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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 JUNE 30, 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
-------------- ----------------------
Common Stock ($.10 par value) American Stock Exchange
10% Collateralized Subordinated New York Stock Exchange
Debentures Due July 31, 2005
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF CLASS
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 July 31, 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 June 30, 2002
and December 31, 2001........................................................ 3
Consolidated Statements of Income for the
Six Months Ended June 30, 2002 and 2001...................................... 5
Consolidated Statements of Income for the
Three Months Ended June 30, 2002 and 2001.................................... 7
Consolidated Statements of Comprehensive Income for the
Six Months Ended June 30, 2002 and 2001
Three Months Ended June 30, 2002 and 2001.................................... 9
Consolidated Statements of Changes in Stockholders' Equity for the
Six Months Ended June 30, 2002............................................... 10
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2002 and 2001...................................... 11
Notes to Consolidated Financial Statements........................................ 12
2 Managements's Discussion and Analysis of
Financial Condition and Results of Operations..................................... 23
3 Quantitative and Qualitative Disclosures about Market Risk........................... 34
PART II - OTHER INFORMATION
1 thru 6 Exhibits, Reports on Form 8-K and Signature Page..................................... 35
Page 2
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
JUNE 30, DECEMBER 31,
2002 2001
---------- -----------
(UNAUDITED)
REAL ESTATE
Investments in HRP ...................... $13,409 $12,261
Receivables and other assets
Related parties ...................... 166 242
Other ................................ 57 55
------- -------
13,632 12,558
TEXTILE PRODUCTS
Inventories ............................. 18,214 16,753
Receivables
Trade and other ...................... 12,209 11,896
Related party ........................ 2,107 5,217
Property, plant and equipment, net ...... 9,167 9,426
Investment in joint venture ............. 1,400 676
Prepaids, deposits and other assets ..... 621 1,030
------- -------
43,718 44,998
OTHER
Deferred tax asset, net ................. 4,591 5,677
Cash and cash equivalents ............... 2,463 3,006
Investment in HEC ....................... 1,423 --
Restricted cash ......................... 974 966
Hotel held for use - assets ............. 490 448
Prepaids, deposits and other assets ..... 447 408
------- -------
10,388 10,505
DISCONTINUED OPERATIONS
Hotels held for sale
Properties, net ...................... -- 6,602
Receivables and other assets ......... -- 1,104
Deferred tax asset ................... -- 1,800
------- -------
-- 9,506
------- -------
TOTAL ................................ $67,738 $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
JUNE 30, DECEMBER 31,
2002 2001
---------- ----------
(UNAUDITED)
REAL ESTATE
Accounts payable and accrued expenses ................................. $ 658 $ 1,133
TEXTILE PRODUCTS
Loans payable ......................................................... 14,884 16,255
Accounts payable and accrued expenses ................................. 8,149 9,390
-------- --------
23,033 25,645
OTHER
10% Collateralized Subordinated Debentures ............................ 6,652 6,677
Deferred revenue - noncompetition agreement ........................... 4,632 5,840
Interest and other accrued expenses ................................... 3,938 4,167
Term loan ............................................................. 2,780 --
Capital lease obligations ............................................. 1,304 1,386
Hotel held for use - liabilities ...................................... 640 529
Convertible loan from stockholder ..................................... -- 1,500
-------- --------
Total other liabilities ............................................ 19,946 20,099
DISCONTINUED OPERATIONS
Hotels held for sale
Accounts payable and accrued expenses .............................. 537 2,198
Loans payable ...................................................... -- 11,609
-------- --------
537 13,807
-------- --------
TOTAL LIABILITIES .................................................. 44,174 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 ................................................... (17,019) (23,729)
Accumulated other comprehensive income ................................ 221 250
Treasury stock, 1,034,760 shares at both dates; at cost ............... (15,330) (15,330)
-------- --------
TOTAL STOCKHOLDERS' EQUITY ......................................... 22,564 15,883
-------- --------
TOTAL .............................................................. $ 67,738 $ 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)
SIX MONTHS ENDED
JUNE 30,
-------------------------
2002 2001
-------- --------
REAL ESTATE
Fees
Related parties ............................................ $ 2,378 $ 3,741
Other ...................................................... 50 167
Equity income from investments in HRP ......................... 947 1,168
-------- --------
3,375 5,076
Administrative expenses ....................................... 513 1,038
Amortization .................................................. 336 336
Litigation expense ............................................ -- 2,265
-------- --------
849 3,639
-------- --------
Income from real estate operations ......................... 2,526 1,437
TEXTILE PRODUCTS
Sales
Trade ...................................................... 34,771 35,418
Related party .............................................. 8,981 293
Equity income from joint venture .............................. 723 101
-------- --------
44,475 35,812
Cost of sales ................................................. 37,204 29,976
Administrative and selling expenses ........................... 5,614 5,239
Interest ...................................................... 374 570
-------- --------
43,192 35,785
-------- --------
Income from textile products operations .................... 1,283 27
OTHER
Amortization of deferred revenue - noncompetition agreement ... 1,208 201
Hotel revenue ................................................. 898 892
Interest and other income ..................................... 308 73
Equity loss from investment in HEC ............................ (77) --
-------- --------
2,337 1,166
Administrative expenses ....................................... 974 819
Hotel expenses ................................................ 930 902
Interest expense .............................................. 430 1,309
-------- --------
2,334 3,030
-------- --------
Other income (loss), net ................................... 3 (1,864)
-------- --------
Income (loss) from continuing operations before income taxes 3,812 (400)
Income taxes ............................................... (1,354) (655)
-------- --------
Income (loss) from continuing operations ................... 2,458 (1,055)
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)
SIX MONTHS ENDED
JUNE 30,
------------------------
2002 2001
-------- --------
Income from discontinued operations, net of tax
Income from discontinued operations - Hotels .................................. $ 3,734 $ 10
Income from discontinued operations - Energy .................................. -- 10,734
-------- --------
Income from discontinued operations ......................................... 3,734 10,744
-------- --------
Income before extraordinary loss and cumulative effect
of changes in accounting principles ........................................... 6,192 9,689
Extraordinary loss from early extinguishment of debt ............................ -- (810)
-------- --------
Income before cumulative effect of changes in accounting principles ............. 6,192 8,879
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 .......................................................................... 6,760 8,839
Preferred stock dividend ........................................................ 50 50
-------- --------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS ......................................... $ 6,710 $ 8,789
======== ========
PER COMMON SHARE
BASIC
Income (loss) from continuing operations after preferred dividend ............. $ 1.77 $ (0.78)
Income from discontinued operations ........................................... 2.74 7.54
Extraordinary loss from early extinguishment of debt .......................... -- (0.56)
Income (loss) from cumulative effect of changes in accounting principles ...... 0.42 (0.03)
-------- --------
Net income available to common stockholders ................................. $ 4.93 $ 6.17
======== ========
ASSUMING DILUTION
Income (loss) from continuing operations after preferred dividend ............. $ 1.66 $ (0.78)
Income from discontinued operations ........................................... 2.54 7.54
Extraordinary loss from early extinguishment of debt .......................... -- (0.56)
Income (loss) from cumulative effect of changes in accounting principles ...... 0.38 (0.03)
-------- --------
Net income available to common stockholders ................................. $ 4.58 $ 6.17
======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ........................................................................... 1,361 1,425
======== ========
Assuming Dilution ............................................................... 1,470 1,425
======== ========
See accompanying notes to consolidated financial statements.
