<PAGE> 1
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
MARK ONE
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD from ___________________ TO __________________
FOR THE PERIOD ENDED JUNE 30, 1999 COMMISSION FILE NUMBER: 1-8303
------------------------------------
THE HALLWOOD GROUP INCORPORATED
(Exact name of registrant as specified in its charter)
------------------------------------
<TABLE>
<S> <C>
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)
</TABLE>
Registrant's telephone number, including area code: (214) 528-5588
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
1,254,751 shares of Common Stock, $.10 par value per share, were
outstanding at July 31, 1999.
===============================================================================
<PAGE> 2
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
ITEM NO. PART I - FINANCIAL INFORMATION PAGE
-------- ------------------------------ ----
<S> <C> <C>
1 Financial Statements (Unaudited):
Consolidated Balance Sheets as of June 30, 1999
and December 31, 1998.................................................. 3-4
Consolidated Statements of Income for the
Six Months Ended June 30, 1999 and 1998................................ 5-6
Consolidated Statements of Income for the
Three Months Ended June 30, 1999 and 1998.............................. 7-8
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1999 and 1998................................ 9
Notes to Consolidated Financial Statements................................. 10-18
2 Managements's Discussion and Analysis of
Financial Condition and Results of Operations.............................. 19-28
3 Quantitative and Qualitative Disclosures about Market Risk..................... 29
PART II - OTHER INFORMATION
---------------------------
1 thru 6 Exhibits, Reports on Form 8-K and Signature Page............................... 30-33
</TABLE>
Page 2
<PAGE> 3
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
------------ ------------
<S> <C> <C>
ASSET MANAGEMENT
REAL ESTATE
Investments in HRP .................................. $ 10,195 $ 9,771
Receivables and other assets ........................ 1,335 687
------------ ------------
11,530 10,458
ENERGY
Investments in HEC .................................. 5,617 --
Oil and gas properties, net ......................... -- 11,479
Current assets of HEP ............................... -- 2,895
Noncurrent assets of HEP ............................ -- 1,219
Receivables and other assets ........................ -- 482
------------ ------------
5,617 16,075
Total asset management assets .................... 17,147 26,533
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Inventories ......................................... 18,333 16,708
Receivables ......................................... 14,547 11,713
Property, plant and equipment, net .................. 9,123 8,738
Other ............................................... 847 889
------------ ------------
42,850 38,048
HOTELS
Properties, net ..................................... 31,230 31,810
Receivables and other assets ........................ 4,067 3,845
------------ ------------
35,297 35,655
Total operating subsidiaries assets .............. 78,147 73,703
OTHER
Deferred tax asset, net ............................. 6,348 6,348
Cash and cash equivalents ........................... 1,614 769
Other ............................................... 993 1,191
Restricted cash ..................................... 988 708
------------ ------------
Total other assets ............................... 9,943 9,016
------------ ------------
TOTAL ............................................ $ 105,237 $ 109,252
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
Page 3
<PAGE> 4
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
------------ ------------
<S> <C> <C>
ASSET MANAGEMENT
REAL ESTATE
Accounts payable and accrued expenses ................................... $ 753 $ 775
Loan payable ............................................................ 500 500
------------ ------------
1,253 1,275
ENERGY
Loan payable ............................................................ 1,467 2,267
Accounts payable and accrued expenses ................................... 395 1,144
Long-term obligations of HEP ............................................ -- 5,306
Current liabilities of HEP .............................................. -- 3,949
------------ ------------
1,862 12,666
------------ ------------
Total asset management liabilities ................................... 3,115 13,941
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Loan payable ............................................................ 12,500 9,900
Accounts payable and accrued expenses ................................... 9,015 7,646
------------ ------------
21,515 17,546
HOTELS
Loans payable ........................................................... 30,094 30,354
Accounts payable and accrued expenses ................................... 2,665 2,120
------------ ------------
32,759 32,474
------------ ------------
Total operating subsidiaries liabilities ............................. 54,274 50,020
OTHER
7% Collateralized Senior Subordinated Debentures ........................ 14,529 14,727
10% Collateralized Subordinated Debentures .............................. 6,789 6,808
Interest and other accrued expenses ..................................... 1,523 1,818
------------ ------------
Total other liabilities .............................................. 22,841 23,353
------------ ------------
TOTAL LIABILITIES .................................................... 80,230 87,314
REDEEMABLE PREFERRED STOCK
Series B, 250,000 shares issued and outstanding;
stated at redemption value .......................................... 1,000 1,000
STOCKHOLDERS' EQUITY
Preferred stock, 250,000 shares issued and outstanding as Series B ...... -- --
Common stock, issued 1,597,204 shares at both dates;
outstanding 1,254,751 shares at both dates ........................... 160 160
Additional paid-in capital .............................................. 54,823 54,823
Accumulated deficit ..................................................... (21,607) (24,676)
Treasury stock, 342,453 shares at both dates; at cost ................... (9,369) (9,369)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY ........................................... 24,007 20,938
------------ ------------
TOTAL ................................................................ $ 105,237 $ 109,252
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
Page 4
<PAGE> 5
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
ASSET MANAGEMENT
REAL ESTATE
Fees ................................................ $ 4,607 $ 2,635
Equity income from investments in HRP ............... 762 848
------------ ------------
5,369 3,483
Administrative expenses ............................. 1,172 1,015
Depreciation and amortization ....................... 336 336
Interest ............................................ -- 58
------------ ------------
1,508 1,409
------------ ------------
Income from real estate operations ............... 3,861 2,074
ENERGY
Gas revenues ........................................ 1,677 1,845
Oil revenues ........................................ 603 743
Other income ........................................ 235 74
Equity loss from investments in HEC ................. (1) --
------------ ------------
2,514 2,662
Depreciation, depletion and amortization ............ 849 686
Operating expenses .................................. 796 800
Administrative expenses ............................. 537 446
Interest ............................................ 217 275
------------ ------------
2,399 2,207
------------ ------------
Income from energy operations .................... 115 455
------------ ------------
Income from asset management operations .......... 3,976 2,529
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Sales ............................................... 44,269 45,612
Cost of sales ....................................... 38,023 39,442
Administrative and selling expenses ................. 4,688 4,532
Interest ............................................ 465 548
------------ ------------
43,176 44,522
------------ ------------
Income from textile products operations .......... 1,093 1,090
</TABLE>
See accompanying notes to consolidated financial statements.
Page 5
<PAGE> 6
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------------------
OPERATING SUBSIDIARIES (CONTINUED) 1999 1998
------------ ------------
<S> <C> <C>
HOTELS
Sales .................................................... $ 12,196 $ 10,346
Operating expenses ....................................... 9,780 8,980
Depreciation and amortization ............................ 1,413 1,338
Interest ................................................. 1,238 501
------------ ------------
12,431 10,819
Loss from hotel operations ............................ (235) (473)
------------ ------------
Income from operating subsidiaries .................... 858 617
OTHER
Fee income ............................................... 241 275
Interest on short-term investments and other income ...... 10 204
Litigation settlement .................................... -- 1,025
------------ ------------
251 1,504
Administrative expenses .................................. 1,244 1,360
Interest ................................................. 595 459
------------ ------------
1,839 1,819
------------ ------------
Other loss, net ....................................... (1,588) (315)
------------ ------------
Income before income taxes and extraordinary loss ........ 3,246 2,831
Income taxes ............................................. 127 207
------------ ------------
Income before extraordinary loss ........................ 3,119 2,624
Extraordinary loss from early extinguishment of debt ..... -- (375)
------------ ------------
NET INCOME ...................................................... $ 3,119 $ 2,249
============ ============
PER COMMON SHARE
BASIC
Income before extraordinary loss ......................... $ 2.45 $ 2.05
Extraordinary loss from early extinguishment of debt ..... -- (0.30)
------------ ------------
Net income ............................................ $ 2.45 $ 1.75
============ ============
ASSUMING DILUTION
Income before extraordinary loss ......................... $ 2.41 $ 1.97
Extraordinary loss from early extinguishment of debt ..... -- (0.29)
------------ ------------
Net income ............................................ $ 2.41 $ 1.68
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
Page 6
<PAGE> 7
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
1999 1998
------------ ------------
<S> <C> <C>
ASSET MANAGEMENT
REAL ESTATE
Fees ................................................ $ 3,343 $ 1,393
Equity income from investments in HRP ............... 373 496
------------ ------------
3,716 1,889
Administrative expenses ............................. 654 460
Depreciation and amortization ....................... 168 168
------------ ------------
822 628
------------ ------------
Income from real estate operations ............... 2,894 1,261
ENERGY
Gas revenues ........................................ 783 982
Oil revenues ........................................ 285 317
Other income ........................................ 140 24
Equity loss from investments in HEC ................. (1) --
------------ ------------
1,207 1,323
Depreciation, depletion and amortization ............ 338 309
Operating expenses .................................. 269 401
Administrative expenses ............................. 202 221
Interest ............................................ 96 129
------------ ------------
905 1,060
------------ ------------
Income from energy operations .................... 302 263
------------ ------------
Income from asset management operations .......... 3,196 1,524
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Sales ............................................... 22,411 22,297
Cost of sales ....................................... 19,015 19,284
Administrative and selling expenses ................. 2,389 2,269
Interest ............................................ 243 279
------------ ------------
21,647 21,832
------------ ------------
Income from textile products operations .......... 764 465
</TABLE>
See accompanying notes to consolidated financial statements.
