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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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, 2006
OR
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: 1-15135
CHANDLER (U.S.A.), INC.
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1325906
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1010 MANVEL AVENUE, CHANDLER, OKLAHOMA 74834
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (405) 258-0804
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 a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act.)
Large accelerated filer Accelerated filer Non-accelerated filer X
--- --- ---
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES NO X
--- ---
The number of common shares, $1.00 par value, of the registrant
outstanding on July 31, 2006 was 2,484, which are owned by Chandler Insurance
Company, Ltd.
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PAGE i
CHANDLER (U.S.A.), INC.
INDEX
-----
PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS:
- ------------------------------
Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005 ...... 1
Consolidated Statements of Operations for the three months
ended June 30, 2006 and 2005 .......................................... 2
Consolidated Statements of Operations for the six months
ended June 30, 2006 and 2005 .......................................... 3
Consolidated Statements of Comprehensive Income for the three
months ended June 30, 2006 and 2005 ................................... 4
Consolidated Statements of Comprehensive Income for the six
months ended June 30, 2006 and 2005 ................................... 5
Consolidated Statements of Cash Flows for the six months
ended June 30, 2006 and 2005 .......................................... 6
Notes to Interim Consolidated Financial Statements ......................... 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------------------------------------------------------------------------
RESULTS OF OPERATIONS .................................................. 10
---------------------
ITEM 4. CONTROLS AND PROCEDURES ........................................... 15
- --------------------------------
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings ................................................ 16
Item 1A. Risk Factors ..................................................... 16
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ...... 16
Item 3. Defaults Upon Senior Securities .................................. 16
Item 4. Submission of Matters to a Vote of Security Holders .............. 16
Item 5. Other Information ................................................ 16
Item 6. Exhibits ......................................................... 16
Signatures ................................................................. 17
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
June 30, December 31,
2006 2005
----------- ------------
ASSETS (Unaudited)
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $13,055 and $11,789 in 2006 and 2005, respectively) ..... $ 12,310 $ 11,330
Unrestricted (amortized cost $58,774 and $61,954 in 2006 and 2005, respectively) ... 56,129 60,405
Equity securities at fair value (cost $4,067 and $8,558 in
2006 and 2005, respectively) ....................................................... 4,545 9,071
----------- ------------
Total investments .................................................................. 72,984 80,806
Cash and cash equivalents ($268 and $209 restricted in 2006 and 2005, respectively) .. 14,571 5,510
Premiums receivable, less allowance for non-collection
of $163 and $223 at 2006 and 2005, respectively .................................... 25,601 28,346
Reinsurance recoverable on paid losses, less allowance for
non-collection of $238 at 2006 ...................................................... 3,048 2,875
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $158 and $174 at 2006 and 2005, respectively ...................... 48,600 54,708
Reinsurance recoverable on unpaid losses from related parties ........................ 14,651 14,284
Prepaid reinsurance premiums ......................................................... 7,775 9,763
Prepaid reinsurance premiums to related parties ...................................... 12,114 12,247
Deferred policy acquisition costs .................................................... 1,902 1,225
Property and equipment, net .......................................................... 8,548 8,640
Amounts due from related parties ..................................................... 8,973 9,360
State insurance licenses, net ........................................................ 3,745 3,745
Other assets ......................................................................... 14,225 13,550
----------- ------------
Total assets ......................................................................... $ 236,737 $ 245,059
=========== ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses .......................................... $ 103,901 $ 109,541
Unearned premiums ................................................................... 51,174 55,034
Policyholder deposits ............................................................... 5,787 5,684
Accrued taxes and other payables .................................................... 5,898 5,221
Premiums payable .................................................................... 2,800 2,181
Premiums payable to related parties ................................................. 636 113
Senior debentures ................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts .......................... 20,620 20,620
----------- ------------
Total liabilities .................................................................. 197,795 $ 205,373
----------- ------------
Shareholder's equity
Common stock, $1.00 par value, 50,000 shares authorized;
2,484 shares issued and outstanding ................................................ 2 2
Paid-in surplus ..................................................................... 60,584 60,584
Accumulated deficit ................................................................. (19,722) (19,913)
Accumulated other comprehensive income (loss):
Unrealized loss on investments available for sale, net of deferred income taxes ..... (1,922) (987)
----------- ------------
Total shareholder's equity ......................................................... 38,942 39,686
----------- ------------
Total liabilities and shareholder's equity ........................................... $ 236,737 $ 245,059
=========== ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 2
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Three months ended June 30,
-----------------------------
2006 2005
------------ ------------
Premiums and other revenues
Direct premiums written and assumed ....................... $ 25,199 $ 24,501
Reinsurance premiums ceded ................................ (3,477) (4,759)
Reinsurance premiums ceded to related parties ............. (6,520) (5,371)
------------ ------------
Net premiums written and assumed ......................... 15,202 14,371
Decrease in unearned premiums ............................. 1,786 1,923
------------ ------------
Net premiums earned ...................................... 16,988 16,294
Investment income, net ..................................... 779 683
Interest income, net from related parties .................. 191 162
Realized investment gains, net ............................. 133 3
Other income ............................................... 95 59
------------ ------------
Total premiums and other revenues ........................ 18,186 17,201
------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $2,794 and $3,748 in
2006 and 2005, respectively .............................. 12,053 7,727
Policy acquisition costs, net of ceding commissions
received from related parties of $2,483 and $2,046 in
2006 and 2005, respectively .............................. 2,753 2,838
General and administrative expenses ....................... 3,317 3,522
Interest expense .......................................... 667 629
------------ ------------
Total operating costs and expenses ....................... 18,790 14,716
------------ ------------
Income (loss) before income taxes .......................... (604) 2,485
Federal income tax benefit (provision) ..................... 211 (890)
