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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 SEPTEMBER 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
--- ---
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 October 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 September 30, 2007 and December 31, 2006 ..1
Consolidated Statements of Operations for the three months
ended September 30, 2007 and 2006 ........................................2
Consolidated Statements of Operations for the nine months
ended September 30, 2007 and 2006 ........................................3
Consolidated Statements of Comprehensive Income for the three
months ended September 30, 2007 and 2006 .................................4
Consolidated Statements of Comprehensive Income for the nine
months ended September 30, 2007 and 2006 .................................5
Consolidated Statements of Cash Flows for the nine months
ended September 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
- --------------------------------
PART II - OTHER INFORMATION
- ---------------------------
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)
September 30, December 31,
2007 2006
------------- --------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $34,202 and $19,830 in 2007 and 2006, respectively) ......... $ 33,828 $ 19,151
Unrestricted (amortized cost $37,486 and $48,557 in 2007 and 2006, respectively) ....... 37,026 47,228
Equity securities at fair value (cost $533 and $1,587 in 2007 and 2006, respectively) ... 675 1,921
------------- --------------
Total investments ...................................................................... 71,529 68,300
Cash and cash equivalents ($417 and $450 restricted in 2007 and 2006, respectively) ...... 23,250 21,403
Accrued investment income ................................................................ 5,311 5,022
Premiums receivable, less allowance for non-collection of $157 and $170 at
2007 and 2006, respectively ............................................................. 27,027 31,008
Reinsurance recoverable on paid losses ................................................... 1,124 1,087
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $187 and $130 at 2007 and 2006, respectively .......................... 26,321 25,588
Reinsurance recoverable on unpaid losses from related parties ............................ 17,338 15,584
Prepaid reinsurance premiums ............................................................. 3,336 7,603
Prepaid reinsurance premiums to related parties .......................................... 12,921 13,506
Deferred policy acquisition costs ........................................................ 1,447 845
Property and equipment, net .............................................................. 8,449 8,457
Amounts due from related parties ......................................................... 11,708 9,584
State insurance licenses, net ............................................................ 3,745 3,745
Other assets ............................................................................. 9,173 11,040
------------- --------------
Total assets ............................................................................. $ 222,679 $ 222,772
============= ==============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses .............................................. $ 86,628 $ 83,253
Unearned premiums ....................................................................... 46,598 53,217
Policyholder deposits ................................................................... 7,608 7,663
Accrued taxes and other payables ........................................................ 5,269 5,119
Premiums payable ........................................................................ 2,526 1,955
Premiums payable to related parties ..................................................... 743 1,002
Senior debentures ....................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts .............................. 20,620 20,620
------------- --------------
Total liabilities ...................................................................... 176,971 179,808
------------- --------------
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 ..................................................................... (14,421) (16,517)
Accumulated other comprehensive income (loss):
Unrealized loss on investments available for sale, net of deferred income taxes ......... (457) (1,105)
------------- --------------
Total shareholder's equity ............................................................. 45,708 42,964
------------- --------------
Total liabilities and shareholder's equity ............................................... $ 222,679 $ 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 September 30,
---------------------------------
2007 2006
------------ ------------
Premiums and other revenues
Direct premiums written and assumed .......................... $ 21,894 $ 30,096
Reinsurance premiums ceded ................................... (2,701) (6,643)
Reinsurance premiums ceded to related parties ................ (5,782) (7,195)
------------ ------------
Net premiums written and assumed ........................... 13,411 16,258
Decrease (increase) in unearned premiums ..................... 3,099 (229)
------------ ------------
Net premiums earned ........................................ 16,510 16,029
Investment income, net ......................................... 918 7,158
Interest income, net from related parties ...................... 248 208
Realized investment gains, net ................................. 34 352
Other income ................................................... 369 74
------------ ------------
Total premiums and other revenues ............................ 18,079 23,821
------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $4,407 and $4,175 in
2007 and 2006, respectively ................................ 10,230 13,789
Policy acquisition costs, net of ceding commissions
received from related parties of $2,200 and $2,735 in
2007 and 2006, respectively ................................ 3,197 3,225
