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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
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SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
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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
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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
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The number of common shares, $1.00 par value, of the registrant
outstanding on July 31, 2007 was 2,484, which are owned by Chandler
Insurance Company, Ltd.
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Page i
CHANDLER (U.S.A.), INC.
INDEX
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PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS:
- --------------------------------
Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006 ..1
Consolidated Statements of Operations for the three months
ended June 30, 2007 and 2006 ........................................2
Consolidated Statements of Operations for the six months
ended June 30, 2007 and 2006 ........................................3
Consolidated Statements of Comprehensive Income for the three
months ended June 30, 2007 and 2006 .................................4
Consolidated Statements of Comprehensive Income for the six
months ended June 30, 2007 and 2006 .................................5
Consolidated Statements of Cash Flows for the six months
ended June 30, 2007 and 2006 ........................................6
Notes to Interim Consolidated Financial Statements ....................7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- --------------------------------------------------------------------------
RESULTS OF OPERATIONS ..........................................11
---------------------
ITEM 4. CONTROLS AND PROCEDURES ........................................17
- ----------------------------------
ITEM 4T. CONTROLS AND PROCEDURES ........................................17
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PART II - OTHER INFORMATION
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Item 1. Legal Proceedings ............................................18
Item 1A. Risk Factors .................................................18
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ..18
Item 3. Defaults Upon Senior Securities ..............................18
Item 4. Submission of Matters to a Vote of Security Holders ..........18
Item 5. Other Information ............................................18
Item 6. Exhibits .....................................................18
Signatures ...............................................................19
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
June 30, December 31,
2007 2006
------------- --------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $34,195 and $19,830 in 2007 and 2006, respectively) ..... $ 33,090 $ 19,151
Unrestricted (amortized cost $40,343 and $48,557 in 2007 and 2006, respectively) ... 39,289 47,228
Equity securities at fair value (cost $0 and $1,587 in 2007 and 2006, respectively).. 132 1,921
------------- --------------
Total investments .................................................................. 72,511 68,300
Cash and cash equivalents ($141 and $450 restricted in 2007 and 2006, respectively) .. 18,246 21,403
Accrued investment income ............................................................ 5,454 5,022
Premiums receivable, less allowance for non-collection of $172 and $170 at
2007 and 2006, respectively ......................................................... 30,467 31,008
Reinsurance recoverable on paid losses ............................................... 1,487 1,087
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $112 and $130 at 2007 and 2006, respectively ...................... 25,406 25,588
Reinsurance recoverable on unpaid losses from related parties ........................ 16,755 15,584
Prepaid reinsurance premiums ......................................................... 3,586 7,603
Prepaid reinsurance premiums to related parties ...................................... 14,248 13,506
Deferred policy acquisition costs .................................................... 1,634 845
Property and equipment, net .......................................................... 8,323 8,457
Amounts due from related parties ..................................................... 11,944 9,584
State insurance licenses, net ........................................................ 3,745 3,745
Other assets ......................................................................... 10,525 11,040
------------- --------------
Total assets ......................................................................... $ 224,331 $ 222,772
============= ==============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses .......................................... $ 85,335 $ 83,253
Unearned premiums ................................................................... 51,273 53,217
Policyholder deposits ............................................................... 7,317 7,663
Accrued taxes and other payables .................................................... 6,511 5,119
Premiums payable .................................................................... 1,508 1,955
Premiums payable to related parties ................................................. 475 1,002
Senior debentures ................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts .......................... 20,620 20,620
------------- --------------
Total liabilities .................................................................. 180,018 179,808
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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 ................................................................. (14,935) (16,517)
Accumulated other comprehensive income (loss):
Unrealized loss on investments available for sale, net of deferred income taxes ..... (1,338) (1,105)
------------- --------------
Total shareholder's equity ......................................................... 44,313 42,964
------------- --------------
Total liabilities and shareholder's equity ........................................... $ 224,331 $ 222,772
============= ==============
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,
-----------------------------
2007 2006
------------ ------------
Premiums and other revenues
Direct premiums written and assumed .......................... $ 24,120 $ 25,199
Reinsurance premiums ceded ................................... (2,811) (3,477)
Reinsurance premiums ceded to related parties ................ (6,562) (6,520)
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Net premiums written and assumed ........................... 14,747 15,202
Decrease in unearned premiums ................................ 1,123 1,786
------------ ------------
