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 March 31, 1999
Commission file number 0-16090
Hallmark Financial Services, Inc.
(Exact name of small business issuer as specified in its charter)
Nevada 87-0447375
(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
3 cents per share - 11,048,133 shares outstanding as of May 10, 1999.
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Page Number
Consolidated Balance Sheets at March 31, 1999
(unaudited) and December 31, 1998 3
Consolidated Statements of Income (unaudited)
for the three months ended March 31, 1999
and March 31, 1998 4
Consolidated Statements of Cash Flows (unaudited)
for the three months ended March 31, 1999 and
March 31, 1998 5
Notes to Consolidated Financial Statements (unaudited) 6
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
March 31 December 31
ASSETS 1999 1998
(Unaudited)
<S> <C> <C>
Investments:
Debt securities, held-to-maturity,
at amortized cost $ 3,249,520 $ 4,444,606
Equity securities, available-for-sale,
at market value 149,860 151,375
Short-term investments, at cost which
approximates market value 6,982,442 3,256,879
Total investments 10,381,822 7,852,860
Cash and cash equivalents 5,532,759 6,776,274
Restricted cash 1,782,927 1,768,927
Prepaid reinsurance premiums 6,413,836 5,110,204
Premium finance notes receivable
(net of allowance for doubtful accounts 6,988,362 5,287,945
of $101,476 in 1999 and $52,119 in 1998)
Premiums receivable 1,158,442 1,048,689
Reinsurance recoverable 13,528,523 13,900,496
Deferred policy acquisition costs 2,717,571 2,088,902
Excess of cost over net assets acquired
(net of accumulated amortization of
$1,367,319 in 1999 and $1,328,065 in 1998) 4,862,895 4,902,149
Current federal income tax recoverable - 150,031
Deferred federal income taxes 57,286 43,636
Accrued investment income 32,878 68,042
Other assets 585,625 622,798
$ 54,042,926 $ 49,620,953
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes payable $ 7,082,714 $ 7,098,383
Unpaid losses and loss adjustment expenses 15,698,479 16,014,569
Unearned premiums 10,139,584 7,733,624
Reinsurance balances payable 3,136,392 2,097,564
Deferred ceding commissions 1,703,346 1,349,142
Drafts outstanding 685,519 739,817
Accrued ceding commission refund 961,403 744,686
Current federal income taxes payable 153,405 -
Accounts payable and other accrued expenses 2,292,854 1,958,920
Accrued litigation costs 950,000 950,000
Total liabilities 42,803,696 38,686,705
<PAGE>
Commitments and contingencies (Note 4)
Stockholders' equity:
Common stock, $.03 par value, authorized
100,000,000 shares; issued 11,854,610
shares in 1999 and 1998 355,638 355,638
Capital in excess of par value 10,875,212 10,875,212
Retained earnings 1,061,716 755,994
Accumulated other comprehensive income (10,169) (9,429)
Treasury stock, 806,477 shares, at cost (1,043,167) (1,043,167)
Total stockholders' equity 11,239,230 10,934,248
$ 54,042,926 $ 49,620,953
</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
March 31
1999 1998
<S> <C> <C>
Gross premiums written $ 10,165,693 $ 11,758,440
Ceded premiums written ( 5,970,307) ( 7,931,134)
Net premiums written $ 4,195,386 $ 3,827,306
Revenues:
Gross premiums earned $ 7,759,732 $ 10,336,542
Earned premiums ceded ( 4,666,676) ( 7,031,474)
Net premiums earned 3,093,056 3,305,068
Investment income, net of expenses 173,557 185,286
Finance charges 437,721 619,168
Interest income - note receivable - 13,182
Processing and service fees 463,950 297,677
Other income 101,963 89,202
Total revenues 4,270,247 4,509,583
Benefits, losses and expenses:
Losses and loss adjustment expenses 5,256,731 7,052,435
Reinsurance recoveries (3,436,200) (5,058,430)
Net losses and loss adjustment expenses 1,820,531 1,994,005
Acquisition costs, net (274,466) (129,587)
Other acquisition and underwriting expenses 1,332,601 1,474,657
Operating expenses 709,492 452,983
Interest expense 146,947 184,848
Amortization of intangible assets 39,255 48,172
Total benefits, losses and expenses 3,774,360 4,025,078
