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, 2000
Commission file number 0-16090
Hallmark Financial Services, Inc.
---------------------------------
(Exact name of small business issuer as specified in its charter)
Nevada 87-0447375
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(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
14651 Dallas Parkway, Suite 900 Dallas, Texas 75240
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(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 - 11,048,133 shares
outstanding as of August 12, 2000.
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Page Number
-----------
Consolidated Balance Sheets at June 30, 2000 3
(unaudited) and December 31, 1999
Consolidated Statements of Income (unaudited) for 4
the three and six months ended June 30, 2000 and
Consolidated Statements of Cash Flows (unaudited) 5
for the six months ended June 30, 2000 and June
Notes to Consolidated Financial Statements 6
(unaudited)
<PAGE>
<TABLE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
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<CAPTION>
June 30 December 31
ASSETS 2000 1999
(Unaudited)
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<S> <C> <C>
Investments:
Debt securities, held-to-maturity, at
amortized cost $ 5,947,411 $ 3,831,657
Equity securities, available-for-sale, at
market value 142,345 142,901
Short-term investments, at cost which
approximates market value 6,933,080 6,373,491
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Total investments 13,022,836 10,348,049
Cash and cash equivalents 4,439,648 5,786,069
Restricted cash 3,440,297 3,422,297
Prepaid reinsurance premiums 10,141,424 7,673,196
Premiums receivable from lender (net of
allowance for doubtful accounts of
$148,348 in 2000 and $68,287 in 1999) 12,078,702 9,058,958
Premiums receivable 1,531,416 741,613
Reinsurance recoverable 18,745,297 15,673,241
Deferred policy acquisition costs 3,466,442 2,741,076
Excess of cost over net assets acquired (net
of accumulated amortization of $1,563,587
in 2000 and $1,485,080 in 1999) 4,666,627 4,745,134
Deferred federal income taxes 324,727 212,059
Accrued investment income 90,543 52,721
Other assets 1,033,656 547,820
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$ 72,981,615 $ 61,002,233
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<PAGE>
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes payable $ 10,872,291 $ 9,288,366
Unpaid losses and loss adjustment expenses 20,722,304 17,804,254
Unearned premiums 15,349,131 11,761,723
Reinsurance balances payable 3,595,796 2,623,603
Deferred ceding commissions 2,884,994 2,142,097
Drafts outstanding 1,272,195 901,471
Current federal income taxes payable 7,776 46,124
Accrued ceding commission refund 1,490,047 1,251,614
Accounts payable and other accrued expenses 3,571,550 2,516,222
Accrued litigation costs 950,000 950,000
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Total liabilities 60,716,084 49,285,474
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Stockholders' equity
Common stock, $.03 par value, authorized
100,000,000 shares issued 11,854,610
shares in 2000 and 1999 355,638 355,638
Capital in excess of par value 10,875,212 10,875,212
Retained earnings 2,092,277 1,543,304
Accumulated other comprehensive income (14,429) (14,228)
Treasury stock, 806,477 shares, at cost (1,043,167) (1,043,167)
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Total stockholders' equity 12,265,531 11,716,759
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$ 72,981,615 $ 61,002,233
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The accompanying notes are an integral part
of the consolidated financial statements
</TABLE>
<PAGE>
<TABLE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended Six Months Ended
June 30 June 30
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2000 1999 2000 1999
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<S> <C> <C> <C> <C>
Gross premiums written $ 12,870,742 $ 8,241,565 $ 26,098,589 $ 18,407,258
Ceded premiums written (7,662,205) (4,723,427) (15,401,396) (10,693,734)
----------- ----------- ----------- -----------
Net Premiums written $ 5,208,537 $ 3,518,138 $ 10,697,193 $ 7,713,524
=========== =========== =========== ===========
Revenues:
Gross premiums earned 11,863,434 8,259,477 22,511,182 16,019,209
Earned premiums ceded (6,831,799) (4,822,930) (12,933,169) (9,489,605)
----------- ----------- ----------- -----------
Net Premiums earned 5,031,635 3,436,547 9,578,013 6,529,604
Investment income, net of expenses 292,550 178,920 518,347 352,476
Finance charges - 528,567 - 966,288
Processing and service fees 1,318,337 542,674 2,690,329 1,006,624
Other income 82,033 91,370 166,761 193,333
----------- ----------- ----------- -----------
Total revenues 6,724,555 4,778,078 12,953,450 9,048,325
----------- ----------- ----------- -----------
