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 JUNE 30, 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 July 31, 2001.
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2
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
<Table>
<Caption>
ITEM NO. PART I -- FINANCIAL INFORMATION PAGE
- -------- ------------------------------- ----
1 Financial Statements (Unaudited):
Consolidated Balance Sheets as of June 30, 2001
and December 31, 2000................................................. 3
Consolidated Statements of Operations for the
Six Months Ended June 30, 2001 and 2000............................... 5
Consolidated Statements of Operations for the
Three Months Ended June 30, 2001 and 2000............................. 7
Consolidated Statements of Changes in Stockholders' Equity for the
Six Months Ended June 30, 2001........................................ 9
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2001 and 2000............................... 10
Notes to Consolidated Financial Statements................................. 11
2 Managements's Discussion and Analysis of
Financial Condition and Results of Operations.............................. 23
3 Quantitative and Qualitative Disclosures about Market Risk.................... 30
PART II -- OTHER INFORMATION
----------------------------
1 thru 6 Exhibits, Reports on Form 8-K and Signature Page.............................. 31
</Table>
Page 2
3
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
ASSETS
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2001 2000
-------- -----------
REAL ESTATE
Investments in HRP .................... $11,801 $ 6,973
Receivables and other assets
Related parties .................... 279 165
Other .............................. 68 268
------- -------
12,148 7,406
TEXTILE PRODUCTS
Inventories ........................... 16,196 16,413
Receivables ........................... 12,783 13,170
Property, plant and equipment, net .... 9,498 9,785
Other ................................. 2,259 2,111
------- -------
40,736 41,479
OTHER
Cash and cash equivalents ............. 12,821 901
Deferred tax asset, net ............... 7,264 5,333
Restricted cash ....................... 954 937
Other ................................. 531 1,424
------- -------
21,570 8,595
------- -------
TOTAL .............................. $74,454 $57,480
======= =======
</Table>
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
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2001 2000
-------- ------------
REAL ESTATE
Accounts payable and accrued expenses ................................. $ 744 $ 777
TEXTILE PRODUCTS
Loans payable ......................................................... 13,372 12,910
Accounts payable and accrued expenses ................................. 6,027 7,195
-------- --------
19,399 20,105
OTHER
Interest, litigation and other accrued expenses ....................... 10,249 3,820
Deferred revenue ...................................................... 7,049 --
10% Collateralized Subordinated Debentures ............................ 6,702 6,725
Convertible loans from stockholder .................................... 4,000 2,500
Senior Secured Term Loan .............................................. -- 15,094
-------- --------
28,000 28,139
DISCONTINUED OPERATIONS
Net liabilities -- Hotels ............................................. 4,672 4,841
Net assets -- Energy .................................................. -- (9,196)
-------- --------
4,672 (4,355)
-------- --------
TOTAL LIABILITIES .................................................. 52,815 44,666
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 ............................................ 54,452 54,416
Accumulated deficit ................................................... (19,135) (27,924)
Treasury stock, 971,360 shares at both dates; at cost ................. (14,918) (14,918)
-------- --------
TOTAL STOCKHOLDERS' EQUITY ......................................... 20,639 11,814
-------- --------
TOTAL .............................................................. $ 74,454 $ 57,480
======== ========
</Table>
See accompanying notes to consolidated financial statements.
Page 4
5
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
SIX MONTHS ENDED
JUNE 30,
----------------------
2001 2000
-------- --------
REAL ESTATE
Fees
Related parties ................................................. $ 3,741 $ 2,859
Other ........................................................... 167 172
Equity income from investments in HRP .............................. 1,168 349
-------- --------
5,076 3,380
Litigation expense ................................................. 2,265 --
Administrative expenses ............................................ 1,038 759
Depreciation and amortization ...................................... 336 336
-------- --------
3,639 1,095
-------- --------
Income from real estate operations .............................. 1,437 2,285
TEXTILE PRODUCTS
Sales .............................................................. 35,711 39,306
Cost of sales ...................................................... 29,875 33,148
Administrative and selling expenses ................................ 5,239 4,776
Interest ........................................................... 570 582
-------- --------
35,684 38,506
-------- --------
Income from textile products operations ......................... 27 800
OTHER
Fees -- amortization of deferred revenue ........................... 201 --
Interest on short-term investments and other income ................ 73 64
-------- --------
274 64
Interest expense ................................................... 1,309 1,547
Administrative expenses ............................................ 819 951
-------- --------
2,128 2,498
-------- --------
Other loss, net ................................................. (1,854) (2,434)
-------- --------
Income (loss) from continuing operations before income taxes .... (390) 651
Income taxes .................................................... 655 315
-------- --------
Income (loss) from continuing operations ........................ (1,045) 336
</Table>
See accompanying notes to consolidated financial statements.
Page 5
6
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
SIX MONTHS ENDED
JUNE 30,
----------------------
2001 2000
-------- --------
Income (loss) from discontinued operations, net of tax
Income from discontinued operations -- Energy ......................... $ 10,734 $ 1,337
Loss from discontinued operations -- Hotels ........................... -- (1,416)
-------- --------
Income (loss) from discontinued operations ......................... 10,734 (79)
Income before extraordinary loss and loss from cumulative effect
of SFAS No. 133 adoption .............................................. 9,689 257
Extraordinary loss from early extinguishment of debt ..................... (810) --
-------- --------
Income before loss from cumulative effect of SFAS No. 133 adoption ....... 8,879 257
Loss from cumulative effect of SFAS No. 133 adoption ..................... (40) --
-------- --------
NET INCOME ................................................................... 8,839 257
Preferred stock dividend ................................................. 50 50
-------- --------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS .................................. $ 8,789 $ 207
======== ========
PER COMMON SHARE
Basic
Income (loss) from continuing operations, after preferred dividend .... $ (0.77) $ 0.20
Income (loss) from discontinued operations ............................ 7.54 (0.05)
Extraordinary loss from early extinguishment of debt .................. (0.57) --
Loss from cumulative effect of SFAS No. 133 adoption .................. (0.03) --
-------- --------
Net income available to common stockholders ........................ $ 6.17 $ 0.15
======== ========
Assuming Dilution
Income (loss) from continuing operations, after preferred dividend .... $ (0.77) $ 0.20
Income (loss) from discontinued operations ............................ 7.54 (0.06)
Extraordinary loss from early extinguishment of debt .................. (0.57) --
Loss from cumulative effect of SFAS No. 133 adoption .................. (0.03) --
-------- --------
Net income available to common stockholders ........................ $ 6.17 $ 0.14
======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic .................................................................... 1,425 1,425
======== ========
Assuming Dilution ........................................................ 1,425 1,434
======== ========
</Table>
See accompanying notes to consolidated financial statements.