Income from operations before federal
income taxes 495,887 484,505
Federal income tax expense 190,165 182,651
Net income $ 305,722 $ 301,854
Basic and diluted earnings per share $ 0.03 $ 0.03
</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>
Three Months Ended
March 31
1999 1998
<S> <C> <C>
Cash flows from operating activities:
Net income $ 305,722 $ 301,854
Adjustments to reconcile net income
to cash provided by (used in)
operating activities:
Depreciation and amortization expense 79,807 97,649
Change in deferred federal income taxes (13,650) 24,187
Change in prepaid reinsurance premiums (1,303,632) (899,660)
Change in premiums receivable (109,753) (193,731)
Change in deferred policy acquisition
costs (628,669) (317,908)
Change in deferred ceding commissions 354,204 188,417
Change in unpaid losses and loss
adjustment expenses (316,090) (616,583)
Change in unearned premiums 2,405,960 1,421,898
Change in reinsurance recoverable 371,973 242,237
Change in reinsurance balances payable 1,038,828 821,203
Change in current federal income tax
recoverable 150,031 200,000
Change in current federal income tax
payable 153,405 -
Change in accrued ceding commission
refund 216,717 322,787
Change in all other liabilities 279,633 791,294
Change in all other assets (52,792) (181,771)
Net cash provided by operating
activities 2,931,694 2,201,873
Cash flows from investing activities:
Purchases of property and equipment (5,883) (30,285)
Premium finance notes originated (6,756,533) (9,639,391)
Premium finance notes repaid 5,188,928 7,649,034
Repayment of note receivable - 1,091,744
Change in restricted cash (14,000) (15,600)
Maturities and redemptions of
investment securities 1,181,473 163,810
Purchase of short-term investments (5,425,562) (3,671,797)
Maturities of short-term investments 1,700,000 1,537,000
Net cash used in investing activities (4,131,577) (2,915,485)
Cash flows from financing activities:
Repayment of short-term borrowings ( 43,632) ( 14,183)
Cash used in financing activities ( 43,632) ( 14,183)
<PAGE>
Decrease in cash and cash equivalents (1,243,515) ( 727,795)
Cash and cash equivalents at
beginning of period 6,776,274 5,814,127
Cash and cash equivalents at end
of period $ 5,532,759 $ 5,086,332
</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
March 31, 1999 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, 1998 for a description of accounting policies and certain
other disclosures. Certain items in the 1998 interim financial statements
have been reclassified to conform to the 1999 presentation.
The results of operations for the period ended March 31, 1999 are not
necessarily indicative of the operating results to be expected for the full
year.
Note 2 - 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 Reinsurance Company ("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 3 - 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
<PAGE>
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
(including interest) with the court of $1,331,457 as of March 31, 1999 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
March 31, 1999. 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.
Note 4 - Subsequent Events
On January 25, 1999, the Company executed a letter of intent with
Onyx Insurance Group, Inc. ("Onyx") calling for Onyx to acquire a majority
stake in Hallmark in return for an approximately $8 million equity
investment. The completion of the proposed transaction was subject to the
execution of definitive agreements, shareholder and regulatory approval and
other customary conditions. On May 4, 1999, the Company terminated the
letter of intent with Onyx due to the inability of the parties to negotiate
a definitive agreement in a timely manner.
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 property and casualty insurance products.
The Company's business primarily involves marketing, underwriting and
premium financing of non-standard automobile insurance, as well as claims
adjusting and other insurance related services.