Net premiums earned ........................................ 15,870 16,988
Investment income, net ......................................... 860 779
Interest income, net from related parties ...................... 248 191
Realized investment gains, net ................................. 26 133
Other income ................................................... 168 95
------------ ------------
Total premiums and other revenues .......................... 17,172 18,186
------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $3,784 and $2,794 in
2007 and 2006, respectively ................................ 9,366 12,053
Policy acquisition costs, net of ceding commissions
received from related parties of $2,495 and $2,483 in
2007 and 2006, respectively ................................ 3,032 2,753
General and administrative expenses .......................... 3,034 3,317
Interest expense ............................................. 678 667
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Total operating costs and expenses ......................... 16,110 18,790
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Income (loss) before income taxes .............................. 1,062 (604)
Federal income tax benefit (provision) ......................... (394) 211
------------ ------------
Net income (loss) ............................................ $ 668 $ (393)
============ ============
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,
--------------------------------
2007 2006
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Premiums and other revenues
Direct premiums written and assumed ....................... $ 51,453 $ 54,734
Reinsurance premiums ceded ................................ (2,313) (9,848)
Reinsurance premiums ceded to related parties ............. (14,919) (12,771)
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Net premiums written and assumed ........................ 34,221 32,115
Decrease (increase) in unearned premiums .................. (1,331) 1,738
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Net premiums earned ..................................... 32,890 33,853
Investment income, net ...................................... 2,020 1,496
Interest income, net from related parties ................... 460 369
Realized investment gains, net .............................. 61 189
Other income ................................................ 995 142
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Total premiums and other revenues ......................... 36,426 36,049
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Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $8,026 and $6,393 in
2007 and 2006, respectively ............................. 20,033 22,168
Policy acquisition costs, net of ceding commissions
received from related parties of $5,674 and $4,848 in
2007 and 2006, respectively ............................. 6,282 5,924
General and administrative expenses ....................... 6,249 6,308
Interest expense .......................................... 1,355 1,322
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Total operating costs and expenses ...................... 33,919 35,722
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Income before income taxes .................................. 2,507 327
Federal income tax provision ................................ (925) (136)
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Net income ................................................ $ 1,582 $ 191
============= ============
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,
--------------------------------
2007 2006
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Net income (loss) ........................................... $ 668 $ (393)
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Other comprehensive loss, before income tax:
Unrealized losses on securities:
Unrealized holding losses arising during period ......... (484) (740)
Less: Reclassification adjustment for gains included in
net income (loss) ..................................... (26) (133)
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Other comprehensive loss, before income tax ................. (510) (873)
Income tax benefit related to items of other
comprehensive loss ........................................ 174 297
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Other comprehensive loss, net of income tax ................. (336) (576)
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Comprehensive income (loss) ................................. $ 332 $ (969)
============= ============
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,
--------------------------------
2007 2006
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Net income .................................................. $ 1,582 $ 191
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Other comprehensive loss, before income tax:
Unrealized losses on securities:
Unrealized holding losses arising during period ......... (292) (1,228)
Less: Reclassification adjustment for gains included in
net income ............................................ (61) (189)
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Other comprehensive loss, before income tax ................. (353) (1,417)
Income tax benefit related to items of other
comprehensive loss ........................................ 120 482
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Other comprehensive loss, net of income tax ................. (233) (935)
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Comprehensive income (loss) ................................. $ 1,349 $ (744)
============= ============
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,
------------------------------
2007 2006
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OPERATING ACTIVITIES
Net income .................................................................. $ 1,582 $ 191
Add (deduct):
Adjustments to reconcile net income to cash provided by operating activities:
Realized investment gains, net .......................................... (61) (189)
Net (gains) losses on sale of property and equipment .................... 5 (1)
Amortization and depreciation expense ................................... 706 680
Provision for non-collection of premiums ................................ 40 46
Provision for non-collection of reinsurance recoverables ................ 24 42
Net change in non-cash balances relating to operating activities:
Accrued investment income ............................................. (432) 6
Premiums receivable ................................................... 501 2,699
Reinsurance recoverable on paid losses ................................ (441) (231)
Reinsurance recoverable on unpaid losses .............................. 199 6,124
Reinsurance recoverable on unpaid losses from related parties ......... (1,171) (367)
Prepaid reinsurance premiums .......................................... 4,017 1,988