Page 6
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
JUNE 30,
-------------------------
2002 2001
-------- --------
REAL ESTATE
Fees
Related parties .............................................. $ 1,266 $ 1,836
Other ........................................................ 43 92
Equity income from investments in HRP ........................... 414 483
-------- --------
1,723 2,411
Administrative expenses ......................................... 293 511
Amortization .................................................... 168 168
Litigation expense .............................................. -- 2,265
-------- --------
461 2,944
-------- --------
Income (loss) from real estate operations .................... 1,262 (533)
TEXTILE PRODUCTS
Sales
Trade ........................................................ 18,415 17,653
Related party ................................................ 4,516 281
Equity income from joint venture ................................ 149 101
-------- --------
23,080 18,035
Cost of sales ................................................... 19,151 14,840
Administrative and selling expenses ............................. 2,945 2,550
Interest ........................................................ 208 268
-------- --------
22,304 17,658
Income from textile products operations ...................... 776 377
OTHER
Amortization of deferred revenue - noncompetition agreement ..... 604 201
Hotel revenue ................................................... 458 460
Interest and other income ....................................... 4 68
Equity loss from investment in HEC .............................. (36) --
-------- --------
1,030 729
Administrative expenses ......................................... 592 584
Hotel expenses .................................................. 493 449
Interest expense ................................................ 225 563
-------- --------
1,310 1,596
-------- --------
Other income (loss), net ..................................... (280) (867)
-------- --------
Income (loss) from continuing operations before income taxes.. 1,758 (1,023)
Income taxes ................................................. (616) (383)
-------- --------
Income (loss) from continuing operations ..................... 1,142 (1,406)
See accompanying notes to consolidated financial statements.
Page 7
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
JUNE 30,
----------------------
2002 2001
------- -------
Income from discontinued operations, net of tax
Income (loss) from discontinued operations - Hotels ................. $ 2,258 $ (11)
Income from discontinued operations - Energy ........................ -- 5,806
------- -------
Income from discontinued operations ............................... 2,258 5,795
------- -------
Income before extraordinary loss ...................................... 3,400 4,389
Extraordinary loss from early extinguishment of debt .................. -- (801)
------- -------
NET INCOME ................................................................ 3,400 3,588
Preferred stock dividend .............................................. 50 50
------- -------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS ............................... $ 3,350 $ 3,538
======= =======
PER COMMON SHARE
BASIC
Income (loss) from continuing operations after preferred dividend ... $ 0.80 $ (1.02)
Income from discontinued operations ................................. 1.66 4.06
Extraordinary loss from early extinguishment of debt ................ -- (0.56)
------- -------
Net income available to common stockholders ....................... $ 2.46 $ 2.48
======= =======
ASSUMING DILUTION
Income (loss) from continuing operations after preferred dividend ... $ 0.80 $ (1.02)
Income from discontinued operations ................................. 1.66 4.06
Extraordinary loss from early extinguishment of debt ................ -- (0.56)
------- -------
Net income available to common stockholders ....................... $ 2.46 $ 2.48
======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ................................................................. 1,361 1,425
======= =======
Assuming Dilution ..................................................... 1,361 1,425
======= =======
See accompanying notes to consolidated financial statements.
Page 8
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
2002 2001 2002 2001
------- ------- ------- -------
NET INCOME .................................................. $ 3,400 $ 3,588 $ 6,760 $ 8,839
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
Realized upon disposition of energy investment ... -- 3,009 -- 3,009
Amortization of interest rate swap ................... (15) -- (29) --
------- ------- ------- -------
Other comprehensive income (loss) ................ (15) 3,009 (29) --
------- ------- ------- -------
COMPREHENSIVE INCOME ........................................ $ 3,385 $ 6,597 $ 6,731 $ 8,839
======= ======= ======= =======
See accompanying notes to consolidated financial statements.
Page 9
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TREASURY STOCK TOTAL
------------------- PAID-IN ACCUMULATED COMPREHENSIVE ------------------- STOCKHOLDERS'
SHARES PAR VALUE CAPITAL DEFICIT INCOME SHARES COST EQUITY
-------- -------- ---------- ---------- ------------- -------- -------- -----------
BALANCE, JANUARY 1, 2002 ...... 2,396 $ 240 $ 54,452 $(23,729) $ 250 1,035 $(15,330) $ 15,883
Net income ................ 6,760 6,760
Preferred stock dividend .. (50) (50)
Pro rata share of
stockholders' equity
transactions from equity
investment:
Amortization of interest
rate swap ............. (29) (29)
-------- -------- -------- -------- -------- -------- -------- --------
BALANCE, JUNE 30, 2002 ........ 2,396 $ 240 $ 54,452 $(17,019) $ 221 1,035 $(15,330) $ 22,564
======== ======== ======== ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
Page 10
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
---------------------
2002 2001
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ................................................................ $ 6,760 $ 8,839
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of deferred revenue - noncompetition agreement ............ (1,208) (201)
Equity income from textile products joint venture ...................... (723) (101)
(Income) loss from cumulative effect of changes in accounting principles (568) 40
(Increase) decrease in deferred tax asset .............................. 1,086 (1,931)
Equity income from investments in HRP .................................. (947) (1,168)
Depreciation and amortization .......................................... 1,026 1,143
Equity loss from investment in HEC ..................................... 77 --
Amortization of deferred gain from debenture exchange .................. (25) (23)
Litigation expense ..................................................... -- 2,265
Extraordinary loss from early extinguishment of debt ................... -- 810
Net change in textile products assets and liabilities .................. 503 (718)
Net change in other assets and liabilities ............................. (470) 248
Discontinued operations:
Extraordinary gain from extinguishment of hotel debt ................ (5,789) --
Net change in other hotel assets and liabilities .................... 242 56
(Increase) decrease in deferred tax asset ........................... 1,800 1,793
Gain from disposition of Hallwood Energy ............................ -- (8,725)
Equity income from investments in Hallwood Energy ................... -- (1,837)
-------- --------
Net cash provided by operating activities ........................ 1,764 490
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in HEC common stock ............................................ (1,500) --
Investments in textile products property and equipment .................... (369) (413)
Investment in hotel held for use .......................................... (17) --
Discontinued operations:
Proceeds from sale of Hallwood Energy .................................. -- 18,000
Proceeds from noncompetition agreement ................................. -- 7,250
-------- --------
Net cash provided by (used in) investing activities ................. (1,886) 24,837
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings and loans payable ........................... 3,429 2,044
Repayment of bank borrowings and loans payable ............................ (3,714) (15,176)
Payment of deferred loan costs ............................................ (86) --
Payment of preferred stock dividend ....................................... (50) (50)
Discontinued operations:
Repayment of hotel bank borrowings and loans payable ................... -- (225)
-------- --------
Net cash (used in) financing activities ............................. (421) (13,407)
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .......................... (543) 11,920
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................................ 3,006 901
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD ...................................... $ 2,463 $ 12,821
======== ========
See accompanying notes to consolidated financial statements.
