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, 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
--- ---
1,882,483 shares of Common Stock, $.10 par value per share,
were outstanding at November 5, 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 September 30, 1999
and December 31, 1998.................................................. 3-4
Consolidated Statements of Income for the
Nine Months Ended September 30, 1999 and 1998.......................... 5-6
Consolidated Statements of Income for the
Three Months Ended September 30, 1999 and 1998......................... 7-8
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998.......................... 9
Notes to Consolidated Financial Statements................................. 10-18
2 Managements's Discussion and Analysis of
Financial Condition and Results of Operations.............................. 19-28
3 Quantitative and Qualitative Disclosures about Market Risk..................... 29
PART II - OTHER INFORMATION
---------------------------
1 thru 6 Exhibits, Reports on Form 8-K and Signature Page............................... 30-33
Page 2
3
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
ASSETS
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------ -----------
ASSET MANAGEMENT
REAL ESTATE
Investments in HRP ........................ $ 10,260 $ 9,771
Receivables and other assets .............. 1,685 687
-------- --------
11,945 10,458
ENERGY
Investments in HEC ........................ 5,878 --
Oil and gas properties, net ............... -- 11,479
Current assets of HEP ..................... -- 2,895
Noncurrent assets of HEP .................. -- 1,219
Receivables and other assets .............. -- 482
-------- --------
5,878 16,075
-------- --------
Total asset management assets .......... 17,823 26,533
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Inventories ............................... 17,708 16,708
Receivables ............................... 13,409 11,713
Property, plant and equipment, net ........ 9,030 8,738
Other ..................................... 794 889
-------- --------
40,941 38,048
HOTELS
Properties, net ........................... 30,740 31,810
Receivables and other assets .............. 3,826 3,845
-------- --------
34,566 35,655
-------- --------
Total operating subsidiaries assets .... 75,507 73,703
OTHER
Deferred tax asset, net ................... 6,348 6,348
Other ..................................... 1,167 1,191
Restricted cash ........................... 1,018 708
Cash and cash equivalents ................. 454 769
-------- --------
Total other assets ..................... 8,987 9,016
-------- --------
TOTAL .................................. $102,317 $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
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------ -----------
ASSET MANAGEMENT
REAL ESTATE
Accounts payable and accrued expenses ................................... $ 742 $ 775
Loan payable ............................................................ 500 500
--------- ---------
1,242 1,275
ENERGY
Loan payable ............................................................ 1,067 2,267
Accounts payable and accrued expenses ................................... 395 1,144
Long-term obligations of HEP ............................................ -- 5,306
Current liabilities of HEP .............................................. -- 3,949
--------- ---------
1,462 12,666
--------- ---------
Total asset management liabilities ................................... 2,704 13,941
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Loan payable ............................................................ 11,400 9,900
Accounts payable and accrued expenses ................................... 7,861 7,646
--------- ---------
19,261 17,546
HOTELS
Loans payable ........................................................... 29,975 30,354
Accounts payable and accrued expenses ................................... 3,125 2,120
--------- ---------
33,100 32,474
--------- ---------
Total operating subsidiaries liabilities ............................. 52,361 50,020
OTHER
7% Collateralized Senior Subordinated Debentures ........................ 14,429 14,727
10% Collateralized Subordinated Debentures .............................. 6,779 6,808
Interest and other accrued expenses ..................................... 906 1,818
--------- ---------
Total other liabilities .............................................. 22,114 23,353
--------- ---------
TOTAL LIABILITIES .................................................... 77,179 87,314
REDEEMABLE PREFERRED STOCK
Series B, 250,000 shares issued and outstanding;
stated at redemption value .......................................... 1,000 1,000
STOCKHOLDERS' EQUITY (NOTE 9)
Preferred stock, 250,000 shares issued and outstanding as Series B ...... -- --
Common stock, issued 2,396,163 shares at both dates;
outstanding 1,882,483 shares at both dates ........................... 240 160
Additional paid-in capital .............................................. 54,743 54,823
Accumulated deficit ..................................................... (21,476) (24,676)
Treasury stock, 513,680 shares at both dates; at cost ................... (9,369) (9,369)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY ........................................... 24,138 20,938
--------- ---------
TOTAL ................................................................ $ 102,317 $ 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)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1999 1998
------- -------
ASSET MANAGEMENT
REAL ESTATE
Fees ........................................... $ 6,751 $ 4,107
Equity income from investments in HRP .......... 1,001 1,364
------- -------
7,752 5,471
Administrative expenses ........................ 1,724 1,442
Depreciation and amortization .................. 504 504
Interest ....................................... -- 58
------- -------
2,228 2,004
------- -------
Income from real estate operations .......... 5,524 3,467
ENERGY
Gas revenues ................................... 1,677 2,830
Oil revenues ................................... 603 1,081
Other income ................................... 235 56
Equity income from investments in HEC .......... 190 --
------- -------
2,705 3,967
Depreciation, depletion and amortization ....... 849 1,206
Operating expenses ............................. 796 1,133
Administrative expenses ........................ 537 679
Interest ....................................... 249 411
------- -------
2,431 3,429
------- -------
Income from energy operations ............... 274 538
------- -------
Income from asset management operations ..... 5,798 4,005
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Sales .......................................... 63,172 63,420
Cost of sales .................................. 54,028 54,847
Administrative and selling expenses ............ 6,987 6,684
Interest ....................................... 690 741
------- -------
61,705 62,272
------- -------
Income from textile products operations ..... 1,467 1,148
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)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
1999 1998
-------- --------
OPERATING SUBSIDIARIES (CONTINUED)
HOTELS
Sales .................................................... $ 17,295 $ 16,013
Operating expenses ....................................... 14,745 14,004
Depreciation and amortization ............................ 2,105 2,051
Interest ................................................. 1,869 847
-------- --------
18,719 16,902
-------- --------
Loss from hotel operations ............................ (1,424) (889)
-------- --------
Income from operating subsidiaries .................... 43 259
OTHER
Fee income ............................................... 241 412
Interest on short-term investments and other income ...... 94 142
Litigation settlement .................................... -- 1,025
-------- --------
335 1,579
Administrative expenses .................................. 1,813 1,982
Interest ................................................. 893 706
-------- --------
2,706 2,688
-------- --------
Other loss, net ....................................... (2,371) (1,109)
-------- --------
Income before income taxes and extraordinary loss ........ 3,470 3,155
Income taxes ............................................. 220 340
-------- --------
Income before extraordinary loss ......................... 3,250 2,815
Extraordinary loss ....................................... -- (375)
-------- --------
NET INCOME ...................................................... $ 3,250 $ 2,440
======== ========
PER COMMON SHARE (NOTE 9)
BASIC
Income before extraordinary loss ......................... $ 1.70 $ 1.47
Extraordinary loss ....................................... -- (0.20)
-------- --------
Net income ............................................ $ 1.70 $ 1.27
======== ========
ASSUMING DILUTION
Income before extraordinary loss ......................... $ 1.67 $ 1.41
Extraordinary loss ....................................... -- (0.19)
-------- --------
Net income ............................................ $ 1.67 $ 1.22
======== ========
See accompanying notes to consolidated financial statements.
