##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For The Quarterly Period Ended September 30, 2005
 or
 o
    
    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 000-50891
 SPECIALTY UNDERWRITERS ALLIANCE, INC.
  Delaware
    
    20-0432760(State or other jurisdiction of incorporation or
    
    (I.R.S. Employer Identificationorganization)
    
    Number)
 222 South Riverside Plaza
Chicago, Illinois
    
    60606(Address of principal executive office)
    
    (Zip Code)
 (888) 782-4672
  o þ
 o þ
 o þ




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SPECIALTY UNDERWRITERS ALLIANCE, INC.
 INDEX
 Page No.PART I  FINANCIAL INFORMATION
    
    
    3Item 1: Financial Statements
    
    
    3Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3: Quantitative and Qualitative Disclosures About Market Risk
    
    
    17Item 4: Controls and Procedures
    
    
    19PART II  OTHER INFORMATION
    
    
    20Item 1: Legal Proceedings
    
    
    20Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    20Item 3: Defaults Upon Senior Securities
    
    
    20Item 4: Submission of Matters to a Vote of Security Holders
    
    
    20Item 5: Other Information
    
    
    20Item 6: Exhibits
    
    
    20Signatures
    
    
    21Certifications
    
    
    23CertificationCertificationCertificationCertification
  2




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1: Financial Statements
 Balance Sheets
 Specialty
Underwriters Alliance, Inc.UnauditedSeptember 30,
    
    
    December 31,2005
    
    
    2004(dollars in thousands)AssetsFixed maturity investments, at fair value (amortized cost: $91,279 and $50,455)
    
    $
    90,105
    
    
    $
    50,465Short-term investments, at amortized cost (which approximates fair value)
    
    
    5,821
    
    
    
    47,370Total investments
    
    
    95,926
    
    
    
    97,835Cash and cash equivalents
    
    
    3,502
    
    
    
    8,986Insurance receivables
    
    
    41,923
    
    
    
    Reinsurance recoverable on unpaid loss and loss adjustment expenses
    
    
    89,578
    
    
    
    95,959Prepaid reinsurance premiums
    
    
    4,552
    
    
    
    3Investment income accrued
    
    
    729
    
    
    
    677Equipment and capitalized software at cost (less accumulated depreciation of $982 and $0)
    
    
    3,415
    
    
    
    2,389Intangible assets
    
    
    10,745
    
    
    
    10,745Deferred acquisition costs
    
    
    8,679
    
    
    
    Other assets
    
    
    1,964
    
    
    
    637Total assets
    
    $
    261,013
    
    
    $
    217,231LiabilitiesLoss and loss adjustment expense reserves
    
    $
    97,102
    
    
    $
    95,959Unearned insurance premiums
    
    
    47,568
    
    
    
    3Payable for securities purchased
    
    
    
    
    
    
    1,000Accounts payable and other liabilities
    
    
    11,106
    
    
    
    1,339Total liabilities
    
    
    155,776
    
    
    
    98,301Commitments (Note 4)Stockholders equityCommon stock
Class A at $.01 par value per share 
authorized 30,000,000 and 75,000,000 shares; issued and outstanding 14,680,688 shares
    
    
    147
    
    
    
    147Common stock
Class B at $.01 par value per share 
authorized 2,000,000 shares; issued and outstanding 120,164 and 26,316 shares
    
    
    1
    
    
    
    Paid-in capital  Class A
    
    
    127,256
    
    
    
    127,256Paid-in capital  Class B
    
    
    1,066
    
    
    
    250Accumulated deficit
    
    
    (22,059
    )
    
    
    (8,733
    )Accumulated other comprehensive income (loss)
    
    
    (1,174
    )
    
    
    10Total stockholders equity
    
    
    105,237
    
    
    
    118,930Total liabilities and stockholders equity
    
    $
    261,013
    
    
    $
    217,231
  3




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##### Table of Contents



Statements of Operations and Comprehensive Income (Loss)
(Unaudited)
 Specialty
Underwriters
    
    
    
    Potomac Insurance CompanyAlliance, Inc. (Successor)
    
    
    
    of Illinois (Predecessor)Three Months Ended
    
    
    Nine Months Ended
    
    
    
    Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,
    
    
    
    September 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    
    2004
    
    
    2004(dollars in thousands)RevenuesEarned insurance premiums
    
    $
    8,271
    
    
    $
    
    
    
    $
    11,773
    
    
    $
    
    
    
    
    $
    
    
    
    $
    Net investment income
    
    
    874
    
    
    
    
    
    
    
    2,710
    
    
    
    
    
    
    
    
    426
    
    
    
    1,218Net realized gain (losses)
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    
    43
    
    
    
    (59
    )Other revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    19,145
    
    
    
    
    
    
    
