-------- -------- ------- ------- --------
Net Asbestos Liability $ 479 $(20,819) $15,454 $ 6,091 $ 1,205
======== ======== ======= ======= ========
Restricted Cash
Insurance Proceeds $ 14,530 $ 302 $(6,091) $ 8,741
29
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 thousands):
Nine Months Ended Nine Months Ended
September 30, September 30,
2006 2005
---- ----
Beginning balance $ 2,125 $ 2,721
Accruals 2,962 2,580
Charges (3,014) (3,163)
---------- ----------
Ending balance $ 2,073 $ 2,138
========== ==========
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 September 30, 2006 and December 31,
2005 are as follows:
(In thousands)
September 30, December 31,
2006 2005
---- ----
Current
Pre-petition other payables and
accrued interest $ 31,965 $ 23,990
Non-current
Debt (at face value) 100,000 100,000
Pension liability 14,215 16,871
Other post-retirement benefit obligation 8,528 8,407
Pre-petition other liabilities 13,413 13,583
----------- -----------
Non-current 136,156 138,861
----------- -----------
Total liabilities subject to compromise $ 168,121 $ 162,851
=========== ===========
30
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)
September 30, December 31,
2006 2005
---- ----
Accrued warranty, marketing and sales promotion $ 17,647 $ 19,129
Employee compensation and related benefits 3,966 3,674
Other 2,126 269
----------- -----------
Total accrued liabilities $ 23,739 $ 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 September 30, 2006 and December
31, 2005 (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").
31
The following summarizes the components of the net periodic benefit cost
for the Pension and Other Benefit Plans for the three months ended September 30,
2006 and 2005:
(In thousands)
Three Months Ended Three Months Ended
September 30, 2006 September 30, 2005
------------------ ------------------
Other Other
Pension Benefits Pension Benefits
--------- --------- --------- ---------
Components of Net Periodic Benefit Cost:
Service cost $ 274 $ 46 $ 285 $ 46
Interest cost 1,138 128 1,092 130
Expected return on plan assets (994) -- (976) --
Recognized net actuarial loss 525 15 280 15
Amortization of transition obligation -- -- (9) --
Amortization of prior service cost (53) 9 (72) (47)
--------- --------- --------- ---------
Net periodic benefit cost $ 890 $ 198 $ 600 $ 144
========= ========= ========= =========
The weighted average assumptions used to determine net periodic benefit
cost were as follows:
September 30, 2006 September 30, 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%
32
The following summarizes the components of the net periodic benefit cost
for the Pension and Other Benefit Plans for the nine months ended September 30,
2006 and 2005:
(In thousands)
Nine Months Ended Nine Months Ended
September 30, 2006 September 30, 2005
------------------ ------------------
Other Other
Pension Benefits Pension Benefits
----------- ----------- ----------- -----------
Components of Net Periodic Benefit Cost:
Service cost $ 995 $ 97 $ 995 $ 138
Interest cost 3,364 266 3,280 390
Expected return on plan assets (2,988) -- (2,738) --
Recognized net actuarial loss 1,256 18 1,049 45
Amortization of transition obligation -- -- (45) --
Amortization of prior service cost (161) 32 (216) (141)
----------- ----------- ----------- -----------
Net periodic benefit cost $ 2,466 $ 413 $ 2,325 $ 432
=========== =========== =========== ===========
The weighted average assumptions used to determine net periodic benefit
cost were as follows:
September 30, 2006 September 30, 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%
33
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 Part I 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.