Page 6
7
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------
1999 1998
-------- --------
ASSET MANAGEMENT
REAL ESTATE
Fees ........................................... $ 2,144 $ 1,390
Equity income from investments in HRP .......... 239 516
-------- --------
2,383 1,906
Administrative expenses ........................ 552 427
Depreciation and amortization .................. 168 168
-------- --------
720 595
-------- --------
Income from real estate operations .......... 1,663 1,311
ENERGY
Equity income from investments in HEC .......... 191 --
Gas revenues ................................... -- 985
Oil revenues ................................... -- 338
Other .......................................... -- (18)
-------- --------
191 1,305
Depreciation, depletion and amortization ....... -- 520
Operating expenses ............................. -- 333
Administrative expenses ........................ -- 233
Interest ....................................... 32 136
-------- --------
32 1,222
-------- --------
Income from energy operations ............... 159 83
-------- --------
Income from asset management operations ..... 1,822 1,394
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Sales .......................................... 18,903 17,808
Cost of sales .................................. 16,005 15,405
Administrative and selling expenses ............ 2,299 2,152
Interest ....................................... 225 193
-------- --------
18,529 17,750
-------- --------
Income from textile products operations ..... 374 58
See accompanying notes to consolidated financial statements.
Page 7
8
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------
1999 1998
------- -------
OPERATING SUBSIDIARIES (CONTINUED)
HOTELS
Sales .................................................... $ 5,099 $ 5,667
Operating expenses ....................................... 4,965 5,024
Depreciation and amortization ............................ 692 713
Interest ................................................. 631 346
------- -------
6,288 6,083
------- -------
Loss from hotel operations ............................ (1,189) (416)
------- -------
Loss from operating subsidiaries ...................... (815) (358)
OTHER
Interest on short-term investments and other income ...... 84 20
Fee income ............................................... -- 137
------- -------
84 157
Administrative expenses .................................. 569 622
Interest ................................................. 298 247
------- -------
867 869
------- -------
Other loss, net ....................................... (783) (712)
------- -------
Income before income taxes ............................... 224 324
Income taxes ............................................. 93 133
------- -------
NET INCOME ...................................................... $ 131 $ 191
======= =======
PER COMMON SHARE (NOTE 9)
BASIC ....................................................... $ 0.07 $ 0.10
======= =======
ASSUMING DILUTION ........................................... $ 0.07 $ 0.10
======= =======
See accompanying notes to consolidated financial statements.
Page 8
9
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
1999 1998
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ....................................................... $ 3,250 $ 2,440
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, depletion and amortization ...................... 4,362 4,817
Equity in net income of HRP ................................... (1,001) (1,364)
Distributions from HEP ........................................ 545 1,552
Undistributed income from HEP ................................. (484) (1,968)
Amortization of deferred gain from debenture exchanges ........ (327) (397)
Equity in net income of HEC ................................... (190) --
Preferred dividend from HEC ................................... 11 --
Extraordinary loss from extinguishment of debt ................ -- 375
Net change in textile products assets and liabilities ......... (2,443) 3,264
Net change in other assets and liabilities .................... (1,095) (554)
Net change in energy assets and liabilities ................... (481) 75
-------- --------
Net cash provided by operating activities .................. 2,147 8,240
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in textile products property and equipment ........... (1,139) (569)
Capital expenditures for hotels .................................. (826) (1,295)
Net change in restricted cash for investing activities ........... (310) (270)
Investment in HEP by general partner ............................. (50) (171)
Investments in energy property and equipment ..................... (8) (149)
Purchase of hotel properties and related assets .................. -- (20,378)
-------- --------
Net cash used in investing activities ......................... (2,333) (22,832)
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of bank borrowings and loans payable ................... (1,579) (4,912)
Proceeds from bank borrowings and loans payable .................. 1,500 18,550
Payment of preferred stock dividends ............................. (50) (50)
Repurchase of 7% Debentures ...................................... -- (2,146)
Purchase of common stock for treasury ............................ -- (250)
-------- --------
Net cash provided by (used in) financing activities ....... (129) 11,192
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS ............................ (315) (3,400)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ....................... 769 4,737
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD ............................. $ 454 $ 1,337
======== ========
See accompanying notes to consolidated financial statements.
Page 9
10
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS AND ACCOUNTING POLICIES
Interim Consolidated Financial Statements. The accompanying unaudited
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.
