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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended June 30, 2004
Commission file number 0-16090
HALLMARK FINANCIAL SERVICES, INC.
---------------------------------
(Exact name of registrant as specified in its charter)
Nevada 87-0447375
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
777 Main Street, Suite 1000, Fort Worth, Texas 76102
---------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (817) 348-1600
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 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 ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No X
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: Common Stock, par value
$.03 per share - 36,462,291 shares outstanding as of August 13, 2004.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Page Number
-----------
Consolidated Balance Sheets at June 30, 2004 3
(unaudited) and December 31, 2003
Consolidated Statements of Operations (unaudited) 4
for the three months and six months ended June 30,
2004 and June 30, 2003
Consolidated Statements of Cash Flows (unaudited) 5
for the six months ended June 30, 2004 and June 30,
2003
Notes to Consolidated Financial Statements 6
(unaudited)
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
June 30 December 31
ASSETS 2004 2003
------ ---------- ----------
(unaudited) (audited)
Investments:
Debt securities, available-for-sale,
at market value $ 26,134 $ 25,947
Equity securities, available-for-sale,
at market value 3,692 3,573
Short-term investments, available-for-sale,
at market value 2,711 335
---------- ----------
Total investments 32,537 29,855
Cash and cash equivalents 8,783 10,520
Restricted cash and investments 6,210 5,366
Prepaid reinsurance premiums 8 291
Premiums receivable 3,713 4,076
Accounts receivable 2,656 3,395
Reinsurance recoverable 5,166 10,516
Deferred policy acquisition costs 7,743 7,146
Excess of cost over fair value
of net assets acquired 4,836 4,836
Intangible assets 499 513
Current federal income tax recoverable - 625
Deferred federal income taxes 3,993 3,961
Other assets 3,019 2,753
---------- ----------
$ 79,163 $ 83,853
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Notes payable $ 627 $ 991
Unpaid losses and loss adjustment expenses 22,166 28,456
Unearned premiums 5,160 5,862
Unearned revenue 11,610 10,190
Accrued agent profit sharing 685 1,511
Accrued ceding commission payable 1,208 1,164
Pension liability 1,201 1,237
Current federal income tax payable 120 -
Accounts payable and other accrued expenses 6,420 7,045
---------- ----------
49,197 56,456
Commitments and Contingencies
Stockholders' equity:
Common stock, $.03 par value, authorized
100,000,000 shares Issued 36,856,610
shares in 2004 and 2003 1,106 1,106
Capital in excess of par value 19,648 19,693
Retained earnings 10,159 7,254
Accumulated other comprehensive income (loss) (471) (93)
Treasury stock, 409,319 shares in 2004 and
484,319 in 2003, at cost (476) (563)
---------- ----------
Total stockholders' equity 29,966 27,397
---------- ----------
$ 79,163 $ 83,853
========== ==========
The accompanying notes are an integral part
of the consolidated financial statements
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30 June 30
--------------------- ----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Gross premiums written $ 7,011 $ 7,849 $ 15,764 $ 29,764
Ceded premiums written 1 1,218 25 (7,180)
-------- -------- -------- --------
Net premiums written 7,012 9,067 15,789 22,584
Change in net unearned premiums 932 2,361 419 1,346
-------- -------- -------- --------
Net premiums earned 7,944 11,428 16,208 23,930
Investment income, net of expenses 344 260 623 454
Finance charges 536 991 1,083 2,080
Commission and fees 5,295 4,347 10,490 7,697
Processing and service fees 1,524 977 3,004 2,285
Other income 7 42 15 319
-------- -------- -------- --------
Total revenues 15,650 18,045 31,423 36,765
Losses and loss adjustment expenses 4,422 7,551 9,649 16,441
Other operating costs and expenses 9,004 9,395 17,443 18,165
Interest expense 21 432 45 875
Amortization of intangible asset 7 7 14 14
-------- -------- -------- --------
Total expenses 13,454 17,385 27,151 35,495
-------- -------- -------- --------
Income before income tax and
extraordinary gain 2,196 660 4,272 1,270
Income tax expense 703 225 1,367 432
-------- -------- -------- --------
Income before extraordinary gain 1,493 435 2,905 838
Extraordinary gain - (36) - 8,116
-------- -------- -------- --------
Net income $ 1,493 $ 399 $ 2,905 $ 8,954
======== ======== ======== ========
Basic earnings per share:
Income before extraordinary gain $ 0.04 $ 0.04 $ 0.08 $ 0.07
Extraordinary gain - - - 0.73
-------- -------- -------- --------
Net income $ 0.04 $ 0.04 $ 0.08 $ 0.80
======== ======== ======== ========
Diluted earnings per share:
Income before extraordinary gain $ 0.04 $ 0.04 $ 0.08 $ 0.07
Extraordinary gain - (0.01) - 0.70
-------- -------- -------- --------
Net income $ 0.04 $ 0.03 $ 0.08 $ 0.77
======== ======== ======== ========
The accompanying notes are an integral part
of the consolidated financial statements
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In thousands)
Six Months Ended
June 30
------------------------
2004 2003
---------- ----------
Cash flows from operating activities:
Net income $ 2,905 $ 8,954
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Extraordinary gain on acquisition of subsidiary - (8,116)
Depreciation and amortization expense 224 322
Change in deferred federal income taxes 122 -
Change in prepaid reinsurance premiums 283 4,700
Change in premiums receivable 313 (408)
Change in accounts receivable 739 (847)
Change in deferred policy acquisition costs (597) 211
Change in unpaid losses and loss
adjustment expenses (6,290) (2,687)
Change in unearned premiums (702) (6,047)
Change in unearned revenue 1,420 2,932
Change in accrued agent profit sharing (826) (231)
Change in reinsurance recoverable 5,350 5,360
Change in reinsurance balances payable - (2,704)
Change in current federal income tax
payable/recoverable 745 754
Change in accrued ceding commission payable 44 (64)
Change in all other liabilities (661) 2,868
Change in all other assets (269) (1,087)
---------- ----------
Net cash provided by operating activities 2,800 3,910
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (75) (231)
Acquisition of subsidiary - 6,945
Premium finance notes repaid,
net of finance notes originated 51 3,610
Change in restricted cash and investments (3,269) (32)
Purchase of fixed maturity and equity securities (1,138) (80)
Maturities and redemptions of investment
securities 2,634 4,214
Net redemptions (purchases) of short-term
investments (2,376) 7,443
---------- ----------
Net cash (used in) provided by
investing activities (4,173) 21,869
---------- ----------
Cash flows from financing activities:
Net advances from lender - (3,028)
Repayment of borrowings (364) (420)
---------- ----------
Net cash used in financing activities (364) (3,448)
---------- ----------
Increase (decrease) in cash and cash equivalents (1,737) 22,331
Cash and cash equivalents at beginning of period 10,520 8,453
---------- ----------
Cash and cash equivalents at end of period $ 8,783 $ 30,784
========== ==========
In the first six months of 2004, the Company transferred $2.4 million of
fixed maturity investments from restricted investments to debt securities,
available-for-sale. The Company paid $500 thousand in taxes and $45
thousand in interest in the first six months of 2004. The Company paid
$0.4 million in interest in the first six months of 2003.
The accompanying notes are an integral part
of the consolidated financial statements
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 only of normal recurring
adjustments, necessary for a fair statement of the financial position of
Hallmark Financial Services, Inc. ("HFS") and subsidiaries (collectively,
the "Company") as of June 30, 2004 and the consolidated results of
operations and cash flows for the periods presented. The preparation of
financial statements requires the use of management's estimates. 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 of America ("GAAP") have been condensed or
omitted. Reference is made to the Company's annual consolidated financial
statements for the year ended December 31, 2003 for a description of
accounting policies and certain other disclosures. Certain items in the
2003 financial statements have been reclassified to conform to the 2004
presentation.
The results of operations for the period ended June 30, 2004 are not
necessarily indicative of the operating results to be expected for the full
year.
Recently Adopted Accounting Pronouncements
In December 2002, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"). The
Statement amends SFAS 123 to provide alternative methods of transition for
voluntary change to the fair value based method of accounting for stock-
based employee compensation. In addition, SFAS 148 amends the disclosure
requirements of SFAS 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results.
SFAS 148 is effective for financial statements for fiscal years ending
after December 15, 2002. Effective January 1, 2003, the Company adopted the
prospective method provisions of SFAS 148.
