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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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)
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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 July 31, 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 June 30, 2008 (unaudited)
and December 31, 2007 ..................................................1
Consolidated Statements of Operations for the three months
ended June 30, 2008 and 2007 (unaudited) ...............................2
Consolidated Statements of Operations for the six months
ended June 30, 2008 and 2007 (unaudited) ...............................3
Consolidated Statements of Comprehensive Income for the three
months ended June 30, 2008 and 2007 (unaudited) ........................4
Consolidated Statements of Comprehensive Income for the six
months ended June 30, 2008 and 2007 (unaudited) ........................5
Consolidated Statements of Cash Flows for the six months
ended June 30, 2008 and 2007 (unaudited) ...............................6
Notes to Interim Consolidated Financial Statements (unaudited) ............7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------------------------------------------------------------------------
RESULTS OF OPERATIONS ...........................................12
---------------------
ITEM 4T. CONTROLS AND PROCEDURES .........................................18
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PART II - OTHER INFORMATION
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Item 1. Legal Proceedings ............................................18
Item 1A. Risk Factors .................................................18
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ..18
Item 3. Defaults Upon Senior Securities ..............................18
Item 4. Submission of Matters to a Vote of Security Holders ..........18
Item 5. Other Information ............................................18
Item 6. Exhibits .....................................................18
Signatures ...............................................................19
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
June 30, December 31,
2008 2007
------------- --------------
(Unaudited)
Assets
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $34,201 and $32,416 in 2008 and 2007, respectively) ...... $ 34,397 $ 32,670
Unrestricted (amortized cost $44,530 and $30,484 in 2008 and 2007, respectively) .... 44,241 30,387
Equity securities at fair value (cost $0 in 2008 and 2007) ........................... 76 141
Short-term investments ............................................................... 760 1,045
------------- --------------
Total investments ................................................................... 79,474 64,243
Cash and cash equivalents ($1,956 and $146 restricted in 2008 and 2007, respectively).. 22,393 32,956
Accrued investment income ............................................................. 1,042 874
Premiums receivable, less allowance for non-collection of $144 and $134 at
2008 and 2007, respectively ......................................................... 26,846 28,128
Reinsurance recoverable on paid losses ................................................ 1,061 1,100
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $264 and $239 at 2008 and 2007, respectively ...................... 38,638 36,036
Reinsurance recoverable on unpaid losses from related parties ......................... 20,352 18,688
Prepaid reinsurance premiums .......................................................... 3,072 3,105
Prepaid reinsurance premiums to related parties ....................................... 12,594 12,928
Deferred policy acquisition costs ..................................................... 1,198 1,118
Property and equipment, net ........................................................... 8,107 8,255
Amounts due from related parties ...................................................... 12,030 11,506
State insurance licenses, net ......................................................... 3,745 3,745
Other assets .......................................................................... 11,273 11,685
------------- --------------
Total assets .......................................................................... $ 241,825 $ 234,367
============= ==============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ........................................... $ 108,150 $ 100,590
Unearned premiums .................................................................... 45,241 46,389
Policyholder deposits ................................................................ 8,263 7,947
Accrued taxes and other payables ..................................................... 6,153 5,777
Premiums payable ..................................................................... 1,501 2,263
Premiums payable to related parties .................................................. 56 198
Senior debentures .................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ........................... 20,620 20,620
------------- --------------
Total liabilities ................................................................... 196,963 190,763
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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 .................................................................. (15,713) (17,179)
Accumulated other comprehensive income (loss):
Unrealized gain (loss) on investments available for sale,
net of deferred income taxes ........................................................ (11) 197
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Total shareholder's equity .......................................................... 44,862 43,604
------------- --------------
Total liabilities and shareholder's equity ............................................ $ 241,825 $ 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 June 30,
-----------------------------
2008 2007
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Premiums and other revenues
