UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): December 3, 2002
HALLMARK FINANCIAL SERVICES, INC.
---------------------------------
(Exact name of registrant as specified in its charter)
Nevada 0-16090 87-0447375
----------------- ------------ -------------------
(State or other (Commission (IRS Employer
jurisdiction File Number) Identification No.)
of incorporation)
14651 Dallas Parkway, Suite 900, Dallas, Texas 75254
---------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 404-1637
Not Applicable
(Former name or former address, if changed since last report.)
The Registrant hereby amends Item 7(a) and Item 7(b) of its Current
Report on Form 8-K filed on December 4, 2002, for the purpose of providing
financial statements required in connection with the Registrant's
acquisition of Millers General Agency, Inc., Financial and Actuarial
Resources, Inc. and Effective Litigation Management, Inc.
Item 7. Financial Statements and Exhibits.
a) Financial statements of business acquired.
Report of Independent Accountants
To the Boards of Directors and Stockholders of
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
In our opinion, the accompanying combined balance sheets and the related
combined statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Millers
General Agency, Inc., Effective Litigation Management, Inc. and Financial
and Actuarial Resources, Inc. at December 31, 2001, and the results of their
operations and their cash flows for the eleven months ended November 30,
2002 and the year ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. These
financial statements are the responsibility of the Companies' management;
our responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States
of America, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Dallas, Texas
February 12, 2003
Report of Independent Accountants
To the Boards of Directors and Stockholder of
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
In our opinion, the accompanying combined balance sheet and the related
combined statement of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Millers
General Agency, Inc., Effective Litigation Management, Inc. and Financial
and Actuarial Resources, Inc. at December 31, 2002, and the results of their
operations and their cash flows for the month ended December 31, 2002 in
conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the
Companies' management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
As discussed in Note 1 to the combined financial statements, Millers General
Agency, Inc., Effective Litigation Management, Inc. and Financial and
Actuarial Resources, Inc. were acquired by Hallmark Financial Services, Inc.
effective December 1, 2002 in a purchase business combination recorded under
the push-down method of accounting, resulting in a new basis of accounting
for the successor period beginning December 1, 2002.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Dallas, Texas
February 12, 2003
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
COMBINED BALANCE SHEETS
December 31,
----------------------------
2002 2001
(Successor) (Predecessor)
----------- -----------
ASSETS
------
Cash and cash equivalents $ 825,876 $ -
Accounts receivable 2,128,942 1,411,393
Prepaid agent commission 3,899,393 2,622,819
Other current assets 15,788 8,173
----------- -----------
Total current assets 6,869,999 4,042,385
Furniture, fixtures and equipment, net 486,398 143,265
Profit sharing commission receivable 866,663 -
Deferred tax asset 642,129 889,542
Goodwill 2,434,049 -
Other intangible assets 540,319 -
----------- -----------
Total assets $ 11,839,557 $ 5,075,192
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Unearned revenue $ 6,871,690 $ 4,478,238
Accounts payable 406,970 212,326
Commission payable 593,821 -
Accrued agent profit sharing 449,789 341,777
Payable to Phoenix Indemnity Insurance Co. 480,000 -
Current portion of long term notes payable 83,517 315,959
Other current liabilities 410,059 387,584
----------- -----------
Total current liabilities 9,295,846 5,735,884
Commitments and contingencies
Long term notes payable - 83,517
Pension liability 603,863 -
----------- -----------
Total long term liabilities 603,863 83,517
----------- -----------
Total liabilities 9,899,709 5,819,401
Common stock 2,100 2,100
Additional paid-in capital 2,097,900 900
Retained earnings (accumulated deficit) 1,796 (747,209)
Accumulated other comprehensive income (loss) (161,948) -
----------- -----------
Total stockholders' equity 1,939,848 (744,209)
Total liabilities and stockholders' equity $ 11,839,557 $ 5,075,192
=========== ===========
The accompanying notes are an integral part
of these financial statements
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
