-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UQbrPsegPH0Ubj6wmeVlxyTb/eOig458kiPN2w9RSWrKMouipXwS/a8tfMWnS1Fs 1W4fhLio0ioLU/YyN11ntw== 0000819913-98-000012.txt : 19980814 0000819913-98-000012.hdr.sgml : 19980814 ACCESSION NUMBER: 0000819913-98-000012 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980813 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: HALLMARK FINANCIAL SERVICES INC CENTRAL INDEX KEY: 0000819913 STANDARD INDUSTRIAL CLASSIFICATION: INSURANCE CARRIERS, NEC [6399] IRS NUMBER: 870447375 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: SEC FILE NUMBER: 000-16090 FILM NUMBER: 98684329 BUSINESS ADDRESS: STREET 1: 14651 DALLAS PKWY STE 900 CITY: DALLAS STATE: TX ZIP: 75240 BUSINESS PHONE: 2149342400X118 MAIL ADDRESS: STREET 1: 14651 DALLAS PKWY STREET 2: STE 900 CITY: DALLAS STATE: TX ZIP: 75240 FORMER COMPANY: FORMER CONFORMED NAME: ACOI INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: AMERICAN CREDIT OPTICAL INC /DE/ DATE OF NAME CHANGE: 19910611 FORMER COMPANY: FORMER CONFORMED NAME: PYRAMID GROWTH INC DATE OF NAME CHANGE: 19890124 10QSB 1 CONFORMED COPY SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 1998 Commission file number 0-16090 Hallmark Financial Services, Inc. (Exact name of small business issuer as specified in its charter) Nevada 87-044737 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 14651 Dallas Parkway, Suite 900 Dallas, Texas 75240 (Address of principal executive offices) (Zip Code) Issuer's telephone number, including area code: (972) 404-1637 Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 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 APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: Common Stock, par value $.03 per share - 10,663,277 shares outstanding as of August 7, 1998. PART I FINANCIAL INFORMATION Item 1. Financial Statements INDEX TO FINANCIAL STATEMENTS Page Number Consolidated Balance Sheets at June 30, 1998 (unaudited) and December 31, 1997 3 Consolidated Statements of Income (unaudited) for the three and six months ended June 30, 1998 and June 30, 1997 4 Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 1998 and June 30, 1997 5 Notes to Consolidated Financial Statements (unaudited) 6 HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS June 30 December 31 ASSETS 1998 1997 (Unaudited) Investments: Debt securities, held-to-maturity, at amortized cost $ 4,246,047 $4,966,141 Equity securities, available-for-sale, at market value 152,169 152,359 Short-term investments, at cost which approximates market value 7,120,326 2,970,838 Total investments 11,518,542 8,089,338 Cash and cash equivalents 4,217,977 5,814,127 Restricted cash 1,372,137 1,340,937 Prepaid reinsurance premiums 7,952,952 8,414,250 Premium finance notes receivable (net of allowance for doubtful accounts 8,625,552 7,878,758 of $119,978 in 1998 and $83,788 in 1997) Premiums receivable 966,325 844,140 Note receivable - 1,149,280 Reinsurance recoverable 15,359,564 16,549,352 Deferred policy acquisition costs 2,967,447 3,143,378 Excess of cost over net assets acquired (net of accumulated amortization of $1,249,557 in 1998 and $1,171,050 in 1997) 4,980,656 5,059,164 Current federal income tax recoverable 227,848 639,216 Deferred federal income taxes 118,467 67,539 Accrued investment income 40,141 42,780 Other assets 893,311 788,232 $ 59,240,919 $59,820,491 LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Notes payable $ 8,878,573 $ 8,157,297 Unpaid losses and loss adjustment expenses 16,564,220 17,732,289 Unearned premiums 11,416,720 11,603,482 Reinsurance balances payable 2,177,465 2,960,040 Deferred ceding commissions 2,079,049 2,256,669 Drafts outstanding 715,962 721,413 Accrued ceding commission refund 2,022,158 1,623,395 Accounts payable and other accrued expenses 3,153,384 2,934,793 Accrued litigation costs 950,000 950,000 Total liabilities 47,957,531 48,939,378 Commitments and contingencies (Note 4) Stockholders' equity: Common stock, $.03 par value, authorized 100,000,000 shares; issued 10,963,277 shares in 1998 and 10,962,277 shares in 1997 328,898 328,868 Capital in excess of par value 10,349,885 10,349,665 Retained earnings 1,204,605 802,580 Treasury stock, 300,000 shares, at cost (600,000) (600,000) Total stockholders' equity 11,283,388 10,881,113 $ 59,240,919 $59,820,491
