Tempus Partners Turnaround Specialist!

Remaking History – The Turnaround At Conseco

Everyone knew the bankruptcy filing of Conseco Inc. was one of the largest in U.S. corporate history. But few people knew that the job of turning the company around would be even larger.

With more than $52 billion in assets, the petition of the one-time high-flying financial services corporation in December of 2002 ranked behind only WorldCom’s $107 billion bankruptcy and the $63 billion filing of Enron Corp.

Its excesses and downfall were well-documented. There was the lavish lifestyle of its founder and former CEO Stephen Hilbert; the hundreds of millions of dollars the company loaned to its directors; and the rapid succession of acquisitions the company made during the 1980s and 1990s including a final, ruinous blunder.

In its darkest days Conseco was billions of dollars in debt with its operations in turmoil. Insurance regulators had downgraded the company. Debt-rating agencies had lowered their scores and stock analysts were questioning the company’s accounting methods.

But Conseco survived and its recovery is a lesson for other failing companies looking for a lifeline. The right team of experienced turnaround specialists can impartially evaluate a company, swiftly eliminate weaknesses and focus on its strengths. In the case of Conseco, that team was Tempus Partners.

This is a case study of how William J. Shea, L. Michael Hone and their Tempus associates returned Conseco to profitability by restructuring the company’s debt, reorganizing its operations and marshalling some of the country’s top financial and legal experts to act as outside advisors. Today, Conseco is actively traded with a market capitalization of more than $3 billion.

“When you undertake a turnaround it doesn’t make a difference what the business is, as long as your people have certain skill sets,” says Shea. “We had a game plan and the people to implement it at Conseco.”

One Deal Too Many

For most of the 1980s and 90s Conseco could do no wrong. Through numerous acquisitions the Indianapolis-based firm became one of the largest insurers in the country and a darling on Wall Street. After going public in 1985, Conseco’s stock soared with an average total return of 47 percent per year from 1988 to 1998.

But Conseco’s fortunes turned in April of 1998 when it acquired Green Tree Financial Corp, a Minnesota mobile home lender, for $6 billion. The plan was to market a broader array of services to each other’s customers. Conseco was a major seller of life insurance, annuities and supplemental health insurance such as cancer, heart, stroke and Medicare coverage. Green Tree was the largest originator of loans for the manufactured housing market and the second largest provider of private credit cards.

Conseco had little success with Green Tree's working-class consumers because, as Hone would later say, “It’s hard to sell them more insurance when they could barely pay their mortgages.”

Investors were sour on the deal, driving the stock price down 15 percent on the day it was announced. Three months later the company began a series of write-downs when it announced second-quarter after-tax charges of $498 million, mostly the result of unexpected loan prepayments. About $350 million of the charge was earmarked to cover increasing prepayment rates at Green Tree.

Losses began to mount including $407 million in the second quarter and $487 million in the third. Thousands of jobs were cut, mostly at Green Tree. In very little time it had become a very large drain on Conseco.

Shea Joins Conseco

During the final third of 2001, Shea and then Hone joined Conseco. Shea was recruited to become president and chief operating officer in September by then-Chairman and CEO Gary Wendt, along with Thomas Lee Partners of Boston, one of the country’s top private equity firms, which held more than $400 million worth of Conseco stock. His background in reviving flagging companies was well known. In 2001 he and Hone completed a successful turnaround of Centennial Technologies of Wilmington, MA, a firm nearly ruined when management fraud was discovered in 1997.

Bankruptcy was not on Shea’s mind when he joined Conseco, but the company’s finances were eroding fast. Conseco’s earnings growth in the 1990s had been from its successive acquisitions, not from improved operations. Questionable accounting methods were pumping up near-term profits, but exposing the company to drastic revisions in the future. And there was also the company’s debt. Conseco was paying $550 million to $600 million annually in debt service, strangling its cash flow.

“Underlying what looked like a fairly healthy company was some very inappropriate accounting,” says Shea. “There were businesses that didn’t have any earnings power because there were a lot of losses that hadn’t been recognized on the balance sheet.

“As things started to crumble,” he added, “there wasn’t any way to support that debt load with the earnings of the company.”

Shea took the debt problem head-on. In January of 2002 an $800 million debt relief plan was announced. Another $170 million was gained through the later sale of subsidiaries Manhattan National Life Insurance and Conseco Variable Insurance Co. He also limited the company’s financial exposure by settling a class-action lawsuit filed by shareholders. And he settled a dispute in Texas that a Conseco company had failed to promptly pay health-care claims.