Page 7
<PAGE> 8
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
------------------------------
OPERATING SUBSIDIARIES (CONTINUED) 1999 1998
------------ ------------
<S> <C> <C>
HOTELS
Sales .................................................... $ 5,741 $ 5,348
Operating expenses ....................................... 4,743 4,555
Depreciation and amortization ............................ 689 669
Interest ................................................. 627 249
------------ ------------
6,059 5,473
------------ ------------
Loss from hotel operations ............................ (318) (125)
------------ ------------
Income from operating subsidiaries .................... 446 340
OTHER
Fee income ............................................... 104 138
Interest on short-term investments and other income ...... 5 73
Litigation settlement .................................... -- 1,025
------------ ------------
109 1,236
Administrative expenses .................................. 721 795
Interest ................................................. 300 220
------------ ------------
1,021 1,015
------------ ------------
Other income (loss), net .............................. (912) 221
------------ ------------
Income before income taxes and extraordinary loss ........ 2,730 2,085
Income taxes ............................................. 116 112
------------ ------------
Income before extraordinary loss ......................... 2,614 1,973
Extraordinary loss from extinguishment of debt ........... -- (68)
------------ ------------
NET INCOME ...................................................... $ 2,614 $ 1,905
============ ============
PER COMMON SHARE
BASIC
Income before extraordinary loss ......................... $ 2.04 $ 1.53
Extraordinary loss from early extinguishment of debt ..... -- (0.05)
------------ ------------
Net income ............................................... $ 2.04 $ 1.48
============ ============
ASSUMING DILUTION
Income before extraordinary loss ......................... $ 2.01 $ 1.47
Extraordinary loss from early extinguishment of debt ..... -- (0.05)
------------ ------------
Net income ............................................... $ 2.01 $ 1.42
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
Page 8
<PAGE> 9
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................................... $ 3,119 $ 2,249
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, depletion and amortization ................... 3,214 3,088
Undistributed income from HEP .............................. (484) (1,378)
Distributions from HEP ..................................... 545 984
Amortization of deferred gain from debenture exchanges ..... (217) (269)
Extraordinary loss from extinguishment of debt ............. -- 375
Equity in net income of HRP ................................ (762) (848)
Equity in net loss of HEC .................................. 1 --
Net change in textile products assets and liabilities ...... (3,085) 1,067
Net change in energy assets and liabilities ................ (399) (628)
Net change in other assets and liabilities ................. (592) 339
------------ ------------
Net cash provided by operating activities ............... 1,340 4,979
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in textile products property and equipment ........ (964) (299)
Capital expenditures for hotels ............................... (683) (997)
Net change in restricted cash for investing activities ........ (280) (158)
Investments in energy property and equipment .................. (8) (131)
Investment in HEP by general partner .......................... (50) (171)
------------ ------------
Net cash used in investing activities ................... (1,985) (1,756)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings and loans payable ............... 2,600 --
Repayment of bank borrowings and loans payable ................ (1,060) (2,577)
Payment of preferred stock dividends .......................... (50) (50)
Repurchase of 7% Debentures ................................... -- (2,146)
Purchase of common stock for treasury ......................... -- (250)
------------ ------------
Net cash provided by (used in) financing activities ..... 1,490 (5,023)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .............. 845 (1,800)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .................... 769 4,737
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD .......................... $ 1,614 $ 2,937
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
Page 9
<PAGE> 10
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS AND ACCOUNTING POLICIES
Interim Consolidated Financial Statements. The consolidated financial
statements of The Hallwood Group Incorporated (the "Company") have been
prepared in accordance with the instructions to Form 10-Q and do not
include all of the information and disclosures required by generally
accepted accounting principles, although, in the opinion of management, all
adjustments considered necessary for a fair presentation have been
included. These financial statements should be read in conjunction with the
audited consolidated financial statements and related disclosures thereto
included in Form 10-K for the year ended December 31, 1998.
Comprehensive Income. The Company had no items of other comprehensive
income in the periods presented.
Reclassifications. Certain reclassifications have been made to the
prior period amounts to conform to the classifications used in the current
period. The reclassifications had no effect on previously reported net
income.
New Accounting Pronouncements. Statement of Financial Accounting
Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities" was issued in June 1998. The original effective date for
periods beginning after June 15, 1999 has been extended one year to June
15, 2000. The Company is currently not planning on early adoption, and has
not had an opportunity to evaluate the impact of the provisions on its
consolidated financial statements relating to future adoption.
2. INVESTMENTS IN REAL ESTATE AFFILIATE (DOLLAR AMOUNTS IN THOUSANDS):
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999 AMOUNT AT INCOME FROM INVESTMENTS
------------------------- WHICH CARRIED AT FOR THE SIX MONTHS ENDED
COST OR ------------------------- JUNE 30,
NUMBER OF ASCRIBED JUNE 30, DECEMBER 31, -------------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 1999 1998 1999 1998
- ------------------------------------ ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
HALLWOOD REALTY PARTNERS, L.P. ...
- General partner interest ....... -- $ 8,650 $ 3,568 $ 3,877 $ 29 $ 30
- Limited partner interest ....... 413,040 5,377 6,627 5,894 733 818
---------- ---------- ---------- ---------- ----------
Totals ........................ -- $ 14,027 $ 10,195 $ 9,771 $ 762 $ 848
========== ========== ========== ========== ==========
</TABLE>
At June 30, 1999, Hallwood Realty, LLC ("Hallwood Realty") and HWG,
LLC, wholly owned subsidiaries of the Company, owned a 1% general partner
interest and a 25% limited partner interest in its Hallwood Realty
Partners, L.P. ("HRP") affiliate, respectively. The Company accounts for
its investment in HRP using the equity method of accounting. In addition to
recording its share of net income, the Company also records its pro rata
share of any partner capital transactions reported by HRP. The carrying
value of the Company's investments includes such non-cash adjustments for
its pro-rata share of HRP's capital transactions ,with corresponding
adjustments to additional paid-in capital. The cumulative amount of such
adjustments, from the original date of investment through June 30, 1999,
resulted in a $49,000 decrease in the carrying value.
The carrying value of the Company's general partner interest includes
the value of intangible rights to provide asset management and property
management services. The Company amortizes that portion of the general
partner interest ascribed to those management rights. For the six months
ended June 30, 1999 and 1998 such amortization was $336,000 in each period.
The Company has pledged 89,269 HRP limited partner units to
collateralize the $500,000 promissory note and 30,035 limited partner units
to secure hotel leases. A negative pledge over all of the Company's limited
partner units was canceled in June 1999 concurrent with an amendment of the
Company's energy term loan.
The quoted market price and the Company's carrying value per limited
partner unit (Quotron symbol HRY) at June 30, 1999 were $61.25 and $16.04,
respectively. The general partner interest is not publicly traded.
Page 10
<PAGE> 11
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
3. INVESTMENTS IN ENERGY AFFILIATE (DOLLAR AMOUNTS IN THOUSANDS):
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999 AMOUNT AT INCOME (LOSS) FROM INVESTMENTS
------------------------- WHICH CARRIED AT FOR THE SIX MONTHS ENDED
COST OR ------------------------- JUNE 30,
NUMBER OF ASCRIBED JUNE 30, DECEMBER 31, -------------------------
DESCRIPTION OF INVESTMENT UNITS VALUE 1999 1998 1999 1998
- ------------------------------------ ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
HALLWOOD ENERGY CORPORATION
- - Common stock ..................... 1,800,000 $ 5,217 $ 5,216 -- $ (1) --
- - Preferred stock .................. 43,816 401 401 -- -- --
---------- ---------- ---------- ---------- ----------
Totals .......................... $ 5,618 $ 5,617 -- $ (1) --
========== ========== ========== ========== ==========
</TABLE>
In December 1998, Hallwood Energy Partners, L.P. ("HEP") and its
affiliate, Hallwood Consolidated Resources Corporation ("HCRC"), jointly
announced a proposal to consolidate HEP with HCRC and the energy interests
of the Company into a new, publicly-traded entity to be called Hallwood
Energy Corporation ("HEC"). On April 30, 1999, a Joint Proxy
Statement/Prospectus for the consolidation was declared effective by the
Securities and Exchange Commission and was mailed to HEP unitholders and
HCRC stockholders as of the April 14, 1999 record date. On June 8, 1999,
HEC announced that the consolidation was approved by the HEP unitholders,
the HCRC stockholders and the Company and that the consolidation was
completed as of that date. At its inception, the common stock of HEC was
owned 56% by the Class A unitholders of HEP, 26% by the stockholders of
HCRC and 18% by the Company. HEP's Class C unitholders received redeemable
preferred stock in HEC. The Company received 1,800,000 shares of common
stock (18% of the total outstanding) and 43,816 shares of preferred stock
(1.9% of the total outstanding) in HEC, in exchange for the contribution of
its energy interests.
The consolidation created an exploration and production company with
estimated reserves of approximately 213 billion cubic feet of natural gas
equivalent. At June 30, 1999, HEC had total assets of approximately $202
million and total liabilities of approximately $126 million. Because of the
larger size of HEC, management anticipates that the new company will have
the ability to take advantage of opportunities that are unavailable to
smaller entities and will have a better ability to raise capital. The
principal objectives of HEC are to explore for, develop, acquire and
produce oil and gas properties.
