e10vqza
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
MARK ONE
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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FOR THE TRANSITION PERIOD FROM TO |
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For the Period Ended June 30, 2005 Commission File Number: 1-8303 |
The Hallwood Group Incorporated
(Exact name of registrant as specified in its charter)
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| Delaware
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51-0261339 |
(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification Number) |
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| 3710 Rawlins, Suite 1500 |
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| Dallas, Texas
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75219 |
| (Address of principal executive offices)
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(Zip Code) |
Registrant’s telephone number, including area code: (214) 528-5588
Securities Registered Pursuant to Section 12(b) of the Act:
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Name of Each Exchange |
| Title of Class |
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On Which Registered |
| Common Stock ($0.10 par value)
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American Stock Exchange |
Securities Registered Pursuant to Section 12(g) of the Act:
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| 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 þ NO o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12B-2 of the Act).
YES o NO þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12B-2 of
the Act).
YES o NO þ
1,511,218 shares of Common Stock, $.10 par value per share, were outstanding at July 31, 2005.
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
EXPLANATORY NOTE
This Form 10-Q/A amendment to the Company’s Quarterly Report on Form 10-Q for the period ended
June 30, 2005 is being filed to amend certain disclosures in Part I, Item 2 — “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” related to the portion of
total sales attributable to military sales and to sales to a major customer by the Company’s
Brookwood subsidiary, which were reported incorrectly due to a clerical error.
The total sales reported in the Company’s financial statements for the three months and six
months ended June 30, 2005 and 2004 are unchanged. All other information in the Form 10-Q,
including the financial statements, is unchanged from the original filing. This filing amends only
the disclosures related to military sales and sales to a major customer and does not otherwise
update the disclosures in the Form 10-Q as originally filed and does not reflect events occurring
after the original filing of the Form 10-Q.
Provided below is a schedule indicating sales information, as originally filed, and corrected
information (in thousands):
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2005 Periods |
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2004 Periods |
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As Reported |
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Corrected |
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As Reported |
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Corrected |
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SECOND QUARTER |
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Military Sales |
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$ |
13,479 |
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$ |
18,158 |
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$ |
13,124 |
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$ |
19,621 |
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Major Customer |
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11,625 |
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15,309 |
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9,071 |
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12,929 |
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SIX MONTH PERIOD |
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Military Sales |
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$ |
35,084 |
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$ |
39,762 |
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$ |
29,588 |
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$ |
36,085 |
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Major Customer |
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29,802 |
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33,485 |
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19,636 |
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23,494 |
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The financial statements and related footnotes in the originally filed Form 10-Q are not
included with this Form 10-Q/A as they are unchanged. Disclosures in the following paragraphs of
Management’s Discussion and Analysis of Financial Condition and Results of Operations are effected
by the changes in the supplemental disclosures: “Overview — Brookwood”, “Revenues” and “Expenses”.
Page 2
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
Page 3
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
General. Until July 2004, the Company was a diversified holding company with interests in
textiles, real estate and energy. Since that time, the Company has disposed of its interests in
Hallwood Realty Partners, L.P. (“HRP”), which constituted substantially all of its real estate
activities, and its minority investments in Hallwood Energy Corporation (“HEC”) and Hallwood Energy
III, L.P (“HE III”). The Company received total cash proceeds from these transactions in the
amount of approximately $178,000,000, including approximately $55,000,000 in July 2005 from the
disposition of HE III. These proceeds were used to repay bank debt, the Company’s 10% Debentures
and other obligations. In addition, the Company paid a cash distribution in partial liquidation to
its stockholders of approximately $56,789,000 ($37.70 per share) on May 27, 2005, and the board of
directors has declared an additional cash distribution in partial liquidation of approximately
$9,300,000 ($6.17 per share) payable on August 18, 2005 to stockholders of record on August 12,
2005. The Company had approximately $68,000,000 in cash and marketable securities at August 12,
2005.
Continuing Operations. The Company derives substantially all of its revenues from continuing
operations from the textile activities of its Brookwood subsidiary, and consequently, the Company’s
success is highly dependent upon Brookwood’s success. Although the Company’s textile activities
have generated substantial positive cash flow in recent years, there is no assurance that this
trend will continue. In addition, the remaining energy entities will require significant
additional capital investment over the next few years to acquire additional properties and to
adequately explore and develop existing and newly acquired properties.
Brookwood. Brookwood’s success will be influenced in varying degrees by its ability to
continue sales to existing customers, cost and availability of supplies, Brookwood’s response to
competition, its ability to generate new markets and products, and the effect of trade regulation.
While Brookwood has enjoyed substantial growth in its military business during each of the
past three years, there is no assurance this trend will continue. The U.S. government is releasing
contracts for shorter periods than in the past. Therefore, Brookwood’s flow of orders from the
companies from whom it derives its military business has been more volatile. Although military
sales for the six months of 2005 were 10% higher than the comparable period in 2004, military sales
for the 2005 second quarter declined 7% from the comparable 2004 period. Based on orders received
through July 31, 2005, Brookwood’s management believes that military sales may decline during the
remainder of 2005. Orders from the military for goods generally were significantly affected by the
increased activity of the U.S. military in recent years. If this activity does not continue to
increase or declines, then orders from the military generally, including orders for Brookwood’s
products, may be similarly affected. However, the Company is unable at this time to predict future
sales trends.
Unstable global nylon pricing is creating cost increases, which, together with product mix,
are beginning to soften Brookwood’s margins, a trend that is likely to continue.
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 breathable, waterproof laminate materials, which have been well received by its customer
base. 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 or that competitors will not
aggressively seek to replace products sold by Brookwood.