Prepaid reinsurance premiums to related parties ....................... (742) 133
Deferred policy acquisition costs ..................................... (789) (677)
Other assets .......................................................... 611 274
Unpaid losses and loss adjustment expenses ............................ 2,082 (5,640)
Unearned premiums ..................................................... (1,944) (3,860)
Policyholder deposits ................................................. (346) 103
Accrued taxes and other payables ...................................... 1,558 177
Premiums payable ...................................................... (447) 619
Premiums payable to related parties ................................... (527) 523
------------ ------------
Cash provided by operating activities ................................... 4,425 2,640
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INVESTING ACTIVITIES
Unrestricted fixed maturities available for sale:
Purchases ............................................................... (9,617) (995)
Maturities .............................................................. 3,197 2,635
Equity securities available for sale:
Purchases ............................................................... (5,278) (3,178)
Sales ................................................................... 6,925 7,858
Investment in limited partnership ......................................... - (502)
Cost of property and equipment purchased .................................. (297) (330)
Proceeds from sale of property and equipment .............................. 14 46
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Cash provided by (applied to) investing activities ...................... (5,056) 5,534
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FINANCING ACTIVITIES
Payments and loans from related parties ................................... 263 967
Payments and loans to related parties ..................................... (2,623) (580)
Bank loan proceeds ........................................................ - 500
Payments on bank loan ..................................................... (166) -
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Cash provided by (applied to) financing activities ...................... (2,526) 887
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Increase (decrease) in cash and cash equivalents during the period .......... (3,157) 9,061
Cash and cash equivalents at beginning of period ............................ 21,403 5,510
------------ ------------
Cash and cash equivalents at end of period .................................. $ 18,246 $ 14,571
============ ============
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, 2007 AND 2006
(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, 2006. 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, 2007 are not necessarily indicative of the results that
may be expected for the year. Certain reclassifications of prior year
amounts have been made to conform to the 2007 presentation.
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 two reportable operating segments: property and
casualty insurance and agency. The segments are managed separately due
to the differences in the nature of the insurance products and services
sold. Following the sale of a subsidiary in 2002 that was engaged in
agency operations, agency operations were not significant on a
consolidated basis and therefore not reported as a separate segment.
Effective January 1, 2007, NAICO transferred its existing property and
inland marine business in its standard lines and political subdivisions
programs to Praetorian Insurance Company ("Praetorian") through an
arrangement between Praetorian and CIMI. Under this arrangement, CIMI
receives commission income for the business it produces for Praetorian.
Since this new arrangement is expected to result in a significant
increase in agency revenues, the agency segment is now reported
separately.
The following table presents a summary of Chandler USA's operating
segments for the three and six month periods ended June 30, 2007 and 2006:
Property
and
casualty Intersegment Reported
insurance Agency eliminations balances
------------ ------------ ------------ ------------
(In thousands)
THREE MONTHS ENDED JUNE 30, 2007
Revenues from external customers (1) ........... $ 15,925 $ 113 $ - $ 16,038
Intersegment revenues .......................... 39 1,142 (1,181) -
Segment profit (loss) before income taxes (2) .. 643 419 - 1,062
THREE MONTHS ENDED JUNE 30, 2006
Revenues from external customers (1) ........... $ 17,064 $ 19 $ - $ 17,083
Intersegment revenues .......................... - 677 (677) -
Segment profit (loss) before income taxes (2) .. (1,289) 685 - (604)
SIX MONTHS ENDED JUNE 30, 2007
Revenues from external customers (1) ........... $ 33,019 $ 866 $ - $ 33,885
Intersegment revenues .......................... 51 2,124 (2,175) -
Segment profit (loss) before income taxes (2) .. 1,130 1,377 - 2,507
Segment assets ................................. 223,132 6,709 (5,510) 224,331
SIX MONTHS ENDED JUNE 30, 2006
Revenues from external customers (1) ........... $ 33,970 $ 25 $ - $ 33,995
Intersegment revenues .......................... - 1,339 (1,339) -
Segment profit (loss) before income taxes (2) .. (1,019) 1,346 - 327
Segment assets ................................. 236,203 3,895 (3,361) 236,737
<FN>
- ------------------------------------------------------
(1) Consists of net premiums earned and other income.
(2) Includes net realized investment gains.
PAGE 8
Net premiums earned and losses and loss adjustment expenses within
the property and casualty insurance 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, interest 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 insurance segment.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2007 2006 2007 2006
------------ ------------ ---------- ------------
(In thousands)
INSURANCE PROGRAM
---------------------------------------
NET PREMIUMS EARNED
Standard lines ........................ $ 15,223 $ 13,467 $ 30,728 $ 26,626
Political subdivisions ................ 944 1,443 1,934 2,917
Homeowners ............................ (304) 1,822 (10) 3,891
Surety bonds .......................... 62 44 129 111
Other (1) ............................. (55) 212 109 308
------------ ------------ ---------- ------------
$ 15,870 $ 16,988 $ 32,890 $ 33,853
============ ============ ========== ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard lines ........................ $ 9,187 $ 7,368 $ 18,414 $ 15,398
Political subdivisions ................ 427 880 1,290 1,489
Homeowners ............................ (124) 1,308 (22) 2,013
Surety bonds .......................... (112) 2,319 (90) 3,202
Other (1) ............................. (12) 178 441 66
------------ ------------ ---------- ------------
$ 9,366 $ 12,053 $ 20,033 $ 22,168
============ ============ ========== ============
<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.
