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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, 2003
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)
Telephone number: (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 an accelerated filer (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, 2003
------------------------------- -------------------------------------
Class A Common Stock 3,651,190
Class B Common Stock 4,608,945
1
CONGOLEUM CORPORATION
Index
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of
September 30, 2003 (unaudited) and December 31, 2002............. 3
Condensed Consolidated Statements of Operations for the
three and nine months ended September 30, 2003 and 2002
(unaudited)...................................................... 4
Condensed Consolidated Statements of Cash Flows for
the nine months ended September 30, 2003 and 2002 (unaudited).... 5
Notes to Unaudited Condensed Consolidated Financial
Statements (unaudited)........................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk........... 32
Item 4. Controls and Procedures.............................................. 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................... 33
Item 2. Changes in Securities and Use of Proceeds............................ 33
Item 3. Defaults Upon Senior Securities...................................... 33
Item 4. Submission of Matters to a Vote of Security Holders.................. 33
Item 5. Other Information.................................................... 33
Item 6. Exhibits and Reports on Form 8-K..................................... 33
Signatures ................................................................ 36
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONGOLEUM CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2003 2002
--------- ---------
(Unaudited)
(Dollars in thousands)
ASSETS
Current assets:
Cash and cash equivalents ................................... $ 7,993 $ 18,277
Restricted cash ............................................. 4,117 --
Accounts and notes receivable, net .......................... 19,786 17,034
Inventories ................................................. 45,655 50,725
Prepaid expenses and other current assets ................... 4,253 7,868
Deferred income taxes ....................................... 7,901 7,901
--------- ---------
Total current assets ..................................... 89,705 101,805
Property, plant and equipment, net .............................. 89,173 93,556
Other assets .................................................... 8,248 8,630
--------- ---------
Total assets ............................................. $ 187,126 $ 203,991
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ............................................ $ 11,551 $ 14,647
Accrued expenses ............................................ 25,960 33,021
Revolving credit loan ....................................... 8,497 --
Asbestos-related expenses ................................... 10,150 21,295
Accrued taxes ............................................... 111 59
Deferred income taxes ....................................... 3,954 3,954
--------- ---------
Total current liabilities ................................ 60,223 72,976
Long-term debt .................................................. 99,761 99,724
Other liabilities ............................................... 11,780 11,782
Deferred income taxes ........................................... 3,947 3,947
Accrued pension liability ....................................... 22,018 22,932
Accrued postretirement benefit obligation ....................... 8,774 8,708
--------- ---------
Total liabilities ........................................ 205,940 220,069
STOCKHOLDERS' EQUITY (DEFICIT)
Class A common stock, par value $0.01 per share; 20,000,000
shares Authorized; 4,736,950 shares issued as of September
30, 2003 and December 31, 2002 .............................. 47 47
Class B common stock, par value $0.01 per share; 4,608,945
shares Authorized, issued and outstanding as of September
30, 2003 and December 31, 2002 .............................. 46 46
Additional paid-in capital ...................................... 49,105 49,105
Retained deficit ................................................ (43,315) (40,016)
Accumulated minimum pension liability adjustment ................ (17,447) (17,447)
--------- ---------
(11,564) (8,265)
Less Class A common stock held in Treasury, at cost; 1,085,760
shares at September 30, 2003 and December 31, 2002 .......... 7,813 7,813
--------- ---------
Total stockholders' equity (deficit) ..................... (19,377) (16,078)
--------- ---------
Total liabilities and stockholders' equity (deficit) ..... $ 187,126 $ 203,991
========= =========
The accompanying notes are an integral part
of the condensed consolidated financial statements.
3
CONGOLEUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ----------------------
2003 2002 2003 2002
(In thousands, except
per share amounts)
Net sales ..................................................... $ 61,139 $ 57,736 $ 169,715 $ 183,638
Cost of sales ................................................. 46,126 42,188 129,779 137,862
Selling, general and administrative expenses .................. 13,356 12,921 39,072 39,589
-------- -------- --------- ---------
Income from operations .................................... 1,657 2,627 864 6,187
Other income (expense):
Interest income ........................................... 7 83 55 202
Interest expense .......................................... (2,278) (2,091) (6,748) (6,250)
Other income .............................................. 310 349 946 1,157
-------- -------- --------- ---------
Income (loss) before income taxes and cumulative
effect of accounting change ....................... (304) 968 (4,883) 1,296
Provision (benefit) for income taxes .......................... (1,584) 416 (1,584) 549
-------- -------- --------- ---------
Net income (loss) before cumulative effect of
accounting change, basic and diluted .............. 1,280 552 $ (3,299) 747
Cumulative effect of accounting change ........................ -- -- -- (10,523)
-------- -------- --------- ---------
Net income (loss) ......................................... $ 1,280 $ 552 $ (3,299) $ (9,776)
======== ======== ========= =========
Net income (loss) per common share before cumulative
effect of accounting change, basic and diluted .... $ 0.15 $ 0.07 $ (0.40) $ .09
Cumulative effect of accounting change ................. -- -- -- (1.27)
-------- -------- --------- ---------
Net income (loss) per common share, basic and diluted .. $ 0.15 $ 0.07 $ (0.40) $ (1.18)
======== ======== ========= =========
Weighted average number of common shares outstanding ... 8,260 8,260 8,260 8,260
======== ======== ========= =========
The accompanying notes are an integral part
of the condensed consolidated financial statements.
4
CONGOLEUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
--------------------
2003 2002
(In thousands)
Cash flows from operating activities:
Net loss ........................................................ $ (3,299) $ (9,776)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation ................................................. 8,352 7,946
Amortization ................................................. 419 419
Deferred income taxes ........................................ -- 2,518
Cumulative effect of accounting change ....................... -- 10,523
Changes in certain assets and liabilities:
Accounts and notes receivable ............................. (2,752) (6,346)
Inventories ............................................... 5,070 2,179
Prepaid expenses and other assets ......................... 3,615 2,497
Accounts payable .......................................... (3,096) (3,499)
Accrued expenses .......................................... (18,154) 1,520
Other liabilities ......................................... (850) (3,071)
-------- --------
Net cash (used in) provided by operating activities .... (10,695) 4,910
-------- --------
Cash flows from investing activities:
Capital expenditures ......................................... (3,969) (6,708)
Maturities of short-term investments ......................... -- 1,416
-------- --------
Net cash used in investing activities .................. (3,969) (5,292)
-------- --------
Financing activities:
Net short-term borrowings .................................... 8,497 --
Net change in restricted cash ................................ (4,117) --
-------- --------
Net cash provided by financing activities .............. 4,380 --
-------- --------
Net decrease in cash and cash equivalents .......................... (10,284) (382)
Cash and cash equivalents:
Beginning of period ............................................. 18,277 15,257
-------- --------
End of period ................................................... $ 7,993 $ 14,875
======== ========
The accompanying notes are an integral part
of the condensed consolidated financial statements.
5
CONGOLEUM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Congoleum Corporation (the "Company" or "Congoleum") 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's financial position, results of operations and cash
flow have been included. Operating results for the three and nine-month periods
ended September 30, 2003 are not necessarily indicative of the results that may
be expected for the year ended December 31, 2003. 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, 2002.
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 2002, Congoleum experienced a significant increase in the number of
asbestos claims against it and exhausted its primary insurance coverage. While
the Company had previously purchased over $1 billion in insurance coverage in
excess of the primary coverage, approximately 25% - 30% of that coverage was
placed with carriers that are now insolvent. Furthermore, the solvent carriers
that underwrote the balance of the coverage have disputed their coverage
obligations for the Company's asbestos claims liability. The Company's dispute
with its excess insurance carriers is the subject of ongoing coverage
litigation. As a result, the Company was forced to fund all costs for defense
and indemnity related to asbestos claims after its primary coverage had been
exhausted. In light of this situation, the Company began exploring various
strategic alternatives to deal with the asbestos situation.
6
On January 13, 2003, the Company announced that it had begun preliminary
settlement negotiations with attorneys it believed represented the majority of
plaintiffs with asbestos claims pending against it, and that upon successful
completion of those negotiations, it intended to seek confirmation of a
pre-packaged plan of reorganization under Chapter 11 of the Bankruptcy Code. On
March 31, 2003, the Company reached an agreement in principle with attorneys it
believes represented more than 75% of the known present claimants with asbestos
claims pending against Congoleum.
The agreement in principle contemplates a Chapter 11 reorganization and
confirmation of a pre-packaged plan that would leave trade and other unsecured
nonasbestos creditors unimpaired and would resolve all pending and future
asbestos claims against the Company, including any derivative liability of
American Biltrite Inc., the Company's controlling shareholder ("ABI"), and the
Company's distributors from claims asserted against the Company as may be
afforded under Section 524(g)(4) of the Bankruptcy Code. Approval of an asbestos
channeling injunction pursuant to Section 524(g)(4) of the Bankruptcy Code would
require the supporting votes of at least 75% of the asbestos claimants with
claims against the Company who vote on the plan. Resolution of Congoleum's
asbestos liability through a pre-packaged reorganization plan is subject to
various other conditions as well, including approval by the bankruptcy court.
