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 March 31, 2005
Commission file number 0-16090
Hallmark Financial Services, Inc.
(Exact name of registrant 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.)
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 - 36,841,791 shares outstanding as of May 13, 2005.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Page Number
-----------
Consolidated Balance Sheets at March 31, 2005
(unaudited) and December 31, 2004 3
Consolidated Statements of Operations (unaudited) for
the three months ended March 31, 2005 and March 31, 2004 4
Consolidated Statements of Cash Flows (unaudited) for
the three months ended March 31, 2005 and March 31, 2004 5
Notes to Consolidated Financial Statements (unaudited) 6
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31 December 31
ASSETS 2005 2004
------ ---------- ----------
(unaudited) (audited)
Investments:
Debt securities, available-for-sale,
at market value $ 32,687 $ 28,206
Equity securities, available-for-sale,
at market value 3,406 3,580
Short-term investments, available-for-sale,
at market value 1,633 335
---------- ----------
Total investments 37,726 32,121
Cash and cash equivalents 6,278 12,901
Restricted cash and investments 6,480 6,509
Premiums receivable 4,358 4,103
Accounts receivable 2,391 3,494
Reinsurance recoverable 1,937 3,083
Deferred policy acquisition costs 7,847 7,475
Excess of cost over fair value
of net assets acquired 4,836 4,836
Intangible assets 479 486
Deferred federal income taxes 5,170 5,173
Other assets 2,483 2,330
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Total assets $ 79,985 $ 82,511
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Unpaid losses and loss adjustment expenses $ 19,205 $ 19,648
Unearned premiums 6,786 6,192
Unearned revenue 11,512 11,283
Accrued agent profit sharing 458 1,875
Accrued ceding commission payable 1,691 1,695
Pension liability 2,160 2,180
Current federal income tax payable 166 1,343
Accounts payable and other accrued expenses 3,995 5,639
---------- ----------
Total liabilities 45,973 49,855
Commitments and Contingencies
Stockholders' equity:
Common stock, $.03 par value (authorized
100,000,000 shares; issued 36,856,610
shares in 2005 and 2004) 1,106 1,106
Capital in excess of par value 19,640 19,647
Retained earnings 14,918 13,103
Accumulated other comprehensive income (1,240) (759)
Treasury stock, at cost (354,319 shares
in 2005 and 379,319 in 2004) (412) (441)
---------- ----------
Total stockholders' equity 34,012 32,656
---------- ----------
$ 79,985 $ 82,511
========== ==========
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)
Three Months Ended
March 31
------------------------
2005 2004
---------- ----------
Gross premiums written $ 10,634 $ 8,753
Ceded premiums written - 24
---------- ----------
Net premiums written 10,634 8,777
Change in unearned premiums (594) (513)
---------- ----------
Net premiums earned 10,040 8,264
Investment income, net of expenses 411 279
Finance charges 540 547
Commission and fees 4,812 5,195
Processing and service fees 1,634 1,480
Other income 8 8
---------- ----------
Total revenues 17,445 15,773
Losses and loss adjustment expenses 6,026 5,227
Other operating costs and expenses 8,705 8,439
Interest expense 3 24
Amortization of intangible asset 7 7
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Total expenses 14,741 13,697
Income before tax 2,704 2,076
Income tax expense 889 664
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Net income $ 1,815 $ 1,412
========== ==========
Net income per share:
Basic $ 0.05 $ 0.04
========== ==========
Diluted $ 0.05 $ 0.04
========== ==========
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)
Three Months Ended
March 31
------------------------
2005 2004
---------- ----------
Cash flows from operating activities:
Net income $ 1,815 $ 1,412
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Depreciation and amortization expense 72 112
Deferred federal income tax expense 266 177
Change in prepaid reinsurance premiums - 281
Change in premiums receivable (255) (135)
Change in accounts receivable 1,103 (91)
Change in deferred policy acquisition costs (372) (509)
Change in unpaid losses and loss
adjustment expenses (443) (4,694)
Change in unearned premiums 594 232
Change in unearned revenue 229 688
Change in accrued agent profit sharing (1,417) (1,146)
Change in reinsurance recoverable 1,146 3,081
Change in current federal income tax
payable/recoverable (1,177) 664
Change in accrued ceding commission payable (4) 1
Change in all other liabilities (1,618) (254)
Change in all other assets (180) (146)
---------- ----------
Net cash used in operating activities (241) (327)
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (52) (46)
Premium finance notes originated,
net of finance notes repaid - (68)
Change in restricted cash and investments 29 (2,335)
Purchases of debt and equity securities (5,076) -
Maturities and redemptions of investment
securities 1 1,000
Net purchases of short-term investments (1,297) (110)
---------- ----------
Net cash used in investing activities (6,395) (1,559)
---------- ----------
Cash flows from financing activities:
Proceeds from exercise of employee
stock options 13 -
Repayment of borrowings - (182)
---------- ----------
Net cash provided by (used in)
financing activities 13 (182)
---------- ----------
Decrease in cash and cash equivalents (6,623) (2,068)
Cash and cash equivalents at beginning of period 12,901 10,520
---------- ----------
Cash and cash equivalents at end of period $ 6,278 $ 8,452
========== ==========
Supplemental Cash Flow Information:
Interest paid $ 3 $ 24
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Taxes paid $ 1,800 $ -
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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 March 31, 2005 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 US generally accepted accounting
principles ("GAAP") have been condensed or omitted. Reference is made to
the Company's annual consolidated financial statements for the year ended
December 31, 2004 for a description of accounting policies and certain other
disclosures. Certain items in the 2004 financial statements have been
reclassified to conform to the 2005 presentation.