New Accounting Pronouncements. Statement of Financial Accounting
Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133") was issued in June 1998. The original
effective date for periods beginning after June 15, 1999 has been extended
one year to June 15, 2000, accordingly the Company will be required to
adopt SFAS No. 133 on January 1, 2001. The Company is currently not
planning on early adoption, and has not had an opportunity to evaluate the
impact of the provisions on its consolidated financial statements relating
to future adoption.
2. INVESTMENTS IN REAL ESTATE AFFILIATE (DOLLAR AMOUNTS IN THOUSANDS):
AS OF SEPTEMBER 30, 1999 AMOUNT AT INCOME FROM INVESTMENTS
------------------------- WHICH CARRIED AT FOR THE NINE MONTHS ENDED
COST OR --------------------------- SEPTEMBER 30,
NUMBER OF ASCRIBED SEPTEMBER 30, DECEMBER 31, -------------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 1999 1998 1999 1998
- ------------------------- --------- -------- ------------ ----------- -------- ---------
HALLWOOD REALTY PARTNERS, L.P.
- - General partner interest ........ -- $ 8,650 $ 3,408 $ 3,877 $ 43 $ 35
- - Limited partner interest ........ 413,040 5,377 6,852 5,894 958 1,329
-------- -------- -------- -------- ---------
Totals ......................... $ 14,027 $ 10,260 $ 9,771 $ 1,001 $ 1,364
======== ======== ======== ======== =========
At September 30, 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, the Company also records its pro rata
share of any partner capital transactions reported by HRP. The carrying
value of the Company's investments 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,
1999, resulted in a $49,000 decrease in the carrying value.
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 those management rights. For the nine months
ended September 30, 1999 and 1998 such amortization was $504,000 in each
period.
The Company has pledged 89,269 HRP limited partner units to secure the
$500,000 promissory note and 30,035 HRP limited partner units to secure
hotel operating leases. A negative pledge over all of the Company's limited
partner units was canceled in June 1999 concurrent with an amendment to the
Company's energy term loan.
Page 10
11
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
The quoted market price and the Company's carrying value per limited
partner unit (Quotron symbol HRY) at September 30, 1999 were $53.50 and
$16.59, respectively. The general partner interest is not publicly traded.
3. INVESTMENTS IN ENERGY AFFILIATE (DOLLAR AMOUNTS IN THOUSANDS):
AS OF SEPTEMBER 30, 1999 AMOUNT AT INCOME FROM INVESTMENTS
------------------------- WHICH CARRIED AT FOR THE NINE MONTHS ENDED
COST OR --------------------------- SEPTEMBER 30,
NUMBER OF ASCRIBED SEPTEMBER 30, DECEMBER 31, -------------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 1999 1998 1999 1998
- ------------------------- --------- -------- ------------ ----------- -------- ---------
HALLWOOD ENERGY CORPORATION
- - Common stock .................... 1,800,000 $ 5,299 $ 5,477 -- $ 179 --
- - Preferred stock ................. 43,816 401 401 -- 11 --
-------- ---------- ---------- -------- ---------
Totals ......................... $ 5,700 $ 5,878 -- $ 190 --
======== ========== ========== ======== =========
In December 1998, Hallwood Energy Partners, L.P. ("HEP") and its
affiliate, Hallwood Consolidated Resources Corporation ("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 ("HEC"). On April 30, 1999, a Joint Proxy
Statement/Prospectus for the consolidation was declared effective by the
Securities and Exchange Commission and was mailed to HEP unitholders and
HCRC stockholders as of the April 14, 1999 record date. On June 8, 1999,
HEC announced that the consolidation was approved by the HEP unitholders,
the HCRC stockholders and the Company and that the consolidation was
completed as of that date. At its inception, the common stock of HEC was
owned 56% by the Class A unitholders of HEP, 26% by the stockholders of
HCRC and 18% by the Company. HEP's Class C unitholders received redeemable
preferred stock in HEC. The Company received 1,800,000 shares of common
stock (18% of the total outstanding) and 43,816 shares of preferred stock
(1.9% of the total outstanding) in HEC, in exchange for the contribution of
its energy interests.
The consolidation created an exploration and production company with
estimated reserves of approximately 213 billion cubic feet of natural gas
equivalent. At September 30, 1999, HEC had total assets of approximately
$204 million and total liabilities of approximately $128 million. Because
of the larger size of HEC, 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. The
principal objectives of HEC are to explore for, develop, acquire and
produce oil and gas properties.
As of the June 8, 1999 consummation date, the Company no longer
proportionally consolidates its energy business. The investment in HEC is
accounted for under the equity method as the Company is deemed to exercise
significant influence over HEC's operational and financial policies. The
assets and liabilities of the Company's energy business were combined at
the consummation date to establish the initial investment in HEC of
$5,700,000, as follows (in thousands):
DESCRIPTION AMOUNT
----------- ------
Oil and gas properties ...................... $ 10,809
Current assets of HEP ....................... 3,267
Noncurrent assets of HEP .................... 1,194
Receivables and other assets ................ 64
Long-term obligations of HEP ................ (6,872)
Current liabilities of HEP .................. (2,160)
Accounts payable and accrued expenses ....... (602)
--------
$ 5,700
========
In accordance with the equity method of accounting, the Company records
its pro-rata share of HEC's net income (loss) available to common
stockholders, its share of HEC's preferred dividends and its pro rata share
of
Page 11
12
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
any capital transactions. The Company's proportionate share of the
underlying equity in net assets of HEC exceeded its investment by
$4,391,000 on the consummation date, which is being amortized at a rate
which approximates the depletion of HEC's reserves.
The quoted market price and the Company's carrying value per common
share (Quotron symbol HECO) at September 30, 1999 was $6.75 and $3.04,
respectively, and per preferred share (Quotron symbol HECOP) was $8.31 and
$9.15, respectively.