At June 30, 2004, the Company had a stock-based employee compensation
plan for key employees and a non-qualified plan for non-employee directors,
which are described more fully in Note 13 to the Company's Form 10-KSB for
December 31, 2003. Prior to 2003, the Company accounted for those plans
under the recognition and measurement provisions of APB Opinion No. 25,
"Accounting for Stock Issued to Employees", and related Interpretations.
Effective January 1, 2003, the Company adopted the fair value recognition
provisions of FASB Statement No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). Under the prospective method of adoption
selected by the Company under the provisions of SFAS 148, compensation cost
is recognized for all employee awards granted, modified, or settled after
the beginning of the fiscal year in which the recognition provisions are
first applied. Results for prior years have not been restated.
The following table illustrates the effect on net income and earnings per
share if the fair value based method had been applied to all outstanding and
unvested awards in each period.
Three Months Ended Six Months Ended
June 30, June 30,
(in thousands) 2004 2003 2004 2003
------- ------- ------- -------
Net income as reported $ 1,493 $ 399 $ 2,905 $ 8,954
Add: Stock-based employee
compensation expenses
included in reported net
income, net of related
tax effects 5 8 10 8
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards,
net of related tax effect (9) (17) (17) (26)
------- ------- ------- -------
Pro forma net income $ 1,489 $ 390 $ 2,898 $ 8,936
======= ======= ======= =======
Earnings per share:
Basic-as reported $ 0.04 $ 0.04 $ 0.08 $ 0.80
======= ======= ======= =======
Basic-pro forma $ 0.04 $ 0.03 $ 0.08 $ 0.80
======= ======= ======= =======
Diluted-as reported $ 0.04 $ 0.03 $ 0.08 $ 0.77
======= ======= ======= =======
Diluted-pro forma $ 0.04 $ 0.03 $ 0.08 $ 0.77
======= ======= ======= =======
Note 2 - Reinsurance
American Hallmark Insurance Company of Texas ("Hallmark"), a wholly
owned subsidiary of HFS, is involved in the assumption and cession of
reinsurance from/to other companies. The Company remains obligated to its
policyholders in the event that the reinsurers do not meet their obligations
under the reinsurance agreements.
Under its reinsurance arrangements, the Company earns ceding
commissions based on loss ratio experience on the portion of policies it
cedes. The Company receives a provisional commission as policies are
produced as an advance against the later determination of the commission
actually earned. The provisional commission is adjusted periodically on a
sliding scale based on expected loss ratios.
The following table shows earned premiums ceded and reinsurance loss
recoveries by period (in thousands):
Three Months Six Months
Ended Ended
June 30, June 30,
2004 2003 2004 2003
------ ------ ------ ------
Ceded earned premiums $ 1 $ 4,073 $ 258 $12,088
Reinsurance recoveries $ 537 $ 2,602 $ 211 $ 7,772
Note 3 - Segment Information
The Company pursues its business activities through integrated
insurance groups managing non-standard personal automobile insurance (the
"Personal Lines Group") and commercial insurance (the "Commercial Lines
Group"). The members of the Personal Lines Group are American Hallmark
Insurance Company ("Hallmark"), an authorized Texas property and casualty
insurance company; Phoenix Indemnity Insurance Company ("Phoenix"), an
authorized Arizona property and casualty insurance company; American
Hallmark General Agency ("AHGA"), a managing general agency; Hallmark
Finance Corporation ("HFC"), a premium finance company; and Hallmark Claims
Services ("HCS"), a claims administrator. The members of the Commercial
Lines Group are a managing general agency, Hallmark General Agency, Inc.
("HGA") and a third party claims administrator, Effective Claims Management,
Inc. ("ECM").