Page 6
7
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED
JUNE 30,
----------------------
2001 2000
-------- --------
REAL ESTATE
Fees
Related parties ................................................. $ 1,836 $ 1,460
Other ........................................................... 92 65
Equity income from investments in HRP .............................. 483 76
-------- --------
2,411 1,601
Litigation expense ................................................. 2,265 --
Administrative expenses ............................................ 511 394
Depreciation and amortization ...................................... 168 168
-------- --------
2,944 562
-------- --------
Income (loss) from real estate operations ....................... (533) 1,039
TEXTILE PRODUCTS
Sales .............................................................. 17,934 19,283
Cost of sales ...................................................... 14,739 16,304
Administrative and selling expenses ................................ 2,550 2,406
Interest ........................................................... 268 320
-------- --------
17,557 19,030
-------- --------
Income from textile products operations ......................... 377 253
OTHER
Fees -- amortization of deferred revenue ........................... 201 --
Interest on short-term investments and other income ................ 68 55
-------- --------
269 55
Interest expense ................................................... 563 769
Administrative expenses ............................................ 584 481
-------- --------
1,147 1,250
-------- --------
Other loss, net ................................................. (878) (1,195)
-------- --------
Income (loss) from continuing operations before income taxes .... (1,034) 97
Income taxes .................................................... 383 65
-------- --------
Income (loss) from continuing operations ........................ (1,417) 32
</Table>
See accompanying notes to consolidated financial statements.
Page 7
8
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED
JUNE 30,
--------------------
2001 2000
------- -------
Income (loss) from discontinued operations, net of tax
Income from discontinued operations -- Energy ................ $ 5,806 $ 655
Loss from discontinued operations -- Hotels .................. -- (757)
------- -------
Income (loss) from discontinued operations ................ 5,806 (102)
Income (loss) before extraordinary loss ......................... 4,389 (70)
Extraordinary loss from early extinguishment of debt ............ (801) --
------- -------
NET INCOME (LOSS) ................................................... 3,588 (70)
Preferred stock dividend ........................................ 50 50
------- -------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS .................. $ 3,538 $ (120)
======= =======
PER COMMON SHARE
Basic
Loss from continuing operations, after preferred dividend .... $ (1.03) $ (0.01)
Loss from discontinued operations ............................ 4.07 (0.07)
Extraordinary loss from early extinguishment of debt ......... (0.56) --
------- -------
Net income (loss) available to common stockholders ........ $ 2.48 $ (0.08)
======= =======
Assuming Dilution
Loss from continuing operations, after preferred dividend .... $ (1.03) $ (0.01)
Loss from discontinued operations ............................ 4.07 (0.07)
Extraordinary loss from early extinguishment of debt ......... (0.56) --
------- -------
Net income (loss) available to common stockholders ........ $ 2.48 $ (0.08)
======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ........................................................... 1,425 1,425
======= =======
Assuming Dilution ............................................... 1,425 1,425
======= =======
</Table>
See accompanying notes to consolidated financial statements.
Page 8
9
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TREASURY STOCK TOTAL
------------------ PAID-IN ACCUMULATED COMPREHENSIVE ---------------- STOCKHOLDERS'
SHARES PAR VALUE CAPITAL DEFICIT LOSS SHARES COST EQUITY
------ --------- ---------- ----------- ------------- ------ -------- -------------
BALANCE, JANUARY 1, 2001............. 2,396 $240 $54,416 $(27,924) $ -- 971 $(14,918) $11,814
Net income......................... 8,839 8,839
Preferred stock dividend........... (50) (50)
Pro rata share of stockholders'
equity transactions related to
SFAS No. 133 from equity
investment:
Cumulative effect................ (4,311) (4,311)
Realize upon disposition
of Hallwood Energy............. 36 3,009 3,045
Change in fair value of
derivatives................. 1,302 1,302
----- ---- ------- -------- ------- --- -------- -------
BALANCE, JUNE 30, 2001............... 2,396 $240 $54,452 $(19,135) $ -- 971 $(14,918) $20,639
===== ==== ======= ======== ======= === ======== =======
</Table>
See accompanying notes to consolidated financial statements.