In furtherance of the agreement in principle, on April 10, 2003, the
Company and various asbestos claimants entered into the Claimant Agreement (as
defined in Note 6 "Asbestos Liabilities"). As contemplated by the Claimant
Agreement, the Company also entered into the Collateral Trust Agreement (as
defined in Note 6 "Asbestos Liabilities") which established the Collateral Trust
(as defined in Note 6 "Asbestos Liabilities") to distribute funds in accordance
with the terms of the Claimant Agreement and the Security Agreement (as defined
in Note 6 "Asbestos Liabilities") pursuant to which the Company granted the
Collateral Trust a security interest in the Collateral (as defined in Note 6
"Asbestos Liabilities").
As contemplated by the Claimant Agreement, the Company may enter into
settlement agreements with asbestos claimants prior to commencement of its
Chapter 11 reorganization case. The value of the settled claims pursuant to
those settlements, and certain existing unfunded settlements already entered
into between the Company and certain asbestos claimants, will be secured, fully
or partially, as further provided by the Claimant Agreement, by the Collateral.
The Company expects that, under the pre-packaged plan, the Plan Trust (as
defined in Note 6 "Asbestos Liabilities") will be established upon consummation
of the Company's confirmed Chapter 11 plan of reorganization. As contemplated by
the Claimant Agreement and the Collateral Trust Agreement, upon consummation of
the plan of reorganization and establishment of the Plan Trust, the assets in
the Collateral Trust would be transferred to the Plan Trust.
The Company expects that the Plan Trust would fund the settlement of all
pending and future asbestos claims (including any claims contemplated by the
Claimant Agreement that are unsatisfied as of the confirmation of the plan of
reorganization by the bankruptcy court) and protect Congoleum from future
asbestos-related litigation by channeling all asbestos claims (including any
claims contemplated by the Claimant Agreement that are unsatisfied as of the
confirmation of the plan of reorganization by the bankruptcy court) to the Plan
Trust pursuant to Section 524(g) of the Bankruptcy Code.
7
On June 6, 2003, the Company executed amendments to the Claimant Agreement
and the Collateral Trust Agreement, which amendments provided additional time
for the parties to review and respond to information required to participate in
the settlement. Pursuant to those amendments, the Company entered into a
termination agreement, which terminated the Security Agreement, and entered into
a new security agreement, the terms of which are materially similar to the terms
of the Security Agreement.
Congoleum expects its trade and other unsecured nonasbestos creditors
would be unimpaired under its pre-packaged Chapter 11 plan and that its trade
creditors would be paid in the ordinary course of business.
On October 27, 2003, the Company began soliciting acceptances for its
pre-packaged plan of reorganization. The voting deadline to accept or reject the
plan is December 19, 2003, unless extended by the Company. The Company expects
to commence its pre-packaged Chapter 11 case in late December 2003 and hopes to
obtain confirmation of its plan during the third quarter of 2004.
Based on its pre-packaged bankruptcy strategy for resolving its asbestos
liability, the Company has made provision in its financial statements for the
minimum amount of the range of estimates for its contribution and costs to
effect its plan to settle asbestos liabilities through a plan trust established
under Section 524(g) of the Bankruptcy Code. The Company recorded a charge of
$17.3 million in the fourth quarter of 2002 to increase its recorded liability
to the estimated minimum of $21.3 million. Actual amounts that will be
contributed to the Plan Trust and costs for pursuing and implementing the plan
of reorganization could be materially higher. During the nine months ended
September 30, 2003, the Company paid $11.1 million from the asbestos reserve in
legal fees, indemnity settlements, and reorganization costs related to asbestos
litigation.
For more information regarding the Company's asbestos liability and plan
for resolving that liability, please refer to Note 6 "Asbestos Liabilities."
There can be no assurance that the Company will be successful in realizing its
goals in this regard or in obtaining the necessary votes, consents and approvals
or in implementing its desired plan terms. As a result, any plan of
reorganization pursued by the Company or confirmed by a bankruptcy court could
vary significantly from the description in this report, and the estimated costs
and contributions to effect the contemplated plan of reorganization 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 approvals, and there can be no
assurance that such conditions, approvals and other requirements will be
satisfied or obtained, or that there may not be delays, which could be
significant, in satisfying or obtaining them. Delays in obtaining the necessary
supporting votes in favor of the Company's plan of reorganization, as well as
any other delays in getting the Company's plan of reorganization approved by the
bankruptcy court, could result in a proceeding that takes longer, and is more
costly, than the Company has estimated. Furthermore, any such delay could result
in the Company's pre-packaged plan of reorganization not being confirmed by the
bankruptcy court or in the abandonment of the pre-packaged plan of
reorganization in favor of a non-prepackaged plan of reorganization. If a
pre-packaged plan of
8
reorganization is abandoned in favor of a non-prepackaged plan of
reorganization, the Company would likely incur significantly more costs due to
the likely substantial litigation that would ensue among the Company, its
insurers and the Company's asbestos claimants, as well as other possible
parties. Also, obtaining confirmation of a plan under those circumstances would
likely take a considerable amount of time and effort in order for the various
parties involved to negotiate a plan in light of their potentially adverse
interests. There can be no assurance that the terms of any non-prepackaged plan
of reorganization would be on terms as favorable to the Company, its
shareholders, holders of its 8-5/8% Senior Notes Due 2008 (the "Senior Notes")
and other nonasbestos-related constituents as the expected terms of the
Company's anticipated pre-packaged plan of reorganization.
2. Recent Accounting Principles
In July 2001, the Financial Accounting Standards Board issued SFAS No.
142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 142 is
effective for fiscal years beginning after December 15, 2001. SFAS No. 142
provides that goodwill and intangible assets with indefinite lives will not be
amortized, but rather will be tested for impairment on an annual basis. SFAS No.
142 was effective for the Company as of January 1, 2002. During the first
quarter of 2002, the Company performed a transitional impairment test of
goodwill and concluded that there was an impairment. The Company compared the
implied fair value of goodwill to the carrying value of goodwill and it was
determined that based on the fair value of the Company's assets and liabilities,
there should be no goodwill recorded. Accordingly, the Company recorded an
impairment loss of $10.5 million during the first quarter of 2002, which has
been recorded as a cumulative effect of a change in accounting principle.
The impact of the adoption of SFAS 142 on the Company's financial
statements also resulted in the elimination of $324 thousand of goodwill
amortization expense or $.04 per share for the nine months ended September 30,
2002.
The Financial Accounting Standards Board ("FASB") has issued Statement of
Financial Accounting Standards ("SFAS") No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS No. 148"). SFAS No. 148 amends
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The Company has not elected to
change to the fair value based method of accounting for stock-based employee
compensation and continues to account for its stock option plans in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees". Had the Company accounted for its stock option plans in accordance
with SFAS 123, the pro forma compensation expense from stock options would have
increased the reported net loss per share for the nine months ended September
30, 2003 and 2002 by $.01 and $.01, respectively.
9
For the Nine Months Ended
September 30,
(Dollars in thousands except per share amounts) 2003 2002
---- ----
Net loss:
As reported $ (3,299) $ (9,776)
Pro forma compensation (53) (55)
--------- ---------
As adjusted $ (3,352) $ (9,831)
========= =========
Net loss per share, basic and diluted:
As reported $ (0.40) $ (1.18)
Pro forma compensation (0.01) (0.01)
--------- ---------
As adjusted $ (0.41) $ (1.19)
========= =========
In November 2002, FASB Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FASB Interpretation No. 45") was issued. The
accounting recognition provisions of FASB Interpretation No. 45 were effective
January 1, 2003 on a prospective basis. They require that a guarantor recognize,
at the inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. Under prior accounting
principles, a guarantee would not have been recognized as a liability until a
loss was probable and estimable. The Company did not initiate such guarantees
during the nine months ended September 30, 2003, and had not previously entered
into any other arrangements with third parties within the scope of FASB
Interpretation No. 45, except as discussed below.
Pursuant to a Joint Venture Agreement entered into in 1992, the Company
had agreed to indemnify ABI against certain claims arising from operations of
the floor tile business it acquired from ABI. Substantially all payments under
this agreement, which amounted to $229 thousand prior to 2003 and $1,125
thousand in the first nine months of 2003, are for legal fees in connection with
resolution of Congoleum's asbestos liabilities. The Company's provision for
costs to resolve its asbestos liabilities includes an estimate of amounts
expected to be paid pursuant to this indemnification obligation. See Note 6 for
further discussion regarding the impact of the Company's planned pre-packaged
reorganization on this indemnification obligation.
