10-Q 1 eps1889.txt CONGOLEUM CORPORATION 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 June 30, 2005 or |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to _________ Commission File Number 1-13612 CONGOLEUM CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 02-0398678 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 3500 Quakerbridge Road P.O. Box 3127 Mercerville, NJ 08619-0127 (Address of principal executive offices, including zip code) (609) 584-3000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES |X| NO |_| Indicate by check mark whether the registrant is 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 July 31, 2005 ----------------------------- -------------------------------- Class A Common Stock 3,651,590 Class B Common Stock 4,608,945 CONGOLEUM CORPORATION Index Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Consolidated Balance Sheets as of June 30, 2005 (unaudited) and December 31, 2004.................................. 3 Condensed Consolidated Statements of Operations for the Three and Six Months ended June 30, 2005 and 2004 (unaudited)...... 4 Condensed Consolidated Statements of Cash Flows for the Six Months ended June 30, 2005 and 2004 (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.......................................... 24 Item 3. Quantitative and Qualitative Disclosures About Market Risk......... 36 Item 4. Controls and Procedures............................................ 36 PART II. OTHER INFORMATION Item 1. Legal Proceedings.................................................. 37 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........ 37 Item 3. Defaults Upon Senior Securities.................................... 37 Item 4. Submission of Matters to a Vote of Security Holders................ 37 Item 5. Other Information.................................................. 37 Item 6. Exhibits........................................................... 38 Signature................................................................... 39 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets (In thousands, except per share amounts)
June 30, 2005 December 31, (unaudited) 2004 ----------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents ..................................................... $ 21,397 $ 29,710 Restricted cash ............................................................... 11,083 15,682 Accounts receivable, less allowances of $1,468 and $1,174 as of June 30, 2005 and December 31, 2004, respectively ......................... 20,823 17,621 Inventories ................................................................... 44,867 39,623 Prepaid expenses and other current assets ..................................... 2,366 5,124 Deferred income taxes ......................................................... 10,678 10,678 ----------------------------------------------------------------------------------------------------------- Total current assets ..................................................... 111,214 118,438 Property, plant, and equipment, net ............................................. 76,271 79,550 Other assets, net ............................................................... 14,726 14,894 ----------------------------------------------------------------------------------------------------------- Total assets ............................................................. $ 202,211 $ 212,882 ----------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable .............................................................. $ 14,105 $ 10,296 Accrued liabilities ........................................................... 20,738 26,395 Asbestos-related liabilities .................................................. 22,430 21,079 Revolving credit loan ......................................................... 10,137 9,500 Accrued taxes ................................................................. 1,442 1,670 Liabilities subject to compromise - current ..................................... 18,883 14,225 ----------------------------------------------------------------------------------------------------------- Total current liabilities ................................................ 87,735 83,165 Asbestos-related liabilities .................................................... 2,738 2,738 Other liabilities ............................................................... -- -- Deferred income taxes ........................................................... 10,678 10,678 Liabilities subject to compromise - long term ................................... 136,999 137,290 ----------------------------------------------------------------------------------------------------------- Total liabilities ........................................................ 238,150 233,871 ----------------------------------------------------------------------------------------------------------- STOCKHOLDERS' EQUITY (DEFICIT) Class A common stock, par value $0.01; 20,000,000 shares authorized; 4,736,950 shares issued and 3,651,590 shares outstanding as of June 30, 2005 and December 31, 2004 ........................................................... 47 47 Class B common stock, par value $0.01; 4,608,945 shares authorized, issued and outstanding at June 30, 2005 and December 31, 2004 .......................... 46 46 Additional paid-in capital ...................................................... 49,106 49,106 Retained deficit ................................................................ (58,780) (43,830) Accumulated other comprehensive loss ............................................ (18,545) (18,545) -------- -------- (28,126) (13,176) Less Class A common stock held in treasury, at cost; 1,085,760 shares at June 30, 2005 and December 31, 2004 ......................................... 7,813 7,813 ----------------------------------------------------------------------------------------------------------- Total stockholders' equity (deficit) ....................................... (35,939) (20,989) ------- ------- ----------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity (deficit) ....................... $ 202,211 $ 212,882 -----------------------------------------------------------------------------------------------------------
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 Six Months Ended June 30, June 30, -------------------- ---------------------- 2005 2004 2005 2004 (In thousands, except per share amounts) Net sales ..................................... $ 58,108 $ 62,951 $ 115,738 $ 114,951 Cost of sales ................................. 44,338 46,065 88,307 84,514 Selling, general and administrative expenses .. 26,127 13,017 37,860 25,002 -------- -------- --------- --------- Income (loss) from operations ............ (12,357) 3,869 (10,429) 5,435 Other income (expense): Interest income .......................... 84 -- 182 -- Interest expense ......................... (2,618) (2,314) (5,118) (4,559) Other income ............................. 293 421 415 665 -------- -------- --------- --------- (Loss) Income before taxes ............... (14,598) 1,976 (14,950) 1,541 Provision for income taxes .................... -- 616 -- 616 -------- -------- --------- --------- Net (Loss) income ............................. $(14,598) $ 1,360 $ (14,950) $ 925 ======== ======== ========= ========= Net (Loss) income per common share, basic ..... $ (1.77) $ 0.16 $ (1.81) $ 0.11 ======== ======== ========= ========= Net (Loss) income per common share, diluted ... $ (1.77) $ 0.16 $ (1.81) $ 0.11 ======== ======== ========= ========= Weighted average number of common shares outstanding, basic ........................ 8,260 8,260 8,260 8,260 ======== ======== ========= ========= Weighted average number of common shares outstanding, diluted ...................... 8,260 8,363 8,260 8,363 ======== ======== ========= =========
The accompanying notes are an integral part of the condensed consolidated financial statements. 4 CONGOLEUM CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended June 30, ---------------------- 2005 2004 (In thousands) Cash flows from operating activities: Net (loss) income ............................................................. $(14,950) $ 925 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation .............................................................. 5,434 5,410 Amortization .............................................................. 192 304 Asbestos-related charge ................................................... 15,455 -- Deferred income taxes ..................................................... -- 551 Changes in certain assets and liabilities: Accounts and notes receivable ........................................ (3,202) (10,644) Inventories .......................................................... (5,244) 1,804 Prepaid expenses and other assets .................................... 1,400 2,692 Accounts payable ..................................................... 3,809 7,817 Accrued expenses ..................................................... (1,024) 12,753 Asbestos-related expenses ............................................ (12,927) (1,385) Asbestos-related expense reimbursements from insurance settlement .... 6,091 -- Other liabilities .................................................... (518) (335) -------- -------- Net cash (used in) provided by operating activities ............. (5,484) 19,892 -------- -------- Cash flows from investing activities: Capital expenditures ...................................................... (2,155) (1,355) Proceeds from asset retirement ............................................ -- 30 -------- -------- Net cash used in investing activities ........................... (2,155) (1,325) Cash flows from financing activities: Net short-term borrowings ................................................. 637 5,030 Net change in restricted cash ............................................. (1,311) (2,091) -------- -------- Net cash provided by financing activities ....................... (674) 2,939 -------- -------- Net (decrease) increase in cash and cash equivalents ............................... (8,313) 21,506 Cash and cash equivalents: Beginning of period ........................................................... 29,710 2,169 -------- -------- End of period ................................................................. $ 21,397 $ 23,675 ======== ========
The accompanying notes are an integral part of the condensed consolidated financial statements. 5 CONGOLEUM CORPORATION NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2005 (Unaudited) 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal and recurring adjustments as well as provisions to effect its plan to settle asbestos liability) considered necessary for a fair presentation of Congoleum Corporation's (the "Company" or "Congoleum") condensed consolidated financial position, results of operations and cash flows have been included. Operating results for the three and six months period ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. 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, 2004. 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 of the Notes to Unaudited Condensed Consolidated Financial Statements, 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"). On December 31, 2003, Congoleum filed a voluntary petition with the United States Bankruptcy Court for the District of New Jersey (Case No. 03-51524) seeking relief under Chapter 11 of the Bankruptcy Code as a means to resolve claims asserted against it related to the use of asbestos in its products decades ago. During 2003, Congoleum obtained the requisite votes of asbestos personal injury claimants necessary to seek approval of a proposed, pre-packaged Chapter 11 plan of reorganization. In January 2004, the Company filed its proposed plan of reorganization and disclosure statement with the Bankruptcy Court. On November 8, 2004, Congoleum filed a modified plan of reorganization and related documents with the Bankruptcy Court reflecting the result of further negotiations with representatives of the Asbestos Claimants' Committee, the Future Claimants' Representative and other asbestos claimant representatives. The Bankruptcy Court approved the disclosure statement and plan voting procedures on December 9, 2004 and Congoleum obtained the requisite votes of asbestos personal injury claimants necessary to seek approval of the modified 6 plan. On April 22, 2005, Congoleum announced that it had reached an agreement in principle with representatives of the Asbestos Claimants' Committee and the Future Claimants' Representative to make certain modifications to its proposed plan of reorganization and related documents governing the settlement and payment of asbestos-related claims against Congoleum. Under the agreed-upon modifications, asbestos claimants with claims settled under Congoleum's pre-petition settlement agreements would agree to forbear from exercising the security interest they were granted and share on a pari passu basis with all other present and future asbestos claimants in insurance proceeds and other assets of the trust to be formed upon confirmation of the plan under Section 524(g) of the Bankruptcy Code (the "Plan Trust") to pay asbestos claims against Congoleum. On July 22, 2005, Congoleum filed an amended plan of reorganization and related documents with the Bankruptcy Court which reflected the result of these negotiations as well as certain other technical modifications. The Bankruptcy Court approved the disclosure statement and voting procedures on July 28, 2005 and Congoleum