Business Context and Reporting Period
This Form 10-Q covers the period ended September 30, 2003, for Conseco, Inc. (formerly Conseco, Inc., an Indiana corporation, now a Delaware corporation). The filing reflects the company's emergence from Chapter 11 bankruptcy protection under a confirmed Plan of Reorganization effective September 10, 2003. Consequently, the financial statements utilize "fresh start" accounting, creating a "Successor" entity distinct from the "Predecessor" (Old Conseco). The Predecessor's financials are presented for the eight months ended August 31, 2003, while the Successor's financials cover the one month ended September 30, 2003. The company exited its finance business (Conseco Finance Corp.) and variable annuity business (Conseco Variable Insurance Company) as discontinued operations.
Key Financial Metrics
Successor (One Month Ended Sept 30, 2003):
- Total Revenues: $366.3 million
- Net Income: $24.2 million
- Net Income Applicable to Common Stock: $18.9 million
- Earnings Per Share (Basic): $0.19
- Earnings Per Share (Diluted): $0.17
- Total Assets: $29,859.9 million
- Total Liabilities: $27,062.5 million
- Shareholders' Equity: $2,797.4 million
- Cash and Cash Equivalents: $1,746.4 million ($1,724.3 million unrestricted + $22.1 million restricted)
- Investment Borrowings: $524.4 million
- Notes Payable (Direct Corporate Obligations): $1,300.0 million (New Credit Facility)
Predecessor (Eight Months Ended Aug 31, 2003):
- Total Revenues: $3,202.2 million
- Net Income: $2,201.7 million (Driven primarily by a $3,151.4 million gain on discharge of prepetition liabilities)
- Net Cash Provided by Operating Activities: $747.3 million
Material Changes vs. Prior Comparable Period
Comparisons between the Successor (Sept 2003) and Predecessor (Sept 2002) are not directly comparable due to the adoption of fresh start accounting and the restructuring of the capital structure.
- Capital Structure: The Predecessor's equity was wiped out. The Successor emerged with a new capital structure consisting of a $1.3 billion senior secured bank credit facility, $859.7 million in liquidation preference Preferred Stock, and 100 million shares of new Common Stock.
- Debt: Prepetition debt of approximately $4.1 billion was discharged. The Successor holds a new $1.3 billion credit facility.
- Assets: The Successor revalued assets to fair value. Notably, the General Motors building (valued at $1,336.3 million on the Predecessor balance sheet) was sold in September 2003 for $636.8 million, resulting in no gain or loss relative to the fresh start value.
- Goodwill: Goodwill was revalued to $1,102.8 million at the Effective Date (Aug 31, 2003) and reduced to $935.4 million by Sept 30, 2003, due to the utilization of net deferred tax assets.
- Discontinued Operations: The finance business (CFC) and variable annuity business (CVIC) were sold or liquidated, removing significant assets and liabilities from the balance sheet compared to the 2002 period.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook:
- Reorganization: The company successfully emerged from bankruptcy with a positive outlook from A.M. Best (assigned "B (Fair)" with a positive outlook) and S&P (assigned "B+" with positive CreditWatch).
- Strategic Focus: Management is focusing on higher margin products, expense reductions, and stabilizing profitability, particularly in long-term care policies.
- Credit Facility Covenants: The New Credit Facility requires the company to achieve an A.M. Best "A-" rating by August 15, 2005 (or Dec 31, 2005 if certain ratios are met). Failure to do so constitutes an event of default.
Risks and Contingencies:
- Rating Downgrades: Further downgrades could trigger defaults on the credit facility, increase policyholder lapses, and reduce sales.
- Long-Term Care Losses: Loss ratios for long-term care products exceeded 96% in the one month ended Sept 30, 2003. The company strengthened claim reserves by $87 million in Q3 2003 and may need to contribute additional capital to subsidiaries to meet regulatory capital requirements.
- Litigation: The company faces numerous lawsuits, including securities fraud class actions (stayed during bankruptcy, stay lifted Oct 2003), derivative suits, and sales practice litigation. While the company believes many are without merit, aggregate outcomes could be material.
- Liquidity: As a holding company, Conseco depends on dividends and distributions from subsidiaries to service its $1.3 billion debt. Regulatory restrictions on dividend payments from insurance subsidiaries could limit liquidity.
Unusual Items:
- Reorganization Items: The Predecessor recognized $2,163.0 million in reorganization items for the two months ended Aug 31, 2003, including a $3,151.4 million gain on debt discharge and $950.0 million in fresh start adjustments.
- Investment Writedowns: During the eight months ended Aug 31, 2003, the company recorded $45.9 million in writedowns of fixed maturity investments deemed other-than-temporarily impaired.
Important Facts for Investor Verification
- Debt Covenants: Verify the company's ability to meet the A.M. Best "A-" rating requirement by 2005 to avoid default on the $1.3 billion credit facility.
- Long-Term Care Reserves: Monitor the adequacy of reserves for long-term care products, given the high loss ratios and recent $87 million reserve strengthening.
- Capital Contributions: Confirm if additional capital contributions are required to be made to insurance subsidiaries to maintain statutory capital ratios above 250%.
- Litigation Exposure: Track the status of the securities fraud class actions and derivative suits now that the bankruptcy stay has been lifted.
- Dividend Restrictions: Assess the impact of state insurance regulations and consent orders (specifically in Texas) on the ability of subsidiaries to transfer cash to the parent company for debt service.
- Investment Portfolio: Review the composition of the investment portfolio, specifically the exposure to below-investment grade securities and structured securities, for potential future impairments.