3. Inventories
A summary of the major classifications of inventories stated at the lower
of LIFO cost or market is as follows:
September 30, December 31,
(Dollars in thousands) 2003 2002
------- -------
Finished goods ...................... $36,160 $38,702
Work-in-process ..................... 3,310 3,467
Raw materials and supplies .......... 6,185 8,556
------- -------
Total Inventories ................ $45,655 $50,725
======= =======
10
4. Income (Loss) Per Share
Net income (loss) per share is calculated by dividing net income (loss) by
the weighted average number of shares of common stock outstanding. There were
678,500 shares that were excluded from the diluted earnings per share
calculation because those shares pertained to unexercised outstanding stock
options having a per share strike price greater than the market price.
5. Commitments and Contingencies
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 are not reduced by the expected amount of insurance recoveries. Such
estimated insurance recoveries are reflected in other noncurrent assets to the
extent they are considered probable of recovery.
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 three other instances, although not named as a PRP, the Company
has received a request for information. The pending proceedings in which the
Company is a named PRP currently relate to four disposal sites in New Jersey,
Pennsylvania, Maryland and Connecticut 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 in connection with those sites
depends on many factors, including the volume of material contributed to the
site, the number of other PRP's 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 to which the Company has been named a PRP
relates to a recycling facility site in Elkton, Maryland. The PRP group at this
site is made up of 81 companies; substantially all of which are large
financially solvent entities. Two removal actions were substantially complete as
of December 31, 1998; however, the groundwater remediation phase has not begun
and the remedial investigation/feasibility study related to the groundwater
remediation has not been approved. The PRP group estimated that future costs of
groundwater remediation, based on engineering and consultant studies conducted,
would be approximately $26 million. Congoleum's proportionate share, based on
waste disposed at the site, is estimated to be approximately 5.8%.
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 self-guaranteed certain remediation funding sources and
financial responsibilities. Estimated total cleanup costs, including capital
outlays and future maintenance costs for soil and groundwater remediation are
primarily based on engineering studies.
11
The outcome of these matters could result in significant expenses or
judgments that could have a material adverse effect on the financial position of
the Company.
The Company is a defendant in a large number of asbestos-related lawsuits
and has announced its intent to file a pre-packaged plan of reorganization under
Chapter 11 of the Bankruptcy Code as part of its strategy to resolve this
liability. For more information regarding the Company's asbestos liability and
plan for resolving that liability, please refer to Notes 1 and 6.
6. Asbestos Liabilities
Planned Settlement and Reorganization
On January 13, 2003, the Company announced that it had begun preliminary
settlement negotiations with attorneys it believes represent the majority of
plaintiffs with asbestos claims pending against it, and that upon successful
completion of these negotiations, it intends to seek confirmation of a
pre-packaged plan of reorganization under Chapter 11 of the Bankruptcy Code. On
March 31, 2003, the Company reached an agreement in principle with attorneys it
believes represented more than 75% of the known present claimants with asbestos
claims pending against Congoleum.
The agreement in principle contemplates a Chapter 11 reorganization
seeking confirmation of a pre-packaged plan that would leave trade and other
unsecured nonasbestos creditors unimpaired and would resolve all pending and
future asbestos claims against the Company, including any derivative liability
of ABI and the Company's distributors that derive from claims asserted against
the Company as may be afforded under Section 524(g)(4) of the Bankruptcy Code.
Approval of an asbestos channeling injunction pursuant to Section 524(g) of the
Bankruptcy Code would require the supporting votes of at least 75% of the
asbestos claimants with claims against the Company who vote on the plan.
Resolution of Congoleum's asbestos liability through a pre-packaged
reorganization plan is subject to various other conditions as well, including
approval by the bankruptcy court.
In furtherance of the agreement in principle, on April 10, 2003, the
Company entered into a settlement agreement with various asbestos claimants (the
"Claimant Agreement"). As contemplated by the Claimant Agreement, the Company
also entered into a trust agreement (the "Collateral Trust Agreement") which
established a trust (the "Collateral Trust") to distribute funds in accordance
with the terms of the Claimant Agreement and a security agreement (the "Security
Agreement") pursuant to which the Company granted the Collateral Trust a
security interest in the Company's rights under its applicable insurance
coverage and payments from its insurers for asbestos claims (the "Collateral").
The Claimant Agreement establishes a compensable disease valuation matrix
(the "Matrix") and allows claimants who qualify and participate in the Claimant
Agreement to settle their claim for the Matrix value secured in whole or in part
by the security interest in the Collateral. The Collateral Trust Agreement
provides for distribution of trust assets according to various requirements that
give priority (subject to aggregate distribution limits) to participating
claimants
12
who had pre-existing unfunded settlement agreements ("pre-existing settlement
agreements") with the Company and participating claimants who qualify for
payment under unfunded settlement agreements entered into by the Company with
plaintiffs that have asbestos claims pending against the Company and which
claims are 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").
Pursuant to the terms and conditions of the Claimant Agreement, the
Company will settle claims pertaining to a pre-existing settlement agreement or
trial-listed settlement agreement, which settled claims will be fully secured by
the Collateral, and all other claims with claimants electing to participate on
the terms and conditions of the Claimant Agreement, which settled claims will be
partially secured by the Collateral in an amount equal to 75% of the settled
value, with the remaining 25% of the settled value being unsecured. The Company
expects that, under the plan, a trust will be established upon consummation of
the Company's confirmed Chapter 11 plan of reorganization (the "Plan Trust"). As
contemplated by the Claimant Agreement and the Collateral Trust Agreement, upon
consummation of the plan and establishment of the Plan Trust, the assets in the
Collateral Trust would be transferred to the Plan Trust. The Company expects
that the Plan Trust would fund the settlement of all pending and future asbestos
claims (including any claims contemplated by the Claimant Agreement that are
unsatisfied as of the confirmation of the plan of reorganization by the
bankruptcy court) and protect Congoleum from future asbestos-related litigation
by channeling all asbestos claims (including any claims contemplated by the
Claimant Agreement that are unsatisfied as of the confirmation of the plan of
reorganization by the bankruptcy court) to the Plan Trust pursuant to Section
524(g) of the Bankruptcy Code.
On June 6, 2003, the Company executed amendments to the Claimant Agreement
and the Collateral Trust Agreement, which amendments provided additional time
for the parties to review and respond to information required to participate in
the settlement. Pursuant to those amendments, the Company entered into a
termination agreement, which terminated the Security Agreement, and entered into
a new security agreement, the terms of which are materially similar to the terms
of the Security Agreement.
The Company expects that its trade and other unsecured nonasbestos
creditors would be unimpaired under its pre-packaged Chapter 11 plan and that
its trade creditors would be paid in the ordinary course of business.
On October 27, 2003, the Company began soliciting acceptances for its
pre-packaged plan of reorganization. The voting deadline to accept or reject the
plan is December 19, 2003 unless extended by the Company. The Company expects to
commence its pre-packaged Chapter 11 case in late December 2003 and hopes to
obtain confirmation of its plan by the third quarter of 2004.
The Company expects to issue a promissory note (the "Company Note") to the
Plan Trust as part of the Company's anticipated pre-packaged Chapter 11 plan of
reorganization. The Company expects that the original principal amount of the
Company Note will be $2,738,234.75 (the "Original Principal Amount") and will be
subject to increase as of the later of June 30, 2005 and the last trading day of
the 90 consecutive trading day period commencing on the first anniversary of the
13
effective date of the Company's confirmed pre-packaged Chapter 11 plan of
reorganization (the "Principal Adjustment Date") in an amount equal to the
excess, if any, of the amount by which 51% of the Company's market
capitalization as of the Principal Adjustment Date (based upon (subject to
certain exceptions) the total number of shares of the Company's common stock
outstanding as of such date multiplied by the average of the closing trading
prices of the Company's Class A common stock for the 90 consecutive trading days
ending on the Principal Adjustment Date) exceeds the Original Principal Amount
(the "Additional Principal Amount"), plus any accrued but unpaid interest or
other amounts that may be added to such principal amount pursuant to the terms
of the Company Note. The Company expects that interest on outstanding principal
of the Company Note will accrue at a rate of 9% per annum. The Company further
expects that interest on the Original Principal Amount will accrue and be
payable quarterly and that interest on the Additional Principal Amount will
accrue quarterly and be added to the Additional Principal Amount as additional
principal. The Company expects that upon the earlier of August 1, 2008 and the
date that all of the Senior Notes are repaid in full, interest on the then
outstanding Additional Principal Amount will then accrue and be payable
quarterly.