Page 11
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
NOTE 1 -- INTERIM CONSOLIDATED FINANCIAL STATEMENTS AND ACCOUNTING POLICIES
Interim Consolidated Financial Statements. The 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 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.
In 2000, Brookwood formed a joint venture with an unrelated third party that is
also in a textile related industry. The joint venture has been developing
advanced lightweight, water resistant fabrics which have been well received by
customers. Continued development of these fabrics for military, industrial and
consumer applications is a key element of Brookwood's business plan.
Discontinued Operations. In December 2000, the Company decided to
discontinue and dispose of its hotel segment, which at that time consisted of
five properties; accordingly, 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 June
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 held for use."
In March 2001, the Company announced the sale of its energy segment;
accordingly, energy operations were 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, accounted for on the equity method of
accounting.
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
Page 12
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
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 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.
Statement of Financial Accounting Standards No. 146 - Accounting for Costs
Associated with Exit or Disposal Activities ("SFAS No. 146) was issued in June
2002, and will be adopted by the Company on January 1, 2003. This statement
addresses financial accounting and reporting of costs associated with exit or
disposal activities. The Company has not yet determined the effect adopting SFAS
No. 146 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 JUNE 30, 2002 AMOUNT AT INCOME FROM INVESTMENTS
------------------------ WHICH CARRIED AT FOR THE SIX MONTHS ENDED
COST OR ----------------------- JUNE 30,
NUMBER OF ASCRIBED JUNE 30, DECEMBER 31, -----------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 2002 2001 2002 2001
------------------------- --------- -------- -------- -------- -------- --------
HALLWOOD REALTY PARTNERS, L.P. ....
- General partner interest ........ -- $ 8,650 $ 1,606 $ 1,943 $ 43 $ 66
- Limited partner interest ........ 330,432 8,799 11,803 10,318 904 1,102
-------- -------- -------- -------- --------
Totals ......................... $ 17,449 $ 13,409 $ 12,261 $ 947 $ 1,168
======== ======== ======== ======== ========
At June 30, 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 June 30, 2002, resulted in a $1,699,000 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.
Page 13
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
The carrying value of the Company's general partner interest of HRP
includes the value of intangible rights to provide asset management and property
management services. The Company amortizes that portion of the general partner
interest ascribed to the management rights. For the six months ended June 30,
2002 and 2001 such amortization was $336,000 in each period.
As further discussed in Note 11, the Delaware Court of Chancery in July
2001 rendered its opinion regarding certain litigation involving the Company.
The court determined that the defendants, including the Company, should pay to
HRP a judgment of $3,417,000 plus pre-judgment interest of approximately
$2,891,000 from August 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 June 30, 2002 were $68.75 and $35.72,
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"). HEC is presently in the
developmental stage, having drilled four test wells, the results of which are
being analyzed to determine if any of the wells may ultimately become
economially feasible to place into commercial production and, if so, to
determine the extent of future development. The Company owns approximately 24%
of HEC and accounts for the investment using the equity method of accounting. It
reported an equity loss, representing its pro rata share of HEC's net loss, of
$36,000 and $77,000 in the three month and six month periods ended June 30,
2002, respectively.
NOTE 4 -- LOANS PAYABLE
Loans payable at the balance sheet dates are as follows (in thousands):
JUNE 30, DECEMBER 31,
2002 2001
------- -------
Textile Products
Revolving credit facility, prime + 0.25% or
Libor + 3.25%, due January 2004 ................................ $12,649 $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 ................. 717 806
Equipment term loan, Libor + 3.25%, due March 2007 ................ 518 --
------- -------
14,884 16,255
Other
Term loan, 7% fixed, due April 2005 ................................ 2,780 --
Revolving credit facility, prime + 0.50% or
Libor + 3.25%, due April 2005 .................................. -- --
Capital lease obligations, 12.18% fixed , due December 2004 ........ 1,304 1,386
Convertible loan from stockholder, 10% fixed, repaid March 2002 .... -- 1,500
------- -------
4,084 2,886
------- -------
Total .......................................................... $18,968 $19,141
======= =======
Page 14
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
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 as defined. Borrowings are
collateralized by accounts receivable, inventory imported under trade letters of
credit, certain finished goods inventory, certain 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 prime plus 0.25% (5.00% at June 30, 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 June 30, 2002, Brookwood was in compliance with its loan covenants
and had an additional $773,000 of borrowing base availability under its
revolving line of credit facility.
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 June 30, 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%. 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 June 30, 2002), with a maturity date
of March 2007 and a monthly principal and interest payment of $10,253. Brookwood
has $458,000 availability under this facility.
The outstanding balance of the combined Key Bank credit facilities at June
30, 2002 was $14,884,000.
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"). 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 outstanding principal balance of the loan at
June 30, 2002 was $2,780,000.
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, and 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 lease 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.
Page 15
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
The combined monthly lease payment is $46,570 and the effective interest rate is
12.18%. Interest expense in the amount of $112,000, representing the full
interest costs through expiration of the capital leases associated with the two
disposed hotels, has been accrued at June 30, 2002, as a reduction of gain from
extinguishment of debt. The outstanding principal and interest balance at June
30, 2002 was $1,304,000.
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 loan agreements 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.
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
Brookwood. Balance sheet amounts are detailed below (in thousands):
JUNE 30, DECEMBER 31,
DESCRIPTION 2002 2001
----------- ------ ------
10% Debentures (face amount) ......................... $6,468 $6,468
Unamortized gain, net of accumulated amortization .... 184 209
------ ------
Totals ......................................... $6,652 $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 hotel asset held for use, and prior year operating
results have been reclassified to continuing operations in the other segment.