But troubles continued. By late summer of 2002 three major credit agencies lowered their ratings on Conseco bonds and the company’s stock price plunged below $1. The board of directors and major creditors such as Bank of America and JPMorgan Chase & Co. had had enough. In October Wendt was asked to resign as chief executive officer, but remained as chairman. Day-to-day management of the company was given to Shea.

Shea asked a trusted group of advisors to assist. He retained Lazard, the international debt restructuring advisor and the Chicago law firm of Kirkland & Ellis, which had advised on other major corporate bankruptcies.

“We had the right advisors in place and they gave us options,” says Shea. “Their recommendation was to take it through bankruptcy. Not everyone agreed. But even the Tommy Lee guys, who had $500 million in there, felt that bankruptcy was right.”

On Dec. 17, 2002, Conseco filed for Chapter 11 bankruptcy protection after Shea and the board reached an agreement with the major creditors to restructure about $6.5 billion in debt.

The Tempus Team Steps In

When Shea replaced Wendt as CEO, Hone, whom Shea had brought on shortly after being named president, stepped up as chief operating officer of the Conseco Insurance Group. He began streamlining a corporation that had done little to integrate more than 40 acquisitions.

“When we took over, Conseco was really 40 companies thrown together in the cornfields of Indianapolis,” says Hone. “Both the organizational chart and the IT system looked like a wad of spaghetti.”

Most of Conseco’s companies used separate computer systems, which led to such customer service problems as inaccurate policy information and poor oversight of claims. Similarly there were troubles when compensating or recovering debts from agents. In some cases agents who owed money to one Conseco subsidiary were being paid by another.

Hone, who had managed the recovery of other technology companies including PSC Inc., in Rochester, N.Y., Centennial Technologies in Boston, and Bizfon Inc. in Salem, NH, called on many of the same Tempus associates who had joined him at those companies.

Jacques Assour was brought in as senior VP of operations. Richard Stathes was named executive VP of sales & service. Richard Pulsifer also joined the sales department as a vice president, first focusing on agent debt and then resurrecting and managing the “worksite” operating team.

“They’re all experts in their own fields of operations, IT, accounting, sales, marketing and customer service,” says Hone. “That’s why I have them on my team. They’re driven, very effective, very efficient and they aren’t looking for glory. They’re looking to get the job done.”

Hone identified several priorities including:

· Stabilize relationships with key partners, especially independent marketing operations (IMOs) and insurance agents.

· Develop new Conseco products for IMOs and agents to sell.

· Reorganize Conseco’s call center – the company’s frontline when interacting with customers and policyholders.

Hone began by assuring IMOs and insurance agents that it was Conseco’s holding company that had filed for bankruptcy. The insurance company itself still had products in health, life and annuities.

“We weren’t out of business and we weren’t going out of business,” says Hone.

But there was a touchy issue of about $50 million in debt owed to the company by agents. When a policy was sold, Conseco would pay an advance on the agent’s commission, which it would recover through the customer’s monthly payments. If the customer cancelled the policy, the agent was expected to repay the outstanding portion of the advance.

However, Conseco wasn’t collecting from the agents for cancelled policies. Many couldn’t pay their debt, some couldn’t be found. So Conseco officials tried to recover their money by pursuing the IMOs, where the agents were licensed. When a sales person makes a sale, he receives a commission. That sales person has a manager who earns an override on the commission and the IMO, often the next level up, also earns an override. Conversely, the IMO is ultimately responsible for the sales agent’s debt.

But often the IMOs, who were typically established professionals successfully selling Conseco insurance products, were unaware there was a debt issue with a lower agent. They argued that Conseco should not have paid commissions to unscrupulous sales people. Conseco was in danger of destroying its product distribution channel by alienating its productive IMOs.

“It was our responsibility to take care of the policyholder once the agent brought them to us,” says Hone. “But our customer, the person who brings us new revenue, was not the policyholder. It was the agents and the IMOs and Conseco had not treated them well. So we worked hard to change that.”

Hone and Pulsifer found a solution. Insurance rating agencies had downgraded the financial strength of Conseco’s insurance units. Sales were declining. Agents not beholden to Conseco were selling more highly rated products. They proposed that liable IMOs pay off the debt by selling more Conseco policies.

“It would have been short-sighted to tell them to pay us the $50,000 they owed and then never do business with them again,” says Pulsifer. “We tried to take a real negative that was destroying our distribution channel and turn it into a positive by using it to motivate them to sell for us.”