The Company pursues its business activities through an integrated
insurance group, (collectively, the "Insurance Group"), the members of
which are an authorized Texas property and casualty insurance company,
American Hallmark Insurance Company of Texas ("Hallmark"); a managing
general agent, 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. The Company's
principal reinsurers are Kemper Reinsurance Company ("Kemper") and Dorinco
Reinsurance Company ("Dorinco"), and they collectively assume 75% of
Hallmark s risk. HFC finances annual and six-month policy premiums
<PAGE>
through its premium finance program. 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, premium finance service charges and service fees. Other
sources of funds are from financing and investment activities.
Net cash provided by the Company s consolidated operating activities
increased $.7 million during the first quarter of 1999 compared to the
first quarter of 1998. This increase is principally due to the increase in
unearned premiums which is partially offset by decreases in various other
liabilities. Cash used by investing activities increased approximately
$1.2 million. During the first quarter of 1998, the Company received
approximately $1.1 million in proceeds from a note receivable. No such
proceeds were received during 1999 as the note was repaid during the second
quarter of 1998. Additionally, the Company increased its purchase of
short-term investments during the first quarter of 1999 to capitalize on
higher yields of discount notes as compared to overnight investments.
On a consolidated basis, the Company's liquidity increased
approximately $1.3 million during the first quarter of 1999. The Company's
total cash, cash equivalents and investments (excluding restricted cash of
approximately $1.8 million) at March 31, 1999 and December 31, 1998 were
$15.9 million and $14.6 million respectively. This increased liquidity is
primarily due to the combined effect of increased cash inflows from third
party processing, increased policy production relative to year-end 1998,
and increased retention of policy fees (as discussed below).
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 $15.9 million at March 31, 1999,
$2.2 million (as compared to approximately $2.8 million at December 31,
1998) 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 three months of 1999 and 1998, Hallmark paid
or accrued $175,000 and $200,000, respectively, in management fees.
Management anticipates that Hallmark will continue to pay management fees
periodically during the remainder of 1999, and this should continue to be a
moderate source of unrestricted liquidity. While the Company has never
received a dividend from Hallmark and there is no immediate plan to pay a
dividend, management is re-examining its current dividend policy.
Commissions from the Company's annual policy program for independent
agents represent a source of unrestricted liquidity when annual policy
production is level or increasing from the most recent previous quarters.
Under this program, AHGA offers independent agents the ability to write
annual policies and six-month policies, but commissions to substantially
<PAGE>
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
$4.5 million during the first quarter of 1999 as compared to $5.1 million
during the first quarter of 1998. During the first quarter of 1999, AHGA
received $.9 million in commissions related to this program from Hallmark,
and paid earned commissions of $.4 million to independent agents. This has
resulted in increased unrestricted liquidity for the Company.
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
increased to $1.7 million at March 31, 1999 from $1.3 million at December
31, 1998. Deferred policy acquisition costs as of March 31, 1999 increased
$0.6 million as compared to December 31, 1998. The increase in deferred
ceding commission income and deferred policy acquisition costs is primarily
due to the increase in Hallmark's core premium volume, particularly with
respect to annual volume, during the first quarter of 1999 as compared to
the third and fourth quarter of 1998.
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 increase in the reinsurance balances
payable is due to increased premium volume during the first quarter of 1999
as compared to the fourth quarter of 1998.
At March 31, 1999, Hallmark reported statutory capital and surplus of
approximately $5.3 million which reflects an approximate 2% decrease over
the balance reported at December 31, 1998. On a rolling-twelve months
premium basis, Hallmark s premium-to-surplus ratio for the twelve months
ended March 31, 1999 was 2.24 to 1 as compared to 2.13 to 1 for the year
ended December 31, 1998 and 2.44 to 1 for the twelve months ended March 31,
1998. Management does not presently expect Hallmark to require additional
capital during 1999 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.
Effective January 1, 1999, Hallmark amended its existing reinsurance
treaties with Kemper and Dorinco whereby the minimum commission rate was
increased by 1%, and Hallmark retains 100% of the policy fees as compared
to 62.5% previously. These changes have positively impacted liquidity
during the first quarter of 1999.