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 as a means to resolve claims asserted against it
related to the use of asbestos in its products decades ago. On December 31,
2003, Congoleum filed a voluntary petition with the Bankruptcy Court 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 ACC, the FCR 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 ACC and the FCR 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 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 March 2006, Congoleum filed the Eighth Plan. In
addition, CNA filed a plan of reorganization and the Bondholders' Committee also
34
filed a plan of reorganization. In May 2006, the Bankruptcy Court ordered all
parties in interest in Congoleum's reorganization proceedings to participate in
global mediation discussions. Several mediation sessions took place from June
through September 2006. During the initial mediation negotiations, Congoleum
reached an agreement in principle, subject to mutually agreeable definitive
documentation, with the ACC, the FCR and ABI, on certain terms of the Ninth
Plan, which Congoleum filed and proposed jointly with the ACC on August 11,
2006. CNA and the Bondholders' Committee jointly filed a new, competing plan on
August 18, 2006 and each withdrew its prior plan of reorganization. Following
further mediated negotiations, Congoleum, the ACC, the FCR, ABI and the
Bondholders' Committee reached agreement on terms of the Tenth Plan, which
Congoleum filed jointly with the ACC on September 15, 2006. Following the
Bondholders' Committee's withdrawal of support for CNA's plan, CNA filed the CNA
Plan. On October 23, 2006, Congoleum and the ACC jointly filed a revised version
of the Tenth Plan (the Eleventh Plan) which reflected minor technical changes
agreed to by the various parties supporting Congoleum's plan. On October 26,
2006, the Bankruptcy Court held a hearing to consider the adequacy of the
disclosure statements with respect to the Tenth Plan and the CNA Plan and to
hear arguments on respective summary judgment motions that the Tenth Plan and
the CNA Plan are not confirmable as a matter of law. The Bankruptcy Court
provisionally approved the disclosure statements for both the Tenth Plan and the
CNA Plan subject to the Bankruptcy Court's ruling on the respective summary
judgment motions which are pending. Because the Tenth and Eleventh Plans are
substantially identical, the Company believes rulings issued with respect to the
Tenth Plan will also apply to the Eleventh Plan.
There can be no assurance that the Company will not amend the Eleventh
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 and the Federal District Court, or that such approvals will be
received in a timely fashion, that its plan will be confirmed, that its plan, if
confirmed, will become effective, or that there will be sufficient funds to pay
for continued protracted litigation over its plan of reorganization. It is
unclear whether the Bankruptcy Court will approve the CNA Plan or whether the
CNA Plan, 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 Eleventh Plan. Certain other parties have
also filed various objections to Congoleum's previously proposed plans of
reorganization and may file objections to the Eleventh Plan. Furthermore, an ad
hoc committee of noteholders claiming to hold 44.96% of the Senior Notes has
threatened to vote against the Eleventh Plan. While Congoleum intends to seek to
obtain the required acceptances of the Eleventh Plan from all necessary classes
of creditors (if the summary judgment motion regarding the Tenth Plan is
denied), the Eleventh Plan provides an alternative treatment for holders of the
Senior Notes and stockholders, in the event sufficient noteholders do not
consent to the plan, which will materially affect the recoveries of these
classes. In the event that the holders of the Senior Notes do not vote to accept
the Eleventh Plan by the requisite number and amount required by the Bankruptcy
Code, then Plan confirmation shall be sought in accordance with the Cramdown
Treatment. Pursuant to the Cramdown Treatment, the Senior Notes and existing
Class A and Class B Common Stock would be cancelled and the Senior Note holders
would receive their pro rata share, with the Plan Trust, of Common Stock of
Congoleum, as determined by the Bankruptcy Court in the Confirmation Order.
35
The terms of the Eleventh Plan could be amended or modified as a result of
further negotiations with various parties. The terms of the CNA Plan are
materially different from the terms of the Eleventh Plan, and the CNA Plan 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 Eleventh Plan. The Company expects
that it will take until some time in the first quarter of 2007 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 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,
which motion was denied in June 2006 and the Avoidance Actions remain pending.
Under the terms of the Eleventh 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 Eleventh Plan. The Eleventh
Plan incorporates a compromise and settlement of the asbestos personal injury
claims that were settled prior to the petition date under the Claimant Agreement
and other pre-petition settlement agreements. Settlement values under the
Eleventh Plan differ from values under previous plans, the Claimant Agreement,
and other pre-petition settlement agreements. As a result of such differences
and the potential results of the Avoidance Actions, the liability associated
with the asbestos personal injury claims against Congoleum may be materially
different than the present estimates of such items. 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 as based on the Eleventh Plan. Actual
amounts that will be contributed to the Plan Trust and costs for pursuing and
implementing the Eleventh 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 Eleventh Plan or any new amended
plan of reorganization, or the proposal or solicitation of additional plans by
other parties could result in a proceeding that takes longer and is more costly
than the Company has estimated.