The carrying value of the leasehold interest was $286,000 and $331,000, at June
30, 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 discharged the Company from any
further loan obligation. The Company recognized a gain from extinguishment of
debt of $2,552,000, before a deferred tax charge of $875,000 in the 2002 first
quarter, which has been classified within discontinued operations.
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 June 2002
and the Company recognized a
Page 16
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
gain from extinguishment of debt in the amount of $3,237,000, before a deferred
tax charge of $925,000 in the 2002 second quarter, which had been classified
within discontinued operations.
A summary of the non-recourse loans payable associated with the hotels held
for sale is detailed below (in thousands):
JUNE 30, DECEMBER 31,
DESCRIPTION 2002 2001
----------- -------- ----------
Term loan, 7.86% fixed, extinguished May 2002 ........ -- $ 6,514
Term loan, 8.20% fixed, extinguished January 2002 .... -- 5,095
-------
Total ........................................... -- $11,609
=======
The Company is a defendant in two lawsuits in connection with the
disposition of hotel properties in 2001. Plaintiffs allege violations of
franchise and lease agreements and seek damages of approximately $1,500,000. 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. Management believes that the claims are without merit and
intends to vigorously defend the cases.
A summary of discontinued hotels operations is detailed below (in
thousands)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2002 2001 2002 2001
------- ------- ------- -------
Gain from extinguishment of debt ...................... $ 3,237 $ -- $ 5,789 $ --
Deferred federal income tax (expense) ................. (925) -- (1,800) --
Sales ................................................. 67 2,320 282 5,943
------- ------- ------- -------
2,379 2,320 4,271 5,943
Expenses
Operating expenses .................................. 66 1,829 323 5,039
Interest expense .................................... 46 668 183 1,248
Other disposition costs ............................. 9 -- 31 --
Loss reserve (recovery) ............................. -- (166) -- (354)
------- ------- ------- -------
121 2,331 537 5,933
------- ------- ------- -------
Income (loss) from discontinued hotel operations .... $ 2,258 $ (11) $ 3,734 $ 10
======= ======= ======= =======
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 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
Page 17
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
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 is detailed below (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ---------------------
2002 2001 2002 2001
------- -------- ---- --------
Gain from disposition of investment in HEC .......... -- $ 8,725 -- $ 8,725
Deferred income tax benefit (expense) ............... -- (2,914) -- 672
Current income tax (expense) ........................ -- (500) -- (500)
Equity income from investment in Hallwood Energy .... -- 495 -- 1,837
-------- --------
Income from discontinued energy operations ........ -- $ 5,806 -- $ 10,734
======== ========
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 $1,208,000 and $604,000 in the six months and three
months ended June 30, 2002, compared to $201,000 in the 2001 second quarter.
NOTE 8 -- INCOME TAXES
The following is a schedule of the income tax expense (benefit) (in
thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
2002 2001 2002 2001
------- ------- ------- -------
Continuing Operations
Federal
Deferred ............... $ 520 $ 334 $ 1,086 $ 534
Current ................ 11 (33) 23 (12)
------- ------- ------- -------
Sub-total .......... 531 301 1,109 522
State ..................... 85 82 245 133
------- ------- ------- -------
Total .............. $ 616 $ 383 $ 1,354 $ 655
======= ======= ======= =======
Discontinued Operations
Federal
Deferred ............... $ 925 $ 2,914 $ 1,800 $ (672)
Current ................ -- 400 -- 400
------- ------- ------- -------
Sub-total .......... 925 3,314 1,800 (272)
State ..................... -- 100 -- 100
------- ------- ------- -------
Total .............. $ 925 $ 3,414 $ 1,800 $ (172)
======= ======= ======= =======
The amount of the deferred tax asset (net of valuation allowance) was
$4,591,000 at June 30, 2002 (all of which is attributable to continuing
operations). 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 if necessary, to supplement income from operations to
fully realize the net recorded tax benefits before their expiration.
Page 18
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
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.
NOTE 9 -- SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED
JUNE 30,
--------------------------
2002 2001
-------- --------
Supplemental schedule of non-cash investing and
financing activities:
Hotel assets and liabilities relinquished in
connection with debt extinguishment
Loan payable ............................... $ 11,609 --
Other liabilities, net ..................... 837 --
Hotel properties ........................... (6,552) --
Deferred tax asset ......................... (1,800) --
--------
$ 4,094 --
========
Pro rata share of stockholders' equity transactions
of equity investment:
Adoption of SFAS No. 133
Cumulative effect .......................... $ -- $ (4,311)
Realized upon disposition of energy
investment ............................... -- 3,009
Change in fair value of derivatives ........ -- 1,302
Amortization of interest rate swap ............. (29) --
-------- --------
Other comprehensive loss ................... $ (29) $ --
======== ========
Supplemental disclosures of cash payments:
Interest paid ..................................... $ 988 $ 1,877
Income taxes paid (refunded) ...................... (184) 537
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2002 2001 2002 2001
------- ------- ------- -------
INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS
Income (loss) from continuing operations ............ $ 1,142 $(1,406) $ 2,458 $(1,055)
Less dividend on preferred stock .................... (50) (50) (50) (50)
Impact of assumed loan conversion ................... -- -- 28 --
------- ------- ------- -------
Income (loss) from continuing operations available to
common stockholders - basic ....................... $ 1,092 $(1,456) $ 2,436 $(1,105)
======= ======= ======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ............................................... 1,361 1,425 1,361 1,425
Incremental shares from assumed loan conversions .... -- -- 109 --
------- ------- ------- -------
Assuming dilution ................................... 1,361 1,425 1,470 1,425
======= ======= ======= =======
Page 19
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
The options issued under the Company's stock option plan are antidilutive
for all periods presented.
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 judgment amount represents
what the court determined was an underpayment by the Company. 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 CV1115) alleging violations of the
Securities Exchange Act of 1934 by certain purchasers of HRP's limited
partnership units, including Gotham Partners, L.P., Gotham Partners, III L.P.,
Private Management Group, Inc., Interstate Properties, Steven Roth and EFO
Realty, Inc., by virtue of those purchasers' misrepresentations and/or omissions
in connection with filings required under the Securities Exchange Act of 1934.
The complaint further alleged that the defendants, by acquiring more than 15% of
the outstanding HRP limited partnership units, have triggered certain rights
under its Unit Purchase Rights Agreement, for which HRP was seeking declaratory
relief. HRP sought various forms of relief, including declaratory judgments,
divestiture, corrective disclosures, a "cooling-off" period and damages,
including costs and disbursements. Discovery was completed in December 2000 and
trial was held in February 2001. 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. On
June 3, 2002 the Second Circuit denied the petition.
