During 2001, SNTL's Chapter 11 companies continued their Chapter 11 proceedings, which began on April 26, 2000, when the Chapter 11 companies filed a petition with the Bankruptcy Court seeking protection under Chapter 11 of the United States Bankruptcy Code. On October 31, 2001, the Chapter 11 companies filed their Chapter 11 Joint Plan of Reorganization and Original Disclosure Statement with the Bankruptcy Court. The Plan is subject to amendment and requires approval by the Bankruptcy Court before the Plan can be solicited to all parties entitled to vote on the Plan. A hearing has been scheduled for April 9, 2002 in order to determine whether the Disclosure Statement contains adequate information so as to enable those entitled to vote on the Plan to make an informed decision about the Plan.
Year ended December 31, 2001 as compared to year ended December 31, 2000
Commission income from front company business, see "Business-Front Company Business", for the year ended December 31, 2001 was zero, as compared to $28.3 million for the year ended December 31, 2000. The $28.3 million decrease is due to the decrease in premiums generated from the run-off of the fronting arrangements that existed at the time of the seizure of the liquidating companies by the CDI. Also, SNIS and SNIA have not entered into any new fronting arrangements and presently have no source of commission revenue.
Claims services income was zero for the year ended December 31, 2001, as compared to $26.0 million for the year ended December 31, 2000. The claims services income in 2000 is a reimbursement from the liquidating companies to SNIA pursuant to the CSA effective January 1, 2000. See "Business-Underwriting Manager Agreement and Claims Services Agreement".
Reorganization items are income and expenses associated with the Company's Chapter 11 filing. For the year ended December 31, 2001, reorganization items, excluding net interest income earned on accumulated cash resulting from Chapter 11 proceeding, was $2.7 million as compared to $2.3 million for the year ended December 31, 2000. The $2.7 million incurred during 2001 consisted primarily of professional fees and the $2.3 million incurred during 2000 consisted of $2.0 million in professional fees and $0.3 million in retention bonuses to key employees as incentive to remain employed during the Chapter 11 reorganization. The Company anticipates that additional reorganization costs will be incurred throughout the Chapter 11 reorganization.
Commission income from front company business, see "Business-Front Company Business", for the years ended December 31, 2000 and 1999 were $28.3 million and $39.2 million, respectively. The $10.9 million decrease is primarily due to a decrease in premiums generated from the various fronting arrangements. In the fourth quarter of 2000, we recorded a $12.6 million bad debt allowance against the commission receivables due from the front company business. This bad debt allowance was recorded to reflect the uncertainty of collecting the commission receivable from the front companies since the front companies have filed claims against us in the Bankruptcy Court in excess of the accounts receivable. We continue to assert rights of offset and other methods to effectuate collection of the commission receivable from the front company business.
proceeding, in the amount of $1.6 million has been classified on the consolidated statement of operations as a reorganization item.
Interest expense increased $2.1 million or 20.0% to $12.4 million for the year ended December 31, 2000, as compared to the year ended December 31, 1999. The increase in interest expense was primarily due to the increase in the variable interest rate of the long-term bank debt. See "-Liquidity and Capital Resources."
Discontinued operations for the year ended December 31, 1999 recorded a loss of $368.9 million due to $333.6 million disposal of SNTL's investment in the five insurance companies that the CDI seized and conserved, see "Business-California Insurance Department Seizure and Conservation", as well as, a $35.3 million loss on current year operations. Since the Company wrote-off its investment in discontinued operations in 1999 no such charge was recognized in 2000. The table below summarizes the components that make up the results of discontinued operations. See "Business-Discontinued Insurance Company Operations."
Under Chapter 11, actions to enforce certain claims against the Company are stayed if the claims arose, or are based on, events that occurred on or before the filing date. The ultimate terms of settlement of these claims will be determined in accordance with a plan of reorganization which requires the approval of the impaired prepetition creditors and stockholders and confirmation by the Bankruptcy Court. Other liabilities may arise or be subject to compromise as a result of rejection of executory contracts, including leases, or the Bankruptcy Court's resolution of claims for contingencies and other disputed amounts. The ultimate resolution of such liabilities, all of which are subject to compromise, will be part of a plan of reorganization. Until a plan of reorganization is confirmed by the Bankruptcy Court, only such payments on prepetition liabilities that are approved by the Bankruptcy Court will be made. There is no assurance that our plan of reorganization will be approved or confirmed by the Bankruptcy Court.
A capital structure that will enable the Company to generate sufficient cash flow after reorganization to meet its restructured obligations and current obligations is an important part of the plan of reorganization. Accordingly, the rights of prepetition creditors and the ultimate payment of their claims may be substantially altered and, in some cases, eliminated under the Bankruptcy Code. It is not possible at this time to predict the ultimate outcome of the Chapter 11 filing or its effects on the Company's business or on the interests of creditors or stockholders.
We have capitalized the costs of our internally developed software for internal use according to Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." In 2001, we continued our project, which began in October 2000, to resurrect, update, and expand our premium and claim system software that we received copies of pursuant to the Global Settlement Agreement. See "-The Global Settlement Agreement." The capital expenditures relating to
this project totaled $2.1 million and $0.2 million in 2001 and 2000, respectively. The estimated cost to complete all phases of this project by July 2002 is approximately $0.8 million. The capital expenditures, net of amortization for phases of this project in service, are recorded on our consolidated balance sheet as Capitalized internally developed software costs in the amount of $2.1 million and $0.2 million at December 31, 2001 and 2000, respectively. As each phase of the project is placed in service, the software will be amortized by the straight-line method over its estimated useful life, which is currently estimated at seven years. However, the remaining useful life of our software will necessarily depend on facts and circumstances in the future, such as possible future technological innovations, changes in operating strategies, or failure to obtain approval and confirmation of our Plan of Reorganization by the Bankruptcy Court. If any one of these events takes place, the Company will be required write-down the value of this asset as a charge to operations.
The Company has engaged several former SNTL employees and certain related parties to provide consultation services in the areas of technical support, software development, and litigation support. Most of the former employees terminated their employment with the liquidating companies from 1996 to 2000. There are a few consultants who are still currently employed with the liquidating companies. In addition, some of the former employees left to pursue job opportunities with companies that are currently providing products and/or services to us. The following describes the business purpose of the various arrangements and the associated payments. There are no contractual or other commitments as a result of the business arrangement.
Edward Shoop, a former SNTL senior executive, was engaged in November 2000 to provide actuarial consultation related to the FHC litigation. We made payments to Edward Shoop for fees and expenses totaling $90 thousand and $4 thousand in 2001 and 2000, respectively.
Intransaction, Inc. was engaged in November 2000 to develop E-Comp Quote, which is an internet based policy quoting system. In addition, Intransaction handles the internet security access function. Intransaction, Inc. is owned and operated by Najib Syed, a former SNTL data processing employee. We made payments to Intransaction, Inc. totaling $93 thousand and $16 thousand in 2001 and 2000, respectively.
Microserve Computer Co. ("Microserve") was engaged in 2001 to develop our corporate website, as well as the policy and claim forms for each state. Microserve currently employs a former SNTL data processing employee, Gene Rivera. We made payments to Microserve totaling $17 thousand in 2001.
Pursuant to the Plan, Cap Z or its assignee or affiliate is to receive a $25 million Administrative Claim for its substantial contribution in formulating the Plan. Cap Z has provided critical support and service in arriving at a SNTL Acquiror. Besides finding the appropriate candidate to sponsor the Plan, Cap Z was also instrumental in finding the sponsor the requisite management consultant team to implement SNIS and SNIA's reorganization. Cap Z is to receive an Allowed Administrative Claim for $25 million, which will be paid as an Unsecured Claim.
Seaman Insurance Investors, L.L.C. ("SII") is a California limited liability company formed for the purpose of making equity investments in funds and portfolio companies. J. Chris Seaman, President and CEO of SNTL, is the appointed manager of SII. SII is one of approximately 104 limited partners in Capital Z Financial Services Fund II, L.P. SNTL is one of approximately 40 investors in SII. We invested $50.0 thousand, $150.0 thousand, and $300.0 thousand during 1998, 1999, and 2000, respectively, completing our $0.5 million commitment to SII.