The following is additional business segment information for the three
and six months ended June 30 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
------- ------- ------- -------
Revenues
--------
Personal Lines Group $ 9,956 $ 13,414 $ 20,215 $ 27,447
Commercial Lines Group 5,693 4,631 11,206 9,318
Corporate 1 - 2 -
------- ------- ------- -------
Consolidated $ 15,650 $ 18,045 $ 31,423 $ 36,765
======= ======= ======= =======
Income before tax and
extraordinary gain
------------------
Personal Lines Group $ 1,949 $ 1,135 $ 3,585 $ 2,083
Commercial Lines Group 585 189 1,255 489
Corporate (338) (664) (568) (1,302)
------- ------- ------- -------
Consolidated $ 2,196 $ 660 $ 4,272 $ 1,270
======= ======= ======= =======
The following is additional business segment information as of the
following dates (in thousands):
June 30, Dec. 31,
2004 2003
-------- --------
Assets
------
Personal Lines Group $ 63,052 $ 68,247
Commercial Lines Group 15,598 13,365
Corporate 513 2,241
-------- --------
Consolidated $ 79,163 $ 83,853
======== ========
Note 4 - Deferred Policy Acquisition Costs
Total deferred and amortized policy acquisition costs for the three and six
months ending June 30, 2004 and 2003 (in thousands) were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
------- ------- ------- -------
Deferred $ (5,189) $ (1,036) $(11,337) $ (4,362)
Amortized 5,101 1,498 10,740 4,573
------- ------- ------- -------
Net Deferred $ (88) $ 462 $ (597) $ 211
======= ======= ======= =======
Note 5 - Earnings per Share
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 128 (" SFAS No. 128"), "Earnings Per Share," requiring
presentation of both basic and diluted earnings per share.
The following table sets forth basic and diluted weighted average shares
outstanding for the periods indicated (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
------- ------- ------- -------
Weighted average shares - basic 36,447 11,238 36,428 11,147
Effect of dilutive securities 164 342 139 402
------- ------- ------- -------
Weighted average shares -
assuming dilution 36,611 11,580 36,567 11,549
======= ======= ======= =======
Options to purchase 126,000 shares and 75,000 shares of common stock at
prices ranging from $0.75 to $1.00 were outstanding during the three months
ending June 30, 2004 and 2003, respectively, and options to purchase 526,000
shares and 76,000 shares of common stock at prices ranging from $0.68 to
$1.00 were outstanding during the six months ending June 30, 2004 and 2003,
respectively, but were not included in the computation of diluted earnings
per share because the inclusion would result in an anti-dilutive effect in
periods where the option exercise price exceeded the average market price
per share for the period.
Note 6 - Comprehensive Income
The following table sets forth comprehensive income for the periods
indicated (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
------- ------- ------- -------
Net income $ 1,493 $ 399 $ 2,905 $ 8,954
Unrealized gain (loss)
on available for sale
securities, net of tax (683) 25 (378) 60
------- ------- ------- -------
Other comprehensive
income (loss) (683) 25 (378) 60
------- ------- ------- -------
Comprehensive income $ 810 $ 424 $ 2,527 $ 9,014
======= ======= ======= =======
Item 2. Management's Discussion and Analysis or Plan of Operation.
Introduction. Hallmark Financial Services, Inc. ("HFS") and its wholly
owned subsidiaries (collectively, the "Company") engage in the sale of
property and casualty insurance products. The Company's business involves
marketing and underwriting of non-standard automobile insurance primarily in
Texas, Arizona, and New Mexico; marketing of commercial insurance in Texas,
New Mexico, Idaho, Oregon and Washington; and providing third party claims
administration and other insurance related services.
The Company pursues its business activities through integrated
insurance groups managing non-standard personal automobile insurance (the
"Personal Lines Group") and commercial insurance (the "Commercial Lines
Group"). The members of the Personal Lines Group are American Hallmark
Insurance Company ("Hallmark"), an authorized Texas property and casualty
insurance company; Phoenix Indemnity Insurance Company ("Phoenix"), an
authorized Arizona property and casualty insurance company; American
Hallmark General Agency ("AHGA"), a managing general agency; Hallmark
Finance Corporation ("HFC"), a premium finance company; and Hallmark Claims
Services ("HCS"), a claims administrator. The members of the Commercial
Lines Group are a managing general agency, Hallmark General Agency, Inc.
("HGA") and a third party claims administrator, Effective Claims Management,
Inc. ("ECM").
The Personal Lines Group provides non-standard automobile liability and
physical damage insurance through Hallmark and Phoenix for drivers who do
not qualify for or cannot obtain standard-rate insurance. Prior to April 1,
2003, Hallmark assumed the reinsurance of 100% of the Texas non-standard
automobile policies produced by AHGA and underwritten by State & County
Mutual Fire Insurance Company ("State & County") and retroceded 55%
of the business to Dorinco Reinsurance Company ("Dorinco"). Under this
arrangement, Hallmark remained obligated to policyholders in the event
Dorinco did not meet its obligations under the retrocession agreement.
