1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
MARK ONE
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
----------------- --------------------
FOR THE PERIOD ENDED MARCH 31, 2001 COMMISSION FILE NUMBER: 1-8303
------------------------------------
THE HALLWOOD GROUP INCORPORATED
(Exact name of registrant as specified in its charter)
------------------------------------
DELAWARE 51-0261339
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3710 RAWLINS, SUITE 1500
DALLAS, TEXAS 75219
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 528-5588
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO --- ---
1,424,789 shares of Common Stock, $.10 par value per share, were
outstanding at April 30, 2001.
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2
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
ITEM NO. PART I - FINANCIAL INFORMATION PAGE
-------- ------------------------------ ----
1 Financial Statements (Unaudited):
Consolidated Balance Sheets as of March 31, 2001
and December 31, 2000........................................................ 3-4
Consolidated Statements of Income for the
Three Months Ended March 31, 2001 and 2000................................... 5-6
Consolidated Statements of Changes in Stockholders' Equity for the
Three Months Ended March 31, 2001 and 2000................................... 7
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2001 and 2000................................... 8
Notes to Consolidated Financial Statements........................................ 9-20
2 Managements's Discussion and Analysis of
Financial Condition and Results of Operations..................................... 21-26
3 Quantitative and Qualitative Disclosures about Market Risk........................... 27
PART II - OTHER INFORMATION
1 thru 6 Exhibits, Reports on Form 8-K and Signature Page..................................... 28-44
Page 2
3
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
ASSETS
MARCH 31, DECEMBER 31,
2001 2000
-------- -----------
REAL ESTATE
Investments in HRP ..................... $ 7,462 $ 6,973
Receivables and other assets
Related parties ..................... 288 165
Other ............................... 106 268
-------- --------
7,856 7,406
TEXTILE PRODUCTS
Inventories ............................ 17,275 16,413
Receivables ............................ 14,114 13,170
Property, plant and equipment, net ..... 9,766 9,785
Other .................................. 2,178 2,111
-------- --------
43,333 41,479
OTHER
Deferred tax asset, net ................ 5,133 5,333
Cash and cash equivalents .............. 2,319 901
Other .................................. 1,322 1,424
Restricted cash ........................ 945 937
-------- --------
9,719 8,595
DISCONTINUED OPERATIONS
Net assets - Energy .................... 11,114 9,196
Net liabilities - Hotels ............... (4,942) (4,841)
-------- --------
6,172 4,355
-------- --------
TOTAL ............................... $ 67,080 $ 61,835
======== ========
See accompanying notes to consolidated financial statements.
Page 3
4
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
MARCH 31, DECEMBER 31,
2001 2000
-------- -----------
REAL ESTATE
Accounts payable and accrued expenses ................................. $ 780 $ 777
TEXTILE PRODUCTS
Loans payable ......................................................... 13,168 12,910
Accounts payable and accrued expenses ................................. 9,188 7,195
-------- --------
22,356 20,105
OTHER
Senior Secured Term Loan .............................................. 14,321 15,094
10% Collateralized Subordinated Debentures ............................ 6,713 6,725
Convertible loans from stockholder .................................... 4,000 2,500
Interest and other accrued expenses ................................... 3,854 3,820
-------- --------
Total other liabilities ............................................ 28,888 28,139
-------- --------
TOTAL LIABILITIES .................................................. 52,024 49,021
REDEEMABLE PREFERRED STOCK
Series B, 250,000 shares issued and outstanding ....................... 1,000 1,000
STOCKHOLDERS' EQUITY
Preferred stock, 250,000 shares issued and outstanding as Series B .... -- --
Common stock, issued 2,396,149 shares at both dates;
outstanding 1,424,789 shares at both dates ......................... 240 240
Additional paid-in capital ............................................ 54,416 54,416
Accumulated deficit ................................................... (22,673) (27,924)
Accumulated other comprehensive loss .................................. (3,009) --
Treasury stock, 971,360 shares at both dates; at cost ................. (14,918) (14,918)
-------- --------
TOTAL STOCKHOLDERS' EQUITY ......................................... 14,056 11,814
-------- --------
TOTAL .............................................................. $ 67,080 $ 61,835
======== ========
See accompanying notes to consolidated financial statements.
Page 4
5
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
--------------------
2001 2000
-------- --------
REAL ESTATE
Fees
Related parties .......................................... $ 1,905 $ 1,398
Other .................................................... 75 106
Equity income from investments in HRP ....................... 685 274
-------- --------
2,665 1,778
Administrative expenses ..................................... 527 364
Depreciation and amortization ............................... 168 168
-------- --------
695 532
-------- --------
Income from real estate operations ....................... 1,970 1,246
TEXTILE PRODUCTS
Sales ....................................................... 17,777 20,024
Cost of sales ............................................... 15,136 16,844
Administrative and selling expenses ......................... 2,689 2,370
Interest .................................................... 302 262
-------- --------
18,127 19,476
-------- --------
Income (loss) from textile products operations ........... (350) 548
OTHER
Interest on short-term investments and other income ......... 5 7
Interest expense ............................................ 746 778
Administrative expenses ..................................... 235 469
-------- --------
981 1,247
-------- --------
Other loss, net .......................................... (976) (1,240)
-------- --------
Income from continuing operations before income taxes .... 644 554
Income taxes ............................................. (272) (250)
-------- --------
Income from continuing operations ........................ 372 304
See accompanying notes to consolidated financial statements.
Page 5
6
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------
2001 2000
------- -------
Income (loss) from discontinued operations, net of tax
Income from discontinued operations - Energy ....................... $ 4,928 $ 682
Loss from discontinued operations - Hotels ......................... -- (659)
------- -------
Income from discontinued operations ............................. 4,928 23
Income before extraordinary loss and loss from cumulative effect
of SFAS No. 133 adoption ........................................... 5,300 327
Extraordinary loss from early extinguishment of debt .................. (9) --
------- -------
Income before loss from cumulative effect of SFAS No. 133 adoption .... 5,291 327
Loss from cumulative effect of SFAS No. 133 adoption .................. (40) --
------- -------
NET INCOME ................................................................ $ 5,251 $ 327
======= =======
PER COMMON SHARE
Basic
Income from continuing operations .................................. $ 0.26 $ 0.21
Income from discontinued operations ................................ 3.46 0.02
Extraordinary loss from early extinguishment of debt ............... -- --
Loss from cumulative effect of SFAS No. 133 adoption ............... (0.03) --
------- -------
Net income ...................................................... $ 3.69 $ 0.23
======= =======
Assuming Dilution
Income from continuing operations .................................. $ 0.25 $ 0.21
Income from discontinued operations ................................ 2.85 0.02
Extraordinary loss from early extinguishment of debt ............... -- --
Loss from cumulative effect of SFAS No. 133 adoption ............... (0.03) --
------- -------
Net income ...................................................... $ 3.07 $ 0.23
======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ................................................................. 1,425 1,425
======= =======
Assuming Dilution ..................................................... 1,727 1,455
======= =======
See accompanying notes to consolidated financial statements.
Page 6
7
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TREASURY STOCK
------------------ PAID-IN ACCUMULATED COMPREHENSIVE --------------
SHARES PAR VALUE CAPITAL DEFICIT LOSS SHARES COST
------ --------- ---------- ----------- ------------- ------ ----
BALANCE, JANUARY 1, 2001..................... 2,396 $240 $54,416 $(27,924) $ -- 971 $(14,918)
Net income............................... 5,251
Pro rata share of stockholders'
equity transactions from equity
investment:
Cumulative effect of SFAS
No. 133 adoption.................... (4,311)
Change in fair value of derivatives.... 1,302
----- ---- ------- -------- ------- --- --------
BALANCE, MARCH 31, 2001...................... 2,396 $240 $54,416 $(22,673) $(3,009) 971 $(14,918)
===== ==== ======= ======== ======= === ========
TOTAL
STOCKHOLDERS'
EQUITY
------------
BALANCE, JANUARY 1, 2001..................... $11,814
Net income............................... 5,251
Pro rata share of stockholders'
equity transactions from equity
investment:
Cumulative effect of SFAS
No. 133 adoption.................... (4,311)
Change in fair value of derivatives.... 1,302
-------
BALANCE, MARCH 31, 2001...................... $14,056
=======
See accompanying notes to consolidated financial statements.