36
On August 18, 2006, an explosion and fire caused extensive damage to
components of a major production line at the Company's Marcus Hook facility. By
implementing a seven day operation on its other production line and purchasing
base material from a competitor, the Company has been able to meet all
production requirements. The Company expects its insurance carrier will pay
substantially all excess costs (beyond a deductible) for replacing the damaged
equipment and lost production capacity. Fabrication of replacement equipment is
underway and the Company anticipates that the line will be operational by the
end of 2006. The financial impact in the third quarter of 2006 as a result of
lost overhead absorption, lost sales and deductibles and uninsured expenses is
estimated to be approximately $0.8 million. The Company does not anticipate any
impact to operating results as a result of this incident, in the fourth quarter
of 2006. However, if the Company experiences any significant unforeseen delays
or difficulties with its alternative production arrangements, the procurement
and installation of replacement equipment, or obtaining insurance reimbursements
for the excess costs associated with the loss, it could have a material adverse
impact on its business, results of operations, and financial condition.
Three and nine months ended September 30, 2006 as compared to three and
nine months ended December 30, 2005:
Three months ended Nine months ended
September 30, September 30,
2006 2005 2006 2005
Net sales $57,460 $60,507 $173,440 $176,245
Cost of sales 44,562 47,270 133,661 135,577
-------- ------- -------- --------
Gross profit 12,898 22.4% 13,237 21.9% 39,779 22.9% 40,668 23.1%
Selling, general and
administrative
expenses 10,681 18.6% 10,556 17.4% 31,338 18.1% 32,962 18.7%
Asbestos related
reorganization
charges -- -- -- 15,454
-------- ------- -------- --------
Operating income (loss) 2,217 2,681 8,441 (7,748)
Interest expense (2,916) (2,670) (8,517) (7,788)
Other income, net 181 314 511 911
-------- ------- -------- --------
Income (loss) before (518) 325 435 (14,625)
taxes
Provision for income
taxes (94) -- 22 --
-------- ------- -------- --------
Net income (loss) $ (424) $ 325 $ 413 $(14,625)
======== ======= ======== ========
Net sales for the three months ended September 30, 2006 totaled $57.5
million as compared to $60.5 million for the same period in the prior year, a
decrease of $3.0 million or 5.0%. The decrease primarily reflected the impact of
weak retail demand for residential sheet products and lower sales in the
commercial tile category partially offset by selling price increases. Net sales
for the nine months ended September 30, 2006 were $173.4 million as compared to
$176.2 million for the nine months ended September 30, 2005, a decrease of $2.8
million or 1.6%. The decrease reflected the impact of lower sales in the mid- to
high-end resilient sheet category, lower sales of commercial tile and less
demand for promotional product. Selling price increases instituted in late 2005
and September 2006 partially offset this decrease.
37
Gross profit for the three months ended September 30, 2006 totaled $12.9
million or 22.4% of net sales, compared to $13.2 million, or 21.9% of net sales,
for the same period last year. The improvement in gross margin percent reflects
the impact of selling price increases (6.6% of net sales) partially offset by
higher raw material and utility costs which reduced margins by approximately
2.5% of net sales and an unfavorable product mix (which reduced margins by 2.8%
of net sales). Gross profit for the nine months ended September 30, 2006 totaled
$39.8 million, or 22.9% of net sales, compared to $40.7 million, or 23.1% of net
sales, for the same period last year. The major factors leading to the
deterioration in gross margin were the increases in raw material and utility
costs experienced during the second half of 2005, which reduced margins by
approximately 3.0% of net sales. In addition, the lower sales of high priced
sheet products negatively impacted product mix and gross margins by
approximately 1.3% of net sales. This was partially mitigated by a 4.1%
improvement in gross margins resulting from selling price increases.
Selling, general and administrative expenses were $10.7 million for the
three months ended September 30, 2006, as compared to $10.6 million for the same
period last year. The reduction in expense reflects lower merchandising expenses
(down $0.2 million) and lower freight expense ($0.1 million) partially offset by
higher medical and pension expenses ($0.2 million). As a percent of net sales,
selling, general and administrative expenses totaled 18.6% of net sales for the
third quarter of 2006 versus 17.4% for the same period last year. Selling,
general and administrative expenses were $31.3 million for the nine months ended
September 30, 2006 as compared to $33.0 million for the nine months ended
September 30, 2005, a decrease of $1.7 million. The reduction in expenses
primarily reflects lower merchandising related expenses ($0.6 million), lower
compensation costs related to workforce reduction ($0.6 million) and lower
freight costs for shipments to home centers ($0.2 million). As a percent of net
sales, selling, general and administrative costs were 18.1% for the nine months
ended September 30, 2006 compared to 18.7% for the same period last year.
