UNITED STATES
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, 2006
Commission file number 0-16090
Hallmark Financial Services, Inc.
---------------------------------
(Exact name of registrant as specified in its charter)
Nevada 87-0447375
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
777 Main Street, Suite 1000, Fort Worth, Texas 76102
---------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (817) 348-1600
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No X
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes ___ No X
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
$.18 per share - 17,759,905 shares outstanding as of August 3, 2006.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Page Number
-----------
Consolidated Balance Sheets at June 30, 2006
(unaudited) and December 31, 2005 3
Consolidated Statements of Operations (unaudited)
for the three months and six months ended June 30,
2006 and June 30, 2005 4
Consolidated Statements of Stockholders' Equity and
Comprehensive Income (unaudited) for the three months
and six months ended June 30, 2006 and June 30, 2005 5
Consolidated Statements of Cash Flows (unaudited) for
the three months and six months ended June 30, 2006
and June 30, 2005 6
Notes to Consolidated Financial Statements (unaudited) 7
Hallmark Financial Services, Inc. and Subsidiaries
Consolidated Balance Sheets
($ in thousands)
June 30 December 31
ASSETS 2006 2005
------ ---------- ----------
(unaudited) (audited)
Investments:
Debt securities, available-for-sale,
at market value $ 117,280 $ 79,360
Equity securities, available-for-sale,
at market value 4,389 3,403
Short-term investments, available-for-sale,
at market value 49,956 12,281
---------- ----------
Total investments 171,625 95,044
Cash and cash equivalents 13,402 44,528
Restricted cash and investments 41,165 13,802
Premiums receivable 47,994 26,530
Accounts receivable 28,403 2,083
Prepaid reinsurance premium 1,585 767
Reinsurance recoverable 1,530 444
Deferred policy acquisition costs 12,564 9,164
Excess of cost over fair value
of net assets acquired 31,781 4,836
Intangible assets 27,220 459
Deferred federal income taxes - 3,992
Other assets 9,837 7,257
---------- ----------
Total assets $ 387,106 $ 208,906
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes payable $ 48,345 $ 30,928
Note payable to related party 12,500 -
Structured settlements 24,065 -
Unpaid losses and loss adjustment expenses 52,099 26,321
Unearned premiums 69,264 36,027
Unearned revenue 9,326 4,055
Reinsurance balances payable 513 116
Accrued agent profit sharing 1,253 2,173
Accrued ceding commission payable 11,438 11,430
Pension liability 2,935 2,932
Deferred federal income taxes 1,893 -
Current federal income tax payable 1,913 300
Accounts payable and other accrued expenses 36,573 9,436
---------- ----------
Total liabilities 272,117 123,718
Commitments and Contingencies
Stockholders' equity:
Common stock, $.18 par value (authorized
33,333,333 shares in 2006 and 16,666,667
shares in 2005; issued 17,767,773 shares
in 2006 and 14,476,102 shares in 2005) 3,198 2,606
Additional paid in capital 93,663 62,907
Retained earnings 21,873 22,289
Accumulated other comprehensive loss (3,668) (2,597)
Treasury stock, at cost (7,827 shares in 2006
and 2,470 in 2005) (77) (17)
---------- ----------
Total stockholders' equity 114,989 85,188
---------- ----------
$ 387,106 $ 208,906
========== ==========
The accompanying notes are an integral part
of the consolidated financial statements
Hallmark Financial Services, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
($ in thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30 June 30
--------------------- ----------------------
2006 2005 2006 2005
-------- -------- -------- --------
Gross premiums written $ 47,876 $ 8,839 $ 95,611 $ 19,473
Ceded premiums written (2,484) - (4,440) -
-------- -------- -------- --------
Net premiums written 45,392 8,839 91,171 19,473
Change in unearned premiums (11,133) 824 (28,478) 230
-------- -------- -------- --------
Net premiums earned 34,259 9,663 62,693 19,703
Investment income, net of expenses 2,236 451 4,593 862
Realized loss (1,283) (41) (1,366) (41)
Finance charges 1,216 509 1,903 1,049
Commission and fees 10,016 5,628 22,280 10,440
Processing and service fees 727 1,570 1,584 3,204
Other income 16 5 20 13
-------- -------- -------- --------
Total revenues 47,187 17,785 91,707 35,230
Losses and loss adjustment expenses 20,199 5,515 36,889 11,541
Other operating costs and expenses 20,027 9,150 41,053 17,855
Interest expense 1,662 102 3,247 105
Interest expense from amortization
of discount on convertible notes 8,508 - 9,625 -
Amortization of intangible asset 573 7 1,146 14
-------- -------- -------- --------
Total expenses 50,969 14,774 91,960 29,515
Income (loss) before tax (3,782) 3,011 (253) 5,715
Income tax expense (benefit) (940) 1,007 163 1,896
-------- -------- -------- --------
Net income (loss) $ (2,842) $ 2,004 $ (416) $ 3,819
======== ======== ======== ========
Common stockholders net income
(loss) per share:
Basic $ (0.18) $ 0.20 $ (0.03) $ 0.45
======== ======== ======== ========
Diluted $ (0.18) $ 0.20 $ (0.03) $ 0.44
======== ======== ======== ========
The accompanying notes are an integral part
of the consolidated financial statements
Hallmark Financial Services, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
(Unaudited)
($ in thousands)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ----------------------
2006 2005 2006 2005
-------- -------- -------- --------
Common Stock
Balance, beginning of period $ 2,609 $ 1,106 $ 2,606 $ 1,106
Conversion of note payable
to common stock 589 - 589 -
Issuance of common stock
in rights offering - 1,500 - 1,500
Issuance of common stock
upon option exercises - - 3 -
-------- -------- -------- --------
Balance, end of period 3,198 2,606 3,198 2,606
Additional Paid-In Capital
Balance, beginning of period 69,034 19,640 62,907 19,647
Discount on convertible notes,
net of tax 34 - 6,066 -
Conversion of note payable
to common stock 24,562 - 24,562 -
Issuance of common stock
in rights offering - 43,422 - 43,422
Equity based compensation 33 14 57 23
Exercise of stock options - (178) 71 (194)
-------- -------- -------- --------
Balance, end of period 93,663 62,898 93,663 62,898
Retained Earnings
Balance, beginning of period 24,715 14,918 22,289 13,103
Net income (loss) (2,842) 2,004 (416) 3,819
-------- -------- -------- --------
Balance, end of period 21,873 16,922 21,873 16,922
Accumulated Other Comprehensive
Income (Loss)
Balance, beginning of period (3,417) (1,240) (2,597) (759)
Additional minimum pension liability,
net of tax 32 - 32 30
Unrealized gains (losses) on
securities, net of tax (283) 276 (1,103) (235)
-------- -------- -------- --------
Balance, end of period (3,668) (964) (3,668) (964)
Treasury Stock
Balance, beginning of period (77) (412) (17) (441)
Acquisition of treasury shares - - (100) -
Exercise of stock options - 395 40 424
-------- -------- -------- --------
Balance, end of period (77) (17) (77) (17)
-------- -------- -------- --------
Stockholders' Equity $ 114,989 $ 81,445 $ 114,989 $ 81,445
======== ======== ======== ========
Net income (loss) $ (2,842) $ 2,004 $ (416) $ 3,819
Additional minimum pension
liability, net of tax 32 - 32 30
Unrealized gains (losses)
on securities, net of tax (283) 276 (1,103) (235)
-------- -------- -------- --------
Comprehensive Income (Loss) $ (3,093) $ 2,280 $ (1,487) $ 3,614
======== ======== ======== ========
The accompanying notes are an integral part
of the consolidated financial statements
Hallmark Financial Services, Inc. and Subsidiaries
Consolidated Statement of Cash Flows
(Unaudited)
($ in thousands)
Six Months Ended
June 30
------------------------
2006 2005
---------- ----------
Cash flows from operating activities:
Net income (loss) $ (416) $ 3,819
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Depreciation and amortization expense 1,605 178
Interest expense related to amortization
of discount on convertible notes 9,625 -
Deferred federal income tax expense (5,671) 512
Realized loss on investments 1,366 41
Change in prepaid reinsurance premiums (818) -
Change in premiums receivable (20,346) 271
Change in accounts receivable (269) 1,083
Change in deferred policy acquisition costs (3,400) (628)
Change in unpaid losses and loss adjustment
expenses 16,288 (1,147)
Change in unearned premiums 29,293 (230)
Change in unearned revenue (4,088) 839
Change in accrued agent profit sharing (920) (934)
Change in reinsurance recoverable (446) 1,652
Change in reinsurance balances payable (252) -
Change in current federal income tax
payable/recoverable 726 (1,160)
Change in accrued ceding commission payable 8 (494)
Change in all other liabilities 6,854 (1,024)
Change in all other assets 508 (601)
---------- ----------
Net cash provided by operating activities 29,647 2,177
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (249) (164)
Premium finance notes repaid,
net of finance notes originated (2,368) -
Acquisition of subsidiaries, net of cash acquired (25,964) -
Change in restricted cash and investments (24,541) (70)
Purchases of debt and equity securities (35,683) (8,802)
Maturities and redemptions of investment
securities 13,268 538
Net redemptions (purchases) of short-term
investments (37,776) 3
---------- ----------
Net cash used in investing activities (113,313) (8,495)
---------- ----------
Cash flows from financing activities:
Proceeds from exercise of employee stock options 40 230
Proceeds from stockholder rights offering - 44,922
Proceeds from issuance of trust preferred
securities - 30,928
Debt issuance costs - (907)
Proceeds from issuance of convertible debt 25,000 -
Proceeds from note payable to related party 12,500 -
Proceeds from revolving loan on credit facility 15,000 -
---------- ----------
Net cash provided by financing activities 52,540 75,173
---------- ----------
Increase (decrease) in cash and cash equivalents (31,126) 68,855
Cash and cash equivalents at beginning of period 44,528 12,901
---------- ----------
Cash and cash equivalents at end of period $ 13,402 $ 81,756
========== ==========
Supplemental Cash Flow Information:
Interest paid $ 2,384 $ 8
---------- ----------
Taxes paid $ 5,082 $ 2,544
---------- ----------
The accompanying notes are an integral part
of the consolidated financial statements
Hallmark Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
1. General
Hallmark Financial Services, Inc. ("Hallmark" and, together with
subsidiaries, "we", "us", "our") is a diversified property/casualty
insurance group that serves businesses and individuals in specialty and
niche markets. We market, distribute, underwrite and service our commercial
and personal property/casualty insurance products through four operating
units, each of which has a specific focus. Our HGA Operating Unit
primarily handles standard commercial insurance, our TGA Operating Unit
concentrates on excess and surplus lines commercial insurance, our Phoenix
Operating Unit focuses on non-standard personal automobile insurance and our
Aerospace Operating Unit specializes in general aviation insurance. The
subsidiaries comprising our TGA Operating Unit and our Aerospace Operating
Unit were acquired effective January 1, 2006. The insurance policies
produced by our four operating units are written by our three insurance
company subsidiaries as well as unaffiliated insurers. Our insurance
company subsidiaries are American Hallmark Insurance Company of Texas
("AHIC"), Phoenix Indemnity Insurance Company ("PIIC") and Gulf States
Insurance Company ("GSIC").