The accompanying notes are an integral part of the consolidated financial statements. HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended Six Months Ended June 30 June 30 1998 1997 1998 1997 Gross premiums written $ 8,399,198 $ 9,667,920 $20,157,639 $20,808,399 Ceded premiums written (5,346,653) ( 6,748,087) (13,277,787) (14,594,550) Net premiums written $ 3,052,545 $ 2,919,833 $ 6,879,852 $ 6,213,849 Revenues: Gross premiums earned $10,007,858 $10,399,017 $20,344,400 $20,579,531 Earned premiums ceded ( 6,707,611) ( 7,333,943) (13,739,085) (14,534,915) Net premiums earned 3,300,247 3,065,074 6,605,315 6,044,616 Investment income, net of expenses 204,313 214,725 389,599 399,280 Finance charges 504,888 8,243 1,124,056 10,670 Interest income - note receivable 865 157,791 14,047 190,245 Processing and service fees 446,065 482,560 743,742 896,267 Other income 125,607 110,648 214,809 174,300 Total revenues 4,581,985 4,039,041 9,091,568 7,715,378 Benefits, losses and expenses: Losses and loss adjustment expenses 6,462,235 7,029,042 13,514,670 13,705,765 Reinsurance recoveries (4,344,154) (5,125,120) (9,402,583) (10,163,994) Net losses and loss adjustment expenses 2,118,081 1,903,922 4,112,087 3,541,771 Acquisition costs, net 127,803 (213,692) (1,784) (493,003) Other acquisition and underwriting expenses 1,170,645 1,476,469 2,639,722 2,817,280 Operating expenses 733,925 385,349 1,192,487 864,127 Interest expense 196,487 173,745 381,335 217,808 Amortization of intangible assets 57,085 61,887 105,257 105,257 Total benefits, losses and expenses 4,404,026 3,787,680 8,429,104 7,053,240 Income from operations before federal income taxes 177,959 251,361 662,464 662,138 Federal income tax expense 77,788 127,792 260,439 232,655 Net income 100,171 123,569 402,025 429,483 Other comprehensive income, net of tax: Unrealized gains on debt and equity securities 137 366 2,099 1,082 Comprehensive income $ 100,308 $ 123,935 $ 404,124 $ 430,565 Basic and diluted earnings per share $ 0.01 $ 0.01 $ 0.04 $ 0.04
The accompanying notes are an integral part of the consolidated financial statements. HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 30 1998 1997 Cash flows from operating activities: Net income $ 402,025 $ 429,483 Adjustments to reconcile net income to cash provided by (used in) operating activities: Depreciation and amortization expense 203,692 190,502 Change in deferred federal income taxes (50,928) 133,362 Change in prepaid reinsurance premiums 461,298 (59,635) Change in premiums receivable (122,185) (191,250) Change in deferred policy acquisition costs 175,931 (349,404) Change in deferred ceding commissions (177,620) (143,599) Change in unpaid losses and loss adjustment expenses (1,168,069) (3,137,992) Change in unearned premiums (186,762) 228,868 Change in reinsurance recoverable 1,189,788 2,856,967 Change in reinsurance balances payable (782,575) 35,677 Change in current federal income tax recoverable 411,368 - Change in accrued ceding commission refund 398,763 306,567 Change in all other liabilities 213,139 286,089 Change in all other assets (174,433) 80,309 Net cash provided by operating activities 793,432 665,944 Cash flows from investing activities: Purchases of property and equipment ( 53,242) ( 44,537) Premium finance notes originated (15,882,308) - Premium finance notes repaid 15,135,565 - Purchase of note receivable - (6,513,156) Repayment of note receivable 1,149,280 - Change in restricted cash (31,200) - Maturities and redemptions of investment securities 720,285 1,159,661 Purchase of short-term investments (6,686,488) (3,013,345) Maturities of short-term investments 2,537,000 5,145,873 Net cash used in investing activities (3,111,108) (3,265,504) Cash flows from financing activities: Proceeds from common stock issued 250 - Proceeds from notes payable/bank credit line 750,000 7,000,000 Repayment of short-term borrowings (28,724) (26,002) Payment of borrowing cost - (90,701) Cash provided by financing activities 721,526 6,883,297 (Decrease) Increase in cash and cash equivalents (1,596,150) 4,283,737 Cash and cash equivalents at beginning of period 5,814,127 4,749,388 Cash and cash equivalents at end of period $4,217,977 $9,033,125
The accompanying notes are an integral part of the consolidated financial statements. HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES Item 1. Notes to Consolidated Financial Statements (Unaudited). Note 1 - Summary of Accounting Policies In the opinion of management, the accompanying consolidated financial statements contain all adjustments, consisting primarily of normal recurring adjustments, necessary to present fairly the financial position of Hallmark Financial Services, Inc. and subsidiaries (the "Company") as of June 30, 1998 and the consolidated results of operations and cash flows for the periods presented. The accompanying financial statements have been prepared by the Company without audit. Certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles ("GAAP") have been condensed