4. 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, management expects the court
to enter a final order approving the settlement which will be payable by
December 1999. In accordance with the terms of the energy consolidation,
the Company's liability to pay the settlement amount is limited to
$395,000, which had previously been recorded by the Company at the time of
the tender offer.
5. LOANS PAYABLE
Loans payable at the balance sheet dates are detailed below by business
segment (in thousands):
SEPTEMBER 30, 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 ......................... 1,067 2,267
Textile Products
Revolving credit facility, prime + .25%, due January 2000 ..... 11,400 9,900
Hotels
Term loan, 7.50% fixed, due October 2008 ...................... 17,024 17,198
Term loan, 7.86% fixed, due January 2008 ...................... 6,599 6,667
Term loan, 8.20% fixed, due November 2007 ..................... 5,164 5,209
Term loan, libor + 7.5%, due October 2005 ..................... 1,188 1,280
------- -------
29,975 30,354
------- -------
Total ..................................................... $42,942 $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
Page 12
13
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
"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 1998 first quarter.
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.
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 was collateralized by
all of the Company's HEP limited partner units, its investment in HEPGP and
Hallwood GP, Inc. and HEPGP's direct interests in certain oil and gas
properties. Significant terms included: (i) maturity date of May 15, 2000;
(ii) monthly principal payments of $133,000, plus interest; (iii) interest
rate of libor plus 3.5% (8.88% at September 30, 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.
In connection with the consolidation of the energy companies, the
Company amended the term loan to provide for the assumption of the
obligation by the Company. The outstanding principal balance, interest rate
and repayment terms remained identical to the original note and credit
agreement. The amendment further provided for (i) the release of all
collateral previously pledged; (ii) the pledge of all 1,800,000 common
shares and 43,816 preferred shares of HEC that were received at the
completion of the energy consolidation; and (iii) a covenant which requires
that the market value of the pledged HEC shares shall, at all times, be at
least 300% of the loan's outstanding principal balance. The outstanding
balance of the term loan at September 30, 1999 was $1,067,000.
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 (8.5% at September 30, 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. Brookwood's revolving credit facility matures in January
2000 and management, which is currently conducting loan negotiations,
believes the facility can be replaced at that time. The outstanding balance
at September 30, 1999 was $11,400,000.
At December 31, 1998, Brookwood was not in compliance with a covenant
contained in the Credit Agreement, which requires a minimum consolidated
capital expenditure of $1,313,000 in a calendar year. 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
Page 13
14
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
(earnings before interest, depreciation, taxes and amortization) 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 September 30, 1999 was
$17,024,000.
The mezzanine loan for $1,300,000 includes the following significant
terms: (i) interest rate of libor plus 7.5% (12.44% at September 30, 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 September 30, 1999 was $1,188,000.
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 September 30, 1999 was $6,599,000.
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
September 30, 1999 was $5,164,000.
6. 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"). 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 senior 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.
Management is currently exploring alternatives to refinance the 7%
Debentures which mature in July 2000.
Page 14
15
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
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, $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 is 8.9%.
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):
SEPTEMBER 30, DECEMBER 31,
DESCRIPTION 1999 1998
----------- ------------ -----------
7% Debentures (face amount) ................. $14,088 $14,088
Unamortized gain from exchange, net of
accumulated amortization ................. 341 639
------- -------
Totals ................................ $14,429 $14,727
======= =======
10% Debentures (face amount) ................ $ 6,468 $ 6,468
Unamortized gain from exchange, net of
accumulated amortization ................. 311 340
------- -------
Totals ................................ $ 6,779 $ 6,808
======= =======
7. INCOME TAXES
The following is a summary of the income tax expense (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1999 1998 1999 1998
----- ----- ----- ----
Federal
Current ................... $ 3 $ 10 $ 28 $ 40
Deferred .................. -- -- -- --
----- ----- ----- ----
Sub-total .............. 3 10 28 40
State ........................ 90 123 192 300
----- ----- ----- ----
Total .................. $ 93 $ 133 $ 220 $340
===== ===== ===== ====
State tax expense is an estimate based upon taxable income allocated to
those states in which the Company does business, at their respective tax
rates.
Page 15
16
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
The amount of the deferred tax asset (net of valuation allowance) was
$6,348,000 at September 30, 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.
8. SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
DESCRIPTION 1999 1998
----------- -------- --------
Supplemental schedule of non cash investing and financing activities:
Conversion of energy investment to equity method from proportional
consolidation method at consummation of energy consolidation
Oil and gas properties ............................................. $ 10,809 --
Current assets of HEP .............................................. 3,267 --
Noncurrent assets of HEP ........................................... 1,194 --
Receivables and other assets ....................................... 64 --
Long-term obligations of HEP ....................................... (6,872) --
Current liabilities of HEP ......................................... (2,160) --
Accounts payable and accrued expenses .............................. (602) --
-------- --------
$ 5,700 --
======== ========
Exchange of 10% Debentures for 7% Debentures .......................... -- $ 6,821
Supplemental disclosures of cash payments:
Interest paid ......................................................... $ 3,926 $ 3,038
Income taxes paid ..................................................... 838 446
9. 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
DESCRIPTION 1999 1998 1999 1998
----------- ------ ------ ------ ------
NET INCOME
Net income, as reported .......................... $ 131 $ 191 $3,250 $2,440
Less: Dividends on preferred stock ............... -- -- 50 50
------ ------ ------ ------
Net income available to common stockholders ...... $ 131 $ 191 $3,200 $2,390
====== ====== ====== ======
AVERAGE SHARES OUTSTANDING
Outstanding shares - basic ....................... 1,883 1,883 1,883 1,883
Stock options .................................... 30 66 28 78
------ ------ ------ ------
Outstanding shares - assuming dilution ........... 1,913 1,949 1,911 1,961
====== ====== ====== ======
NET INCOME PER COMMON SHARE
Basic ............................................ $ 0.07 $ 0.10 $ 1.70 $ 1.27
Assuming dilution ................................ $ 0.07 $ 0.10 $ 1.67 $ 1.22
On October 28, 1999, the Company announced that its board of
directors authorized a three-for-two stock split, payable in the form
of a stock dividend, of one share of common stock of the Company for
each
Page 16
17
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
two issued shares of common stock. The stock dividend had a record date
of October 28, 1999 and payable date of November 5, 1999. All
references to the number of common shares and the presentation of
earnings per common share have been retroactively adjusted for the
three-for-two stock split.
