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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, 2004
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 ________
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 an accelerated filer (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, 2004 was 2,484, which are owned by Chandler Insurance Company, Ltd.
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PAGE i
CHANDLER (U.S.A.), INC.
INDEX
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PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1.
- -------
Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003 ....... 1
Consolidated Statements of Operations for the three months
ended June 30, 2004 and 2003 .......................................... 2
Consolidated Statements of Operations for the six months
ended June 30, 2004 and 2003 .......................................... 3
Consolidated Statements of Comprehensive Income for the three
months ended June 30, 2004 and 2003 ................................... 4
Consolidated Statements of Comprehensive Income for the six
months ended June 30, 2004 and 2003 ................................... 5
Consolidated Statements of Cash Flows for the six months
ended June 30, 2004 and 2003 .......................................... 6
Notes to Interim Consolidated Financial Statements ......................... 7
ITEM 2.
- -------
Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................. 9
ITEM 4.
- -------
Controls and Procedures ..................................................... 13
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings .............................................. 14
Item 2. Changes in Securities and Use of Proceeds ....................... 14
Item 3. Defaults Upon Senior Securities ................................ 14
Item 4. Submission of Matters to a Vote of Security Holders ............ 14
Item 5. Other Information .............................................. 14
Item 6. Exhibits and Reports on Form 8-K ............................... 14
Signatures ................................................................. 15
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
June 30, December 31,
2004 2003
----------- ------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $7,454 and $7,622 in 2004 and 2003, respectively) ..... $ 7,197 $ 7,677
Unrestricted (amortized cost $70,426 and $53,549 in 2004 and 2003, respectively).. 68,959 54,303
Equity securities available for sale, at fair value ............................... 92 92
----------- ------------
Total investments ................................................................ 76,248 62,072
Cash and cash equivalents ($101 and $601 restricted in 2004 and 2003, respectively)... 4,546 7,126
Premiums receivable, less allowance for non-collection
of $106 and $133 at 2004 and 2003, respectively .................................... 18,994 20,304
Reinsurance recoverable on paid losses, less allowance for
non-collection of $3,129 and $2,934 at 2004 and 2003, respectively ................. 3,655 9,036
Reinsurance recoverable on paid losses from related parties .......................... - 271
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $259 and $380 at 2004 and 2003, respectively ..................... 46,471 48,688
Reinsurance recoverable on unpaid losses from related parties ........................ 12,580 9,737
Prepaid reinsurance premiums ......................................................... 9,513 15,269
Prepaid reinsurance premiums to related parties ...................................... 11,475 9,521
Deferred policy acquisition costs ................................................... 1,093 165
Property and equipment, net ......................................................... 9,493 9,879
Amounts due from related parties .................................................... 11,928 9,642
State insurance licenses, net ....................................................... 3,745 3,745
Other assets ......................................................................... 15,101 12,758
----------- ------------
Total assets ........................................................................ $ 224,842 $ 218,213
=========== ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ........................................ $ 98,495 $ 87,768
Unearned premiums ................................................................. 48,952 47,325
Policyholder deposits ............................................................. 4,241 4,807
Accrued taxes and other payables .................................................. 6,046 5,617
Premiums payable ................................................................... 773 983
Premiums payable to related parties ................................................ 446 -
Senior debentures .................................................................. 6,979 7,254
Junior subordinated debentures issued to affiliated trusts ........................ 20,620 20,620
----------- ------------
Total liabilities ............................................................... 186,552 174,374
----------- ------------
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 ................................................................ (21,219) (17,342)
Accumulated other comprehensive income (loss):
Unrealized gain (loss) on investments available for sale, net
of deferred income taxes ......................................................... (1,077) 595
----------- ------------
Total shareholder's equity ....................................................... 38,290 43,839
----------- ------------
Total liabilities and shareholder's equity ........................................... $ 224,842 $ 218,213