The Company further expects that all principal on the Company Note then
outstanding together with any accrued but unpaid interest will be payable in
full on the tenth anniversary of the date of the Company Note, subject to the
right of the Plan Trust to accelerate all amounts then owed on the Company Note
following an uncured event of default under the Company Note. The Company
expects that events of default under the Company Note would include the failure
to pay interest and principal prior to the expiration of a 10-day grace period
following the applicable due date, the occurrence of an event of default under
the indenture governing the Senior Notes, the breach by the Company of any
covenant or agreement contained in the Company Note which remains uncured 30
days following notice by the Plan Trust to the Company and ABI of the breach and
a material breach of the pledge agreement (the "ABI Pledge Agreement") by ABI
(which agreement is discussed below) which remains uncured 30 days following
notice by the Plan Trust to ABI and the Company of the breach. The Company
expects that the terms of the Company Note would provide that, upon the
occurrence of an event of default under the Company Note, the Company and ABI
would have 10 days from the date they receive notice that an event of default
has occurred to cure the event of default. The Company further expects that the
Company Note would provide that, if the event of default remains uncured after
the 10-day cure period, the aggregate outstanding principal amount of the
Company Note together with any accrued but unpaid interest thereon would become
immediately due and payable if the event of default relates to an uncured event
of default of the indenture governing the Company's Senior Notes, and with
regard to other events of default of the Company Note, the Plan Trust may, upon
notice to the Company and ABI, declare the aggregate outstanding principal
amount of the Company Note together with any accrued but unpaid interest thereon
to be immediately due and payable. The Company further expects that the Plan
Trust's rights to payment under the Company Note will be subordinate and subject
in right of payment to the prior payment in full of all amounts owing and
payable pursuant to the Senior Notes and the Company's credit facility, except
that regularly scheduled interest payments under the Company Note are expected
to be payable by the Company so long as no default or event of default has
occurred or is continuing under the indenture governing the Company's Senior
Notes or the Company's credit facility.
14
The Company expects that, pursuant to the ABI Pledge Agreement, ABI will
pledge all of the shares of the Company's common stock that ABI owns, together
with any other equity interests and rights ABI may own or hold in the Company,
as of the date of the Company Note as collateral for the Company's obligations
under the Company Note. In addition, the Company further understands that, as
additional security under the Company Note, the Company Note, the ABI Pledge
Agreement and the anticipated terms of the Company's pre-packaged Chapter 11
plan of reorganization would also provide that any amounts that the Plan Trust
would be obligated to pay ABI pursuant to any rights of indemnity that ABI may
have against the Plan Trust for asbestos-related claims pursuant to the
Company's pre-packaged Chapter 11 plan of reorganization or a certain Joint
Venture Agreement, entered into in 1992, as to which both the Company and ABI
are parties to (as amended, the "Joint Venture Agreement"), will not be paid by
the Plan Trust until after any amounts due and payable to the Plan Trust under
the Company Note have been paid in full to the Plan Trust. Until such time, any
such indemnity payments that would otherwise have been payable by the Plan Trust
to ABI, would be set aside by the Plan Trust and held in escrow by the Plan
Trust for ABI's benefit and pledged by ABI as additional collateral securing the
Company's obligations under the Company Note until released from such escrow and
paid to ABI, as further provided under the Company's anticipated pre-packaged
Chapter 11 plan of reorganization, the Company Note and the ABI Pledge
Agreement.
The Company further expects that the Company Note, the ABI Pledge
Agreement and the Company's pre-packaged Chapter 11 plan of reorganization would
also provide that the Company would be prohibited from making any payments to
ABI pursuant to any rights of indemnity that ABI may have against the Company
for claims pursuant to the Joint Venture Agreement until after any amounts due
and payable to the Plan Trust under the Company Note have been paid in full to
the Plan Trust. Until such time, any such indemnity payments that would
otherwise have been payable to ABI by the Plan Trust, will be paid by the
Company to the Plan Trust and the Plan Trust will set aside and hold in escrow
such amounts for ABI's benefit and ABI will pledge such amounts as additional
collateral securing the Company's obligations under the Company Note until
released from such escrow and paid to ABI, as further provided under the
Company's pre-packaged Chapter 11 plan of reorganization, the Company Note and
the ABI Pledge Agreement.
The Company expects that ABI would be allowed to prepay the principal
amount of the Company Note, in whole but not in part, without any penalty or
premium at any time following the Principal Adjustment Date and that any
interest that may have accrued but not yet been paid at the time of any
principal repayment would be due and payable at the time of the principal
repayment. The Company expects that it would be obligated to repay ABI for any
amounts paid by ABI pursuant to the Company Note, which repayment obligation
would by evidenced by a promissory note or notes to be issued by the Company to
ABI. It is expected that any such note would have similar payment terms as those
expected to be afforded to the Plan Trust with regard to the Company Note, which
rights of repayment are expected to be subordinate and subject in right of
payment to the prior payment in full of all amounts owing and payable to the
Plan Trust with regard to the Company Note and with regard to amounts owing and
payable pursuant to the Senior Notes and credit facility, except that the right
of full subordination with regard to the Senior Notes and credit facility would
contain an exception that would allow the Company to make regularly scheduled
interest payments to ABI pursuant to any such note so long as no default or
event of default has occurred or is continuing under the indenture or the
Company's credit facility.
15
It is further expected that if ABI prepaid the Company Note and ABI sold
all or substantially all of the shares of the Company's stock that it held as of
the Principal Adjustment Date during the three-year period following such date,
it would be obligated to make a contribution to the Plan Trust if the equity
value of the Company implied by the price paid to ABI for the shares of the
Company's stock exceeded the greater of $2,738,234.75 or 51% of the Company's
market capitalization as of the Principal Adjustment Date (based upon (subject
to certain exceptions) the total number of shares of the Company's common stock
outstanding as of such date multiplied by the average of the closing trading
prices of the Company's Class A common stock for the 90 consecutive trading days
ending on the Principal Adjustment Date). In such instance, it is expected that
the Company's pre-packaged plan of reorganization would obligate ABI to pay to
the Plan Trust an amount equal to 50% of such excess amount. Under the expected
terms of the Company's pre-packaged Chapter 11 plan of reorganization, the
Company would be obligated to repay ABI for any amounts paid by ABI to the Plan
Trust pursuant to this obligation. In satisfaction of this repayment obligation,
it is expected that the Company would issue a promissory note to ABI in a
principal amount equal to the amount of any such payments made by ABI plus any
accrued but unpaid interest or other amounts that may be added to such principal
amount pursuant to the terms of the promissory note which would be subordinate
and subject in right of payment to the prior payment in full of all amounts
owing and payable pursuant to the Senior Notes and credit facility, except that
regularly scheduled interest payments could be paid on such note so long as no
default or event of default has occurred or is continuing under the indenture
governing the Senior Notes or the Company's credit facility.
The Company further expects that the Plan Trust would be able to transfer
the Company Note, in whole but not in part, at any time following the Principal
Adjustment Date. Upon any transfer of the Company Note, the amounts pledged by
ABI and held in escrow by the Plan Trust for ABI's benefit with regard to ABI's
indemnity rights discussed above, will be paid by the Plan Trust, first, to the
Plan Trust in repayment of principal then outstanding on the Company Note
together with any accrued but unpaid interest thereon and, second, any amounts
remaining would be distributed by the Plan Trust to ABI.
The Company further expects that ABI will make a cash contribution in the
amount of $250,000 to the Plan Trust upon the formation of the Plan Trust.
The Company has understood that, as part of the Company's pre-packaged
Chapter 11 plan of reorganization, ABI's goal was to have all current and future
asbestos claims that may be asserted against it channeled to the Plan Trust. At
the present time, the Company's pre-packaged Chapter 11 plan of reorganization
does not provide relief to ABI for all asbestos claims that may be asserted
against it and does not include an assignment of ABI's insurance policies to the
Plan Trust. ABI has not abandoned its goal of obtaining that relief at a future
time if circumstances change so that the Company and ABI believe that ABI could
attain its desired channeling relief without posing significant risks to the
success of the Company's plan or ABI, its insurance coverage and its business.
Both the Company and ABI, however, presently believe that it is unlikely that
ABI will be successful in realizing its goal in this regard, and the Company
understands that ABI is not actively pursuing this goal at this time.
16
As previously discussed, under the expected terms of the Company's 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 Company and ABI do not expect that any other asbestos claims that
may be asserted against ABI would be channeled to the Plan Trust. The Company
and ABI also expect that the contributions ABI would make to the Plan Trust will
differ from the contributions previously publicly disclosed that might be made
by ABI if it were to receive its desired relief and are expected to consist of
those items referred to above in this Note 6.
While the Company believes its contemplated pre-packaged Chapter 11 plan
is feasible and in the best interest of all the Company's constituents, there
are sufficient risks and uncertainties such that no assurances of the outcome
can be given. In addition, the costs to effect this plan, consisting principally
of legal and advisory fees and contributions to the Plan Trust, including one or
more notes expected to be contributed to the Plan Trust by the Company are
expected to be approximately $21.3 million at a minimum. Of this estimated
amount, the Company paid, during the nine months ended September 30, 2003, $11.1
million for legal fees, indemnity settlements and reorganization costs related
to asbestos litigation.