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 three years.
During March 2004, the lease was extended for three years and during
March 2007, the lease was extended for an additional three years with
monthly rental installments equal to the sum of (i) $13,834 plus (ii)
interest on the unpaid lease balance at 1% over JP Morgan Chase Bank
prime which was 9.25% at June 30, 2007. Chandler USA has the option to
repurchase the equipment at the end of the lease for approximately $1.9
million (the "Balloon Payment"), or may elect to have the lessor sell
the equipment. If the election to sell the equipment is made, Chandler
USA would retain any proceeds exceeding the Balloon Payment. If the
proceeds were less than the Balloon Payment, Chandler USA would be
required to pay the difference between the proceeds and the Balloon
Payment, not to exceed approximately $1.5 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 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.
PAGE 9
NOTE 4. LITIGATION
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 $20,182,499. 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 $20,182,499 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
punitive 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 with
interest from the date the losses and loss expenses were paid.
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.
On October 30, 2006, NAICO filed its Motion for Entry of Judgment
requesting that the Trial Court enter judgment on the jury verdicts for
a total of $100,577,559 plus court costs and anticipated attorney fees
for appeals. Of the total requested judgment, $70,000,000 was punitive
damages and $8,328,824 was prejudgment interest through November 1,
2006. Prejudgment interest accrues at the rate of $4,561 per day based
upon an 8.25% interest rate. NAICO requested attorney fees of $4,566,236
through entry of judgment. The Trial Court denied that request on
January 5, 2007. Gulsby has filed a separate motion for judgment that
includes a request for fees. NAICO expects the Trial Court to enter
final judgment during 2007. After judgment is entered, all parties may
file post-judgment motions. The Court has entered several interlocutory
orders since January 5, 2007 setting aside the verdicts in favor of
NAICO on its claims against Gulf Liquids and Williams and all verdicts
for punitive damages. The Court may modify these orders prior to entry
of a final judgment. Following the Court's rulings on post-judgment
motions, all parties may appeal all or any of those rulings or judgments.
PAGE 10
During the third quarter of 2006, NAICO increased the estimated
recovery on the surety bond claims related to the construction of the
two gas processing plants which resulted in a decrease in losses and
loss adjustment expenses incurred of $4.7 million. Unpaid losses and
loss adjustment expenses decreased $22.7 million, reinsurance
recoverable on unpaid losses and loss adjustment expenses decreased
$16.8 million, and reinsurance recoverable on paid losses and loss
adjustment expenses decreased $1.2 million as of June 30, 2007 as a
result of increasing the estimated recovery. NAICO has also recorded
$7.0 million of interest income for its estimate of prejudgment
interest through June 30, 2007, including a recovery for a pre-verdict
settlement with certain other parties.
NOTE 5. 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 No. 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 No. 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 No.
133. SFAS No. 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. Chandler USA adopted SFAS No. 155
effective January 1, 2007. The adoption of SFAS No. 155 did not have a
material impact on its consolidated financial statements.
In March 2006, the FASB issued SFAS No. 156, "Accounting for
Servicing of Financial Assets - an amendment of FASB Statement No. 140."
SFAS No. 156 amends SFAS No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities." SFAS No. 156
requires an entity to separately recognize financial assets as servicing
assets or servicing liabilities 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 are required.
Chandler USA adopted SFAS No. 156 effective January 1, 2007. The
adoption of SFAS No. 156 did not have a material impact on its
consolidated financial statements.
In July 2006, the FASB issued FASB Interpretation ("FIN") No. 48,
"Accounting for Uncertainty in Income Taxes," which clarifies the
accounting for uncertainty in income taxes recognized in the financial
statements in accordance with SFAS No. 109, "Accounting for Income
Taxes." FIN 48 provides guidance regarding the recognition,
measurement, presentation and disclosure of a tax position taken or
expected to be taken in a tax return as well as the derecognition of a
tax position previously recognized in the financial statements.