Page 9
10
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
SIX MONTHS ENDED
JUNE 30,
----------------------
2001 2000
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ........................................................ $ 8,839 $ 257
Adjustments to reconcile net income to net cash provided by
operating activities:
Litigation expense ............................................. 2,265 --
Depreciation, depletion and amortization ....................... 1,143 979
Equity in net income of HRP .................................... (1,168) (349)
Extraordinary loss from early extinguishment of debt ........... 810 --
(Increase) decrease in deferred tax asset ...................... (1,931) 170
Amortization of deferred revenue -- noncompetition agreement ... (201) --
Loss from cumulative effect of SFAS No. 133 adoption ........... 40 --
Amortization of deferred gain from debenture exchange .......... (23) (21)
Net change in textile products assets and liabilities .......... (819) (591)
Net change in other assets and liabilities ..................... 248 1,604
Discontinued operations:
Gain from disposition of Hallwood Energy .................... (8,725) --
Equity in net income of Hallwood Energy ..................... (1,837) (1,337)
Decrease in deferred tax asset .............................. 1,793 --
Net change in other hotel assets and liabilities ............ 56 (228)
Depreciation and amortization ............................... -- 1,452
Preferred dividends from Hallwood Energy .................... -- 11
-------- --------
Net cash provided by operating activities ............... 490 1,947
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in textile products property and equipment ............ (413) (623)
Payments for textile products business acquisition ................ -- (1,479)
Discontinued operations:
Proceeds from sale of Hallwood Energy common stock ............. 18,000 --
Proceeds from noncompetition agreement ......................... 7,250 --
Capital expenditures for hotels ................................ -- (616)
Purchase of minority shares in energy affiliate ................ -- (465)
Proceeds from sale of Hallwood Energy preferred stock .......... -- 303
Net change in restricted cash for investing activities ......... -- 79
-------- --------
Net cash provided by (used in) investing activities ..... 24,837 (2,801)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings and loans payable ................... 2,044 2,887
Repayment of bank borrowings and loans payable .................... (15,176) (1,431)
Payment of preferred stock dividend ............................... (50) (50)
Discontinued operations:
Repayment of hotel bank borrowings and loans payable ........... (225) (465)
-------- --------
Net cash provided by (used in) financing activities ..... (13,407) 941
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS ............................. 11,920 87
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ........................ 901 926
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD .............................. $ 12,821 $ 1,013
======== ========
</Table>
See accompanying notes to consolidated financial statements.
Page 10
11
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 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. 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 liabilities (assets) 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)
established 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 had such instruments. Accordingly, the Company was
required to record its pro rata 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 as an adjustment to income its pro rata 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. On a
quarterly basis during 2001, HRP has recorded changes in the estimated fair
value of the cap in interest expense.
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 were designated as
cash flow hedges, changes in the fair value of the derivatives were
recognized in other comprehensive income until the hedged item was
recognized in earnings. Hedge effectiveness was 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, were recognized immediately in
current earnings.
Page 11
12
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 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 period through the
May 11, 2001 sale date, $83,000, representing the ineffective portion of
the Company's proportionate share of the cash flow hedges, was charged
against earnings. The accumulated other comprehensive loss was realized
upon disposition of the Company's investment in Hallwood Energy.
Statement of Financial Accounting Standards No. 141 - Business
Combinations ("SFAS No. 141") is effective July 1, 2001 and prohibits
pooling-of-interests accounting for acquisitions. Statement of Financial
Accounting Standards No. 142 -- Goodwill and Other Intangible Assets ("SFAS
No. 142") is effective January 1, 2002 and specifies that goodwill and some
intangible assets will no longer be amortized but instead will be subject
to periodic impairment testing. The Company has not yet determined the
effect adopting SFAS No. 142 will have on its financial statements.
Other Comprehensive Loss. The components of other comprehensive loss
for the three and six months ended June 30, 2001 are shown as follows (in
thousands):
<Table>
<Caption>
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, 2001 JUNE 30, 2001
---------------- ------------------
Pro rata share of other comprehensive loss
from discontinued operations -- energy:
Accumulated other comprehensive loss, beginning
of period .............................................. $ -- $(3,009)
Cumulative effect of SFAS No. 133 adoption ............. (4,311) --
Realize upon disposition of energy investment .......... 3,009 3,009
Change in fair value of derivatives from settlement .... 1,302 --
------- -------
Accumulated other comprehensive loss, end of period ........ $ -- $ --
======= =======
</Table>
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)
<Table>
<Caption>
AS OF JUNE 30, 2001 AMOUNT AT INCOME FROM INVESTMENTS
--------------------- WHICH CARRIED AT FOR THE SIX MONTHS ENDED
COST OR ------------------------ JUNE 30,
NUMBER OF ASCRIBED JUNE 30, DECEMBER 31, ------------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 2001 2000 2001 2000
------------------------- -------- -------- -------- ----------- -------- --------
HALLWOOD REALTY PARTNERS, L.P.
- -- General partner interest ....... -- $ 8,650 $ 2,260 $ 2,529 $ 66 $ 26
- -- Limited partner interest ....... 330,432 8,799 9,541 4,444 1,102 323
-------- -------- -------- -------- --------
Totals ......................... $ 17,449 $ 11,801 $ 6,973 $ 1,168 $ 349
======== ======== ======== ======== ========
</Table>
At June 30, 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. The Company's
share of the underlying equity in net assets of HRP exceeded its investment
by $4,849,000, which is being amortized 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 partners' 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 June 30, 2001, resulted in a $1,871,000 decrease in the carrying
value of the HRP investment.
Page 12
13
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
As further discussed in Note 10, the Delaware Court of Chancery
rendered its opinion regarding certain litigation involving the
Company in July 2001. The court determined that the defendants,
including the Company, should pay to HRP a judgment of $3,417,000 plus
pre-judgment interest of approximately $2,893,000 from August 1995.
Accordingly, the Company has accrued the obligation as of June 30,
2001. The judgment amount, which represented the court's determination
of an underpayment by the Company for certain limited partnership
units purchased by the Company in 1995 from HRP, was considered
additional purchase price and was added to the Company's investment in
the limited partnership units. The interest component of the judgment
has been recorded as an expense, net of the Company's pro-rata share
of the income that will be reported by HRP when the judgment is paid.
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 six months ended June 30, 2001 and 2000 such amortization was
$336,000 in each period.
The Company has pledged 30,035 HRP limited partner units to secure
certain capital leases.
