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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 MARCH 31, 2008
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, a non-accelerated filer, or a smaller
reporting company. See the definitions of "large accelerated filer,"
"accelerated filer" and "smaller reporting company" in Rule 12b-2 of the
Exchange Act.
Large accelerated filer Accelerated filer
-- --
Non-accelerated filer X (Do not check if a smaller reporting company)
--
Smaller reporting company
--
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 April 30, 2008 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
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ITEM 1. FINANCIAL STATEMENTS:
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Consolidated Balance Sheets as of March 31, 2008 (unaudited)
and December 31, 2007 ..................................................1
Consolidated Statements of Operations for the three months
ended March 31, 2008 and 2007 (unaudited) ..............................2
Consolidated Statements of Comprehensive Income for the three
months ended March 31, 2008 and 2007 (unaudited) .......................3
Consolidated Statements of Cash Flows for the three months
ended March 31, 2008 and 2007 (unaudited) ..............................4
Notes to Interim Consolidated Financial Statements (unaudited) ...........5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
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RESULTS OF OPERATIONS .............................................8
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ITEM 4T. CONTROLS AND PROCEDURES ............................................14
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PART II - OTHER INFORMATION
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Item 1. Legal Proceedings ................................................14
Item 1A. Risk Factors .....................................................14
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ......14
Item 3. Defaults Upon Senior Securities ..................................14
Item 4. Submission of Matters to a Vote of Security Holders ..............14
Item 5. Other Information ................................................14
Item 6. Exhibits .........................................................14
Signatures ..................................................................15
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
March 31, December 31,
2008 2007
------------- --------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $36,892 and $32,416 in 2008 and 2007, respectively) .... $ 37,863 $ 32,670
Unrestricted (amortized cost $33,129 and $30,484 in 2008 and 2007, respectively) .. 33,584 30,387
Equity securities available for sale, at fair value (cost $0 in 2008 and 2007) ..... 141 141
Short-term investments ............................................................. 950 1,045
------------- --------------
Total investments ................................................................. 72,538 64,243
Cash and cash equivalents ($416 and $146 restricted in 2008 and 2007, respectively).. 29,293 32,956
Accrued investment income ........................................................... 831 874
Premiums receivable, less allowance for non-collection
of $149 and $134 at 2008 and 2007, respectively .................................... 30,817 28,128
Reinsurance recoverable on paid losses .............................................. 1,028 1,100
Reinsurance recoverable on unpaid losses, less allowance for non-collection
of $284 and $239 at 2008 and 2007, respectively .................................... 37,550 36,036
Reinsurance recoverable on unpaid losses from related parties ....................... 19,657 18,688
Prepaid reinsurance premiums ........................................................ 3,426 3,105
Prepaid reinsurance premiums to related parties ..................................... 13,684 12,928
Deferred policy acquisition costs ................................................... 1,280 1,118
Property and equipment, net ......................................................... 8,138 8,255
Amounts due from related parties .................................................... 11,187 11,506
State insurance licenses, net ....................................................... 3,745 3,745
Other assets ........................................................................ 10,491 11,685
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Total assets ........................................................................ $ 243,665 $ 234,367
============= ==============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ......................................... $ 105,731 $ 100,590
Unearned premiums .................................................................. 49,230 46,389
Policyholder deposits .............................................................. 7,127 7,947
Accrued taxes and other payables ................................................... 6,042 5,777
Premiums payable ................................................................... 2,078 2,263
Premiums payable to related parties ................................................ 801 198
Senior debentures .................................................................. 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ......................... 20,620 20,620
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Total liabilities ................................................................. 198,608 190,763
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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 ................................................................ (16,563) (17,179)
Accumulated other comprehensive income:
Unrealized gain on investments available for sale, net of deferred income taxes ... 1,034 197
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Total shareholder's equity ........................................................ 45,057 43,604
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Total liabilities and shareholder's equity .......................................... $ 243,665 $ 234,367
============= ==============
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 March 31,
--------------------------------
2008 2007
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Premiums and other revenues
Direct premiums written and assumed ........................... $ 30,203 $ 27,333
Reinsurance premiums ceded .................................... (2,724) 498
Reinsurance premiums ceded to related parties ................. (8,205) (8,357)
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Net premiums written and assumed ............................. 19,274 19,474
Increase in unearned premiums ................................. (1,764) (2,454)
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Net premiums earned .......................................... 17,510 17,020
Investment income, net .......................................... 890 1,160
Interest income, net from related parties ....................... 188 212
Realized investment gains, net .................................. - 35
