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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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
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FOR THE PERIOD ENDED MARCH 31, 2002 COMMISSION FILE NUMBER: 1-8303
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THE HALLWOOD GROUP INCORPORATED
(Exact name of registrant as specified in its charter)
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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
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF CLASS ON WHICH REGISTERED
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Common Stock ($.10 par value) American Stock Exchange
10% Collateralized Subordinated Debentures Due July 31, 2005 New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF CLASS
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Series B Redeemable Preferred Stock
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
--- ---
1,361,343 shares of Common Stock, $.10 par value per share,
were outstanding at April 30, 2002.
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
ITEM NO. PART I - FINANCIAL INFORMATION PAGE
-------- ----
1 Financial Statements (Unaudited):
Consolidated Balance Sheets as of March 31, 2002
and December 31, 2001........................................... 3
Consolidated Statements of Income for the
Three Months Ended March 31, 2002 and 2001...................... 5
Consolidated Statements of Comprehensive Income for the
Three Months Ended March 31, 2002 and 2001...................... 7
Consolidated Statements of Changes in Stockholders' Equity for the
Three Months Ended March 31, 2002............................... 8
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2002 and 2001...................... 9
Notes to Consolidated Financial Statements........................... 10
2 Management's Discussion and Analysis of
Financial Condition and Results of Operations........................ 21
3 Quantitative and Qualitative Disclosures about Market Risk.............. 27
PART II - OTHER INFORMATION
1 thru 6 Exhibits, Reports on Form 8-K and Signature Page........................ 28
Page 2
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
MARCH 31, DECEMBER 31,
2002 2001
------------ ------------
(UNAUDITED)
REAL ESTATE
Investments in HRP ................................. $ 13,178 $ 12,261
Receivables and other assets
Related parties ................................. 74 242
Other ........................................... 58 55
------------ ------------
13,310 12,558
TEXTILE PRODUCTS
Inventories ........................................ 17,498 16,753
Receivables
Other ........................................... 12,640 11,896
Related parties ................................. 7,409 5,217
Property, plant and equipment, net ................. 9,404 9,426
Investment in joint venture ........................ 1,250 676
Prepaids, deposits and other assets ................ 885 1,030
------------ ------------
49,086 44,998
OTHER
Deferred tax asset, net ............................ 5,111 5,677
Cash and cash equivalents .......................... 1,957 3,006
Investment in HEC .................................. 1,459 --
Prepaids, deposits and other assets ................ 1,270 408
Restricted cash .................................... 971 966
Hotel assets held for use .......................... 471 448
------------ ------------
11,239 10,505
DISCONTINUED OPERATIONS
Hotels held for sale
Properties, net ................................. 3,832 6,602
Deferred tax asset, net ......................... 925 1,800
Receivables and other assets .................... 461 1,104
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5,218 9,506
------------ ------------
TOTAL ........................................... $ 78,853 $ 77,567
============ ============
See accompanying notes to consolidated financial statements.
Page 3
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY
MARCH 31, DECEMBER 31,
2002 2001
------------ ------------
(UNAUDITED)
REAL ESTATE
Accounts payable and accrued expenses ....................... $ 744 $ 1,133
TEXTILE PRODUCTS
Accounts payable and accrued expenses ....................... 15,605 9,390
Loans payable ............................................... 13,717 16,255
------------ ------------
29,322 25,645
OTHER
10% Collateralized Subordinated Debentures .................. 6,665 6,677
Deferred revenue - noncompetition agreement ................. 5,236 5,840
Interest and other accrued expenses ......................... 3,760 4,167
Term loan ................................................... 3,000 --
Capital lease obligations ................................... 1,287 1,386
Hotel liabilities held for use .............................. 569 529
Convertible loan from stockholder ........................... -- 1,500
------------ ------------
Total other liabilities .................................. 20,517 20,099
DISCONTINUED OPERATIONS
Hotels held for sale
Loans payable ............................................ 6,514 11,609
Accounts payable and accrued expenses .................... 1,527 2,198
------------ ------------
8,041 13,807
------------ ------------
TOTAL LIABILITIES ........................................ 58,624 60,684
REDEEMABLE PREFERRED STOCK
Series B, 250,000 shares issued and outstanding ............. 1,000 1,000
STOCKHOLDERS' EQUITY
Preferred stock, 250,000 shares issued and outstanding
as Series B .............................................. -- --
Common stock, issued 2,396,103 shares at both dates;
outstanding 1,361,343 shares at both dates ............... 240 240
Additional paid-in capital .................................. 54,452 54,452
Accumulated deficit ......................................... (20,369) (23,729)
Accumulated other comprehensive income ...................... 236 250
Treasury stock, 1,034,760 shares at both dates; at cost ..... (15,330) (15,330)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY ............................... 19,229 15,883
------------ ------------
TOTAL .................................................... $ 78,853 $ 77,567
============ ============
See accompanying notes to consolidated financial statements.
Page 4
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------
2002 2001
------------ ------------
REAL ESTATE
Fees
Related parties .......................................... $ 1,112 $ 1,905
Other .................................................... 7 75
Equity income from investments in HRP ....................... 533 685
------------ ------------
1,652 2,665
Administrative expenses ..................................... 220 527
Amortization ................................................ 168 168
------------ ------------
388 695
------------ ------------
Income from real estate operations ....................... 1,264 1,970
TEXTILE PRODUCTS
Sales ....................................................... 20,821 17,777
Equity income from joint venture ............................ 574 --
------------ ------------
21,395 17,777
Cost of sales ............................................... 18,053 15,136
Administrative and selling expenses ......................... 2,669 2,689
Interest .................................................... 166 302
------------ ------------
20,888 18,127
------------ ------------
Income (loss) from textile products operations ........... 507 (350)
OTHER
Amortization of deferred revenue -
noncompetition agreement .................................. 604 --
Hotel revenue ............................................... 440 432
Interest and other income ................................... 304 5
Equity loss from investment in HEC .......................... (41) --
------------ ------------
1,307 437
Hotel expenses .............................................. 437 453
Administrative expenses ..................................... 382 235
Interest expense ............................................ 205 746
------------ ------------
1,024 1,434
------------ ------------
Other income (loss), net ................................. 283 (997)
------------ ------------
Income from continuing operations before income taxes .... 2,054 623
Income taxes ............................................. (738) (272)
------------ ------------
Income from continuing operations ........................ 1,316 351
See accompanying notes to consolidated financial statements.
Page 5
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
---------------------------
2002 2001
------------ ------------
Income from discontinued operations, net of tax
Income from discontinued operations - Hotels .................................. $ 1,476 $ 21
Income from discontinued operations - Energy .................................. -- 4,928
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Income from discontinued operations ......................................... 1,476 4,949
------------ ------------
Income before extraordinary loss and cumulative effect
of changes in accounting principles ........................................... 2,792 5,300
Extraordinary loss from early extinguishment of debt ............................ -- (9)
------------ ------------
Income before cumulative effect of changes in accounting principles ............. 2,792 5,291
Income (loss) from cumulative effect of changes in accounting principles
Income from cumulative effect of SFAS No. 142 adoption ........................ 568 --
Loss from cumulative effect of SFAS No. 133 adoption .......................... -- (40)
------------ ------------
Income (loss) from cumulative effect of changes in accounting principles .... 568 (40)
------------ ------------
NET INCOME .......................................................................... $ 3,360 $ 5,251
============ ============
PER COMMON SHARE
BASIC
Income from continuing operations ............................................. $ 0.97 $ 0.25
Income from discontinued operations ........................................... 1.08 3.47
Extraordinary loss from early extinguishment of debt .......................... -- --
Income (loss) from cumulative effect of changes in accounting principles ...... 0.42 (0.03)
------------ ------------
Net income .................................................................. $ 2.47 $ 3.69
============ ============
ASSUMING DILUTION
Income from continuing operations ............................................. $ 0.85 $ 0.23
Income from discontinued operations ........................................... 0.94 2.87
Extraordinary loss from early extinguishment of debt .......................... -- --
Income (loss) from cumulative effect of changes in accounting principles ...... 0.36 (0.03)
------------ ------------
Net income .................................................................. $ 2.15 $ 3.07
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ........................................................................... 1,361 1,425
============ ============
Assuming Dilution ............................................................... 1,579 1,727
============ ============
See accompanying notes to consolidated financial statements.