2. Basis of Presentation
Our unaudited consolidated financial statements included herein have
been prepared in accordance with U.S. generally accepted accounting
principles ("GAAP") and include our accounts and the accounts of our
subsidiaries. All significant intercompany 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, 2005
included in our Annual Report on Form 10-K filed with the SEC.
The interim financial data as of June 30, 2006 and 2005 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, 2006 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.
Redesignation of Segments
Effective January 1, 2006, our Commercial Insurance Operation has been
redesignated as our HGA Operating Unit and our Personal Insurance Operation
has been redesignated as our Phoenix Operating Unit, in each case without
change in the composition of the reporting segment.
Reverse Stock Split
All share and per share amounts have been adjusted to reflect a one-
for-six reverse split of all issued and unissued shares of our authorized
common stock effected July 31, 2006, and a corresponding increase in the par
value of our authorized common stock from $0.03 per share to $0.18 per
share.
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 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"). SFAS
148 amended FASB Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("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 amended 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.
Effective January 1, 2003, we adopted the prospective method provisions of
SFAS 148. Under the prospective method, we have applied the fair value
based method of accounting for our stock-based payments for option grants
after December 31, 2002.
In December 2004, FASB issued Statement of Financial Accounting
Standards No. 123R "Share-Based Payment" ("SFAS 123R"), which revises SFAS
123 and supersedes Accounting Principles Board ("APB") Opinion No. 25 ("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. We adopted SFAS 123R on January 1, 2006 using the modified-
prospective transition method. Under the modified-prospective transition
method, compensation cost recognized during the period should include
compensation cost for all share-based payments granted to, but not yet
vested as of January 1, 2006, based on grant date fair value estimates in
accordance with the original provisions of SFAS 123 and compensation cost
for all share-based payments granted after January 1, 2006 in accordance
with SFAS 123R. Since we adopted the fair value method of SFAS 123 under
the prospective method provision of SFAS 148 beginning January 1, 2003, we
have a small amount of unvested share-based payments granted prior to
January 1, 2003. During the first six months of 2006, we recognized
approximately $5 thousand of additional compensation expense under SFAS
123R. SFAS 123R also requires the benefits of tax deductions in excess of
recognized stock compensation cost to be reported as a financing cash flow,
rather than as an operating cash flow as previously required. (See Note 4,
"Share-Based Payment Arrangements.")
Had compensation cost for all of our stock option grants under our
stock compensation plans been determined based on fair value at the grant
date in accordance with the fair value provisions of SFAS 123, our net
income and earnings per share for the three and six months ended June 30,
2005 would have been the pro forma amounts indicated below. Actual results
for the three and six months ended June 30, 2006 have been determined in
accordance with the fair value provisions of SFAS 123R and, therefore, pro
forma results for such period are not necessary.
Three Months Six Months
Ended Ended
June 30, June 30,
(in thousands) 2005 2005
--------------------
Net income as reported $ 2,004 $ 3,819
Add: Stock-based compensation expenses
included in reported net income, net of
related tax effects 9 15
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (12) (21)
--------------------
Pro forma net income $ 2,001 $ 3,813
====================
Earnings per share:
Basic-as reported $ 0.20 $ 0.45
====================
Basic-pro forma $ 0.20 $ 0.45
====================
Diluted-as reported $ 0.20 $ 0.44
====================
Diluted-pro forma $ 0.20 $ 0.44
====================
3. Business Combinations
We account for business combinations using the purchase method of
accounting. The cost of an acquired entity is allocated to the assets
acquired (including identified intangible assets) and liabilities assumed
based on their estimated fair values. The excess of the cost of an acquired
entity over the net of the amounts assigned to assets acquired and
liabilities assumed is an asset referred to as "excess of cost over net
assets acquired" or "goodwill." Indirect and general expenses related to
business combinations are expensed as incurred.
Effective January 1, 2006, we acquired all of the issued and
outstanding capital stock of the subsidiaries now comprising the TGA
Operating Unit for an aggregate cash purchase price of up to $45.6 million,
consisting of unconditional consideration of $37.6 million and contingent
consideration of $8.0 million. Of the unconditional consideration, $13.9
million was paid at closing and $14.3 million will be paid on or before
January 1, 2007 and $9.5 million will be paid on or before January 1, 2008.
The payment of any contingent consideration is conditioned on the sellers
complying with certain restrictive covenants and the TGA Operating Unit
achieving certain operational objectives related to premium production and
loss ratios. The contingent consideration, if any, will be payable on or
before March 30, 2009, unless the sellers elect to defer payment until March
30 of any subsequent year in order to permit further development of the loss
ratios. In addition to the purchase price, we will pay $2.0 million to the
sellers in consideration of their compliance with certain restrictive
covenants, including a covenant not to compete for a period of five years
after closing. Of this additional amount, $750 thousand was paid at
closing, $750 thousand will be paid on or before January 1, 2007 and $500
thousand will be paid on or before January 1, 2008.
Texas General Agency, Inc. ("Texas General Agency") is a managing
general agency involved in the marketing, underwriting and servicing of
property and casualty insurance products, with a particular emphasis on
commercial automobile and general liability risks produced on an excess and
surplus lines basis. The other affiliated companies in the TGA Operating
Unit are Texas General Agency's wholly owned insurance subsidiary, GSIC,
which reinsures a portion of the business written by Texas General Agency;
TGA Special Risk, Inc. ("TGASRI"), which brokers mobile home insurance; and
Pan American Acceptance Corporation ("PAAC"), which finances premiums on
property and casualty insurance products marketed by Texas General
Agency and TGASRI. Interim GAAP financial statements for the subsidiaries
now comprising the TGA Operating Unit are not available for 2005 and,
therefore, quarterly supplemental pro forma disclosures are not included in
this report.
Effective January 1, 2006, we also acquired all of the issued and
outstanding membership interests in the subsidiaries now comprising the
Aerospace Operating Unit, for an aggregate consideration of up to $15.0
million, consisting of unconditional consideration of $12.5 million due in
cash at closing and contingent consideration of up to $2.5 million. The
unconditional consideration of $12.5 million is allocated $11.9 million to
the purchase price and $0.6 million to the seller's compliance with certain
restrictive covenants, including a covenant not to compete for a period of
five years after closing. The payment of contingent consideration is
conditioned on the seller complying with its restrictive covenants and the
Aerospace Operating Unit achieving certain operational objectives related to
premium production and loss ratios. The contingent consideration, if any,
will be payable in cash on or before March 30, 2009, unless the seller
elects to defer a portion of the payment in order to permit further
development of loss ratios.
Our Aerospace Operating Unit is involved in the marketing and servicing
of general aviation property and casualty insurance products with a
particular emphasis on private and small commercial aircraft. Interim GAAP
financial statements for the subsidiaries now comprising our Aerospace
Operating Unit are not available for 2005 and, therefore, quarterly
supplemental pro forma disclosures are not included in this report.
4. Supplemental Cash Flow Information
Effective January 1, 2006, we acquired the subsidiaries now comprising
our TGA Operating Unit and our Aerospace Operating Unit. (See Note 3,
"Business Combinations.") In conjunction with the acquisitions, cash and
cash equivalents were used in the acquisitions as follows (in thousands):
TGA Aerospace
Operating Operating
Unit Unit
--------------------
Fair value of tangible assets excluding
cash and cash equivalents $ 52,906 $ 8,391
Fair value of intangible assets acquired 31,585 12,575
Capitalized direct expenses 232 36
Structured settlement (23,542) -
Liabilities assumed (48,522) (7,697)
--------------------
Cash and cash equivalents used in acquisitions $ 12,659 $ 13,305
====================
For the six months ended June 30, 2006 and 2005, we had non-cash stock-
based compensation expense of $57 thousand and $23 thousand, respectively.
5. Share-Based Payment Arrangements
Our 2005 Long Term Incentive Plan ("2005 LTIP") is a stock compensation
plan for key employees and non-employee directors that was approved by the
shareholders on May 26, 2005. There are 833,333 shares authorized for
issuance under the 2005 LTIP. Our 1994 Key Employee Long Term Incentive
Plan (the "Employee Plan") and 1994 Non-Employee Director Stock Option Plan
(the "Director Plan") both expired in 2004.
As of June 30, 2006, there were incentive stock options to purchase
197,500 shares of our common stock outstanding under the 2005 LTIP, leaving
635,833 shares reserved for future issuance. As of June 30, 2006, there
were incentive stock options to purchase 101,917 shares outstanding under
the Employee Plan and non-qualified stock options to purchase 25,000 shares
outstanding under the Director Plan. In addition, as of June 30, 2006,
there were outstanding non-qualified stock options to purchase 16,667 shares
of our common stock granted to certain non-employee directors outside the
Director Plan in lieu of fees for service on our board of directors in 1999.
The exercise price of all such outstanding stock options is equal to the
fair market value of our common stock on the date of grant.
Options granted under the Employee Plan prior to October 31, 2003, vest
40% six months from the date of grant and an additional 20% on each of the
first three anniversary dates of the grant and terminate ten years from the
date of grant. Options granted under the 2005 LTIP and the Employee Plan
after October 31, 2003, vest 10%, 20%, 30% and 40% on the first, second,
third and fourth anniversary dates of the grant, respectively, and terminate
five to ten years from the date of grant. All options granted under the
Director Plan vest 40% six months from the date of grant and an additional
10% on each of the first six anniversary dates of the grant and terminate
ten years from the date of grant. The options granted to non-employee
directors outside the Director Plan fully vested six months after the date
of grant and terminate ten years from the date of grant.
A summary of the status of our stock options as of and changes during
the year-to-date ended June 30, 2006 is presented below:
Weighted
Average
Weighted Remaining Aggregate
Average Contractual Intrinsic
Number of Exercise Term Value
Shares Price (Years) ($000)
--------------------------------------------
Outstanding at January 1, 2006 252,750 $ 4.92 - -
Granted 109,166 $ 11.34 - -
Exercised (20,833) $ 5.50 - -
Forfeited or expired - $ - - -
---------
Outstanding at June 30, 2006 341,083 $ 6.93 6.8 $ 1,504
Exercisable at June 30, 2006 90,833 $ 3.70 4.0 $ 694
The following table details the intrinsic value of options exercised,
total cost of share-based payments charged against income before income tax
benefit and the amount of related income tax benefit recognized in income
for the periods indicated (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
Intrinsic value of options
exercised $ - $ 240 $ 103 $ 260
Cost of share-based payments $ 33 $ 14 $ 57 $ 23
Income tax benefit of
share-based payments
recognized in income $ 11 $ 5 $ 20 $ 8
As of June 30, 2006, there was $1.1 million of total unrecognized
compensation cost related to non-vested share-based compensation
arrangements granted under our plans, of which $0.1 million is expected to
be recognized in 2006, $0.3 million is expected to be recognized in each of
2007, 2008 and 2009 and $0.1 million is expected to be recognized in 2010.
The fair value of each stock option granted is estimated on the date of
grant using the Black-Scholes option pricing model. Expected volatilities
are based on historical volatility of Hallmark's shares. The risk-free
interest rates for periods within the contractual term of the options are
based on rates for U.S. Treasury Notes with maturity dates corresponding to
the options expected lives on the dates of grant.