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 20
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 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 $974,000, including accrued interest,
to the Company from the escrow account. The noteholder filed an appeal on April
19, 2002. The parties have filed their appeal and reply briefs and oral
arguments before the Delaware Supreme Court have been scheduled for September
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. 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. 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"). Interest on the
contingent obligation was imputed at 12.75% through December 31, 2001. In
December 2001, the Company accrued an additional $500,000 under this agreement,
all of which is expected to be paid in 2002. The contingent obligation of
$3,250,000 at June 30, 2002, is the amount of all remaining payments under the
Separation Agreement and is included in other accrued expenses.
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 six months ended June 30, 2002 and 2001, respectively (in thousands):
REAL TEXTILE DISCONTINUED CONSOL
ESTATE PRODUCTS OTHER OPERATIONS -IDATED
------- --------- -------- ------------ ---------
SIX MONTHS ENDED JUNE 30, 2002
Total revenue from external sources....... $ 3,375 $ 44,475 $ 2,337 $ 50,187
======= ======== ======== =========
Operating income.......................... $ 2,526 $ 1,283 $ 3,809
======= ========
Unallocable income, net................... $ 3 3
======== ---------
Income from continuing operations
before income taxes.................... $ 3,812
=========
Income from discontinued operations....... $ 3,734 $ 3,734
======== =========
SIX MONTHS ENDED JUNE 30, 2001
Total revenue from external sources....... $ 5,076 $ 35,812 $ 1,166 $ 42,054
======= ======== ======== =========
Operating income (loss)................... $ 1,437 $ 27 $ 1,464
======= ========
Unallocable expenses, net................. $ (1,864) (1,864)
======== ---------
Income (loss) from continuing operations
before income taxes.................... $ (400)
=========
Income from discontinued operations....... $ 10,744 $ 10,744
======== =========
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. Total assets of the Company's operating segments have
not materially changed since the December 31, 2001 annual report.
Page 21
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
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 months and six month
periods ended June 30, 2002 and 2001, respectively, would have been the pro
forma amounts indicated below (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ ------------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net income, as reported .............................. $ 3,400 $ 3,588 $ 6,760 $ 8,839
Add back amortization:
Real estate - negative goodwill .................... -- (56) -- (113)
Textile products - positive goodwill ............... -- 72 -- 107
Deduct cumulative effect of change in accounting
principle:
Real estate - negative goodwill .................... -- -- (568) --
---------- ---------- ---------- ----------
-- 16 (568) (6)
---------- ---------- ---------- ----------
Net income - pro forma ............................... $ 3,400 $ 3,604 $ 6,192 $ 8,833
========== ========== ========== ==========
Net income per common share - assuming dilution,
as reported ........................................ $ 2.46 $ 2.48 $ 4.58 $ 6.17
Adjustments .......................................... -- 0.01 (0.38) --
---------- ---------- ---------- ----------
Net income per common share - assuming dilution,
pro forma .......................................... $ 2.46 $ 2.49 $ 4.20 $ 6.17
========== ========== ========== ==========
Page 22
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 $3,400,000 for the second quarter ended
June 30, 2002, compared to net income of $3,588,000 in 2001. Net income for the
six month periods was $6,760,000 and $8,839,000, respectively.
Income from continuing operations was $1,142,000 in the quarter, compared
to a loss of $1,406,000 in 2001. Revenue from continuing operations for the 2002
second quarter was $25,833,000, compared to $21,175,000 in 2001. Income and
revenue from continuing operations for the six months in 2002 was $2,458,000 and
$50,187,000, compared to a loss of $1,055,000 and $42,054,000 in 2001.
The Company had been engaged in four business segments - real estate,
textile products, energy and hotels. During 2001 the Company sold its energy
investment recording an $8.7 million gain and generating net cash proceeds of
$11.1 million and commenced divestiture of its hotel operations. As of June 30,
2002, the Company had disposed of all of its hotel properties, apart from one
leased property held for use which it continues to operate. The disposition of
the energy and hotel business segments significantly improved the Company's
liquidity position by the cash generated from sale of the energy investment and
reduction of cash required to fund hotel operations. Future results are largely
dependent on the remaining real estate and textile products business segments.
Apart from executive level support, both segments operate autonomously utilizing
separate management teams and operating systems.
Fee income from real estate operations has remained consistent in recent
years, with an occasional spike in lease fees due to the execution of a large
lease or development fee due to completion of a major project. Correspondingly,
during the same period expenses have been fairly steady, except for the
litigation expense in 2001. Cash flow from operations, excluding the litigation
expense, was $4.5 million, $4.7 million and $6.8 million, respectively, for the
three years ended December 31, 2001. Future cash flows are largely dependent on
the leasing, development and management activities of the Company's subsidiaries
on behalf of HRP.
The Company continues to face litigation risk related to its real estate
operations, as the plaintiff in the aforementioned matter has appealed the
court's award of monetary damages and seeks recision of certain transactions
involving HRP's limited partner units as a remedy. An adverse ruling could
impact the Company's general partner and limited partner ownership interests and
disrupt the Company's cash flow stream.
Textile products sales continues to experience severe competitive pressures
from low-cost imports. This industry has been in decline in the United States;
however, Brookwood continues to identify new market niches to replace sales lost
to importers. In addition to its existing products and proprietary technologies,
Brookwood has been developing advanced lightweight, water resistant fabrics
which have been well received by its customers. Continued development of these
fabrics for military, industrial and consumer applications is a key element of
Brookwood's business plan. The ongoing enterprise value of Brookwood is
contingent on its ability to adapt to the global textile industry; however,
there can be no assurance that the positive results of the past can be
sustained.
The textile products business is not interdependent with any of the
Company's other business operations. The parent company does not guarantee the
Brookwood bank debt and is not obligated to contribute additional capital. If
the textile products business were to deteriorate, creditors could look only to
Brookwood's assets for the satisfaction of its obligations.
The Company reentered the energy business in January 2002 through a $1.5
million investment in a newly-formed private energy company, of which the
Company holds an approximate 24% equity interest. At the present time this
company is in the development stage, having drilled four test wells, the results
of which are being analyzed to determine if any of the wells may ultimately
become economically feasible to place into commercial production and, if so, to
determine the extent of future development.
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.
Page 23
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
REAL ESTATE
The real estate segment reported income of $1,262,000 for the second
quarter and $2,526,000 for the six month period of 2002, compared to a loss of
$533,000 and income of $1,437,000 in 2001, respectively.