General and administrative expenses .......................... 3,056 3,385
Interest expense ............................................. 675 685
------------ ------------
Total operating costs and expenses ......................... 17,158 21,084
------------ ------------
Income before income taxes ..................................... 921 2,737
Federal income tax provision ................................... (407) (862)
------------ ------------
Net income ................................................... $ 514 $ 1,875
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
--------------------------------
2007 2006
------------- ------------
Premiums and other revenues
Direct premiums written and assumed ....................... $ 73,347 $ 84,830
Reinsurance premiums ceded ................................ (5,014) (16,491)
Reinsurance premiums ceded to related parties ............. (20,701) (19,966)
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Net premiums written and assumed ........................ 47,632 48,373
Decrease in unearned premiums ............................. 1,768 1,509
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Net premiums earned ..................................... 49,400 49,882
Investment income, net ...................................... 2,938 8,654
Interest income, net from related parties ................... 708 577
Realized investment gains, net .............................. 95 541
Other income ................................................ 1,364 216
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Total premiums and other revenues ......................... 54,505 59,870
------------- ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $12,433 and $10,568 in
2007 and 2006, respectively ............................. 30,263 35,957
Policy acquisition costs, net of ceding commissions
received from related parties of $7,874 and $7,583 in
2007 and 2006, respectively ............................. 9,479 9,149
General and administrative expenses ....................... 9,305 9,693
Interest expense .......................................... 2,030 2,007
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Total operating costs and expenses ...................... 51,077 56,806
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Income before income taxes .................................. 3,428 3,064
Federal income tax provision ................................ (1,332) (998)
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Net income ................................................ $ 2,096 $ 2,066
============= ============
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 September 30,
--------------------------------
2007 2006
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Net income .................................................. $ 514 $ 1,875
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Other comprehensive income, before income tax:
Unrealized gains on securities:
Unrealized holding gains arising during period .......... 1,369 1,505
Less: Reclassification adjustment for gains included in
net income ............................................ (34) (352)
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Other comprehensive income, before income tax ............... 1,335 1,153
Income tax provision related to items of other
comprehensive income ...................................... (454) (392)
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Other comprehensive income, net of income tax ............... 881 761
------------- ------------
Comprehensive income ........................................ $ 1,395 $ 2,636
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
--------------------------------
2007 2006
------------- ------------
Net income .................................................. $ 2,096 $ 2,066
------------- ------------
Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains arising during period .......... 1,077 277
Less: Reclassification adjustment for gains included in
net income ............................................ (95) (541)
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Other comprehensive income (loss), before income tax ........ 982 (264)
Income tax benefit (provision) related to items of other
comprehensive income (loss) ............................... (334) 90
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Other comprehensive income (loss), net of income tax ........ 648 (174)
------------- ------------
Comprehensive income ........................................ $ 2,744 $ 1,892
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 6
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
-------------------------------
2007 2006
------------ ------------
OPERATING ACTIVITIES
Net income .................................................................. $ 2,096 $ 2,066
Add (deduct):
Adjustments to reconcile net income to cash provided by operating activities:
Realized investment gains, net .......................................... (95) (541)
Net (gains) losses on sale of property and equipment .................... (6) 5
Amortization and depreciation expense ................................... 1,065 1,024
Provision for non-collection of premiums ................................ 41 81
Provision for non-collection of reinsurance recoverables ................ 126 75
Net change in non-cash balances relating to operating activities:
Accrued investment income ............................................. (289) (6,206)
Premiums receivable ................................................... 3,940 (46)
Reinsurance recoverable on paid losses ................................ (106) 1,180
Reinsurance recoverable on paid losses from related parties ........... - (155)
Reinsurance recoverable on unpaid losses .............................. (790) 25,989
Reinsurance recoverable on unpaid losses from related parties ......... (1,754) (437)
Prepaid reinsurance premiums .......................................... 4,267 1,475
Prepaid reinsurance premiums to related parties ....................... 585 (615)
Deferred policy acquisition costs ..................................... (602) 229
Other assets .......................................................... 1,490 1,148
