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, 2005
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
$.03 per share - 86,841,791 shares outstanding as of August 5, 2005.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Page Number
-----------
Consolidated Balance Sheets at June 30, 2005 3
(unaudited) and December 31, 2004
Consolidated Statements of Operations (unaudited) 4
for the three months and six months ended June 30,
2005 and June 30, 2004
Consolidated Statements of Stockholders' Equity and 5
Comprehensive Income (unaudited) for the three months
and six months ended June 30, 2005 and June 30, 2004
Consolidated Statements of Cash Flows (unaudited) for 6
the six months ended June 30, 2005 and June 30, 2004
Notes to Consolidated Financial Statements (unaudited) 7
Hallmark Financial Services, Inc.
Consolidated Balance Sheets
($ in thousands)
June 30 December 31
ASSETS 2005 2004
------ ---------- ----------
(unaudited) (audited)
Investments:
Debt securities, available-for-sale,
at market value $ 35,223 $ 28,206
Equity securities, available-for-sale,
at market value 4,315 3,580
Short-term investments, available-for-sale,
at market value 335 335
---------- ----------
Total investments 39,873 32,121
Cash and cash equivalents 81,756 12,901
Restricted cash and investments 6,579 6,509
Premiums receivable 3,832 4,103
Accounts receivable 2,411 3,494
Reinsurance recoverable 1,431 3,083
Deferred policy acquisition costs 8,103 7,475
Excess of cost over fair value
of net assets acquired 4,836 4,836
Intangible assets 472 486
Deferred federal income taxes 4,782 5,173
Other assets 3,973 2,330
---------- ----------
Total assets $ 158,048 $ 82,511
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Unpaid losses and loss adjustment expenses $ 18,501 $ 19,648
Unearned premiums 5,962 6,192
Unearned revenue 12,122 11,283
Note payable 30,928 -
Accrued agent profit sharing 941 1,875
Accrued ceding commission payable 1,201 1,695
Pension liability 2,145 2,180
Current federal income tax payable 183 1,343
Accounts payable and other accrued expenses 4,620 5,639
---------- ----------
Total liabilities 76,603 49,855
Commitments and Contingencies
Stockholders' equity:
Common stock, $.03 par value (authorized
100,000,000 shares; issued 86,856,610
shares in 2005 and 36,856,610 shares
in 2004) 2,606 1,106
Additional paid in capital 62,898 19,647
Retained earnings 16,922 13,103
Accumulated other comprehensive income (964) (759)
Treasury stock, at cost (14,819 shares
in 2005 and 379,319 in 2004) (17) (441)
---------- ----------
Total stockholders' equity 81,445 32,656
---------- ----------
$ 158,048 $ 82,511
========== ==========
The accompanying notes are an integral part
of the consolidated financial statements
Hallmark Financial Services, Inc.
Consolidated Statements of Operations
(Unaudited)
($ in thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30 June 30
--------------------- ----------------------
2005 2004 2005 2004
-------- -------- -------- --------
Gross premiums written $ 8,839 $ 7,011 $ 19,473 $ 15,764
Ceded premiums written - 1 - 25
-------- -------- -------- --------
Net premiums written 8,839 7,012 19,473 15,789
Change in unearned premiums 824 932 230 419
-------- -------- -------- --------
Net premiums earned 9,663 7,944 19,703 16,208
Investment income, net of expenses 451 344 862 623
Realized loss (41) - (41) -
Finance charges 509 536 1,049 1,083
Commission and fees 5,628 5,295 10,440 10,490
Processing and service fees 1,570 1,524 3,204 3,004
Other income 5 7 13 15
-------- -------- -------- --------
Total revenues 17,785 15,650 35,230 31,423
Losses and loss adjustment expenses 5,515 4,422 11,541 9,649
Other operating costs and expenses 9,150 9,004 17,855 17,443
Interest expense 102 21 105 45
Amortization of intangible asset 7 7 14 14
-------- -------- -------- --------
Total expenses 14,774 13,454 29,515 27,151
Income before tax 3,011 2,196 5,715 4,272
Income tax expense 1,007 703 1,896 1,367
-------- -------- -------- --------
Net income $ 2,004 $ 1,493 $ 3,819 $ 2,905
======== ======== ======== ========
Net income per share:
Basic $ 0.03 $ 0.04 $ 0.08 $ 0.07
======== ======== ======== ========
Diluted $ 0.03 $ 0.04 $ 0.07 $ 0.07
======== ======== ======== ========
The accompanying notes are an integral part
of the consolidated financial statements
Hallmark Financial Services, Inc.