As of the June 8, 1999 consummation date, the Company no longer
proportionally consolidates its energy business. The investment in HEC will
be accounted for under the equity method because the Company is able to
exercise significant influence over HEC's operational and financial
policies. The assets and liabilities of the Company's energy business were
combined at the consummation date to establish the initial investment in
HEC of $5,618,000, as follows (in thousands):
<TABLE>
<CAPTION>
DESCRIPTION AMOUNT
----------- ------
<S> <C>
Oil and gas properties.......................... $10,809
Current assets of HEP........................... 3,267
Noncurrent assets of HEP........................ 1,194
Receivables and other assets.................... 64
Long-term obligations of HEP.................... (6,872)
Current liabilities of HEP...................... (2,160)
Accounts payable and accrued expenses........... (684)
-------
$ 5,618
=======
</TABLE>
In accordance with the equity method of accounting, the Company records
its pro-rata share of HEC's net income (loss) available to common
stockholders and its pro rata share of any capital transactions reported by
HEC. The Company's proportionate share of the underlying equity in net
assets of HEC exceeded its investment by $4,472,000 on the consummation
date, which is being amortized at a rate which approximates the depletion
of HEC's reserves.
Page 11
<PAGE> 12
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
The quoted market price and the Company's carrying value per share at
June 30, 1999 of the HEC common stock (Quotron symbol HECO) are $6.00 and
$2.90, respectively, and the HEC preferred stock (Quotron symbol HECOP) are
$8.13 and $9.15, respectively.
4. LITIGATION, CONTINGENCIES AND COMMITMENTS
Reference is made to Note 18 to the consolidated financial statements
contained in Form 10-K for the year ended December 31, 1998.
In connection with the Ravenswood, Noland and Cede & Company litigation
matters over the November 1998 tender offer and merger of the former
Hallwood Energy Corporation into the Company, we expect the court to enter
a final order approving the settlement which will be payable by December
1999. In accordance with the terms of the energy consolidation, the
Company's liability to pay the settlement amount is limited to $395,000,
which had previously been recorded by the Company at the time of the tender
offer.
5. LOANS PAYABLE
Loans payable at the balance sheet dates are detailed below by business
segment (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
---------- ----------
<S> <C> <C>
Real Estate
Promissory note, 8%, originally due March 1998 (see below) ......... $ 500 $ 500
Energy
Term loan, libor + 3.5%, due May 2000 .............................. 1,467 2,267
Textile Products
Revolving credit facility, prime + .25%, due January 2000 .......... 12,500 9,900
Hotels
Term loan, 7.50% fixed, due October 2008 ........................... 17,080 17,198
Term loan, 7.86% fixed, due January 2008 ........................... 6,621 6,667
Term loan, 8.20% fixed, due November 2007 .......................... 5,174 5,209
Term loan, libor + 7.5%, due October 2005 .......................... 1,219 1,280
---------- ----------
30,094 30,354
---------- ----------
Total .......................................................... $ 44,561 $ 43,021
========== ==========
</TABLE>
Further information regarding loans payable is provided below:
Real Estate
Promissory note. In connection with the settlement of an obligation
related to the Company's Integra Hotels, Inc. subsidiary, the Company
issued a four-year, $500,000 promissory note due March 1998. The note is
secured by a pledge of 89,269 HRP limited partner units. The settlement
agreement also provided that the pledgee had the right to receive an
additional payment in an amount equal to 25% of the increase in the value
of the HRP units over the base amount of $8.44 per unit, but in no event
more than an additional $500,000 (the "HRP Participation Amount"). During
the original term of the note, the Company accrued the full amount of
$500,000 as a charge to interest expense, of which $50,000 was recorded in
the 1998 first quarter.
The Company tendered full payment, including the HRP Participation
Amount totaling $1,000,000, in March 1998, although it reserved its rights
to litigate the validity of an earlier tender that was rejected by the
Page 12
<PAGE> 13
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
noteholder. The noteholder refused acceptance of the March 1998 tendered
payment and instituted litigation in the State of Delaware. The litigation
is currently in the discovery phase and a trial date has not yet been
scheduled.
Energy
Term loan. In November 1997, the Company's HEPGP Ltd. partnership
("HEPGP") amended, restated and increased its term loan to $4,000,000 from
the First Union Bank of North Carolina. The term loan was collateralized by
all of the Company's HEP limited partner units, its investment in HEPGP and
Hallwood GP, Inc. and HEPGP's direct interests in certain oil and gas
properties. Significant terms included: (i) maturity date of May 15, 2000;
(ii) monthly principal payments of $133,000, plus interest; (iii) interest
rate of libor plus 3.5% (8.49% at June 30, 1999); (iv) a limited negative
pledge relating to substantially all of the Company's HRP limited partner
units; and (v) restrictions on the declaration of distributions or
redemptions of partnership interests.
In connection with the consolidation of the energy companies, the
Company amended the term loan to provide for the assumption of the
obligation by the Company. The outstanding principal balance, interest rate
and repayment terms remained identical to the original note and credit
agreement. The amendment further provided for (i) the release of all
collateral previously pledged; (ii) the pledge of all 1,800,000 common
shares and 43,816 preferred shares of HEC that were received at the
completion of the energy consolidation; and (iii) a covenant which requires
that the market value of the pledged HEC shares shall, at all times, be at
least 300% of the loan's outstanding principal balance. The outstanding
balance of the term loan at June 30, 1999 was $1,467,000.
Textile Products
Revolving credit facility. In January 1997, the Company's Brookwood
subsidiary entered into a revolving credit facility in an amount of up to
$14,000,000 ($15,000,000 between April and June) with The Bank of New York
(the "Credit Agreement"). Borrowings are collateralized by accounts
receivable, inventory imported under trade letters of credit, certain
finished goods inventory, the machinery and equipment of Brookwood's
subsidiaries and all of the issued and outstanding capital stock of
Brookwood and its subsidiaries. The Credit Agreement expires on January 7,
2000 and bears interest, at Brookwood's option, at one-quarter percent over
prime (8.00% at June 30, 1999) or libor plus 2.25%. The facility was
amended to increase the maximum amount to $17,500,000 for the periods April
through December 1997, and May through August 1998, and permanently
increase the maximum amount to $15,000,000 thereafter and to change certain
financial covenants. Availability for direct borrowings and letter of
credit obligations under the facility are limited to the lesser of the
facility or the formula borrowing base, as defined in the agreement. The
facility contains covenants, which include maintenance of certain financial
ratios, restrictions on dividends and repayment of debt or cash transfers
to the Company. The outstanding balance at June 30, 1999 was $12,500,000.
At December 31, 1998, Brookwood was not in compliance with a covenant
contained in the Credit Agreement, which requires a minimum consolidated
capital expenditure of $1,313,000 in a calendar year. On March 26, 1999,
Brookwood entered into an Amendment No. 5 and Waiver to Credit Agreement,
whereby the Bank waived the minimum consolidated capital expenditure
requirement for the calendar year ended December 31, 1998 only, and amended
that section of the Credit Agreement relating to the minimum ratio of
EBIDTA (earnings before interest, depreciation, taxes and amortization) to
consolidated fixed charges by inserting "except for the four consecutive
quarters ending March 31, 1999, and for said period only."
Page 13
<PAGE> 14
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
Hotels
Term Loans. In September 1998, the Company formed two wholly-owned
subsidiaries, Hallwood Hotels -- OKC, Inc. to acquire the fee interest in
the Embassy Suites hotel in Oklahoma City, Oklahoma for $18,250,000 and the
related mortgage term loan; and Hallwood Hotels -- OKC Mezz, Inc. to
acquire a mezzanine term loan related to that fee acquisition. Prior to the
fee acquisition, the Company held a leasehold interest in the hotel.
The mortgage loan for $17,250,000 includes the following significant
terms: (i) fixed interest rate of 7.5%; (ii) monthly loan payments of
$127,476, based upon a 25-year amortization schedule, with a maturity date
of October 2008; (iii) prepayment permitted after November 2000, subject to
yield maintenance provisions and; (iv) various other financial and
non-financial covenants. The outstanding balance at June 30, 1999 was
$17,080,000.
The mezzanine loan for $1,300,000 includes the following significant
terms: (i) interest rate of libor plus 7.5% (12.44% at June 30, 1999); (ii)
maturity date of October 2005; and (iii) prepayment permitted at any time
without penalty, upon 30-day notice to lender. The outstanding balance at
June 30, 1999 was $1,219,000.
Term loan. In December 1997, the Company's Brock Suite Greenville, Inc.
subsidiary entered into a new $6,750,000 mortgage loan, collateralized by
the GuestHouse hotel located in Greenville, South Carolina, which replaced
the former term loan. Significant terms include: (i) fixed interest rate of
7.86%; (ii) monthly loan payments of $51,473 based upon 25-year
amortization schedule with a maturity date of January 2008; (iii)
prepayment permitted after December 1999, subject to yield maintenance
provisions and (iv) various other financial and non-financial covenants.
The outstanding balance at June 30, 1999 was $6,621,000.