Benefits, losses and expenses:
Losses and loss adjustment expenses 11,571,810 6,281,791 21,118,143 11,538,522
Reinsurance recoveries (7,654,285) (4,015,104) (14,044,111) (7,451,304)
----------- ----------- ----------- -----------
Net losses and loss adjustment expenses 3,917,525 2,266,687 7,074,032 4,087,218
Acquisition costs, net 83,546 (114,077) 17,531 (388,542)
Other acquisition and underwriting
expenses 958,248 1,176,582 2,123,396 2,509,196
Operating expenses 1,137,221 925,144 2,282,175 1,634,623
Interest expense 273,273 148,076 504,747 295,023
Amortization of intangible assets 39,253 39,253 78,507 78,507
----------- ----------- ----------- -----------
Total benefits, losses and expenses 6,409,066 4,441,665 12,080,388 8,216,025
----------- ----------- ----------- -----------
Income from operations before
federal income taxes 315,489 336,413 873,062 832,300
Federal income tax expense 120,362 139,641 324,089 329,807
----------- ----------- ----------- -----------
Net income $ 195,127 $ 196,772 $ 548,973 $ 502,493
=========== =========== =========== ===========
Basic and diluted earnings per share $ 0.02 $ 0.02 $ 0.05 $ 0.05
=========== =========== =========== ===========
Common stock shares outstanding 11,048,133 11,048,133 11,048,133 11,048,133
=========== =========== =========== ===========
The accompanying notes are an integral part
of the consolidated financial statements
</TABLE>
<PAGE>
<TABLE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30
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2000 1999
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<S> <C> <C>
Cash flows from operating activities:
Net income $ 548,973 $ 502,493
Adjustments to reconcile net loss to cash
provided by (used in) operating activities:
Depreciation and amortization expense 164,443 132,553
Change in deferred Federal income taxes (112,668) 29,148
Change in prepaid reinsurance premiums (2,468,228) (1,204,129)
Change in premiums receivable (789,803) (121,514)
Change in deferred policy acquisition (725,366) (693,956)
Change in deferred ceding commissions 742,897 305,414
Change in unpaid losses and loss 2,918,050 (57,894)
Change in unearned premiums 3,587,408 2,388,049
Change in reinsurance recoverable (3,072,056) 131,904
Change in reinsurance balances payable 972,193 23,549
Change in current federal income tax (38,348) 320,279
Change in accrued ceding commission refund 238,433 329,609
Change in all other liabilities 1,426,052 526,539
Change in all other assets (524,190) 50,192
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Net cash provided by operating 2,867,790 2,662,236
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Cash flows from investing activities:
Purchases of property and equipment (85,604) (27,208)
Premium finance notes originated (18,295,128) (12,096,418)
Premium finance notes repaid 15,275,384 10,295,533
Change in restricted cash (18,000) (26,000)
Purchases of debt securities (3,101,030) -
Maturities and redemptions of
investment securities 985,831 1,795,338
Purchase of short-term investments (9,559,589) (8,386,203)
Maturities of short-term investments 9,000,000 3,800,000
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Net cash used in investing activities (5,798,136) (4,644,957)
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Cash flows from financing activities:
Repayment of borrowings (215,298) (31,732)
Net advances from lender 1,799,223 -
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Net cash provided by (used in)
financing activities 1,583,925 (31,732)
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Decrease in cash and cash equivalents (1,346,421) (2,014,453)
Cash and cash equivalents at beginning of period 5,786,069 6,776,274
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Cash and cash equivalents at end of period $ 4,439,648 $ 4,761,821
========== ==========
The accompanying notes are an integral part
of the consolidated financial statements
</TABLE>
<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,
2000 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 accounting principles generally
accepted in the United States ("GAAP") have been condensed or omitted.
Reference is made to the Company's annual consolidated financial statements
for the year ended December 31, 1999 for a description of accounting
policies and certain other disclosures. Certain items in the 1999 interim
financial statements have been reclassified to conform to the 2000
presentation.
The results of operations for the period ended June 30, 2000 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 between the
Company and its reinsurers. During the periods presented, the Company
retained 25% and ceded 75% of the risk to their reinsurers. Effective July
1, 2000, the Company has entered into a new reinsurance agreement whereby
the Company retains 35% of the risk.