10. SEGMENT AND RELATED INFORMATION
The following represents the Company's reportable segment position for
the nine months ended September 30, 1999 and 1998, respectively (in
thousands):
REAL TEXTILE CONSOL
ESTATE ENERGY PRODUCTS HOTELS OTHER -IDATED
-------- -------- -------- --------- -------- --------
NINE MONTHS ENDED SEPTEMBER 30, 1999
Total revenue from external sources .... $ 7,752 $ 2,705 $ 63,172 $ 17,295 $ 335 $ 91,259
======== ======== ======== ========= ======== ========
Operating income (loss) ................ $ 5,524 $ 274 $ 1,467 $ (1,424) $ -- $ 5,841
======== ======== ======== ========= ========
Unallocable expenses, net .............. $ (2,371) (2,371)
======== ========
Income before income taxes ............. $ 3,470
========
NINE MONTHS ENDED SEPTEMBER 30, 1998
Total revenue from external sources .... $ 5,471 $ 3,967 $ 63,420 $ 16,013 $ 1,579 $ 90,450
======== ======== ======== ========= ========= ========
Operating income (loss) ................ $ 3,467 $ 538 $ 1,148 $ (889) $ -- $ 4,264
======== ======== ======== ========= =========
Unallocable expenses, net .............. $ (1,109) (1,109)
========= ========
Income before income taxes and
extraordinary gain (loss) .......... $ 3,155
========
Extraordinary gain (loss) .............. $ (482) $ 107 $ (375)
======== ========= ========
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, except for the conversion to the equity
method from the proportional consolidation method of accounting for the
energy segment as a result of the energy consolidation.. The total assets
of the Company have not materially changed since the December 31, 1998
annual report, although (i) the assets of the energy segment declined
approximately $10.2 million due to the conversion to the equity method, and
(ii) the assets of the textile products segment increased by approximately
$2.9 million due to seasonal fluctuations.
11. SEPARATION AGREEMENT
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 7% Debentures and
completion of the consolidation of the Company's energy interests with HEP
and HCRC to form HEC. The energy consolidation was completed on June 8,
1999.
Mr. Troup currently holds options to purchase 37,200 shares of the
Company's common stock. In addition, a trust of which members of Mr.
Troup's family are beneficiaries, currently owns 305,196 shares of the
Company's common stock. Upon satisfaction of the remaining conditions, Mr.
Troup will surrender his options, the trust will surrender all of its
shares of common stock to the Company, the options and stock will be
canceled and Mr. Troup will resign from all positions with the Company, HRP
and HEC.
In exchange, the Company will transfer to the trust or Mr. Troup 82,608
units of HRP, 360,000 shares of common stock of HEC, and all of the
Company's interest in the Enclave Suites resort in Orlando, Florida and any
other condominium hotel projects currently in process. In addition, the
Company will pay quarterly to Mr.
Page 17
18
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
Troup the lesser of 20% of the net cash flow from its real estate
management activities for the preceding quarter or $125,000, subject to
termination in certain events.
HRP and HEC have agreed to register the trust's and/or Mr. Troup's
units or shares in those entities upon request by Mr. Troup and the
Company, at the Company's expense. The Company will have the 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.
Mr. Troup and the trust have given an irrevocable proxy to the Company to
vote all their HRP units and HEC shares on any and all matters in and
according to the Company's sole discretion, until Mr. Troup or the trust
sell the units or shares.
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.
12. NEW YORK STOCK EXCHANGE LISTING
On September 17, 1999, the Company announced that it was in discussions
with the New York Stock Exchange ("NYSE"), regarding the continued listing
of the Company's common shares on the NYSE. It reported that, if for any
reason the Company's shares were no longer listed on the NYSE, the Company
would apply for listing on the American Stock Exchange or Nasdaq National
Market System and is confident that it can comply with the listing
requirements of either.
Page 18
19
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 $131,000 for the third quarter ended
September 30, 1999, compared to net income of $191,000 in the 1998 period.
The nine month reported net income of $3,250,000, compared to net income of
$2,440,000 in the prior-year period. Total revenue for the 1999 third
quarter was $26,660,000, compared to $26,843,000 in the 1998 period. For
the nine months, revenue was $91,259,000, compared to $90,450,000 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 $2,144,000 for the quarter ended September 30,
1999 increased by $754,000, or 54%, from $1,390,000 in the prior-year
period. Fee income of $6,751,000 for the nine months increased by
$2,644,000, or 64%, from $4,107,000 for the similar period a year ago. 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
and various third parties. The increases in 1999 were due primarily to a
$2,460,000 leasing commission earned during 1999, $714,000 of which was
recorded in the 1999 third quarter, in connection with the leasing of a
six-story, 151,000 square feet commercial office building owned by HRP.
One-half of the lease commission was paid in 1999 and the remainder is
payable at the date of occupancy, which is expected to occur in the second
or third quarter of 2000.
The equity income from investments in HRP represents the Company's
recognition of its pro rata share of income reported by HRP and
amortization of negative goodwill. For the 1999 third quarter, the Company
reported income of $239,000 compared to $516,000 in the period a year ago.