Prior to 1999, the Company had a bank credit line which was used to
fund premium finance notes of HFC. The bank credit line was not renewed
upon its expiration. Assuming a modest growth in premium volumes, the
Company intends to funds its premium finance notes with internally
generated funds during 1999. According to the Dorinco loan agreement,
principal payments on the Dorinco loan were to commence on March 31, 1999.
In March 1999, the loan agreement was amended whereby the commencement of
principal payments has been delayed until September 30, 1999.
The Company continues to pursue third party claims handling and
administrative contracts. The Company also continues to provide program
administration for three unaffiliated managing general agencies (the
<PAGE>
"unaffiliated MGAs") and claims handling services for four unaffiliated
MGAs. Under these contracts, the Company, as program administrator,
performs certain administrative functions, including but not limited to,
cash management, underwriting and rate-setting reviews, underwriting and
policy processing (on two of the programs) and claims handling (on four
programs). Hallmark assumes a pro-rata share of the business produced
under the unaffiliated MGAs programs (ranging from 15% to 25%) with the
remaining percentage of the business assumed by Hallmark s principal
reinsurers. The premium volume ceded from these programs is considered a
part of Hallmark's premium volume commitment to one of its principal
reinsurers. Additionally, the Company has entered into a preliminary
agreement to provide claims handling and statistical reporting for an
unaffiliated commercial general agency.
Management is continuing to investigate opportunities for future
growth and expansion. 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 first quarter
of 1999 decreased approximately 14% in relation to gross premiums written
during the same period in 1998. The decrease in gross premiums written
was primarily due to price-competitive market conditions in the Texas non-
standard auto industry which have adversely impacted premium volumes since
the second quarter of 1998. Net premiums written (after reinsurance) for
the first quarter of 1999 increased approximately 10% over the same period
in 1998. The increase in net premiums written is due to the combined effect
of Hallmark s retention of 100% of the policy fees (effective January 1,
1999) and the increased assumption of business written by four unaffiliated
MGAs. As previously discussed under Financial Condition and Liquidity, the
reinsurance treaties with Dorinco and Kemper were amended whereby Hallmark
retains 100% of all policy fees written as compared to retention of 62.5%
previously. Hallmark assumes between 15% and 25% of the business produced
by the unaffiliated MGAs. Since this business is not reinsured, the
impact on net premiums written is intensified. The increased assumption of
the third party business and the increased retention of policy fees was
offset by a decrease in core State & County premiums written thus
accounting for the decrease in gross premiums written.
Premiums earned (prior to reinsurance) for the first quarter of 1999
decreased approximately 25% as compared to the same period of 1998. For
the first quarter of 1999, net premiums earned (after reinsurance)
decreased 6% in relation to the same period of 1998. The
disproportionate change in premiums earned (prior to and after reinsurance)
is due to the assumption of premiums produced by the unaffiliated MGAs
which are fully retained by the Company, and thus have a greater impact on
net premiums earned.
Net incurred loss ratio (computed on net premiums earned after
reinsurance) for the first quarter of 1999 was 59% compared to 60% for the
same respective period of 1998. The loss ratio between 1999 and 1998 is
slightly improved primarily due to the retention of 100% of the policy fees
effective January 1, 1999 which is offset by increased loss ratios on the
third party assumed business and the proration of policy fees on annual
business. During 1998 Hallmark increased its assumption of unaffiliated
MGA business by adding three additional contracts. The overall loss ratio
on the assumed business produced by the unaffiliated MGAs is higher than
<PAGE>
the loss ratio on the core State and County business. Also during the
third quarter of 1998, the Company introduced a new annual program pursuant
to which the policy fee is prorated over the life of the policy instead of
fully earned as under the previous annual program. This change in
recognition of policy fees has lowered earned premium thus contributing to
an increase in loss ratio. Unearned policy fees (before any cancellation)
on annual/six month policies to be recognized in future periods were
$640,083.
