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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
MARK ONE
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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FOR THE PERIOD ENDED MARCH 31, 2003 COMMISSION FILE NUMBER: 1-8303
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THE HALLWOOD GROUP INCORPORATED
(Exact name of registrant as specified in its charter)
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DELAWARE 51-0261339
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3710 RAWLINS, SUITE 1500
DALLAS, TEXAS 75219
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 528-5588
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF CLASS ON WHICH REGISTERED
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Common Stock ($0.10 par value) American Stock Exchange
10% Collateralized Subordinated Debentures Due July 31, 2005 New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF CLASS
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
----- -----
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12B-2 of the Act).
YES NO X
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1,361,343 shares of Common Stock, $.10 par value per share, were
outstanding at April 30, 2003.
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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
ITEM NO. PART I - FINANCIAL INFORMATION PAGE
-------- ------------------------------ ----
1 Financial Statements (Unaudited):
Consolidated Balance Sheets as of March 31, 2003
and December 31, 2002.................................. 3
Consolidated Statements of Income for the
Three Months Ended March 31, 2003 and 2002............. 5
Consolidated Statements of Comprehensive Income for the
Three Months Ended March 31, 2003 and 2002............. 7
Consolidated Statements of Changes in Stockholders' Equity
for the Three Months Ended March 31, 2003.............. 8
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2003 and 2002............. 9
Notes to Consolidated Financial Statements.................. 10
2 Managements's Discussion and Analysis of
Financial Condition and Results of Operations............... 23
3 Quantitative and Qualitative Disclosures about Market Risk..... 32
4 Controls and Procedures and Internal Controls.................. 32
PART II - OTHER INFORMATION
1 thru 6 Other Information, Exhibits and Reports on Form 8-K............ 33
Signature Page................................................. 34
Officers' Certifications....................................... 35
Index to Exhibits.............................................. 37
Page 2
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
(UNAUDITED)
REAL ESTATE
Investments in HRP ..................... $ 13,638 $ 13,525
Receivables and other assets
Related parties ..................... 624 732
Other ............................... 40 60
------------ ------------
14,302 14,317
TEXTILE PRODUCTS
Inventories ............................ 19,133 18,913
Receivables ............................ 18,002 15,743
Property, plant and equipment, net ..... 9,180 9,315
Prepaids, deposits and other assets .... 473 548
------------ ------------
46,788 44,519
OTHER
Deferred tax asset, net ................ 3,825 4,221
Investment in HEC ...................... 3,364 3,313
Cash and cash equivalents .............. 1,285 1,377
Hotel assets held for use .............. 350 362
Prepaids, deposits and other assets
Other ............................... 319 317
Related parties ..................... 116 140
Restricted cash ........................ -- 982
------------ ------------
9,259 10,712
------------ ------------
TOTAL ............................... $ 70,349 $ 69,548
============ ============
See accompanying notes to consolidated financial statements.
Page 3
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
(UNAUDITED)
REAL ESTATE
Accounts payable and accrued expenses ............. $ 246 $ 1,306
TEXTILE PRODUCTS
Loans payable ..................................... 13,804 13,247
Accounts payable and accrued expenses ............. 11,297 10,803
------------ ------------
25,101 24,050
OTHER
10% Collateralized Subordinated Debentures ........ 6,612 6,625
Separation Agreement obligations .................. 3,875 4,000
Loans payable ..................................... 3,378 2,817
Deferred revenue - noncompetition agreement ....... 2,819 3,424
Interest and other accrued expenses ............... 1,008 1,274
Capital lease obligations ......................... 938 1,066
Hotel accounts payable and accrued expenses ....... 919 850
------------ ------------
Total other liabilities ........................ 19,549 20,056
TOTAL LIABILITIES .............................. 44,896 45,412
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 ........................ 54,429 54,452
Accumulated deficit ............................... (15,064) (16,417)
Accumulated other comprehensive income ............ 178 191
Treasury stock, 1,034,760 shares at both
dates; at cost ................................. (15,330) (15,330)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY ..................... 24,453 23,136
------------ ------------
TOTAL .......................................... $ 70,349 $ 69,548
============ ============
See accompanying notes to consolidated financial statements.
Page 4
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------
2003 2002
------------ ------------
REAL ESTATE
Fees
Related parties ........................................... $ 1,207 $ 1,112
Other ..................................................... 40 7
Equity income from investments in HRP ........................ 316 533
------------ ------------
1,563 1,652
Administrative expenses ...................................... 256 220
Amortization ................................................. 168 168
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424 388
------------ ------------
Income from real estate operations ........................ 1,139 1,264
TEXTILE PRODUCTS
Sales ........................................................ 24,799 20,821
Equity income from joint venture ............................. -- 574
------------ ------------
24,799 21,395
Cost of sales ................................................ 20,210 18,053
Administrative and selling expenses .......................... 3,552 2,669
Interest ..................................................... 149 166
------------ ------------
23,911 20,888
------------ ------------
Income from textile products operations ................... 888 507
OTHER
Amortization of deferred revenue - noncompetition agreement .. 604 604
Hotel revenue ................................................ 337 440
Equity income (loss) from investment in HEC .................. 51 (41)
Interest and other income .................................... 1 304
------------ ------------
993 1,307
Hotel expenses ............................................... 448 437
Administrative expenses ...................................... 428 382
Interest expense ............................................. 203 205
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1,079 1,024
------------ ------------
Other income (loss), net .................................. (86) 283
------------ ------------
Income from continuing operations before income taxes ..... 1,941 2,054
Income taxes .............................................. (588) (738)
------------ ------------
Income from continuing operations ......................... 1,353 1,316
See accompanying notes to consolidated financial statements.
Page 5
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
---------------------------
2003 2002
------------ ------------
Income from discontinued hotel operations, net of tax ................ $ -- $ 1,476
------------ ------------
Income before cumulative effect of change in accounting principle .. 1,353 2,792
Income from cumulative effect of change in accounting principle ...... -- 568
------------ ------------
NET INCOME ............................................................... $ 1,353 $ 3,360
============ ============
PER COMMON SHARE
BASIC
Income from continuing operations .................................. $ 0.99 $ 0.97
Income from discontinued operations ................................ -- 1.08
Income from cumulative effect of change in accounting principle .... -- 0.42
------------ ------------
Net income ....................................................... $ 0.99 $ 2.47
============ ============
ASSUMING DILUTION
Income from continuing operations .................................. $ 0.99 $ 0.85
Income from discontinued operations ................................ -- 0.94
Income from cumulative effect of change in accounting principle .... -- 0.36
------------ ------------
Net income ....................................................... $ 0.99 $ 2.15
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ................................................................ 1,361 1,361
============ ============
Assuming dilution .................................................... 1,361 1,579
============ ============
See accompanying notes to consolidated financial statements.
Page 6
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------
2003 2002
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NET INCOME ....................................................................... $ 1,353 $ 3,360
Other Comprehensive Income (Loss)
Pro rata share of other comprehensive income (loss) from equity investments
Amortization of interest rate swap ........................................ (13) (14)
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COMPREHENSIVE INCOME ............................................................. $ 1,340 $ 3,346
========== ==========
See accompanying notes to consolidated financial statements.
