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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 June 30, 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 August 8, 2003: 346,007,133
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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
June 30, December 31,
2003 2002
---- ----
(unaudited)
Investments:
Actively managed fixed maturities at fair value (amortized cost: 2003 - $19,050.1;
2002 - $18,989.8).................................................................... $20,286.9 $19,417.4
Equity securities at fair value (cost: 2003 - $132.4; 2002 - $161.4)................... 141.0 156.0
Mortgage loans......................................................................... 1,230.1 1,308.3
Policy loans........................................................................... 520.6 536.2
Venture capital investment in AT&T Wireless Services, Inc. at fair value
(cost: 2003 and 2002 - $14.2)....................................................... 33.5 25.0
Other invested assets ................................................................. 386.3 340.8
--------- ---------
Total investments.................................................................. $22,598.4 21,783.7
Cash and cash equivalents:
Held by the parent company............................................................. 29.7 41.9
Held by subsidiaries................................................................... 1,364.4 1,227.0
Accrued investment income................................................................. 394.1 389.8
Cost of policies purchased................................................................ 1,042.3 1,170.0
Cost of policies produced................................................................. 1,902.6 2,014.4
Reinsurance receivables................................................................... 892.0 934.2
Income tax assets......................................................................... 53.4 101.5
Goodwill.................................................................................. 100.0 100.0
Assets held in separate accounts and investment trust .................................... 417.2 447.0
Assets of discontinued operations......................................................... - 17,624.3
Other assets.............................................................................. 745.0 675.2
--------- ---------
Total assets....................................................................... $29,539.1 $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
June 30, December 31,
2003 2002
---- ----
(unaudited)
Liabilities:
Liabilities for insurance and asset accumulation products:
Interest-sensitive products.............................................................. $13,126.1 $13,469.5
Traditional products..................................................................... 8,159.9 7,971.4
Claims payable and other policyholder funds.............................................. 901.9 909.2
Liabilities related to separate accounts and investment trust............................ 417.2 447.0
Other liabilities.......................................................................... 982.1 673.5
Liabilities of discontinued operations..................................................... - 17,624.3
Investment borrowings...................................................................... 585.5 669.7
--------- ---------
Total liabilities not subject to compromise.......................................... 24,172.7 41,764.6
--------- ---------
Liabilities subject to compromise.......................................................... 4,971.7 4,873.3
--------- ---------
Total liabilities.................................................................... 29,144.4 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 and 2002 - 346,007,133).................. 3,497.4 3,497.0
Accumulated other comprehensive income..................................................... 1,143.4 580.6
Retained deficit........................................................................... (6,669.3) (6,629.7)
--------- ---------
Total shareholders' deficit.......................................................... (1,526.8) (2,050.4)
--------- ---------
Total liabilities and shareholders' deficit.......................................... $29,539.1 $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 Six months ended
June 30, June 30,
------------------- -----------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues:
Insurance policy income................................................... $ 813.9 $ 874.5 $1,687.5 $ 1,823.6
Net investment income:
Insurance and fee-based segment general account assets.................. 346.0 390.8 694.3 794.4
Equity-indexed and separate account products............................ 41.5 (55.7) 18.4 (73.7)
Venture capital income (loss) related to investment in
AT&T Wireless Services, Inc........................................... 6.0 (23.7) 8.5 (100.0)
Other................................................................... 6.1 3.0 9.2 5.0
Net realized investment gains (losses) ................................... (2.3) (223.6) 10.7 (253.2)
Fee revenue and other income.............................................. 12.8 18.4 26.5 40.6
-------- --------- -------- ---------
Total revenues........................................................ 1,224.0 983.7 2,455.1 2,236.7
-------- --------- -------- ---------
Benefits and expenses:
Insurance policy benefits................................................. 872.6 749.6 1,731.3 1,586.5
Provision for losses...................................................... 15.8 100.0 31.1 140.0
Interest expense (contractual interest of $97.2 and $194.8 for the three
and six months ended June 30, 2003, respectively)....................... 73.5 82.8 147.1 164.3
Amortization.............................................................. 138.6 250.1 296.6 435.0
Other operating costs and expenses........................................ 148.4 141.7 303.3 317.1
Special charges........................................................... - 48.2 - 68.2
Extraordinary gain on extinguishment of debt.............................. - (1.8) - (1.8)
