================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
[ ] 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 1-9250
Conseco, Inc.
(Debtor-In-Possession as of December 17, 2002)
Indiana No. 35-1468632
---------------------- -------------------------------
State of Incorporation IRS Employer Identification No.
11825 N. Pennsylvania Street
Carmel, Indiana 46032 (317) 817-6100
- -------------------------------------- --------------
Address of principal executive offices Telephone
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 [ X ] No [ ]
Shares of common stock outstanding as of May 12, 2003: 346,007,133
================================================================================
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
ASSETS
March 31, December 31,
2003 2002
---- ----
(unaudited)
Investments:
Actively managed fixed maturities at fair value (amortized cost: 2003 - $18,837.1;
2002 - $18,989.8).......................................................................... $19,457.4 $19,417.4
Equity securities at fair value (cost: 2003 - $155.2; 2002 - $161.4)......................... 154.1 156.0
Mortgage loans............................................................................... 1,273.6 1,308.3
Policy loans................................................................................. 528.2 536.2
Venture capital investment in AT&T Wireless Services, Inc. at fair value (cost: 2003 - $14.2;
2002- $14.2).............................................................................. 27.5 25.0
Other invested assets ....................................................................... 341.2 340.8
--------- ---------
Total investments........................................................................ 21,782.0 21,783.7
Cash and cash equivalents:
Held by the parent company................................................................... 34.3 41.9
Held by subsidiaries......................................................................... 1,529.7 1,227.0
Accrued investment income....................................................................... 395.4 389.8
Cost of policies purchased...................................................................... 1,114.4 1,170.0
Cost of policies produced....................................................................... 1,962.2 2,014.4
Reinsurance receivables......................................................................... 899.5 934.2
Income tax assets............................................................................... 64.4 101.5
Goodwill........................................................................................ 100.0 100.0
Assets held in separate accounts and investment trust .......................................... 453.6 447.0
Assets of discontinued operations............................................................... - 17,624.3
Other assets.................................................................................... 712.9 675.2
--------- ---------
Total assets............................................................................. $29,048.4 $46,509.0
========= =========
(continued on next page)
The accompanying notes are an integral part
of the consolidated financial statements.
2
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED BALANCE SHEET, continued
(Dollars in millions)
LIABILITIES AND SHAREHOLDERS' DEFICIT
March 31, December 31,
2003 2002
---- ----
(unaudited)
Liabilities:
Liabilities for insurance and asset accumulation products:
Interest-sensitive products.............................................................. $13,127.0 $13,469.5
Traditional products..................................................................... 8,048.5 7,971.4
Claims payable and other policyholder funds.............................................. 917.9 909.2
Liabilities related to separate accounts and investment trust............................ 453.6 447.0
Other liabilities.......................................................................... 882.9 673.5
Income tax liability....................................................................... - -
Liabilities of discontinued operations..................................................... - 17,624.3
Investment borrowings...................................................................... 754.2 669.7
--------- ---------
Total liabilities not subject to compromise.......................................... 24,184.1 41,764.6
--------- ---------
Liabilities subject to compromise.......................................................... 4,942.0 4,873.3
--------- ---------
Total liabilities.................................................................... 29,126.1 46,637.9
--------- ---------
Minority interest:
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts......... 1,921.5 1,921.5
Shareholders' deficit:
Preferred stock............................................................................ 501.7 501.7
Common stock and additional paid-in capital (no par value, 1,000,000,000 shares
authorized, shares issued and outstanding: 2003 - 346,007,133; 2002 - 346,007,133)....... 3,497.3 3,497.0
Accumulated other comprehensive income..................................................... 650.5 580.6
Retained deficit........................................................................... (6,648.7) (6,629.7)
--------- ---------
Total shareholders' deficit.......................................................... (1,999.2) (2,050.4)
--------- ---------
Total liabilities and shareholders' deficit.......................................... $29,048.4 $46,509.0
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
3
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions, except per share data)
(unaudited)
Three months ended
March 31,
--------------------
2003 2002
---- ----
Revenues:
Insurance policy income.................................................................................. $ 873.6 $ 949.1
Net investment income:
Insurance and fee-based segment general account assets................................................. 349.5 403.6
Equity-indexed and separate account products........................................................... (23.1) (18.0)
Venture capital income (loss) related to investment in AT&T Wireless Services, Inc..................... 2.5 (76.3)
Other.................................................................................................. 1.9 2.0
Net realized investment gains (losses) .................................................................. 13.0 (29.6)
Fee revenue and other income............................................................................. 13.7 22.2
-------- ---------
Total revenues....................................................................................... 1,231.1 1,253.0
-------- ---------
Benefits and expenses:
Insurance policy benefits................................................................................ 858.7 836.9
Provision for losses..................................................................................... 15.3 40.0
Interest expense (contractual interest for 2003 of $97.6)................................................ 73.6 81.5
Amortization............................................................................................. 158.0 184.9
Other operating costs and expenses....................................................................... 154.9 175.4
Special charges.......................................................................................... - 20.0
Reorganization items..................................................................................... 18.1 -
-------- ---------
Total benefits and expenses.......................................................................... 1,278.6 1,338.7
-------- ---------
Loss before income taxes, minority interest, discontinued operations
and cumulative effect of accounting change........................................................ (47.5) (85.7)
Income tax benefit on period income......................................................................... (14.6) (26.1)
-------- ---------
Loss before minority interest, discontinued operations
and cumulative effect of accounting change........................................................ (32.9) (59.6)
Minority interest:
Distributions on Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts, net of income taxes............................................................. - 29.2
-------- ---------
Loss before discontinued operations and cumulative effect of accounting change....................... (32.9) (88.8)
Discontinued operations, net of income taxes................................................................ 13.9 (7.1)
Cumulative effect of accounting change for goodwill impairment, net of income taxes......................... - (2,949.2)
-------- ---------
Net loss............................................................................................. (19.0) (3,045.1)
Preferred stock dividends................................................................................... - 1.0
-------- ---------
Net loss applicable to common stock.................................................................. $ (19.0) $(3,046.1)
======== =========
(continued)
The accompanying notes are an integral part
of the consolidated financial statements.
4
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF OPERATIONS, continued
(Dollars in millions, except per share data)
(unaudited)
Three months ended
March 31,
-------------------
2003 2002
---- ----
Loss per common share:
Basic:
Weighted average shares outstanding...................................................... 346,007,100 345,208,900
=========== ===========
Loss before discontinued operations
and cumulative effect of accounting change............................................. $(.09) $ (.26)
Discontinued operations.................................................................. .04 (.02)
Cumulative effect of accounting change................................................... - (8.54)
----- ------
Net loss............................................................................. $(.05) $(8.82)
===== ======
Diluted:
Weighted average shares outstanding...................................................... 346,007,100 345,208,900
=========== ===========
Loss before discontinued operations
and cumulative effect of accounting change........................................... $(.09) $ (.26)
Discontinued operations.................................................................. .04 (.02)
Cumulative effect of accounting change................................................... - (8.54)
----- ------
Net loss............................................................................. $(.05) $(8.82)
===== ======
The accompanying notes are an integral part
of the consolidated financial statements.
5
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
(Dollars in millions)
(unaudited)
Common stock Accumulated other Retained
Preferred and additional comprehensive earnings
Total stock paid-in capital income (loss) (deficit)
----- ----- --------------- ------------- -------
Balance, January 1, 2003............................. $(2,050.4) $501.7 $3,497.0 $580.6 $(6,629.7)
Comprehensive income, net of tax:
Net loss........................................ (19.0) - - - (19.0)
Change in unrealized appreciation
of investments (net of applicable income tax
expense of $14.1)............................. 69.9 - - 69.9 -
---------
Total comprehensive income.................. 50.9
Change in shares for stock options and for
employee benefit plans.......................... .3 - .3 - -
--------- ------ -------- ------- ---------
Balance, March 31, 2003.............................. $(1,999.2) $501.7 $3,497.3 $ 650.5 $(6,648.7)
========= ====== ======== ======= =========
Balance, January 1, 2002............................. $ 4,753.0 $499.6 $3,484.3 $(439.0) $ 1,208.1
Comprehensive loss, net of tax:
Net loss........................................ (3,045.1) - - - (3,045.1)
Change in unrealized depreciation of
investments (net of applicable income tax
benefit of $31.9)............................. (56.7) - - (56.7) -
---------
Total comprehensive loss.................... (3,101.8)
Issuance of shares for stock options and for
employee benefit plans.......................... 11.9 - 11.9 - -
Payment-in-kind dividends on convertible
preferred stock................................. 1.0 1.0 - - -
Dividends on preferred stock...................... (1.0) - - - (1.0)
--------- ------ -------- ------- ---------
Balance, March 31, 2002.............................. $ 1,663.1 $500.6 $3,496.2 $(495.7) $(1,838.0)
========= ====== ======== ======= =========
The accompanying notes are an integral part
of the consolidated financial statements.