or omitted. Reference is made to the Company's annual consolidated financial statements for the year ended December 31, 1997 for a description of accounting policies and certain other disclosures. Certain items in the 1997 interim financial statements have been reclassified to conform to the 1998 presentation. The results of operations for the period ended June 30, 1998 are not necessarily indicative of the operating results to be expected for the full year. Recently Adopted Accounting Pronouncement The Company has adopted SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. New Accounting Pronouncement In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for reporting information about operating segments in annual financial statements and requires reporting of selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS No. 131 is effective for financial statement periods beginning after December 15, 1997. However, the requirements of SFAS No. 131 are not applicable in interim financial statements in the initial year of adoption. Management does not anticipate that this pronouncement will have a material effect on the Company's consolidated financial condition or results of operations. Note 2 - Note Receivable During 1997, approximately $6,500,000 in proceeds from a $7,000,000 loan from Dorinco Reinsurance Company ("Dorinco") was used to repay external borrowing by Peregrine Premium Finance L.C. ("Peregrine") incurred to fund premium finance notes pursuant to the financing and servicing arrangement between the Company and Peregrine. As of June 30, 1998, this note receivable has been repaid. Note 3 - Reinsurance The Company is involved in the assumption and cession of reinsurance from/to other companies. The Company remains obligated to its policyholders in the event that reinsurers do not meet their obligations under the reinsurance agreements. Effective March 1, 1992, the Company entered into a reinsurance arrangement with State & County Mutual Fire Insurance Company ("State & County"), an unaffiliated company, to assume 100% of the nonstandard auto business produced by the Company and underwritten by State & County. The arrangement is supplemented by a separate retrocession agreement effective July 1, 1997 between the Company, Kemper Reinsurance Company ("Kemper") and Dorinco. From July 1, 1996 to June 30, 1997, the Company supplemented this arrangement with a separate retrocession agreement with Kemper, Dorinco and Odyssey Reinsurance Corporation. Prior to July 1, 1996, the Company had a separate retrocession agreement with Vesta Fire Insurance Corporation. Under each of the agreements, the Company retains 25% and cedes 75% of the risk to the reinsurers. Note 4 - Commitments and Contingencies In March 1997, a jury returned a verdict against the Company and in favor of a former director and officer of the Company in the amount of approximately $517,000 on the basis of contractual and statutory indemnification claims. The court subsequently granted the plaintiff s motion for attorneys fees of approximately $271,000, court costs of approximately $39,000 and pre-judgment and post-judgment interest, and rendered final judgment on the verdict. The Company believes the outcome in this case was both legally and factually incorrect and has appealed the judgment. During the fourth quarter of 1997, the Company deposited $1,248,758 into the registry of the court in order to stay execution on the judgment pending the result of such appeal. The amount on deposit with the court of $1,295,158 as of June 30, 1998 has been included as restricted cash in the accompanying balance sheet. Although the Company intends to aggressively pursue its appeal, the Company is presently unable to determine the likelihood of a favorable result. Further, a favorable ruling on some portions of the appeal could entail the necessity for a new trial. Therefore, the Company established a reserve of $950,000 during the fourth quarter of 1997 for loss contingencies related to this case. This reserve remains unchanged as of June 30, 1998. The possible range of loss in the event of an ultimately unfavorable outcome to this case exceeds the amount presently reserved. Conversely, in the event of a favorable resolution of the case, the expenses incurred could be less than the reserve amount. Therefore, future adjustments to the reserve may be required. Item 2. Management's Discussion and Analysis or Plan of Operation. Introduction. Hallmark Financial Services, Inc. ("HFS") and its wholly owned subsidiaries (collectively referred to herein as the "Company") engage in the sale of insurance products on credit terms, primarily to lower and