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 September 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
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(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 - 36,477,291 shares outstanding as of November 12, 2004.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Page Number
-----------
Consolidated Balance Sheets at September 30, 2004
(unaudited) and December 31, 2003 3
Consolidated Statements of Operations (unaudited)
for the three months and nine months ended
September 30, 2004 and September 30, 2003 4
Consolidated Statements of Cash Flows (unaudited)
for the nine months ended September 30, 2004 and
September 30, 2003 5
Notes to Consolidated Financial Statements (unaudited) 6
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30 December 31
ASSETS 2004 2003
------ ---------- ----------
(unaudited) (audited)
Investments:
Debt securities, available-for-sale,
at market value $ 26,672 $ 25,947
Equity securities, available-for-sale,
at market value 3,771 3,573
Short-term investments, available-for-sale,
at market value 3,055 335
---------- ----------
Total investments 33,498 29,855
Cash and cash equivalents 9,288 10,520
Restricted cash and investments 6,518 5,366
Prepaid reinsurance premiums 10 291
Premiums receivable 3,360 4,076
Accounts receivable 2,071 3,395
Reinsurance recoverable 4,975 10,516
Deferred policy acquisition costs 7,639 7,146
Excess of cost over fair value
of net assets acquired 4,836 4,836
Intangible assets 493 513
Current federal income tax recoverable - 625
Deferred federal income taxes 4,032 3,961
Other assets 3,431 2,753
---------- ----------
$ 80,151 $ 83,853
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Notes payable $ - $ 991
Unpaid losses and loss adjustment expenses 20,970 28,456
Unearned premiums 5,108 5,862
Unearned revenue 11,672 10,190
Accrued agent profit sharing 999 1,511
Accrued ceding commission payable 1,022 1,164
Pension liability 1,022 1,237
Current federal income tax payable 1,092 -
Accounts payable and other accrued expenses 6,271 7,045
---------- ----------
48,156 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 19,639 19,693
Retained earnings 11,702 7,254
Accumulated other comprehensive income (11) (93)
Treasury stock, 379,319 shares in 2004 and
484,319 in 2003, at cost (441) (563)
---------- ----------
Total stockholders' equity 31,995 27,397
---------- ----------
$ 80,151 $ 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 Nine Months Ended
September 30 September 30
--------------------- ----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Gross premiums written $ 7,410 $ 6,640 $ 23,174 $ 36,404
Ceded premiums written - 246 25 (6,934)
-------- -------- -------- --------
Net premiums written 7,410 6,886 23,199 29,470
Change in net unearned premiums 54 2,509 473 3,855
-------- -------- -------- --------
Net premiums earned 7,464 9,395 23,672 33,325
Investment income, net of expenses 371 360 994 822
Realized gain (loss) (57) (305) (57) (313)
Finance charges 561 856 1,644 2,936
Commission and fees 5,745 4,709 16,235 12,406
Processing and service fees 1,556 1,224 4,560 3,509
Other income 6 127 21 446
-------- -------- -------- --------
Total revenues 15,646 16,366 47,069 53,131
Losses and loss adjustment expenses 4,451 6,155 14,100 22,596
Other operating costs and expenses 8,903 9,559 26,346 27,724
Interest expense 16 359 61 1,234
Amortization of intangible asset 7 7 21 21
-------- -------- -------- --------
Total expenses 13,377 16,080 40,528 51,575
-------- -------- -------- --------
Income before income tax and
extraordinary gain 2,269 286 6,541 1,556
Income tax expense 726 66 2,093 498
-------- -------- -------- --------
Income before extraordinary gain $ 1,543 $ 220 $ 4,448 $ 1,058
Extraordinary gain - - - 8,116
-------- -------- -------- --------
Net income $ 1,543 $ 220 $ 4,448 $ 9,174
======== ======== ======== ========