=========== ============
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,
--------------------------------
2004 2003
------------- ------------
Premiums and other revenues
Direct premiums written and assumed .......................... $ 28,326 $ 27,352
Reinsurance premiums ceded ................................... 78 (8,183)
Reinsurance premiums ceded to related parties ................. (8,131) (5,612)
------------- ------------
Net premiums written and assumed ............................ 20,273 13,557
Decrease (increase) in unearned premiums ...................... (3,541) 864
------------- ------------
Net premiums earned ......................................... 16,732 14,421
Interest income, net ........................................... 641 551
Interest income, net from related parties ....................... 108 111
Realized investment gains, net ................................. - 1,787
Other income .................................................... 67 2,823
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Total premiums and other revenues ........................... 17,548 19,693
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Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $5,290 and $3,220 in
2004 and 2003, respectively ................................ 15,561 9,125
Policy acquisition costs, net of ceding commissions
received from related parties of $3,083 and $1,845 in
2004 and 2003, respectively ................................ 3,266 3,222
General and administrative expenses .......................... 3,049 3,357
Interest expense .............................................. 593 600
------------- ------------
Total operating costs and expenses .......................... 22,469 16,304
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Income (loss) before income taxes .............................. (4,921) 3,389
Federal income tax benefit (provision) .......................... 1,624 (598)
------------- ------------
Net income (loss) ............................................. $ (3,297) $ 2,791
============= ============
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,
--------------------------------
2004 2003
------------- ------------
Premiums and other revenues
Direct premiums written and assumed .......................... $ 59,987 $ 60,460
Reinsurance premiums ceded ................................... (9,072) (20,617)
Reinsurance premiums ceded to related parties ................. (14,882) (13,918)
------------- ------------
Net premiums written and assumed ............................ 36,033 25,925
Decrease (increase) in unearned premiums ...................... (5,429) 3,033
------------- ------------
Net premiums earned ......................................... 30,604 28,958
Interest income, net ........................................... 1,776 1,037
Interest income, net from related parties ....................... 211 221
Realized investment gains, net .................................. 463 1,938
Other income .................................................... 546 3,032
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Total premiums and other revenues ........................... 33,600 35,186
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Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $7,970 and $6,390 in
2004 and 2003, respectively ................................ 26,193 17,834
Policy acquisition costs, net of ceding commissions
received from related parties of $5,640 and $4,593 in
2004 and 2003, respectively ................................ 5,774 6,119
General and administrative expenses .......................... 6,362 6,997
Interest expense .............................................. 1,188 1,158
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Total operating costs and expenses .......................... 39,517 32,108
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Income (loss) before income taxes .............................. (5,917) 3,078
Federal income tax benefit (provision) .......................... 2,040 (510)
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Net income (loss) ............................................. $ (3,877) $ 2,568
============= ============
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,
--------------------------------
2004 2003
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Net income (loss) .............................................. $ (3,297) $ 2,791
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Other comprehensive loss, before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period ..... (3,004) 483
Less: Reclassification adjustment for gains included
in net income (loss) ...................................... - (1,787)
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Other comprehensive loss, before income tax ..................... (3,004) (1,304)
Income tax benefit related to items of other
comprehensive loss ........................................... 1,021 73
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Other comprehensive loss, net of income tax ..................... (1,983) (1,231)
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Comprehensive income (loss) ..................................... $ (5,280) $ 1,560
============= ============
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,
--------------------------------
2004 2003
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Net income (loss) .............................................. $ (3,877) $ 2,568
------------- ------------
Other comprehensive loss, before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period ..... (2,070) 1,703
Less: Reclassification adjustment for gains included
in net income (loss) ...................................... (463) (1,938)