The textile industry is also significantly affected by legislation and administrative actions
restricting or liberalizing trade among world textile producing and consuming countries such as the
North American Free Trade Agreement (“NAFTA”), the World Trade Organization (“WTO”), the
anti-dumping and countervailing duty remedies and enforcement activities by the U.S. Government,
and the value of the United States dollar in relation to other currencies and world economic
developments. However, under NAFTA there are no textile and apparel quotas between the United
States and either Mexico or Canada for products that meet certain origin criteria. Tariffs among
the three countries are either already zero or are being phased out. Also, the WTO recently phased
out textile and apparel quotas. The United States has also approved the Central American Free
Trade Agreement (‘CAFTA”) with five Central American countries (Costa Rica, El Salvador, Guatemala,
Honduras and Nicaragua). Under CAFTA, textile and apparel originating from CAFTA countries will be
duty and quota-free, provided that yarn formed in the United States or other CAFTA countries is
used to produce the fabric. In addition, the United States recently implemented bilateral free
trade agreements with Chile, Australia, Israel, Jordan and Singapore. Although these actions have
the effect of
Page 4
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
exposing Brookwood’s market to the lower price structures of the other countries and,
therefore, continuing to increase competitive pressures, management is not able to predict their
specific impact.
Energy. Since January 2002, the Company has invested approximately $22,180,000 in various
private energy companies. The Company owns between 20% and 28% of the entities (between 16% and 22%
on a fully diluted basis) and accounts for the investments using the equity method of accounting.
These private energy companies are or have been principally involved in drilling, gathering and
sale of natural gas in the Barnett Shale formation of Johnson County, Texas and surrounding
counties, and conducting 3-D seismic surveys over optioned land in South Louisiana to determine if
further oil and gas exploratory activity is warranted.
On July 18, 2005, HE III completed a merger with Chesapeake. The merger agreement provided
for a total price of $246,500,000 for all of the HE III production and reserves, as well as the
operational and administrative infrastructure in Johnson County, and was subject to reduction for
outstanding debt, transaction costs, changes in working capital and certain other matters. After
these reductions and adjustments, Chesapeake paid a total of approximately $235,000,000 at the
closing, including debt owed by HE III, and management of HE III anticipates that an additional
$2,500,000 will be paid upon final calculation of working capital.
In exchange for its interest in HE III, the Company received a cash payment of $54,800,000 in
July 2005 and anticipates that it will receive an additional $600,000 after calculation of HE III’s
working capital is completed. The Company will report the gain from the disposition of its
investment in the 2005 third quarter.
The Company’s Hallwood Petroleum, LLC subsidiary (“HPL”) commenced operation in October 2004
as an administrative and management company to facilitate record keeping and processing for the
energy affiliates and has no financial value. All revenues are credited to, and all costs are
borne by, the other energy affiliates with no profit element. All assets nominally in the name of
HPL are held solely for the benefit of the other energy affiliates. HPL was formed as a subsidiary
of the Company as a convenience and it was not intended that it have any financial impact on the
Company. In the 2005 second quarter, the Company determined that its ownership of this
pass-through entity created unnecessary complexity, therefore HPL was transferred for nominal
consideration to officers of the energy affiliates that are not officers of the Company. The
transfer was completed on May 11, 2005.
Discontinued Operations. The Company’s real estate activities were conducted primarily
through the Company’s wholly owned subsidiaries. One of the subsidiaries served as the general
partner of HRP, a publicly traded master limited partnership. Revenues were generated from the
receipt of management fees, leasing commissions and other fees from HRP and third parties and the
Company’s 22% pro rata share of earnings of HRP using the equity method of accounting.
In July 2004, HRP was merged with a subsidiary of HRPT. As a result, HRP became a
wholly-owned subsidiary of HRPT and was no longer a publicly traded limited partnership. The
general partner interest in HRP was also sold to a HRPT subsidiary in a separate transaction and
the management agreements for the properties were terminated. The Company no longer holds any
interest in HRP. The Company received $66,119,000 for its investments in HRP and related assets.
In December 2000, the Company decided to discontinue and dispose of its hotel segment, which
at that time consisted of five hotel properties. Accordingly, the Company’s hotel operations were
reclassified as a discontinued operation. Two hotels were disposed of in 2001 and two hotels were
disposed of in 2002. The Company continued to operate a leasehold interest in one hotel until
December 2004, when the hotel subsidiary entered into a Lease Termination and Mutual Release
Agreement. As of December 31, 2004 the Company had no further operations associated with the hotel
segment.
Presentation
The Company intends the discussion of it financial condition and results of operations that
follows to provide information that will assist in understanding its financial statements, the
changes in certain key items in those financial statements from year to year, and the primary
factors that accounted for those changes, as well as how certain accounting principles, policies
and estimates affect its financial statements.
Following the disposition of its real estate and hotel business segments, the Company
determined that its financial statements should be changed from a segmented format to a classified
format; therefore, substantial reclassifications have been made to the 2004 financial statements.
Page 5
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Income (loss) and revenue from continuing operations for the 2005 second quarter were
$(4,317,000) and $35,857,000, respectively, compared to $10,660,000 and $35,554,000 in 2004.
Income (loss) and revenue from continuing operations for the 2005 six month period were
$(3,411,000) and $73,183,000, respectively, compared to $15,978,000 and $66,794,000 in 2004.
The Company reported income of $2,967,000 from discontinued operations in the 2004 second
quarter, and $11,368,000 in the 2004 six month period.
The Company reported a net (loss) of $(4,317,000) for the second quarter, compared to net
income of $13,627,000 in 2004. Net income (loss) was $(3,411,000) and $27,346,000 for the six
month periods, respectively.
