##### 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 June 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
  SPECIALTY UNDERWRITERS ALLIANCE, INC.
  Delaware
(State or other jurisdiction of incorporation or
organization)
    
    20-0432760
(I.R.S. Employer Identification
Number)222 South Riverside Plaza
Chicago, Illinois
    
    60606(Address of principal executive office)
    
    (Zip Code)
 (888) 782-4672
 þ o
 o þ
    1




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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 Conditionand Results of Operations
    
    
    13Item 3:
    
    Quantitative and Qualitative Disclosures About Market Risk.
    
    
    18Item 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
    
    
    21Item 6:
    
    Exhibits
    
    
    21Signatures
    
    
    22Partner Agent AgreementSecurities Purchase AgreementCertificationCertificationCertificationCertification
  2




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##### Table of Contents



PART I   FINANCIAL INFORMATION
 
 Item 1: Financial Statements
  Balance Sheets
 Specialty Underwriters Alliance, Inc.
 UnauditedJune 30,
    
    
    December 31,2005
    
    
    2004(dollars in thousands)AssetsFixed maturity investments, at fair value (amortized cost: $90,566 and $50,455)
    
    $
    90,501
    
    
    $
    50,465Short-term investments, at amortized cost (which approximates fair value)
    
    
    4,655
    
    
    
    47,370Total investments
    
    
    95,156
    
    
    
    97,835Cash and cash equivalents
    
    
    1,020
    
    
    
    8,986Insurance receivables
    
    
    25,360
    
    
    
    Reinsurance recoverable on unpaid loss and loss adjustment expenses
    
    
    84,304
    
    
    
    95,959Prepaid reinsurance premiums
    
    
    3,264
    
    
    
    3Investment income accrued
    
    
    1,133
    
    
    
    677Equipment and capitalized software at cost (less accumulated depreciation of $836 and $0)
    
    
    3,681
    
    
    
    2,389Intangible assets
    
    
    10,745
    
    
    
    10,745Deferred acquisition costs
    
    
    5,297
    
    
    
    Other assets
    
    
    2,677
    
    
    
    637Total assets
    
    $
    232,637
    
    
    $
    217,231LiabilitiesLoss and loss adjustment expense reserves
    
    $
    86,411
    
    
    $
    95,959Unearned insurance premiums
    
    
    29,575
    
    
    
    3Payable for securities purchased
    
    
    
    
    
    
    1,000Accounts payable and other liabilities
    
    
    5,798
    
    
    
    1,339Total liabilities
    
    
    121,784
    
    
    
    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 83,707 and 26,316 shares
    
    
    1
    
    
    
    Paid-in capital  Class A
    
    
    127,256
    
    
    
    127,256Paid-in capital  Class B
    
    
    749
    
    
    
    250Accumulated deficit
    
    
    (17,235
    )
    
    
    (8,733
    )Accumulated other comprehensive income (loss)
    
    
    (65
    )
    
    
    10Total stockholders equity
    
    
    110,853
    
    
    
    118,930Total liabilities and stockholders equity
    
    $
    232,637
    
    
    $
    217,231
  3




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##### Table of Contents



Statements of Income and Comprehensive Income
(Unaudited)
 Specialty Underwriters'
    
    
    
    
    
    
    
    Potomac Insurance CompanyAlliance, Inc. (Successor)
    
    
    
    
    
    
    
    of Illinois (Predecessor)Three Months Ended
    
    
    Six Months Ended
    
    
    
    Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,
    
    
    
    June 30,2005
    
    
    2004
    
    
    2005
    
    
    2004
    
    
    
    2004
    
    
    2004(dollars in thousands)Revenues:Earned insurance premiums
    
    $
    3,032
    
    
    $
    
    
    
    $
    3,502
    
    
    $
    
    
    
    
    $
    (2,752
    )
    
    $
    Net investment income
    
    
    1,043
    
    
    
    
    
    
    
    1,836
    
    
    
    
    
    
    
    
    432
    
    
    
    792Net realized losses
    
    
    (3
    )
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    
    (202
    )
    
    
    (102
    )Other revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    4,072
    
    
    
