1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
MARK ONE
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD from __________ TO __________
FOR THE PERIOD ENDED MARCH 31, 1999 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 April 30, 1999.
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2
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
ITEM NO. PART I - FINANCIAL INFORMATION PAGE
- -------- ------------------------------ ----
1 Financial Statements (Unaudited):
Consolidated Balance Sheets as of March 31, 1999
and December 31, 1998.................................................. 3-4
Consolidated Statements of Income for the
Three Months Ended March 31, 1999 and 1998............................. 5-6
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 1999 and 1998............................. 7
Notes to Consolidated Financial Statements................................. 8-15
2 Managements's Discussion and Analysis of
Financial Condition and Results of Operations.............................. 16-25
3 Quantitative and Qualitative Disclosures about Market Risk..................... 26
PART II - OTHER INFORMATION
---------------------------
1 thru 6 Exhibits, Reports on Form 8-K and Signature Page............................... 27-49
Page 2
3
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
ASSETS
MARCH 31, DECEMBER 31,
1999 1998
---------- ------------
ASSET MANAGEMENT
REAL ESTATE
Investments in HRP ............................. $ 9,991 $ 9,771
Receivables and other assets ................... 376 687
---------- ----------
10,367 10,458
ENERGY
Oil and gas properties, net .................... 11,191 11,479
Current assets of HEP .......................... 2,381 2,895
Noncurrent assets of HEP ....................... 1,211 1,219
Receivables and other assets ................... 342 482
---------- ----------
15,125 16,075
---------- ----------
Total asset management assets ............... 25,492 26,533
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Inventories .................................... 18,530 16,708
Receivables .................................... 16,299 11,713
Property, plant and equipment, net ............. 8,985 8,738
Other .......................................... 863 889
---------- ----------
44,677 38,048
HOTELS
Properties, net ................................ 31,476 31,810
Receivables and other assets ................... 4,449 3,845
---------- ----------
35,925 35,655
---------- ----------
Total operating subsidiaries assets ......... 80,602 73,703
OTHER
Deferred tax asset, net ........................ 6,348 6,348
Other .......................................... 1,279 1,191
Cash and cash equivalents ...................... 1,043 769
Restricted cash ................................ 846 708
---------- ----------
Total other assets .......................... 9,516 9,016
---------- ----------
TOTAL ....................................... $ 115,610 $ 109,252
========== ==========
See accompanying notes to consolidated financial statements.
Page 3
4
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
MARCH 31, DECEMBER 31,
1999 1998
---------- ------------
ASSET MANAGEMENT
REAL ESTATE
Accounts payable and accrued expenses ............................... $ 687 $ 775
Loan payable ........................................................ 500 500
---------- ----------
1,187 1,275
ENERGY
Long-term obligations of HEP ........................................ 5,013 5,306
Current liabilities of HEP .......................................... 3,912 3,949
Loan payable ........................................................ 1,867 2,267
Accounts payable and accrued expenses ............................... 1,124 1,144
---------- ----------
11,916 12,666
---------- ----------
Total asset management liabilities ............................... 13,103 13,941
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Loan payable ........................................................ 13,400 9,900
Accounts payable and accrued expenses ............................... 10,469 7,646
---------- ----------
23,869 17,546
HOTELS
Loans payable ....................................................... 30,222 30,354
Accounts payable and accrued expenses ............................... 2,706 2,120
---------- ----------
32,928 32,474
---------- ----------
Total operating subsidiaries liabilities ......................... 56,797 50,020
OTHER
7% Collateralized Senior Subordinated Debentures .................... 14,628 14,727
10% Collateralized Subordinated Debentures .......................... 6,798 6,808
Interest and other accrued expenses ................................. 1,841 1,818
---------- ----------
Total other liabilities .......................................... 23,267 23,353
---------- ----------
TOTAL LIABILITIES ................................................ 93,167 87,314
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 shares at both dates ....................... 160 160
Additional paid-in capital .......................................... 54,823 54,823
Accumulated deficit ................................................. (24,171) (24,676)
Treasury stock, 342,453 shares at both dates; at cost ............... (9,369) (9,369)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY ....................................... 21,443 20,938
---------- ----------
TOTAL ............................................................ $ 115,610 $ 109,252
========== ==========
See accompanying notes to consolidated financial statements.
Page 4
5
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-----------------------------
1999 1998
---------- ----------
ASSET MANAGEMENT
REAL ESTATE
Fees ........................................... $ 1,264 $ 1,305
Equity income from investments in HRP .......... 388 352
---------- ----------
1,652 1,657
Administrative expenses ........................ 518 555
Depreciation and amortization .................. 168 168
Interest ....................................... -- 58
---------- ----------
686 781
---------- ----------
Income from real estate operations .......... 966 876
ENERGY
Gas revenues ................................... 894 863
Oil revenues ................................... 318 426
Other income ................................... 95 50
---------- ----------
1,307 1,339
Operating expenses ............................. 527 399
Depreciation, depletion and amortization ....... 511 377
Administrative expenses ........................ 335 225
Interest ....................................... 121 146
---------- ----------
1,494 1,147
---------- ----------
Income (loss) from energy operations ........ (187) 192
---------- ----------
Income from asset management operations ..... 779 1,068
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Sales .......................................... 21,858 23,315
Cost of sales .................................. 19,008 20,158
Administrative and selling expenses ............ 2,299 2,263
Interest ....................................... 222 269
---------- ----------
21,529 22,690
---------- ----------
Income from textile products operations ..... 329 625
See accompanying notes to consolidated financial statements.