Revenues
Textile products sales of $35,289,000 decreased by $265,000, or 1%, in the 2005 second
quarter, compared to $35,554,000 in 2004. Sales for the six month period increased by $4,890,000,
or 7%, to $71,684,000, compared to $66,794,000 in the 2004 period. The increase for the six month
period was principally due to an increase of sales of specialty fabric to U.S. military
contractors. Military sales for the 2005 second quarter were $18,158,000, of which one customer
accounted for $15,309,000, compared to $19,621,000 and $12,929,000 in the 2004 quarter,
respectively. Military sales for the 2005 six month period totaled $39,762,000, of which one
customer accounted for $33,485,000, compared to $36,085,000 and $23,494,000 in 2004, respectively.
The Company’s HPL subsidiary commenced operation in October 2004 as an administrative and
management company to facilitate recordkeeping and processing for the energy affiliates. All costs
were rebilled to energy affiliates with no anticipated profit element. In the 2005 second quarter,
the Company determined that its ownership of this pass-through entity created unnecessary
complexity; therefore, HPL was transferred for nominal consideration to officers of the energy
affiliates that are not officers of the Company. The transfer was completed on May 11, 2005. The
administrative fees from energy affiliates were $568,000 in the 2005 second quarter (prior to the
transfer) and $1,499,000 for the 2005 six month period.
Expenses
Textile products cost of sales of $27,822,000 for the 2005 second quarter increased by
$1,981,000, or 8%, compared to $25,841,000 in 2004. For the six months, cost of sales increased by
$6,438,000, or 13%, to $56,502,000 from $50,064,000 in 2004. The increases were principally due to
increased sales. The reduced gross profit margin for the 2005 second quarter (21.2% versus 27.3%)
and for the 2005 six month period (21.2% versus 25.0%) principally resulted from changes in product
mix and increased costs, particularly energy and chemicals, offset by increased sales for the six
month period.
Administrative and selling expenses were comprised of the following:
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Three Months Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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2005 |
|
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2004 |
|
|
2005 |
|
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2004 |
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Corporate |
|
$ |
7,409 |
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$ |
756 |
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$ |
8,853 |
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$ |
1,298 |
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Textile products |
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4,034 |
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|
|
3,383 |
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|
|
8,489 |
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|
|
7,068 |
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Energy |
|
|
568 |
|
|
|
— |
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|
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1,499 |
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— |
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Total |
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$ |
12,011 |
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$ |
4,139 |
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$ |
18,841 |
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$ |
8,366 |
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Corporate administrative expenses were $7,409,000 for the 2005 second quarter, compared
to $756,000 for 2004. For the six months, corporate expenses were $8,853,000, compared to
$1,298,000 in 2004. The increases of $6,653,000 and $7,555,000 in the 2005 quarter and six month
periods, respectively, were primarily attributable to bonus awards in the 2005 second quarter
of $5,000,000 to Mr. Gumbiner and $905,000 to those officers of the Company, other than Mr.
Gumbiner, who held options to purchase common stock of the Company, in lieu of amounts such option
holders would have received, had they exercised their options prior to the record date of the cash
distribution in partial liquidation. The 2005 period increases were also the result of increased
consulting and professional fees and overhead costs.
Page 6
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Textile products administrative and selling expenses of $4,034,000 for the 2005 second quarter
increased by $651,000, or 19%, from the 2004 amount of $3,383,000. The increase was primarily
attributable to higher payroll costs, increases in receivable reserves and losses on disposal of
fixed assets, partially offset by a decline in royalties associated with the sales of fabric to
military contractors. For the six months, textile expenses of $8,489,000 increased by $1,421,000,
or 20%, from $7,068,000 in 2004. The increase in the six month period was primarily attributable
to higher royalties associated with the sales of fabric to military contractors, payroll,
insurance, changes in receivable reserves and losses on disposal of fixed assets.
Administrative costs for the Company’s HPL energy subsidiary, which commenced operations in
October 2004, were $568,000 in the 2005 second (prior to the transfer) quarter and $1,499,000 for
the 2005 six month period. As previously noted, HPL was transferred to two officers of the energy
affiliates on May 11, 2005.
Other Income (Loss)
Interest and other income was $200,000 in the 2005 second quarter and $848,000 for the six
months, compared to $1,000 and $3,000 in 2004. The 2005 increases were principally due to interest
income earned on higher balances of cash and cash equivalents and income from investments in
marketable securities.
Equity income (loss) from investments in energy affiliates, relating to the Company’s pro rata
share of income (loss) in the affiliates, was comprised of the following:
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Three Months Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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2005 |
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2004 |
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2005 |
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2004 |
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HE III |
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$ |
516 |
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|
$ |
— |
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$ |
351 |
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$ |
— |
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HE II |
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(2 |
) |
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|
— |
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(78 |
) |
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— |
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Hallwood Exploration |
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|
(14 |
) |
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6 |
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|
|
(79 |
) |
|
|
(4 |
) |
HEC |
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|
— |
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|
433 |
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|
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— |
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|
524 |
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Total |
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$ |
500 |
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|
$ |
439 |
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$ |
194 |
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$ |
520 |
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HE III commenced commercial production and sales of natural gas in June 2004, while HE II
and Hallwood Exploration remain in the development stage. As discussed in Note 18, on July 18,
2005, HE III completed a merger with Chesapeake Energy Corporation and one of its subsidiaries
(“Chesapeake”), under which Chesapeake acquired HE III.
In March 2005, an agreement was entered into with a former officer of the energy affiliates,
who is not otherwise affiliated with the Company, to purchase the officer’s four percent profits
interest in the energy affiliates for $4,000,000, of which $3,500,000 was ascribed to HE III and
$250,000 each to HE II and Hallwood Exploration. The purchase was settled by the energy affiliates
on July 1, 2005. The energy affiliates recorded the purchase amount as compensation expense in the
2005 first quarter and the Company reflected its pro rata share, approximately $1,100,000, as a
reduction of the equity income from the energy affiliates.