Page 7
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
----------------------- PAID-IN ACCUMULATED COMPREHENSIVE
SHARES PAR VALUE CAPITAL DEFICIT INCOME
---------- ---------- ---------- ----------- -------------
BALANCE, JANUARY 1, 2003 .................. 2,396 $ 240 $ 54,452 $ (16,417) $ 191
Net income ............................ 1,353
Pro rata share of partners' capital
transactions from equity investment:
Exercise of stock options ........... (23)
Amortization of interest rate swap .. (13)
---------- ---------- ---------- ---------- ------------
BALANCE, MARCH 31, 2003 ................... 2,396 $ 240 $ 54,429 $ (15,064) $ 178
========== ========== ========== ========== ============
TREASURY STOCK TOTAL
------------------------ STOCKHOLDERS'
SHARES COST EQUITY
----------- ---------- ------------
BALANCE, JANUARY 1, 2003 .................. 1,035 $ (15,330) $ 23,136
Net income ............................ 1,353
Pro rata share of partners' capital
transactions from equity investment:
Exercise of stock options ........... (23)
Amortization of interest rate swap .. (13)
---------- ---------- ----------
BALANCE, MARCH 31, 2003 ................... 1,035 $ (15,330) $ 24,453
========== ========== ==========
See accompanying notes to consolidated financial statements.
Page 8
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ............................................................. $ 1,353 $ 3,360
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Decrease in restricted cash ......................................... 982 --
Amortization of deferred revenue - noncompetition agreement ......... (604) (604)
Depreciation and amortization ....................................... 570 521
Deferred tax expense................................................. 396 566
Equity income from investments in HRP ............................... (316) (533)
Equity income/loss from investment in HEC ........................... (51) 41
Amortization of deferred gain from debenture exchange ............... (13) (12)
Equity income from textile products joint venture ................... -- (574)
Income from cumulative effect of changes in accounting principles ... -- (568)
Net change in textile products assets and liabilities ............... (1,910) 2,679
Net change in other assets and liabilities .......................... (1,000) (563)
Discontinued operations:
Net change in other hotel assets and liabilities ................. (250) 199
Gain from extinguishment of hotel debt ........................... -- (2,552)
Deferred tax expense.............................................. -- 875
------------ ------------
Net cash provided by (used in) operating activities .............. (843) 2,835
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in textile products property and equipment ................. (239) (303)
Investment in HEC common stock ......................................... -- (1,500)
Investment in hotel held for use ....................................... -- (8)
Investment in marketable securities .................................... -- (901)
------------ ------------
Net cash (used in) investing activities .......................... (239) (2,712)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings and loans payable ........................ 1,555 3,000
Repayment of bank borrowings and loans payable ......................... (565) (4,137)
Payment of deferred loan costs ......................................... -- (35)
------------ ------------
Net cash provided by (used in) financing activities ............. 990 (1,172)
------------ ------------
DECREASE IN CASH AND CASH EQUIVALENTS ...................................... (92) (1,049)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............................. 1,377 3,006
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................................... $ 1,285 $ 1,957
============ ============
See accompanying notes to consolidated financial statements.
Page 9
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 1 -- INTERIM CONSOLIDATED FINANCIAL STATEMENTS, NEW ACCOUNTING
PRONOUNCEMENTS AND RECLASSIFICATIONS
Interim Consolidated Financial Statements. The consolidated financial
statements of The Hallwood Group Incorporated (the "Company") (AMEX: HWG) 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, 2002.
Continuing Operations. The Company is a holding company that classifies its
primary continuing business operations into two segments; real estate and
textile products. During 2002, the Company re-entered the energy business as a
28% owner in a private energy company - Hallwood Energy Corporation ("HEC"), but
it is not considered a material business segment.
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 an
integrated textile service firm that develops and produces innovative fabrics
and related products through specialized finishing, treating and coating
processes. Brookwood's subsidiary, Strategic Technical Alliance, LLC ("STA")
produces advanced breathable, waterproof laminate materials for military
applications. Continued development of these fabrics for military, industrial
and consumer applications is a key element of Brookwood's business plan.
During 2002, the Company invested $3,500,000 in HEC. HEC is presently in
the developmental stage having drilled 7 test wells in the Barnett Shale
Formation of Johnson County, Texas. The Company owns 28% of HEC and accounts for
the investment using the equity method of accounting. Certain of the Company's
officers and directors are investors in HEC. See Note 3.
Discontinued Operations. In December 2000, the Company discontinued its
hotel segment, which at that time consisted of five hotel properties. Two hotels
were disposed of in 2001, one hotel was sold in January 2002 and the lender
completed a foreclosure on one hotel in May 2002. The Company continues to
operate a leasehold interest in one hotel.
New Accounting Pronouncements. Statement of Financial Accounting Standards
No. 148 - Accounting for Stock Based Compensation - Transition and Disclosure,
an Amendment of FASB Statement No. 123 ("SFAS No. 148"), was issued in December
2002. This statement provides new transition methods if an entity adopts the
fair value based method of valuing stock-based compensation suggested in SFAS
No. 123 - Accounting for Stock Based Compensation, as well as requiring
additional disclosures in interim and annual financial statements. No options
have been granted since 2000. As all options were fully vested as of December
31, 2000, there is no difference between the historical operations and pro forma
operations for the periods presented herein had the expense provisions of SFAS
No. 123 been adopted.
Reclassifications. Certain reclassifications have been made to prior year
amounts to conform to the classifications used in the current year.
Page 10
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 2 -- INVESTMENTS IN HRP (DOLLAR AMOUNTS IN THOUSANDS)
AS OF MARCH 31, 2003 AMOUNT AT INCOME FOR THE
----------------------- WHICH CARRIED AT THREE MONTHS ENDED
COST OR ------------------------ MARCH 31,
NUMBER OF ASCRIBED MARCH 31, DECEMBER 31, -----------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 2003 2002 2003 2002
------------------------- ---------- ---------- ---------- ------------ ---------- ----------
HALLWOOD REALTY PARTNERS, L.P .....
- General partner interest ........ -- $ 8,650 $ 1,199 $ 1,350 $ 16 $ 27
- Limited partner interest ........ 330,432 8,799 12,439 12,175 300 506
---------- ---------- ---------- ---------- ----------
Totals ......................... $ 17,449 $ 13,638 $ 13,525 $ 316 $ 533
========== ========== ========== ========== ==========
At March 31, 2003, 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. In addition to recording its share of HRP's net income, the Company
also records non-cash adjustments for the elimination of intercompany profits
with a corresponding adjustment to equity income, its pro rata share of HRP's
partner capital transactions with corresponding adjustments to additional
paid-in capital and its pro rata share of HRP's comprehensive income. The
cumulative amount of such non-cash adjustments, from the original date of
investment through March 31, 2003, resulted in a $1,819,000 decrease in the
carrying value of the HRP investment. 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. In accordance with Statement of Financial Accounting
Standards No. 142 - Goodwill and Other Intangibles ("SFAS No. 142") the
unamortized amount of such "negative goodwill" in the amount of $568,000, as of
January 1, 2002 was recorded as income from cumulative effect of a change in
accounting principle.
The carrying value of the Company's investment in the general partner
interest of HRP includes the value of intangible rights to provide asset
management and property management services. The Company amortizes that portion
of the general partner interest ascribed to the management rights. For the three
months ended March 31, 2003 and 2002 such amortization was $168,000 in each
period. At March 31, 2003, the remaining unamortized cost was $392,000.
As further discussed in Note 12, Hallwood Realty, the Company and other
defendants are involved in various litigation matters. An unfavorable decision
in any of the matters could have an adverse impact on the Company and its
investment in HRP.
The Company has pledged 300,397 HRP limited partner units to collateralize
the Term Loan and Revolving Credit Facility and the remaining 30,035 units to
secure all of the capital leases.
The quoted market price per unit and the Company's carrying value per
limited partner unit (AMEX symbol HRY) at March 31, 2003 were $86.50 and $37.64,
respectively. The general partner interest is not publicly traded.