------------ ------------
Net income (loss) ......................................... $ (393) $ 1,595
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
-------------------------------
2006 2005
------------ ------------
Premiums and other revenues
Direct premiums written and assumed ............................ $ 54,734 $ 56,162
Reinsurance premiums ceded ..................................... (9,848) (10,530)
Reinsurance premiums ceded to related parties .................. (12,771) (13,285)
------------ ------------
Net premiums written and assumed .............................. 32,115 32,347
Decrease in unearned premiums .................................. 1,738 171
------------ ------------
Net premiums earned ........................................... 33,853 32,518
Investment income, net .......................................... 1,496 1,352
Interest income, net from related parties ....................... 369 314
Realized investment gains, net .................................. 189 3
Other income .................................................... 142 123
------------ ------------
Total premiums and other revenues ............................. 36,049 34,310
------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $6,393 and $7,334 in
2006 and 2005, respectively ................................... 22,168 15,627
Policy acquisition costs, net of ceding commissions
received from related parties of $4,848 and $5,025 in
2006 and 2005, respectively ................................... 5,924 5,190
General and administrative expenses ............................ 6,308 6,393
Interest expense ............................................... 1,322 1,245
------------ ------------
Total operating costs and expenses ............................ 35,722 28,455
------------ ------------
Income before income taxes ...................................... 327 5,855
Federal income tax provision .................................... (136) (2,105)
------------ ------------
Net income ..................................................... $ 191 $ 3,750
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Three months ended June 30,
----------------------------
2006 2005
------------ ------------
Net income (loss) ............................................... $ (393) $ 1,595
------------ ------------
Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period ....... (740) 1,368
Less: Reclassification adjustment for gains included
in net income (loss) ......................................... (133) (3)
------------ ------------
Other comprehensive income (loss), before income tax ............ (873) 1,365
Income tax benefit (provision) related to items of other
comprehensive income (loss) .................................... 297 (464)
------------ ------------
Other comprehensive income (loss), net of income tax ............ (576) 901
------------ ------------
Comprehensive income (loss) ..................................... $ (969) $ 2,496
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
----------------------------
2006 2005
------------ ------------
Net income ...................................................... $ 191 $ 3,750
------------ ------------
Other comprehensive loss, before income tax:
Unrealized losses on securities:
Unrealized holding losses arising during period ............... (1,228) (44)
Less: Reclassification adjustment for gains
included in net income ....................................... (189) (3)
------------ ------------
Other comprehensive loss, before income tax ..................... (1,417) (47)
Income tax benefit related to items of other
comprehensive income ........................................... 482 16
------------ ------------
Other comprehensive loss, net of income tax ..................... (935) (31)
------------ ------------
Comprehensive income (loss) ..................................... $ (744) $ 3,719
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 6
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
---------------------------
2006 2005
------------ ------------
OPERATING ACTIVITIES
Net income .............................................................. $ 191 $ 3,750
Add (deduct):
Adjustments to reconcile net income to cash provided by
(applied to) operating activities:
Realized investment gains, net ........................................ (189) (3)
Net gains on sale of property and equipment ........................... (1) (5)
Amortization and depreciation expense ................................. 680 737
Provision for non-collection of premiums .............................. 46 51
Provision for non-collection of reinsurance recoverables .............. 42 57
Net change in non-cash balances relating to operating activities:
Premiums receivable .................................................. 2,699 (1,653)
Reinsurance recoverable on paid losses ............................... (231) 343
Reinsurance recoverable on paid losses from related parties .......... - 83
Reinsurance recoverable on unpaid losses ............................. 6,124 9,189
Reinsurance recoverable on unpaid losses from related parties ........ (367) (965)
Prepaid reinsurance premiums ......................................... 1,988 1,232
Prepaid reinsurance premiums to related parties ...................... 133 755
Deferred policy acquisition costs .................................... (677) (1,024)
Other assets ......................................................... 280 3,042
Unpaid losses and loss adjustment expenses ........................... (5,640) (13,559)
Unearned premiums .................................................... (3,860) (2,159)
Policyholder deposits ................................................ 103 151
Accrued taxes and other payables ..................................... 177 64
Premiums payable ..................................................... 619 (1,612)
Premiums payable to related parties .................................. 523 140
------------ ------------
Cash provided by (applied to) operating activities .................... 2,640 (1,386)
------------ ------------
INVESTING ACTIVITIES
Unrestricted fixed maturities available for sale:
Purchases ............................................................. (995) (3,977)
Sales ................................................................. - 2,091
Maturities ............................................................ 2,635 388
Equity securities available for sale:
Purchases ............................................................. (3,178) (51)
Sales ................................................................. 7,858 -
Investment in limited partnership ...................................... (502) -
Cost of property and equipment purchased ............................... (330) (258)
Proceeds from sale of property and equipment ........................... 46 58
------------ ------------
Cash provided by (applied to) investing activities .................... 5,534 (1,749)
------------ ------------
FINANCING ACTIVITIES
Payments and loans from related parties ................................ 967 1,408
Payments and loans to related parties .................................. (580) (615)
Bank loan proceeds ..................................................... 500 -
------------ ------------
Cash provided by financing activities ................................. 887 793
------------ ------------
Increase (decrease) in cash and cash equivalents during the period ...... 9,061 (2,342)
Cash and cash equivalents at beginning of period ........................ 5,510 6,870
------------ ------------
Cash and cash equivalents at end of period .............................. $ 14,571 $ 4,528
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 7
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Chandler
(U.S.A.), Inc. ("Chandler USA") have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They do not
include all information and footnotes required by generally accepted accounting
principles for complete financial statements. However, except as disclosed
herein, there have been no material changes in the information included in
Chandler USA's Annual Report on Form 10-K for the year ended December 31, 2005.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
The results of operations for the three and six month periods ended June 30,
2006 are not necessarily indicative of the results that may be expected for
the year.