Term loan. In October 1997, the Company's Brock Suite Tulsa, Inc.
subsidiary entered into a new $5,280,000 mortgage loan collateralized by
the GuestHouse hotel in Tulsa, Oklahoma, which replaced the former term
loan. Significant terms include: (i) fixed interest rate of 8.20%; (ii)
monthly loan payments of $41,454, based upon 25-year amortization schedule,
with a maturity date of November 2007; (iii) prepayment permitted after
October 2001, subject to yield maintenance provisions and; (iv) various
other financial and non-financial covenants. The outstanding balance at
June 30, 1999 was $5,174,000.
6. DEBENTURES
7% Collateralized Senior Subordinated Debentures. In March 1993, the
Company completed an exchange offer whereby $27,481,000 of its former 13.5%
Debentures were exchanged for a new issue of 7% Collateralized Senior
Subordinated Debentures due July 31, 2000 (the" 7% Debentures"). Interest
is payable quarterly in arrears, in cash, and the 7% Debentures are secured
by a pledge of all of the capital stock of the Brookwood and Hallwood
Hotels, Inc. subsidiaries. The common and preferred stock of Brookwood are
subject to a senior pledge in favor of The Bank of New York.
Between 1994 and 1997, the Company repurchased 7% Debentures having a
principal value of $4,673,000. These repurchases satisfied the Company's
obligation to retire 10% of the original issue ($2,748,000) prior to March
1996, and partially satisfied the Company's obligation to retire an
additional 15% of the original issue ($4,122,000) prior to March 1998. In
January 1998, the Company repurchased 7% Debentures with a face amount of
$2,253,000 for $2,146,000, to fully satisfy the balance of the sinking fund
requirement contained in the indenture. The repurchase resulted in an
extraordinary gain from debt extinguishment of $107,000 in the 1998 first
quarter.
Management is currently exploring alternatives to refinance the 7%
Debentures which mature in July 2000.
10% Collateralized Subordinated Debentures. In June 1998, the Company
announced a commission-free exchange offer to all holders of 7% Debentures.
The Company offered to exchange 7% Debentures for a new issue of 10%
Collateralized Subordinated Debentures ("10% Debentures"), due July 31,
2005, $100 principal amount of 10% Debentures for each $100 principal
amount of 7% Debentures tendered. Terms and conditions
Page 14
<PAGE> 15
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
of the exchange offer were described in an exchange offer circular, dated
June 22, 1998, and a supplemental modification letter dated July 31, 1998,
both of which were mailed to all holders of 7% Debentures. The 7%
debentureholders tendered $6,467,830, or 31%, of the outstanding principal
amount, prior to the August 28, 1998 expiration date of the exchange offer.
The 10% Debentures were listed on The New York Stock Exchange and
commenced trading on August 31, 1998. The direct costs of the exchange
offer, in the amount of $131,000, were expensed in 1998. For accounting
purposes, a pro-rata portion of the $1,121,000 unamortized gain
attributable to the 7% Debentures, in the amount of $353,000, was allocated
to the 10% Debentures, and will be amortized over the term of the 10%
Debentures using the effective interest method. As a result, the effective
interest rate is 8.9%.
The 10% Debentures are secured by a first and senior lien on the
capital stock of the Company's Brock Suite Hotels, Inc. subsidiary and by a
subordinate and junior lien on the capital stock of the Brookwood and
Hallwood Hotels, Inc. subsidiaries which are pledged to secure the 7%
Debentures .
Balance sheet amounts are detailed below (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
DESCRIPTION 1999 1998
-------------------------------------------- ------------ ------------
<S> <C> <C>
7% Debentures (face amount) ..................................... $ 14,088 $ 14,088
Unamortized gain from exchange, net of
accumulated amortization ..................................... 441 639
------------ ------------
Totals .................................................... $ 14,529 $ 14,727
============ ============
10% Debentures (face amount) .................................... $ 6,468 $ 6,468
Unamortized gain from exchange, net of
accumulated amortization ..................................... 321 340
------------ ------------
Totals .................................................... $ 6,789 $ 6,808
============ ============
</TABLE>
7. INCOME TAXES
The following is a summary of the income tax expense (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
--------------------- ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Federal
Current ........................ $ 20 $ 20 $ 25 $ 30
Deferred ....................... -- -- -- --
-------- -------- -------- --------
Sub-total ................... 20 20 25 30
State ............................. 96 92 102 177
-------- -------- -------- --------
Total ....................... $ 116 $ 112 $ 127 $ 207
======== ======== ======== ========
</TABLE>
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.
The amount of the deferred tax asset (net of valuation allowance) was
$6,348,000 at June 30, 1999. The deferred tax asset arises principally from
the anticipated utilization of the Company's NOLs and tax credits from the
implementation of various tax planning strategies.
Page 15
<PAGE> 16
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
8. SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
DESCRIPTION 1999 1998
----------------------------------- ---------- ----------
<S> <C> <C>
Supplemental schedule of non cash investing and financing activities:
Conversion of energy investment to equity method from proportional
consolidation method at consummation of energy consolidation
Oil and gas properties ............................................. $ 10,809 --
Current assets of HEP .............................................. 3,267 --
Noncurrent assets of HEP ........................................... 1,194 --
Receivables and other assets ....................................... 64 --
Long-term obligations of HEP ....................................... (6,872) --
Current liabilities of HEP ......................................... (2,160) --
Accounts payable and accrued expenses .............................. (684) --
---------- ----------
$ 5,618 --
========== ==========
Supplemental disclosures of cash payments:
Interest paid ......................................................... $ 2,664 $ 1,995
Income taxes paid ..................................................... 147 371
</TABLE>
9. COMPUTATION OF EARNINGS PER SHARE
The following table reconciles the Company's net income to net income
available to common stockholders, and the number of equivalent common
shares used in the calculation of net income for the basic and assumed
dilution methods (in thousands, except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
DESCRIPTION 1999 1998 1999 1998
------------------------------------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
NET INCOME
Net income, as reported ............................. $ 2,614 $ 1,905 $ 3,119 $ 2,249
Less: Dividends on preferred stock .................. 50 50 50 50
---------- ---------- ---------- ----------
Net income available to common stockholders ......... $ 2,564 $ 1,855 $ 3,069 $ 2,199
========== ========== ========== ==========
AVERAGE SHARES OUTSTANDING
Outstanding shares - basic .......................... 1,255 1,255 1,255 1,255
Stock options ....................................... 20 55 19 53
---------- ---------- ---------- ----------
Outstanding shares - assuming dilution .............. 1,275 1,310 1,274 1,308
========== ========== ========== ==========
NET INCOME PER COMMON SHARE
Basic ............................................... $ 2.04 $ 1.48 $ 2.45 $ 1.75
Assuming dilution ................................... $ 2.01 $ 1.42 $ 2.41 $ 1.68
</TABLE>
Page 16
<PAGE> 17
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
10. SEGMENT AND RELATED INFORMATION
The following represents the Company's reportable segment position for
the six months ended June 30, 1999 and 1998, respectively (in thousands):
<TABLE>
<CAPTION>
REAL TEXTILE CONSOL
ESTATE ENERGY PRODUCTS HOTELS OTHER -IDATED
-------- ------- --------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
SIX MONTHS ENDED JUNE 30, 1999
Total revenue from external sources....... $ 5,369 $ 2,514 $ 44,269 $ 12,196 $ 251 $ 64,599
======== ======= ========= ========= ======== =========
Operating income (loss)................... $ 3,861 $ 115 $ 1,093 $ (235)$ -- $ 4,834
======== ======= ========= ========= ========
Unallocable expenses, net................. $ (1,588) (1,588)
======== ---------
Income before income taxes................ $ 3,246
=========
SIX MONTHS ENDED JUNE 30, 1998
Total revenue from external sources....... $ 3,483 $ 2,662 $ 45,612 $ 10,346 $ 1,504 $ 63,607
======== ======= ========= ========= ======== =========
Operating income (loss)................... $ 2,074 $ 455 $ 1,090 $ (473)$ -- $ 3,146
======== ======= ========= ========= ========
Unallocable expenses, net................. $ (315) (315)
======== ---------
Income before income taxes and
extraordinary gain (loss)............. $ 2,831
=========
Extraordinary gain (loss) from early
extinguishment of debt................ $ (482) $ -- $ -- $ -- $ 107 $ (375)
======== ======= ========= ========= ======== =========
</TABLE>
No differences have occurred in the basis or methodologies used in the
preparation of this interim segment information from those used in the
December 31, 1998 annual report. The total assets of the Company have not
materially changed since the December 31, 1998 annual report, although (i)
the assets of the energy segment declined approximately $10.5 million due
to the conversion to the equity method from the proportional consolidation
method of accounting following the consummation of the energy
consolidation, and (ii) the assets of the textile products segment
increased by approximately $4.8 million due to seasonal fluctuations.
11. SEPARATION AGREEMENT
On May 11, 1999, the Company announced that it had reached an agreement
(the "Agreement") with Mr. Brian M. Troup, president and a director of the
Company, regarding a separation of their interests. Completion of the
Agreement is conditioned on, among other things, a satisfactory refinancing
of the $14,088,000 outstanding principal amount of the 7% Debentures and
completion of the consolidation of the Company's energy interests with HEP
and HCRC to form HEC.
Mr. Troup currently holds options to purchase a total of 37,200 shares
of the Company's common stock. In addition, a trust of which members of Mr.