Effective April 1, 2003, Hallmark assumes the reinsurance of 45% of the
Texas non-standard automobile policies produced by AHGA and underwritten
either by State & County (for policies written from April 1, 2003 through
September 30, 2003) or Old American County Mutual Fire Insurance Company
("OACM") (for policies written after September 30, 2003). The remaining 55%
of each policy is directly assumed by Dorinco. Under these new reinsurance
arrangements, Hallmark is obligated to policyholders only for the portion of
risk assumed by Hallmark. Phoenix underwrites non-standard auto insurance
produced by independent agents and retains 100% of the premium and
losses for the business it writes. Effective July 1, 2003, the Company
discontinued HFC's premium finance program and shifted focus to a six month
direct bill program. HCS provides claims adjustment, salvage, subrogation
recovery and litigation services to Hallmark, Phoenix and Dorinco.
The Commercial Lines Group, through HGA, markets commercial insurance
policies through independent agents. HGA produces policies on behalf of
Clarendon National Insurance Company ("CNIC") under a general agency
agreement where it receives a commission based on the premium written with
CNIC. ECM provides fee-based claims adjustment, salvage and subrogation
recovery, and litigation services on behalf of CNIC.
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, and processing and service fees. Other sources of funds are
from financing and investment activities.
On a consolidated basis, the Company's cash and investments (excluding
restricted cash and investments) at June 30, 2004 were $41.3 million
compared to $40.4 million at December 31, 2003.
Net cash provided by the Company's consolidated operating activities
was $2.8 million for the first six months of 2004 compared to $3.9 million
for the first six months of 2003. The decrease in operating cash flow
is due mostly to a reduction in Personal Lines premium volume causing
an approximate $4.2 million reduction in premiums collected. This was
partially offset by an approximate $3.0 million increase in collected ceding
commission revenue due primarily to increased premium writings by Commercial
Lines in 2004.
Cash used by investing activities during the first six months of 2004
was $4.2 million as compared to cash provided of $21.9 million for the same
period in 2003. The acquisition of Phoenix in 2003 produced a net cash
increase of $6.9 million. The decrease was additionally attributable to
redemption of short-term investments in the first six months of 2003 of $7.4
million compared to purchases of short-term investments in 2004 of $2.4
million; repaid premium finance notes in 2003 of $3.6 million; transfer of
$3.3 million to restricted investments in 2004 for the benefit of OACM;
purchase of available-for-sale securities in 2004 of $1.1 million compared
to $0.1 million in 2003; and redemption of available-for-sale securities of
$2.6 million in 2004 as compared to $4.2 million in 2003.
Cash used in financing activities decreased by $3.1 million in the
first six months of 2004 as compared to the same period of 2003 due to the
discontinuation of the premium finance program in 2003. As a result, the
Company did not receive any advances in 2004 from the premium finance
lender.
HFS is dependent on dividend payments and management fees from its
insurance companies and free cash flow of its non-insurance companies to
meet operating expenses and debt obligations. As of June 30, 2004, cash and
invested assets of HFS were $0.4 million. Cash and invested assets of non-
insurance subsidiaries were $5.8 million as of June 30, 2004. Property and
casualty insurance companies domiciled in the State of Texas are limited in
the payment of dividends to their shareholders in any twelve-month period,
without the prior written consent of the Texas Department of Insurance
("TDI"), to the greater of statutory net income for the prior calendar year
or 10% of its statutory policyholders' surplus as of the prior year end.
Dividends may only be paid from unassigned surplus funds. During 2004,
Hallmark's ordinary dividend capacity is $2.2 million. Phoenix, domiciled
in Arizona, is limited in the payment of dividends to the lesser of 10% of
prior year policyholder's surplus or prior year's net investment income,
without prior written approval from the Arizona Department of Insurance
("AZDOI"). During 2004, Phoenix's ordinary dividend capacity is $0.6
million. Neither Hallmark nor Phoenix declared a dividend to HFS during the
first six months of 2004. Hallmark paid a $0.2 million dividend to HFS in
2004 that was declared in 2003.