    14,482
    
    
    
    
    
    
    
    
    470
    
    
    
    1,160ExpensesLoss and loss adjustment expenses
    
    
    6,414
    
    
    
    
    
    
    
    9,204
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of deferred acquisition costs
    
    
    1,383
    
    
    
    
    
    
    
    2,123
    
    
    
    
    
    
    
    
    
    
    
    
    Service company fees
    
    
    2,188
    
    
    
    2,169
    
    
    
    6,596
    
    
    
    2,507
    
    
    
    
    
    
    
    
    Other operating expenses
    
    
    3,984
    
    
    
    643
    
    
    
    9,885
    
    
    
    3,000
    
    
    
    
    
    
    
    
    Financing expenses
    
    
    
    
    
    
    (703
    )
    
    
    
    
    
    
    4,044
    
    
    
    
    
    
    
    
    Total expenses
    
    
    13,969
    
    
    
    2,109
    
    
    
    27,808
    
    
    
    9,551
    
    
    
    
    
    
    
    
    Pretax income (loss)
    
    
    (4,824
    )
    
    
    (2,109
    )
    
    
    (13,326
    )
    
    
    (9,551
    )
    
    
    
    470
    
    
    
    1,160Federal income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (164
    )
    
    
    (406
    )Net income (loss)
    
    
    (4,824
    )
    
    
    (2,109
    )
    
    
    (13,326
    )
    
    
    (9,551
    )
    
    
    
    306
    
    
    
    754Net change in unrealized gains and losses for
investments held, after tax
    
    
    (1,109
    )
    
    
    
    
    
    
    (1,184
    )
    
    
    
    
    
    
    
    240
    
    
    
    (214
    )Recognition of unrealized gains and losses for
investments sold, after tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (28
    )
    
    
    38Comprehensive income (loss)
    
    $
    (5,933
    )
    
    $
    (2,109
    )
    
    $
    (14,510
    )
    
    $
    (9,551
    )
    
    
    $
    518
    
    
    $
    578Earnings (loss) per share available
to common stockholders (in dollars)Basic
    
    $
    (0.32
    )
    
    $
    (210,900.00
    )
    
    $
    (0.90
    )
    
    $
    (955,100.00
    )
    
    
    $
    NM
    
    
    $
    NMDiluted
    
    $
    (0.32
    )
    
    $
    (210,900.00
    )
    
    $
    (0.90
    )
    
    $
    (955,100.00
    )
    
    
    $
    NM
    
    
    $
    NMAverage Shares OutstandingBasic
    
    
    14,782
    
    
    
    
    
    
    
    14,748
    
    
    
    
    
    
    
    NM
    
    
    
    NMDiluted
    
    
    14,782
    
    
    
    
    
    
    
    14,748
    
    
    
    
    
    
    
    NM
    
    
    
    NM
  4




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Statement of Stockholders Equity
 AccumulatedCommon
    
    
    Paid-in
    
    
    Common
    
    
    Paid-in
    
    
    Retained
    
    
    Other
    
    
    TotalStock
    
    
    Capital
    
    
    Stock
    
    
    Capital
    
    
    Earnings
    
    
    Comprehensive
    
    
    Stockholders(Successor)
    
    Class A
    
    
    Class A
    
    
    Class B
    
    
    Class B
    
    
    (Deficit)
    
    
    Income (Loss)
    
    
    Equity(dollars in thousands)Balance at December 31, 2004
    
    
    147
    
    
    
    127,256
    
    
    
    
    
    
    
    250
    
    
    
    (8,733
    )
    
    
    10
    
    
    
    118,930Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (13,326
    )
    
    
    
    
    
    
    (13,326
    )Net change in unrealized investment
losses, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,184
    )
    
    
    (1,184
    )Stock issuance
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    816
    
    
    
    
    
    
    
    
    
    
    
    817Balance at September 30, 2005
    
    $
    147
    
    
    $
    127,256
    
    
    $
    1
    
    
    $
    1,066
    
    
    $
    (22,059
    )
    
    $
    (1,174
    )
    
    $
    105,237
  5




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Statements of Cash Flows
(Unaudited)
 Specialty
Underwriters
    
    
    
    Potomac Insurance CompanyAlliance, Inc. (Successor)
    
    
    
    of Illinois (Predecessor)Nine Months Ended
    
    
    
    Nine Months EndedSeptember 30,
    
    
    
    September 30,2005
    
    
    2004
    
    
    
    2004(dollars in thousands)Cash flows from operationsNet income (loss)
    
    $
    (13,326
    )
    
    $
    (9,551
    )
    
    
    $
    754Charges (credits) to reconcile net income to cash
flows from operations:Change in deferred income tax
    
    
    
    
    
    
    
    
    
    
    