COMBINED STATEMENTS OF OPERATIONS
Eleven Months One Month Twelve Months
Ending Ending Ending
November 30, December 31, December 31,
2002 2002 2001
(Predecessor) (Successor) (Predecessor)
----------- ----------- -----------
Revenues
Commissions and fees $ 10,863,314 $ 1,560,798 $ 9,417,949
Interest and other income 13,992 500 12,993
----------- ----------- -----------
Total revenues 10,877,306 1,561,298 9,430,942
Expenses
Commissions and other
selling expenses 6,649,989 740,636 5,648,707
Salaries and employee benefits 1,256,885 423,108 1,382,514
General and administrative 1,945,318 356,177 1,780,833
Depreciation and amortization 72,243 37,425 140,354
Interest expense 22,298 832 50,228
----------- ----------- -----------
Total expenses 9,946,733 1,558,178 9,002,636
Income before taxes 930,573 3,120 428,306
Federal income tax expense 344,896 1,324 161,890
----------- ----------- -----------
Net income $ 585,677 $ 1,796 $ 266,416
=========== =========== ===========
The accompanying notes are an integral part
of these financial statements
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Retained Other Total
Additional Earnings Comprehensive
Number of Par Paid in (Accumulated Income Stockholders'
Shares Value Capital Deficit) (Loss) Equity
--------- ------- --------- ----------- ---------- -----------
December 31, 2000 (Predecessor) 2,100 $ 2,100 $ 900 $ (1,013,625) $ - $ (1,010,625)
Net income 266,416 266,416
--------- ------- --------- ----------- ---------- -----------
December 31, 2001 (Predecessor) 2,100 $ 2,100 $ 900 $ (747,209) $ - $ (744,209)
Predecessor net income for
the eleven months ending
November 30, 2002 585,677 585,677
--------- ------- --------- ----------- ---------- -----------
November 30, 2002 (Predecessor) 2,100 $ 2,100 $ 900 $ (161,532) $ - $ (158,532)
========= ======= ========= =========== ========== ===========
December 1, 2002 (Successor) 2,100 $ 2,100 $2,097,900 $ - $ - $ 2,100,000
Comprehensive loss:
Successor net income for the one
month ending December 31, 2002 1,796 1,796
Other comprehensive loss:
Minimum pension liability (255,438) (255,438)
Tax effect of minimum pension
liability 93,490 93,490
---------- -----------
Net minimum pension liability (161,948) (161,948)
-----------
Total comprehensive loss (160,152)
===========
--------- ------- --------- ----------- ---------- -----------
December 31, 2002 (Successor) 2,100 $ 2,100 $2,097,900 $ 1,796 $ (161,948) $ 1,939,848
========= ======= ========= =========== ========== ===========
The accompanying notes are an integral part
of these financial statements.
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
COMBINED STATEMENTS OF CASH FLOWS
Eleven Months One Month Twelve Months
Ending Ending Ending
November 30, December 31, December 31,
2002 2002 2001
(Predecessor) (Successor) (Predecessor)
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 585,677 $ 1,796 $ 266,416
Adjustments to reconcile net income to cash
provided by (used in) operating activities:
Depreciation and amortization 72,243 37,425 140,354
Gain on sale of office furniture (9,000) - -
Change in accounts receivable 21,126 (170,051) (829,181)
Change in prepaid commissions (1,240,372) (36,203) (363,761)
Change in profit sharing receivable (803,002) (63,661) -
Change in deferred tax asset 2,929 (1,215) 164,725
Change in unearned revenue 1,641,599 183,229 297,564
Change in commission payable - 593,821 -
Change in accrued agent profit sharing 35,730 72,281 (449,608)
Change in other current assets - (7,614) -
Change in other current liabilities 275,675 271,200 94,355
----------- ----------- -----------
Net cash provided by (used in)
operating activities 582,605 881,008 (679,136)
----------- ----------- -----------
Cash flows from investing activities:
Purchases of furniture, fixtures and equipment (1,022) - (72,304)
Proceeds from sales of furniture, fixtures
and equipment 9,000 - 3,075
----------- ----------- -----------
Net cash provided by (used in)
investing activities 7,978 - (69,229)
----------- ----------- -----------
Cash flows from financing activities:
Book overdraft (302,041) (27,707) 329,756
Repayment of borrowings (288,534) (27,425) (288,862)
----------- ----------- -----------
Net cash provided by (used in)
financing activities (590,583) (55,132) 40,894
----------- ----------- -----------
Net increase (decrease) in cash
and cash equivalents - 825,876 (707,471)
Cash at beginning of period $ - $ - $ 707,471
----------- ----------- -----------
Cash at end of period $ - $ 825,876 $ -
=========== =========== ===========
Supplemental cash flow information:
Interest paid $ 22,298 $ 832 $ 49,887
=========== =========== ===========
Income taxes paid $ - $ - $ 10,718
=========== =========== ===========
The accompanying notes are an integral part
of these financial statements.