Pending Asbestos Claims
The Company has been served notice that it is one of many defendants in
approximately 19,473 pending lawsuits (including workers' compensation cases)
involving approximately 102,485 individuals as of September 30, 2003, alleging
personal injury or death from exposure to asbestos or asbestos-containing
products. There were approximately 16,156 lawsuits at December 31, 2002 that
involved approximately 56,567 individuals. Activity related to asbestos claims
was as follows:
Nine months ended Year ended
September 30, December 31,
2003 2002
---------------------------------------------------------------------
Beginning claims ............. 16,156 6,563
New claims ................... 3,849 10,472
Settlements .................. (62) (69)
Dismissals ................... (470) (810)
---------------------------------------------------------------------
Ending claims ................ 19,473 16,156
======= =======
In addition, the Company has been advised by a number of attorneys
representing plaintiffs that they have filed claims against the Company for
which notice has not yet been served or which have been added by amendments to
existing complaints. While the Company cannot presently determine how many
additional such claimants there may be, the Company has been advised by
plaintiffs' counsel of over 5,000 additional filed claimants, for which the
Company has not yet been served.
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
17
products are nonfriable (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 nonfriable. 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 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 coverage was exhausted. The exhaustion of limits 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 indemnity coverage plus related defense costs before
their policies were implicated. On April 10, 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. Although Congoleum is not a party to this case, the decision in the
Spaulding Case is likely binding on Congoleum and its primary insurance
companies. Thus, based on the Spaulding Case decision, the primary insurance
companies are obligated to provide the additional coverage previously disputed
by the excess carriers. As of December 31, 2002, the Company had entered into
additional settlement agreements with asbestos claimants exceeding the amount of
previously disputed coverage. While the excess carriers have objected to the
reasonableness of several of these settlements, Congoleum believes that the
primary insurance company will now cover these settlements. Notwithstanding that
the primary insurance company will likely pay these settlements, Congoleum also
believes that the excess carriers 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 and have also raised various objections to the Company's
planned reorganization strategy and negotiations.
The excess insurance carriers have objected to the global settlement of
the asbestos claims currently pending against Congoleum ("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, and also
contend the Claimant Agreement is not fair, reasonable or in good faith.
Congoleum disputes the allegations and contentions of the excess insurance
carriers. On Friday, November 7, 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. Discovery continues in the coverage litigation.
18
Given the actions of its excess insurance carriers, the Company believes
it likely that, pending settlement with or payment of re-opened limits by the
primary policies, it will have to continue funding asbestos-related expenses for
defense expense and indemnity itself until it files for Chapter 11 protection,
which it expects will occur in late December 2003.
Payments Related to Asbestos Claims
The following table sets forth amounts paid during the first nine months
of 2003 and the full year 2002 to defend and settle claims:
Nine Months Ended Year Ended
($ in millions) September 30, 2003 December 31, 2002
------------------ -----------------
Indemnity costs paid by the Company's
insurance carriers $ 0.0 $ 1.3
Indemnity costs paid by the Company 0.8 2.7
Defense costs paid by the Company 3.9 1.4
Indemnity settled with insurance proceeds
Assignment 10.6 14.4
The Company's primary insurance carriers paid defense costs in addition to
the above amounts through August 2002. Such amounts were not reported to the
Company by year of payment, and have not been included in the table.
At September 30, 2003, there were $0.1 million in additional settlements
outstanding that the Company had entered into but not yet funded.
The Company is seeking recovery from its insurance carriers of the amounts
it has paid for defense and indemnity, and intends to seek recovery for any
future payments of defense and indemnity. In light of the assignment of and
grant of a security interest in certain rights in and proceeds of its applicable
insurance to the Collateral Trust and the planned reorganization, the Company
does not anticipate recovering these costs from the insurance companies.
Accounting for Asbestos-Related Claims
Costs per claim vary widely depending on a number of factors, including
the nature of the alleged exposure, the injury alleged, and the jurisdiction
where the claim was litigated. As of September 30, 2003, the Company has
incurred defense and indemnity costs aggregating $62.7 million, to resolve
asbestos-related claims involving over 39,200 claimants, the substantial
majority of which has been paid by the Company's insurance carriers or by
assignments of future insurance recoveries.
It is the Company's accounting policy to conduct a detailed analysis of
its asbestos-related liabilities and the insurance coverage applicable to those
liabilities when appropriate. During the fourth quarter of 2002, an outside
actuary was engaged to conduct an updated analysis of the Company's
asbestos-related liabilities. Developments during the latter part of 2002
included a significant increase in claims filed against the Company and higher
settlement requirements, and the exhaustion of primary
19
insurance coverage combined with a dispute of coverage by its excess insurance
carriers. These developments in turn led to the Company's announced plan to file
for bankruptcy. In light of these changed circumstances, the Company and the
outside actuary engaged to conduct the updated analysis do not believe a
reasonable or meaningful estimate of these liabilities for future claims can be
developed. However, the study did conclude that the minimum gross liability for
the 56,567 known claimants at December 31, 2002, using historical settlement
payments, was $310 million. This amount does not include defense costs,
liability for the 30,000 additional claimants purportedly existing at December
31, 2002, or for future claims, which the study concluded could not be
reasonably estimated in light of the available data and uncertainty arising from
an announced Chapter 11 reorganization filing.
Under the terms of the Claimant Agreement, the Company's claims processing
agent has processed 102,482 claims of these, 56,241 claims met the requirements
of the Claimant Agreement and are valued at $200 million. The remaining 46,241
claims did not meet the requirements as not meeting the requirements of the
Claimant Agreement. However, these claimants are entitled to submit additional
documentation in response to the rejection, so it cannot presently be determined
how many of these claims may subsequently meet the requirements of the Claimant
Agreement. The claims processing agent has indicated that if all claims
requiring additional documentation were accepted as submitted, the additional
liability for these claims would be $480 million.
The Company's estimated minimum gross liability is substantially in excess
of both the total assets of the Company as well as the Company's previous
estimates made in prior periods of the maximum liability for both known and
unasserted claims. 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 the reorganization. The Company estimates the minimum amount of
the contributions and costs to be $21.3 million, which it has recorded as a
current liability. During the fourth quarter of 2002, the Company recorded a
charge of $17.3 million to increase its recorded liability to the $21.3 million
minimum estimated. The maximum amount of 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 given the accounting for its estimate of future
asbestos-related costs.
Amounts Recorded in Financial Statements
The table below provides an analysis of changes in the Company's asbestos
reserves from December 31, 2002 to September 30, 2003:
(In Thousands)
Accrued asbestos-related expenses
At December 31, 2002 $ 21,295
Payments (11,145)
--------
Balance at September 30, 2003 $ 10,150
========
20
During the nine months ended September 30, 2003, the Company paid $11.1
million from the asbestos reserve in legal fees, indemnity settlements, and
reorganization plan costs related to asbestos litigation.
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
for the related products is recognized. The following table sets forth activity
in the Company's warranty reserves for the nine-month periods ended September
30, 2003 and September 30, 2002 (in millions):
September 30, September 30,
2003 2002
------------- -------------
Beginning balance .................... $ 2.6 $ 2.5
Accruals ............................. 5.0 4.3
Charges .............................. (4.7) (3.5)
----- -----
Ending balance ....................... $ 2.9 $ 3.3
===== =====
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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 involves risks,
uncertainties and assumptions. 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. Factors that could cause or
contribute to the Company's actual results differing from its expectations
include those factors discussed elsewhere in this report, including in the
section of this report entitled, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Risk Factors That May Affect
Future Results," in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002 and in the Company's other filings with the Securities and
Exchange Commission.
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.
21
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 2002, Congoleum experienced a significant increase in the number of
asbestos claims against it and exhausted its primary insurance coverage. While
the Company had previously purchased over $1 billion in insurance coverage in
excess of the primary coverage, approximately 25% - 30% of that coverage was
placed with carriers that are now insolvent. Furthermore, the solvent carriers
that underwrote the balance of the coverage have disputed their coverage
obligations for the Company's asbestos claims liability. The Company's dispute
with its excess insurance carriers is the subject of ongoing coverage
litigation. As a result, the Company was forced to fund all costs for defense
and indemnity related to asbestos claims after its primary coverage had been
exhausted. In light of this situation, the Company began exploring various
strategic alternatives to deal with the asbestos situation.
On January 13, 2003, the Company announced that it had begun preliminary
settlement negotiations with attorneys it believed represented the majority of
plaintiffs with asbestos claims pending against it, and that upon successful
completion of those negotiations, it intended to seek confirmation of a
pre-packaged plan of reorganization under Chapter 11 of the Bankruptcy Code. On
March 31, 2003, the Company reached an agreement in principle with attorneys it
believes represents more than 75% of the known present claimants with asbestos
claims pending against Congoleum.
The agreement in principle contemplates a Chapter 11 reorganization and
confirmation of a pre-packaged plan that would leave trade and other unsecured
creditors unimpaired and would resolve all pending and future asbestos claims
against the Company, including any derivative liability of ABI and the Company's
distributors from claims asserted against the Company as may be afforded under
section 524(g)(4) of the Bankruptcy Code. Approval of an asbestos channeling
injunction under Section 524(g) of the Bankruptcy Code would require the
supporting votes of at least 75% of the asbestos claimants with claims against
the Company who vote on the plan. Resolution of Congoleum's asbestos liability
through a pre-packaged reorganization plan is subject to various other
conditions as well, including approval by the bankruptcy court.