Troup's family are beneficiaries, currently owns 305,196 shares of the
Company's common stock. Upon satisfaction of the remaining conditions, Mr.
Troup will surrender his options, the trust will surrender all of its
shares of common stock to the Company, the options and stock will be
canceled and Mr. Troup will resign from all positions with the Company, HRP
and HEC.
In exchange, the Company will transfer to the trust or Mr. Troup 82,608
units of HRP, 360,000 shares of common stock of HEC, and all of the
Company's interest in the Enclave Suites resort in Orlando, Florida and any
other condominium hotel projects currently in process. In addition, the
Company will pay quarterly to Mr. Troup the lesser of 20% of the net cash
flow from its real estate management activities for the preceding quarter
or $125,000, subject to termination in certain events.
HRP and HEC have agreed to register the trust's and/or Mr. Troup's
units or shares in those entities upon request by Mr. Troup and the
Company, at the Company's expense. The Company will have the right to
Page 17
<PAGE> 18
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
purchase all of these units and shares at the then current trading price
for a period of six months after the effectiveness of the Agreement.
Thereafter, Mr. Troup may sell the units and shares subject to certain
restrictions, including a right of first refusal in favor of the Company.
Mr. Troup and the trust have given an irrevocable proxy to the Company to
vote all their HRP units and HEC shares on any and all matters in and
according to the Company's sole discretion, until Mr. Troup or the trust
sell the units or shares.
There is no assurance that the conditions to completion of the
Agreement will be satisfied or that the Agreement will be completed. Until
completion, the parties do not anticipate any change in their
relationships.
Page 18
<PAGE> 19
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Company reported net income of $2,614,000 for the second quarter
ended June 30, 1999, compared to net income of $1,905,000 in the 1998
period. The six month reported net income of $3,119,000, compared to net
income of $2,249,000 in the prior-year period. Total revenue for the 1999
second quarter was $33,184,000, compared to $32,093,000 in the prior-year
period. For the six months, revenue was $64,599,000, compared to
$63,607,000 in the prior period.
Following is an analysis of the results of operations by asset
management and operating subsidiaries divisions and by the real estate,
energy, textile products and hotels business segments.
ASSET MANAGEMENT. The reportable segments of the Company's asset management
division consist of real estate and energy.
REAL ESTATE.
Revenue. Fee income of $3,343,000 for the quarter ended June 30, 1999
increased by $1,950,000, or 140%, from $1,393,000 in the prior-year period.
Fee income of $4,607,000 for the six months increased by $1,972,000, or
75%, from $2,635,000 for the similar period a year ago. Fees are derived
from the Company's asset management, property management, leasing and
construction supervision services provided to its Hallwood Realty Partners,
L.P. affiliate, a real estate master limited partnership and various third
parties. The increase was due primarily to a $1,746,000 leasing commission
earned in connection with the leasing of a five-story, 125,000 square feet
commercial office building owned by HRP. One-half of the lease commission
was paid in June 1999 and the remainder is payable at the date of
occupancy, which is expected to be in the first or second quarter of 2000.
The equity income from investments in HRP represents the Company's
recognition of its pro rata share of the income reported by HRP and
amortization of negative goodwill. For the 1999 second quarter, the Company
reported income of $373,000 compared to $496,000 in the period a year ago.
The comparative six month amounts were income of $762,000 in 1999 and
$848,000 in 1998. The decreases resulted from lower operating income in the
1999 periods attributable to higher interest and administrative expenses.
The 1998 equity income is exclusive of the Company's $482,000 pro-rata
share of HRP's $1,876,000 loss on early extinguishment of debt, which is
reported separately as part of the extraordinary item.
Expenses. Administrative expenses of $654,000 increased by $194,000 in
the 1999 second quarter from $460,000, and for the six month period,
increased by $157,000 to $1,172,000 from $1,015,000 in the prior-year
period. The increase was primarily attributable to the payments of
commissions to third party brokers associated with fee income.
Amortization expense of $168,000 for the second quarter and $336,000
for the six months in both the 1999 and 1998 periods relate to Hallwood
Realty's general partner investment in HRP to the extent allocated to
management rights.
Interest expense for the 1999 six months decreased to -0- from $58,000
in the prior-year period. The amount relates to the $500,000 promissory
note, which had reached maturity.
ENERGY.
Revenue. Prior to the energy consolidation of HEP, HCRC and the energy
interests of the Company into the newly formed HEC, which was consummated
on June 8, 1999, the Company's energy investment consisted of two wholly
owned energy related subsidiaries and certain energy assets owned directly
by the Company. The general partner interest in HEP, owned by one of the
Company's subsidiaries, entitled the general partner to interests in HEP's
properties ranging from 2% to 25%. The Company also owned an approximate
6.5% interest in HEP limited partner units. The Company and its energy
subsidiaries formerly accounted for their ownership
Page 19
<PAGE> 20
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
of HEP using the proportionate consolidation method of accounting, whereby
they record their proportionate share of HEP's revenues and expenses,
current assets, current liabilities, noncurrent assets, long-term
obligations and fixed assets.
Pursuant to the terms of the consolidation, the Company received
1,800,000 shares of common stock (18% of the total outstanding) and 43,816
shares of preferred stock (1.9% of the total outstanding) in HEC, in
exchange for the contribution of its energy interests. As of the
consummation date, the Company no longer fully consolidates its energy
business. The investment in HEC is being accounted for under the equity
method because the Company is able to exercise significant influence over
HEC's operational and financial policies. Accordingly, the revenue and
expense items of the energy segment reflect proportionally consolidated
amounts through June 8, 1999 only. Thereafter, the Company records its
pro-rata share of HEC's net income (loss) available to common stockholders
as a single item - Equity income (loss) from investments in HEC.
Gas revenue for the 1999 second quarter decreased $199,000 to $783,000
from $982,000. For the six months, gas revenue decreased $168,000 to
$1,677,000 from $1,845,000. The decrease in gas revenue for the six months
was primarily due to a decrease in production to 855,000 mcf from 879,000
mcf, and a decrease in the average gas price to $1.96 per mcf from $2.10
per mcf. The decrease in gas production is due to the shorter 1999 period
(activity through June 8 only), partially offset by an increase from HEC's
acquisition of a volumetric production payment during May 1998. Oil revenue
for the 1999 second quarter decreased by $32,000 to $285,000 from $317,000.
For the six months oil revenue decreased by $140,000 to $603,000 from
$743,000. The decrease for the six months was due to a decrease in the
average price per barrel to $13.11 from $13.27, and a decrease in
production to 46,000 barrels from 56,000 barrels due to normal production
declines and the shorter 1999.
Other income consists primarily of acquisition fee and interest income,
as well as a share of HEC's interest income, facilities income from two
gathering systems in New Mexico, pipeline revenue, equity in income of
affiliate and miscellaneous income or expense. The increase in other income
to $140,000 for the 1999 second quarter from $24,000 in the 1998 period and
to $235,000 for the 1999 six month period from $74,000 in 1998 are
primarily due to an increase of incentive payment income from HEP's
acquisition of a volumetric production payment during May 1998 and an
increase in HEC's equity in income of affiliate.
The equity loss from investments in HEC of $1,000 in the 1999 second
quarter represents the Company's recognition of its pro rata share (18%
ownership interest) of HEC's loss available to common stockholders for the
period June 9 through June 30, 1999.
Expenses. Operating expenses decreased by $132,000 to $269,000 for the
1999 second quarter from $401,000 in the prior-year quarter and decreased
by $4,000 to $796,000 for the six months from $800,000 in 1998 as a result
of the shorter 1999 period described above.
Depreciation, depletion and amortization increased by $29,000 to
$338,000 for the 1999 second quarter compared to $309,000 in the 1998
quarter and increased by $163,000 to $849,000 from $686,000 for the six
months. The increases are attributable to a higher depletion rate and
higher capitalized costs during 1999.
Administrative expenses decreased by $19,000 for the 1999 second
quarter to $202,000 from $221,000 in the 1998 quarter and increased by
$91,000 for the 1999 six month period to $537,000 from $446,000 due to
changes in allocated internal overhead expense.
Interest expense decreased by $33,000 to $96,000 for the 1999 second
quarter compared to $129,000 in 1998 and decreased by $58,000 to $217,000
for the 1999 six month period from $275,000, primarily due to a decline in
the principal balance of the energy term loan.
Page 20
<PAGE> 21
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OPERATING SUBSIDIARIES. The reportable segments of the Company's operating
subsidiaries division consist of textile products and hotels.
TEXTILE PRODUCTS.
Revenue. Sales of $22,411,000 increased $114,000, or less than 1%, in
the 1999 second quarter, compared to $22,297,000 in the 1998 quarter. The
comparative six month sales decreased $1,343,000, or 3%, to $44,269,000
from $45,612,000 in 1998. Demand for Brookwood's textile products in the
distribution divisions decreased in 1999, compared to the 1998 periods due
to lower priced Asian imports and U.S. customers moving production out of
the country, while in the second quarter, sales increased at the Kenyon
dying and finishing plant.
Expenses. Cost of sales of $19,015,000 decreased $269,000, or 1%, in
the 1999 second quarter, from $19,284,000 in the 1998 quarter. The
comparative six month cost of sales decreased $1,419,000, or 4%, to
$38,023,000 from $39,442,000 in the 1998 period. The decrease in cost of
sales was principally the result of the decreased sales. The higher gross
profit margin for the 1999 second quarter (15.2% versus 13.5%) and the six
month periods (14.1% versus 13.5%) resulted from higher gross profit
margins at the Kenyon plant, due to higher volumes and increased operating
efficiencies.