The quoted market price and the Company's carrying value per limited
partner unit (AMEX symbol HRY) at June 30, 2001 were $56.00 and
$28.88, 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):
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2001 2000
------- ------------
Textile Products
Revolving credit facility, prime + .25% or
Libor + 3.00%, due December 2002.................................... $11,480 $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 .................................... 892 973
------- -------
13,372 12,910
Other
Convertible loans from stockholder, 10% fixed, due at various
dates from March 2005 to March 2006 ................................ 4,000 2,500
Senior Secured Term Loan, 10.25% fixed, repaid May 2001 ................ -- 15,094
------- -------
4,000 17,594
------- -------
Total .............................................................. $17,372 $30,504
======= =======
</Table>
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 June 30, 2001, Brookwood had an additional $570,000 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
Page 13
14
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
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 (7.00% at June 30, 2001) or Libor plus 3.00%
(6.87% at June 30, 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 and obtained a
waiver in April 2001. Brookwood was in compliance with its coverage ratio
covenant for the 2001 second quarter.
Acquisition Credit Facility. The Key Credit Agreement includes 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 (7.75% at
June 30, 2001) or Libor plus 3.25% (7.12% at June 30, 2001).
Equipment Credit Facility. The Key Credit Agreement includes 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% (6.62% at June 30, 2001).
The outstanding balance of the combined Key Bank credit facilities at
June 30, 2001 was $13,372,000.
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 bore interest at
a fixed rate of 10.25%, was scheduled to mature in December 2004, was fully
amortizing and required a monthly payment of $385,000. Collateral was
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 contained 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 Senior Secured
Term Loan was fully repaid in May 2001 with a portion of the proceeds from
the sale of the Company's investment in Hallwood Energy.
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 loan agreements with an entity associated with
its chairman and principal stockholder, Anthony J. Gumbiner, as indicated
below.
<Table>
<Caption>
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
==========
</Table>
Page 14
15
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
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 (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% 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 former 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):
<Table>
<Caption>
JUNE 30, DECEMBER 31,
DESCRIPTION 2001 2000
----------- -------- ------------
10% Debentures (face amount) .............. $6,468 $6,468
Unamortized gain from exchange, net of
accumulated amortization ............... 234 257
------ ------
Totals .............................. $6,702 $6,725
====== ======
</Table>
As a result of certain hotel properties of the Company being placed
into receivership, as further discussed in Note 5, the Company determined
that a technical default occurred under the terms of the Indenture for the
10% Debentures. The Indenture provides that upon the occurrence of the
default, the principal and accrued interest on the 10% Debentures shall
automatically become due and payable. The trustee for the 10% Debentures,
mailed a notice (the "Notice") to debentureholders on July 27, 2001,
informing the holders of the default. The Notice stated that the holders of
a majority of the outstanding principal amount of the 10% Debentures, on
behalf of all holders, may waive the default. If the default is waived, and
the Company has deposited sufficient funds to pay overdue interest and
other costs, then the majority holders may rescind and annul the
declaration of acceleration and its consequences. The Company intends to
solicit such a waiver from the debentureholders. There can be no assurance
that a waiver will be obtained however.
5. DISCONTINUED OPERATIONS -- HOTELS
The Company's hotel segment experienced cash flow difficulties during
2000 due to weaker occupancy and average daily rates. In December 2000, the
Company decided to discontinue 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. As part of the planned disposition,
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.
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
Page 15
16
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
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):
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2001 2000
-------- ------------
Loans payable ........................................... $ 29,333 $ 29,350
Accounts payable and accrued expenses ................... 2,480 3,140
Capital leases .......................................... 1,566 1,774
Properties, net ......................................... (25,212) (25,783)
Receivables and other assets ............................ (1,599) (1,639)
Restricted cash ......................................... (596) (701)
Deferred tax asset ...................................... (1,300) (1,300)
-------- --------
Net liabilities of discontinued hotel operations .... $ 4,672 $ 4,841
======== ========
</Table>
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2001 2000 2001 2000
-------- -------- -------- --------
Sales .................................................. $ 2,779 $ 4,946 $ 6,834 $ 9,978
Expenses
Operating expenses ................................ 2,255 4,294 5,893 8,548
Interest expense .................................. 690 670 1,295 1,381
Reduction in loss reserve ......................... (166) -- (354) --
Depreciation and amortization ..................... -- 739 -- 1,465
-------- -------- -------- --------
Total expenses ................................ 2,779 5,703 6,834 11,394
-------- -------- -------- --------
Loss from discontinued hotel operations............ $ -- $ (757) $ -- $ (1,416)
======== ======== ======== ========
</Table>
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 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.
A summary of the non-recourse loans payable is detailed below (in
thousands):
<Table>
<Caption>
JUNE 30, 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..... 6,514 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................................... $29,333 $29,350
======= =======
</Table>
Page 16
17
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
As previously discussed, certain of the Company's subsidiaries are in
default on each of these term loans and foreclosure 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 $1,682,000 at June 30,
2001. The combined monthly lease payments are $46,570 and are current
through July 2001. The leases commenced January 2000 and expire December
2004, bear an effective interest rate of 12.18% and have an outstanding
balance of $1,566,000 and $1,774,000 at June 30, 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., agreed to 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 was 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. The Company received $18,000,000 for the
tender of its 1,440,000 shares of common stock on May 11, 2001 and received
an additional amount of $7,250,000, pursuant to the terms of a
noncompetition agreement that was paid by Pure upon the completion of the
merger in June 2001.
Under the noncompetition agreement, the Company agreed to refrain from
taking certain actions (described below) without the prior written consent
of Pure and Hallwood Energy. These covenants were 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 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 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 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.