Page 6
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------
2002 2001
------------ ------------
NET INCOME ................................................................. $ 3,360 $ 5,251
Other Comprehensive Income (Loss)
Pro rata share of other comprehensive income from equity investments
Adoption of SFAS No. 133
Cumulative effect ................................................ -- (4,311)
Change in fair value of derivatives .............................. -- 1,302
Amortization of interest rate swap .................................. (14) --
------------ ------------
Other comprehensive loss ...................................... (14) (3,009)
------------ ------------
COMPREHENSIVE INCOME ....................................................... $ 3,346 $ 2,242
============ ============
See accompanying notes to consolidated financial statements.
Page 7
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
------------------------ PAID-IN ACCUMULATED COMPREHENSIVE
SHARES PAR VALUE CAPITAL DEFICIT INCOME
---------- ---------- -------------- -------------- --------------
BALANCE, JANUARY 1, 2002 ................... 2,396 $ 240 $ 54,452 $ (23,729) $ 250
Net income ............................... 3,360
Pro rata share of stockholders'
equity transactions from equity
investment:
Amortization of interest rate swap ..... (14)
---------- ---------- -------------- -------------- --------------
BALANCE, MARCH 31, 2002 .................... 2,396 $ 240 $ 54,452 $ (20,369) $ 236
========== ========== ============== ============== ==============
TREASURY STOCK TOTAL
----------------------- STOCKHOLDERS'
SHARES COST EQUITY
---------- ---------- --------------
BALANCE, JANUARY 1, 2002 ................... 1,035 $ (15,330) $ 15,883
Net income ............................... 3,360
Pro rata share of stockholders'
equity transactions from equity
investment:
Amortization of interest rate swap ..... (14)
---------- ---------- --------------
BALANCE, MARCH 31, 2002 .................... 1,035 $ (15,330) $ 19,229
========== ========== ==============
See accompanying notes to consolidated financial statements.
Page 8
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------
2002 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .......................................................... $ 3,360 $ 5,251
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of deferred revenue - noncompetition agreement ...... (604) --
Equity income from textile products joint venture ................ (574) --
(Income) loss from cumulative effect of changes in accounting
principles ..................................................... (568) 40
Decrease in deferred tax asset ................................... 566 200
Equity income from investments in HRP ............................ (533) (685)
Depreciation and amortization .................................... 521 589
Equity loss from investment in HEC ............................... 41 --
Amortization of deferred gain from debenture exchange ............ (12) (12)
Extraordinary loss from early extinguishment of debt ............. -- 9
Net change in textile products assets and liabilities ............ 2,679 85
Net change in other assets and liabilities ....................... (563) 272
Discontinued operations:
Extraordinary gain from extinguishment of hotel debt .......... (1,677) --
Net change in other hotel assets and liabilities .............. 199 79
Increase in deferred tax asset ................................ -- (3,586)
Equity income from investments in Hallwood Energy ............. -- (1,342)
------------ ------------
Net cash provided by operating activities ..................... 2,835 900
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in HEC common stock ...................................... (1,500) --
Investments in textile products property and equipment .............. (303) (367)
Investment in hotel held for use .................................... (8) --
Investment in marketable securities ................................. (901) --
------------ ------------
Net cash (used in) investing activities ....................... (2,712) (367)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings and loans payable ..................... 3,000 1,798
Repayment of bank borrowings and loans payable ...................... (4,137) (813)
Payment of deferred loan costs ...................................... (35) --
Discontinued operations:
Repayment of hotel bank borrowings and loans payable ............. -- (100)
------------ ------------
Net cash provided by (used in) financing activities .......... (1,172) 885
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .................... (1,049) 1,418
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .......................... 3,006 901
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................................ $ 1,957 $ 2,319
============ ============
See accompanying notes to consolidated financial statements.
Page 9
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
NOTE 1 -- INTERIM CONSOLIDATED FINANCIAL STATEMENTS AND ACCOUNTING POLICIES
Interim Consolidated Financial Statements. The consolidated financial
statements of The Hallwood Group Incorporated (the "Company") have been prepared
in accordance with the instructions to Form 10-Q and do not include all of the
information and disclosures required by accounting principles generally accepted
in the United States of America, although, in the opinion of management, all
adjustments considered necessary for a fair presentation have been included.
These financial statements should be read in conjunction with the audited
consolidated financial statements and related disclosures thereto included in
Form 10-K for the year ended December 31, 2001.
Continuing Operations. The Company's real estate activities are conducted
primarily through wholly-owned subsidiaries. One of the subsidiaries serves as
the general partner of Hallwood Realty Partners, L.P. ("HRP"), a publicly traded
master limited partnership. Revenues are generated through the Company's pro
rata share of earnings of HRP on the equity method of accounting and the receipt
of management fees, leasing commissions and other fees from HRP and third
parties.
The textile products operations are conducted through the Company's wholly
owned Brookwood Companies Incorporated ("Brookwood") subsidiary. Brookwood is a
complete textile service firm that develops and produces innovative fabrics and
related products through specialized finishing, treating and coating processes.
Discontinued Operations. In May 2001, the Company decided to discontinue
and dispose of its energy segment, accordingly, this former business segment has
been reclassified as a discontinued operation. Prior to the disposition, the
Company's energy revenues consisted of its pro rata share of earnings of
Hallwood Energy Corporation ("Hallwood Energy"), a publicly traded oil and gas
company, on the equity method of accounting.
In December 2000, the Company decided to discontinue and dispose of its
hotel segment, which at that time consisted of five hotel properties.
Accordingly, the Company's hotel operations were reclassified as a discontinued
operation. Two hotels were disposed of in 2001, one hotel was sold in January
2002 and the lender completed a foreclosure on one hotel in May 2002. The
Company determined in late 2001 that it would retain and continue to operate a
leasehold interest in one hotel. Balance sheet presentation for the two hotels
which have been disposed of in 2002 are reported as "Hotels held for sale" and
the retained leasehold interest as "Hotel assets held for use."
New Accounting Pronouncements. Statement of Financial Accounting Standards
No. 141 - Business Combinations ("SFAS No. 141") became effective July 1, 2001
and prohibits pooling-of-interests accounting for acquisitions. Statement of
Financial Accounting Standards No. 142 - Goodwill and Other Intangible Assets
("SFAS No. 142") became effective January 1, 2002 and specifies that goodwill
and some intangible assets will no longer be amortized but instead will be
subject to periodic impairment testing. The effect of adopting SFAS No. 142 had
an impact on the Company's financial statements to the extent that the
unamortized amount of negative goodwill associated with the Company's equity
investment in HRP was accounted for as a cumulative effect adjustment.
Statement of Financial Accounting Standards No. 143 - Accounting for Asset
Retirement Obligations ("SFAS No. 143") was issued in June 2001, and will be
adopted by the Company on January 1, 2003. This Statement addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. The
Company has not yet determined the effect adopting SFAS No. 143 will have on its
financial statements.
Statement of Financial Accounting Standards No. 144 - Accounting for the
Impairment or Disposal of Long- lived Assets ("SFAS No. 144") was issued in
August 2001, and was adopted by the Company on January 1, 2002. This Statement
supersedes SFAS No. 121, "Accounting for the Impairment of Long-lived Assets and
for Long-lived Assets to Be Disposed Of ", and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions", for the disposal of
a segment of a business (as previously defined in that Opinion). This statement
retains the requirements of SFAS No. 121 to (a) recognize an impairment
Page 10
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
loss, only if the carrying amount of a long-lived asset is not recoverable from
its undiscounted cash flows and (b) measure an impairment loss as the difference
between the carrying amount and fair value of the asset. This statement requires
that a long-lived asset to be abandoned, exchanged for a similar productive
asset, or distributed to owners in a spinoff be considered held and used until
it is disposed of. The accounting model for long-lived assets to be disposed of
by sale is used for all long-lived assets, whether previously held and used or
newly acquired. The accounting model retains the requirement of SFAS No. 121 to
measure a long-lived asset classified as held for sale at the lower of its
carrying amount or fair value less cost to sell and to cease depreciation. This
statement requires that the current and historical results of disposed
properties and assets held for sale be classified as discontinued operations.