Page 7
8
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------
2001 2000
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ..................................................... $ 5,251 $ 327
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in net income of HRP ................................. (685) (274)
Depreciation, depletion and amortization .................... 589 477
Decrease in deferred tax asset .............................. 200 170
Loss from cumulative effect of SFAS No. 133 adoption ........ 40 --
Amortization of deferred gain from debenture exchange ....... (12) (10)
Extraordinary loss from early extinguishment of debt ........ 9 --
Net change in other assets and liabilities .................. 272 116
Net change in textile products assets and liabilities ....... 85 71
Discontinued operations:
Increase in deferred tax asset ........................... (3,586) --
Equity in net income of Hallwood Energy .................. (1,342) (682)
Net change in other hotel assets and liabilities ......... 79 (68)
Depreciation and amortization ............................ -- 725
Preferred dividends from Hallwood Energy ................. -- 11
------- -------
Net cash provided by operating activities ................ 900 863
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in textile products property and equipment ......... (367) (334)
Payments for textile products business acquisition ............. -- (1,479)
Purchase of minority shares in energy affiliate ................ -- (465)
Discontinued operations:
Capital expenditures for hotels ............................. -- (308)
Proceeds from sale of Hallwood Energy preferred stock ....... -- 303
Net change in restricted cash for investing activities ...... -- 179
------- -------
Net cash used in investing activities .................... (367) (2,104)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings and loans payable ................ 1,798 2,302
Repayment of bank borrowings and loans payable ................. (813) (704)
Discontinued operations:
Repayment of hotel bank borrowings and loans payable ........ (100) (217)
------- -------
Net cash provided by financing activities ............... 885 1,381
------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS .......................... 1,418 140
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ..................... 901 926
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD ........................... $ 2,319 $ 1,066
======= =======
See accompanying notes to consolidated financial statements.
Page 8
9
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS AND ACCOUNTING POLICIES
Interim Consolidated Financial Statements. The consolidated financial
statements of The Hallwood Group Incorporated (the "Company") have been
prepared in accordance with the instructions to Form 10-Q and do not
include all of the information and disclosures required by accounting
principles generally accepted in the United States of America, although, in
the opinion of management, all adjustments considered necessary for a fair
presentation have been included. These financial statements should be read
in conjunction with the audited consolidated financial statements and
related disclosures thereto included in Form 10-K for the year ended
December 31, 2000.
Discontinued Operations. In December 2000, the Company adopted a formal
plan to discontinue and dispose of its hotel operations. In March 2001, the
Company agreed to sell its investment in its Hallwood Energy affiliate,
which represented the Company's energy operations, subject to Hallwood
Energy's shareholder approval which was obtained in May 2001. Accordingly,
the former hotel and energy operations have been reported as a separate
component of operations and the assets and liabilities have been combined
and included in net assets (liabilities) of discontinued operations in the
balance sheet. See also Notes 5 and 6.
New Accounting Pronouncements. Statement of Financial Accounting
Standards No. 133 - Accounting for Derivative Instruments and Hedging
Activities ("SFAS No. 133") was effective for the Company on January 1,
2001. SFAS No. 133 (as amended by SFAS No. 137 and SFAS No. 138)
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and
for hedging activities. All derivatives, whether designated in hedging
relationships or not, are required to be recorded on the balance sheet at
fair value. If the derivative is designated as a fair-value hedge, the
changes in the fair value of the derivative and the hedged item are
recognized in earnings. If the derivative is designated as a cash flow
hedge, changes in the fair value of the derivative are recorded in other
comprehensive income and are recognized in the income statement when the
hedged item affects earnings. These statements define new requirements for
designation and documentation of hedging relationships as well as ongoing
effectiveness assessments in order to use hedge accounting. For a
derivative that does not qualify as a hedge, changes in fair value will be
recognized in earnings.
In connection with its adoption, all derivatives within the Company
were identified pursuant to SFAS No. 133 requirements. The Company
determined it did not directly have any derivative instruments, however,
HRP and Hallwood Energy do have such instruments. Accordingly, the Company
was required to record its proportional share of any impact of these
instruments in accordance with the equity method of accounting.
HRP determined it had one derivative, an interest rate cap. This
derivative was designated as a cash flow hedge. Hedge effectiveness is
measured based on using the intrinsic value of the interest rate cap. All
changes in the fair value of the time value of the cap are recorded
directly to earnings. With the January 1, 2001 adoption of SFAS No. 133,
the Company recorded in income its proportionate share of the cumulative
effect of the adoption of $40,000, or the amount of the difference between
the carrying value as of January 1, 2001 and the estimated fair value, all
of which represented change in time value. The impact on the Company's
financial statements for the 2001 first quarter was $4,000, which was
recorded in equity income from investments in HRP, as the estimated fair
value of the interest rate cap was reduced as of March 31, 2001.
Hallwood Energy determined that all of its oil and gas commodity swaps
and collars, as well as its interest rate swaps should be designated as
cash flow hedges. Since Hallwood Energy's derivatives are designated as
cash flow hedges, changes in the fair value of the derivatives will be
recognized in other comprehensive income until the hedged item is
recognized in earnings. Hedge effectiveness will be measured based on the
relative changes in the fair value between the derivative contract and the
hedged item over time. Any changes in fair value resulting from
ineffectiveness, as defined by SFAS No. 133, will be recognized immediately
in current earnings.
Page 9
10
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
The adoption of SFAS No. 133, as of January 1, 2001, resulted in the
recognition by the Company of its pro rata share of these derivatives, as a
reduction in the carrying value of its investment in Hallwood Energy by
$4,311,000, with a corresponding change to a component of stockholders'
equity, accumulated other comprehensive loss. During the 2001 first
quarter, $83,000, representing the ineffective portion of the Company's
proportionate share of the cash flow hedges was included in earnings. As of
March 31, 2001, the fair values of the Company's pro rata share of the cash
flow hedges consisted of a reduction in its investment in the carrying
value of Hallwood Energy of $3,009,000, with a corresponding adjustment
reducing other comprehensive loss. Hallwood Energy expects that the losses
under its cash flow hedges will be reclassified from other comprehensive
loss to earnings during the next twelve months.
Other Comprehensive Income (Loss). The components of other
comprehensive income (loss) for the three months ended March 31, 2001 are
shown as follows (in thousands):
Pro rata share of other comprehensive loss from discontinued
operations - energy:
Cumulative effect of SFAS No. 133 adoption
as of January 1, 2001................................... $(4,311)
Change in fair value of derivatives from settlement
during the three months ended March 31, 2001............ 1,302
-------
Accumulated other comprehensive loss.......................... $(3,009)
=======
Reclassifications. Certain reclassifications have been made to prior
year amounts to conform to the classifications used in the current year.
2. INVESTMENTS IN REAL ESTATE AFFILIATE (DOLLAR AMOUNTS IN THOUSANDS)
AS OF MARCH 31, 2001 AMOUNT AS INCOME FROM INVESTMENTS
-------------------- WHICH CARRIED AT FOR THE THREE MONTHS ENDED
COST OR ---------------------- MARCH 31,
NUMBER OF ASCRIBED MARCH 31, DECEMBER 31, ----------------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 2001 2000 2001 2000
------------------------- --------- ---------- --------- ------------ ------ -------
HALLWOOD REALTY PARTNERS, L.P.