Page 17
18
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
A summary of the net assets, as of the balance sheet dates, and income
from discontinued energy operations, are detailed below (in thousands):
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2001 2000
-------- ------------
Investment in Hallwood Energy ....................... $ -- (7,403)
Deferred tax asset .................................. -- (1,793)
------- -------
Net assets of discontinued energy operations .... $ -- $(9,196)
======= =======
</Table>
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
DESCRIPTION 2001 2000 2001 2000
----------- -------- -------- -------- --------
Gain from disposition of investment in Hallwood Energy .... $ 8,725 $ -- $ 8,725 $ --
Equity income from investment in Hallwood Energy .......... 495 655 1,837 1,337
Deferred income tax benefit (expense) ..................... (2,914) -- 672 --
Current income tax (expense) .............................. (500) -- (500) --
-------- -------- -------- --------
Income from discontinued energy operations ............ $ 5,806 $ 655 $ 10,734 $ 1,337
======== ======== ======== ========
</Table>
The Company began amortizing the deferred revenue from the
noncompetition agreement in the amount of $7,250,000, over a three-year
period commencing June 1, 2001. The amortization is being reported as fee
income in the "Other" section of the statement of operations.
Prior to the disposition of its common stock interest in Hallwood
Energy, the Company accounted for its investment using the equity method of
accounting, as the Company exercised 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
by $4,391,000, which was being amortized at a rate which approximated 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 recorded its pro-rata share
of any capital transactions.
Page 18
19
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
7. INCOME TAXES
The following is a summary of the income tax expense (benefit) for
both continuing operations and discounted operations (in thousands):
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -----------------
2001 2000 2001 2000
------ ------ ------ ------
Federal
Deferred tax (benefit) .... $3,248 $ -- $ (138) $ 170
Current tax ............... 366 5 387 27
------ ------ ------ ------
Sub-total ............. 3,614 5 249 197
State .......................... 183 60 234 118
------ ------ ------ ------
Total ................. $3,797 $ 65 $ 483 $ 315
====== ====== ====== ======
</Table>
Income tax expense (benefit) from continuing operations and
discontinued operations are as follows:
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -----------------
2001 2000 2001 2000
------ ------ ------ ------
Continuing operations .......... $ 383 $ 65 $ 655 $ 315
Discontinued operations ........ 3,414 -- (172) --
------ ------ ------ ------
Total ................. $3,797 $ 65 $ 483 $ 315
====== ====== ====== ======
</Table>
The amount of the deferred tax asset (net of valuation allowance) for
the Company's continuing operations was $7,264,000 at June 30, 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
$1,300,000 associated with its discontinued hotel operations as of June 30,
2001, principally due to the anticipated utilization of the Company's NOLs
from the disposition of certain hotel properties.
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 19
20
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
8. SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
SIX MONTHS ENDED
JUNE 30,
--------------------
DESCRIPTION 2001 2000
----------- ------- -------
Supplemental schedule of non-cash investing and
financing activities:
Pro rata share of stockholders' equity
transactions related to SFAS No. 133
of equity investment:
Cumulative effect .............................. $(4,311) --
Realize upon disposition of Hallwood Energy .... 3,009
Change in fair value of derivatives ............ 1,302 --
------- -------
Accumulated other comprehensive loss ........... $ -- --
======= =======
Other
HRP ............................................ $ -- $ 291
Hallwood Energy ................................ 36 84
Supplemental disclosures of cash payments:
Interest paid ...................................... $ 1,877 $ 3,273
Income taxes paid .................................. 537 185
</Table>
9. COMPUTATION OF EARNINGS PER SHARE
The following table reconciles the Company's income (loss) from
continuing operations to income (loss) 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):
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
DESCRIPTION 2001 2000 2001 2000
----------- ------- ------- ------- -------
INCOME AVAILABLE TO COMMON STOCKHOLDERS
Income (loss) from continuing operations ........... $(1,417) $ 32 $(1,045) $ 336
Less preferred stock dividend ...................... (50) (50) (50) (50)
------- ------- ------- -------
Income (loss) from continuing operations ........... $(1,467) $ (18) $(1,095) $ 286
======= ======= ======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic .............................................. 1,425 1,425 1,425 1,425
Assumed issuance of shares from exercise of
stock options ................................. -- -- -- 54
Assumed repurchase of shares from stock options
proceeds ....................................... -- -- -- (45)
------- ------- ------- -------
Assuming dilution .................................. 1,425 1,425 1,425 1,434
======= ======= ======= =======
</Table>
The impact of the convertible loans from stockholder was anti-dilutive
for the three month and six month periods ended June 30, 2001, due to the
loss from continuing operations.
Page 20
21
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
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
defendants 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 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. On July 18, 2001, the
Delaware Court of Chancery rendered its opinion. In its decision, the court
determined that an option plan and a sale of units to Hallwood in
connection with a reverse unit split implemented by HRP in 1995 were in
compliance with HRP's partnership agreement. The court also found that the
sale of units to Hallwood in connection with a 1995 odd-lot offer by HRP
did not comply with certain procedures required by the HRP partnership
agreement. The court ruled that the defendants other than HRP pay a
judgment in the amount of $3,417,000, plus pre-judgment interest of
approximately $2,893,000 from August 1995 to HRP. The amount represents
what the court determined was an underpayment by Hallwood. The court's
judgment is not final until all rehearings and appeals have been exhausted.
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 CV1115)
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 sought 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. Both parties have filed briefs with the Second Circuit, but the
oral argument has not been scheduled.
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 trial was held
on June 25, 2001 in the Delaware Court of Chancery. The court requested
post-trial briefings, which are scheduled to be completed in August 2001.
Management is not able to predict the outcome of the litigation.
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
Page 21
22
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
contingent obligation in the amount of $3,054,000 at June 30, 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 $199,000 and $205,000
for the six months ended June 30, 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.
