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.
<PAGE>
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
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
June 30 December 31
ASSETS 1998 1997
(Unaudited)
<S> <C> <C>
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
<PAGE>
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
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
<S> <C> <C> <C> <C>
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
<PAGE>
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
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
Six Months Ended
June 30
1998 1997
<S> <C> <C>
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
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
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.
<PAGE>
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
<PAGE>
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.
<PAGE>
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
<PAGE>
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,
<PAGE>
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
<PAGE>
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
<PAGE>
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.
<PAGE>
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.
<PAGE>
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)
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
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.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> $
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 0
<DEBT-CARRYING-VALUE> 4,246,047
<DEBT-MARKET-VALUE> 11,322,544
<EQUITIES> 152,169
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 11,518,542
<CASH> 4,217,977
<RECOVER-REINSURE> 15,359,564
<DEFERRED-ACQUISITION> 888,398
<TOTAL-ASSETS> 59,240,919
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 11,416,720
<POLICY-OTHER> 2,177,465
<POLICY-HOLDER-FUNDS> 6,841,504
<NOTES-PAYABLE> 8,878,573
0
0
<COMMON> 328,898
<OTHER-SE> 10,954,490
<TOTAL-LIABILITY-AND-EQUITY> 59,240,919
6,605,315
<INVESTMENT-INCOME> 389,599
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 2,096,654
<BENEFITS> 4,112,087
<UNDERWRITING-AMORTIZATION> (1,784)
<UNDERWRITING-OTHER> 4,318,801
<INCOME-PRETAX> 662,464
<INCOME-TAX> 260,439
<INCOME-CONTINUING> 402,025
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 402,025
<EPS-PRIMARY> 0.04
<EPS-DILUTED> 0.04
<RESERVE-OPEN> 17,732,289
<PROVISION-CURRENT> 13,174,285
<PROVISION-PRIOR> 254,783
<PAYMENTS-CURRENT> (6,381,046)
<PAYMENTS-PRIOR> (8,216,091)
<RESERVE-CLOSE> 16,564,220
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