The comparative nine month amounts were income of $1,001,000 in 1999 and
$1,364,000 in 1998. The decreases resulted from HRP's lower operating
income in the 1999 periods attributable to higher administrative expenses.
The 1998 equity income is exclusive of the Company's $482,000 pro-rata
share of HRP's $1,876,000 loss on early extinguishment of debt, which is
reported separately as part of the net extraordinary loss.
Expenses. Administrative expenses of $552,000 increased by $125,000 in
the 1999 third quarter from $427,000, and for the nine month period,
increased by $282,000 to $1,724,000 from $1,442,000 in the prior-year
period. The increase was primarily attributable to the payments of
commissions to third party brokers associated with the increased fee
income.
Amortization expense of $168,000 for the third quarter and $504,000 for
the nine months in both the 1999 and 1998 periods relate to Hallwood
Realty's general partner investment in HRP to the extent allocated to
management rights.
Interest expense for the 1998 nine months of $58,000 relates to the
$500,000 promissory note, which had reached maturity.
ENERGY.
Revenue. Prior to the energy consolidation of HEP, HCRC and the energy
interests of the Company into the newly formed HEC, which was consummated
on June 8, 1999, the Company's energy investment consisted of two wholly
owned energy related subsidiaries and certain energy assets owned directly
by the Company. The general partner interest in HEP, owned by one of the
Company's subsidiaries, entitled the general partner to interests in HEP's
properties ranging from 2% to 25%. The Company also owned an approximate
6.5% interest in HEP limited partner units. The Company and its energy
subsidiaries formerly accounted for their ownership
Page 19
20
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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.
Pursuant to the terms of the consolidation, the Company received
1,800,000 shares of common stock (18% of the total outstanding) and 43,816
shares of preferred stock (1.9% of the total outstanding) in HEC, in
exchange for the contribution of its energy interests. As of the
consummation date, the Company no longer fully consolidates its energy
business. The investment in HEC is being accounted for under the equity
method as the Company is deemed to exercise significant influence over
HEC's operational and financial policies. Accordingly, the revenue and
expense items of the energy segment reflect proportionally consolidated
amounts through June 8, 1999. Thereafter, the Company records its pro-rata
share of HEC's net income available to common stockholders and preferred
dividends received as a single line item - Equity income from investments
in HEC.
The 1999 revenues and expenses from energy operations reflect
proportionally consolidated results through June 8, 1999, therefore no
revenues and expenses were reported in the 1999 third quarter other than
equity income from investments in HEC and interest expense on the Company's
energy term loan. Comparisons between 1999 and 1998 for the three month and
nine month periods are generally not meaningful because of the conversion
to the equity method of accounting as a result of the energy consolidation.
Gas revenue for the 1999 and 1998 nine month periods were $1,677,000
and $2,830,000, respectively. HEC's gas production for the 1999 period
(through June 8) and 1998 nine-month period were 855,000 mcf and 1,386,000
mcf, respectively. The average gas price for the 1999 nine month period was
$1.96 per mcf, compared to the 1998 average gas price of $2.04 per mcf. Oil
revenue for the 1999 and 1998 nine months were $603,000 and $1,081,000,
respectively. HEC's oil production for the 1999 period (through June 8) and
1998 nine month periods were 46,000 barrels and 80,000 barrels,
respectively. The average price per barrel for the 1999 nine month period
was $13.11, compared to the 1998 average price per barrel of $13.51.
Other income consists primarily of acquisition fee and interest income,
as well as a share of HEC's interest income, facilities income from two
gathering systems in New Mexico, pipeline revenue, equity in income of
affiliate and miscellaneous income or expense. The increase in other income
to $235,000 for the 1999 nine month period from $56,000 in 1998 is
primarily due to an increase in HEC's equity in income of affiliate.
The equity income from investments in HEC of $191,000 in the 1999 third
quarter represents the Company's recognition of its pro rata share (18%
ownership interest) of HEC's income available to common stockholders and a
cash dividend on its preferred stock. The nine month equity income of
$190,000 was for the period June 9 through September 30, 1999.
Expenses. Depreciation, depletion and amortization decreased by
$357,000 to $849,000 for the nine months compared to $1,206,000 in 1998,
primarily as a result of the shorter 1999 period described above.
Operating expenses decreased by $337,000 to $796,000 for the 1999 nine
month period from $1,133,000 in the prior-year, primarily as a result of
the shorter 1999 period described above.
Administrative expenses decreased by $142,000 for the 1999 nine month
period to $537,000 from $679,000 in 1998, primarily as a result of the
shorter 1999 period described above.
Interest expense in the 1999 third quarter of $32,000 is solely
attributable to the energy term loan, which had a remaining balance of
$1,067,000 at September 30, 1999. Interest expense decreased by $162,000 to
$249,000 for the 1999 nine months compared to $411,000 in 1998, primarily
as a result of the shorter 1999 period described above.
Page 20
21
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OPERATING SUBSIDIARIES. The reportable segments of the Company's operating
subsidiaries division consist of textile products and hotels.
TEXTILE PRODUCTS.
Revenue. Sales of $18,903,000 increased $1,095,000, or 6%, in the 1999
third quarter, compared $17,808,000 in the 1998 quarter. The comparative
nine month sales of $63,172,000 were slightly lower than the $63,420,000 in
1998. Demand for Brookwood's textile products in the distribution divisions
decreased in the first half of 1999, compared to the 1998 periods, due to
lower priced Asian imports and U.S. customers moving production out of the
country, while in the third quarter, sales increased at the Kenyon dying
and finishing plant and in the distribution divisions.