The following table details the grant date fair value and related
assumptions for the periods indicated (in thousands). There were no options
granted in either the first quarter of 2006 or 2005.
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
Grant date fair value per share $ 6.26 $ 4.01 $ 6.26 $ 4.01
Expected term 5 5 5 5
Expected volatility 59.1% 62.5% 59.1% 62.5%
Risk free interest rate 4.9% 3.9% 4.9% 3.9%
6. Segment Information
The following is business segment information for the three months and
six months ended June 30, 2006 and 2005 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
Revenues:
---------
HGA Operating Unit $ 19,264 $ 6,575 $ 36,804 $ 12,855
TGA Operating Unit 15,184 - 29,283 -
Phoenix Operating Unit 11,890 11,195 22,687 22,356
Aerospace Operating Unit 1,962 - 3,831 -
Corporate (1,113) 15 (898) 19
------- ------- ------- -------
Consolidated $ 47,187 $ 17,785 $ 91,707 $ 35,230
======= ======= ======= =======
Pre-tax income (loss):
----------------------
HGA Operating Unit $ 2,773 1,472 $ 6,133 2,540
TGA Operating Unit 3,426 - 5,154 -
Phoenix Operating Unit 2,393 2,460 4,444 4,902
Aerospace Operating Unit 13 - (96) -
Corporate (12,387) (921) (15,888) (1,727)
------- ------- ------- -------
Consolidated $ (3,782) $ 3,011 $ (253) $ 5,715
======= ======= ======= =======
The following is additional business segment information as of the dates
indicated (in thousands):
June 30, Dec. 31,
2006 2005
-------- --------
Assets
------
HGA Operating Unit $ 141,529 $ 136,220
TGA Operating Unit 124,992 -
Phoenix Operating Unit 67,697 68,264
Aerospace Operating Unit 22,564 -
Corporate 30,324 4,422
-------- --------
Consolidated $ 387,106 $ 208,906
======== ========
7. Reinsurance
We reinsure a portion of the risk we underwrite in order to control the
exposure to losses and to protect capital resources. We cede to reinsurers
a portion of these risks and pay premiums based upon the risk and exposure
of the policies subject to such reinsurance. Ceded reinsurance involves
credit risk and is generally subject to aggregate loss limits. Although the
reinsurer is liable to us to the extent of the reinsurance ceded, we are
ultimately liable as the direct insurer on all risks reinsured. Reinsurance
recoverables are reported after allowances for uncollectible amounts. We
monitor the financial condition of reinsurers on an ongoing basis and review
our reinsurance arrangements periodically. Reinsurers are selected based on
their financial condition, business practices and the price of their product
offerings. Refer to Note 6 of our Form 10-K for the year ended December 31,
2005 for more discussion of our reinsurance.
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,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
Ceded earned premiums $ 2,199 $ - $ 3,596 $ -
Reinsurance recoveries $ 118 $ 10 $ 894 $ (381)
8. Notes 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, 2006,
the note balance was $30.9 million.
On January 27, 2006, we borrowed $15.0 million under our revolving
credit facility to fund the cash required to close the acquisition of the
subsidiaries now comprising our TGA Operating Unit. As of June 30, 2006,
the balance on the revolving note was $15.0 million. (See Note 3, "Business
Combinations" and Note 12, "Credit Facilities.") Also included in notes
payable is $2.4 million of various short-term notes payable to banks by
PAAC, bearing variable interest rates ranging from 7.5% to 8.0%. (See Note
12, "Credit Facilities").
9. Note Payable to Related Party
On January 3, 2006, we executed a promissory note payable to Newcastle
Partners, L.P. in the amount of $12.5 million in order to obtain funding to
complete the acquisition of the subsidiaries now comprising our Aerospace
Operating Unit. The promissory note bears interest at the rate of 10% per
annum. The principal of the promissory note, together with accrued and
unpaid interest, became due and payable on demand as of June 30, 2006. As
of June 30, 2006 the promissory note balance was $12.5 million.
10. Convertible Notes Payable
On January 27, 2006, we issued $25.0 million in subordinated
convertible promissory notes to Newcastle Special Opportunity Fund I, L.P.
and Newcastle Special Opportunity Fund II, L.P., which are investment
partnerships managed by an entity controlled by Mark E. Schwarz, our
Executive Chairman. Each convertible note bore interest at 4% per annum,
which rate increased to 10% per annum in the event of default. Interest was
payable quarterly in arrears commencing March 31, 2006. Principal and all
accrued but unpaid interest was due at maturity on July 27, 2007. The
principal and accrued interest on the convertible notes was converted to
approximately 3.3 million shares of our common stock during the second
quarter of 2006.
In accordance with the FASB Emerging Issues Task Force ("EITF") Issue
No. 98-5 "Accounting for Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios" and EITF Issue No.
00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments,"
the convertible notes contained a beneficial conversion feature requiring a
discount to the carrying amount of the notes equal to (i) the difference
between the stated conversion rate and the market price of our common stock
on the date of issuance, multiplied by (ii) the number of shares into which
the notes were convertible. Per EITF Issue No. 98-5 and EITF Issue No. 00-
27, upon issuance we recorded a $9.6 million discount to the convertible
notes which was amortized straight line as interest expense over the term of
the convertible notes, with the unamortized balance of the discount expensed
upon conversion of the notes in the second quarter of 2006. The discount to
the convertible notes was offset by increases to deferred federal income
taxes and additional paid in capital. The discount on the convertible notes
had no ultimate effect on our book value.
Interest expense resulting from amortization of the discount on the
convertible notes during the first six months of 2006 was $9.6 million.
This interest expense had the effect of reducing our operating income for
the period, but had no effect on our cash flow.
11. Structured Settlements
In connection with the acquisition of the subsidiaries now comprising
our TGA Operating Unit, we recorded a payable for the future guaranteed
payments of $25.0 million discounted at 4.4%, the rate of two-year U.S.
Treasuries (the only investment permitted on the trust account securing such
future payments and which is classified in restricted cash and investments
on our balance sheet). (See Note 3, "Business Combinations.") As of June
30, 2006, the balance of the structured settlements was $24.1 million.
12. Credit Facilities
On June 29, 2005, we entered into a credit facility with The Frost
National Bank. The credit facility was amended and restated on January 27,
2006 to a $20.0 million revolving credit facility, with a $5.0 million
letter of credit sub-facility. We borrowed $15.0 million under the
revolving credit facility to fund the cash required to close the acquisition
of the subsidiaries now comprising our TGA Operating Unit. Principal
outstanding under the revolving credit facility generally bears interest
at the three month Eurodollar rate plus 2.00%, payable quarterly in
arrears. We pay letter of credit fees at the rate of 1.00% per annum. Our
obligations under the revolving 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
revolving 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. The amended
and restated credit agreement terminates on January 27, 2008. As of June
30, 2006, there was $15.0 million outstanding under our revolving credit
facility, and we were in compliance with or had obtained waivers of all of
our covenants. In the third quarter of 2005, we issued a $4.0 million
letter of credit under this facility to collateralize certain obligations
under the agency agreement between our HGA Operating Unit and Clarendon
National Insurance Company effective July 1, 2004.
PAAC has a $5.0 million revolving credit facility with JPMorgan Chase
Bank which terminates June 30, 2007. Principal outstanding under this
revolving credit facility generally bears interest at 1% above the
prime rate. PAAC's obligations under this revolving credit facility are
secured by its premium finance notes receivables. This revolving credit
facility contains various restrictive covenants which, among other things,
require PAAC to maintain minimum amounts of tangible net worth and working
capital. As of June 30, 2006, $2.3 million was outstanding under this
revolving credit facility and PAAC was in compliance with all of its
covenants.
13. 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,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
Deferred $ (8,678) $ (5,537) $(17,590) $(11,624)
Amortized 6,653 5,280 14,190 10,996
------- ------- ------- -------
Net $ (2,025) $ (257) $ (3,400) $ (628)
======= ======= ======= =======
14. 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,
------------------- -------------------
2006 2005 2006 2005
------------------- -------------------
Weighted average shares - basic 15,780 9,878 15,133 8,486
Effect of dilutive securities - 90 - 103
------------------- -------------------
Weighted average shares -
assuming dilution 15,780 9,968 15,133 8,589
=================== ===================
For the three months and six months ended June 30, 2005, no shares
attributable to outstanding stock options were excluded from the calculation
of diluted earnings per share. For the three and six months ended June 30,
2006, we reported a net loss, therefore, we excluded the effect of dilutive
securities in the calculation of diluted loss per share as the inclusion of
these securities would have been anti-dilutive.
15. Net Periodic Pension Cost
The following table details the net periodic pension cost incurred by
period (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2006 2005 2006 2005
------------------- -------------------
Interest cost $ 172 $ 182 $ 343 $ 363
Amortization of net loss 40 19 80 38
Expected return on plan assets (157) (184) (314) (368)
------------------- -------------------
Net periodic pension cost $ 55 $ 17 $ 109 $ 33
=================== ===================
We contributed $74 thousand and $32 thousand to our frozen defined
benefit cash balance plan during the three months ended June 30, 2006 and
2005, respectively, and contributed $106 thousand and $68 thousand during
the six months ended June 30, 2006 and 2005, respectively. Refer to Note 13
of our Form 10-K for the year ended December 31, 2005 for more discussion of
our retirement plans.
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 which,
through its subsidiaries, engages in the sale of property/casualty insurance
products to businesses and individuals. Our business involves marketing,
distributing, underwriting and servicing commercial insurance in Texas, New
Mexico, Idaho, Oregon, Montana, Louisiana, Oklahoma and Washington;
marketing, distributing, underwriting and servicing non-standard personal
automobile insurance in Texas, New Mexico, Arizona, Oklahoma and Idaho;
marketing, distributing, underwriting and servicing general aviation
insurance in 48 states; and providing other insurance related services. We
pursue our business activities through subsidiaries whose operations are
organized into producing units and are supported by our insurance company
subsidiaries.
Our non-carrier insurance activities are organized by producing units into
the following operational segments:
* HGA Operating Unit. Our HGA Operating Unit includes the standard lines
commercial property/casualty insurance products and services handled by
our Hallmark General Agency, Inc. and Effective Claims Management, Inc.
subsidiaries.
* TGA Operating Unit. Our TGA Operating Unit includes the excess
and surplus lines commercial property/casualty insurance products
and services handled by our Texas General Agency, Inc., Pan
American Acceptance Corporation ("PAAC") and TGA Special Risk, Inc.
subsidiaries. Our TGA Operating Unit also includes a relatively small
amount of personal lines insurance handled by these subsidiaries. The
subsidiaries comprising our TGA Operating Unit were acquired effective
January 1, 2006.
* Phoenix Operating Unit. Our Phoenix Operating Unit includes the non-
standard personal automobile insurance products and services handled
by American Hallmark General Agency, Inc. and Hallmark Claims Services,
Inc., both of which do business as Phoenix General Agency.
* Aerospace Operating Unit. Our Aerospace Operating Unit includes
the general aviation insurance products and services handled by our
Aerospace Insurance Managers, Inc., Aerospace Special Risk, Inc. and
Aerospace Claims Management Group, Inc. subsidiaries. The subsidiaries
comprising our Aerospace Operating Unit were acquired effective January
1, 2006.
