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
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(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