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
Notes to Combined Financial Statements
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc. (hereinafter collectively
referred to as the "Company") are a regional managing general agency, a
third party claims administrator and a financial administrative service
company, respectively. The Company markets through an independent
agency force low hazard commercial insurance policies primarily in the
rural areas of Texas, New Mexico, Idaho, Oregon and Washington. The
Company also underwrites and administers the claims on these insurance
policies. On December 1, 2002, the Company was acquired by Hallmark
Financial Services, Inc. ("HFS") in a purchase business combination
recorded under the "push down" method of accounting, resulting in a new
basis of accounting for the "Successor" period beginning December 1,
2002. Information relating to all "Predecessor" periods prior to the
acquisition is presented using the Company's historical basis of
accounting.
Basis of Combination
The accompanying combined financial statements include the accounts of
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc. Combined financial statements
are presented due to the related operations and management of the
Company. All significant intercompany accounts and transactions have
been eliminated in the combined financial statements.
Revenue Recognition
Commission revenue and commission expense related to insurance policies
serviced by the Company are recognized during the period covered by the
policy. Profit sharing commission is recognized when the ratio of
ultimate losses and loss expenses incurred to earned premium ("loss
ratio") as determined by a qualified actuary fall below contractual
thresholds. The profit sharing commission is an estimate that varies
with the estimated loss ratio and is sensitive to changes in that
estimate. For each 0.5% change in the loss ratio, the profit sharing
commission changes by approximately $120,000.
Claim servicing fees are recognized during the period covered by the
insurance policy with a portion of the fees related to casualty claims
deferred and recognized over two years following the expiration of the
policy.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are carried at cost, less accumulated
depreciation. Depreciation is provided on the straight-line method over
the useful lives of 5 years for office furniture and equipment, 3 years
for software and 10 years for leasehold improvements. Gains and losses
on dispositions are shown on the statement of operations as other
income.
Cash and Cash Equivalents
Cash and cash equivalents includes an overnight investment sweep
account at Bank of America, N.A. used to fund the operations of the
Millers General Agency, Inc.
Agent Profit Sharing Commission
The Company annually pays a profit sharing commission to its
independent agency force based upon the results of the business
produced by each agent. The Company estimates and accrues this
liability to commission expense in the year the business is produced.
Federal Income Taxes
The Company accounts for taxes (including deferred taxes) utilizing the
asset and liability method, as required by Statement of Financial
Accounting Standards No. 109 ("FAS 109"). Under this method, balance
sheet amounts for deferred income taxes are computed based on the tax
effect of the differences between the financial reporting and federal
income tax bases of assets and liabilities using tax rates which are
expected to be in effect when these differences are anticipated to
reverse.
In accordance with FAS 109, total tax expense (or benefit) is the
amount of income taxes expected to be paid (or received) for the
current year plus (or minus) the deferred income tax expense (or
benefit) represented by the change in deferred income tax accounts at
the beginning and end of the year. The effect of changes in tax rates
and federal income tax laws are reflected in income in the period such
changes are enacted.
The tax effect of future taxable temporary differences (liabilities)
and future deductible temporary differences (assets) are separately
calculated and recorded when such differences arise. A valuation
allowance, reducing any recognized deferred tax asset, must be recorded
if it is determined that it is more likely than not that such deferred
tax will not be realized.
Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires management
to make estimates and assumptions. This affects amounts reported in the
financial statements and the disclosure of contingent assets and
liabilities. Actual results could differ from those estimates.
2. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consist of the following:
December 31, December 31,
2002 2001
---------- ----------
Office furniture and equipment $ 377,564 $ 265,922
Software 389,696 79,648
Leasehold improvements 19,850 -
---------- ----------
787,110 345,570
Accumulated depreciation (300,712) (202,305)
---------- ----------
$ 486,398 $ 143,265
========== ==========
Depreciation expense was $47,906 for the eleven months ending November
30, 2002 and $8,748 for the one month ending December 31, 2002, as
compared to $51,806 for the twelve months ending December 31, 2001.
Amortization expense was $24,337 for the eleven months ending November
30, 2002 and $28,677 for the one month ending December 31, 2002, as
compared to $88,548 for the twelve months ending December 31, 2001.