Basic earnings per share:
Income before extraordinary gain $ 0.04 $ 0.01 $ 0.12 $ 0.08
Extraordinary gain - - - 0.65
-------- -------- -------- --------
Net income $ 0.04 $ 0.01 $ 0.12 $ 0.73
======== ======== ======== ========
Diluted earnings per share:
Income before extraordinary gain $ 0.04 $ 0.01 $ 0.12 $ 0.08
Extraordinary gain - - - 0.63
-------- -------- -------- --------
Net income $ 0.04 $ 0.01 $ 0.12 $ 0.71
======== ======== ======== ========
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)
Nine Months
September 30
------------------------
2004 2003
---------- ----------
Cash flows from operating activities:
Net income $ 4,448 $ 9,174
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 341 485
Change in deferred federal income taxes (124) 166
Change in prepaid reinsurance premiums 281 7,264
Change in premiums receivable 664 (1,223)
Change in accounts receivable 1,324 (774)
Change in deferred policy acquisition costs (493) (1,772)
Change in unpaid losses and loss
adjustment expenses (7,486) (4,716)
Change in unearned premiums (754) (10,201)
Change in unearned revenue 1,482 3,159
Change in accrued agent profit sharing (512) 318
Change in reinsurance recoverable 5,541 8,512
Change in reinsurance balances payable - (3,029)
Change in current federal income tax
payable/recoverable 1,717 385
Change in accrued ceding commission payable (142) (1,594)
Change in all other liabilities (989) 1,429
Change in all other assets (289) 513
---------- ----------
Net cash provided by (used in)
operating activities 5,009 (20)
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (364) (293)
Acquisition of subsidiary - 6,945
Premium finance notes collected,
net of finance notes originated 52 9,476
Change in restricted cash and investments (3,467) (5,052)
Purchase of fixed maturity and equity securities (2,506) (16,854)
Maturities and redemptions of investment
securities 3,411 6,384
Net redemptions (purchases) of short-term
investments (2,376) 8,904
---------- ----------
Net cash (used in) provided by
investing activities (5,250) 9,510
---------- ----------
Cash flows from financing activities:
Proceeds from rights offering - 10,000
Net advances from lender - (9,504)
Repayment of borrowings (991) (9,230)
---------- ----------
Net cash used in financing activities (991) (8,734)
Increase (decrease) in cash and cash equivalents (1,232) 756
Cash and cash equivalents at beginning of period 10,520 8,453
---------- ----------
Cash and cash equivalents at end of period $ 9,288 $ 9,209
========== ==========
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 September 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 September 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 September 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 Nine Months Ended
September 30 September 30
(in thousands) 2004 2003 2004 2003
------- ------- ------- -------
Net income as reported $ 1,543 $ 220 $ 4,448 $ 9,174
Add: Stock-based employee
compensation expenses
included in reported net
income, net of related
tax effects 5 8 15 16
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards,
net of related tax effect (8) (17) (25) (43)
------- ------- ------- -------
Pro forma net income $ 1,540 $ 211 $ 4,438 $ 9,147
======= ======= ======= =======
Earnings per share:
Basic-as reported $ 0.04 $ 0.01 $ 0.12 $ 0.73
======= ======= ======= =======
Basic-pro forma $ 0.04 $ 0.01 $ 0.12 $ 0.73
======= ======= ======= =======
Diluted-as reported $ 0.04 $ 0.01 $ 0.12 $ 0.71
======= ======= ======= =======
Diluted-pro forma $ 0.04 $ 0.01 $ 0.12 $ 0.71
======= ======= ======= =======
Note 2 - Supplemental Cash Flow Information
The Company transferred $2.4 million of fixed maturity investments from
restricted investments to debt securities, available-for-sale, during the
first nine months of 2004. The Company paid $500 thousand in taxes and $61
thousand in interest during the first nine months of 2004.