At the same time, Hone put more emphasis on product development. A new process was developed that brought together all of the people involved in selling and delivering policies including underwriters, marketing and sales people and agents. Ultimately the integrated process was able to roll out new products more quickly and efficiently than Conseco’s old approach. And it had the bonus of making agents more invested in Conseco’s business.

“That sort of communication with agents had not been done before,” says Hone. “It really made them more committed to the product.”

Improving Conseco’s call centers – which fielded questions from IMOs, agents and policyholders - was also crucial in the company’s turnaround. To save money Wendt had transferred the call center to India. It was a disastrous move as the personnel fielding the calls were generally unqualified.

“It wasn’t organized correctly,” says Hone. “You had people working hard but not doing the right thing. They didn’t understand that the customer was the agent and the IMO, not the policy holders. If they quit selling the product we were going out of business.”

Conseco brought the call center back to the U.S. Though there was still the job of condensing the company’s 30-plus computer systems, Hone asked Stathes to tackle customer service by recruiting better hires. Stathes began hiring better educated personnel, improved their training through his in-house “Conseco University” seminars, and enticed them to stay by promising careers in the field.

Hone turned to Assour to improve the efficiency of Conseco’s operations. Quickly Assour saw that no one was monitoring quality control. He named one person from each department to a quality control committee, whose job was to insure that each group within Operations had appropriate processes in place with the required resources.

Additionally, Assour clamped down on “leakage” - payment due to errors made by adjusters within Conseco – by having the company’s actuaries forecast payments for claims just as the sales department would forecast revenues. If the amount of money paid out in a month exceeded the forecast figure, he wanted to know why.

“We found out that because of an error in the software system, some doctors who sent a bill more than once got paid more than once,” says Assour. “The system was supposed to compare each bill coming in to assure they weren’t redundant. It wasn’t doing that and that was a big problem. We corrected that.”

Conseco Comes Back

In March of 2003, Conseco Finance, the subsidiary that brought Conseco down, was sold in two parts for a total of $1.2 billion. A trio of investors that included J.C. Flowers & Co., Fortress Investment Group and Cerberus Partners, Ltd, acquired Conseco Finance’s servicing platform, while GE Capital purchased Mill Creek Bank, the lender that funded Conseco Finance’s private-label credit card business.

The following September Conseco officially emerged from Chapter 11. The stock that once traded for less than $1, opened at more than $20 per share.

“Conseco was a bear of a job, but well worth the effort,” says Hone. “The company has turned around. Today it’s well-financed, reorganized and reenergized, with good products and a bright future ahead.”

When Centennial Technologies, Inc. was acquired by California-based Solectron Corporation in May 2001 for $108 million, the acquisition marked the successful conclusion of a dramatic turnaround in Centennial’s fortunes. Located 20 minutes north of Boston in Wilmington, Massachusetts, Centennial had been a leading manufacturer of custom and industry-standard PC memory cards for makers of telecommunications, networking and mobile computing equipment. In 1996, Centennial was the hottest company on the New York Stock Exchange — its shares advanced 451 percent that year alone. Founded in 1987 and publicly owned since 1994, Centennial was the toast of a market that had gone crazy for technology stocks. At its height it had a market capitalization of nearly $1 billion.

Then disaster struck. Early in 1997, members of Centennial’s board of directors discovered that the company’s senior managers had been manipulating its financial results for several years. This news set in motion a rapid-fire sequence of events that sent the company into a tailspin. Centennial’s chief executive officer was fired on February 11, 1997, and trading of the company’s stock was halted the same day. When it resumed trading a week later, the stock plummeted from a high of $444 a share on December 30th to just $25. The Securities and Exchange Commission and Federal Bureau of Investigation quickly descended on Centennial and more than 40 shareholder suits were eventually filed against the company and its board. Suspicion, recriminations and paranoia threatened to tear the company apart.

Centennial’s survival was very much in doubt.This case study tracks how a dedicated team of experienced managers, led by former Chairman of the Board William Shea and former Chief Executive Officer L. Michael Hone, ultimately saved Centennial. The study shows that speed and decisiveness were key when dealing with a crisis of this magnitude. It also demonstrates the significance of bringing in a new management team that had worked together in previous turnaround assignments. And it shows that in a turnaround situation, whether a company survives is ultimately up to its customers. Realizing it was the beleaguered company’s best chance for the future, Hone and his teammates were determined not to lose a single customer throughout the turnaround process — and they didn’t.