Unpaid losses and loss adjustment expenses ............................ 3,375 (23,630)
Unearned premiums ..................................................... (6,619) (2,370)
Policyholder deposits ................................................. (55) 282
Accrued taxes and other payables ...................................... 402 (158)
Premiums payable ...................................................... 571 481
Premiums payable to related parties ................................... (259) (113)
------------ ------------
Cash provided by (applied to) operating activities ...................... 7,383 (236)
------------ ------------
INVESTING ACTIVITIES
Unrestricted fixed maturities available for sale:
Purchases ............................................................... (13,965) (995)
Sales ................................................................... 5,016 -
Maturities .............................................................. 5,286 2,726
Equity securities available for sale:
Purchases ............................................................... (5,811) (3,178)
Sales ................................................................... 6,925 11,135
Investment in limited partnership ......................................... - (502)
Cost of property and equipment purchased .................................. (661) (415)
Proceeds from sale of property and equipment .............................. 50 49
------------ ------------
Cash provided by (applied to) investing activities ...................... (3,160) 8,820
------------ ------------
FINANCING ACTIVITIES
Payments and loans from related parties ................................... 1,730 1,260
Payments and loans to related parties ..................................... (3,854) (1,698)
Bank loan proceeds ........................................................ - 500
Payments on bank loan ..................................................... (252) (81)
------------ ------------
Cash applied to financing activities .................................... (2,376) (19)
------------ ------------
Increase in cash and cash equivalents during the period ..................... 1,847 8,565
Cash and cash equivalents at beginning of period ............................ 21,403 5,510
------------ ------------
Cash and cash equivalents at end of period .................................. $ 23,250 $ 14,075
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 7
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 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
nine month periods ended September 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 nine month periods ended September 30, 2007 and
2006:
Property
and
casualty Intersegment Reported
insurance Agency eliminations balances
------------ ------------ ------------ ------------
(In thousands)
THREE MONTHS ENDED SEPTEMBER 30, 2007
Revenues from external customers (1) ........... $ 16,620 $ 259 $ - $ 16,879
Intersegment revenues .......................... 7 1,170 (1,177) -
Segment profit (loss) before income taxes (2) .. 299 622 - 921
THREE MONTHS ENDED SEPTEMBER 30, 2006
Revenues from external customers (1) ........... $ 16,065 $ 38 $ - $ 16,103
Intersegment revenues .......................... - 847 (847) -
Segment profit (loss) before income taxes (2) .. 1,859 878 - 2,737
NINE MONTHS ENDED SEPTEMBER 30, 2007
Revenues from external customers (1) ........... $ 49,638 $ 1,126 $ - $ 50,764
Intersegment revenues .......................... 58 3,294 (3,352) -
Segment profit (loss) before income taxes (2) .. 1,430 1,998 - 3,428
Segment assets ................................. 220,742 7,622 (5,685) 222,679
NINE MONTHS ENDED SEPTEMBER 30, 2006
Revenues from external customers (1) ........... $ 50,035 $ 63 $ - $ 50,098
Intersegment revenues .......................... - 2,187 (2,187) -
Segment profit (loss) before income taxes (2) .. 840 2,224 - 3,064
Segment assets ................................. 221,246 4,814 (4,198) 221,862
<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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- ------------------------------
2007 2006 2007 2006
------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAM
---------------------------------------
NET PREMIUMS EARNED
Standard lines ........................ $ 15,639 $ 13,832 $ 46,367 $ 40,458
Political subdivisions ................ 787 1,211 2,722 4,128
Homeowners ............................ - 819 (10) 4,710
Surety bonds .......................... 32 39 162 150
Other (1) ............................. 52 128 159 436
------------ ------------ ------------ ------------
$ 16,510 $ 16,029 $ 49,400 $ 49,882
============ ============ ============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
---------------------------------------
Standard lines ........................ $ 9,862 $ 17,822 $ 28,275 $ 33,220
Political subdivisions ................ 248 429 1,538 1,918
Homeowners ............................ (21) 440 (43) 2,453
Surety bonds .......................... 177 (4,958) 87 (1,756)
Other (1) ............................. (36) 56 406 122
------------ ------------ ------------ ------------
$ 10,230 $ 13,789 $ 30,263 $ 35,957
============ ============ ============ ============
<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 8.75%
at September 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 filed a separate motion for
judgment that includes a request for fees. The Court has also denied
Gulsby's request for attorney fees and has entered interlocutory orders
reducing the amounts awarded to Gulsby by the jury verdicts. The Court
has also 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. NAICO
expects the Trial Court to enter final judgment during the fourth quarter
of 2007 or the first quarter of 2008. After judgment is entered, all
parties may file post-judgment motions. 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 September 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 September 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 nine month periods
ended September 30, 2007 and 2006:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
THREE MONTHS ENDED SEPTEMBER 30, 2007 2006 2007 2006