Page 11
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 3 -- INVESTMENT IN HEC (DOLLAR AMOUNTS IN THOUSANDS)
AS OF MARCH 31,2003 AMOUNT AT INCOME (LOSS) FOR THE
--------------------------- WHICH CARRIED AT THREE MONTHS ENDED
COST OR --------------------------- MARCH 31,
NUMBER OF ASCRIBED MARCH 31, DECEMBER 31, ---------------------------
DESCRIPTION OF INVESTMENT SHARES VALUE 2003 2002 2003 2002
------------------------- ------------ ------------ ------------ ------------ ------------ ------------
HALLWOOD ENERGY CORPORATION
Common stock ............. 1,750 $ 3,500 $ 3,364 $ 3,313 $ 51 $ (41)
============ ============ ============ ============ ============
The Company owns approximately 28% of HEC. It accounts for the investment
using the equity method of accounting and records its pro rata share of HEC's
net income (loss), stockholder's equity transactions and comprehensive income
(loss) adjustments, if any.
During 2002, the Company invested $3,500,000 in HEC, which is presently in
the development stage, having drilled seven test wells in the Barnett Shale
formation of Johnson County, Texas. After constructing a gas gathering system,
HEC commenced commercial production and sales from three of the seven wells in
February 2003. Currently, six wells are producing and one well has been
temporarily abandoned. Aggregate production, including royalty owner share and
minor working interest participation, rose to three million cubic feet of gas
per day during the first week of May 2003, and was approximately two million
cubic feet of gas per day at May 14, 2003.
HEC currently plans to drill between 10 and 20 wells during the balance of
2003; however, this number may vary based upon a variety of operational and
economic conditions. Whether HEC drills 10 or 20 additional wells this year,
additional capital will be required. HEC currently anticipates that it will
solicit equity contributions from its shareholders in combination with
commercial, secured bank borrowings to meet its capital requirements. Depending
on the level of bank borrowings, coupled with the ultimate level of well
development activity, HEC has requested from its shareholders additional equity
contributions over the next several months of approximately $3,300,000. Based on
the Company's ownership, its board of directors has resolved to make an
additional equity contribution of approximately $925,000.
HEC holds oil and gas leases covering approximately 37,500 gross and
33,500 net acres of undeveloped leasehold, predominantly in Johnson County,
Texas as of May 1, 2003.
Certain of the Company's officers and directors are investors in HEC.
Page 12
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 4 -- LOANS PAYABLE
Loans payable at the balance sheet dates are as follows (in thousands):
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
Textile Products
Revolving credit facility, prime + .25% or
Libor + 3.00%, due January 2004 ............................... $ 10,755 $ 10,000
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 ............... 575 623
Subordinated secured promissory note, prime rate, due July 2004 .. 510 596
Equipment term loan, 5.10% fixed, due March 2007 ................. 445 469
Equipment term loan, 4.67% fixed, due December 2007 .............. 290 298
Subordinated promissory note, non-interest bearing,
due February 2005 ............................................. 229 261
------------ ------------
13,804 13,247
Other
Loans payable
Term loan, 7% fixed, due April 2005 ........................... 2,078 2,317
Revolving credit facility, prime + 0.50% or
Libor + 3.25%, due April 2005 ............................... 1,300 500
------------ ------------
Sub total ................................................. 3,378 2,817
Capital lease obligations, 12.18% fixed , due December 2004 ...... 938 1,066
------------ ------------
4,316 3,883
------------ ------------
Total ......................................................... $ 18,120 $ 17,130
============ ============
Further information regarding loans payable is provided below:
Textile Products
Revolving Credit Facility. The Company's Brookwood subsidiary has a
revolving credit facility in an amount up to $17,000,000 with Key Bank National
Association ("Key Credit Agreement"). 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 in the agreement.
Borrowings are collateralized by accounts receivable, inventory imported under
trade letters of credit, certain finished goods inventory, machinery and
equipment and all of the issued and outstanding capital stock of Brookwood and
its subsidiaries. The Key Credit Agreement has a maturity date of January 2,
2004, bears interest at Brookwood's option of prime + 0.25% (4.50% at March 31,
2003) or Libor plus 3.25%, contains various covenants, including maintenance of
certain financial ratios, restrictions on dividends and repayment of debt or
cash transfers to the Company. The outstanding balance at March 31, 2003 was
$10,755,000.
Cash dividends and tax sharing payments to the Company are contingent upon
Brookwood's compliance with the covenants contained in the loan agreement.
Brookwood was not in compliance with its minimum net income covenant at December
31, 2002. Brookwood obtained a waiver for this violation from the lender and
believes it will be in compliance with all of its covenants for 2003. The Key
Credit Agreement does not contain a minimum net income covenant for 2003. At
March 31, 2003, Brookwood was in compliance with its loan covenants.
As of March 31, 2003, Brookwood had approximately $4,950,000 of borrowing
base availability.
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% (5.25% at March 31, 2003) or Libor plus
3.25%. Brookwood has borrowed $1,000,000 under this facility.
Page 13
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
Subordinated Secured Promissory Note. Brookwood was a 50% partner in STA
with an unrelated third party until September 2002. In September 2002, STA
purchased the shares owned by the unrelated third party partner, making STA a
wholly owned Brookwood subsidiary, and gave the seller a promissory note in the
amount of $596,000. The note bears interest at the prime rate (4.25% at March
31, 2003), requires a quarterly payment of approximately $85,000 and is due in
July 2004. The outstanding balance at March 31, 2003 was $510,000.
Equipment Credit Facility and Term Loans. The Key Credit Agreement provides
for a $2,000,000 equipment revolving credit line. The facility bears interest at
Libor plus 2.75%. In May 2000, Brookwood borrowed $1,000,000 under this credit
line, which was converted into a term loan, at a fixed rate of 9.37%, with a
maturity date of October 2005. In February and December 2002, Brookwood borrowed
an additional $542,000 and $298,000 under this facility and converted those
amounts into term loans, at fixed rates of 5.10% and 4.67%, with maturities of
March and December 2007, respectively. Brookwood has $690,000 availability under
this facility. The outstanding balance at March 31, 2003 was $1,310,000.
Subordinated Promissory Note. As part of the purchase price related to the
acquisition of an entity in 2000, Brookwood gave the seller a $375,000
subordinated promissory note dated March 2002. The interest free note is being
fully amortized over thirty-six months and has a maturity date of February 2005.
The outstanding balance at March 31, 2003 was $229,000.
In January 2004, the Brookwood revolving and acquisition facilities, with a
balance of $11,755,000 at March 31, 2003, mature. The Company intends to extend
or refinance these facilities prior to their maturity.
The outstanding balance of the combined Key Bank credit facilities at March
31, 2003 was $13,804,000.
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 a $1,500,000
convertible loan from stockholder. The term loan bears interest at a fixed rate
of 7%, matures April 2005 and is fully amortizing requiring a monthly payment of
$92,631. The outstanding principal balance of the term loan at March 31, 2003
was $2,078,000.
The revolving credit facility bears interest at the Company's option of
prime plus 0.50%, or Libor plus 3.25%, and matures April 2005. The interest rate
is 4.75% at March 31, 2003. The Company borrowed an additional $800,000 under
the facility in March 2003 and therefore has $2,700,000 of unused borrowing
capacity.
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 March 31, 2003
and December 31, 2002, the Company was in compliance with its loan covenants
under the Term Loan and Revolving Credit Facility.
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. The combined monthly lease
payment is $46,570 and the effective interest rate is 12.18%. The outstanding
principal balance at March 31, 2003 was $938,000.