Consolidated Statements of Stockholders' Equity and Comprehensive Income
(Unaudited)
($ in thousands)
Three Months Ended Six Months Ended
June 30 June 30
--------------------- ----------------------
2005 2004 2005 2004
-------- -------- -------- --------
Common Stock
Balance, beginning of period $ 1,106 $ 1,106 $ 1,106 $ 1,106
Issuance of common stock in
rights offering (50,000,000
shares in 2005) 1,500 - 1,500 -
-------- -------- -------- --------
Balance, end of period 2,606 1,106 2,606 1,106
Additional Paid-In Capital
Balance, beginning of period 19,640 19,641 19,647 19,693
Issuance of common stock in
rights offering (50,000,000
shares in 2005), net of $78
in expenses 43,422 - 43,422 -
Equity based compensation 14 7 23 14
Exercise of stock options (178) - (194) (59)
-------- -------- -------- --------
Balance, end of period 62,898 19,648 62,898 19,648
Retained Earnings
Balance, beginning of period 14,918 8,666 13,103 7,254
Net income 2,004 1,493 3,819 2,905
-------- -------- -------- --------
Balance, end of period 16,922 10,159 16,922 10,159
Accumulated Other Comprehensive
Income (Loss)
Balance, beginning of period (1,240) 212 (759) (93)
Additional minimum pension liability,
net of tax - - 30 -
Unrealized gains (losses) on
securities, net of tax 276 (683) (235) (378)
-------- -------- -------- --------
Balance, end of period (964) (471) (964) (471)
Treasury Stock
Balance, beginning of period (412) (476) (441) (563)
Exercise of stock options 395 - 424 87
-------- -------- -------- --------
Balance, end of period (17) (476) (17) (476)
--------------------------------------------------
Stockholders' Equity $ 81,445 $ 29,966 $ 81,445 $ 29,966
==================================================
Net income $ 2,004 $ 1,493 $ 3,819 $ 2,905
Additional minimum pension
liability, net of tax - - 30 -
Unrealized gains (losses)
on securities, net of tax 276 (683) (235) (378)
--------------------------------------------------
Comprehensive Income $ 2,280 $ 810 $ 3,614 $ 2,527
==================================================
The accompanying notes are an integral part
of the consolidated financial statements
Hallmark Financial Services, Inc.
Consolidated Statement of Cash Flows
(Unaudited)
($ in thousands)
Six Months Ended
June 30
------------------------
2005 2004
---------- ----------
Cash flows from operating activities:
Net income $ 3,819 $ 2,905
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Depreciation and amortization expense 178 224
Deferred federal income tax expense 512 122
Realized loss on investments 41 -
Change in prepaid reinsurance premiums - 283
Change in premiums receivable 271 313
Change in accounts receivable 1,083 739
Change in deferred policy acquisition costs (628) (597)
Change in unpaid losses and loss adjustment
expenses (1,147) (6,290)
Change in unearned premiums (230) (702)
Change in unearned revenue 839 1,420
Change in accrued agent profit sharing (934) (826)
Change in reinsurance recoverable 1,652 5,350
Change in current federal income tax payable/
recoverable (1,160) 745
Change in accrued ceding commission payable (494) 44
Change in all other liabilities (1,024) (661)
Change in all other assets (601) (297)
---------- ----------
Net cash provided by operating activities 2,177 2,772
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (164) (75)
Premium finance notes repaid,
net of finance notes originated - 51
Change in restricted cash and investments (70) (3,269)
Purchases of debt and equity securities (8,802) (1,138)
Maturities and redemptions of investment
securities 538 2,634
Net purchases of short-term investments 3 (2,376)
---------- ----------
Net cash used in investing activities (8,495) (4,173)
---------- ----------
Cash flows from financing activities:
Proceeds from exercise of employee stock options 230 28
Proceeds from stockholder rights offering 44,922 -
Proceeds (repayments) of borrowings 30,928 (364)
Debt issuance costs (907) -
---------- ----------
Net cash provided by (used in)
financing activities 75,173 (336)
---------- ----------
Decrease in cash and cash equivalents 68,855 (1,737)
Cash and cash equivalents at beginning of period 12,901 10,520
---------- ----------
Cash and cash equivalents at end of period $ 81,756 $ 8,783
========== ==========
Supplemental Cash Flow Information:
Interest paid $ 8 $ 45
---------- ----------
Taxes paid $ 2,554 $ 500
---------- ----------
The accompanying notes are an integral part
of the consolidated financial statements
Hallmark Financial Services, Inc.