Expenses. Cost of sales of $16,005,000 increased $600,000, or 4%, in
the 1999 third quarter, from $15,405,000 in the 1998 quarter. The nine
month cost of sales decreased by $819,000 to $54,028,000, or 1%, compared
to $54,847,000 in the 1998 period. The respective changes in cost of sales
were principally the result of changes in sales revenues. The higher gross
profit margin for the 1999 third quarter (15.3% versus 13.5%) and the nine
month periods (14.5% versus 13.5%) resulted from higher gross profit
margins at the Kenyon plant, due to higher volumes and increased operating
efficiencies.
Administrative and selling expenses of $2,299,000 increased by
$147,000 in the 1999 third quarter from $2,152,000 for the comparable 1998
period, and increased $303,000 for the nine month period to $6,987,000 from
$6,684,000 for the comparable 1998 period. The increases were attributable
to higher consulting and other professional fees associated with increased
sales in the third quarter.
Interest expense of $225,000 increased by $32,000 in the 1999 third
quarter from $193,000 in 1998, and decreased by $51,000 for the nine months
to $690,000 in 1999 from $741,000 due to fluctuations in average borrowings
and lower interest rates.
HOTELS.
Revenue. Sales of $5,099,000 in the 1999 third quarter decreased by
$568,000, or 10%, from the year-ago amount of $5,667,000. The 1999
nine-month hotel sales of $17,295,000 increased by $1,282,000, or 8%,
compared to $16,013,000 for the 1998 period. The decrease for the third
quarter is due to a decline at the Company's three GuestHouse Suite hotels
attributable to an ongoing $3.0 million renovation expected to be completed
in the fourth quarter of 1999. The increase for the nine month period is
primarily due to management fee revenues from the July 1998 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, partially offset by declines
at the Company's three GuestHouse Suite hotels. The Holiday Inn revenues
increased by $1,247,000 for the nine months, as a result of increased
occupancy and average daily rate following the completion of an extensive
renovation project in April 1998 and improved weather conditions in 1999.
For the hotel segment, average daily rate increased 1.3% and average
occupancy level decreased 11.4% in the 1999 nine months compared to the
prior-year period.
Expenses. Operating expenses of $4,965,000 for the 1999 third quarter
decreased by $59,000, or 1%, from $5,024,000 in 1998. The 1999 nine month
hotel operating expenses increased by $741,000, or 5%, to $14,745,000,
compared to $14,004,000 for the 1998 period. The increase for the nine
months is primarily attributable to operating expenses for the Enclave
Suites and Holiday Inn, partially offset by reduced rent for the Embassy
Suites hotel, which was a leasehold prior to the fee interest being
acquired in September 1998.
Depreciation and amortization expense decreased by $21,000 to $692,000
for the 1999 third quarter from $713,000 in the prior-year period.
Depreciation and amortization for the 1999 and 1998 nine month periods were
$2,105,000 and $2,051,000, respectively. The increase for the nine months
is primarily due to the
Page 21
22
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
amortization of the owner's rental contracts and depreciation of related
real estate at the Enclave Suites and the fee interest in the Embassy
Suites.
Interest expense increased by $285,000 to $631,000 for the 1999 third
quarter from $346,000 in 1998 and increased by $1,022,000 to $1,869,000 for
the nine month period from $847,000, principally due to the September 1998
term loans to acquire the Embassy Suites fee interest.
OTHER.
Revenue. Fee income in the 1999 third quarter of $-0- and $241,000 for
the nine months compares to the 1998 amounts of $137,000 and $412,000,
respectively. The decreases are due to the termination of a consulting
contract with the Company's energy affiliate following the completion of
the energy consolidation on June 8, 1999.
Interest on short-term investments and other income increased by
$64,000 to $84,000 for the 1999 third quarter from $20,000 in 1998 and for
the nine months decreased by $48,000 to $94,000 from $142,000. The
fluctuations were attributable to interest income earned on the Company's
short-term investments and rental income from the subleasing of executive
office space formerly occupied by an affiliated entity.
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 revenue in the 1998 second quarter.
Expenses. Administrative expenses of $569,000 for the 1999 third
quarter decreased by $53,000 from the prior-year amount of $622,000. For
the nine months, the decrease was $169,000 to $1,813,000 from $1,982,000.
The declines are primarily attributable to the inclusion in 1998 of
compensation expense recorded upon the acquisition of certain unexercised
stock options and costs of the debenture exchange offer, partially offset
by the elimination of certain overhead reimbursements from the Company's
energy affiliate following the completion of the energy consolidation.
Interest expense of $298,000 for the 1999 third quarter increased by
$51,000 from the prior year amount of $247,000 and increased by $187,000
for the nine months to $893,000 from $706,000 due to the August 1998
debenture exchange offer, whereby approximately $6.5 million of 7%
debentures were exchanged for a new issue of 10% debentures.
Income taxes. Income taxes were $93,000 for the 1999 third quarter
compared to $133,000 in the 1998 quarter. The respective quarters included
$90,000 and $123,000 for state taxes. Income taxes were $220,000 for the
1999 nine month period, compared to $340,000 in 1998. The respective state
tax expense was $192,000 and $300,000. 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 September 30, 1999, the Company had approximately $99,000,000 of
net operating loss carryforwards ("NOLs") and temporary differences to
reduce future federal income tax liabilities. 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
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
of the NOLs. Management periodically re-evaluates its tax planning
strategies based upon changes in facts and circumstances and, accordingly,
considers potential adjustments to the valuation allowance of the deferred
tax asset. Although the use of such carryforwards could, under certain
circumstances, be limited, the Company is presently unaware of the
occurrence of any event which would result in the imposition of such
limitations.
Extraordinary loss. For the 1998 nine month period, the Company
recognized an extraordinary loss from early extinguishment of debt of
$375,000, which was comprised of the Company's $482,000 pro-rata share of
HRP's $1,876,000 nine month loss on early extinguishment of debt, offset by
a $107,000 gain from the January 1998 purchase of 7% Debentures, having a
face amount of $2,253,000, at a discounted amount of $2,146,000.
