8-K/A 1 hfs8kaa012703.txt FORM 8-K/A AMENDMENT CURRENT REPORT JANUARY 27, 2003 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): January 27, 2003 HALLMARK FINANCIAL SERVICES, INC. --------------------------------- (Exact name of registrant as specified in its charter) Nevada 0-16090 87-0447375 ---------------------------- ----------- ------------------- (State or other jurisdiction (Commission (IRS Employer of incorporation) File Number) Identification No.) 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 January 29, 2003 and its amended Current Report on Form 8-K/A filed on April 14, 2003, for the purpose of correctly reporting Rule 11-02 (b)(5) of Regulation S-X, regarding Pro Forma financial statements required in connection with the Registrant's acquisition of Phoenix Indemnity Insurance Company. Item 7. Financial Statements and Exhibits. a) Financial statements of business acquired [This space left blank intentionally.] Report of Independent Accountants To Board of Directors of Phoenix Indemnity Insurance Company In our opinion, the accompanying balance sheet as of December 31, 2002 and the related statements of operations, comprehensive income, stockholder's equity and cash flows present fairly, in all material respects, the financial position of Phoenix Indemnity Insurance Company at December 31, 2002, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's 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. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Dallas, Texas April 14, 2003 Report of Independent Accountants To Board of Directors of Phoenix Indemnity Insurance Company We have audited the accompanying balance sheet of Phoenix Indemnity Insurance Company (the "Company") as of December 31, 2001 and the related statements of operations, comprehensive income, stockholder's equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2001 and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. December 10, 2002 (January 27, 2003 as to Note 12) /s/ Deloitte and Touche LLP Phoenix Indemnity Insurance Company BALANCE SHEETS December 31, 2002 2001 ----------- ----------- ASSETS ------ Investments: Debt securities, at estimated fair value, cost of $8,072,325 for 2002 and $11,812,870 for 2001 $ 8,355,363 $ 11,986,036 Equity securities, at estimated fair value, cost of $1,898,483 for 2002 and $1,984,113 for 2001 2,182,548 2,209,192 Short-term investments 334,881 334,902 ----------- ----------- Total investments 10,872,792 14,530,130 Cash and cash equivalents 6,944,946 12,161,194 Investment income due and accrued 126,900 97,071 Reinsurance receivables 11,086,237 12,305,940 Prepaid reinsurance 38,264 4,231,383 Premium receivable, net of allowance of $403,581 for 2002 and $416,792 for 2001 1,745,534 2,901,058 Deferred policy acquisition costs 918,429 115,377 Property and equipment, net 65,414 198,458 Due from affiliates, net 487,536 449,998 Other assets 21,744 48,543 ----------- ----------- Total assets $ 32,307,796 $ 47,039,152 =========== =========== LIABILITIES AND STOCKHOLDER'S EQUITY ------------------------------------ Reserve for losses and loss adjustment expenses $ 15,740,230 $ 21,408,007 Unearned premium 4,014,141 7,045,450 Reinsurance payable - 4,522,999 Accounts payable and accrued expenses 800,858 533,324 Other liabilities 232,497 244,462 ----------- ----------- Total liabilities 20,787,726 33,754,242 Commitments and contingencies (Note 11) Stockholder's equity: Common stock, $6 par value; 500,000 shares authorized, issued and outstanding 3,000,000 3,000,000 Additional paid-in capital 18,795,457 19,658,190 Accumulated deficit) (10,644,100) (9,632,238) Accumulated other comprehensive income, net of tax 368,713 258,958 ----------- ----------- Total stockholder's equity 11,520,070 13,284,910 ----------- ----------- Total liabilities and stockholder's equity $ 32,307,796 $ 47,039,152 =========== =========== The accompanying notes are an integral part of these financial statements Phoenix Indemnity Insurance Company STATEMENTS OF OPERATIONS Year Ended December 31 2002 2001 ----------- ----------- Revenues: Net premiums earned $ 16,717,486 $ 21,879,973 Net investment income 593,757 1,860,209 Net realized capital gains and losses 34,662 843,671 ----------- ----------- Total revenues 17,345,905 24,583,853 ----------- ----------- Costs and expenses: Losses and loss adjustment expenses 12,883,053 15,883,816 Amortization of deferred policy acquisition costs 4,315,028 5,432,936 Underwriting and operating expenses 716,017 4,057,903 ----------- ----------- Total costs and expenses 17,914,098 25,374,655 ----------- ----------- Operating loss (568,193) (790,802) Other expense (502,769) (582,055) ----------- ----------- Loss before income taxes (1,070,962) (1,372,857) Income tax expense (benefit) (59,100) 260,000 ----------- ----------- Net loss $ (1,011,862) $ (1,632,857) =========== =========== The accompanying notes are an integral part of these financial statements Phoenix Indemnity Insurance Company STATEMENTS OF COMPREHENSIVE INCOME Year Ended December 31 2002 2001 ----------- ----------- Net loss $ (1,011,862) $ (1,632,857) Other comprehensive income (loss), before income tax: Unrealized holding gains (losses) arising during period 134,193 (1,586,249) Reclassification adjustment for gains (losses) included in net loss 34,662 843,671 ----------- ----------- Other comprehensive income (loss), before income tax 168,855 (742,578) Income tax benefit (provision) related to items of other comprehensive income (loss) (59,100) 260,000 ----------- ----------- Other comprehensive income (loss), net of income tax 109,755 (482,578) ----------- ----------- Net comprehensive loss $ (902,107) $ (2,115,435) =========== =========== The accompanying notes are an integral part of these financial statements Phoenix Indemnity Insurance Company STATEMENTS OF STOCKHOLDER'S EQUITY Accumulated Other Additional Comprehensive Total Common Paid in Accumulated Income Stockholder's Stock Capital Deficit (Loss) Equity ----------- ----------- ----------- ----------- ----------- Balance at January 1, 2001 $ 3,000,000 $ 21,158,190 $ (7,999,381) $ 741,536 $ 16,900,345 Net loss (1,632,857) (1,632,857) Change in net unrealized holding gains losses), net of tax provision of $260,000 (482,578) (482,578) Return of capital (1,500,000) (1,500,000) ----------- ----------- ----------- ----------- ----------- Balance at December 31, 2001 3,000,000 19,658,190 (9,632,238) 258,958 13,284,910 Net loss (1,011,862) (1,011,862) Changes in net unrealized holding gains (losses), net of tax benefit of $59,000 109,755 109,755 Capital contribution 337,267 337,267 Return of capital (1,200,000) (1,200,000) ----------- ----------- ----------- ----------- ----------- Balance at December 31, 2002 $ 3,000,000 $ 18,795,457 $(10,644,100) 368,713 $ 11,520,070 =========== =========== =========== =========== =========== The accompanying notes are an integral part of these financial statements.