- General partner interest...... -- $ 8,650 $2,403 $2,529 $ 20 $ 18
- Limited partner interest...... 330,432 4,302 5,059 4,444 665 256
------- ------ ------ ---- ----
Totals....................... $12,952 $7,462 $6,973 $685 $274
====== ====== ====== ==== ====
At March 31, 2001, Hallwood Realty, LLC ("Hallwood Realty") and HWG,
LLC, wholly owned subsidiaries of the Company, owned a 1% general
partner interest and a 21% limited partner interest in its Hallwood
Realty Partners, L.P. ("HRP") affiliate, respectively. The Company
accounts for its investment in HRP using the equity method of
accounting. In addition to recording its share of HRP's net income, the
Company also records amortization of the amount, $4,849,000, that the
Company's share of the underlying equity in net assets of HRP exceeded
its investment on the straight line basis over 19 years. The Company
also records non-cash adjustments for the elimination of intercompany
profits with a corresponding adjustment to equity income, and its
pro-rata share of HRP's partner capital transactions with corresponding
adjustments to additional paid-in capital. The cumulative amount of
such non-cash adjustments, from the original date of investment through
March 31, 2001, resulted in a $1,764,000 decrease in the carrying value
of the HRP investment.
The carrying value of the Company's general partner interest of HRP
includes the value of intangible rights to provide asset management and
property management services. The Company amortizes that portion of the
general partner interest ascribed to the management rights. For the
three months ended March 31, 2001 and 2000 such amortization was
$168,000 in each period.
Page 10
11
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
The Company has pledged 300,397 HRP limited partner units to
collateralize the Senior Secured Term Loan and the remaining 30,035
units to secure capital leases.
The quoted market price and the Company's carrying value per limited
partner unit (AMEX symbol HRY) at March 31, 2001 were $67.00 and
$15.31, respectively. The general partner interest is not publicly
traded.
3. LOANS PAYABLE
Loans payable at the balance sheet dates are detailed below by business
segment (in thousands):
MARCH 31, DECEMBER 31,
2001 2000
-------- ------------
Textile Products
Revolving credit facility, prime + .25% or
Libor + 3.00%, due December 2002......................................... $11,235 $10,937
Acquisition credit facility, prime + 1.00% or
Libor + 3.25%, due December 2002 ........................................ 1,000 1,000
Equipment credit facility, prime + .25% or
Libor + 2.75%, due October 2005 ........................................ 933 973
------- -------
13,168 12,910
Other
Senior Secured Term Loan, 10.25% fixed, due December 2004 ................... 14,321 15,094
Convertible loans from stockholder, 10% fixed, due at various
dates from March 2005 to March 2006 ..................................... 4,000 2,500
------- -------
18,321 17,594
------- -------
Total ................................................................... $31,489 $30,504
======= =======
Further information regarding loans payable is provided below:
Textile Products
Revolving Credit Facility. In December 1999, the Company's Brookwood
subsidiary entered into a revolving credit facility in an amount up to
$17,000,000 with Key Bank National Association ("Key Credit Agreement") to
replace its former credit facility. Availability for direct borrowings and
letter of credit obligations under the Key Credit Agreement are limited to
the lesser of the facility amount or the borrowing base so defined in the
agreement. As of March 31, 2001, Brookwood had an additional $1,178,000 of
borrowing base availability. Borrowings are collateralized by accounts
receivable, inventory imported under trade letters of credit, certain
finished goods inventory, machinery and equipment and all of the issued and
outstanding capital stock of Brookwood and its subsidiaries. The Key Credit
Agreement expires in December 2002 and bears interest at Brookwood's option
of one-quarter percent over prime (8.25% at March 31, 2001) or Libor plus
3.00% (8.15% at March 31, 2001). The loan agreement contains covenants,
which include maintenance of certain financial ratios, restrictions on
dividends and repayment of debt or cash transfers to the parent company.
At June 30, 2000 and September 30, 2000, Brookwood was not in
compliance with a coverage ratio covenant contained in the Key Credit
Agreement and subsequently obtained a waiver of the violation. The waiver
provided for an increase of 0.50% in interest rates on the revolving credit
facility and the acquisition credit facility, effective October 2000,
restrictions on the payments to the parent company and certain other
restrictive provisions. Cash dividends and tax sharing payments to the
parent company are contingent upon Brookwood's compliance with the
covenants contained in the loan agreement. At December 31, 2000, Brookwood
was in compliance with its coverage ratio covenant, however, Brookwood did
not achieve its coverage ratio for the 2001 first quarter. Accordingly, in
April 2001, Brookwood obtained a waiver of this violation.
Page 11
12
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
Acquisition Credit Facility. The Key Credit Agreement also provides for
a $2,000,000 acquisition revolving credit line. Brookwood borrowed
$1,000,000 under this line during the year ended December 31, 2000. This
facility bears interest at Brookwood's option of one percent over prime
(9.00% at March 31, 2001) or Libor plus 3.25%.
Equipment Credit Facility. The Key Credit Agreement also provides for a
$2,000,000 equipment revolving credit line. Brookwood borrowed $1,000,000
under this line during the year ended December 31, 2000. The facility bears
interest at Libor + 2.75% (7.81% at March 31, 2001).
The outstanding balance of the combined Key Bank credit facilities at
March 31, 2001 was $13,168,000.
Other
Senior Secured Term Loan. In December 1999, the Company and its HWG,
LLC subsidiary entered into an $18,000,000 credit agreement with First Bank
Texas, N.A. and other financial institutions (the "Senior Secured Term
Loan"). Proceeds were used to repay the 7% Debentures, the energy term loan
and provide working capital. The Senior Secured Term Loan bears interest at
a fixed rate of 10.25%, matures in December 2004, is fully amortizing and
requires a monthly payment of $385,000. Collateral is comprised of (i)
300,397 HRP limited partner units; (ii) 1,440,000 shares of Hallwood Energy
common stock; (iii) a senior lien on the capital stock of the Hallwood
Hotels, Inc. subsidiary; and (iv) a senior lien on the capital stock of the
Brock Suite Hotels, Inc. subsidiary. The Senior Secured Term Loan contains
various financial and non-financial covenants, including the maintenance of
certain financial ratios, and restrictions on certain new indebtedness and
the payment of dividends. The outstanding balance at March 31, 2001 was
$14,321,000.
At June 30, 2000, the Company was not in compliance with a coverage
ratio covenant contained in the Senior Secured Term Loan. Management
obtained a waiver as part of a formal loan amendment, which incorporates
certain modifications to the covenant calculation. At December 31, 2000,
the Company was in compliance with the loan covenants for the Senior
Secured Term Loan, however, projections indicated that the Company might
not have been able to maintain its cash flow coverage ratio covenants
during 2001. The Company initiated discussions with its lender and entered
into a loan amendment, which modified the covenant for 2001 for the Senior
Secured Term Loan. The Company was in compliance with the modified covenant
at March 31, 2001, and management believes that it will satisfy the new
coverage ratio covenant for the remainder of 2001, based upon currently
available projections.
Convertible Loans from Stockholder. In order to provide sufficient
funds to meet the Company's cash flow requirements and maintain compliance
with the loan covenants contained in the Senior Secured Term Loan, the
Company entered into various loans with an entity associated with its
chairman and principal stockholder, Anthony J. Gumbiner, as indicated
below.
Page 12
13
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
LOAN CONVERSION MATURITY
LOAN DATE AMOUNT PRICE DATE
--------- ------ ---------- --------
March 2000............... $1,500,000 $10.13 March 2005
September 2000........... 1,000,000 6.47 September 2005
March 2001............... 1,500,000 6.12 March 2006
----------
Total.................... $4,000,000
==========
Significant terms for the three loans include: (i) term of five years;
(ii) fixed interest rate of 10%; (iii) interest and principal payments
deferred until maturity date; (iv) unsecured and subordinated to the Senior
Secured Term Loan ; and (v) convertible into common stock of the Company at
a conversion price equal to 115% of the market price on the date each of
the loans was approved by the Company's independent board members.