In December 2004, HEC completed a merger with Chesapeake under which Chesapeake acquired HEC.
Accordingly, no equity income (loss) from this investment was recorded in 2005.
Interest expense was comprised of the following:
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Three Months Ended |
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Six Months Ended |
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| |
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June 30, |
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|
June 30, |
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| |
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
Textile products |
|
$ |
168 |
|
|
$ |
96 |
|
|
$ |
302 |
|
|
$ |
196 |
|
Corporate |
|
|
— |
|
|
|
295 |
|
|
|
— |
|
|
|
584 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
168 |
|
|
$ |
391 |
|
|
$ |
302 |
|
|
$ |
780 |
|
|
|
|
|
|
|
|
|
|
|
|
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Page 7
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Textile products interest expense principally relates to Brookwood’s Key Bank revolving
credit facility. Increases in interest expense year to year were principally due to changes in the
average outstanding amounts and increasing interest rates. Corporate interest expense principally
relates to the Company’s former Amended and Restated Credit Agreement and 10% Debentures. The
Company repaid the Amended and Restated Credit Agreement in July 2004 and redeemed the 10%
Debentures in September 2004.
At December 31, 2004, the Company had recorded a receivable for $500,000 for the anticipated
additional amount the Company would receive from the disposition of its HEC investment upon final
calculation of HEC’s working capital. In April 2005, the Company received $387,000 as its
proportionate share of the working capital. Accordingly, the Company reduced the gain from the
disposition of HEC by $113,000 in the 2005 first quarter.
Amortization of deferred revenue of $403,000 and $1,007,000 in the 2004 second quarter and six
month periods, respectively, was attributable to the noncompetition agreement associated with the
sale of the Company’s investment in Former Hallwood Energy in May 2001. Under the noncompetition
agreement, the Company agreed to refrain from taking certain actions without prior consent,
including, among other items, directly or indirectly engaging in certain oil and gas activities in
certain geographic areas, for a period of three years. The original $7,250,000 cash payment was
amortized over a three year period which ended in May 2004.
In 1999, the Company entered into a separation agreement (the “Separation Agreement”) with a
former officer and director and related trust. The Company had an option to extinguish certain
future cash payments. In June 2004, the Company exercised the option. At which time, the Company
recognized a gain from extinguishment of the Separation Agreement in the amount of $375,000, which
was the excess of the remaining obligation over the $3,000,000 exercise price.
Income Taxes
Following is a schedule of income tax expense (benefit) (in thousands):
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|
| |
|
Three Months Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, |
|
| |
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Continuing Operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current |
|
$ |
650 |
|
|
$ |
220 |
|
|
$ |
656 |
|
|
$ |
221 |
|
Deferred |
|
|
(252 |
) |
|
|
(5,206 |
) |
|
|
239 |
|
|
|
(7,891 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Sub-total |
|
|
398 |
|
|
|
(4,986 |
) |
|
|
895 |
|
|
|
(7,670 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
State |
|
|
475 |
|
|
|
727 |
|
|
|
983 |
|
|
|
1,181 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
873 |
|
|
$ |
(4,259 |
) |
|
$ |
1,878 |
|
|
$ |
(6,489 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discontinued Operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current |
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
Deferred |
|
|
— |
|
|
|
(2,340 |
) |
|
|
— |
|
|
|
(9,642 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Sub-total |
|
|
— |
|
|
|
(2,340 |
) |
|
|
— |
|
|
|
(9,642 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
State |
|
|
— |
|
|
|
21 |
|
|
|
— |
|
|
|
47 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
— |
|
|
$ |
(2,319 |
) |
|
$ |
— |
|
|
$ |
(9,595 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense in the 2005 periods includes the impact of limitations on the
deductibility of executive compensation in excess of $1,000,000 per year.
The 2004 deferred tax benefits were principally attributable to the anticipated utilization of
NOLs, carryovers and tax credits that were previously reserved, to offset the gain on the sale of
its general partner and limited partner interests in HRP and an increase in projected income from
operations due to improved results at Brookwood and earnings from the Company’s energy
activities. To the extent that the elimination of the valuation allowance was attributable to the
appreciation in the market value of
Page 8
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
the investments in HRP, the deferred tax benefit was allocated
to discontinued operations. The state tax expense is an estimate based upon taxable income
allocated to those states in which the Company does business at their respective tax rates.
During 2004, the Company utilized all of its available net operating loss carryforwards
(“NOLs”), depletion carryforwards and tax credits to offset taxable income. Accordingly, at June
30, 2005, the deferred tax asset is attributable solely to temporary differences, which can be
utilized to offset projected income from operations.
Although the use of such carryforwards in 2004 to offset taxable income could have been
limited under certain circumstances, the Company is not aware of the occurrence of any event which
would result in such limitations. In addition, utilization of NOLs in 2004 could have been limited
if changes in the Company’s stock ownership had created a change in control, as provided in
Section 382 of the Internal Revenue Code of 1986, as amended. The Company believes no such changes
occurred.
Discontinued Real Estate Operations
The Company’s real estate business segment has been reclassified to discontinued
operations as a result of the July 2004 sale of its investments in HRP and the termination of the
associated management contracts.