Income from operations totaled $2.2 million for the quarter ended
September 30, 2006, compared to an income from operations of $2.7 million for
the same period last year reflecting lower gross margins. Income from operations
was $8.4 million for the nine months ended September 30, 2006 compared to a loss
of $7.7 million for the nine months ended September 30, 2005 after a charge for
asbestos reorganization costs of $15.5 million. The improvement in operating
income in 2006 reflects the reorganization related charge taken in 2005, coupled
with lower selling, general and administrative expenses experienced in 2006.
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 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.
38
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 nine months of 2006, the Company paid $17.8
million in fees and expenses related to implementation of its planned
reorganization under Chapter 11 and litigation with certain insurance companies.
Furthermore, at September 30, 2006 the Company had incurred but not paid
approximately $9 million in additional fees and expenses for services rendered
through that date.
Under previous plans, Congoleum's assignment of insurance recoveries to
the Plan Trust was net of costs incurred by Congoleum in connection with
insurance coverage litigation, and Congoleum was entitled to withhold from
recoveries, or seek reimbursement from the Plan Trust, for coverage litigation
costs incurred after January 1, 2003 and for $1.3 million in claims processing
fees paid in connection with claims settled under the Claimant Agreement. A
receivable was recorded for these costs as they were paid. Under the Eleventh
Plan, Congoleum would be entitled to reimbursement of only the $1.3 million in
claims processing fees and would not collect the balance of these receivables
($18.8 million at September 30, 2006). The write-off, as well as forgiveness of
indebtedness income pursuant to the Eleventh Plan and any other applicable
charges or credits are expected to be recorded at a future date, the net effect
of which cannot be determined.
Congoleum expects to spend a further $19.2 million at a minimum in fees,
expenses, and trust contributions in connection with obtaining confirmation of
its plan of reorganization (in addition to the $6.0 million insurance settlement
being held as restricted cash). It also expects to spend a further $4.4 million
at a minimum in connection with insurance coverage litigation costs, for which
it will not be reimbursed as discussed above. Required expenditures could be
materially higher than these estimates.
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 at September 30, 2006 is approximately $30.5 million, including interest
on the unpaid interest due, of which $3.6 million was owed at the time of the
Chapter 11 filing. In February 2006, the Bankruptcy Court ordered GHR to
disgorge all fees and certain expenses it was paid by Congoleum. The amount of
the disgorgement is approximately $9.6 million. In October 2006, Congoleum and
GHR entered into a settlement agreement (the "GHR Settlement") under which GHR
would pay Congoleum approximately $9.2 million in full satisfaction of the
disgorgement order. The payment would be made over time according to a formula
based on GHR's earnings. Congoleum has filed a motion seeking Bankruptcy Court
approval of the GHR Settlement which is pending. Pursuant to the terms of the
Eleventh Plan, the net proceeds of the GHR disgorgement would be used to reduce
the obligations of Congoleum to the Plan Trust by first being applied to reduce
or satisfy principal and accrued interest under the Plan Trust Note and
thereafter to reduce or satisfy principal and accrued interest under the New
Convertible Security.
39
Under the terms of the Eleventh Plan, on the Effective Date, the Plan
Trust will provide a loan to Congoleum, which loan is intended, when combined
with cash on hand and available drawings under the revolving credit facility, to
provide Congoleum with $18 million of total liquidity, on a pro forma basis as
of December 31, 2006. If the Effective Date occurs after December 31, 2006, the
total liquidity required by Congoleum, and thus the amount of the Plan Trust
Note, will be as mutually agreed among the ACC, the FCR, the Claimants'
Representative and Congoleum. The proceeds of the Plan Trust Note will only be
used for working capital and general corporate purposes. The Plan Trust Note
will be due and payable on December 31, 2011, will bear interest at 10% per
annum payable semi-annually until the maturity date, and will contain such
covenants, warranties, and representations as agreed among Congoleum, the ACC,
the FCR and the Claimants' Representative. The principal amount of the Plan
Trust Note, which is subject to review and approval by the FCR and the ACC, may
not exceed $14 million unless both the FCR and ACC agree. There can be no
assurance either or both would agree to any such request from Congoleum, or that
Congoleum would obtain any other consents that might be necessary to increase
the amount of the Plan Trust Note.