6
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(unaudited)
Three months ended
March 31,
--------------------
2003 2002
---- ----
Cash flows from operating activities:
Insurance policy income....................................................................... $ 739.5 $ 818.3
Net investment income......................................................................... 345.4 946.8
Fee revenue and other income.................................................................. 13.7 85.3
Insurance policy benefits..................................................................... (618.7) (666.1)
Interest expense.............................................................................. - (360.6)
Policy acquisition costs...................................................................... (117.6) (145.0)
Special charges............................................................................... - (14.0)
Reorganization items.......................................................................... (2.8) -
Other operating costs......................................................................... (134.0) (367.7)
Taxes......................................................................................... 33.4 (34.0)
--------- ----------
Net cash provided by operating activities................................................... 258.9 263.0
--------- ----------
Cash flows from investing activities:
Sales of investments.......................................................................... 2,380.2 6,345.9
Maturities and redemptions of investments..................................................... 494.5 502.6
Purchases of investments...................................................................... (2,571.0) (7,216.4)
Cash received from the sale of finance receivables, net of expenses........................... - 346.2
Principal payments received on finance receivables............................................ - 2,189.7
Finance receivables originated................................................................ - (2,289.3)
Other......................................................................................... .4 (38.0)
--------- -----------
Net cash provided (used) by investing activities ........................................... 304.1 (159.3)
--------- ----------
Cash flows from financing activities:
Amounts received for deposit products......................................................... 496.6 1,162.7
Withdrawals from deposit products............................................................. (849.0) (1,259.4)
Issuance of notes payable..................................................................... - 1,839.1
Payments on notes payable..................................................................... - (2,093.6)
Change in cash held in restricted accounts for settlement of borrowings....................... - (124.9)
Investment borrowings......................................................................... 84.5 (874.1)
--------- ---------
Net cash used by financing activities..................................................... (267.9) (1,350.2)
--------- ---------
Net increase (decrease) in cash and cash equivalents...................................... 295.1 (1,246.5)
Cash and cash equivalents, beginning of period................................................... 1,268.9 3,060.8
--------- ---------
Cash and cash equivalents, end of period......................................................... $ 1,564.0 $ 1,814.3
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
7
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following notes should be read together with the notes to the
consolidated financial statements included in the 2002 Form 10-K of Conseco,
Inc.
PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
Conseco, Inc. ("CNC") is the top tier holding company for our insurance
business. Our insurance business is operated through subsidiaries owned directly
and indirectly by CIHC, Incorporated ("CIHC"), an intermediate holding company
that is controlled by CNC. Our finance business was operated through Conseco
Finance Corp. ("CFC"), a wholly-owned subsidiary of CIHC, and its subsidiaries.
As a result of the formalization of the plans to sell the finance business and
the filing of petitions under Chapter 11 of Title 11 of the United States
Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court
for the Northern District of Illinois (the "Bankruptcy Court") by CFC and
certain of its subsidiaries, the finance business was accounted for as a
discontinued operation in 2002. A number of additional steps were completed
during the quarter ended March 31, 2003 related to CFC's sale and restructuring.
On January 8, 2003, the Bankruptcy Court approved the sale and bidding
procedures that would be followed to conduct an auction for the sale of CFC's
businesses and assets. On February 3, 2003, 18 additional subsidiaries of CFC
filed petitions under the Bankruptcy Code. On March 5, 2003, the auction to sell
CFC's businesses was concluded. A significant condition to the Bankruptcy Court
approval and completion of the sale of CFC was the restructuring of servicing
fee arrangements for CFC's managed portfolio of manufactured housing loans under
more favorable terms. Such restructuring was completed and the Bankruptcy Court
entered final orders approving the terms of the sale of CFC on March 14, 2003.
CFC expects the sale, which is subject to various closing conditions, to close
in May 2003. If the contemplated transactions are completed as expected, no
proceeds will be paid to Conseco as a result of its ownership of CFC. On April
1, 2003, CFC filed its liquidating plan of reorganization with the Bankruptcy
Court. Conseco no longer controls CFC. As of March 31, 2003, Conseco no longer
includes the assets and liabilities of CFC in its consolidated balance sheet.
Our subsidiaries operate throughout the United States. We sometimes collectively
refer to CNC, together with its consolidated subsidiaries, as "we," "Conseco" or
the "Company."
Our insurance subsidiaries develop, market and administer supplemental
health insurance, annuity, individual life insurance and other insurance
products. Our finance business had historically provided a variety of finance
products including manufactured housing and floor plan loans, home equity
mortgages, home improvement and consumer product loans and private label credit
cards.
On December 17, 2002 (the "Petition Date"), CNC, CIHC, CTIHC, Inc. and
Partners Health Group, Inc. (collectively, the "Debtors") filed voluntary
petitions for reorganization under the Bankruptcy Code in the Bankruptcy Court.
The following discussion provides general background information regarding the
Debtors' Chapter 11 cases, but is not intended to be a comprehensive summary.
The Debtors are currently operating their business as debtors-in-possession
pursuant to the Bankruptcy Code. As debtors-in-possession, the Debtors are
authorized to continue to operate as ongoing businesses, but may not engage in
transactions outside the ordinary course of business without approval of the
Bankruptcy Court, after notice and an opportunity for a hearing. The Company's
insurance subsidiaries are separate legal entities and are not included in the
petitions filed by the Debtors.
CFC and Conseco Finance Servicing Corp. also filed petitions under the
Bankruptcy Code with the Bankruptcy Court on the Petition Date. In addition, on
February 3, 2003, the following subsidiaries of CFC filed petitions under the
Bankruptcy Code with the Bankruptcy Court: Conseco Finance Corp. - Alabama,
Conseco Finance Credit Corp., Conseco Finance Consumer Discount Company, Conseco
Finance Canada Holding Company, Conseco Finance Canada Company, Conseco Finance
Loan Company, Rice Park Properties Corporation, Landmark Manufactured Housing,
Inc., Conseco Finance Net Interest Margin Finance Corp. I, Conseco Finance Net
Interest Margin Finance Corp. II, Green Tree Finance Corp. - Two, Green Tree
Floorplan Funding Corp., Conseco Agency of Nevada, Inc., Conseco Agency of New
York, Inc., Conseco Agency, Inc., Conseco Agency of Alabama, Inc., Conseco
Agency of Kentucky, Inc., Crum-Reed General Agency, Inc. The foregoing entities
are referred to as the "Finance Company Debtors." The Finance Company Debtors
filed a separate plan of reorganization and disclosure statement in connection
with their bankruptcy proceedings. The bankruptcy proceedings of the Debtors and
the Finance Company Debtors are referred to as the "Chapter 11 Cases".
Since commencing operations in 1982, CNC pursued a strategy of growth
through acquisitions. Primarily as a result of these acquisitions and the
funding requirements necessary to operate and expand the acquired businesses,
CNC amassed outstanding indebtedness of approximately $6.0 billion as of June
30, 2002. In 2001 and early 2002, we undertook a series of steps designed to
reduce and extend the maturities of our parent company debt. Notwithstanding
these efforts, the Company's financial position continued to deteriorate,
principally due to our leveraged condition, losses experienced by our finance
business and realized losses in certain investments.
8
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
As a result of these developments, on August 9, 2002, we announced that we
would seek to fundamentally restructure the Company's capital, and announced
that we had retained legal and financial advisors to assist us in these efforts.