Other income .................................................... 412 827
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Total premiums and other revenues ............................ 19,000 19,254
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Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $4,055 and $4,242 in
2008 and 2007, respectively .................................. 10,936 10,667
Policy acquisition costs, net of ceding commissions
received from related parties of $3,120 and $3,179 in
2008 and 2007, respectively .................................. 3,243 3,250
General and administrative expenses ........................... 3,160 3,215
Interest expense .............................................. 652 677
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Total operating costs and expenses ........................... 17,991 17,809
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Income before income taxes ...................................... 1,009 1,445
Federal income tax provision .................................... (393) (531)
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Net income .................................................... $ 616 $ 914
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Three months ended March 31,
--------------------------------
2008 2007
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Net income ................................................. $ 616 $ 914
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Other comprehensive income, before income tax:
Unrealized gains on securities:
Unrealized holding gains arising during period .......... 1,268 192
Less: Reclassification adjustment for gains included
in net income .......................................... - (35)
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Other comprehensive income, before income tax .............. 1,268 157
Income tax provision related to items of other
comprehensive income ..................................... (431) (54)
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Other comprehensive income, net of income tax .............. 837 103
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Comprehensive income ....................................... $ 1,453 $ 1,017
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Three months ended March 31,
------------------------------
2008 2007
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OPERATING ACTIVITIES
Net income .................................................................. $ 616 $ 914
Add (deduct):
Adjustments to reconcile net income to cash provided by
(applied to) operating activities:
Realized investment gains, net ............................................ - (35)
Net gains on sale of property and equipment ............................... (2) (2)
Amortization and depreciation ............................................. 364 355
Provision for non-collection of premiums .................................. 15 1
Provision for non-collection of reinsurance recoverables .................. 127 7
Net change in non-cash balances relating to operating activities:
Accrued investment income ................................................ 43 (329)
Premiums receivable ...................................................... (2,704) (3,040)
Reinsurance recoverable on paid losses ................................... (10) (269)
Reinsurance recoverable on unpaid losses ................................. (1,559) 576
Reinsurance recoverable on unpaid losses from related parties ............ (969) (697)
Prepaid reinsurance premiums ............................................. (321) 3,697
Prepaid reinsurance premiums to related parties .......................... (756) (1,200)
Deferred policy acquisition costs ........................................ (162) (778)
Other assets ............................................................. 749 619
Unpaid losses and loss adjustment expenses ............................... 5,141 515
Unearned premiums ........................................................ 2,841 (43)
Policyholder deposits .................................................... (820) (543)
Accrued taxes and other payables ......................................... 265 685
Premiums payable ......................................................... (185) 292
Premiums payable to related parties ...................................... 603 (990)
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Cash provided by (applied to) operating activities ........................ 3,276 (265)
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INVESTING ACTIVITIES
Short-term investments:
Purchases ................................................................. (285) -
Maturities ................................................................ 380 -
Unrestricted fixed maturities available for sale:
Purchases ................................................................. (8,507) (4,649)
Maturities ................................................................ 1,250 2,083
Equity securities available for sale:
Purchases ................................................................. - (4,517)
Sales ..................................................................... - 6,139
Cost of property and equipment purchased ................................... (129) (195)
Proceeds from sale of property and equipment ............................... 33 11
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Cash applied to investing activities ...................................... (7,258) (1,128)
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FINANCING ACTIVITIES
Payments and loans from related parties .................................... 493 263
Payments and loans to related parties ...................................... (174) (1,413)
Payments on bank loan ...................................................... - (82)
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Cash provided by (applied to) financing activities ........................ 319 (1,232)
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Decrease in cash and cash equivalents during the period ..................... (3,663) (2,625)
Cash and cash equivalents at beginning of period ............................ 32,956 21,403
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Cash and cash equivalents at end of period .................................. $ 29,293 $ 18,778
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2008 AND 2007
(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
accounting principles generally accepted in the United States of America
("GAAP") 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 GAAP 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, 2007. 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-month period ended March 31, 2008 are not necessarily indicative of the
results that may be expected for the year.
The consolidated financial statements include the accounts of Chandler
USA and all wholly owned subsidiaries that meet consolidation requirements
including National American Insurance Company ("NAICO") and Chandler
Insurance Managers, Inc. ("CIMI").
NOTE 2. SEGMENT INFORMATION
Chandler USA has 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.