NOTE 5 -- 10% COLLATERALIZED SUBORDINATED DEBENTURES
The Company has an issue of 10% Collateralized Subordinated Debentures
("10% Debentures") outstanding due July 31, 2005. The 10% Debentures are listed
on The New York Stock Exchange. For financial reporting purposes a
Page 14
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
pro-rata portion of an unamortized gain in the original amount of $353,000 was
allocated to the 10% Debentures from a previous debenture issue, and 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):
MARCH 31, DECEMBER 31,
DESCRIPTION 2003 2002
----------------------------------------------------- ------------ ------------
10% Debentures (face amount) ........................ $ 6,468 $ 6,468
Unamortized gain, net of accumulated amortization ... 144 157
------------ ------------
Totals ........................................ $ 6,612 $ 6,625
============ ============
NOTE 6 -- SEPARATION AGREEMENT
In 1999, the Company entered into the Separation Agreement. The Separation
Agreement provided that a former officer and director and related trust exchange
their 24% stock ownership in the Company, for 20% of the Company's limited
partner interest in HRP, 20% of the Company's common stock interest in the
former Hallwood Energy Corporation ("Former HEC"), all of the Company's interest
in its condominium hotel business and future cash payments contingent on the net
cash flow from the Company's real estate management activities, that being the
lesser of 20% of the net cash flow from its real estate management activities
for the preceding quarter or $125,000. These future cash payments are subject to
termination or extinguishment in certain events. The Separation Agreement
obligation of $3,875,000 and $4,000,000 at March 31, 2003 and December 31, 2002,
respectively, represents the estimated future cash payments to the trust through
the period ending December 2004. The Company has an option to extinguish the
future cash payments at any time prior to its expiration in December 2004 upon
the payment of $3,000,000.
NOTE 7 -- DISCONTINUED OPERATIONS - HOTELS
In December 2000, the Company discontinued 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 former hotel segment consisted of three owned
properties and two leased properties.
As of June 2002, the Company completed the disposition of all four hotel
properties it had previously designated as discontinued operations.
The Company determined that it would retain its leasehold interest in the
GuestHouse Suites hotel in Huntsville, Alabama. The Company continues to operate
the hotel, subject to a lease concession from the owner. Accordingly, this hotel
has been classified as an asset held for use and operating results are reported
within continuing operations.
Page 15
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
A summary of the income from discontinued hotels operations for the quarter
ended March 31, 2002 is detailed below (in thousands):
Revenue and Gain from Disposition
Gain from extinguishment of debt ............... $ 2,552
Sales .......................................... 215
------------
2,767
Expenses
Deferred federal income tax expense ............ 875
Operating expenses ............................. 256
Interest expense ............................... 137
Litigation and other disposition costs ......... 23
------------
1,291
------------
Income from discontinued hotel operations ...... $ 1,476
============
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; however, concurrently with the
sale, it entered into a loan modification and assumption agreement which
included a release that discharged the Company from any further loan
obligations. 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 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 and completed the foreclosure in June 2002. The Company recognized a
gain from extinguishment of debt of $3,237,000, before a deferred tax charge of
$925,000, in the 2002 second quarter.
The Company was a defendant in two lawsuits regarding guaranties of certain
obligations of the Embassy Suites and Holiday Inn hotels. In February 2003, the
Company settled both matters. The Company agreed (i) to pay $150,000 in cash and
to issue a non-interest bearing promissory note in the amount of $250,000
payable in equal monthly installments over eighteen months, in exchange for a
full release regarding the Embassy Suites hotel and (ii) to pay $250,000 in cash
in exchange for a full release regarding the Holiday Inn hotel. In December
2002, the Company recorded an additional loss provision in the amount of
$247,000 to fully accrue for these two litigation matters.
NOTE 8 -- DEFERRED REVENUE - NONCOMPETITION AGREEMENT
In March 2001, the Company agreed to sell its investment in Former HEC,
which represented the Company's former energy operations, to Pure Resources II,
Inc., an indirect wholly owned subsidiary of Pure Resources, Inc. ("Pure"). The
Company received $18,000,000 for the tender of its shares of common stock in May
2001 and received an additional amount of $7,250,000, pursuant to the terms of a
noncompetition agreement that was paid by Pure upon the completion of the merger
in June 2001.
Under the noncompetition agreement, the Company agreed to refrain from
taking certain actions without the prior written consent of Pure and Former HEC.
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 also
agreed to keep Former HEC's confidential and proprietary information strictly
confidential.
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 was $604,000 in each of the quarters ended March 31, 2003
and 2002.
Page 16
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 9 -- INCOME TAXES
The following is a schedule of the income tax expense (in thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------------
2003 2002
------------ ------------
Continuing Operations
Federal
Deferred ...................... $ 396 $ 566
Current ....................... 29 11
------------ ------------
Sub-total .................. 425 577
State ............................ 163 161
------------ ------------
Total ......................... $ 588 $ 738
============ ============
Discontinued Operations
Federal
Deferred ...................... $ -- $ 875
============ ============
The amount of the deferred tax asset (net of valuation allowance) was
$3,825,000 at March 31, 2003. 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 an anticipated
gain from the potential sale of the HRP limited partner units and projected
income from operations.
State tax expense is an estimate based upon taxable income allocated to
those states in which the Company does business, at their respective tax rates.
Page 17
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 10 -- SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED
MARCH 31,
----------------------------
DESCRIPTION 2003 2002
----------------------------------------------------------------------- ------------ ------------
Supplemental schedule of non-cash investing and financing activities:
Hotel assets and liabilities relinquished in connection with debt
extinguishment:
Loan payable ................................................... -- $ 5,095
Other liabilities, net ......................................... -- 227
Hotel properties ............................................... -- (2,770)
Deferred tax asset ............................................. -- (875)
------------ ------------
-- $ 1,677
============ ============
Pro rata share of partner capital transactions of equity investment
in HRP:
Amortization of interest rate swap ................................ $ (13) $ (14)
Exercise of stock options ......................................... (23) --
Supplemental disclosures of cash payments:
Interest paid ........................................................ $ 374 $ 526
Income taxes paid .................................................... 424 161
NOTE 11 -- COMPUTATION OF INCOME 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 for the basic and assuming dilution methods (in thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------------
DESCRIPTION 2003 2002
------------------------------------------------------ ------------ ------------
INCOME AVAILABLE TO COMMON STOCKHOLDERS
Income from continuing operations .......................... $ 1,353 $ 1,316
Interest expense (net of tax) of assumed loan conversion ... -- 28
------------ ------------
Income from continuing operations available to
common stockholders - assuming dilution ................ $ 1,353 $ 1,344
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ...................................................... 1,361 1,361
Potential shares from assumed loan conversion .............. -- 218
------------ ------------
Assuming dilution .......................................... 1,361 1,579
============ ============
Page 18
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 12 -- 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, 2002.
Litigation.. In June 1997, an action was filed against the Company, HRP,
the general partner Hallwood Realty Corporation, a predecessor entity to
Hallwood Realty, LLC, and the directors of Hallwood Realty Corporation by Gotham
Partners, L.P. in the Delaware Court of Chancery, styled Gotham Partners, L.P.
v. Hallwood Realty Partners, L.P., et al (C.A. No. 15754). This action 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 to HRP in the
amount of $3,417,000, plus pre-judgment interest of approximately $2,891,000
from August 1995. 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. 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. Oral arguments before the
Delaware Supreme Court were heard in February 2002, and a rehearing en banc was
held in March 2002. In August 2002, the Supreme Court affirmed the judgment of
the trial court that the remaining defendants other than HRP are jointly and
severally liable to HRP. The Supreme Court reversed the trial court's
determination of damages, and remanded the case to the trial court to fashion
appropriate relief. A hearing on the remand proceedings was held before the
Delaware Court of Chancery in October 2002. A further hearing on the remand is
scheduled to take place in May 2003, with a decision by the Court of Chancery to
follow. Since the appellate court reversed the judgment, any subsequent ruling
by the trial court on remand may be more or less favorable to the Company.