The Company early adopted the requirements of this statement and accordingly,
hotel assets disposed of or to be disposed of have been reclassified as
discontinued operations for each of the periods presented.
Statement of Financial Accounting Standards No. 145 - Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections ("SFAS No. 145") was issued in May 2002 and is effective for fiscal
years beginning and transactions occurring after May 15, 2002. This statement
rescinds certain authoritative pronouncements and amends, clarifies or describes
the applicability of others. The Company has not yet determined the effect
adopting SFAS No. 145 will have on its financial statements.
Reclassifications. Certain reclassifications have been made to prior year
amounts to conform to the classifications used in the current year.
NOTE 2 -- INVESTMENTS IN REAL ESTATE AFFILIATE (DOLLAR AMOUNTS IN THOUSANDS)
AS OF MARCH 31,2002 AMOUNT AT INCOME FROM INVESTMENTS
--------------------------- WHICH CARRIED AT FOR THE THREE MONTHS ENDED
COST OR --------------------------- MARCH 31,
NUMBER OF ASCRIBED MARCH 31, DECEMBER 31, ---------------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 2002 2001 2002 2001
------------------------- ------------ ------------ ------------ ------------ ------------ ------------
HALLWOOD REALTY PARTNERS, L.P.
- General partner interest ........ -- $ 8,650 $ 1,800 $ 1,943 $ 27 $ 20
- Limited partner interest ........ 330,432 8,799 11,378 10,318 506 665
------------ ------------ ------------ ------------ ------------
Totals ......................... $ 17,449 $ 13,178 $ 12,261 $ 533 $ 685
============ ============ ============ ============ ============
At March 31, 2002, Hallwood Realty, LLC ("Hallwood Realty") and HWG, LLC,
wholly owned subsidiaries of the Company, owned a 1% general partner interest
and a 21% limited partner interest in its HRP affiliate, respectively. The
Company accounts for its investment in HRP using the equity method of
accounting. Prior to January 1, 2002, the Company recorded amortization of the
amount that the Company's share of the underlying equity in net assets of HRP
exceeded its investment on the straight line basis over nineteen years, which
was $568,000 as of January 1, 2002. In accordance with SFAS No. 142, the
unamortized amount of such "negative goodwill" has been recorded as income from
cumulative effect of a change in accounting principle. The Company also records
non-cash adjustments for the elimination of intercompany profits with a
corresponding adjustment to equity income, its pro-rata share of HRP's partner
capital transactions with corresponding adjustments to additional paid-in
capital and its pro-rata share of HRP's comprehensive income. The cumulative
amount of such non-cash adjustments, from the original date of investment
through March 31, 2002, resulted in a $1,674,000 decrease in the carrying value
of the HRP investment. In 2001, the Company also recognized an extraordinary
loss of $9,000 from the recognition of the Company's pro rata share of HRP's
extraordinary loss from early extinguishment of debt and a $40,000 loss from the
Company's pro rata share of HRP's loss from cumulative effect of SFAS No. 133
adoption.
The carrying value of the Company's general partner interest of HRP
includes the value of intangible rights to provide asset management and property
management services. The Company amortizes that portion of the general partner
interest ascribed to the management rights. For the three months ended March 31,
2002 and 2001 such amortization was $168,000 in each period.
As further discussed in Note 11, the Delaware Court of Chancery rendered
its opinion regarding certain litigation involving the Company in July 2001. The
court determined that the defendants, including the Company, should pay to HRP a
judgment of $3,417,000 plus pre-judgment interest of approximately $2,891,000
from August
Page 11
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
1995. The judgment amount, which represented the court's determination of an
underpayment by the Company for certain limited partnership units purchased by
the Company in 1995 from HRP, was considered additional purchase price and was
added to the Company's investment in the limited partnership units. The interest
component of the judgment was recorded as an expense, net of the Company's pro
rata share of the income that will be reported by HRP. In October 2001, the
Company paid $6,405,000, including post-judgment interest, to HRP, subject to an
arrangement that it be returned in full or part if the judgment is modified or
reversed on appeal.
The Company has pledged 300,397 HRP limited partner units to collateralize
the Term Loan and Revolving Credit Facility and the remaining 30,035 units to
secure all of the capital leases.
The quoted market price per unit and the Company's carrying value per
limited partner unit (AMEX symbol HRY) at March 31, 2002 were $70.00 and $34.43,
respectively. The general partner interest is not publicly traded.
NOTE 3 -- INVESTMENT IN HEC
In January 2002, the Company invested $1,500,000 in a newly-formed private
energy company - Hallwood Energy Corporation ("HEC"). The Company owns
approximately 24% of HEC and accounts for the investment using the equity method
of accounting. The Company reported an equity loss, representing its pro rata
share of HEC's net loss, of $41,000 in the 2002 first quarter.
NOTE 4 -- LOANS PAYABLE
Loans payable at the balance sheet dates are as follows (in thousands):
MARCH 31, DECEMBER 31,
2002 2001
------------ ------------
Textile Products
Revolving credit facility, prime + .25% or
Libor + 3.25%, due January 2004 ................................. $ 11,413 $ 14,449
Acquisition credit facility, prime + 1.00% or
Libor + 3.25%, due January 2004 ................................. 1,000 1,000
Equipment term loan, 9.37% fixed, due October 2005 .................. 762 806
Equipment term loan, Libor + 3.25%, due March 2007 .................. 542 --
------------ ------------
13,717 16,255
Other
Term loan, 7% fixed, due April 2005 ................................. 3,000 --
Revolving credit facility, prime + 0.50% or
Libor + 3.25%, due April 2005 ................................... -- --
Capital lease obligations, 12.18% fixed, due December 2004 .......... 1,287 1,386
Convertible loan from stockholder, 10% fixed, repaid March 2002 ..... -- 1,500
------------ ------------
4,287 2,886
------------ ------------
Total ........................................................... $ 18,004 $ 19,141
============ ============
Further information regarding loans payable is provided below:
Textile Products
Revolving Credit Facility. In December 1999, the Company's Brookwood
subsidiary entered into a revolving credit facility in an amount up to
$17,000,000 with Key Bank National Association ("Key Credit Agreement") to
replace its former credit facility. Availability for direct borrowings and
letter of credit obligations under the Key Credit Agreement are limited to the
lesser of the facility amount or the borrowing base so defined in the agreement.
As of March 31, 2002, Brookwood had an additional 4,490,000 of borrowing base
availability. Borrowings are
Page 12
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
collateralized by accounts receivable, inventory imported under trade letters of
credit, certain finished goods inventory, machinery and equipment and all of the
issued and outstanding capital stock of Brookwood and its subsidiaries. The Key
Credit Agreement has been extended through January 2, 2004, bears interest at
Brookwood's option of one-quarter percent over prime (5.00% at March 31, 2002)
or Libor plus 3.25%, contains covenants, including minimum net income levels by
quarter, maintenance of certain financial ratios, restrictions on dividends and
repayment of debt or cash transfers to the parent company.
Cash dividends and tax sharing payments to the parent company are
contingent upon Brookwood's compliance with the covenants contained in the loan
agreement. At March 31, 2002, Brookwood was in compliance with its loan
covenants.
Acquisition Credit Facility. The Key Credit Agreement provides for a
$2,000,000 acquisition revolving credit line. This facility bears interest at
Brookwood's option of prime plus 1.00% (5.75% at March 31, 2002) or Libor plus
3.25%. Brookwood has borrowed $1,000,000 under this facility.
Equipment Credit Facility. The Key Credit Agreement provides for a
$2,000,000 equipment revolving credit line. The facility bears interest at Libor
plus 2.75%. Brookwood has borrowed $1,542,000 under this facility.