11. SEGMENT AND RELATED INFORMATION
The following represents the Company's reportable segment operations
for the six months ended June 30, 2001 and 2000, respectively (in
thousands):
<Table>
<Caption>
REAL TEXTILE DISCONTINUED CONSOL-
ESTATE PRODUCTS OTHER OPERATIONS IDATED
-------- -------- -------- ------------ --------
SIX MONTHS ENDED JUNE 30, 2001
Total revenue from external sources .... $ 5,076 $ 35,711 $ 274 $ 41,061
======== ======== ======== ========
Operating income ....................... $ 1,437 $ 27 $ 1,464
======== ========
Unallocable expenses, net .............. $ (1,854) (1,854)
======== --------
Loss from continuing operations
before income taxes ................ $ (390)
========
Income from discontinued operations .... $ 10,734 $ 10,734
======== ========
SIX MONTHS ENDED JUNE 30, 2000
Total revenue from external sources .... $ 3,380 $ 39,306 $ 64 $ 42,750
======== ======== ======== ========
Operating income ....................... $ 2,285 $ 800 $ 3,085
======== ========
Unallocable expenses, net .............. $ (2,434) (2,434)
======== --------
Income from continuing operations
before income taxes ................ $ 651
========
Loss from discontinued operations ...... $ (79) $ (79)
======== ========
</Table>
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 completed the sale of its Hallwood Energy
investment during 2001. Management believes that these strategies 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.
Page 22
23
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 $3,588,000 for the second quarter
ended June 30, 2001, compared to a net loss of $70,000 in 2000. Revenue
from continuing operations for the 2001 second quarter was $20,614,000,
compared to $20,939,000 in 2000. Net income and revenue from continuing
operations for the six months was $8,839,000 and $41,061,000, compared to
$257,000 and $42,750,000 in 2000, respectively.
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 a loss of $533,000 for the second
quarter and income of $1,437,000 for the six month period of 2001, compared
to income of $1,039,000 and $2,285,000 in 2000, respectively.
Revenues. Fee income of $1,928,000 for the 2001 second quarter
increased by $403,000, or 26%, from $1,525,000 in 2000. Fee income of
$3,908,000 for the six months increased by $877,000, or 29%, from
$3,031,000 for similar period 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 periods.
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 second quarter, the Company reported equity income
of $483,000, compared to $76,000 in 2000. For the six months, income was
$1,168,000, compared to $349,000 in 2000. The increases resulted
principally from gains from property sales by HRP, partially offset by
increased litigation costs. Litigation costs decreased in the 2001 second
quarter due to the conclusion of the trial discussed below. The 2001 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. Litigation expense of $2,265,000 was recorded in the 2001
second quarter. As further discussed in Note 10, the Delaware Court of
Chancery rendered its opinion regarding certain litigation involving the
Company in July 2001. The court determined that the defendants, including
the Company, should pay to HRP a judgment of $3,417,000 plus pre-judgment
interest of approximately $2,893,000. Accordingly, the Company has accrued
the obligation as of June 30, 2001. The judgment amount, which represented
the court's determination of an underpayment by the Company for certain
limited partnership units purchased by the Company in 1995 from HRP, was
considered additional purchase price and was added to the Company's
investment in the limited partnership units. The interest component of the
judgment has been recorded as an expense, net of the Company's pro-rata
share of the income that will be reported by HRP when the judgment is paid.
Administrative expenses of $511,000 increased by $117,000, or 30%, in
the 2001 second quarter, compared to $394,000 in 2000. For the six months,
the increase was $279,000 to $1,038,000, from $759,000 in 2000. The
increases were primarily attributable to the payments of commissions to
third party brokers associated with leasing income.
Amortization expense of $168,000 for the second quarter, and $336,000
for the six months in both the 2001 and 2000 periods relate to the
Company's general partner investment in HRP to the extent allocated to
management rights.
Page 23
24
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
TEXTILE PRODUCTS
The textile products segment reported income of $377,000 and $27,000
for the second quarter and six month periods of 2001, compared to income of
$253,000 and $800,000 in 2000, respectively.
Revenue. Sales of $17,934,000 decreased $1,349,000, or 7%, in the 2001
second quarter, compared to $19,283,000 in the 2000 quarter. The
comparative six month sales decreased by $3,595,000, or 9%, to $35,711,000
from $39,306,000 in the 2000 period. The sales decreases were 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
decreases were partially offset by increased revenues from new customers
and new production processes.
Expenses. Cost of sales of $14,739,000 decreased $1,565,000, or 10%,
in the 2001 second quarter, from $16,304,000 in the 2000 quarter. The
comparative six month cost of sales of $29,875,000 decreased by $3,273,000,
or 10%, compared to $33,148,000 in 2000. The decreases in cost of sales
were principally the result of the decreases in sales. The higher gross
profit margin for the 2001 second quarter (17.8% versus 15.4%) and the six
month periods (16.3% versus 15.7%) resulted from higher margin sales to new
customers and from new production processes.
Administrative and selling expenses of $2,550,000 increased by
$144,000, or 6%, in the 2001 second quarter from $2,406,000 for the
comparable 2000 period. The six month amount of $5,239,000 increased by
$463,000, or 10%, from $4,776,000 for the comparable 2000 period. The
increases resulted from costs incurred in a brief strike at the dying and
finishing plant and the development of new products and business.
Interest expense of $268,000 decreased by $52,000, or 16%, for the
2001 second quarter from $320,000 in 2000, due to lower interest rates. The
six month amount of $570,000 decreased by $12,000, from $582,000 for the
comparable 2000 period.
OTHER
The other segment reported a loss of $878,000 and $1,854,000 for the
second quarter and six month periods of 2001, compared to a loss of
$1,195,000 and $2,434,000 in 2000, respectively.
Revenue. Fee revenue of $201,000 in the 2001 second quarter and six
month periods is attributable to the amortization of deferred revenue of
$7,250,000 from the noncompetition agreement entered into by the Company in
connection with the sale of its Hallwood Energy investment. It is being
amortized over a three-year period commencing June 1, 2001.
Interest on short-term investments and other income increased by
$13,000 to $68,000 for the 2001 second quarter from $55,000 in 2000. For
the six months, the amounts increased by $9,000 to $73,000 from $64,000.