Direct premiums written and assumed .......................... $ 20,191 $ 24,120
Reinsurance premiums ceded ................................... (2,095) (2,811)
Reinsurance premiums ceded to related parties ................ (5,398) (6,562)
------------ ------------
Net premiums written and assumed ........................... 12,698 14,747
Decrease in unearned premiums ................................ 2,545 1,123
------------ ------------
Net premiums earned ........................................ 15,243 15,870
Investment income, net ......................................... 847 860
Interest income, net from related parties ...................... 158 248
Realized investment gains, net ................................. 4 26
Other income ................................................... 416 168
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Total premiums and other revenues ............................ 16,668 17,172
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Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $3,576 and $3,784 in
2008 and 2007, respectively ................................ 8,380 9,366
Policy acquisition costs, net of ceding commissions
received from related parties of $2,052 and $2,495 in
2008 and 2007, respectively ................................ 3,124 3,032
General and administrative expenses .......................... 3,119 3,034
Interest expense ............................................. 627 678
------------ ------------
Total operating costs and expenses ......................... 15,250 16,110
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Income before income taxes ..................................... 1,418 1,062
Federal income tax provision ................................... (568) (394)
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Net income ................................................... $ 850 $ 668
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
--------------------------------
2008 2007
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Premiums and other revenues
Direct premiums written and assumed ....................... $ 50,394 $ 51,453
Reinsurance premiums ceded ................................ (4,819) (2,313)
Reinsurance premiums ceded to related parties ............. (13,603) (14,919)
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Net premiums written and assumed ........................ 31,972 34,221
Decrease (increase) in unearned premiums .................. 781 (1,331)
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Net premiums earned ..................................... 32,753 32,890
Investment income, net ...................................... 1,737 2,020
Interest income, net from related parties ................... 346 460
Realized investment gains, net .............................. 4 61
Other income ................................................ 828 995
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Total premiums and other revenues ......................... 35,668 36,426
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Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $7,631 and $8,026 in
2008 and 2007, respectively ............................. 19,316 20,033
Policy acquisition costs, net of ceding commissions
received from related parties of $5,172 and $5,674 in
2008 and 2007, respectively ............................. 6,367 6,282
General and administrative expenses ....................... 6,279 6,249
Interest expense .......................................... 1,279 1,355
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Total operating costs and expenses ...................... 33,241 33,919
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Income before income taxes .................................. 2,427 2,507
Federal income tax provision ................................ (961) (925)
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Net income ................................................ $ 1,466 $ 1,582
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See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Three months ended June 30,
--------------------------------
2008 2007
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Net income .................................................. $ 850 $ 668
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Other comprehensive loss, before income tax:
Unrealized losses on securities:
Unrealized holding losses arising during period ......... (1,579) (484)
Less: Reclassification adjustment for gains included in
net income ............................................ (4) (26)
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Other comprehensive loss, before income tax ................. (1,583) (510)
Income tax benefit related to items of other
comprehensive loss ........................................ 538 174
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Other comprehensive loss, net of income tax ................. (1,045) (336)
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Comprehensive income (loss) ................................. $ (195) $ 332
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
-------------------------------
2008 2007
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Net income .................................................. $ 1,466 $ 1,582
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Other comprehensive loss, before income tax:
Unrealized losses on securities:
Unrealized holding losses arising during period ......... (311) (292)
Less: Reclassification adjustment for gains included in
net income ............................................ (4) (61)
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Other comprehensive loss, before income tax ................. (315) (353)
Income tax benefit related to items of other
comprehensive loss ........................................ 107 120
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Other comprehensive loss, net of income tax ................. (208) (233)