------------- ------------
Other comprehensive loss, before income tax ..................... (2,533) (235)
Income tax benefit related to items of other
comprehensive loss ........................................... 861 80
------------- ------------
Other comprehensive loss, net of income tax ..................... (1,672) (155)
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Comprehensive income (loss) ..................................... $ (5,549) $ 2,413
============= ============
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,
--------------------------------
2004 2003
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OPERATING ACTIVITIES
Net income (loss) .................................................. $ (3,877) $ 2,568
Add (deduct):
Adjustments to reconcile net income (loss) to cash provided by
(applied to) operating activities:
Realized investment gains, net .................................. (463) (1,938)
Gain on retirement of debentures ................................ (36) (2,227)
Net gains on sale of property and equipment ..................... (371) (642)
Amortization and depreciation expense ........................... 750 737
Provision for non-collection of premiums ........................ (32) 150
Provision for non-collection of reinsurance recoverables ........ 324 183
Net change in non-cash balances relating to operating activities:
Premiums receivable ........................................... 1,342 281
Reinsurance recoverable on paid losses ........................ 4,936 (377)
Reinsurance recoverable on paid losses from related parties ... 271 (135)
Reinsurance recoverable on unpaid losses ...................... 2,337 4,352
Reinsurance recoverable on unpaid losses from related parties.. (2,843) 484
Prepaid reinsurance premiums .................................. 5,756 2,968
Prepaid reinsurance premiums to related parties ............... (1,954) (1,137)
Deferred policy acquisition costs ............................. (928) (454)
Other assets .................................................. (1,506) 2,215
Unpaid losses and loss adjustment expenses .................... 10,727 (8,499)
Unearned premiums ............................................. 1,627 (4,864)
Policyholder deposits ......................................... (566) 138
Accrued taxes and other payables .............................. 797 673
Premiums payable .............................................. (210) (877)
Premiums payable to related parties ........................... 446 -
------------- ------------
Cash provided by (applied to) operating activities .............. 16,527 (6,401)
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INVESTING ACTIVITIES
Unrestricted fixed maturities available for sale:
Purchases ....................................................... (30,756) (12,261)
Sales ........................................................... 12,176 10,676
Maturities ...................................................... 2,056 1,866
Equity securities available for sale:
Sales ........................................................... - 1,720
Cost of property and equipment purchased .......................... (95) (369)
Proceeds from sale of property and equipment ...................... 41 74
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Cash provided by (applied to) investing activities .............. (16,578) 1,706
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FINANCING ACTIVITIES
Proceeds from issuance of trust preferred securities .............. - 13,000
Payment on retirement of debentures ............................... (225) (7,250)
Debt issue costs .................................................. (18) (456)
Payments and loans from related parties ........................... 1,812 397
Payments and loans to related parties ............................. (4,098) (379)
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Cash provided by (applied to) financing activities .............. (2,529) 5,312
------------- ------------
Increase (decrease) in cash and cash equivalents during the period .. (2,580) 617
Cash and cash equivalents at beginning of period .................... 7,126 9,336
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Cash and cash equivalents at end of period .......................... $ 4,546 $ 9,953
============= ============
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, 2004 AND 2003
(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, 2003.
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,
2004 are not necessarily indicative of the results that may be expected for
the year. Certain reclassifications of prior years have been made to conform
to the 2004 presentation.
The consolidated financial statements include the accounts of Chandler
USA and all wholly owned subsidiaries that meet consolidation requirements
including National American Insurance Company ("NAICO").
Chandler USA is wholly owned by Chandler Insurance Company, Ltd.
("Chandler Insurance"), a Cayman Islands company. Prior to December 2003,
Chandler USA was a wholly owned subsidiary of Chandler Insurance (Barbados),
Ltd. ("Chandler Barbados") which, in turn, was a wholly owned subsidiary of
Chandler Insurance. In December 2003, Chandler Barbados was dissolved
following the transfer of its assets, liabilities and business to Chandler
Insurance. Chandler Insurance assumed the obligations of Chandler Barbados
including those under its reinsurance agreements with NAICO pursuant to a
Distribution Agreement and a General Conveyance. The reorganization of
Chandler Barbados and Chandler Insurance was approved by the Cayman Islands
Monetary Authority, the Supervisor of Insurance in Barbados and the Oklahoma
Insurance Department.