We ultimately decided to seek to reorganize under Chapter 11 of the Bankruptcy
Code.
Under the Bankruptcy Code, actions to collect prepetition indebtedness, as
well as most pending litigation, are stayed and other contractual obligations
against the Debtors generally may not be enforced. Absent an order of the
Bankruptcy Court, substantially all prepetition liabilities are subject to
settlement under a plan of reorganization to be voted upon by creditors and
other stakeholders and approved by the Bankruptcy Court. On March 18, 2003, the
Bankruptcy Court approved the Debtors' Second Amended Disclosure Statement (the
"Disclosure Statement"), summarizing the terms of the Debtors' Second Amended
Joint Plan of Reorganization (the "Plan"), as containing adequate information,
as such term is defined in Section 1125 of the Bankruptcy Code, to permit the
solicitation of votes from creditors on whether to accept the Plan. The Debtors
commenced solicitation on April 4, 2003. The voting record date was set as March
19, 2003 and the deadline for returning completed ballots, originally set for
May 14, 2003, was extended to May 21, 2003. A hearing to consider confirmation
of the Plan is scheduled to begin on May 28, 2003. The Debtors will emerge from
bankruptcy if and when the Plan receives the requisite stakeholder approval and
is approved by the Bankruptcy Court, and all conditions to the consummation of
the Plan have been satisfied or waived.
The United States Trustee has appointed a creditors committee representing
the unsecured creditors of the Debtors and a TOPrS committee representing the
claims of the holders of the Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts ("Trust Preferred Securities"). Before the
Petition Date, the Company met with and provided materials to certain
prepetition committees and entered into extensive arms-length negotiations with
committees representing the holders of bank debt and publicly held notes of CNC.
Shortly before the Petition Date, the Company reached a non-binding agreement in
principle with respect to the general terms of a restructuring with certain
prepetition committees. However, there can be no assurance that the appointed
committees will support the Debtors' positions in the bankruptcy proceedings or
approve the Plan. The TOPrS committee has raised certain objections to the Plan
which are summarized in the Disclosure Statement. Disagreements between the
Debtors and the appointed committees could protract the bankruptcy proceedings,
could negatively impact the Company's ability to operate and the results of
those operations during bankruptcy, and could delay the Debtors' emergence from
bankruptcy.
The Debtors previously filed with the Bankruptcy Court schedules of assets
and liabilities of the Debtors as reflected on our books and records. Subject to
certain limited exceptions, the Bankruptcy Court established a bar date of
February 21, 2003, for all prepetition claims against the Debtors. A bar date is
the date by which claims against the Debtors must be filed if the claimants wish
to receive any distribution in the bankruptcy proceedings. The Debtors notified
all known or potential claimants subject to the February 21, 2003 bar date of
their need to file a proof of claim with the Bankruptcy Court. Approximately
9,000 proofs of claim were filed on or before the February 21, 2003 bar date and
the Company has begun objecting to claims and otherwise reconciling claims that
differ from the Debtors' records. Any differences that cannot be resolved
through negotiations between the Debtors and the claimant will be resolved by
the Bankruptcy Court. Certain creditors have filed claims substantially in
excess of amounts reflected in the Debtors' records. Accordingly, the ultimate
number and amount of allowed claims is not presently known. Similarly, the
ultimate distribution with respect to allowed claims is not presently known.
We have filed several motions in the Chapter 11 Cases pursuant to which the
Bankruptcy Court has granted us authority or approval with respect to various
items required by the Bankruptcy Code and/or necessary for our reorganization
efforts. We have obtained orders providing for, among other things: (i) payment
of prepetition and postpetition employee compensation and benefits; and (ii)
continuing a key-employee retention plan.
Under the priority schedule established by the Bankruptcy Code, certain
postpetition and prepetition liabilities need to be satisfied before unsecured
creditors and holders of CNC's common and preferred stock and Trust Preferred
Securities are entitled to receive any distribution. The Plan (as summarized in
the Disclosure Statement) sets forth the Debtors' proposed treatment of claims
and equity interests. No assurance can be given as to what values, if any, will
be ascribed in the bankruptcy proceedings to each of these constituencies. Our
Plan would result in holders of CNC's common stock and preferred stock (other
than Series F Common-Linked Convertible Preferred Stock ("Series F Preferred
Stock")) receiving no value and the holders of CNC's Trust Preferred Securities
and Series F Preferred Stock receiving little value on account of the
cancellation of their interests. In addition, holders of unsecured claims
against the Debtors would, in most cases, receive less than full recovery for
the cancellation of their interests.
9
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
At this time, it is not possible to predict with certainty the effect of
the Chapter 11 Cases on our business or various creditors, or when we will
emerge from Chapter 11. Our future results depend upon our confirming and
successfully implementing, on a timely basis, a plan of reorganization.
DISCONTINUED FINANCE BUSINESS - PLANNED SALE OF CFC
In October 2002, we announced that we had engaged financial advisors to
pursue various alternatives with respect to our finance business and that CNC's
board of directors had approved a plan to sell or seek new investors for our
finance business. On December 19, 2002, CFC entered into an Asset Purchase
Agreement (the "Asset Purchase Agreement") with CFN Investment Holdings LLC
("CFN"), an affiliate of Fortress Investment Group LLC, J.C. Flowers & Co. LLC
and Cerberus Capital Management, L.P., pursuant to which CFC would, subject to
the satisfaction of certain conditions, sell all or substantially all of its
assets (the "CFC Assets") in a sale pursuant to Section 363 of the Bankruptcy
Code as part of CFC's Chapter 11 proceedings, subject to the right of CFN to
exclude certain assets from its purchase. In accordance with Section 363 of the
Bankruptcy Code and the terms of the Asset Purchase Agreement, CFC continued to
seek alternative transactions that would provide greater value to CFC and its
creditors than the transactions contemplated by the Asset Purchase Agreement.
As part of CFC's efforts to seek alternative transactions that would
provide greater value to CFC, and in accordance with the bidding procedures
order approved by the Bankruptcy Court, CFC conducted an auction for the sale of
its businesses and assets. Potential bidders were allowed to participate in the
auction if they submitted bids for the purchase of the CFC Assets that, by their
own terms or aggregated with other bids, were for more than the purchase price
payable under the Asset Purchase Agreement, plus the amount of the break-up fee
of $30 million, plus $5 million in expense reimbursements, plus the profit
sharing rights relating to the manufactured housing business. The auction, which
commenced on February 28, 2003, promptly adjourned, and was continued to March
4, 2003, ultimately concluding the morning of March 5, 2003.
At the auction, CFC, with the assistance of its advisors, analyzed each of
the bids presented and determined that CFN's bid of $970 million in cash, plus
the assumption of certain liabilities, represented the highest and best bid. The
terms of the sale included an option for CFC to sell the assets of Mill Creek
Bank, Inc. ("Mill Creek Bank", formerly known as Conseco Bank, Inc.) to General
Electric Capital Corporation ("GE") for approximately $310 million in cash, plus
certain assumed liabilities, which option, if exercised, would provide CFN with
a credit of $270 million to its $970 million bid.
On March 6, 2003, CFC received an offer from Berkadia Equity Holdings,
L.L.C. ("Berkadia") that purported to be a bid in the recently concluded
auction. Concurrently therewith, Berkadia filed an objection to the sale that
the Bankruptcy Court heard, and summarily dismissed, on March 7, 2003. After
further negotiations during the March 7-14, 2003 period, CFN and GE
significantly increased the amount of cash to be paid for the CFC Assets.
Ultimately, each of the major constituencies, including the CFC Committee, the
Ad Hoc Securitization Holders' Committee, U.S. Bank as securitization trustee
for the certificate holders of certain lower-rated securities that are senior in
payment priority to the interest-only securities (the "B-2 securities"), and
Federal National Mortgage Association, as a major bond holder, agreed to support
the sale of CFC Assets to CFN and GE. The total value to be received as part of
the transactions with CFN and GE upon closing is expected to be approximately
$1.3 billion, representing approximately $1.1 billion in cash and approximately
$200 million in assumed liabilities, subject to certain purchase price
adjustments. On March 14, 2003, the Bankruptcy Court entered orders approving
the terms of the sale of the CFC Assets free and clear of all liens to each of
CFN and GE. The closing of the sale of the CFC Assets is subject to various
closing conditions, but is currently expected to occur in the second quarter of
2003.