The retained premium produced by these producing units is supported by the
following insurance company subsidiaries:
* American Hallmark Insurance Company of Texas ("AHIC") presently retains
all of the risks on the commercial property/casualty policies marketed
by our HGA Operating Unit and assumes a portion of the risks on the
commercial property/casualty policies marketed by our TGA Operating
Unit.
* Gulf States Insurance Company ("GSIC"), which was acquired effective
January 1, 2006, presently assumes a portion of the risks on the
commercial property/casualty policies marketed by our TGA Operating
Unit.
* Phoenix Indemnity Insurance Company ("PIIC") presently assumes all of
the risks on the non-standard personal automobile policies marketed by
our Phoenix Operating Unit and assumes a portion of the risks on the
aviation property/casualty products marketed by our Aerospace Operating
Unit.
Effective January 1, 2006, our insurance company subsidiaries entered into a
pooling arrangement pursuant to which AHIC retains 59.9% of the total net
premiums written by all of our operating units, PIIC retains 34.1% of our
total net premiums written and GSIC retains 6.0% of our total net premiums
written.
Prior to January 1, 2006, our HGA Operating Unit was referred to as our
Commercial Insurance Operation and our Phoenix Operating Unit was referred
to as our Personal Insurance Operation. The retained premium produced by
our operating units was supported by our AHIC and PIIC insurance
subsidiaries. Discussions for periods prior to January 1, 2006 do not
include the operations of our TGA Operating Unit or our Aerospace Operating
Unit, each of which was acquired effective January 1, 2006. All share and
per share amounts have been adjusted to reflect a one-for-six reverse split
of all issued and unissued shares of our authorized common stock effected
July 31, 2006.
Results of Operations
Management Overview. During the three months and six months ended June
30, 2006, our total revenues were $47.2 million and $91.7 million,
representing a 165.3% and 160.3% increase, respectively, over the $17.8
million and $35.2 million in total revenues for the comparable periods of
2005. The acquisitions of the TGA Operating Unit and the Aerospace
Operating Unit in the first quarter of 2006 contributed $17.1 million and
$33.1 million to the increase in total revenues for the three months and six
months ended June 30, 2006, respectively, as compared to the same periods in
2005. The following table provides additional information concerning the
increases in revenue contributed by these acquisitions (in thousands):
Three Months Six Months
Ended Ended
June 30, 2006 June 30, 2006
------------- -------------
Third party commission revenue $ 9,119 $ 19,956
Earned premium on retained business 7,009 11,388
Investment income, finance charges and
other revenue items 1,018 1,770
--------- ---------
Revenue contributions from acquisitions $ 17,146 $ 33,114
========= =========
The retention of business produced by the HGA Operating Unit that was
previously retained by third parties also contributed $16.9 million and
$31.2 million to the increase in revenue for the three months and six months
ended June 30, 2006, respectively, but was partially offset by lower ceding
commission revenue of $4.3 million and $7.6 million and lower processing and
services fees of $0.8 million and $1.5 million for the three and six months
ended June 30, 2006, respectively, attributable to the shift from a third-
party agency structure to an insurance underwriting structure. Earned
premiums from our Phoenix Operating Unit contributed $0.7 million and $0.4
million to the increase in revenue for the three and six months ended June
30, 2006, respectively, but were offset by lower ceding commission revenue
of $0.4 million and $0.5 million and lower processing and service fees of
$0.1 million and $0.2 million for the three and six months ended June 30,
2006, respectively. The investment of funds derived from the implementation
of our 2005 capital plan contributed another $1.5 million and $2.9 million
to revenue for the three and six months ended June 30, 2006, respectively.
These increases were partially offset by other-than-temporary impairment
charges on our equity investment portfolio of $1.2 million for the three and
six months ended June 30, 2006.
We reported net loss of $2.8 million and $0.4 million for the three
months and six months ended June 30, 2006, respectively, as compared to net
income of $2.0 million and $3.8 million in the same periods in the prior
year. On a diluted per share basis, net loss was $0.18 and $0.03 for the
three months and six months ended June 30, 2006, respectively, and net
income per share was $0.20 and $0.44 for the same periods in 2005.
During the three months and six months ended June 30, 2006, we recorded
$8.5 million and $9.6 million, respectively, of interest expense from
amortization attributable to the deemed discount on convertible promissory
notes issued in January, 2006. (See Note 10, "Convertible Notes Payable.")
In the absence of this non-cash expense, our net income for the three
months and six months ended June 30, 2006 would have been $2.5 million and
$5.7 million, respectively, representing a 25.7% and 47.9% increase over the
similar periods of 2005. The following is a reconciliation of our net
income without such interest expense to our reported results (in thousands).
Management believes this reconciliation provides useful supplemental
information in evaluating the operating results of our business. This
disclosure should not be viewed as a substitute for net loss determined in
accordance with GAAP:
Three Months Six Months
Ended Ended
June 30, 2006 June 30, 2006
------------- -------------
Income excluding interest expense from
amortization of discount, net of tax $2,520 $5,650
------------- -------------
Interest expense from amortization
of discount 8,508 9,625
Less related tax effect (3,146) (3,559)
------------- -------------
5,362 6,066
------------- -------------
Net loss ($2,842) ($416)
============= =============
Excluding the interest expense from amortization of discount , the
increase in net income for the three and six months ended June 30, 2006
versus the same periods in 2005 was primarily attributable to additional
revenue from the retention of the HGA Operating Unit business, quarterly
results from the newly acquired TGA Operating Unit and additional investment
income, partially offset by additional loss and loss adjustment expense of
the HGA Operating Unit, additional operating expenses attributable to the
retention of business produced by our HGA Operating Unit, additional
operating expenses attributable to our newly acquired operating units,
interest expense on our trust preferred securities and interest expense on
borrowings to finance the acquisitions of our TGA Operating Unit and our
Aerospace Operating Unit.
The following is additional business segment information for the three
months and six months ended June 30, 2006 and 2005 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
Revenues:
---------
HGA Operating Unit $ 19,264 $ 6,575 $ 36,804 $ 12,855
TGA Operating Unit 15,184 - 29,283 -
Phoenix Operating Unit 11,890 11,195 22,687 22,356
Aerospace Operating Unit 1,962 - 3,831 -
Corporate (1,113) 15 (898) 19
------- ------- ------- -------
Consolidated $ 47,187 $ 17,785 $ 91,707 $ 35,230
======= ======= ======= =======
Pre-tax income (loss):
----------------------
HGA Operating Unit $ 2,773 1,472 $ 6,133 2,540
TGA Operating Unit 3,426 - 5,154 -
Phoenix Operating Unit 2,393 2,460 4,444 4,902
Aerospace Operating Unit 13 - (96) -
Corporate (12,387) (921) (15,888) (1,727)
------- ------- ------- -------
Consolidated $ (3,782) $ 3,011 $ (253) $ 5,715
======= ======= ======= =======
Second Quarter 2006 as compared to the Second Quarter 2005
HGA Operating Unit
Beginning in the third quarter of 2005, our HGA Operating Unit began
retaining written premium through AHIC that was previously retained by third
parties. This resulted in net written premium for the HGA Operating Unit of
$21.4 million for the quarter ended June 30, 2006.
Total revenue for the HGA Operating Unit of $19.3 million for the
second quarter of 2006 was $12.7 million more than the $6.6 million reported
in the second quarter of 2005. This 193.0% increase in total revenue was
primarily due to net premiums earned of $16.9 million for the quarter from
the issuance of AHIC policies produced by the HGA Operating Unit. Increased
net investment income contributed an additional $1.0 million to the increase
in revenue for the quarter. These increases in revenue were partially
offset by lower ceding commission revenue of $4.3 million and lower
processing and service fees of $0.8 million, in both cases due to the shift
from a third party agency structure to an insurance underwriting structure.
Pre-tax income for our HGA Operating Unit of $2.8 million for the
second quarter of 2006 increased $1.3 million, or 88.4%, over the $1.5
million reported for the second quarter of 2005. Increased revenue, as
discussed above, was the primary reason for the increase in pre-tax income,
partially offset by increased loss and loss adjustment expenses of $10.0
million and additional production expenses of $1.4 million. The HGA
Operating Unit reported a loss ratio of 59.4% for the second quarter of
2006. Our HGA Operating Unit had no loss ratio for the second quarter of
2005 because we did not retain any of the premium produced by our HGA
Operating Unit for this period.
TGA Operating Unit
The subsidiaries comprising our TGA Operating Unit were all acquired
effective January 1, 2006. The $15.2 million of revenues was derived mostly
from third party commission revenue of $7.5 million on the portion of
business produced by the TGA Operating Unit that was retained by third
parties and from $6.8 million of earned premium on produced business that
was assumed by GSIC or AHIC. The remaining $0.9 million of revenue was
primarily derived from investment income and finance charges.
Pre-tax income for our TGA Operating Unit of $3.4 million was due
primarily to revenue as discussed above less (i) incurred loss and loss
adjustment expenses of $3.7 million on the portion of the business assumed
by GSIC or AHIC, (ii) $7.5 million in operating expenses, comprised mostly
of commission expense and salary related expenses, and (iii) $0.5 million of
amortization of intangible assets acquired in the acquisition of the
subsidiaries comprising our TGA Operating Unit. The TGA Operating Unit
reported a loss ratio of 54.2% for the second quarter of 2006. We do not
have a comparable loss ratio for the same period in 2005 as we acquired the
subsidiaries comprising the TGA Operating Unit effective January 1, 2006.
Phoenix Operating Unit
Net premium written for our Phoenix Operating Unit increased $1.9
million during the second quarter of 2006 to $10.7 million compared to $8.8
million in the second quarter of 2005.
Revenue for the Phoenix Operating Unit increased 6.2% to $11.9 million
for the second quarter of 2006 from $11.2 million for the same period in
2005. Higher earned premium of $0.7 million and higher investment income
of $0.3 million was partiallyoffset by lower third party commission revenue
of $0.4 million andlower processing and service fee revenue of $0.1 million
recognized in the second quarter of 2006 due to the 100% assumption of the
Texas non-standard personal automobile premium beginning late in 2004.
Pre-tax income for the Phoenix Operating Unit decreased $0.1 million,
or 2.7%, for the second quarter of 2006 compared to the second quarter of
2005. The primary reason for the decline in pre-tax income for the quarter
was due to increased losses and loss adjustment expenses of $1.0 million as
evidenced by an increase in the loss ratio to 62.3% versus 57.2% reported
in the second quarter of 2005. A competitive pricing environment with a
bias towards decreasing rates, as well as favorable reserve development
recognized in 2005, were the primary reasons for the increase in the loss
ratio. The increase in losses and loss adjustment expenses was partially
offset by the increases in revenue discussed above.
Aerospace Operating Unit
The subsidiaries comprising our Aerospace Operating Unit were all
acquired effective January 1, 2006. The $2.0 million of revenues was
derived mostly from third party commission revenue on the portion of
business retained by third parties. We plan to begin retaining a portion of
the premium produced by our Aerospace Operating Unit commencing in the third
quarter of 2006.