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Comprehensive income ........................................ $ 1,258 $ 1,349
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 6
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
------------------------------
2008 2007
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OPERATING ACTIVITIES
Net income .................................................................. $ 1, 466 $ 1,582
Add (deduct):
Adjustments to reconcile net income to cash provided by operating activities:
Realized investment gains, net .......................................... (4) (61)
Net (gains) losses on sale of property and equipment .................... (4) 5
Amortization and depreciation ........................................... 749 706
Provision for non-collection of premiums ................................ 25 40
Provision for non-collection of reinsurance recoverables ................ 139 24
Net change in non-cash balances relating to operating activities:
Accrued investment income ............................................. (168) (432)
Premiums receivable ................................................... 1,257 501
Reinsurance recoverable on paid losses ................................ (74) (441)
Reinsurance recoverable on unpaid losses .............................. (2,628) 199
Reinsurance recoverable on unpaid losses from related parties ......... (1,664) (1,171)
Prepaid reinsurance premiums .......................................... 33 4,017
Prepaid reinsurance premiums to related parties ....................... 334 (742)
Deferred policy acquisition costs ..................................... (80) (789)
Other assets .......................................................... 490 611
Unpaid losses and loss adjustment expenses ............................ 7,560 2,082
Unearned premiums ..................................................... (1,148) (1,944)
Policyholder deposits ................................................. 316 (346)
Accrued taxes and other payables ...................................... 376 1,558
Premiums payable ...................................................... (762) (447)
Premiums payable to related parties ................................... (142) (527)
------------ ------------
Cash provided by operating activities ................................... 6,071 4,425
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INVESTING ACTIVITIES
Short-term investments:
Purchases ............................................................... (665) -
Maturities .............................................................. 950 -
Unrestricted fixed maturities available for sale:
Purchases ............................................................... (22,412) (9,617)
Sales ................................................................... 270 -
Maturities .............................................................. 6,029 3,197
Equity securities available for sale:
Purchases ............................................................... - (5,278)
Sales ................................................................... - 6,925
Cost of property and equipment purchased .................................. (325) (297)
Proceeds from sale of property and equipment .............................. 42 14
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Cash applied to investing activities .................................... (16,111) (5,056)
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FINANCING ACTIVITIES
Payments and loans from related parties ................................... 1,025 263
Payments and loans to related parties ..................................... (1,548) (2,623)
Payments on bank loan ..................................................... - (166)
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Cash applied to financing activities .................................... (523) (2,526)
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Decrease in cash and cash equivalents during the period ..................... (10,563) (3,157)
Cash and cash equivalents at beginning of period ............................ 32,956 21,403
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Cash and cash equivalents at end of period .................................. $ 22,393 $ 18,246
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 7
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 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 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, 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 and six month periods ended June 30,
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 and six month periods ended June 30, 2008 and 2007:
Property
and
casualty Intersegment Reported
insurance Agency eliminations balances
------------ ------------ ------------ ------------
(In thousands)
THREE MONTHS ENDED JUNE 30, 2008
Revenues from external customers (1) ........... $ 15,395 $ 264 $ - $ 15,659
Intersegment revenues .......................... 12 724 (736) -
Segment profit (loss) before income taxes (2) .. 1,253 165 - 1,418
THREE MONTHS ENDED JUNE 30, 2007
Revenues from external customers (1) ........... $ 15,925 $ 113 $ - $ 16,038
Intersegment revenues .......................... 39 1,142 (1,181) -
Segment profit (loss) before income taxes (2) .. 643 419 - 1,062
SIX MONTHS ENDED JUNE 30, 2008
Revenues from external customers (1) ........... $ 32,991 $ 590 $ - $ 33,581
Intersegment revenues .......................... 23 1,720 (1,743) -
Segment profit (loss) before income taxes (2) .. 1,759 668 - 2,427
Segment assets ................................. 240,707 8,327 (7,209) 241,825
SIX MONTHS ENDED JUNE 30, 2007
Revenues from external customers (1) ........... $ 33,019 $ 866 $ - $ 33,885
Intersegment revenues .......................... 51 2,124 (2,175) -
Segment profit (loss) before income taxes (2) .. 1,130 1,377 - 2,507
Segment assets ................................. 223,132 6,709 (5,510) 224,331
<FN>
- ------------------------------------------------------
(1) Consists of net premiums earned and other income.
(2) Includes net realized investment gains.