Notes to Consolidated Financial Statements (Unaudited)
1. General
Hallmark Financial Services, Inc., ("Hallmark" and, together with
subsidiaries, "we", "us", "our") is an insurance holding company engaged in
the sale of property and casualty insurance products. Our business involves
the marketing and underwriting of non-standard personal automobile insurance
in Texas, New Mexico and Arizona; marketing commercial insurance in Texas,
New Mexico, Idaho, Oregon and Washington; affiliate and third party claims
administration; and other insurance related services. We pursue our
business activities through integrated insurance groups handling 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
("AHIC"), an authorized Texas property and casualty insurance company;
Phoenix Indemnity Insurance Company ("PIIC"), an authorized Arizona property
and casualty insurance company; American Hallmark General Agency, Inc.
("AHGA"), a managing general agency; and Hallmark Claims Services, Inc.
("HCS"), an affiliate and third party 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 second quarter of 2005, we completed a $45.0 million
shareholder rights offering and a $30.0 million private placement of trust
preferred securities. As a result of these capital enhancements, A.M. Best
announced on June 21, 2005 the upgrades of the financial strength ratings of
AHIC to A- (excellent) from B (fair) and PIIC to B+ (very good) from B-
(fair).
During the third quarter of 2005, we intend to begin underwriting and
issuing AHIC policies for the commercial insurance business produced by HGA
in order to capture the underwriting margin that is currently paid to
a third party insurer. After we have obtained all required regulatory
approvals, we also intend to consolidate the underwriting of our non-
standard personal automobile insurance business into PIIC during the third
quarter of 2005. As a result of these changes, we expect AHIC to become a
part of the Commercial Lines Group during the third quarter of 2005.
2. Basis of Presentation
Our unaudited consolidated financial statements included herein have
been prepared in accordance with accounting principles generally accepted in
the United States of America ("GAAP") and include our accounts and the
accounts of our subsidiaries. All significant inter-company accounts and
transactions have been eliminated in consolidation. Certain information and
footnote disclosures normally included in financial statements prepared
in accordance with GAAP have been condensed or omitted pursuant to rules
and regulations of the Securities and Exchange Commission ("SEC") for
interim financial reporting. These financial statements should be read in
conjunction with our audited financial statements for the year ended
December 31, 2004 included in our report on Form 10-K filed with the SEC.
The interim financial data as of June 30, 2005 and 2004 is unaudited.
However, in the opinion of management, the interim data includes all
adjustments, consisting only of normal recurring adjustments, necessary for
a fair statement of the results for the interim periods. The results of
operations for the period ended June 30, 2005 are not necessarily indicative
of the operating results to be expected for the full year.
Reclassification
Certain previously reported amounts have been reclassified in order to
conform to current year presentation. Such reclassification had no effect
on net income or stockholders' equity.
Use of Estimates in the Preparation of the Financial Statements
Our preparation of financial statements in conformity with GAAP
requires us to make estimates and assumptions that affect our reported
amounts of assets and liabilities and our disclosure of contingent assets
and liabilities at the date of our financial statements, as well as our
reported amounts of revenues and expenses during the reporting period.
Actual results could differ materially from those estimates.
Recently Issued Accounting Standards
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 that all such transactions be accounted for using a fair
value based method. In April 2005, the SEC 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 our results of operations or
financial position.