TDI regulates financial transactions between Hallmark, HFS and
affiliated companies. Applicable regulations require TDI's approval of
management and expense sharing contracts and similar transactions. AHGA
paid $0.3 million in management fees in 2004 to HFS and HFC paid $0.3
million in management fees to HFS in 2003.
The AZDOI regulates financial transactions between Phoenix and
affiliated companies. Applicable regulations require AZDOI's approval of
management and expense sharing contracts and similar transactions. Phoenix
paid $0.6 million in management fees during the first six months of 2004 to
AHGA.
Results of Operations
Three Months Ending June 30, 2004 as compared to Three Months Ending
June 30, 2003
Total revenues for the quarter ended June 30, 2004, decreased $2.4
million, or 13%, as compared to the same period of 2003, primarily as a
result of a $3.5 million decline in total revenues from the Personal Lines
Group partially offset by a $1.1 million increase in total revenues from the
Commercial Lines Group. Income before tax and extraordinary gain for the
quarter ended June 30, 2004, increased $1.5 million, or 233%, as compared to
the same period in 2003. The improvement in operating earnings for the
second quarter of 2004 compared to the second quarter of 2003 reflects
improved underwriting results in the Personal Lines Group, additional
commission revenue in the Commercial Lines Group and overall reduced
interest expenses.
The following is additional business segment information for the three
months ended June 30, 2004 and 2003 (in thousands):
2004 2003
-------- --------
Revenues
--------
Personal Lines Group $ 9,956 $ 13,414
Commercial Lines Group 5,693 4,631
Corporate 1 -
-------- --------
Consolidated $ 15,650 $ 18,045
======== ========
Income before tax and extraordinary gain
----------------------------------------
Personal Lines Group $ 1,949 $ 1,135
Commercial Lines Group 585 189
Corporate (338) (664)
-------- --------
Consolidated $ 2,196 $ 660
======== ========
Personal Lines Group
Net premiums written decreased $2.1 million during the second quarter
of 2004 to $7.0 million compared to $9.1 million in the second quarter of
2003. The decrease in net premiums written was primarily attributable to
the cancellation of unprofitable agents and programs, a shift in marketing
focus from annual term premium financed policies to six month term direct
bill policies and a reduction in policy counts caused by increased rates.
Net premiums earned decreased $3.5 million to $7.9 million for the quarter
ended June 30, 2004, as compared to the same period of 2003. Net premiums
earned declined more than net premiums written due to the decrease in the
rate of reduction in written premium for the months prior to the quarter
ended June 30, 2004 as compared to the same period in 2003. Primarily as a
result of the decline in net premiums earned, total revenue for the Personal
Lines Group decreased $3.5 million or 26%, for the second quarter of 2004 to
$10.0 million from $13.4 million for the same period in 2003.
Even though revenue for the Personal Lines Group declined, pre-tax
income increased $0.8 million, or 72% for the second quarter of 2004
compared to the second quarter of 2003. The increase in pre-tax income was
due largely to improved underwriting results as shown by a loss ratio
(defined as loss and loss adjustment expenses divided by net premiums
earned) of 56.0% for the second quarter of 2004 as compared to 66.7% for the
same period of 2003. Other operating costs and expenses declined $1.0
million for the Personal Lines Group due primarily to a $0.5 million
reduction in Phoenix policy service fees that were paid to a third party
in 2003. In 2004, the Company performed these services internally with
existing staff. Also contributing to the reduction in operating expenses
was a $0.2 million reduction in salary and related expenses due to the
successful integration of the Phoenix operations in late 2003 and the
overall reduction in premium volume. Interest expense was $0.1 million less
for the second quarter of 2004 as compared to the same period in 2003 due to
the discontinuation of the premium finance program in July, 2003.
Commercial Lines Group
Total revenue for the Commercial Lines Group of $5.7 million for the
second quarter of 2004 was $1.1 million more than the $4.6 million reported
in the second quarter of 2003. The improvement was primarily due to
additional commission revenue of $0.7 million and claim servicing fee
revenue of $0.3 million in the second quarter of 2004 as compared to the
same period in 2003. Increased commercial premium volume was the primary
cause of the increased commission and claim fee revenue for the quarter.