On April 23, 2003, an action was filed against HRP's general partner,
Hallwood Realty, LLC (the "General Partner"), its directors and HRP as nominal
defendant by High River Limited Partnership ("High River"), which is wholly
owned by Carl C. Icahn, in the Court of Chancery of the State of Delaware,
styled High River Limited Partnership v. Hallwood Realty, LLC, et al, (C.A. No.
20276). The action challenges the unit purchase rights agreement dated November
30, 1990, between HRP and EquiServe Trust Company, N.A., as rights agent, as
amended (the "Rights Plan"). High River claims in the suit that defendants have
wrongfully utilized the Rights Plan to prevent High River and other third
parties from purchasing 15 percent or more of the units of HRP, while at the
same time exempting the General Partner and its affiliates and subsidiaries from
the provisions of the Rights Plan. High River asserts that if defendants make
additional purchases of units, they could render removal of the General Partner
pursuant to the two-thirds removal provision of the partnership agreement
impossible, thereby impeding or preventing the High River tender offer. The
complaint seeks as relief an order preventing defendants from treating the
General Partner as exempt from or otherwise not subject to the definition of
Acquiring Person under the Rights Agreement, or, alternatively, preventing
defendants from treating High River as an Acquiring Person under the Rights
Agreement or applying the Rights Agreement to the High River tender offer. An
initial request by High River for an expedited hearing on the matter was denied.
On April 28, 2003, a putative class action lawsuit was filed against the
General Partner, its directors and HRP as nominal defendant by three purported
unitholders of HRP in the Court of Chancery of the State of Delaware, styled
I.G. Holdings, Inc., et al, v. Hallwood Realty LLC, et al, (C.A. No. 20283). The
action asserts that in allegedly refusing to consider a tender offer by High
River for the units of HRP, the defendants are not acting in good faith and
Page 19
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
are deriving an improper personal benefit in impeding a potential removal of the
General Partner or a sale of control of HRP, in breach of their fiduciary duties
under the partnership agreement. The complaint seeks as relief an order
requiring the General Partner to consider the High River tender offer, an order
preventing the General Partner or its affiliates from acquiring units or
otherwise improperly entrenching the General Partner or impeding a transaction
that would maximize value for the public unitholders, an order directing the
defendants to use the Rights Plan fairly, and damages.
The Company was a party to certain litigation in the Delaware Court of
Chancery styled, Corporate Property Associates 6 and Corporate Property
Associates 7 v. The Hallwood Group Incorporated (C.A. 15661 - NC), that involves
a four-year, $500,000 promissory note of the Company due March 1998. The note
was secured by a pledge of 89,269 HRP limited partner units. The agreement under
which the note was issued also provided that the pledgee ("CPA," or the
"Noteholder") had the right to receive up to an additional $500,000 based on the
increase in price of the HRP units (the "HRP Participation Amount"). In 1996,
the Company and CPA entered into an agreement under which the Company would pay
off the principal and interest on the note and all other obligations between the
parties would be ended. Subsequently, CPA refused to go forward with the
agreement and this litigation was instituted. In December 1999, the Company and
the Noteholder entered into an agreement, approved by the court, which provided
that (i) the Company pay the face amount of $500,000 plus $83,000 of accrued
interest to the Noteholder; (ii) the Company deposit $900,000 into an escrow
account to secure the maximum amount which could be payable by the Company,
including a potential claim of $400,000 for legal fees; and (iii) that the
noteholder release its collateral of 89,269 HRP units. The parties reserved
their rights to proceed with the litigation. Trial was held in June 2001 in the
Delaware Court of Chancery. In February 2002, the court rendered its decision in
favor of the Company. In March 2002, the court entered an order that provided
for the return of approximately $971,000, including accrued interest, to the
Company from the escrow account. The Noteholder filed an appeal in April 2002.
Oral arguments before the Delaware Supreme Court were heard in September 2002,
and a rehearing en banc was held in November 2002. In March 2003, the Delaware
Supreme Court issued its opinion reversing the finding of the Trial Court that
certain language in the letter agreement in question constituted a general
release of Hallwood's obligations. On March 21, 2003, the parties submitted to
the Chancery Court an agreed proposed Order and Judgment, which was signed by
the Court and terminated the litigation. The Order and Judgment provided for
payment out of the escrowed funds of approximately $547,000 to CPA and $437,000
to the Company. The Company received its share of the escrowed funds on March
31, 2003.
The Company was a defendant in two lawsuits regarding guaranties of certain
obligations of the Embassy Suites and Holiday Inn hotels. In February 2003, the
Company settled both matters. The Company agreed (i) to pay $150,000 in cash and
to issue a non-interest bearing promissory note in the amount of $250,000
payable in equal monthly installments over 18 months, in exchange for a full
release regarding the Embassy Suites hotel, and (ii) $250,000 in cash in
exchange for a full release regarding the Holiday Inn hotel. In December 2002,
the Company recorded an additional loss provision in the amount of $247,000 to
fully accrue for these two litigation matters.
The Company and its subsidiaries are from time to time involved in various
other legal proceedings in the ordinary course of their respective businesses.
Management believes that the resolution of the aforementioned litigation matters
will not have a material adverse effect on the financial condition, results of
operations or cash flows of the Company.
Contingencies. The Company has committed to make additional contributions
to the capital of Hallwood Realty, the general partner of HRP, upon demand, up
to a maximum aggregate amount of $13,118,000, subject to the terms of a
subscription agreement, to the extent Hallwood Realty has insufficient capital
to satisfy creditors of HRP. As of the date of this report no such demands have
been made.
In December 1999, the Company distributed certain assets and incurred a
contingent obligation, under the Separation Agreement. The contingent
obligation, in the amount of $4,000,000 at December 31, 2002, was the estimated
value of the remaining payments under the Separation Agreement. In December 2001
the Company evaluated the contingent obligation and accrued an additional
$500,000 under this agreement, which was paid in 2002. Similarly, the Company
reevaluated the obligation at December 2002, and determined that a further cost
of $1,000,000 should be accrued, which is expected to be paid in 2003 and 2004.
The Company has an option to
Page 20
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
extinguish the future cash payments at any time prior to its expiration in
December 2004 upon payment of $3,000,000.
In February 2000, Brookwood, through a wholly owned subsidiary, acquired
the assets of a company in a textile products-related industry. The purchase
price was $1,479,000 in cash plus contingent payments of up to $3,000,000, based
on specified levels of earnings over the next four years. Effective December 31,
2001, in consideration of thirty six monthly payments aggregating approximately
$375,000, the contingent obligation was reduced to a percentage of cash flow
from the acquired subsidiaries, as defined, for the remaining years under the
agreement. As of March 31, 2003, no amounts have been paid or were owed in
relation to the contingency payments.
Page 21
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTE 13 -- SEGMENT AND RELATED INFORMATION
The following represents the Company's reportable segment operations for
the three months ended March 31, 2003 and 2002, respectively (in thousands):
REAL TEXTILE DISCONTINUED CONSOL
ESTATE PRODUCTS OTHER OPERATIONS -IDATED
------ -------- ----- ------------ -------
THREE MONTHS ENDED MARCH 31, 2003
Total revenue from external sources........ $ 1,563 $ 24,799 $ 993 $ 27,355
======== ======== ======== ========
Operating income........................... $ 1,139 $ 888 $ 2,027
======== ========
Unallocable (loss) income, net............. $ (86) (86)
======== --------
Income from continuing operations
before income taxes..................... $ 1,941
========
THREE MONTHS ENDED MARCH 31, 2002
Total revenue from external sources........ $ 1,652 $ 21,395 $ 1,307 $ 24,354
======== ======== ======== ========
Operating income........................... $ 1,264 $ 507 $ 1,771
======== ========
Unallocable income, net.................... $ 283 283
======== --------
Income from continuing operations
before income taxes..................... $ 2,054
========
Income from discontinued operations........ $ 1,476 $ 1,476
======== ========
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, 2002 annual report. The total assets for the Company's operating segments
have not materially changed since the December 31, 2002 annual report.