3. Equity Compensation Plans
We have stock options outstanding under stock-based compensation plans
for key employees and non-employee directors. Effective January 1, 2003, we
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 Six Months Ended
June 30, June 30,
(in thousands) 2005 2004 2005 2004
------- ------- ------- -------
Net income as reported $ 2,004 $ 1,493 $ 3,819 $ 2,905
Add: Stock-based employee
compensation expenses
included in reported net
income, net of related
tax effects 9 5 15 10
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards,
net of related tax effect (12) (9) (21) (17)
------- ------- ------- -------
Pro forma net income $ 2,001 $ 1,489 $ 3,813 $ 2,898
======= ======= ======= =======
Earnings per share:
Basic-as reported $ 0.03 $ 0.04 $ 0.08 $ 0.07
======= ======= ======= =======
Basic-pro forma $ 0.03 $ 0.04 $ 0.07 $ 0.07
======= ======= ======= =======
Diluted-as reported $ 0.03 $ 0.04 $ 0.07 $ 0.07
======= ======= ======= =======
Diluted-pro forma $ 0.03 $ 0.03 $ 0.07 $ 0.07
======= ======= ======= =======
4. Segment Information
The following is business segment information for the three and six
months ended June 30, 2005 and 2004 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
------- ------- ------- -------
Revenues
--------
Personal Lines Group $ 11,195 $ 9,956 $ 22,356 $ 20,215
Commercial Lines Group 6,575 5,693 12,855 11,206
Corporate 15 1 19 2
------- ------- ------- -------
Consolidated $ 17,785 $ 15,650 $ 35,230 $ 31,423
======= ======= ======= =======
Pre-tax income (loss)
---------------------
Personal Lines Group $ 2,460 $ 2,099 $ 4,902 $ 3,885
Commercial Lines Group 1,472 735 2,540 1,555
Corporate (921) (638) (1,727) (1,168 )
------- ------- ------- -------
Consolidated $ 3,011 $ 2,196 $ 5,715 $ 4,272
======= ======= ======= =======
The following is additional business segment information as of the
dates indicated (in thousands):
June 30, 2005 Dec. 31, 2004
------------- -------------
Assets
------
Personal Lines Group $ 80,701 $ 63,136
Commercial Lines Group 75,197 18,557
Corporate 2,150 818
--------- ---------
Consolidated $ 158,048 $ 82,511
========= =========
5. Reinsurance
Prior to April 1, 2003, AHIC 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. We remain
obligated to our policyholders in the event that the reinsurers do not meet
their obligations under the reinsurance agreements.
Under our prior reinsurance arrangements, we continue to earn ceding
commissions based on incurred loss experience on the portion of the policies
ceded. We 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 Six Months Ended
June 30, June 30,
2005 2004 2005 2004
------- ------- ------- -------
Ceded earned premiums $ - $ 1 $ - $ 258
Reinsurance recoveries $ 10 $ 537 $ (381) $ 211
6. Note Payable
On June 21, 2005, our newly formed trust subsidiary completed a private
placement of $30.0 million of 30-year floating rate trust preferred
securities. Simultaneously, we borrowed $30.9 million from the trust
subsidiary and contributed $30.0 million to AHIC in order to increase
policyholder surplus. The note bears an initial interest rate of 7.725%
until June 15, 2015, at which time interest will adjust quarterly to the
three month LIBOR rate plus 3.25 percentage points. As of June 30, 2005,
the note balance was $30.9 million.
7. Credit Facility
On June 29, 2005, we entered into a credit facility with The Frost
National Bank. The credit facility was amended on July 15, 2005, to reduce
the interest rate. Under this credit facility, the maximum amount available
to us from time to time is $7.5 million, which may include up to $2.0
million under a revolving line of credit, up to $3.5 million in five-year
term loans and up to $7.5 million in five-year stand-by letters of credit.
The borrowings under our credit facility will accrue interest at an annual
rate of three month LIBOR plus 2.00% and we will pay letter of credit fees
at the rate of 1.00% per annum. Our obligations under the credit facility
are secured by a security interest in the capital stock of all of our
subsidiaries, guaranties of all of our subsidiaries and the pledge of
substantially all of our assets. The credit facility contains covenants
which, among other things, require us to maintain certain financial and
operating ratios and restrict certain distributions, transactions and
organizational changes. As of June 30, 2005, there were no outstanding
amounts due under our credit facility, and we were in compliance with all of
our covenants.
8. Deferred Policy Acquisition Costs
The following table shows total deferred and amortized policy
acquisition costs by period (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
------- ------- ------- -------
Deferred $ (5,537) $ (5,189) $(11,624) $(11,337)
Amortized 5,280 5,101 10,996 10,740
------- ------- ------- -------
Net Deferred $ (257) $ (88) $ (628) $ (597)
======= ======= ======= =======
9. 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,
2005 2004 2005 2004
------- ------- ------- -------
Weighted average shares - basic 59,270 42,417 50,916 42,395
Effect of dilutive securities 535 164 615 139
------- ------- ------- -------
Weighted average shares -
assuming dilution 59,805 42,581 51,531 42,534
======= ======= ======= =======
For the three and six months ended June 30, 2004, 126,000 shares and
526,000 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. There were no outstanding stock options that were
excluded from the calculation of diluted earnings per share for the three
and six months ended June 30, 2005.