The consolidated financial statements include the accounts of Chandler USA
and all wholly owned subsidiaries that meet consolidation requirements
including National American Insurance Company ("NAICO") and Chandler Insurance
Managers, Inc. ("CIMI").
NOTE 2. SEGMENT INFORMATION
Chandler USA has one reportable operating segment for property and
casualty insurance. Net premiums earned and losses and loss adjustment
expenses within the property and casualty segment can be identified to
Chandler USA designated insurance programs. Chandler USA's chief operating
decision makers review net premiums earned and losses and loss adjustment
expenses in assessing the performance of an insurance program. In addition,
Chandler USA's chief operating decision makers consider many other factors
such as the lines of business offered within an insurance program and the
states in which the insurance programs are offered. Certain discrete financial
information is not readily available by insurance program, including assets,
investment income, and investment gains or losses, allocated to each insurance
program. Chandler USA does not consider its insurance programs to be
reportable segments, however, the following supplemental information pertaining
to each insurance program's net premiums earned and losses and loss adjustment
expenses is presented for the property and casualty segment.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2006 2005 2006 2005
------------ ------------ ---------- ------------
(In thousands)
INSURANCE PROGRAM
- -----------------------------------------
NET PREMIUMS EARNED
Standard property and casualty .......... $ 13,467 $ 13,934 $ 26,626 $ 27,949
Political subdivisions .................. 1,443 1,700 2,917 3,477
Homeowners .............................. 1,822 449 3,891 449
Surety bonds ............................ 44 127 111 439
Other (1) ............................... 212 84 308 204
------------ ------------ ---------- ------------
$ 16,988 $ 16,294 $ 33,853 $ 32,518
============ ============ ========== ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard property and casualty .......... $ 7,368 $ 7,801 $ 15,398 $ 14,257
Political subdivisions .................. 880 1,302 1,489 2,159
Homeowners .............................. 1,308 325 2,013 325
Surety bonds ............................ 2,319 (1,313) 3,202 (823)
Other (1) ............................... 178 (388) 66 (291)
------------ ------------ ---------- ------------
$ 12,053 $ 7,727 $ 22,168 $ 15,627
============ ============ ========== ============
<FN>
- ------------------------------------------------------
(1) This program is comprised primarily of the run-off of other discontinued
programs and NAICO's participation in various mandatory workers compensation
pools.
PAGE 8
NOTE 3. COMMITMENTS AND CONTINGENCIES
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for a three year term.
During March 2004, the lease was extended for an additional three years with
monthly rental installments equal to the sum of (i) $17,512 plus (ii) interest
on the unpaid lease balance at a floating interest rate of 1% over JP Morgan
Chase Bank prime, which was 9.25% at June 30, 2006. Chandler USA has exercised
its option to repurchase the equipment at the end of the lease for
approximately $2.4 million.
Chandler USA has guaranteed the obligations of Chandler Capital Trust I
and Chandler Capital Trust II (the "Capital Trusts"). The Capital Trusts are
wholly owned non-consolidated subsidiaries of Chandler USA that have a total
of $20.0 million of trust preferred securities outstanding. Chandler USA
guarantees payment of distributions and the redemption price of the trust
preferred securities until the securities are redeemed in full.
NOTE 4. NEW ACCOUNTING STANDARDS
In February 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 155, "ACCOUNTING FOR
CERTAIN HYBRID FINANCIAL INSTRUMENTS - AN AMENDMENT OF FASB STATEMENTS NO. 133
AND 140." SFAS 155 amends SFAS No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES," and SFAS No. 140, "ACCOUNTING FOR TRANSFERS AND
SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES." This
Statement also resolves issues addressed in Statement No. 133 Implementation
Issue No. D1, "APPLICATION OF STATEMENT 133 TO BENEFICIAL INTERESTS IN
SECURITIZED FINANCIAL ASSETS." SFAS 155 permits fair value remeasurement for
any hybrid financial instrument that contains an embedded derivative that
otherwise would require bifurcation and clarifies which interest-only strips
and principal-only strips are not subject to the requirements of SFAS 133.