Page 5
6
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-----------------------------
1999 1998
---------- ----------
OPERATING SUBSIDIARIES (CONTINUED)
HOTELS
Sales .................................................. $ 6,455 $ 4,998
Operating expenses ..................................... 5,037 4,425
Depreciation and amortization .......................... 724 669
Interest ............................................... 610 252
---------- ----------
6,371 5,346
---------- ----------
Income (loss) from hotel operations ................. 84 (348)
---------- ----------
Income from operating subsidiaries .................. 413 277
OTHER
Fee income ............................................. 137 137
Interest on short-term investments and other income .... 6 68
---------- ----------
143 205
Administrative expenses ................................ 523 565
Interest ............................................... 296 239
---------- ----------
819 804
---------- ----------
Other loss, net ..................................... (676) (599)
---------- ----------
Income before income taxes and extraordinary loss ...... 516 746
Income taxes ........................................... 11 95
---------- ----------
Income before extraordinary loss ...................... 505 651
Extraordinary loss from early extinguishment of debt ... -- (307)
---------- ----------
NET INCOME .................................................... $ 505 $ 344
========== ==========
PER COMMON SHARE
BASIC
Income before extraordinary loss ....................... $ 0.40 $ 0.51
Extraordinary loss from early extinguishment of debt ... -- (0.24)
---------- ----------
Net income .......................................... $ 0.40 $ 0.27
========== ==========
ASSUMING DILUTION
Income before extraordinary loss ....................... $ 0.40 $ 0.49
Extraordinary loss from early extinguishment of debt ... -- (0.23)
---------- ----------
Net income .......................................... $ 0.40 $ 0.26
========== ==========
See accompanying notes to consolidated financial statements.
Page 6
7
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-----------------------------
1999 1998
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ............................................................. $ 505 $ 344
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation, depletion and amortization ............................ 1,719 1,568
Undistributed income from HEP ....................................... (546) (691)
Distributions from HEP .............................................. 511 413
Amortization of deferred gain from debenture exchanges .............. (109) (130)
Extraordinary loss from extinguishment of debt ...................... -- 307
Equity in net income of HRP ......................................... (388) (352)
Net change in textile products assets and liabilities ............... (3,575) (603)
Net change in energy assets and liabilities ......................... 128 291
Net change in other assets and liabilities .......................... 30 (104)
---------- ----------
Net cash provided by (used in) operating activities .............. (1,725) 1,043
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in textile products property and equipment ................. (531) (98)
Capital expenditures for hotels ........................................ (296) (572)
Net change in restricted cash for investing activities ................. (138) (182)
Investments in energy property and equipment ........................... (4) (199)
---------- ----------
Net cash used in investing activities ............................ (969) (1,051)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings and loans payable ........................ 3,500 --
Repayment of bank borrowings and loans payable ......................... (532) (638)
Repurchase of 7% Debentures ............................................ -- (2,146)
Purchase of common stock for treasury .................................. -- (250)
---------- ----------
Net cash provided by (used in) financing activities ............. 2,968 (3,034)
---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ....................... 274 (3,042)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............................. 769 4,737
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................................... $ 1,043 $ 1,695
========== ==========
See accompanying notes to consolidated financial statements.
Page 7
8
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(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 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, 1998.
Comprehensive Income. The Company had no items of other comprehensive
income in the periods presented.
Reclassifications. Certain reclassifications have been made to the
prior period amounts to conform to the classifications used in the current
period. The reclassifications had no effect on previously reported net
income.
2. INVESTMENTS IN REAL ESTATE AFFILIATE (DOLLAR AMOUNTS IN THOUSANDS):
AMOUNT AT
AS OF MARCH 31, 1999 WHICH CARRIED AT INCOME FROM INVESTMENTS
-------------------- ----------------------- FOR THE THREE MONTHS ENDED
COST OR MARCH 31,
BUSINESS SEGMENTS AND NUMBER OF ASCRIBED MARCH 31, DECEMBER 31, --------------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 1999 1998 1999 1998
------------------------- --------- -------- --------- ------------ ------ ------
REAL ESTATE AFFILIATE
HALLWOOD REALTY PARTNERS, L.P. (A)
- General partner interest...... -- $ 8,650 $ 3,723 $ 3,877 $ 14 $ 13
- Limited partner interest...... 413,040 5,377 6,268 5,894 374 339
------- ------- ------- ----- -----
Totals....................... $14,027 $ 9,991 $ 9,771 $ 388 $ 352
======= ======= ======= ===== =====
(A) At March 31, 1999, Hallwood Realty LLC ("Hallwood Realty") and HWG,
LLC, wholly owned subsidiaries of the Company, owned a 1% general
partner interest and a 25% limited partner interest in its Hallwood
Realty Partners, L.P. ("HRP") affiliate, respectively. The Company
accounts for its investment in HRP using the equity method of
accounting. In addition to recording its share of 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 March 31, 1999, resulted
in a $49,000 decrease in the carrying value of the HRP investment.
The carrying value of the Company's general partner interest of HRP
includes the value of intangible rights to provide asset management
and property management services. The Company amortizes that portion
of the general partner interest ascribed to the management rights. For
the three months ended March 31, 1999 and 1998 such amortization was
$168,000 in each period.
The Company has pledged 89,269 HRP limited partner units to
collateralize the $500,000 promissory note and 24,035 units to secure
hotel equipment leases. Subject to these pledges, all of the units are
negatively pledged to secure the energy term loan.
The quoted market price and the Company's carrying value per limited
partner unit (Quotron symbol HRY) at March 31, 1999 were $51.87 and
$15.17, respectively. The general partner interest is not publicly
traded.
Page 8
9
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
3. LITIGATION, CONTINGENCIES AND COMMITMENTS
Reference is made to Note 18 to the consolidated financial statements
contained in Form 10-K for the year ended December 31, 1998.
In connection with the Ravenswood, Noland and Cede & Company
litigation matters over the November 1998 tender offer and merger of the
former Hallwood Energy Corporation into the Company, it is anticipated that
the Court will enter a final order approving the settlement in May 1999 and
the settlement amount will be payable 30 days after entry of the order. In
the event that the proposed consolidation plan of the energy companies, as
further discussed in Note 9, is consummated, the liability of the Company
to pay the settlement amount will be assumed by the new Hallwood Energy
Corporation.