In accordance with FASB Statement No. 128 "Earnings Per Share" ("SFAS
128"), we have restated the basic and diluted weighted average shares
outstanding for the three months and six months ended June 30, 2004 for the
effect of a bonus element from our stockholder rights offering that was
successfully completed in the second quarter of 2005. According to SFAS
128, there is an assumed bonus element in a rights issue whose exercise
price is less than the market value of the stock at the close of the rights
offering period. This bonus element is treated as a stock dividend for
reporting earnings per share.
10. Net Periodic Pension Cost
We have recognized $33 thousand in net periodic pension cost during the
first six months of 2005. The components of this cost are interest cost of
$363 thousand, amortization of net loss of $38 thousand and expected return
on plan assets of ($368) thousand.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Introduction
Hallmark Financial Services, Inc., ("Hallmark" and, together with
subsidiaries, "we", "us", "our") is an insurance holding company engaged in
the sale of property and casualty insurance products. Our business involves
the marketing and underwriting of non-standard personal automobile insurance
in Texas, New Mexico and Arizona; marketing commercial insurance in Texas,
New Mexico, Idaho, Oregon and Washington; affiliate and third party claims
administration; and other insurance related services. We pursue our
business activities through integrated insurance groups handling 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
("AHIC"), an authorized Texas property and casualty insurance company;
Phoenix Indemnity Insurance Company ("PIIC"), an authorized Arizona property
and casualty insurance company; American Hallmark General Agency, Inc.
("AHGA"), a managing general agency; and Hallmark Claims Services, Inc.
("HCS"), an affiliate and third party 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 second quarter of 2005, we completed a $45.0 million
shareholder rights offering and a $30.0 million private placement of trust
preferred securities. As a result of these capital enhancements, A.M. Best
announced on June 21, 2005 the upgrades of the financial strength ratings of
AHIC to A- (excellent) from B (fair) and PIIC to B+ (very good) from B-
(fair).
During the third quarter of 2005, we intend to begin underwriting and
issuing AHIC policies for the commercial insurance business produced by HGA
in order to capture the underwriting margin that is currently paid to a
third party insurer. After we have obtained all required regulatory
approvals, we also intend to consolidate the underwriting of our non-
standard personal automobile insurance business into PIIC during the third
quarter of 2005. As a result of these changes, we expect AHIC to become a
part of the Commercial Lines Group during the third quarter of 2005.
Financial Condition and Liquidity
Sources and uses of funds. Our sources of funds are from insurance
related operations, financing activities and investing activities. Major
sources of funds from operations include premiums collected (net of policy
cancellations and premiums ceded), commissions, and processing and service
fees. On a consolidated basis, our cash and investments (excluding
restricted cash and investments) at June 30, 2005 were $121.6 million
compared to $45.0 million at December 31, 2004. Most of this increase was
attributable to net proceeds of $44.9 million from a stockholder rights
offering and $29.1 million from the issuance of trust preferred securities.
Net cash provided by our consolidated operating activities was $2.2
million for the first six months of 2005 compared to $2.8 million for the
first six months of 2004. The decrease in operating cash flow primarily
resulted from increased tax payments of $2.0 million over the prior year and
increased paid operating expenses of $0.5 million caused mostly by incentive
compensation payments of $0.9 million paid in the first quarter of 2005.
These amounts were partially offset by $1.9 million from increased retention
of non-standard automobile premium in 2005 and increased commercial premium
production, net of resulting paid loss and loss adjustment expenses,
collected ceding commissions and claims fees.
Cash used by investing activities during the first six months of 2005
was $8.5 million as compared to $4.2 million for the same period in 2004.
The increase in cash used in investing activities is mainly due to increased
purchases of debt and equity securities of $7.7 million and a decrease in
net maturities and redemptions of securities of $2.1 million. These were
partially offset by a $3.2 million decrease in cash and investments
transferred to restricted accounts and a $2.4 million decrease in net
purchases of short-term investments.