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard lines .................. $ 25,270 $ 23,091 $ 15,639 $ 13,832
Political subdivisions .......... 1,203 3,406 787 1,211
Homeowners ...................... - 1,924 - 819
Surety bonds .................... 46 57 32 39
Other ........................... 51 128 52 128
------------ ------------ ------------ ------------
TOTAL ........................... $ 26,570 $ 28,606 $ 16,510 $ 16,029
============ ============ ============ ============
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2007 2006 2007 2006
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard lines .................. $ 75,085 $ 67,860 $ 46,367 $ 40,458
Political subdivisions .......... 3,987 11,276 2,722 4,128
Homeowners ...................... 502 7,410 (10) 4,710
Surety bonds .................... 231 215 162 150
Other ........................... 162 438 159 436
------------ ------------ ------------ ------------
TOTAL ........................... $ 79,967 $ 87,199 $ 49,400 $ 49,882
============ ============ ============ ============
Gross premiums earned decreased $2.0 million or 7% and $7.2 million or
8% in the third quarter and first nine months of 2007, respectively, compared
to the 2006 periods. Gross premiums earned in the homeowners program
decreased $1.9 million and $6.9 million in the third quarter and first nine
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 $2.7 million and $8.4
million in the third quarter and first nine months, respectively, due to the
transfer of this business to Praetorian Insurance Company ("Praetorian") as
explained further below. Partially offsetting these decreases were increases
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 increased $481,000 or 3% and decreased $482,000 or
1% for the third quarter and first nine months of 2007, respectively. The
increase in the third quarter was due primarily to an increase of $1.8
million in the standard lines program that was partially offset by a
decrease of $819,000 in the discontinued homeowners program. The decrease
in net premiums earned in the first nine months of 2007 was due primarily
to a decrease of $4.7 million in the discontinued homeowners program and to
the transfer of property and inland marine business in the standard lines
and political subdivisions programs to Praetorian. The decreases were
largely offset by an increase of $5.9 million in the standard lines program.
Net premiums earned for property and inland marine business in the
standard lines and political subdivisions programs decreased $414,000 and
$1.1 million in the third quarter and first nine months, respectively, due
to the transfer of this business 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 third quarter and first nine
months of 2007.
PAGE 13
Gross premiums earned in the standard lines program increased $2.2
million or 9% and $7.2 million or 11% in the third quarter and first nine
months of 2007, respectively, compared to the 2006 periods. Gross premiums
earned for workers compensation business increased $1.2 million and $4.0
million in the third quarter and first nine months of 2007, respectively,
and gross premiums earned for automobile liability increased $1.9 million
and $6.5 million in these periods. A decrease in other liability premiums
partially offset these increases. Net premiums earned increased $1.8
million and $5.9 million in the third quarter and first nine months of
2007, respectively, due primarily to the increase in gross premiums earned.
Gross premiums earned in the political subdivisions program decreased
$2.2 million or 65% and $7.3 million or 65% in the third quarter and first
nine 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 $424,000 and $1.4 million in the third quarter and first nine
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 did not
vary significantly from the 2006 periods. NAICO is no longer actively
marketing its surety bond program.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At September 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
25% 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 and third quarters of 2007. Net investment income
included $6.3 million in the third quarter and first nine months of 2006
in prejudgment interest income accrued for this verdict. 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 $84,000 or 10% and
increased $291,000 or 12% in the third quarter and first nine months of
2007, respectively, due primarily to an increase in cash and invested
assets. Cash and invested assets were $94.8 million at September 30, 2007
compared to $85.1 million at September 30, 2006. Net interest income from
related parties increased $40,000 or 19% and $131,000 or 23% in the third
quarter and first nine months of 2007, respectively, due primarily to an
increase in the amount due from related parties.
Net realized investment gains were $34,000 and $95,000 during the
third quarter and first nine months of 2007, respectively. Net realized
investment gains were $352,000 and $541,000 during the third quarter and
first nine months of 2006.
OTHER INCOME
Other income was $369,000 and $1.4 million in the third quarter and
first nine months of 2007, respectively, compared to $74,000 and $216,000
in the third quarter and first nine 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 62.0% and 61.3% for the third quarter and first
nine months of 2007, compared to 86.0% and 72.1% 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 third
quarter of 2007, losses and loss adjustment expenses incurred related to
prior accident years were $14,000. In the first nine months of 2007, loss
development was redundant by $287,000. An increase in losses incurred in
the 1997-2005 accident years of $5.9 million in the first nine months of
2007 was offset by a reduction in losses incurred in the 2006 accident year
of $6.1 million. During 2006, adverse loss development totaling $958,000
and $4.8 million in the third quarter and first nine months of 2006,
respectively, increased the respective loss ratios by 6.0 and 9.7 percentage
points. The adverse loss development in 2006 was due primarily to an
increase in losses for prior accident years in the standard lines program.