A summary of discontinued real estate operations is provided below (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, 2005 |
|
| |
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Revenues and Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fees |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Related parties |
|
$ |
— |
|
|
$ |
1,239 |
|
|
$ |
— |
|
|
$ |
2,413 |
|
Other |
|
|
— |
|
|
|
40 |
|
|
|
— |
|
|
|
66 |
|
Equity income (loss) from investments in HRP |
|
|
— |
|
|
|
(134 |
) |
|
|
— |
|
|
|
178 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
— |
|
|
|
1,145 |
|
|
|
— |
|
|
|
2,657 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Administrative expenses |
|
|
— |
|
|
|
304 |
|
|
|
— |
|
|
|
536 |
|
Litigation costs |
|
|
— |
|
|
|
18 |
|
|
|
— |
|
|
|
49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
— |
|
|
|
322 |
|
|
|
— |
|
|
|
585 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax |
|
|
— |
|
|
|
823 |
|
|
|
— |
|
|
|
2,072 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income Taxes |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred federal income tax benefit |
|
|
— |
|
|
|
(2,340 |
) |
|
|
— |
|
|
|
(9,642 |
) |
Current federal and state income tax expense |
|
|
— |
|
|
|
21 |
|
|
|
— |
|
|
|
47 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
— |
|
|
|
(2,319 |
) |
|
|
— |
|
|
|
(9,595 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from discontinued real estate operations |
|
$ |
— |
|
|
$ |
3,142 |
|
|
$ |
— |
|
|
$ |
11,667 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues. Fees for the 2004 periods were derived from the Company’s asset
management, property management, leasing and construction supervision services provided to HRP and
various third parties prior to the sale of HRP in July 2004. Equity income from investments in HRP
represented the Company’s pro rata share of the net income reported by HRP, adjusted for the
elimination of intercompany profits.
Expenses. Administrative expenses included salaries and related costs, office costs and
leasing commissions. Litigation expense represented interest on the remaining balance due to HRP
in the Gotham Partners, L.P. matter, in the amount of $1,877,000, which was paid in May 2004.
The deferred tax benefit for the 2004 periods is disproportionate to income before income tax
due to the recording of a deferred tax benefit attributable to the anticipated gain from the sale
of the Company’s investments in HRP and the related reduction in the valuation allowance.
Page 9
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Discontinued Hotel Operations
In December 2004, the Company’s Brock Suite Huntsville, Inc. subsidiary entered into a Lease
Termination and Mutual Release Agreement with the landlord of the GuestHouse Suites hotel in
Huntsville, Alabama. As of December 31, 2004, the Company had no further operations in the hotel
segment. Operating results for this hotel have been reclassified to discontinued operations for
all periods presented.
A summary of discontinued hotel operations is provided below (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, 2005 |
|
| |
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales |
|
$ |
— |
|
|
$ |
380 |
|
|
$ |
— |
|
|
$ |
742 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses |
|
|
— |
|
|
|
520 |
|
|
|
— |
|
|
|
968 |
|
Depreciation and amortization |
|
|
— |
|
|
|
31 |
|
|
|
— |
|
|
|
62 |
|
Interest expense |
|
|
— |
|
|
|
3 |
|
|
|
— |
|
|
|
9 |
|
Litigation and other disposition costs |
|
|
— |
|
|
|
1 |
|
|
|
— |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
— |
|
|
|
555 |
|
|
|
— |
|
|
|
1,041 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from discontinued hotel operations |
|
$ |
— |
|
|
$ |
(175 |
) |
|
$ |
— |
|
|
$ |
(299 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses for the Huntsville hotel included $269,000 and $188,000 for lease
expense and repairs and maintenance, respectively, for the 2004 six month period. Interest expense
related to a capital lease obligation repaid in June 2004.
Investment in Energy Affiliates
Hallwood Energy III, L.P.
The Company owned approximately 28% (24% after consideration of profit interests) of HE III.
The Company accounted for this investment using the equity method of accounting and recorded its
pro rata share of HE III’s net income (loss), partner capital transactions and comprehensive
income (loss) adjustments, if any.
In 2004, the Company invested $4,705,000 in HE III, which was formed primarily to acquire and
develop oil and gas lease holdings in the Barnett Shale formation of Johnson and Hill Counties,
Texas. In March 2005, the Company invested an additional $4,251,000.
In June 2004, HE III acquired from HEC approximately 15,000 net acres of undeveloped
leasehold, three proven developed non-producing natural gas properties, a limited amount of gas
transmission line and various other assets. As the purchase was from a related entity, the assets
were recorded at net carrying value of approximately $4,400,000, of which the Company’s
proportionate share was approximately $1,232,000. During July 2004, HE III entered into an
agreement with Chesapeake, which owned approximately 12,000 net acres contiguous to that of HE III,
wherein it assigned a 44% interest in its lease holdings to Chesapeake, which in turn assigned a
56% interest in its lease holdings to HE III. Under the joint operating agreement between the two
entities, HE III had been designated as operator.
In December 2004, in connection with the sale of HEC, the Company, as a shareholder in HEC,
received its proportionate share of debt from HE III owed to HEC in the amount of $1,995,000, which
it contributed to HE III as an additional capital investment. In addition, the Company received
its proportionate share of HEC’s investment in its Hallwood SWD, Inc. subsidiary, with a carrying
value of approximately $1,250,000, which was also contributed to HE III as an additional capital
investment.
HE III commenced commercial production and sales of natural gas in June 2004.
Page 10
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As of July 18, 2005, HE III had drilled, acquired or was in the process of drilling 36 wells
in the Barnett Shale formation in Johnson County, Texas. Twenty-four wells were producing, two
wells were being drilled, eight wells were in the completion process and two wells were saltwater
disposal wells. On that date, HE III held oil and gas leases covering approximately 29,000 gross
and 14,000 net acres of undeveloped leasehold, predominantly in Johnson County, Texas. Natural gas
production was approximately 21 million cubic feet per day, net to HE III’s interest.