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
increase in the credit balance of acquisition costs, net is primarily due
to the deferral of commission expense related to the third party
unaffiliated MGAs business during the first quarter of 1999 (there was no
deferral during the first quarter of 1998) which is partially offset by
lower ceding commission income and lower State & County core acquisition
costs in 1999 than in 1998 due to lower annual/six month policy production
during the first quarter of 1999 as compared to the first quarter of 1998.
Other acquisition and underwriting expenses decreased approximately
10% during the first quarter of 1999 as compared to the same respective
period of 1998. The decrease in expenses is primarily attributable to the
combined effect of (1) decreases in variable expenses (such as salaries and
related expenses, commission expense, front fees and premium taxes on the
core State & County business) due to lower volumes, and reduced management
resources spent on insurance operations and (2) a 1% increase in the
minimum ceding commission. Management resources focused on building the
third party processing and program administration business are allocated to
operating expenses rather than acquisition and underwriting expenses.
These decreases are partially offset by an increase in commission expenses
related to assumption of business written by unaffiliated MGAs.
Additionally, ceding commission income decreased during 1999 as a result of
a decrease in core State & County premium volume.
Operating expenses include non-insurance operations 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 approximately 57% for the first quarter of 1999 as compared to
the same period of 1998. The increase in operating expense is primarily
attributable to increased expenses related to the processing of third party
contracts. During the first quarter of 1998, the Company only provided
processing for one unaffiliated MGA as compared to four contracts during
the first quarter of 1999.
Finance charges represent interest earned on premium notes issued by
HFC. During the first quarter of 1999, finance charges decreased 29% as
compared to the same period of 1998. This decrease is attributable to the
decreased core State & County premium volume.
Processing and service fees represents income earned on third party
processing and servicing contracts with unaffiliated MGAs. Processing and
service fees for the first quarter of 1999 increased approximately 56% as
compared to the same period of 1998 as a result of the increase in the
number of the Company s contracts with third party unaffiliated MGAs.
<PAGE>
Year 2000 Compliance
General. The Year 2000 problem concerns the inability of some
computerized systems to properly recognize and process date-sensitive
information on and after January 1, 2000, due to the use of only the last
two digits to identify a year. During 1998, the Company implemented a Year
2000 compliance program to assess and remedy Year 2000 issues affecting the
Company. As a result, the Company presently expects that all of its
material systems and equipment will be ready for the Year 2000 transition.
State of Readiness. The Company's primary information technology
systems may be classified in the following categories:
Insurance Systems: These systems consist of mainframe hardware and
the Company s proprietary software programs that support its day-to-day
insurance operations (including policy issuance, premiums collection and
claims handling) and periodic batch processing and regulatory reporting.
Premium Finance Systems: These systems consist of personal computer
software programs from a third-party vendor which support HFC's premium
finance activities.
Investment Portfolio Systems: These systems consist of personal
computer software programs from a third-party vendor which support the
tracking and management of the Company s investment portfolio.
General Ledger Systems: These systems consist of personal computer
software programs from a third-party vendor which support the Company's
accounting and management information functions.
All of the Company's insurance systems have been modified to be Year
2000 compliant. Year 2000 modifications and additional enhancements to the
programs supporting day-to-day insurance operations have been written,
tested and demonstrated to be fully operational. Modifications to the
programs supporting periodic batch processing and regulatory reporting have
been written and are being implemented and tested as such applications are
required in the course of the Company's business. The Company presently
expects that all such periodic batch processing and regulatory reporting
programs will be fully tested and operational by the end of the third
quarter of 1999.
The Company's premium finance systems, investment portfolio systems,
and general ledger systems have been certified by the vendors to be Year
2000 compliant and are fully implemented.
In addition, the Company has tested all material equipment and
facilities known to contain embedded computer chips and believes them to be
Year 2000 compliant. The Company has also corresponded with all of its
major reinsurers to assure their Year 2000 readiness.