SFAS 140 is amended to eliminate the prohibition on a qualifying special-
purpose entity from holding a derivative financial instrument that pertains to
a beneficial interest other than another derivative financial instrument. SFAS
155 is effective for all financial instruments acquired or issued during fiscal
years beginning after September 15, 2006. Chandler USA does not expect this
statement to have a material impact on its consolidated financial statements.
In March 2006, the FASB isued SFAS No. 156, "ACCOUNTING FOR SERVICING OF
FINANCIAL ASSETS - AN AMENDMENT OF FASB STATEMENT NO. 140." SFAS No. 156
amends SFAS 140, "ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS
AND EXTINGUISHMENTS OF LIABILITIES." SFAS 156 requires an entity to separately
recognize financial assets as servicing assets or servicing entities each time
it undertakes an obligation to service a financial asset by entering into
certain kinds of servicing contracts. The entity must also initially measure
all separately recognized servicing assets and servicing liabilities at fair
value, if practicable. Servicing assets and servicing liabilities subsequently
measured at fair value must be separately presented in the statement of
financial position and additional disclosures for all separately recognized
servicing assets and servicing liabilities. SFAS 156 is effective for Chandler
USA's fiscal year beginning January 1, 2007. Chandler USA does not expect this
statement to have a material impact on its consolidated financial statements.
NOTE 5. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
During the second quarter of 2006, CIMI purchased two limited partnership
units in Basin Drilling #2 LP for $2,000, and purchased 8% cumulative
subordinated debentures in the amount of $500,000. The timing of payment of
interest and principal on the debentures is subject to various restrictions
contained in the cumulative subordinated debenture note. The purpose of the
partnership is to own and operate an oil and gas drilling rig.
CIMI financed the purchase with a $500,000 variable rate bank loan.
Principal and interest payments are due on the bank loan in five quarterly
installments beginning September 1, 2006. Interest is payable at 1% over New
York Prime, which was 9.25% at June 30, 2006.
The partnership is managed by Basin Management, LLC ("BMLLC") who is the
General Partner. A director of NAICO and Chandler USA is the Manager for
BMLLC, and is also a director of the bank and a significant shareholder of the
bank holding company that provided the bank loan described above.
PAGE 9
NOTE 6. SUBSEQUENT EVENTS
In October 1999, NAICO provided surety bonds for Gulsby Engineering, Inc.
("Gulsby") in connection with contracts between Gulf Liquids New River Project,
LLC ("Gulf Liquids") and Gulsby for the construction of two gas processing
plants in Louisiana. During 2001, Gulsby became unable to pay various vendors
resulting in payments to vendors by NAICO totaling $20,182,498.53. In August
2001, NAICO filed suit in federal court in Louisiana alleging that Gulf
Liquids had breached its obligations under the bonds by materially altering
certain contracts and that, as a result, NAICO was exonerated on the bonds and
should recover the amounts paid to vendors. In the fall of 2001, Gulsby and Bay
Limited, another contractor with whom Gulsby had entered into a joint venture
for the construction of other gas processing plants for Gulf Liquids, filed
lawsuits relating to those plants in Houston, Texas. Gulf Liquids filed
original actions and counterclaims. NAICO intervened in the Texas lawsuits and,
in addition, sued Williams Energy Marketing and Trading (which later became
Williams Power Company, Inc.) ("Williams") alleging fraud, breach of contract,
tortious interference with contractual relations, conspiracy and alter ego.
These claims were asserted against both Gulf Liquids and Williams. Gulf Liquids
asserted counterclaims alleging breach of contract against NAICO and requesting
contractual and statutory damages ranging from $40 million to $80 million.
The cases were consolidated for trial in the 215th Judicial District Court in
Harris County, Texas.
The trial in the Harris County cases began in late April 2006, and
concluded August 1, 2006. The jury found in favor of NAICO and Gulsby, Bay
Limited and the joint venture between Gulsby and Bay Limited (Gulsby-Bay Plant
Partners) on all counts and fixed damages against Gulf Liquids and Williams
totaling $402,568,089.53. The damages determined by the jury included a total
of $325 million in punitive damages. Among other findings, the jury found:
1. Williams tortiously interfered with NAICO's contractual relationship with
Gulsby and Gulf Liquids; and
2. Williams fraudulently induced NAICO to issue the surety bonds; and
3. Williams defrauded NAICO after the bonds were issued; and
4. Williams' actions were malicious; and
5. Gulf Liquids fraudulently induced NAICO to issue the surety bonds; and
6. Gulf Liquids breached its obligations to NAICO under the bonds; and
7. Williams is responsible for the claims against Gulf Liquids because Gulf
Liquids is the alter ego of Williams; and
8. There were material alterations (cardinal changes) to the contracts NAICO
bonded.
The amounts the jury found owing to NAICO include $20,182,498.53 in actual
damages, against both Gulf Liquids and Williams, $20 million in punitive
damages against Gulf Liquids, and $50 million in punitive damages against
Williams. The verdicts in favor of Gulsby included $20,941,436 in actual
damages against both Gulf Liquids and Williams, $25 million in punitive damages
against Gulf Liquids and $60 million in actual damages against Williams.
NAICO is subrogated to any recovery by Gulsby to the extent of NAICO's
losses on the bonds including loss adjustment expenses.
A significant amount of NAICO's losses on the surety bonds were ceded to
various reinsurers and NAICO will be required to reimburse these reinsurers in
accordance with the agreements between NAICO and the reinsurers.
Because the verdicts are recent and the final judgments are not yet
defined, Chandler USA is unable to presently assess the ultimate outcome of
these matters. Such amounts may be modified or vacated prior to or after entry
of judgment. Accordingly, Chandler USA's consolidated financial statements as
of June 30, 2006 do not include the results of the jury verdicts from the trial
discussed above.
PAGE 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Some of the statements made in this Form 10-Q report, as well as
statements made by Chandler (U.S.A.), Inc. ("Chandler USA") in periodic press
releases and oral statements made by Chandler USA's officials constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known
and unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of Chandler USA to be materially different
from any future results, performance or achievements expressed or implied by
the forward-looking statements. Such factors include, among other things,
(i) general economic and business conditions; (ii) interest rate changes;
(iii) competition and regulatory environment in which Chandler USA and its
subsidiaries operate, including the ability to implement price increases;
(iv) claims frequency; (v) claims severity; (vi) catastrophic events of
unanticipated frequency or severity; (vii) the number of new and renewal policy
applications submitted to National American Insurance Company ("NAICO") by its
agents; (viii) the ability of NAICO to obtain adequate reinsurance in amounts
and at rates that will not adversely affect its competitive position; (ix) the
ability of NAICO to collect reinsurance recoverables; (x) the ability of NAICO
to maintain favorable insurance company ratings; and (xi) various other factors.
RESULTS OF OPERATIONS
PREMIUMS EARNED
The following table sets forth premiums earned on a gross basis (before
reductions for premiums ceded to reinsurers) and on a net basis (after such
reductions) for each insurance program for the three and six month periods
ended June 30, 2006 and 2005:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- --------------------------
THREE MONTHS ENDED JUNE 30, 2006 2005 2006 2005
----------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard property and casualty .... $ 22,503 $ 23,458 $ 13,467 $ 13,934
Political subdivisions ............ 3,880 4,819 1,443 1,700
Homeowners ........................ 2,691 518 1,822 449
Surety bonds ...................... 63 181 44 127
Other ............................. 213 84 212 84
------------ ------------ ------------ ------------
TOTAL ............................. $ 29,350 $ 29,060 $ 16,988 $ 16,294
============ ============ ============ ============
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- --------------------------
SIX MONTHS ENDED JUNE 30, 2006 2005 2006 2005
----------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard property and casualty .... $ 44,769 $ 47,135 $ 26,626 $ 27,949
Political subdivisions ............ 7,870 9,836 2,917 3,477
Homeowners ........................ 5,486 518 3,891 449
Surety bonds ...................... 158 625 111 439
Other ............................. 310 206 308 204
------------ ------------ ------------ ------------
TOTAL ............................. $ 58,593 $ 58,320 $ 33,853 $ 32,518
============ ============ ============ ============
Gross premiums earned increased $290,000 or 1% and $273,000 or less than
1% in the second quarter and first six months of 2006, respectively, compared
to the 2005 periods. Net premiums earned increased $694,000 or 4% and
increased $1.3 million or 4% for the second quarter and first six months of
2006, respectively. Gross and net premiums earned in the homeowners program in
the 2006 periods offset the decreases in premiums earned in the other programs.
The homeowners program began in the second quarter of 2005. NAICO discontinued
this program in the second quarter of 2006 due primarily to increased
catastrophe exposure.
PAGE 11
Gross premiums earned in the standard property and casualty program
decreased $955,000 or 4% and $2.4 million or 5% in the second quarter and first
six months of 2006, respectively, compared to the 2005 periods. Gross premiums
earned in Texas decreased $2.1 million and $5.3 million in the second quarter
and first six months of 2006, respectively, compared to the 2005 periods while
gross premiums earned in Oklahoma increased $813,000 and $2.1 million in the
respective periods compared to the 2005 periods. Net premiums earned in this
program decreased $467,000 or 3% and $1.3 million or 5% in the second quarter
and first six months of 2006, respectively, compared to the 2005 periods, due
primarily to the decrease in gross premiums earned.
Gross premiums earned in the political subdivisions program decreased
$939,000 or 19% and $2.0 million or 20% in the second quarter and first six
months of 2006, respectively, compared to the 2005 periods. The decrease in
gross premiums earned is due primarily to increased competition in the school
districts portion of the program in Oklahoma. Net premiums earned in this
program decreased $257,000 or 15% and $560,000 or 16% in the second quarter and
first six months of 2005, respectively. The decrease in net premiums earned
was significantly less than the decrease in gross premiums earned because this
program has a larger portion of property risks than other programs, and
property risks have more reinsurance than other lines of business.
In the second quarter of 2005, NAICO began writing homeowner and dwelling
policies in the state of Texas through a managing general agent. NAICO
discontinued this program during the second quarter of 2006 due primarily to
increased catastrophe exposures.