Pre-tax income for the Aerospace Operating Unit of $13,000 for the
second quarter of 2006 was due to revenue discussed above less operating
expenses of $1.8 million, comprised mostly of commission expense and salary
related expenses, and $0.1 million of amortization of intangible assets
acquired in the acquisition of Aerospace.
Corporate
Corporate revenue decreased $1.1 million for the second quarter of 2006
as compared to the same period in 2005. The decrease was primarily due
to $1.2 million in other-than-temporary impairment charges on our equity
investment portfolio. This was partially offset by $0.3 million in interest
earned on a trust account established in the first quarter of 2006 securing
the guaranteed future payments to the sellers of the subsidiaries now
comprising our TGA Operating Unit. (See Note 3, "Business Combinations"
and Note 11, "Structured Settlements.") Corporate pre-tax loss was $12.4
million for the second quarter of 2006 as compared to $0.9 million for the
same period in 2005. The increased loss was primarily due to decreased
revenue and $8.5 million in interest expense from amortization
attributable to the deemed discount on convertible promissory notes
issued in January, 2006. (See Note 10, "Convertible Notes Payable.")
This interest expense had no impact on our cash flow or our book value.
Also contributing to the increased corporate pre-tax loss was additional
interest expense of $1.5 million in the second quarter of 2006 comprised
of: (i) $0.5 million from the trust preferred securities issued in the
second quarter of 2005 (see Note 8, "Notes Payable"); (ii) $0.3 million
from the related party promissory note issued in January 2006 (see Note
9, "Note Payable to Related Party"); (iii) $0.3 million of amortization
of the discount on the future guaranteed payments to the sellers of
the subsidiaries now comprising the TGA Operating Unit (see Note 11,
"Structured Settlements"); (iv) $0.3 million from borrowings under our
revolving credit facility in January 2006 (see Note 8, "Notes Payable" and
Note 12, "Credit Facilities"); and (v) $0.1 million from the issuance
of convertible notes issued in January 2006 (see Note 10, "Convertible
Notes Payable"). Also contributing to the increase in pre-tax loss was the
decrease in revenue discussed above.
Year-to-Date 2006 as compared to Year-to-Date 2005
HGA Operating Unit
Beginning in the third quarter of 2005, our HGA Operating Unit began
retaining written premium through AHIC that was previously retained by third
parties. This resulted in net written premium for the HGA Operating Unit of
$43.1 million for the six months ended June 30, 2006.
Total revenue for our HGA Operating Unit of $36.8 million for the first
six months of 2006 was $23.9 million more than the $12.9 million reported in
the same period of 2005. This 186.3% increase in total revenue was
primarily due to net premiums earned of $31.2 million from the issuance of
AHIC policies produced by our HGA Operating Unit. Increased net investment
income contributed an additional $1.8 million to the increase in revenue for
the six months ended June 30, 2006. These increases in revenue were
partially offset by lower ceding commission revenue of $7.6 million and
lower processing and service fees of $1.5 million, in both cases due to the
shift from a third party agency structure to an insurance underwriting
structure.
Pre-tax income for our HGA Operating Unit of $6.1 million for the first
six months of 2006 increased $3.6 million, or 141.5%, over the $2.5 million
reported for the first six months of 2005. Increased revenue, as discussed
above, was the primary reason for the increase in pre-tax income, partially
offset by increased loss and loss adjustment expenses of $17.8 million and
additional production expenses of $2.5 million. The HGA Operating Unit
reported a loss ratio of 57.2% for the first six months of 2006. Our HGA
Operating Unit had no loss ratio for the first six months of 2005 because we
did not retain any of the premium produced by our HGA Operating Unit for
this period.
TGA Operating Unit
The subsidiaries comprising our TGA Operating Unit were all acquired
effective January 1, 2006. The $29.3 million of revenues was derived mostly
from third party commission revenue of $16.6 million on the portion of
business produced by our TGA Operating Unit that was retained by third
parties and from $11.0 million of earned premium on produced business that
was assumed by GSIC or AHIC. The remaining $1.7 million of revenue was
primarily derived mostly from investment income and finance charges.
Pre-tax income for the TGA Operating Unit of $5.2 million was primarily
due to revenue as discussed above less: (i) incurred loss and loss
adjustment expenses of $6.3 million on the portion of the business assumed
by GSIC or AHIC; (ii) $16.7 million in operating expenses, comprised mostly
of commission expense and salary related expenses; and (iii) $1.0 million of
amortization of intangible assets acquired in the acquisition of the
subsidiaries comprising our TGA Operating Unit. The TGA Operating Unit
reported a loss ratio of 57.3% for the six months ended June 30, 2006. We
do not have a comparable loss ratio for the same period in 2005 as we
acquired the subsidiaries comprising the TGA Operating Unit effective
January 1, 2006.
Phoenix Operating Unit
Net premium written for our Phoenix Operating Unit increased $2.3
million during the first six months of 2006 to $21.8 million compared to
$19.5 million in the first six months of 2005.
Revenue for the Phoenix Operating Unit increased 1.5% to $22.7 million
for the first six months of 2006 from $22.4 million for the same period in
2005. Higher earned premium of $0.4 million and higher investment income of
$0.5 million was partially offset by lower ceding commission revenue of $0.5
million and lower processing and service fees of $0.2 million due to the
100% assumption of the Texas non-standard automobile premium beginning late
in 2004.
Pre-tax income for the Phoenix Operating Unit decreased $0.5 million,
or 9.3%, for the first six months of 2006 compared to the first six months
of 2005. The primary reason for the decline in pre-tax income for the first
six months of 2006 was increased losses and loss adjustment expenses of $1.0
million as evidenced by an increase in the loss ratio to 62.4% versus 58.7%
reported in the first six months of 2005. A competitive pricing environment
with a bias towards decreasing rates, as well as favorable reserve
development recognized in 2005, were the primary reasons for the increase in
the loss ratio. The increase in losses and loss adjustment expenses was
partially offset by the increase in revenue discussed above.
Aerospace Operating Unit
The subsidiaries comprising our Aerospace Operating Unit were all
acquired effective January 1, 2006. The $3.8 million of revenues was
derived mostly from third party commission revenue on the portion of
business retained by third parties.
Pre-tax loss for our Aerospace Operating Unit of $96,000 for the first
six months of 2006 was due to revenue discussed above less: (i) operating
expenses of $3.6 million, comprised mostly of commission expense and salary
related expenses; (ii) loss and loss adjustment expenses of $0.2 million;
and (iii) $0.2 million of amortization of intangible assets acquired in the
acquisition of the subsidiaries now comprising our Aerospace Operating Unit.
Corporate
Corporate revenue decreased $0.9 million for the first six months
of 2006 as compared to the same period in 2005. The decrease was primarily
due to $1.2 million in other-than-temporary impairment charges on our
equity investment portfolio. This was partially offset by $0.5 million in
interest earned on a trust account established in the first quarter of
2006 securing the guaranteed future payments to the sellers of the
subsidiaries now comprising our TGA Operating Unit. (See Note
3, "Business Combinations" and Note 11, "Structured Settlements.")
Corporate pre-tax loss was $15.9 million for the first six months of
2006 as compared to $1.7 million for the same period in 2005. The
increased loss was primarily due to decreased revenue and $9.6 million
in interest expense from amortization attributable to the deemed discount on
convertible promissory notes issued in January, 2006. (See Note 10,
"Convertible Notes Payable.") This interest expense had no impact on our
cash flow or our book value. Also contributing to the increased corporate
pre-tax loss was additional interest expense of $3.0 million in the
first six months of 2006 comprised of: (i) $1.1 million from the trust
preferred securities issued in the second quarter of 2005 (see Note 8,
"Notes Payable"); (ii) $0.6 million from the related party promissory note
issued in January 2006 (see Note 9, "Note Payable to Related Party"); (iii)
$0.5 million of amortization of the discount on the future guaranteed
payments to the sellers of the subsidiaries now comprising our TGA Operating
Unit (see Note 11, "Structured Settlements"); (iv) $0.5 million from
borrowings under our revolving credit facility in January 2006 (see Note 8,
"Notes Payable" and Note 12, "Credit Facilities"); and (v) $0.3 million from
the issuance of convertible notes issued in January 2006 (see Note 10,
"Convertible Notes Payable").
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. 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, 2006, Hallmark had $2.6 million in cash and invested assets. Cash and
invested assets of our non-insurance subsidiaries were $3.5 million as of
June 30, 2006.
Property and casualty insurance companies domiciled in the State of
Texas are limited in the payment of dividends to their shareholders in any
12-month period, without the prior written consent of the Texas Department
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 2006,
AHIC's ordinary dividend capacity is $6.4 million. PIIC, domiciled in
Arizona, is limited in the payment of dividends to the lesser of 10% of
prior year policyholders surplus or prior year's net investment income,
without prior written approval from the Arizona Department of Insurance.
During 2006, PIIC's ordinary dividend capacity is $1.6 million. GSIC,
domiciled in Oklahoma, is limited in the payment of dividends to the greater
of 10% of prior year policyholders surplus or prior year's statutory
net income, without prior written approval from the Oklahoma Insurance
Department. During 2006, GSIC's ordinary dividend capacity is $0.1 million.
None of AHIC, PIIC or GSIC paid a dividend to Hallmark during the first six
months of 2006. Neither AHIC nor PIIC paid a dividend to Hallmark during
2005.
The Texas Department of Insurance, the Arizona Department of Insurance
and the Oklahoma Insurance Department each regulates financial transactions
between our insurance subsidiaries and their affiliated companies.
Applicable regulations require approval of management fees, expense sharing
contracts and similar transactions. Phoenix General Agency paid $0.8 million
in management fees to Hallmark during the first six months of 2006 but did
not pay any management fees during the same period of 2005. PIIC paid $0.6
million in management fees to Phoenix General Agency during the first six
months of 2006 and paid $0.7 million in management fees to Phoenix General
Agency during the same period in 2005. AHIC did not pay any management fees
during the first six months of 2006 or 2005. GSIC did not pay any management
fees during the first six months of 2006.
Comparison of June 30, 2006 to December 31, 2005
On a consolidated basis, our cash and investments (excluding restricted
cash and investments) at June 30, 2006 were $185.0 million compared to
$139.6 million at December 31, 2005. The acquisitions of the subsidiaries
comprising our TGA Operating Unit and our Aerospace Operating Unit accounted
for $21.0 million of this increase, while the remainder of the increase was
primarily the result of the retention of business produced by our HGA
Operating Unit and TGA Operating Unit.
Comparison of Six Months Ended June 30, 2006 and June 30, 2005
Net cash provided by our consolidated operating activities was $29.6
million for the first six months of 2006 compared to $2.2 million for the
first six months of 2005. The increase in operating cash flow primarily
resulted from the retention of HGA Operating Unit and TGA Operating Unit
business in the first six months of 2006 that was not retained by us in the
same period in 2005. The net effect on operating cash flow was an increase
of $27.8 million resulting from an increase in collected premiums net of
paid losses and loss adjustment expenses partially offset by lower collected
commission and claim fee revenue. Increased collected commission revenue
from the acquisition of the subsidiaries comprising our TGA Operating Unit
and Aerospace Operating Unit and increased collected investment income were
offset by increased operating expenses from these acquisitions, additional
interest paid on debt financing these acquisitions and increased tax
deposits on higher taxable earnings.