4. LOANS PAYABLE
Loans payable at the balance sheet dates are detailed below by
business segment (in thousands):
MARCH 31, DECEMBER 31,
1999 1998
---------- ------------
Real Estate
Promissory note, 8%, originally due March 1998 (see below) .... $ 500 $ 500
Energy
Term loan, libor + 3.5%, due May 2000 ......................... 1,867 2,267
Textile Products
Revolving credit facility, prime + .25%, due January 2000 ..... 13,400 9,900
Hotels
Term loan, 7.50% fixed, due October 2008 ...................... 17,137 17,198
Term loan, 7.86% fixed, due January 2008 ...................... 6,644 6,667
Term loan, 8.20% fixed, due November 2007 ..................... 5,191 5,209
Term loan, libor + 7.5%, due October 2005 ..................... 1,250 1,280
---------- ----------
30,222 30,354
---------- ----------
Total ..................................................... $ 45,989 $ 43,021
========== ==========
Further information regarding loans payable 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 1998. The note is
secured by a pledge of 89,269 HRP limited partner units. The settlement
agreement also provided that the pledgee 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"). During
the original term of the note, the Company accrued the full amount of
$500,000 as a charge to interest expense, of which $50,000 was recorded in
the quarter ended March 31, 1998.
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 March 1998 tendered
payment 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.
Page 9
10
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
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 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% (8.45% at March 31, 1999); (iv) a limited negative pledge relating to
substantially all of the Company's HRP limited partner units; and (v)
restrictions on the declaration of distributions or redemptions of partnership
interests. The outstanding balance at March 31, 1999 was $1,867,000.
Long term obligations. Included in the consolidated balance sheets are the
Company's share of the long-term obligations of its affiliated entity, Hallwood
Energy Partners, L.P. ("HEP"), in the amount of $5,013,000 and $5,306,000 at
March 31, 1999 and December 31, 1998, respectively.
Textile Products
Revolving credit facility. In January 1997, the Company's Brookwood
subsidiary entered into a revolving credit facility in an amount of up to
$14,000,000 ($15,000,000 between April and June) with The Bank of New York (the
"Credit Agreement"). 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
Credit Agreement expires on January 7, 2000 and bears interest, at Brookwood's
option, at one-quarter percent over prime (8.00% at March 31, 1999) or libor
plus 2.25%. The facility was amended to increase the maximum amount to
$17,500,000 for the periods April through December 1997, and May through August
1998, and permanently increase the maximum amount to $15,000,000 thereafter and
to change certain financial covenants. 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 March 31, 1999 was $13,400,000.
At December 31, 1998, Brookwood was not in compliance with two covenants
contained in the Credit Agreement, which requires a minimum consolidated capital
expenditure of $1,500,000 in a calendar year and a minimum ratio of EBIDTA
(earnings before interest, depreciation, taxes and amortization) to consolidated
fixed charges of 1.00 to 1.00 for four consecutive quarters. On March 26, 1999,
Brookwood entered into an Amendment No. 5 and Waiver to Credit Agreement,
whereby the Bank waived the minimum consolidated capital expenditure requirement
for the calendar year ended December 31, 1998 only, and amended that section of
the Credit Agreement relating to the minimum ratio of EBIDTA to consolidated
fixed charges by inserting "except for the four consecutive quarters ending
March 31, 1999, and for said period only."
Hotels
Term Loans. In September 1998, the Company formed two 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 the related
mortgage term loan; and Hallwood Hotels -- OKC Mezz, Inc. to acquire a mezzanine
term 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 includes 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 permitted after November 2000, subject to yield maintenance
provisions and; (iv) various other financial and non-financial covenants. The
outstanding balance at March 31, 1999 was $17,137,000.
Page 10
11
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
The mezzanine loan for $1,300,000 includes the following significant
terms: (i) interest rate of libor plus 7.5% (12.47% at March 31, 1999);
(ii) maturity date of October 2005; and (iii) prepayment permitted at any
time without penalty, upon 30-day notice to lender. The outstanding balance
at March 31, 1999 was $1,250,000.
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 GuestHouse 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 March 31, 1999 was $6,644,000.
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 GuestHouse 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
March 31, 1999 was $5,191,000.
5. DEBENTURES
7% Collateralized Senior Subordinated Debentures. 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 The Bank of
New York.
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.
10% Collateralized Subordinated Debentures. In June 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 10%
Collateralized Subordinated Debentures ("10% Debentures"), due July 31,
2005, in the ratio of $100 principal amount of 10% Debentures for each $100
principal amount of 7% Debentures tendered. 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, prior to
the August 28, 1998 expiration date of the exchange offer.
The 10% Debentures were listed on The New York Stock Exchange and
commenced trading on August 31, 1998. The direct costs of the exchange
offer, in the amount of $131,000, were expensed in 1998. 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 term of the 10%
Debentures using the effective interest method. As a result, the effective
interest rate for financial reporting is 8.9%.