The increases were attributable to increased interest income on invested
funds from the sale of Hallwood Energy. The 2000 second quarter included a
gain of $50,000 on the sale of a miscellaneous investment.
Expenses. Interest expense in the amount of $563,000 for the 2001
second quarter decreased by $206,000 from the prior year amount of
$769,000. For the six months, interest expense decreased by $238,000 to
$1,309,000 from $1,547,000 in 2000. The decreases were primarily due to the
principal amortization on the Senior Secured Term Loan and its payoff on
May 15, 2001 with a portion of the proceeds from the sale of Hallwood
Energy.
Administrative expenses of $584,000 for the 2001 second quarter
increased by $103,000, from the prior-year amount of $481,000. For the six
months, administrative expenses decreased by $132,000 to $819,000 from
$951,000 in 2000. The fluctuations are primarily attributable to consulting
and other professional fees.
Page 24
25
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INCOME TAXES
Income taxes from continuing operations was an expense of $383,000 for
the 2001 second quarter, compared to an expense of $65,000 in 2000. The
2001 second quarter included a $334,000 non cash federal deferred benefit,
a $34,000 federal current benefit and $83,000 for state taxes. The 2000
quarter included a $5,000 federal current charge and $60,000 for state
taxes. Income taxes were $655,000 for the 2001 six months period, compared
to expense of $315,000 in 2000. 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 an expense of $3,414,000 in the 2001 second
quarter, including a deferred income tax charge of $2,914,000, a federal
current charge of $400,000 and $100,000 for state taxes associated with its
discontinued operations, principally due to the utilization of the
Company's NOL's from the sale of its investment in Hallwood Energy. For the
six months, the Company recorded a net tax benefit of $172,000, including a
deferred income tax benefit was $672,000, a federal current expense of
$400,000 and current state tax was $100,000.
As of June 30, 2001, the Company had approximately $75,000,000 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 $25,189,000 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 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.
Page 25
26
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 have been reported as a single line
item -- Loss from Discontinued Operations. Discontinued operations for the
three months and six months ended June 30, 2001 and 2000 are presented
below:
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
DESCRIPTION 2001 2000 2001 2000
----------- -------- -------- -------- --------
Sales .......................................... $ 2,779 $ 4,946 $ 6,834 $ 9,978
Expenses
Operating expenses ......................... 2,255 4,294 5,893 8,548
Interest expense ........................... 690 670 1,295 1,381
Reduction in loss reserve .................. (166) -- (354) --
Depreciation and amortization .............. -- 739 -- 1,465
-------- -------- -------- --------
Total expenses ......................... 2,779 5,703 6,834 11,394
-------- -------- -------- --------
Loss from discontinued hotel operations .... $ -- $ (757) $ -- $ (1,416)
======== ======== ======== ========
</Table>
Revenue. Sales of $2,779,000 in the 2001 second quarter decreased by
$2,167,000, from the year-ago amount of $4,946,000. For the six months, the
decrease was $3,144,000 to $6,834,000, compared to $9,978,000 in 2000. The
decreases were 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 $2,255,000 for the 2001 second quarter
were down $2,039,000 from $4,294,000 in 2000. For the six months, operating
expenses decreased by $2,655,000 to $5,893,000 from $8,548,000 in 2000. The
decreases were primarily due to the aforementioned February 2001 lease
termination. Interest expense of $690,000 in the 2001 second quarter and
$1,295,000 for the six months are comparable to the 2000 amounts of
$670,000 and $1,381,000, respectively. Receivers have been appointed for
the three hotels owned by the Company, although foreclosures and/or
dispositions have not yet been completed for any of the properties.
Depreciation and amortization expense was not recorded for the 2001 periods
due to the classification of the hotel operations as a discontinued
operation. The expense for the 2000 second quarter and six month periods
were $739,000 and $1,465,000, respectively.
During calendar 2001, the Company anticipates the recording of
extraordinary gain from debt extinguishment as hotel dispositions are
completed. Operating losses at the hotels during 2001 have not been
recognized, as these operating losses will be offset by the anticipated
disposition gains. The operating losses will be recognized when the gains
are realized.
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, to Pure Resources II, an indirect subsidiary of Pure Resources,
Inc., subject to Hallwood Energy's shareholder approval which was obtained
in May 2001. Accordingly, energy operations have been segregated from the
Company's continuing operations and reported as a single
Page 26
27
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
line item -- Income from Discontinued Operations. Operations for the three
months and six months ended June 30, 2001 and 2000 are presented below:
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
DESCRIPTION 2001 2000 2001 2000
----------- -------- -------- -------- --------
Gain from disposition of investment in Hallwood Energy .... $ 8,725 $ -- $ 8,725 $ --
Equity income from investment in Hallwood Energy .......... 495 655 1,837 1,337
Deferred income tax benefit (expense) ..................... (2,914) -- 672 --
Current income tax expense ................................ (500) -- (500) --
-------- -------- -------- --------
Income from discontinued energy operations ............ $ 5,806 $ 655 $ 10,734 $ 1,337
======== ======== ======== ========
</Table>
The Company received $18,000,000 for the tender of its 1,440,000
shares of common stock of Hallwood Energy on May 11, 2001 and received an
additional amount of $7,250,000 pursuant to the terms of a noncompetition
agreement, that was paid by Pure upon the completion of the merger in June
2001. The Company began amortizing the deferred revenue of $7,250,000 from
the noncompetition agreement over a three-year period commencing June 1,
2001. The amortization is reported as fee income in the "Other" section of
the statement of operations.
The equity income in the 2001 first quarter from investment in
Hallwood Energy 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 periods,
compared to 2000, as a 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 2001 amounts reflect earnings
through the sale date of May 11, 2001.
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. In
the 2001 second quarter, the Company recorded a deferred tax expense of
$2,914,000, current federal tax expense of $400,000 and state taxes of
$100,000, at the consummation of the sale.