Page 23
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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, 1999
totaled $454,000.
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 a total of 119,304 HRP limited
partnership units as collateral for a promissory note and certain hotel lease
obligations, and has the ability to pledge its remaining units to secure
additional financing.
All of the Company's energy activities are conducted through HEC, following
the consummation of the energy consolidation on June 8, 1999. The Company has
pledged its investments in HEC, consisting of 1,800,000 common shares and 43,816
preferred shares, as collateral for the energy term loan. The preferred stock is
entitled to an annual cumulative dividend of $1.00 per share. HEC has no current
plans to pay cash dividends on its common stock.
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, 1999, Brookwood had $3,210,000 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.
The Company received a cash dividend of $400,000 in October 1999 and received
$200,000 under its tax sharing agreement in the nine months ended September 30,
1999. An additional tax payment is expected to be received in December 1999. At
December 31, 1998, Brookwood was not in compliance with covenant contained in
the Credit Agreement, which requires a minimum consolidated capital expenditure
of $1,313,000 in a calendar year. 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, which is currently conducting loan negotiations, believes
the facility can be 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 being funded from the Company's capital reserves and lease
facilities. As of October 31, 1999, the Huntsville property was fully completed;
the Greenville property 80% completed; and the Tulsa property 60% completed. The
renovation of these properties is expected to be completed by December 31, 1999.
Management believes that it will have sufficient funds from operations to
satisfy its current obligations, and is currently exploring alternatives to
refinance the 7% Debentures which mature in July 2000.
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 has identified and assessed its non-information technology systems
("Non-IT
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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), 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. These systems were
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 completed a survey in September 1999 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. None have indicated that they
expect to encounter any serious problems.
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 the fourth quarter of 1999 at
minimal cost. (4) Payroll - Year 2000 compliant software was purchased and
installed in the fourth quarter of 1998 at minimal cost.
In July 1999, HRP completed a survey 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 included the identification of certain on-site,
non-information technology systems that could be vulnerable to the Year 2000
issue. These non-information technology systems included, but were not limited
to, access gates, alarms, elevators, heating and air conditioning systems,
irrigation systems, security systems, thermostats, and utility meters and
switches. During early November 1999, HRP completed the remaining Year 2000
upgrades and replacements found in the property survey. Total costs, including
information and non-information technology systems, are not expected to exceed
$100,000.
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. HRP has utilized and will
continue to utilize, as necessary, external and internal resources to reprogram,
replace and test its systems for Year 2000 modifications. 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 increased time delays associated with posting of information,
and 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.
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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 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. HEC's Year 2000 Plan has four phases: (i) assessment, (ii)
inventory, (iii) remediation, testing and implementation and (iv) contingency
plans. Approximately eighteen months ago, HEC 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 HEC's IT systems that must be updated or replaced
in order to be Year 2000 compliant. Remediation, testing and implementation was
substantially completed by September 30, 1999, and the contingency plans phase
is scheduled to be completed by November 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. HEC's
assessment of the readiness of third parties, whose IT systems might have an
impact on HEC's business, has thus far not indicated any material problems;
responses have been received to approximately 70% of the inquiries made.
With regard to HEC's Non-IT systems, HEC believes that most of these
systems can be brought into compliance on schedule. Because Non-IT systems are
embedded chips, it is difficult to determine with complete accuracy where all
such systems are located. However, to the best knowledge of HEC's management,
the assessment of third party readiness is complete.
Although it is difficult to estimate the total costs of implementing the
plan through January 1, 2000 and beyond, HEC's preliminary estimate is that such
costs will not be material. To date, HEC has determined that its IT systems are
either compliant or can be made compliant for less than $100,000. 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 from 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 HEC's IT and Non-IT systems, as well as
to the systems of third parties. Such failures could materially and adversely
affect HEC'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, HEC is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the HEC
results of operations, cash flow or financial condition. Primarily because of
its reliance on third party suppliers, the Company is not is not currently able
to determine the consequences of Year 2000 failures, however, 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 HEC. HEC has contacted 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 purchasers and pipelines will not guaranty
their state of readiness, to date, none have indicated that they expect to
encounter any serious problems. HEC 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.
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 has been
installed and tested. All operating programs will be modified and fully
operational by November 30, 1999. (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 and is now compliant. (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.
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Additionally, Brookwood has surveyed 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. None have indicated that they expect to encounter any serious
problems.
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 increased time delays associated with posting of information ,
and 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
purchased updated software for its existing system that is Year 2000 compliant.
The software update was installed and tested in the 1999 third 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 purchased updated software for its existing system
that is Year 2000 compliant. The software update was installed and tested in
October 1999 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 systems,
including telephone systems, will be Year 2000 compliant by November 30, 1999 at
an anticipated cost of less than $100,000.
The Company, with the help of outside vendors, has reviewed its facilities
to determine non-information systems which might be Year 2000 vulnerable.
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 increased time delays associated with posting of information,
and 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 complete and that its remediation is
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
approximately 90% complete. The Company anticipates completing the Year 2000
project by December 31, 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.
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.
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.
Page 28
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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 September 30, 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 HEC 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, HEC's deliverable volumes. HEC 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 September 30, 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 September 30, 1999, the Company's total outstanding loans
and debentures payable of $63,498,000 were comprised of $49,843,000 of fixed
rate debt and $13,655,000 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 $1,270,000,
assuming that outstanding debt remained at current levels.
Page 29
30
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) 27 - Financial Data Schedule Page 33
(b) Reports on Form 8-K None
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31
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 12, 1999 By: /s/ Melvin J. Melle
--------------------------------------------
Melvin J. Melle, Vice President
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
Page 31
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
27 Financial Data Schedule
Page 32