Page 11
12
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
The 10% Debentures are secured by a first and senior lien on the
capital stock of the Company's Brock Suite 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):
MARCH 31, DECEMBER 31,
DESCRIPTION 1999 1998
-------------------------------------------- ---------- ------------
7% Debentures (face amount) ........................... $ 14,088 $ 14,088
Unamortized gain from exchange, net of
accumulated amortization ........................... 540 639
---------- ----------
Totals .......................................... $ 14,628 $ 14,727
========== ==========
10% Debentures (face amount) .......................... $ 6,468 $ 6,468
Unamortized gain from exchange, net of
accumulated amortization ........................... 330 340
---------- ----------
Totals .......................................... $ 6,798 $ 6,808
========== ==========
6. INCOME TAXES
The following is a summary of the income tax expense (in thousands):
THREE MONTHS ENDED
MARCH 31,
--------------------
1999 1998
------ ------
Federal
Current ............................................ $ 5 $ 10
Deferred ........................................... -- --
------ ------
Sub-total ....................................... 5 10
State ................................................. 6 85
------ ------
Total ........................................... $ 11 $ 95
====== ======
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
$6,348,000 at March 31, 1999. 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 12
13
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
7. SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED
MARCH 31, DECEMBER 31,
DESCRIPTION 1999 1998
-------------------------------------------- ---------- ------------
Supplemental disclosures of cash payments:
Interest paid ..................................... $ 1,351 $ 1,045
Income taxes paid ................................. 43 204
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 assumed
dilution methods (in thousands, except per share amounts):
THREE MONTHS ENDED
MARCH 31, DECEMBER 31,
DESCRIPTION 1999 1998
-------------------------------------------- ---------- ------------
NET INCOME
Net income, as reported ............................... $ 505 $ 344
Less: Dividends on preferred stock .................... -- --
---------- ----------
Net income available to common stockholders ........... $ 505 $ 344
========== ==========
AVERAGE SHARES OUTSTANDING
Outstanding shares - basic ............................ 1,255 1,256
Stock options ......................................... 18 59
---------- ----------
Outstanding shares - assuming dilution ................ 1,273 1,315
========== ==========
NET INCOME PER COMMON SHARE
Basic.................................................. $ 0.40 $ 0.27
Assuming dilution...................................... $ 0.40 $ 0.26
9. PROPOSED CONSOLIDATION PLAN OF ENERGY COMPANIES
In December 1998, HEP and its affiliate, Hallwood Consolidated
Resources Corporation ("HCRC"), a publicly-traded oil and gas company
(NASDAQ:HCRC), jointly announced a proposal to consolidate HEP with HCRC
and the energy interests of the Company into a new, publicly-traded entity
to be called Hallwood Energy Corporation. After the consolidation, the
common stock of Hallwood Energy Corporation will be owned 56% by the
current Class A unitholders of HEP, 26% by the current stockholders of HCRC
and 18% by the Company. HEP's current Class C unitholders will receive
redeemable preferred stock in the new entity.
Because of the larger size of the new corporation, management
anticipates that the new company will have the ability to take advantage of
opportunities that are unavailable to smaller entities and will have a
better ability to raise capital. Hallwood Energy Corporation will focus on
reserve growth. On April 30, 1999, a Joint Proxy Statement/Prospectus for
the consolidation was declared effective by the Securities and Exchange
Commission and was mailed by May 4, 1999 to HEP unitholders and HCRC
stockholders as of the April 14, 1999 record date. The consolidation must
be approved by a majority of each class of outstanding units of HEP and of
the outstanding shares of HCRC. The consummation of the consolidation is
also subject to a number of other conditions. If consummated, the Company
will no longer fully consolidate this business, but will account for it
under the equity method.
Page 13
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
10. SEGMENT AND RELATED INFORMATION
The following represents the Company's reportable segment position for
the three months ended March 31, 1999 and 1998, respectively (in
thousands):
REAL TEXTILE
ESTATE ENERGY PRODUCTS HOTELS OTHER CONSOLIDATED
-------- -------- -------- -------- -------- ------------
THREE MONTHS ENDED MARCH 31, 1999
Total revenue from external sources .... $ 1,652 $ 1,307 $ 21,858 $ 6,455 $ 143 $ 31,415
======== ======== ======== ======== ======== ============
Operating income (loss) ................ $ 966 $ (187) $ 329 $ 84 $ -- $ 1,192
======== ======== ======== ======== ======== ============
Unallocable expenses, net .............. $ (676) (676)
======== ------------
Income before income taxes................ $ 516
============
THREE MONTHS ENDED MARCH 31, 1998
Total revenue from external sources .... $ 1,657 $ 1,339 $ 23,315 $ 4,998 $ 205 $ 31,514
======== ======== ======== ======== ======== ============
Operating income (loss)................... $ 876 $ 192 $ 625 $ (348) $ -- $ 1,345
======== ======== ======== ======== ========
Unallocable expenses, net................. $ (599) (599)
======== ------------
Income before income taxes and
extraordinary gain (loss)............. $ 746
============
Extraordinary gain (loss) from early
extinguishment of debt................ $ (414) $ -- $ -- $ -- $ 107 $ (307)
======== ======== ======== ======== ======== ============
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, 1998 annual report. The total assets for the Company's
operating segments have not materially changed since the December 31, 1998
annual report, although assets of the Company's textile products segment
have increased by approximately $6.6 million due to seasonal fluctuations.
11. SUBSEQUENT EVENT
On May 11, 1999, the Company announced that it had reached an
agreement (the "Agreement") with Mr. Brian M. Troup, president and a
director of the Company, regarding a separation of their interests.
Completion of the Agreement is conditioned on, among other things, a
satisfactory refinancing of the $14,088,000 outstanding principal amount of
the Company 7% Debentures and completion of the consolidation of the
Company's energy interests with HEP and HCRC to form a new Hallwood Energy
Corporation.
Mr. Troup currently holds options to purchase a total of 37,200 shares
of the Company common stock. In addition, a trust of which members of Mr.
Troup's family are beneficiaries, currently owns 305,196 shares of the
Company common stock. Pursuant to the Agreement, upon satisfaction of the
conditions, Mr. Troup will surrender his options, the trust will surrender
all of its shares of the Company stock to the Company, the options and
stock will be canceled and Mr. Troup will resign from all positions with
the Company, the general partner of HRP and Hallwood Energy Corporation.
In exchange, the Company will transfer to the trust or Mr. Troup
82,608 units of HRP, 360,000 shares of common stock of Hallwood Energy
Corporation, and all of the Company's interest in the Enclave Suites resort
in Orlando, Florida and all other condominium hotel projects currently in
process. In addition, the Company will pay Mr. Troup quarterly up to 20% of
the net cash flow from its Hallwood Commercial Real Estate, LLC subsidiary
or $125,000, subject to termination in certain events.
HRP and Hallwood Energy Corporation have agreed to register the
trust's or Mr. Troup's shares in those entities upon request by Mr. Troup
and the Company, at the Company's expense. The Company will have the
Page 14
15
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
right to purchase all of these units and shares at the then current trading
price for a period of six months after the effectiveness of the Agreement.