4. DEBENTURES
10% Collateralized Subordinated Debentures. The 10% Debentures are
listed on The New York Stock Exchange. For accounting purposes, a pro-rata
portion of the unamortized gain attributable to the 7% Debentures, in the
amount of $353,000, was allocated to the 10% Debentures, and is being
amortized over the term of the 10% Debentures using the effective interest
method. As a result, the effective interest rate for financial reporting is
8.9%.
The 10% Debentures are secured by a junior lien on the capital stock of
the Brookwood, Hallwood Hotels, Inc. and Brock Suite Hotels, Inc.
subsidiaries.
Balance sheet amounts for the 10% Debentures are detailed below (in
thousands):
MARCH 31, DECEMBER 31,
DESCRIPTION 2001 2000
----------- --------- ------------
10% Debentures (face amount)................................... $6,468 $6,468
Unamortized gain from exchange, net of
accumulated amortization.................................... 245 257
------ ------
Totals................................................... $6,713 $6,725
====== ======
5. DISCONTINUED OPERATIONS - HOTELS
The Company's hotel segment, principally the three GuestHouse Suites
Plus hotels, experienced cash flow difficulties during 2000 due to weaker
occupancy and average daily rates. Management discontinued the payment of
the mortgage and/or lease payments on the GuestHouse properties in October
2000, and commenced discussion with the parties regarding loan or lease
modifications. In December 2000, the Company decided to discontinue and
dispose of its hotel segment, principally by allowing its non-recourse debt
holders to assume ownership of the properties through foreclosures or by
selling or otherwise disposing of its hotel properties. The Company's hotel
segment consisted of three owned properties and two leased properties. As
part of the planned disposition, in December 2000 the Company evaluated the
operations and economic environment in which each of the hotels operated
and determined it was appropriate to record an impairment of long lived
assets of $4,000,000 to their estimated fair market values. The term loans
on the hotel properties are non-recourse and will be repaid from sales
proceeds, if any, or extinguished upon completion of foreclosure
proceedings initiated by the lenders. The capital lease obligations will be
repaid by the sale of leased property or other considerations.
Page 13
14
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
In January 2001, a receiver was appointed to administer the disposition
of the GuestHouse Suites Plus hotel in Greenville, South Carolina. In
February 2001, the Company signed an Agreement to Terminate Lease with the
landlord of the Holiday Inn and Suites Hotel in Sarasota, Florida. In March
2001, receivers were appointed to administer the disposition of the
GuestHouse Suites Plus hotel in Tulsa, Oklahoma and the Airport Embassy
Suites Hotel in Oklahoma City, Oklahoma, respectively. The Company is
presently in negotiations with the landlord of the GuestHouse Suites Plus
hotel in Huntsville, Alabama regarding the disposition of that leased
property. The Company anticipates that it will not receive any amounts in
excess of the non-recourse debt outstanding.
A summary of the net liabilities, as of the balance sheet dates, and loss
from discontinued hotel operations are detailed below (in thousands):
MARCH 31, DECEMBER 31,
2001 2000
--------- -----------
Loans payable.................................................. $29,331 $ 29,350
Accounts payable and accrued expenses.......................... 3,262 3,140
Capital leases................................................. 1,693 1,774
Properties, net................................................ (25,886) (25,783)
Receivables and other assets................................... (1,562) (1,639)
Restricted cash................................................ (596) (701)
Deferred tax asset............................................. (1,300) (1,300)
------ --------
Net liabilities of discontinued operations................. $ 4,942 $ 4,841
======= ========
THREE MONTHS ENDED
MARCH 31,
--------------------
2001 2000
------ ------
Sales.......................................................... $4,056 $5,032
Expenses
Operating expenses........................................ 3,638 4,254
Interest expense.......................................... 605 712
Loss reserve.............................................. (187) --
Depreciation and amortization............................. -- 725
------- -----
Total expenses........................................ 4,056 5,691
------ -----
Loss from discontinued operations......................... $ -- $(659)
====== =====
During calendar 2001 the Company anticipates the recording of
extraordinary gains from debt extinguishment as hotel dispositions are
completed. The Company estimates that the results of discontinued
operations from the December 31, 2000 measurement date to the expected
final disposition will be a slight loss, however, such amount was not
accrued as these operating losses will be offset by anticipated gains and
will therefore be recognized when the gains are realized.
Page 14
15
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
A summary of the non-recourse loans payable is detailed below (in
thousands):
MARCH 31, DECEMBER 31,
DESCRIPTION 2001 2000
----------- --------- ------------
Term loan, 7.50% fixed, due October 2008.................. $16,723 $16,742
Term loan, 7.86% fixed, due January 2008.................. 6,512 6,512
Term loan, 8.20% fixed, due November 2007................. 5,093 5,093
Term loan, Libor + 7.5%, due October 2005................. 1,003 1,003
------- -------
Total................................................ $29,331 $29,350
======= =======
As previously discussed, the Company is in default on each of these
term loans and foreclosures procedures have been initiated by the
lenders.
Capital Leases. The Company has guaranteed the capital lease
obligations for the three GuestHouse Suites hotels by pledging 30,035
limited partner units of HRP with a market value of $2,012,000 at March 31,
2001. The combined monthly lease payments are $46,570 and are current
through April 2001. The leases commenced January 2000 and expire December
2004, bear an effective interest rate of 12.18% and have an outstanding
balance of $1,693,000 and $1,774,000 at March 31, 2001 and December 31,
2000, respectively.
6. DISCONTINUED OPERATIONS - ENERGY
On March 30, 2001, Hallwood Energy Corporation ("Hallwood Energy")
announced that it had signed a definitive merger agreement pursuant to
which Pure Resources II, Inc., an indirect wholly owned subsidiary of Pure
Resources, Inc., will acquire all the outstanding common stock of Hallwood
Energy at a price of $12.50 per share and all the outstanding shares of
Series A Cumulative Preferred Stock of Hallwood Energy at a price of
$10.84 per share. The all-cash transaction, which is subject to a number
of conditions, is structured as a first step tender offer followed by a
cash merger to acquire all remaining shares of Hallwood Energy. The
Company also agreed to tender all of its shares of common stock in the
tender offer and granted to Pure an irrevocable proxy to vote in favor of
the merger, on the same terms as provided in the merger agreement. Pure
commenced its tender offer on April 10, 2001, with an expiration date of
May 8, 2001. On May 9, 2001, Pure announced that it had successfully
completed its initial tender offer, and had acquired approximately 85% of
the Hallwood Energy common stock and 78% of the Hallwood Energy preferred
stock. Pure also announced a subsequent offering period to expire on May
15, 2001, unless extended. The Company received $18,000,000 for the tender
of its 1,440,000 shares of common stock on May 11, 2001 and expects to
receive an additional amount of $7,250,000 pursuant to the terms of a
noncompetition agreement, that will be paid by Pure at the completion of
the merger, which is expected to occur by September 2001, but the timing
is uncertain.
Under the noncompetition agreement, the Company has agreed to refrain
from taking certain actions (described below) without the prior written
consent of Pure and Hallwood Energy. These covenants are made by the
Company in consideration of the transactions contemplated by the merger
agreement and the payment by Pure to the Company. For a period of three
(3) years after the effective date of the merger agreement, the Company
will not, directly or indirectly, engage in oil and gas activities in
certain geographic areas without the prior consent of Pure. The Company
has also agreed to keep Hallwood Energy's confidential and proprietary
information strictly confidential. For six (6) months after any payment is
made for any shares of Hallwood Energy stock pursuant to the offer,
neither the Company nor any of its affiliates will, directly or
Page 15
16
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
indirectly, hire any person who is presently an employee of Hallwood
Energy or any existing or future affiliate of Hallwood Energy (whether or
not he or she remains an affiliate of Hallwood Energy), unless such
employee has been involuntarily terminated by Hallwood Energy.