Cash used by investing activities during the first six months of 2006
was $113.3 million as compared to $8.5 million for the same period in 2005.
The increase in cash used by investing activities is mostly due to
additional purchases of debt, equity and short-term securities of $64.7
million and the acquisitions of the subsidiaries comprising our TGA
Operating Unit and our Aerospace Operating Unit in the first quarter of 2006
which used $26.0 million, net of cash acquired. Also contributing to the
increase in cash used by investing activities was the funding of $25.0
million to a trust account securing the future guaranteed payments to the
sellers of the subsidiaries comprising our TGA Operating Unit, as well as
PAAC's $2.4 million repayment of premium finance notes, net of premium
finance notes originated. Partially offsetting these uses was a $12.7
million increase in net redemptions of short-term investments in the first
six months of 2006 versus the same period in 2005.
Cash provided by financing activities during the first six months of
2006 was $52.5 million as compared to $75.2 million for the same period of
2005. The cash provided in 2006 was primarily from the issuance of three
debt instruments in January. The first was a promissory note payable to
Newcastle Partners, L.P. ("Newcastle Partners") in the amount of $12.5
million to fund the cash required to close the Aerospace acquisition. This
note bears interest at the rate of 10% per annum. The unpaid principal
balance of the promissory note, together with all accrued and unpaid
interest, became due and payable on demand as of June 30, 2006. The second
debt instrument was $25.0 million in subordinated convertible promissory
notes to the Newcastle Special Opportunity Fund I, L.P. and Newcastle
Special Opportunity Fund II, L.P, (the "Opportunity Funds"). The principal
and accrued interest on the convertible notes was converted to approximately
3.3 million shares of our common stock during the second quarter of 2006.
The $25.0 million raised with these notes was used to fund a trust account
securing future guaranteed payments to the sellers of the subsidiaries now
comprising our TGA Operating Unit. The third debt instrument was $15.0
million borrowed under our revolving credit facility to fund the cash
required to close the acquisition of the subsidiaries now comprising our TGA
Operating Unit. Newcastle Partners and the Opportunity Funds are each an
affiliate of our Executive Chairman, Mark E.Schwarz.
Credit Facilities
On June 29, 2005, we entered into a credit facility with The Frost
National Bank. The credit facility was amended and restated on January 27,
2006 to a $20.0 million revolving credit facility, with a $5.0 million
letter of credit sub-facility. We borrowed $15.0 million under the
revolving credit facility to fund the cash required to close the acquisition
of the subsidiaries now comprising our TGA Operating Unit. Principal
outstanding under the revolving credit facility generally bears interest at
the three month Eurodollar rate plus 2.00%, payable quarterly in arrears.
We pay letter of credit fees at the rate of 1.00% per annum. Our
obligations under the revolving 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
revolving 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. The amended
and restated credit agreement terminates on January 27, 2008. As of June
30, 2006, there was $15.0 million outstanding under our revolving credit
facility, and we were in compliance with or had obtained waivers of all of
our covenants. We have obtained a waiver through January 1, 2007 of a
covenant requiring us to maintain a net underwriting profit calculated on
the basis of statutory accounting principles. The waiver was necessary
primarily as a result of the immediate expensing under statutory accounting
principles of policy acquisition costs attributable to the increased
retention of premiums produced by our HGA Operating Unit and our TGA
Operating Unit, which costs are amortized over the life of the policy under
U.S. generally accepted accounting principles. In the third quarter of
2005, we issued a $4.0 million letter of credit under this facility to
collateralize certain obligations under the agency agreement between our HGA
Operating Unit and Clarendon National Insurance Company effective July 1,
2004.
PAAC has a $5.0 million revolving credit facility with JPMorgan Chase
Bank which terminates June 30, 2007. Principal outstanding under this
revolving credit facility generally bears interest at 1% above the
prime rate. PAAC's obligations under this revolving credit facility are
secured by its premium finance notes receivables. This revolving credit
facility contains various restrictive covenants which, among other things,
require PAAC to maintain minimum amounts of tangible net worth and working
capital. As of June 30, 2006, $2.3 million was outstanding under this
revolving credit facility and PAAC was in compliance with all of its
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, 2006,
the note balance was $30.9 million.
Other Debt Obligations.
On January 3, 2006, we executed a promissory note payable to Newcastle
Partners in the amount of $12.5 million in order to obtain funding to
complete the acquisition of the subsidiaries now comprising the Aerospace
Operating Unit. The promissory note bears interest at 10% per annum prior to
maturity and at the maximum rate allowed under applicable law upon default.
Interest is payable on the first business day of each month. The principal
of the promissory note, together with accrued but unpaid interest, became
due on demand as of June 30, 2006.
On January 27, 2006, we issued an aggregate of $25.0 million in
subordinated convertible promissory notes to the Opportunity Funds. Each
convertible note bore interest at 4% per annum, which rate increased to 10%
per annum in the event of default. Interest was payable quarterly in arrears
commencing March 31, 2006. Principal and all accrued but unpaid interest was
due at maturity on July 27, 2007. The principal and accrued interest on the
convertible notes was converted to approximately 3.3 million shares of our
common stock during the second quarter of 2006.
Structured Settlements
In connection with our acquisition of the subsidiaries now comprising
our TGA Operating Unit, we issued to the sellers promissory notes in the
aggregate principal amount of $23.7 million payable $14.2 million on or
before January 1, 2007, and $9.5 million on or before January 1, 2008. We
are also obligated to pay to the sellers an additional $0.8 million on or
before January 1, 2007 and an additional $0.5 million on or before January
1, 2008 in consideration of the sellers' compliance with certain restrictive
covenants, including a covenant not to compete for a period of five years
after closing. We secured payment of these future installments of purchase
price and restrictive covenant consideration by depositing $25.0 million in
a trust account for the benefit of the sellers. We recorded a payable for
future guaranteed payments to the sellers of $25.0 million discounted at
4.4%, the rate of two-year U.S. Treasuries purchased as the only permitted
investment of the trust account. The trust account is classified in
restricted cash and investments on our balance sheet. As of June 30, 2006,
the balance of the structured settlements was $24.1 million.
Conclusion
Based on budgeted and year-to-date cash flow information, we believe
that we have sufficient liquidity to meet our projected insurance
obligations, operational expenses and capital expenditure requirements for
the next 12 months. However, additional capital is required to satisfy our
$12.5 million obligation to Newcastle Partners which became payable on
demand as of June 30, 2006. No demand has been made, and a portion of the
net proceeds to us from our previously announced stock offering are intended
to be used to repay this indebtedness to Newcastle Partners.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
As of June 30, 2006, there had been no material changes in the market
risks described in the Company's Form 10-K for the year ended December 31,
2005.
Item 4. Controls and Procedures.
The principal executive officer and principal 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 principal executive
officer and principal 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 principal executive officer and principal 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 1A. Risk Factors.
In addition to the other information set forth in this report, you
should carefully consider the following risk factors:
Our success depends on our ability to price accurately the risks we
underwrite.
Our results of operations and financial condition depend on our ability to
underwrite and set premium rates accurately for a wide variety of risks.
Adequate rates are necessary to generate premiums sufficient to pay losses,
loss settlement expenses and underwriting expenses and to earn a profit. To
price our products accurately, we must collect and properly analyze a
substantial amount of data; develop, test and apply appropriate pricing
techniques; closely monitor and timely recognize changes in trends; and
project both severity and frequency of losses with reasonable accuracy. Our
ability to undertake these efforts successfully, and as a result price our
products accurately, is subject to a number of risks and uncertainties, some
of which are outside our control, including:
* the availability of sufficient reliable data and our ability to properly
analyze available data;
* the uncertainties that inherently characterize estimates and assumptions;
* our selection and application of appropriate pricing techniques; and
* changes in applicable legal liability standards and in the civil
litigation system generally.
Consequently, we could underprice risks, which would adversely affect our
profit margins, or we could overprice risks, which could reduce our sales
volume and competitiveness. In either case, our profitability could be
materially and adversely affected.
Our results may fluctuate as a result of cyclical changes in the
property/casualty insurance industry.
All of our revenue is attributable to property/casualty insurance, which as
an industry is cyclical in nature and has historically been characterized by
soft markets followed by hard markets. A soft market is a period of
relatively high levels of price competition, less restrictive underwriting
standards and generally low premium rates. A hard market is a period of
capital shortages resulting in lack of insurance availability, relatively
low levels of competition, more selective underwriting of risks and
relatively high premium rates. If we find it necessary to reduce premiums or
limit premium increases due to competitive pressures on pricing in a
softening market, we may experience a reduction in our premiums written and
in our profit margins and revenues, which could adversely affect our
financial results.
Estimating reserves is inherently uncertain. If our loss reserves are not
adequate, it will have an unfavorable impact on our results.
We maintain loss reserves to cover our estimated ultimate liability for
unpaid losses and loss adjustment expenses for reported and unreported
claims incurred as of the end of each accounting period. Reserves represent
management's estimates of what the ultimate settlement and administration of
claims will cost and are not reviewed by an independent actuary. These
estimates, which generally involve actuarial projections, are based on
management's assessment of facts and circumstances then known, as well as
estimates of future trends in claim severity and frequency, judicial
theories of liability, and other factors. These variables are affected by
both internal and external events, such as changes in claims handling
procedures, inflation, judicial trends and legislative changes. Many of
these factors are not quantifiable. Additionally, there may be a significant
reporting lag between the occurrence of an event and the time it is reported
to us. The inherent uncertainties of estimating reserves are greater for
certain types of liabilities, particularly those in which the various
considerations affecting the type of claim are subject to change and in
which long periods of time may elapse before a definitive determination of
liability is made. Reserve estimates are continually refined in a regular
and ongoing process as experience develops and further claims are reported
and settled. Adjustments to reserves are reflected in the results of the
periods in which such estimates are changed. For example, a 1% change in
June 30, 2006 unpaid losses and loss adjustment expenses would have produced
a $0.5 million change to pretax earnings. Our gross loss and loss adjustment
expense reserves totaled $52.1 million at June 30, 2006. Our loss and loss
adjustment expense reserves, net of reinsurance recoverables, were $50.6
million at that date. Because setting reserves is inherently uncertain,
there can be no assurance that the current reserves will prove adequate.
Our failure to maintain favorable financial strength ratings could
negatively impact our ability to compete successfully.
Third-party rating agencies assess and rate the claims-paying ability of
insurers based upon criteria established by the agencies. During 2005, A.M.
Best, a nationally recognized insurance industry rating service and
publisher, upgraded the financial strength rating of PIIC, from "B" (Fair)
to "B+" (Very Good), and upgraded the financial strength rating of AHIC,
from "B" (Fair) to "A-" (Excellent). Our insurance company subsidiaries have
historically been rated on an individual basis. However, effective January
1, 2006, our insurance company subsidiaries entered into a pooling
arrangement whereby AHIC would retain 59.9% of the net premiums written,
PIIC would retain 34.1% of the net premiums written and GSIC would retain
6.0% of the net premiums written. As a result, in June 2006, A.M. Best
notified us that our insurance company subsidiaries would be rated on a
pooled basis and assigned a rating of "A-" (Excellent) to each of our
individual insurance company subsidiaries and to the pool formed by our
insurance company subsidiaries.