plans to commence solicitation of acceptances of the plan by the end of August 2005. A hearing to consider confirmation of the plan is scheduled to begin December 13, 2005. There can be no assurance that the Company will receive the acceptances necessary for confirmation of the proposed amended plan of reorganization, that the proposed amended plan will not be modified further, that the amended plan will receive necessary court approvals from the Bankruptcy Court or the Federal District Court, or that such approvals will be received in a timely fashion, that the amended plan will be confirmed, or that the amended plan, if confirmed, will become effective. Congoleum is presently involved in litigation with certain insurance carriers related to disputed insurance coverage for asbestos related liabilities, and certain insurance carriers filed various objections to Congoleum's previously proposed plans of reorganization and related matters and are expected to file objections to the current plan. Certain other parties have also filed various objections to Congoleum's previously proposed plans of reorganization and may file objections to the proposed amended plan. The proposed amended plan of reorganization, if confirmed, would leave non-asbestos creditors unimpaired and would resolve all pending and future asbestos claims against the Company. The proposed amended plan of reorganization would provide, among other things, for an assignment of certain rights in, and proceeds of, Congoleum's applicable insurance to the Plan Trust that would fund the settlement of all pending and future asbestos claims and protect the Company from future asbestos-related litigation by channeling all asbestos claims to the Plan Trust under Section 524(g) of the Bankruptcy Code. Other creditors would be unimpaired under the plan. The Bankruptcy Court has authorized the Company to pay trade creditors in the ordinary course of business. The Company expects that it will take until the first quarter of 2006 at the earliest to obtain confirmation of its proposed amended plan of reorganization. Based on its proposed amended plan of reorganization, the Company has made provision in its financial statements for the minimum amount of the range of estimates for its contribution to effect its plan to settle asbestos liabilities through the Plan Trust. The Company recorded charges aggregating $26 million in prior years and a further $15.5 million in the second quarter of 2005, to provide for the estimated minimum costs of completing its reorganization given the revised timeline for anticipated confirmation. Actual amounts that will be contributed to the Plan Trust and costs for pursuing and implementing the plan of reorganization could be materially higher. For more information regarding the Company's asbestos liability and plan for resolving that liability, please refer to Note 6 of the Notes to Unaudited Condensed Consolidated Financial Statements. There can be no assurance that the Company will be successful in realizing its goals in this regard or in obtaining 7 confirmation of its proposed amended plan of reorganization or that any confirmed plan will become effective. As a result, any alternative plan of reorganization pursued by the Company or confirmed by a bankruptcy court could vary significantly from the description in this Quarterly Report on Form 10-Q and the estimated costs and contributions to effect the contemplated amended 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 and Federal District Court approvals, and there can be no assurance that such conditions, approvals and other requirements will be satisfied or obtained. Delays in getting the Company's amended 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. AICPA Statement of Position 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code" ("SOP 90-7") provides financial reporting guidance for entities that are reorganizing under the Bankruptcy Code. The Company implemented this guidance in consolidated financial statements for periods after December 31, 2003. Pursuant to SOP 90-7, companies are required to segregate pre-petition liabilities that are subject to compromise and report them separately on the balance sheet. Liabilities that may be affected by a plan of reorganization are recorded at the amount of the expected allowed claims, even if they may be settled for lesser amounts. Substantially all of the Company's liabilities at December 31, 2003 have been reclassified as liabilities subject to compromise. Obligations arising post-petition, and pre-petition obligations that are secured, are not classified as liabilities subject to compromise. Additional pre-petition claims (liabilities subject to compromise) may arise due to the rejection of executory contracts or unexpired leases, or as a result of the allowance of contingent or disputed claims. 2. Recent Accounting Principles: Stock Based Compensation In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), Share-Based Payment. SFAS No. 123(R) replaces SFAS No. 123, Accounting for Stock-Based Compensation, supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees and amends SFAS No. 95, Statement of Cash Flows. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Pro forma disclosure is no longer an alternative to financial statement recognition. SFAS No. 123(R) was originally effective for public companies at the beginning of the first interim or annual period beginning after June 15, 2005. In April 2005, the Securities and Exchange Commission (SEC) provided for a phased-in implementation process for public companies. Based on the Company's year end of December 31, the Company must adopt SFAS No. 123(R) on January 1, 2006. 8 SFAS No. 123(R) allows for either prospective recognition of compensation expense or retrospective recognition, which may be back to the original issuance of SFAS No. 123 or only to interim periods in the year of adoption. The Company is currently evaluating these transition methods and determining the effect on the Company's consolidated results of operations and whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS No. 123. For 2005, the Company will continue to disclose stock-based compensation information in accordance with FASB Statement No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation--Transition and Disclosure--an Amendment of FASB Statement No. 123," and Statement No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation." A reconciliation of consolidated net income (loss), as reported, to pro forma consolidated net income (loss) including compensation expense for the Company's stock-based plans as calculated based on the fair value at the grant dates for awards made under these plans in accordance with the provisions of SFAS 123 as amended by SFAS 148, as well as a comparison of as reported and pro forma basic and diluted earnings per share follows (in thousands, except per share data):
For the Three Months For the Six Months Ended June 30, Ended June 30, 2005 2004 2005 2004 -------- -------- -------- -------- (dollars in thousands, except per share amounts) Net income (loss): As reported $(14,598) $ 1,360 $(14,950) $ 925 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (55) (53) (114) (104) -------- -------- -------- -------- As adjusted $(14,653) $ 1,307 $(15,064) $ 821 ======== ======== ======== ======== Net income (loss) per share: As reported basic and diluted $ (1.77) $ 0.16 $ (1.81) $ 0.11 Pro forma compensation expense (.01) (0.01) (.01) (0.01) -------- -------- -------- -------- Pro forma basic and diluted $ (1.78) $ 0.15 $ (1.82) $ 0.10 ======== ======== ======== ========
3. Inventories A summary of the major components of inventories is as follows (in thousands): June 30, December 31, 2005 2004 --------- ------------ Finished goods $ 35,461 $ 32,811 Work-in-process 2,163 1,415 Raw materials and supplies 7,243 5,397 ----------------------------------------------------------- Total inventories $ 44,867 $ 39,623 =========================================================== 9 4. Income/(Loss) Per Share Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is calculated by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents outstanding during the period, unless their effect is anti-dilutive. 5. Environmental and Other Liabilities The Company records a liability for environmental remediation claims when a cleanup program or claim payment becomes probable and the costs can be reasonably estimated. As assessments and cleanup programs progress, these liabilities are adjusted based upon the progress in determining the timing and extent of remedial actions and the related costs and damages. The recorded liabilities, totaling $4.6 million at June 30, 2005 and at December 31, 2004, are not reduced by the amount of insurance recoveries. Such estimated insurance recoveries approximated $2.1 million at June 30, 2005 and at December 31, 2004, and are reflected in other noncurrent assets and 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 four other instances, although not named as a PRP, the Company has received a request for information. The pending proceedings relate to eight disposal sites in New Jersey, Pennsylvania, and Maryland in which recovery from generators of hazardous substances is sought for the cost of cleaning up the contaminated waste sites. The Company's ultimate liability and funding obligations in connection with those sites depends on many factors, including the volume of material contributed to the site, the number of other PRPs and their financial viability, the remediation methods and technology to be used and the extent to which costs may be recoverable from insurance. However, under CERCLA, and certain other laws, the Company as a PRP, can be held jointly and severally liable for all environmental costs associated with a site. The most significant exposure 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 and a groundwater treatment system was installed thereafter. EPA recently selected a remedy for the soil and shallow groundwater; however, the remedial investigation/feasibility study related to the deep groundwater has not been completed. The PRP group estimates that future costs of the remedy recently selected by EPA based on engineering estimates would be approximately $11 million. Congoleum's proportionate share, based on waste disposed at the site, is estimated to be approximately 5.7%, or $0.7 million. The majority of Congoleum's share of costs is presently being paid by one of its insurance carriers, whose remaining policy limits for this claim will cover approximately half this amount. Congoleum expects the balance to be funded by other insurance carriers and the Company. 10 The Company also accrues remediation costs for certain of the Company's owned facilities on an undiscounted basis. The Company has entered into an administrative consent order with the New Jersey Department of Environmental Protection and has established a remediation trust fund of $100 thousand as financial assurance for certain remediation funding obligations. Estimated total cleanup costs of $ 1.7 million, including capital outlays and future maintenance costs for soil and groundwater remediation, are primarily based on engineering studies. Of this amount, $0.3 million is included in current liabilities subject to compromise and $1.4 million is included in non-current liabilities subject to compromise. The Company anticipates that these matters will be resolved over a period of years and that after application of expected insurance recoveries, funding the costs will not have a material adverse impact on the Company's liquidity or financial position. However, unfavorable developments in these matters could result in significant expenses or judgments that could have a material adverse effect on the financial position of the Company. 6. Asbestos Liabilities Claims Settlement and Chapter 11 Reorganization In early 2003, the Company announced that it was seeking to resolve its asbestos liabilities through confirmation of a pre-packaged plan of reorganization under Chapter 11 of the Bankruptcy Code, and later in 2003, consistent with this strategy, the Company entered into a settlement agreement with various asbestos personal injury claimants (the "Claimant Agreement"). As contemplated by the Claimant Agreement, the Company also entered into agreements establishing a pre-petition trust (the "Collateral Trust") to distribute funds in accordance with the terms of the Claimant Agreement and granting the Collateral Trust a security interest in its rights under applicable insurance coverage and payments from insurers for asbestos claims. Under the terms of the Company's most recent amended plan of reorganization, participants in the Claimant Agreement who vote in favor of the plan agree to forbear from exercising the security interest in and priority rights to distributions from the Collateral Trust. The Claimant Agreement established a compensable disease valuation matrix (the "Matrix") and allowed claimants who qualified to participate in the Claimant Agreement (the "Qualifying Claimants") to settle their claims for the Matrix value, secured in part (75%) by a security interest in the collateral granted to the Collateral Trust. The Collateral Trust provides for distribution of trust assets according to various requirements that give priority (subject to aggregate distribution limits) to participating claimants who had pre-existing unfunded settlement agreements ("Pre-Existing Settlement Agreements") with the Company and participating claimants who qualified for payment under unfunded settlement agreements entered into by the Company with plaintiffs that had asbestos claims pending against the Company and which claims were scheduled for trial after the effective date of the Claimant Agreement but prior to the commencement of the Company's anticipated Chapter 11 reorganization case ("Trial-Listed Settlement Agreements"). The Claimant Agreement incorporated Pre-Existing Settlement Agreements and the settlement of certain Trial-Listed Settlement Agreement claims for a fully secured claim against the Collateral Trust, and it settled all other claims for a secured claim against the Collateral Trust equal to 75% of the claim value and an unsecured claim for the remaining 25%. Under the proposed amended plan of reorganization, after the establishment of the Plan Trust, the assets in the Collateral Trust would be transferred to the Plan Trust and any claims subject to the Claimant Agreement would be channeled to the Plan Trust and paid in accordance with the terms of the proposed amended plan, which incorporates the forbearance. 