    
    
    
    
    5,337
    
    
    
    
    
    
    
    
    (2,524
    )
    
    
    690Expenses:Loss and loss adjustment expenses
    
    
    2,319
    
    
    
    
    
    
    
    2,790
    
    
    
    
    
    
    
    
    (1,721
    )
    
    
    Amortization of deferred acquisition costs
    
    
    640
    
    
    
    
    
    
    
    740
    
    
    
    
    
    
    
    
    (124
    )
    
    
    Service company fees
    
    
    2,203
    
    
    
    323
    
    
    
    4,408
    
    
    
    338
    
    
    
    
    
    
    
    
    Other operating expenses
    
    
    2,920
    
    
    
    1,916
    
    
    
    5,901
    
    
    
    2,357
    
    
    
    
    (722
    )
    
    
    Financing expenses
    
    
    
    
    
    
    3,395
    
    
    
    
    
    
    
    4,747
    
    
    
    
    
    
    
    
    Accretion of loss and loss adjustment expenses to fair value
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50
    )
    
    
    Total expenses
    
    
    8,082
    
    
    
    5,634
    
    
    
    13,839
    
    
    
    7,442
    
    
    
    
    (2,617
    )
    
    
    Pretax income (loss)
    
    
    (4,010
    )
    
    
    (5,634
    )
    
    
    (8,502
    )
    
    
    (7,442
    )
    
    
    
    93
    
    
    
    690Federal income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (33
    )
    
    
    (242
    )Net income (loss)
    
    
    (4,010
    )
    
    
    (5,634
    )
    
    
    (8,502
    )
    
    
    (7,442
    )
    
    
    
    60
    
    
    
    448Net change in unrealized gains and losses for investments held, after tax
    
    
    1,096
    
    
    
    
    
    
    
    (75
    )
    
    
    
    
    
    
    
    (624
    )
    
    
    (454
    )Recognition of unrealized gains and losses for investments sold, after tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    131
    
    
    
    66Comprehensive net income (loss)
    
    $
    (2,914
    )
    
    $
    (5,634
    )
    
    $
    (8,577
    )
    
    $
    (7,442
    )
    
    
    $
    (433
    )
    
    $
    60Earnings (loss) per share available
to common stockholders (in dollars)Basic
    
    $
    (0.27
    )
    
    $
    (563,400.00
    )
    
    $
    (0.58
    )
    
    $
    (744,200.00
    )
    
    
    $NM
    
    $NMDiluted
    
    $
    (0.27
    )
    
    $
    (563,400.00
    )
    
    $
    (0.58
    )
    
    $
    (744,200.00
    )
    
    
    $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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,502
    )
    
    
    
    
    
    
    (8,502
    )Net change in unrealized investment
losses, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (75
    )
    
    
    (75
    )Stock issuance
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    499
    
    
    
    
    
    
    
    
    
    
    
    500Balance at June 30, 2005
    
    $
    147
    
    
    $
    127,256
    
    
    $
    1
    
    
    $
    749
    
    
    $
    (17,235
    )
    
    $
    (65
    )
    
    $
    110,853
  5




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Statements of Cash Flows
(Unaudited)
 Potomac InsuranceSpecialty Underwriters'
    
    
    
    Company of IllinoisAlliance, Inc. (Successor)
    
    
    
    (Predecessor)Six Months Ended
    
    
    
    Six Months EndedJune 30,
    
    
    
    June 30,2005
    
    
    2004
    
    
    
    2004(dollars in thousands)Cash flows from operations:Net income (loss)
    
    $
    (8,502
    )
    
    $
    (7,442
    )
    
    
    $
    448Charges (credits) to reconcile net income to cash
flows from operations:Federal income tax expense
    
    
    
    
    
    
    
    
    
    
    
    242Net realized losses
    
    
    1
    
    
    
    
    
    
    
    
    102Amortization of bond discount
    
    
    109
    
    
    
    
    
    
    
    
    Depreciation
    
    
    836
    
    
    
    
    
    
    
    
    Net change in:Reinsurance recoverable on unpaid loss and loss adjustment expense reserves
    