Thereafter, Mr. Troup may sell the units and shares subject to certain
restrictions, including a right of first refusal in favor of the Company.
There is no assurance that the conditions to completion of the
Agreement will be satisfied or that the Agreement will be completed. Until
completion, the parties do not anticipate any change in their
relationships.
Page 15
16
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 $505,000 for the first quarter
ended March 31, 1999, compared to net income of $344,000 in the 1998
period. Total revenue for the 1999 first quarter was $31,415,000, compared
to $31,514,000 in the prior-year period.
Following is an analysis of the results of operations by asset
management and operating subsidiaries divisions and by the real estate,
energy, textile products and hotels business segments.
ASSET MANAGEMENT. The reportable segments of the Company's asset management
division consist of real estate and energy.
REAL ESTATE.
Revenue. Fee income of $1,264,000 for the quarter ended March 31, 1999
decreased by $41,000, or 3%, from $1,305,000 in the prior-year period. 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 decrease was due primarily to
decreased construction services in the 1999 first quarter.
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 1999 first quarter, the Company
reported income of $388,000 compared to $352,000 in the period a year ago.
The increase resulted from HRP's improved operating performance in the 1999
first quarter. The 1998 equity income is exclusive of the company's
$414,000 pro-rata share of HRP's $1,611,000 loss on early extinguishment of
debt, which is reported separately as an extraordinary item.
Expenses. Administrative expenses of $518,000 decreased by $37,000, or
7%, in the 1999 first quarter, compared to $555,000 in the prior-year
quarter. The decline was primarily attributable to the payments of
commissions to third party brokers associated with fee income.
Amortization expense of $168,000 in both the 1999 and 1998 quarters
relate to Hallwood Realty's general partner investment in HRP to the extent
allocated to management rights.
Interest expense for the 1999 first quarter decreased to -0- from
$58,000 in the prior-year quarter. The 1998 amount relates to the $500,000
promissory note, which has reached maturity and is secured by 89,269 HRP
limited partner units.
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 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 HCRC affiliate, and accounts for its investment in
HCRC under the equity method.
Gas revenue for the 1999 first quarter increased $31,000, or 4%, to
$894,000 from $863,000, primarily as a result of an increase in production
to 478,000 mcf from 412,000 mcf, partially offset by a decrease in the
Page 16
17
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
average gas price to $1.87 per mcf from $2.09 per mcf. The increase in gas
production is due to HEP's acquisition of a volumetric production payment
during May 1998. Oil revenue for the 1999 first quarter decreased $108,000,
or 25%, to $318,000 from $426,000, due to a decrease in the average price
per barrel to $11.36 from $14.20, and a decrease in production to 28,000
barrels from 30,000 barrels due to normal production declines.
Other income 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 increase in other
income to $95,000 for the 1999 first quarter from $50,000 in the 1998
period is primarily due to an increase of incentive payment income from
HEP's acquisition of a volumetric production payment during May 1998.
Expenses. Operating expenses increased by $128,000, or 32%, to
$527,000 for the 1999 first quarter from $399,000 in the prior-year
quarter, as a result of increased production taxes and operating expenses
resulting from the increased gas production described above.
Depreciation, depletion and amortization increased by $134,000, or
36%, to $511,000 for the 1999 first quarter compared to $377,000 in the
1998 quarter. The increase is attributable to higher depletion, from the
increase in gas production and higher capitalized costs during 1999.
Administrative expenses increased by $110,000, or 49%, for the 1999
first quarter to $335,000 from $225,000 in the 1998 quarter due to an
increase in allocated internal overhead, principally higher salaries
expense.
Interest expense decreased by $25,000 to $121,000 for the 1999 first
quarter compared to $146,000 in 1998, primarily due to a decline in the
principal balance of the Company's term loan.
OPERATING SUBSIDIARIES. The reportable segments of the Company's operating
subsidiaries division consist of textile products and hotels.
TEXTILE PRODUCTS.
Revenue. Sales of $21,858,000 decreased $1,457,000, or 6%, in the 1999
first quarter, compared to $23,315,000 in the 1998 quarter. Demand for the
Company's textile products in all divisions decreased in 1999, compared to
the 1998 quarter due to lower priced Asian imports and U.S. customers
moving production out of the country.
Expenses. Cost of sales of $19,008,000 decreased $1,150,000, or 6% in
the 1999 first quarter, from $20,158,000 in the 1998 quarter. The decrease
in cost of sales was principally the result of the decreased sales. The
lower gross profit margin for the 1999 first quarter (13.0% versus 13.5%)
resulted from lower gross profit margins at the Kenyon dying and finishing
plant, due to competitive market pressures experienced in 1999 and
operating cost increases not recoverable through an increase in sales
prices.
Administrative and selling expenses of $2,299,000 increased by $36,000
in the 1999 first quarter from $2,263,000 for the comparable 1998 period.
Interest expense of $222,000 decreased by $47,000 for the 1999 first
quarter from $269,000 in 1998 due to lower average borrowings and lower
interest rates.
HOTELS.
Revenue. Sales of $6,455,000 in the 1999 first quarter increased by
$1,457,000, or 29%, from the year-ago amount of $4,998,000. The increase
was primarily due to management fee revenues from the July 1998
Page 17
18
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
acquisition of owners rental contracts and related real estate at the
Enclave Suites, a resort condominium hotel in Orlando, Florida and
increased revenues at the Longboat Key, Florida Holiday Inn and Suites. The
Holiday Inn revenues increased by $813,000, as a result of the completion
of an extensive renovation project in April 1998 and improved weather
conditions. For the hotel segment, average daily rate increased 4.3% and
average occupancy level increased 5.5% in the 1999 first quarter compared
to the prior-year quarter.
Expenses. Operating expenses of $5,037,000 for the 1999 first quarter
were up $612,000, or 14%, from $4,425,000 in 1998. The increase is
primarily attributable to operating expenses for the Enclave Suites and
Holiday Inn, partially offset by reduced rent for the Oklahoma City,
Oklahoma Embassy Suites hotel, which was a leasehold prior to the fee
interest being acquired by the Company in September 1998.