Cash provided by financing activities during the first six months of
2005 was $75.2 million as compared to cash used in financing activities of
$0.3 million for the same period of 2004. The cash provided in 2005 was
from net proceeds of $44.9 million from the stockholder rights offering,
$30.0 million from the issuance of trust preferred securities, net of
related debt issuance costs and $0.2 million from the exercise of stock
options. The cash used in 2004 was from $0.4 million repaid on a note
payable that was partially offset by $28 thousand in proceeds from the
exercise of stock options.
As a holding company, Hallmark is dependent on dividend payments and
management fees from its subsidiaries to meet operating expenses and debt
obligations. As of June 30, 2005, Hallmark had $0.2 million in cash and
invested assets. Cash and invested assets of our non-insurance subsidiaries
were $7.0 million as of June 30, 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 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 2005, AHIC's ordinary dividend capacity is $1.5 million. PIIC,
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 2005, PIIC's ordinary dividend capacity is $0.8
million. Neither AHIC nor PIIC paid a dividend to Hallmark during the first
six months of 2005.
TDI regulates financial transactions between AHIC and affiliated
companies. Applicable regulations require TDI's approval of management
fees, expense sharing contracts and similar transactions. AHGA paid $0.8
million and $0.3 million in management fees to Hallmark during the first six
months of 2005 and 2004, respectively.
AZDOI regulates financial transactions between PIIC and affiliated
companies. Applicable regulations require AZDOI's approval of management
fees, expense sharing contracts and similar transactions. PIIC paid $0.6
million in management fees to AHGA during the first six months of both 2005
and 2004.
Credit facility. On June 29, 2005, we entered into a credit facility
with The Frost National Bank. The credit facility was amended on July 15,
2005, to reduce the interest rate. Under this credit facility, the maximum
amount available to us from time to time is $7.5 million, which may include
up to $2.0 million under a revolving line of credit, up to $3.5 million in
five-year term loans and up to $7.5 million in five-year stand-by letters of
credit. The borrowings under our credit facility will accrue interest at an
annual rate of three month LIBOR plus 2.00% and we will pay letter of credit
fees at the rate of 1.00% per annum. Our obligations under the credit
facility are secured by a security interest in the capital stock of all of
our subsidiaries, guaranties of all of our subsidiaries and the pledge of
substantially all of our assets. The credit facility contains covenants
which, among other things, require us to maintain certain financial and
operating ratios and restrict certain distributions, transactions and
organizational changes. As of June 30, 2005, there were no outstanding
amounts due under our credit facility, and we were in compliance with all of
our covenants.
Trust preferred securities. On June 21, 2005, our newly formed trust
subsidiary completed a private placement of $30.0 million of 30-year
floating rate trust preferred securities. Simultaneously, we borrowed $30.9
million from the trust subsidiary and contributed $30.0 million to AHIC in
order to increase policyholder surplus. The note bears an initial interest
rate of 7.725% until June 15, 2015, at which time interest will adjust
quarterly to the three month LIBOR rate plus 3.25 percentage points. As of
June 30, 2005, the note balance was $30.9 million.
Results of Operations
Management Overview. During the second quarter of fiscal 2005, our
total revenues were $17.8 million, representing a 13.6% increase over the
$15.7 million in total revenues for the comparable period of fiscal 2004.
For the first six months of fiscal 2005, our total revenues were $35.2
million, which was 12.1% more than the $31.4 million in total revenues for
the comparable period in fiscal 2004. We reported net income of $2.0
million and $3.8 million for the three and six months ended June 30, 2005,
respectively. This represents a 34.2% and 31.5% increase over our net
income for the three and six months ended June 30, 2004, respectively. On a
diluted per share basis, net income was $0.03 and $0.07 for the three and
six months ended June 30, 2005, respectively, as compared to $0.04 and $0.07
for the same periods in the prior year. During the second quarter of 2005,
we issued 50.0 million shares in a stockholder rights offering, which
diluted the per share results in 2005 as compared to 2004.
The increase in total revenues for the first six months of fiscal 2005
as compared to the first six months 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 to the
combined impact of increased premium volume and improved commission terms in
the Commercial Lines Group. The increase in net income for the first six
months 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.