EXTRAORDINARY LOSS FROM EARLY EXTINGUISHMENT OF DEBT
In the 2001 second quarter, the Company recognized an extraordinary
loss from early extinguishment of debt of $801,000, from the write off of
the unamortized deferred loan costs associated with the repayment of the
Senior Secured Term Loan.
The loss of $9,000 in the 2001 first quarter resulted from the
recognition of the Company's pro rata share of an extraordinary loss from
early extinguishment of debt reported by HRP.
Page 27
28
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 June 30, 2001
totaled $12,821,000.
As discussed in Note 6, the Company tendered its 1,440,000 shares of
common stock in Hallwood Energy, 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 received an additional
$7,250,000, pursuant to the terms of a noncompetition agreement upon
completion of the merger in June 2001.
The Senior Secured Term Loan, with a remaining balance of $14,059,000,
was fully repaid in May 2001 with a portion of the proceeds from the sale
of the Hallwood Energy investment.
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 tax sharing payments
from Brookwood. In response to these matters, management decided to
discontinue its hotel operations in December 2000 and sold its Hallwood
Energy investment in May 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.
As a result of certain hotel properties of the Company being placed
into receivership, the Company determined that a technical default occurred
under the terms of the Indenture for the 10% Debentures. The Indenture
provides that upon the occurrence of the default, the principal and accrued
interest on the 10% Debentures shall automatically become due and payable.
The trustee for the 10% Debentures, mailed a notice (the "Notice") to
debentureholders on July 27, 2001, informing the holders of the default.
The Notice stated that the holders of a majority of the outstanding
principal amount of the 10% Debentures, on behalf of all holders, may waive
the default. If the default is waived and the Company has deposited
sufficient funds to pay overdue interest and other costs, then the majority
holders may rescind and annul the declaration of acceleration and its
consequences. The Company intends to solicit such a waiver from the
debentureholders. There can be no assurance that a waiver will be obtained
however. See also Note 5.
In July 2001, the Delaware Court of Chancery rendered its opinion
regarding certain litigation involving the Company. The court determined
that the defendants, including the Company, should pay to HRP a judgment of
$3,417,000 plus pre-judgment interest of approximately $2,893,000.
Accordingly, the Company has accrued this obligation as of June 30, 2001.
The court's judgment is not final until all rehearings and appeals have
been exhausted.
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 30,035 of its HRP limited
partnership units to secure certain capital leases. 330,432 HRP units, and
the Company's real estate subsidiaries are unencumbered and are available
to serve as collateral for any new credit facilities.
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 June 30, 2001,
Brookwood had $570,000 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.
Page 28
29
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Although Brookwood was in compliance with its loan covenants at
December 31, 2000, projections indicated that Brookwood may not be able to
maintain its cash flow coverage ratio covenant during 2001. Brookwood did
not achieve its coverage ratio for the 2001 first quarter. In April 2001,
Brookwood obtained a waiver of this violation. Brookwood was in compliance
with its coverage ratio covenant for the 2001 second quarter.
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 June 30, 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. 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
Hallwood Energy investment and its ability to obtain new credit facilities,
the Company believes it 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 and industrial parks in the markets served; fees for leasing,
construction and acquisition of real estate properties; lease and rental
rates and occupancy levels obtained; the ability to compete successfully
with foreign textile production and the ability to generate new products
and market new and existing products. 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.
Page 29
30
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 June 30, 2001, other than the elimination of
market risks associated with its former Hallwood Energy affiliate.
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 June 30, 2001, the Company's total
outstanding loans and debentures payable of $23,840,000 (excluding debt
associated with the discontinued hotel operations) were comprised of
$10,468,000 of fixed rate debt and $13,372,000 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 $477,000, assuming that outstanding
debt remained at current levels.
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 June 30, 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.
Page 30
31
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 included within this Form 10-Q.
2 Changes in Securities None
3 Defaults upon Senior Securities
(i) Certain of the Company's hotel subsidiaries are in default on
term loans associated with the respective hotel properties and
foreclosure proceedings have been initiated by the lenders.
(ii) As a result of the aforementioned hotel properties being placed
into receivership, a technical default occurred under the terms
of the Indenture for the 10% Debentures.
4 Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Stockholders held on May 17, 2001,
stockholders voted on two proposals:
(i) To elect two directors, one of which is to hold office for one
year and one of which is to hold office for three years and until
a successor is elected and qualified:
<Table>
<Caption>
Nominee Director Votes For Against Term of Office
---------------- --------- ------- --------------
Charles A. Crocco, Jr. 1,390,226 5,974 one year
J. Thomas Talbot 1,389,726 6,474 three years
</Table>
(ii) To amend the 1995 stock option plan:
<Table>
<Caption>
Votes For Against Abstain
--------- ------- -------
1,362,836 29,164 4,200
</Table>
5 Other Information None
6 Exhibits and Reports on Form 8-K
(a) Exhibits
(i) 10.24 -- Letter from Trustee, dated July 27, 2001, regarding
Notice of Declaration of Acceleration Due to Event
of Default to Holders of the 10% Collateralized
Subordinated Debentures, filed herewith
(b) Reports on Form 8-K
(i) Dated July 25, 2001 -- Disclosure of judicial decision in
Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., et
al (c.a. No. 15754)
(ii) Dated July 27, 2001 -- Disclosure of technical default
regarding 10% Collateralized Subordinated Debentures,
including Trustee's Notice to Debentureholders dated
July 27, 2001.
Page 31
32
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: August 13, 2001 By: /s/ Melvin J. Melle
------------------------------
Melvin J. Melle, Vice President
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
Page 32
33
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
INDEX TO EXHIBITS
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
10.24 Letter from Trustee, dated July 27, 2001, regarding Notice of
Declaration of Acceleration Due to Event of Default to Holders of the
Company's 10% Collateralized Subordinated Debentures
</Table>
Page 33