Phoenix Indemnity Insurance Company STATEMENTS OF CASH FLOWS Year Ended December 31 2002 2001 ----------- ----------- Cash flows from operating activities: Net loss $ (1,011,862) $ (1,632,857) Adjustments to reconcile net income to cash used in operating activities: Depreciation and amortization 133,044 102,906 Deferred income taxes (59,100) 260,000 Net realized gains on investments (34,662) (843,671) Changes in operating assets and liabilities: Accrued investment income (29,829) 220,660 Reinsurance receivables 1,901,975 (7,744,902) Premiums receivables 1,155,524 5,069,883 Deferred acquisition costs (803,051) 849,817 Other assets 26,799 11,843 Reserve for losses and loss adjustment expenses (5,667,777) (5,565,009) Unearned premiums 1,161,810 (5,915,381) Accounts payable and accrued expenses 267,534 (348,830) Reinsurance payable (5,205,271) 3,483,038 Due from affiliate, net (37,538) (651,418) Other liabilities 26,212 9,318 ----------- ----------- Net cash used in operating activities (8,176,192) (12,694,603) Cash flows from investing activities: Purchases of property and equipment - (8,389) Proceeds from investment maturities and sales 7,178,439 33,027,062 Purchases of investments (3,355,783) (6,645,100) Change in other investments 21 (17,776) ----------- ----------- Net cash provided by investing activities 3,822,677 26,355,797 Cash flows from financing activities: Capital contribution 337,267 - Return of Capital (1,200,000) (1,500,000) ----------- ----------- Net cash used in financing activities (862,733) (1,500,000) Net (decrease) increase in cash and cash equivalents (5,216,248) 12,161,194 Cash and cash equivalents, beginning of year 12,161,194 - ----------- ----------- Cash and cash equivalents, end of year $ 6,944,946 $ 12,161,194 =========== =========== Supplemental cash flow disclosures: Cash paid during the year for: Income taxes $ - $ 333,510 =========== =========== The accompanying notes are an integral part of these financial statements. 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization Phoenix Indemnity Insurance Company (the "Company"), a stock property and casualty insurer, is licensed in 24 states and currently writes non- standard private passenger automobile coverages in New Mexico and Arizona. At December 31, 2002 the Company was a wholly owned subsidiary of Millers American Group, Inc. ("MAG"), a holding company incorporated in Texas. MAG also owned, prior to December 1, 2002, Trilogy Holdings, Inc. ("Trilogy"), The Millers Insurance Company ("Millers"), Millers Holding Corporation, Inc. ("Holding"), a wholly owned subsidiary of Millers, The Millers Casualty Insurance Company ("Casualty"), and Millers General Agency, Inc. ("MGA"). On December 1, 2002, Hallmark Financial Services Inc. ("Hallmark") acquired MGA. Effective January 1, 2003, Hallmark acquired the Company. Summary of significant accounting policies The accompanying financial statements are presented in conformity with accounting principles generally accepted in the United States of America ("GAAP"). These accounting principles differ in certain respects from accounting practices prescribed or permitted by the Arizona Department of Insurance. Use of Estimates - The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates include those used in determining deferred policy acquisition costs and reserves for losses and loss adjustment expenses. Actual results could differ significantly from those estimates. Investments - Debt and equity securities and other investments are classified as available for sale and are carried at estimated fair values with unrealized holding gains and losses net of income tax effects are reported as a separate component of equity until realized. Realized gains and losses upon disposition of securities are determined by using the specific identification method. Costs of debt securities and equity securities are adjusted for impairments, which are declines in value that are considered to be other than temporary. Impairment adjustments are included in "Net realized capital gains and losses." In evaluating whether a decline in value is other than temporary, the Company considers several factors including, but not limited to the following: (1) whether the decline is substantial; (2) the duration (generally greater than six months); (3) the reasons for the decline in value (credit event, interest related or market fluctuation); (4) the Company's ability and intent to hold the investments for a period of time to allow for a recovery of value; and (5) the financial condition of and near-term prospects of the issuer. Cash and Cash Equivalents - The Company considers all investments with maturities at acquisition of three months or less to be cash equivalents. Deferred Policy Acquisition Costs - Acquisition costs such as commissions, premium taxes and certain other expenses which vary with and are directly related to the production of business, are deferred and amortized over the effective period of the related insurance policies. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to premiums to be earned, loss and loss adjustment expenses and certain other maintenance costs expected to be incurred as the premiums are earned but does not include consideration of anticipated investment income. To the extent that deferred policy acquisition costs are not realizable, the deficiency is charged to income currently. Reinsurance Receivables - Reinsurance is commonly utilized within the industry as a means of risk sharing, and the Company is involved in many reinsurance treaties to protect from catastrophic losses. The reinsuring companies are obligated to the Company to the extent of the reinsured portion of the underlying risks. The amounts for ceded losses, loss adjustment expenses and unearned premiums represent a continuing liability for the Company in the event that reinsurers are unable to meet their obligations under the reinsurance agreements. Property and Equipment - Property and equipment are stated at cost less accumulated depreciation. Depreciation and amortization are computed using the straight-line method with estimated useful lives ranging from 5 to 7 years for furniture and equipment. Reserve for Losses and Loss Adjustment Expenses - The reserve for unpaid losses and loss adjustment expenses is based on aggregate case basis estimates for reported losses and estimates of incurred but not reported losses based on past experience. Such reserve is based upon estimates and, while management believes that the amount is fairly stated, the ultimate liability may vary from the amount provided. The methods used to make such estimates and to establish the resulting liability are continually reviewed and any adjustments to these methods are reflected in current operations. Premiums - Premiums are earned on a pro rata basis over the terms of the policies. Unearned premiums represent the portion of premiums written that relates to the unexpired terms of the policies in force. Prepaid reinsurance represents the unearned portion of premiums paid to reinsurers. Earned premiums include amounts relating to assumed reinsurance and are stated net of reinsurance ceded. Income Taxes - Effective September 1, 2000, the Company was included in MAG's consolidated federal income tax return. Federal income taxes are calculated as if the Company and MAG filed on a separate return basis. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities of their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period the change becomes effective. Recently issued accounting pronouncements In June 2001, the FASB issued SFAS No. 141 "Business Combinations" ("SFAS 141") and No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 prohibits the use of the pooling of interests method for business combinations initiated after June 30, 2001 and also applies to all business combinations accounted for by the purchase method that are completed after June 30, 2001. There are also transition provisions that apply to business combinations completed before July 1, 2001 that were accounted for by the purchase method. SFAS 142 is effective for fiscal years beginning after December 15, 2001 for all goodwill and intangible assets recognized in an entity's statement of financial position at that date regardless of when those assets were initially recognized. The adoption of SFAS 141 and SFAS 142 did not have a material effect on the Company's financial statements. The FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143") in June 2001 and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144") in August 2001. SFAS 143 addresses reporting for future legal obligations associated with the retirement of tangible long-lived assets and the related asset retirement costs. SFAS 144 supercedes earlier guidance with respect to accounting for assets that are impaired or will be disposed of through sale or otherwise and is effective for years beginning after December 15, 2001. The adoption of SFAS 143 and SFAS 144 did not have a material effect on the Company's financial statements. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No 13, and Technical Corrections" ("SFAS 145"). SFAS 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment of that Statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." This Statement also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers." This Statement amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. SFAS 145 is effective for financial statements issued on or after May 15, 2002. The adoption of SFAS 145 did not have a material effect on the Company's financial statements. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated With Exit or Disposal Activities" ("SFAS 146"). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not expect the adoption of SFAS 146 to have a material effect on its financial statements. In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions" ("SFAS 147"). Except for transactions between two or more mutual enterprises, this Statement removes acquisitions of financial institutions from the scope of both Statement 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with SFAS 141 and SFAS 142. In addition, this Statement amends SFAS 144 to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor - and borrower-relationship intangible assets and credit cardholder intangible assets. This statement was effective October 1, 2002. The adoption of SFAS 147 did not have a material effect on the Company's financial statements. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for years ending after December 15, 2002. The adoption of FIN 45 did not have a material effect on the Company's financial statements. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock- Based Compensation-Transition and Disclosure" ("SFAS 148"). The Statement amends 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 amends 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. SFAS 148 is effective for financial statements for fiscal years ending after December 15, 2002. The adoption of SFAS 148 did not have a material effect on the Company's financial statements. In January 2003, the FASB issued Interpretation No. 46 "Consolidation of Variable Interest Entities, an interpretation of ARB 51" ("FIN 46"). The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights ("variable interest entities" or "VIEs") and how to determine when and which business enterprise should consolidate the VIE (the "primary beneficiary"). This new model for consolidation applies to an entity which either (1) the equity investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity's activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. The Company does not expect the adoption of FIN 46 to have a material effect on its financial statements. Statutory financial information The Company prepares its statutory basis financial statements in accordance with accounting principles and practices prescribed or permitted by the Arizona Department of Insurance. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. In March 1998, the NAIC adopted the Codification of Statutory Accounting Principles ("Codification"). The Codification, which is intended to standardize regulatory accounting and reporting for the insurance industry, was effective January 1, 2001. However, statutory accounting principles will continue to be established by individual state laws and permitted practices. The impact of adoption of the Codification was not material to the Company's statutory basis capital and surplus. Reconciliations of statutory basis capital and surplus as of December 31, 2002 and 2001, to the respective amounts as reported in the accompanying financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") are as follows: 2002 2001 ----------- ----------- Statutory basis capital and surplus $ 10,137,673 $ 11,492,335 Deferred acquisition costs 918,429 115,377 Reinstatement of non-admitted assets 49,590 106,764 Adjustment of written premiums ceded 131,340 1,393,039 Adjustment of the carrying value of investment securities 283,038 177,395 ----------- ----------- GAAP stockholder's equity $ 11,520,070 $ 13,284,910 =========== =========== Reconciliations of statutory basis net loss for the years ended December 31, 2002 and 2001, to the respective amounts as reported in the accompanying financial statements prepared in accordance with GAAP are as follows: 2002 2001 ----------- ----------- Statutory basis net loss $ (2,877,621) $ (1,803,714) Adjustment of bad debt allowance 319,751 - Changes in deferred acquisition costs 803,052 (849,817) Valuation allowances on premiums receivable - (137,768) Valuation allowances on related party receivables - (766,713) Adjustment of written premiums ceded - 1,393,039 Recovery of intercompany balance receivable 593,423 - Realized gains on sales of investments 12,872 792,116 Deferred income taxes 59,100 (260,000) Other income 77,561 - ----------- ----------- GAAP net loss as reported herein $ (1,011,862) $ (1,632,857) =========== =========== 2. INVESTMENTS Net investment income for the years ended December 31 is as follows: 2002 2001 ----------- ----------- Gross investment income: Debt securities $ 374,451 $ 1,330,753 Equity securities 105,876 157,540 Cash and cash equivalents 123,376 389,342 Other 4,678 54 ----------- ----------- Total investment income 608,381 1,877,689 Less investment expenses (14,624) (17,480) ----------- ----------- Net investment income $ 593,757 $ 1,860,209 =========== =========== Proceeds from sales, gross realized gains, gross realized losses, and net realized gains (losses) from sales of investment securities for the years ended December 31, 2002 and 2001, consist of the following: December 31, 2002 ----------------------------------------------------- Gross Gross Net Realized Realized Realized Proceeds Gains Losses Gains ----------- ----------- ----------- ----------- Bonds $ 7,108,665 $ 269,895 $ (6,738) $ 263,157 Common stocks (non- affiliated) 69,774 52,132 - 52,132 ----------- ----------- ----------- ----------- $ 7,178,439 $ 322,027 $ (6,738) $ 315,289 =========== =========== =========== =========== December 31, 2001 ----------------------------------------------------- Gross Gross Net Realized Realized Realized Proceeds Gains Losses Gains ----------- ----------- ----------- ----------- Bonds $ 31,072,176 $ 815,794 $ (73,203) $ 742,591 Preferred stocks 1,448,886 125,152 (24,072) 101,080 ----------- ----------- ----------- ----------- $ 32,521,062 $ 940,946 $ (97,275) $ 843,671 =========== =========== =========== =========== At December 31, 2002, the Company identified two debt securities, which were considered to be impaired, and reduced their carrying values by $212,640. Also at December 31, 2002, the Company identified two equity securities, which were considered to be impaired, and reduced their carrying value by $67,987. These impairment losses have been included in "Net realized capital gains and losses". The cost or amortized cost, gross unrealized gains and losses, and estimated fair value of investments in available-for-sale securities as of December 31, 2002 and 2001, are as follows: December 31, 2002 ------------------------------------------------- Cost or Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ---------- ---------- Debt securities: U.S. Treasury activities and obligations of U.S. government agencies $ 3,601,171 $ 174,923 $ - $ 3,776,094 Corporate securities 4,471,154 108,115 - 4,579,269 ---------- ---------- ---------- ---------- Total debt maturities $ 8,072,325 $ 283,038 $ - $ 8,355,363 ========== ========== ========== ========== Equity securities: Preferred stocks $ 1,220,700 $ 84,330 $ (6,500) $ 1,298,530 Common stocks 677,783 229,113 (22,878) 884,018 ---------- ---------- ---------- ---------- Total equity securities $ 1,898,483 $ 313,443 $ (29,378) $ 2,182,548 ========== ========== ========== ========== December 31, 2001 ------------------------------------------------- Cost or Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ---------- ---------- Debt securities: U.S. Treasury activities and obligations of U.S. government agencies $ 5,394,235 $ 337,363 $ (64,552) $ 5,667,046 Corporate securities 6,418,635 - (99,645) 6,318,990 ---------- ---------- ---------- ---------- Total debt maturities $11,812,870 $ 337,363 $ (164,197) $11,986,036 ========== ========== ========== ========== Equity securities: Preferred stocks $ 1,220,700 $ 31,800 $ (22,500) $ 1,230,000 Common stocks 763,413 273,385 (57,606) 979,192 ---------- ---------- ---------- ---------- Total equity securities $ 1,984,113 $ 305,185 $ (80,106) $ 2,209,192 ========== ========== ========== ========== Property and casualty insurance companies are required to maintain assets with state regulatory authorities. Such assets are included as components of debt securities and have an aggregate fair value of $3,601,172 and $3,968,916 at December 31, 2002 and 2001, respectively. The amortized cost