Suspicions about the company had first surfaced in late 1996 when an article in Financial World magazine cast doubt on a claim made by Centennial CEO Emanuel Pinez that he had degrees from Hebrew University and the London School of Economics. Shea, a former BankBoston Corp. vice chairman and chief financial officer who joined Centennial’s board shortly before Pinez’s scheme was uncovered, took the lead. He and other directors confronted Pinez with the facts in the article. Initially Pinez denied that he had misled the board and investors about his background, but when Shea and other board members probed deeper over the next few days, Pinez finally conceded that he had lied about the degrees. Far more troubling was his admission that he, along with CFO James Murphy, had cooked the company’s books by recording millions of dollars in phony sales.

Pinez ultimately was indicted on federal charges of insider trading and securities fraud and sentenced to five years in prison. Murphy pled guilty to securities fraud. Centennial was delisted from the New York Stock Exchange, and the SEC forced the company to restate its earnings for a three-and-a-half year period.

In an effort to control this significant damage, Shea made several quick decisions. As soon as Pinez was relieved of his duties, Shea brought in a crisis management firm, Chicago-based Jay Alix & Associates, to run Centennial while he dealt with the fraud. He also hired a law firm to represent the board, and directed the company’s accounting firm to conduct a full-scale audit. Shea’s most controversial decision was to have the entire board — himself included — undergo extensive background checks to make sure there were no more problems that would further damage the company’s credibility.

Shea also began to look for a permanent management team, and following an extensive search the board recruited Hone in August 1997 to join Centennial as president and CEO. Hone was a veteran of corporate turnarounds, having directed the recovery of PSC Inc., a Rochester, N.Y.-based company that made hand-held scanning equipment. The board also liked the fact that Hone has an extensive background in sales and that he is very comfortable working with customers. If Centennial was to be saved, it had to retain its most important customers. Within six weeks of his arrival, Hone had recruited two members of his PSC team to join him at Centennial. Jacques Assour, who has a Ph.D. in electrophysics and engineering, was brought in as senior vice president in charge of operations, while Richard Stathes became senior vice president for sales and marketing. A third PSC veteran, Mary Gallahan, was retained as a consultant on personnel matters. She later joined the company as a vice president for human resources and administration.

Hone and his team made several immediate decisions. One was to assess Centennial’s personnel, including senior managers below Pinez and Murphy. The company’s vice president of operations was replaced with Assour and a complete revamping of the sales and marketing effort resulted in several replacements there as well. In total, approximately 15 people were fired during Hone’s early months at the company. But other managers who had nothing to do with Pinez’s scheme were encouraged to stay, and did.

Hone also looked carefully at Centennial’s business model and soon decided that its core business — the design and manufacture of PC memory cards — could power the company’s growth if managed properly. Consequently, the company sold off several peripheral businesses that Centennial had either acquired or built, including plants in the United Kingdom and Taiwan.

Centennial’s expansion had been financed with a $24 million loan from BankBoston Corp., but early on, it was clear that Centennial couldn’t afford to carry that much debt. The company persuaded BankBoston to not foreclose on the loan until he could pay it off by disposing of unwanted assets. The BankBoston loan was replaced with an operating line of credit from Congress Financial , a commercial finance company, and then later with funding from Fleet Financial Corp.

Shareholder suits placed an additional demand on Hone’s time and attention. Investors were shaken and outraged by the discovery of fraud and the collapse of Centennial’s stock price. Hone had numerous conversations with institutional and individual shareholders in which he asked for patience and forbearance. In many instances, investors simply wanted someone to complain to — and Hone, with his easy-going manner, listened. The final settlement, announced in June of 1999, called for shareholders to receive 37 percent more shares in the company. Had Centennial not settled the matter as quickly as it did, litigation costs might have forced it to file for reorganization under Chapter 11 of the U.S. Bankruptcy Code. As it was, the company spent $1.5 million dealing with the shareholder suits.

As one might expect, internal morale was quite low when the new management team took over. Attrition reached nearly 25 percent in 1997 as many Centennial employees, fearing for their jobs given the company’s precarious financial condition, left on their own accord. The physical plant had been allowed to deteriorate, and a stronger company-wide work ethic needed to be instilled.