Overall, CFC is seeking to maximize the value obtainable from all
restructuring transactions it contemplates as part of its Chapter 11 filing.
However, there can be no assurance that any such transaction will be completed.
Moreover, if such a transaction is completed, no proceeds resulting therefrom
will be available to satisfy any creditors, other than creditors of CFC or
parties with a security interest in CFC's assets.
10
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared on a
going concern basis, which assumes continuity of operations and realization of
assets and liabilities in the ordinary course of business, and in accordance
with Statement of Position 90-7 "Financial Reporting by Entities in
Reorganization under the Bankruptcy Code" ("SOP 90-7"). Accordingly, all
prepetition liabilities subject to compromise have been segregated in the
consolidated balance sheet and classified as "liabilities subject to compromise"
at the estimated amount of allowable claims.
Pursuant to SOP 90-7, professional fees associated with the Chapter 11
Cases are expensed as incurred and reported as reorganization items. Interest
expense is reported only to the extent that it will be paid during the Chapter
11 Cases or when it is probable that it will be an allowed claim. During the
first quarter of 2003, the Company recognized a charge of $18.1 million
associated with the Chapter 11 Cases for fees payable to professionals to assist
with the filing of the Chapter 11 Cases.
The Company is currently operating under the jurisdiction of Chapter 11 of
the Bankruptcy Code and the Bankruptcy Court, and continuation as a going
concern is contingent upon our ability to obtain confirmation of the Plan,
return to profitability, generate sufficient cash flows from operations and
obtain financing sources to meet our future obligations and many other
bankruptcy considerations and risks related to our business and financial
condition. These matters raise substantial doubt about Conseco's ability to
continue as a going concern. The accompanying consolidated financial statements
do not include any adjustments relating to the recoverability and classification
of recorded asset amounts or the amounts and classification of liabilities that
might result from the outcome of these uncertainties. Additionally, our Plan
will materially change amounts reported in the consolidated financial
statements, which do not give effect to all adjustments of the carrying value of
assets and liabilities that are necessary as a consequence of a reorganization
under Chapter 11 of the Bankruptcy Code.
Our unaudited consolidated financial statements reflect normal recurring
adjustments that are necessary to present fairly Conseco's financial position
and results of operations on a basis consistent with that of our prior audited
consolidated financial statements. As permitted by rules and regulations of the
Securities and Exchange Commission applicable to quarterly reports on Form 10-Q,
we have condensed or omitted certain information and disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles ("GAAP"). We have also reclassified certain amounts from
the prior periods to conform to the 2003 presentation. These reclassifications
have no effect on net income or shareholders' equity. Results for interim
periods are not necessarily indicative of the results that may be expected for a
full year.
During the third quarter of 2002, Conseco entered into an agreement to sell
Conseco Variable Insurance Company ("CVIC"), its wholly owned subsidiary and the
primary writer of its variable annuity products. The sale was completed in
October 2002. The operating results of CVIC have been reported as discontinued
operations in all periods presented in the accompanying consolidated statement
of operations. See the note to the consolidated financial statements entitled
"Discontinued Operations."
During 2001, we stopped renewing a large portion of our major medical lines
of business. These lines of business are referred to herein as the "major
medical business in run-off".
When we prepare financial statements in conformity with GAAP, we are
required to make estimates and assumptions that significantly affect various
reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reporting periods. For example, we use significant estimates
and assumptions in calculating values for the cost of policies produced, the
cost of policies purchased, retained interest in securitization trusts
(including interest-only securities and certain lower-rated securities that are
senior in payment priority to the interest-only securities (the "B-2
securities")), certain investments, servicing rights, assets and liabilities
related to income taxes, goodwill, liabilities for insurance and asset
accumulation products, the guarantee liability related to interests in
securitizations, liabilities related to litigation, guaranty fund assessment
accruals, liabilities related to guarantees of securitized debt issued in
conjunction with certain sales of finance receivables and liabilities related to
guarantees of bank loans and the related interest loans to certain current and
former directors, officers and key employees, gain on sale of finance
receivables and allowance for credit losses on finance receivables. If our
future experience differs from these estimates and assumptions, our financial
statements would be materially affected.
11
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Our consolidated financial statements exclude the results of material
transactions between us and our consolidated affiliates, or among our
consolidated affiliates.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"), in June 2001. Under the new rule, intangible assets with an
indefinite life are no longer amortized in periods subsequent to December 31,
2001, but are subject to annual impairment tests (or more frequent under certain
circumstances), effective January 1, 2002. The Company determined that all of
its goodwill had an indefinite life and was therefore subject to the new rules.
The Company adopted SFAS 142 on January 1, 2002.
Pursuant to the transitional rules of SFAS 142, we completed the two-step
impairment test during 2002 and, as a result of that test, we recorded the
cumulative effect of the accounting change for the goodwill impairment charge of
$2,949.2 million. The impairment charge is reflected as the cumulative effect of
an accounting change in the accompanying consolidated statement of operations
for the three months ended March 31, 2002. Subsequent impairment tests will be
performed on an annual basis, or more frequently if circumstances indicate a
possible impairment. Subsequent impairment charges are classified as an
operating expense.
Changes in the carrying amount of goodwill for the three months ended March
31, 2003 and 2002, are as follows:
Three months ended
March 31,
------------------
2003 2002
---- ----
(Dollars in millions)
Goodwill balance, beginning of period....................................... $100.0 $ 3,695.4
Cumulative effect of accounting change...................................... - (2,949.2)
Reduction of tax valuation contingencies established at acquisition date
for acquired companies.................................................. - (146.2)
------ ---------
Goodwill balance, end of period............................................. $100.0 $ 600.0
====== =========
12
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Pursuant to the transitional rules of SFAS 142, the cumulative effect of
the accounting change for goodwill impairment is reflected in the consolidated
financial statements for the quarter ended March 31, 2002. Accordingly, the
consolidated statement of operations for the three months ended March 31, 2002,
has been restated to reflect the change as summarized below (dollars in
millions, except per share data):
Net loss, applicable to common stock as reported................ $ (96.9)
Cumulative effect of accounting change.......................... (2,949.2)
---------
Net loss applicable to common stock, as adjusted................ $(3,046.1)
=========
Net loss per common share:
Basic:
Net loss, as reported..................................... $ (.28)
Cumulative effect of accounting change.................... (8.54)
------
Net loss, as adjusted..................................... $(8.82)
======
Diluted:
Net loss, as reported..................................... $ (.28)
Cumulative effect of accounting change.................... (8.54)
------
Net loss, as adjusted..................................... $(8.82)
======
LIABILITIES SUBJECT TO COMPROMISE
Under the Bankruptcy Code, actions by creditors to collect indebtedness
owed prior to the Petition Date are stayed and certain other prepetition
contractual obligations may not be enforced against the Debtors. We have
received approval from the Bankruptcy Court to pay certain prepetition
liabilities including employee salaries and wages, benefits and other employee
obligations. All other prepetition liabilities have been classified as
"liabilities subject to compromise" in the accompanying consolidated balance
sheet.
The following table summarizes the components of the liabilities included
in the line "liabilities subject to compromise" in our consolidated balance
sheet (dollars in millions):
March 31, December 31,
2003 2002
--------- ------------
Other liabilities
Liability for guarantee of bank loans to current and former
directors, officers and key employees to purchase
CNC common stock................................................... $ 482.0 $ 480.8
Interest payable...................................................... 204.2 171.6
Accrual for distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts............... 90.1 90.1
Liability for litigation.............................................. 41.8 41.8
Liability for retirement benefits pursuant to executive
employment agreements.............................................. 22.6 22.6
Liability for deferred compensation................................... 2.1 2.3
Other payables........................................................ 7.2 7.0
-------- --------
Total other liabilities subject to compromise...................... 850.0 816.2
Notes payable - direct corporate obligations.............................. 4,092.0 4,057.1
-------- --------
Total liabilities subject to compromise............................ $4,942.0 $4,873.3
======== ========
13
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
The following table summarizes condensed consolidating financial
information segregating such information between the Debtors and non-Debtor
subsidiaries.