<PAGE>
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
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 $1,391,006 as of June 30, 2000 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, 2000.
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.
[This space left blank intentionally]
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.
<PAGE>
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. Prior to July 1,
2000, the Company's principal reinsurers, GE Reinsurance Corporation and
Dorinco Reinsurance Company ("Dorinco"), collectively assumed 75% of
Hallmark's risk. Effective July 1, 2000, Dorinco assumed 65% of the risk
with Hallmark retaining the remaining 35%. HFC finances annual and six-
month policy premiums 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.
Additionally, AHGA provides premium processing, underwriting, reinsurance
accounting and cash management for unaffiliated managing general agents
("MGAs"). HCS provides fee-based claims adjustment, salvage, subrogation
recovery and litigation services to Hallmark and unaffiliated MGAs.
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, processing fees, and premium finance service fees. Other
sources of funds are from financing and investment activities.
Net cash provided by the Company's consolidated operating activities
was $0.2 million greater during the first six months of 2000 than during the
first six months of 1999. This increase is principally due to increased
annual policy premium volume. Cash used by investing activities increased
approximately $1.2 million. As a result of increased annual policy premium
volume, HFC originated more premium finance notes than it received in
premium finance payments. Cash provided by financing activities increased
$1.6 million as a result of net advances under HFC's secured financing
arrangement with an unaffiliated third party.
On a consolidated basis, the Company's liquidity increased $1.4 million
during the first six months of 2000. The Company's total cash, cash
equivalents and investments (excluding restricted cash of $3.4 million) at
June 30, 2000 and December 31, 1999 were $17.5 million and $16.1 million,
respectively. This increased liquidity is primarily due to increased policy
production during fiscal 2000.
<PAGE>
A substantial portion of the Company's liquid assets is held by
Hallmark and is not available for general corporate purposes. Of the
Company's consolidated liquid assets of $17.5 million at June 30, 2000, $1.2
million (as compared to approximately $0.9 million at December 31, 1999)
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 2000 and 1999, Hallmark paid or accrued management fees of
$100,000 and $325,000, respectively. Management anticipates that Hallmark
will continue to pay management fees periodically during the remainder of
2000, and this should continue to be a moderate source of unrestricted
liquidity. The Company has never received a dividend from Hallmark and
there is no immediate plan to pay a dividend.
During the first six months of 2000, the amount of funding available to
fund premium finance notes under the secured financing arrangement with the
unaffiliated third party was increased to $10.0 million from $8.0 million.
As of June 30, 2000, HFC had an outstanding balance on advances under the
financing arrangement of approximately $8.6 million at an interest rate of
10%. Under the financing arrangement, the maximum additional advances
available to HFC at June 30, 2000 were $1.4 million.
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 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 $12.2
million during the first six months of 2000 as compared to $7.5 million
during the first six months of 1999. During the first six months of 2000,
AHGA received $2.5 million in commissions related to this program from
Hallmark, and paid earned commissions of approximately $1.5 million to
independent agents. This has resulted in increased unrestricted liquidity
for the Company. During the first six months of 1999, AHGA received $1.6
million in commissions related to this program from Hallmark, and paid
earned commissions of $0.9 million to independent agents.
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 approximately $2.9 million at June 30, 2000 from $2.1 million
at December 31, 1999. Deferred policy acquisition costs as of June 30, 2000
increased $0.7 million as compared to December 31, 1999. The increase in
deferred ceding commission income and deferred policy acquisition costs is
primarily due to the increase in Hallmark's core State and County annual
premium volume.
<PAGE>
Premium receivable from lender increased $3.0 million during 2000 as a
result of increased annual policy production during the first six months of
2000 as compared to the last six months of 1999. Prepaid reinsurance
premiums, unpaid losses and LAE, reinsurance recoverable and unearned
premiums increased as expected in relation to increased premium writings.
Accounts payable and other accrued expenses increased as a result of
increased commissions due to independent agents under the earned commission
program.
At June 30, 2000, Hallmark's statutory capital and surplus was
approximately $6.2 million, which reflects a 3% increase over the balance
reported at December 31, 1999. On a rolling-twelve months premium basis,
Hallmark's premium-to-surplus ratio for the twelve months ended June 30,
2000 was 2.98 to 1 as compared to 2.57 to 1 for the year ended December 31,
1999 and 2.88 to 1 at June 30, 1999. Management does not presently expect
Hallmark to require additional capital during 2000 to fund existing
operations, due, in part, to its election to discontinue reinsuring two
unaffiliated MGA programs as discussed below.