These financial strength ratings are used by policyholders, insurers,
reinsurers and insurance and reinsurance intermediaries as an important
means of assessing the financial strength and quality of insurers. These
ratings are not evaluations directed to potential purchasers of our common
stock and are not recommendations to buy, sell or hold our common stock. Our
ratings are subject to change at any time and could be revised downward or
revoked at the sole discretion of the rating agencies. We believe that the
ratings assigned by A.M. Best are an important factor in marketing our
products. Our ability to retain our existing business and to attract new
business in our insurance operations depends largely on these ratings. Our
failure to maintain our ratings, or any other adverse development with
respect to our ratings, could cause our current and future independent
agents and insureds to choose to transact their business with more highly
rated competitors. If A.M. Best downgrades our ratings or publicly indicates
that our ratings are under review, it is likely that we would not be able to
compete as effectively with our competitors, and our ability to sell
insurance policies could decline. If that happens, our sales and earnings
would decrease. For example, many of our agencies and insureds have
guidelines that require us to have an A.M. Best financial strength rating of
"A-" or higher. A reduction of our A.M. Best rating below "A-" would prevent
us from issuing policies to insureds or potential insureds with such ratings
requirements. Because lenders and reinsurers will use our A.M. Best ratings
as a factor in deciding whether to transact business with us, the failure of
our insurance company subsidiaries to maintain their current ratings could
dissuade a lender or reinsurance company from conducting business with us or
might increase our interest or reinsurance costs. In addition, a ratings
downgrade by A.M. Best below "A-" would require us to post collateral in
support of our obligations under certain of our reinsurance agreements
pursuant to which we assume business.
The loss of key executives could disrupt our business.
Our success will depend in part upon the continued service of certain key
executives. Our success will also depend on our ability to attract and
retain additional executives and personnel. We do not have employment
agreements with our Chief Executive Officer or any other of our executive
officers other than employment agreements entered into in connection with
the acquisitions of the subsidiaries now comprising our TGA Operating Unit
and our Aerospace Operating Unit. The loss of key personnel, or our
inability to recruit and retain additional qualified personnel, could cause
disruption in our business and could prevent us from fully implementing our
business strategies, which could materially and adversely affect our
business, growth and profitability.
Our industry is very competitive, which may unfavorably impact our results
of operations.
The property/casualty insurance market, our primary source of revenue,
is highly competitive and, except for regulatory considerations, has
very few barriers to entry. According to A.M. Best, there were 3,120
property/casualty insurance companies and 2,019 property/casualty insurance
groups operating in North America as of July 22, 2005. Our HGA Operating
Unit and TGA Operating Unit compete with a variety of large national
commercial lines carriers such as Hartford, Zurich, St. Paul Travelers and
Safeco, as well as numerous smaller regional companies. Although our Phoenix
Operating Unit competes with large national insurers such as Allstate, State
Farm and Progressive, as a participant in the non-standard personal
automobile marketplace, its primary competition consists of numerous
regional companies and managing general agencies. Our Aerospace Operating
Unit competes primarily with several other companies specializing in general
aviation insurance, including Houston Casualty Corp., Phoenix Aviation, W.
Brown & Company and London Aviation Underwriters. Our competitors include
entities which have, or are affiliated with entities which have, greater
financial and other resources than we have. In addition, competitors may
attempt to increase market share by lowering rates. In that case, we could
experience reductions in our underwriting margins, or sales of our insurance
policies could decline as customers purchase lower-priced products from our
competitors. Losing business to competitors offering similar products at
lower prices, or having other competitive advantages, could adversely affect
our results of operations.
Our results may be unfavorably impacted if we are unable to obtain adequate
reinsurance.
As part of our overall risk and capacity management strategy, we purchase
reinsurance for significant amounts of risk, especially catastrophe risks
that we and our insurance company subsidiaries underwrite. Our catastrophe
and non-catastrophe reinsurance facilities are subject to annual renewal. We
may be unable to maintain our current reinsurance facilities or to obtain
other reinsurance facilities in adequate amounts and at favorable rates. The
amount, availability and cost of reinsurance are subject to prevailing
market conditions beyond our control and may affect our ability to write
additional premiums as well as our profitability. If we are unable to obtain
adequate reinsurance protection for the risks we have underwritten, we will
either be exposed to greater losses from these risks or we will reduce the
level of business that we underwrite, which will reduce our revenue.
If the companies that provide our reinsurance do not pay our claims in a
timely manner, we could incur severe losses.
We purchase reinsurance by transferring, or ceding, part of the risk we have
assumed to a reinsurance company in exchange for part of the premium we
receive in connection with the risk. Although reinsurance makes the
reinsurer liable to us to the extent the risk is transferred or ceded to the
reinsurer, it does not relieve us of our liability to our policyholders.
Accordingly, we bear credit risk with respect to our reinsurers. We cannot
assure that our reinsurers will pay all of our reinsurance claims, or that
they will pay our claims on a timely basis. At June 30, 2006, we had a total
of $3.1 million due us from reinsurers, including $1.5 million of
recoverables from losses and $1.6 million in prepaid reinsurance premiums.
The largest amount due us from a single reinsurer as of June 30, 2006 was
$1.1 million reinsurance and premium recoverable from GE Reinsurance Corp.
If any of our reinsurers are unable or unwilling to pay amounts they owe us
in a timely fashion, we could suffer a significant loss or a shortage of
liquidity, which would have a material adverse effect on our business and
results of operations.
Catastrophic losses are unpredictable and may adversely affect our results
of operations, liquidity and financial condition.
Property/casualty insurance companies are subject to claims arising out of
catastrophes that may have a significant effect on their results of
operations, liquidity and financial condition. Catastrophes can be caused by
various events, including hurricanes, windstorms, earthquakes, hail storms,
explosions, severe winter weather and fires, and may include man-made
events, such as the September 11, 2001 terrorist attacks on the World Trade
Center. The incidence, frequency, and severity of catastrophes are
inherently unpredictable. The extent of losses from a catastrophe is a
function of both the total amount of insured exposure in the area affected
by the event and the severity of the event. Claims from catastrophic events
could reduce our net income, cause substantial volatility in our financial
results for any fiscal quarter or year or otherwise adversely affect our
financial condition, liquidity or results of operations. Catastrophes may
also negatively affect our ability to write new business. Increases in the
value and geographic concentration of insured property and the effects of
inflation could increase the severity of claims from catastrophic events in
the future.
Catastrophe models may not accurately predict future losses.
Along with other insurers in the industry, we use models developed by third-
party vendors in assessing our exposure to catastrophe losses that assume
various conditions and probability scenarios. However, these models do not
necessarily accurately predict future losses or accurately measure losses
currently incurred. Catastrophe models, which have been evolving since the
early 1990s, use historical information about various catastrophes and
detailed information about our in-force business. While we use this
information in connection with our pricing and risk management activities,
there are limitations with respect to their usefulness in predicting losses
in any reporting period. Examples of these limitations are significant
variations in estimates between models and modelers and material increases
and decreases in model results due to changes and refinements of the
underlying data elements and assumptions. Such limitations lead to
questionable predictive capability and post-event measurements that have not
been well understood or proven to be sufficiently reliable. In addition, the
models are not necessarily reflective of company or state-specific policy
language, demand surge for labor and materials or loss settlement expenses,
all of which are subject to wide variation by catastrophe. Because the
occurrence and severity of catastrophes are inherently unpredictable and may
vary significantly from year to year, historical results of operations may
not be indicative of future results of operations.
We are subject to comprehensive regulation, and our results may be
unfavorably impacted by these regulations.
We are subject to comprehensive governmental regulation and supervision.
Most insurance regulations are designed to protect the interests of
policyholders rather than of the stockholders and other investors of the
insurance companies. These regulations, generally administered by the
department of insurance in each state in which we do business, relate to,
among other things:
* approval of policy forms and rates;
* standards of solvency, including risk-based capital measurements,
which are a measure developed by the National Association of Insurance
Commissioners and used by the state insurance regulators to identify
insurance companies that potentially are inadequately capitalized;
* licensing of insurers and their agents;
* restrictions on the nature, quality and concentration of investments;
* restrictions on the ability of insurance company subsidiaries to pay
dividends;
* restrictions on transactions between insurance company subsidiaries and
their affiliates;
* requiring certain methods of accounting;
* periodic examinations of operations and finances;
* the use of non-public consumer information and related privacy issues;
* the use of credit history in underwriting and rating;
* limitations on the ability to charge policy fees;
* the acquisition or disposition of an insurance company or of any company
controlling an insurance company;
* involuntary assignments of high-risk policies, participation in
reinsurance facilities and underwriting associations, assessments
and other governmental charges;
* restrictions on the cancellation or non-renewal of policies and, in
certain jurisdictions, withdrawal from writing certain lines of business;
* prescribing the form and content of records of financial condition to be
filed;
* requiring reserves for unearned premium, losses and other purposes; and
* with respect to premium finance business, the federal Truth-in-Lending
Act and similar state statutes. In states where specific statutes have
not been enacted, premium finance is generally subject to state usury
laws that are applicable to consumer loans.
State insurance departments also conduct periodic examinations of the
affairs of insurance companies and require filing of annual and other
reports relating to the financial condition of insurance companies, holding
company issues and other matters. Our business depends on compliance with
applicable laws and regulations and our ability to maintain valid licenses
and approvals for our operations. Regulatory authorities may deny or revoke
licenses for various reasons, including violations of regulations. Changes
in the level of regulation of the insurance industry or changes in laws or
regulations themselves or interpretations by regulatory authorities could
have a material adverse affect on our operations. In addition, we could face
individual, group and class-action lawsuits by our policyholders and others
for alleged violations of certain state laws and regulations. Each of these
regulatory risks could have an adverse effect on our profitability.
State statutes limit the aggregate amount of dividends that our subsidiaries
may pay Hallmark, thereby limiting its funds to pay expenses and dividends.
Hallmark is a holding company and a legal entity separate and distinct from
its subsidiaries. As a holding company without significant operations of its
own, Hallmark's principal sources of funds are dividends and other sources
of funds from its subsidiaries. State insurance laws limit the ability of
Hallmark's insurance company subsidiaries to pay dividends and require our
insurance company subsidiaries to maintain specified minimum levels of
statutory capital and surplus. The aggregate maximum amount of dividends
permitted by law to be paid by an insurance company does not necessarily
define an insurance company's actual ability to pay dividends. The actual
ability to pay dividends may be further constrained by business and
regulatory considerations, such as the impact of dividends on surplus, by
our competitive position and by the amount of premiums that we can write.
Without regulatory approval, the aggregate maximum amount of dividends that
could be paid to Hallmark in 2006 by our insurance company subsidiaries is
$8.1 million. State insurance regulators have broad discretion to limit the
payment of dividends by insurance companies and Hallmark's right to
participate in any distribution of assets of one of our insurance company
subsidiaries is subject to prior claims of policyholders and creditors
except to the extent that its rights, if any, as a creditor are recognized.