3. FEDERAL INCOME TAXES
The components of federal income tax expense (benefit) are as follows:
Eleven Months One Month Twelve Months
Ending Ending Ending
November 30, December 31, December 31,
2002 2002 2001
(Predecessor) (Successor) (Predecessor)
--------- --------- ---------
Current $ 341,967 $ 2,538 $ (2,836)
Deferred 2,929 (1,214) 164,726
--------- --------- ---------
$ 344,896 $ 1,324 $ 161,890
========= ========= =========
Total income tax expense (benefit) is different from the amount
computed using statutory tax rates applied to pre-tax income for the
following reasons:
Eleven Months One Month Twelve Months
Ending Ending Ending
November 30, December 31, December 31,
2002 2002 2001
(Predecessor) (Successor) (Predecessor)
--------- --------- ---------
Tax expense at
statutory rates $ 316,395 $ 1,062 $ 145,624
Meals and entertainment 794 98 164
Nondeductible dues - 58 30
State tax 27,707 106 16,072
--------- --------- ---------
Total income tax expense $ 344,896 $ 1,324 $ 161,890
========= ========= =========
Deferred tax assets are attributable to the following temporary
differences:
December 31, December 31,
2002 2001
---------- ----------
Unearned commissions $ 2,303,576 $ 1,655,605
Goodwill (2,200) 290,313
Prepaid commissions (1,441,606) (969,656)
Accrued agent profit sharing - (164,241)
Profit sharing commission receivable (320,405) -
Agency relationship amortization (199,756) -
Pension liability 221,014 -
Federal NOL 77,071 77,071
All others 4,435 450
---------- ----------
$ 642,129 $ 889,542
Valuation allowance - -
---------- ----------
$ 642,129 $ 889,542
========== ==========
As of December 1, 2002, the Company had a tax net operating loss
carryforward of approximately $226,679 for income tax purposes which
expires between 2019 and 2021. There are certain limitations that
could be imposed by the Internal Revenue Code regarding the amount of
carryforwards that may be utilized each year. The Company had a
current tax payable (receivable) balance of $308,456 and ($36,050) as
of December 31, 2002 and 2001, respectively.
4. INTANGIBLE ASSETS
The Company's intangible assets are composed of $2,434,049 of goodwill
and $540,319 for the Company's relationships with its independent
agents. These assets were acquired on December 1, 2002 with the
acquisition of the Company by Hallmark Financial Services, Inc.
The Company's agency relationships are valued at $542,580 and are
being amortized over twenty years. The Company recognized $2,261 of
amortization expense for the one month ending December 31, 2002 and
will recognize $27,129 in amortization expense for each of the next
five years and $404,674 for the remainder of the asset's life.
5. NOTES PAYABLE
The Company's notes payable balance of $83,517 as of December 31, 2002
consists of two notes payable to Millers Insurance Company. Each of
these notes carries an interest rate of 9% and matures in March 2003.
[This space left blank intentionally.]
6. RETIREMENT PLANS
Certain employees of the Company were participants in a defined benefit
cash balance plan covering all full-time employees who had completed
at least 1,000 hours of service. This plan was frozen in March 2001
in anticipation of distribution of plan assets to members upon plan
termination. All participants were vested when the plan was frozen.
11 month 1 month Year
Ending Ending Ending
11/30/02 12/31/02 12/31/01
(Predecessor) (Successor) (Predecessor)
----------- ----------- -----------
Assumptions (end of period)
Discount rate used in determining
benefit obligation 6.50% 6.50% 7.25%
Rate of compensation increase N/A N/A N/A
Reconciliation of funded status
(end of period):
Vested benefit obligation $(11,792,123) $(11,755,854) $(10,793,748)
Accumulated benefit obligation (11,794,169) (11,757,910) (10,830,974)
Projected benefit obligation (11,794,169) (11,757,910) (10,830,974)
Fair value of plan assets 11,445,744 11,154,047 12,528,900
----------- ----------- -----------
Funded status $ (348,425) $ (603,863) $ 1,697,926
Unrecognized net obligation/(asset) - - -
Unrecognized prior service cost - - -
Unrecognized actuarial (gain)/loss 2,450,806 267,798 228,554
----------- ----------- -----------
Prepaid/(accrued) pension cost $ 2,102,381 $ (336,065) $ 1,926,480
Changes in projected benefit obligation:
Benefit obligation as of beginning
of period $ 10,830,974 $ 11,794,169 $ 9,419,143
Service cost - - 18,672
Interest cost 710,763 63,625 757,443
Plan amendments - - -
Actuarial liability (gain)/loss 1,213,134 (3,994) 1,756,078
Effect of curtailment (plan freeze) - - (170,729)
Benefits paid (960,702) (95,890) (949,633)
----------- ----------- -----------
Benefit obligation as of end of period $ 11,794,169 $ 11,757,910 $ 10,830,974
11 month 1 month Year
Ending Ending Ending
11/30/02 12/31/02 12/31/01
(Predecessor) (Successor) (Predecessor)
----------- ----------- -----------
Change in plan assets:
Fair value of plan assets as of
beginning of period $ 12,528,900 $ 11,445,744 $ 14,542,959
Actual return on plan assets
(net of expenses) (122,454) (195,807) (1,064,426)
Employer contributions - - -
Benefits paid (960,702) (95,890) (949,633)
----------- ----------- -----------
Fair value of plan assets as
of end of period $ 11,445,744 $ 11,154,047 $ 12,528,900
----------- ----------- -----------
Net periodic pension cost:
Service cost - benefits earned
during the period $ - $ - $ 18,672
Interest cost on projected
benefit obligation 710,763 63,625 757,443
Expected return on plan assets (886,664) (75,985) (1,044,192)
Amortizations
Net obligation/(asset) - - 9,385
Unrecognized prior service cost - - (12,518)
Unrecognized (gain)/loss - - (24,155)
----------- ----------- -----------
Net periodic pension cost (credit) $ (175,901) $ (12,360) $ (295,365)
Discount rate (beginning of year) 7.25% 6.50% 7.75%
Expected return on plan assets 8.00% 8.00% 8.00%
Rate of compensation increase N/A N/A 5.00%
As of December 31, 2002, the fair value of the plan assets was composed
of cash and cash equivalents of $740,031, bonds and notes of $5,661,985
and equity securities of $4,752,031.