middle income customers. Its target market encompasses the substantial number of Americans who either are denied credit from banks, credit card companies and other conventional credit sources, or have never established a bank account or credit history. Currently, the Company's business primarily involves marketing, underwriting and premium financing of non-standard automobile insurance. Additionally, the Company provides fee-based claims adjusting and related services for affiliates and third parties. The Company conducts these activities through an integrated insurance group, the dominant members of which are a property and casualty insurance company, American Hallmark Insurance Company of Texas ("Hallmark"); a managing general agency, American Hallmark General Agency, Inc. ("AHGA"); a network of affiliated insurance agencies known as the American Hallmark Agencies ("Hallmark Agencies"); a premium finance company, Hallmark Finance Corporation ("HFC"); and a claims handling and adjustment firm, Hallmark Claims Service, Inc. ("HCS"). The Company operates only in Texas. Hallmark provides non-standard automobile liability and physical damage insurance through reinsurance arrangements with several unaffiliated companies. Through arrangements with State & County Mutual Fire Insurance Company ("State & County"), Hallmark provides insurance primarily for high risk drivers who do not qualify for standard-rate insurance. Under supplementary quota-share reinsurance agreements, Hallmark cedes a substantial portion of its risk and retains the balance. Effective July 1, 1996, Hallmark entered into a new reinsurance treaty with Kemper Reinsurance Company ("Kemper"), Dorinco Reinsurance Company ("Dorinco"), and Odyssey Reinsurance Corporation ("Odyssey"), ceding a total of 75% of its risk. Effective July 1, 1997, the treaty was renewed with Kemper and Dorinco assuming a total of 75% of the risk under substantially the same terms and conditions, except that Hallmark was allowed to retain 100% of the policy fees on a six-month program commenced during late-July 1997 (versus 62.5% for monthly and annual programs). Previously, HFC offered premium financing to Hallmark policyholders through a financing and servicing arrangement with an unaffiliated premium finance company. Beginning late-June 1997, HFC began issuing its own premium finance notes funded by the proceeds of loan agreements executed in March 1997. AHGA manages the marketing of Hallmark policies through a network of retail insurance agencies which operate under the American Hallmark Agencies name, and through independent agents operating under their own respective names. Financial Condition and Liquidity The Company's sources of funds are principally derived from insurance related operations. Major sources of funds from operations include premiums collected (net of policy cancellations and premiums ceded), ceding commissions, finance charges and third party processing and service fees. Other sources of funds are from financing and investment activities. While net cash from the Company's consolidated operating and investing activities remained relatively constant, cash provided by financing activities decreased significantly during the six months ended June 30, 1998 compared to the six months ended June 30, 1997. Cash generated from 1998 financing activities was considerably lower due to a $7 million financing transaction with Dorinco in 1997 with no comparable financing activity in 1998. The Company used approximately $6.5 million of the Dorinco loan proceeds to repay external borrowing by Peregrine Premium Finance L.C. ("Peregrine"), an unaffiliated premium finance company (See Note 2 to the Consolidated Financial Statements). Prior to June 1997, the Company offered premium financing to policyholders through a financing and servicing arrangement with Peregrine. Effective late-June 1997, the Company began issuing its own premium finance notes through HFC. On a consolidated basis, the Company's liquidity increased approximately $1.8 million during the first six months of 1998. The Company's total cash, cash equivalents and investments (excluding restricted cash of approximately $1.4 million) at June 30, 1998 and December 31, 1997 were $15.7 million and $13.9 million respectively. This increased liquidity is primarily due to higher core State & County premium volumes during the first quarter of 1998 compared to the fourth quarter of 1997. The increase in core State & County premium volumes impacts liquidity since Hallmark receives from its reinsurers a 30% provisional ceding commission on core premium volumes ceded to reinsurers. Reinsurance treaty terms