Costs to Address Year 2000 Issues. The Company is executing its Year
2000 program primarily with existing internal resources. The principal
costs associated with these internal resources are payroll and benefits of
employees engaged in Year 2000 projects as part of their normal duties.
The Company does not separately track these internal costs attributable to
its Year 2000 program.
<PAGE>
The Company has also incurred costs for outside consultants and
systems upgrades in connection with its Year 2000 program. As a result of
Year 2000 issues, the Company elected to upgrade its premium finance
systems and general ledger systems during 1998 and 1999, respectively. No
other significant projects have been accelerated or deferred due to Year
2000 issues. The costs of these consultants and upgrades have not been,
and are not expected to be in the future, material to the results of
operations or financial condition of the Company. All costs of Year 2000
compliance have been recorded as an expense in the period incurred.
Risks and Contingency Plans. The Company believes that its most
critical information technology systems are presently Year 2000 compliant
and expects the remainder of its Year 2000 program to be completed as
scheduled. Therefore, any adverse consequences from Year 2000 issues will
result from presently unforeseen circumstances. As a result, the Company
has not made an assessment of worst case Year 2000 scenarios or developed
any continency plans.
Although the Company believes that it is adequately addressing the
Year 2000 issue, there can be no assurance that Year 2000 problems will not
have a material adverse effect on its business, financial condition or
results of operations. In addition, disruptions in the economy generally
resulting from Year 2000 failures could have a material adverse affect on
the Company.
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 3 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.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) No exhibits are filed herewith.
(b) On February 17, 1999, the Company filed a report on Form 8-K
disclosing the execution of a letter of intent with Onyx Insurance Group,
Inc.
Exhibit Description
10(a) Form of Amendment No. 2 to the Loan Agreement dated March 11,
1997 between Hallmark Financial Services, Inc. and Dorinco
Reinsurance Company.
<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
duly authorized.
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
Date: May 14, 1999 /s/ Ramon D. Phillips
Ramon D. Phillips, President
(Chief Executive Officer)
Date: May 14, 1999 /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 & Other assets. Refer to actual 10QSB submission.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> $
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 0
<DEBT-CARRYING-VALUE> 3,249,520
<DEBT-MARKET-VALUE> 6,982,442
<EQUITIES> 149,860
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 10,381,822
<CASH> 5,532,759
<RECOVER-REINSURE> 13,528,523
<DEFERRED-ACQUISITION> 1,014,225
<TOTAL-ASSETS> 54,042,926
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 10,139,584
<POLICY-OTHER> 3,136,392
<POLICY-HOLDER-FUNDS> 5,043,181
<NOTES-PAYABLE> 7,082,714
0
0
<COMMON> 355,638
<OTHER-SE> 10,883,592
<TOTAL-LIABILITY-AND-EQUITY> 54,042,926
3,093,056
<INVESTMENT-INCOME> 173,557
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 1,003,634
<BENEFITS> 1,820,531
<UNDERWRITING-AMORTIZATION> (274,466)
<UNDERWRITING-OTHER> 2,228,295
<INCOME-PRETAX> 495,887
<INCOME-TAX> 190,165
<INCOME-CONTINUING> 305,722
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 305,722
<EPS-PRIMARY> 0.03
<EPS-DILUTED> 0.03
<RESERVE-OPEN> 16,014,569
<PROVISION-CURRENT> 4,450,879
<PROVISION-PRIOR> 750,026
<PAYMENTS-CURRENT> (1,581,588)
<PAYMENTS-PRIOR> (3,935,407)
<RESERVE-CLOSE> 15,698,479
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
AMENDMENT NO. 2
Loan Agreement Between Hallmark Financial Services, Inc.
And Dorinco Reinsurance Company
This Amendment No. 2 is made and entered into effective as of March
5, 1999, by and between Hallmark Financial Services, Inc., a Nevada
corporation (the "Borrower"), and Dorinco Reinsurance Company, a Michigan
corporation (the "Lender").