Gross premiums earned in the surety bond program decreased $118,000 or 65%
and $467,000 or 75% in the second quarter and first six months of 2006,
respectively, compared to the 2005 periods. Net premiums earned in the surety
bond program decreased $83,000 or 65% and $328,000 or 75% in the second quarter
and first six months of 2006, respectively. NAICO is no longer actively
marketing its surety bond program.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At June 30, 2006, Chandler USA's investment portfolio consisted primarily
of fixed income U.S. Treasury and government agency bonds, high-quality
corporate bonds, equity securities and mutual funds that invest in equity
securities, with approximately 17% invested in cash and money market
instruments. Income generated from this portfolio is largely dependent upon
prevailing levels of interest rates. Chandler USA's portfolio contains no
non-investment grade bonds or real estate investments. Chandler USA also
receives interest income from related parties on intercompany loans.
Net investment income, excluding interest income from related parties,
increased $96,000 or 14% and $144,000 or 11% in the second quarter and first
six months of 2006, respectively, due to an increase in invested assets and to
higher interest rates in 2006. Cash and invested assets were $87.6 million at
June 30, 2006 compared to $85.8 million at June 30, 2005. Net interest income
from related parties increased $29,000 or 18% and $55,000 or 18% in the second
quarter and first six months of 2006, respectively, due primarily to higher
interest rates during 2006.
Chandler USA had net realized investment gains of $133,000 during the
second quarter of 2006 compared to $3,000 during the second quarter of 2005.
Net realized investment gains were $189,000 during the first six months of 2006
compared to $3,000 during the first six months of 2005. The net realized gains
in 2006 were from sales of equity securities.
LOSSES AND LOSS ADJUSTMENT EXPENSES
Chandler USA estimates losses and loss adjustment expenses based on
historical experience and payment and reporting patterns for the type of risk
involved. These estimates are based on data available at the time of the
estimate and are periodically reviewed by independent professional actuaries.
Although such estimates are management's best estimates of the expected values,
the ultimate liability for unpaid claims may vary from these values.
PAGE 12
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 71.0% and 65.5% for the second quarter and first six
months of 2006, compared to 47.4% and 48.1% in the corresponding 2005 periods.
The increase in the 2006 loss ratios was due primarily to an increase in losses
incurred related to prior accident years in the surety bond program, and to an
increase in losses in the current accident year in the standard property and
casualty program and the political subdivisions program. In the second quarter
and first six months of 2006, losses and loss adjustment expenses incurred
related to prior accident years were $2.7 million and $3.8 million,
respectively, and increased the respective loss ratios by 15.8 and 11.2
percentage points. The adverse loss development during 2006 was due primarily
to an increase in surety bond losses in the 2001 accident year which resulted
from the settlement of an open bond claim and from a significant increase in
legal expenses related to recovery efforts for another bond claim. NAICO
ceased marketing its surety bond program in 2005. During 2005, adverse loss
development totaling $876,000 and $1.8 million for the second quarter and first
six months of 2005, respectively, increased the respective loss ratios by 5.4
and 5.6 percentage points. The adverse loss development in 2005 was due
primarily to an increase in losses for prior accident years in the standard
property and casualty program and the political subdivisions program. This was
partially offset by a reduction in losses for prior accident years in the
surety bond program.
Weather-related losses from wind and hail totaled $446,000 and $559,000 in
the second quarter and first six months of 2006 and increased the respective
loss ratios by 2.6 and 1.7 percentage points. Weather-related losses totaled
$48,000 and $110,000 in the second quarter and first six months of 2005, and
increased the respective 2005 loss ratios by less than 1.0 percentage point.
POLICY ACQUISITION COSTS
Policy acquisition costs consist of costs associated with the acquisition
of new and renewal business and generally include direct costs such as premium
taxes, commissions to agents and ceding companies and premium-related
assessments and indirect costs such as salaries and expenses of personnel who
perform and support underwriting activities. NAICO also receives ceding
commissions from the reinsurers who assume premiums from NAICO under certain
reinsurance contracts and the ceding commissions are accounted for as a
reduction of policy acquisition costs. Direct policy acquisition costs and
ceding commissions are deferred and amortized over the terms of the policies.
When the sum of anticipated losses, loss adjustment expenses and unamortized
policy acquisition costs exceeds the related unearned premiums, including
anticipated investment income, a provision for the indicated deficiency is
recorded.
The following table sets forth Chandler USA's policy acquisition costs for
each of the three and six month periods ended June 30, 2006 and 2005:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
(In thousands)
Commissions expense ........................ $ 3,525 $ 3,709 $ 8,150 $ 7,593
Other premium related assessments .......... 221 223 502 444
Premium taxes .............................. 534 585 1,182 1,326
Excise taxes ............................... 65 54 128 133
Other expense .............................. 196 182 378 351
---------- ---------- ---------- ----------
Total direct expenses ...................... 4,541 4,753 10,340 9,847
Indirect underwriting expenses ............. 1,496 1,621 2,999 3,342
Commissions received from reinsurers ....... (3,195) (2,895) (6,738) (6,975)
Adjustment for deferred acquisition costs .. (89) (641) (677) (1,024)
---------- ---------- ---------- ----------
Net policy acquisition costs ............... $ 2,753 $ 2,838 $ 5,924 $ 5,190
========== ========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 24.0% and 24.4% for the second quarter and first six
months of 2006, compared to 26.0% and 23.5% in the corresponding year ago
periods. Commission expense as a percentage of gross written and assumed
premiums was 14.0% and 14.9% in the second quarter and the first six months of
2006 compared to 15.1% and 13.5% in the corresponding 2005 periods.