Chandler USA adopted FIN 48 effective January 1, 2007. The adoption
of FIN 48 did not have a material impact on its consolidated financial
statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements," which defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles, and
expands disclosures about fair value measurements. The statement does
not require new fair value measurements, but is applied to the extent
that other accounting pronouncements require or permit fair value
measurements. The statement emphasizes that fair value is a market-
based measurement that should be determined based on the assumptions
that market participants would use in pricing an asset or liability.
Companies will be required to disclose the extent to which fair value
is used to measure assets and liabilities, the inputs used to develop
the measurements, and the effect of certain of the measurements on
earnings (or changes in net assets) for the period. Chandler USA will
be required to adopt SFAS No. 157 as of January 1, 2008. Chandler USA
does not expect this statement to have a material impact on its
consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Postretirement
Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)."
This statement requires the company to recognize the funded status of
its defined benefit postretirement plans as an asset or liability in
its financial statements. In addition, the statement eliminates the
use of a measurement date that is different than the date of the
company's year-end financial statements. Chandler USA has adopted
SFAS No. 158 effective December 31, 2006. The adoption of SFAS No. 158
did not have a material impact on its consolidated financial statements.
PAGE 11
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities-Including an amendment of
FASB Statement No. 115." SFAS No. 159 permits companies to choose to
measure many financial instruments and certain other items at fair value at
specified election dates. Upon adoption, an entity shall report unrealized
gains and losses on items for which the fair value option has been elected
in earnings at each subsequent reporting date. Most of the provisions
apply only to entities that elect the fair value option. However, the
amendment to SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," applies to all entities with available for sale and
trading securities. SFAS No. 159 is effective as of the beginning of an
entity's first fiscal year that begins after November 15, 2007. Chandler
USA is currently evaluating the impact that SFAS No. 159 will have, if any,
on its consolidated financial statements.
In March 2007, the FASB ratified Emerging Issues Task Force Issue
("EITF") No. 06-10, ACCOUNTING FOR DEFERRED COMPENSATION AND POST
RETIREMENT BENEFIT ASPECTS OF COLLATERAL ASSIGNMENT SPLIT-DOLLAR LIFE
INSURANCE ARRANGEMENTS. EITF 06-10 provides guidance for determining a
liability for the postretirement benefit obligation and for recognition
and measurement of the associated asset based on the terms of the
collateral assignment agreement. EITF 06-10 is effective for fiscal years
beginning after December 15, 2007. Chandler USA has evaluated EITF 06-10
and has determined that its adoption is not expected to have a material
impact on its consolidated financial statements.
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 including ongoing litigation matters.
PAGE 12
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, 2007 and 2006:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
THREE MONTHS ENDED JUNE 30, 2007 2006 2007 2006
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard lines ................... $ 24,687 $ 22,503 $ 15,223 $ 13,467
Political subdivisions ........... 1,271 3,880 944 1,443
Homeowners ....................... 28 2,691 (304) 1,822
Surety bonds ..................... 89 63 62 44
Other ............................ (54) 213 (55) 212
------------ ------------ ------------ ------------
TOTAL ............................ $ 26,021 $ 29,350 $ 15,870 $ 16,988
============ ============ ============ ============
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
SIX MONTHS ENDED JUNE 30, 2007 2006 2007 2006
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard lines ................... $ 49,815 $ 44,769 $ 30,728 $ 26,626
Political subdivisions ........... 2,784 7,870 1,934 2,917
Homeowners ....................... 503 5,486 (10) 3,891
Surety bonds ..................... 184 158 129 111
Other ............................ 111 310 109 308
------------ ------------ ------------ ------------
TOTAL ............................ $ 53,397 $ 58,593 $ 32,890 $ 33,853
============ ============ ============ ============
Gross premiums earned decreased $3.3 million or 11% and $5.2 million
or 9% in the second quarter and first six months of 2007, respectively,
compared to the 2006 periods. Gross premiums earned in the homeowners
program decreased $2.7 million and $5.0 million in the second quarter and
first six months of 2007, respectively. This program was discontinued
during 2006. Gross premiums earned for property and inland marine
business in the standard lines and political subdivisions programs
decreased $3.0 million and $5.7 million in the second quarter and first
six months, respectively, due to the transfer of this business to
Praetorian Insurance Company ("Praetorian") as explained further below.
Partially offsetting these decreases were an increase in workers
compensation and automobile liability premiums in the standard lines
program.
Effective January 1, 2007, the property and inland marine lines of
insurance that were previously written by NAICO in the standard lines and
political subdivisions programs are being written by Praetorian through
an arrangement between Praetorian and CIMI. NAICO also transferred its
existing property and inland marine business in these programs to
Praetorian under this new arrangement effective January 1, 2007. Under
this arrangement, CIMI receives commission income for the business it
produces for Praetorian. CIMI is responsible for the payment of
commissions to the producing agents, and is also responsible for
providing underwriting and loss control services for this business.