The Company sponsors a defined contribution profit sharing plan whereby
all employees are eligible to participate on the first day of the
quarter following their employment date and are considered fully-vested
after five years of service. Participants are permitted to contribute
1% to 15% of their annual compensation on a tax deferred basis and the
Company has matched 50% on the first 6% contributed by each employee.
Employer contributions approximated $23,318 for the first eleven months
of 2002 and $2,034 for the one month ending December 31, 2002, as
compared to $15,497 contributed for the twelve months ending December
31, 2001. Profit sharing contributions are based on the Company's
performance and are authorized annually at the discretion of the Board
of Directors. There were no profit sharing contributions made to the
plan in 2002 or 2001.
7. COMMON STOCK
Common stock consists of the following:
December 31, December 31,
2002 2001
---------- ----------
Millers General Agency, Inc. common
stock, $1.00 par value, 100 shares
authorized and issued $ 100 $ 100
Effective Litigation Management, Inc.
common stock $1.00 par value, 1,000
shares authorized and issued 1,000 1,000
Financial and Actuarial Resources, Inc.
common stock $1.00 par value, 1,000
shares authorized and issued 1,000 1,000
---------- ----------
$ 2,100 $ 2,100
========== ==========
8. COMMITMENTS AND CONTINGENCIES
The Company was self-insured for medical and dental coverage for its
employees, with stop-loss coverage for individual claims exceeding
$50,000. As of January 1, 2003, the Company is fully insured for
medical claims of its employees. Total expense for medical claims were
$82,362 for the first eleven months of 2002 and $21,979 for the one
month ending December 31, 2002 as compared to $130,700 for the twelve
months ending December 31, 2001.
The Company currently reimburses its former parent, Millers American
Group ("MAG") for rent under MAG's operating lease. MAG leases office
space under an operating lease that expires in 2009 with an option to
terminate the lease in 2005. The lease provides for increasing rents
over the lease term. Rental expense on space formerly occupied by the
Company, and space currently occupied under the MAG lease was $143,234
for the first eleven months of 2002 and $48,362 for the one month
ending December 31, 2002 as compared to $126,302 for the twelve months
ending December 31, 2001. The Company intends to either have this
lease assigned to it or to sublease this space from MAG at its current
terms.
Future minimum lease payments as of December 31, 2002 are as follows:
2003 $491,475
2004 $486,798
2005 $506,892
2006 $500,151
2007 $494,148
Thereafter $947,117
Item 7. Financial Statements and Exhibits.