On the Effective Date, if the holders of the Senior Note Claims (as a
class) vote to accept the Eleventh Plan, Congoleum will issue and contribute the
New Convertible Security to the Plan Trust in satisfaction of section 524(g) of
the Bankruptcy Code. The New Convertible Security will have the following terms:
(i) an initial aggregate principal amount of $2,738,234.75, such principal
amount being subject to increase in the amount, if any, by which 36% of
Congoleum's market capitalization based on average trading prices for
Congoleum's Class A Common Stock at the close of trading for the 90 consecutive
trading days beginning on the one- or two-year anniversary of the Effective Date
(depending on the reset date selected by the Plan Trust), exceeds such initial
principal amount; (ii) an initial interest rate per annum equal to 9% of the
principal amount, payable semi-annually in arrears, with such interest rate per
annum to reset to the rate of 5% of the principal amount on the tenth
anniversary of the Effective Date and payable at such reset interest rate per
annum until maturity; (iii) redeemable for the principal amount at the option of
the Plan Trust or Congoleum on or anytime after the tenth anniversary of the
Effective Date; (iv) a maturity date on the fifteenth anniversary of the
Effective Date if not redeemed or otherwise paid earlier; (v) convertible into
the number of shares of Class A Common Stock (on a fully diluted basis with all
Class B Common Stock converted to Class A Common Stock) which, when combined
with the number of shares of Class A Common Stock held by the Plan Trust
immediately prior to the conversion date, will result in the Plan Trust owning
51% of the voting common shares outstanding on a fully diluted basis immediately
after the conversion on the conversion date and 51% of the total economic equity
value of Congoleum outstanding on a fully diluted basis immediately after the
conversion on the conversion date, such conversion to take place at the option
of the Plan Trust upon the occurrence and at any time during the continuance of
an event of default of the obligation to pay interest; (vi) secured only by a
first priority lien and security interest, pari passu only with the security for
the Plan Trust Note, on distributions of recoveries from a law firm that are to
be pledged to the Plan Trust; (vii) no voting rights except upon conversion; and
(viii) contractually subordinated in priority and payment to the New Senior
Notes; provided, however, that in the absence of a default under the New
Indenture, payments due under the New Convertible Security will be made in the
ordinary course in accordance with its terms. The principal adjustment feature
could result in the principal amount of the New Convertible Security increasing
materially.
40
Under the terms of the Eleventh Plan, if holders of the Senior Notes vote
to accept the Plan by the requisite number and amount required by the Bankruptcy
Code, the Senior Notes would be cancelled and Congoleum would issue the New
Senior Notes in the aggregate principal amount of $100 million which shall be
payable semi-annually at the rate of 10% per annum until a maturity date of
August 1, 2011. The New Senior Notes would be secured by a lien on or security
interest in all of Congoleum's assets (subject to certain limitations), which
security interest will be subordinate in priority only to Congoleum's working
capital credit facility. The New Senior Notes would be contractually senior in
priority and right of payment to the Plan Trust Note and the New Convertible
Security, with the exception of certain litigation recoveries from a law firm
that are to be pledged to the Plan Trust. In addition to the New Senior Notes,
holders of the Senior Notes may receive an additional $5 million from Congoleum,
to be paid from insurance recoveries, contingent upon Congoleum consummating
certain insurance recoveries, which $5 million will be held in escrow and paid
to the Bondholders if certain contingencies occur and conditions are met.
While Congoleum is seeking to obtain the required acceptances of the
Eleventh Plan from all necessary classes of creditors, the Eleventh Plan
provides an alternative treatment for holders of the Senior Notes and
stockholders in the event sufficient note holders do not consent to the Eleventh
Plan. This alternative treatment will materially affect the recoveries of these
classes. In the event that the holders of the Senior Notes do not vote to accept
the Eleventh Plan by the requisite number and amount required by the Bankruptcy
Code, then Plan confirmation will be sought in accordance with the Cramdown
Treatment. Pursuant to the Cramdown Treatment, the Senior Notes and existing
Class A and Class B Common Stock would be cancelled and the Senior Note holders
would receive their pro rata share of Common Stock with the Plan Trust, as
determined by the Bankruptcy Court in the Confirmation Order.