    
    11,655
    
    
    
    
    
    
    
    
    23,507Loss and loss adjustment expense reserves
    
    
    (9,548
    )
    
    
    
    
    
    
    
    (38,516
    )Insurance premiums receivable
    
    
    (25,360
    )
    
    
    
    
    
    
    
    Unearned insurance premiums
    
    
    29,572
    
    
    
    
    
    
    
    
    (4,611
    )Deferred acquisition costs
    
    
    (5,297
    )
    
    
    
    
    
    
    
    674Prepaid reinsurance premiums
    
    
    (3,261
    )
    
    
    
    
    
    
    
    Deferred charges
    
    
    
    
    
    
    4,038Other, net
    
    
    1,960
    
    
    
    2,766
    
    
    
    
    382Net cash flows (used for) provided by operations
    
    
    (7,835
    )
    
    
    (638
    )
    
    
    
    (17,772
    )Cash flows from investing activities:Acquisition deposit
    
    
    
    
    
    
    (500
    )
    
    
    
    Net decrease in short-term investments
    
    
    42,715
    
    
    
    
    
    
    
    
    11,388Sales of fixed maturity investments
    
    
    6,259
    
    
    
    
    
    
    
    
    7,189Redemptions, calls and maturities of fixed maturity investments
    
    
    
    
    
    
    
    
    
    
    
    2,912Purchases of fixed maturity investments
    
    
    (46,480
    )
    
    
    
    
    
    
    
    (13,204
    )Unsettled net investment purchases (sales)
    
    
    (997
    )
    
    
    
    
    
    
    
    (772
    )Purchase of equipment and capitalized software
    
    
    (2,128
    )
    
    
    (231
    )
    
    
    
    Net cash flows (used for) provided by investing activities
    
    
    (631
    )
    
    
    (731
    )
    
    
    
    7,513Cash flows from financing activities:Proceeds from short-term borrowings
    
    
    
    
    
    
    1,200
    
    
    
    
    Issuance of common stock
    
    
    500
    
    
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    500
    
    
    
    1,200
    
    
    
    
    Net (decrease) increase in cash and cash equivalents
during the period
    
    
    (7,966
    )
    
    
    (169
    )
    
    
    
    (10,259
    )Cash and cash equivalents at beginning of the period
    
    
    8,986
    
    
    
    200
    
    
    
    
    10,307Cash and cash equivalents at end of the period
    
    $
    1,020
    
    
    $
    31
    
    
    
    $
    48
  6




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (dollars in thousands)
 Note 1  Basis of Presentation
     7




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (dollars in thousands)
 Note 2. Net Loss Per Share
  Three Months Ended
    
    
    Three Months EndedJune 30, 2005
    
    
    June 30, 2004Net loss, as reported
    
    $
    (4,010
    )
    
    $
    (5,634
    )Average common shares outstanding
(basic and diluted)
    
    
    14,754
    
    
    
    Net Loss Per Share (in dollars)
    
    $
    (0.27
    )
    
    $
    (563,400.00
    )
 Six Months Ended
    
    
    Six Months EndedJune 30, 2005
    
    
    June 30, 2004Net loss, as reported
    
    $
    (8,502
    )
    
    $
    (7,442
    )Average common shares outstanding
(basic and diluted)
    
    
    14,731
    
    
    
    Net Loss Per Share (in dollars)
    
    $
    (0.58
    )
    
    $
    (744,200.00
    )
 Note 3. Income Taxes
  8




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




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (dollars in thousands)
 Note 5. Stock Options
   WeightedAverageExerciseNumber
    
    
    Price PerOption Plan Activity
    
    of Shares
    
    
    ShareBalance at March 31, 2005
    
    
    651,466
    
    
    $
    9.51Options granted
    
    
    80,000
    
    
    
    8.31Options exercised
    
    
    
    
    
    
    Options forfeited
    
    
    (10,000
    )
    
    
    9.00Balance at June 30, 2005
    
    
    721,466
    
    
    
    9.38Options exercisable at June 30, 2005
    
    
    
    
    
    
    