Weather-related losses from wind and hail totaled $35,000 and $109,000
in the third quarter and first nine months of 2007 and increased the
respective loss ratios by 0.2 percentage points in both periods.
Weather-related losses totaled $93,000 and $652,000 in the third quarter
and first nine months of 2006, and increased the respective 2006 loss
ratios by 0.6 and 1.3 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 nine month periods ended September 30, 2007 and
2006:
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, SEPTEMBER 30,
---------------------- ----------------------
2007 2006 2007 2006
---------- ---------- ---------- ----------
(In thousands)
Commissions expense .......................... $ 3,139 $ 4,026 $ 10,418 $ 12,176
Other premium related assessments ............ 245 346 766 848
Premium taxes ................................ 490 563 1,642 1,745
Excise taxes ................................. 58 72 207 200
Other expense ................................ 187 191 640 569
---------- ---------- ---------- ----------
Total direct expenses ........................ 4,119 5,198 13,673 15,538
Indirect underwriting expenses ............... 1,500 1,547 4,420 4,546
Commissions received from reinsurers ......... (2,608) (4,425) (8,012) (11,163)
Adjustment for deferred acquisition costs .... 186 905 (602) 228
---------- ---------- ---------- ----------
Net policy acquisition costs ................. $ 3,197 $ 3,225 $ 9,479 $ 9,149
========== ========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct
written and assumed premiums were 25.7% and 24.7% for the third quarter and
first nine months of 2007, compared to 22.4% and 23.7% in the corresponding
year ago periods. Commissions expense as a percentage of gross written and
assumed premiums was 14.3% and 14.2% in the third quarter and the first nine
months of 2007 compared to 13.4% and 14.4% in the corresponding 2006 periods.
PAGE 15
Indirect underwriting expenses were 6.9% and 6.0% of total direct
written and assumed premiums in the third quarter and first nine months of
2007, respectively, compared to 5.1% and 5.4% 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. The increase in the 2007 percentages were due
primarily to the transfer of the property and inland marine business in the
standard lines and political subdivisions programs to Praetorian. Indirect
underwriting expenses decreased $47,000 and $126,000 in the third quarter
and first nine months of 2007, respectively. Commissions received from
reinsurers as a percent of ceded reinsurance premiums were 30.7% and 31.2%
in the third quarter and first nine months of 2007, respectively, compared
to 32.0% and 30.6% in the corresponding 2006 periods.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 11.3% and 11.4% of gross
premiums earned and other income in the third quarter and first nine months
of 2007, respectively, compared to 11.8% and 11.1% 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 decreased $10,000 and increased $23,000 in the third
quarter and first nine 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.
A portion of Chandler USA's junior subordinated debentures were issued
with a floating interest rate.
LIQUIDITY AND CAPITAL RESOURCES
In the first nine months of 2007, Chandler USA provided $7.4 million
in cash from operations. Cash provided by operations included a decrease
in premiums receivable and prepaid reinsurance premiums of $3.9 million
and $4.9 million, respectively. This was partially offset by a decrease
in unearned premiums of $6.6 million. Unpaid losses and loss adjustment
expenses increased $3.4 million during the first nine months of 2007. This
was partially offset by a decrease in reinsurance recoverable on unpaid
losses of $2.5 million. In the first nine months of 2006, Chandler USA
used $236,000 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 September 30, 2007, the total amount of cash and
securities restricted as a result of these arrangements was $34.2 million
which was an increase of $14.6 million from December 31, 2006. This increase
was due to an increase in the amount of reinsurance that NAICO assumed during
2007.
At September 30, 2007, Chandler USA's parent company, Chandler Insurance
Company, Ltd., owed approximately $11.7 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.
PAGE 16
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 8.75%
at September 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 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.
PAGE 17
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.
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. The Court has
also denied Gulsby's request for attorney fees and has entered
interlocutory orders reducing the amounts awarded to Gulsby by the jury
verdicts. The Court has also 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. NAICO expects the Trial Court to enter final judgment during
the fourth quarter of 2007 or the first quarter of 2008. After judgment
is entered, all parties may file post-judgment motions. 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.
PAGE 18
ITEM 4T. CONTROLS AND PROCEDURES
Not applicable.
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
-----------------
None.
Item 6. EXHIBITS
--------
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: November 12, 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)