WHEREAS, Borrower and Lender have entered into a Loan Agreement dated
March 10, 1997, which Loan Agreement has previously been amended by an
Amendment No. 1 executed by Borrower on July 31, 1998 and by Lender on
August 14, 1998 (as amended, the "Agreement"); and
WHEREAS, Borrower and Lender desire to further amend the Agreement as
provided herein;
THEREFORE, in consideration of the mutual covenants contained herein the
parties hereby amend the Agreement as set forth below.
A. Subsection 3.d. of the Agreement is hereby deleted in its entirety
and the following Subsection 3.d. substituted in its place:
"3. Collateral.
"d. As of the date of any reporting period required by law or the
Texas Department of Insurance, the stockholders equity of HFC (determined
in accordance with generally accepted accounting principles) shall be less
than the amount set forth below for the calendar year indicated:
1997 $6,640,000
1998 $6,950,000
1999 $7,400,000
2000 $9,200,000
2001 and thereafter $9,450,000 or"
B. Subsection 4.e. of the Agreement is hereby deleted in its entirety
and the following Subsection 4.e. substituted in its place:
"4. Conditions to this Agreement.
"e. Reinsurance Treaty. Borrower shall have caused AH to
offer, for the time period set forth in the table contained in this
paragraph, to reinsure a portion of its Personal Lines Auto Quota Share
Reinsurance with Lender, the form and content of such reinsurance treaty to
be substantially similar to Exhibit D attached to and made a part of this
Agreement, in amounts sufficient to allow for the following schedule of
ceded premiums:
Treaty Years Ceded Premium
07/01/97 to 06/30/99 $ 33,000,000
07/01/99 to 06/30/00 $ 25,048,000
07/01/00 to 06/30/01 $ 26,914,240
07/01/01 to 06/30/02 $ 28,929,779
07/01/02 to 06/30/03 $ 31,106,562
07/01/03 to 06/30/04 $ 33,457,486"
<PAGE>
C. Subsection 6.m.(ii) of the Agreement is hereby deleted in its
entirety and the following Subsections 6.m.(ii) substituted in its place:
"6. Affirmative Covenants.
"m. Statutory Capital and Surplus.
"(ii) Borrower shall cause HFC to maintain the following
minimum stockholders' equity (determined in accordance with generally
accepted accounting principles) as of the date of each reporting period
required by law or required by the Texas Department of Insurance:
1997 $ 6,530,000
1998 $ 6,750,000
1999 $ 7,050,000
2000 $ 8,800,000
2001 $ 9,300,000"
D. Subsection 6.o. of the Agreement is hereby deleted in its
entirety and the following Subsections 6.o. substituted in its place:
"6. Affirmative Covenants.
"o. Reinsurance Treaty. Borrower shall cause AH to continue
to offer, for the time period set forth in the table contained in this
paragraph, to reinsure a portion of its Personal Lines Auto Quota Share
Reinsurance with Lender, the form and content of such reinsurance treaty to
be substantially similar to Exhibit D attached hereto, in amounts
sufficient to allow for the following schedule of ceded premiums:
Treaty Years Ceded Premium
07/01/97 to 06/30/99 $ 33,000,000
07/01/99 to 06/30/00 $ 25,048,000
07/01/00 to 06/30/01 $ 26,914,240
07/01/01 to 06/30/02 $ 28,929,779
07/01/02 to 06/30/03 $ 31,106,562
07/01/03 to 06/30/04 $ 33,457,486"
Except as expressly amended hereby, all terms and conditions of the
Agreement shall remain in full force and effect.
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this Amendment
No. 2 to be effective as of the date set forth above.
BORROWER:
HALLMARK FINANCIAL SERVICES, INC.
By: /s/Linda H. Sleeper
Name: Linda H. Sleeper
Title: Executive Vice President
LENDER:
DORINCO REINSURANCE COMPANY
By:
Name:
Title:
