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 SEPTEMBER 30, 1998 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 [ ]
1,254,751 shares of Common Stock, $.10 par value per share, were
outstanding at October 31, 1998.
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2
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
ITEM NO. PART I - FINANCIAL INFORMATION PAGE
-------- ------------------------------ ----
1 Financial Statements:
Consolidated Balance Sheets as of September 30, 1998
and December 31, 1997 . . . . . . . . . . . . . . . . . . 3-4
Consolidated Statements of Operations for the
Nine Months Ended September 30, 1998 and 1997 . . . . . . 5-6
Consolidated Statements of Operations for the
Three Months Ended September 30, 1998 and 1997 . . . . . . 7-8
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1998 and 1997 . . . . . . 9
Notes to Consolidated Financial Statements . . . . . . . . . 10-16
2 Managements's Discussion and Analysis of
Financial Condition and Results of Operations . . . . . . 17-24
PART II - OTHER INFORMATION
---------------------------
1 thru 6 Exhibits, Reports on Form 8-K and Signature Page . . . . . . 25-26
Page 2
3
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- -------------
ASSET MANAGEMENT (unaudited)
REAL ESTATE
Investments in HRP ........................ $ 7,569 $ 7,197
Receivables and other assets .............. 619 1,063
------------- -------------
8,188 8,260
ENERGY
Oil and gas properties, net ............... 10,242 9,589
Current assets of HEP ..................... 2,815 2,657
Noncurrent assets of HEP .................. 1,451 1,859
Receivables and other assets .............. 59 434
------------- -------------
14,567 14,539
------------- -------------
Total asset management assets ......... 22,755 22,799
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Inventories ............................... 15,987 17,935
Receivables ............................... 13,119 14,296
Property, plant and equipment, net ........ 8,614 9,057
Other ..................................... 866 938
------------- -------------
38,586 42,226
HOTELS
Properties, net ........................... 32,357 14,168
Receivables and other assets .............. 4,414 1,742
------------- -------------
36,771 15,910
------------- -------------
Total operating subsidiaries assets ... 75,357 58,136
OTHER
Deferred tax asset, net ................... 2,040 2,040
Cash and cash equivalents ................. 1,337 4,737
Other ..................................... 844 1,557
Restricted cash ........................... 759 489
------------- -------------
Total other assets .................... 4,980 8,823
------------- -------------
TOTAL ................................. $ 103,092 $ 89,758
============= =============
Page 3
4
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------------- --------------
ASSET MANAGEMENT (unaudited)
REAL ESTATE
Accounts payable and accrued expenses .............................. $ 735 $ 1,295
Loan payable ....................................................... 500 500
-------------- --------------
1,235 1,795
ENERGY
Long-term obligations of HEP ....................................... 4,670 4,731
Current liabilities of HEP ......................................... 3,380 2,793
Loan payable ....................................................... 2,667 3,867
Accounts payable and accrued expenses .............................. 595 548
-------------- --------------
11,312 11,939
-------------- --------------
Total asset management liabilities ............................. 12,547 13,734
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Loan payable ....................................................... 10,200 13,800
Accounts payable and accrued expenses .............................. 7,882 7,771
-------------- --------------
18,082 21,571
HOTELS
Loans payable ...................................................... 30,457 12,019
Accounts payable and accrued expenses .............................. 2,007 1,607
-------------- --------------
32,464 13,626
-------------- --------------
Total operating subsidiaries liabilities ....................... 50,546 35,197
OTHER
7% Collateralized Senior Subordinated Debentures ................... 14,824 24,292
10% Collateralized Subordinated Debentures ......................... 6,818 --
Interest and other accrued expenses ................................ 1,046 1,364
-------------- --------------
Total other liabilities ........................................ 22,688 25,656
-------------- --------------
TOTAL LIABILITIES .............................................. 85,781 74,587
REDEEMABLE PREFERRED STOCK
Series B, 250,000 shares issued and outstanding;
stated at redemption value .................................... 1,000 1,000
STOCKHOLDERS' EQUITY
Preferred stock, 250,000 shares issued and outstanding as
Series B .......................................................... -- --
Common stock, issued 1,597,204 shares at both dates;
outstanding 1,254,751 and 1,261,757 shares, respectively ....... 160 160
Additional paid-in capital ......................................... 54,823 54,823
Accumulated deficit ................................................ (29,303) (31,693)
Treasury stock, 342,453 and 335,447 shares, respectively, at cost .. (9,369) (9,119)
-------------- --------------
TOTAL STOCKHOLDERS' EQUITY ..................................... 16,311 14,171
-------------- --------------
TOTAL .......................................................... $ 103,092 $ 89,758
============== ==============
Page 4
5
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
1998 1997
-------------- --------------
ASSET MANAGEMENT
REAL ESTATE
Fees ......................................... $ 4,107 $ 3,648
Equity income from investments in HRP ........ 882 625
-------------- --------------
4,989 4,273
Administrative expenses ...................... 1,442 1,427
Depreciation and amortization ................ 504 504
Interest ..................................... 58 120
Provisions for loss .......................... -- 81
-------------- --------------
2,004 2,132
-------------- --------------
Income from real estate operations ....... 2,985 2,141
ENERGY
Gas revenues ................................. 2,830 2,781
Oil revenues ................................. 1,081 1,502
Other income ................................. 56 247
-------------- --------------
3,967 4,530
Depreciation, depletion and amortization ..... 1,206 982
Operating expenses ........................... 1,133 1,075
Administrative expenses ...................... 679 726
Interest ..................................... 411 306
-------------- --------------
3,429 3,089
-------------- --------------
Income from energy operations ............ 538 1,441
-------------- --------------
Income from asset management operations .. 3,523 3,582
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Sales ........................................ 63,420 70,139
Cost of sales ................................ 54,847 60,769
Administrative and selling expenses .......... 6,684 6,858
Interest ..................................... 741 775
-------------- --------------
62,272 68,402
-------------- --------------
Income from textile products operations .. 1,148 1,737
Page 5
6
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
OPERATING SUBSIDIARIES (CONTINUED) 1998 1997
-------------- --------------
HOTELS
Sales ................................................ $ 16,013 $ 16,543
Operating expenses ................................... 14,004 13,268
Depreciation and amortization ........................ 2,051 2,000
Interest ............................................. 847 1,106
-------------- --------------
16,902 16,374
-------------- --------------
Income (loss) from hotel operations .............. (889) 169
-------------- --------------
Income from operating subsidiaries ............... 259 1,906
ASSOCIATED COMPANY
Income from investment in ShowBiz .................... -- 19,416
Interest ............................................. -- 607
-------------- --------------
Income from associated company ................... -- 18,809
OTHER
Litigation settlement ................................ 1,025 --
Fee income ........................................... 412 423
Interest on short-term investments and other income .. 142 862
-------------- --------------
1,579 1,285
Administrative expenses .............................. 1,982 2,095
Interest ............................................. 706 2,931
-------------- --------------
2,688 5,026
-------------- --------------
Other loss, net .................................. (1,109) (3,741)
-------------- --------------
Income before income taxes and extraordinary gain .... 2,673 20,556
Income taxes ......................................... 340 9,776
-------------- --------------
Income before extraordinary gain ..................... 2,333 10,780
Extraordinary gain from early extinguishment
of debt ............................................. 107 877
-------------- --------------
NET INCOME ................................................. $ 2,440 $ 11,657
============== ==============
PER COMMON SHARE
BASIC
Income before extraordinary gain ..................... $ 1.82 $ 7.38
Extraordinary gain from early extinguishment
of debt ............................................. 0.08 0.60
-------------- --------------
Net income ....................................... $ 1.90 $ 7.98
============== ==============
ASSUMING DILUTION
Income before extraordinary gain ..................... $ 1.75 $ 7.20
Extraordinary gain from early extinguishment
of debt ............................................. 0.08 0.59
-------------- --------------
Net income ....................................... $ 1.83 $ 7.79
============== ==============
Page 6
7
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
1998 1997
-------------- --------------
ASSET MANAGEMENT
REAL ESTATE
Fees ................................................ $ 1,390 $ 1,120
Equity income from investments in HRP ............... 516 219
-------------- --------------
1,906 1,339
Administrative expenses ............................. 427 313
Depreciation and amortization ....................... 168 168
Provision for loss .................................. -- 81
Interest ............................................ -- 40
-------------- --------------
595 602
-------------- --------------
Income from real estate operations .............. 1,311 737
ENERGY
Gas revenues ........................................ 985 1,071
Oil revenues ........................................ 338 482
Other income (loss) ................................. (18) 23
-------------- --------------
1,305 1,576
Depreciation, depletion and amortization ............ 520 355
Operating expenses .................................. 333 415
Administrative expenses ............................. 233 218
Interest ............................................ 136 82
-------------- --------------
1,222 1,070
-------------- --------------
Income from energy operations ................... 83 506
-------------- --------------
Income from asset management operations ......... 1,394 1,243
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Sales ............................................... 17,808 19,655
Cost of sales ....................................... 15,405 17,221
Administrative and selling expenses ................. 2,152 2,200
Interest ............................................ 193 247
-------------- --------------
17,750 19,668
-------------- --------------
Income (loss) from textile products operations .. 58 (13)
Page 7
8
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
OPERATING SUBSIDIARIES (CONTINUED) 1998 1997
-------------- --------------
HOTELS
Sales ............................................... $ 5,667 $ 5,107
Operating expenses .................................. 5,024 4,239
Depreciation and amortization ....................... 713 626
Interest ............................................ 346 374
-------------- --------------
6,083 5,239
-------------- --------------
Loss from hotel operations ...................... (416) (132)
-------------- --------------
Loss from operating subsidiaries ................ (358) (145)
OTHER
Fee income .......................................... 137 138
Interest on short-term investments and other income . 20 298
-------------- --------------
157 436
Administrative expenses ............................. 622 718
Interest ............................................ 247 711
-------------- --------------
869 1,429
-------------- --------------
Other loss, net ................................. (712) (993)
-------------- --------------
Income before income taxes .......................... 324 105
Income taxes ........................................ 133 50
-------------- --------------
NET INCOME ................................................ $ 191 $ 55
============== ==============
NET INCOME PER COMMON SHARE
Basic ............................................... $ 0.15 $ 0.04
============== ==============
Assuming Dilution ................................... $ 0.15 $ 0.04
============== ==============
Page 8
9
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
1998 1997
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ................................................. $ 2,440 $ 11,657
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation, depletion and amortization ................ 4,817 4,367
Undistributed income from HEP ........................... (1,968) (2,684)
Distributions from HEP .................................. 1,552 1,427
Equity in net (income) of HRP ........................... (882) (625)
Amortization of deferred gain from debenture exchange ... (397) (448)
Extraordinary gain from extinguishment of debt .......... (107) (877)
Equity in net (income) of ShowBiz ....................... -- (1,139)
Gain from sale of investment in ShowBiz ................. -- (18,277)
Net change in deferred tax asset ........................ -- 8,960
Payment of ShowBiz Participation Amount ................. -- (1,256)
Net change in accrued interest on 13.5% Debentures ...... -- 1,313
Provision for loss ...................................... -- 81
Net change in textile products assets and liabilities ... 3,264 (1,941)
Net change in other assets and liabilities .............. (554) 856
Net change in energy assets and liabilities ............. 75 98
-------------- --------------
Net cash provided by operating activities ........... 8,240 1,512
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of hotel properties and related assets ............ (20,378) --
Investments in hotel properties ............................ (1,295) (1,044)
Investments in textile products property and equipment ..... (569) (903)
Net change in restricted cash for investing activities ..... (270) (276)
Investment in HEP by general partner ....................... (171) --
Investments in energy property and equipment ............... (149) (164)
Net proceeds from sale of investment in ShowBiz ............ -- 40,323
Purchase of minority shares of HEC ......................... -- (648)
-------------- --------------
Net cash provided by (used in) investing
activities ...................................... (22,832) 37,288
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings and loans payable ............ 18,550 1,650
Repayment of bank borrowings and loans payable ............. (4,912) (13,048)
Repurchase of 7% Debentures ................................ (2,146) --
Purchase of common stock for treasury ...................... (250) (8,373)
Payment of preferred stock dividends ....................... (50) (50)
Repurchase of 13.5% Debentures ............................. -- (12,875)
-------------- --------------
Net cash provided by (used in) financing
activities ...................................... 11,192 (32,696)
-------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .......... (3,400) 6,104
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................ 4,737 7,495
-------------- --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ...................... $ 1,337 $ 13,599
============== ==============
Page 9
10
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS AND ACCOUNTING POLICIES
Interim Consolidated Financial Statements. The interim 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 generally
accepted accounting principles, 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, 1997.
Accounting Policies. The Company has adopted Statement of Financial
Accounting Standards No. 130 - Reporting Comprehensive Income, effective
January 1, 1998. The Company had no items of other comprehensive income
for the periods presented herein.
In June 1998, SFAS No. 133 - Accounting for Derivative Instruments
and Hedging Activities was issued, which requires companies to recognize
all derivatives as either assets or liabilities in the balance sheet and
measure those instruments at fair value. The changes in the fair value of
a derivative depends on the intended use of the derivative. The Company
currently has hedging contracts in its energy segment as related to oil and
gas activities. The statement is effective for all quarters for fiscal
years beginning after June 15, 1999. The Company has not fully assessed
the impact that will result from adopting SFAS No. 133.
2. INVESTMENTS IN REAL ESTATE AFFILIATE AND ASSOCIATED COMPANY (DOLLAR AMOUNTS
IN THOUSANDS):
AS OF SEPTEMBER 30, 1998 AMOUNT AT INCOME FROM INVESTMENTS
------------------------- WHICH CARRIED AT FOR THE NINE MONTHS ENDED
COST OR -------------------------- SEPTEMBER 30,
BUSINESS SEGMENTS AND NUMBER OF ASCRIBED SEPTEMBER 30, DECEMBER 31, -------------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 1998 1997 1998 1997
------------------------- ------------ ----------- ------------ ----------- ----------- -----------
REAL ESTATE AFFILIATE
HALLWOOD REALTY PARTNERS, L.P. (A)
- General partner interest ......... -- $ 8,650 $ 3,955 $ 4,435 $ 30 $ 19
- Limited partner interest ......... 413,040 5,381 3,614 2,762 852 606
----------- ----------- ----------- ----------- -----------
Totals ......................... $ 14,031 $ 7,569 $ 7,197 $ 882 $ 625
=========== =========== =========== =========== ===========
ASSOCIATED COMPANY
SHOWBIZ PIZZA TIME, INC. (B)
- Common stock
Equity in earnings ............. $ 1,139
Gain on sale of shares ......... 18,277
-----------
Totals ......................... $ 19,416
===========
(A) At September 30, 1998, Hallwood Realty Corporation ("HRC"), a wholly
owned subsidiary of the Company, owned a 1% general partner interest
and the Company owned a 25% limited partner interest in its Hallwood
Realty Partners, L.P. ("HRP") affiliate. The Company accounts for its
investment in HRP using the equity method of accounting. In addition
to recording its share of net income (loss), the Company also records
its pro rata share of any partner capital transactions reported by
HRP. The carrying value of the Company's investment in HRP includes
such non-cash adjustments for its pro-rata share of HRP's capital
transactions with corresponding adjustments to additional paid-in
capital. The cumulative amount of such adjustments from the original
date of investment through September 30, 1998, resulted in a $49,000
decrease in the carrying value of the HRP investment.
The carrying value of the Company's general partner interest
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 nine months ended September 30, 1998 and 1997 such
amortization was $504,000 in each period.
Page 10
11
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
As discussed in Note 4, the Company has pledged 89,269 limited
partner units to collateralize a promissory note in the principal
amount of $500,000 and issued a limited negative pledge on all of
the HRP units, including the 89,269 pledged units, to secure the
energy term loan.
The quoted market price and the Company's carrying value per limited
partner unit (Quotron symbol HRY) at September 30, 1998 were $56.00
and $8.75, respectively. The general partner interest is not publicly
traded.
(B) The Company accounted for its investment in ShowBiz Pizza Time, Inc.
("ShowBiz") using the equity method of accounting. For the 1997
nine month period the equity income was $1,139,000. ShowBiz changed
its name in June 1998 to CEC Entertainment, Inc.
In March 1997, the Company completed the sale of its entire
2,632,983 shares of ShowBiz common stock at $15.68 per share, net
of underwriting commissions. A portion of the proceeds from the
sale was used to repay a $7,000,000 line of credit and a $4,000,000
promissory note. The Company reported a gain of $18,277,000 from
the transaction.
3. LITIGATION, CONTINGENCIES AND COMMITMENTS
Reference is made to Note 17 to the consolidated financial statements
contained in Form 10-K for the year ended December 31, 1997. There has
been no significant change since that time.
4. LOANS PAYABLE
Loans payable at the balance sheet dates are detailed below by business
segment (in thousands):
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------------- --------------
Real Estate
Promissory note, 8%, originally due March 1998 (see below) .. $ 500 $ 500
Energy
Term loan, libor + 3.5%, due May 2000 ....................... 2,667 3,867
Textile Products
Revolving credit facility, prime + .25%, due January 2000 ... 10,200 13,800
Hotels
Term loan, 7.5% fixed, due October 2008 ..................... 17,250 --
Term loan, 7.86% fixed, due January 2008 .................... 6,687 6,750
Term loan, 8.20% fixed, due November 2007 ................... 5,220 5,269
Term loan, libor + 7.5%, due October 2005 ................... 1,300 --
-------------- --------------
30,457 12,019
-------------- --------------
Total .................................................... $ 43,824 $ 30,186
============== ==============
Further information by business segment is provided below:
Real Estate
Promissory note. In connection with the settlement of an obligation
related to the Company's Integra Hotels, Inc. subsidiary, the Company
issued a four-year, $500,000 promissory note due March 8, 1998. The
Page 11
12
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
note is secured by a pledge of 89,269 HRP limited partner units. The
settlement agreement also provided that the noteholder had the right to
receive an additional payment in an amount equal to 25% of the increase in
the value of the HRP units over the base amount of $8.44 per unit, but in
no event more than an additional $500,000 (the "HRP Participation Amount").
The Company accrued the full amount of $500,000 as a charge to interest
expense, of which $50,000 and $90,000 were recorded in the nine months
ended September 30, 1998 and 1997, respectively.
The Company tendered full payment, including the HRP Participation
Amount totaling $1,000,000, in March 1998, although it reserved its rights
to litigate the validity of an earlier tender that was rejected by the
noteholder. The noteholder refused acceptance of the tendered payment and
returned it to the Company and instituted litigation in the State of
Delaware. The litigation is currently in the discovery phase and a trial
date has not yet been scheduled.
Energy
Term loan. In November 1997, the Company's HEPGP Ltd. partnership
("HEPGP") amended, restated and increased its term loan to $4,000,000 from
the First Union Bank of North Carolina. The term loan is collateralized by
all of the Company's HEP limited partner units and its investment in HEPGP
and Hallwood GP, Inc. HEPGP has also pledged its direct interests in
certain oil and gas properties. Other significant terms include: (i)
maturity date of May 15, 2000; (ii) monthly principal payments of $133,000,
plus interest; (iii) interest rate of libor plus 3.5% (9.09% at September
30, 1998); (iv) a limited negative pledge relating to the Company's HRP
limited partner units; and (v) restrictions on the declaration of
distributions or redemptions of partnership interests. The outstanding
balance at September 30, 1998 was $2,667,000.
Included in the consolidated balance sheets are the Company's share of
long-term obligations of its affiliated entity, Hallwood Energy Partners,
L.P. ("HEP") in the amount of $4,670,000 and $4,731,000 at September 30,
1998 and December 31, 1997, respectively.
Textile Products
Revolving credit facility. In January 1997, the Company's Brookwood
subsidiary entered into a new revolving credit facility in an amount of up
to $14,000,000 ($15,000,000 between April and June 1997) with The Bank of
New York ("BNY"). The facility was amended on April 30, 1998 to
temporarily increase the facility to $17,500,000 for the period between
March and August 1998, and to permanently increase the amount to
$15,000,000 thereafter. Borrowings are collateralized by accounts
receivable, inventory imported under trade letters of credit, certain
finished goods inventory, the machinery and equipment of Brookwood's
subsidiaries and all of the issued and outstanding capital stock of
Brookwood and its subsidiaries. The BNY facility expires on January 7,
2000 and bears interest, at Brookwood's option, at one-quarter percent over
prime (8.50% at September 30, 1998) or libor plus 2.25%. Availability for
direct borrowings and letter of credit obligations under the facility are
limited to the lesser of the facility or the formula borrowing base, as
defined in the agreement. The facility contains covenants, which include
maintenance of certain financial ratios, restrictions on dividends and
repayment of debt or cash transfers to the Company. The outstanding
balance at September 30, 1998 was $10,200,000.
Hotels
Term Loans. In September 1998, the Company formed two new
wholly-owned subsidiaries, Hallwood Hotels - OKC Inc. to acquire the fee
interest in the Embassy Suites hotel in Oklahoma City, Oklahoma for
$18,250,000, and Hallwood Hotels - OKC Mezz, Inc. to acquire a mezzanine
loan related to that fee acquisition. Prior to the fee acquisition, the
Company held a leasehold interest in the hotel. The mortgage loan for
$17,250,000 included the following significant terms: (i) fixed interest
rate of 7.5%; (ii) monthly loan payments of $127,476, based upon a 25-year
amortization schedule, with a maturity date of October 2008; (iii)
prepayment
Page 12
13
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
permitted after November 2000, subject to yield maintenance provisions and;
(iv) various other financial and non-financial covenants.
The mezzanine loan for $1,300,000 included the following significant
terms: (i) interest rate of libor plus 7.5% (13.15% at September 30, 1998),
subject to an interest rate cap of 15%; (iii) maturity date of October
2005; and (iv) prepayment permitted at any time without penalty, upon
30-day notice to lender.
Term loan. In December 1997, the Company's Brock Suite Greenville,
Inc. subsidiary entered into a new $6,750,000 mortgage loan, collateralized
by the Residence Inn hotel located in Greenville, South Carolina, which
replaced the former term loan. Significant terms include: (i) fixed
interest rate of 7.86%; (ii) monthly loan payments of $51,473 based upon
25-year amortization schedule with a maturity date of January 2008; (iii)
prepayment permitted after December 1999, subject to yield maintenance
provisions and (iv) various other financial and non-financial covenants.
The outstanding balance at September 30, 1998 was $6,687,000.
Term loan. In October 1997, the Company's Brock Suite Tulsa, Inc.
subsidiary entered into a new $5,280,000 mortgage loan collateralized by
the Residence Inn hotel in Tulsa, Oklahoma, which replaced the former term
loan. Significant terms include: (i) fixed interest rate of 8.20%; (ii)
monthly loan payments of $41,454, based upon 25-year amortization
schedule, with a maturity date of November 2007; (iii) prepayment permitted
after October 2001, subject to yield maintenance provisions and; (iv)
various other financial and non-financial covenants. The outstanding
balance at September 30, 1998 was $5,220,000.
5. 7% COLLATERALIZED SENIOR SUBORDINATED DEBENTURES AND 10% COLLATERALIZED
SUBORDINATED DEBENTURES
1993 Exchange Offer. In March 1993, the Company completed an exchange
offer whereby $27,481,000 of its former 13.5% Debentures were exchanged for
a new issue of 7% Collateralized Senior Subordinated Debentures due July
31, 2000 (the" 7% Debentures"), and purchased for cash $14,538,000 of its
13.5% Debentures at 80% of face value. Interest is payable quarterly in
arrears, in cash, and the 7% Debentures are secured by a pledge of all of
the capital stock of the Brookwood and Hallwood Hotels, Inc. subsidiaries.
The common and preferred stock of Brookwood are subject to a prior pledge
in favor of BNY.
Between 1994 and 1997, the Company repurchased 7% Debentures having a
principal value of $4,673,000. These repurchases satisfied the Company's
obligation to retire 10% of the original issue ($2,748,000) prior to March
1996, and partially satisfied the Company's obligation to retire an
additional 15% of the original issue ($4,122,000) prior to March 1998. In
January 1998, the Company repurchased 7% Debentures with a face amount of
$2,253,000 for $2,146,000, to fully satisfy the balance of the sinking fund
requirement contained in the indenture. The repurchase resulted in an
extraordinary gain from debt extinguishment of $107,000 in the 1998 first
quarter.
1998 Exchange Offer. On June 17, 1998, the Company announced a
commission-free exchange offer to all holders of 7% Debentures. The
Company offered to exchange 7% Debentures for a new issue of 8.5%
Collateralized Subordinated Debentures, due July 31, 2005, in the ratio of
$100 principal amount of 8.5% Debentures for each $100 principal amount of
7% Debentures tendered. On July 31, 1998 the Company extended the
expiration date to August 28, 1998, and increased the interest rate from
8.5% to 10% for the new issue (the "10% Debentures"). Terms and
conditions of the exchange offer were described in an exchange offer
circular, dated June 22, 1998, and a supplemental modification letter dated
July 31, 1998, both of which were mailed to all holders of 7% Debentures.
The 7% debentureholders tendered $6,467,830, or 31%, of the outstanding
principal amount.
The 10% Debentures were listed on The New York Stock Exchange and
commenced trading on Monday, August 31, 1998. The direct costs of the
exchange offer, in the amount of $113,000, were expensed in the 1998 third
quarter. For accounting purposes, a pro-rata portion of the $1,121,000
unamortized gain attributable to the 7% Debentures, in the amount of
$353,000, was allocated to the 10% Debentures, and will be amortized over
the
Page 13
14
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
term of the 10% Debentures using the effective interest method, which
decreased the rate for financial reporting to 8.94%.
The 10% Debentures are secured by a first and senior lien on the
capital stock of the Company's Brock Suites Hotels, Inc. subsidiary and by a
subordinate and junior lien on the capital stock of the Brookwood and
Hallwood Hotels, Inc. subsidiaries which are pledged to secure the 7%
Debentures.
Balance sheet amounts are detailed below (in thousands):
SEPTEMBER 30, DECEMBER 31,
DESCRIPTION 1998 1997
---------------------------------------- -------------- --------------
7% Debentures (face amount) ............ $ 14,087 $ 22,808
Unamortized gain from exchange, net of
accumulated amortization ............ 737 1,484
-------------- --------------
14,824 24,292
10% Debentures (face amount) ........... 6,468 --
Unamortized gain from exchange, net of
accumulated amortization ............ 350 --
-------------- --------------
6,818 --
-------------- --------------
Totals ........................... $ 21,642 $ 24,292
============== ==============
6. INCOME TAXES
The following is a summary of income tax expense (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
1998 1997 1998 1997
-------------- -------------- -------------- --------------
Federal
Current ....... $ 10 $ 10 $ 40 $ 535
Deferred ...... -- -- -- 8,960
-------------- -------------- -------------- --------------
Sub-total .. 10 10 40 9,495
State ............ 123 40 300 281
-------------- -------------- -------------- --------------
Total ...... $ 133 $ 50 $ 340 $ 9,776
============== ============== ============== ==============
As a result of the substantial tax gain from the March 1997 sale of
ShowBiz, the Company recorded a related non-cash deferred federal tax
charge of $8,960,000 in the 1997 first quarter, which reflected the
realization of tax benefits from the utilization of the Company's tax net
operating loss carryforwards ("NOLs") and a current federal tax charge of
$500,000 for alternative minimum tax.
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 amount of the deferred tax asset (net of valuation allowance) was
$2,040,000 at September 30, 1998. 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.
Page 14
15
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
7. SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
DESCRIPTION 1998 1997
--------------------------------------------- -------------- --------------
Supplemental schedule of noncash investing and financing activities:
Exchange of 10% Debentures for 7% Debentures ...................... $ 6,821 $ --
Issuance of treasury stock in exchange for
common shares of ShowBiz:
Investment in ShowBiz .......................................... -- 3,820
Reduction of additional paid-in capital ........................ -- 2,626
-------------- --------------
Reduction in treasury stock .................................... -- 6,446
Repayment of note payable from funds held in
restricted cash ................................................ -- 375
Recording of proportionate share of stockholders'
equity transaction of equity investments ....................... -- 143
Supplemental disclosures of cash payments:
Interest paid ..................................................... $ 3,038 $ 5,550
Income taxes paid ................................................. 446 655
8. COMPUTATION OF EARNINGS PER SHARE
The following table reconciles the Company's net income to net income
available to common stockholders, and the number of equivalent common
shares used in the calculation of net income for the basic and assuming
dilution methods (in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
DESCRIPTION 1998 1997 1998 1997
--------------------------------------------- -------------- -------------- -------------- --------------
NET INCOME
Net income, as reported ..................... $ 191 $ 55 $ 2,440 $ 11,657
Less: Dividends on preferred stock .......... -- -- 50 50
-------------- -------------- -------------- --------------
Net income available to common
stockholders .............................. $ 191 $ 55 $ 2,390 $ 11,607
============== ============== ============== ==============
AVERAGE SHARES OUTSTANDING
Outstanding shares - basic .................. 1,255 1,262 1,255 1,455
Stock options ............................... 44 37 52 35
-------------- -------------- -------------- --------------
Outstanding shares - assuming dilution ...... 1,299 1,299 1,307 1,490
============== ============== ============== ==============
NET INCOME PER COMMON SHARE
Basic ....................................... $ 0.15 $ 0.04 $ 1.90 $ 7.98
============== ============== ============== ==============
Assuming dilution ........................... $ 0.15 $ 0.04 $ 1.83 $ 7.79
============== ============== ============== ==============
Page 15
16
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
9. HOTEL ACQUISITIONS
In July 1998, the Company completed the purchase of 315 owner's rental
contracts, real estate and certain other assets at The Enclave Suites, a
resort condominium hotel located in Orlando, Florida for $2,100,000. The
acquisition was funded by working capital.
In September 1998, the Company purchased the fee interest in the
Embassy Suites hotel in Oklahoma City, Oklahoma for $18,250,000, which was
financed by term loans. See also Note 4.
Page 16
17
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 $191,000 for the third quarter
ended September 30, 1998, compared to net income of $55,000 in the 1997
period. The nine month net income was $2,440,000 compared to net income of
$11,657,000 in the 1997 period. Total revenue for the 1998 third quarter
was $26,843,000, compared to $28,113,000 in the prior-year period. For the
nine months, revenue was $89,968,000, compared to $116,186,000 in the
prior-year period. The 1997 nine months results included a gain of
$18,277,000 from the sale of the Company's investment in ShowBiz, partially
offset by a related tax charge (principally non-cash) of $9,485,000.
Following is an analysis of the results of operations by asset
management, operating subsidiaries and associated company divisions; and by
the real estate, energy, textile products, hotels and restaurant business
segments within those divisions.
Asset Management. The business segments of the Company's asset
management division consist of real estate and energy.
REAL ESTATE.
Revenue. Fee income of $1,390,000 for the quarter ended September 30,
1998 increased by $270,000, or 24%, from $1,120,000 in the prior-year
period. Fee income of $4,107,000 for the nine months increased by $459,000,
or 13%, from $3,648,000 for the similar period a year ago. Fees are
derived from 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 increases are due primarily to increased
leasing fees and brokerage fees earned from various third parties.
The equity income from investments in HRP represents the Company's
recognition of its pro rata share of the income reported by HRP and
amortization of negative goodwill. For the 1998 third quarter, the Company
reported income of $516,000 compared to income of $219,000 in the period a
year ago. The comparative nine month amounts were income of $882,000 in
1998 and $625,000 in 1997. The three and nine month increase resulted
principally from HRP's improved operating performance in 1998, partially
offset by an extraordinary loss from early extinguishment of debt.
Expenses. Administrative expenses of $427,000 and $1,442,000 , in the
1998 third quarter and nine month periods, increased from $313,000 and
$1,427,000 in the comparable 1997 periods, due to higher leasing
commissions paid in connection with higher leasing fees earned.
Amortization expense of $168,000 for the third quarter and $504,000
for the nine months in both the 1998 and 1997 periods relate to HRC's
general partner investment in HRP to the extent allocated to management
rights.
Interest expense decreased to $-0- from $40,000 in the third quarter
and to $58,000 from $120,000 in the nine month period for 1998 and 1997,
respectively, primarily due to reduced charges in the 1998 periods for the
HRP Participation Amount discussed in Note 4.
The provision for loss of $81,000 in the 1997 third quarter relates to
the uncollectibility of a tenant receivable deposit from the December 1995
sale of the United Kingdom office-retail property.
ENERGY.
Revenue. After the Company's successful completion of the tender
offer for the minority shares of Hallwood Energy Corporation ("HEC") and
the subsequent merger of HEC in November 1996, it effectively acquired
ownership of the assets formerly held by HEC. Following the merger,
certain HEC assets were transferred to two wholly owned entities. The two
entities, in addition to other energy assets which remain with the Company,
constitute the Company's
Page 17
18
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
investment in the energy industry. The general partner interest in HEP
entitles the general partner to interests in HEP's properties ranging from
2% to 25%. The Company also owns an approximate 6.5% interest in HEP
limited partner units. The Company and its energy subsidiaries account for
their ownership of HEP using the proportionate consolidation method of
accounting, whereby they record their proportionate share of HEP's revenues
and expenses, current assets, current liabilities, noncurrent assets,
long-term obligations and fixed assets. HEP owns approximately 46% of its
affiliate, Hallwood Consolidated Resources Corporation ("HCRC"), which HEP
accounts for under the equity method.
Gas revenue for the 1998 third quarter decreased $86,000, or 8%, to
$985,000 from $1,071,000. For the nine months, gas revenue increased
$49,000, or 2%, to $2,830,000 from $2,781,000. The increase in gas revenue
for the nine months was due primarily to an increase in production to
1,386,000 mcf from 1,158,000 mcf, partially offset by a decrease in the
average gas price to $2.04 from $2.40 per mcf. Oil revenue for the 1998
third quarter decreased $144,000, or 30%, to $338,000 from $482,000. For
the nine months, oil revenue declined by $421,000, or 28%, to $1,081,000
from $1,502,000. The decrease for the nine months was attributable to a
decrease in the average price per barrel to $13.51 from $20.30, partially
offset by an increase in production to 80,000 barrels from 74,000 barrels.
The increase in oil and gas production is primarily due to the acquisition
of a volumetric production payment during May 1998.
Other income (loss) consists primarily of acquisition fee and interest
income, as well as a share of HEP's interest income, facilities income from
two gathering systems in New Mexico, pipeline revenue, equity in income of
affiliates and miscellaneous income or expense. The decreases in other
income to $(18,000) for the 1998 quarter from $23,000 in the 1997 period
and to $56,000 for the 1998 nine month period from $247,000 in the 1997
period are primarily due to a decrease in HEP's equity in earnings of
affiliate, due to property impairments taken by HEP's affiliate in 1998, of
which $188,000 relates to the Company.