The results of operations for the period ended March 31, 2005 are not
necessarily indicative of the operating results to be expected for the full
year.
In December 2004, the Financial Accounting Standards Board ("FASB")
issued Statement No. 123R "Share-Based Payment" ("SFAS 123R"), which revises
FASB Statement No. 123 ("SFAS 123") and supersedes APB 25. SFAS 123R
eliminates an entity's ability to account for share-based payments using APB
25 and requires all such transactions to be accounted for using a fair value
based method. In April 2005, the Securities and Exchange Commission deferred
the effective date of SFAS 123R from the first interim or annual period
beginning after June 15, 2005 to the next fiscal year beginning after
June 15, 2005. SFAS 123R is not expected to have a material impact on the
Company's consolidated financial statements.
Note 2 - Equity Compensation Plans
The Company has stock options outstanding under a stock-based employee
compensation plan for key employees and a non-qualified plan for non-
employee directors. These plans both expired in 2004 and are described
more fully in Note 10 to the Company's Form 10-K for the year ended
December 31, 2004. Effective January 1, 2003, the Company adopted the fair
value recognition provisions of SFAS 123 and the prospective method of
adoption provided under FASB Statement No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS 148"). 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
March 31
(in thousands) 2005 2004
------ ------
Net income as reported $ 1,815 $ 1,412
Add: Stock-based employee compensation
expenses included in reported net income,
net of related tax effects 6 5
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (9) (8)
------ ------
Pro forma net income $ 1,812 $ 1,409
====== ======
Earnings per share:
Basic-as reported $ 0.05 $ 0.04
====== ======
Basic-pro forma $ 0.05 $ 0.04
====== ======
Diluted-as reported $ 0.05 $ 0.04
====== ======
Diluted-pro forma $ 0.05 $ 0.04
====== ======
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 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 ("AHGA"), a managing general agency; 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
months ended March 31, 2005 and 2004 (in thousands):
Three Months Ended
March 31,
2005 2004
-------- --------
Revenues
--------
Personal Lines Group $ 11,161 $ 10,259
Commercial Lines Group 6,280 5,513
Corporate 4 1
-------- --------
Consolidated $ 17,445 $ 15,773
======== ========
Pre-tax income (loss)
---------------------
Personal Lines Group $ 2,442 $ 1,786
Commercial Lines Group 1,068 820
Corporate (806) (530)
-------- --------
Consolidated $ 2,704 $ 2,076
======== ========
The following is additional business segment information as of the
dates indicated (in thousands):
Mar. 31, Dec. 31,
2005 2004
-------- --------
Assets
------
Personal Lines Group $ 61,830 $ 63,136
Commercial Lines Group 17,770 18,557
Corporate 385 818
-------- --------
Consolidated $ 79,985 $ 82,511
======== ========
Note 4 - Reinsurance
Prior to April 1, 2003, Hallmark ceded reinsurance to other companies.
These reinsurance arrangements are more fully described in Note 5 to the
Company's Form 10-K for the year ended December 31, 2004. The Company
remains obligated to its policyholders in the event that the reinsurers do
not meet their obligations under the reinsurance agreements.
Under its prior reinsurance arrangements, the Company continues to earn
ceding commissions based on loss ratio experience on the portion of the
policies ceded. The Company received a provisional commission as policies
were produced as an advance against the later determination of the
commission actually earned.