and estimated fair value of debt securities at December 31, 2002, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties. December 31, 2002 --------------------------- Estimated Amortized Fair Cost Value ----------- ----------- Due in one year or less $ - $ - Due after one year through five years 6,025,335 6,285,277 Due after five years through ten years 1,184,982 1,208,078 Due after ten years 862,008 862,008 ----------- ----------- Total $ 8,072,325 $ 8,355,363 =========== =========== 3. FAIR VALUE OF FINANCIAL INSTRUMENTS In the normal course of business, the Company invests in various financial assets and incurs various financial liabilities. Estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The Company's financial instruments include: cash and cash equivalents, investments, premiums and reinsurance receivable, reinsurance premiums payable, accounts payable and drafts outstanding. The Company has estimated that the carrying amount of cash and cash equivalents, short-term investments, premiums and reinsurance receivable, reinsurance premiums payable, accounts payable and drafts outstanding approximates fair value due to the short-term maturities of these instruments. The fair value of the Company's investments was $10,537,911 as of December 31, 2002, which exceeded the amortized cost by $567,103. The fair value of the Company's investments was $14,195,228 as of December 31, 2001, which exceeded the amortized cost by $398,245. 4. DEFERRED POLICY ACQUISITION COSTS Deferred policy acquisition costs ("DPAC") and the components of the change in DPAC were as follows: Year Ended December 31, --------------------------- 2002 2001 ----------- ----------- Balance, beginning of year $ 115,377 $ 965,194 Change in balance: Deferrals 5,002,703 4,583,119 Amortization (4,015,593) (4,622,467) Premium deficiency (184,058) (810,469) ----------- ----------- Net change 803,052 (849,817) ----------- ----------- Balance, end of year $ 918,429 $ 115,377 =========== =========== 5. PROPERTY AND EQUIPMENT Property and equipment are carried at cost, less allowances for depreciation, and consist of the following at December 31, 2002 and 2001: 2002 2001 ----------- ----------- Leasehold improvements $ 7,200 $ 7,200 Furniture and equipment 2,275,853 2,275,853 ----------- ----------- 2,283,053 2,283,053 Accumulated depreciation (2,217,639) (2,084,595) ----------- ----------- Property and equipment, net $ 65,414 $ 198,458 =========== =========== Depreciation expense was $133,044 and $217,027 for 2002 and 2001, respectively. 6. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the reserve for losses and loss adjustment expenses is summarized as follows (in thousands): 2002 2001 ----------- ----------- Balance at January 1 $ 21,408 $ 26,973 Less reinsurance receivables 8,115 4,483 ----------- ----------- Net balance at January 1 13,293 22,490 Incurred related to: Current year 12,184 18,870 Prior years 699 (2,986) ----------- ----------- Total incurred 12,883 15,884 ----------- ----------- Paid related to: Current year 6,467 12,085 Prior years 9,517 12,996 ----------- ----------- Total paid 15,984 25,081 ----------- ----------- Net balance at December 31 10,192 13,293 Plus reinsurance receivables 5,548 8,115 ----------- ----------- Balance at December 31 $ 15,740 $ 21,408 =========== =========== Changes in the provision for incurred losses and loss adjustment expenses are the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims. For the year ended December 31, 2002 and 2001, the provisions for incurred losses and loss adjustment expenses attributable to insured events of prior years increased by approximately $0.7 million and decreased approximately $3.0 million, respectively, as a result of higher than anticipated losses and loss adjustment expenses in 2002 and lower than anticipated losses and loss adjustment expenses in 2001 principally on auto liability lines of insurance. 7. REINSURANCE The Company limits the maximum net loss on any one incident by reinsuring (ceding) certain levels of risks principally through quota share agreements with other insurers or reinsurers, either on an automatic basis under general reinsurance contracts or on an individual risk basis. Reinsurance contracts do not relieve the Company from obligations to its policyholders. In the event that the reinsuring companies are unable to meet their obligations under reinsurance agreements significant losses to the Company could occur. Management believes that all amounts currently due from reinsurers are fully collectible. For the years ended December 31, 2002 and 2001, amounts assumed and ceded under reinsurance agreements were as follows (in thousands): December 31, 2002 ------------------------------------------------- Direct Assumed Ceded Net ---------- ---------- ---------- ---------- Premiums written $ 24,312 $ 19 $ (6,270) $ 18,061 Earned premium 30,346 46 (13,675) 16,717 Losses and loss adjustment expenses incurred 22,083 479 (9,679) 12,883 December 31, 2001 ------------------------------------------------- Direct Assumed Ceded Net ---------- ---------- ---------- ---------- Premiums written $ 35,521 $ 1,823 $ (23,414) $ 13,930 Earned premium 39,360 3,899 (21,379) 21,880 Losses and loss adjustment expenses incurred 29,050 3,016 (16,182) 15,884 The maximum amount of unearned premium which would have been due from or to the Company if all of the Company's reinsurance had been canceled as of December 31, 2002 and 2001, would be as follows: 2002 2001 --------- --------- Assumed unearned premium reserve payable $ 3,893 $ 31,500 Ceded unearned prepaid premium 38,264 4,231,000 The Company has unsecured reinsurance recoverables for loss and loss adjustment expenses, unearned premiums ceded, and contingent commissions, net of related allowance for doubtful accounts, which are significant in relation to stockholder's equity, with the following reinsurers: 2002 2001 --------- --------- St. Paul Fire & Marine Insurance Company $ 112,000 $1,050,000 Acceptance Insurance Company - 805,000 AXA Reassurances - 7,918,000 8. INCOME TAXES The Company's federal tax return was combined with MAG, Trilogy, Millers, Millers Holding, Casualty, and MGA. The method of tax allocation among the companies was