Revenues. Fee income of $1,309,000 for the 2002 quarter decreased by
$619,000, or 32%, from $1,928,000 in 2001. Fee income of $2,428,000 for the six
months decreased by $1,480,000, or 38%, from $3,908,000 for the similar period
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 decreases were due primarily
to lower leasing and construction supervision fees, which are cyclical in
nature, in the 2002 periods.
Equity income from investments in HRP represents the Company's recognition
of its pro rata share of net income reported by HRP, adjusted for the
elimination of intercompany income. For the 2002 second quarter, the Company
reported equity income of $414,000 compared to $483,000 in the prior-year
period. For the 2002 six months, the equity income was $947,000, compared to
$1,168,000. The decreases resulted principally from gains from property sales by
HRP in 2001, partially offset by decreased litigation costs. The 2001 equity
income amounts were 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 were reported separately.
Expenses. Administrative expenses of $293,000 in the 2002 second quarter
decreased by $218,000, or 43%, compared to $511,000 in 2001. For the six months,
the decrease was $525,000 to $513,000, from $1,038,000 in 2001. The decreases
were primarily attributable to the payments of commissions associated with
leasing income during the 2001 periods.
Amortization expense of $168,000 for the second quarter, and $336,000 for
the six months in both the 2002 and 2001 periods relates to Hallwood Realty's
general partner investment in HRP allocated to management rights, which is being
amortized over a ten year period ending in October 2003. At June 30, 2002 there
was $896,000 of unamortized investment remaining.
Litigation expense in 2001 relates to the interest portion of the judgment
accrued in June 2001 and paid in October 2001 by the Company to HRP as described
in Note 11 to the consolidated financial statements.
TEXTILE PRODUCTS
The textile products segment reported income of $776,000 and $1,283,00 for
the second quarter and six month periods of 2002, compared to income of $377,000
and $27,000 in 2001, respectively.
Revenue. Sales of $22,931,000 increased by $4,997,000, or 28%, in the 2002
second quarter, compared to $17,934,000 in the 2001 quarter. The comparative six
month sales increased by $8,041,000, or 23%, to $43,752,000 from $35,711,000 in
the 2001 period. The sales increases were principally due to renewed activity in
the military business.
During 2001 Brookwood formed a joint venture with an unrelated party that
is also in a textile-related industry. The joint venture is 50% owned by each
partner who also shares equally the operating and management decision-making.
Brookwood's investment is accounted for utilizing the equity method of
accounting as it does not exercise control over the joint venture. Brookwood's
equity income from the joint venture was $149,000 in the 2002 second quarter and
$723,000 for the six month period, compared to $101,000 in each of the 2001
periods, respectively.
Expenses. Cost of sales of $19,151,000 increased by $4,311,000, or 29%, in
the 2002 second quarter, compared to $14,840,000 in the 2001 second quarter. The
comparative six month cost of sales of $37,204,000 increased by $7,228,000, or
24%, compared to $29,976,000. The increases in cost of sales were primarily the
result of the increase
Page 24
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
in sales. The lower gross profit margin for the 2002 second quarter (16.5% vs.
17.3%) and the six month periods (15.0% vs. 16.1%) resulted from the sales
increase in military business which has lower gross profit margins.
Administrative and selling expenses of $2,945,000 increased by $395,000, or
15%, in the 2002 second quarter from $2,550,000 for the comparable 2001 quarter.
The six month amount of $5,614,000 increased by $375,000, or 7%, from $5,239,000
in the comparable 2001 period. The increases resulted primarily from increases
in indirect and administrative payroll costs.
Interest expense of $208,000 decreased by $60,000, or 22%, in the 2002
second quarter from $268,000 in 2001. For the six months, interest expense of
$374,000 decreased by $196,000, or 34%, from $570,000 for the comparable 2001
period. The decreases were primarily the result of lower interest rates.
OTHER
The other segment reported a loss of $280,000 for the second quarter of
2002, compared to a loss of $867,000 in 2001. For the six months, the other
segment reported a gain of $3,000, compared to a loss of $1,864,000 in 2001. The
2002 three month and six month periods included amortization of deferred revenue
from a noncompetition agreement, and 2001 included interest on the former senior
secured term loan that was repaid in May 2001.
Revenue. Amortization of deferred revenue was $604,000 and $1,208,000 in
the 2002 second quarter and six month periods, respectively, compared to
$201,000 in the 2001 second quarter only, which 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 agreement is being
amortized over the three year period ending June 2004.
Hotel revenue, which relates entirely to the leased GuestHouse Suites Plus
hotel in Huntsville, Alabama that the Company continues to operate, was $458,000
in the 2002 second quarter and $898,000 for the six months, compared to $460,000
and $892,000 in the respective 2001 periods.
Interest and other income decreased by $64,000 to $4,000 for the 2002
second quarter from $68,000 in 2001. The 2001 second quarter included a gain of
$50,000 on the sale of a miscellaneous investment. The six month amount of
$308,000 increased by $235,000 from $73,000 for the comparable 2001 period. The
increase was attributable to a gain of $296,000 on the exercise of an option and
sale of a marketable security in the 2002 first quarter.
Equity loss of $36,000 for the quarter and $77,000 for the six months
relates to the Company's pro rata share of loss from HEC's operations which
commenced in 2002.
Expenses. Administrative expenses of $592,000 for the 2002 second quarter
increased by $8,000, from the prior-year amount of $584,000. For the six months,
administrative expenses increased by $155,000 to $974,000 from $819,000 in 2001.
The increases are primarily attributable to 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,
increased by $44,000, or 10%, to $493,000 in the 2002 second quarter, compared
to $449,000 in 2001. For the six months, hotel expenses increased by $28,000 to
$930,000 from $902,000 in 2001. The increases are principally due to an increase
in the property's repairs and maintenance expense.
Interest expense in the amount of $225,000 for the 2002 second quarter
decreased by $338,000 from the prior year amount of $563,000. For the six
months, interest expense decreased by $879,000 to $430,000 from $1,309,000 in
2001. The decreases were primarily due to the May 2001 early extinguishment of
the former Senior Secured Term Loan, the repayment of the stockholder loans and
imputed interest costs in the 2001 periods associated with the Separation
Agreement, partially offset by interest costs on the new Term Loan and Revolving
Credit Facility, obtained in March 2002.
Page 25
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INCOME TAXES
Income taxes relating to continuing operations were $616,000 for the 2002
second quarter, compared to $383,000 in 2001. The 2002 quarter included a
$520,000 non cash federal deferred charge, an $11,000 federal current charge and
$85,000 for state taxes. The 2001 quarter included a $334,000 non cash federal
deferred charge, a $33,000 federal current (benefit) and $82,000 for state
taxes. Income taxes were $1,354,000 for the 2002 six month period, compared to
$655,000 in 2001. The six months in 2002 included a deferred tax change of
$1,086,000 , a current tax charge of $23,000 and state tax expense of $245,000.