11 In October 2003, the Company began soliciting acceptances for its proposed pre-packaged plan of reorganization and the Company received the votes necessary for acceptance of the plan in late December 2003. On November 8, 2004, Congoleum announced that it had filed a modified plan of reorganization and related documents with the Bankruptcy Court reflecting the result of further negotiations with representatives of the Asbestos Claimants' Committee, the Future Claimants' Representative and other asbestos claimant representatives. The Bankruptcy Court approved the disclosure statement and plan voting procedures on December 9, 2004 and a hearing began on April 12, 2005 to consider confirmation of the plan. The Company received the acceptances necessary for confirmation of its plan as then constituted at that time. On April 22, 2005, Congoleum announced that it had reached an agreement in principle with representatives of the Asbestos Claimants' Committee and the Future Claimants' Representative to make certain modifications to its proposed plan of reorganization and related documents governing the settlement and payment of asbestos related claims against Congoleum. Under the agreed-upon modifications, asbestos claimants with claims settled under Congoleum's pre-petition settlement agreements would agree to forbear from exercising the security interest they were granted and share on a pari passu basis with all other present and future asbestos claimants in insurance proceeds and other assets of the Plan Trust. On July 22, 2005, Congoleum filed an amended plan of reorganization and related documents with the Bankruptcy Court, which reflected the result of these negotiations as well as certain other technical modifications. The Bankruptcy Court approved the disclosure statement and voting procedures on July 28, 2005 and Congoleum plans to commence solicitation of acceptances of the plan by the end of August 2005. A hearing to consider confirmation of the plan is scheduled to begin December 13, 2005. There can be no assurance that the Company will receive the acceptances necessary for confirmation of the proposed amended plan of reorganization, that the proposed amended plan will not be modified further, that the amended plan will receive necessary court approvals from the Bankruptcy Court or the federal District Court, or that such approvals will be received in a timely fashion, that the amended plan will be confirmed, or that the amended plan, if confirmed, will become effective. Congoleum is presently involved in litigation with certain insurance carriers related to disputed insurance coverage for asbestos related liabilities, and certain insurance carriers filed various objections to Congoleum's previously proposed plans of reorganization and related matters and are expected to file objections to the current plan. Certain other parties have also filed various objections to Congoleum's previously proposed plans of reorganization and may file objections to the proposed amended plan. In May 2005, the Company entered into a settlement agreement with one of its excess insurance carriers over coverage for asbestos-related claims. Under the terms of the settlement, certain AIG companies will pay approximately $103 million over ten years to the Plan Trust. The settlement resolves coverage obligations of policies with a total of $114 million in liability limits for 12 asbestos bodily injury claims, and is subject to the effectiveness of Congoleum's proposed amended plan of reorganization. In June 2005, the Company entered into a settlement agreement with certain underwriters at Lloyd's, London, which has been approved by the Bankruptcy Court, pursuant to which the certain underwriters will pay approximately $20 million into an escrow account in exchange for a release of insurance coverage obligations. The escrow agent will transfer the funds to the Plan Trust once the plan goes effective and the Bankruptcy Court approves the payment. In August 2005, the Company entered into a settlement agreement with Federal Insurance Company pursuant to which Federal will pay $4 million to the Plan Trust once the plan goes effective and the Bankruptcy Court approves the payment. This agreement is subject to Bankruptcy Court approval. Court approval of these settlement agreements has been or may be appealed by other insurance carriers who are not party to the agreements. Under the proposed amended plan of reorganization and related documents, Congoleum's assignment of insurance recoveries to the Plan Trust is net of costs incurred in connection with insurance coverage litigation. Congoleum is entitled to withhold from recoveries, or seek reimbursement from the Plan Trust, for coverage litigation costs incurred after January 1, 2003 in excess of $6 million of coverage litigation costs. Furthermore, once insurance recoveries exceed $375 million, Congoleum is entitled to withhold from recoveries, or seek reimbursement from the Plan Trust, for the first $6 million. Congoleum also paid $1.3 million in claims processing fees in connection with claims settled under the Claimant Agreement. Congoleum is entitled to withhold from recoveries, or seek reimbursement from the Plan Trust, for the $1.3 million claims processing fee once insurance recoveries exceed $375 million. In connection with modifications to the plan and Collateral Trust, Congoleum agreed to indemnify the Claimants Counsel and the trustee of the Collateral Trust for all acts relating to the modifications of the plan and the Collateral Trust made after April 1, 2005, including attorneys' fees, up to a maximum of $3 million. The Company's proposed amended plan of reorganization and related documents provide for the channeling of asbestos property damage claims in addition to asbestos personal injury claims to the Plan Trust. There were no property damage claims asserted against the Company at the time of its bankruptcy filing. The Bankruptcy Court approved an order establishing a bar date of May 3, 2004 for the filing of asbestos property damage claims. The claims agent appointed in the Company's bankruptcy proceeding advised the Company that, as of the bar date, it received 35 timely filed asbestos property damage claims asserting liquidated damages in the amount of approximately $0.8 million plus additional unspecified amounts. The Company objected to certain claims on various grounds, and the Bankruptcy Court ultimately allowed 19 claims valued at $133 thousand. The Company expects to issue a promissory note (the "Company Note") to the Plan Trust as part of the Company's proposed amended plan of reorganization. Under the terms of the proposed plan, 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 last trading day of the 90 consecutive trading day period commencing on the first anniversary of the effective date of the Company's confirmed 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 13 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. This adjustment amount could result in the principal amount of the note increasing materially. For example, if the adjustment amount were calculated during the 90 consecutive day trading period ended June 30, 2005, the resulting adjustment amount would be $16.6 million. Under the terms of the proposed amended plan, interest on the outstanding principal of the Company Note will accrue at a rate of 9% per annum, with interest on the Original Principal Amount payable quarterly and interest on the Additional Principal Amount added to the Additional Principal Amount as additional principal. 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 become payable quarterly. Under the terms of the proposed amended plan of reorganization 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. 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 its controlling shareholder, American Biltrite Inc. ("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 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. 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 under the indenture governing the Company's Senior Notes, and with regard to other events of default under 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 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. The proposed amended plan of reorganization contemplates 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. As additional security for the Company Note, the ABI Pledge Agreement and the terms of the Company's proposed amended plan of reorganization provide that any amounts that 14 the Company 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 proposed amended plan of reorganization, the Company Note and the ABI Pledge Agreement. The Company Note, the ABI Pledge Agreement and the Company's proposed amended plan of reorganization 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 Company 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 proposed amended plan of reorganization, the Company Note and the ABI Pledge Agreement. Under the proposed amended plan of reorganization ABI would be permitted 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 any interest that may have accrued but not yet paid at the time of any principal repayment would be due and payable at the time of the principal repayment. The Company 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. 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. The proposed amended plan of reorganization also provides that if ABI prepays the Company Note and ABI sells all or substantially all of the shares of the Company's stock that it holds as of the Principal Adjustment Date during the three-year period following such date, ABI 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 15 for the 90 consecutive trading days ending on the Principal Adjustment Date). In such instance, the proposed amended plan would obligate ABI to pay to the Plan Trust an amount equal to 50% of such excess amount. Under the terms of the Company's proposed amended 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, 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 proposed amended plan provides 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. ABI has agreed to make a cash contribution in the amount of $250 thousand to the Plan Trust upon the formation of the Plan Trust. Under the expected terms of the Company's proposed amended plan of reorganization, 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 proposed amended plan of reorganization does not provide that any other asbestos claims that may be asserted against ABI would be channeled to the Plan Trust. While the Company believes its proposed amended modified plan is feasible and should be confirmed by the Bankruptcy Court, there are sufficient risks and uncertainties such that no assurances of the outcome can be given. In addition, the remaining costs to effect the reorganization process, consisting principally of legal and advisory fees and contributions to the Plan Trust, including one or more notes expected to be contributed to the Plan Trust by the Company, are expected to be approximately $16.5 million at a minimum, not including any Additional Principal Amount arising from revaluation of the Company Note, and could be materially higher. Pending Asbestos Claims In 2003, the Company was one of many defendants in approximately 22 thousand pending lawsuits (including workers' compensation cases) involving approximately 106 thousand individuals, alleging personal injury or death from exposure to asbestos or asbestos-containing products. Claims involving approximately 80 thousand individuals have been settled pursuant to the Claimant Agreement and litigation related to unsettled or new claims is presently stayed by the Bankruptcy Code. The Company expects unsettled and future claims to be handled in accordance with the terms of its plan of reorganization and the Plan Trust. 