Reorganization items...................................................... 14.4 - 32.5 -
-------- --------- -------- ---------
Total benefits and expenses........................................... 1,263.3 1,370.6 2,541.9 2,709.3
-------- --------- -------- ---------
Loss before income taxes, minority interest, discontinued operations
and cumulative effect of accounting change......................... (39.3) (386.9) (86.8) (472.6)
Income tax expense (benefit):
Tax benefit on period losses.............................................. (16.6) (135.2) (31.2) (161.3)
Valuation allowance for deferred tax assets............................... - 1,003.0 - 1,003.0
-------- --------- -------- ---------
Loss before minority interest, discontinued operations
and cumulative effect of accounting change......................... (22.7) (1,254.7) (55.6) (1,314.3)
Minority interest:
Distributions on Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts, net of income taxes................... - 29.2 - 58.4
-------- --------- -------- -----------
Loss before discontinued operations and cumulative
effect of accounting change......................................... (22.7) (1,283.9) (55.6) (1,372.7)
Discontinued operations, net of income taxes................................. 2.1 (49.2) 16.0 (56.3)
Cumulative effect of accounting change for goodwill impairment, net of
income taxes.............................................................. - - - (2,949.2)
-------- --------- -------- ---------
Net loss.............................................................. (20.6) (1,333.1) (39.6) (4,378.2)
Preferred stock dividends.................................................... - .9 - 1.9
-------- --------- -------- ---------
Net loss applicable to common stock................................... $ (20.6) $(1,334.0) $ (39.6) $(4,380.1)
======== ========= ======== =========
(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 Six months ended
June 30, June 30,
------------------ -----------------
2003 2002 2003 2002
---- ---- ---- ----
Loss per common share:
Basic:
Weighted average shares outstanding........................ 346,007,000 346,005,000 346,007,000 345,607,000
=========== =========== =========== ===========
Loss before discontinued operations and cumulative
effect of accounting change.............................. $(.07) $(3.72) $(.16) $ (3.97)
Discontinued operations.................................... .01 (.14) .05 (.16)
Cumulative effect of accounting change..................... - - - (8.54)
----- ------ ----- ------
Net loss................................................. $(.06) $(3.86) $(.11) $(12.67)
===== ====== ===== =======
Diluted:
Weighted average shares outstanding........................ 346,007,000 346,005,000 346,007,000 345,607,000
=========== =========== =========== ===========
Loss before discontinued operations and cumulative
effect of accounting change............................ $(.07) $(3.72) $(.16) $ (3.97)
Discontinued operations.................................... .01 (.14) .05 (.16)
Cumulative effect of accounting change..................... - - - (8.54)
----- ------ ----- ------
Net loss............................................... $(.06) $(3.86) $(.11) $(12.67)
===== ====== ===== =======
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........................................ (39.6) - - - (39.6)
Change in unrealized appreciation
of investments (net of applicable income tax
expense of $26.2)............................. 562.8 - - 562.8 -
---------
Total comprehensive income.................. 523.2
Change in shares for employee benefit plans....... .4 - .4 - -
--------- ------ -------- -------- ---------
Balance, June 30, 2003............................... $(1,526.8) $501.7 $3,497.4 $1,143.4 $(6,669.3)
========= ====== ======== ======== =========
Balance, January 1, 2002............................. $ 4,753.0 $499.6 $3,484.3 $ (439.0) $ 1,208.1
Comprehensive loss, net of tax:
Net loss........................................ (4,378.2) - - - (4,378.2)
Change in unrealized depreciation of
investments (net of applicable income tax
expense of $82.4)............................. 143.1 - - 143.1 -
---------
Total comprehensive loss.................... (4,235.1)
Issuance of shares for stock options and for
employee benefit plans.......................... 15.1 - 15.1 - -
Payment-in-kind dividends on convertible
preferred stock................................. 1.9 1.9 - - -
Dividends on preferred stock...................... (1.9) - - - (1.9)
--------- ------- -------- -------- ---------
Balance, June 30, 2002............................... $ 533.0 $501.5 $3,499.4 $ (295.9) $(3,172.0)
========= ====== ======== ======== =========
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)
Six months ended
June 30,
----------------
2003 2002
---- ----
Cash flows from operating activities:
Insurance policy income........................................................................ $ 1,431.2 $ 1,557.9
Net investment income.......................................................................... 716.5 1,837.1
Fee revenue and other income................................................................... 26.5 158.3
Insurance policy benefits...................................................................... (1,132.7) (1,261.4)
Interest expense............................................................................... - (726.4)
Policy acquisition costs....................................................................... (227.1) (271.0)
Special charges................................................................................ - (33.3)
Reorganization items........................................................................... (10.9) -
Other operating costs.......................................................................... (335.5) (669.4)
Taxes.......................................................................................... 76.3 (114.5)
--------- ---------
Net cash provided by operating activities.................................................... 544.3 477.3
--------- ---------
Cash flows from investing activities:
Sales of investments........................................................................... 4,286.2 11,498.9
Maturities and redemptions of investments...................................................... 1,198.0 766.8