Starting with improved communication, Hone’s team gradually turned this situation around. Hone began holding monthly company meetings where, among other things, he briefed employees on Centennial’s financial performance. Afternoon gatherings were planned regularly to celebrate special events. The company’s office complex was spruced up with new paint, carpet and reconditioned furniture, and cubicles replaced most private offices to promote a more open atmosphere. Employees also were required to adhere to a more stringent business casual dress code and to arrive for work on time, which contributed to a more professional environment.

Six months into Centennial’s revival, Hone gave stock options to all of its employees. By the time the transaction with Solectron closed, Centennial employees owned 21 percent of the company’s stock and options. He also began to increase salaries to market rates, and installed a 401(k) plan, first with no company match, then with an increasingly larger contribution. He replaced Centennial’s health insurance coverage with a broader, more generous plan.

Simultaneous with the rebuilding of morale, Hone and his team began to rebuild certain key aspects of operations. Where prior Centennial managers had no quick way of checking whether a particular batch of PC cards was being completed on schedule, or had been shipped, within three months of his arrival, operations chief Assour had installed a management information system that enabled him to track the progress of client orders. Assour also loaded the new system with cost data for all the company’s standard products so that Centennial’s sales people could make informed decisions when they offered quotes to prospective customers — particularly when competitive pressure forced them to lower their price. Previously, the sales staff did not have a clear idea of whether a particular piece of business would be profitable at an indicated price.

The sales and customer service operation also had to be rebuilt virtually from the ground up, a job that fell largely to Stathes. Under Centennial’s old management, the sales effort relied on a group of highly paid individuals who worked in the company’s Wilmington location, rarely visited customers and sold primarily on price. In addition to being very expensive, this also was the wrong type of sales force for the direction that Hone wanted to take the company, which was to emphasize Centennial’s custom design capability and which required people with greater technical knowledge. In the first year, Stathes established a new customer service unit and virtually replaced the entire sales staff with field representatives throughout the U.S. For international stabilization and expansion, the company hired John Nugent, another former PSC associate, as vice president of international operations. Nugent opened a sales and support office in the U.K. and hired a team to fuel growth.

While Hone and Stathes were rebuilding the sales team, they were also paying close attention to the customers that Centennial already had. Its largest and most important customer was Nortel Networks, and Centennial provided Nortel with a level of service that none of its competitors were willing to offer. Recently the company was given Nortel’s P.R.I.D.E award in recognition of its quality service. Other loyal customers that have stayed in the fold include Compaq Computer, Lucent Technologies, 3Com, Symbol Technologies, Intermec Technologies and United Parcel Service. In the end, Centennial kept all its key customers throughout a crisis that, by all rights, should have sent customers scurrying for other suppliers. Hone and his team also convinced Centennial’s various suppliers to stick with the company despite its well-publicized problems. Ultimately, the loyalty of its customers and suppliers was the single-most important factor in Centennial’s revival. Keeping the product pipeline flowing brought cash into the company and gave the turnaround team valuable time to fix other serious problems. Richard Pulsifer joined the team in June of 1999 as vice president and chief financial officer to help manage the company’s financial, legal and SEC issues.

There is no doubt that Centennial’s survival was aided in large measure by the experience and teamwork of a group of managers who had worked together before, particularly in turnaround situations. Because they knew one another well and understood each other’s work style, the team of Hone, Stathes, Assour, Nugent and Gallahan were able to focus all of their attention on the job that needed to be done without the distraction of internal politics or personality clashes. Functioning successfully in a corporate crisis situation requires clear thinking, decisive action and long hours in an intense, pressure-filled environment. In contrast, a turnaround team that has never worked together to effectively resolve a crisis situation loses valuable time building trust and sorting out their own interpersonal dynamics.

Although Centennial’s stock price never returned to the heady days of 1996, that earlier valuation reflected both an exuberant stock market and the company’s misleading financial results. After three years of level growth as Centennial’s management team sold off non-performing assets and rebuilt the company, strong top line growth returned in the fiscal year ending March 31, 2001, when sales grew 127 percent to $80.8 million compared to 1999. Net income for the period was $14.3 million. The company’s shares have been traded on the Nasdaq system since November 2000.

Solectron’s purchase price of $108 million reflects a 49 percent premium over Centennial’s 30-day average stock price of approximately $14. The company’s shareholders, who might have lost their entire investment in 1997 when the company was delisted on the New York Stock Exchange, were finally rewarded for their perseverance. And Centennial, which once seemed destined for the corporate scrap heap, will become the centerpiece of Solectron’s custom PC card business, where the California-based company previously had a relatively small presence.