b) Pro forma financial information
The following unaudited Pro Forma Consolidated Balance Sheet of
Hallmark Financial Services, Inc. ("HFS") is presented as if the
acquisition of Millers General Agency, Inc. ("MGA"), Effective
Litigation Management, Inc. ("ELM") and Financial and Actuarial
Resources, Inc. ("FAR") had occurred on September 30, 2002. The
following unaudited Pro Forma Consolidated Statements of Operations
of HFS for the nine months ended September 30, 2002 and for the
year ended December 31, 2001 assume these transactions as described
above had occurred as of January 1, 2001. The Pro Forma Consolidated
Balance Sheet was derived from the Consolidated Balance Sheet of HFS
and its subsidiaries filed with HFS' Quarterly Report on Form 10-QSB
as of and for the nine months ended September 30, 2002. The Pro
Forma Consolidated Statements of Operations were derived from the
Consolidated Statements of Operations of HFS and its subsidiaries filed
with HFS' Quarterly Report on Form 10-QSB as of and for the nine months
ended September 30, 2002 and Annual Report on Form 10-KSB as of and
for the year ended December 31, 2001. In management's opinion,
all of the material adjustments necessary to reflect the effects
of the acquisition transactions have been made. The Pro Forma
Consolidated Balance Sheet is not necessarily indicative of what the
actual financial position would have been assuming such transactions
had been completed as of September 30, 2002, nor does it purport
to present the future financial position of HFS. Additionally, the
Pro Forma Consolidated Statements of Operations are not necessarily
indicative of what the actual results of operations of HFS would have
been assuming such transactions had been completed at the beginning of
the periods presented, nor do they purport to present the results of
operations for future periods. Further, the Pro Forma Consolidated
Statement of Operations for the interim period ended September 30,
2002 is not necessarily indicative of the results of operations for a
full year.
The Acquisition
On December 3, 2002, HFS acquired from Millers American Group, Inc.
("Millers") all of the outstanding stock of two inactive subsidiaries,
ELM and FAR. HFS simultaneously acquired from The Millers Insurance
Company ("MIC"), an indirect subsidiary of Millers, all of the
outstanding stock of MGA, an active Texas managing general agency, as
well as certain contracts and fixed assets. Immediately following
these transactions, the newly acquired subsidiaries of HFS employed
all MIC personnel and began providing fee-based claims and financial
administrative services to MIC. The effective date of the above
transactions is December 1, 2002.
The aggregate purchase price for the acquired subsidiaries and assets
was $2,580,000, consisting of $2,100,000 in cash and MGA's assumption
of $480,000 in debt owed by MIC to Phoenix Indemnity Insurance Company
("Phoenix"), another indirect subsidiary of Millers. The purchase
price was determined through negotiations between HFS and Millers.
HFS funded the cash portion of the purchase price from an interim
financing facility previously provided by Newcastle Partners, L.P., an
affiliate of Mark E. Schwarz, Chairman of HFS.
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition.
At December 1, 2002
($000s)
Current assets $ 5,234
Furniture, fixtures and equipment 522
Deferred tax asset, net 547
Other non-current assets 803
Intangible assets 543
Goodwill 2,434
Total assets acquired 10,083
Current liabilities 7,635
Additional minimum pension liability 348
Total liabilities assumed 7,983
Net assets acquired $ 2,100
The acquired intangible assets of $543,000 represent the estimated
fair value of MGA's relationship with its independent agents. These
assets are being amortized over twenty years.
The Company is considering an election under Internal Revenue Code
Section 338(h)(10) that would, if made, cause the tax basis of the
assets acquired to increase from historic carrying value to fair market
value, resulting in some amount of tax deductible goodwill. The
balance of the deferred tax asset as of the date of acquisition would
be reduced to zero with a corresponding increase to goodwill.
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
UNAUDITED CONSOLIDATED PRO FORMA BALANCE SHEET
($ in thousands)
Hallmark
Financial MGA, ELM Combined Consolidated
Services, Inc. and FAR Historical Pro forma Pro forma
September 30, September 30, September 30, Adjustments September 30,
2002 2002 2002 2002
-------------- ------------- ------------- ----------- -------------
Assets
Investments:
Debt securities, held to maturity,
at amortized cost $ 8,280 $ 8,280 $ 8,280
Equity securities, available for sale,
at market value 93 93 93
Short-term investments, at cost
which approximates Market value 6,442 6,442 6,442
------- ------- ------- ------- -------
Total investments 14,815 - 14,815 - 14,815
Cash and cash equivalents 6,361 27 6,388 6,388
Restricted cash 1,607 1,607 1,607
Prepaid reinsurance premiums 9,068 9,068 9,068
Premiums receivable from lender for
financed premiums (net of allowance
for doubtful accounts of $172) 11,510 11,510 11,510
Premiums receivable 891 891 891
Reinsurance recoverable 13,272 13,272 13,272
Commission and fee receivable - 1,859 1,859 569 (a) 2,428