subject to written agreement, approved by the Board of Directors, whereby the allocation was based upon separate return calculations with current credit for net losses. Intercompany tax balances are settled annually when the return is filed. As of December 31, 2002, the Company had operating loss carry forwards in the amount of approximately $5,300,000. All operating loss carry forwards will expire in 2021. The Company has no income taxes incurred in current and prior years that will be available for recoupment in the event of future losses. The income tax provision consist of the following components for the years ended December 31: 2002 2001 --------- --------- Current $ - $ - Deferred (59,100) 260,000 --------- --------- Provision for income taxes $ (59,100) $ 260,000 ========= ========= The provision for federal income taxes incurred is different from that which would be obtained by applying the statutory federal income tax rate to income before income taxes. The significant items causing this difference are as follows: 2002 2001 --------- --------- Provision (benefit) computed at statutory rate $ (328,987) $ (597,290) Change in valuation allowance 285,000 1,030,000 Dividends received deduction (21,573) (38,413) Tax exempt interest - (5,979) Investments - (138,613) Other 6,460 10,295 --------- --------- Provision for income taxes $ (59,100) $ 260,000 ========= ========= The tax effect of temporary differences are separately calculated and recorded when such differences arise. A valuation allowance, reducing any recognized deferred tax asset, is recorded if it is determined that it is more likely than not that such deferred tax asset will not be realized. The Company established a valuation allowance of $4,285,000 and $4,627,000 at December 31, 2002 and 2001, respectively, as it determined that it is not more likely than not that the Company will realize the benefit of its deferred tax assets. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows (in thousands): 2002 2001 --------- --------- Deferred tax assets: Discounted losses and loss adjustment expense reserves and unearned premiums $ 635 $ 1,253 Tax credit and net operating loss carryforwards 1,849 772 Goodwill 1,978 2,147 Investment impairments 176 81 Premium receivable allowance 152 531 Other deferred assets 92 73 --------- --------- Total deferred tax assets 4,882 4,857 --------- --------- Deferred policy acquisition costs 321 40 Unrealized holding gain on investments 198 139 Other deferred tax liabilities 78 51 --------- --------- Total deferred tax liabilities 597 230 Valuation allowance (4,285) (4,627) --------- --------- Net deferred tax asset $ - $ - ========= ========= 9. DIVIDEND RESTRICTIONS Arizona insurance regulations generally limit distributions of unassigned surplus made by property and casualty insurers in any year, without prior regulatory approval, to the lesser of 10% of policyholders' surplus of the previous year-end or net investment income for the prior year. No distributions are available in 2003 without prior regulatory approval. Distributions of $1,200,000 and $1,500,000 were made during 2002 and 2001, respectively. The distribution for 2002 exceeded the amount allowed by the Arizona Department of Insurance and was subsequently reclassified as a return of shareholder's capital. 10.RELATED PARTY TRANSACTIONS The Company had a receivable of $480,000 from MGA at December 31, 2002. Hallmark assumed the obligation to the Company in connection with its acquisition of MGA effective December 1, 2002. A portion of the receivable in the amount of $337,267, is included in equity as a capital contribution for the year ended December 31, 2002. The Company had receivables of $549,004 from Millers and payables of $99,004 to MAG at December 31, 2001. The Company repaid capital of $1,200,000 and $1,500,000 to MAG during 2002 and 2001, respectively. The Company paid management fees of $1,200,000 to MAG during 2002 and 2001, respectively. The Company has an agreement whereby MAG provides policy and claims administration services through a third party administrator. Fees for such services are based on varying percentages of earned premiums, fees per policy processed or fees per claim processed. Total fees paid to MAG under this agreement during the year ended December 31, 2002 were $2,371,306 for policy administration and $2,056,410 for claim administration. Total fees paid to MAG under this agreement during the year ended December 31, 2001 were $2,949,375 for policy administration and $3,813,129 for claims administration. During the year ended December 31, 2002, MAG defaulted on payments of $510,000 to the third party administrator for policy and claims services for the Company's business. The Company had previously paid MAG for such services pursuant to an inter-company agreement. The Company has continued receiving services from the third party administrator after year-end and is now paying the provider directly for such services. 11. COMMITMENTS AND CONTINGENCIES In the normal course of its operations, the Company has been named as defendant in various legal actions, some of which seek substantial amounts for denied claims and other punitive damages. In the opinion of management and its legal counsel, the ultimate liability, if any resulting from the disposition of these claims, will not have a material adverse effect on the Company's financial position, results of operations or cash flows. 