16 Nearly all asbestos-related claims that have been brought against the Company to date allege that various diseases were caused by exposure to asbestos-containing products, including resilient sheet vinyl and tile manufactured by the Company (or, in the workers' compensation cases, exposure to asbestos in the course of employment with the Company). The Company discontinued the manufacture of asbestos-containing sheet products in 1983 and asbestos-containing tile products in 1974. In general, governmental authorities have determined that asbestos-containing sheet and tile products are 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 of coverage for general and product liability claims. Through August 2002, substantially all asbestos-related claims and defense costs were paid through primary insurance coverage. In August 2002, the Company received notice that its primary insurance limits had been paid in full. The payment of limits in full by one of the primary insurance companies was based on its contention that limits in successive policies were not cumulative for asbestos claims and that Congoleum was limited to only one policy limit for multiple years of coverage. Certain excess insurance carriers claimed that the non-cumulation provisions of the primary policies were not binding on them and that there remained an additional $13 million in primary insurance limits plus related defense costs before their policies were implicated. There is insurance coverage litigation currently pending between Congoleum and its excess insurance carriers, and the guaranty funds and associations for the State of New Jersey. The litigation was initiated on September 15, 2001, by one of Congoleum's excess insurers (the "Coverage Action"). 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. Congoleum has reached a settlement agreement ("Insurance Settlement") with the insurance carrier whose policies contained the non-cumulation provisions, pursuant to which the insurance carrier will pay Congoleum $15.4 million in full satisfaction of the applicable policy limits, of which $14.5 million has been paid to date. Pursuant to the terms of the Security Agreement, the Company is obligated to pay any insurance proceeds it receives under the Insurance Settlement, net of any fees and expenses it may be entitled to deduct, to the Collateral Trust. Payment of such fees and expenses are subject to Bankruptcy Court order or approval. The Company does not expect this Insurance Settlement to have a material effect on its financial condition or results of operations. As of December 31, 2002, the Company had entered into additional settlement agreements with asbestos claimants exceeding the amount of previously disputed coverage. The excess carriers have objected to the reasonableness of several of these settlements, and Congoleum believes that they will continue to dispute the reasonableness of the settlements and contend that their policies still are not implicated and will dispute their coverage for that and other various reasons in ongoing coverage litigation. The excess insurance carriers have also raised various objections to the Company's previously proposed plans of reorganization and are expected to raise objections to the proposed amended plan. 17 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. The excess insurance carriers 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 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. On April 19, 2004, the court denied motions for summary judgment by the excess carriers that the Claimant Agreement was not binding on them because Congoleum had breached the consent and cooperation clauses of their insurance policies by, among other things, entering into the Claimant Agreement without their consent. Congoleum argues, among other things, that it was entitled to enter into the Claimant Agreement and/or the Claimant Agreement was binding on the excess insurance carriers because they were in breach of their policies and/or had denied coverage and/or had created a conflict with Congoleum by reserving rights to deny coverage and/or the Claimant Agreement was fair, reasonable and in good faith and/or there was and is no prejudice to the excess insurance carriers from the Claimant Agreement and/or the excess insurance carriers had breached their duties of good faith and fair dealing. On August 12, 2004, the Court entered a case management order that divides the trial into three phases. A new judge was assigned to the case effective February 23, 2005 and the schedule was modified as a result. On February 22, 2005, the Court ruled on a series of summary judgment motions filed by various insurers. The Court denied a motion for summary judgment filed by certain insurers, holding that there were disputed issues of fact regarding whether the Claimant Agreement and other settlement agreements between Congoleum and the claimants had released Congoleum and the insurers from any liability for the asbestos bodily injury claims of the claimants who signed the Claimant Agreement and the other settlement agreements. The Court also denied another motion for summary judgment filed by various insurers who argued that they did not have to cover the liability arising from the Claimant Agreement because they had not consented to it. The Court granted summary judgment regarding Congoleum's bad faith claims against excess insurers (other than first-layer excess insurers), holding that the refusal of these excess insurers to cover the Claimant Agreement was at least fairly debatable and therefore not in bad faith. The first phase of the trial began on August 2, 2005 and will address all issues and claims relating to whether the insurers are obligated to provide coverage under the policies at issue in this litigation for the global Claimant Agreement entered into by Congoleum, including but not limited to all issues and claims relating to both Congoleum's decision and conduct in entering into the Claimant Agreement and filing a pre-packaged bankruptcy and the insurance company defendants' decisions and conduct in opposing the Claimant Agreement and Congoleum's pre-packaged bankruptcy, the reasonableness and good faith of the Claimant Agreement, whether the Claimant Agreement breached any insurance 18 policies and, if so, whether the insurance companies suffered any prejudice, and whether the insurance companies' opposition to the Claimant Agreement and bankruptcy and various other conduct by the insurers has breached their duties of good faith and fair dealing such that they are precluded from asserting that Congoleum's decision to enter into the Claimant Agreement constitutes any breach(es) on the part of Congoleum. The Company believes, however, that even if the insurers were to succeed in the first phase of the Coverage Action, such result would not deprive individual claimants of the right to seek payment from the insurers who issued the affected insurance policies or negotiating settlements with some or all of the signatories to the Claimant Agreement and seeking payment from its insurers for such settlements, nor would such result preclude the Company from amending the Claimant Agreement and seeking recovery under the Claimant Agreement as amended; moreover, the Company does not believe that it would be deprived of coverage-in-place insurance for future obligations of or demands upon the insurers under the applicable insurance policies. However, there can be no assurances of the outcome of these matters or their potential effect on the Company's ability to obtain approval of its plan of reorganization. The second phase of the trial will address all coverage issues, including but not limited to trigger and allocation. The final phase of the trial will address bad faith punitive damages, if appropriate. On March 18, 2005, the Company filed a motion in the Bankruptcy Court asking the Bankruptcy Court to vacate its prior order lifting the automatic stay in bankruptcy to permit the Coverage Action to proceed. The Company requested that the Coverage Action proceedings be stayed until the Company has completed its plan confirmation process in the Bankruptcy Court. A hearing on the Company's motion was held on April 12, 2005 and the motion was denied. Given the actions of its excess insurance carriers, the Company believes it likely that it would currently have to fund any asbestos-related expenses for defense expense and indemnity itself. However, litigation by asbestos claimants against the Company is stayed pursuant to the Company's bankruptcy proceedings, and the Company does not anticipate its future expenditures for defense and indemnity of asbestos-related claims, other than expenditures pursuant to its proposed (or an alternative) plan of reorganization, will be significant. Accounting for Asbestos-Related Claims Under the terms of the Claimant Agreement, the Company's claims processing agent processed 79,630 claims meeting the requirements of the Claimant Agreement with a settlement value of $466 million. In addition, Pre-Existing Settlement Agreements and Trial-Listed Settlement Agreements with claims secured by the Collateral Trust total $25 million. As a result of tabulating ballots on its fourth amended plan, the Company is also aware of claims by claimants whose claims were not determined under the Claimant Agreement but who have submitted claims with a value of $512 million based on the settlement values applicable in the current amended plan. The Company's gross liability of $491 million for these settlements and contingent liability for the additional $512 million in unsettled claims 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. 19 Therefore, the Company believes the most meaningful measure of its probable loss due to asbestos litigation is the amount it will have to contribute to the Plan Trust plus the costs to effect its reorganization under Chapter 11. At June 30, 2005, the Company estimates the minimum remaining amount of the contributions and costs to be $16.5 million, of which it has recorded $13.8 million as a current liability and $2.7 million as a non-current liability. These amounts do not include the liability associated with a $14.5 million insurance settlement recorded as restricted cash, which the Company expects to contribute, less any amounts withheld pursuant to reimbursement arrangements, to the Plan Trust. At June 30, 2005 this liability (comprised of the original settlement plus interest to date, less $6.1 million in reimbursements approved by the bankruptcy court) amounted to $8.6 million and is included in current asbestos-related liabilities. The Company recorded charges aggregating $26 million in prior years and a further $15.5 million in the second quarter of 2005, to provide for the estimated minimum costs of completing its reorganization given the revised timeline for anticipated confirmation. Additional charges may be required in the future should the minimum estimated cost increase. The maximum amount of the range of possible asbestos-related losses is limited to the going concern or liquidation value of the Company, an amount which the Company believes is substantially less than the minimum gross liability for the known claims against it. The Company has not attempted to make an estimate of its probable insurance recoveries for financial statement purposes given the accounting for its estimate of future asbestos-related costs. Substantially all future insurance recoveries have been assigned to the Collateral Trust or Plan Trust. Amounts Recorded in Financial Statements The table below provides an analysis of changes in the Company's asbestos reserves and related receivables from December 31, 2004 to June 30, 2005:
Reimbursement From Balance at Reserve Insurance Balance at (in thousands) 12/31/04 Spending Addition Settlements 6/30/05 ------------------------------------------------------------------------ Reserves Current $ 6,550 $ (5,832) $13,092 -- $ 13,810 Long-Term 2,738 -- -- -- 2,738 Receivables Current (1,509) (7,095) 2,362 $6,091 (151) Long-Term (7,300) -- -- -- (7,300) ------------------------------------------------------------------------ Net Asbestos Liability $ 479 $(12,927) $15,454 $6,091 $ 9,097 ======== ======== ======= ====== ======== Restricted Cash Insurance Proceeds $ 14,530 (6,091) 182 -- $ 8,621
20 7. Product Warranties The Company provides product warranties for specific product lines and accrues for estimated future warranty cost in the period in which the revenue is recognized. The following table sets forth activity in the Company's warranty reserves (in millions) for the: Six Months Ended Six Months Ended June 30, June 30, 2005 2004 ---- ---- Beginning balance $ 2.8 $ 2.7 Accruals 1.7 2.7 Charges (2.0) (2.6) ----- ----- Ending balance $ 2.5 $ 2.8 ===== ===== 8. Liabilities Subject to Compromise As a result of the Company's Chapter 11 filing (see Notes 1 and 6 to the Unaudited Condensed Consolidated Financial Statements), pursuant to SOP 90-7, the Company is required to segregate pre-petition liabilities that are subject to compromise and report them separately on the consolidated balance sheet. Liabilities that may be affected by a plan of reorganization are recorded at the amount of the expected allowed claims, even if they may be settled for lesser amounts. Substantially all of the Company's pre-petition debt is recorded at face value and is classified within liabilities subject to compromise. In addition, the Company's accrued interest expense on its Senior Notes is also recorded in liabilities subject to compromise. Liabilities subject to compromise at June 30, 2005 and December 31, 2004 are as follows: (In thousands) June 30, December 31, 2005 2004 -------------------------------------------------------------------------------- Current Other pre-petition payables and accrued interest $ 18,883 $ 14,225 Non-current Debt (at face value) 100,000 100,000 Pension liability 16,487 16,936 Other post-retirement benefit obligation 8,145 8,303 Other pre-petition liabilities 12,367 12,051 --------- --------- -------------------------------------------------------------------------------- Non-current 136,999 137,290 ----------- -------------------------------------------------------------------------------- Total liabilities subject to compromise $ 155,882 $ 151,515 ========= ========= ================================================================================ Additional pre-petition claims (liabilities subject to compromise) may arise due to the rejection of executory contracts or unexpired leases, or as a result of the allowance of contingent or disputed claims. 21 9. Accrued Liabilities A summary of the significant components of accrued liabilities consists of the following: (In thousands) June 30, December 31, 2005 2004 ---------------------------------------------------------------------------- Accrued warranty, marketing and sales promotion $15,455 $18,487 Employee compensation and related benefits 3,475 4,735 Other 1,808 3,173 ---------------------------------------------------------------------------- Total accrued liabilities $20,738 $26,395 ============================================================================ As a result of the Company's Chapter 11 bankruptcy filing and in accordance with SOP 90-7, certain liabilities are included in liabilities subject to compromise on the balance sheet as of June 30, 2005 (see Note 8). 10. Pension Plans The Company sponsors several non-contributory defined benefit pension plans covering most of the Company's employees. Benefits under the plans are based on years of service and employee compensation. Amounts funded annually by the Company are actuarially determined using the projected unit credit and unit credit methods and are equal to or exceed the minimum required by government regulations. The Company also maintains health and life insurance programs for retirees (reflected in the table below in "Other Benefits"). The following summarizes the components of the net periodic benefit cost for the Pension and Other Benefit Plans for the three months ended June 30, 2005 and 2004:
(In thousands) Three Months Ended Three Months Ended June 30, 2005 June 30, 2004 ------------- ------------- Other Other Pension Benefits Pension Benefits ------- -------- ------- -------- Components of Net Periodic Benefit Cost: Service cost ........................... $ 355 $ 46 $ 323 $ 43 Interest cost .......................... 1,094 130 1,066 121 Expected return on plan assets ......... (881) -- (845) -- Recognized net actuarial loss .......... 385 15 362 12 Amortization of transition obligation .. (18) -- (18) -- Amortization of prior service cost ..... (72) (47) (71) (116) ------- ----- ------- ----- Net periodic benefit cost .................. $ 863 $ 144 $ 817 $ 60 ======= ===== ======= =====
22 The weighted average assumptions used to determine net periodic benefit cost were as follows:
June 30, 2005 June 30, 2004 ------------- ------------- Pension Other Benefits Pension Other Benefits ------- -------------- ------- -------------- Discount rate................................... 6.25% 6.25% 6.25% 6.25% Expected long-term return on plan assets....... 7.00% -- 7.00% -- Rate of compensation increase................... 4.00% -- 4.00% -- 5.50% 5.50%
The following summarizes the components of the net periodic benefit cost for the Pension and Other Benefit Plans for the six months ended June 30, 2005 and 2004:
(In thousands) Six Months Ended Six Months Ended June 30, 2005 June 30, 2004 ------------- ------------- Other Other Pension Benefits Pension Benefits ------- -------- ------- -------- Components of Net Periodic Benefit Cost: Service cost ........................... $ 710 $ 92 $ 647 $ 85 Interest cost .......................... 2,188 260 2,132 242 Expected return on plan assets ......... (1,762) -- (1,690) -- Recognized net actuarial loss .......... 769 30 723 24 Amortization of transition obligation .. (36) (36) -- Amortization of prior service cost ..... (144) (94) (143) (231) ------- ----- ------- ----- Net periodic benefit cost .................. $ 1,725 $ 288 $ 1,633 $ 120 ======= ===== ======= =====
The weighted average assumptions used to determine net periodic benefit cost were as follows:
June 30, 2005 June 30, 2004 ------------- ------------- Pension Other Benefits Pension Other Benefits ------- -------------- ------- -------------- Discount rate................................... 6.25% 6.25% 6.25% 6.25% Expected long-term return on plan assets....... 7.00% -- 7.00% -- Rate of compensation increase................... 4.00% -- 4.00% -- 5.50% 5.50%
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and notes thereto contained in Item 1 of this Quarterly Report on Form 10-Q. 23 Results of Operations The Company's business is cyclical and is affected by the same economic factors that affect the remodeling and housing industries in general, including the availability of credit, consumer confidence, changes in interest rates, market demand and general economic conditions. In addition to external economic factors, the Company's results are sensitive to sales and manufacturing volume, competitors' pricing, consumer preferences for flooring products, raw material costs and the mix of products sold. The manufacturing process is capital intensive and requires substantial investment in facilities and equipment. The cost of operating these facilities generally does not vary in direct proportion to production volume and, consequently, operating results fluctuate disproportionately with changes in sales volume. On December 31, 2003, Congoleum filed a voluntary petition with the United States Bankruptcy Court for the District of New Jersey (Case No. 03-51524) seeking relief under Chapter 11 of the Bankruptcy Code as a means to resolve claims asserted against it related to the use of asbestos in its products decades ago. During 2003, Congoleum obtained the requisite votes of asbestos personal injury claimants necessary to seek approval of a proposed, pre-packaged Chapter 11 plan of reorganization. In January 2004, the Company filed its proposed plan of reorganization and disclosure statement with the Bankruptcy Court. On November 8, 2004, Congoleum filed a modified plan of reorganization and related documents with the Bankruptcy Court reflecting the result of further negotiations with representatives of the Asbestos Claimants' Committee, the Future Claimants' Representative and other asbestos claimant representatives. The Bankruptcy Court approved the disclosure statement and plan voting procedures on December 9, 2004 and Congoleum obtained the requisite votes of asbestos personal injury claimants necessary to seek approval of the modified plan. On April 22, 2005, Congoleum announced that it had reached an agreement in principle with representatives of the Asbestos Claimants' Committee and the Future Claimants' Representative to make certain modifications to its proposed plan of reorganization and related documents governing the settlement and payment of asbestos related claims against Congoleum. Under the agreed-upon modifications, asbestos claimants with claims settled under Congoleum's pre-petition settlement agreements would agree to forbear from exercising the security interest they were granted and share on a pari passu basis with all other present and future asbestos claimants in insurance proceeds and other assets of the trust to be formed upon confirmation of the plan (the "Plan Trust") to pay asbestos claims against Congoleum. On July 22, 2005, Congoleum filed an amended plan of reorganization and related documents with the Bankruptcy Court, which reflected the result of these negotiations as well as certain other technical modifications. The Bankruptcy Court approved the disclosure statement and voting procedures on July 28, 2005 and Congoleum will commence solicitation of acceptances of the plan by the end of August 2005. There can be no assurance that the Company will receive the acceptances necessary for confirmation of the proposed plan of reorganization, that the proposed amended plan will not be modified further, that the amended plan will receive necessary court approvals from the Bankruptcy Court or the federal District Court, or that such approvals will be received in a timely fashion, that the amended plan will be confirmed, or that the amended plan, if confirmed, will become effective. Congoleum is presently involved in litigation with certain insurance carriers related to disputed insurance coverage for asbestos related liabilities, and certain insurance carriers filed various objections to Congoleum's previously proposed plans of reorganization and related matters. Although Congoleum has considered the views of its insurance carriers when preparing its amended plan, it is possible that a plan which will satisfy the requirements of Section 524(g) of the Bankruptcy Code with respect to asbestos creditors will not resolve all objections raised by some or all of the insurance carriers. Certain other parties have also filed various objections to Congoleum's previously proposed plans of reorganization and may file objections to the proposed amended plan. 24 The proposed amended plan of reorganization, if confirmed, would leave non-asbestos creditors unimpaired and would resolve all pending and future asbestos claims against the Company. The proposed amended plan of reorganization would provide, among other things, for an assignment of certain rights in, and proceeds of, Congoleum's applicable insurance to the Plan Trust that would fund the settlement of all pending and future asbestos claims and protect the Company from future asbestos-related claims and litigation by channeling all asbestos claims to the Plan Trust pursuant to the provisions of Section 524(g) of the Bankruptcy Code. Other creditors would be unimpaired under the plan. The Company anticipates that it will take until the first quarter of 2006, at the earliest, to obtain confirmation of its proposed amended plan of reorganization. In anticipation of Congoleum's commencement of the Chapter 11 cases, Congoleum entered into a settlement agreement with various asbestos personal injury claimants (the "Claimant Agreement"), which provides for an aggregate settlement value of at least $491 million. As contemplated by the Claimant Agreement, Congoleum also entered into agreements establishing a pre-petition trust (the "Collateral Trust") to distribute funds in accordance with the terms of the Claimant Agreement and granting the Collateral Trust a security interest in its rights under applicable insurance coverage and payments from insurers for asbestos claims. Under Congoleum's proposed amended plan of reorganization, after the establishment of the Plan Trust, the assets in the Collateral Trust would be transferred to the Plan Trust and any claims subject to the Claimant Agreement would be channeled to the Plan Trust and paid in accordance with the terms of the proposed amended plan. As a result of tabulating ballots on its fourth amended plan, the Company is also aware of claims by claimants whose claims were not determined under the Claimant Agreement but who have submitted claims with a value of $512 million based on the settlement values applicable in the current amended plan. Based on its proposed amended plan of reorganization, the Company has made provisions in its financial statements for the minimum amount of the range of estimates for its contribution to the Plans Trust and costs to effect the proposed plan to settle asbestos liabilities through the Plan Trust. The Company recorded charges aggregating $26 million in prior years and a further $15.5 million in the second quarter of 2005, to provide for the estimated minimum costs of completing its reorganization given the revised timeline for anticipated confirmation. Actual amounts that will be contributed to the Plan Trust and costs for pursuing and implementing the plan of reorganization could be materially higher, and the Company may record significant additional charges should the minimum estimated cost increase. For more information regarding the Company's asbestos liability and plan for resolving that liability, please refer to Notes 1 and 17 of the Notes to Consolidated Financial Statements contained in Item 8 of the Company's Annual Report on Form 10-K for the year ended December 31, 2004. In addition, please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors That May Affect Future Results - The Company has significant asbestos liability and funding exposure, and its proposed amended plan of reorganization may not be confirmed" for a discussion of certain factors that could cause actual results to differ from the Company's goals for resolving its asbestos liability through the proposed plan of reorganization. 