Deferred policy acquisition costs 1,246 1,246 1,246
Prepaid commissions - 3,835 3,835 3,835
Excess of cost over net assets acquired 4,431 4,431 2,434 (c) 6,865
Current federal income taxes recoverable - (81) (81) (81)
Deferred federal income taxes 279 893 1,172 128 (e) 1,300
Accrued investment income 69 69 69
Other assets 733 103 836 993 (b)(d) 1,829
------- ------- ------- ------- -------
Total assets $ 64,282 $ 6,636 $ 70,918 $ 4,124 $ 75,042
======= ======= ======= ======= =======
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
UNAUDITED CONSOLIDATED PRO FORMA BALANCE SHEET
($ in thousands)
Hallmark
Financial MGA, ELM Combined Consolidated
Services, Inc. and FAR Historical Pro forma Pro forma
September 30, September 30, September 30, Adjustments September 30,
2002 2002 2002 2002
-------------- ------------- ------------- ----------- -------------
Liabilities and stockholders' equity
Liabilities:
Notes payable $ 12,317 $ 165 $ 12,482 $ 2,100 (f) $ 14,582
Unpaid losses and loss adjustment expense 17,202 17,202 17,202
Unearned premiums 15,367 15,367 15,367
Unearned commissions and fees - 5,953 5,953 569 (a) 6,522
Accrued agent profit sharing - 643 643 643
Reinsurance balances payable 3,217 3,217 3,217
Drafts outstanding 610 610 610
Accrued ceding commission refund 2,217 2,217 2,217
Accounts payable and other accrued expenses 2,506 427 2,933 2,933
Pension liability - 349 (e) 349
Current federal income taxes payable 67 67 67
------- ------- ------- ------- -------
Total liabilities 53,503 7,188 60,691 3,018 63,709
Stockholders' equity:
Common stock 356 2 358 (2) 356
Capital in excess of (b)(c)(d)
par value 10,875 1 10,876 1,108 (e)(f) 11,984
Retained earnings 591 (555) 36 36
Accumulated other comprehensive income - -
Treasury stock (1,043) - (1,043) (1,043)
------- ------- ------- ------- -------
Total stockholders' equity 10,779 (552) 10,227 1,106 11,333
------- ------- ------- ------- -------
Total liabilities and stockholders' equity $ 64,282 $ 6,636 $ 70,918 $ 4,124 $ 75,042
======= ======= ======= ======= =======
(a) Recognition of claim fee receivable and unearned claim fee revenue of $569 for
the assignment of a claims administration agreement to the Company.
(b) Recognition of fixed assets acquired separately from the acquisition of MGA,
ELM and FAR from Millers Insurance Company of $450.
(c) Recognition of $2,434 of goodwill from the Hallmark Financial Services, Inc.
acquisition of the Company.
(d) Recognition of $543 of agency relationship intangible asset from the Hallmark
Financial Services, Inc. acquisition of the Company.
(e) Recognition of a minimum pension liability of $349 and resulting tax effect of
$128 from the frozen defined benefit cash balance plan.
(f) Recognition of $2,100 of 11.75% fixed rate debt incurred to complete the acquisition.
[This space left blank intentionally.]
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
UNAUDITED CONSOLIDATED PRO FORMA STATEMENTS OF OPERATIONS
($ in thousands)
Hallmark Financial MGA, ELM Combined Historical Pro forma
Services, Inc. and FAR Twelve Months Twelve Months
12 Months Ending 12 Months Ending Ending Pro forma Ending
December 31, 2001 December 31, 2001 December 31, 2001 Adjustments December 31, 2001
----------------- ----------------- ----------------- ----------- -----------------
Gross premiums written $ 49,614 $ 49,614 $ 49,614
Ceded premiums written (33,822) (33,822) (33,822)
-------- -------- --------
Net premiums written $ 15,792 $ 15,792 $ 15,792
======== ======== ========
Revenues
Gross premiums earned $ 49,525 $ - $ 49,525 $ - $ 49,525
Ceded premiums earned (33,149) (33,149) (33,149)
-------- -------- -------- ------ --------
Net premiums earned 16,376 - 16,376 - 16,376
Commission income - 9,297 9,297 9,297
Investment income, net of expenses 1,043 1,043 1,043
Finance charges 3,095 3,095 3,095
Processing and service fees 1,120 120 1,240 1,240
Other income 368 13 381 381
-------- -------- -------- ------ --------
Total revenue 22,002 9,430 31,432 - 31,432
Benefits, losses and expenses:
Losses and loss adjustment expenses 43,735 43,735 43,735
Reinsurance recoveries (27,857) (27,857) (27,857)
-------- -------- -------- ------ --------
Net losses and loss adjustment expenses 15,878 - 15,878 - 15,878
Acquisition costs, net (399) (399) (399)
Other acquisition and underwriting expenses
(net of ceding commission) 3,673 5,649 9,322 9,322
Operating expenses 3,346 3,303 6,649 344 (a) 6,993
Interest expense 1,021 50 1,071 247 (c) 1,318
Amortization of intangible assets 157 157 27 (b) 184
Litigation costs - - -
-------- -------- -------- ------ --------
Total benefits, losses and expenses 23,676 9,002 32,678 618 33,296
Loss from operations before federal income (1,674) 428 (1,246) (618) (1,864)
Federal income tax benefit (544) 162 (382) (229) (611)
-------- -------- -------- ------ --------
Net (loss) income $ (1,130) $ 266 $ (864) $ (389) $ (1,253)
======== ======== ======== ====== ========
Basic and diluted (loss) earnings per share
(11,049,133 shares outstanding) $ (0.10) $ 0.02 $ (0.08) $ (0.04) $ (0.11)
======== ======== ======== ====== ========
(a) Includes twelve months of depreciation expense of $344 of acquired fixed assets
from Millers Insurance Company separate from the acquisition of MGA, ELM and FAR.