Expenses. Depreciation, depletion and amortization increased to
$520,000 for the 1998 third quarter and $1,206,000 for the nine months
compared to $355,000 and $982,000 in the 1997 periods. The increases for
the periods are attributable to increased depletion in 1998 due to a higher
depletion rate caused by the increase in production and higher capitalized
costs.
Operating expenses decreased by $82,000 to $333,000 for the 1998 third
quarter from $415,000 in the prior-year quarter and increased by $58,000 to
$1,133,000 for the nine months from $1,075,000 as a result of increased
production taxes resulting from the increased production described above.
Administrative expenses increased by $16,000 for the 1998 third
quarter to $233,000 from $218,000 in the 1997 quarter and decreased by
$45,000 to $679,000 for the 1998 nine month period from $726,000 in 1997
due to a decrease in allocated internal overhead.
Interest expense increased by $54,000 to $136,000 for the 1998 third
quarter compared to $82,000 in 1997 and increased by $105,000 to $411,000
for the 1998 nine month period, compared to $306,000 in 1997, due to an
increase in the Company's term loan in November 1997 and an increase in the
pro rata share of HEP's interest expense due to HEP's higher outstanding
debt in 1998.
Operating Subsidiaries. The business segments of the Company's
operating subsidiaries consist of textile products and hotels.
TEXTILE PRODUCTS.
Revenue. Sales of $17,808,000 decreased $1,847,000, or 9%, in the
1998 third quarter, compared to $19,655,000 in the 1997 quarter. The
comparative nine month sales decreased $6,719,000, or 10%, to $63,420,000
in 1998 from $70,139,000 in 1997. Sales by the distribution businesses
were lower in the 1998 periods than in 1997, due to decreased demand for
textile products in consumer markets, which was partially offset by
increased sales of industrial products.
Page 18
19
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This appears to be the result of a high level of U.S. consumer spending on
durable goods versus nondurable, unusual weather patterns affecting
outerwear sales and availability of lower priced Asian imports. The
decrease in sales at the processing plants in the three and nine month
periods was 2%.
Expenses. Cost of sales of $15,405,000 in 1998 decreased $1,816,000,
or 11%, from $17,221,000 in the 1997 third quarter and decreased $5,922,000,
or 10%, to $54,847,000 from $60,769,000 for the nine months. The decrease
in cost of sales was principally the result of the decrease of sales
revenue. The increased gross profit margin for the 1998 third quarter
(13.5% versus 12.4%) and the nine-month periods (13.5% versus 13.4%)
resulted from higher gross profit margins at the processing plants due to
operating efficiencies.
Administrative and selling expenses of $2,152,000 decreased by
$48,000 in the 1998 third quarter from $2,200,000 for the comparable 1997
period, and decreased $174,000 for the 1998 nine-month period to $6,684,000
from $6,858,000 for the comparable 1997 period. The decreases are due to
reduced operating expenses associated with the decrease in sales revenue.
Interest expense decreased by $54,000 to $193,000 for the 1998 third
quarter from $247,000 in 1997, and decreased by $34,000 for the 1998 nine
months to $741,000 from $775,000 in 1997 due to lower average borrowings
during the periods.
HOTELS
Revenue. Sales of $5,667,000 in the 1998 third quarter increased by
$560,000, or 11%, from the 1997 amount of $5,107,000. The 1998 nine-month
hotel sales of $16,013,000 decreased by $530,000, or 3%, compared to
$16,543,000 for the 1997 period. The sales increase in the 1998 third
quarter was primarily due to management fee revenues from The Enclave
Suites, a resort condominium hotel, acquired in July 1998. The sales
decline for the nine months was primarily due to an extensive renovation
project and adverse weather conditions at the Longboat Key Holiday Inn,
partially offset by revenues from The Enclave Suites. For the remaining
hotel properties, the average daily rate declined 3.0% and the average
occupancy level declined 0.4% in the 1998 nine months compared to the 1997
period.
Expenses. Operating expenses of $5,024,000 for the 1998 third quarter
were up $785,000, or 19%, from $4,239,000 in 1997. The 1998 nine month
hotel operating expenses increased by $736,000 to $14,004,000, compared to
$13,268,000 for the 1997 period. The increases for the three month and
nine month periods was primarily attributable to operating expenses at The
Enclave Suites property.
Depreciation and amortization expense increased by $87,000 to $713,000
for the 1998 third quarter from $626,000 in the 1997 period. Depreciation
and amortization for the 1998 and 1997 nine month periods were $2,051,000
and $2,000,000, respectively. The increase is attributable to The Enclave
Suites and the acquisition of the fee interest in the Oklahoma City Embassy
Suites.
Interest expense decreased by $28,000 to $346,000 for the 1998 third
quarter from $374,000 in 1997 and decreased by $259,000 to $847,000 for the
nine month period from $1,106,000, principally due to the refinancing of
the mortgage loans in the 1997 fourth quarter on the Residence Inn hotels
in Tulsa, Oklahoma and Greenville, South Carolina at more favorable
interest rates, partially offset by additional interest costs from the
September 1998 term loans to acquire the fee interest in the Oklahoma City
Embassy Suites hotel.
ASSOCIATED COMPANY
Revenue. The 1997 nine month period income of $18,809,000 includes
$1,139,000 from the Company's pro-rata share of ShowBiz results using the
equity method of accounting prior to the sale, and a gain of $18,277,000
from the sale of its investment. In March 1997 the Company sold its entire
2,632,983 ShowBiz shares at $15.68 per share, net of underwriting
commissions. See Note 2.
Page 19
20
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Expenses. Interest expense of $607,000 for the 1997 nine months was
primarily attributable to the settlement of litigation involving the
ShowBiz Participation Amount with the Integra Unsecured Creditors Trust.
The Company had recorded the potential amount of $1,675,000 for the ShowBiz
Participation Amount associated with the $4,000,000 promissory note in the
1997 first quarter, which was adjusted to the settlement amount in the 1997
third quarter.
OTHER
Revenue. In May 1998, the Company favorably settled a 1996 litigation
claim involving its former merchant banking activities for $1,025,000 in
cash, which was reported as income in the 1998 second quarter. Fee income
in the 1998 third quarter of $137,000 and $412,000 for the nine months
compares to the 1997 amounts of $138,000 and $423,000, respectively.
Interest on short-term investments and other income decreased by $278,000
to $20,000 for the 1998 third quarter and decreased by $720,000 to
$142,000 for the 1998 nine months from $298,000 and $862,000, respectively.
The decreases were primarily attributable to lower interest income earned
on the Company's short-term investments, and lower rental income from the
subleasing of executive office space formerly occupied by the Company's
affiliated entity, Integra-A Hotel and Restaurant Company, which expired in
May 1998.