25 Three and six months ended June 30, 2005 as compared to three and six months ended June 30, 2004. Net sales for the quarter ended June 30, 2005 were $58.1 million as compared to $63.0 million for the quarter ended June 30, 2004, a decrease of $4.9 million or 7.7%. The decrease resulted primarily from the impact of a $4.4 million reduction by a major distributor of its inventory of the Company's products as compared to a $3.8 million increase in the second quarter of 2004. Additional factors contributing to the decline were lower sales of do-it-yourself tile due to the loss of a major home center customer (down 67%), partially offset by higher sales in the manufactured housing category (up 0.9%) and the impact of selling price increases instituted in late 2004 and 2005 (10%). Net sales for the six months ended June 30, 2005 totaled $115.7 million as compared to $115.0 million for the same period in the prior year, an increase of $0.7 million or 0.7%. The increase reflects higher sales to the manufactured housing category (up 3.7%) and the impact of selling price increases instituted in late 2004 and 2005 (up 10%) substantially offset by a $3.5 million inventory decrease by a major customer in the first half of 2005 versus a $1.7 million increase in the first half of 2004, lower sales of do-it-yourself tile to the mass merchandiser category (down 59.4%) and lower sales of residential products (down 5.7%). Gross profit for the quarter ended June 30, 2005 totaled $13.8 million, or 23.7% of net sales, compared to $16.9 million, or 26.8% of net sales, for the same period last year. The major factor leading to the reduction in gross margin percent was the sharp rise in raw material costs experienced during the fourth quarter of 2004 and continuing into the second quarter of 2005, which reduced margins by 11.5 percentage points of net sales, coupled with a less profitable sales mix (1.1 percentage points of net sales). This was partially mitigated by the 10.0 percentage point increase in selling prices, as well as improved plant efficiencies and cost reduction programs which benefited gross margins by an additional 0.1 percentage point. Gross profit for the six months ended June 30, 2005 was $27.4 million or 23.7% of net sales, compared to $30.4 million, or 26.5% of net sales for the same period in the prior year. The lower gross profit dollars and margin percent reflect the same factors impacting the second quarter 2005. Selling, general and administrative expenses were $ 26.1 million for the quarter ended June 30, 2005 as compared to $13.0 million for the quarter ended June 30, 2004, an increase of $13.1 million. The increase in expenses reflects a charge of $15.5 million taken during the second quarter of 2005 in connection with the revised time and cost estimate for completion of the Company's Chapter 11 reorganization. Operating expenses excluding this charge declined by $2.3 million reflecting lower incentive related expenses of $1.0 million and a reduction of $0.9 million in merchandising and sales support related costs. As a percent of net sales, selling, general and administrative costs were 44.9% (18.3% before the asbestos related charge) for the quarter ended June 30, 2005 compared to 20.7% for the same period last year. Selling, general and administrative expenses for the six months ended June 30, 2005 totaled $37.9 or 32.7% of sales as compared to $25.0 million or 21.7% for the same period last year, with the increase due to the asbestos related charge. The loss from operations was $12.4 million for the quarter ended June 30, 2005 compared to income of $3.9 million for the quarter ended June 30, 2004. The reduction in operating income was primarily due to the asbestos related charge, together with lower sales and related gross margin dollars. For the six months 26 ended June 30, 2005 loss from operations totaled $10.4 million as compared to income from operations of $5.4 million for the same period in the prior year due to the asbestos related charge and the impact of higher raw material costs. Liquidity and Capital Resources The consolidated financial statements of the Company have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Accordingly, the unaudited condensed consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern. As described more fully in the Notes to the Unaudited Condensed Consolidated Financial Statements contained in Item 1 of this Quarterly Report on Form 10-Q, there is substantial doubt about the Company's ability to continue as a going concern unless it obtains relief from its substantial asbestos liabilities through a successful reorganization under Chapter 11 of the Bankruptcy Code. The Company is a defendant in a large number of asbestos-related lawsuits and on December 31, 2003 filed a pre-packaged plan of reorganization under Chapter 11 of the United States Bankruptcy Code as part of its strategy to resolve this liability. See Notes 1 and 6 of the Notes to the Unaudited Condensed Consolidated Financial Statements, which are contained in Item 1 of this Quarterly Report on Form 10-Q. These matters will have a material adverse impact on liquidity and capital resources. During the second quarter of 2005, the Company paid $8.5 million in fees (bringing the total year to date spending to $12.9 million) and expenses related to implementation of its planned reorganization under Chapter 11 and litigation with certain insurance companies. Pursuant to terms of the Claimant Agreement and related documents, Congoleum is entitled to reimbursement for certain expenses it incurs for claims processing costs and expenses in connection with pursuit of insurance coverage. At June 30, 2005, Congoleum had $7.5 million recorded as a receivable for such reimbursements. The amount and timing of reimbursements that will be received will depend on when the trust receives funds from insurance settlements or other sources and whether the insurance proceeds exceed $375 million, which is the required threshold for reimbursement of the first $7.3 million spent by Congoleum. Congoleum believes this threshold will eventually be met, although there can be no assurances to that effect. Congoleum expects to spend a further $16.5 million at a minimum in fees, expenses, and trust contributions in connection with obtaining confirmation of its plan, which amount is recorded in its reserve for asbestos-related liabilities (in addition to the $8.6 million insurance settlement being held as restricted cash). It also expects to spend a further $7.5 million at a minimum in connection with pursuit of insurance coverage, for which it expects to be reimbursed as discussed above. The Company currently holds $3.7 million in restricted cash that can be used to offset future coverage cost spending, subject to approval by the Bankruptcy Court. Required expenditures could be materially higher than these estimates. As part of the Company's proposed amended plan of reorganization, Congoleum expects that it will also issue a promissory note to the Plan Trust. Under the terms of the proposed amended plan, the original principal amount of the Company Note will be approximately $2.7 million and will be subject to increase as of the last trading day of the 90 consecutive trading day period commencing on the first anniversary of the effective date of the Company's plan of reorganization in an amount approximately equal to the excess, if any, of the amount by which 51% of the Company's market capitalization as of that date 27 exceeds $2.7 million. This adjustment amount could result in the principal amount of the note increasing materially. For example, if the adjustment amount were calculated for the period ended June 30, 2005, the resulting adjustment amount would be $16.6 million. Although the scheduled repayment date for this note does not occur until its tenth anniversary of issuance, this debt may affect Congoleum's ability to obtain other sources of financing or refinance existing obligations. In addition, it is expected that the terms of the Note will require the Company to make interest payments prior to such note's maturity date. The proposed amended plan and Plan Trust agreement, as modified, would obligate Congoleum, together with the Plan Trust, to indemnify certain asbestos claimant representatives for all costs and liabilities (including attorneys' fees) relating to the negotiation of the modification of the plan and the collateral trust. Congoleum's indemnification obligations in this regard are capped under the modified plan and Plan Trust agreement at $3.0 million. In addition, the plan would further obligate Congoleum to fund any actual costs in excess of $2.0 million incurred by such asbestos claimant representatives in connection with the confirmation of the plan, subject to Bankruptcy Court approval of those costs. Unrestricted cash and cash equivalents, including short-term investments at June 30, 2005, were $21.4 million, a decrease of $8.3 million from December 31, 2004. Net cash used by operations during the first six months of 2005 was $5.5 million, as compared to $19.9 million of cash provided by operations in the first half of 2004. The increase in cash used by operations in the first six months of 2005 versus the first six months of 2004 was primarily due to higher inventories, higher asbestos related payments and higher payments of accrued liabilities. Under the terms of its revolving credit agreement, payments on the Company's accounts receivable are deposited in an account assigned by the Company to its lender and the funds in that account are used by the lender to pay down any loan balance. Funds deposited in this account but not yet applied to the loan balance, which amounted to $2.5 million and $1.2 million at June 30, 2005 and December 31, 2004, respectively, are recorded as restricted cash. Additionally, $8.6 million of a $14.5 million settlement received in August 2004 from an insurance carrier, which is subject to the lien of the Collateral Trust, is included as restricted cash at June 30, 2005. The Company expects to contribute these funds, less any amounts withheld pursuant to reimbursement arrangements, to the Plan Trust formed upon confirmation of its proposed amended plan of reorganization. Working capital was $23.5 million at June 30, 2005, down from $35.3 million at December 31, 2004. The ratio of current assets to current liabilities at June 30, 2005 was 1.3 versus 1.4 at December 31, 2004. Capital expenditures for the six months ended June 30, 2005 totaled $2.2 million. The Company is currently planning capital expenditures of approximately $6.0 million in 2005 and between $6 million and $7 million in 2006, primarily for maintenance and improvement of plants and equipment, which it expects to fund with cash from operations and credit facilities. In January 2004, the Bankruptcy Court authorized entry of a final order approving Congoleum's debtor-in-possession financing, which replaced its pre-petition credit facility on substantially similar terms. The debtor-in-possession financing agreement (as amended and approved by the Bankruptcy Court to date) provides a revolving credit facility expiring on December 31, 2005 with borrowings up to $30.0 million. Interest is based on 0.75% above the prime rate. This financing agreement contains certain covenants, which include the maintenance of minimum earnings before interest, taxes, depreciation and amortization ("EBITDA"). It also includes restrictions on the 28 incurrence of additional debt and limitations on capital expenditures. The covenants and conditions under this financing agreement must be met in order for the Company to borrow from the facility. The Company was in compliance with these covenants at June 30, 2005. Borrowings under this facility are collateralized by inventory and receivables. At June 30, 2005, based on the level of receivables and inventory, $27.4 million was available under the facility, of which $6.0 million was utilized for outstanding letters of credit and $10.1 million was utilized by the revolving loan. The Company anticipates that its debtor-in-possession financing facility will be replaced with a revolving credit facility on substantially similar terms upon confirmation of its proposed amended plan of reorganization. While the Company expects the facilities discussed above will provide it with sufficient liquidity, there can be no assurances that it will continue to be in compliance with the required covenants, that the Company will be able to obtain a similar or sufficient facility upon exit from bankruptcy, or that the debtor-in-possession facility (as extended) will be renewed prior to that facility's expiration. The Company's principal sources of capital are net cash provided by operating activities and borrowings under its financing agreement. Although the Company did not generate cash from operations in the first six months of 2005, the Company anticipates that it will generate cash from operations during the balance of 2005. The Company believes that net cash provided by operating activities and borrowings under its financing agreement will be adequate to fund working capital requirements, debt service payments, and planned capital expenditures for the foreseeable future, plus its current estimates for costs to settle and resolve its asbestos liabilities through its proposed amended plan of reorganization. The Company's inability to obtain confirmation of its proposed amended plan in a timely manner would have a material adverse effect on the Company's ability to fund its operating, investing and financing requirements. The Company also anticipates it will be able to obtain exit financing upon confirmation of its proposed amended plan although there can be no assurance that such financing will be obtained. Such financing will be required to replace its debtor-in-possession credit facility and permit the Company to pay accrued interest on its Senior Notes and other obligations needed to be satisfied in connection with the confirmation of the proposed amended plan of reorganization. If the Company's cash flow from operations is materially less than anticipated, and/or if the costs in connection with seeking confirmation of the proposed amended plan of reorganization or in connection with the insurance coverage litigation are materially more than anticipated, or if sufficient funds from insurance proceeds are not available at confirmation to reimburse coverage litigation costs as expected, the contemplated exit financing, when combined with net cash provided from operating activities, may not provide sufficient funds and the Company may not be able to obtain confirmation of and go effective with the proposed amended plan of reorganization. In addition to the provision for asbestos litigation discussed previously, the Company has also recorded what it believes are adequate provisions for environmental remediation and product-related liabilities (other than asbestos-related claims), including provisions for testing for potential remediation of conditions at its own facilities. The Company is subject to federal, state and local environmental laws and regulations and certain legal and administrative claims are pending or have been asserted against the Company. Among these claims, the Company is a named party in several actions associated with waste disposal sites (more fully discussed in Note 5 to the Unaudited Condensed Consolidated Financial Statements). 