The following is additional business segment information for the three
and six months ended June 30, 2005 and 2004 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
------- ------- ------- -------
Revenues
--------
Personal Lines Group $ 11,195 $ 9,956 $ 22,356 $ 20,215
Commercial Lines Group 6,575 5,693 12,855 11,206
Corporate 15 1 19 2
------- ------- ------- -------
Consolidated $ 17,785 $ 15,650 $ 35,230 $ 31,423
======= ======= ======= =======
Pre-tax income (loss)
---------------------
Personal Lines Group $ 2,460 $ 2,099 $ 4,902 $ 3,885
Commercial Lines Group 1,472 735 2,540 1,555
Corporate (921) (638) (1,727) (1,168)
------- ------- ------- -------
Consolidated $ 3,011 $ 2,196 $ 5,715 $ 4,272
======= ======= ======= =======
Second Quarter 2005 as compared to the Second Quarter 2004
Personal Lines Group
Net premium written increased $1.8 million during the second quarter of
2005 to $8.8 million compared to $7.0 million in the second quarter of 2004.
The increase was due mainly to AHIC 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, AHIC assumed only 45%
of this business. Total premium production for the second quarter of 2005
declined $1.5 million, or 14.7%, from the $10.4 million produced in the
second quarter of 2004. The decline in produced premium was reflective of
increased competition.
Revenue for the Personal Lines Group increased 12.4% to $11.2 million
for the second quarter of 2005 from $10.0 million for the same period in
2004. Increased net premium earned of $1.7 million due to higher assumed
premium volume was the primary cause of this increase. This increase in net
premiums earned was partially offset by a $0.4 million decrease in ceding
commission income due to AHIC assuming 100% of the Texas non-standard
automobile business effective October 1, 2004.
Pre-tax income for the Personal Lines Group increased $0.4 million, or
17.2%, for the second quarter of 2005 compared to the second quarter of
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 $0.2 million to the
increase in pre-tax income. Lower salary and related expenses contributed
$0.1 million, lower technical service costs from integrating PIIC's back
office systems that were previously outsourced contributed $0.1 million and
increased investment income contributed $0.1 million to the increased pre-
tax income for the second quarter of 2005. These increases were partially
offset by a loss ratio (defined as loss and loss adjustment expenses divided
by net premiums earned) of 57.2% for the second quarter of 2005 as compared
to 56.0% for the same period in 2004, which decreased pre-tax income by $0.1
million.
Commercial Lines Group
Total revenue for the Commercial Lines Group of $6.6 million for the
second quarter of 2005 was $0.9 million more than the $5.7 million reported
in the second quarter of 2004. This 15.5% increase in total revenue was
primarily due to additional commission revenue of $0.7 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 second quarter of 2005 was
$19.2 million as compared to $18.1 million in the second quarter of 2004.
We do not currently bear the primary underwriting risk for this business
and, therefore, the resulting premiums and claims are not reflected in our
reported results.
Pre-tax income for the Commercial Lines Group of $1.5 million for the
second quarter of 2005 increased $0.7 million, or 100.3%, over the $0.7
million reported for the second quarter of 2004. Increased revenue,
as discussed above, was the primary reason for the increase in pre-tax
income, partially offset by additional agent commissions of $0.2 million
attributable to the increased premium volume.
Corporate
Corporate pre-tax loss was $0.9 million for the second quarter of 2005
as compared to $0.6 million for the same period in 2004. The increase was
due mostly to the transfer of accounting positions from both the Personal
Lines Group and Commercial Lines Group to Corporate.
Year-to-Date 2005 as compared to Year-to-Date 2004
Personal Lines Group
Net premium written increased $3.7 million during the first six months
of 2005 to $19.5 million compared to $15.8 million in the same period of
2004. The increase was due mainly to AHIC 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, AHIC assumed
only 45% of this business. Total premium production for the first six
months of 2005 declined $3.9 million, or 16.7%, from the $23.2 million
produced in the first six months of 2004. The decline in produced premium
was reflective of increased competition.
Revenue for the Personal Lines Group increased 10.6% to $22.4 million
for the first six months of 2005 from $20.2 million for the same period in
2004. Increased net premium earned of $3.5 million due to higher assumed
premium volume was the primary cause of this increase. This increase in net
premiums earned was partially offset by a $1.3 million decrease in ceding
commission income due to AHIC assuming 100% of the Texas non-standard
automobile business effective October 1, 2004.
Pre-tax income for the Personal Lines Group increased $1.0 million, or
26.2%, for the first six months of 2005 compared to the same period of 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 approximately $0.3 million
to the increase in pre-tax income. Lower technical service costs from
integrating PIIC's back office systems that were previously outsourced
contributed $0.3 million, lower salary and related expenses contributed $0.2
million, and a loss ratio of 58.7% for the first six months of 2005 as
compared to 59.9% for the same period in 2004 contributed $0.2 million to
the increase in pre-tax income.