Purchases of investments....................................................................... (5,331.8) (11,764.7)
Cash received from the sale of finance receivables, net of expenses............................ - 619.6
Principal payments received on finance receivables............................................. - 4,323.7
Finance receivables originated................................................................. - (4,423.0)
Other.......................................................................................... (35.9) (105.0)
--------- ----------
Net cash provided by investing activities ................................................... 116.5 916.3
--------- ----------
Cash flows from financing activities:
Amounts received for deposit products.......................................................... 994.9 2,304.2
Withdrawals from deposit products.............................................................. (1,446.3) (2,537.2)
Issuance of notes payable...................................................................... - 4,259.6
Payments on notes payable...................................................................... - (5,434.7)
Ceding commission received on reinsurance transactions......................................... - 83.0
Change in cash held in restricted accounts for settlement of borrowings........................ - 34.5
Investment borrowings.......................................................................... (84.2) (1,637.8)
Dividends on preferred shares and distributions on
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts........... - (56.8)
--------- ----------
Net cash used by financing activities...................................................... (535.6) (2,985.2)
--------- ----------
Net increase (decrease) in cash and cash equivalents....................................... 125.2 (1,591.6)
Cash and cash equivalents, beginning of period.................................................... 1,268.9 3,060.8
--------- ----------
Cash and cash equivalents, end of period.......................................................... $ 1,394.1 $ 1,469.2
========= ==========
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.
We accounted for our finance business as a discontinued operation in 2002 once
we formalized plans to sell our finance business and CFC and certain of its
subsidiaries filed 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"). We completed a
number of additional steps in 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 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. That restructuring was completed and the Bankruptcy Court
entered final orders approving the terms of the sale of CFC on March 14, 2003.
On April 1, 2003, CFC filed its liquidating plan of reorganization with the
Bankruptcy Court. The sale of CFC's business and assets was concluded in the
second quarter of 2003. No proceeds from the sale will be paid to CNC as a
result of its ownership of CFC. As a result of these events, CNC no longer
controls CFC. As of March 31, 2003, CNC 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 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.
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.
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 subject to confirmation by the
Bankruptcy Court. On March 18, 2003, the Bankruptcy Court approved the Debtors'
Second Amended Disclosure
8
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Statement (the "Disclosure Statement"), summarizing the terms of the Debtors'
Second Amended Joint Plan of Reorganization (as subsequently amended, 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
June 6, 2003. A hearing to consider confirmation of the Plan began on June 13,
2003. On June 16, 2003, the Debtors filed a Third Amended Joint Plan of
Reorganization. On July 15, 2003, the Debtors filed a Fourth Amended Joint Plan
of Reorganization, principally reflecting modifications to the non-debtor
release provision and related components of the Plan.
On August 2, 2003, the Debtors filed an amended declaration of the voting
agent, which noted that all classes, other than the holders of the
Company-obligated mandatorily redeemable preferred securities of subsidiary
trusts ("Trust Preferred Securities" or "TOPrS"), voted to accept the Plan. On
July 31, 2003, CNC announced that it had reached an agreement-in-principle with
the TOPrS, and the Debtors expect to file a Fifth Amended Joint Plan of
Reorganization incorporating the terms of this settlement. The Debtors will
emerge from bankruptcy if and when the Plan, as amended, is approved by the
Bankruptcy Court, and all conditions to the consummation of the Plan have been
satisfied or waived.
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 are
to be eligible 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 been 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. Although the ultimate number and
amount of allowed claims is not presently known, on July 11, 2003, the Debtors
filed a declaration of the claims agent regarding the status of general
unsecured claims.
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 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 receiving no 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.
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, our plan of reorganization.
DISCONTINUED FINANCE BUSINESS - 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
9
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
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, and Federal National Mortgage
Association, as a major bond holder, agreed to support the sale of CFC Assets to
CFN and GE. 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 was completed in June 2003. No
proceeds resulting from the sale are available to satisfy the creditors of CNC
or CIHC.
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 six months of 2003, the Company recognized a charge of $32.5 million
associated with the Chapter 11 Cases for fees payable to professionals to assist
with the filing of the Chapter 11 Cases.
We are 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 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.