Expenses. Administrative expenses of $622,000 for the 1998 third
quarter decreased by $96,000, or 13%, from the prior year amount of
$718,000, and declined in the 1998 nine month period by $113,000, or 5%, to
$1,982,000, compared to the prior year amount of $2,095,000. The 1998 nine
month expenses reflect lower consulting and accounting fees, partially
offset by compensation expense recorded upon the acquisition of certain
unexercised stock options and costs of the debenture Exchange Offer.
Interest expense in the amount of $247,000 for the 1998 third quarter
decreased by $464,000 from the prior year amount of $711,000 and decreased
by $2,225,000 for the 1998 nine months to $706,000 from the prior year
amount of $2,931,000. The decreases were primarily due to (i) repurchase
of $12,875,000 of its 13.5% Debentures pursuant to a self-tender offer in
June 1997; (ii) redemption of the remaining $14,287,000 balance of its
outstanding 13.5% Debentures in December 1997; (iii) repurchase of 7%
Debentures with a face amount of $2,253,000 in January 1998, to satisfy the
balance of a sinking fund requirement contained in the indenture; (iv)
offset by the completion of the August 1998 Exchange Offer, which exchanged
$6,468,000 of 7% Debentures for 10% Debentures. See Note 5.
Income taxes. Income taxes were $133,000 for the 1998 third quarter
and $50,000 in the 1997 quarter. The 1998 quarter included a $10,000
federal current charge and $123,000 for state taxes, compared to the 1997
third quarter which included a $10,000 federal current charge and $40,000
for state taxes. The 1998 nine month period income taxes of $340,000
included a $40,000 federal current charge and $300,000 for state taxes.
The 1997 nine month period income taxes of $9,776,000 included an
$8,960,000 non-cash federal deferred tax charge, a federal current charge
of $535,000 for alternative minimum tax (both charges primarily relating
to the ShowBiz sale) and $281,000 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. See Note 6.
As of September 30, 1998, the Company had approximately $115,000,000
of tax net operating loss carryforwards ("NOLs") and temporary differences
to reduce future federal income tax liability, including $42,944,000 of
NOLs which expire in the 1998 calendar year. Based upon the Company's
current expectations and available tax planning strategies, management has
determined that taxable income will more likely than not be sufficient to
utilize approximately $6,000,000 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 hotel properties
and certain other assets, that could be implemented, if necessary, to
supplement income from operations to fully realize the 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
Page 20
21
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 the imposition of such
limitations.
Extraordinary gain from early extinguishment of debt. The Company
recognized an extraordinary gain from debt extinguishment of $107,000 in
the 1998 first quarter from the purchase of 7% Debentures having a face
amount of $2,253,000 for a discounted amount of $2,146,000. During the
1997 second quarter, the Company recognized an extraordinary gain of
$877,000, which was attributable to the partial repurchase of 13.5%
Debentures pursuant to the self-tender offer completed in June 1997.
Page 21
22
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 September 30, 1998
totaled $1,337,000.
The Company's real estate segment generates funds principally from its
property management and leasing activities, without significant additional
capital costs. All of the HRP limited partnership units are subject to a
limited negative pledge on the Company's energy term loan. If the Company
pledges designated HRP units, as defined, having a market value up to
$2,000,000, the negative pledge can be released. Additionally, a portion of
the HRP units have been pledged to secure a $500,000 promissory note.
The Company's energy segment generates funds from operating and financing
activities. Cash flow is subject to fluctuating oil and gas production and
prices. In accordance with the proportionate consolidation method of
accounting, the Company reports its share of the long-term obligations of its
HEP affiliate which was $4,670,000 at September 30, 1998. HEP's borrowings are
secured by a first lien on approximately 80% in value of HEP's oil and gas
properties. HEP's unused borrowing capacity under the revolving credit
agreement was $12,300,000 at September 30, 1998. HEPGP amended, restated and
increased its term loan to $4,000,000 in November 1997 which had a balance of
$2,667,000 at September 30, 1998. The term loan contains a provision which
prohibits HEPGP from making any distribution to the Company during the term of
the loan which matures in May 2000.
In February 1998, HEP closed its public offering of 1.8 million Class C
units priced at $10.00 per unit. Proceeds to HEP, net of underwriting
discounts and expenses, were approximately $16,517,000. HEP used $14,000,000
of the net proceeds to repay borrowings and applied the remaining amount
towards the repayment of HEP's outstanding contract settlement obligation.
Brookwood maintains a revolving line of credit facility with The Bank of
New York, which is collateralized by accounts receivable, certain inventory and
equipment. At September 30, 1998, Brookwood had $3,943,000 of unused borrowing
capacity on its line of credit. The Company received a $500,000 cash dividend
from Brookwood on its preferred stock in April 1998 and received an additional
$284,000 cash dividend in September 1998. Future dividends will be paid as
permitted by the revolver, which allows for dividends to be paid to the extent
of 80% of cash flow after capital expenditures.
The Company's hotel segment generates cash flow from operating six hotels
(one Holiday Inn and one condominium hotel in Florida, one Embassy Suites and
one Residence Inn in Oklahoma, and one Residence Inn each in Alabama and South
Carolina). The sale of hotel properties may also provide a source of
liquidity; however, sales transactions may be impacted by the inability of
prospective purchasers to obtain equity capital or suitable financing. The
Company has recently renovated the Longboat Key Holiday Inn hotel with part of
the financing provided by the owner, and has been informed by Marriott that
substantial renovations will have to be made to each of the three Residence Inn
hotels prior to the renewal of their franchise in January 2000. Considering
the magnitude of the costs to maintain the current Marriott franchises, the
Company has applied for membership in the Best Western International system.
The costs associated with upgrades required by Best Western are expected to
average $1,000,000 per hotel property. The Company believes it can finance the
upgrades through lease financing agreements. In July 1998, the Company
acquired the owner's rental contracts, real estate, certain other assets and a
contract to manage a resort condominium hotel in Orlando, Florida. In
September 1998, the Company acquired the fee interest in the Embassy Suites
hotel in Oklahoma City, Oklahoma for $18,250,000, which was financed by
$18,550,000 in term loans. See Note 4.
Management believes that it will have sufficient funds for operations and
to satisfy its obligations.
Information Systems and the Year 2000. The Company realizes that many of
the world's information systems and/or computer programs currently do not have
the ability to recognize four digit date code fields and accordingly, they do
not have the ability to distinguish a year that begins with "20" instead of the
familiar "19". If not corrected, many computer applications could fail, become
unstable, stop working altogether, or create erroneous or incorrect results.
Therefore, many companies and organizations are spending considerable resources
to update and modify their systems for year 2000 compliance.
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company developed a program to review and modify, where necessary, its
computers and computer programming (information technology systems) to process
transactions and/or operate in the year 2000 and beyond. Additionally, the
Company is in the process of identifying and assessing its non-information
technology systems, which are generally more difficult to assess because they
often contain embedded technology that may be subject to year 2000 problems.
The Company has identified three of its primary systems which are vulnerable to
the year 2000 issue: (1) General Ledger/Accounts Payable. These systems were
modified by the vendor at no cost to the Company during the third quarter of
1998 and are now year 2000 compliant; (2) Shareholder and Debentureholder
Services. Such services are processed through outside transfer agent
providers, who have indicated that their most critical systems have already
been tested, although additional systems will be tested through the first part
of 1999. These systems will be modified by the vendors at no cost to the
Company; (3) Payroll. Such services are processed through an outside payroll
vendor. The Company has purchased updated year 2000 compliant software from
the vendor and it will be installed in the fourth quarter of 1998 at minimal
cost to the Company.
As a diversified holding company operating in four industry segments, the
Company relies heavily on the accounting and reporting information provided by
its subsidiaries and affiliated companies. All have established year 2000
programs to ensure compliance and the Company continues to monitor their status
to determine that all necessary modifications are completed and tested.
Provided below is a summary of the year 2000 programs of subsidiaries and
affiliated companies:
Real Estate. The Company's HRP affiliate has identified four primary
systems which are subject to the year 2000 issue: (1) General Ledger/Accounts
Payable/Accounts Receivable. These systems were modified by the vendor at no
cost to HRP and are now year 2000 compliant; (2) Commercial Lease
Administration. This system is year 2000 compliant; (3) K-1 Processing.
HRP's current K-1 tax reporting system is not year 2000 compliant. HRP has
selected a tested and compliant system which will be installed in 1999 at
minimal cost; (4) Payroll. HRP has purchased year 2000 compliant software
from its outside payroll vendor and it will be installed in the fourth quarter
of 1998 at minimal cost.
Energy. The Company's HEP affiliate has substantially completed its
assessment phase and has identified the information technology systems which
must be updated and is in the process of completing their remediation, testing
and implementation. In particular, its reservoir engineering software must be
updated or replaced. Assessment of HEP's non-information technology systems is
not yet completed, although HEP believes that most of these systems can be
brought into compliance on schedule. HEP's preliminary estimate of the cost of
its year 2000 compliance program for both its information technology and
non-information technology systems indicates that such costs will not be
material.
Textile Products. The Company's Brookwood subsidiary has identified three
primary systems which are subject to the year 2000 issue: (1) General
Ledger/Accounts Payable/Accounts Receivable/Inventory. Brookwood has purchased
a year 2000 compliant system for its converting business which is currently
being installed and tested. The system will be fully operational by the 1999
second quarter. (2) Payroll. Kenyon's time-clock payroll system is not
presently year 2000 compliant, although it is anticipated that updated software
will be installed and tested by the 1999 second quarter at minimal cost to
Kenyon. (3) Factory Production. Kenyon has determined that substantially all
of its machinery and equipment is not date-sensitive. Further testing is
ongoing, although no year 2000 problems are anticipated.
Hotels. The Company's hotel segment has identified four primary systems.
(1) General Ledger/Accounts Payable. The day-to-day accounting functions at
the hotel properties are out-sourced to a third party vendor. The vendor has
installed and is currently testing a new software system that is year 2000
compliant. It is anticipated that the software will be fully operational by
the 1999 first quarter at no cost to the Company. (2) Reservations. The
Company is currently working with the various franchisors to ensure year 2000
compliance and proper interfacing of all computer software, and is not aware of
any compliance problems. (3) Payroll. The day-to-day payroll functions at
the hotel properties are out-sourced to a third party vendor. The vendor has
installed and is currently testing a new software system that is year 2000
compliant. It is anticipated that the software will be fully operational by
the 1999 first quarter at no cost to the Company. (4) Facilities. Physical
inspections at the hotels are ongoing to determine that any date sensitive
equipment is year 2000 compliant. Other than the telephone systems,
substantially all equipment is already year 2000 compliant and it is
anticipated that all physical
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
systems, including telephone systems, will be year 2000 compliant by the 1999
second quarter at an anticipated cost of less than $100,000.
Additionally, the Company is surveying all of its significant service
providers and other external parties to determine their compliance with the
year 2000 issue and what impact, if any, their efforts will have on the
Company's business and operations. The Company anticipates completing its
survey of service providers and vendors by the 1999 first quarter.
The Company will utilize both internal and external resources to achieve
year 2000 compliance. The Company estimates that its identification and
assessment activities are approximately 75% complete. And that its remediation
is approximately 50% complete. As described earlier, the Company expects all
of its internal efforts will be completed by the second quarter of 1999.
However, there can be no guarantee that the Company will be able to identify
all potential year 2000 problems or to fully remediate all year 2000 problems
on a timely basis. The Company anticipates completing the year 2000 project by
June 30, 1999.
In the event that a system will not be year 2000 compliant, the Company
will assess the potential risk and, to the extent it is feasible, transfer its
business to an alternate vendor. The failure to correct a material year 2000
problem could result in an interruption, or failure of, certain normal business
activities or operations. Such failures could materially and adversely affect
the Company's results of operations, liquidity, and financial condition. Due
to the year end uncertainty inherent in the year 2000 problem, resulting in
part from the uncertainty of year 2000 readiness of third party vendors, the
Company is unable to determine at this time whether the consequences of year
2000 failures will have a material impact on the Company's results of
operations, liability, or financial condition. The Company believes, however,
that its year 2000 compliance plan and time line provides adequate staffing,
resources and time to mitigate and proactively respond to any unforeseen year
2000 problems in a timely manner. The Company plans to devote all resources
that would be required to resolve any such issues in a timely manner that might
arise from matters not previously considered.
The total costs for the Company and its hotel and textile products
subsidiaries (excluding the unconsolidated real estate and energy affiliates,
of which the Company must only bear a proportionate share) are estimated to be
less than $200,000. The cost of year 2000 compliance and the estimated date of
completion of necessary modifications are based on the Company's best
estimates, which were derived from various assumptions of future events,
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ materially
from those anticipated.
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25
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item
1 Legal Proceedings
Reference is made to Note 3 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) 10.31 - Promissory note and related mortgage and security
agreement in the original amount of $17,250,000, dated
September 11, 1998, between Hallwood Hotels - OKC,
Inc., as Maker, and WMF Capital Corp., as Lender, filed
herewith.
10.32 - Promissory note and related loan agreement in the
original amount of $1,300,000, dated September 11,
1998, between Hallwood Hotels - OKC Mezz, Inc., as
Maker, and Commercial Mortgage Investment Trust, Inc.,
as Lender, filed herewith.
(ii) 27 - Financial Data Schedule
(b) Reports on Form 8-K None
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26
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: November 13, 1998 By: /s/ Melvin J. Melle
-----------------------------------------
Melvin J. Melle, Vice President
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
Page 26
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INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION
------- -------------------------------------------------------
(i) 10.31 - Promissory note and related mortgage and security
agreement in the original amount of $17,250,000, dated
September 11, 1998, between Hallwood Hotels - OKC,
Inc., as Maker, and WMF Capital Corp., as Lender, filed
herewith.
10.32 - Promissory note and related loan agreement in the
original amount of $1,300,000, dated September 11,
1998, between Hallwood Hotels - OKC Mezz, Inc., as
Maker, and Commercial Mortgage Investment Trust, Inc.,
as Lender, filed herewith.
(ii) 27 - Financial Data Schedule