NAICO handles all claims for this business under a separate claims
handling agreement with Praetorian. Management believes this new
arrangement will allow Chandler USA's subsidiaries to offer more
competitive property and inland marine programs for its agents. In
addition, NAICO will no longer be required to purchase reinsurance for
the significant insured values associated with this business.
Net premiums earned decreased $1.1 million or 7% and $1.0 million
or 3% for the second quarter and first six months of 2007, respectively.
The decrease was due primarily to a decrease of $2.1 million and $3.9
million in the second quarter and first six months of 2007, respectively,
in the discontinued homeowners program and a decrease of $385,000 and
$705,000 in property and inland marine business that was transferred to
Praetorian. The decrease in net premiums earned for the business
transferred to Praetorian was much less than the decrease in gross
premiums earned due to the significant amounts of reinsurance that NAICO
had purchased for this business. This reinsurance was also cancelled
which resulted in a significant decrease in reinsurance premiums ceded
during the second quarter and first six months of 2007.
PAGE 13
Gross premiums earned in the standard lines program increased $2.2
million or 10% and increased $5.0 million or 11% in the second quarter and
first six months of 2007, respectively, compared to the 2006 periods.
Gross premiums earned for workers compensation business increased $1.0
million and $2.8 million in the second quarter and first six months of
2007, respectively, and gross premiums earned for automobile liability
increased $2.9 million and $4.7 million in these periods. A decrease in
other liability premiums partially offset these increases. Net premiums
earned increased $1.8 million and $4.1 million in the second quarter and
first six months of 2007, respectively, due primarily to the increase in
gross premiums earned.
Gross premiums earned in the political subdivisions program decreased
$2.6 million or 67% and $5.1 million or 65% in the second quarter and
first six months of 2007, respectively, compared to the 2006 periods. The
decrease in gross premiums earned is due primarily to the transfer of the
property and inland marine business in this program to Praetorian as
described previously, and to increased competition in the school districts
portion of the program in Oklahoma. Net premiums earned in this program
decreased $499,000 or 35% and $983,000 or 34% in the second quarter and
first six months of 2007, respectively. The decrease in net premiums
earned was significantly less than the decrease in gross premiums earned
because of the significant amounts of reinsurance that NAICO had purchased
for the property and inland marine lines of business in this program.
In 2005, NAICO began writing homeowner and dwelling policies in the
state of Texas through a managing general agent. NAICO discontinued this
program during 2006 due primarily to increased catastrophe exposures.
Gross and net premiums earned in the surety bond program experienced
minor increases compared to the 2006 periods. NAICO is no longer actively
marketing its surety bond program.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At June 30, 2007, Chandler USA's investment portfolio consisted
primarily of fixed income U.S. Treasury and government agency bonds,
high-quality corporate bonds and equity securities with approximately
20% 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 included $317,000 in the first quarter of 2007 in
prejudgment interest income accrued for a favorable jury verdict in
civil litigation in 2006 regarding certain surety bond claims. No
prejudgment interest was accrued during the second quarter of 2007.
See "LITIGATION" and Note 4 of Notes to Interim Consolidated Financial
Statements.
Net investment income, excluding interest income from related
parties and the prejudgment interest accrual, increased $81,000 or 10%
and $207,000 or 14% in the second quarter and first six months of 2007,
respectively, due primarily to higher interest rates and an increase in
cash and invested assets. Cash and invested assets were $90.8 million
at June 30, 2007 compared to $87.6 million at June 30, 2006. Net
interest income from related parties increased $57,000 or 30% and $91,000
or 25% in the second quarter and first six months of 2007, respectively,
due primarily to higher interest rates and to an increase in the amount
due from related parties.
Net realized investment gains were $26,000 and $61,000 during the
second quarter and first six months of 2007, respectively. Net realized
investment gains were $133,000 and $189,000 during the second quarter
and first six months of 2007. The net realized gains in 2007 and 2006
were from sales of equity securities.
OTHER INCOME
Other income was $168,000 and $995,000 in the second quarter and
first six months of 2007, respectively, compared to $95,000 and $142,000
in the second quarter and first six months of 2006. The increase in the
2007 periods was due to the transfer of NAICO's property and inland
marine business in the standard lines and political subdivisions programs
to Praetorian under a new arrangement effective January 1, 2007. Under
this arrangement, CIMI receives commission income for the business it
produces for Praetorian.