The 2001 six month amount included a deferred tax charge of $534,000, a federal
current (benefit) of $12,000 and state tax expense of $133,000. 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 June 30, 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 $13,500,000 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
that could be implemented, if necessary, to supplement income from operations to
fully realize the net recorded tax benefits before their expiration. Management
has considered such strategies in reaching its conclusion that, more likely than
not, taxable income will be sufficient to utilize a portion of the NOLs before
expiration; however, future levels of operating income and taxable gains are
dependent upon general economic conditions and other factors beyond the
Company's control. Accordingly, no assurance can be given that sufficient
taxable income will be generated for utilization of the NOLs. Management
periodically re-evaluates its tax planning strategies based upon changes in
facts and circumstances and, accordingly, considers potential adjustments to the
valuation allowance of the deferred tax asset. Although the use of such
carryforwards could, under certain circumstances, be limited, the Company is
presently unaware of the occurrence of any event which would result in such
limitations.
Page 26
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 former
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 -- Income
Loss from Discontinued Operations, which for three months and the six months
ended June 30, 2002 and 2001 are presented below (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ -----------------------
2002 2001 2002 2001
------- ------- ------- -------
Gain from extinguishment of debt ...................... $ 3,237 $ -- $ 5,789 $ --
Deferred federal income tax (expense) ................. (925) -- (1,800) --
Sales ................................................. 67 2,320 282 5,943
------- ------- ------- -------
2,379 2,320 4,271 5,943
Expenses
Operating expenses .................................. 66 1,829 323 5,039
Interest expense .................................... 46 668 183 1,248
Other disposition costs ............................. 9 -- 31 --
Loss reserve (recovery) ............................. -- (166) -- (354)
------- ------- ------- -------
121 2,331 537 5,933
------- ------- ------- -------
Income (loss) from discontinued hotels operations ... $ 2,258 $ (11) $ 3,734 $ 10
======= ======= ======= =======
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 $2,552,000, before a
deferred tax charge 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 June 2002 and the Company
recognized a gain from extinguishment of debt in the 2002 second quarter in the
amount of $3,237,000, before a deferred tax charge of $925,000. Sales of $67,000
in the 2002 second quarter decreased by $2,253,000, from the year-ago amount of
$2,320,000. For the six months, the decrease was $5,661,000 to $282,000,
compared to $5,943,000 in 2001. The decreases were primarily due to the February
2001 termination of the lease for the Longboat Key Holiday Inn and Suites hotel
in Sarasota, Florida 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 $66,000 for the 2002 second quarter
decreased by $1,763,000 from $1,829,000 in 2001. For the six months, operating
expenses decreased by $4,716,000 to $323,000 from $5,039,000 in 2001. The
decrease is primarily due to the aforementioned dispositions. Interest expense
of $46,000 in the 2002 first quarter decreased by $622,000 from $668,000 in 2001
and decreased by $1,065,000 to $183,000 from $1,248,000 for the six months,
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. The disposition costs of $9,000 for the 2002 second
quarter and $31,000 for the six months are primarily legal costs associated with
the disposition of the hotels. Depreciation and amortization expense was not
recorded for the periods due to the classification of the hotel operations as a
discontinued operation.
Page 27
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 announced the sale of 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 and six months ended
June 30, 2001 are presented below (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
2002 2001 2002 2001
------ -------- ------ --------
Gain from disposition of investment in Hallwood Energy .... -- $ 8,725 -- $ 8,725
Deferred income tax (expense) benefit ..................... -- (2,914) -- 672
Current income tax (expense) .............................. -- (500) -- (500)
Equity income from investment in Hallwood Energy .......... -- 495 -- 1,837
-------- --------
Income from discontinued energy operations .............. -- $ 5,806 -- $ 10,734
======== ========
The Company received $18,000,000 for the tender of its 1,440,000 shares of
common stock in May 2001 and recorded a gain of $8,725,000 from the sale. The
Company 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, which the Company began amortizing in June 2001 in the other
business segment.
The equity income in the 2001 second quarter and six month periods from
investment in Hallwood Energy of $495,000 and $1,837,000, respectively,
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 anticipated sale of its investment in Hallwood Energy
in the 2001 second quarter. In the 2001 second quarter the Company recorded a
deferred tax expense of $2,914,000, current federal tax expense of $400,000 and
state taxes of $100,000.
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 28
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RELATED PARTY TRANSACTIONS
HRP. The Company's real estate subsidiaries earn asset management, property
management leasing and construction supervision fees for their management of
HRP's real estate properties. Hallwood Realty earns: (i) an asset management fee
equal to 1% of the net aggregate base rents of HRP's properties, (ii)
acquisition fees equal to 1% of the purchase price of acquired properties and;
(iii) disposition fees equal to 10% of the amount by which the sales price of
certain properties exceed the purchase price of such property. Hallwood Realty
is also reimbursed for general and administrative costs, at cost, for
administrative level salaries and compensation bonuses, employee and director
insurance and allocated overhead costs. HCRE earns property management, leasing
and construction supervision fees. The management contracts with HRP expires on
June 30, 2004 and provide for: (i) a property management fee equal to 2.85% of
cash receipts collected from tenants; (ii) leasing fees equal to the current
commission market rate as applied to net aggregate rent (none exceeding 6% of
the net aggregate rent); and (iii) construction supervision fees for
administering construction projects equal to 5% of total construction or tenant
improvement costs.
A summary of the fees earned from HRP is detailed below (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ -----------------------
2002 2001 2002 2001
------- ------- ------- -------
Property management fees .......... $ 520 $ 515 $ 994 $ 1,037
Leasing fees ...................... 464 758 690 1,714
Asset management fees ............. 154 153 309 308
Construction supervision fees ..... 128 431 385 562
Acquisition fees .................. -- (21) -- 120
------- ------- ------- -------
Total ........................... $ 1,266 $ 1,836 $ 2,378 $ 3,741
======= ======= ======= =======
HSC Financial Corporation. The Company has entered into a financial
consulting contract with HSC Financial Corporation ("HSC"), a corporation
associated with Mr. Anthony J. Gumbiner, the Company's chairman and principal
stockholder. The contract provides for HSC to furnish and perform international
consulting and advisory services to the Company and its subsidiaries, including
strategic planning and merger activities, at a rate of $795,000 per year
($495,000 prior to May 2001). HSC is also eligible for bonuses from the Company
or its subsidiaries, subject to approval by the Company's board of directors.