Note 3 - 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 Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
------ ------ ------ ------
Ceded earned premiums $ (2) $ 2,515 $ 256 $14,603
Reinsurance recoveries $ 563 $ 2,574 $ 774 $10,346
Note 4 - 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 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, Inc. ("AHGA"), a
managing general agency; Hallmark Finance Corporation ("HFC"), a premium
finance company; and Hallmark Claims Service, Inc. ("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 nine months ended September 30 (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
------- ------- ------- -------
Revenues
--------
Personal Lines Group $ 9,321 $ 11,321 $ 29,538 $ 38,768
Commercial Lines Group 6,325 5,045 17,529 14,363
Corporate - - 2 -
------- ------- ------- -------
Consolidated $ 15,646 $ 16,366 $ 47,069 $ 53,131
======= ======= ======= =======
Income before tax and
---------------------
extraordinary gain
------------------
Personal Lines Group $ 1,873 $ 683 $ 5,759 $ 3,091
Commercial Lines Group 1,167 351 2,719 814
Corporate (771) (748) (1,937) (2,349)
------- ------- ------- -------
Consolidated $ 2,269 $ 286 $ 6,541 $ 1,556
======= ======= ======= =======
The following is additional business segment information as of the following
dates (in thousands):
Sept. 30, Dec. 31,
2004 2003
-------- --------
Assets
------
Personal Lines Group $ 63,599 $ 68,247
Commercial Lines Group 15,921 13,365
Corporate 631 2,241
-------- --------
Consolidated $ 80,151 $ 83,853
======== ========
Note 5 - Deferred Policy Acquisition Costs
Total deferred and amortized policy acquisition costs for the three and nine
months ending September 30, 2004 and 2003 (in thousands) were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
------- ------- ------- -------
Deferred $ (5,940) $(15,271) $(17,277) $(19,634)
Amortized 6,044 14,206 16,784 18,780
------- ------- ------- -------
Net Deferred $ 104 $ (1,065) $ (493) $ (854)
======= ======= ======= =======
Note 6 - 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 Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
------- ------- ------- -------
Weighted average shares - basic 36,458 15,166 36,438 12,501
Effect of dilutive securities 283 206 193 310
------- ------- ------- -------
Weighted average shares -
assuming dilution 36,741 15,372 36,631 12,811
======= ======= ======= =======
Options to purchase 100,000 shares and 76,000 shares of common stock at
prices ranging from $0.75 to $1.00 were outstanding during the three months
ending September 30, 2004 and 2003, respectively, and options to purchase
125,000 shares and 76,000 shares of common stock at prices ranging from
$0.75 to $1.00 were outstanding during the nine months ending September 30,
2004 and 2003, respectively, but in each case 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 7 - Comprehensive Income
The following table sets forth comprehensive income for the periods
indicated (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
------- ------- ------- -------
Net income $ 1,543 $ 220 $ 4,448 $ 9,174
Pension liability, net of tax - (8) - (8)
Unrealized gain on available
for sale securities,
net of tax 460 355 82 414
------- ------- ------- -------
Other comprehensive income 460 347 82 406
------- ------- ------- -------
Comprehensive income $ 2,003 $ 567 $ 4,530 $ 9,580
======= ======= ======= =======
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 of Texas ("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, Inc. ("AHGA"), a managing general agency; Hallmark
Finance Corporation ("HFC"), a premium finance company; and Hallmark Claims
Service, Inc. ("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 assumed 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 was directly assumed by Dorinco. Under these reinsurance
arrangements, Hallmark is obligated to policyholders only for the portion of
risk assumed by Hallmark. Effective October 1, 2004, Hallmark entered into
a new quota share reinsurance agreement with OACM pursuant to which Hallmark
will assume the reinsurance of 100% of the Texas non-standard automobile
policies produced by AHGA after September 30, 2004. This agreement
supersedes the quota share reinsurance agreement between the parties
effective October 1, 2003. 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 September 30, 2004 were $42.8 million
compared to $40.4 million at December 31, 2003.
The Company's consolidated operating activities provided cash of $5.0
million for the first nine months of 2004 compared to cash used of $20
thousand for the first nine months of 2003. The increased operating cash
flow was primarily the result of a $5.0 million reduction in claims payments
attributable to improved loss experience and the planned reduction in
personal lines premium volume; a $4.7 million increase in ceding commissions
collected; and a $1.4 million reduction in interest payments resulting from
the retirement of a related party debt during the third quarter of 2003.
The improved operating cash flow was partially offset by a $3.7 million
decrease in collected personal lines premiums and a $2.3 million settlement
of a Phoenix bad faith claim in the first quarter of 2004.
Cash used by investing activities during the first nine months of 2004
was $5.3 million as compared to cash provided of $9.5 million for the
same period in 2003. During the first nine months of 2004, the Company
transferred $3.5 million into a restricted investment account for the
benefit of OACM and State & County, purchased $2.5 million of available
for sale securities and had net purchases of $2.4 million of short term
investments. These cash outlays were partially offset by $3.4 million
collected from the redemption of available for sale securities.
Cash used in financing activities decreased by $7.7 million in the
first nine months of 2004 as compared to the same period of 2003 primarily
due to the discontinuation of the premium finance program in 2003. As a
result, the Company did not repay any advances from the premium finance
lender in 2004. During the first nine months of 2003 the Company repaid
$9.5 million in premium finance advances. Also, in the third quarter of
2003, the Company received $10.0 million in proceeds from a rights offering,
of which the Company used $9.2 million to pay off a note payable to a
related party. During the third quarter 2004, the Company used $1.0 million
to pay off a note payable to Dorinco.