During 2000 Brookwood borrowed $1,000,000 under this facility, and in
September 2000 converted that amount into a term loan, at a fixed rate of 9.37%,
with a maturity of October 2005 and a monthly principal and interest payment of
$20,938. During 2002 Brookwood borrowed an additional $542,000 under this
facility and in February 2002 converted that amount into a term loan, at a
variable rate of Libor plus 3.25% (5.10% at March 31, 2002), with a maturity
date of March 2007 and a monthly principal and interest payment of $10,253.
The outstanding balance of the combined Key Bank credit facilities at March
31, 2002 was $13,717,000.
Other
Term Loan and Revolving Credit Facility. In March 2002, the Company and its
HWG, LLC subsidiary entered into a $7,000,000 credit agreement with First Bank &
Trust , N.A. The facility is comprised of a $3,000,000 term loan and a
$4,000,000 revolving credit facility (the "Term Loan and Revolving Credit
Facility"). The term loan proceeds were used in part to repay the aforementioned
$1,500,000 convertible loan from stockholder in March 2002, bears interest at a
fixed rate of 7%, matures April 1, 2005 and is fully amortizing requiring a
monthly payment of $92,631. The revolving credit facility bears interest at the
Company's option of prime plus 0.50%, or Libor plus 3.25%, and matures April 1,
2005. Collateral for the Term Loan and Revolving Credit Facility is 300,397 HRP
limited partner units. The credit agreement contains various financial and
non-financial covenants, including the maintenance of financial ratios,
restrictions on new indebtedness and the payment of dividends. The Company has
not drawn any funds on the Revolving Credit Facility, and therefore has
$4,000,000 of unused borrowing capacity.
Capital Lease Obligations. During 1999, the Company's Brock Suite Hotels
subsidiaries entered into three separate five-year capital leasing agreements
for furniture, fixtures and building improvements at a cost of $2,085,000 for
three GuestHouse Suites Plus properties. The Company has pledged 30,035 HRP
limited partner units as additional collateral to secure the leases. The lease
terms commenced January 2000 and expire in December 2004. The combined monthly
lease payment is $46,570 and the effective interest rate is 12.18%. The
outstanding principal balance at March 31, 2002 was $1,287,000.
Convertible Loan from Stockholder. In order to provide sufficient funds to
meet the Company's cash flow requirements and maintain compliance with the loan
covenants contained in the former Senior Secured Term Loan, the Company entered
into three loans with an entity associated with its chairman and principal
stockholder, Anthony J. Gumbiner. Two loans were repaid in December 2001 and the
remaining loan was repaid in March 2002 in the amount of $1,648,000, which
represented principal of $1,500,000 and accrued interest of $148,000.
Page 13
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
NOTE 5 -- DEBENTURES
10% Collateralized Subordinated Debentures. The 10% Collateralized
Subordinated Debentures are listed on The New York Stock Exchange. For financial
reporting purposes a pro-rata portion of an unamortized gain in the original
amount of $353,000, allocated to the 10% Debentures from a previous debenture
issue, is being amortized over its term. As a result, the effective interest
rate is 8.9%.
The 10% Debentures are secured by a junior lien on the capital stock of the
Brookwood subsidiary and certain hotel subsidiaries. Balance sheet amounts are
detailed below (in thousands):
MARCH 31, DECEMBER 31,
DESCRIPTION 2002 2001
----------- ------------ ------------
10% Debentures (face amount) ........................... $ 6,468 $ 6,468
Unamortized gain, net of accumulated amortization ...... 197 209
------------ ------------
Totals ........................................... $ 6,665 $ 6,677
============ ============
NOTE 6 -- DISCONTINUED OPERATIONS - HOTEL ASSETS HELD FOR SALE
In December 2000, the Company decided to discontinue and dispose of its
hotel segment, principally by allowing its non-recourse debtholders to assume
ownership of the properties through foreclosure or by selling or otherwise
disposing of its hotel properties. The Company's hotel segment consisted of
three owned properties and two leased properties.
The Company determined that it would retain its leasehold interest in the
GuestHouse Suites hotel in Huntsville, Alabama. The Company continues to operate
the hotel, subject to a lease concession from the owner. Accordingly, this hotel
has been classified as an asset held for use. Prior year operating results for
the hotel have been reclassified to continuing operations in the "other"
segment. The carrying value was $311,000 and $331,000, at March 31, 2002 and
December 31, 2001, respectively.
In January 2002, with assistance and consent of the mortgage lender, the
Company sold the GuestHouse Suites hotel in Tulsa, Oklahoma for $3,000,000. The
Company received no cash proceeds from the sale. In connection with the sale,
the parties entered into a loan modification and assumption agreement which,
among other terms, included a release that discharges the Company from any
further loan obligation associated with the Tulsa hotel. The Company recognized
a gain from extinguishment of debt of $1,677,000, net of tax of $875,000, in the
2002 first quarter.
In February 2002, the mortgage lender for the GuestHouse Suites hotel in
Greenville, South Carolina obtained a court judgement of foreclosure. In
connection with the foreclosure, the lender waived its right to a deficiency
judgement against the Company. The lender completed the foreclosure in May 2002
and it is anticipated that the Company will recognize a gain from extinguishment
of debt in the 2002 second quarter in the amount of approximately $1,900,000,
net of tax.
A summary of the non-recourse loans payable associated with the hotels held
for sale is detailed below (in thousands):
MARCH 31, DECEMBER 31,
DESCRIPTION 2002 2001
----------- ------------ ------------
Term loan, 7.86% fixed, extinguished May 2002 ......... $ 6,514 $ 6,514
Term loan, 8.20% fixed, extinguished January 2002 ..... -- 5,095
------------ ------------
Total ............................................ $ 6,514 $ 11,609
============ ============
Page 14
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
The owner of the Longboat Key Holiday Inn hotel has made a claim against
the Company under a guaranty which is in discovery, and the franchiser of the
Embassy Suites hotel has made a claim for liquidated damages under a franchise
contract which is in mediation.
A summary of the income from discontinued hotels operations is detailed
below (in thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------------
2002 2001
------------ ------------
Gain from extinguishment of debt, net of $875 tax charge .... $ 1,677 $ --
Sales ....................................................... 215 3,623
------------ ------------
1,892 3,623
Expenses
Operating expenses ..................................... 256 3,209
Interest expense ....................................... 137 580
Other disposition costs ................................ 23 --
Loss reserve ........................................... -- (187)
------------ ------------
416 3,602
------------ ------------
Income from discontinued hotel operations .............. $ 1,476 $ 21
============ ============
NOTE 7 -- DISCONTINUED OPERATIONS - ENERGY
In March 2001, the Company agreed to sell its investment in its Hallwood
Energy affiliate, which represented the Company's energy operations, to Pure
Resources II, Inc., an indirect wholly owned subsidiary of Pure Resources, Inc.,
subject to Hallwood Energy's shareholder approval which was obtained in May
2001. The all-cash transaction was structured as a first step tender offer
followed by a cash merger to acquire all remaining shares of Hallwood Energy.
The Company received $18,000,000 for the tender of its 1,440,000 shares of
common stock in May 2001 and received an additional amount of $7,250,000,
pursuant to the terms of a noncompetition agreement that was paid by Pure upon
the completion of the merger in June 2001.
Under the noncompetition agreement, the Company agreed to refrain from
taking certain actions without the prior written consent of Pure and Hallwood
Energy. These covenants were made by the Company in consideration of the
transactions contemplated by the merger agreement and the payment by Pure to the
Company. For a period of three years after the effective date of the merger
agreement, the Company will not, directly or indirectly, engage in oil and gas
activities in certain geographic areas without the prior consent of Pure. The
Company has also agreed to keep Hallwood Energy's confidential and proprietary
information strictly confidential.
Accordingly, energy operations have been segregated from the Company's
continuing operations and reported as discontinued operations. A summary of the
income from discontinued energy operations for the 2001 quarter is detailed
below (in thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------------
2002 2001
------------ ------------
Equity income from investment in Hallwood Energy ... -- $ 1,342
Deferred income tax benefit ........................ -- 3,586
------------ ------------
Income from discontinued energy operations .... -- $ 4,928
============ ============
Page 15
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
The sale of its common stock investment in Hallwood Energy resulted in a
gain of $8,725,000 in the 2001 second quarter. The Company began amortizing the
deferred revenue from the noncompetition agreement in the amount of $7,250,000,
over a three-year period commencing June 2001. The amortization, which is
reported in the "other" section of the statement of income, was $604,000 in the
quarter ended March 31, 2002.