Condensed Consolidating Balance Sheet as of March 31, 2003
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
--------------- -------------- ------------ ------------
ASSETS
Cash and cash equivalents....................................... $ 38.8 $ 1,525.2 $ - $ 1,564.0
Investments..................................................... 6.0 21,776.0 - 21,782.0
Investment in wholly-owned subsidiaries
(eliminated in consolidation)............................... 5,656.8 1,239.0 (6,895.8) -
Receivable from affiliates
(eliminated in consolidation)............................... 1,274.3 1,157.7 (2,432.0) -
Income tax assets............................................... 81.4 46.0 (63.0) 64.4
Other assets.................................................... 65.3 5,572.7 - 5,638.0
--------- --------- --------- ---------
Total assets.......................................... $ 7,122.6 $31,316.6 $(9,390.8) $29,048.4
========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Liabilities:
Liabilities for insurance and asset accumulation products... $ - $22,547.0 $ - $22,547.0
Payables to subsidiaries (eliminated in consolidation)...... 6.4 1,297.0 (1,303.4) -
Other liabilities........................................... 15.6 1,621.5 - 1,637.1
Liabilities subject to compromise........................... 4,942.0 - - 4,942.0
Affiliated liabilities subject to compromise................ 1,177.4 - (1,177.4) -
--------- --------- --------- ---------
Total liabilities..................................... 6,141.4 25,465.5 (2,480.8) 29,126.1
--------- --------- --------- ---------
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts....................................... 1,921.5 - - 1,921.5
Shareholders' equity (deficit):
Preferred stock............................................. 1,649.7 - (1,148.0) 501.7
Common stock and additional paid-in capital (no par value,
1,000,000,000 shares authorized, shares issued and
outstanding: 2003 - 346,007,133; 2002 - 346,007,133)..... 3,497.5 6,346.1 (6,346.3) 3,497.3
Accumulated other comprehensive income...................... 650.5 650.5 (650.5) 650.5
Retained earnings (deficit)................................. (6,738.0) (1,145.5) 1,234.8 (6,648.7)
--------- --------- --------- ---------
Total shareholders' equity (deficit).................. (940.3) 5,851.1 (6,910.0) (1,999.2)
--------- --------- --------- ---------
Total liabilities and shareholders' equity (deficit).. $ 7,122.6 $31,316.6 $(9,390.8) $29,048.4
========= ========= ========= =========
14
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Condensed Consolidating Balance Sheet as of December 31, 2002
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
--------------- -------------- ------------ ----------------
ASSETS
Cash and cash equivalents....................................... $ 41.5 $ 1,227.4 $ - $ 1,268.9
Investments..................................................... 5.9 21,777.8 - 21,783.7
Investment in wholly-owned subsidiaries
(eliminated in consolidation)............................... 5,521.5 1,239.0 (6,760.5) -
Receivable from affiliates
(eliminated in consolidation)............................... 1,280.3 1,153.7 (2,434.0) -
Income tax assets............................................... 77.8 23.7 - 101.5
Other assets.................................................... 66.8 5,663.8 - 5,730.6
Assets of discontinued operations............................... 17,624.3 - - 17,624.3
--------- --------- --------- ---------
Total assets.......................................... $24,618.1 $31,085.4 $(9,194.5) $46,509.0
========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Liabilities:
Liabilities for insurance and asset accumulation products... $ - $22,797.1 $ - $22,797.1
Payables to subsidiaries (eliminated in consolidation)...... 4.8 1,298.3 (1,303.1) -
Other liabilities........................................... - 1,343.2 1,343.2
Liabilities of discontinued operations...................... 17,624.3 - - 17,624.3
Liabilities subject to compromise........................... 4,873.3 - - 4,873.3
Affiliated liabilities subject to compromise................ 1,177.4 - (1,177.4) -
---------- --------- --------- ---------
Total liabilities..................................... 23,679.8 25,438.6 (2,480.5) 46,637.9
--------- --------- --------- ---------
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts....................................... 1,921.5 - - 1,921.5
Shareholders' equity (deficit):
Preferred stock............................................. 1,644.7 - (1,143.0) 501.7
Common stock and additional paid-in capital (no par value,
1,000,000,000 shares authorized, shares issued and
outstanding: 2002 - 346,007,133)......................... 3,497.3 6,393.4 (6,393.7) 3,497.0
Accumulated other comprehensive income...................... 580.6 470.0 (470.0) 580.6
Retained earnings (deficit)................................. (6,705.8) (1,216.6) 1,292.7 (6,629.7)
--------- --------- --------- ---------
Total shareholders' equity (deficit).................. (983.2) 5,646.8 (6,714.0) (2,050.4)
--------- --------- --------- ---------
Total liabilities and shareholders' equity (deficit).. $24,618.1 $31,085.4 $(9,194.5) $46,509.0
========= ========= ========= =========
15
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Condensed Consolidating Statement of Operations
for the three months ended March 31, 2003
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
--------------- -------------- ------------ ------------
Revenues:
Insurance policy income....................................... $ - $ 873.6 $ - $ 873.6
Net investment income......................................... 1.4 326.9 - 328.3
Net investment income from venture capital investments........ - 2.5 - 2.5
Fee and interest income - affiliated.......................... .2 9.3 (9.5) -
Net investment losses......................................... - 13.0 - 13.0
Fee revenue and other income.................................. .2 13.5 - 13.7
------ -------- ------- --------
Total revenue........................................... 1.8 1,238.8 (9.5) 1,231.1
------ -------- ------- --------
Expenses:
Insurance policy benefits..................................... - 858.7 - 858.7
Provision for losses.......................................... 1.2 14.1 - 15.3
Interest expense.............................................. 70.8 2.8 - 73.6
Interest expense - affiliated................................. - 7.6 (7.6) -
Amortization.................................................. - 158.0 - 158.0
Operating costs and expenses - affiliated..................... 2.7 - (2.7) -
Operating costs and expenses.................................. 3.5 151.4 - 154.9
Reorganization items.......................................... 18.1 - - 18.1
------ -------- ------- --------
Total expenses.......................................... 96.3 1,192.6 (10.3) 1,278.6
------ -------- ------- --------
Income (loss) before income taxes, equity in
undistributed earnings of subsidiaries and
distributions on Company- obligated mandatorily
redeemable preferred securities
of subsidiary trusts................................. (94.5) 46.2 .8 (47.5)
Income tax benefit on period income........................... (3.6) (11.0) - (14.6)
------ -------- ------- --------
Income (loss) before equity in undistributed earnings
of subsidiaries and discontinued operations........ (90.9) 57.2 .8 (32.9)
Equity in undistributed earnings of subsidiaries before
discontinued operations (eliminated in consolidation).... 65.3 - (65.3) -
------ -------- ------- -------
Income (loss) before discontinued operations............ (25.6) 57.2 (64.5) (32.9)
Discontinued operations....................................... - 13.9 - 13.9
------ -------- ------- -------
Net income (loss)....................................... (25.6) 71.1 (64.5) (19.0)
Preferred stock dividends - affiliated........................ 6.6 - (6.6) -
------ -------- ------- -------
Income (loss) applicable to common stock................ $(32.2) $ 71.1 $ (57.9) $ (19.0)
====== ======== ======= =======
16
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
Condensed Consolidating Statement of Cash Flows
for the three months ended March 31, 2003
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
--------------- -------------- ------------ ------------
Net cash provided (used) by operating activities.............. $(1.3) $ 260.4 $(.2) $ 258.9
Net cash provided (used) by investing activities.............. (1.2) 305.3 - 304.1
Net cash used by financing activities......................... (.1) (268.0) .2 (267.9)
----- -------- ---- --------
Net increase (decrease) in cash and cash equivalents.......... (2.6) 297.7 - 295.1
Cash and cash equivalents, beginning of period................ 41.5 1,227.4 - 1,268.9
----- -------- ---- --------
Cash and cash equivalents, end of period................... $38.9 $1,525.1 $ - $1,564.0
===== ======== ==== ========
Subject to certain limited exceptions, the Bankruptcy Court established a
bar date of February 21, 2003, for all prepetition claims against the Debtors. A
bar date is the date by which claims against the Debtors must be filed if the
claimants wish to receive any distribution in the Chapter 11 Cases. The Debtors
have notified all known or potential claimants subject to the February 21, 2003,
bar date of their need to file a proof of claim with the Bankruptcy Court.