As a result of the planned disposition of its energy assets, the
Company has classified the investment and operations as discontinued
operations as of March 31, 2001.
A summary of the net assets, as of the balance sheet dates, and income
from discontinued energy operations, including tax benefit, are detailed
below (in thousands):
MARCH 31, DECEMBER 31,
2001 2000
--------- ------------
Investment in Hallwood Energy.................................. $ 5,735 $7,403
Deferred tax asset............................................. 5,379 1,793
------- ------
Net assets of discontinued operations...................... $11,114 $9,196
======= ======
THREE MONTHS ENDED
MARCH 31,
------------------
2001 2000
-------- -------
Equity income from investment in Hallwood Energy............... $1,342 $682
Deferred income tax benefit.................................... 3,586 --
------ ----
Income from discontinued operations....................... $4,928 $682
====== ====
The Company recorded a deferred income tax benefit of $3,586,000 in the
2001 first quarter, principally due to the anticipated utilization of the
Company's NOL's from the sale of its investment in Hallwood Energy.
Information pertaining to the Company's investment in Hallwood Energy
is provided below (in thousands):
AS OF MARCH 31, 2001 AMOUNT AS INCOME FROM INVESTMENTS
-------------------- WHICH CARRIED AT FOR THE THREE MONTHS ENDED
COST OR ---------------------- MARCH 31,
NUMBER OF ASCRIBED MARCH 31, DECEMBER 31, ----------------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 2001 2000 2001 2000
------------------------- --------- ---------- --------- ------------ ------ -------
HALLWOOD ENERGY CORPORATION
- Common stock.................. 1,440,000 $5,397 $5,735 $7,403 $1,342 $671
- Preferred stock............... -- -- -- -- 11
------ ------ ------ ------ ----
Totals..................... $5,397 $5,735 $7,403 $1,342 $682
====== ====== ====== ====== ====
At March 31, 2001, the Company owned a 15% common stock interest in
Hallwood Energy. The Company accounted for its investment using the
equity method of accounting, as the Company exercises significant
influence over Hallwood Energy's operational and financial policies. The
Company's share of the underlying equity in net assets of Hallwood
Energy exceeded its investment on the date of the Energy Consolidation
by $4,391,000, which is being amortized at a rate which approximates the
depletion rate of Hallwood Energy's reserves. In addition to recording
its share of Hallwood Energy's net income available to common
stockholders, the Company also recorded its preferred dividends (prior
to the February 2000 sale of its preferred stock). The Company also
records its pro-rata share of any capital transactions. The cumulative
amount of such adjustments from June 1999, the date of the Energy
Consolidation, through March 31, 2001, resulted in a $3,045,000 decrease
in the carrying amount of the investment. The quoted market price and
the Company's carrying value per common share (NASDAQ symbol HECO) at
March 31, 2001 were $12.33 and $3.99, respectively.
Page 16
17
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
7. INCOME TAXES
The following is a summary of the income tax expense (benefit) (in
thousands):
THREE MONTHS ENDED
MARCH 31,
------------------
2001 2000
------- -------
Federal
Deferred tax (benefit)........................... $(3,386) $170
Current tax...................................... 21 22
------- ----
Sub-total..................................... (3,365) 192
State .............................................. 51 58
------- ----
Total......................................... $(3,314) $250
======= ====
The above amounts are inclusive of the related income tax expense
(benefit) associated with the discontinued operations. Income tax
expense (benefit) from continuing operations and discontinued
operations are as follows:
THREE MONTHS ENDED
MARCH 31,
-----------------------
2001 2000
------- ------
Continuing operations............................... $ 272 $250
Discontinued operations............................. (3,586) --
------- ----
Total......................................... $(3,314) $250
======= ====
The amount of the deferred tax asset (net of valuation allowance) for
the Company's continuing operations was $5,333,000 at March 31, 2001. The
deferred tax asset arises principally from the anticipated utilization of
the Company's NOLs and tax credits from the implementation of various tax
planning strategies, which include the potential sale of certain real
estate investments, that could be implemented, if necessary, to supplement
income from operations to fully realize the net recorded tax benefits
before their expiration. The Company also had a deferred tax asset of
$6,679,000 associated with its discontinued operations as of March 31,
2001, principally due to the anticipated utilization of the Company's NOLs
from the sale of its investment in Hallwood Energy.
State tax expense is an estimate based upon taxable income allocated to
those states in which the Company does business, at their respective tax
rates.
Page 17
18
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
8. SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED
MARCH 31,
---------------------
DESCRIPTION 2001 2000
----------- -------- --------
Supplemental schedule of non-cash investing and
financing activities:
Pro rata share of stockholders' equity
transactions of equity investment:
Cumulative effect of SFAS No. 133 adoption................... $(4,311) --
Change in fair value of derivatives.......................... 1,302 --
- ----- ------
Accumulated other comprehensive loss...................... $(3,009) --
======= ======
Supplemental disclosures of cash payments:
Interest paid................................................... $1,100 $1,536
Income taxes paid............................................... 130 102
9. COMPUTATION OF EARNINGS PER SHARE
The following table reconciles the Company's income from continuing
operations to income from continuing operations available to common
stockholders assuming dilution, and the number of common shares used in the
calculation of net income for the basic and assumed dilution methods (in
thousands):
THREE MONTHS ENDED
MARCH 31,
------------------
DESCRIPTION 2001 2000
----------- -------- --------
INCOME AVAILABLE TO COMMON STOCKHOLDERS
Income from continuing operations................................... $ 372 $ 304
Impact of assumed loan conversion................................... 53 4
------ ------
Income available to common stockholders before
cumulative effect of SFAS No. 133 adoption and
extraordinary loss.............................................. $ 425 $ $308
====== ======
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ............................................................. 1,425 1,425
Incremental shares from assumed loan conversions.................... 302 18
Assumed issuance of shares from stock options exercised............. -- 54
Assumed repurchase of shares from stock options proceeds............ -- (42)
----- ------
Assuming dilution............................................... 1,727 1,455
===== ======
10. LITIGATION, CONTINGENCIES AND COMMITMENTS
Reference is made to Notes 9 and 18 to the consolidated financial
statements contained in Form 10-K for the year ended December 31, 2000.
Beginning in 1997, the Company and its HRP affiliate have been involved
in two lawsuits that were brought by Gotham Partners, L.P. in the Delaware
Court of Chancery. The first suit filed in February 1997, styled Gotham
Partners, L.P. v. Hallwood Realty Partners, L.P. and Hallwood Realty
Corporation (C.A. No.15578), sought access to certain books and records of
HRP and was subsequently settled, allowing certain access. The suit was
dismissed on April 9, 2001. The second action, filed in June 1997, styled
Gotham Partners, L.P. v. Hallwood Realty
Page 18
19
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
Partners, L.P., et al (C.A. No.15754), against the Company, HRP, HRC and
the directors of HRC, alleges claims of breach of fiduciary duties, breach
of HRP's partnership agreement and fraud in connection with certain
transactions involving HRP's limited partnership units in the mid 1990's.
The Company is alleged to have aided and abetted the alleged breaches. In
June 2000, after completing fact discovery, all parties moved for summary
judgment on several issues. In September and October 2000, the Delaware
court issued three separate written opinions resolving the summary judgment
motions. In the opinions, the court ruled that trial would be required as
to all issues, except that (i) Gotham was found to have standing to pursue
its derivative claims; (ii) defendants were entitled to judgment dismissing
the fraud claim; (iii) the general partner was entitled to judgment
dismissing the breach of fiduciary duty claims brought against it; and (iv)
the general partner's outside directors were entitled to judgment
dismissing all claims brought against them. A five-day trial was held in
January 2001. The court requested post-trial briefings, which were
completed by mid-April 2001. Final arguments were made before the court on
May 1, 2001. Given the nature of the plaintiff's claims and the usual
uncertainties in litigation, management is not able to predict the outcome
of the litigation or whether any of the claims or defenses will ultimately
be successful.