The following table presents a summary of Chandler USA's operating segments
for the three month periods ended March 31, 2008 and 2007:
Property
and
casualty Intersegment Reported
insurance Agency eliminations balances
------------ ------------ ------------ ------------
(In thousands)
THREE MONTHS ENDED MARCH 31, 2008
Revenues from external customers (1) ... $ 17,596 $ 326 $ - $ 17,922
Intersegment revenues .................. 11 996 (1,007) -
Segment profit before income taxes (2).. 506 503 - 1,009
Segment assets ......................... 242,201 8,375 (6,911) 243,665
THREE MONTHS ENDED MARCH 31, 2007
Revenues from external customers (1) ... $ 17,093 $ 754 $ - $ 17,847
Intersegment revenues .................. 12 982 (994) -
Segment profit before income taxes (2).. 488 957 - 1,445
Segment assets ......................... 222,052 6,117 (4,546) 223,623
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<FN>
(1) Consists of net premiums earned and other income.
(2) Includes net realized investment gains.
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.
PAGE 6
THREE MONTHS ENDED MARCH 31,
--------------------------------
2008 2007
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(In thousands)
INSURANCE PROGRAM
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NET PREMIUMS EARNED
Standard lines .......................... $ 16,736 $ 15,505
Political subdivisions .................. 700 991
Homeowners .............................. - 294
Surety bonds ............................ 34 67
Other (1) ............................... 40 163
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$ 17,510 $ 17,020
============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard lines .......................... $ 10,429 $ 9,227
Political subdivisions .................. 436 862
Homeowners .............................. (7) 102
Surety bonds ............................ 56 22
Other (1) ............................... 22 454
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$ 10,936 $ 10,667
============ ============
<FN>
- -----------------------------------------
(1) This category is comprised primarily of the run-off of 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 6.25% at March
31, 2008. 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.
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.
PAGE 7
The trial in the Harris County cases began in late April 2006, and
concluded August 1, 2006. The jury found in favor of NAICO, 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 included $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.
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 December 31, 2006 as a result of increasing the estimated
recovery. NAICO also recorded $6.6 million of interest income for its
estimate of prejudgment interest through December 31, 2006, including a
recovery for a pre-verdict settlement with certain other parties.
On January 28, 2008, the court entered a final judgment denying Gulf
Liquid's claims against NAICO and Gulsby, denying all of NAICO's claims
against Gulf Liquids and Williams, and entering judgment for Gulsby against
Gulf Liquids for $15,651,927 plus interest at 7.25% compounded annually
from January 28, 2008 until paid. The court also ordered Gulf Liquids to
pay Gulsby's taxable court costs, estimated at $100,000. All parties may
appeal all or any of these judgments.
In the fourth quarter of 2007, as a result of this final judgment,
NAICO decreased the estimated recovery on the surety bond claims related to
the construction of the two gas processing plants which resulted in an
increase in losses and loss adjustment expenses incurred of $1.8 million.
Unpaid losses and loss adjustment expenses increased $12.7 million and
reinsurance recoverable on unpaid losses and loss adjustment expenses
increased $10.9 million as of December 31, 2007 as a result of decreasing
the estimated recovery. NAICO also decreased accrued interest income by
$4.5 million for its estimate of prejudgment interest income.
NOTE 5. NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") periodically issues
new accounting standards in a continuing effort to improve standards of
financial accounting and reporting. Chandler USA has reviewed the recently
issued pronouncements and concluded that the following new accounting
standards are applicable to Chandler USA.
In September 2006, the FASB issued Statement of Financial Accounting
Standards ("SFAS") 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 has adopted SFAS No. 157
as of January 1, 2008. The adoption of SFAS No. 157 did not have a material
impact on its consolidated financial statements.
PAGE 8
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.
Chandler USA has adopted SFAS No. 159 as of January 1, 2008. The adoption of
SFAS No. 159 did not have a material impact 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 No. 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. Chandler USA has adopted EITF No. 06-10 effective January 1,
2008. The adoption of EITF No. 06-10 did not have a material impact on its
consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about
Derivative Instruments and Hedging Activities - an amendment of FASB
Statement No. 133." SFAS No. 161 changes the disclosure requirements for
derivative instruments and hedging activities. Entities are required to
provide enhanced disclosures about (a) how and why an entity uses
derivative instruments, (b) how derivative instruments and related hedged
items are accounted for under SFAS No. 133 and its related interpretations,
and (c) how derivative instruments and related hedged items affect an
entity's financial position, financial performance and cash flows. The
guidance in SFAS No. 161 is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with
early application encouraged. Chandler USA is currently evaluating the
impact that SFAS No. 161 will have, if any, 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 9
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 month periods ended
March 31, 2008 and 2007:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
THREE MONTHS ENDED MARCH 31, 2008 2007 2008 2007
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard lines ................... $ 26,208 $ 25,128 $ 16,736 $ 15,505
Political subdivisions ........... 1,066 1,512 700 991
Homeowners ....................... - 475 - 294
Surety bonds ..................... 48 95 34 67
Other ............................ 40 166 40 163
------------ ------------ ------------ ------------
TOTAL ............................ $ 27,362 $ 27,376 $ 17,510 $ 17,020
============ ============ ============ ============
Gross premiums earned in the first quarter of 2008 were essentially
unchanged compared to the first quarter of 2007. An increase in gross
premiums earned in the standard lines program was offset by a decrease in
gross premiums earned in the homeowners program which was discontinued during
2006, and by a decrease in gross premiums earned in the political
subdivisions program. Net premiums earned increased $490,000 or 3% in the
first quarter of 2008 compared to the first quarter of 2007.