provide for an adjustment to the provisional ceding commission based upon loss experience 60 days following the end of two years for the first treaty year and annually thereafter. As of August 30, 1998, the first ceding commission adjustment for the first and second treaty years ended June 30, 1997 and 1998, respectively, will occur. As anticipated, an accrued ceding commission refund of approximately $2 million as of June 30, 1998 will be paid by Hallmark to the reinsurers by August 30, 1998 based upon an adjusted commission of 26.3%. A substantial portion of the Company's liquid assets are held by Hallmark and are not available for general corporate purposes. Of the Company's consolidated liquid assets of $15.7 million at June 30, 1998, $1.7 million (as compared to $1.5 million at December 31, 1997) represents non-restricted cash. Since state insurance regulations restrict financial transactions between an insurance company and its affiliates, HFS is limited in its ability to use Hallmark funds for its own working capital purposes. Furthermore, dividends and loans by Hallmark to the Company are restricted and subject to Texas Department of Insurance ("TDI") approval. However, TDI has sanctioned the payment of management fees, commissions and claims handling fees by Hallmark to HFS and affiliates. During the first six months of 1998 and 1997, Hallmark paid or accrued $350,000 and $400,000, respectively, in management fees. Management anticipates that Hallmark will continue to pay management fees periodically during the remainder of 1998, and this should continue to be a moderate source of unrestricted liquidity. Management is committed to maintaining the surplus strength of Hallmark and has no current plans to pay any dividends from Hallmark to the Company. Commissions from the Company's annual policy program for independent agents represent a source of unrestricted liquidity. Under this program, AHGA offers independent agents the ability to write annual policies and, since mid-1997, six-month policies, but commissions to substantially all independent agents are paid monthly on an earned basis. However, consistent with customary industry practice, Hallmark pays total commissions up-front to AHGA based on the entire annual/six-months premiums written. Independent agent production of annual policies was approximately $7.7 million during the first six months of 1998 as compared to $8.0 million during the first six months of 1997. During the first six months of 1998, AHGA received $1.8 million in commissions related to this program from Hallmark, and will pay earned commissions of $1.6 million to independent agents. During 1997, AHGA received approximately $3.0 million in commissions related to this annual policy program from Hallmark, of which $1.1 million is being paid to independent agents during 1998 as earned. Ceding commission income represents a significant source of funds to the Company. A portion of ceding commission income and policy acquisition costs is deferred and recognized as income and expense, respectively, as related net premiums are earned. Deferred ceding commission income decreased to approximately $2.1 million at June 30, 1998 from approximately $2.3 million at December 31, 1997. Deferred policy acquisition costs as of June 30, 1998 decreased approximately $0.2 million as compared to December 31, 1997. The decrease in deferred ceding commission income and deferred policy acquisition costs is primarily due to the decrease in Hallmark s core premium volume during the second quarter of 1998. During the second quarter of 1998, the Company received an advance of approximately $0.8 million from a bank credit line. As of June 30, 1998, the Company had not entered into any new debt agreements, and was in compliance with all debt covenants of the bank credit line and the Dorinco loan. The Company anticipates renewing the bank credit line upon its expiration in September 1998. Unpaid losses and loss adjustment expenses ("LAE") decreased approximately 7% primarily due to a continuation of a trend begun in 1996 of settling more claims than received, thus reducing the number of claims included in unpaid losses and LAE. Accordingly, reinsurance recoverables decreased proportionately. Reinsurance balances payable represents premiums written which are due to reinsurers. These balances are paid on a 60 day lag in accordance with reinsurance treaties. The decrease in the reinsurance balances payable is due to the decreased premium volume during the second quarter of 1998 as compared to the fourth quarter of 1997. At June 30, 1998, Hallmark reported statutory capital and surplus of approximately $5.6 