In February 2000, HRP filed a lawsuit in the United States District
Court for the Southern District of New York styled Hallwood Realty
Partners, L.P. v. Gotham Partners, L.P., et al (Civ. No. 00 CV 115)
alleging violations of the Securities Exchange Act of 1934 by certain
purchasers of HRP's limited partnership units, including Gotham Partners,
L.P., Gotham Partners, III L.P., Private Management Group, Inc., Interstate
Properties, Steven Roth and EFO Realty, Inc., by virtue of those
purchasers' misrepresentations and/or omissions in connection with filings
required under the Securities Exchange Act of 1934. The complaint further
alleged that the defendants, by acquiring more than 15% of the outstanding
HRP limited partnership units, have triggered certain rights under its Unit
Purchase Rights Agreement, for which HRP was seeking declaratory relief.
HRP was seeking various forms of relief, including declaratory judgments,
divestiture, corrective disclosures, a "cooling-off" period and damages,
including costs and disbursements. Discovery was completed in December 2000
and trial was held in February 2001. On February 23, 2001, the Court
rendered a decision in favor of the defendants and on February 28, 2001,
the Court ordered the complaint dismissed. HRP filed a Notice of Appeal on
March 29, 2001 with respect to the February 28, 2001 dismissal of the
complaint. A briefing schedule has been set by the Second Circuit, but the
appeal has not yet been perfected.
In December 1999, the Company deposited $900,000 into an escrow account
to secure the maximum amount which could be payable by the Company in a
lawsuit brought by a former promissory note holder. The discovery phase has
been completed and the action will now proceed to trial, which is scheduled
for June 2001.
In December 1999 the Company distributed certain assets and incurred a
contingent obligation, under the agreement to separate the interests of its
former president and director (the "Separation Agreement"). The contingent
obligation in the amount of $3,080,000 at March 31, 2001, is the present
value of the remaining payments under the Separation Agreement and is
included in other accrued expenses. Interest on the contingent obligation
has been imputed at 12.75% and amounted to $100,000 and $103,000 for the
three months ended March 31, 2001 and 2000, respectively.
In February 2000, the Company, through a wholly owned subsidiary,
acquired the assets of a company in a textile products-related industry.
The purchase price was $1,450,000 in cash plus contingent payments of up to
$3,000,000 based on specified levels of earnings over the next four years.
No amounts are currently due under the contingency portion of the purchase
agreement.
Page 19
20
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
11. SEGMENT AND RELATED INFORMATION
The following represents the Company's reportable segment operations
for the three months ended March 31, 2001 and 2000, respectively (in
thousands):
REAL TEXTILE DISCONTINUED CONSOL
ESTATE PRODUCTS OTHER OPERATIONS -IDATED
------ -------- ----- ------------ -------
THREE MONTHS ENDED MARCH 31, 2001
Total revenue from external sources....... $ 2,665 17,777 $ 5 $ 20,447
======= ======== ======== ========
Operating income (loss)................... $ 1,970 (350) $ 1,620
======= ========
Unallocable expenses, net................. $ (976) (976)
======== --------
Income from continuing operations
before income taxes................... $ 644
========
Income from discontinued operations....... $ 4,928 $ 4,928
======== ========
THREE MONTHS ENDED MARCH 31, 2000
Total revenue from external sources....... $ 1,778 $ 20,024 $ 7 $ 21,809
======= ======== ======== =======
Operating income.......................... $ 1,246 $ 548 $ 1,794
======= ========
Unallocable expenses, net................. $ (1,240) (1,240)
======== --------
Income from continuing operations
before income taxes................... $ 554
========
Income from discontinued operations....... $ 23 $ 23
======== ========
No differences have occurred in the basis or methodologies used in the
preparation of this interim segment information from those used in the
December 31, 2000 annual report. The total assets for the Company's
operating segments have not materially changed since the December 31, 2000
annual report, other than the reclassification of the Company's investment
in energy assets to discontinued operations.
12. STOCKHOLDER LOANS
During 2000, the Company borrowed a total of $2,500,000 from its
chairman and principal stockholder and an additional $1,500,000 in March
2001. Several factors contributed to the Company's cash flow needs,
including difficulties experienced by the Company's hotel operations and
restrictions on the availability of distributions and payments from
Brookwood. In response to these matters, management decided to discontinue
its hotel operations and entered into an agreement for the sale of its
Hallwood Energy investment during 2001. Management believes that these
strategies will allow the Company to return to profitability with
sufficient liquidity. In addition, the principal stockholder committed to
loan the Company additional funds during the balance of 2001, if required.
Although the Company and Brookwood were in compliance with their
respective loan covenants at December 31, 2000, projections indicated that
the Company and Brookwood may not be able to maintain their cash flow
coverage ratio covenants during 2001. The Company initiated discussions
with its lender and entered into a loan amendment, which modified the
covenant for the Senior Secured Term Loan. The Company was in compliance
with the modified covenant at March 31, 2001, and management believes that
it will satisfy the new coverage ratio covenant for the remainder of 2001,
based upon currently available projections. Brookwood did not achieve its
coverage ratio for the 2001 first quarter. Accordingly, in April 2001,
Brookwood obtained a waiver of this violation.
Page 20
21
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Company reported net income of $5,251,000 for the first quarter
ended March 31, 2001, compared to net income of $327,000 in 2000. Income
from continuing operations was $372,000 in the first quarter of 2001,
compared to $304,000 in 2000. Revenue from continuing operations for the
2001 first quarter was $20,447,000, compared to $21,809,000 in 2000.
Following is an analysis of the results of continuing operations by the
real estate and textile products business segments, and the discontinued
operations for the hotel and energy business segments.
REAL ESTATE
The real estate segment reported income of $1,970,000 for the first
quarter of 2001 compared to $1,246,000 in 2000.
Revenues. Fee income of $1,980,000 for the quarter ended March 31, 2001
increased by $476,000, or 32%, from $1,504,000 in 2000. Fees are derived
from the Company's asset management, property management, leasing and
construction supervision services provided to its Hallwood Realty Partners,
L.P. affiliate, a real estate master limited partnership ("HRP") and
various third parties. The increase was due primarily to higher leasing
fees in the 2001 first quarter.
Equity income from investments in HRP represents the Company's
recognition of its pro rata share of net income reported by HRP, adjusted
for the elimination of intercompany income and amortization of negative
goodwill. For the 2001 first quarter, the Company reported equity income of
$685,000 compared to $274,000 in the prior-year period. The increase
resulted principally from gains from property sales by HRP, partially
offset by increased litigation costs. The 2001 first quarter equity income
was exclusive of the Company's $9,000 pro rata share of HRP's extraordinary
loss from early extinguishment of debt and its $40,000 pro rata share of
HRP's loss from cumulative effect of SFAS No. 133 adoption, both of which
are reported separately.
Expenses. Administrative expenses of $527,000 increased by $163,000, or
45%, in the 2001 first quarter, compared to $364,000 in 2000. The increase
was primarily attributable to the payments of commissions to third party
brokers associated with leasing income.
Amortization expense of $168,000 in both the 2001 and 2000 quarters
relate to Hallwood Realty's general partner investment in HRP to the extent
allocated to management rights.
TEXTILE PRODUCTS
The textile products segment reported a loss of $350,000 for the first
quarter of 2001, compared to income of $548,000 in 2000.
Revenue. Sales of $17,777,000 decreased $2,247,000, or 11%, in the 2001
first quarter, compared to $20,024,000 in the 2000 quarter. The sales
decrease was principally in the distribution business as a result of lower
overall demand and the continued trend of U.S. customers moving production
out of the country. The decrease was partially offset by increased revenues
at the dying and finishing and laminating plants, as a result of revenues
from new customers and new production processes.