Administrative and selling expenses of $2,389,000 increased by
$120,000 in the 1999 second quarter from $2,269,000 for the comparable 1998
period and increased $156,000 for the six month period to $4,688,000 from
$4,532,000 for the comparable 1998 period. The increases were attributable
to higher consulting and other professional fees.
Interest expense of $243,000 decreased by $36,000 for the 1999 second
quarter from $279,000 in 1998 and decreased by $83,000 for the six months
to $465,000 from $548,000 due to lower average borrowings and lower
interest rates.
HOTELS.
Revenue. Sales of $5,741,000 in the 1999 second quarter increased by
$393,000, or 7%, from the year-ago amount of $5,348,000. The 1999 six-month
hotel sales of $12,196,000 increased by $1,850,000, or 18%, compared to
$10,346,000 for the 1998 period. The increases for the second quarter and
six month periods are primarily due to management fee revenues from the
July 1998 acquisition of owners rental contracts and related real estate at
the Enclave Suites, a resort condominium hotel in Orlando, Florida and
increased revenues at the Longboat Key, Florida Holiday Inn and Suites,
partially offset by declines at the Company's three GuestHouse Suite hotels
attributable to an ongoing $3.0 million renovation expected to be completed
in the second half of 1999. The Holiday Inn revenues increased by
$1,039,000 for the six months, as a result of increased occupancy and
average daily rate following the completion of an extensive renovation
project in April 1998 and improved weather conditions. For the hotel
segment, average daily rate increased 1.6% and average occupancy level
decreased 6.7% in the 1999 six months compared to the prior-year period.
Expenses. Operating expenses of $4,743,000 for the 1999 second quarter
were up $188,000, or 4%, from $4,555,000 in 1998. The 1999 six month hotel
operating expenses increased by $800,000, or 9%, to $9,780,000, compared to
$8,980,000 for the 1998 period. The increases are primarily attributable to
operating expenses for the Enclave Suites and Holiday Inn, partially offset
by reduced rent for the Oklahoma City, Oklahoma Embassy Suites hotel, which
was a leasehold prior to the fee interest being acquired by the Company in
September 1998.
Depreciation and amortization expense increased by $20,000 to $689,000
for the 1999 second quarter from $669,000 in the prior-year period.
Depreciation and amortization for the six month periods were $1,413,000 and
$1,338,000, respectively. The increases are primarily due to the
acquisition of the owner's rental contracts and related real estate at the
Enclave Suites and the fee interest in the Embassy Suites.
Page 21
<PAGE> 22
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Interest expense increased by $378,000 to $627,000 for the 1999 second
quarter from $249,000 in 1998 and increased by $737,000 to $1,238,000 for
the six month period from $501,000, principally due to the September 1998
term loans to acquire the Embassy Suites fee interest.
OTHER.
Revenue. Fee income in the 1999 second quarter of $104,000 and $241,000
for the six months compares to the 1998 amounts of $138,000 and $275,000,
respectively. The decreases are due to the termination of a consulting
contract with the Company's energy affiliate following the completion of
the energy consolidation on June 8, 1999.
Interest on short-term investments and other income decreased by
$68,000 to $5,000 for the 1999 second quarter from $73,000 in 1998 and for
the six month interest expense decreased by $194,000 to $10,000 from
$204,000. The decrease was attributable to lower interest income earned on
the Company's short-term investments and lower rental income from the
subleasing of executive office space formerly occupied by an affiliated
entity, which master lease expired in May 1998.
In May 1998, the Company favorably settled a 1996 litigation claim
involving its former merchant banking activities for $1,025,000 in cash,
which was reported as income in the 1998 second quarter.
Expenses. Administrative expenses of $721,000 for the 1999 second
quarter decreased by $74,000 from the prior-year amount of $795,000. For
the six months the decrease was $116,000 to $1,244,000 from $1,360,000. The
declines are primarily attributable to the inclusion in the 1998 periods of
compensation expense recorded upon the acquisition of certain unexercised
stock options and costs of the debenture exchange offer.
Interest expense of $300,000 for the 1999 second quarter increased by
$80,000 from the prior year amount of $220,000 and increased by $136,000
for the six months to $595,000 from $459,000 due to the increased average
interest rate following the August 1998 debenture exchange offer.
Income taxes. Income taxes were $116,000 for the 1999 second quarter
compared to $112,000 in the 1998 quarter. The respective quarters included
$96,000 and $92,000 for state taxes. Income taxes were $127,000 for the
1999 six month period, compared to $207,000 in 1998. For the six months,
the respective state tax expense was $102,000 and $177,000. State tax
expense is an estimate based upon taxable income allocated to those states
in which the Company does business at their respective tax rates.
As of June 30, 1999, the Company had approximately $99,000,000 of net
operating loss carryforwards ("NOLs") and temporary differences to reduce
future federal income tax liabilities. Based upon the Company's
expectations and available tax planning strategies, management has
determined that taxable income will more likely than not be sufficient to
utilize approximately $18,670,000 of the NOLs prior to their ultimate
expiration in the year 2010.
Management believes that the Company has certain tax planning
strategies available, which include the potential sale of certain real
estate investments and hotel properties, that could be implemented, if
necessary, to supplement income from operations to fully realize the
recorded tax benefits before their expiration. Management has considered
such strategies in reaching its conclusion that, more likely than not,
taxable income will be sufficient to utilize a portion of the NOLs before
expiration; however, future levels of operating income and taxable gains
are dependent upon general economic conditions and other factors beyond the
Company's control. Accordingly, no assurance can be given that sufficient
taxable income will be generated for utilization of the NOLs. Management
periodically re-evaluates its tax planning strategies based upon changes in
facts and circumstances and, accordingly, considers potential adjustments
to the valuation allowance of the deferred tax asset. Although the use of
such carryforwards could, under certain circumstances, be limited, the
Company is presently unaware of the occurrence of any event which would
result in the imposition of such limitations.
Page 22
<PAGE> 23
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Extraordinary loss from early extinguishment of debt. The Company
recognized an extraordinary loss from early debt extinguishment of $68,000
in the 1998 second quarter due to the Company's pro-rata share of HRP's
$265,000 loss on early extinguishment of debt. For the six months the loss
was $375,000, which was comprised of the Company's $482,000 pro-rata share
of HRP's $1,876,000 six month loss on early extinguishment of debt, offset
by a $107,000 gain from the January 1998 purchase of 7% Debentures having a
face amount of $2,253,000 for a discounted amount of $2,146,000.
Page 23
<PAGE> 24
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The Company's unrestricted cash and cash equivalents at June 30, 1999
totaled $1,614,000.
The Company's real estate segment generates funds principally from its
property management and leasing activities, without significant additional
capital costs. The Company has pledged a total of 119,304 HRP limited
partnership units as collateral for a term loan and certain hotel lease
obligations, and has the ability to pledge all of its remaining units to secure
additional financing.
All of the Company's energy activities are conducted through HEC, following
the consummation of the energy consolidation on June 8, 1999. The Company has
pledged its investments in HEC, consisting of 1,800,000 common shares and 43,816
preferred shares, as collateral for the energy term loan. HEC has no current
plans to pay cash dividends on its common stock. The preferred stock is entitled
to an annual cumulative dividend of $1.00 per share.
Brookwood maintains a revolving line of credit facility with The Bank of
New York, which is collateralized by accounts receivable, certain inventory and
equipment. At June 30, 1999, Brookwood had $1,926,000 of unused borrowing
capacity on its line of credit. In the year ended December 31, 1998, the Company
received a $784,000 cash dividend and $394,000 under its tax sharing agreement.
A cash dividend for 1999, if any, is contingent upon Brookwood's compliance with
the covenants contained in its loan agreement. At December 31, 1998, Brookwood
was not in compliance with covenant contained in the Credit Agreement, which
requires a minimum consolidated capital expenditure of $1,313,000 in a calendar
year. On March 26, 1999, Brookwood entered into an Amendment No. 5 and Waiver to
Credit Agreement, whereby the Bank waived the minimum consolidated capital
expenditure requirement for the calendar year ended December 31, 1998 only, and
amended that section of the Credit Agreement relating to the minimum ratio of
EBIDTA to consolidated fixed charges by inserting "except for the four
consecutive quarters ending March 31, 1999, and for said period only."
Brookwood's revolving credit facility matures in January 2000 and management
believes the facility can be renewed or replaced at that time.
Although major capital expenditures are periodically required under
franchise agreements, cash flow from hotel operations have typically contributed
to the Company's working capital. Sales of hotels are also a source of
liquidity; however, a sale may be impacted by the ability of prospective
purchasers to obtain equity capital or suitable financing. The Company completed
a renovation of the Holiday Inn and Suites hotel in April 1998, partly financed
by the owner in the form of higher lease payments. In April 1999 the Company
converted its three Residence Inn hotels to GuestHouse Suites Plus franchises.