Approximately 9,000 proofs of claim have been filed in connection with the
February 21, 2003, bar date, and the Debtors have begun reconciling claims that
differ from their records. Any remaining differences that cannot be resolved by
negotiated agreement between the Debtors and the claimants will be resolved by
the Bankruptcy Court.
Certain creditors have filed claims substantially in excess of amounts
reflected in the Debtors' records. Consequently, the amount included in the
consolidated balance sheet at March 31, 2003, as "liabilities subject to
compromise" may be adjusted.
ACCOUNTING FOR INVESTMENTS
We classify our fixed maturity securities into three categories: (i)
"actively managed" (which we carry at estimated fair value); (ii) "trading"
(which we carry at estimated fair value); and (iii) "held to maturity" (which we
carry at amortized cost). We had no fixed maturity securities in the "trading"
or "held to maturity" categories at March 31, 2003 or December 31, 2002.
Accumulated other comprehensive income is primarily comprised of unrealized
gains on actively managed fixed maturity investments. Such amounts, included in
shareholders' equity (deficit) as of March 31, 2003, and December 31, 2002, were
as follows:
March 31, December 31,
2003 2002
---- ----
(Dollars in millions)
Unrealized gains on investments....................................................... $ 592.5 $448.1
Adjustments to cost of policies purchased and cost of policies produced............... (168.2) (95.3)
Deferred income tax benefit........................................................... 235.5 249.6
Other................................................................................. (9.3) (21.8)
------- ------
Accumulated other comprehensive income........................................... $ 650.5 $580.6
======= ======
17
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
VENTURE CAPITAL INVESTMENT IN AT&T WIRELESS SERVICES, INC.
At March 31, 2003, our venture capital investments consisted of 4.1 million
shares of AT&T Wireless Services, Inc. ("AWE") with a value of $27.5 million.
Our investment in AWE is carried at estimated fair value, with changes in fair
value recognized as investment income (loss). We recognized venture capital
investment income (losses) of $2.5 million and ($76.3) million during the first
three months of 2003 and 2002, respectively.
AMORTIZATION OF THE COST OF POLICIES PURCHASED
The cost assigned to the right to receive future cash flows from insurance
contracts existing at the date of an acquisition is referred to as the cost of
policies purchased, which is an intangible asset subject to amortization. We
amortize these costs using the interest rate credited to the underlying
insurance policy: (i) in relation to the estimated gross profits for universal
life-type and investment-type products; or (ii) in relation to future
anticipated premium revenue for other products.
When we realize a gain or loss on investments backing our universal life or
investment-type products, we adjust the amortization to reflect the change in
estimated gross profits from the products due to the gain or loss realized and
the effect of the event on future investment yields. We also adjust the cost of
policies purchased for the change in amortization that would have been recorded
if actively managed fixed maturity securities had been sold at their stated
aggregate fair value and the proceeds reinvested at current yields. We include
the impact of this adjustment in accumulated other comprehensive income within
shareholders' deficit.
The amortization related to the cost of policies purchased was $43.4
million and $57.2 million in the first three months of 2003 and 2002,
respectively. The Company expects to amortize approximately 12 percent of the
December 31, 2002, balance of cost of policies purchased in 2003, 11 percent in
2004, 9 percent in 2005, 8 percent in 2006 and 7 percent in 2007.
EARNINGS PER SHARE
A reconciliation of net income (loss) and shares used to calculate basic
and diluted earnings per share is as follows:
Three months ended
March 31,
-------------------
2003 2002
---- ----
(Dollars in millions
and shares in thousands)
Net loss........................................................................................ $(19.0) $(3,045.1)
Preferred stock dividends....................................................................... - (1.0)
------ ---------
Net loss applicable to common ownership for basic earnings per share....................... $(19.0) $(3,046.1)
====== =========
Shares:
Weighted average shares outstanding for basic and diluted
earnings per share......................................................................... 346,007 345,209
======= =======
There were no dilutive common stock equivalents during the 2003 and 2002
periods because of the net loss realized by the Company during such periods.
18
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
The following summarizes the equivalent common shares for securities that
were not included in the computation of diluted earnings per share during the
three months ended March 31, 2003 and 2002, because doing so would have been
antidilutive in the periods presented.
Three months ended
March 31,
-----------------
2003 2002
---- ----
(Shares in thousands)
Equivalent common shares that were antidilutive during the period:
Stock options............................................................................... - 2,476
Employee benefit plans...................................................................... 874 926
Assumed conversion of convertible preferred stock........................................... 29,129 28,132
------ ------
Antidilutive equivalent common shares..................................................... 30,003 31,534
====== ======
BUSINESS SEGMENTS
We have historically managed our business operations through two segments,
based on the products offered, in addition to the corporate segment.
Insurance and fee-based segment. Our insurance and fee-based segment
provides supplemental health, annuity and life insurance products to a broad
spectrum of customers through multiple distribution channels, each focused on a
specific market segment. These products are primarily marketed through career
agents, professional independent producers and direct marketing. Fee-based
activities include services performed for other companies, including investment
management and insurance product marketing.
Finance segment. CFC historically provided a variety of finance products
including: (i) loans for the purchase of manufactured housing, home improvements
and various consumer products; (ii) home equity loans; and (iii) private label
credit card programs. As a result of the formalization of the plan to sell the
finance business and the filing of petitions under the Bankruptcy Code by the
Finance Company Debtors, the finance business was accounted for as a
discontinued business in Conseco's consolidated financial statements in 2002. As
of March 31, 2003, Conseco no longer includes the assets and liabilities of CFC
in its consolidated financial statements.
Corporate and other segment. Our corporate segment includes certain
investment activities, such as our venture capital investment in AWE. In
addition, the corporate segment includes interest expense related to the
Company's corporate debt, special corporate charges, income (loss) from the
major medical business in run-off and other income and expenses. Corporate
expenses are net of charges to our subsidiaries for services provided by the
corporate operations.
19
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
Operating information regarding the insurance and corporate segments was as
follows:
Three months ended
March 31,
------------------
2003 2002
---- ----
(Dollars in millions)
Revenues:
Insurance and fee-based segment:
Insurance policy income:
Annuities.............................................................. $ 38.8 $ 28.5
Supplemental health.................................................... 576.0 573.2
Life................................................................... 153.7 181.8
Other.................................................................. 20.2 30.5
Net investment income (a)................................................ 321.4 379.9
Fee revenue and other income (a)......................................... 13.4 26.7
Net realized investment gains (losses) (a).............................. 13.0 (29.6)
--------- --------
Total insurance and fee-based segment revenues...................... 1,136.5 1,191.0
--------- --------
Corporate and other:
Net investment income.................................................... 3.1 2.0
Venture capital gain (loss) related to investment in AWE................. 2.5 (76.3)
Revenue from the major medical business in run-off....................... 89.0 141.0
--------- --------
Total corporate segment revenues.................................... 94.6 66.7
--------- --------
Eliminations............................................................. - (4.7)
--------- --------
Total revenues...................................................... 1,231.1 1,253.0
--------- --------
Expenses:
Insurance and fee-based segment:
Insurance policy benefits................................................ 784.9 750.0
Amortization............................................................. 148.6 162.1
Interest expense on investment borrowings................................ 2.6 7.0
Other operating costs and expenses....................................... 143.2 136.2
Special charges.......................................................... - 3.0
--------- --------
Total insurance and fee-based segment expenses....................... 1,079.3 1,058.3
--------- --------
(continued on the following page)
20
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
(continued from previous page)
Three months ended
March 31,
------------------
2003 2002
---- ----
(Dollars in millions)
Corporate and other:
Interest expense on corporate debt....................................... 70.9 74.5
Provision for losses and interest expense related to stock
purchase plan.......................................................... 15.3 40.0
Expenses from the major medical business in run-off...................... 89.0 141.0
Other corporate expenses, less charges to subsidiaries for
services provided...................................................... 6.0 12.6
Reorganization items..................................................... 18.1 -
Special charges.......................................................... - 17.0
-------- --------
Total corporate segment expenses....................................... 199.3 285.1
-------- --------
Eliminations............................................................... - (4.7)
-------- --------
Total expenses......................................................... 1,278.6 1,338.7
-------- --------
Income (loss) before income taxes, minority interest and cumulative effect of
accounting change:
Insurance and fee-based operations....................................... 57.2 132.7
Corporate interest expense and other items............................... (104.7) (218.4)
-------- --------
Loss before income taxes, minority interest, discontinued operations
and cumulative effect of accounting change......................... $ (47.5) $ (85.7)
======== ========
- --------------------
(a) It is not practicable to provide additional components of revenue by product
or service.