Expenses. Cost of sales of $15,136,000 decreased $1,708,000, or 10%, in
the 2001 first quarter, from $16,844,000 in the 2000 quarter. The decrease
in cost of sales was principally the result of the decrease in sales. The
lower gross profit margin for the 2001 first quarter (14.9% versus 15.9%)
resulted from the sales decrease in the distribution businesses, which have
higher gross profit margins than the two processing plants with increased
sales. Administrative and selling expenses of $2,689,000 increased by
$319,000, or 13%, in the 2001 first quarter from $2,370,000 for the
comparable 2000 period. The increase resulted from costs incurred in a
brief strike at the dying and finishing plant and the development of new
products and business. Interest expense
Page 21
22
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
of $302,000 increased by $40,000, or 15%, for the 2001 first quarter from
$262,000 in 2000, due to higher interest rates and an increase of
borrowings.
OTHER
The other segment reported a loss of $976,000 for the first quarter of
2001, compared to a loss of $1,240,000 in 2000.
Revenue. Interest on short-term investments and other income decreased
by $2,000 to $5,000 for the 2001 first quarter from $7,000 in 2000.
Expenses. Interest expense in the amount of $746,000 for the 2001 first
quarter decreased by $32,000 from the prior year amount of $778,000. The
decrease was primarily due to the principal amortization on the Senior
Secured Term Loan. Administrative expenses of $235,000 for the 2001 first
quarter decreased by $234,000, from the prior-year amount of $469,000, due
to lower consulting and other professional fees.
INCOME TAXES
Income taxes within continuing operations were $272,000 for the 2001
first quarter of 2001, compared to $250,000 in 2000. The 2001 quarter
included a $200,000 non cash federal deferred charge, a $21,000 federal
current charge and $51,000 for state taxes. The 2000 quarter included a
$170,000 non cash federal deferred charge, a $22,000 federal current charge
and $58,000 for state taxes. The state tax expense is an estimate based
upon taxable income allocated to those states in which the Company does
business at their respective tax rates. The Company recorded a deferred
income tax benefit of $3,586,000 in the 2001 first quarter associated with
its discontinued operations, principally due to the anticipated utilization
of the Company's NOL's from the sale of its investment in Hallwood Energy.
As of March 31, 2001, the Company had approximately $97,000,000 of tax
net operating loss carryforwards ("NOLs") and temporary differences to
reduce future federal income tax liability. Based upon the Company's
expectations and available tax planning strategies, management has
determined that taxable income will more likely than not be sufficient to
utilize approximately $34,741,000 of the NOLs prior to their ultimate
expiration in the year 2011.
Management believes that the Company has certain tax planning
strategies available, which include the planned sale of the Company's
energy investment and the potential sale of certain real estate
investments, that could be implemented, if necessary, to supplement income
from operations to fully realize the net recorded tax benefits before their
expiration. Management has considered such strategies in reaching its
conclusion that, more likely than not, taxable income will be sufficient to
utilize a portion of the NOLs before expiration; however, future levels of
operating income and taxable gains are dependent upon general economic
conditions and other factors beyond the Company's control. Accordingly, no
assurance can be given that sufficient taxable income will be generated for
utilization of the NOLs. Management periodically re-evaluates its tax
planning strategies based upon changes in facts and circumstances and,
accordingly, considers potential adjustments to the valuation allowance of
the deferred tax asset. Although the use of such carryforwards could, under
certain circumstances, be limited, the Company is presently unaware of the
occurrence of any event which would result in such limitations.
DISCONTINUED OPERATIONS - HOTELS
In December 2000, the Company decided to discontinue its hotel
operations and dispose of its hotel segment, principally by allowing its
non-recourse debtholders to assume ownership of the properties through
foreclosures or by selling or otherwise disposing of its hotel properties.
The company's hotel segment consisted of three owned properties and two
leased properties. In accordance with accounting standards for reporting
discontinued operations, hotel operations have been segregated from the
Company's continuing operations and
Page 22
23
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
have been reported as a single line item -- Loss from Discontinued
Operations. Discontinued operations for the three months ended March 31,
2001 and 2000 are presented below:
THREE MONTHS ENDED
MARCH 31,
----------------------
2001 2000
-------- -------
Sales ...................................................... $4,056 $5,032
Expenses
Operating expenses........................................ 3,638 4,254
Interest expense.......................................... 605 712
Loss reserve.............................................. (187) --
Depreciation and amortization............................. -- 725
----- ------
Total expenses........................................ 4,056 5,691
----- ------
Loss from discontinued operations......................... $ -- $ (659)
===== ======
Revenue. Sales of $4,056,000 in the 2001 first quarter decreased by
$976,000, from the year-ago amount of $5,032,000. The decrease was
primarily due to the February 2001 termination of the lease for the
Longboat Key Holiday Inn and Suites hotel in Sarasota, Florida.
Expenses. Operating expenses of $3,638,000 for the 2001 first quarter
were down $616,000 from $4,254,000 in 2000. The decrease is primarily due
to the aforementioned February 2001 lease termination. Interest expense of
$605,000 in the 2001 first quarter decreased by $107,000 from $712,000 in
1999, principally due to principal amortization on the various hotel term
loans and the interest expense associated with capital leases at the three
GuestHouse properties. Depreciation and amortization expense was not
recorded for the 2001 first quarter due to the classification of the hotel
operations as a discontinued operation. The expense for the 2000 first
quarter was $725,000.
The Company anticipates recognition of an extraordinary gain upon final
disposition of these assets.
DISCONTINUED OPERATIONS - ENERGY
In March 2001, the Company agreed to sell its investment in its
Hallwood Energy affiliate, which represented the Company's energy
operations, subject to Hallwood Energy's shareholder approval which was
obtained in May 2001. Accordingly, energy operations segregated from the
Company's continuing operations and have been reported as a single line
item - Income from Discontinued Operations. Operations for the three months
ended March 31, 2001 and 2000 are presented below:
THREE MONTHS ENDED
MARCH 31,
------------------
2001 2000
------- ------
Equity income from investment in Hallwood Energy............... $1,342 $682
Deferred income tax benefit.................................... 3,586 --
------ ----
Income from discontinued operations....................... $4,928 $682
====== ====
The equity income in the 2001 first quarter from investment in Hallwood
Energy of $1,342,000 represents the Company's pro rata share (15%) of
income available to common stockholders, and amortization of negative
goodwill. Hallwood Energy's income increased significantly in the 2001
first quarter, compared to 2000, as a
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
result of higher oil and gas prices and savings associated with the
disposition of certain non-strategic properties and the completion of the
Energy Consolidation.
The Company recorded a deferred income tax benefit of $3,586,000 in the
2001 first quarter, principally due to the anticipated utilization of the
Company's NOL's from the sale of its investment in Hallwood Energy.
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25
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The Company's unrestricted cash and cash equivalents at March 31, 2001
totaled $2,319,000.
As discussed in Note 6, the Company agreed to tender its 1,440,000
shares of common stock in Hallwood Energy to Pure Resources II, Inc.,
pursuant to a tender offer and merger agreement announced on March 30,
2001. The Company received $18,000,000 for the tender of its shares on May
11, 2001 and expects to receive an additional amount of $7,250,000 pursuant
to the terms of a noncompetition agreement, that will be paid by Pure at
the completion of the merger, which is expected to occur by September 2001,
but the timing is uncertain.
Proceeds from the sale of the Hallwood Energy investment are expected
to be used to retire a portion of the Company's outstanding loans payable,
although such amount is uncertain at the present time, and the remainder
will be available for working capital purposes.