million which reflects an increase over the balance reported at December 31, 1997. On an annualized-premium basis, Hallmark's premium-to-surplus ratio at June 30, 1998 was 2.47 to 1 as compared to 2.35 to 1 at December 31, 1997 and 2.27 to 1 at June 30, 1997. Management does not presently expect Hallmark to require additional capital during 1998 to fund existing operations. However, while programs currently in place should provide sufficient capital for near-term growth, additional capital or strategic alliances may be required to fund future expansion of the Company. Liquidity was positively impacted by increased core State & County volumes during the first quarter of 1998. Management has continued to focus on the performance of the Company's core State & County business with emphasis on claims operations, marketing and product enhancements. The Company has continued initiatives begun in 1997 and has offered a new 1998 Awards program to stimulate production by independent agents. However, intense competition among an increased number of non-standard programs in the marketplace, as well as competitive premium pricing and payment terms, has negatively impacted premium volumes, and in turn, liquidity during the second quarter of 1998. Effective late-July 1998, the Company is rolling out a new annual program which, among other things, offers a lower down payment. The lower down payment is primarily due to a change in treatment of the policy fee. The new program will provide for financing of a higher policy fee with collection over the policy term while the previous annual program provided for the collection of the entire, although lower, policy fee up-front along with the down payment. This annual program change significantly improves the Company's competitive ranking with respect to down payment in all territories. Management expects core State & County premium volumes, and ultimately, liquidity to be favorably impacted by this change. However, in the near-term, earnings and liquidity could be negatively affected due to the proration and collection of the policy fee over the policy term as compared to the collection of a fully earned policy fee under the previous annual program. Other factors favorably impacting liquidity include the anticipated receipt of a tax refund of approximately $500,000 during the third quarter of 1998, continued emphasis on cost containment, and reduced borrowing costs for the Company's premium finance program. As of June 30, 1998, the Company has $6.25 million available under the bank credit line to fund premium finance notes. The Company continues to pursue third party claims handling and administrative contracts. The Company continues to provide its program administration and claims handling services under a contract effective January 1, 1997 with an unaffiliated managing general agency (the "unaffiliated MGA"). Under this three-year contract, the Company, as program administrator, performs certain administrative functions, including but not limited to, cash management, underwriting and rate-setting reviews, and claims handling. Hallmark is assuming a 20% pro-rata share in the business produced under this unaffiliated MGA's program with the remaining 80% of the business assumed by Hallmark s principal reinsurers. The related premium volume will be considered as part of Hallmark's premium volume commitments to its principal reinsurers. Additionally, an agreement with another unaffiliated MGA began April 1, 1998 with the Company providing not only program administration and claims handling, but also, underwriting and policy processing. Under this program, Hallmark assumes a 25% pro-rata share in the business produced with Hallmark's principal reinsurers assuming the remainder. The Company has entered into a new agreement with another unaffiliated MGA to begin approximately October 1, 1998. The Company will again be providing program administration, claims handling and underwriting and policy processing. Hallmark will assume 15% of the business produced. Management intends to continue to investigate opportunities for future growth and expansion. Although the Company currently has no plans which would require significant additional external funding during 1998, additional capital or strategic alliances may be required to fund future expansion of the Company. Results of Operations Gross premiums written (prior to reinsurance) for the three and six months ended June 30, 1998 decreased 13% and 3%, respectively, in relation to gross premiums written during the same periods in 1997. The respective decreases in gross premiums written were primarily due to changing market conditions