Depreciation and amortization expense increased by $55,000 to $724,000
for the 1999 first quarter from $669,000 in the prior-year period. The
increase was primarily due to the acquisition of the owner's rental
contracts and related real estate at the Enclave Suites and the fee
interest in the Embassy Suites.
Interest expense increased by $358,000 to $610,000 for the 1999 first
quarter from $252,000 in 1998, principally due to the September 1998 term
loans to acquire the Embassy Suites fee interest.
OTHER.
Revenue. Fee income in the 1999 first quarter of $137,000 was
unchanged from the 1998 amount.
Interest on short-term investments and other income decreased by
$62,000 to $6,000 for the 1999 first quarter from $68,000 in 1998. The
decrease was 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 an affiliated entity, which
master lease expired in May 1998.
Expenses. Administrative expenses of $523,000 for the 1999 first
quarter decreased by $42,000 from the prior-year amount of $565,000 due to
lower office overhead and travel costs.
Interest expense in the amount of $296,000 for the 1999 quarter
increased by $57,000 from the prior year amount of $239,000. The increase
was primarily due to the August 1998 debenture exchange offer.
Income taxes. Income taxes were $11,000 for the 1999 first quarter and
$95,000 in the 1998 quarter. The 1999 quarter included a $5,000 federal
current charge and $6,000 for state taxes. The 1998 quarter included a
$10,000 federal current charge and $85,000 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.
As of March 31, 1999, the Company had approximately $99,000,000 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 $18,670,000 of the NOLs prior to their ultimate
expiration in the year 2010.
Management believes that the Company has certain tax planning
strategies available, which include the potential sale of certain real
estate investments and hotel properties, 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 strategies based upon changes in
facts and circumstances and, accordingly, considers potential adjustments
to the valuation allowance of the deferred tax
Page 18
19
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 loss from early extinguishment of debt. The Company
recognized an extraordinary loss from debt extinguishment of $307,000 in
the 1998 quarter due to the $414,000 pro-rata share of HRP's $1,611,000
loss on early extinguishment of debt, net of a $107,000 gain from the
January 1998 purchase of 7% Debentures having a face amount of $2,253,000
for a discounted amount of $2,146,000.
Page 19
20
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The Company's unrestricted cash and cash equivalents at March 31, 1999
totaled $1,043,000.
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 113,304 of its HRP limited
partnership units as collateral for a term loan and certain hotel lease
obligations. In addition, substantially all of the HRP limited partnership
units are subject to a limited negative pledge for 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.
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 and its subsidiaries report their share
of HEP's long-term obligations totaling $5,013,000 at March 31, 1999. 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 $11,300,000 at March 31, 1999. HEPGP
amended, restated and increased its term loan to $4,000,000 in November
1997 and had a balance of $1,867,000 at March 31, 1999. 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.
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 March 31, 1999, Brookwood had $1,197,000 of
unused borrowing capacity on its line of credit. In the year ended December
31, 1998, the Company received a $784,000 cash dividend and $394,000 under
its tax sharing agreement from Brookwood. A cash dividend for 1999, if any,
is contingent upon Brookwood's compliance with the covenants contained in
its loan agreement. At December 31, 1998, Brookwood was not in compliance
with two covenants contained in its Credit Agreement, which requires a
minimum consolidated capital expenditure of $1,500,000 in a calendar year
and a minimum ratio of EBIDTA (earnings before interest, depreciation,
taxes and amortization) to consolidated fixed charges of 1.00 to 1.00 for
four consecutive quarters. On March 26, 1999, Brookwood entered into an
Amendment No. 5 and Waiver to Credit Agreement, whereby the Bank waived the
minimum consolidated capital expenditure requirement for the calendar year
ended December 31, 1998 only, and amended that section of the Credit
Agreement relating to the minimum ratio of EBIDTA to consolidated fixed
charges by inserting "except for the four consecutive quarters ending March
31, 1999, and for said period only." Brookwood's revolving credit facility
matures in January 2000 and management believes the facility can be renewed
or replaced at that time.
Although major capital expenditures are periodically required under
franchise agreements, cash flow from hotel operations have typically
contributed to the Company's working capital. Sales of hotels are also a
source of liquidity; however, a sale may be impacted by the ability of
prospective purchasers to obtain equity capital or suitable financing. The
Company completed a renovation of the Holiday Inn and Suites hotel in April
1998, partly financed by the owner in the form of higher lease payments. In
April 1999 the Company converted its three Residence Inn hotels to
GuestHouse Suites Plus franchises. Renovations to meet the new franchiser's
standards, totaling approximately $3,000,000, are expected to be funded
from the Company's capital reserves and equipment lease facilities.
Management believes that it will have sufficient funds for operations
and to satisfy its current obligations. Management is currently exploring
alternatives to refinance the 7% Debentures which mature in July 2000.
Page 20
21
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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.
The Company developed a program to review and modify, where necessary, its
computers and computer programming (information technology ("IT") 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 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 was installed in
1998 at minimal cost to the Company.
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 third quarter.
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. HRP developed a program to review and modify, where necessary,
its computers, computer programming and building systems to process transactions
and/or operate in the Year 2000 and beyond. HRP identified that its four primary
business systems, which are vulnerable to the Year 2000 issue, are: (1) General
Ledger/Accounts Payable/Accounts Receivable Systems - These systems were
modified by the vendor at no cost to HRP during the third quarter of 1998 and
are now Year 2000 compliant. (2) Commercial Lease Administration - The system
used by HRP is Year 2000 compliant. (3) K-1 Processing - HRP maintains data used
to process its partners Schedule K-1(s) for tax reporting purposes in an
environment that 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's payroll was processed in a non-compliant system through an outside payroll
vendor until Year 2000 compliant software was purchased and installed in the
fourth quarter of 1998 at minimal cost.