NOTE 8 -- INCOME TAXES
The following is a schedule of the income tax expense (benefit) (in
thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------------
2002 2001
------------ ------------
Continuing Operations
Federal
Deferred ............ $ 566 $ 200
Current ............. 11 21
------------ ------------
Sub-total ........ 577 221
State .................. 161 51
------------ ------------
Total ............... $ 738 $ 272
============ ============
Discontinued Operations
Federal
Deferred (benefit)... $ 875 $ (3,586)
============ ============
The amount of the deferred tax asset (net of valuation allowance) for the
Company was $6,036,000 at March 31, 2002 ($5,111,000 attributable to continuing
operations and $925,000 attributable to hotels held for sale). The deferred tax
asset arises principally from the anticipated utilization of the Company's NOLs
and tax credits from the implementation of various tax planning strategies,
which include the potential sale of certain real estate investments and
anticipated gains from debt extinguishment associated with the hotels held for
sale that could be implemented, if necessary, to supplement income from
operations to fully realize the net recorded tax benefits before their
expiration.
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 16
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
NOTE 9 -- SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED
MARCH 31,
----------------------------
DESCRIPTION 2002 2001
----------- ------------ ------------
Supplemental schedule of non-cash investing and financing activities:
Hotel assets and liabilities relinquished in connection with
debt extinguishment
Loan payable ................................................... $ 5,095 --
Other liabilities, net ......................................... 227 --
Hotel properties ............................................... (2,770) --
Deferred tax asset ............................................. (875) --
------------ ------------
$ 1,677 --
============ ============
Pro rata share of stockholders' equity transactions of equity
investment:
Adoption of SFAS No. 133
Cumulative effect .............................................. $ -- $ (4,311)
Change in fair value of derivatives ............................ -- 1,302
Amortization of interest rate swap ................................ (14) --
------------ ------------
Other comprehensive loss ....................................... $ (14) $ (3,009)
============ ============
Supplemental disclosures of cash payments:
Interest paid ........................................................ $ 526 $ 1,100
Income taxes paid .................................................... 161 130
NOTE 10 -- COMPUTATION OF EARNINGS PER SHARE
The following table reconciles the Company's income from continuing
operations to income from continuing operations available to common
stockholders assuming dilution, and the number of common shares used in the
calculation of net income for the basic and assumed dilution methods (in
thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------
DESCRIPTION 2002 2001
----------- -------- --------
INCOME AVAILABLE TO COMMON STOCKHOLDERS
Income from continuing operations........................ $1,316 $351
Impact of assumed loan conversion........................ 28 53
------ -----
Income from continuing operations available to
common stockholders - basic.......................... $1,344 $404
====== =====
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic .................................................. 1,361 1,425
Incremental shares from assumed loan conversions......... 218 302
------ -----
Assuming dilution........................................ 1,579 1,727
====== =====
Page 17
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
NOTE 11 -- 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, 2001.
Beginning in 1997, the Company and its HRP affiliate have been defendants
in two lawsuits that were brought by Gotham Partners, L.P. in the Delaware Court
of Chancery. The first suit filed in February 1997, styled Gotham Partners, L.P.
v. Hallwood Realty Partners, L.P. and Hallwood Realty Corporation (C.A.
No.15578), sought access to certain books and records of HRP and was
subsequently settled, allowing certain access. The suit was dismissed in April
2001. The second action, filed in June 1997, styled Gotham Partners, L.P. v.
Hallwood Realty Partners, L.P., et al (C.A. No.15754), against the Company, HRP,
HRC and the directors of HRC, alleges claims of breach of fiduciary duties,
breach of HRP's partnership agreement and fraud in connection with certain
transactions involving HRP's limited partnership units in the mid 1990's. The
Company is alleged to have aided and abetted the alleged breaches. In June 2000,
after completing fact discovery, all parties moved for summary judgment on
several issues. In September and October 2000, the Delaware court issued three
separate written opinions resolving the summary judgment motions. In the
opinions, the court ruled that trial would be required as to all issues, except
that (i) Gotham was found to have standing to pursue its derivative claims; (ii)
defendants were entitled to judgment dismissing the fraud claim; (iii) the
general partner was entitled to judgment dismissing the breach of fiduciary duty
claims brought against it; and (iv) the general partner's outside directors were
entitled to judgment dismissing all claims brought against them. A five-day
trial was held in January 2001. In July 2001, the Delaware Court of Chancery
rendered its opinion. In its decision, the court determined that an option plan
and a sale of units to the Company in connection with a reverse unit split
implemented by HRP in 1995 were in compliance with HRP's partnership agreement.
The court also found that the sale of units to the Company in connection with a
1995 odd-lot offer by HRP did not comply with certain procedures required by the
HRP partnership agreement. The court ruled that the defendants other than HRP
pay a judgment in the amount of $3,417,000, plus pre-judgment interest of
approximately $2,891,000 from August 1995 to HRP. The amount represents what the
court determined was an underpayment by the Company. The court's judgment is not
final until all rehearings and appeals have been exhausted. In August 2001, the
plaintiff and certain defendants appealed the Court of Chancery's judgment to
the Delaware Supreme Court. Those appeals are pending. Oral arguments were heard
on February 12, 2002 and a rehearing en banc was held on March 26, 2002. In
October 2001, the Company paid $6,405,000, including post judgment interest, to
HRP, subject to an arrangement that it be returned in full or part if the
judgment is modified or reversed on appeal. If the appellate court reverses the
judgment, any subsequent ruling by the trial court on remand may be more or less
favorable to the Company.
In February 2000, HRP filed a lawsuit in the United States District Court
for the Southern District of New York styled Hallwood Realty Partners, L.P. v.
Gotham Partners, L.P., et al (Civ. No. 00 CV 115) alleging violations of the
Securities Exchange Act of 1934 by certain purchasers of HRP's limited
partnership units, including Gotham Partners, L.P., Gotham Partners, III L.P.,
Private Management Group, Inc., Interstate Properties, Steven Roth and EFO
Realty, Inc., by virtue of those purchasers' misrepresentations and/or omissions
in connection with filings required under the Securities Exchange Act of 1934.
The complaint further alleged that the defendants, by acquiring more than 15% of
the outstanding HRP limited partnership units, have triggered certain rights
under its Unit Purchase Rights Agreement, for which HRP was seeking declaratory
relief. HRP sought various forms of relief, including declaratory judgments,
divestiture, corrective disclosures, a "cooling-off" period and damages,
including costs and disbursements. Discovery was completed in December 2000 and
trial was held in February 2001. In February 2001, the court rendered a decision
in favor of the defendants and the court ordered the complaint dismissed. HRP
filed a Notice of Appeal in March 2001 with respect to the February 2001
dismissal of the complaint and other matters. All parties filed briefs with the
Second Circuit. Oral arguments were heard on March 4, 2002. On April 11, 2002,
the U.S. Court of Appeals for the Second Circuit upheld the lower court's ruling
in favor of the defendants. On April 25, 2002, HRP filed with the court a
Petition for Rehearing en banc with respect to the April 11, 2002 decision.
In December 1999, the Company deposited $900,000 into an escrow account to
secure the maximum amount which could be payable by the Company in a lawsuit
brought by a former promissory note holder. The trial was held
Page 18
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
in June 2001 in the Delaware Court of Chancery. The parties submitted post-trial
briefings in September 2001. In February 2002, the court rendered its decision
in favor of the Company. On March 22, 2002, the court entered an order that
provides for the return of approximately $971,000, including accrued interest,
to the Company from the escrow account. The noteholder filed an appeal on April
19, 2002. It is anticipated that the parties will file their appeal and reply
briefs prior to August 2002.