The Company provides program administration for three unaffiliated MGAs
and claims handling services for four unaffiliated MGAs. Under these
contracts, the Company, as program administrator, performs certain
administrative functions, including cash management, underwriting and rate-
setting reviews, underwriting and policy processing (on two of the programs)
and claims handling. Hallmark assumes a pro-rata share of the business
produced under each of the unaffiliated MGAs programs (ranging from 15% to
25%) with the remaining percentage of the business assumed by Hallmark's
principal reinsurers. Effective July 1, 2000, two of the unaffiliated MGA
programs have discontinued writing new business due to non-renewal of their
reinsurance treaties. The Company will continue to perform functions as
defined in the respective contracts during the run-off period.
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 three and six
months ended June 30, 2000 increased approximately 56% and 42%,
respectively, in relation to gross premiums written during the same periods
in 1999. Net premiums written (after reinsurance) for the three and six
months ended June 30, 2000 increased 48% and 39%, respectively, over the
same periods in 1999. The increase in premiums written was due to the
increase in the core State & County premium volume and increased premium
volume from assumed business produced by unaffiliated MGAs as compared to
the prior year.
Premiums earned (prior to reinsurance) for the three and six months
ended June 30, 2000 increased approximately 44% and 41%, respectively, as
compared to the same periods of 1999. For the three and six months ended
June 30, 2000, net premiums earned (after reinsurance) increased 46% and
47%, respectively, as compared to the same periods of 1999. The
disproportionate change in premiums earned prior to and after reinsurance is
due to policy fees and the assumption of increased premiums produced by the
unaffiliated MGAs, both of which are fully retained by the Company and thus
have a greater impact on net premiums earned.
<PAGE>
Net incurred loss ratios (computed on net premiums earned after
reinsurance) for the three and six months ended June 30, 2000 were 78% and
74%, respectively, compared to 66% and 63% for the same periods of 1999.
Hail damage during 2000 accounted for approximately 2% of the increased loss
ratio. The remaining increase is attributable to the increased loss ratios
on the core State & County business and the assumed unaffiliated MGA
business. Two of the unaffiliated MGA programs have been cancelled
effective July 1, 2000. The loss ratios on these two programs exceeded
113%.
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 debit balance of acquisition costs, net is primarily due to
a larger increase in ceding commission income (credits) than in acquisition
costs (debits) along with an increase in the deferral rate (of both credits
and debits).
Other acquisition and underwriting expenses for the three and six
months ended June 30, 2000 decreased approximately 19% and 15%,
respectively, as compared to the same periods of 1999. The decrease in
expenses is primarily attributable to the combined effect of (1) increased
ceding commission income as a result of increased core State & County
premium volume and (2) increased management resources spent on premium
finance operations and third party administrative and claims handling
contracts. 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 and other variable
expenses associated with increased premium volume.
Operating expenses include expenses related to premium finance
operations, general corporate overhead, and third party administrative and
claims handling contracts. Related revenues are derived from
service/consulting fees. Operating expenses increased approximately 23% and
40%, respectively, during the three and six months ended June 30, 2000 as
compared to the same periods of 1999. The majority of this increase is
attributable to the variable expenses related to increased volume in the
Company's premium finance operations, the deployment of management and staff
resources to the development, administration and/or processing of third
party contracts and the development of technological improvements in
information systems.
During 1999, the Company earned finance charges (interest) on premium
notes issued by HFC. The Company has not earned finance charges during 2000
as the result of a secured financing and servicing arrangement with an
unaffiliated third party to fund HFC's premium finance activities. This
arrangement was initiated during the fourth quarter of 1999. As HFC
services the premium finance notes for the unaffiliated third party, income
derived from the premium finance notes is reflected in processing and
service fees.
<PAGE>
Processing and service fees represent income earned on the servicing
arrangement with the unaffiliated third party (as discussed above) and third
party processing and servicing contracts with unaffiliated MGAs. Processing
and service fees for the three and six months of 2000 increased
approximately $0.8 million and $1.7 million as compared to 1999 principally
as a result of the premium finance servicing arrangement with the
unaffiliated third party.