Gross premiums earned in the standard lines program increased $1.1
million or 4% in the first quarter of 2008 compared to the first quarter of
2007. The increase was primarily due to increases in workers compensation
and automobile liability premiums. Net premiums earned increased $1.2
million or 8% in the first quarter of 2008 versus the first quarter of 2007,
due to the increase in gross earned premiums.
Gross premiums earned in the political subdivisions program decreased
$446,000 or 29% in the first quarter of 2008 compared to the first quarter
of 2007 due primarily to increased competition related to Oklahoma school
districts. Net premiums earned in the political subdivisions program
decreased $291,000 or 29% in the first quarter of 2008 versus the first
quarter of 2007.
Gross and net premiums earned in the surety bond program decreased
$47,000 and $33,000, respectively, from the first quarter of 2007. NAICO
no longer actively markets its surety bond program.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At March 31, 2008, Chandler USA's investment portfolio consisted
primarily of fixed income U.S. Treasury and government agency bonds,
high-quality corporate bonds and certificates of deposit insured by the
FDIC, with approximately 29% 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 for the accrual of prejudgment interest on a favorable
jury verdict in civil litigation in 2006 regarding certain surety bond
claims. 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 $47,000 or 6% in the first
quarter of 2008 versus the first quarter of 2007 due primarily to an
increase in cash and invested assets. Cash and invested assets were $101.8
million at March 31, 2008 compared to $88.1 million at March 31, 2007. Net
interest income from related parties was $188,000 in the first quarter of
2008 compared to $212,000 in the first quarter of 2007. The decrease in the
2008 quarter was due to lower interest rates.
There were no net realized investment gains in the first quarter of
2008. Net realized investment gains were $35,000 in the first quarter of
2007.
PAGE 10
OTHER INCOME
Other income was $412,000 in the first quarter of 2008 compared to
$827,000 in the first quarter of 2007. The decrease was primarily
attributable to commission income received by CIMI during the first quarter
of 2007 for the transfer of NAICO's existing property and inland marine
business in the standard lines and political subdivisions programs.
Effective January 1, 2007, the property and inland marine lines of
insurance that were previously written by NAICO in these programs are
being written by Praetorian Insurance Company ("Praetorian") through an
arrangement between Praetorian and CIMI. CIMI receives commission income
for the business it produces for Praetorian.
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 62.5% for the first quarter of 2008 versus 62.7%
in the first quarter of 2007. During the first quarter of 2008, NAICO
experienced adverse loss development totaling $181,000 which increased the
2008 loss ratio by 1.0 percentage point. During 2007, loss development was
redundant by $458,000 which decreased the 2007 loss ratio by 2.7 percentage
points. Weather-related losses from wind and hail were not significant in
the first quarter of 2008 or 2007.
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 the 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 month periods ended March 31, 2008 and 2007:
THREE MONTHS ENDED MARCH 31,
----------------------------
2008 2007
------------ ------------
(In thousands)
Commissions expense ......................... $ 4,325 $ 3,906
Other premium related assessments ........... 308 258
Premium taxes ............................... 577 571
Excise taxes ................................ 82 83
Other expense ............................... 148 239
------------ ------------
Total direct expenses ....................... 5,440 5,057
Indirect underwriting expenses .............. 1,575 1,463
Commissions received from reinsurers ........ (3,610) (2,493)
Adjustment for deferred acquisition costs ... (162) (777)
------------ ------------
Net policy acquisition costs ................ $ 3,243 $ 3,250
============ ============
Total gross direct and indirect expenses as a percentage of direct
written and assumed premiums were 23.2% for the first quarter of 2008 versus
23.9% for the first quarter of 2007. Commissions expense as a percentage of
gross written and assumed premiums was 14.3% for the first quarter of 2008
and 2007.