Renovations to meet the new franchiser's standards, totaling approximately
$3,000,000, are expected to be funded from the Company's capital reserves and
lease facilities. As of July 15, 1999, the Huntsville property was 50%
completed; the Tulsa property 25% completed; and the Greenville property 20%
completed. The renovation of these properties is expected to be substantially
complete by September 15, October 15 and December 15, 1999, respectively.
Management believes that it will have sufficient funds for operations to
satisfy its current obligations, and is currently exploring alternatives to
refinance the 7% Debentures which mature in July 2000.
INFORMATION SYSTEMS AND THE YEAR 2000.
The Company realizes that many of the world's information systems and/or
computer programs currently do not have the ability to recognize four digit date
code fields and accordingly, they do not have the ability to distinguish a year
that begins with "20" instead of the familiar "19". If not corrected, many
computer applications could fail, become unstable, stop working altogether, or
create erroneous or incorrect results. Therefore, many companies and
organizations are spending considerable resources to update and modify their
systems for Year 2000 compliance.
The Company developed a program to review and modify, where necessary, its
computers and computer programming (information technology ("IT") systems) to
process transactions and/or operate in the Year 2000 and beyond. Additionally,
the Company is in the process of identifying and assessing its non-information
technology systems ("Non-IT" systems), which are generally more difficult to
assess because they often contain embedded
Page 24
<PAGE> 25
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
technology that may be subject to year 2000 problems. The Company has identified
three of its primary systems which are vulnerable to the year 2000 issue: (1)
General Ledger/Accounts Payable. These systems were modified by the vendor at no
cost to the Company during 1998 and are now year 2000 compliant; (2) Shareholder
and Debentureholder Services. Such services are processed through outside
transfer agent providers, who have indicated that their most critical systems
have already been tested, although additional systems will be tested during
1999. These systems will be modified by the vendors at no cost to the Company;
(3) Payroll. Such services are processed through an outside payroll vendor. The
Company has purchased updated year 2000 compliant software from the vendor and
it was installed in 1998 at minimal cost to the Company.
Additionally, the Company is surveying all of its significant service
providers and other external parties to determine their compliance with the Year
2000 issue and what impact, if any, their efforts will have on the Company's
business and operations. The Company anticipates completing its survey of
service providers and vendors by the 1999 third quarter.
As a diversified holding company operating in four industry segments, the
Company relies heavily on the accounting and reporting information provided by
its subsidiaries and affiliated companies. All have established Year 2000
programs to ensure compliance, and the Company continues to monitor their status
to determine that all necessary modifications are completed and tested.
Provided below is a summary of the Year 2000 programs of subsidiaries and
affiliated companies:
Real Estate. HRP developed a program to review and modify, where necessary,
its computers, computer programming and building systems to process transactions
and/or operate in the Year 2000 and beyond. HRP identified that its four primary
business systems, which are vulnerable to the Year 2000 issue, are: (1) General
Ledger/Accounts Payable/Accounts Receivable Systems - These systems were
modified by the vendor at no cost to HRP during the third quarter of 1998 and
are now Year 2000 compliant. (2) Commercial Lease Administration - The system
used by HRP is Year 2000 compliant. (3) K-1 Processing - HRP maintains data used
to process its partners Schedule K-1(s) for tax reporting purposes in an
environment that is not Year 2000 compliant. HRP has selected a tested and
compliant system which will be installed in the fourth quarter of 1999 at
minimal cost. (4) Payroll - Year 2000 compliant software was purchased and
installed in the fourth quarter of 1998 at minimal cost.
In July 1999, HRP completed a survey of its significant service providers
and other external parties to determine their compliance with the Year 2000
issue and what impact, if any, their efforts will have on HRP's business and
operations. This survey included the identification of certain on-site,
non-information technology systems that could be vulnerable to the Year 2000
issue. These non-information technology systems included, but were not limited
to, access gates, alarms, elevators, heating and air conditioning systems,
irrigation systems, security systems, thermostats, and utility meters and
switches.
HRP has utilized and will continue to utilize, as necessary, external and
internal resources to reprogram, replace and test its systems for Year 2000
modifications. HRP anticipates completing the remaining Year 2000 upgrades and
replacements by October 31, 1999. Total costs, including information and
non-information technology systems, are not expected to exceed $100,000.
Although HRP believes that it will not have any detrimental effects on its
operations from Year 2000 compliance issues, there can be no assurance that the
systems of other companies, on which HRP's systems may rely, will be converted
timely, or converted in a manner that is compatible with HRP's systems, or that
any such failures by such other companies would not have a material adverse
effect or risk to HRP. HRP plans to devote all resources that would be required
to resolve any such issues in a timely manner. In the event of a complete
failure of our information technology systems, HRP would be able to continue the
affected functions either manually or through the use of non-Year 2000 compliant
systems. The primary costs associated with such a necessity would probably
include increased time delays associated with posting of information, and
increased personnel to manually process the information. HRP does not currently
have a contingency plan in place and believes, based upon current knowledge,
that one is not needed.
Page 25
<PAGE> 26
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The cost of Year 2000 compliance and the estimated date of completion of
necessary modifications are based on HRP's best estimates, which were derived
from various assumptions of future events, including the continued availability
of certain resources, third party modification plans and other factors. However,
there can be no guarantee that these estimates will be achieved and actual
results could differ significantly from those anticipated.
Energy. HEC's Year 2000 Plan has four phases: (i) assessment, (ii)
inventory, (iii) remediation, testing and implementation and (iv) contingency
plans. Approximately eighteen months ago, HEC began its phase one assessment of
its particular exposure to problems that might arise as a result of the new
millennium. The assessment and inventory phases have been substantially
completed and have identified HEC's IT systems that must be updated or replaced
in order to be Year 2000 compliant. Remediation, testing and implementation are
scheduled to be completed by August 31, 1999, and the contingency plans phase is
scheduled to be completed by September 30, 1999.
However, the effects of the Year 2000 problem on IT systems are exacerbated
because of the interdependence of computer systems in the United States. HEC's
assessment of the readiness of third parties, whose IT systems might have an
impact on HEC's business, has thus far not indicated any material problems;
responses have been received to approximately 70% of the inquiries made.
With regard to HEC's Non-IT systems, HEC believes that most of these
systems can be brought into compliance on schedule. HEC's assessment of third
party readiness is not yet completed. Because Non-IT systems are embedded chips,
it is difficult to determine with complete accuracy where all such systems are
located. As part of its plan, HEC is making formal and informal inquiries of its
vendors, customers and transporters in an effort to determine the third party
systems that might have embedded technology requiring remediation.
Although it is difficult to estimate the total costs of implementing the
plan through January 1, 2000 and beyond, HEC's preliminary estimate is that such
costs will not be material. To date, HEC has determined that its IT systems are
either compliant or can be made compliant for less than $100,000. However,
although management believes that its estimates are reasonable, there can be no
assurance, for the reasons stated in the next paragraph, that the actual cost of
implementing the plan will not differ materially from the estimated costs.
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. This risk exists both as to HEC's IT and Non-IT systems, as well as
to the systems of third parties. Such failures could materially and adversely
affect HEC's results of operations, cash flow and financial condition. Due to
the general uncertainty inherent in the Year 2000 problem, resulting in part
from the uncertainty of the Year 2000 readiness of third party suppliers,
vendors and transporters, HEC is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the HEC
results of operations, cash flow or financial condition. Although HEC is not
currently able to determine the consequences of Year 2000 failures, its current
assessment is that its area of greatest potential risk in its third party
relations is in connection with the transporting and marketing of the oil and
gas produced by HEC. HEC is contacting the various purchasers and pipelines with
which it regularly does business to determine their state of readiness for the
Year 2000. Although in general the purchases and pipelines will not guaranty
their state of readiness, the responses received to date have indicated no
material problems. HEC believes that in a worst case scenario, the failure of
its purchasers and transporters to conduct business in a normal fashion could
have a material adverse effect on cash flow for a period of six to nine months.
HEC's Year 2000 plan is expected to significantly reduce HEC's level of
uncertainty about the compliance and readiness of these material third parties.
The evaluation of third party readiness will be followed by HEC's development of
contingency plans, if necessary.
Textile Products. The Company's Brookwood subsidiary has identified three
primary systems which are subject to the Year 2000 issue: (1) General
Ledger/Accounts Payable/Accounts Receivable/Inventory. Brookwood has purchased a
Year 2000 compliant computer for its converting business which has been
installed and tested. All operating programs will be modified and fully
operational by the 1999 third quarter. (2) Payroll. The processing plant's
time-clock payroll system was not Year 2000 compliant, although updated software
was installed and tested in April 1999 and is now compliant. (3) Factory
Production. To date Brookwood has determined that substantially
Page 26
<PAGE> 27
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
all of its machinery and equipment is not date-sensitive. Further testing is
ongoing, although no Year 2000 problems are anticipated.
Additionally, Brookwood is surveying all of its significant service
providers and other external parties to determine their compliance with the Year
2000 issue and what impact, if any, their efforts will have on Brookwood's
business and operations. This survey includes the identification of certain
non-information technology systems that may be Year 2000 sensitive. Once these
systems have been fully identified, Brookwood will determine, with the help of
outside vendors, whether these systems are vulnerable to the Year 2000 issue.
Potential non-information technology systems include, but are not limited to
factory production equipment. Brookwood anticipates finalizing its survey of
service providers and vendors during the third quarter of 1999. To date,
Brookwood has determined that substantially all of its machinery and equipment
relating to factory production is not date sensitive. Further testing is
on-going, although no Year 2000 problems are anticipated.