12. SUBSEQUENT EVENTS In 2002, Hallmark purchased from a bank a promissory note in default payable by MAG (the "Millers Note") which was guaranteed by Trilogy and secured by all of the issued and outstanding capital stock of Millers and the Company. In lieu of immediate foreclosure of the collateral securing the Millers Note, Hallmark negotiated with MAG to accept all of the outstanding capital stock of the Company in satisfaction of $7.0 million of the outstanding balance of the Millers Note. The proposed exchange was contingent on execution of a mutually acceptable definitive agreement and regulatory approval of Hallmark's Form A application for change of control previously filed with the Arizona Department of Insurance. The Arizona Department of Insurance approved the transaction on January 27, 2003. The effective date of the transaction was January 1, 2003. Therefore, effective January 1, 2003, the Company became a wholly-owned subsidiary of Hallmark. Item 7. Financial Statements and Exhibits b) Pro forma financial information The following unaudited Pro Forma Consolidated Balance Sheet of Hallmark is presented as if the acquisition of the Company had occurred on December 31, 2002. The following unaudited Pro Forma Consolidated Statements of Operations of Hallmark for the year ended December 31, 2002 assume this transaction had occurred as of January 1, 2002. The Pro Forma Consolidated Balance Sheet was derived from the Consolidated Balance Sheet of Hallmark and its subsidiaries filed with Hallmark's Annual Report on Form 10-KSB as of and for the year ended December 31, 2002. The Pro Forma Consolidated Statement of Operations were derived from the Consolidated Statements of Operations of Hallmark and its subsidiaries filed with Hallmark's Annual Report on Form 10-KSB as of and for the year ended December 31, 2002. In management's opinion, all of the material adjustments necessary to reflect the effects of the acquisition transaction have been made. The Pro Forma Consolidated Balance Sheet is not necessarily indicative of what the actual financial position would have been assuming the transaction had been completed as of December 31, 2002, nor does it purport to present the future financial position of Hallmark. Additionally, the Pro Forma Consolidated Statement of Operations is not necessarily indicative of what the actual results of operations of Hallmark would have been assuming the transaction had been completed at the beginning of the period presented, nor does it purport to present the results of operations for future periods. The Acquisition In 2002, Hallmark purchased from a bank a promissory note in default payable by MAG (the "Millers Note") which was guaranteed by Trilogy and secured by all of the issued and outstanding capital stock of Millers and the Company. In lieu of immediate foreclosure of the collateral securing the Millers Note, Hallmark negotiated with MAG to accept all of the outstanding capital stock of the Company in satisfaction of $7.0 million of the outstanding balance of the Millers Note. The proposed exchange was contingent on execution of a mutually acceptable definitive agreement and regulatory approval of Hallmark's Form A application for change of control previously filed with the Arizona Department of Insurance. The Arizona Department of Insurance approved the transaction on January 27, 2003. The effective date of the transaction was January 1, 2003. Therefore, effective January 1, 2003, the Company became a wholly-owned subsidiary of Hallmark. The acquisition of the Company was accounted for by Hallmark as a purchase transaction in accordance with SFAS 141. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed by Hallmark at the date of acquisition: At January 1, 2003 ($ In Thousands) Investments $ 10,873 Cash and cash equivalents 6,945 Furniture, fixtures and equipment - Deferred tax asset, net 3,365 Other assets 12,997 Intangible assets - Goodwill - -------- Total assets acquired 34,180 -------- Unpaid losses and loss adjustment expense 15,886 Other liabilities 3,642 -------- Total liabilities assumed 19,528 -------- Net assets acquired $ 14,652 ======== Hallmark Financial Services, Inc. UNAUDITED CONSOLIDATED PRO FORMA BALANCE SHEET ($ in thousands) Hallmark Financial Phoenix Indemnity Consolidated Services, Inc. Insurance Company Combined Proforma Pro forma December 31, 2002 December 31, 2002 Historical Adjustments December 31, 2002 (Audited) (Audited) December 31, 2002 (Unaudited) (Unaudited) ------------ ------------ ------------ ------------ ------------ Assets Investments: Debt securities, held to maturity, at amortized cost $ 7,679 $ 8,355 $ 16,034 $ - $ 16,034 Equity securities, available for sale, at market value 122 2,183 2,305 2,305 Short-term investments, at cost which approximates market value 8,927 335 9,262 9,262 ------------ ------------ ------------ ------------ ------------ Total investments 16,728 10,873 27,601 - 27,601 Cash and cash equivalents 8,453 6,945 15,398 15,398 Restricted cash 1,072 1,072 1,072 Prepaid reinsurance premiums 8,550 38 8,588 8,588 Premiums receivable from lender for financed premiums (net of allowance for doubtful accounts) 11,593 11,593 11,593 Premiums receivable 1,012 1,745 2,757 2,757 Accounts receivable 2,129 128 2,257 2,257 Reinsurance recoverable 12,929 11,086 24,015 24,015 Deferred policy acquisition costs 1,367 918 2,285 (918) (c) 1,367 Prepaid commissions 3,899 3,899 3,899 Excess of cost over net assets acquired 5,171 5,171 5,171 Intangible assets 540 540 - (b)(c) 540 Note receivable 6,500 6,500 (6,500) (d) - Current federal income taxes recoverable 33 33 33 Deferred federal income taxes 1,021 1,021 3,365 (c) 4,386 Other assets 1,832 575 2,407 (575) (a)(c) 1,832 ------------ ------------ ------------ ------------ ------------ Total assets $ 82,829 $ 32,308 $ 115,137 $ (4,628) $ 110,509 ============ ============ ============ ============ ============ (a) Elimination of intercompany balance (b) Recognition of $706 of acquired identified intangible assets for insurance in force and licenses (c) Adjustments of assets acquired and liabilities assumed to estimated fair value as required by SFAS 141 (d) Consolidation entry