10
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Our unaudited consolidated financial statements reflect normal recurring
adjustments that are necessary to present fairly our 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, CNC 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, certain investments, assets and liabilities related
to income taxes, goodwill, liabilities for insurance and asset accumulation
products, liabilities related to litigation, guaranty fund assessment accruals
and liabilities related to guarantees of bank loans and the related interest
loans to certain current and former directors, officers and key employees. If
our future experience differs from these estimates and assumptions, our
financial statements would be materially affected.
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 six months ended June 30, 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.
11
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Changes in the carrying amount of goodwill for the six months ended June
30, 2003 and 2002, are as follows:
Six months ended
June 30,
------------------
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
====== =========
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):
June 30, 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................................................... $ 483.3 $ 480.8
Interest payable...................................................... 237.1 171.6
Accrual for distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary trusts............... 90.1 90.1
Liability for retirement benefits pursuant to executive
employment agreements.............................................. 22.6 22.6
Liability for deferred compensation................................... 2.1 2.3
Other liabilities..................................................... 9.0 48.8
-------- --------
Total other liabilities subject to compromise...................... 844.2 816.2
Notes payable - direct corporate obligations.............................. 4,127.5 4,057.1
-------- --------
Total liabilities subject to compromise............................ $4,971.7 $4,873.3
======== ========
12
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 June 30, 2003
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
ASSETS
Cash and cash equivalents...................................... $ 28.5 $ 1,365.6 $ - $ 1,394.1
Investments.................................................... 6.2 22,592.2 - 22,598.4
Investment in wholly-owned subsidiaries
(eliminated in consolidation).............................. 6,179.1 1,239.0 (7,418.1) -
Receivable from affiliates
(eliminated in consolidation).............................. 1,257.8 1,164.4 (2,422.2) -
Income tax assets.............................................. 91.2 25.1 (62.9) 53.4
Other assets................................................... 72.7 5,420.7 (.2) 5,493.2
--------- ---------- --------- ---------
Total assets......................................... $ 7,635.5 $31,807.0 $(9,903.4) $29,539.1
========= ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Liabilities:
Liabilities for insurance and asset accumulation products.. $ - $22,605.1 $ - $22,605.1
Payables to subsidiaries (eliminated in consolidation)..... 8.2 1,288.0 (1,296.2) -
Other liabilities.......................................... 23.0 1,544.6 - 1,567.6
Liabilities subject to compromise.......................... 4,971.7 - - 4,971.7
Affiliated liabilities subject to compromise
(eliminated in consolidation)........................... 1,177.4 - (1,177.4) -
--------- --------- --------- ---------
Total liabilities.................................... 6,180.3 25,437.7 (2,473.6) 29,144.4
--------- --------- --------- ---------
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts........................... 1,921.5 - - 1,921.5
Shareholders' equity (deficit):
Preferred stock............................................ 1,654.6 - (1,152.9) 501.7
Common stock and additional paid-in capital (no par value,
1,000,000,000 shares authorized, shares issued and
outstanding: 2003 and 2002 - 346,007,133)............... 3,497.7 6,346.1 (6,346.4) 3,497.4
Accumulated other comprehensive income..................... 1,143.4 1,143.4 (1,143.4) 1,143.4
Retained earnings (deficit)................................ (6,762.0) (1,120.2) 1,212.9 (6,669.3)
--------- --------- --------- ---------
Total shareholders' equity (deficit)................. (466.3) 6,369.3 (7,429.8) (1,526.8)
--------- --------- --------- ---------
Total liabilities and shareholders' equity (deficit). $ 7,635.5 $31,807.0 $(9,903.4) $29,539.1
========= ========= ========= =========
13
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
(eliminated in consolidation)......................... 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
========= ========= ========= =========
14
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 June 30, 2003
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
Revenues:
Insurance policy income....................................... $ - $ 813.9 $ - $ 813.9
Net investment income......................................... 1.6 392.0 - 393.6
Net investment income from venture capital investments........ - 6.0 - 6.0
Fee and interest income - affiliated
(eliminated in consolidation).............................. .2 9.2 (9.4) -
Net investment losses......................................... (.3) (2.0) - (2.3)
Fee revenue and other income.................................. .1 12.7 - 12.8
------ -------- ------ --------
Total revenue........................................... 1.6 1,231.8 (9.4) 1,224.0
------ -------- ------ --------
Expenses:
Insurance policy benefits..................................... - 872.6 - 872.6
Provision for losses.......................................... 1.3 14.5 - 15.8
Interest expense.............................................. 69.8 3.7 - 73.5
Interest expense - affiliated (eliminated in consolidation)... - 7.6 (7.6) -
Amortization.................................................. - 138.6 - 138.6
Operating costs and expenses - affiliated
(eliminated in consolidation).............................. 2.6 - (2.6) -
Operating costs and expenses.................................. (29.9) 178.3 - 148.4
Reorganization items.......................................... 14.4 - - 14.4
------ -------- ------ --------
Total expenses.......................................... 58.2 1,215.3 (10.2) 1,263.3
------ -------- ------ --------
Income (loss) before income taxes, equity in undistributed
earnings of subsidiaries and distributions on Company-
obligated mandatorily redeemable preferred securities
of subsidiary trusts................................. (56.6) 16.5 .8 (39.3)
Income tax benefit on period income........................... (9.9) (6.7) - (16.6)
------ -------- ------ --------
Income (loss) before equity in undistributed earnings
of subsidiaries and discontinued operations........ (46.7) 23.2 .8 (22.7)
Equity in undistributed earnings of subsidiaries before
discontinued operations (eliminated in consolidation).... 29.3 - (29.3) -
------ -------- ------ --------
Income (loss) before discontinued operations............ (17.4) 23.2 (28.5) (22.7)
Discontinued operations....................................... - 2.1 - 2.1
------ -------- ------ --------
Net income (loss)....................................... (17.4) 25.3 (28.5) (20.6)
Preferred stock dividends - affiliated........................ 6.6 - (6.6) -
------ -------- ------ --------
Income (loss) applicable to common stock................ $(24.0) $ 25.3 $(21.9) $ (20.6)
====== ======== ====== ========
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 six months ended June 30, 2003
(Dollars in millions)
Conseco and Subsidiaries Conseco, Inc.
subsidiaries in not in and subsidiaries
reorganization reorganization Eliminations consolidated
-------------- -------------- ------------ ------------
Revenues:
Insurance policy income..................................... $ - $1,687.5 $ - $1,687.5
Net investment income....................................... 3.0 718.9 - 721.9
Net investment income from venture capital investments...... - 8.5 - 8.5
Fee and interest income - affiliated
(eliminated in consolidation)............................ .4 18.5 (18.9) -
Net investment gains (losses)............................... (.3) 11.0 - 10.7
Fee revenue and other income................................ .3 26.2 - 26.5
------- -------- ------ --------
Total revenue......................................... 3.4 2,470.6 (18.9) 2,455.1
------- -------- ------ --------
Expenses:
Insurance policy benefits................................... - 1,731.3 - 1,731.3
Provision for losses........................................ 2.5 28.6 - 31.1
Interest expense............................................ 140.6 6.5 - 147.1
Interest expense - affiliated (eliminated in consolidation). - 15.2 (15.2) -
Amortization................................................ - 296.6 - 296.6
Operating costs and expenses - affiliated
(eliminated in consolidation)............................ 5.3 - (5.3) -
Operating costs and expenses................................ (26.4) 329.7 - 303.3
Reorganization items........................................ 32.5 - - 32.5
------- -------- ------ --------
Total expenses........................................ 154.5 2,407.9 (20.5) 2,541.9
------- -------- ------ --------
Income (loss) before income taxes, equity in
undistributed earnings of subsidiaries and
distributions on Company-obligated mandatorily
redeemable preferred securities of subsidiary
trusts............................................. (151.1) 62.7 1.6 (86.8)
Income tax benefit on period income......................... (13.5) (17.7) - (31.2)
------- -------- ------ --------
Income (loss) before equity in undistributed earnings
of subsidiaries and discontinued operations...... (137.6) 80.4 1.6 (55.6)
Equity in undistributed earnings of subsidiaries before
discontinued operations (eliminated in consolidation).. 94.6 - (94.6) -
------- -------- ------ --------
Income (loss) before discontinued operations.......... (43.0) 80.4 (93.0) (55.6)
Discontinued operations..................................... - 16.0 - 16.0
------- -------- ------ --------
Net income (loss)..................................... (43.0) 96.4 (93.0) (39.6)
Preferred stock dividends - affiliated...................... 13.2 - (13.2) -
------- -------- ------ --------
Income (loss) applicable to common stock.............. $ (56.2) $ 96.4 $(79.8) $ (39.6)
======= ======== ====== ========
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 six months ended June 30, 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............ $(10.9) $ 556.0 $ (.8) $ 544.3
Net cash provided (used) by investing activities............ (1.9) 127.2 (8.8) 116.5
Net cash provided (used) by financing activities............ (.2) (545.0) 9.6 (535.6)
------ -------- ---- --------
Net increase (decrease) in cash and cash equivalents........ (13.0) 138.2 - 125.2
Cash and cash equivalents, beginning of period.............. 41.5 1,227.4 - 1,268.9
------ -------- ---- --------
Cash and cash equivalents, end of period................. $ 28.5 $1,365.6 $ - $1,394.1
====== ========= ==== ========
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 June 30, 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).