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 29 future cost and timing of payments are indeterminable due to such unknown factors as the magnitude of cleanup costs, the timing and extent of the remedial actions that may be required, the determination of the Company's liability in proportion to other potentially responsible parties, and the extent to which costs may be recoverable from insurance. The Company has recorded provisions in its financial statements for the estimated probable loss associated with all known general and environmental contingencies. While the Company believes its estimate of the future amount of these liabilities is reasonable, and that they will be paid over a period of five to ten years, the timing and amount of such payments may differ significantly from the Company's assumptions. Although the effect of future government regulation could have a significant effect on the Company's costs, the Company is not aware of any pending legislation which would reasonably have such an effect. There can be no assurances that the costs of any future government regulations could be passed along to its customers. Estimated insurance recoveries related to these liabilities are reflected in other non-current assets. The outcome of these environmental matters could result in significant expenses incurred by or judgments assessed against the Company. Risk Factors That May Affect Future Results Some of the information presented in or incorporated by reference in this report constitutes "forward-looking statements," within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks, uncertainties and assumptions. These statements can be identified by the use of the words such as "anticipate," "believe," "estimate," "expect," "intend," "plan," "project" and other words of similar meaning. In particular, these include statements relating to intentions, beliefs or current expectations concerning, among other things, future performance, results of operations, the outcome of contingencies such as bankruptcy and other legal proceedings, and financial conditions. These statements do not relate strictly to historical or current facts. These forward-looking statements are based on the Company's expectations, as of the date of this report, of future events, and the Company undertakes no obligation to update any of these forward-looking statements. Although the Company believes that these expectations are based on reasonable assumptions, within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from its expectations. Readers are cautioned not to place undue reliance on any forward-looking statements. Any or all of these statements may turn out to be incorrect. By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. Any forward-looking statements made in this report speak only as of the date of such statement. It is not possible to predict or identify all factors that could potentially cause actual results to differ materially from expected and historical results. Factors that could cause or contribute to the Company's actual results differing from its expectations include those factors discussed below and in the Company's other filings with the Securities and Exchange Commission. The Company has significant asbestos liability and funding exposure, and its proposed amended plan of reorganization may not be confirmed. As more fully set forth in Notes 1 and 6 of the Notes to Unaudited Condensed Consolidated Financial Statements, which are included in this Quarterly Report on Form 10-Q, the Company has significant liability and funding exposure for asbestos claims. The Company has entered into settlement agreements 30 with various asbestos claimants totaling $491 million and is aware of additional unsettled claims with a proposed settlement value of $512 million. Satisfaction of this obligation pursuant to the terms of the proposed amended plan of reorganization is dependent on a determination by the Bankruptcy Court that the plan has satisfied certain criteria under the Bankruptcy Code, among other things. There can be no assurance that the Company will be successful in obtaining confirmation of its proposed amended plan of reorganization in a timely manner or at all, and any alternative plan of reorganization pursued by the Company or confirmed by the Bankruptcy Court and the federal District Court could vary significantly from the description set forth in this Quarterly Report on Form 10-Q. Furthermore, the estimated costs and contributions to effect the contemplated proposed plan of reorganization or an alternative plan could be significantly greater than currently estimated. Any plan of reorganization pursued by the Company will be subject to numerous conditions, approvals and other requirements, including Bankruptcy Court and federal District Court approvals, and there can be no assurance that such conditions, approvals and other requirements will be satisfied or obtained. Confirmation of Congoleum's plan of reorganization will depend on the Company obtaining exit financing to provide it with sufficient liquidity to pay accrued interest and other obligations upon the plan going effective. If the Company's cash flow from operations is materially less than anticipated, and/or if the costs in connection with seeking confirmation of the proposed amended plan of reorganization or in connection with the insurance coverage litigation are materially more than anticipated, or if sufficient funds from insurance proceeds are not available at confirmation to reimburse coverage litigation costs as expected, the Company may be unable to obtain sufficient exit financing, when combined with net cash provided from operating activities, to provide sufficient funds and the Company may not be able to obtain confirmation of and go effective with the proposed amended plan of reorganization. Some additional factors that could cause actual results to differ from the Company's goals for resolving its asbestos liability through the amended plan of reorganization bankruptcy filing include: (i) the future cost and timing of estimated asbestos liabilities and payments, (ii) the availability of insurance coverage and reimbursement from insurance companies that underwrote the applicable insurance policies for the Company for asbestos-related claims, (iii) the costs relating to the execution and implementation of any plan of reorganization pursued by the Company, (iv) timely reaching agreement with other creditors, or classes of creditors, that exist or may emerge, (v) satisfaction of the conditions and obligations under the Company's outstanding debt instruments, (vi) the response from time to time of the Company's and ABI's lenders, customers, suppliers and other constituencies to the ongoing process arising from the Company's strategy to settle its asbestos liability, (vii) the Company's ability to maintain debtor-in-possession financing sufficient to provide it with funding that may be needed during the pendency of its Chapter 11 case and to obtain exit financing sufficient to provide it with funding that may be needed for its operations after emerging from the bankruptcy process, in each case, on reasonable terms, (viii) timely obtaining sufficient creditor and court approval of any reorganization plan pursued by it, (ix) costs of, developments in and the outcome of insurance coverage litigation pending in New Jersey State Court involving Congoleum and certain insurers, (x) the extent to which the Company is able to obtain reimbursement for costs of the coverage litigation, and (xi) 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 amended plan of reorganization, such failure would have a material adverse effect upon its business, results of operations and financial condition. 31 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 the plan of reorganization it has proposed or any plan that may be proposed in the future. To date, the Company has expended significant amounts pursuant to resolving its asbestos liability relating to its proposed amended Chapter 11 plan of reorganization. To the extent any federal legislation is enacted, which does not credit the Company for amounts paid by the Company pursuant to its plan of reorganization or requires the Company to pay significant amounts to any national trust or otherwise, such legislation could have a material adverse effect on the Company's business, results of operations and financial condition. As a result of the Company's significant liability and funding exposure for asbestos claims, there can be no assurance that if it were to incur any unforecasted or unexpected liability or disruption to its business or operations it would be able to withstand that liability or disruption and continue as an operating company. For further information regarding the Company's asbestos liability, insurance coverage and strategy to resolve its asbestos liability, please see Notes 1 and 6 of Notes to Unaudited Condensed Consolidated Financial Statements, which are included in this Quarterly Report on Form 10-Q. The Company may incur substantial liability for environmental, product and general liability claims in addition to asbestos-related claims, and its insurance coverage and its likely recoverable insurance proceeds may be substantially less than the liability incurred by the Company for these claims. Environmental Liabilities. Due to the nature of the Company's business and certain of the substances which are or have been used, produced or discharged by the Company, the Company's operations are subject to extensive federal, state and local laws and regulations relating to the generation, storage, disposal, handling, emission, transportation and discharge into the environment of hazardous substances. The Company has historically expended substantial amounts for compliance with existing environmental laws or regulations, including environmental remediation costs at both third-party sites and Company-owned sites. The Company will continue to be required to expend amounts in the future for costs related to prior activities at its facilities and third party sites, and for ongoing costs to comply with existing environmental laws; such amounts may be substantial. There is no certainty that these amounts will not have a material adverse effect on its business, results of operations and financial condition because, as a result of environmental requirements becoming increasingly strict, the Company is unable to determine the ultimate cost of compliance with environmental laws and enforcement policies. Moreover, in addition to potentially having to pay substantial amounts for compliance, future environmental laws or regulations may require or cause the Company to modify or curtail its operations, which could have a material adverse effect on the Company's business, results of operations and financial condition. 32 Product and General Liabilities. In the ordinary course of its business, the Company becomes involved in lawsuits, administrative proceedings, product liability claims (in addition to asbestos-related claims) and other matters. In some of these proceedings, plaintiffs may seek to recover large and sometimes unspecified amounts and the matters may remain unresolved for several years. These matters could have a material adverse effect on the Company's business, results of operations and financial condition if the Company is unable to successfully defend against or settle these matters, its insurance coverage is insufficient to satisfy unfavorable judgments or settlements relating to these matters, or the Company is unable to collect insurance proceeds relating to these matters. The Company is dependent upon a continuous supply of raw materials from third party suppliers and would be harmed if there were a significant, prolonged disruption in supply or increase in its raw material costs. The Company's business is dependent upon a continuous supply of raw materials from third party suppliers. The principal raw materials used by the Company in its manufacture of sheet and tile flooring are vinyl resins, plasticizers, latex, limestone, stabilizers, cellulose paper fibers, urethane and transfer print 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. Raw material prices in 2004 and early 2005 increased significantly and recent industry supply conditions for specialty resins used in flooring have been very tight, despite significant price increases, in part due to an explosion at a large resin plant in 2004 that destroyed the plant. Although the Company has been able to obtain sufficient supplies of specialty resin, there can be no assurances that it may not have difficulty in the future, particularly if global supply conditions deteriorate. The Company believes that suitable alternative suppliers are available for substantially all of its raw material requirements, although quantities of certain materials available from alternative suppliers may be in limited supply and production trials may be required to qualify new materials for use. 