PAGE 13
Indirect underwriting expenses were 5.9% and 5.5% of total direct written
and assumed premiums in the second quarter and first six months of 2006,
respectively, compared to 6.6% and 6.0% in the corresponding 2005 periods.
Indirect expenses include general overhead and administrative costs associated
with the acquisition of new and renewal business, some of which is relatively
fixed in nature, thus, the percentage of such expenses to direct written and
assumed premiums will vary depending on Chandler USA's overall premium volume.
Commissions received from reinsurers as a percent of ceded reinsurance premiums
were 32.0% and 29.8% in the second quarter and first six months of 2006,
respectively, compared to 28.6% and 29.3% in the corresponding 2005 periods.
The percentage increase in the second quarter of 2006 is due primarily to an
increase in premiums ceded during the second quarter of 2006 under a quota
share reinsurance contract with Chandler Insurance Company, Ltd. ("Chandler
Insurance"). Quota share reinsurance contracts typically have a ceding
commission while excess of loss reinsurance contracts generally do not.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 11.3% and 10.8% of gross premiums
earned in the second quarter and first six months of 2006, respectively,
compared to 12.1% and 11.0% for the corresponding 2005 periods. General and
administrative expenses have historically not varied in direct proportion to
Chandler USA's revenues. A portion of such expenses is allocated to policy
acquisition costs (indirect underwriting expenses) and loss and loss adjustment
expenses based on various factors including employee counts, salaries,
occupancy and specific identification. Because certain types of expenses are
fixed in nature, the percentage of such expenses to revenues will vary
depending on Chandler USA's overall premium volume.
INTEREST EXPENSE
Interest expense increased $38,000 and $77,000 in the second quarter and
first six months of 2006, respectively, compared to the 2005 periods.
Substantially all of Chandler USA's interest expense is related to its
outstanding senior debentures and junior subordinated debentures. The increase
in the 2006 periods was due primarily to the increase in interest rates during
2005 and 2006, as a portion of Chandler USA's junior subordinated debentures
were issued with a floating interest rate.
LIQUIDITY AND CAPITAL RESOURCES
In the first six months of 2006, Chandler USA provided $2.6 million in
cash from operations. Cash provided by operations included decreases in
premiums receivable of $2.7 million and prepaid reinsurance premiums of $2.1
million, and an increase in premiums payable of $1.1 million. These were
partially offset by a decrease in unearned premiums of $3.9 million. Unpaid
losses and loss adjustment expenses decreased $5.6 million during the first six
months of 2006. This was offset by a decrease in reinsurance recoverable on
unpaid losses of $5.8 million. In the first six months of 2005, Chandler USA
used $1.4 million in cash from operations.
At June 30, 2006, Chandler Insurance owed approximately $9.0 million to
Chandler USA versus $9.4 million at December 31, 2005 under an Intercompany
Credit Agreement (the "Credit Agreement") covering intercompany loans between
the parties. The Credit Agreement requires interest to be paid at the prime
interest rate published in the Wall Street Journal each month, and balances
owed by either party are payable at any time upon demand.
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for a three year term.
During March 2004, the lease was extended for an additional three years with
monthly rental installments equal to the sum of (i) $17,512 plus (ii) interest
on the unpaid lease balance at a floating interest rate of 1% over JP Morgan
Chase Bank prime, which was 9.25% at June 30, 2006. Chandler USA has exercised
its option to repurchase the equipment at the end of the lease for
approximately $2.4 million.
Chandler USA is a holding company receiving cash principally through
borrowings, subsidiary dividends and other payments, subject to various
regulatory restrictions. The capacity of insurance companies to write
insurance is based on maintaining liquidity and capital resources sufficient
to pay claims and expenses as they become due. The primary sources of
liquidity for Chandler USA's subsidiaries are funds generated from insurance
premiums, investment income, capital contributions from Chandler USA and
proceeds from sales and maturities of portfolio investments. The principal
expenditures are payment of losses and loss adjustment expenses, insurance
operating expenses and commissions.
PAGE 14
A significant portion of Chandler USA's consolidated assets represents
assets of NAICO that may not be immediately transferable to Chandler USA in
the form of shareholder dividends, loans, advances or other payments.
Statutes and regulations governing NAICO and other insurance companies
domiciled in Oklahoma regulate the payment of shareholder dividends and other
payments by NAICO to Chandler USA. Under applicable Oklahoma statutes and
regulations, NAICO is permitted to pay shareholder dividends only out of
statutory earned surplus. To the extent NAICO has statutory earned surplus,
NAICO may pay shareholder dividends only to the extent that such dividends are
not defined as extraordinary dividends or distributions. If the dividends are,
under applicable statutes and regulations, extraordinary dividends or
distributions, regulatory approval must be obtained. Under the applicable
Oklahoma statute, and subject to the availability of statutory earned surplus,
the maximum shareholder dividend that may be declared (or cash or property
distribution that may be made) by NAICO in any one calendar year without
regulatory approval is the greater of (i) NAICO's statutory net income,
excluding realized capital gains, for the preceding calendar year; or (ii) 10%
of NAICO's statutory policyholders' surplus as of the preceding calendar year
end, not to exceed NAICO's statutory earned surplus.