Commercial Lines Group
Total revenue for the Commercial Lines Group of $12.8 million for the
first six months of 2005 was $1.6 million more than the $11.2 million
reported in the same period of 2004. This 14.7% increase in total revenue
was primarily due to additional commission revenue of $1.3 million in the
first six months 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. There was also additional claim
fee revenue of $0.3 million due to increased commercial premium produced in
2005. Earned premium generated by the Commercial Lines Group for the first
six months of 2005 was $38.1 million as compared to $35.6 million in the
same period of 2004. We do not currently bear the primary underwriting risk
for this business and, therefore, the resulting premiums and claims are not
reflected in our reported results.
Pre-tax income for the Commercial Lines Group of $2.5 million for the
first six months of 2005 increased $1.0 million, or 63.3%, over the
$1.5 million reported for the same period of 2004. Increased revenue,
as discussed above, was the primary reason for the increase in pre-tax
income, partially offset by additional agent commissions of $0.6 million
attributable to the increased premium volume.
Corporate
Corporate pre-tax loss was $1.7 million for the first six months of
2005 as compared to $1.2 million for the same period in 2004. The increase
was due mostly to the transfer of accounting positions from both the
Personal Lines Group and Commercial Lines Group to Corporate.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
As of June 30, 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.
(a) The Company's Annual Meeting of Shareholders was held on
May 26, 2005. Of the 36,856,610 shares of common stock
of the Company entitled to vote at the meeting,
35,970,948 shares were present in person or by proxy.
(b) At the Annual Meeting, 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 35,951,338
James H. Graves 35,967,538
George R. Manser 35,967,538
Scott T. Berlin 35,967,538
James C. Epstein 35,967,388
(c) At the Annual Meeting, the 2005 Long Term Incentive Plan
was approved with 25,327,777 shares voting for the Plan.
There was no other business to come before the Annual
Meeting.
Item 5. Other Information.
None.
Item 6. Exhibits.
The following exhibits are filed herewith or
incorporated herein by reference:
Exhibit
Number Description
------ -----------
3(a) Articles of Incorporation of the registrant, as amended
(incorporated by reference to Exhibit 3(a) to the
registrant's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1993).
3(b) By-Laws of the registrant, as amended.
4(a) Specimen certificate for Common Stock, $0.03 par value
per share, of the registrant (incorporated by reference
to Exhibit 4 to the registrant's Annual Report on Form
10-KSB for the fiscal year ended December 31, 1991).
4(b) Indenture dated as of June 21, 2005, between Hallmark
Financial Services, Inc. and JPMorgan Chase Bank,
National Association (incorporated by reference to
Exhibit 4.1 to the registrant's Form 8-K filed June 27,
2005).
4(c) Amended and Restated Declaration of Trust of Hallmark
Statutory Trust I dated as of June 21, 2005, among
Hallmark Financial Services, Inc., as sponsor, Chase
Bank USA, National Association, as Delaware trustee,
and JPMorgan Chase Bank, National Association, as
institutional trustee, and Mark Schwarz and Mark
Morrison, as administrators (incorporated by reference
to Exhibit 4.2 to the registrant's Form 8-K filed June
27, 2005).
4(d) Form of Junior Subordinated Debt Security Due 2035
(incorporated by reference to Exhibit 4.1 to the
registrant's Form 8-K filed June 27, 2005).
4(e) Form of Capital Security Certificate (incorporated by
reference to Exhibit 4.2 to the registrant's Form 8-K
filed June 27, 2005).
4(f) Credit Agreement dated June 29, 2005, between Hallmark
Financial Services, Inc. and The Frost National Bank
(incorporated by reference to Exhibit 4.1 to the
registrant's Form 8-K filed July 6, 2005).
4(g) First Amendment to Credit Agreement dated July 15, 2005,
between Hallmark Financial Services, Inc. and The Frost
National Bank.
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.
32(b) Certification of Chief Financial Officer Pursuant to 18
U.S.C. 1350.
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 5, 2005 /s/ Mark E. Schwarz
---------------------------------------------
Mark E. Schwarz, Chairman
(Chief Executive Officer)
Date: August 5, 2005 /s/ Mark J. Morrison
---------------------------------------------
Mark J. Morrison, Executive Vice President
(Chief Operating Officer and Chief Financial
Officer)