Additionally, the Company reimburses HSC for reasonable and necessary expenses
in providing office space and administrative services. A summary of the fees and
expenses paid to HSC are detailed below (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -----------------
2002 2001 2002 2001
---- ---- ---- ----
Consulting fees ........................ $199 $161 $398 $285
Office and administrative expenses ..... 22 22 41 41
---- ---- ---- ----
Total ................................ $221 $183 $439 $326
==== ==== ==== ====
Hallwood Investments Limited. During 2000 and 2001, the Company entered
into loan agreements totaling $4,000,000 with Hallwood Investments Limited, an
entity with which Mr. Gumbiner is associated. Several factors contributed to the
Company's cash flow needs at the time, including difficulties experienced by the
Company's hotel operations and restriction on the availability of distributions
and payments from Brookwood. The loans bore an interest rate of 10% and were
repaid in December 2001 and March 2002.
Hallwood Energy Corporation. 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
Page 29
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
and accounts for the investment using the equity method of accounting. Certain
of the Company's current officers and directors and certain officers and
directors of its former energy affiliate are investors in the new entity.
Brookwood. In 2000, Brookwood formed a joint venture with an unrelated
third party that is also in a textile related industry. Brookwood is a 50% joint
venture partner. The joint venture has been developing advanced lightweight,
water resistant water resistant fabrics. Brookwood reported sales to the joint
venture of $4,516,000 and $8,981,000 for the three month and six month periods
ended June 30, 2002, respectively, compared to $281,000 and $293,000 in the
comparable 2001 periods.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The Company and its Brookwood subsidiary have entered into various
obligations and commitments in the ordinary course of conducting its business
operations, which are provided below as of June 30, 2002 (in thousands):
PAYMENTS DUE BY JUNE 30,
-----------------------------------------------------------------------
2003 2005 2007 THEREAFTER TOTAL
------- ------- ------- ---------- -------
OBLIGATIONS
Long term debt
Term Loan and Revolving
Credit Facility ............. $ 947 $ 1,833 $ -- $ -- $ 2,780
10% Debentures ................ -- -- 6,468 -- 6,468
Loans payable (Brookwood) ..... 291 14,306 287 -- 14,884
Capital lease obligations ....... 512 792 -- -- 1,304
Operating leases ................ 1,065 1,893 1,124 1,883 5,965
------- ------- ------- ------- -------
Total ....................... $ 2,815 $18,824 $ 7,879 $ 1,883 $31,401
======= ======= ======= ======= =======
AMOUNT OF COMMITMENT EXPIRATION BY JUNE 30,
---------------------------------------------------------
2003 2005 2007 THEREAFTER TOTAL
---- ---- ---- ---------- ----
COMMITMENTS (Brookwood)
Letters of Credit ........ $265 $ -- -- -- $265
Employment contracts ..... 167 267 -- -- 434
---- ---- -- -- ----
Total .................. $432 $267 -- -- $699
==== ==== == == ====
Page 30
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company's new Term Loan and Revolving Credit Facility acquired in
March 2002, and 10% Debentures require compliance with various loan covenants
and financial ratios, which, if not met, will trigger a default. The Term Loan
and Revolving Credit Facility requires a minimum debt service coverage ratio, as
defined, for each rolling four quarter period, a senior leverage ratio, as
defined, and a minimum collateral value coverage. Additionally, Brookwood's
credit agreement requires compliance with various loan covenants and financial
ratios, principally a minimum net income and debt service coverage ratio and a
debt to equity ratio.
The principal ratios at June 30, 2002 are provided below:
DESCRIPTION REQUIRED AMOUNT ACTUAL
----------- --------------- ------
TERM LOAN AND REVOLVING CREDIT FACILITY
Net cash flow, as defined must exceed $3,400,000 $3,817,000
Debt service coverage must exceed 1.2 to 1.0 1.47
Senior leverage must be less than 2.5 to 1.0 1.46
Collateral value coverage must exceed 200% of loan balance 743%
BROOKWOOD CREDIT AGREEMENT
Minimum net income, as defined must exceed $750,000 ytd 6/30/02 $773,000
Debt service coverage must exceed 1.25 to 1.00 1.71
Debt to equity must be less than 50% 48%
The Indenture for the 10% Debentures contains various covenants, which
if violated, may result in a call of the entire issue. The principal covenants
prohibit any subsidiary of the Company from commencing receivership, bankruptcy
or insolvency proceedings.
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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 June 30, 2002
totaled $2,463,000.
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.
At June 30, 2002, the Company was in compliance with its loan covenants. 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 June 30, 2002,
Brookwood had an additional $773,000 of borrowing base availability under its
revolving line of credit facility. 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 June 30, 2002,
Brookwood was in compliance with all of 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. In
the fourth quarter of 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, and
recorded as a charge to operations the amount 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 June 30, 2002, the
Company continues to operate one hotel, which has been classified as hotel held
for use. The Company did not receive any proceeds from completion of foreclosure
or sale of hotel properties and all non-recourse debt has been extinguished.
Payments on the three capital leases continue to be made by the Company or its
one operating hotel subsidiary.
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
In the interest of providing stockholders with certain information
regarding the Company's future plans and operations, certain statements set
forth in this Form 10-Q are forward-looking statements. Although any
forward-looking statement expressed by or on behalf of the Company is, to the
knowledge and in the judgment of the officers and directors, expected to prove
true and come to pass, management is not able to predict the future with
absolute certainty. Forward-looking statements involve known and unknown risks
and uncertainties, which may cause the Company's actual performance and
financial results in future periods to differ materially from any projection,
estimate or forecasted result. Among others, these risks and uncertainties
include, the ability to obtain financing or refinance maturing debt; a potential
oversupply of commercial office buildings 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 33
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 six months ended June 30, 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 June 30, 2002, the Company's total outstanding loans and
debentures payable of $25,436,000 (excluding debt associated with the
discontinued hotel operations) were comprised of $11,787,000 of fixed rate debt
and $13,649,000 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 $254,000, assuming that
outstanding debt remained at current levels.
The Company's real estate division through its investment in HRP will
sometimes use derivative financial instruments to achieve a desired mix of fixed
versus floating rate debt. As of June 30, 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 34
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
At the Company's Annual Meeting of Stockholders held on May 16, 2002,
stockholders voted on one proposal:
(a) To elect one director to hold office for three years and until a
successor is elected and qualified:
Nominee Director Votes For Withheld Term of Office
---------------- --------- -------- --------------
Charles A. Crocco, Jr. 1,246,004 26,488 three years
5 Other Information
None
6 Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K None
Page 35
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE HALLWOOD GROUP INCORPORATED
Dated: August 14, 2002 By: /s/ Melvin J. Melle
-------------------------------------
Melvin J. Melle, Vice President
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
Page 36