Additionally, HRP 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 HRP's business and
operations. This survey includes the identification of certain on-site,
non-information technology systems that may be Year 2000 sensitive. Once these
systems have been fully identified, HRP will determine, with the help of outside
vendors, whether these systems are vulnerable to the Year 2000 issue. Potential
non-information technology systems include, but are not limited to, access
gates, alarms, elevators, heating and air conditioning systems, irrigation
systems, security systems, thermostats, and utility meters and switches. HRP
anticipates finalizing its survey of service providers and vendors during the
third quarter of 1999.
Page 21
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
HRP will utilize external and internal resources to reprogram, replace and
test its systems for Year 2000 modifications. HRP anticipates completing the
Year 2000 project, which includes repairing or replacing any vulnerable systems,
by September 30, 1999. Total costs, including information and non-information
technology systems, are not expected to exceed $100,000. In the event that a
system will not be Year 2000 compliant, HRP will assess the potential risk and,
to the extent it is feasible, transfer its business to an alternate vendor.
Although HRP believes that it will not have any detrimental effects on its
operations from Year 2000 compliance issues, there can be no assurance that the
systems of other companies, on which HRP's systems may rely, will be converted
timely, or converted in a manner that is compatible with HRP's systems, or that
any such failures by such other companies would not have a material adverse
effect or risk to HRP. HRP 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. In the event of a complete failure of our information
technology systems, HRP would be able to continue the affected functions either
manually or through the use of non-Year 2000 compliant systems. The primary
costs associated with such a necessity would probably include (1) increased time
delays associated with posting of information, and (2) increased personnel to
manually process the information. HRP does not currently have a contingency plan
in place and believes, based upon current knowledge, that one is not needed.
The cost of Year 2000 compliance and the estimated date of completion of
necessary modifications are based on HRP'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 significantly from those anticipated.
Energy. HEP's Year 2000 Plan has four phases: (i) assessment, (ii)
inventory, (iii) remediation, testing and implementation and (iv) contingency
plans. Approximately twelve months ago, HEP began its phase one assessment of
its particular exposure to problems that might arise as a result of the new
millennium. The assessment and inventory phases have been substantially
completed and have identified HEP's IT systems that must be updated or replaced
in order to be Year 2000 compliant. In particular, the software used by HEP for
reservoir engineering must be updated or replaced. Remediation, testing and
implementation are scheduled to be completed by June 30, 1999, and the
contingency plans phase is scheduled to be completed by September 30, 1999.
However, the effects of the Year 2000 problem on IT systems are exacerbated
because of the interdependence of computer systems in the United States. HEP's
assessment of the readiness of third parties whose IT systems might have an
impact on HEP's business has thus far not indicated any material problems;
responses have been received to approximately 50% of the 172 inquiries made.
With regard to HEP's Non-IT systems, HEP believes that most of these
systems can be brought into compliance on schedule. HEP's assessment of third
party readiness is not yet completed. Because Non IT systems are embedded chips,
it is difficult to determine with complete accuracy where all such systems are
located. As part of its plan, HEP is making formal and informal inquiries of its
vendors, customers and transporters in an effort to determine the third party
systems that might have embedded technology requiring remediation.
Although it is difficult to estimate the total costs of implementing the
plan through January 1, 2000 and beyond, HEP's preliminary estimate is that such
costs will not be material. To date, HEP has determined that its IT systems are
either compliant or can be made compliant for less than $150,000. However,
although management believes that its estimates are reasonable, there can be no
assurance, for the reasons stated in the next paragraph, that the actual cost of
implementing the plan will not differ materially form the estimated costs.
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. This risk exists both as to HEP's IT and Non IT systems, as well as
to the systems of third parties. Such failures could materially and adversely
affect HEP's results of operations, cash flow and financial condition. Due to
the general uncertainty inherent in the Year 2000 problem, resulting in part
from the uncertainty of the Year 2000 readiness of third party suppliers,
vendors and transporters, HEP is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the HEP
results of
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
operations, cash flow or financial condition. Although HEP is not currently able
to determine the consequences of Year 2000 failures, its current assessment is
that its area of greatest potential risk in its third party relations is in
connection with the transporting and marketing of the oil and gas produced by
HEP. HEP is contacting the various purchasers and pipelines with which it
regularly does business to determine their state of readiness for the Year 2000.
Although in general the purchases and pipelines will not guaranty their state of
readiness, the responses received to date have indicated no material problems.
HEP believes that in a worst case scenario, the failure of its purchasers and
transporters to conduct business in a normal fashion could have a material
adverse effect on cash flow for a period of six to nine months. HEP's Year 2000
plan is expected to significantly reduce HEP's level of uncertainty about the
compliance and readiness of these material third parties. The evaluation of
third party readiness will be followed by HEP's development of contingency
plans.
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 computer for its converting business which is currently
being installed and tested. All operating programs will be modified and fully
operational by the 1999 third quarter. (2) Payroll. The processing plant's
time-clock payroll system was not Year 2000 compliant, although updated software
was installed and tested in April 1999. (3) Factory Production. To date
Brookwood 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.
Additionally, Brookwood 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 Brookwood's
business and operations. This survey includes the identification of certain
non-information technology systems that may be Year 2000 sensitive. Once these
systems have been fully identified, Brookwood will determine, with the help of
outside vendors, whether these systems are vulnerable to the Year 2000 issue.
Potential non-information technology systems include, but are not limited to
factory production equipment. Brookwood anticipates finalizing its survey of
service providers and vendors during the second quarter of 1999. To date,
Brookwood has determined that substantially all of its machinery and equipment
relating to factory production is not date sensitive. Further testing is
on-going, although no Year 2000 problems are anticipated.
Although Brookwood believes that it will not have any detrimental effects
on its operations from Year 2000 compliance issues, there can be no assurance
that the systems of other companies, on which Brookwood's systems may rely, will
be converted timely, or converted in a manner that is compatible with
Brookwood's systems, or that any such failures by such other companies would not
have a material adverse effect or risk to Brookwood. Brookwood 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. In the event of
a complete failure of information technology systems, Brookwood would be able to
continue the affected functions either manually or through the use of non-Year
2000 compliant systems. The primary costs associated with such a necessity would
probably include (1) increased time delays associated with posting of
information , and (2) increased personnel to manually process the information.