NOTE 2. LITIGATION
Certain officers and directors of Chandler USA and Chandler Insurance
were named as defendants in certain litigation involving CenTra, Inc. This
litigation was concluded in 2002. In accordance with its Articles of
Association, Chandler Insurance and its subsidiaries have advanced the
litigation expenses of these persons in exchange for undertakings to repay
such expenses if those persons are later determined to have breached the
standard of conduct provided in the Articles of Association. These expenses
together with certain other expenses may be recovered from Chandler Insurance's
director and officer liability insurance policy (the "D&O Insurer"). As a
result of various events in 1995, 1996 and 1997, Chandler Barbados and Chandler
USA recorded estimated recoveries of costs from its D&O Insurer totaling
$3,456,000 and $1,044,000, respectively, for reimbursable amounts previously
paid that relate to allowable defense and litigation costs for such parties.
Chandler Barbados and Chandler USA received payment for a 1995 claim during
1996 in the amount of $636,000 and $159,000, respectively. The balance of
$2,820,000 and $885,000 is included in other assets in Chandler Insurance's and
Chandler USA's respective balance sheets. Chandler Insurance assumed this
receivable from Chandler Barbados during December 2003 under the reorganization
of these companies. Chandler Insurance and its subsidiaries contend they are
entitled to a total of $5 million under the applicable insurance policy to the
extent they have advanced reimbursable expenses. The D&O Insurer contends that
certain policy provisions exclude coverage for these claims. On August 22,
2001, Chandler Insurance and its subsidiaries, including Chandler USA, filed
an action in the State District Court in Oklahoma City, Oklahoma ("Oklahoma
State Court") alleging that the director and officer liability insurance
policies should be rescinded and seeking repayment of more than $5 million in
premiums they previously paid. During June 2004, Chandler Insurance and
Chandler USA received payment in the amount of $558,000 and $167,000,
respectively, in exchange for releasing certain insurers with respect to
policies covering periods from June 28, 1997 up to June 28, 2002. Chandler
Insurance and its subsidiaries are currently involved in litigation with the
insurer for payment of the policy balance or rescission and repayment of
premiums previously paid for policy periods from June 28, 1992 to June 28,
1997. The litigation is pending in the Oklahoma State Court. The case is
still in the early pleading stages and Chandler USA cannot predict the date of
resolution or the outcome of this case. Chandler Insurance and its
subsidiaries may or may not recover the remaining policy limits or the
remaining previously paid premiums and could incur significant costs in
resolving this matter.
PAGE 8
Transamerica Occidental Life Insurance Company ("Transamerica") reinsured
NAICO for certain workers compensation risks during 1989, 1990 and 1991.
Beginning in 1996, Transamerica refused to pay NAICO for balances that it owed
under the reinsurance treaties. On March 15, 2004, an arbitration panel
ordered Transamerica to pay the losses and loss adjustment expenses owed to
NAICO in the amount of $1,607,704 plus interest at 6%, or approximately
$577,000, plus $25,000 in costs. NAICO has received payment for these amounts.
Chandler USA and its subsidiaries are not parties to any other 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.