PAGE 8
Net premiums earned and losses and loss adjustment expenses within the
property and casualty insurance segment can be identified to Chandler USA
designated insurance programs. Chandler USA's chief operating decision
makers review net premiums earned and losses and loss adjustment expenses
in assessing the performance of an insurance program. In addition, Chandler
USA's chief operating decision makers consider many other factors such as
the lines of business offered within an insurance program and the states in
which the insurance programs are offered. Certain discrete financial
information is not readily available by insurance program, including assets,
interest income, and investment gains or losses, allocated to each insurance
program. Chandler USA does not consider its insurance programs to be
reportable segments, however, the following supplemental information
pertaining to each insurance program's net premiums earned and losses and
loss adjustment expenses is presented for the property and casualty
insurance segment.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2008 2007 2008 2007
------------ ------------ ---------- ------------
(In thousands)
INSURANCE PROGRAM
---------------------------------------
NET PREMIUMS EARNED
Standard lines ........................ $ 14,490 $ 15,223 $ 31,226 $ 30,728
Political subdivisions ................ 698 944 1,398 1,934
Homeowners ............................ - (304) - (10)
Surety bonds .......................... 19 62 53 129
Other (1) ............................. 36 (55) 76 109
------------ ------------ ---------- ------------
$ 15,243 $ 15,870 $ 32,753 $ 32,890
============ ============ ========== ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard lines ........................ $ 7,749 $ 9,187 $ 18,178 $ 18,414
Political subdivisions ................ 419 427 855 1,290
Homeowners ............................ 43 (124) 36 (22)
Surety bonds .......................... 120 (112) 176 (90)
Other (1) ............................. 49 (12) 71 441
------------ ------------ ---------- ------------
$ 8,380 $ 9,366 $ 19,316 $ 20,033
============ ============ ========== ============
<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 6.0%
at June 30, 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.
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 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. Gulf Liquids has
appealed the judgment entered in favor of Gulsby and the denial of its
claims against NAICO and Gulsby. NAICO has appealed the trial court's
denial of its claims against Gulf Liquids and Williams and seeks entry of
judgment upon the jury verdicts for the amounts the jury found should be
awarded to NAICO. Gulsby has also appealed the trial court's final
judgment, contending that judgment should be entered in its favor against
Gulf Liquids and Williams in accordance with the jury verdicts.
PAGE 10
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") 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.
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,
but did not elect the fair value option prescribed under SFAS No. 159 for
any financial assets or liabilities that were not otherwise required to be
measured at fair value. 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.
In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally
Accepted Accounting Principles." SFAS No. 162 identifies the sources of
accounting principles and the framework for selecting the principles to be
used in the preparation of financial statements of nongovernmental entities
that are presented in conformity with generally accepted accounting
principles in the United States. It will be effective 60 days following
the SEC's approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, "The Meaning of Present Fairly in Conformity
With Generally Accepted Accounting Principles." Chandler USA does not
expect this statement to have a material impact on its consolidated
financial statements.
PAGE 11
In May 2008, the FASB issued SFAS No. 163, "Accounting for Financial
Guarantee Insurance Contracts - an interpretation of FASB Statement No.
60." SFAS No. 163 requires that an insurance enterprise recognize a claim
liability prior to an event of default when there is evidence that credit
deterioration has occurred in an insured financial obligation. It also
clarifies how Statement 60 applies to financial guarantee insurance
contracts, including the recognition and measurement to be used to account
for premium revenue and claim liabilities, and requires expanded disclosures
about financial guarantee insurance contracts. It is effective for financial
statements issued for fiscal years beginning after December 15, 2008, except
for some disclosures about the insurance enterprise's risk-management
activities. SFAS No. 163 requires that disclosures about the risk-management
activities of the insurance enterprise be effective for the first period
beginning after issuance. Except for those disclosures, earlier application
is not permitted. Chandler USA does not issue financial guarantee insurance
contracts. The adoption of SFAS No. 163 will not have any impact on its
consolidated financial statements.
NOTE 6. FAIR VALUE MEASUREMENTS
Effective January 1, 2008, Chandler USA adopted SFAS No. 157 which
establishes a framework for measuring fair value and requires specific
disclosures regarding assets and liabilities that are measured at fair
value. SFAS No. 157 defines fair value as the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. SFAS No. 157 ranks
the quality and reliability of the information used to determine fair values
into three broad categories, with the highest priority given to Level 1
inputs and the lowest priority to Level 3 inputs. These levels are defined
by SFAS No. 157 as follows:
Level 1 - Quoted prices (unadjusted) in active markets for identical
assets or liabilities that the reporting entity has the ability to
access at the measurement date.