Brookwood does not currently have a contingency plan in place and believes,
based upon current knowledge, that one is not needed.
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 second quarter at no cost to the Company. (2) Reservations. The Company is
currently working with the various franchisers 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 second
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
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
equipment is already Year 2000 compliant and it is anticipated that all physical
systems, including telephone systems, will be Year 2000 compliant by the 1999
third quarter at an anticipated cost of less than $100,000.
The Company is also reviewing its facilities to determine non-information
systems which might be Year 2000 vulnerable. Once these systems have been fully
identified, the Company will determine, with the help of outside vendors,
whether these systems are vulnerable to the Year 2000 issue. Potential
non-information technology systems include, but are not limited to, access
doors, alarms, elevators, heating and air conditioning systems, irrigation
systems, security systems, thermostats, utility meters and switches and, as
previously mentioned, telephone systems.
Although the Company believes that its hotel subsidiaries will not
experience Year 2000 compliance issues which will have a detrimental effect on
operations, there can be no assurance that the systems of other companies, on
which the Company's systems may rely, will be converted timely, or converted in
a manner that is compatible with the Company's systems, or that any such
failures by such other companies would not have a material adverse effect or
risk to the Company. The Company plans to devote all resources that would be
required to resolve any such issues in a timely manner arising from matters not
previously considered. In the event of a complete failure of information
technology systems, the Company would be able to continue the affected functions
either manually or through the use of non-Year 2000 compliant systems. The
primary costs associated with such a necessity would probably include (1)
increased time delays associated with posting of information, and (2) increased
personnel to manually process the information. The Company does not currently
have a contingency plan in place and believes, based upon current knowledge,
that one is not needed.
General. 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. The Company expects all of its internal efforts
will be completed by the third 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 September 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, 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 pro-actively 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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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
In the interest of providing stockholders with certain information
regarding the Company's future plans and operations, certain statements set
forth in this Form 10-Q are forward-looking statements. Although any
forward-looking statement expressed by or on behalf of the Company is, to the
knowledge and in the judgment of the officers and directors, expected to prove
true and come to pass, management is not able to predict the future with
absolute certainty. Forward-looking statements involve known and unknown risks
and uncertainties, which may cause the Company's actual performance and
financial results in future periods to differ materially from any projection,
estimate or forecasted result. Among others, these risks and uncertainties
include, the ability to obtain financing or refinance maturing debt; a potential
oversupply of commercial office buildings, industrial parks and hotels in the
markets served; the volatility of oil and gas prices; the ability to continually
replace and expand oil and gas reserves; the imprecise process of estimating oil
and gas reserves and future cash flows; and uncertainties inherent in the Year
2000 computer problems that may affect the Company and each of its business
segments.
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM. 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not directly have any derivative financial instruments in
place as of March 31, 1999, nor does it have foreign operations. Also, the
Company does not enter into financial instrument transactions for trading or
other speculative purposes. However, the Company's energy division through its
investment in HEP has attempted to hedge the exposure related to its variable
debt and its sales of forecasted oil and natural gas production in amounts,
which it believes are prudent based on the prices of available derivatives and,
in the case of production hedges, HEP's deliverable volumes. HEP attempts to
manage the exposure to adverse changes in the fair value of its fixed rate debt
agreements by issuing fixed rate debt only when business conditions and markets
are favorable. Management does not consider the portion attributable to the
Company to be significant in relation to these derivative instruments.
As of March 31, 1999, HRP had a single "pay fixed/receive variable"
interest rate swap agreement with highly rated counterparties in which the
interest payments are calculated on a notional amount. Management does not
consider the portion attributable to the Company to be significant on this
derivative instrument.
The Company is exposed to market risk due to fluctuations in interest
rates. The Company utilizes both fixed rate and variable rate debt to finance
its operations. As of March 31, 1999, the Company's total outstanding loans and
debentures payable of $66,545,000 were comprised of $50,028,000 of fixed rate
debt and $16,517,000 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 $1,330,000, assuming that
outstanding debt remained at current levels.
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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
At the Company's Annual Meeting of Stockholders held on May 5, 1999,
stockholders voted on one proposal:
(i) To elect one director to hold office for three years and until a
successor is elected and qualified:
Nominee Director Votes For Votes Withheld
---------------- --------- --------------
Brian M. Troup 1,210,149 5,494
As a result of the above, the nominee director was elected for an
additional three-year term. The continuing directors are Messrs.
Gumbiner, Crocco and Talbot.
5 Other Information None
6 Exhibits and Reports on Form 8-K
(a) Exhibits
(i) 10.33 - Amendment No. 5, dated as of
March 26, 1999, to Credit Agreement,
dated as of January 7, 1997, among
Brookwood Companies Incorporated,
Kenyon Industries, Inc., Brookwood
Laminating, Inc., as Borrowers, and
The Bank of New York, filed herewith. Page 30 to 32
(ii) 10.34 - Agreement, as of May 5, 1999, among
The Hallwood Group Incorporated,
Epsilon Trust and Brian Troup, filed
herewith. Page 33 to 48
(iii) 27 - Financial Data Schedule Page 49
(b) Reports on Form 8-K None
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28
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE HALLWOOD GROUP INCORPORATED
Dated: May 13, 1999 By: /s/ Melvin J. Melle
-----------------------------------
Melvin J. Melle, Vice President
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.33 Amendment No. 5, dated as of March 26, 1999, to Credit Agreement,
dated as of January 7, 1997, among Brookwood Companies
Incorporated, Kenyon Industries, Inc., Brookwood Laminating,
Inc., as Borrowers, and The Bank of New York.
10.34 Agreement, as of May 5, 1999, among The Hallwood Group
Incorporated, Epsilon Trust and Brian Troup
27 Financial Data Schedule
Page 29