Sale of HE III. On July 18, 2005, HE III completed a merger with Chesapeake for the sale of
HE III. The merger agreement provided for a total price of $246,500,000 for all of the HE III
production and reserves, as well as the operational and administrative infrastructure in Johnson
County, and was subject to reduction for outstanding debt, transaction costs, changes in working
capital and certain other matters. After these reductions and adjustments, Chesapeake paid a total
of approximately $235,000,000 at the closing, including debt owed by HE III, and management of HE
III anticipates that an additional $2,500,000 will be paid upon final calculation of working
capital.
In exchange for its interest in HE III, the Company received a cash payment of $54,800,000 in
July 2005 and anticipates that it will receive an additional $600,000 after calculation of HE III’s
working capital is completed. The Company will report the gain from the disposition of its
investment in the 2005 third quarter. The Company also received a distribution for its
proportionate share of certain pipe inventory owned by HE III, with a proportionate carrying value
of approximately $1,395,000, which was contributed to HE II as an additional capital investment.
Prior to the sale, HE III had four drilling rigs in operation. Three of the rigs remained
with the buyer and the other rig will be utilized in connection with drilling operations at HE II.
Certain of the Company’s officers and directors are investors in HE III. In addition,
individual members of management of HE III, including one director and officer and one officer of
the Company, hold a profit interest in HE III.
Hallwood Energy II, L.P.
At June 30, 2005, the Company owned approximately 24% (19% after consideration of profit
interests) of HE II. It accounts for this investment using the equity method of accounting and
records its pro rata share of HE II’s net income (loss), partner capital transactions and
comprehensive income (loss) adjustments, if any.
In September 2004, the Company invested $2,430,000 in HE II, which was formed to explore
various oil and gas exploration opportunities, primarily in Texas, and in areas not associated with
HEC and HE III. In June 2005, the Company invested an additional $1,215,000. As of August 1,
2005, HE II holds oil and gas leases covering approximately 42,000 gross and 38,000 net acres of
undeveloped leasehold in Reeves, Culberson and Hill counties. HE II plans to commence drilling
activities in the 2005 third and fourth quarters. Additional HE II prospects are being evaluated
which may alter the current drilling schedule. HE II has one drilling rig available for operation
and a second rig under construction is currently designated for drilling on HE II’s leases.
In addition, the Company received a distribution for its proportionate share of certain pipe
inventory owned by HE III, with a proportionate carrying value of approximately $1,395,000, which
was contributed to HE II as an additional capital investment.
In connection with the July 2005 disposition of HE III, HE II sold all of its 856 net acres
lease holdings in Johnson County, Texas to Chesapeake for $3,000,000. The Company will record its
pro rata share of the gain from this transaction in the 2005 third quarter.
Certain of the Company’s officers and directors are investors in HE II. In addition,
individual members of management of HE II, including one director and officer and one officer of
the Company, hold a profit interest in HE II.
Hallwood Exploration, L.P.
The Company owned approximately 20% (16% after consideration of profit interests) of Hallwood
Exploration. It accounts for this investment using the equity method of accounting.
In 2004, the Company invested $1,318,000 in Hallwood Exploration, which was formed to develop
an oil and gas opportunity in South Louisiana. In June 2005, the Company invested an additional
$203,000. Hallwood Exploration has
Page 11
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
acquired seismic lease options over approximately 36,000 acres,
and is currently in the process of conducting a 3-D seismic survey over the optioned land to
determine if further oil and gas exploratory activity is warranted.
Certain of the Company’s officers and directors are investors in Hallwood Exploration.
In addition, individual members of management of Hallwood Exploration including one director and
officer and one officer of the Company, hold a profit interest in Hallwood Exploration.
Hallwood Energy Corporation
The Company owned approximately 28% (22% after consideration of stock options) of HEC. It
accounted for the investment using the equity method of accounting and recorded its pro rata share
of HEC’s net income (loss), stockholders’ equity transactions and comprehensive income
(loss) adjustments, if any. The Company invested $3,500,000 in HEC during 2002, $1,997,000 in
2003, and $566,000 in 2004.
Sale of HEC. In December 2004, HEC completed a merger with Chesapeake, under which Chesapeake
acquired HEC. In exchange for its interest in HEC, the Company received a cash payment of
$53,793,000 in December 2004 and received an additional amount of $387,000 in April 2005 from the
settlement of HEC’s working capital. The Company also received its proportionate share of the HE
III debt in the amount of $1,995,000, which it contributed to HE III as an additional capital
contribution and its proportionate interest in Hallwood SWD, Inc., the former HEC subsidiary that
owned the Worthington saltwater disposal well, with a carrying value of approximately $1,250,000,
which it contributed to HE III as an additional capital contribution.
Certain of the Company’s officers and directors were investors in HEC. In addition,
individual members of management of HEC, including one director and officer and one officer of the
Company, had stock options in HEC.
Critical Accounting Policies
There have been no changes to the critical accounting policies identified and set forth in the
Company’s Form 10-K for the year ended December 31, 2004.
Related Party Transactions
HRP. The Company’s real estate subsidiaries earned asset management, property
management, leasing and construction supervision fees for their management of HRP’s real
estate properties. The management contracts with HRP, which were scheduled to expire on June 30,
2004, were amended in April 2004 to expire on the closing date of the merger with HRPT, which was
completed on July 16, 2004. A summary of the fees earned from HRP is detailed below (in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, |
|
| |
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Property management fees |
|
$ |
— |
|
|
$ |
518 |
|
|
$ |
— |
|
|
$ |
995 |
|
Construction supervision fees |
|
|
— |
|
|
|
109 |
|
|
|
— |
|
|
|
447 |
|
Leasing fees |
|
|
— |
|
|
|
457 |
|
|
|
— |
|
|
|
663 |
|
Asset management fees |
|
|
— |
|
|
|
155 |
|
|
|
— |
|
|
|
308 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
— |
|
|
$ |
1,239 |
|
|
$ |
— |
|
|
$ |
2,413 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Hallwood Realty was also reimbursed for certain costs and expenses, at cost, for
administrative level salaries and bonuses, employee and director insurance and allocated overhead
costs. In addition, since HRP did not employ any individuals, the compensation and other costs
related to approximately 90 employees rendering services on behalf of HRP and its properties were
reimbursed to Hallwood Realty and HCRE by HRP.