Although total revenues for the three and six months ended June 30, 2000
increased approximately 41% and 43%, respectively, compared to the same
periods of 1999, net inceome for both periods was flat. Marketing
fragmentation and capital over-capacity in the insurance industry over the
last several years have depressed premium rates. The cumulative effect of
inadequate rates, coupled with hail storm claims in the first half of the
year mitigated the impact of increased revenues on profitability.
Recent Developments
Management believes that recent trends emerging in the Texas insurance
industry may provide the foundation for increasing future profitability of
the Company. Initial indicators reflect a marketplace characterized by
higher premium rates and a decrease in active competitors. The Company has
been strategically increasing premium rates since November 1999, and intends
to systematically implement additional rate increases to optimize
underwriting profits. As part of the continual management of its
independent agents, the Company is actively working to increase the
profitability of the business produced by its agent base through targeted
rate increases, more stringent underwriting guidelines and heightened agent
performance requirements (including agency underwriting performance,
operational quality standards and premium production commitments).
Additionally, management is in the process of implementing a phased
program to strengthen its information technology capabilities in several
areas. The thrust of the first phase is to enhance Company and agency
relationships by improving content and timeliness of information to support
its agents in servicing their customers. The Company is currently testing
the first phase internally. The Company expects to commence testing by
selected agents during the third quarter of fiscal 2000, with a full
implementation beginning in the fourth quarter. The emphasis of the second
phase will be to implement point-of-sale technology to support agents in
more promptly and efficiently producing new business, as well as to improve
the quality and timeliness of service to existing policy holders. Testing
of this phase is scheduled for early 2001. When fully implemented, these
information technology enhancements should result in cost savings for both
the Company and its participating agents.
<PAGE>
The expectation of increased premium rates in the Texas marketplace is
largely the result of recent tightening in the availability of reinsurance
on acceptable terms. Partially as a result of this development, effective
July 1, 2000, Hallmark entered into a new reinsurance agreement with
Dorinco, one of the two primary reinsurers under the prior arrangement.
Under the new reinsurance agreement, Hallmark has increased its risk
retention to 35% (from 25% under the previous arrangements) and Dorinco, as
the sole reinsurer, has increased its participation to 65% (from 37.5%
previously). In addition, the new agreement increases the provisional
ceding commission from 30% to 32%; decreases the minimum ceding commission
from 27.5% to 21%; and increases the ratio for computing earned ceding
commissions above the minimum from 0.7:1 to 1:1 (i.e., the number of
percentage points by which the earned commission is increased over the
minimum is now equal to the number of percentage points by which the
reinsurance loss ratio decreases from an established benchmark). Under the
agreement, Hallmark retains the provisional commission (also the maximum)
received from July 1, 2000, through the third quarter of 2002, at which time
the earned ceding commission will be determined based on the developed
reinsurance loss ratio as of June 30, 2002.
Management believes that Hallmark's new reinsurance agreement is
advantageous to the Company in light of the current reinsurance market.
Although the decrease in the minimum ceding commission exposes Hallmark to
reduced ceding commission income (especially in the near term), the increase
in both the provisional ceding commission and the ratio for computing earned
ceding commissions provides the potential for enhancing future profits. In
addition, short term liquidity will be favorably impacted by the increase in
the provisional ceding commissions, as well as Hallmark's continued
retention of 100% of policy fees.
Principally as a result of the inability of many MGA's to secure
acceptable reinsurance terms, the Company has curtailed active pursuit of
full service third party program administration contracts. For the
foreseeable future, the Company plans to limits its marketing of third party
services primarily to claims handling contracts.
<PAGE>
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.
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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 on Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security-Holders.
The Company's Annual Meeting of Shareholders was held on
( a ) May 25, 2000. Of the 11,048,133 shares of common stock of
the Company entitled to vote at the meeting, 8,885,984
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, 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) The exhibit listed in the Exhibit Index appearing on page
14 is filed herewith.
(b) The Company did not file any Form 8-K Current Reports
during the second quarter of 2000.
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Exhibit Index
Exhibit
Number Description
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10(a) Seventh Amendment to Office Lease for 14651 Dallas
Parkway, Suite 900, dated January 1, 1995, between
American Hallmark Insurance Company of Texas and Fults
Management Company, as agent for The Prudential
Insurance Company of America.
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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: August 12, 2000 /s/ Ramon D. Phillips
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Ramon D. Phillips, President (Chief
Date: August 12, 2000 Executive Officer)
/s/ John J. DePuma
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John J. DePuma, Chief Financial Officer