In November of 1999, SNTL entered into agreements with Thomas I. Boggs, Jr., Arnold J. Senter, William L. Gentz, Robert E. Nagle and J. Chris Seaman (all officers of SNTL at the time of entering into these agreements), each of whom had purchased shares of SNTL in the 1998 rights offering. SNTL lent funds to the participants sufficient to pay the purchase price for the common stock and any resulting tax liability and the participants signed a promissory note, and pledged to SNTL, as collateral, stock options, warrants and shares of common stock and restricted stock (including shares of common stock purchased in the rights offering). Under the terms of this pledge, if the amount outstanding under any promissory note (including interest) exceeds the value of the collateral, then the borrower is obligated to either prepay a portion of the promissory note or pledge additional securities as collateral, in either case, in an amount equal to the shortfall. The agreements provided that the collateral securing the promissory notes would be valued at no less than $10 per share in the event that the note became due and payable upon the occurrence of certain events, including conservation of SNTL's insurance companies, and no more than $20 per share in any event. Following the conservation and seizure in March 2000, the Company exercised its right to apply the collateral, valued at $10 per share pursuant to the agreements, to the amounts due and payable under the promissory notes. Consequently, all promissory notes were retired.
In December 1998, the acquisition of BIG was funded with (a) senior debt financing in the amount of $110.0 million and (b) equity financing in the amount of $200.1 million. The senior debt financing was obtained pursuant to the terms of a Credit Agreement dated as of December 10, 1998, among SNTL, Chase, as administrative agent, and various lending institutions ("long-term bank debt"). Prior to incurring the indebtedness, we obtained the consent of holders of the outstanding Trust Preferred Securities of the Trust, a subsidiary of SNTL, authorizing the Preferred Trustee of the Trust to waive a provision of the covenant limiting the incurrence of indebtedness set forth in the Senior Subordinated Indenture dated as of December 3, 1997 between SNTL, as issuer, and Wilmington Trust Company, as trustee. This waiver was effected pursuant to the First Supplemental Indenture, dated as of November 17, 1998, between SNTL and the Wilmington Trust Company, as trustee. However, on April 26, 2000 we filed for relief under Chapter 11 of the United States Bankruptcy Code, as described in Business-Chapter 11 Petition and Reorganization. As a result of the Chapter 11 filing, all required repayments of principal and interest under the terms of the Credit Agreement for the long-term bank debt have been suspended, except for a $5.4 million distribution, less certain bank expenses charged to SNTL, plus interest, all netting to $5.2 million, was paid to the bank syndicate on December 4, 2000, pursuant to a November 9, 2000, order by the Bankruptcy Court. See "Business-Commercial Compensation Casualty Company Merger and Distribution." We have continued to accrue interest on the long-term bank debt, per the terms of SNTL being in default of the Credit Agreement, at a rate that equals the Prime Rate plus 2%. The long-term bank debt principal and interest are classified on our consolidated balance sheet at December 31, 2001 and 2000, under the category of liabilities subject to compromise under reorganization proceedings.
Pursuant to the terms of the Stock Purchase Agreement dated as of May 5, 1998 (the "Stock Purchase Agreement") among SNTL and IP Delaware, IP Bermuda and Cap Z (Cap Z subsequently assigned its rights and obligations thereunder to IP II) (collectively, the "Purchasers"), SNTL agreed to pay a commitment fee in the form of warrants to purchase an aggregate of 734,000 shares of our common stock at $16.75 per share to the Purchasers or their designees (or, in the case of Cap Z, assignee) and Zurich Centre Investments Limited ("ZCIL") or its designee as compensation, in the case of the Purchasers, for agreeing to purchase that number of shares necessary to bring the total proceeds of the Rights Offering, Employee Participation and the IP Stock Issuance to $200.0 million, and, in the case of ZCIL, for ZCIL's
While the Company anticipates that additional reorganization costs will be incurred throughout the Chapter 11 reorganization, we do not presently foresee any expenditures during the next twelve months other than those arising in the normal course of business.
Our 2000 and prior consolidated federal income tax returns reflected approximately $1.0 billion of NOLs. The Internal Revenue Code ("IRC") permits NOLs to be carried back two years, or carried forward 20 years, to offset any consolidated taxable income in those years. Approximately $256.2 million of SNTL's $1.0 billion of NOLs was generated in 2000, and, if not used in future years, will expire at the end of 2020. Approximately $577.0 million of NOLs generated in 1999 expire at the end of 2019 and the remaining $193.0 million of NOLs expire between 2001 and 2018. SNTL's 1998 and 1999 consolidated returns did not generate taxable income, so there is no benefit to be gained from carrying-back any of our NOLs. We expect that our 2001 consolidated return will result in an additional increase to our NOLs at December 31, 2001. The NOLs have value to the extent they can be used in future years to offset SNTL's taxable income, if any, prior to the NOL's expiration dates. Our ability to continue as a going concern is
Summarized quarterly financial data for 2001 and 2000 is as follows (in thousands, except per share data):