HFS is dependent on dividend payments and management fees from its
insurance subsidiaries and free cash flow of its non-insurance subsidiaries
to meet operating expenses and debt obligations. As of September 30, 2004,
cash and invested assets of HFS were $0.3 million. Cash and invested assets
of non-insurance subsidiaries were $6.8 million as of September 30, 2004.
As a property and casualty insurance company domiciled in Texas, Hallmark is
limited in the payment of dividends to its 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 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 nine 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 $0.5 million in management fees in 2004 to HFS and HFC paid $0.5
million in management fees to HFS in 2003.
The AZDOI regulates financial transactions between Phoenix, HFS and
affiliated companies. Applicable regulations require AZDOI's approval of
management and expense sharing contracts and similar transactions. Phoenix
has paid $0.9 million in management fees to AHGA during 2004.
Results of Operations
Three Months Ending September 30, 2004 as compared to Three Months Ending
September 30, 2003
Total revenues for the quarter ended September 30, 2004, decreased $0.7
million, or 4%, as compared to the same period of 2003, primarily as a
result of a $2.0 million reduction in total revenues from the Personal Lines
Group partially offset by a $1.3 million increase in total revenues from the
Commercial Lines Group. However, income before tax and extraordinary gain
for the quarter ended September 30, 2004, increased $2.0 million, or 693%,
as compared to the same period in 2003. The improvement in operating
earnings for the third quarter of 2004 compared to the third quarter of 2003
reflects improved underwriting results in the Personal Lines Group,
additional commission revenue in the Commercial Lines Group and an overall
reduction in interest expense as a result of the repayment of a related
party note in September 2003.
The following is additional business segment information for the three
months ended September 30, 2004 and 2003 (in thousands):
2004 2003
-------- --------
Revenues
--------
Personal Lines Group $ 9,321 $ 11,321
Commercial Lines Group 6,325 5,045
Corporate - -
-------- --------
Consolidated $ 15,646 $ 16,366
======== ========
Income before tax and
---------------------
extraordinary gain
------------------
Personal Lines Group $ 1,873 $ 683
Commercial Lines Group 1,167 351
Corporate (771) (748)
-------- --------
Consolidated $ 2,269 $ 286
======== ========
Personal Lines Group
Net premiums written increased $0.5 million during the third quarter of
2004 to $7.4 million compared to $6.9 million in the third quarter of 2003.
Net premiums earned decreased $1.9 million to $7.5 million for the quarter
ended September 30, 2004, as compared to $9.4 million in the same period of
2003. Primarily as a result of the decline in net premiums earned, total
revenue for the Personal Lines Group decreased $2.0 million or 18%, to $9.3
million for the third quarter of 2004 from $11.3 million for the same period
in 2003.
Although revenue for the Personal Lines Group declined, its pre-tax
income increased $1.2 million, or 174%, for the third quarter of 2004
compared to the third quarter of 2003. The increase in pre-tax income was
due largely to improved underwriting results as evidenced by a loss ratio
(defined as loss and loss adjustment expenses divided by net premiums
earned) of 60.0% for the third quarter of 2004 as compared to 66.3% for the
same period of 2003. Other operating costs and expenses declined $0.6
million for the Personal Lines Group due primarily to a $0.4 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 third 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 $6.3 million for the
third quarter of 2004 was $1.3 million more than the $5.0 million reported
in the third quarter of 2003. The improvement was primarily due to
additional commission revenue of $1.1 million and claim servicing fee
revenue of $0.2 million in the third quarter of 2004 as compared to the
same period in 2003. Increased commercial premium volume and improved
underwriting results were the cause of the increased commission and claim
fee revenue for the quarter. Earned premium generated by the Commercial
Lines Group for the third quarter of 2004 was $18.3 million as compared to
$16.2 million in the third 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 $1.2 million for the
third quarter of 2004 increased $0.8 million, or 232%, over the $0.4 million
reported for the third 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 $0.3 million due to the increased
premium volume and increased salary and related expenses of $0.2 million.
Corporate
Corporate pre-tax loss increased nominally to $0.8 million for the
third quarter of 2004 as compared to the same period in 2003. A $0.3
million increase in salary and related expenses was offset by a $0.3 million
reduction in interest expense for the third quarter of 2004 as compared to
the same period in 2003 due to the repayment of a related party note in
September 2003.