The Company is currently a defendant in two lawsuits in connection with the
disposition of two hotel properties. Plaintiffs allege violations of franchise
and lease agreements and seek damages of approximately $1,500,000. Management
believes that the claims are without merit and intends to vigorously defend the
cases.
In December 1999 the Company distributed certain assets and incurred a
contingent obligation, under the agreement to separate the interests of its
former president and director (the "Separation Agreement"). The contingent
obligation of $3,375,000 at March 31, 2002, is the amount of the remaining
payments under the Separation Agreement and is included in other accrued
expenses. At December 2001, the Company accrued an additional $500,000 under
this agreement, which is expected to be paid in 2002. Interest on the contingent
obligation was imputed at 12.75% through December 31, 2001 and amounted to
$100,000 for the three months ended March 31, 2001. The Company discontinued
imputing interest at December 31, 2001, although it paid $125,000 under the
terms of the Separation Agreement in the 2002 first quarter.
In February 2000, the Company, through a wholly owned subsidiary, acquired
the assets of a company in a textile products-related industry. The purchase
price was $1,450,000 in cash plus contingent payments of up to $3,000,000 based
on specified levels of earnings over the next four years. Effective December 31,
2001, in consideration of 36 monthly payments aggregating approximately
$375,000, the contingent obligation had been reduced to a percentage of cash
flow from the acquired subsidiaries, as defined, for the remaining years under
this agreement.
NOTE 12 -- SEGMENT AND RELATED INFORMATION
The following represents the Company's reportable segment operations for
the three months ended March 31, 2002 and 2001, respectively (in thousands):
REAL TEXTILE DISCONTINUED CONSOL
ESTATE PRODUCTS OTHER OPERATIONS -IDATED
------------ ------------ ------------ ------------ ------------
THREE MONTHS ENDED MARCH 31, 2002
Total revenue from external sources .... $ 1,652 $ 21,395 $ 1,307 $ 24,354
============ ============ ============ ============
Operating income ....................... $ 1,264 $ 507 $ 1,771
============ ============
Unallocable income net ................. $ 283 283
============ ------------
Income from continuing operations
before income taxes ................ $ 2,054
============
Income from discontinued operations .... $ 1,476 $ 1,476
============ ============
THREE MONTHS ENDED MARCH 31, 2001
Total revenue from external sources .... $ 2,665 $ 17,777 $ 437 $ 20,879
============ ============ ============ ============
Operating income (loss) ................ $ 1,970 $ (350) $ 1,620
============ ============
Unallocable expenses, net .............. $ (997) (997)
============ ------------
Income from continuing operations
before income taxes ................ $ 623
============
Income from discontinued operations .... $ 4,949 $ 4,949
============ ============
Page 19
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
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, 2001 annual report. The total assets for the Company's operating segments
have not materially changed since the December 31, 2001 annual report.
NOTE 13 -- CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES
SFAS No. 142 became effective January 1, 2002 and specifies that goodwill
and some intangible assets will no longer be amortized but instead will be
subject to periodic impairment testing. The effect of adopting SFAS No. 142 by
the Company resulted in the recording of income from the cumulative effect of a
change in accounting principle in the amount of $568,000, which represented the
unamortized amount of negative goodwill associated with the Company's equity
investment in HRP.
During 2001, management had conducted an analysis of the carrying value of
certain intangible assets related to the textile products segment and recorded
an impairment charge of $1,446,000 as of December 31, 2001. The Company no
longer has any recorded goodwill or intangible assets that would be subject to
amortization or impairment testing.
Had the provisions of SFAS No. 142 been applied retroactively, the
Company's net income and net income per share for the three month periods ended
March 31, 2002 and 2001 would have been the pro forma amounts indicated below
(in thousands, except per share amounts):
THREE MONTHS ENDED
MARCH 31,
----------------------------
DESCRIPTION 2002 2001
----------- ------------ ------------
Net income, as reported ......................................... $ 3,360 $ 5,251
Add back amortization:
Real estate - negative goodwill ............................. -- (57)
Textile products - positive goodwill ........................ -- 35
Deduct cumulative effect of change in accounting principle:
Real estate - negative goodwill ............................. (568) --
------------ ------------
(568) (22)
------------ ------------
Net income - pro forma .......................................... $ 2,792 $ 5,229
============ ============
Net income per common share - assuming dilution, as reported .... $ 2.15 $ 3.07
Adjustments ..................................................... (0.36) (0.01)
------------ ------------
Net income per common share - pro forma ......................... $ 1.79 $ 3.06
============ ============
Page 20
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Company reported net income of $3,360,000 for the first quarter ended
March 31, 2002, compared to net income of $5,251,000 in 2001. Income from
continuing operations was $1,316,000 in 2002, compared to $351,000 in 2001.
Revenue from continuing operations was $24,354,000 in 2002, compared to
$20,879,000 in 2001.
Following is an analysis of the results of continuing operations for the
real estate and textile products business segments, and the discontinued
operations for the hotel and energy business segments.
REAL ESTATE
The real estate segment reported income of $1,264,000 for the first quarter
of 2002 compared to $1,970,000 in 2001.
Revenues. Fee income of $1,119,000 for the quarter ended March 31, 2002
decreased by $861,000, or 43%, from $1,980,000 in 2001. Fees are derived from
the Company's asset management, property management, leasing and construction
supervision services provided to its Hallwood Realty Partners, L.P. affiliate, a
real estate master limited partnership ("HRP") and various third parties. The
decrease was due primarily to lower leasing fees in the 2002 first quarter.
Equity income from investments in HRP represents the Company's recognition
of its pro rata share of net income reported by HRP, adjusted for the
elimination of intercompany income. For the 2002 first quarter, the Company
reported equity income of $533,000 compared to $685,000 in the prior-year
period. The decrease resulted principally from gains from property sales by HRP
in 2001, partially offset by decreased litigation costs. The 2001 first quarter
equity income was exclusive of the Company's $9,000 pro rata share of HRP's
extraordinary loss from early extinguishment of debt and its $40,000 pro rata
share of HRP's loss from cumulative effect of SFAS No. 133 adoption, both of
which are reported separately.
Expenses. Administrative expenses of $220,000 decreased by $307,000, or
58%, in the 2002 first quarter, compared to $527,000 in 2001. The decrease was
primarily attributable to the payments of commissions to third party brokers
associated with leasing income.
Amortization expense of $168,000 in both the 2002 and 2001 quarters relate
to Hallwood Realty's general partner investment in HRP to the extent allocated
to management rights.
TEXTILE PRODUCTS
The textile products segment reported income of $507,000 for the first
quarter of 2002, compared to a loss of $350,000 in 2001.
Revenue. Sales of $20,821,000 increased $3,044,000, or 17%, in the 2002
first quarter, compared to $17,777,000 in the 2001 quarter. The sales increase
was principally due to renewed activity in the military business.
Brookwood formed a joint venture with an unrelated third party that is also
in a textile-related industry. The joint venture is 50%-owned by Brookwood and
50%-owned by its joint venture partner with operating and management decision
making and venture profits and losses shared equally by both parties. As
Brookwood does not exercise control over the joint venture, the investment is
accounted for utilizing the equity method of accounting. Brookwood's equity
income from joint venture was $574,000 in the 2002 first quarter.
Expenses. Cost of sales of $18,053,000 increased by $2,917,000, or 19%, in
the 2002 first quarter, compared to $15,136,000 in the 2001 quarter. The
increase in cost of sales was principally the result of the increase in sales.
The lower gross profit margin for the 2002 first quarter (13.3% versus 14.9%)
resulted from the sales increase in the military business, which has lower gross
profit margins. Administrative and selling expenses of $2,669,000 decreased by
$20,000 in the 2002 first quarter from $2,689,000 for the comparable
Page 21
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
2001 period. Interest expense of $166,000 decreased by $136,000, or 45%, for the
2002 first quarter from $302,000 in 2001, principally due to a decrease in
interest rates.
OTHER
The other segment reported income of $283,000 for the first quarter of
2002, compared to a loss of $997,000 in 2001.