The following table shows earned premiums ceded and reinsurance loss
recoveries by period (in thousands):
Three Months Ended
March 31,
2005 2004
-------- --------
Ceded earned premiums $ - $ 257
Reinsurance recoveries $ (391) $ (326)
Note 5 - Deferred Policy Acquisition Costs
Total deferred and amortized policy acquisition costs for the three months
ending March 31, 2005 and 2004 (in thousands) were as follows:
Three Months Ended
March 31,
2005 2004
-------- --------
Deferred $ (6,087) $ (6,148)
Amortized 5,715 5,639
-------- --------
Net Deferred $ (372) $ (509)
======== ========
Note 6 - Earnings per Share
The Company has adopted the provisions of FASB Statement 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
March 31,
2005 2004
-------- --------
Weighted average shares - basic 36,493 36,443
Effect of dilutive securities 694 127
-------- --------
Weighted average shares - assuming dilution 37,187 36,570
======== ========
For the three months ended March 31, 2005 and 2004, -0- and 771,000 shares,
respectively, attributable to outstanding stock options were excluded from
the calculation of diluted earnings per share because the exercise prices of
the stock options were greater than or equal to the average price of the
common shares and, therefore, their inclusion would have been anti-dilutive.
Note 7 - Comprehensive Income
The following table sets forth comprehensive income for the periods
indicated (in thousands):
Three Months Ended
March 31,
2005 2004
-------- --------
Net Income $ 1,815 $ 1,412
Additional pension liability, net of tax 30 -
Unrealized gain/(loss) on available
for sale securities, net of tax (511) 305
-------- --------
Other comprehensive income (loss) (481) 305
-------- --------
Comprehensive income $ 1,334 $ 1,717
======== ========
Note 8 - Net Periodic Pension Cost
The Company recognized $16 thousand in net periodic pension cost during the
first quarter of 2005. The components of this cost are interest cost of
$181 thousand, amortization of net loss of $19 thousand and expected return
on plan assets of ($184) thousand.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Management Overview
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 subsidiaries organized into a Personal Lines
Group, which handles non-standard personal automobile insurance, and a
Commercial Lines Group, which handles commercial insurance. 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
("AHGA"), a managing general agency; 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").
During the first quarter of fiscal 2005, total revenues of the Company
were $17.4 million, representing a 10.6% increase over the $15.8 million in
total revenues for the comparable period of fiscal 2004. For the three
months ended March 31, 2005, the Company reported net income of $1.8
million, representing a 28.5% increase over the $1.4 million reported in the
first quarter of 2004. On a diluted per share basis, net income was $0.05
for the three months ended March 31, 2005 as compared to $0.04 for the same
period in the prior year.
The increase in total revenues for the quarter ended March 31, 2005 as
compared to the first quarter of fiscal 2004 was primarily attributable to
increased premium assumption by the Personal Lines Group as a result of
changes in Hallmark's reinsurance arrangements and the combined impact of
increased premium volume and improved commission terms in the Commercial
Lines Group. The increase in net income for the first quarter of 2005
versus the same period in 2004 reflects ongoing initiatives to improve
underwriting performance in both operating units, increased premium
assumption by the Personal Lines Group and additional commission revenue in
the Commercial Lines Group.
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), 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 March 31, 2005
were $44.0 million compared to $45.0 million at December 31, 2004.
Net cash used by the Company's consolidated operating activities was
$0.2 million for the first three months of 2005 compared to $0.3 million for
the first three months of 2004. The change in operating cash flow primarily
resulted from a $1.7 million increase in collected premiums due to more
assumed premium than the first quarter of 2004 and a $1.5 million decrease
in net loss and loss adjustment expenses paid due to improved underwriting
performance, partially offset by a $1.8 million tax deposit made in the
first quarter of 2005, incentive compensation payments of $0.9 million paid
in the first quarter of 2005 and a $0.1 million reduction in collected
ceding commissions due to increased premium assumption.
Cash used by investing activities during the first three months of 2005
was $6.4 million as compared to $1.6 million for the same period in 2004.
The increase in cash used in investing activities is mainly due to the
purchase of $5.1 million in debt and equity securities in the first quarter
of 2005, the $1.2 million increase in net purchases of short-term
investments and the maturity of $1.0 million in debt securities in the first
quarter of 2004, partially offset by a transfer of $2.3 million into
restricted cash and investments in the first quarter of 2004.
Cash provided by financing activities was $13 thousand in proceeds from
the exercise of employee stock options in the first three months of 2005 as
compared to cash used in financing activities of $0.2 million from the
repayment on a note payable to Dorinco during the same period in 2004.