In furtherance of the agreement in principle, on April 10, 2003, the
Company and various asbestos claimants entered into the Claimant Agreement. As
contemplated by the Claimant Agreement, the Company also entered into the
Collateral Trust Agreement which established the Collateral Trust to distribute
funds in accordance with the terms of the Claimant Agreement and the Security
Agreement pursuant to which the Company granted the Collateral Trust a security
interest in the Collateral. As contemplated by the Claimant Agreement, the
Company may enter into settlement agreements with asbestos claimants prior to
its commencement of its Chapter 11 reorganization case. The value of the settled
claims pursuant to those settlements, and certain existing unfunded settlements
already entered into between the Company and certain asbestos claimants, will be
secured, fully or partially, as further provided by the Claimant Agreement, by
the Collateral.
22
The Company expects that, under the plan, the Plan Trust will be
established upon consummation of the Company's confirmed pre-packaged Chapter 11
plan of reorganization. As contemplated by the Claimant Agreement and the
Collateral Trust Agreement, upon consummation of the plan and establishment of
the Plan Trust, the assets in the Collateral Trust would be transferred to the
Plan Trust.
The Company expects that the Plan Trust would fund the settlement of all
pending and future asbestos claims (including any claims contemplated by the
Claimant Agreement that are unsatisfied as of the confirmation of the plan of
reorganization by the Bankruptcy Court) and protect Congoleum from future
asbestos-related litigation by channeling all asbestos claims (including any
claims contemplated by the Claimant Agreement that are unsatisfied as of the
confirmation of the plan of reorganization by the Bankruptcy Court) to the Plan
Trust pursuant to Section 524(g) of the Bankruptcy Code.
Based on its pre-packaged bankruptcy strategy for resolving its asbestos
liability, the Company has made provision in its financial statements for the
minimum amount of the range of estimates for its contribution and costs to
effect its plan to settle asbestos liabilities through a plan trust established
under Section 524(g) of the Bankruptcy Code. The Company recorded a charge of
$17.3 million in the fourth quarter of 2002 to increase its recorded liability
to the estimated minimum of $21.3 million. Actual amounts that will be
contributed to the Plan Trust and costs for pursuing and implementing the plan
of reorganization could be materially higher. During the nine months ended
September 30, 2003, the Company paid $11.1 million from the asbestos reserve in
legal fees, indemnity settlements, and reorganization costs related to asbestos
litigation. The Company believes that its remaining reserves are adequate to
execute its plan of reorganization. For more information regarding the Company's
asbestos liability and plan for resolving that liability, please refer to Notes
1 and 6 of the Notes to Unaudited Condensed Consolidated Financial Statements.
Results of Operations
Three and nine months ended September 30, 2003 as compared to three and nine
months ended September 30, 2002
Net sales for the third quarter of 2003 were $61.1 million, as compared to
$57.7 million in the third quarter of 2002, an increase of $3.4 million or 5.9%.
The increase in third quarter sales was due to sales of newly introduced
products and increased sales to the manufactured housing industry. Year-to-date
net sales for the first nine months of 2003 were $169.7 million, a decrease of
$13.9 million or 7.6% from the first nine months of 2002. Year-to-date sales are
below prior year levels primarily due to lower sales of tile to the home center
channel and lower sales of sheet products to the manufactured housing industry.
Gross profit for the third quarter of 2003 was $15.0 million, down $0.5
million from $15.5 million in the third quarter of 2002. Gross profit as a
percent of net sales decreased to 24.6% in the third quarter of 2003 from 26.9%
in the third quarter of 2002. Gross profit for the first nine months of 2003 was
$39.9 million, as compared to $45.8 million in the first nine months of 2002.
Gross profit as a percent of net sales decreased to 23.5% in the first nine
months of 2003 from 24.9% in the first nine months of 2002. The lower gross
profit margins for the third quarter and first nine months of 2003 versus 2002
is due to a less profitable mix of products sold higher raw material costs and
lower
23
production volumes over which to spread fixed manufacturing costs partly offset
by improved manufacturing efficiency.
Selling, general and administrative expenses were $13.4 million in the
third quarter of 2003, up $0.4 million from the third quarter of 2002. The
increase in selling, general and administrative expenses in the third quarter of
2003 compared with 2002 was due to higher costs for employee benefits, new
product introduction costs, and a severance pay provision for reductions
initiated in the third quarter of 2003 partly offset by expense reductions
initiated earlier in the year. As a percent of net sales, selling, general and
administrative expenses were 21.8% in the third quarter of 2003, as compared to
22.4% in the third quarter of 2002. For the nine months ended September 30,
2003, selling, general and administrative expenses were $ 39.7 million, as
compared to $39.5 million in the same period one year earlier. As a percent of
net sales, selling, general and administrative expenses were 23.0% in the first
nine months of 2003, as compared to 21.6% for the first nine months of 2002. The
increase in year-to-date selling, general and administrative expenses from 2002
to 2003 is due to higher employee benefit costs partly offset by the cost
reductions initiated earlier in 2003.
Income from operations for the third quarter of 2003 was $1.7 million, as
compared to income from operations of $2.6 million in the third quarter of 2002.
The decline in income from operations in the third quarter of 2003 compared with
2002 was primarily due to the less profitable sales mix. Income from operations
for the first nine months of 2003 was $0.9 million, compared to $6.2 million in
the first nine months of 2002. The decline in year-to-date income from
operations was primarily due to lower sales in 2003.
Congoleum recorded a $1.6 million benefit for income taxes in the third
quarter. This was due to its realization of tax additional benefits resulting
from net operating loss carrybacks. Due to the uncertainty of realizing future
tax benefits, Congoleum maintains a valuation allowance against all remaining
net deferred tax assets and anticipates its effective tax rate for the remainder
of 2003 and for 2004 will be 0%.
Liquidity and Capital Resources
The Company is a defendant in a large number of asbestos-related lawsuits
and has announced its intent to file a pre-packaged plan of reorganization under
Chapter 11 of the Bankruptcy Code as part of its strategy to resolve this
liability. See Notes 1 and 6 of the Notes to Unaudited Condensed Consolidated
Financial Statements, which are incorporated herein by reference. These matters
will have a material adverse impact on liquidity and capital resources. In 2003,
the Company anticipates spending $21.3 million in fees, expenses, and indemnity
contributions to effect its planned reorganization under Chapter 11 of the
Bankruptcy Code, $11.1 million of which was spent in the first nine months of
2003.
Unrestricted cash, cash equivalents and short-term investments decreased
$10.3 million for the nine months ended September 30, 2003 to $ 8.0 million, and
short term borrowings increased by $8.5 million. 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. Restricted
cash represents funds deposited in this account but not immediately applied to
the loan balance. Working capital at September 30, 2003 was $29.5 million, up
from $28.8 million at December 31, 2002. The ratio of
24
current assets to current liabilities at September 30, 2003 and December 31,
2002 was 1.5 to one and 1.4 to one, respectively. Cash used by operations was
$10.7 million for the first nine months of 2003, compared to cash provided by
operations of $4.9 million in the first nine months of 2002. The increase in net
cash used by operations in the first nine months of 2003 versus the first nine
months of 2002 was primarily due to $11.1 million in payments for asbestos and
reorganization costs.
Capital expenditures were $4.0 million and $6.7 million for the first nine
months of 2003 and 2002, respectively. Total 2003 capital spending is expected
to be approximately $6.0 million. Required contributions to the Company's
defined benefit pension plans in 2003 are expected to be approximately $4.8
million, of which $3.7 million was paid in the first nine months of 2003.
In December 2001, the Company entered into a new three-year revolving
credit facility (the "Credit Agreement") which provides for borrowings up to
$30.0 million. Interest is based on .75% above a designated prime rate, or 3.25%
over the Adjusted Eurodollar Rate, as applicable and subject to certain
adjustments, depending on meeting the required covenants under the Credit
Agreement. The Credit Agreement contains certain covenants, which include the
maintenance of a minimum tangible net worth and EBITDA (i.e., earnings before
interest, taxes, depreciation and amortization) if borrowing availability falls
below a certain level. It also includes restrictions on the incurrence of
additional debt and limitations on capital expenditures. The covenants and
conditions under the Credit Agreement must be met in order for the Company to
borrow from the facility. Borrowings under this facility are collateralized by
inventory and receivables. At September 30, 2003, based on the level of
receivables and inventory, the Company had borrowing availability of $20.4
million, of which $8.5 million was outstanding under the Credit Agreement and
$4.0 million was utilized for outstanding letters of credit.
In September 2002, the Company and its lender under the Credit Agreement
amended the Credit Agreement to revise certain financial and other covenants.