Nine Months Ending September 30, 2004 as compared to Nine Months Ending
September 30, 2003
Total revenues for the nine months ended September 30, 2004, decreased
$6.1 million, or 11%, as compared to the same period of 2003, primarily as
the result of a $9.2 million decline in total revenues from the Personal
Lines Group partially offset by a $3.1 million increase in total
revenues from the Commercial Lines Group. However, income before tax and
extraordinary gain for the nine months ended September 30, 2004, increased
$5.0 million, or 320%, as compared to the same period in 2003. The
improvement in operating earnings in 2004 compared to 2003 for the first
nine months reflects improved underwriting results in the Personal Lines
Group, additional commission revenue in the Commercial Lines Group and an
overall reduction in interest expense as a result of the repayment of a
related party note in September 2003.
The following is additional business segment information for the nine
months ended September 30, 2004 and 2003 (in thousands):
2004 2003
-------- --------
Revenues
--------
Personal Lines Group $ 29,538 $ 38,768
Commercial Lines Group 17,529 14,363
Corporate 2 -
-------- --------
Consolidated $ 47,069 $ 53,131
======== ========
Income before tax and
---------------------
extraordinary gain
------------------
Personal Lines Group $ 5,759 $ 3,091
Commercial Lines Group 2,719 814
Corporate (1,937) (2,349)
-------- --------
Consolidated $ 6,541 $ 1,556
======== ========
Personal Lines Group
Net premiums written decreased $6.3 million during the first nine
months of 2004 to $23.2 million compared to $29.5 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 $9.6 million to $23.7
million for the nine months ended September 30, 2004, as compared to $33.3
million in the same period of 2003. Primarily as a result of the decline in
net premiums earned, total revenue for the Personal Lines Group decreased
$9.2 million, or 24%, to $29.5 million for the first nine months of 2004
from $38.7 million for the same period in 2003.
Although revenue for the Personal Lines Group declined, its pre-tax
income increased $2.7 million, or 86%, for the first nine months of 2004
compared to the same period of 2003. The increase in pre-tax income was
partially due to improved underwriting results as evidenced by a loss ratio
of 59.9% for the first nine months of 2004 as compared to 68.4% for the same
period of 2003. Also contributing to the increase in pre-tax income was a
$1.3 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. Reduced salary and related expenses due to
the successful integration of the Phoenix operations in late 2003 and the
overall reduction in premium volume contributed $0.6 million to the increase
in pre-tax income. Partially offsetting these increases to pre-tax income
was the discontinuation of the premium finance program in July 2003 which
reduced finance charge revenue by $1.4 million as well as interest expense
by $0.4 million.
Commercial Lines Group
Total revenue for the Commercial Lines Group of $17.5 million for the
first nine months of 2004 was $3.1 million more than the $14.4 million
reported for the same period in 2003. The improvement was primarily due to
a $2.6 million increase in commission revenue and a $0.5 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 nine months of 2004. Earned premium generated by the Commercial Lines
Group for the first nine months of 2004 was $53.9 million compared to $45.9
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 $2.7 million for the
first nine months of 2004 increased $1.9 million, or 234%, over the $0.8
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 production related costs of $1.3 million due
to the increased premium volume.
Corporate
Corporate pre-tax loss was $1.9 million for the first nine months of
2004 as compared to $2.3 million for the same period in 2003. The Company
saved $0.8 million in interest expense for the first nine months of 2004 as
compared to the same period in 2003 due to the repayment of a related party
note in September 2003. This was partially offset by a $0.4 million increase
in salary and related expenses for the first nine months of 2004 as compared
to the same period in 2003.
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.
None.
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
(b) The Company filed the following reports on Form 8-K during the
third quarter of 2004.
Form 8-K filed August 13, 2004 containing a press release
announcing the financial results for the second quarter ended
June 30, 2004.
Exhibit Index
-------------
Exhibit
Number Description
------ -----------
10 Quota Share Reinsurance Agreement dated September 30,
2004 between Old American County Mutual Fire Insurance
Company and American Hallmark Insurance Company of
Texas.
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: November 12, 2004 /s/ Mark E. Schwarz
---------------------------------------------
Mark E. Schwarz, Chairman (Chief
Executive Officer)
Date: November 12, 2004 /s/ Mark J. Morrison
---------------------------------------------
Mark J. Morrison, Executive Vice President
(Chief Financial Officer)