-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ff+qe/3OxtHeXB0JWjex+u3Ed3E0PAAtp1Eh/PYEswkCZ48O+KtSmIUXXASvAY7Y LA5I1o2STICA1tQA2Ejsvw== 0001083750-08-000015.txt : 20080811 0001083750-08-000015.hdr.sgml : 20080811 20080811165750 ACCESSION NUMBER: 0001083750-08-000015 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20080630 FILED AS OF DATE: 20080811 DATE AS OF CHANGE: 20080811 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHANDLER USA INC CENTRAL INDEX KEY: 0001083750 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 731325906 STATE OF INCORPORATION: OK FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-15135 FILM NUMBER: 081007017 BUSINESS ADDRESS: STREET 1: 1010 MANVEL AVE CITY: CHANDLER STATE: OK ZIP: 74834 BUSINESS PHONE: 4052580804 MAIL ADDRESS: STREET 1: 1010 MANVEL AVE CITY: CHANDLER STATE: OK ZIP: 74834 10-Q 1 usa63008edgar.txt CHANDLER (U.S.A.), INC. 6/30/2008 10-Q =============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------------------- FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2008 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from to --------- --------- COMMISSION FILE NUMBER: 1-15135 CHANDLER (U.S.A.), INC. (Exact name of registrant as specified in its charter) OKLAHOMA 73-1325906 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1010 MANVEL AVENUE, CHANDLER, OKLAHOMA 74834 (Address of principal executive offices and zip code) Registrant's telephone number, including area code: (405) 258-0804 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, 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 --- --- 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. =============================================================================== Page i CHANDLER (U.S.A.), INC. INDEX ----- PART I - FINANCIAL INFORMATION - ------------------------------ ITEM 1. FINANCIAL STATEMENTS: - ------------------------------ 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 - -------------------------------- PART II - OTHER INFORMATION - --------------------------- Item 1. Legal Proceedings ............................................18 Item 1A. Risk Factors .................................................18 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ..18 Item 3. Defaults Upon Senior Securities ..............................18 Item 4. Submission of Matters to a Vote of Security Holders ..........18 Item 5. Other Information ............................................18 Item 6. Exhibits .....................................................18 Signatures ...............................................................19 PAGE 1 CHANDLER (U.S.A.), INC. CONSOLIDATED BALANCE SHEETS (Amounts in thousands except share amounts)
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 ------------- -------------- 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 ------------- -------------- 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 ------------ ------------ 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 ------------ ------------ Total premiums and other revenues ............................ 16,668 17,172 ------------ ------------ 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 ------------ ------------ Income before income taxes ..................................... 1,418 1,062 Federal income tax provision ................................... (568) (394) ------------ ------------ 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 ------------- ------------ 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) ------------- ------------ Net premiums written and assumed ........................ 31,972 34,221 Decrease (increase) in unearned premiums .................. 781 (1,331) ------------- ------------ 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 ------------- ------------ Total premiums and other revenues ......................... 35,668 36,426 ------------- ------------ 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 ------------- ------------ Total operating costs and expenses ...................... 33,241 33,919 ------------- ------------ Income before income taxes .................................. 2,427 2,507 Federal income tax provision ................................ (961) (925) ------------- ------------ Net income ................................................ $ 1,466 $ 1,582 ============= ============
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 ------------- ------------ Net income .................................................. $ 850 $ 668 ------------- ------------ 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) ------------- ------------ Other comprehensive loss, before income tax ................. (1,583) (510) Income tax benefit related to items of other comprehensive loss ........................................ 538 174 ------------- ------------ Other comprehensive loss, net of income tax ................. (1,045) (336) ------------- ------------ 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 ------------ ------------ Net income .................................................. $ 1,466 $ 1,582 ------------ ------------ 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) ------------ ------------ Other comprehensive loss, before income tax ................. (315) (353) Income tax benefit related to items of other comprehensive loss ........................................ 107 120 ------------ ------------ Other comprehensive loss, net of income tax ................. (208) (233) ------------ ------------ 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 ------------ ------------ 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 ------------ ------------ 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 ------------ ------------ Cash applied to investing activities .................................... (16,111) (5,056) ------------ ------------ 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) ------------ ------------ Cash applied to financing activities .................................... (523) (2,526) ------------ ------------ 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 ------------ ------------ 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 - ------------------------------------------------------ (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 ============ ============ ========== ============ - ------------------------------------------------------ (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 ---------- 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) EX-31.1 2 exh311for6302008.txt CHANDLER (U.S.A.), INC. 6/30/2008 EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATIONS I, W. Brent LaGere, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Chandler (U.S.A.), Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 8, 2008 /s/ W. Brent LaGere -------------------------------- W. Brent LaGere Chairman of the Board and Chief Executive Officer EXHIBIT 31.1 (CONTINUED) CERTIFICATIONS I, Mark C. Hart, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Chandler (U.S.A.), Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 8, 2008 /s/ Mark C. Hart -------------------------------- Mark C. Hart Senior Vice President - Finance, Chief Financial Officer and Treasurer EX-32.1 3 exh321for6302008.txt CHANDLER (U.S.A.), INC. 6/30/2008 EXHIBIT 32.1 EXHIBIT 32.1 SECTION 1350 CERTIFICATIONS In connection with the Quarterly Report of Chandler (U.S.A.), Inc. (the "Company") on Form 10-Q for the period ending June 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), W. Brent LaGere, as Chief Executive Officer of the Company, and Mark C. Hart, as Chief Financial Officer of the Company, each hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002, to the best of his knowledge, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ W. Brent LaGere -------------------------------- W. Brent LaGere Chief Executive Officer August 8, 2008 /s/ Mark C. Hart -------------------------------- Mark C. Hart Chief Financial Officer August 8, 2008 A signed original of this written statement required by Section 906 has been provided to Chandler (U.S.A.), Inc. and will be retained by Chandler (U.S.A.), Inc. and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----