The Company and its lender under the Credit Agreement further amended the Credit
Agreement in February 2003 to revise certain financial and other covenants on
terms negotiated to reflect the transactions contemplated by the Company's
intended global settlement of its asbestos claims liability. The Company expects
that it and its lender will further amend the Credit Agreement, or will enter
into a new credit agreement that would replace the Credit Agreement, to provide
the Company with debtor-in-possession financing for the period of time that the
Company's Chapter 11 reorganization case remains pending. The Company is seeking
economic terms for debtor-in-possession financing substantially similar to the
economic terms of the Credit Agreement. However, there can be no assurance that
the economic terms of any debtor in possession financing obtained by the Company
will be substantially similar to the economic terms of the Credit Agreement.
In March 2003, the Company and the trustee of the governing the Senior
Notes amended the indenture to expressly provide the Company, under the terms of
that indenture, with greater flexibility to pursue possible resolutions of its
current and future asbestos claims liability, including negotiating a global
settlement with current asbestos plaintiffs, and soliciting acceptances of and
filing a prepackaged plan of reorganization under Chapter 11 of the Bankruptcy
Code. Holders of a majority in aggregate principal amount of the Senior Notes as
of the record date for determining the holders entitled to vote on the proposed
amendment consented to the amendment.
25
In August 2003, the Company and the trustee of the indenture governing the
Senior Notes amended the indenture to expressly provide the Company, under the
terms of that indenture, with greater flexibility to pursue approval of its
pre-packaged plan of reorganization under Chapter 11 of the Bankruptcy Code,
including expressly permitting the Company to issue the Company Note to the Plan
Trust, to reflect certain possible contributions expected to be made by ABI to
the Plan Trust and expressly permitting the Company to issue promissory notes to
ABI as repayment for certain amounts which may be paid by ABI to the Plan Trust.
Holders of a majority in aggregate principal amount of the Senior Notes as of
the record date for determining the holders entitled to vote on the proposed
amendment consented to the amendment.
Under the Credit Agreement, the Company is generally prohibited from
paying dividends on its capital stock. In addition, under the Indenture,
dividend payments are generally limited to 50% of a cumulative consolidated net
income (as determined under the Indenture) earned after June 30, 1998 plus the
amount of net proceeds received by the Company (as determined under the
Indenture) from sales permitted under the Indenture by the Company of its
capital stock. The Company expects that the Congoleum Note will contain
substantially the same restrictions on dividend payments as are contained in the
Indenture.
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. See Note 5 of the Notes to Unaudited Condensed
Consolidated Financial Statements. These actions include possible obligations to
remove or mitigate the effects on the environment of wastes deposited at various
sites, including Superfund sites and certain of the Company's owned and
previously owned facilities. The contingencies also include claims for personal
injury and/or property damage. The exact amount of such future cost and timing
of payments are indeterminable due to such unknown factors as the magnitude of
cleanup costs, the timing and extent of the remedial actions that may be
required, the determination of the Company's liability in proportion to other
potentially responsible parties, and the extent to which costs may be
recoverable from insurance. The Company has recorded provisions in its financial
statements for the estimated probable loss associated with all known general and
environmental contingencies. While the Company believes its estimate of the
future amount of these liabilities is reasonable, and that they will be paid
over a period of five to ten years, the timing and amount of such payments may
differ significantly from the Company's assumptions. Although the effect of
future government regulation could have a significant effect on the Company's
costs, the Company is not aware of any pending legislation, which would
reasonably have such an effect. There can be no assurances that the costs of any
future government regulations could be passed along to its customers. Estimated
insurance recoveries related to these liabilities are reflected in other
noncurrent assets.
The outcome of these environmental matters could result in significant
expenses incurred by or judgments assessed against the Company.
26
The Company's principal sources of capital are net cash provided by
operating activities and borrowings under the Credit Agreement. The Company
believes these sources will be adequate to fund working capital requirements,
debt service payments, planned capital expenditures, and its current estimates
for costs to settle and resolve its asbestos liabilities through its planned
pre-packaged Chapter 11 plan of reorganization. The Company's inability to get
such a plan confirmed in a timely manner would have a material adverse effect on
the Company's ability to fund its operating and investing requirements.
Risk Factors that May Affect Future Results
The Company has significant asbestos liability and funding exposure, and its
strategy for resolving this exposure may not be successful.
As more fully set forth in Notes 1 and 6 of the Notes to Unaudited
Condensed Consolidated Financial Statements, which are included in this report,
the Company has significant liability and funding exposure for asbestos claims.
The Company has reached an agreement in principle with attorneys representing
more than 75% of the known present claimants with asbestos claims pending
against the Company. In furtherance of the agreement in principle, the Company
entered into a settlement agreement with various asbestos claimants, which
provides for a global settlement of more than 75% of the known asbestos personal
injury claims pending against the Company. The agreement in principle also
contemplates a Chapter 11 reorganization and confirmation of a pre-packaged plan
that would leave trade and other unsecured nonasbestos creditors unimpaired and
would resolve all pending and future asbestos claims against the Company,
including any derivative liability of ABI and the Company's distributors from
claims asserted against the Company as may be afforded under section 524(g)(4)
of the Bankruptcy Code. Confirmation of an asbestos channeling injunction
pursuant to Section 524(g) of the Bankruptcy Code would require the supporting
votes of at least 75% of the asbestos claimants with claims against Congoleum
who vote on the plan, as well as a determination by the bankruptcy court that
the plan has satisfied certain criteria under the Bankruptcy Code.
There can be no assurance that the Company will be successful in realizing
its goals in this regard or in obtaining the necessary votes, consents and
approvals or in implementing its desired plan terms. As a result, any settlement
reached by the Company with its asbestos plaintiffs or plan of reorganization
pursued by the Company or confirmed by a bankruptcy court could vary
significantly from the description in this report (including descriptions
incorporated by reference in this report), including the estimated costs and
contributions to effect the contemplated plan of reorganization 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 approvals, and there can be no
assurance that such conditions, approvals and other requirements will be
satisfied or obtained, or that there may not be delays, which could be
significant, in satisfying or obtaining them. Delays in obtaining the necessary
supporting votes in favor of the Company's plan of reorganization, as well as
any other delays in getting the Company's plan of reorganization approved by the
bankruptcy court, could result in a proceeding that takes longer, and is more
costly, than the Company has estimated. Furthermore, any such delay could result
in the Company's pre-packaged plan of reorganization not being confirmed by the
bankruptcy
27
court or in the abandonment of the pre-packaged plan of reorganization in favor
of a non-prepackaged plan of reorganization. If a pre-packaged plan of
reorganization is abandoned in favor of a non-prepackaged plan of
reorganization, the Company would likely incur significantly more costs due to
the likely greater difficulty of negotiating a plan of reorganization with more
impaired classes of creditors. Also, obtaining confirmation of a plan under
those circumstances would likely take a considerable amount of time and effort
in order for the various parties involved to negotiate a plan in light of their
potentially adverse interests. There can be no assurance that the terms of any
non-prepackaged plan of reorganization would be on terms as favorable to the
Company, its shareholders, holders of the Senior Notes and other
nonasbestos-related constituents as the expected terms of the Company's
anticipated pre-packaged plan of reorganization.
Some additional factors that could cause actual results to differ from the
Company's goals for resolving its asbestos liability by pursuing a global
settlement of its pending asbestos claims and soliciting consents for and filing
a prepackaged plan of reorganization bankruptcy filing include: (i) the future
cost and timing of estimated asbestos liabilities and payments and availability
of insurance coverage and reimbursement from insurance companies, which
underwrote the applicable insurance policies for the Company for
asbestos-related claims and other costs relating to the execution and
implementation of any plan of reorganization pursued by the Company, (ii) timely
reaching agreement with other creditors, or classes of creditors, that exist or
may emerge, (iii) satisfaction of the conditions and obligations under the
Company's outstanding debt instruments, and amendments to those outstanding debt
instruments, as necessary, to permit the contemplated note contribution in
connection with the Company's pre-packaged plan of reorganization and to make
certain financial covenants in those debt instruments less restrictive, (iv) the
response from time-to-time of the Company's and its controlling shareholder's,
American Biltrite Inc.'s, lenders, customers, suppliers and other constituencies
to the ongoing process arising from the Company's strategy to settle its
asbestos liability, (v) the Company's ability to obtain debtor-in-possession
financing to provide it with sufficient funding during the pendency of its
Chapter 11 case and exit financing to provide it with sufficient funding for its
operations after emerging from the bankruptcy process, in each case, on
reasonable terms, (vi) timely obtaining sufficient creditor and court approval
of any reorganization plan pursued by it and (vii) compliance with the
Bankruptcy Code, including section 524(g). In any event, if the Company is not
successful in obtaining sufficient creditor and court approval of its
pre-packaged plan of reorganization, such failure would have a material adverse
effect upon its business, results of operations and financial condition.
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 prepackaged Chapter 11 plan of
reorganization. To the extend 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.
28
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 6 of the Notes to Unaudited Condensed Consolidated Financial
Statements, which are included in this report.