ACCOUNTING FOR DERIVATIVES
Our equity-indexed annuity products provide a guaranteed base rate of
return and a higher potential return linked to the performance of the Standard &
Poor's 500 Index ("S&P 500 Index") based on a percentage (the participation
rate) over an annual period. At the beginning of each policy year, a new index
period begins. The Company is able to change the participation rate at the
beginning of each index period, subject to contractual minimums. We buy S&P 500
Call Options in an effort to hedge potential increases to policyholder benefits
resulting from increases in the S&P 500 Index to which the product's return is
linked. We include the cost of the S&P 500 Call Options in the pricing of these
products. Policyholder account balances for these annuities fluctuate in
relation to changes in the values of these options. We reflect changes in the
estimated market value of these options in net investment income. Option costs
that are attributable to benefits provided were $19.2 million and $24.9 million
in the first three months of 2003 and 2002, respectively. These costs are
reflected in the change in market value of the S&P 500 Call Options included in
investment income. Net investment income (loss) related to equity-indexed
products before this expense was $(3.9) million and $8.8 million in the first
three months of 2003 and 2002, respectively. Such amounts were substantially
offset by the corresponding charge to insurance policy benefits. The estimated
fair value of the S&P 500 Call Options was $25.9 million and $32.8 million at
March 31, 2003 and December 31, 2002, respectively. We classify such instruments
as other invested assets. The Company accounts for the options attributed to the
policyholder for the estimated life of the annuity contract as embedded
derivatives as defined by Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities", as amended by
Statement of Financial Accounting Standards No. 137, "Deferral of the Effective
Date of FASB Statement No. 133" and Statement of Financial Accounting Standards
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities" (collectively referred to as "SFAS 138"). The Company records the
change in the fair values of the embedded derivatives in
21
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
current earnings as a component of policyholder benefits. The fair value of
these derivatives, which are classified as "liabilities for interest-sensitive
products", was $268.9 million and $274.0 million at March 31, 2003 and December
31, 2002, respectively.
If the counterparties for the derivatives we hold fail to meet their
obligations, Conseco may have to recognize a loss. Conseco limits its exposure
to such a loss by diversifying among several counterparties believed to be
strong and creditworthy. At March 31, 2003, all of the counterparties were rated
"A" or higher by Standard & Poor's Corporation.
GUARANTEES
We have guaranteed $481.3 million principal amount of bank loans to current
and former directors, officers and key employees (the "D&O loans"). Conseco
defaulted on certain notes, which resulted in the immediate maturity of the D&O
loans through cross-acceleration and cross-default provisions contained in the
governing instruments. The proceeds of the bank loans were used by the
participants to purchase approximately 18.0 million shares of Conseco common
stock in open market or negotiated transactions with independent parties. Such
shares have been held by the D&O lenders as collateral for the loans. In
addition, as of March 31, 2003, Conseco has provided loans to participants for
interest on the D&O loans totaling $193.2 million.
The Company is exploring a number of alternatives to reduce the balance of
certain participants' D&O loans. The plan currently being considered would
reduce the D&O loan balance of certain participants who collectively owe less
than 10 percent of the entire amount due under the stock purchase program.
Conseco also granted a security interest in most of its assets in conjunction
with the guarantee of a portion of the bank loans. During the first three months
of 2003, we established a noncash provision in connection with these guarantees
and loans of $15.3 million. At March 31, 2003, the reserve for losses on the
loan guarantees and on the loans held by Conseco totaled $675.3 million. During
2002, Conseco purchased $55.5 million of loans from the banks utilizing cash
held in a segregated cash account as collateral for our guarantee of the bank
loans (including accrued interest, the balance on these loans was $58.0 million
at March 31, 2003). At March 31, 2003, the guaranteed bank loans and interest
loans exceeded the value of the collateral held and the reserve for losses by
approximately $50.0 million. All participants have agreed to indemnify Conseco
for any loss incurred on their loans. We regularly evaluate these guarantees and
loans in light of the collateral and the creditworthiness of the participants.
CIHC is the guarantor of an aggregate principal amount of $125 million with
respect to CFC's residual and warehouse lines of credit with Lehman Brothers,
Inc. and its affiliates ("Lehman"). Such facilities are collectively referred to
as the "CFC Lehman Facilities". In addition, CIHC is the guarantor of: (i) the
term portion of the Secured Super-Priority Debtor in Possession Credit
Agreement, dated as of December 19, 2002, among CFC, various subsidiaries of
CFC, CIHC and FPS DIP, LLC (the "FPS DIP") and; (ii) a cash management facility
with U.S Bank National Association (the "U.S. Bank Facility"). The term portion
of the FPS DIP provides for funding in a maximum aggregate amount of $60 million
and is fully drawn. The guarantee obligations of CIHC under the FPS DIP and the
U.S. Bank Facility are limited to an aggregate of $125 million. The March 31,
2003 balances outstanding on the CFC Lehman Facilities and CFC's
debtor-in-possession facility were $706.7 million and $60.0 million,
respectively. Assuming the sale of CFC's assets is completed and CFC receives
the proceeds from the sale of such assets as contemplated by the CFN and GE
transactions, Conseco believes the proceeds will be sufficient to satisfy CFC's
obligations pursuant to the Lehman and CFC's debtor-in-possession facility and
all claims senior to such facilities. CFC's unsecured creditors have challenged
Lehman's security position and otherwise are attempting to prevent Lehman from
being paid in full out of the proceeds from the sale of CFC's assets. If Lehman
were not paid in full from the proceeds, Lehman would likely pursue its claim on
the CIHC guarantee which, if successful, could impact the ability of the Debtors
to complete their proposed Plan.
In accordance with the terms of the Company's former Chief Executive
Officer's employment agreement, Bankers Life & Casualty Company, a wholly-owned
subsidiary of the Company, is the guarantor of the former executive's
nonqualified supplemental retirement benefit. The liability for such benefit at
March 31, 2003 was $15.0 million and is included in the caption "Other
liabilities" in the liability section of the consolidated balance sheet.
22
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
REINSURANCE
The cost of reinsurance ceded totaled $74.0 million and $79.1 million in
the first three months of 2003 and 2002, respectively. We deducted this cost
from insurance policy income. In each case, the ceding Conseco subsidiary is
contingently liable for claims reinsured if the assuming company is unable to
pay. Reinsurance recoveries netted against insurance policy benefits totaled
$73.8 million and $53.1 million in the first three months of 2003 and 2002,
respectively. Reinsurance premiums assumed totaled $23.0 million and $23.6
million in the first three months of 2003 and 2002, respectively.
INCOME TAXES
Our income tax expense includes deferred income taxes arising from
temporary differences between the financial reporting bases of assets and
liabilities, capital loss carryforwards and net operating loss carryforwards. In
assessing the realization of deferred income tax assets, we consider whether it
is more likely than not that the deferred income tax assets will be realized.
The ultimate realization of our deferred income tax assets depends upon
generating future taxable income during the periods in which our temporary
differences become deductible and before our net operating loss carryforwards
expire. We evaluate the realizability of our deferred income tax assets by
assessing the need for a valuation allowance on a quarterly basis.