NOTE 14 -- CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
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
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 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 $1,353,000 for the first quarter ended
March 31, 2003, compared to net income of $3,360,000 in 2002. Income from
continuing operations was $1,353,000 in 2003, compared to $1,316,000 in 2002.
Revenue from continuing operations was $27,355,000 in 2003, compared to
$24,354,000 in 2002.
Following is an analysis of the results of continuing operations for the
real estate, textile products and other business segments, as well as the
discontinued operations for the hotel business segment.
REAL ESTATE
The real estate segment reported income of $1,139,000 for the first quarter
of 2003, compared to $1,264,000 in 2002.
Revenues. Fee income of $1,247,000 for 2003 increased by $128,000, or 11%,
compared to $1,119,000 in 2002. Fees are derived from the Company's asset
management, property management, leasing and construction supervision services
provided to HRP and various third parties. The increase was due primarily to
higher leasing fees in the 2003 first quarter.
Equity income from investments in HRP represents the Company's pro rata
share of net income reported by HRP, adjusted for the elimination of
intercompany profits. For the 2003 first quarter, the Company reported equity
income of $316,000, compared to $533,000 in the prior-year period. The decrease
resulted principally from increased property operating and administrative costs
in 2003.
Expenses. Administrative expenses of $256,000 increased by $36,000, or 16%,
in the 2003 first quarter, compared to $220,000 in 2002. The decrease was
primarily attributable to the payments of commissions to third party brokers
associated with leasing income.
Amortization expense of $168,000 in both the 2003 and 2002 quarters related
to Hallwood Realty's general partner investment in HRP to the extent allocated
to management rights.
TEXTILE PRODUCTS
The textile products segment reported income of $888,000 for the first
quarter of 2003, compared to $507,000 in 2002.
Revenue. Sales of $24,799,000 increased $3,978,000, or 19%, in the 2003
first quarter, compared to $20,821,000 in the 2002 first quarter. The increase
was principally due to additional sales of specialty fabric to U.S. military
contractors.
During 2000, Brookwood formed STA, a 50-50 joint venture, with an unrelated
third party that is also in a textile-related industry. STA acquired the 50%
ownership interest not owned by Brookwood in September 2002. Accordingly, STA
became a wholly owned subsidiary in September 2002. Prior to the acquisition,
Brookwood utilized the equity method of accounting for its investment in STA.
Brookwood's equity income from STA was $574,000 in the first quarter of 2002.
Expenses. Cost of sales of $20,210,000 increased by $2,157,000, or 12%, in
the 2003 first quarter, compared to $18,053,000 in the 2002 first quarter. The
increase in cost of sales was principally the result of the increase in sales.
The higher gross profit margin for the 2003 first quarter (18.5% versus 13.3%)
resulted from the sales increase of specialty fabric to military contractors.
Administrative and selling expenses of $3,552,000 increased by $883,000 in the
2003 first quarter, compared to $2,669,000 for the 2002 period. The increase is
primarily attributable to royalties incurred in 2003 to the Company's former
joint venture partner in STA. Interest expense of $149,000 decreased by $17,000,
or 10%, for the 2003 first quarter, compared to $166,000 in 2002, principally
due to a decrease in average borrowings.
Page 23
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OTHER
The other segment reported a loss of $86,000 for the first quarter of 2003,
compared to income of $283,000 in 2002.
Revenue. Amortization of deferred revenue of $604,000 in the 2003 and 2002
quarters is attributable to the noncompetition fee received in connection with
the sale of the Company's investment in Former HEC. The original $7,250,000 cash
payment is being amortized over a three year period which began June 2001.
Hotel revenue was $337,000 in the 2003 first quarter, compared to $440,000
in 2002. The 23% decrease in 2003 was attributable to reduced occupancy,
partially offset by an increased average daily rate. Revenues have been
adversely impacted by a general downturn in the hotel industry and increased
competition in the local market.
Equity income from investment in Hallwood Energy Corporation ("HEC") in the
amount of $51,000 for the 2003 first quarter relates to the Company's pro rata
share of income from HEC's operations, compared to an equity loss of $41,000 in
2002.
Interest and other income decreased to $1,000 for the 2003 first quarter,
compared to $304,000 in 2002, principally attributable to a gain of $296,000 on
the exercise of an option and related sale of a marketable security in the 2002
first quarter.
Expenses. Administrative expenses of $428,000 for the 2003 first quarter
increased by $46,000, or 12%, from the prior-year amount of $382,000, due to
increased professional fees. Interest expense in the amount of $203,000 for the
2003 first quarter decreased by $2,000 from the prior year amount of $205,000.
The decrease was primarily due to the repayment of the stockholder loan in 2002
partially offset by borrowings under the Term Loan and Revolving Credit
Facility.
Hotel expenses, which include operating expenses, depreciation and interest
costs was $448,000 for the 2003 first quarter, which increased by $11,000, or
3%, compared to $437,000 in 2002.
INCOME TAXES
Income taxes relating to continuing operations were $588,000 for the 2003
first quarter, compared to $738,000 in 2002. The 2003 quarter included a
$396,000 non cash federal deferred charge, a $29,000 federal current charge and
$163,000 for state taxes. The 2002 quarter included a $566,000 non cash federal
deferred charge, a $11,000 federal current charge and $161,000 for state taxes.
The state tax expense is an estimate based upon taxable income allocated to
those states in which the Company does business at their respective tax rates.
As of March 31, 2003, the Company had approximately $78,000,000 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 $11,250,000 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
Page 24
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
such limitations. In addition, utilization of NOLs in the future may be limited
if changes in the Company's stock ownership create a change in control, as
provided in Section 382 of the Internal Revenue Code of 1986, as amended.
DISCONTINUED OPERATIONS - 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. 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 --
Loss from Discontinued Operations. Discontinued operations for the three months
ended March 31, 2002 are presented below (in thousands):
Revenue and Gain from Disposition
Gain from extinguishment of debt .............. $2,552
Sales ......................................... 215
------
2,767
Expenses
Deferred federal income tax expense ........... 875
Operating expenses ............................ 256
Interest expense .............................. 137
Litigation and other disposition costs ........ 23
------
1,291
------
Income from discontinued hotels operations .... $1,476
======
As of June 2002, the Company completed the disposition of all four hotel
properties it had previously designated as discontinued operations.
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; however,
concurrently with the sale, it entered into a loan modification and assumption
agreement which included a release that discharges the Company from any further
loan obligations. 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.
Sales of $215,000 in the 2002 first quarter were principally attributable
to the GuestHouse Suites hotel in Greenville, South Carolina, prior to its
disposition in June 2002.
Expenses. Operating expenses of $256,000 and interest expense of $137,000
for the 2002 first quarter related to the Greenville hotel prior to its
disposition. The litigation and other disposition costs principally relate to
legal fees and other expenses in connection with the disposition and resolution
of two litigation matters discussed below.
The Company was a defendant in two lawsuits regarding guaranties of certain
obligations of the Embassy Suites and Holiday Inn hotels. In February 2003, the
Company settled both matters. The Company agreed (i) to pay $150,000 in cash and
to issue a non-interest bearing promissory note in the amount of $250,000
payable in equal monthly installments over eighteen months, in exchange for a
full release regarding the Embassy Suites hotel and (ii) to pay $250,000 in cash
in exchange for a full release regarding the Holiday Inn hotel. In December
2002, the Company recorded an additional loss provision in the amount of
$247,000 to fully accrue for these two litigation matters.