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 June 30, 2003, and December 31, 2002, were
as follows:
June 30, December 31,
2003 2002
---- ----
(Dollars in millions)
Unrealized gains on investments....................................................... $1,196.5 $448.1
Adjustments to cost of policies purchased and cost of policies produced............... (267.2) (95.3)
Deferred income tax benefit........................................................... 223.4 249.6
Other................................................................................. (9.3) (21.8)
-------- ------
Accumulated other comprehensive income........................................... $1,143.4 $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 June 30, 2003, our venture capital investments consisted of 4.1 million
shares of AT&T Wireless Services, Inc. ("AWE") with a value of $33.5 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 $6.0 million and $(23.7) million in the second
quarters of 2003 and 2002, respectively, related to this investment. Our venture
capital investment income (losses) related to this investment were $8.5 million
and $(100.0) million in the first six months of 2003 and 2002, respectively.
COST OF POLICIES PRODUCED
The costs that vary with, and are primarily related to, producing new
insurance business are referred to as cost of policies produced. We amortize
these costs (using the interest rate credited to the underlying policy for
universal life or investment-type products and the projected investment earnings
rate for other products): (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 produced 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 (loss)
within shareholders' deficit.
When we replace an existing insurance contract with another insurance
contract with substantially different terms, all unamortized cost of policies
produced related to the replaced contract is immediately written off. When we
replace an existing insurance contract with another insurance contract with
substantially similar terms, we continue to defer the cost of policies produced
associated with the replaced contract.
We regularly evaluate the recoverability of the unamortized balance of the
cost of policies produced. We consider estimated future gross profits or future
premiums, expected mortality or morbidity, interest earned and credited rates,
persistency and expenses in determining whether the balance is recoverable. If
we determine a portion of the unamortized balance is not recoverable, it is
charged to amortization expense.
COST OF POLICIES PURCHASED
The cost assigned to the right to receive future cash flows from contracts
existing at the date of an acquisition is referred to as the cost of policies
purchased. We also defer renewal commissions paid in excess of ultimate
commission levels related to the purchased policies in this account. The balance
of this account is amortized, evaluated for recovery, and adjusted for the
impact of unrealized gains (losses) in the same manner as the cost of policies
produced described above.
The discount rate we use to determine the value of the cost of policies
purchased is the rate of return we need to earn in order to invest in the
business being acquired. In determining this required rate of return, we
consider many factors including: (i) the magnitude of the risks associated with
each of the actuarial assumptions used in determining expected future cash
flows; (ii) the cost of our capital required to fund the acquisition; (iii) the
likelihood of changes in projected future cash flows that might occur if there
are changes in insurance regulations and tax laws; (iv) the acquired company's
compatibility with other Conseco activities that may favorably affect future
cash flows; (v) the complexity of the acquired company; and (vi) recent prices
(i.e., discount rates used in determining valuations) paid by others to acquire
similar blocks of business.
The amortization related to the cost of policies purchased was $83.3
million and $98.1 million in the first six 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.
18
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
EARNINGS PER SHARE
A reconciliation of net loss and shares used to calculate basic and diluted
loss per share is as follows:
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in millions and shares in thousands)
Net loss.......................................................... $(20.6) $(1,333.1) $(39.6) $(4,378.2)
Preferred stock dividends......................................... - (.9) - (1.9)
------ --------- ------ ---------
Net loss applicable to common ownership
for basic earnings per share............................... $(20.6) $(1,334.0) $(39.6) $(4,380.1)
====== ========= ====== =========
Shares:
Weighted average shares outstanding
for basic and diluted earnings per share..................... 346,007 346,005 346,007 345,607
======= ======= ======= =======
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.
The following summarizes the equivalent common shares for securities that
were not included in the computation of diluted earnings per share during the
three and six months ended June 30, 2003 and 2002, because doing so would have
been antidilutive in the periods presented.
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
(Shares in thousands)
Equivalent common shares that were antidilutive during the period:
Stock options..................................................... - 3,351 - 2,914
Employee benefit plans............................................ 874 889 874 907
Assumed conversion of convertible preferred stock................. 29,129 28,414 29,129 28,273
------ ------ ------ ------
Antidilutive equivalent common shares........................... 30,003 32,654 30,003 32,094
====== ====== ====== ======
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
19
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
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.