Earned premium generated by the Commercial Lines Group for the second
quarter of 2004 was $18.1 million as compared to $15.2 million in the second
quarter of 2003. The Company does not bear the primary underwriting risk
for this business and, therefore, the resulting premiums and claims are not
reflected in the Company's reported results.
Pre-tax income for the Commercial Lines Group of $0.6 million for the
second quarter of 2004 increased $0.4 million over the $0.2 million reported
for the second quarter of 2003. Increased revenue, as discussed above, was
the primary reason for the increase in pre-tax income, partially offset by
additional agent commissions of $0.5 million due to the increased premium
volume and the payment of management fees to HFS of $0.2 million in 2004.
Commercial Lines did not pay any management fees in 2003.
Corporate
Corporate pre-tax loss was $0.3 million for the second quarter of 2004
as compared to $0.7 million for the same period in 2003. The Company saved
$0.3 million in interest expense for the second quarter of 2004 as compared
to the same period in 2003 due to the repayment of a related party note
payable in September 2003. Also contributing to the decrease in pre-tax
loss were additional management fees collected from the Commercial Lines
Group of $0.2 million. Corporate did not collect any management fees in
2003 from the Commercial Lines Group.
Six Months Ending June 30, 2004 as compared to Six Months Ending
June 30, 2003
Total revenues for the six months ended June 30, 2004, decreased $5.3
million, or 15%, as compared to the same period of 2003, primarily as the
result of a $7.2 million decline in total revenues from the Personal Lines
Group partially offset by a $1.9 million increase in total revenues from
the Commercial Lines Group. Income before tax and extraordinary gain for
the six months ended June 30, 2004, increased $3.0 million, or 236%, as
compared to the same period in 2003. The improvement in operating earnings
in 2004 compared to 2003 for the first six months reflects improved
underwriting results in the Personal Lines Group, additional commission
revenue in the Commercial Lines Group and overall reduced interest expenses.
The following is additional business segment information for the six
months ended June 30, 2004 and 2003 (in thousands):
2004 2003
-------- --------
Revenues
--------
Personal Lines Group $ 20,215 $ 27,447
Commercial Lines Group 11,206 9,318
Corporate 2 -
-------- --------
Consolidated $ 31,423 $ 36,765
======== ========
Income before tax and extraordinary gain
----------------------------------------
Personal Lines Group $ 3,585 $ 2,083
Commercial Lines Group 1,255 489
Corporate (568) (1,302)
-------- --------
Consolidated $ 4,272 $ 1,270
======== ========
Personal Lines Group
Net premiums written decreased $6.8 million during the first six months
of 2004 to $15.8 million compared to $22.6 million during the same period of
2003. The decrease in net premiums written was primarily attributable to
the cancellation of unprofitable agents and programs, a shift in marketing
focus from annual term premium financed policies to six month term direct
bill policies and a reduction in policy counts caused by increased rates.
Net premiums earned decreased $7.7 million to $16.2 million for the six
months ended June 30, 2004, as compared to the same period of 2003. Net
premiums earned declined more than net premiums written due to the decrease
in the rate of reduction in written premium for the months prior to the six
months ended June 30, 2004 as compared to the same period in 2003.
Primarily as a result of the decline in net premiums earned, total revenue
for the Personal Lines Group decreased $7.2 million or 26%, for the first
six months of 2004 to $20.2 million from $27.4 million for the same period
in 2003.
Even though revenue for the Personal Lines Group declined, pre-tax
income increased $1.5 million, or 72% for the first six months of 2004
compared to the same period of 2003. The increase in pre-tax income was due
largely to improved underwriting results as shown by a loss ratio of 59.9%
for the first half of 2004 as compared to 69.3% for the same period of 2003.
Other operating costs and expenses declined $1.5 million due primarily to a
$0.9 million reduction in Phoenix policy service fees that were paid to
a third party in 2003. In 2004, the Company performed these services
internally with existing staff. Also contributing to the reduction in
operating expenses was a $0.3 million reduction in salary and related
expenses due to the successful integration of the Phoenix operations in late
2003 and the overall reduction in premium volume. Interest expense was $0.3
million less for the first six months of 2004 as compared to the same period
in 2003 due to the discontinuation of the premium finance program in July,
2003.