NOTE 3. SEGMENT INFORMATION
Chandler USA has one reportable operating segment for property and
casualty insurance. Net premiums earned and losses and loss adjustment
expenses within the property and casualty 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 segment.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- --------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAM
- -----------------------------------------
NET PREMIUMS EARNED
Standard property and casualty .......... $ 14,353 $ 11,258 $ 25,950 $ 22,948
Political subdivisions .................. 1,759 2,355 3,445 4,705
Surety bonds ............................ 462 808 966 1,214
Other (1) ............................... 158 - 243 91
------------ ------------ ------------ ------------
$ 16,732 $ 14,421 $ 30,604 $ 28,958
============ ============ ============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard property and casualty .......... $ 13,138 $ 6,135 $ 20,656 $ 12,886
Political subdivisions .................. 1,327 2,249 3,752 4,057
Surety bonds ............................ 473 677 873 631
Other (1) ............................... 623 64 912 260
------------ ------------ ------------ ------------
$ 15,561 $ 9,125 $ 26,193 $ 17,834
============ ============ ============ ============
- --------------------------------------------------------
(1) This program is comprised primarily of the run-off of other discontinued
programs and NAICO's participation in various mandatory workers
compensation pools and assigned risks.
PAGE 9
NOTE 4. COMMITMENTS AND CONTINGENCIES
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for a three year term.
During March 2004, the lease was extended for an additional three years with
monthly rental installments equal to the sum of (i) $17,512 plus (ii) interest
on the unpaid lease balance at a floating interest rate of 1% over JP Morgan
Chase Bank prime, which was 4.25% at June 30, 2004. Chandler USA has the
option to repurchase the equipment at the end of the lease for approximately
$2.4 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 $1.9
million.
NOTE 5. NEW ACCOUNTING STANDARD
In December 2003, the Financial Accounting Standards Board issued Revised
Interpretation No. 46 ("FIN 46R"), CONSOLIDATION OF VARIABLE INTEREST ENTITIES.
FIN 46R provides guidance on the identification of, and financial reporting
for, entities over which control is achieved through means other than voting
rights. FIN 46R is used to determine whether consolidation is required or,
alternatively, whether the variable-interest model under FIN 46R should be
used to account for existing and new entities. Chandler USA adopted FIN 46R
effective January 1, 2004. The result of adoption was the deconsolidation of
the two capital trusts that were created during 2003 in connection with the
issuance of trust preferred securities. Chandler USA now reports the $20.6
million of junior subordinated debentures that were issued to the capital
trusts on its consolidated balance sheet, and the December 31, 2003 balances
were restated accordingly. The adoption of FIN 46R had no effect on net
earnings.
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.
PAGE 10
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, 2004 and 2003:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- --------------------------
THREE MONTHS ENDED JUNE 30, 2004 2003 2004 2003
------------------------------------ ------------ ------------ ------------ ------------
(In thousands)
Standard property and casualty ..... $ 22,856 $ 23,251 $ 14,353 $ 11,258
Political subdivisions ............. 5,494 7,892 1,759 2,355
Surety bonds ....................... 645 942 462 808
Other .............................. 158 4 158 -
------------ ------------ ------------ ------------
TOTAL .............................. $ 29,153 $ 32,089 $ 16,732 $ 14,421
============ ============ ============ ============
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- --------------------------
SIX MONTHS ENDED JUNE 30, 2004 2003 2004 2003
------------------------------------ ------------ ------------ ------------ ------------
(In thousands)
Standard property and casualty ..... $ 45,532 $ 47,342 $ 25,950 $ 22,948
Political subdivisions ............. 11,254 16,070 3,445 4,705
Surety bonds ....................... 1,331 1,817 966 1,214
Other .............................. 243 95 243 91
------------ ------------ ------------ ------------
TOTAL .............................. $ 58,360 $ 65,324 $ 30,604 $ 28,958
============ ============ ============ ============
Gross premiums earned decreased $2.9 million or 9% and $7.0 million or
11% in the second quarter and first six months of 2004, respectively,
compared to the 2003 periods. Gross premiums earned in Oklahoma decreased
$1.9 million and $4.1 million in the second quarter and first six months of
2004, respectively, from the 2003 periods, and gross premiums earned in Texas
decreased $531,000 and $2.0 million in these periods. These decreases were
primarily the result of NAICO's continued efforts to improve underwriting
profitability and increased competition within the Oklahoma school districts
portion of the political subdivision program. Net premiums earned increased
$2.3 million or 16% and $1.6 million or 6% for the second quarter and first
six months of 2004, respectively, due primarily to changes in NAICO's
reinsurance programs for certain excess of loss and quota share reinsurance.