Hallmark Financial Services, Inc. UNAUDITED CONSOLIDATED PRO FORMA BALANCE SHEET ($ in thousands) Hallmark Financial Phoenix Indemnity Consolidated Services, Inc. Insurance Company Combined Proforma Pro forma December 31, 2002 December 31, 2002 Historical Adjustments December 31, 2002 (Audited) (Audited) December 31, 2002 (Unaudited) (Unaudited) ------------ ------------ ------------ ------------ ------------ Liabilities and stockholder's equity Liabilities: Notes payable $ 1,803 $ - $ 1,803 $ - $ 1,803 Note payable related party 8,600 8,600 8,600 Net advances from lender for financed premiums 10,905 10,905 10,905 Unpaid losses and loss adjustment 17,667 15,740 33,407 146 (c) 33,553 expense Unearned premiums 15,551 4,014 19,565 (918) (c) 18,647 Unearned revenue 6,872 6,872 6,872 Accrued agent profit sharing 450 450 450 Reinsurance balances payable 3,764 3,764 3,764 Accrued ceding commission payable 2,536 2,536 2,536 Accounts payable and other accrued 5,542 1,034 6,576 (488) (a) 6,088 expenses Pension liability 604 604 604 ------------ ------------ ------------ ------------ ------------ Total liabilities 74,294 20,788 95,082 (1,260) 93,822 Stockholder's equity: Common stock 356 3,000 3,356 (3,000) (d) 356 Capital in excess of par value 10,875 18,795 29,670 (18,795) (d) 10,875 Retained earnings (1,491) (10,644) (12,135) 18,796 (d)(c) 6,661 Accumulated other comprehensive income (162) 369 207 (369) (d) (162) Treasury stock (1,043) - (1,043) (1,043) ------------ ------------ ------------ ------------ ------------ Total stockholder's equity 8,535 11,520 20,055 (3,368) 16,687 ------------ ------------ ------------ ------------ ------------ Total liabilities and stockholder's equity $ 82,829 $ 32,308 $ 115,137 $ (4,628) $ 110,509 ============ ============ ============ ============ ============ (a) Elimination of intercompany balance (b) Recognition of $706 of acquired identified intangible assets for insurance in force and licenses (c) Adjustments of assets acquired and liabilities assumed to estimated fair value as required by SFAS 141 (d) Consolidation entry
Hallmark Financial Services, Inc. UNAUDITED CONSOLIDATED PRO FORMA STATEMENTS OF OPERATIONS ($ in thousands, except shares and per share amounts) Hallmark Financial Phoenix Indemnity Combined Historical Pro forma Services, Inc. Insurance Company Twelve Months Twelve Months 12 Months Ending 12 Months Ending Ending Pro forma Ending December 31, 2002 December 31, 2002 December 31, 2002 Adjustments December 31, 2002 ------------ ------------ ------------ ------------ ------------ Revenues Gross premiums earned $ 52,486 $ 17,878 $ 70,364 $ 70,364 Ceded premiums earned (32,273) (1,161) (33,434) (33,434) ------------ ------------ ------------ ------------ ------------ Net premiums earned 20,213 $ 16,717 36,930 36,930 Commission & fees 1,561 1,561 1,561 Investment income, net of expenses 531 594 1,125 1,125 Finance charges 2,484 2,484 2,484 Processing and service fees 457 457 457 Other income 551 35 586 586 ------------ ------------ ------------ ------------ ------------ Total revenue 25,797 17,346 43,143 43,143 Losses and expenses: Losses and loss adjustment expenses 36,463 12,883 49,346 49,346 Reinsurance recoveries (21,161) - (21,161) (21,161) ------------ ------------ ------------ ------------ ------------ Net losses and loss adjustment expenses 15,302 12,883 28,185 28,185 Acquisition costs, net (605) 4,315 3,710 3,710 Other acquisition and underwriting expenses (net of ceding commission) 7,468 7,468 7,468 Operating expenses 2,611 1,219 3,830 3,830 Interest expense 983 983 637 (a) 1,620 Amortization of intangible assets 2 2 2 ------------ ------------ ------------ ------------ ------------ Total benefits, losses and expenses 25,761 18,417 44,178 637 44,815 Net income (loss) from operations before federal income tax 36 (1,071) (1,035) (637) (1,672) Federal income tax expense (benefit) 13 (59) (46) (229) (275) ------------ ------------ ------------ ------------ ------------ Net income (loss) $ 23 $ (1,012) $ (989) $ (408) $ (1,397) ============ ============ ============ ============ ============ Basic and diluted earnings per share (11,049,133 and 11,126,822 shares outstanding) Net income (loss) $ - $ (0.09) $ (0.09) $ (0.04) $ (0.13) ============ ============ ============ ============ ============ (a) Represents additional interest expense of $637 related to debt incurred to complete the acquisition. (b) FASB 141 required Hallmark to estimate the fair value of the Company's assets acquired and liabilities assumed as of the date of the acquisition and allocate the consideration paid to those fair values. Any excess of fair value of net assets acquired over consideration paid is required to first be allocated as a pro rata reduction of the amounts that otherwise would have been assigned to all of the acquired assets except (a) financial assets other than investments accounted for by the equity method, (b) assets to be disposed of by sale, (c) deferred tax assets, (d) prepaid assets relating to pension or other postretirement benefit plans, and (e) any other current assets. If any excess remains after reduction to zero the amounts that otherwise would have been assigned to those assets, that remaining excess must be recognized as an extraordinary gain in the period the acquisition is completed.
The calculation of the fair value of the Company's net assets acquired at January 1, 2003 and the determination of excess of fair value of net assets acquired over cost is as follows (in thousands): Net assets acquired at 1/1/03 (historical basis) $ 11,520 Fair value of acquired identified intangible assets 706 Fair value adjustment to unearned premium 918 Fair value adjustment to loss reserves (146) Reversal of valuation allowance on net deferred tax asset acquired 3,365 ------- Fair value of net assets acquired in 1/1/03 before basis adjustments 16,363 Consideration paid in form of debt incurred to complete the acquisition (6,500) ------- Excess of fair value of net assets acquired over cost at 1/1/03 before basis adjustments 9,863 Pro rata reduction of assets acquired other than specified exceptions: Identified intangible assets (706) Deferred policy acquisition costs (918) Fixed Assets (65) Other assets (22) ------- Excess of fair value of net assets acquired over cost at 1/1/03 $ 8,152 ======= The $8.152 million excess of fair value of net assets acquired over liabilities assumed will be recognized by Hallmark as an extraordinary gain during the quarter ended March 31, 2003. This extraordinary gain is not included in the consolidated pro forma statement of operations above. Item 7. Exhibits Exhibits. 2(a) * Purchase Agreement dated December 6, 2002, among Hallmark Financial Services, Inc., Millers American Group, Inc. and Trilogy Holdings, Inc. * Previously filed with the Company's Form 8-K filed with the Commission on January 27, 2003. 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: May 12, 2003 By: /s/ Timothy A. Bienek -------------------------------- Timothy A. Bienek, President and Chief Operating Officer