Hallwood Investments Limited. The Company has entered into a financial consulting contract
with Hallwood Investments Limited (“HIL”), a corporation associated with Mr. Anthony J.
Gumbiner, the Company’s chairman and principal stockholder. The contract provides for HIL to
furnish and perform international consulting and advisory services to the Company and its
subsidiaries, including strategic planning and merger activities, for annual compensation of
$996,000 ($954,000 prior to March
Page 12
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
2005). Additionally, HIL and Mr. Gumbiner are also eligible for
bonuses from the Company or its subsidiaries, subject to approval by the Company’s or its
subsidiaries’ board of directors. The Company also reimburses HIL for reasonable expenses in
providing office space and administrative services.
A summary of the fees and expenses related to HIL and Mr. Gumbiner are detailed below (in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, |
|
| |
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Bonus |
|
$ |
5,000 |
|
|
$ |
— |
|
|
$ |
5,000 |
|
|
$ |
— |
|
Consulting fees |
|
|
249 |
|
|
|
238 |
|
|
|
491 |
|
|
|
450 |
|
Office space and administrative services |
|
|
216 |
|
|
|
32 |
|
|
|
324 |
|
|
|
58 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
5,465 |
|
|
$ |
270 |
|
|
$ |
5,815 |
|
|
$ |
508 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
On July 6, 2005, a special committee of the board of directors awarded Mr. Gumbiner a
bonus in the amount of $5,000,000. The amount was included in administrative and selling expense in
the 2005 second quarter and paid on July 8, 2005.
In addition, HIL and Mr. Gumbiner perform services for certain affiliated entities that are
not subsidiaries of the Company, for which they receive consulting fees, bonuses or other forms of
compensation and expenses. The Company recognizes a proportionate share of such compensation and
expenses, based upon its ownership percentage in the affiliated entities, through the utilization
of the equity method of accounting.
Contractual Obligations and Commercial Commitments
The Company and its subsidiaries have entered into various contractual obligations and
commercial commitments in the ordinary course of conducting its business operations, which are
provided below as of June 30, 2005 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Payments Due During the Year Ending December 31, |
|
| |
|
2005* |
|
|
2006 |
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
Thereafter |
|
|
Total |
|
Contractual Obligations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long term debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans payable |
|
$ |
170 |
|
|
$ |
352 |
|
|
$ |
11,433 |
|
|
$ |
152 |
|
|
$ |
27 |
|
|
$ |
— |
|
|
$ |
12,134 |
|
Operating leases |
|
|
410 |
|
|
|
640 |
|
|
|
223 |
|
|
|
204 |
|
|
|
— |
|
|
|
— |
|
|
|
1,477 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
580 |
|
|
$ |
992 |
|
|
$ |
11,656 |
|
|
$ |
356 |
|
|
$ |
27 |
|
|
$ |
— |
|
|
$ |
13,611 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Amount of Commitment Expiration |
|
| |
|
During the Year Ending December 31, |
|
| |
|
2005* |
|
|
2006 |
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
Thereafter |
|
|
Total |
|
Commercial Commitments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employment contracts |
|
$ |
183 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
183 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| * |
|
For the six months ending December 31, 2005. |
Financial Covenants
The Company’s former Amended and Restated Credit Agreement and former 10% Debentures
required compliance with various loan covenants and financial ratios, which, if not met, would have
triggered a default. Additionally, Brookwood’s Key Working Capital Credit Facility requires
compliance with various loan covenants and financial ratios, principally a total debt to tangible
net worth ratio and a minimum net income requirement.
Amended and Restated Credit Agreement and 10% Debentures. The Amended and Restated Credit
Agreement and 10% Debentures were repaid in 2004. Prior to their repayment, the Company was in
compliance with the covenants for both borrowings in 2004.
Page 13
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Key Working Capital Revolving Credit Facility. The principal ratios, as defined in the Key
Working Capital Revolving Credit Facility for the last four quarters are provided below (dollar
amounts in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Quarters Ended |
|
| |
|
|
|
|
|
June 30, |
|
|
March 31, |
|
|
December 31, |
|
|
September 30, |
|
| Description |
|
Requirement |
|
|
2005 |
|
|
2005 |
|
|
2004 |
|
|
2004 |
|
Total debt to tangible net worth |
|
must be less than 1.50 |
|
|
0.83 |
|
|
|
0.97 |
|
|
|
0.89 |
|
|
|
0.90 |
|
Net income |
|
must exceed $1 |
|
Yes |
|
Yes |
|
|
N/A |
|
|
|
N/A |
|
EBITDA to total fixed charges |
|
must exceed 1.15 |
|
|
N/A |
|
|
|
N/A |
|
|
|
1.41 |
|
|
|
1.28 |
|
Brookwood was in compliance with its loan covenants under the Key Working Capital
Revolving Credit Facility for the first two quarters in 2005 and for all quarters in 2004.
On March 25, 2005, Brookwood and Key Bank entered into a loan amendment which eliminated the
borrowing base and certain other loan requirements, including the EBITDA to fixed charges covenant.
In addition, the total debt to tangible net worth ratio covenant was reduced to 1.50 from 1.75 and
a new covenant was added that Brookwood shall maintain a minimum quarterly net income of not less
than $1 beginning with the quarter ended March 31, 2005.