Revenue. Amortization of deferred revenue of $604,000 in the 2002 first
quarter is attributable to the noncompetition fee received in connection with
the sale of the Company's investment in Hallwood Energy. The $7,250,000
noncompete cash payment is being amortized over a three year period which began
June 2001.
Hotel revenue, which relates entirely to the leased GuestHouse Suites Plus
hotel in Huntsville, Alabama that the Company continues to operate, was $440,000
in the 2002 first quarter, compared to $432,000 in 2001. The 2% increase in 2002
was attributable to an increased average daily rate, partially offset by reduced
occupancy. Interest and other income increased by $299,000 to $304,000 for the
2002 first quarter from $5,000 in 2001. The increase was principally
attributable to a gain of $296,000 on the exercise of an option and related sale
of a marketable security.
Expenses. Interest expense in the amount of $205,000 for the 2002 first
quarter decreased by $541,000 from the prior year amount of $746,000. The
decrease was primarily due to the May 2001 payoff of the former Senior Secured
Term Loan, the repayment of the stockholder loans and imputed interest costs in
the 2001 quarter associated with the Separation Agreement. Administrative
expenses of $382,000 for the 2002 first quarter increased by $147,000, from the
prior-year amount of $235,000, due to increased consulting and other
professional fees.
Hotel expenses, which include operating expenses, depreciation and interest
costs associated with the GuestHouse Suites Plus hotel in Huntsville, Alabama,
decreased by $16,000, or 4% in the 2002 first quarter, principally as a result
of improved cost controls.
INCOME TAXES
Income taxes relating to continuing operations were $738,000 for the 2002
first quarter, compared to $272,000 in 2001. The 2002 quarter included a
$566,000 non cash federal deferred charge, a $11,000 federal current charge and
$161,000 for state taxes. The 2001 quarter included a $200,000 non cash federal
deferred charge, a $21,000 federal current charge and $51,000 for state taxes.
The state tax expense is an estimate based upon taxable income allocated to
those states in which the Company does business at their respective tax rates.
As of March 31, 2002, the Company had approximately $90,000,000 of tax net
operating loss carryforwards ("NOLs") and temporary differences to reduce future
federal income tax liability. Based upon the Company's expectations and
available tax planning strategies, management has determined that taxable income
will more likely than not be sufficient to utilize approximately $17,750,000 of
the NOLs prior to their ultimate expiration in the year 2020.
Management believes that the Company has certain tax planning strategies
available, which include the potential sale of certain real estate investments
and anticipated gains from debt extinguishment associated with the hotels held
for sale that could be implemented, if necessary, to supplement income from
operations to fully realize the net recorded tax benefits before their
expiration. Management has considered such strategies in reaching its conclusion
that, more likely than not, taxable income will be sufficient to utilize a
portion of the NOLs before expiration; however, future levels of operating
income and taxable gains are dependent upon general economic conditions and
other factors beyond the Company's control. Accordingly, no assurance can be
given that sufficient taxable income will be generated for utilization of the
NOLs. Management periodically re-evaluates its tax planning strategies based
upon changes in facts and circumstances and, accordingly, considers potential
adjustments to the valuation allowance
Page 22
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
of the deferred tax asset. Although the use of such carryforwards could, under
certain circumstances, be limited, the Company is presently unaware of the
occurrence of any event which would result in such limitations.
DISCONTINUED OPERATIONS - HOTELS HELD FOR SALE
In December 2000, the Company decided to discontinue its hotel operations
and dispose of its hotel segment, principally by allowing its non-recourse
debtholders to assume ownership of the properties through foreclosures or by
selling or otherwise disposing of its hotel properties. The Company's hotel
segment consisted of three owned properties and two leased properties. In
accordance with accounting standards for reporting discontinued operations,
hotel operations (apart from the leasehold interest in the GuestHouse Suites
Plus hotel in Huntsville, Alabama that the Company continues to operate and has
been classified as an asset held for use) have been segregated from the
Company's continuing operations and have been reported as a single line item --
Loss from Discontinued Operations. Discontinued operations for the three months
ended March 31, 2002 and 2001 are presented below (in thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------------
2002 2001
------------ ------------
Gain from extinguishment of debt, net of $875 tax charge .... $ 1,677 $ --
Sales ....................................................... 215 3,623
------------ ------------
1,892 3,623
Expenses
Operating expenses ..................................... 256 3,209
Interest expense ....................................... 137 580
Other disposition costs ................................ 23 --
Loss reserve ........................................... -- (187)
------------ ------------
416 3,602
------------ ------------
Income from discontinued hotels operations ............. $ 1,476 $ 21
============ ============
Revenue. In January 2002, with assistance and consent of the mortgage
lender, the Company sold the GuestHouse Suites hotel in Tulsa, Oklahoma for
$3,000,000. The Company received no cash proceeds from the sale. In connection
with the sale, the parties entered into a loan modification and assumption
agreement which, among other terms, included a release that discharges the
Company from any further loan obligation associated with the Tulsa hotel. The
Company recognized a gain from extinguishment of debt of $1,677,000, net of tax,
in the 2002 first quarter. Sales of $215,000 in the 2002 first quarter decreased
by $3,408,000, from the year-ago amount of $3,623,000. The decrease was
primarily due to the February 2001 termination of the lease for the Longboat Key
Holiday Inn and Suites hotel in Sarasota, Florida and the dispositions of the
Oklahoma City, Oklahoma Embassy Suites hotel in June 2001 and Tulsa, Oklahoma
GuestHouse Suites hotel in January 2002.
Expenses. Operating expenses of $256,000 for the 2002 first quarter were
down $2,953,000 from $3,209,000 in 2001. The decrease is primarily due to the
aforementioned dispositions. Interest expense of $137,000 in the 2002 first
quarter decreased by $443,000 from $580,000 in 2001, principally due to
principal amortization and debt extinguishment on the various hotel term loans
and the interest expense associated with capital leases at the three GuestHouse
properties. Depreciation and amortization expense was not recorded for the
periods due to the classification of the hotel operations as a discontinued
operation.
Page 23
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
DISCONTINUED OPERATIONS - ENERGY
In March 2001, the Company agreed to sell its investment in its Hallwood
Energy affiliate, which represented the Company's energy operations, to Pure
Resources II, Inc., an indirect wholly owned subsidiary of Pure Resources, Inc.,
subject to Hallwood Energy's shareholder approval which was obtained in May
2001. Accordingly, energy operations segregated from the Company's continuing
operations have been reported as a single line item - Income from Discontinued
Operations. Operations for the three months ended March 31, 2002 are presented
below (in thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------------
2002 2001
------------ ------------
Equity income from investment in Hallwood Energy .... -- $ 1,342
Deferred income tax benefit ......................... -- 3,586
------------ ------------
Income from discontinued energy operations ..... -- $ 4,928
============ ============
The equity income in the 2001 first quarter from investment in Hallwood
Energy of $1,342,000 represented the Company's pro rata share of income
available to common stockholders, and amortization of negative goodwill.
The Company recorded a deferred income tax benefit of $3,586,000 in the
2001 first quarter, principally due to the anticipated utilization of the
Company's NOL's from the sale of its investment in Hallwood Energy.
The Company received $18,000,000 for the tender of its 1,440,000 shares of
common stock in May 2001 and received an additional amount of $7,250,000,
pursuant to the terms of a noncompetition agreement that was paid by Pure upon
the completion of the merger in June 2001.
Under the noncompetition agreement, the Company agreed to refrain from
taking certain actions without the prior written consent of Pure and Hallwood
Energy. These covenants were made by the Company in consideration of the
transactions contemplated by the merger agreement and the payment by Pure to the
Company. For a period of three years after the effective date of the merger
agreement, the Company will not, directly or indirectly, engage in oil and gas
activities in certain geographic areas without the prior consent of Pure. The
Company has also agreed to keep Hallwood Energy's confidential and proprietary
information strictly confidential.
CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES
SFAS No. 142 became effective January 1, 2002 and specifies that goodwill
and some intangible assets will no longer be amortized but instead will be
subject to periodic impairment testing. The effect of adopting SFAS No. 142 by
the Company resulted in the recording of income from the cumulative effect of a
change in accounting principle in the amount of $568,000, which represented the
unamortized amount of negative goodwill associated with the Company's equity
investment in HRP.