Effective April 1, 2004, NAICO increased its net retention to include 56% of
the layer covering $500,000 excess of $500,000 of loss per occurrence for its
casualty and workers compensation risks. Effective January 1, 2004, NAICO
discontinued a quota share reinsurance arrangement that covered casualty,
workers compensation and physical damage risks produced by certain agents.
These changes increased NAICO's net retention for these lines of business and
also increased net premiums earned.
Gross premiums earned in the standard property and casualty program
decreased $395,000 or 2% and $1.8 million or 4% in the second quarter and first
six months of 2004, respectively, compared to the 2003 periods. The workers
compensation line accounted for $352,000 and $1.7 million of the decrease in
the second quarter and first six months of 2004, respectively. Net premiums
earned in this program increased $3.1 million or 27% and $3.0 million or 13% in
the second quarter and first six months of 2004, respectively, due primarily to
the reinsurance changes described above.
Gross premiums earned in the political subdivisions program decreased
$2.4 million or 30% and $4.8 million or 30% in the second quarter and first six
months of 2004, respectively, compared to the 2003 periods. The decrease in
gross premiums earned is due primarily to increased competition in the school
districts portion of the program in Oklahoma. Net premiums earned in this
program decreased $596,000 or 25% and $1.3 million or 27% in the second quarter
and first six months of 2004, respectively, due primarily to the decrease in
gross premiums earned.
Gross premiums earned in the surety bond program decreased $297,000 or
32% and $486,000 or 27% in the second quarter and first six months of 2004,
respectively, compared to the 2003 periods. The decreases are primarily due
to stricter underwriting policies as NAICO continues to focus on improving
underwriting profitability in this program and to the bail bond portion of the
program that was discontinued during 2003. Gross premiums earned for the bail
bond portion of the program decreased $288,000 and $535,000 in the second
quarter and first six months of 2004, respectively. Net premiums earned in
the surety bond program decreased $346,000 or 43% and $248,000 or 20% in the
second quarter and first six months of 2004, respectively.
PAGE 11
NET INTEREST INCOME AND NET REALIZED INVESTMENT GAINS
At June 30, 2004, Chandler USA's investment portfolio consisted primarily
of fixed income U.S. Government and high-quality corporate bonds, with
approximately 6% 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 interest income, excluding interest income from related parties,
increased $90,000 or 16% and $739,000 or 71% in the second quarter and first
six months of 2004, respectively. The increase in the six month period was due
primarily to an arbitration award in favor of NAICO that included approximately
$577,000 in interest. Excluding the arbitration award, net interest income
increased $162,000 or 16% in the six month period. Cash and invested assets
were $80.8 million at June 30, 2004 compared to $68.4 million at June 30, 2003.
Net interest income from related parties decreased $3,000 or 3% and $10,000 or
5% in the second quarter and first six months of 2004, respectively.
Chandler USA had no net realized investment gains during the second
quarter of 2004 compared to $1.8 million during the second quarter of 2003.
Net realized investment gains were $463,000 during the first six months of
2004 compared to $1.9 million during the first six months of 2003. Realized
investment gains in the second quarter of 2003 included a gain of $1.7 million
from the sale of 19,371 shares of common stock of Insurance Services Office,
Inc.
OTHER INCOME
Other income was $67,000 and $546,000 in the second quarter and first six
months of 2004, respectively, compared to $2.8 million and $3.0 million during
the second quarter and first six months of 2003. The 2003 amounts included a
gain of $2.2 million related to the purchase and cancellation of $10.0 million
of Chandler USA's senior debentures. Other income also included $368,000 in
the first six months of 2004, and $510,000 and $652,000 in the second quarter
and first six months of 2003, respectively for the amortization of the deferred
gain related to the sale and leaseback of certain equipment. The deferred gain
has been fully amortized and no amortization was recorded during the second
quarter of 2004.