During 2000, the Company borrowed a total of $2,500,000 from its
chairman and principal stockholder and an additional $1,500,000 in March
2001. Several factors contributed to the Company's cash flow needs,
including difficulties experienced by the Company's hotel operations and
restrictions on the availability of distributions and payments from
Brookwood. In response to these matters, management decided to discontinue
its hotel operations and entered into an agreement for the sale of its
Hallwood Energy investment in 2001. Management believes that these
strategies will allow the Company to return to profitability with
sufficient liquidity. In addition, the principal stockholder committed to
loan the Company additional funds during the balance of 2001, if required.
Although the Company and Brookwood were in compliance with their
respective loan covenants at December 31, 2000, projections indicated that
the Company and Brookwood may not be able to maintain their cash flow
coverage ratio covenants during 2001. The Company initiated discussions
with its lender and has entered into a loan amendment, which modified the
covenant for the Senior Secured Term Loan. The Company was in compliance
with the modified covenant at March 31, 2001, and management believes that
it will satisfy the new coverage ratio covenant for the remainder of 2001,
based upon currently available projections. Brookwood did not achieve its
coverage ratio for the 2001 first quarter. In April 2001, Brookwood
obtained a waiver of this violation.
The Company's real estate segment generates funds principally from its
property management and leasing activities, without significant additional
capital costs. The Company has pledged 300,397 of its HRP limited
partnership units and the interest in its real estate subsidiaries to
collateralize the Senior Secured Term Loan and the remaining 30,035 HRP
units to secure certain capital leases.
Brookwood maintains a revolving line of credit facility which is
collateralized by accounts receivable, certain inventory and equipment, and
separate acquisition and equipment credit facilities. At March 31, 2001,
Brookwood had $1,178,000 of unused borrowing capacity on its revolving line
of credit. In the year ended December 31, 2000, the Company received a cash
dividend of $400,000 from Brookwood and tax sharing payments of $200,000.
Future cash dividends and tax sharing payments to the parent company are
contingent upon Brookwood's compliance with the covenants contained in the
amended loan agreement.
In February 2000, the Company, through a wholly owned subsidiary,
acquired the assets of a company in a textile products-related industry.
The purchase price was $1,450,000 in cash plus contingent payments of up to
$3,000,000, based on specified levels of earnings over the next four years.
As of March 31, 2001, no contingent amounts were owed.
The Company's hotel segment experienced cash flow difficulties during
2000, due to weaker occupancy and average daily rates at several hotels. In
October 2000, the Company discontinued payments on the first mortgages for
the Greenville and Tulsa GuestHouse Suites Plus hotels and the lease rent
on the Huntsville GuestHouse Suites Plus hotel, and initiated discussions
with the parties regarding loan or lease modifications.
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In December 2000, the Company decided to discontinue its hotel operations
and dispose of its hotel segment principally by allowing its non-recourse
debtholders to assume ownership of the properties through foreclosures or
by selling or otherwise disposing of its hotel properties. The Company
anticipates that in disposing of the hotels, it will not receive any
amounts in excess of the debt outstanding on the properties, but that the
non- recourse debt associated with the properties will be extinguished.
Payments on the three capital leases continue to be made by the Company or
the hotel subsidiaries while operations continue during the disposition
period.
As a result of the receipt of cash proceeds from the sale of its energy
investment, the Company has sufficient liquidity to meet its continuing
obligations.
FORWARD-LOOKING STATEMENTS
In the interest of providing stockholders with certain information
regarding the Company's future plans and operations, certain statements set
forth in this Form 10-Q are forward-looking statements. Although any
forward-looking statement expressed by or on behalf of the Company is, to
the knowledge and in the judgment of the officers and directors, expected
to prove true and come to pass, management is not able to predict the
future with absolute certainty. Forward-looking statements involve known
and unknown risks and uncertainties, which may cause the Company's actual
performance and financial results in future periods to differ materially
from any projection, estimate or forecasted result. Among others, these
risks and uncertainties include, the ability to obtain financing or
refinance maturing debt; a potential oversupply of commercial office
buildings, industrial parks and hotels in the markets served; fees for
leasing, construction and acquisition of real estate properties; lease and
rental rates and occupancy levels obtained; the volatility of oil and gas
prices; the ability to continually replace and expand oil and gas reserves;
and the imprecise process of estimating oil and gas reserves and future
cash flows. These risks and uncertainties are difficult or impossible to
predict accurately and many are beyond the control of the Company. Other
risks and uncertainties may be described, from time to time, in the
Company's periodic reports and filings with the Securities and Exchange
Commission.
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes to the Company's market risks
during the three months ended March 31, 2001.
The Company is exposed to market risk due to fluctuations in interest
rates. The Company utilizes both fixed rate and variable rate debt to
finance its operations. As of March 31, 2001, the Company's total
outstanding loans and debentures payable of $37,957,000 (excluding debt
associated with the discontinued hotel operations) were comprised of
$24,789,000 of fixed rate debt and $13,168,000 of variable rate debt. There
is inherent rollover risk for borrowings as they mature and are renewed at
current market rates. The extent of this risk is not quantifiable or
predictable because of the variability of future interest rates and the
Company's future financing requirements. A hypothetical increase in
interest rates of two percentage points would cause an annual loss in
income and cash flows of approximately $759,000, assuming that outstanding
debt remained at current levels.
The Company's Hallwood Energy affiliate has attempted to hedge the
exposure related to its variable debt and its forecasted oil and natural
gas production in amounts which it believes are prudent based on the prices
of available derivatives and, in the case of production hedges, Hallwood
Energy's deliverable volumes. Hallwood Energy attempts to manage the
exposure to adverse changes in the fair value of its fixed rate debt
agreements by issuing fixed rate debt only when business conditions and
markets are favorable. By hedging only a portion of its market risk
exposures, Hallwood Energy is able to participate in the increased earnings
and cash flows associated with decreases in interest rates and increases in
oil and gas prices; however, it is exposed to risk on the unhedged portion
of its variable debt and oil and gas production.
The Company's real estate division through its investment in HRP will
sometimes use derivative financial instruments to achieve a desired mix of
fixed versus floating rate debt. As of March 31, 2001, HRP had an interest
cap agreement for one of its mortgage loans, which will limit HRP's
exposure to changing interest rates to a maximum of 10%. Management does
not consider the portion attributable to the Company to be significant.
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item
1 Legal Proceedings
Reference is made to Note 10 to the Company's consolidated financial
statements of this Form 10-Q.
2 Changes in Securities None
3 Defaults upon Senior Securities None
4 Submission of Matters to a Vote of Security Holders None
5 Other Information None
6 Exhibits and Reports on Form 8-K
(a) Exhibits
(i) 10.22 - Convertible Unsecured Promissory Note in the amount of $1,500,000,
dated as of March 30, 2001, between Hallwood Investment Company
and Hallwood Investments Limited, filed herewith. Pages 31-39
(ii) 10.23 - Second Amendment to Credit Agreement, by and among HWG, LLC
(Borrower), the Hallwood Group Incorporated (Parent), First Bank &
Trust (Administrative Agent) and the Financial Institutions as parties
hereto (Lenders), dated April 9, 2001, filed herewith Pages 40-44
(b) Reports on Form 8-K None
- ------------------------------------
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29
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
SIGNATURE
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 thereunto duly authorized.
THE HALLWOOD GROUP INCORPORATED
Dated: May 15, 2001 By: /s/ Melvin J. Melle
------------------------------------
Melvin J. Melle, Vice President
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.22 Convertible Unsecured Promissory Note in the amount
of $1,500,000, dated as of March 30, 2001, between
Hallwood Investment Company and Hallwood Investments
Limited.
10.23 Second Amendment to Credit Agreement, by and among
HWG, LLC (Borrower), The Hallwood Group Incorporated
(Parent), First Bank & Trust (Administrative Agent)
and the Financial Institution as parties hereto
(Lenders), dated April 9, 2001.
Page 30