in the non-standard industry which have adversely impacted premium volumes during the second quarter of 1998. Net premiums written (after reinsurance) for the three and six months ended June 30, 1998 increased approximately 4% and 11%, respectively, during the same periods in 1997. The increase in net premiums written is due to the assumption of business produced by third party unaffiliated MGAs. Effective July 1, 1997, Hallmark increased its assumption of the business produced by a third party unaffiliated MGA to 20% from 10% (for the period January 1, 1997 through June 30, 1997), and effective April 1, 1998, Hallmark began assuming 25% of the business produced by another unaffiliated MGA. The disparate change in gross and net premiums written results from the fact that the assumed unaffiliated MGA business included in gross written premiums is not reinsured, thus intensifying the effect on net written premiums. Premiums earned (prior to reinsurance) for the three and six months ended June 30, 1998 decreased slightly as compared to the same periods of 1997. For the three and six months ended June 30, 1998, net premiums earned (after reinsurance) increased approximately 8% and 9%, respectively, in relation to the same periods of 1997. The disproportionate change in premiums earned (prior to and after reinsurance) is due to the assumption of premiums from the unaffiliated MGA's which is not reinsured, and thus the impact on net premiums earned is greater. Net incurred loss ratios (computed on net premiums earned after reinsurance) for the three and six months ended June 30, 1998 were 64% and 62%, respectively, compared to 62% and 59% for the same respective periods of 1997. The increase in the loss ratio between 1998 and 1997, is primarily attributable to changes in the estimate of Incurred But Not Reported reserves during the fourth quarter of 1997. To a lesser extent, the increase is also due to the change in the assumption of the unaffiliated MGA's business to 20% and Hallmark's 25% assumption of the business produced by another unaffiliated MGA effective April 1, 1998. Acquisition costs, net represents the amortization of acquisition costs (and credits) deferred over the past twelve months and the deferral of acquisition costs (and credits) incurred in the current period. The increased amortization expense (acquisition costs, net) during the three and six months ended June 30, 1998 is primarily due to the deferral of lower acquisition costs in 1998 than in 1997 which is partially offset by a higher deferral rate and lower ceding commission income in 1998 than in 1997. As discussed previously, while net premiums written increased, core State & County premium volumes decreased and accordingly, ceding commission income was down. Other acquisition and underwriting expenses decreased approximately 21% and 6%, respectively, during the three and six months ended June 30, 1998 as compared to the same periods of 1997. This decrease is primarily attributable to decreases in salaries and related benefit expenses, agent commission expense due to lower volumes, and management resources spent on insurance operations. These management resources have been focused on developing the third party processing and program administration business and are reallocated to operating expenses (as discussed in the following paragraph). These decreases are partially offset by an increase in commission expenses related to the assumption of business written by third party MGAs. Additionally, ceding commission income decreased during 1998 as a result of a lower ceding commission rate as well as a decrease in the core State & County premium volume. Operating expenses include non-insurance operations expenses which include expenses related to premium finance operations, general corporate overhead, and third party administrative and claims handling contracts. Related revenues are derived from finance charges and service/consulting fees. Operating expenses increased 90% and 38%, respectively, for the three and six months ended June 30, 1998 as compared to the same periods of 1997, while income from finance interest charges and service/consulting fees increased 94% and 106% for the same respective periods. The majority of this increase in operating expenses is attributable to the deployment of management and staff resources devoted to the development, administration and/or processing of third party contracts. Finance charges represent interest earned on premium notes issued by HFC. Prior to June 1997, HFC only directly financed premium notes for the Company's excess and surplus lines subsidiary (the operations of which were