Operating information regarding the insurance and corporate segments was as
follows:
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in millions)
Revenues:
Insurance and fee-based segment:
Insurance policy income:
Annuities............................................... $ 29.7 $ 34.5 $ 68.5 $ 63.0
Supplemental health..................................... 572.9 564.1 1,148.9 1,137.3
Life.................................................... 146.8 133.2 300.5 315.0
Other................................................... 17.5 28.8 37.7 59.3
Net investment income (a)................................. 385.2 330.3 706.6 710.2
Fee revenue and other income (a).......................... 12.8 23.3 26.2 50.0
Net realized investment gains (losses) (a)................ (2.3) (223.6) 10.7 (253.2)
-------- -------- -------- --------
Total insurance and fee-based segment revenues........ 1,162.6 890.6 2,299.1 2,081.6
-------- -------- -------- --------
Corporate and other:
Net investment income..................................... 6.1 3.0 9.2 5.0
Venture capital gain (loss) related to investment in AWE.. 6.0 (23.7) 8.5 (100.0)
Revenue from the major medical business in run-off........ 49.3 118.8 138.3 259.8
-------- -------- -------- --------
Total corporate segment revenues...................... 61.4 98.1 156.0 164.8
-------- -------- -------- --------
Eliminations................................................ - (5.0) - (9.7)
-------- -------- -------- --------
Total revenues........................................ 1,224.0 983.7 2,455.1 2,236.7
-------- -------- -------- --------
Expenses:
Insurance and fee-based segment:
Insurance policy benefits................................. 834.5 665.8 1,619.4 1,415.8
Amortization.............................................. 130.6 232.9 279.2 395.0
Interest expense on investment borrowings................. 3.8 3.3 6.4 10.3
Other operating costs and expenses........................ 148.9 121.7 292.1 257.9
Special charges........................................... - 36.7 - 39.7
-------- -------- -------- ---------
Total insurance and fee-based segment expenses.......... 1,117.8 1,060.4 2,197.1 2,118.7
-------- -------- -------- ---------
(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 Six months ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in millions)
Corporate and other:
Interest expense on corporate debt........................ 69.8 79.5 140.7 154.0
Provision for losses and interest expense related to stock
purchase plan........................................... 15.8 100.0 31.1 140.0
Expenses from the major medical business in run-off....... 49.3 118.8 138.3 259.8
Other corporate expenses, less charges to subsidiaries for
services provided....................................... (3.8) 7.2 2.2 19.8
Extraordinary gain on extinguishment of debt.............. - (1.8) - (1.8)
Reorganization items...................................... 14.4 - 32.5 -
Special charges........................................... - 11.5 - 28.5
-------- -------- -------- --------
Total corporate segment expenses........................ 145.5 315.2 344.8 600.3
-------- -------- -------- --------
Eliminations................................................ - (5.0) - (9.7)
-------- -------- -------- --------
Total expenses.......................................... 1,263.3 1,370.6 2,541.9 2,709.3
-------- -------- -------- --------
Income (loss) before income taxes, minority interest and
cumulative effect of accounting change:
Insurance and fee-based operations........................ 44.8 (169.8) 102.0 (37.1)
Corporate interest expense and other items................ (84.1) (217.1) (188.8) (435.5)
-------- -------- -------- --------
Loss before income taxes, minority interest,
discontinued operations and cumulative effect of
accounting change................................... $ (39.3) $ (386.9) $ (86.8) $ (472.6)
======== ======== ======== ========
- --------------------
(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 $39.4 million and $52.2 million
in the first six 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 $57.8 million and $(18.3) million in the first
six 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 $80.0 million and $32.8 million at
June 30, 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
21
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
Financial Accounting Standards No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities". The Company records the change in
the fair values of the embedded derivatives in current earnings as a component
of policyholder benefits. The fair value of these derivatives, which are
classified as "liabilities for interest-sensitive products", was $319.9 million
and $274.0 million at June 30, 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 June 30, 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. These
shares have been held by the D&O lenders as collateral for the loans. In
addition, as of June 30, 2003, Conseco had provided loans to participants for
interest on the D&O loans totaling $207.8 million.
Under the terms of the Plan, certain eligible participants would have their
initial D&O loan amounts reduced in settlement of certain claims they may have
against the Company. These eligible participants currently 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 six months
of 2003, we established a noncash provision in connection with these guarantees
and loans of $31.1 million. At June 30, 2003, the reserve for losses on the loan
guarantees and on the loans held by Conseco totaled $691.1 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 $59.3 million at
June 30, 2003). At June 30, 2003, the guaranteed bank loans and interest loans
exceeded the value of the collateral held and the reserve for losses by
approximately $60 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 was the guarantor of certain obligations of CFC. The exposure under
the guarantees was limited to the balance of certain credit facilities not to
exceed $250 million. If the Plan is confirmed, CIHC will have no additional
exposure as guarantor of these facilities.