Unrestricted cash and cash equivalents, including short-term investments
at September 30, 2006, were $19.7 million, a decrease of $4.8 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 $4.2 million and $2.0 million at
September 30, 2006 and December 31, 2005, respectively, are recorded as
restricted cash. Additionally, $6.0 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 September
30, 2006. The Company expects to contribute these funds to the Plan Trust.
Working capital was $30.1 million at September 30, 2006, up from $28.0 million
at December 31, 2005. The ratio of current assets to current liabilities at
September 30, 2006 was 1.3 to 1.0, which is unchanged from December 31, 2005.
The ratio of debt to total capital at September 30, 2006 was 0.48 to 1.0 which
is slightly lower since December 31, 2005. Net cash used by operations during
the first nine months of 2006 was $8.6 million, as compared to net cash used by
operations of $10.1 million in the first nine months of 2005. The reduction in
cash used by operations in the first nine months of 2006 versus the first nine
months of 2005 was primarily due to lower working capital requirements for
inventory, prepaid expenses, and settlement of payables and accrued expenses in
2006.
41
Capital expenditures for the nine months ended September 30, 2006 totaled
$2.5 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 September 30, 2006. Borrowings under this facility are collateralized by
inventory and receivables. At September 30, 2006, based on the level of
receivables and inventory, $25.1 million was available under the facility, of
which $5.1 million was utilized for outstanding letters of credit and $14.2
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.
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
42
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 $8.6 million in cash from operations in the first nine months of 2006
(as more fully discussed above), which includes the benefit of $10.1 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 remainder of 2006. Based on
expected costs to complete its reorganization proceedings, the Company
anticipates it will need to obtain the contemplated approximately $14 million
from the Plan Trust Note to provide it with sufficient liquidity when the
Eleventh Plan goes effective. Actual sources and uses of funds to consummate the
effectiveness of the Eleventh Plan or any other plan may differ significantly
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 Eleventh Plan in a timely manner would have a material
adverse effect on the Company's ability to fund its operating, investing and
financing requirements.
43
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 September 30, 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.
44
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.
Item 1A. Risk Factors:
The Company has significant asbestos liability and funding
exposure, and its Eleventh Plan may not be confirmed.
As more fully set forth in Notes 1 and 6 of the Notes to
Unaudited Condensed Consolidated Financial Statements, which
are included in this Quarterly 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. The Eleventh Plan incorporates a compromise
and settlement of the asbestos personal injury claims that
were settled prior to the petition date under the Claimant
Agreement and other pre-petition settlement agreements. Under
the terms of the Eleventh Plan, settlement values differ from
values under previous plans, the Claimant Agreement and other
pre-petition settlement agreements.
There can be no assurance that the Company will not amend the
Eleventh 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 and the Federal District Court, or
that such approvals will be received in a timely fashion, that
its plan will be confirmed, that its plan, if confirmed, will
become effective, or that there will be sufficient funds to
pay for continued protracted litigation over its plan of
reorganization. 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 a
competing plan has been filed by an insurance company. 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 Eleventh 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 Eleventh Plan
contained in this Quarterly Report on Form 10-Q. Furthermore,
the estimated costs and contributions to effect the Eleventh
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.
45
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, 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) compliance with the
Bankruptcy Code, including Section 524(g) and (xi) 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.
46
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 Eleventh Plan could be confirmed in accordance with the
cram down provisions of the Bankruptcy Code which would
materially affect the recoveries of holders of the Senior
Notes, eliminate interests of existing shareholders, and
result in a change of control of Congoleum.
The Eleventh Plan provides that if the holders of the Senior
Notes do not vote to accept the Eleventh Plan by the requisite
number and amount required by the Bankruptcy Code, then Plan
confirmation will be sought in accordance with the cram down
provisions of the Bankruptcy Code. Under the Cramdown
Treatment, the Senior Notes and existing Class A and Class B
Common Stock would be cancelled and the Senior Note holders
would receive, with the Plan Trust, their pro rata share of
Common Stock, as determined by the Bankruptcy Court in the
Confirmation Order. While the value of the shares that the
holders of the Senior Notes would receive cannot be
determined, the Company believes such value will be materially
less than the value of the New Senior Notes that holders of
the Senior Notes would receive if the Cramdown Treatment is
not required. An ad hoc committee of note holders claiming to
hold 44.96% of the Senior Notes has threatened to vote against
the Eleventh Plan, which, if carried out, would result in the
Cramdown Treatment under the Eleventh Plan.