    406Net realized losses
    
    
    1
    
    
    
    
    
    
    
    
    59Amortization of bond discount
    
    
    227
    
    
    
    
    
    
    
    
    Depreciation
    
    
    1,258
    
    
    
    
    
    
    
    
    Write off of capitalized software
    
    
    428
    
    
    
    
    
    
    
    
    Net change in:Reinsurance recoverable on unpaid loss and loss adjustment expense reserves
    
    
    6,381
    
    
    
    
    
    
    
    
    28,097Loss and loss adjustment expense reserves
    
    
    1,143
    
    
    
    
    
    
    
    
    (43,106
    )Insurance premiums receivable
    
    
    (41,923
    )
    
    
    
    
    
    
    
    Unearned insurance premiums
    
    
    47,565
    
    
    
    
    
    
    
    
    (4,767
    )Deferred acquisition costs
    
    
    (8,679
    )
    
    
    
    
    
    
    
    674Prepaid reinsurance premiums
    
    
    (4,549
    )
    
    
    
    
    
    
    
    Deferred charges
    
    
    
    
    
    
    3,570
    
    
    
    
    Other, net
    
    
    8,349
    
    
    
    4,300
    
    
    
    
    4,667Net cash flows used for operations
    
    
    (3,125
    )
    
    
    (1,681
    )
    
    
    
    (13,216
    )Cash flows from investing activitiesAcquisition deposit
    
    
    
    
    
    
    (1,000
    )
    
    
    
    Net decrease in short-term investments
    
    
    41,549
    
    
    
    
    
    
    
    
    3,021Sales of fixed maturity investments
    
    
    6,834
    
    
    
    
    
    
    
    
    15,031Redemptions, calls and maturities of fixed maturity investments
    
    
    
    
    
    
    
    
    
    
    
    13,831Purchases of fixed maturity investments
    
    
    (47,886
    )
    
    
    
    
    
    
    
    (24,171
    )Unsettled net investment purchases
    
    
    (1,000
    )
    
    
    
    
    
    
    
    Purchase of equipment and capitalized software
    
    
    (2,673
    )
    
    
    (466
    )
    
    
    
    Net cash flows (used for) provided by investing activities
    
    
    (3,176
    )
    
    
    (1,466
    )
    
    
    
    7,712Cash flows from financing activitiesProceeds from short-term borrowings
    
    
    
    
    
    
    3,200
    
    
    
    
    Issuance of common stock
    
    
    817
    
    
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    817
    
    
    
    3,200
    
    
    
    
    Net (decrease) increase in cash and cash equivalents
during the period
    
    
    (5,484
    )
    
    
    53
    
    
    
    
    (5,504
    )Cash and cash equivalents at beginning of the period
    
    
    8,986
    
    
    
    200
    
    
    
    
    10,307Cash and cash equivalents at end of the period
    
    $
    3,502
    
    
    $
    253
    
    
    
    $
    4,803
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NOTES
TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (in thousands)
 Note 1  Basis of Presentation
     7




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NOTES
TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (in thousands)
 Note 2. Net Loss Per Share
  Three Months
    
    Three MonthsEnded
    
    EndedSeptember 30,
    
    September 30,2005
    
    2004Net loss, as reported
    
    $
    (4,824
    )
    
    $
    (2,109
    )Average common shares outstanding
(basic and diluted)
    
    
    14,782
    
    
    
    Net Loss Per Share (in dollars)
    
    $
    (0.32
    )
    
    $
    (210,900.00
    )
 Nine Months
    
    Nine MonthsEnded
    
    EndedSeptember 30,
    
    September 30,2005
    
    2004Net loss, as reported
    
    $
    (13,326
    )
    
    $
    (9,551
    )Average common shares outstanding
(basic and diluted)
    
    
    14,748
    
    
    
    Net Loss Per Share (in dollars)
    
    $
    (0.90
    )
    
    $
    (955,100.00
    )
 Note 3. Income Taxes
  8




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (in thousands)
 Note 4. Commitments
    9




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (in thousands)
 Note 5. Stock Options
   WeightedAverageExercisePrice PerNumber
    
    Share (inOption Plan Activity
    
    of Shares
    
    dollars)Balance at June 30, 2005
    
    
    721,466
    
    
    $
    9.38Options granted
    
    
    30,000
    
    
    
    10.02Options exercised
    
    
    
    
    
    
    Options forfeited
    
    
    (24,000
    )
    
    
    9.50Balance at September 30, 2005
    
    
    727,466
    
    
    
    9.40Options exercisable at September 30, 2005
    
    
    
    
    
    
    
    10




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (in thousands)
 Nine Months EndedSeptember 30, 2005(In thousands ofU.S. dollars,except per shareamounts)Net income (loss) as reported
    