A valuation allowance has been provided for the entire balance of net
deferred income tax assets at March 31, 2003, as we believe the realization of
such assets in future periods is uncertain. We reached this conclusion after
considering the availability of taxable income in prior carryback years, tax
planning strategies, and the likelihood of future taxable income exclusive of
reversing temporary differences and carryforwards. This conclusion was greatly
influenced by recent unfavorable developments affecting the Company such as
rating downgrades that decreased the Company's likelihood to generate adequate
future taxable income to realize the tax benefits.
The projected ordinary loss carryforwards and capital loss carryforwards
are $1.8 billion and $351.2 million, respectively, as of March 31, 2003. The
ordinary loss carryforwards include amounts attributed to both CNC and CFC. The
losses are subject to change due to actual results varying from estimates,
income tax examinations, disposition of certain businesses, and the conclusion
of bankruptcy proceedings. Approximately $2.3 million of the ordinary loss
carryforwards will expire in 2003 if not utilized.
At March 31, 2003, Conseco had $351.2 million of capital loss
carryforwards. These carryforwards will expire as follows: $23.3 million in
2006, $299.2 million in 2007 and $28.7 in 2008.
A reconciliation of the U.S. statutory corporate income tax rate to the
effective rate reflected in the consolidated statement of operations is as
follows:
Three months ended
March 31,
------------------
2003 2002
---- ----
U.S. statutory corporate rate.................................................................. (35.0)% (35.0)%
Net deferred benefits not recognized in the current period..................................... 5.0 -
Other nondeductible expenses................................................................... (.6) 2.6
State taxes.................................................................................... (.1) 1.9
------ -----
Effective tax rate...................................................................... (30.7)% (30.5)%
===== =====
23
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
CHANGES IN DIRECT CORPORATE OBLIGATIONS
This note contains information regarding the following notes payable that
were direct corporate obligations of CNC as of March 31, 2003 and December 31,
2002:
March 31, December 31,
2003 2002
---- ----
(Dollars in millions)
$1.5 billion Senior Credit Facility.......................................... $ 1,562.5 $ 1,531.4
8.5% senior notes due 2002................................................... 224.9 224.9
8.5% guaranteed senior notes due 2003........................................ 1.0 1.0
8.125% senior notes due 2003................................................. 63.5 63.5
6.4% senior notes due 2003................................................... 234.1 234.1
6.4% guaranteed senior notes due 2004........................................ 14.9 14.9
10.5% senior notes due 2004.................................................. 24.5 24.5
8.75% senior notes due 2004.................................................. 423.7 423.7
8.75% guaranteed senior notes due 2006....................................... 364.3 364.3
6.8% senior notes due 2005................................................... 99.2 99.2
6.8% guaranteed senior notes due 2007........................................ 150.8 150.8
9.0% senior notes due 2006................................................... 150.8 150.8
9.0% guaranteed senior notes due 2008........................................ 399.2 399.2
10.75% senior notes due 2008................................................. 37.6 37.6
10.75% guaranteed senior notes due 2009...................................... 362.4 362.4
--------- ---------
Total principal amount.................................................. 4,113.4 4,082.3
Unamortized net discount related to issuance of notes payable ............... (29.8) (34.0)
Unamortized fair market value of terminated interest rate swap agreements.... 8.4 8.8
--------- ---------
Less amounts subject to compromise........................................... (4,092.0) (4,057.1)
--------- ---------
Direct corporate obligations............................................ $ - $ -
========= =========
CNC has not made any interest or principal payments on any of its direct
corporate obligations since its August 9, 2002 announcement that it intended to
effectuate a fundamental restructuring of the Company's capital structure. As a
result of its failure to make such payments and the filing of the Chapter 11
Cases, CNC has defaulted on its debt obligations, $481.3 million of principal
amount of the guaranteed D&O loans and approximately $1.9 billion of trust
preferred securities through cross-default provisions contained in the governing
instruments. CNC is also not in compliance with certain covenants under its bank
credit agreement and the guarantees of the D&O loans. During the reorganization
proceedings, the Debtors are not subject to the restrictions contained in the
bank credit agreement and the guarantees of the D&O loans.
CNC has a $1.5 billion credit facility (the "Senior Credit Facility") with
Bank of America, N.A., as administrative agent, and various other lending
institutions. The Senior Credit Facility was scheduled to mature on December 31,
2003. During 2003, $31.1 million of accrued and unpaid interest was added to the
outstanding principal amount of the Senior Credit Facility pursuant to a waiver
dated September 8, 2002.
In 1993, CNC issued $200 million of 8.125% senior notes due February 15,
2003 (the "93 Notes"). In 1994, CCP Insurance, Inc. ("CCP") issued $200 million
of 10.5% senior notes due December 15, 2004 (the "94 Notes"). CNC acquired CCP
by merger on August 31, 1995 and assumed CCP's obligations under the 94 Notes in
connection with the merger.
We sometimes refer to the 93 Notes and the 94 Notes collectively as the
"93/94 Notes." The 93/94 Notes are secured by the stock of CIHC, Conseco Capital
Management, Inc. (a registered investment advisor and wholly-owned subsidiary of
CNC), CFC and certain of its subsidiaries and certain intercompany notes. It is
anticipated that substantially all of CFC's assets will be sold in connection
with the Company's reorganization. Certain of these assets have been pledged to
the holders of the
24
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes To Consolidated Financial Statements
--------------------
93/94 Notes, and if proceeds of these pledged assets are used to pay the 93/94
Notes, then CFC may assert, by subrogation, the rights of such holders against
the Debtors.
The collateral that secures the 93/94 Notes was pledged pursuant to an
"equal and ratable" clause in the indentures governing the 93/94 Notes. The
indentures of the 93/94 Notes provide that if another creditor obtains a
security interest in certain property of CNC or any of its significant
subsidiaries, then the 93/94 Notes will automatically obtain an "equal and
ratable" security interest in such property. Certain parties have alleged that
the legal mechanism by which the 93/94 Notes obtained a security interest
somehow impairs that security interest. Such parties allege that because the
holders of the 93/94 Notes did not provide consideration for the security
interest that they received simply because another party received that security
interest, the 93/94 Notes' security interest may be voided under a theory of
unjust enrichment, fraudulent conveyance or lack of consideration. Wilmington
Trust Company, the indenture trustee under the 93/94 Notes, maintains that any
and all claims with respect to the avoidability of the 93/94 Notes are frivolous
and wholly without merit.
Effective September 9, 2002, we were subject to the default interest rate
on the Senior Credit Facility. Such rate is based on the prime rate plus a
margin of 3.75 percent (such rate averaged 8.0 percent during the first quarter
of 2003). Prior to September 9, 2002, the interest rate on the amended credit
facility was based on an IBOR rate plus a margin of 3.25 percent.
CHANGES IN COMMON STOCK
Changes in the number of shares of common stock outstanding were as
follows:
Three months ended
March 31,
------------------
2003 2002
---- ----
(Shares in thousands)
Balance, beginning of period............................................................. 346,007 344,743
Stock options exercised............................................................... - 1
Shares issued under employee benefit compensation plans............................... - 1,259
------- -------
Balance, end of period................................................................... 346,007 346,003
======= =======
RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires expanded disclosures for
and, in some cases, consolidation of significant investments in variable
interest entities ("VIE"). A VIE is an entity in which the equity investors do
not have the characteristics of a controlling financial interest, or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. Under FIN 46, a
company is required to consolidate a VIE if it is the primary beneficiary of the
VIE. FIN 46 defines primary beneficiary as the party which will absorb a
majority of the VIE's expected losses or receive a majority of the VIE's
expected residual returns, or both. FIN 46 is effective immediately for VIEs
created after January 31, 2003. For VIEs acquired before February 1, 2003, the
additional disclosure requirements are effective for financial statements issued
after January 31, 2003 and the consolidation requirements must be applied not
later than the fiscal year or interim period beginning after June 15, 2003.
The Company has investments in various types of VIEs, some of which require
additional disclosure under FIN 46, and several of which will require
consolidation under FIN 46. As further discussed in the note to the consolidated
financial statements entitled "Investments in Variable Interest Entities",
certain of our investments in VIEs are already consolidated in our financial
statements. We have identified one additional VIE inve