Consequently, Hallmark's ability to pay debts, expenses and cash dividends
to our stockholders may be limited.
Our insurance company subsidiaries are subject to minimum capital and
surplus requirements. Failure to meet these requirements could subject us to
regulatory action.
Our insurance company subsidiaries are subject to minimum capital and
surplus requirements imposed under the laws of Texas, Arizona and Oklahoma.
Any failure by one of our insurance company subsidiaries to meet minimum
capital and surplus requirements imposed by applicable state law will
subject it to corrective action, which may include requiring adoption of a
comprehensive financial plan, revocation of its license to sell insurance
products or placing the subsidiary under state regulatory control. Any new
minimum capital and surplus requirements adopted in the future may require
us to increase the capital and surplus of our insurance company
subsidiaries, which we may not be able to do.
We are subject to assessments and other surcharges from state guaranty
funds, mandatory reinsurance arrangements and state insurance facilities,
which may reduce our profitability.
Virtually all states require insurers licensed to do business therein to
bear a portion of the unfunded obligations of impaired or insolvent
insurance companies. These obligations are funded by assessments, which are
levied by guaranty associations within the state, up to prescribed limits,
on all member insurers in the state on the basis of the proportionate share
of the premiums written by member insurers in the lines of business in which
the impaired, insolvent or failed insurer was engaged. Accordingly, the
assessments levied on us by the states in which we are licensed to write
insurance may increase as we increase our premiums written. In addition, as
a condition to the ability to conduct business in certain states, insurance
companies are required to participate in mandatory reinsurance funds such as
the Texas Property and Casualty Insurance Guaranty Association. The effect
of these assessments and mandatory reinsurance arrangements, or changes in
them, could reduce our profitability in any given period or limit our
ability to grow our business.
We are currently monitoring developments with respect to various state
facilities, such as the Texas FAIR Plan and the Texas Windstorm Insurance
Association, and the various guaranty funds in which we participate. The
ultimate impact of recent catastrophe experience on these facilities is
currently uncertain but could result in the facilities recognizing a
financial deficit or a financial deficit greater than the level currently
estimated. They may, in turn, have the ability to assess participating
insurers when financial deficits occur, adversely affecting our results of
operations. While these facilities are generally designed so that the
ultimate cost is borne by policyholders, the exposure to assessments and the
availability of recoupments or premium rate increases from these facilities
may not offset each other in our financial statements. Moreover, even if
they do offset each other, they may not offset each other in financial
statements for the same fiscal period due to the ultimate timing of the
assessments and recoupments or premium rate increases, as well as the
possibility of policies not being renewed in subsequent years.
Adverse securities market conditions can have a significant and negative
impact on our investment portfolio.
Our results of operations depend in part on the performance of our invested
assets. As of June 30, 2006, 73.6% of our investment portfolio was invested
in fixed-income securities. Certain risks are inherent in connection with
fixed-income securities, including loss upon default and price volatility in
reaction to changes in interest rates and general market factors. In
general, the fair market value of a portfolio of fixed-income securities
increases or decreases inversely with changes in the market interest rates,
while net investment income realized from future investments in fixed-income
securities increases or decreases along with interest rates. In addition,
8.4% of our fixed-income securities have call or prepayment options. This
subjects us to reinvestment risk should interest rates fall and issuers call
their securities. Furthermore, actual net investment income and/or cash
flows from investments that carry prepayment risk, such as mortgage-backed
and other asset-backed securities, may differ from those anticipated at the
time of investment as a result of interest rate fluctuations. An investment
has prepayment risk when there is a risk that cash flows from the repayment
of principal might occur earlier than anticipated because of declining
interest rates or later than anticipated because of rising interest rates.
In addition to the general risks described above, although we maintain an
investment-grade portfolio, our fixed-income securities are also subject to
credit risk. If any of the issuers of our fixed-income securities suffer
financial setbacks, the ratings on the fixed-income securities could fall
(with a concurrent fall in market value) and, in a worst case scenario, the
issuer could default on its obligations. Future changes in the fair market
value of our available-for-sale securities will be reflected in other
comprehensive income. Similar treatment is not available for liabilities.
Therefore, interest rate fluctuations could adversely affect our
stockholders' equity, total comprehensive income and/or our cash flows.
We rely on independent agents and specialty brokers to market our products
and their failure to do so would have a material adverse effect on our
results of operations.
We market and distribute our insurance programs exclusively through
independent insurance agents and specialty insurance brokers. As a result,
our business depends in large part on the marketing efforts of these agents
and brokers and on our ability to offer insurance products and services that
meet the requirements of the agents, the brokers and their customers.
However, these agents and brokers are not obligated to sell or promote our
products and many sell or promote competitors' insurance products in
addition to our products. Some of our competitors have higher financial
strength ratings, offer a larger variety of products, set lower prices for
insurance coverage and/or offer higher commissions than we do. Therefore, we
may not be able to continue to attract and retain independent agents and
brokers to sell our insurance products. The failure or inability of
independent agents and brokers to market our insurance products successfully
could have a material adverse impact on our business, financial condition
and results of operations.
We may experience difficulty in integrating recent or future acquisitions
into our operations.
We completed the acquisitions of the subsidiaries now comprising both our
TGA Operating Unit and our Aerospace Operating Unit during January 2006. We
may pursue additional acquisitions in the future. The successful integration
of newly acquired businesses into our operations will require, among other
things, the retention and assimilation of their key management, sales and
other personnel; the coordination of their lines of insurance products and
services; the adaptation of their technology, information systems and other
processes; and the retention and transition of their customers. Unexpected
difficulties in integrating any acquisition could result in increased
expenses and the diversion of management time and resources. If we do not
successfully integrate any acquired business into our operations, we may not
realize the anticipated benefits of the acquisition, which could have a
material adverse impact on our financial condition and results of
operations. Further, any potential acquisitions may require significant
capital outlays and, if we issue equity or convertible debt securities to
pay for an acquisition, the issuance may be dilutive to our existing
stockholders.
Our geographic concentration ties our performance to the business, weather,
economic and regulatory conditions of certain states.
The following five states account for 94.6% of our gross written premiums
for the six months ended June 30, 2006: Texas (49.1%), Oregon (18.6%), New
Mexico (12.9%), Idaho (8.4%) and Arizona (5.6%). Our revenues and
profitability are subject to the prevailing regulatory, legal, economic,
political, demographic, competitive, weather and other conditions in the
principal states in which we do business. Changes in any of these conditions
could make it less attractive for us to do business in such states and would
have a more pronounced effect on us compared to companies that are more
geographically diversified. In addition, our exposure to severe losses from
localized natural perils, such as windstorms or hailstorms, is increased in
those areas where we have written significant numbers of property/casualty
insurance policies.
The exclusions and limitations in our policies may not be enforceable.
Many of the policies we issue include exclusions or other conditions that
define and limit coverage, which exclusions and conditions are designed to
manage our exposure to certain types of risks and expanding theories of
legal liability. In addition, many of our policies limit the period during
which a policyholder may bring a claim under the policy, which period in
many cases is shorter than the statutory period under which these claims can
be brought by our policyholders. While these exclusions and limitations help
us assess and control our loss exposure, it is possible that a court or
regulatory authority could nullify or void an exclusion or limitation, or
legislation could be enacted modifying or barring the use of these
exclusions and limitations. This could result in higher than anticipated
losses and loss adjustment expenses by extending coverage beyond our
underwriting intent or increasing the number or size of claims, which could
have a material adverse effect on our operating results. In some instances,
these changes may not become apparent until some time after we have issued
the insurance policies that are affected by the changes. As a result, the
full extent of liability under our insurance contracts may not be known for
many years after a policy is issued.
We rely on our information technology and telecommunications systems and the
failure or disruption of these systems could disrupt our operations and
adversely affect our results of operations.
Our business is highly dependent upon the successful and uninterrupted
functioning of our information technology and telecommunications systems. We
rely on these systems to process new and renewal business, provide customer
service, make claims payments and facilitate collections and cancellations,
as well as to perform actuarial and other analytical functions necessary for
pricing and product development. Our systems could fail of their own accord
or might be disrupted by factors such as natural disasters, power
disruptions or surges, computer hackers or terrorist attacks. Failure or
disruption of these systems for any reason could interrupt our business and
adversely affect our results of operations.
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.
The Company's Annual Meeting of Shareholders was held on May 25, 2006.
Of the 14,492,768 shares of common stock of the Company entitled to vote at
the meeting, 14,280,084 shares were present in person or by proxy.
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 Votes For Votes Withheld
--------------- ---------- --------------
Mark E. Schwarz 14,279,747 337
Scott T. Berlin 14,280,050 34
James H. Graves 14,280,050 34
George R. Manser 14,280,025 59
At the Annual Meeting, stockholders of the Company approved an increase
in the authorized capital stock of the Company from 16,666,667 shares of
common stock to 33,333,333 shares of common stock. Votes were cast
14,174,088 in favor of and 105,088 opposing such proposal, with 908 votes
abstaining. The shareholders also approved the convertibility of the
convertible promissory notes issued to the Opportunity Funds in January 2006
in connection with the acquisition of the subsidiaries now comprising our
TGA Operating Unit. Votes were cast 11,913,860 in favor of and 9,454
opposing such proposal, with 9,308 votes abstaining and 2,347,462 broker
non-votes.
All of the foregoing share amounts have been adjusted to reflect a one-
for-six reverse stock split effected July 31, 2006.
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) Restated By-Laws of the registrant, as amended (incorporated
by reference to Exhibit 3.2 to the registrant's registration
statement on Form S-1 filed August 8, 2006).
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
Current Report on 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 Current Report on
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
Current Report on 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 Current Report on Form 8-K
filed June 27, 2005).
4(f) Promissory Note dated January 3, 2006, between Hallmark
Financial Services, Inc. and Newcastle Partners, L.P.
(incorporated by reference to Exhibit 4.1 to the registrant's
Current Report on Form 8-K filed January 5, 2006).
4(g) First Restated Credit Agreement dated January 27, 2006, between
Hallmark Financial Services, Inc. and The Frost National Bank
(incorporated by reference to Exhibit 4.1 to the registrant's
Current Report on Form 8-K filed February 2, 2006).
4(h) Form of Registration Rights Agreement dated January 27, 2006,
between Hallmark Financial Services, Inc. and Newcastle Special
Opportunity Fund I, L.P. and Newcastle Special Opportunity Fund
II, L.P. (incorporated by reference to Exhibit 4.1 to the
registrant's Current Report on Form 8-K filed February 2,
2006).
31(a) Certification of principal executive officer required by
Rule 13a-14(a) or Rule 15d-14(a).
31(b) Certification of principal financial officer required by
Rule 13a-14(a) or Rule 15d-14(a).
32(a) Certification of principal executive officer Pursuant to
18 U.S.C. 1350.
32(b) Certification of principal 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 14, 2006 /s/ Mark J. Morrison
---------------------------------------------
Mark J. Morrison, Chief Executive Officer
and President
(Principal Executive Officer)
Date: August 14, 2006 /s/ Jeffrey R. Passmore
---------------------------------------------
Jeffrey R. Passmore, Chief Accounting Officer
and Senior Vice President
(Principal Financial Officer)