Level 2 - Observable inputs other than quoted prices included within
Level 1 for the asset or liability, either directly or indirectly. If
an asset or liability has a specified term, a Level 2 input must be
observable for substantially the full term of the asset or liability.
Level 3 - Unobservable inputs for the asset or liability.
The following table presents information about Chandler USA's assets
measured at fair value on a recurring basis as of June 30, 2008, and
indicates the fair value hierarchy of the valuation techniques utilized
to determine such values. No liabilities were measured at fair value at
June 30, 2008.
FAIR VALUE MEASUREMENTS AT JUNE 30, 2008
--------------------------------------------------------
Quoted prices Significant
in active other Significant
markets for observable unobservable
identical assets inputs inputs Total
Description (Level 1) (Level 2) (Level 3) fair value
- --------------------------------------- ---------------- ------------ ------------- ------------
(In thousands)
Fixed maturities available for sale .. $ - $ 78,638 $ - $ 78,638
Equity securities available for sale.. - - 76 76
Short-term investments ............... - 760 - 760
---------------- ------------ ------------- ------------
TOTAL ............................... $ - $ 79,398 $ 76 $ 79,474
================ ============ ============= ============
PAGE 12
At June 30, 2008, Chandler USA's equity securities which were measured
at fair value using Level 3 inputs consisted of common stock received in
connection with an unaffiliated entity's conversion to a for-profit
corporation. The fair value of this stock was based upon an analytically
determined valuation from an independent rating organization. The
following table presents additional information about assets measured at
fair value using Level 3 inputs for the three and six month periods ended
June 30, 2008.
Three months Six months
Fair value measurements using significant ended ended
unobservable inputs (Level 3) June 30, 2008 June 30, 2008
------------------------------------------------- --------------- ---------------
(In thousands)
Beginning balance .............................. $ 141 $ 141
Total realized and unrealized gains (losses):
Included in earnings ........................... - -
Included in other comprehensive income ......... (65) (65)
Purchases, issuances and settlements ........... - -
Transfers in and/or out of Level 3 ............. - -
--------------- ---------------
Ending balance ................................. $ 76 $ 76
=============== ===============
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 13
RESULTS OF OPERATIONS
PREMIUMS EARNED
The following table sets forth premiums earned on a gross basis (before
reductions for premiums ceded to reinsurers) and on a net basis (after such
reductions) for each insurance program for the three and six month periods
ended June 30, 2008 and 2007:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
THREE MONTHS ENDED JUNE 30, 2008 2007 2008 2007
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard lines ................... $ 23,052 $ 24,687 $ 14,490 $ 15,223
Political subdivisions ........... 1,065 1,271 698 944
Homeowners ....................... - 28 - (304)
Surety bonds ..................... 27 89 19 62
Other ............................ 36 (54) 36 (55)
------------ ------------ ------------ ------------
TOTAL ............................ $ 24,180 $ 26,021 $ 15,243 $ 15,870
============ ============ ============ ============
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
SIX MONTHS ENDED JUNE 30, 2008 2007 2008 2007
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard lines ................... $ 49,259 $ 49,815 $ 31,226 $ 30,728
Political subdivisions ........... 2,131 2,784 1,398 1,934
Homeowners ....................... - 503 - (10)
Surety bonds ..................... 76 184 53 129
Other ............................ 76 111 76 109
------------ ------------ ------------ ------------
TOTAL ............................ $ 51,542 $ 53,397 $ 32,753 $ 32,890
============ ============ ============ ============
Gross premiums earned decreased $1.8 million or 7% and $1.9 million
or 3% in the second quarter and first six months of 2008, respectively,
compared to the 2007 periods. The decreases were due primarily to a
decrease in automobile liability premiums of $2.8 million and $2.0 million
in the second quarter and first six months of 2008, respectively, which
was due to a decrease in premiums from trucking accounts. The decreases
were partially offset by increases in workers compensation and other
liability premiums in these periods. Net premiums earned decreased
$627,000 or 4% and $137,000 or less than 1% for the second quarter and
first six months of 2008, respectively.