PAGE 14
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.
The percentage of losses and loss adjustment expenses to net
premiums earned ("loss ratio") was 59.0% and 60.9% for the second
quarter and first six months of 2007, compared to 71.0% and 65.5% in
the corresponding 2006 periods. The decrease in the 2007 loss ratios
was due primarily to a decrease in losses incurred related to prior
accident years. In the second quarter of 2007, losses and loss
adjustment expenses incurred related to prior accident years were
$157,000 and increased the loss ratio by 1.0 percentage point. In the
first six months of 2007, loss development was redundant by $301,000
which decreased the loss ratio by 0.9 percentage points. An increase
in losses incurred in the 1997-2005 accident years of $4.9 million in
the first six months of 2007 was offset by a reduction in losses
incurred in the 2006 accident year of $5.2 million. During 2006,
adverse loss development totaling $2.7 million and $3.8 million in the
second quarter and first six months of 2006, respectively, increased
the respective loss ratios by 15.8 and 11.2 percentage points. The
adverse loss development in 2006 was due primarily to an increase in
surety bond losses in the 2001 accident year.
Weather-related losses from wind and hail totaled $48,000 and
$70,000 in the second quarter and first six months of 2007 and
increased the respective loss ratios by 0.3 and 0.2 percentage points.
Weather-related losses totaled $446,000 and $559,000 in the second
quarter and first six months of 2006, and increased the respective
2006 loss ratios by 2.6 and 1.7 percentage points.
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, 2007
and 2006:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2007 2006 2007 2006
---------- ---------- ---------- ----------
(In thousands)
Commissions expense ........................ $ 3,374 $ 3,525 $ 7,279 $ 8,150
Other premium related assessments .......... 263 221 521 502
Premium taxes .............................. 580 534 1,152 1,182
Excise taxes ............................... 66 65 149 128
Other expense .............................. 214 196 453 378
---------- ---------- ---------- ----------
Total direct expenses ...................... 4,497 4,541 9,554 10,340
Indirect underwriting expenses ............. 1,457 1,496 2,920 2,999
Commissions received from reinsurers ....... (2,911) (3,195) (5,404) (6,738)
Adjustment for deferred acquisition costs .. (11) (89) (788) (677)
---------- ---------- ---------- ----------
Net policy acquisition costs ............... $ 3,032 $ 2,753 $ 6,282 $ 5,924
========== ========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct
written and assumed premiums were 24.7% and 24.2% for the second quarter
and first six months of 2007, compared to 24.0% and 24.4% in the
corresponding year ago periods. Commissions expense as a percentage of
gross written and assumed premiums was 14.0% and 14.1% in the second
quarter and the first six months of 2007 compared to 14.0% and 14.9% in
the corresponding 2006 periods.
PAGE 15
Indirect underwriting expenses were 6.0% and 5.7% of total direct
written and assumed premiums in the second quarter and first six months of
2007, respectively, compared to 5.9% and 5.5% in the corresponding 2006
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 31.1% and 31.4% in the second
quarter and first six months of 2007, respectively, compared to 32.0% and
29.8% in the corresponding 2006 periods
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 11.6% and 11.5% of gross
premiums earned and other income in the second quarter and first six months
of 2007, respectively, compared to 11.5% and 10.7% for the corresponding
2006 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 $11,000 and $33,000 in the second quarter
and first six months of 2007, respectively, compared to the 2006 periods.
Substantially all of Chandler USA's interest expense is related to its
outstanding senior debentures and junior subordinated debentures. The
increase in the 2007 periods was due primarily to higher interest rates
during 2007, 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 2007, Chandler USA provided $4.4 million
in cash from operations. Cash provided by operations included a decrease
in prepaid reinsurance premiums of $3.3 million. This was partially
offset by a decrease in unearned premiums of $1.9 million. Unpaid losses
and loss adjustment expenses increased $2.1 million during the first six
months of 2007. This was partially offset by an increase in reinsurance
recoverable on unpaid losses of $1.0 million. In the first six months of
2006, Chandler USA provided $2.6 million in cash from operations.
NAICO is required to deposit cash and securities with regulatory
agencies in which it is licensed as a condition of conducting operations
in the state. In addition, NAICO has deposited cash and securities into
a trust account as collateral for a reinsurance agreement in which NAICO
is the assuming reinsurer. At June 30, 2007, the total amount of cash
and securities restricted as a result of these arrangements was $33.2
million which was an increase of $13.6 million from December 31, 2006.
This increase was due to an increase in the amount of reinsurance that
NAICO assumed during 2007.