    $
    (13,326
    )Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects
    
    
    (720
    )Pro forma net income (loss)
    
    $
    (14,046
    )Basic earnings (loss) per share:As reported
    
    $
    (0.90
    )Pro forma
    
    $
    (0.95
    )Diluted earnings (loss) per share:As reported
    
    $
    (0.90
    )Pro forma
    
    $
    (0.95
    )
  Note 6. Intangible Assets
  11




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (in thousands)
 Note 7. Unpaid Loss and Loss Adjustment Expenses
   12




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Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations
 This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of
federal securities laws, which are intended to be covered by the safe harbors created thereby.
Those statements include, but may not be limited to, the discussions of the Companys operating and
growth strategy. Investors are cautioned that all forward-looking statements involve risks and
uncertainties including, without limitation, those set forth under the caption Risk Factors in
the Business section of the Companys Annual Report on Form 10-K for the year ended December 31,
2004. Although the Company believes that the assumptions underlying the forward-looking statements
contained herein are reasonable, any of the assumptions could prove to be inaccurate, and
therefore, there can be no assurance that the forward-looking statements included in this Quarterly
Report on Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent
in the forward-looking statements included herein, the inclusion of such information should not be
regarded as a representation by the company or any other person that the objectives and plans of
the company will be achieved. The company undertakes no obligation to publicly release any
revisions to any forward-looking statements contained herein to reflect events and circumstances
occurring after the date hereof or to reflect the occurrence of unanticipated events.
  The Company
 Overview
     13




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Results of Operations for the Three and Nine Months Ended September 30, 2005 and Three and Nine
Months Ended September 30, 2004
      14




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15




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##### Table of Contents



Liquidity and Capital Resources
         16




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##### Table of Contents



Recent Accounting Pronouncements
  
 Item 3: Quantitative and Qualitative Disclosures About Market Risk
  Interest Rate Risk
  17




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Estimated
    
    After TaxAssumed Change
    
    Fair Value After
    
    IncreaseFair Value
    
    in Relevant
    
    Change in
    
    (Decrease)Dollars in Thousands
    
    at 9/30/05
    
    Interest Rate
    
    Interest Rate
    
    in Carrying ValueTotal Investments
    
    $
    95,926
    
    
    100 bp decrease
    
    $
    97,444
    
    
    $
    1,51850 bp decrease
    
    $
    96,134
    
    
    $
    20850 bp increase
    
    $
    93,327
    
    
    $
    (2,599
    )100 bp increase
    
    $
    91,877
    
    
    $
    (4,049
    )
 Credit Risk
   9/30/2005
    
    
    12/31/2004Market Value
    
    
    Percent of
    
    
    Market Value
    
    
    Percent of(000) omitted
    
    
    Portfolio
    
    
    (000) omitted
    
    
    PortfolioUS Govt & Other Bonds
    
    $
    37,790
    
    
    
    41.9
    %
    
    $
    15,624
    
    
    
    31.0
    %AA Rated
    
    $
    15,558
    
    
    
    17.3
    %
    
    $
    3,917
    
    
    
    8.0
    %A Rated
    
    $
    36,757
    
    
    
    40.8
    %
    
    $
    30,924
    
    
    
    61.0
    %$
    90,105
    
    
    
    100.0
    %
    
    $
    50,465
    
    
    
    100.0
    %
  18




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Item 4: Controls and Procedures
    19




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PART II  OTHER INFORMATION
 
 Item 1: Legal Proceedings
  
 Item 2: Recent Sales of Unregistered Securities
  
 Item 3: Defaults Upon Senior Securities
  
 Item 4: Submission of Matters to a Vote of Security Holders
  
 Item 5: Other Information
  
 Item 6: Exhibits
  ExhibitNumber
    
    Description31.1
    
    Certification of Courtney C. Smith pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2
    
    Certification of Peter E. Jokiel pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1
    
    Certification of Courtney C. Smith pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 200232.2
    
    Certification of Peter E. Jokiel pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
 20




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SPECIALTY UNDERWRITERS ALLIANCE, INC.(Registrant)Dated: November 14, 2005
    
    By:
    
    /s/ Courtney C. SmithName: Courtney C. SmithTitle: President and Chief Executive Officer(Principal Executive Officer)Dated: November 14, 2005
    
    By:
    
    /s/ Peter E. JokielName: Peter E. JokielTitle: Executive Vice President, Chief FinancialOfficer and Treasurer (Principal Financial Officer)
 21




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##### Table of Contents



ExhibitNumber
    
    Description31.1
    
    Certification of Courtney C. Smith pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2
    
    Certification of Peter E. Jokiel pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1
    
    Certification of Courtney C. Smith pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 200232.2
    
    Certification of Peter E. Jokiel pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
 22