Gross premiums earned in the standard lines program decreased $1.6
million or 7% and $556,000 or 1% in the second quarter and first six
months of 2008, respectively, compared to the 2007 periods. Workers
compensation premiums increased $522,000 and $1.2 million in the second
quarter and first six months of 2008, respectively, and other liability
premiums increased $1.0 million and $952,000 in these periods. However,
automobile liability premiums decreased $2.7 million and $1.8 million in
these periods. Net premiums earned decreased $733,000 or 5% and increased
$498,000 or 2% in the second quarter and first six months of 2008,
respectively.
Gross premiums earned in the political subdivisions program decreased
$206,000 or 16% and $653,000 or 23% in the second quarter and first six
months of 2008, respectively, compared to the 2007 periods. The decrease
in gross premiums earned is due primarily to increased competition related
to Oklahoma school districts. Net premiums earned in this program decreased
$246,000 or 26% and $536,000 or 28% in the second quarter and first six
months of 2008, respectively.
Gross and net premiums earned in the surety bond program decreased from
the 2007 periods. NAICO no longer actively markets its surety bond program.
PAGE 14
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At June 30, 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 22% 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, decreased $13,000 or 2% and increased
$34,000 or 2% in the second quarter and first six months of 2008,
respectively. An increase in cash and invested assets was largely offset
by lower interest rates during 2008. Cash and invested assets were $101.9
million at June 30, 2008 compared to $90.8 million at June 30, 2007. Net
interest income from related parties decreased $90,000 or 36% and $114,000
or 25% in the second quarter and first six months of 2008, respectively,
due primarily to lower interest rates.
Net realized investment gains were $4,000 during the second quarter
and first six months of 2008. Net realized investment gains were $26,000
and $61,000 during the second quarter and first six months of 2007,
respectively.
OTHER INCOME
Other income was $416,000 and $828,000 in the second quarter and first
six months of 2008, respectively, compared to $168,000 and $995,000 in the
second quarter and first six months of 2007. The increase in the second
quarter of 2008 was due primarily to an increase in commission income
related to business produced by CIMI for insurance companies other than
NAICO. The decrease in the first six months of 2008 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 to
Praetorian under a new arrangement effective January 1, 2007. Under this
arrangement, 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 55.0% and 59.0% for the second quarter and first
six months of 2008, compared to 59.0% and 60.9% in the corresponding 2007
periods. The decrease in the 2008 loss ratios was due primarily to a
decrease in losses incurred related to prior accident years. In the
second quarter of 2008, losses and loss adjustment expenses incurred
related to prior accident years were redundant by $696,000 and decreased
the loss ratio by 4.6 percentage points. In the first six months of 2008,
loss development was redundant by $515,000 which decreased the loss ratio
by 1.6 percentage points. In the second quarter of 2007, losses and loss
adjustment expenses incurred related to prior accident years were $157,000
and increased the loss ratio by 1.0 percentage point. In the first six
months of 2007, loss development was redundant by $301,000 which decreased
the loss ratio by 0.9 percentage points.
Weather-related losses from wind and hail totaled $303,000 and
$305,000 in the second quarter and first six months of 2008 and increased
the respective loss ratios by 2.0 and 0.9 percentage points. Weather-
related losses totaled $48,000 and $70,000 in the second quarter and first
six months of 2007, and increased the respective 2007 loss ratios by 0.3
and 0.2 percentage points.
PAGE 15
POLICY ACQUISITION COSTS
Policy acquisition costs consist of costs associated with the
acquisition of new and renewal business and generally include direct costs
such as premium taxes, commissions to agents and ceding companies and
premium-related assessments and indirect costs such as salaries and
expenses of personnel who perform and support underwriting activities.
NAICO also receives ceding commissions from the reinsurers who assume
premiums from NAICO under certain reinsurance contracts and the ceding
commissions are accounted for as a reduction of policy acquisition costs.
Direct policy acquisition costs and ceding commissions are deferred and
amortized over the terms of the policies. When the sum of anticipated
losses, loss adjustment expenses and unamortized policy acquisition costs
exceeds the related unearned premiums, including anticipated investment
income, a provision for the indicated deficiency is recorded.