(b) Includes twelve months amortization expense of $27 of agency relationships.
(c) Includes twelve months of interest expense of $247 related to debt incurred
to complete the acquisition.
Millers General Agency, Inc., Effective Litigation Management, Inc. and
Financial and Actuarial Resources, Inc.
UNAUDITED CONSOLIDATED PRO FORMA STATEMENTS OF OPERATIONS
($ in thousands)
Hallmark Financial MGA, ELM Combined Historical Pro forma
Services, Inc. and FAR Nine Months Nine Months
9 Months Ending 9 Months Ending Ending Pro forma Ending
September 30, 2002 September 30, 2002 September 30, 2002 Adjustments September 30, 2002
----------------- ----------------- ----------------- ----------- -----------------
Gross premiums written $ 37,542 $ 37,542 $ 37,542
Ceded premiums written (22,131) (22,131) (22,131)
-------- -------- --------
Net premiums written $ 15,411 $ 15,411 $ 15,411
======== ======== ========
Revenues
Gross premiums earned $ 38,682 $ - $ 38,682 $ - $ 38,682
Ceded premiums earned (24,388) (24,388) (24,388)
-------- -------- -------- ------ --------
Net premiums earned 14,294 - 14,294 - 14,294
Commission income - 8,435 8,435 8,435
Investment income, net of expenses 417 417 417
Finance charges 1,804 1,804 1,804
Processing and service fees 335 215 550 550
Other income 257 13 270 270
-------- -------- -------- ------ --------
Total revenue 17,107 8,663 25,770 - 25,770
Benefits, losses and expenses:
Losses and loss adjustment expenses 26,584 26,584 26,584
Reinsurance recoveries (15,908) (15,908) (15,908)
-------- -------- -------- ------ --------
Net losses and loss adjustment expenses 10,676 - 10,676 - 10,676
Acquisition costs, net (486) (486) (486)
Other acquisition and underwriting expenses
(net of ceding commission) 4,001 5,642 9,643 9,643
Operating expenses 1,662 2,695 4,357 258 (a) 4,615
Interest expense 630 20 650 185 (c) 835
Amortization of intangible assets - - 20 (b) 20
Litigation costs - - -
-------- -------- -------- ------ --------
Total benefits, losses and expenses 16,483 8,357 24,840 463 25,303
Loss from operations before federal income 624 306 930 (463) 467
Federal income tax benefit 213 114 327 (171) 156
-------- -------- -------- ------ --------
Net income (loss) $ 411 $ 192 $ 603 $ (292) $ 311
======== ======== ======== ====== ========
Basic and diluted earnings (loss) per share
(11,049,133 shares outstanding) $ 0.04 $ 0.02 $ 0.05 $ (0.03) $ 0.03
======== ======== ======== ====== ========
(a) Includes nine months of depreciation expense of $258 of acquired fixed assets
from Millers Insurance Company separate from the acquisition of MGA, ELM and FAR.
(b) Includes nine months of amortization expense of $20 of agency relationships.
(c) Includes nine months of interest expense of $185 related to debt incurred to
complete the acquisition .
Item 7. Exhibits.
Exhibits.
2(a) * Purchase Agreement dated November 26, 2002, among Hallmark
Financial Services, Inc., Millers American Group, Inc. and
The Millers Insurance Company.
2(b) * Assumption Agreement dated December 1, 2002, among The
Millers Insurance Company, Millers General Agency, Inc.
and Phoenix Indemnity Insurance Company.
* Previously filed with the Company's Form 8-K filed with
the Commission on December 4, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
HALLMARK FINANCIAL SERVICES, INC.
Date: February 13, 2003 By: /s/ Timothy A. Bienek
--------------------------------
Timothy A. Bienek, President and
Chief Operating Officer