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 continually seeks to develop new sources which will provide continuity of supply for its raw material requirements. However, there is no certainty that the Company's maintenance of its raw material inventory or its ongoing efforts to develop new sources of supply would be successful in avoiding a material adverse effect on its business, results of operations and financial condition if it were to realize an extended interruption in the supply of its raw materials. In addition, the Company could incur significant increases in the costs of its raw materials. Although the Company generally attempts to pass on increases in the costs of its raw materials to its customers, the Company's ability to do so is, to a large extent, dependent upon the rate and magnitude of any increase, competitive pressures and market conditions for its products. There have been in the past, and may be in the future, periods of time during which increases in these costs cannot be recovered. During those periods of time, there could be a material adverse effect on the Company's business, results of operations and financial condition. 33 The Company operates in a highly competitive flooring industry and some of its competitors have greater resources and broader distribution channels than the Company. The market for the Company's products is highly competitive. The Company encounters competition from three other manufacturers in North America and, to a lesser extent, foreign manufacturers. Some of the Company's competitors have greater financial and other resources and access to capital than the Company. Furthermore, like the Company, one of the Company's major competitors has sought protection under Chapter 11 of the Bankruptcy Code. When such competitor emerges from bankruptcy as a continuing operating company it may have shed much of its pre-filing liabilities and have a competitive cost advantage over the Company as a result of having shed those liabilities. In addition, in order to maintain its competitive position, the Company may need to make substantial investments in its business, including its product development, manufacturing facilities, distribution network and sales and marketing activities. Competitive pressures may also result in decreased demand for the Company's products and in the loss of the Company's market share for its products. Moreover, due to the competitive nature of the Company's industry, the Company may be commercially restricted from raising or even maintaining the sales prices of its products, which could result in the Company incurring significant operating losses if its expenses were to increase or otherwise represent an increased percentage of the Company's sales. The Company's business is subject to general economic conditions and conditions specific to the remodeling and housing industries. The Company is subject to the effects of general economic conditions. A sustained general economic slowdown could have serious negative consequences for the Company's business, results of operations and financial condition. Moreover, the Company's business is cyclical and is affected by the economic factors that affect the remodeling and housing industries in general and the manufactured housing industry specifically, including the availability of credit, consumer confidence, changes in interest rates, market demand and general economic conditions. The Company could realize shipment delays, depletion of inventory and increased production costs resulting from unexpected disruptions of operations at any of the Company's facilities. 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. 34 The Company offers limited warranties on its products which could result in the Company incurring significant costs as a result of warranty claims. The Company offers a limited warranty on all of its products against manufacturing defects. In addition, as a part of its efforts to differentiate mid- and high-end products through color, design and other attributes, the Company offers enhanced warranties with respect to wear, moisture discoloration and other performance characteristics, which generally increase with the price of such products. If the Company were to incur a significant number of warranty claims, the resulting warranty costs could be substantial. The Company is heavily dependent upon its distributors to sell the Company's products and the loss of a major distributor of the Company could have a material adverse effect on the Company's business, results of operations and financial condition. The Company currently sells its products through approximately 17 distributors providing approximately 76 distribution points in the United States and Canada, as well as directly to a limited number of mass market retailers. The Company considers its distribution network very important to maintaining its competitive position. Although the Company has more than one distributor in some of its distribution territories and actively manages its credit exposure to its distributors, the loss of a major distributor could have a materially adverse impact on the Company's business, results of operations and financial condition. The Company derives a significant percentage of its sales from two of its distributors, LaSalle-Bristol Corporation and Mohawk Industries, Inc. LaSalle-Bristol Corporation serves as the Company's distributor in the manufactured housing market, and Mohawk Industries, Inc. serves as a retail market distributor of the Company. These two distributors accounted for 70% of the Company's net sales for the year ended December 31, 2004 and 65% of the Company's net sales for the year ended December 31, 2003. Stockholder votes are controlled by ABI; the Company's interests may not be the same as ABI's interests. ABI owns a majority (approximately 55% as of December 31, 2004) of the outstanding shares of the Company's common stock, representing a 70.1% voting interest. As a result, ABI can elect all of the Company's directors and can control the vote on all matters, including determinations such as: approval of mergers or other business combinations, sales of all or substantially all of the Company's assets, any matters submitted to a vote of the Company's stockholders, issuance of any additional common stock or other equity securities, incurrence of debt other than in the ordinary course of business, the selection and tenure of the Company's Chief Executive Officer, payment of dividends with respect to common stock or other equity securities and other matters that might be favorable to ABI. ABI's ability to prevent an unsolicited bid for us or any other change in control could have an adverse effect on the market price for the Company's common stock. In addition, certain officers of Congoleum are officers of ABI and members of the family group that owns a controlling interest in ABI. Possible future sales of shares by ABI could adversely affect the market for our stock. ABI may sell shares of the Company's common stock in compliance with the federal securities laws. By virtue of ABI's current control of Congoleum, ABI could sell large amounts of shares of the Company's common stock by causing the 35 Company to file a registration statement that would allow them to sell shares more easily. In addition, ABI could sell shares of the Company's common stock without registration. Although the Company can make no prediction as to the effect, if any, that such sales would have on the market price of the Company's common stock, sales of substantial amounts of the Company's common stock, or the perception that such sales could occur, could adversely affect the market price of the Company's common stock. If ABI sells or transfers shares of the Company's common stock as a block, another person or entity could become the Company's controlling stockholder. The Company depends on key executives to run its business, and the loss of any of these executives would likely harm the Company's business. The Company depends on key executives to run its business. The Company's future success will depend largely upon the continued service of these key executives, all whom have no employee contract with the Company, and may terminate their employment at any time without notice. Although certain key executives of the Company are, directly or indirectly, large shareholders of the Company, and thus are less likely to terminate their employment, the loss of any key executive, or the failure by the key executive to perform in his current position, could have a material adverse effect on the Company's business, results of operations or financial condition. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to changes in prevailing market interest rates affecting the return on its investments but does not consider this risk exposure to be material to its financial condition or results of operations. The Company invests primarily in highly liquid debt instruments with strong credit ratings and short-term (less than one year) maturities. The carrying amount of these investments approximates fair value due to the short-term maturities. Over 90% of the Company's outstanding long-term debt as of December 31, 2004 consisted of indebtedness with a fixed rate of interest which is not subject to change based upon changes in prevailing market interest rates. Under its current policies, the Company does not use derivative financial instruments, derivative commodity instruments or other financial instruments to manage its exposure to changes in interest rates, foreign currency exchange rates, commodity prices or equity prices and does not hold any instruments for trading purposes. Item 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures. The Company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this quarterly report (the "Evaluation Date"). Based on this evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company required to be included in the Company's reports filed or submitted under the Exchange Act. 36 (b) Changes in Internal Control Over Financial Reporting. There have not been any changes in the Company's internal control over financial reporting during the last quarter covered by this Quarterly Report that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. OTHER INFORMATION Item 1. Legal Proceedings: The information contained in Note 5 "Environmental and Other Liabilities" and Note 6 "Asbestos Liabilities" of the Notes to Unaudited Condensed Consolidated Financial Statements is incorporated herein by reference. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds: None Item 3. Defaults Upon Senior Securities: The commencement of the Chapter 11 proceedings constituted an event of default under the indenture governing the Company's 8 5/8% Senior Notes. In addition, due to the Chapter 11 proceedings, the Company was precluded from making the interest payments due February 1, 2004, August 1, 2004 and February 1, 2005 on the Senior Notes. The amount of accrued interest that was not paid on the Senior Notes on those dates is approximately $13.0 million. As of June 30, 2005, the principal amount of the Senior Notes is approximately $100 million. These amounts, plus $1,022,000 of accrued interest on the interest due but not paid on February 1, 2004, August 1, 2004 and February 1, 2005 are included in "Liabilities Subject to Compromise." Item 4. Submission of Matters to a Vote of Security Holders: None Item 5. Other Information: None 37 Item 6. Exhibits: (a) Exhibits Exhibit Number Exhibits ------ -------- 3.1 Amended Certificate of Incorporation of the Company 3.2 Amended and Restated Bylaws of the Company 10.1 Settlement Agreement and Release by and between Congoleum Corporation and Liberty Mutual Insurance Company 10.2 Settlement Agreement and Release by, between and among Congoleum Corporation and certain AIG Member Companies 10.3 Confidential Settlement Agreement and Release among Congoleum Corporation, The Plan Trust and Certain Underwriters at Lloyd's, London 10.4 Amendment to the Confidential Settlement Agreement and Release among Congoleum Corporation, The Plan Trust and Certain Underwriters at Lloyd's, London, dated June 22, 2005 31.1 Rule 13a-14(a) Certification of Chief Executive Officer 31.2 Rule 13a-14(a) Certification of Chief Financial Officer 32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 38 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: August 11, 2005 By: /s/ Howard N. Feist III ---------------------------- (Signature) Howard N. Feist III Chief Financial Officer (Duly Authorized Officer and Principal Financial & Accounting Officer) 39 Exhibit Index Exhibit Number Exhibits ------ -------- 3.1 Amended Certificate of Incorporation of the Company(1) 3.2 Amended and Restated Bylaws of the Company(1) 10.1 Settlement Agreement and Release by and between Congoleum Corporation and Liberty Mutual Insurance Company 10.2 Settlement Agreement and Release by, between and among Congoleum Corporation and certain AIG Member Companies 10.3 Confidential Settlement Agreement and Release among Congoleum Corporation, The Plan Trust and Certain Underwriters at Lloyd's, London 10.4 Amendment to the Confidential Settlement Agreement and Release among Congoleum Corporation, The Plan Trust and Certain Underwriters at Lloyd's, London, dated June 22, 2005 31.1 Rule 13a-14(a) Certification of Chief Executive Officer 31.2 Rule 13a-14(a) Certification of Chief Financial Officer 32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of the 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 exhibit bearing the same description filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1996. 40