The Company may incur substantial liability for environmental, product and
general liability claims in addition to asbestos-related claims, and its
insurance coverage and its likely recoverable insurance proceeds may be
substantially less than the liability incurred by the Company for these claims.
Environmental Liabilities. Due to the nature of the Company's business and
certain of the substances which are or have been used, produced or discharged by
the Company, the Company's operations are subject to extensive federal, state
and local laws and regulations relating to the generation, storage, disposal,
handling, emission, transportation and discharge into the environment of
hazardous substances. The Company has historically expended substantial amounts
for compliance with existing environmental laws or regulations, including
environmental remediation costs at both third-party sites and Company-owned
sites. The Company will continue to be required to expend amounts in the future
for costs related to prior activities at its facilities and third party sites,
and for ongoing costs to comply with existing environmental laws, which 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
position 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.
29
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 paper. 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.
The Company believes that suitable alternative suppliers are available for
substantially all of its raw material requirements. However, the Company does
not have readily available alternative sources of supply for specific designs of
transfer print paper, 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
has an ongoing program 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 program
to develop new sources of supply would be successful in avoiding a material
adverse affect 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 as well
as foreign manufacturers. Some of the Company's competitors have greater
financial and other resources and access to capital than the Company.
Furthermore, to the extent any of the Company's competitors make a filing under
Chapter 11 of the Bankruptcy Code and emerge from bankruptcy as a continuing
operating company that has shed much of its pre-filing liabilities, those
competitors may have a competitive cost advantage over the Company as result of
having shed those liabilities. In addition, in order to maintain its competitive
position, the Company may need to make substantial investments in its business,
including its product development, manufacturing facilities, distribution
network and sales and marketing activities. Competitive pressures may also
result in decreased demand for the Company's products and in the loss of the
Company's market share for its products. Moreover, due to the competitive nature
of the Company's industry, the Company may be commercially restricted from
raising or even maintaining the sales prices of its products, which could result
in the Company incurring significant operating losses if its expenses were to
increase or otherwise represent an increased percentage of the Company's sales.
30
The Company 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.
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's products 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 19
distributors providing approximately 56 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. While most of its distributors have marketed the Company's
products for many years, replacements are necessary periodically to maintain the
strength of the Company's distribution network. 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
31
major distributor could have a materially adverse impact on the Company's
business, results of operations and financial condition. The Company derives a
majority of its sales from two of its distributors, LaSalle-Bristol Corporation
and Mohawk Industries, Inc. LaSalle-Bristol Corporation serves as the Company's
distributor in the manufactured housing market, and Mohawk Industries, Inc.
serves as a retail market distributor of the Company.
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.
Substantially all of the Company's outstanding long-term debt as of September
30, 2003 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) Disclosure Controls and Procedures. The Company's management, with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, has 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 report. Based on such evaluation, the
Company's Chief Executive Officer and Chief Financial Officer have concluded
that, as of the end of such period, the Company's disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on
a timely basis, information required to be disclosed by the Company in the
reports that it files or submits under the Exchange Act.
(b) Internal Control Over Financial Reporting. There have not been any
changes in the Company's internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the
fiscal quarter to which this report relates that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings: The information contained in Note 5
"Commitments and Contingencies" and Note 6 "Asbestos
Liabilities" of the Notes to Unaudited Condensed Consolidated
Financial Statements are incorporated herein by reference.
32
Item 2. Changes in Securities and Use of Proceeds: Under the
Company's credit agreement, the Company is subject to certain
financial covenants, including financial covenants relating to
working capital, which require the Company to meet certain
financial measurements. In addition, the Company's credit
agreement and the indenture governing the Company's Senior
Notes contain restrictions on the payment of cash dividends by
the Company on its capital stock. The Company expects that the
Congoleum Note will contain substantially the same
restrictions on dividend payments as are contained in the
indenture governing its Senior Notes. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
Item 3. Defaults Upon Senior Securities: None
Item 4. Submission of Matters to a Vote of Security Holders: None
Item 5. Other Information: None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
Exhibit
Number Exhibits
------ --------
2.1 Plan of Repurchase dated as of February 1,
1995, by and among American Biltrite Inc.,
Hillside Industries Incorporated, Congoleum
Holdings Incorporated, Resilient Holdings
Incorporated and the Company (1)
3.1 Certificate of Incorporation of the Company,
as amended (2)
3.2 Amended and Restated Bylaws of the Company
(2)
4.1 Registration Rights Agreement, dated as of
February 8, 1995 by and between the Company
and Hillside (1)
4.2 Indenture, dated as of August 3, 1998 (the
"1998 Indenture"), by and between the
Company and First Union National Bank, as
trustee (3)
33
4.2.1 First Supplemental Indenture, dated as of
March 28, 2003, between the Company and
Wachovia Bank, National Association (as
successor to First Union National Bank), as
trustee (4)
4.2.2 Second Supplemental Indenture, dated as of
August 7, 2003, between the Company and
Wachovia Bank, National Association (as
successor to First Union National Bank), as
trustee (5)
31.1 Certification of Chief Executive Officer
pursuant to Rule 13a-14(a)/Rule 15d-14(a) of
the Securities Exchange Act of 1934, as
amended, as adopted pursuant to Section 301
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer
pursuant to Rule 13a-14(a)/Rule 15d-14(a) of
the Securities Exchange Act of 1934, as
amended, as adopted pursuant to Section 301
of the Sarbanes-Oxley Act of 2002
32.1 Certification of the Chief Executive Officer
and Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002
- ----------
(1) Incorporated by reference to the exhibits filed with the Company's
Registration Statement on Form S-1 (File No. 33-87282) declared effective
by the Securities and Exchange Commission on February 1, 1995
(2) Incorporated by reference to the exhibits filed with the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 1996
(3) Incorporated by reference to the exhibits filed with the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 1998
(4) Incorporated by reference to the exhibits filed with the Company's Annual
Report on Form 10-K for the year ended December 31, 2002
(5) Incorporated by reference to the exhibits filed with the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 2003
34
(b) Reports on Form 8-K
(i) On July 31, 2003, the Company filed a Current
Report on Form 8-K, dated July 30, 2003, reporting
under Item 5, that the Company had issued a press
release on July 30, 2003 announcing that, as part
of its strategy to resolve its asbestos
liabilities, it was seeking bondholders' approval
of certain amendments to the indenture governing
its 8 5/8 % Senior Notes Due 2008, and disclosing
some of the expected terms of the Company's
anticipated pre-packaged Chapter 11 plan of
reorganization.
(ii) On August 14, 2003, the Company furnished a
Current Report on Form 8-K, dated August 12, 2003,
reporting under Item 12, that the Company had
issued a press release dated August 12, 2003
announcing its financial results for the quarter
ended June 30, 2003.
35
CONGOLEUM CORPORATION
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, 2003 By: /s/ Howard N. Feist III
--------------------------------------------
(Signature)
Howard N. Feist III
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial & Accounting Officer)
36
INDEX TO EXHIBITS
Exhibit
Number Exhibits
------ --------
2.1 Plan of Repurchase dated as of February 1, 1995,
by and among American Biltrite Inc., Hillside
Industries Incorporated, Congoleum Holdings
Incorporated, Resilient Holdings Incorporated and
the Company (1)
3.1 Certificate of Incorporation of the Company, as
amended (2)
3.2 Amended and Restated Bylaws of the Company (2)
4.1 Registration Rights Agreement, dated as of
February 8, 1995 by and between the Company and
Hillside (1)
4.2 Indenture, dated as of August 3, 1998 (the "1998
Indenture"), by and between the Company and First
Union National Bank, as trustee (3)
4.2.1 First Supplemental Indenture, dated as of March
28, 2003, between the Company and Wachovia Bank,
National Association (as successor to First Union
National Bank), as trustee (4)
4.2.2 Second Supplemental Indenture, dated as of August
7, 2003, between the Company and Wachovia Bank,
National Association (as successor to First Union
National Bank), as trustee (5)
31.1 Certification of Chief Executive Officer pursuant
to Rule 13a-14(a)/Rule 15d-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted
pursuant to Section 301 of the Sarbanes-Oxley Act
of 2002
31.2 Certification of Chief Financial Officer pursuant
to Rule 13a-14(a)/Rule 15d-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted
pursuant to Section 301 of the Sarbanes-Oxley Act
of 2002
32.1 Certification of the Chief Executive Officer and
Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
- ----------
(1) Incorporated by reference to the exhibits filed with the Company's
Registration Statement on Form S-1 (File No. 33-87282) declared effective
by the Securities and Exchange Commission on February 1, 1995
(2) Incorporated by reference to the exhibits filed with the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 1996
(3) Incorporated by reference to the exhibits filed with the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 1998
(4) Incorporated by reference to the exhibits filed with the Company's Annual
Report on Form 10-K for the year ended December 31, 2002
(5) Incorporated by reference to the exhibits filed with the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 2003
37