Page 25
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
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.
INVESTMENT IN HALLWOOD ENERGY CORPORATION
The Company owns approximately 28% of HEC. It accounts for the investment
using the equity method of accounting and records its pro rata share of HEC's
net income (loss), stockholder's equity transactions and comprehensive income
(loss) adjustments, if any.
During 2002, the Company invested $3,500,000 in HEC, which is presently in
the development stage, having drilled seven test wells in the Barnett Shale
formation of Johnson County, Texas. After constructing a gas gathering system,
HEC commenced commercial production and sales from three of the seven wells in
February 2003. Currently, six wells are producing and one well has been
temporarily abandoned. Aggregate production, including royalty owner share and
minor working interest participation, rose to three million cubic feet of gas
per day during the first week of May 2003, and was approximately two million
cubic feet of gas per day at May 14, 2003.
HEC currently plans to drill between 10 and 20 wells during the balance of
2003; however, this number may vary based upon a variety of operational and
economic conditions. Whether HEC drills 10 or 20 additional wells this year,
additional capital will be required. HEC currently anticipates that it will
solicit equity contributions from its shareholders in combination with
commercial, secured bank borrowings to meet its capital requirements. Depending
on the level of bank borrowings, coupled with the ultimate level of well
development activity, HEC has requested from its shareholders additional equity
contributions over the next several months of approximately $3,300,000. Based on
the Company's ownership, its board of directors has resolved to make an
additional equity contribution of approximately $925,000.
HEC holds oil and gas leases covering approximately 37,500 gross and 33,500
net acres of undeveloped leasehold, predominantly in Johnson County, Texas as of
May 1, 2003.
CRITICAL ACCOUNTING POLICIES
There have been no changes to critical accounting policies identified and
set forth in the Company's Form 10-K for the year ended December 31, 2002.
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 newly acquired properties
and; (iii) disposition fees with respect to real estate investments, other than
the properties owned at the time of HRP's formation in 1990, equal to 10% of the
amount by which the sales price of a property exceeds the purchase price of such
property. HCRE earns property management, leasing and construction supervision
fees. The management contracts with HRP expire 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.
Page 26
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
A summary of the fees earned from HRP is detailed below (in thousands)
THREE MONTHS ENDED
MARCH 31,
------------------
2003 2002
------ -------
Property management fees .......... $ 486 $ 474
Leasing fees ...................... 385 227
Construction supervision fees ..... 184 257
Asset management fees ............. 152 154
------ ------
Total .......................... $1,207 $1,112
====== ======
Hallwood Realty is 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 does not employ any
individuals, the compensation and other costs related to approximately 90
employees rendering services on behalf of HRP and its properties are reimbursed
to Hallwood Realty and HCRE by HRP.
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. HSC is
also eligible for bonuses from the Company or its subsidiaries, subject to
approval by the Company's or its subsidiaries' board of directors. Additionally,
the Company reimburses HSC for reasonable and necessary expenses of office space
and administrative services.
A summary of the fees and expenses paid to HSC are detailed below (in
thousands):
THREE MONTHS ENDED
MARCH 31,
------------------
2003 2002
------- ------
Consulting fees ............................. $199 $199
Office space and administrative services .... 25 19
---- ----
Total .................................... $224 $218
==== ====
In addition, HSC performs services for certain affiliated entities that are
not subsidiaries of the Company, for which it receives 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.
HEC. During 2002, the Company invested $3,500,000 in HEC, a private energy
company. The Company owns approximately 28% of HEC and accounts for the
investment using the equity method of accounting. Certain of the Company's
officers and directors are investors in HEC.
Brookwood. During 2000, Brookwood formed STA with an unrelated party that
is also in a textile-related industry, principally to produce advanced,
breathable, waterproof laminate materials for military applications. In
September 2002, STA acquired the 50% ownership interest not owned by Brookwood
for $1,000,000 in cash, the issuance of a $596,000 note bearing interest at the
prime rate and royalty payments for three years based upon production under a
specified contract. Accordingly, STA became a wholly owned subsidiary of
Brookwood in September 2002. Brookwood reported sales to STA of $4,325,000 for
the three month period ended March 31, 2002.
Page 27
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 March 31, 2003 (in
thousands):
PAYMENTS DUE DURING THE YEAR ENDING DECEMBER 31,
-------------------------------------------------------------------------------
2003* 2004 2005 2006 2007 THEREAFTER TOTAL
------- ------- ------- ------- ------- ---------- -------
CONTRACTUAL OBLIGATIONS
Long term debt
Term Loan and Revolving
Credit Facility ....................... $ 741 $ 1,052 $ 1,585 $ -- $ -- $ -- $ 3,378
10% Debentures (face amount) ............ -- -- 6,468 -- -- -- 6,468
Loans payable (Brookwood) ............... 626 12,518 383 180 97 -- 13,804
Capital lease obligations ................. 394 544 -- -- -- -- 938
Separation Agreement ...................... 375 3,500 -- -- -- -- 3,875
Operating leases .......................... 840 1,076 834 653 538 1,614 5,555
------- ------- ------- ------- ------- ------- -------
Total ................................. $ 2,976 $18,690 $ 9,270 $ 833 $ 635 $ 1,614 $34,018
======= ======= ======= ======= ======= ======= =======
AMOUNT OF COMMITMENT EXPIRATION
DURING THE YEAR ENDING DECEMBER 31,
-------------------------------------------------------
2003* 2004 2005 2006 2007 THEREAFTER TOTAL
----- ---- ---- ---- ---- ---------- -----
COMMERCIAL COMMITMENTS
Employment contracts ........................... $300 $200 $ 50 -- -- -- $550
Letters of credit .............................. 295 -- -- -- -- -- 295
---- ---- ---- -- -- -- ----
Total ........................................ $595 $200 $ 50 -- -- -- $845
==== ==== ==== == == == ====
----------
* For the nine months ended December 31, 2003.
The Company's Term Loan and Revolving Credit Facility 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 debt
service coverage ratio and a debt to equity ratio.
The principal ratios, as defined in the respective agreements, as of the
end of the first quarter in the year ended December 31, 2003 and as of December
31, 2002 are provided below (dollar amount in thousands):
MARCH 31, DECEMBER 31,
DESCRIPTION REQUIREMENT 2003 2002
----------------------------- ----------- --------- ------------
TERM LOAN AND REVOLVING
CREDIT FACILITY
Net cash flow, as defined must exceed $3,400............................. $5,995 $5,941
Debt service coverage must exceed 1.2 to 1.0......................... 1.77 2.01
Senior leverage must be less than 2.5 to 1.0................... 1.45 1.53
Collateral value coverage must exceed 200% of loan
balance...................................... 769% 877%
The Company was in compliance with its loan covenants under the Term Loan
and Revolving Credit Facility as of December 31, 2002 and March 31, 2003.
Page 28
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
MARCH 31, DECEMBER 31,
DESCRIPTION REQUIREMENT 2003 2002
----------------------------- ----------- --------- ------------
BROOKWOOD CREDIT AGREEMENT
Minimum net income, as defined must exceed $1,500 ytd 12/31/02................ -- $1,436
Debt service coverage must exceed 1.25 to 1.00....................... 2.22 1.91
Debt to equity must be less than 45% in 2003; 50% in 2002..... 40% 39%
Brookwood was in compliance with its loan covenants for all interim periods
during 2002, except for the quarter ended December 31, 2002, when it did not
meet its minimum net income loan covenant. The covenant, which required a
minimum net income of $1,500,000, was not met as Brookwood's net income for the
year ended December 31, 2002 was $1,436,000. Brookwood obtained a waiver for
this violation from the lender. The Key Credit Agreement does not contain a
minimum net income covenant for 2003. Brookwood was in compliance with its
covenants as of March 31, 2003, and believes that it will be in compliance with
its covenants for calendar 2003.