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 93.0% and 85.6% for the second quarter and first six
months of 2004, compared to 63.3% and 61.6% in the corresponding 2003 periods.
The increase in the 2004 loss ratios was due to losses incurred related to
prior accident years of $9.0 million and $12.8 million in the second quarter
and first six months of 2004, respectively. The adverse loss development
during 2004 was generally the result of ongoing analysis of recent loss
development trends that reflect an increase in loss severity in the workers
compensation and liability lines for NAICO's standard property and casualty
program, primarily in the 1997-2001 accident years. Losses and loss adjustment
expenses incurred related to prior accident years were $2.1 million and $3.4
million in the second quarter and first six months of 2003, respectively.
Reserves for unpaid losses and loss adjustment expenses, net of related
reinsurance recoverables, were $39.4 million as of June 30, 2004 compared to
$29.3 million at December 31, 2003, an increase of $10.1 million or 34%.
Weather-related losses from wind and hail totaled $173,000 and $316,000 in the
second quarter and first six months of 2004 and increased the respective loss
ratios by 1.0 percentage point. Weather-related losses totaled $1.3 million
and $1.4 million in the second quarter and first six months of 2003, and
increased the respective 2002 loss ratios by 8.8 and 4.7 percentage points.
PAGE 12
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, 2004 and 2003:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
(In thousands)
Commissions expense ....................... $ 3,844 $ 4,341 $ 8,144 $ 9,295
Other premium related assessments ......... 268 344 564 694
Premium taxes ............................. 653 638 1,387 1,398
Excise taxes .............................. 81 56 149 139
Dividends to policyholders ................ - 9 - 15
Other expense ............................. 119 207 183 351
---------- ---------- ---------- ----------
Total direct expenses ..................... 4,965 5,595 10,427 11,892
Indirect underwriting expenses ............ 1,925 1,943 3,803 3,984
Commissions received from reinsurers ...... (2,846) (3,443) (7,528) (9,303)
Adjustment for deferred acquisition costs.. (778) (873) (928) (454)
---------- ---------- ---------- ----------
Net policy acquisition costs .............. $ 3,266 $ 3,222 $ 5,774 $ 6,119
========== ========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 24.3% and 23.7% for the second quarter and first six
months of 2004, compared to 27.6% and 26.3% in the corresponding year ago
periods. Commission expense as a percentage of gross written and assumed
premiums was 13.6% in the second quarter and the first six months of 2004
compared to 15.9% and 15.4% in the corresponding 2003 periods. The decrease in
commission expense was primarily due to a decrease in contingent commissions to
agents that resulted from higher loss ratios than had been projected for these
agents. Commissions received from reinsurers decreased $597,000 or 17% and
$1.8 million or 19% in the second quarter and first six months of 2004,
respectively, compared to the 2003 periods due to discontinuing certain quota
share reinsurance arrangements.
Indirect underwriting expenses were 6.8% and 6.3% of total direct written
and assumed premiums in the second quarter and first six months of 2004,
respectively, compared to 7.1% and 6.6% in the corresponding 2003 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.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 10.5% and 10.9% of gross premiums
earned in the second quarter and first six months of 2004, respectively,
compared to 10.5% and 10.7% for the corresponding 2003 periods. General and
administrative expenses have historically not varied in direct proportion to
Chandler USA's revenues. A portion of such expenses is allocated to policy
acquisition costs (indirect underwriting expenses) and loss and loss adjustment
expenses based on various factors including employee counts, salaries,
occupancy and specific identification. Because certain types of expenses are
fixed in nature, the percentage of such expenses to revenues will vary
depending on Chandler USA's overall premium volume.