discontinued as of December 31, 1997). Beginning late-June 1997, HFC began financing premiums for Hallmark which has resulted in increased finance interest income during 1998. Interest income on the note receivable represents interest received from Peregrine on funds loaned to Peregrine to extinguish its premium finance bank debt. This note receivable was paid in full during the second quarter of 1998. Interest expense on the Dorinco loan and the bank credit line accounts for the significant increase in interest expense during 1998. Processing and service fees for the six months ended June 30, 1998 represents primarily income earned on third party processing and servicing contracts. Processing and service fees for the six months ended June 30, 1997 represents primarily income earned by HFC pursuant to its financing and servicing arrangement with Peregrine. This arrangement was terminated in June 1997 as HFC began issuing its own premium finance notes. As expected, these fees have significantly decreased during 1998 as the premium notes of Peregrine have been paid in full as of June 30, 1998, and thus no processing fees will be received in the future. Service fees in 1998 increased significantly over the same period of 1997 primarily as a result of the Company s service/consulting contracts with third party unaffiliated MGAs. Other income for 1998 increased slightly over the same period of 1997. The increase is primarily attributable to the collection of agency fees by the Hallmark Agencies. The Hallmark Agencies began collecting this fee during the third quarter 1997 as a result of a regulatory change. This increase is partially offset by decreased outside commissions of the Hallmark Agencies due to scheduled office closures in May and June 1998. Risks Associated with Forward-Looking Statements Included in this Form 10-QSB This Form 10-QSB contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created thereby. These statements include the plans and objectives of management for future operations, including plans and objectives relating to future growth of the Company's business activities and availability of funds. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions, regulatory framework, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Form 10-QSB 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. PART II OTHER INFORMATION Item 1. Legal Proceedings. Except for routine litigation incidental to the business of the Company and as described in Note 4 to the Consolidated Financial Statements of the Company, neither the Company, nor any of the properties of the Company was subject to any material pending or threatened legal proceedings as of the date of this report. Item 2. Changes in Securities. None. Item 3. Defaults upon Security Securities. None. Item 4. Submission of Matters to a Vote of Security-Holders. (a) The Company s Annual Meeting of Shareholders was held on May 27, 1998. Of the 10,662,277 shares of common stock of the Company entitled to vote at the meeting, 7,665,886 shares were present in person or by proxy. (b) The following individuals were elected to serve as directors for the Company: Ramon D. Phillips, Linda H. Sleeper, Raymond A. Kilgore, Jack R. Daugherty, Kenneth H. Jones, Jr., Samuel W. Rizzo, A. R. Dike, James H. Graves, George R. Manser and C. Jeffrey Rogers. (c) There was no other business to come before the meeting. Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) No exhibits are filed herewith. (b) The Company did not file a Current Report on Form 8-K to report any events which occurred during the quarter ended June 30, 1998. SIGNATURES In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duty authorized. HALLMARK FINANCIAL SERVICES, INC. (Registrant) Date: August 12, 1998 /s/ Ramon D. Phillips Ramon D. Phillips, President (Chief Executive Officer) Date: August 12, 1998 /s/ John J. DePuma John J. DePuma, (Chief Financial Officer) EX-27 2
7 Due to format constraints of this Financial Data Schedule (FDS) certain Balance Sheet items were omitted: i.e. Prepaid reinsurance premiums, Premium notes receivable, Installment premiums receivable, Excess of cost over net assets acquired and Other assets. Refer to actual 10QSB submis- sion. 1 $ 6-MOS DEC-31-1998 JAN-01-1998 JUN-30-1998 1 0 4,246,047 11,322,544 152,169 0 0 11,518,542 4,217,977 15,359,564 888,398 59,240,919 0 11,416,720 2,177,465 6,841,504 8,878,573 0 0 328,898 10,954,490 59,240,919 6,605,315 389,599 0 2,096,654 4,112,087 (1,784) 4,318,801 662,464 260,439 402,025 0 0 0 402,025 0.04 0.04 17,732,289 13,174,285 254,783 (6,381,046) (8,216,091) 16,564,220 0
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