In accordance with the terms of the Company's former Chief Executive
Officer's employment agreement, Bankers Life and 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 June 30, 2003 was $17.2 million and is included in the caption "Other
liabilities" in the liability section of the consolidated balance sheet.
REINSURANCE
The cost of reinsurance ceded totaled $149.9 million and $188.1 million in
the first six 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
$137.3 million and $166.0 million in the first six months of 2003 and 2002,
respectively. Reinsurance premiums assumed totaled $46.2 million and $45.1
million in the first six 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
22
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
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 June 30, 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 $1.9 billion and $428.0 million, respectively, as of June 30, 2003. The
ordinary loss carryforwards include amounts attributed to losses incurred as a
result of our prior ownership of CFC and losses from the operation of our other
businesses. 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. The reorganization will
result in an "ownership change" for purposes of Section 382 of the Internal
Revenue Code of 1986, as amended, which may limit the use of ordinary loss
carryforwards and capital loss carryforwards.
At June 30, 2003, Conseco had $428.0 million of capital loss carryforwards.
These carryforwards will expire as follows: $23.2 million in 2006, $299.2
million in 2007 and $105.6 million 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:
Six months ended
June 30,
------------------
2003 2002
---- ----
U.S. statutory corporate rate.................................................................. (35.0)% (35.0)%
Valuation allowance............................................................................ - 212.2
Income tax credits............................................................................. (2.2) (.5)
Other nondeductible expenses................................................................... .9 1.1
State taxes.................................................................................... .4 .3
---- -----
Effective tax rate...................................................................... (35.9)% 178.1%
===== =====
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 June 30, 2003 and December 31,
2002:
June 30, December 31,
2003 2002
---- ----
(Dollars in millions)
$1.5 billion Senior Credit Facility.......................................... $ 1,594.2 $ 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.................................................. 4,145.1 4,082.3
Unamortized net discount related to issuance of notes payable ............... (25.5) (34.0)
Unamortized fair market value of terminated interest rate swap agreements.... 7.9 8.8
--------- ---------
Less amounts subject to compromise........................................... (4,127.5) (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 bankruptcy
proceedings, the Debtors are not subject to the restrictions contained in the
bank credit agreement and the guarantees of the D&O loans, and the Bankruptcy
Code automatically stays any collection of prepetition claims.
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, $62.8 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
24
CONSECO, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION AS OF DECEMBER 17, 2002)
Notes to Consolidated Financial Statements
--------------------------
CNC), CFC and certain of its subsidiaries and certain intercompany notes.
Certain of the assets of CFC have been pledged to the holders of the 93/94
Notes. The Plan proposes that CFC pay the 93/94 Notes.
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 six
months 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:
Six months ended
June 30,
-------------------
2003 2002
---- ----
(Shares in thousands)
Balance, beginning of period............................................................. 346,007 344,743
Stock options exercised............................................................... - 5
Shares issued under employee benefit compensation plans............................... - 1,259
------- -------
Balance, end of period................................................................... 346,007 346,007
======= =======
RECENTLY ISSUED ACCOUNTING STANDARDS
The FASB's Derivative Implementation Group issued SFAS No. 133
Implementation Issue No. B36, "Embedded Derivatives: Modified Coinsurance
Arrangements and Debt Instruments that Incorporate Credit Risk Exposures that
are Unrelated or Only Partially Related to the Creditworthiness of the Obligor
of Those Instruments" ("DIG B36") in April 2003. DIG B36 addresses specific
circumstances under which bifurcation of an instrument into a host contract and
an embedded derivative is required. DIG B36 requires the bifurcation of a
derivative from the receivable or payable related to a modified coinsurance
agreement, where the yield on the receivable and payable is based on a return of
a specified block of assets rather than the creditworthiness of the ceding
company. The effective date of the implementation guidance is October 1, 2003.
We have determined that certain of our reinsurance payable balances contain
embedded derivatives that will be required to be bifurcated pursuant to DIG B36.
While we have not yet determined the fair value of the embedded derivatives, we
do not believe that accounting for them in accordance with DIG B36 will have a
material impact on the Company's consolidated financial position or cash flows.
The FASB issued Financial Accounting Standards No. 149 "Amendment of SFAS
No. 133 on Derivative Instruments and Hedging Activities" ("SFAS 149") in April
2003. SFAS 149 amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under Statement of Financial Accounting S