PAGE 11
Indirect underwriting expenses were 5.2% and 5.4% of total direct
written and assumed premiums in the three month periods ended March 31, 2008
and 2007, respectively. 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 increased $1.1 million in the first quarter of 2008 compared to
the year-ago quarter due primarily to the transfer of NAICO's property and
inland marine business in the standard lines and political subdivisions
programs to Praetorian in the first quarter of 2007. The transfer resulted
in the cancellation of certain quota share reinsurance arrangements that
covered these lines of business.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 11.4% of gross premiums earned
and other income in the first quarter of 2008 and 2007. General and
administrative expenses decreased $55,000 or 2% in the first quarter of 2008
compared to the 2007 quarter. 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 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 was $652,000 in the first quarter of 2008 compared to
$677,000 in the year-ago quarter. Substantially all of Chandler USA's
interest expense is related to its outstanding senior debentures and junior
subordinated debentures. The decrease in the 2008 period was due primarily
to lower interest rates during 2008, as a portion of Chandler USA's junior
subordinated debentures were issued with a floating interest rate.
LIQUIDITY AND CAPITAL RESOURCES
In the first quarter of 2008, Chandler USA provided $3.3 million in
cash from operations. Unpaid losses and loss adjustment expenses increased
$5.1 million and unearned premiums increased $2.8 million during the first
quarter of 2008, but these increases were partially offset by increases in
premiums receivable of $2.7 million, reinsurance recoverable on unpaid
losses of $2.5 million and prepaid reinsurance premiums of $1.1 million.
In the first quarter of 2007, Chandler USA used $265,000 in cash from
operations. Prepaid reinsurance premiums decreased $2.5 million during the
first quarter of 2007, but this was partially offset by an increase in
premiums receivable of $3.0 million.
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 March 31, 2008, the total amount of cash and
securities restricted as a result of these arrangements was $38.3 million
which was an increase of $5.5 million from December 31, 2007. This increase
was due to an increase in the amount of reinsurance that NAICO assumed
during 2008.
At March 31, 2008, Chandler USA's parent company, Chandler Insurance
Company, Ltd., owed approximately $11.2 million to Chandler USA versus
$11.5 million at December 31, 2007 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 6.25%
at March 31, 2008. 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 12
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, 2007, NAICO had statutory earned surplus of $12.5
million. Applying the Oklahoma statutory limits described above, the
maximum shareholder dividend NAICO may pay in 2008 without the approval of
the Oklahoma Department of Insurance is $5.0 million. NAICO did not pay
any shareholder dividends during the first quarter of 2008. NAICO paid cash
shareholder dividends to Chandler USA totaling $1.6 million in the second
quarter of 2007.
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 13
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. On August 1, 2006,
the jury trial concluded in Harris County, Texas, related to the
construction of two gas processing plants in Louisiana. The amounts the
jury found owing to NAICO included approximately $20.2 million in actual
damages and $70.0 million in punitive damages. See Note 4 of Notes to
Consolidated Financial Statements for a discussion of this jury verdict.
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.
On January 28, 2008, the court entered a final judgment denying Gulf
Liquid's claims against NAICO and Gulsby, denying all of NAICO's claims
against Gulf Liquids and Williams, and entering judgment for Gulsby against
Gulf Liquids for $15,651,927 plus interest at 7.25% compounded annually
from January 28, 2008 until paid. The court also ordered Gulf Liquids to
pay Gulsby's taxable court costs, estimated at $100,000. All parties may
appeal all or any of these judgments.
In the fourth quarter of 2007, as a result of this final judgment,
NAICO decreased the estimated recovery on the surety bond claims related
to the construction of the two gas processing plants which resulted in an
increase in losses and loss adjustment expenses incurred of $1.8 million.
Unpaid losses and loss adjustment expenses increased $12.7 million and
reinsurance recoverable on unpaid losses and loss adjustment expenses
increased $10.9 million as of December 31, 2007 as a result of decreasing
the estimated recovery. NAICO also decreased accrued interest income by
$4.5 million for its estimate of prejudgment interest income.
ITEM 4T. 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 CONTROL OVER FINANCIAL REPORTING
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 14
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, 2007.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-----------------------------------------------------------
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
Effective May 13, 2008, Chandler USA's sole shareholder, Chandler
Insurance, re-elected the following individuals to serve on
Chandler USA's Board of Directors:
W. Brent LaGere W. Scott Martin
Mark T. Paden Robert L. Rice
R. Patrick Gilmore William Thomas Keele
Richard L. Evans
Item 5. OTHER INFORMATION
-----------------
None.
Item 6. EXHIBITS
--------
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.
PAGE 15
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 13, 2008 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)