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 March 31, 2005, cash
and invested assets of HFS were $0.2 million. Cash and invested assets of
non-insurance subsidiaries were $6.6 million as of March 31, 2005. 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 Commissioner of Insurance,
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 2005, Hallmark's
ordinary dividend capacity is $1.5 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 AZDOI. During 2005, Phoenix's ordinary dividend
capacity is $0.8 million. Neither Hallmark nor Phoenix paid a dividend to
HFS during the first quarter of 2005.
The Texas Department of Insurance ("TDI") regulates financial transactions
between Hallmark and affiliated companies. Applicable regulations require
TDI's approval of management and expense sharing contracts and similar
transactions. AHGA paid $0.3 million and $0.2 million in management fees to
HFS during the first three months of 2005 and 2004, respectively.
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 $0.3
million in management fees to AHGA during the first three months of 2005 and
2004, respectively.
Results of Operations
Income before tax was $2.7 million for the quarter ended March 31,
2005, compared to $2.1 million for the same period in 2004. The improvement
in pre-tax earnings for the first quarter of 2005 compared to the first
quarter of 2004 reflects increased premium assumption and improved
underwriting results in the Personal Lines Group and additional commission
revenue in the Commercial Lines Group from increased premium volume and
improved commission terms.
The following is additional business segment information for the three
months ended March 31 (in thousands):
2005 2004
-------- --------
Revenues
--------
Personal Lines Group $ 11,161 $ 10,259
Commercial Lines Group 6,280 5,513
Corporate 4 1
-------- --------
Consolidated $ 17,445 $ 15,773
======== ========
Pre-tax income (loss)
---------------------
Personal Lines Group $ 2,442 $ 1,786
Commercial Lines Group 1,068 820
Corporate (806) (530)
-------- --------
Consolidated $ 2,704 $ 2,076
======== ========
Personal Lines Group
Net premium written increased $1.9 million during the first quarter of
2005 to $10.6 million compared to $8.8 million in the first quarter of 2004.
The increase is due mainly to Hallmark assuming 100% of the Texas non-
standard automobile business produced by AHGA and underwritten by a
third party, effective October 1, 2004. Prior to October 1, 2004, Hallmark
assumed only 45% of this business. Total premium production for the first
quarter of 2005 declined $2.3 million, or 18.3%, from the $12.9 million
produced in the first quarter of 2004. The decline in produced premium is
reflective of increased competition from newly capitalized entities entering
the marketplace that are requiring premium growth either organically or
through acquisitions to meet expected revenue targets and return on equity.
This pressure has resulted in a general bias towards neutral overall rate
adjustments with targeted rate decreases.
Revenue for the Personal Lines Group increased 8.8% for the first
quarter of 2005 to $11.2 million from $10.3 million for the same period in
2004. Increased net premium earned of $1.8 million due to higher assumed
premium volume is the primary cause of this increase. This increase in net
premiums earned was partially offset by a $0.9 million decrease in ceding
commission income due to Hallmark assuming 100% of the Texas non-standard
automobile business effective October 1, 2004.
Pre-tax income for the Personal Lines Group increased $0.7 million, or
36.7% for the first quarter of 2005 compared to the first quarter of 2004.
Approximately $0.3 million of the increase in pre-tax income was due to
improved loss experience as evidenced by a loss ratio (defined as loss and
loss adjustment expenses divided by net premiums earned) of 60.2% for the
first quarter of 2005 as compared to 63.6% for the same period in 2004.
Taking into consideration the effect on ceding commissions, increased loss
and loss adjustment expenses and premium production costs, the changes in
premium volume produced and assumed contributed $0.1 million to the increase
in pre-tax income. Lower salary and related expenses contributed $0.2
million and increased investment income contributed $0.1 million to the
increased pre-tax income for the first quarter of 2005 over 2004.
Commercial Lines Group
Total revenue for the Commercial Lines Group of $6.3 million for the
first quarter of 2005 was $0.8 million more than the $5.5 million reported
in the first quarter of 2004. This 13.9% increase in total revenue was
primarily due to additional commission revenue of $0.6 million in the first
quarter of 2005 as compared to the same period in 2004. Increased
commercial premium volume and improved commission terms were the primary
causes of the increased commission revenue for the quarter. Earned premium
generated by the Commercial Lines Group for the first quarter of 2005 was
$18.9 million as compared to $17.5 million in the first quarter of 2004.