At June 30, 2007, Chandler USA's parent company, Chandler Insurance
Company, Ltd., owed approximately $11.9 million to Chandler USA versus
$9.6 million at December 31, 2006 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 three years. During
March 2004, the lease was extended for three years and during March 2007,
the lease was extended for an additional three years with monthly rental
installments equal to the sum of (i) $13,834 plus (ii) interest on the
unpaid lease balance at 1% over JP Morgan Chase Bank prime which was
9.25% at June 30, 2007. Chandler USA has the option to repurchase the
equipment at the end of the lease for approximately $1.9 million (the
"Balloon Payment"), or may elect to have the lessor sell the equipment.
If the election to sell the equipment is made, Chandler USA would retain
any proceeds exceeding the Balloon Payment. If the proceeds were less
than the Balloon Payment, Chandler USA would be required to pay the
difference between the proceeds and the Balloon Payment, not to exceed
approximately $1.5 million.
PAGE 16
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.
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, 2006, NAICO had statutory earned surplus of
$14.0 million. Applying the Oklahoma statutory limits described above,
the maximum shareholder dividend NAICO may pay in 2007 without the
approval of the Oklahoma Department of Insurance is $5.2 million.
NAICO paid a cash shareholder dividend of $1.6 million to Chandler USA
in May 2007. NAICO did not pay any shareholder dividends to Chandler
USA in 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.
LITIGATION
On August 1, 2006, a jury trial concluded in Harris County, Texas,
related to the construction of two gas processing plants in Louisiana.
NAICO had provided surety bonds in connection with the construction of
these plants. The amounts the jury found owing to NAICO include
approximately $20.2 million in actual damages and $70.0 million in
punitive damages. The amounts the jury found owing to Gulsby included
approximately $20.9 million in actual damages and $85.0 million in punitive
damages. NAICO is subrogated to any recovery by Gulsby to the extent of
NAICO's losses on the bonds including loss adjustment expenses with
interest from the date the losses and loss expenses were paid. See Note 4
of Notes to Interim Consolidated Financial Statements for a discussion of
this jury verdict.
PAGE 17
On October 30, 2006, NAICO filed its Motion for Entry of Judgment
requesting that the Trial Court enter judgment for a total of $100.6
million plus court costs and anticipated attorney fees for appeals.
This amount includes $70.0 million in punitive damages, $8.3 million in
prejudgment interest through October 31, 2006, and attorney fees of
$4.6 million through entry of judgment. Prejudgment interest accrues at
the rate of $4,561 per day based upon an 8.25% interest rate. The Trial
Court denied the request for attorney fees on January 5, 2007. NAICO
expects the Trial Court to enter final judgment during 2007. After
judgment is entered, all parties may file post-judgment motions. The
Court has entered several interlocutory orders since January 5, 2007
setting aside the verdicts in favor of NAICO on its claims against Gulf
Liquids and Williams and all verdicts for punitive damages. The Court
may modify these orders prior to entry of a final judgment. Following
the Court's rulings on post-judgment motions, all parties may appeal all
or any of those rulings or judgments.
During the third quarter of 2006, NAICO increased the estimated
recovery on the surety bond claims related to the construction of the two
gas processing plants which resulted in a decrease in losses and loss
adjustment expenses incurred of $4.7 million. In addition, unpaid losses
and loss adjustment expenses decreased $22.7 million, reinsurance
recoverable on unpaid losses and loss adjustment expenses decreased $16.8
million, and reinsurance recoverable on paid losses and loss adjustment
expenses decreased $1.2 million. NAICO also recorded $6.6 million of
interest income for its estimate of prejudgment interest through December
31, 2006 and recorded an additional $317,000 of prejudgment interest
during the first quarter of 2007 including a recovery for a pre-verdict
settlement with certain other parties.
A.M. BEST RATING
Effective May 2, 2007, A.M. Best Company affirmed the financial
strength rating of B+ (Good) and the issuer credit rating (ICR) of
"bbb-" of 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. The outlook
for all ratings has been revised to stable from negative. NAICO's
policyholders surplus has also increased from A.M. Best's financial
size category VI to category VII ($50 million to $100 million).
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.
ITEM 4T. CONTROLS AND PROCEDURES
Not applicable.
PAGE 18
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 4 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, 2006.
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
---------------------------------------------------
None.
Item 5. OTHER INFORMATION
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None.
Item 6. EXHIBITS
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31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.
PAGE 19
SIGNATURES
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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 6, 2007 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
Senior Vice President - Finance, Chief
Financial Officer and Treasurer
(Principal Accounting Officer)