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.
Page 29
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 cash position decreased by $92,000 during the 2003 first
quarter to $1,285,000 as of March 31, 2003. The primary source of cash was
$990,000 provided by financing activities. The primary uses of cash were
$843,000 for operating activities, principally an increase in inventories and
receivables at Brookwood, net of $437,000 received in connection with the
settlement of litigation, and $239,000 for textile products equipment.
The Company principally operates in the real estate and textile products
business segments. During 2002, the Company reentered the energy business as a
minority owner in HEC.
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.
The Company's textile products segment generates funds from the dyeing and
finishing of fabrics and their sale to customers in the consumer, industrial,
medical and military markets. Brookwood maintains a revolving line of credit
facility and separate acquisition and equipment facilities. All facilities have
a maturity of January 2004. At March 31, 2003, Brookwood had approximately
$4,950,000 of unused borrowing capacity on its revolving line of credit
facility. In the year ended December 31, 2002, Brookwood paid $250,000 to the
Company under its tax sharing agreement but no cash dividends. Future cash
dividends and tax sharing payments to the Company are contingent upon
Brookwood's compliance with the covenants contained in the credit facility.
Brookwood was in compliance with its loan covenants for all interim periods in
2002, except for the quarter ended December 31, 2002, when it did not meet its
minimum net income loan covenant. The covenant, which required a minimum net
income of $1,500,000, was not met as Brookwood's net income was $1,436,000.
Brookwood obtained a waiver for this violation from the lender. The loan does
not contain a minimum net income covenant for 2003. Brookwood was in compliance
with its covenants as of March 31, 2003, and believes that it will be in
compliance with its covenants for calendar 2003.
In March 2002, the Company and its HWG, LLC subsidiary entered into the
$7,000,000 Credit Agreement with First Bank & Trust, N.A. The facility is
comprised of a $3,000,000 term loan and a $4,000,000 revolving credit facility
(the "Term Loan and Revolving Credit Facility"). The term loan proceeds were
used in part to repay the $1,500,000 convertible loan from stockholder in March
2002, bears interest at a fixed rate of 7%, matures April 1, 2005 and is fully
amortizing requiring a monthly payment of $92,631. The revolving credit facility
bears interest at the Company's option of prime plus 0.50%, or Libor plus 3.25%,
and matures April 1, 2005. Collateral for the Term Loan and Revolving Credit
Facility is 300,397 HRP limited partner units. The credit agreement contains
various financial and non-financial covenants, including the maintenance of
financial ratios, restrictions on new indebtedness and the payment of dividends.
The Company was in compliance with the loan covenants at March 31, 2003. The
Company borrowed $500,000 under the Revolving Credit Facility in 2002 and
$800,000 in March 2003, and therefore has $2,700,000 of unused borrowing
capacity.
In January 2004, the Brookwood revolving and acquisition facilities, with a
balance of $11,755,000 at March 31, 2003, mature. Brookwood intends to extend or
refinance these facilities prior to their maturity.
In February 2000, Brookwood, acquired the assets of a company in a textile
products-related industry. The purchase price was $1,450,000 in cash plus
contingent payments of up to $3,000,000, based on specified levels of earnings
over the next four years. Effective December 31, 2001, in consideration of
thirty six monthly payments aggregating approximately $375,000, the contingent
obligation was reduced to a percentage of cash flow from the acquired
subsidiaries, as defined, for the remaining years under the agreement.
In May 2003, the Company agreed to invest additional funds in HEC in the
approximate amount of $925,000. Depending upon the timing of the investment, an
additional borrowing under the Company's revolving credit facility may be
required.
Page 30
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 31
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 quarter ended March 31, 2003.
The Company is exposed to market risk due to fluctuations in interest
rates. The Company utilizes both fixed rate and variable rate debt to finance
its operations. As of March 31, 2003, the Company's total outstanding loans and
debentures payable of $24,588,000 were comprised of $11,023,000 of fixed rate
debt and $13,565,000 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 $246,000, assuming that
outstanding debt remained at current levels.
The Company's real estate division through its investment in HRP will
sometimes use derivative financial instruments to achieve a desired mix of fixed
versus floating rate debt. As of March 31, 2003, 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.
ITEM 4. CONTROLS AND PROCEDURES AND INTERNAL CONTROLS
Controls and procedures. It is the conclusion of the Company's principal
executive officer and principal financial officer that the Company's disclosure
controls (as defined in Exchange Act rules 13a-14 and 15d-14), based on their
evaluation of these controls and procedures as of a date within 90 days of the
filing of this Quarterly Report, are effective in timely alerting them to the
material information relating to the Company required to be included in its
periodic filings with the Securities and Exchange Commission. Management
necessarily applied its judgment in assessing the costs and benefits of such
controls and procedures which, by their nature, can provide only reasonable
assurance regarding management's control objectives. The design of any system of
controls and procedures is based in part upon certain assumptions about the
likelihood of future events. There can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions,
regardless of how remote.
The Company's independent auditors have provided written communication to
management and the audit committee on the need to improve the closing process at
the Brookwood subsidiary. Management has begun making improvements to this
process.
Internal controls. Other than noted above, there were no significant
changes in the Company's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
Page 32
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item
----
1 Legal Proceedings
Reference is made to Note 12 to the Company's consolidated
financial statements included within this Form 10-Q.
2 Changes in Securities None
3 Defaults upon Senior Securities None
4 Submission of Matters to a Vote of Security Holders
None
5 Other Information
On May 1, 2003, High River Limited Partnership, an affiliate of Carl C.
Icahn, announced its unsolicited tender offer for any and all of the
outstanding limited partnership units of HRP. On May 7, 2003, HRP
announced that the management, board of directors and professional
advisors of the General Partner were evaluating the offer and has
subsequently advised its unitholders of its recommendation to reject
the tender offer.
6 Exhibits and Reports on Form 8-K
(a) Exhibits
99.1 Certification of Principal Executive Officer and Principal
Financial Officer, dated May 15, 2003, pursuant to 18
U.S.C. Section 1350, adopted pursuant to Section 906 to the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Dated April 22, 2003 - On April 15, 2003, The Hallwood
Group Incorporated issued a press release regarding its
results of operations for the fourth quarter and year
ended December 31, 2002.
----------
Page 33
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE HALLWOOD GROUP INCORPORATED
Dated: May 15, 2003 By: /s/ Melvin J. Melle
--------------------------------
Melvin J. Melle, Vice President
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
Page 34
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CERTIFICATION BY CHIEF EXECUTIVE OFFICER
I, Anthony J. Gumbiner, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Hallwood Group
Incorporated (the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Registrant as of, and for, the period presented in this
quarterly report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003 /s/ Anthony J. Gumbiner
-------------- -------------------------------
By: Anthony J. Gumbiner
Title: Chief Executive Officer
Page 35
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CERTIFICATION BY CHIEF FINANCIAL OFFICER
I, Melvin J. Melle, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Hallwood Group
Incorporated (the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Registrant as of, and for, the period presented in this
quarterly report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003 /s/ Melvin J. Melle
--------------- -------------------------------
By: Melvin J. Melle
Title: Chief Financial Officer
Page 36
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
99.1 Certification of Principal Executive Officer and Principal Financial
Officer, dated May 15, 2003, pursuant to 18 U.S.C. Section 1350, adopted
pursuant to Section 906 to the Sarbanes-Oxley Act of 2002.
Page 37