The following table sets forth Chandler USA's policy acquisition costs
for each of the three and six month periods ended June 30, 2008 and 2007:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2008 2007 2008 2007
---------- ---------- ---------- ----------
(In thousands)
Commissions expense ........................ $ 2,953 $ 3,374 $ 7,278 $ 7,279
Other premium related assessments .......... 239 263 546 521
Premium taxes .............................. 423 580 1,000 1,152
Excise taxes ............................... 54 66 136 149
Other expense .............................. 157 214 306 453
---------- ---------- ---------- ----------
Total direct expenses ...................... 3,826 4,497 9,266 9,554
Indirect underwriting expenses ............. 1,608 1,457 3,183 2,920
Commissions received from reinsurers ....... (2,391) (2,911) (6,001) (5,404)
Adjustment for deferred acquisition costs .. 81 (11) (81) (788)
---------- ---------- ---------- ----------
Net policy acquisition costs ............... $ 3,124 $ 3,032 $ 6,367 $ 6,282
========== ========== ========== ==========
Total direct expenses as a percentage of direct written and assumed
premiums were 18.9% and 18.6% for the second quarter and first six months
of 2008, compared to 18.4% and 18.6% in the corresponding year ago periods.
Commissions expense as a percentage of gross written and assumed premiums
was 14.6% and 14.4% in the second quarter and the first six months of 2008
compared to 14.0% and 14.1% in the corresponding 2007 periods.
Indirect underwriting expenses were 8.0% and 6.3% of total direct
written and assumed premiums in the second quarter and first six months of
2008, respectively, compared to 6.0% and 5.7% in the corresponding 2007
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. Direct premiums written and assumed decreased by
$3.9 million or 16% and $1.1 million or 2% in the second quarter and first
six months of 2008, respectively, which caused the 2008 percentages of such
expenses to direct written and assumed premiums to increase. Commissions
received from reinsurers as a percent of ceded reinsurance premiums were
31.9% and 32.6% in the second quarter and first six months of 2008,
respectively, compared to 31.1% and 31.4% in the corresponding 2007 periods.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 12.7% and 12.0% of gross
premiums earned and other income in the second quarter and first six months
of 2008, respectively, compared to 11.6% and 11.5% for the corresponding
2007 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.
PAGE 16
INTEREST EXPENSE
Interest expense decreased $51,000 and $76,000 in the second quarter
and first six months of 2008, respectively, compared to the 2007 periods.
Substantially all of Chandler USA's interest expense is related to its
outstanding senior debentures and junior subordinated debentures. The
decrease in the 2008 periods 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 six months of 2008, Chandler USA provided $6.1 million
in cash from operations. Cash provided by operations included an increase
in unpaid losses and loss adjustment expenses of $7.6 million. This was
partially offset by an increase in reinsurance recoverable on unpaid losses
of $4.3 million. In the first six months of 2007, Chandler USA provided
$4.4 million in cash from operations.
NAICO is required to deposit cash and securities with regulatory
agencies in which it is licensed as a condition of conducting operations in
the state. In addition, NAICO has deposited cash and securities into a
trust account as collateral for a reinsurance agreement in which NAICO is
the assuming reinsurer. At June 30, 2008, the total amount of cash and
securities restricted as a result of these arrangements was $36.4 million
which was an increase of $3.5 million from December 31, 2007. This
increase was due to an increase in the amount of reinsurance that NAICO
assumed during 2008.
At June 30, 2008, Chandler USA's parent company, Chandler Insurance
Company, Ltd., owed approximately $12.0 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 6.0%
at June 30, 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 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.
PAGE 17
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 paid a cash
shareholder dividend of $1.0 million to Chandler USA in June 2008. NAICO
paid a cash shareholder dividend of $1.6 million to Chandler USA in May 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.
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. Gulf Liquids has
appealed the judgment entered in favor of Gulsby and the denial of its claims
against NAICO and Gulsby. NAICO has appealed the trial court's denial of
its claims against Gulf Liquids and Williams and seeks entry of judgment
upon the jury verdicts for the amounts the jury found should be awarded to
NAICO. Gulsby has also appealed the trial court's final judgment,
contending that judgment should be entered in its favor against Gulf
Liquids and Williams in accordance with the jury verdicts.
PAGE 18
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 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.
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
---------------------------------------------------
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: August 8, 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)