Commercial Lines Group
Total revenue for the Commercial Lines Group of $11.2 million for the
first six months of 2004 was $1.9 million more than the $9.3 million
reported for the same period in 2003. The improvement was primarily due to
a $1.5 million increase in commission revenue and a $0.3 million increase in
claim servicing fee revenue. Commercial premium volume growth was the
primary cause of the increased commission and claim fee revenue for the
first six months of 2004. Earned premium generated by the Commercial Lines
Group for the first six months of 2004 was $35.6 million compared to $29.7
million for the same period in 2003. The Company does not bear the primary
underwriting risk for this business and, therefore, the resulting premiums
and claims are not reflected in the Company's reported results.
Pre-tax income for the Commercial Lines Group of $1.3 million for the
first six months of 2004 increased $0.8 million over the $0.5 million
reported for the same period of 2003. Increased revenue, as discussed
above, was the primary reason for the increase in pre-tax income, partially
offset by additional agent commissions of $0.9 million due to the increased
premium volume and the payment of management fees to HFS of $0.3 million in
2004. Commercial Lines did not pay any management fees in 2003.
Corporate
Corporate pre-tax loss was $0.6 million for the first six months of
2004 as compared to $1.3 million for the same period in 2003. The Company
saved $0.5 million in interest expense for the first six months of 2004 as
compared to the same period in 2003 due to the repayment of a related party
note payable in September 2003. Also contributing to the decrease in pre-
tax loss were additional management fees collected from the Commercial Lines
Group of $0.3 million. Corporate did not collect any management fees in
2003 from the Commercial Lines Group.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Information required under Item 305 of Regulation S-K is not required
in this Form 10-Q.
Item 4. Controls and Procedures.
The Chief Executive Officer and Chief Financial Officer of the Company
have evaluated the Company's disclosure controls and procedures and have
concluded that such controls and procedures are effective as of the end of
the period covered by this report. During the most recent fiscal quarter,
there have been no changes in the Company's internal controls over financial
reporting that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
Risks Associated with Forward-Looking Statements Included in this Form 10-Q
This Form 10-Q 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, weather-related events 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-Q will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements
included herein, the inclusion of such information should not be regarded as
a representation by the Company or any other person that the objectives and
plans of the Company will be achieved.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is engaged in legal proceedings in the ordinary
course of business, none of which, either individually or in
the aggregate, are believed likely to have a material adverse
effect on the consolidated financial position of the Company
or the results of operations, in the opinion of management.
The various legal proceedings to which the Company is a party
are routine in nature and incidental to the Company's
business.
Item 2. Changes in Securities.
None.
Item 3. Defaults on Senior 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 20,
2004. Of the 36,447,291 shares of common stock of the Company
entitled to vote at the meeting, 35,135,155 shares were present
in person or by proxy.
(b) The following individuals were elected to serve as directors of
the Company and received the number of votes set forth opposite
their respective names:
Director Shares Voted For
Mark E. Schwarz 35,134,005
James H. Graves 35,134,005
George R. Manser 35,134,005
Scott T. Berlin 35,134,005
James C. Epstein 35,134,005
(c) There was no other business to come before the Annual Meeting.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) The exhibits listed in the Exhibit Index appearing on page 19
are filed herewith.
(b) The Company filed the following reports on Form 8-K during
the second quarter of 2004.
Form 8-K filed May 12, 2004 containing a press release
announcing the financial results for the first quarter
ended March 31, 2004.
Exhibit Index
-------------
Exhibit
Number Description
------ -----------
31(a) Certification of Chief Executive Officer required by
Rule 13a-14(a) or Rule 15d-14(a).
31(b) Certification of Chief Financial Officer required by
Rule 13a-14(a) or Rule 15d-14(a).
32(a) Certification of Chief Executive Officer Pursuant to 18
U.S.C. 1350 Enacted by Section 906 of the Sarbanes-Oxley
Act of 2002.
32(b) Certification of Chief Financial Officer Pursuant to 18
U.S.C. 1350 Enacted by Section 906 of the Sarbanes-Oxley
Act of 2002.
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 13, 2004 /s/ Mark E. Schwarz
---------------------------------------------
Mark E. Schwarz, Chairman (Chief
Executive Officer)
Date: August 13, 2004 /s/ Mark J. Morrison
---------------------------------------------
Mark J. Morrison, Executive Vice President
(Chief Financial Officer)