8-K/A 1 hfs8ka120302.txt FORM 8-K/A CURRENT REPORT DECEMBER 3, 2002 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