    10




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (dollars in thousands)
 Six Months EndedJune 30, 2005(In thousands of U.S. dollars,except per share amounts)Net income (loss) as reported
    
    $
    (8,502
    )Deduct: Compensation expense
    
    
    (482
    )Pro forma net income (loss)
    
    $
    (8,984
    )Basic earnings (loss) per share:As reported
    
    $
    (0.58
    )Pro forma
    
    $
    (0.61
    )Diluted earnings (loss) per share:As reported
    
    $
    (0.58
    )Pro forma
    
    $
    (0.61
    )
  Note 6. Intangible Assets
  11




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (dollars 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 Three and Six Months Ended June 30, 2005 and Three and Six Months Ended June
30, 2004
     14




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15




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Liquidity and Capital Resources
        16




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Recent Accounting Pronouncements
  17




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Item 3: Quantitative and Qualitative Disclosures About Market Risk
  Interest Rate Risk
   Estimated
    
    
    After TaxAssumed Change
    
    
    Fair Value After
    
    
    IncreaseFair Value
    
    
    in Relevant
    
    
    Change in
    
    
    (Decrease)dollars in thousands
    
    at 6/30/05
    
    
    Interest Rate
    
    
    Interest Rate
    
    
    in Carrying ValueTotal Investments
    
    $
    95,156
    
    
    100 bp decrease
    
    $
    96,817
    
    
    $
    1,66150 bp decrease
    
    $
    95,492
    
    
    $
    33650 bp increase
    
    $
    92,655
    
    
    $
    (2,501
    )100 bp increase
    
    $
    91,165
    
    
    $
    (3,991
    )
 Credit Risk
   18




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6/30/2005
    
    
    12/31/2004(dollars in thousands)Percent of
    
    
    
    
    
    
    Percent ofMarket Value
    
    
    Portfolio
    
    
    Market Value
    
    
    PortfolioUS Govt & Other Bonds
    
    $
    29,912
    
    
    
    33.1
    %
    
    $
    15,624
    
    
    
    31.0
    %AA Rated
    
    $
    16,194
    
    
    
    17.9
    %
    
    $
    3,917
    
    
    
    8.0
    %A Rated
    
    $
    44,395
    
    
    
    49.1
    %
    
    $
    30,924
    
    
    
    61.0
    %$
    90,501
    
    
    
    100.0
    %
    
    $
    50,465
    
    
    
    100.0
    %
  
 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
  For
    
    AgainstCourtney Smith
Peter Jokiel
Robert Dean
Raymond Groth
Paul Philp
Robert Whitehead
Russell Zimmermann
    
    12,757,071
12,758,801
12,758,801
12,758,801
12,758,801
12,758,801
12,758,801
    
    28,430
26,700
26,700
26,700
26,700
26,700
26,700
  For
    
    Against
    
    Abstention12,758,501
    
    
    400
    
    
    
    26,600
  For
    
    Against
    
    Abstention12,785,501
    
    
    400
    
    
    
    26,600
  20




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Item 5: Other Information
  
 Item 6: Exhibits
  ExhibitNumber
    
    Description10.1.1
    
    Partner Agent Agreement, dated May 11, 2005, between the
Registrant and Specialty Risk Solutions, LLC.10.1.2
    
    Securities Purchase Agreement, dated May 11, 2005 between the
Registrant and Specialty Risk Solutions, LLC.31.1
    
    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
 21




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SPECIALTY UNDERWRITERS ALLIANCE, INC.(Registrant)Dated: August 12, 2005
    
    By: /s/ Courtney C. SmithName: Courtney C. SmithTitle: President and Chief Executive OfficerDated: August 12, 2005
    
    By: /s/ Peter E. JokielName: Peter E. JokielTitle: Executive Vice President, Chief FinancialOfficer and Treasurer
 22




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##### Table of Contents



ExhibitNumber
    
    Description10.1.1
    
    Partner Agent Agreement, dated May 11, 2005, between the
Registrant and Specialty Risk Solutions, LLC.10.1.2
    
    Securities Purchase Agreement, dated May 11, 2005 between the
Registrant and Specialty Risk Solutions, LLC.31.1
    
    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
 23