INTEREST EXPENSE
Interest expense decreased $7,000 and increased $30,000 in the second
quarter and first six months of 2004, respectively, compared to the 2003
periods. Substantially all of Chandler USA's interest expense is related to
its outstanding senior debentures and junior subordinated debentures.
PAGE 13
LIQUIDITY AND CAPITAL RESOURCES
In the first six months of 2004, Chandler USA provided $16.5 million in
cash from operations due primarily to the decrease in reinsurance purchased
during 2004 which resulted in an increase in net premiums written of $10.1
million. Cash flow from operations is positively impacted during times when
net premiums written increase since a substantial portion of the claim payments
for any given year will be made in future years. The cash provided by
operations was used primarily to fund purchases of investments and loans to
related parties. In the first six months of 2003, Chandler USA used $6.4
million in cash from operations.
During the first six months of 2004, the market value of NAICO's fixed
maturity investments decreased by $2.1 million due primarily to an increase in
interest rates and to possible future interest rate changes and the effect such
changes have on the market for these investments. Higher interest rates
generally provide for potentially higher interest rates on investable cash flow
and decreases in the market value of existing fixed maturity investments.
At June 30, 2004, Chandler Insurance owed approximately $11.9 million to
Chandler USA versus $9.6 million at December 31, 2003 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 a three year term.
During March 2004, the lease was extended for an additional three years with
monthly rental installments equal to the sum of (i) $17,512 plus (ii) interest
on the unpaid lease balance at a floating interest rate of 1% over JP Morgan
Chase Bank prime, which was 4.25% at June 30, 2004. Chandler USA has the
option to repurchase the equipment at the end of the lease for approximately
$2.4 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 $1.9
million.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report and pursuant to Rule
13a-15 of the Securities Exchange Act of 1934 (the "Exchange Act"), Chandler
USA's management, including the Chief Executive Officer and Chief Financial
Officer, conducted an evaluation of the effectiveness and design of Chandler
USA's disclosure controls and procedures (as that term is defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation,
Chandler USA's Chief Executive Officer and Chief Financial Officer concluded,
as of the end of the period covered by this report, that Chandler USA's
disclosure controls and procedures were effective in recording, processing,
summarizing and reporting information required to be disclosed by Chandler USA,
within the time periods specified in the Securities and Exchange Commission's
rules and forms.
CHANGES IN INTERNAL CONTROLS
In addition and as of the end of the period covered by this report, there
have been no changes in internal control over financial reporting (as defined
in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter to
which this report relates that have materially affected or are reasonably
likely to materially affect, the internal control over financial reporting.
PAGE 14
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings
-----------------
In response to this item, Chandler USA incorporates by reference to
Note 2. Litigation to its Interim Consolidated Financial Statements
contained elsewhere in this report.
Item 2. Changes in Securities and Use of Proceeds
-----------------------------------------
None.
Item 3. Defaults Upon Senior Securities
-------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Effective May 11, 2004, Chandler USA's sole shareholder, Chandler
Insurance, re-elected the following individuals to serve on Chandler
USA's Board of Directors:
W. Brent LaGere W. Scott Martin
Mark T. Paden Robert L. Rice
R. Patrick Gilmore K.R. Price
Richard L. Evans William Thomas Keele
Item 5. Other Information
-----------------
None.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
Index of Exhibits
-----------------
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.
Reports on Form 8-K
-------------------
None.
PAGE 15
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 10, 2004 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
Vice President - Finance, Chief
Financial Officer and Treasurer
(Principal Accounting Officer)
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)) 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) 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
c) 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 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 10, 2004
/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)) 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) 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
c) 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 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 10, 2004
/s/ Mark C. Hart
-----------------------------------
Mark C. Hart
Vice President - Finance,
Chief Financial Officer
and Treasurer
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, 2004 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 10, 2004
/s/ Mark C. Hart
-----------------------------------
Mark C. Hart
Chief Financial Officer
August 10, 2004
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.