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 $1.1 million for the
first quarter of 2005 increased $0.3 million, or 30.2%, over the $0.8
million reported for the first quarter of 2004. Increased revenue, as
discussed above, is the primary reason for the increase in pre-tax income,
partially offset by additional agent commissions of $0.4 million due to the
increased premium volume and increased salary and related expenses of $0.1
million.
Corporate
Corporate pre-tax loss was $0.8 million for the first quarter of 2005
as compared to $0.5 million for the same period in 2004. The increase was
due mostly to the transfer of accounting positions from both the Personal
Lines and Commercial Lines Groups to Corporate.
Strategic Initiatives
The Company is in the process of implementing a strategic plan intended
to enhance its opportunities for profitable growth. The primary elements of
this strategic plan are (i) the infusion of additional working capital,
(ii) the realignment and expansion of the Company's insurance operations,
and (iii) the enhancement of the Company's financial strength ratings.
Management believes that the successful implementation of these and other
related initiatives will position the Company to increase gross premium
written, reduce reliance on reinsurance, pursue geographic expansion,
withstand soft market conditions and explore strategic acquisitions.
However, there is no assurance that all elements of this strategic plan will
be successfully completed or that any of the desired objectives will be
attained.
As a part of the first element of this strategic plan, the Company is
presently offering additional shares of its common stock exclusively to its
existing shareholders pursuant to a rights offering (Form S-3 Registration
Statement No. 333-123993) scheduled to conclude on May 31, 2005. The
successful completion of this offering will add approximately $45.0 million
to the working capital of the Company. In addition, the Company is
presently evaluating alternatives for a $30.0 million private debt issuance
to further enhance working capital sufficiently to achieve the desired
financial strength ratings. This new indebtedness could be in the form of
trust preferred securities, senior or subordinated notes, surplus notes or
bank term loans, or could be comprised of any combination of these debt
vehicles. However, the structure and terms of this new indebtedness have
not yet been finalized. Therefore, there is no assurance that this
placement of debt instruments can be completed on acceptable terms.
The Company has filed applications with insurance regulators in Texas,
New Mexico, Idaho, Oregon and Washington to obtain a certificate of
authority for Hallmark, as an admitted property and casualty company, to
underwrite commercial insurance policies similar to those presently marketed
by our Commercial Lines Group on behalf of a third party. Upon approval of
these applications and the infusion of additional working capital, the
Company intends to consolidate the underwriting of all of its non-standard
automobile insurance in Phoenix and begin underwriting commercial insurance
through Hallmark. As a result, Hallmark would become a component of the
Commercial Lines Group. However, there is no assurance that the necessary
regulatory approval can be timely obtained or that the Company will
successfully implement the realignment of its insurance operations.
Management believes that enhancing the financial strength ratings of
the Company's insurance subsidiaries is critical to fully achieving the
objectives of this strategic plan. The Company has presented the strategic
plan to its primary rating agency and is confident that, upon full
implementation of the plan, the financial strength ratings of Phoenix
and Hallmark will be upgraded. In order to maintain these ratings,
the capitalization and operating performance of the Company's insurance
subsidiaries must be consistent with projections provided to the rating
agency. There is no assurance that the Company will be able to satisfy the
conditions to obtain and maintain these improved financial strength ratings.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
As of March 31, 2005, there had been no material changes in the market
risks described in the Company's Form 10-K for the year ended December 31,
2004.
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, as of the end of the period covered by this report,
such disclosure controls and procedures were effective in ensuring that
information required to be disclosed by the Company in the reports that it
files or submits under the Securities Exchange Act of 1934 is timely
recorded, processed, summarized and reported. The Chief Executive Officer
and Chief Financial Officer also concluded that such disclosure controls and
procedures were effective in ensuring that information required to be
disclosed by the Company in the reports that it files or submits under such
Act is accumulated and communicated to the Company's management, including
its Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure. 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. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon 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 exhibit listed in the Exhibit Index appearing on page 18 is
filed herewith.
(b) The Company filed the following reports on Form 8-K during the
first quarter of 2005.
Form 8-K filed March 9, 2005 announcing the approval of
bonuses for each of the Company's executive officers.
Form 8-K filed March 31, 2005 containing a press release
announcing the financial results for the fourth quarter and
year-ended December 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: May 13, 2005 /s/ Mark E. Schwarz
---------------------------------------------
Mark E. Schwarz, Chairman
(Chief Executive Officer)
Date: May 13, 2005 /s/ Mark J. Morrison
---------------------------------------------
Mark J. Morrison, Executive Vice President
(Chief Operating Officer and Chief Financial
Officer)