As of December 31, 2005, NAICO had statutory earned surplus of $9.6
million. Applying the Oklahoma statutory limits described above, the maximum
shareholder dividend NAICO may pay in 2006 without the approval of the
Oklahoma Department of Insurance is $5.7 million. NAICO did not pay any
shareholder dividends to Chandler USA in 2005 or the first six months of 2006.
In addition to the statutory limits described above, the amount of
shareholder dividends and other payments to affiliates can be further limited
by contractual or regulatory restrictions or other agreements with regulatory
authorities restricting dividends and other payments, including regulatory
restrictions that are imposed as a matter of administrative policy. If
insurance regulators determine that payment of a shareholder dividend or other
payments to an affiliate (such as payments under a tax sharing agreement,
payments for employee or other services, or payments pursuant to a surplus
note) would be hazardous to such insurance company's policyholders or
creditors, the regulators may block such payments that would otherwise be
permitted without prior approval.
Historically, NAICO has played a significant role in the servicing of debt
and other obligations of Chandler USA through the payment of shareholder
dividends. These obligations include $7.0 million of 8.75% senior debentures
due in 2014, $13.4 million of 9.75% junior subordinated debentures due in 2033,
$7.2 million of floating rate junior subordinated debentures due in 2034 and
the obligations under the sale and leaseback transaction discussed previously.
Management's expectation is that Chandler Insurance or other subsidiaries will
be able to meet these obligations in the future. It is possible that dividends
from NAICO may be necessary to service Chandler USA's debt obligations. To the
extent that the restrictions discussed previously limit NAICO's ability to pay
shareholder dividends or other payments to Chandler USA, Chandler USA's ability
to satisfy the debt obligations may also be limited.
A.M. BEST RATING
Effective May 26, 2006, A.M. Best Company affirmed the financial strength
rating of B+ (Very Good) and assigned an issuer credit rating (ICR) of "bbb-"
to NAICO. Concurrently, A.M. Best has affirmed the ICR of "bb-" of NAICO's
parent, Chandler USA, and the debt rating of "bb-" on Chandler USA's 8.75%
senior unsecured debentures due 2014. A.M. Best's outlook for all ratings
remains negative.
As reported by A.M. Best, these rating actions reflect NAICO's
capitalization and management's corrective actions in recent years, including
significantly increasing rates, reducing exposures, improving risk selection
and tightening policy terms and conditions. Offsetting the positive rating
factors has been the occurrence of adverse loss reserve development between
2001 and 2005. Although the majority of the adverse development during this
period impacted accident years 1997 through 2001, more recent accident years
began to develop adversely in 2005.
RECENT EVENTS
See Note 6 of Notes to Interim Consolidated Financial Statements for a
discussion of a favorable jury verdict in civil litigation regarding certain
surety bond claims.
PAGE 15
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report and pursuant to Rule
13a-15 of the Securities Exchange Act of 1934 (the "Exchange Act"), Chandler
USA's management, including the Chief Executive Officer and Chief Financial
Officer, conducted an evaluation of the effectiveness and design of Chandler
USA's disclosure controls and procedures (as that term is defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation,
Chandler USA's Chief Executive Officer and Chief Financial Officer concluded,
as of the end of the period covered by this report, that Chandler USA's
disclosure controls and procedures were effective in recording, processing,
summarizing and reporting information required to be disclosed by Chandler USA,
within the time periods specified in the Securities and Exchange Commission's
rules and forms.
CHANGES IN INTERNAL CONTROLS
In addition and as of the end of the period covered by this report, there
have been no changes in internal control over financial reporting (as defined
in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter to
which this report relates that have materially affected or are reasonably
likely to materially affect, the internal control over financial reporting.
PAGE 16
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings
-----------------
Chandler USA and its subsidiaries are not parties to any material
litigation other than as is routinely encountered in their respective
business activities. While the outcome of these matters cannot be
predicted with certainty, Chandler USA does not expect these matters
to have a material adverse effect on its financial condition, results
of operations or cash flows. See Note 6 of Notes to Interim
Consolidated Financial Statements for a discussion of a favorable jury
verdict in civil litigation regarding certain surety bond claims.
Item 1A. Risk Factors
------------
There have been no material changes from risk factors previously
disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
None.
Item 3. Defaults Upon Senior Securities
-------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Effective May 9, 2006, Chandler USA's sole shareholder, Chandler
Insurance, re-elected the following individuals to serve on Chandler
USA's Board of Directors:
W. Brent LaGere W. Scott Martin
Mark T. Paden Robert L. Rice
R. Patrick Gilmore William Thomas Keele
Richard L. Evans
Item 5. Other Information
-----------------
None.
Item 6. Exhibits
--------
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.
PAGE 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 3, 2006 CHANDLER (U.S.A.), INC.
By: /s/ W. Brent LaGere
-----------------------------------
W. Brent LaGere
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Mark C. Hart
-----------------------------------
Mark C. Hart
Sr. Vice President - Finance, Chief
Financial Officer and Treasurer
(Principal Accounting Officer)