Liquidity and Capital Resources
General. The Company principally operates in the textile products and energy business
segments. The Company’s cash position decreased by $50,951,000 during the 2005 six month
period to $20,598,000 as of June 30, 2005. The primary uses of cash were $56,789,000 for a cash
distribution in partial liquidation paid in May 2005, $5,669,000 for investments in energy
affiliates and $1,452,000 for textile products and other equipment. The principal sources of cash
were $7,308,000 provided by operating activities, $2,998,000 from net bank borrowings and
$2,207,000 from the exercise of stock options.
Textiles. The Company’s textile products segment generates funds from the dyeing,
laminating and finishing of fabrics and their sale to customers in the consumer, industrial,
medical and military markets. Brookwood maintains a $22,000,000 revolving line of credit facility
and a $3,000,000 equipment facility with Key Bank. The facilities have a maturity date of January
2007.
At June 30, 2005, Brookwood had approximately $10,848,000 of unused borrowing capacity on its
Key Working Capital Revolving Credit Facility and $2,018,000 under its equipment facility.
Brookwood made payments to the Company of $2,927,000 in the 2005 six month period and $5,373,000 in
all of 2004 under its tax sharing agreement. In addition, Brookwood paid cash dividends to the
Company of $5,000,000 in the 2005 six month period and $3,000,000 in all of 2004. Future cash
dividends and tax sharing payments to the Company are contingent upon Brookwood’s continued
compliance with the covenants contained in the credit facility. There were no significant capital
requirements as of June 30, 2005.
Energy. The Company has invested $11,014,000, $1,997,000, and $3,500,000 in its various
energy affiliates (of which $6,063,000 was invested in HEC prior to its disposition) in 2004, 2003
and 2002, respectively, and $5,669,000 to date in 2005. The energy affiliates anticipate that
substantial additional capital will be required over the next few years to complete projected
property acquisition, exploration and development costs. As a result, the Company has projected
that up to $4,000,000 may be required for additional capital investment for the remainder of 2005.
The Company believes these contributions can be made from existing cash. The actual level of
investment, however, will depend on a number of factors that cannot be determined at this time,
including future gas prices, costs of field operations, the ability to successfully identify and
acquire prospective properties and drill and complete wells, and the availability of alternative
sources of capital, such as loans from third parties.
Sale of HE III. On July 18, 2005, HE III completed a merger with Chesapeake. The merger
agreement provided for a total price of $246,500,000, which was subject to reduction for
outstanding debt, transaction costs, changes in working capital and certain other matters. After
these reductions and adjustments, Chesapeake paid a total of approximately $235,000,000 at the
closing, including debt owed by HE III, and management of HE III anticipates that an
additional $2,500,000 will be paid upon final calculation of working capital.
In exchange for its interest in HE III, the Company received a cash payment of $54,800,000 in
July 2005 and anticipates that it will receive an additional $600,000 after calculation of HE III’s
working capital is completed. The Company will report the gain from the disposition of its
investment in the 2005 third quarter. In addition, the Company received a distribution for its
Page 14
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
proportionate share of certain pipe inventory owned by HE III, with a proportionate carrying value
of approximately $1,395,000, which was contributed to HE II as an additional capital investment.
Additional Cash Distribution in Partial Liquidation. On July 27, 2005, the Company announced
an additional cash distribution in partial liquidation to stockholders and an equivalent bonus to
option holders. The cash distribution in the amount of $6.17 per share, totaling approximately
$9,324,000 is payable on August 18, 2005 to stockholders of record as of August 12, 2005. The
distribution, along with the distribution discussed in Note 16, approximates the total amount
received from the disposition of its real estate interests and partnership units. The Company held
approximately $68,000,000 in cash and marketable securities on August 12, 2005.
The Company’s ability to generate cash flow from operations will depend on its future
performance and its ability to successfully implement business and growth strategies. The
Company’s performance will also be affected by prevailing economic conditions. Many of these
factors are beyond the Company’s control. With the sale of HRP and HEC in 2004 and HE III in
2005 and its continuing operations, the Company believes it has sufficient funds to meet its
liquidity needs.
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 relate
to management’s future plans, objectives and expectations. Such statements 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 those described in the Company’s Form 10-K for the year ended December 31, 2004 in the
section entitled “Business-Competition, Risks and Other Factors”. 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 15
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
PART II — OTHER INFORMATION
Item
| |
31.1 |
|
Certification of the Chief Executive Officer, pursuant to Section 302
of Sarbanes-Oxley Act of 2002. |
| |
| |
31.2 |
|
Certification of the Chief Financial Officer, pursuant to Section 302
of Sarbanes-Oxley Act of 2002. |
| |
| |
32.1 |
|
Certification of Chief Executive Officer and Chief Financial Officer,
pursuant to Section 906 of Sarbanes-Oxley Act of 2002. |
Page 16
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 25, 2005
|
|
By:
|
|
/s/ Melvin J. Melle |
|
|
|
|
|
|
|
|
|
|
|
|
|
Melvin J. Melle, Vice President
(Duly Authorized Officer and
Principal Financial and
Accounting Officer) |
Page 17
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
INDEX TO EXHIBITS
| |
|
|
| Exhibit |
|
|
| Number |
|
Description |
|
|
|
31.1
|
|
Certification of the Chief Executive Officer, pursuant to Section 302 of
Sarbanes-Oxley Act of 2002. |
|
|
|
31.2
|
|
Certification of the Chief Financial Officer, pursuant to Section 302 of
Sarbanes-Oxley Act of 2002. |
|
|
|
32.1
|
|
Certification of Chief Executive Officer and Chief Financial Officer, pursuant to
Section 906 of Sarbanes-Oxley Act of 2002. |
Page 18