Although Brookwood believes that it will not have any detrimental effects
on its operations from Year 2000 compliance issues, there can be no assurance
that the systems of other companies, on which Brookwood's systems may rely, will
be converted timely, or converted in a manner that is compatible with
Brookwood's systems, or that any such failures by such other companies would not
have a material adverse effect or risk to Brookwood. Brookwood plans to devote
all resources that would be required to resolve any such issues in a timely
manner that might arise from matters not previously considered. In the event of
a complete failure of information technology systems, Brookwood would be able to
continue the affected functions either manually or through the use of non-Year
2000 compliant systems. The primary costs associated with such a necessity would
probably include increased time delays associated with posting of information ,
and increased personnel to manually process the information. Brookwood does not
currently have a contingency plan in place and believes, based upon current
knowledge, that one is not needed.
Hotels. The Company's hotel segment has identified four primary systems.
(1) General Ledger/Accounts Payable. The day-to-day accounting functions at the
hotel properties are out-sourced to a third party vendor. The vendor has
purchased updated software for its existing system that is Year 2000 compliant.
The software update will be installed and tested in the 1999 third quarter at no
cost to the Company. (2) Reservations. The Company is currently working with the
various franchisers to ensure Year 2000 compliance and proper interfacing of all
computer software, and is not aware of any compliance problems. (3) Payroll. The
day-to-day payroll functions at the hotel properties are out-sourced to a third
party vendor. The vendor has purchased updated software for its existing system
that is Year 2000 compliant. The software update will be installed and tested in
the 1999 third quarter at no cost to the Company. The Company is currently
working with the various franchisers to ensure Year 2000 compliance and proper
interfacing of all computer software, and is not aware of any compliance
problems. second quarter at no cost to the Company. (4) Facilities. Physical
inspections at the hotels are ongoing to determine that any date sensitive
equipment is Year 2000 compliant. Other than the telephone systems,
substantially all equipment is already Year 2000 compliant and it is anticipated
that all physical systems, including telephone systems, will be Year 2000
compliant by the 1999 third quarter at an anticipated cost of less than
$100,000.
The Company is also reviewing its facilities to determine non-information
systems which might be Year 2000 vulnerable. Once these systems have been fully
identified, the Company will determine, with the help of outside vendors,
whether these systems are vulnerable to the Year 2000 issue. Potential
non-information technology systems include, but are not limited to, access
doors, alarms, elevators, heating and air conditioning systems, irrigation
systems, security systems, thermostats, utility meters and switches and, as
previously mentioned, telephone systems.
Although the Company believes that its hotel subsidiaries will not
experience Year 2000 compliance issues which will have a detrimental effect on
operations, there can be no assurance that the systems of other companies, on
which the Company's systems may rely, will be converted timely, or converted in
a manner that is compatible with the Company's systems, or that any such
failures by such other companies would not have a material adverse effect or
risk to the Company. The Company plans to devote all resources that would be
required to resolve any such issues in a timely manner arising from matters not
previously considered. In the event of a complete failure of information
technology systems, the Company would be able to continue the affected functions
either manually or
Page 27
<PAGE> 28
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
through the use of non-Year 2000 compliant systems. The primary costs associated
with such a necessity would probably include increased time delays associated
with posting of information, and increased personnel to manually process the
information. The Company does not currently have a contingency plan in place and
believes, based upon current knowledge, that one is not needed.
General. The Company will utilize both internal and external resources to
achieve Year 2000 compliance. The Company estimates that its identification and
assessment activities are approximately 90% complete. And that its remediation
is approximately 75% complete. The Company expects all of its internal efforts
will be completed by the third quarter of 1999. However, there can be no
guarantee that the Company will be able to identify all potential Year 2000
problems or to fully remediate all Year 2000 problems on a timely basis. The
Company anticipates completing the Year 2000 project by September 30, 1999.
In the event that a system will not be Year 2000 compliant, the Company
will assess the potential risk and, to the extent it is feasible, transfer its
business to an alternate vendor. The failure to correct a material Year 2000
problem could result in an interruption, or failure of, certain normal business
activities or operations. Such failures could materially and adversely affect
the Company's results of operations, liquidity, and financial condition. Due to
the year end uncertainty inherent in the Year 2000 problem, resulting in part
from the uncertainty of Year 2000 readiness of third party vendors, the Company
is unable to determine at this time whether the consequences of Year 2000
failures will have a material impact on the Company's results of operations, or
financial condition. The Company believes, however, that its Year 2000
compliance plan and time line provides adequate staffing, resources and time to
mitigate and pro-actively respond to any unforeseen Year 2000 problems in a
timely manner. The Company plans to devote all resources that would be required
to resolve any such issues in a timely manner that might arise from matters not
previously considered.
The total costs for the Company and its hotel and textile products
subsidiaries (excluding the unconsolidated real estate and energy affiliates, of
which the Company must only bear a proportionate share) are estimated to be less
than $200,000. The cost of Year 2000 compliance and the estimated date of
completion of necessary modifications are based on the Company's best estimates,
which were derived from various assumptions of future events, including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
FORWARD-LOOKING STATEMENTS
In the interest of providing stockholders with certain information
regarding the Company's future plans and operations, certain statements set
forth in this Form 10-Q are forward-looking statements. Although any
forward-looking statement expressed by or on behalf of the Company is, to the
knowledge and in the judgment of the officers and directors, expected to prove
true and come to pass, management is not able to predict the future with
absolute certainty. Forward-looking statements involve known and unknown risks
and uncertainties, which may cause the Company's actual performance and
financial results in future periods to differ materially from any projection,
estimate or forecasted result. Among others, these risks and uncertainties
include, the ability to obtain financing or refinance maturing debt; a potential
oversupply of commercial office buildings, industrial parks and hotels in the
markets served; the volatility of oil and gas prices; the ability to continually
replace and expand oil and gas reserves; the imprecise process of estimating oil
and gas reserves and future cash flows; and uncertainties inherent in the Year
2000 computer problems that may affect the Company and each of its business
segments.
Page 28
<PAGE> 29
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not directly have any derivative financial instruments in
place as of June 30, 1999, nor does it have foreign operations. Also, the
Company does not enter into financial instrument transactions for trading or
other speculative purposes. However, the Company's energy division through its
investment in HEC has attempted to hedge the exposure related to its variable
debt and its sales of forecasted oil and natural gas production in amounts,
which it believes are prudent based on the prices of available derivatives and,
in the case of production hedges, HEC's deliverable volumes. HEC attempts to
manage the exposure to adverse changes in the fair value of its fixed rate debt
agreements by issuing fixed rate debt only when business conditions and markets
are favorable. Management does not consider the portion attributable to the
Company to be significant in relation to these derivative instruments.
As of June 30, 1999, HRP had a single "pay fixed/receive variable" interest
rate swap agreement with highly rated counterparties in which the interest
payments are calculated on a notional amount. Management does not consider the
portion attributable to the Company to be significant on this derivative
instrument.
The Company is exposed to market risk due to fluctuations in interest
rates. The Company utilizes both fixed rate and variable rate debt to finance
its operations. As of June 30, 1999, the Company's total outstanding loans and
debentures payable of $65,117,000 were comprised of $49,931,000 of fixed rate
debt and $15,186,000 of variable rate debt. There is inherent rollover risk for
borrowings as they mature and are renewed at current market rates. The extent of
this risk is not quantifiable or predictable because of the variability of
future interest rates and the Company's future financing requirements. A
hypothetical increase in interest rates of two percentage points would cause an
annual loss in income and cash flows of approximately $1,302,000, assuming that
outstanding debt remained at current levels.
Page 29
<PAGE> 30
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
PART II - OTHER INFORMATION
<TABLE>
<CAPTION>
Item
<S> <C> <C>
1 Legal Proceedings
Reference is made to Note 3 to the Company's consolidated financial
statements of this Form 10-Q.
2 Changes in Securities None
3 Defaults upon Senior Securities None
4 Submission of Matters to a Vote of Security Holders None
5 Other Information None
6 Exhibits and Reports on Form 8-K
(a) Exhibits
(i) 27 - Financial Data Schedule Page 33
(b) Reports on Form 8-K None
</TABLE>
Page 30
<PAGE> 31
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE HALLWOOD GROUP INCORPORATED
Dated: August 13, 1999 By: /s/ Melvin J. Melle
------------------------------------
Melvin J. Melle, Vice President
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
Page 31
<PAGE> 32
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
Page 32
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 1,614
<SECURITIES> 15,812
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 18,333
<CURRENT-ASSETS> 0
<PP&E> 59,323
<DEPRECIATION> 18,970
<TOTAL-ASSETS> 105,237
<CURRENT-LIABILITIES> 0
<BONDS> 21,328
1,000
0
<COMMON> 160
<OTHER-SE> 23,847
<TOTAL-LIABILITY-AND-EQUITY> 105,237
<SALES> 0
<TOTAL-REVENUES> 64,599
<CGS> 0
<TOTAL-COSTS> 58,838
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,515
<INCOME-PRETAX> 3,246
<INCOME-TAX> 127
<INCOME-CONTINUING> 3,119
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,119
<EPS-BASIC> 2.45
<EPS-DILUTED> 2.41
</TABLE>