47
Cancellation of the existing shares and issuance of new shares
would result in a complete change of the ownership and control
of Congoleum. While the reaction by customers, suppliers,
employees and others to such a change cannot be determined, it
could have a material adverse effect on Congoleum's business,
results of operations and financial condition.
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.
In April 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
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 submitted such a plan which was accepted by
the Amex, who will continue to monitor Congoleum's progress
toward compliance. There can be no assurance that Congoleum
will be able to achieve such compliance, or that the Amex will
remain satisfied with Congoleum's progress toward compliance.
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.
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
48
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.
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.
49
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.
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, one of the Company's major
competitors has successfully confirmed a plan of
reorganization under Chapter 11 of the Bankruptcy Code. Having
shed much of its pre-filing asbestos and other liabilities,
that competitor may have a competitive cost advantage over the
Company. 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.
50
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.
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.
In August 2006, one of the sheet flooring production lines at
the Company's Marcus Hook, Pennsylvania plant sustained
extensive damage. The Company has largely been able to replace
the capacity of the damaged line through a combination of
available overtime capacity on the other production line at
the Marcus Hook plant and outsourcing. Work on replacing the
damaged line has commenced, and repairs are expected to be
completed during the last quarter of 2006. The Company
believes its property and business interruption insurance
coverage will minimize the costs resulting from the incident,
including the burden of replacing the production capacity.
However, if the Company experiences any significant unforeseen
delays or difficulties with its alternative production
arrangements, the procurement and installation of replacement
equipment, or obtaining insurance reimbursements for the
excess costs associated with the loss, it could have a
material adverse impact on its business, results of
operations, and financial condition.
51
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
13 distributors providing approximately 76 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 68% of the Company's net sales for
the year ended September 30, 2006 and 67% of the Company's net
sales for the year ended December 31, 2005.
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 69.4% 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
52
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 Congoleum 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,
February 1, 2006 and August 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 $30.5 million. As
of September 30, 2006, the principal amount of the Senior
Notes, net of unamortized original issue discount, was $99.8
million. These amounts, which include $3.2 million of accrued
interest on the interest due but not paid from February 1,
2004, August 1, 2004, February 1, 2005, August 1, 2005,
February 1, 2006 and August 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
53
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 and Policy Buyback Agreement and Release,
made as of August 17, 2006, by and between Congoleum
Corporation and Century Insurance Company.
99.2 Eleventh Modified Joint Plan of Reorganization Under
Chapter 11 of the Bankruptcy Code of Congoleum
Corporation, et al., and the Asbestos Claimants'
Committee, dated as of October 23, 2006, including
the Exhibits thereto.
99.3 Proposed Disclosure Statement With Respect to the
Eleventh Modified Joint Plan of Reorganization Under
Chapter 11 of the Bankruptcy Code of Congoleum
Corporation, et al., and the Asbestos Claimants'
Committee, dated as of October 23, 2006, including the
Exhibits thereto (with the exception of Exhibit
A, which is included herein as Exhibit 99.2).
54
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: November 13, 2006 By: /s/ Howard N. Feist III
---------------------------------------
Howard N. Feist III
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial & Accounting Officer)
55
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 and Policy Buyback Agreement and Release,
made as of August 17, 2006, by and between Congoleum
Corporation and Century Insurance Company.
99.2 Eleventh Modified Joint Plan of Reorganization Under
Chapter 11 of the Bankruptcy Code of Congoleum
Corporation, et al., and the Asbestos Claimants'
Committee, dated as of October 23, 2006, including the
Exhibits thereto.
99.3 Proposed Disclosure Statement With Respect to the Eleventh
Modified Joint Plan of Reorganization Under Chapter 11 of the
Bankruptcy Code of Congoleum Corporation, et al., and the
Asbestos Claimants' Committee, dated as of October 23, 2006,
including the Exhibits thereto (with the exception of Exhibit A,
which is included herein as Exhibit 99.2).
(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 September 30, 1996.
56