Page 24
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The Company's unrestricted cash and cash equivalents at March 31, 2002
totaled $1,957,000.
In March 2002, the Company and its HWG, LLC subsidiary entered into the
$7,000,000 Term Loan and Revolving Credit Facility with First Bank & Trust, N.A.
The facility is comprised of a $3,000,000 term loan and a $4,000,000 revolving
credit facility. The term loan proceeds were used in part to repay the
$1,500,000 convertible loan from stockholder in March 2002, bears interest at a
fixed rate of 7%, matures April 1, 2005 and is fully amortizing requiring a
monthly payment of $92,631. The revolving credit facility bears interest at the
Company's option of one-half percent over prime, or Libor plus 3.25%, and
matures April 1, 2005. Collateral for the Term Loan and Revolving Credit
Facility is 300,397 HRP limited partner units. The credit agreement contains
various financial and non-financial covenants, including the maintenance of
financial ratios, restrictions on new indebtedness and the payment of dividends.
The Company has not drawn any funds on the revolving credit facility, and
therefore has $4,000,000 of unused borrowing capacity.
The Company's real estate segment generates funds principally from its
property management and leasing activities, without significant additional
capital costs. The Company has pledged 300,397 of its HRP limited partnership
units and the interest in its real estate subsidiaries to collateralize the Term
Loan and Revolving Credit Facility and the remaining 30,035 HRP units to secure
all of the capital leases.
Brookwood maintains a revolving line of credit facility which is
collateralized by accounts receivable, certain inventory and equipment, and
separate acquisition and equipment credit facilities. At March 31, 2002,
Brookwood had $4,490,000 of unused borrowing capacity on its revolving line of
credit. Future cash dividends and tax sharing payments to the parent company are
contingent upon Brookwood's compliance with the covenants contained in the
amended loan agreement. At March 31, 2002, Brookwood was in compliance with its
loan covenants.
In February 2000, the Company, through a wholly owned subsidiary, acquired
the assets of a company in a textile products-related industry. The purchase
price was $1,450,000 in cash plus contingent payments of up to $3,000,000, based
on specified levels of earnings over the next four years. Effective December 31,
2001, in consideration of thirty six monthly payments aggregating approximately
$375,000, the contingent obligation had been reduced to a percentage of cash
flow from the acquired subsidiaries, as defined, for the remaining years under
the agreement.
The Company's hotel segment experienced cash flow difficulties during 2000,
due to weaker occupancy and average daily rates at several hotels. In December
2000, the Company decided to discontinue its hotel operations and dispose of its
hotel segment principally by allowing its non-recourse debtholders to assume
ownership of the properties through foreclosures or by selling or otherwise
disposing of its hotel properties. At March 31, 2002, the Company operates two
hotels, one of which the Company continues to operate and has been classified as
an asset held for use. The lender completed a foreclosure on the other hotel in
May 2002. The Company has not received any amounts in excess of the debt
outstanding on the properties, but the non-recourse debt associated with the
properties has been extinguished. Payments on the three capital leases continue
to be made by the Company or the hotel subsidiaries while operations continue
during the disposition period.
Page 25
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
In the interest of providing stockholders with certain information
regarding the Company's future plans and operations, certain statements set
forth in this Form 10-Q are forward-looking statements. Although any forward-
looking statement expressed by or on behalf of the Company is, to the knowledge
and in the judgment of the officers and directors, expected to prove true and
come to pass, management is not able to predict the future with absolute
certainty. Forward-looking statements involve known and unknown risks and
uncertainties, which may cause the Company's actual performance and financial
results in future periods to differ materially from any projection, estimate or
forecasted result. Among others, these risks and uncertainties include, the
ability to obtain financing or refinance maturing debt; a potential oversupply
of commercial office buildings and industrial parks in the markets served; fees
for leasing, construction and acquisition of real estate properties; lease and
rental rates and occupancy levels obtained; and the ability to compete
successfully with foreign textile production and the ability to generate new
products. These risks and uncertainties are difficult or impossible to predict
accurately and many are beyond the control of the Company. Other risks and
uncertainties may be described, from time to time, in the Company's periodic
reports and filings with the Securities and Exchange Commission.
Page 26
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes to the Company's market risks during
the three months ended March 31, 2002.
The Company is exposed to market risk due to fluctuations in interest
rates. The Company utilizes both fixed rate and variable rate debt to finance
its operations. As of March 31, 2002, the Company's total outstanding loans and
debentures payable of $24,472,000 (excluding debt associated with the
discontinued hotel operations) were comprised of $12,059,000 of fixed rate debt
and $12,413,000 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 one percentage point would cause an
annual loss in income and cash flows of approximately $245,000, assuming that
outstanding debt remained at current levels.
The Company's real estate division through its investment in HRP will
sometimes use derivative financial instruments to achieve a desired mix of fixed
versus floating rate debt. As of March 31, 2002, HRP had an interest cap
agreement for one of its mortgage loans, which will limit HRP's exposure to
changing interest rates to a maximum of 10%. Management does not consider the
portion attributable to the Company to be significant.
Page 27
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item
1 Legal Proceedings
Reference is made to Note 11 to the Company's consolidated financial
statements included within this Form 10-Q.
2 Changes in Securities None
3 Defaults upon Senior Securities None
4 Submission of Matters to a Vote of Security Holders None
5 Other Information None
6 Exhibits and Reports on Form 8-K
(a) Exhibits
(i) 10.17 Third Amendment to First Amended and Restated
Revolving Credit Loan and Security Agreement,
dated as of May 13, 2002 by and among Key Bank
National Association, Brookwood Companies
Incorporated and certain subsidiaries, filed
herewith.
(ii) 10.19 Promissory Note and Security Agreement
regarding equipment term loan in the amount of
$1,000,000.00, dated as of September 29, 2000,
between Brookwood Companies Incorporated Kenyon
Industries, Inc., Brookwood Laminating, Inc.,
Ashford Bromely, Inc., Xtramile, Inc., and Land
Ocean III, Inc. and Key Leasing, a division of
Key Corporate Capital Inc., fixed interest -
9.37%, due September 29, 2005, filed herewith.
(iii) 10.20 Promissory Note and Security Agreement
regarding equipment term loan, in the amount of
$541,976.24, dated as of February 25, 2002,
between Brookwood Companies Incorporated,
Kenyon Industries, Inc., Brookwood Laminating,
Inc., Ashford Bromely, Inc., Xtramile, Inc. and
Land and Ocean III, Inc and Key Leasing, a
division of Key Corporate Capital Inc., Libor
plus 325 basis points-floating, due February
25, 2007, filed herewith.
(b) Reports on Form 8-K None
Page 28
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE HALLWOOD GROUP INCORPORATED
Dated: May 15, 2002 By: /s/ Melvin J. Melle
-----------------------------------
Melvin J. Melle, Vice President
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
Page 29
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.17 Third Amendment to First Amended and Restated Revolving Credit
Loan and Security Agreement, dated as of May 13, 2002 by and among
Key Bank National Association, Brookwood Companies Incorporated
and certain subsidiaries, filed herewith.
10.19 Promissory Note and Security Agreement regarding equipment term
loan in the amount of $1,000,000.00, dated as of September 29,
2000, between Brookwood Companies Incorporated, Kenyon Industries,
Inc., Brookwood Laminating, Inc., Ashford Bromely, Inc., Xtramile,
Inc., and Land Ocean III, Inc. and Key Leasing, a division of Key
Corporate Capital Inc., fixed interest - 9.37%, due September 29,
2005, filed herewith.
10.20 Promissory Note and Security Agreement regarding equipment term
loan, in the amount of $541,976.24, dated as of February 25, 2002,
between Brookwood Companies Incorporated, Kenyon Industries, Inc.,
Brookwood Laminating, Inc., Ashford Bromely, Inc., Xtramile, Inc.
and Land and Ocean III, Inc and Key Leasing, a division of Key
Corporate Capital Inc., Libor plus 325 basis points-floating, due
February 25, 2007, filed herewith.
Page 30