<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-K
MARK ONE
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM ______________ TO _____________
FOR THE YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NUMBER: 1-8303
THE HALLWOOD GROUP INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 51-0261339
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3710 RAWLINS, SUITE 1500, DALLAS, TEXAS 75219
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 528-5588
Securities Registered Pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- -------------------
<S> <C>
Common Stock ($.10 par value) New York Stock Exchange
7% Collateralized Senior Subordinated Debentures Due July 31, 2000 New York Stock Exchange
10% Collateralized Subordinated Debentures Due July 31, 2005 New York Stock Exchange
</TABLE>
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in, definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the Common Stock, $.10 par value per
share, held by non-affiliates of the registrant, based on the closing price of
$18.06 per share on March 19, 1999 on the New York Stock Exchange, was
$8,873,000.
1,254,751 shares of Common Stock, $.10 par value per share, were
outstanding at March 19, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III is incorporated by reference to
the definitive Proxy Statement for the Annual Meeting of Stockholders of the
Company to be filed with the Securities and Exchange Commission not later than
120 days after December 31, 1998.
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<PAGE> 2
FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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PART I
<S> <C> <C>
Item 1. Business ....................................................................... 2
Item 2. Properties ..................................................................... 5
Item 3. Legal Proceedings .............................................................. 6
Item 4. Submission of Matters to a Vote of Security Holders ............................ 6
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters .......... 7
Item 6. Selected Financial Data ........................................................ 8
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations ...................................................... 9
Item 7(a). Quantitative and Qualitative Disclosures About Market Risk ..................... 19
Item 8. Financial Statements and Supplementary Data .................................... 20
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure ....................................................... 20
PART III
Item 10. Directors and Executive Officers of the Registrant ............................. 21
Item 11. Executive Compensation ......................................................... 21
Item 12. Security Ownership of Certain Beneficial Owners and Management ................. 21
Item 13. Certain Relationships and Related Transactions ................................. 21
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ................ 22
</TABLE>
<PAGE> 3
PART I
ITEM 1. BUSINESS
The Hallwood Group Incorporated ("Hallwood" or the "Company") (NYSE:HWG), a
Delaware corporation, is a diversified holding company and classifies its
business operations into two principal divisions: asset management and operating
subsidiaries. The asset management division includes the commercial real estate
and energy businesses, and the operating subsidiaries division includes the
textile products and hotel businesses. For financial reporting purposes, the
Company operates in four business segments: real estate, energy, textile
products and hotels. Financial information for each industry segment in which
the Company operates is set forth in Note 19 to the consolidated financial
statements.
Asset Management Division.
Real Estate. Real estate activities are conducted primarily through the
Company's wholly owned subsidiaries, HWG, LLC, Hallwood Realty, LLC ("Hallwood
Realty") and Hallwood Commercial Real Estate, LLC ("HCRE"). Hallwood Realty is
the sole general partner of Hallwood Realty Partners, L.P. ("HRP"), a
publicly-traded, master limited partnership (AMEX:HRY). At December 31, 1998,
HRP owned twelve real estate properties in six states containing 5,150,000 net
rentable square feet. Hallwood Realty owns a 1% general partner interest and
HWG, LLC owns a 25% limited partner interest in HRP. Hallwood Realty is
responsible for asset management of HRP and its properties, including the
decisions regarding financing, acquiring and disposing of properties. It also
provides general operating and administrative services to HRP. HCRE is
responsible for on-site property management at all HRP properties, and
properties it manages for third parties, for which it receives managing, leasing
and construction supervision fees.
The Company accounts for its ownership in HRP using the equity method of
accounting, recording its proportionate share of net income (loss) and partners'
capital transactions reported by HRP. The December 31, 1998 financial statements
of HRP are included elsewhere within this document.
Real estate accounted for 7% of the Company's total revenues in the year
ended December 31, 1998, compared to 5% in the year ended December 31, 1997, and
3% in the year ended December 31, 1996.
See Note 13 to the Company's consolidated financial statements.
Energy. Energy operations were consolidated beginning in May 1990, when the
Company increased its ownership of Hallwood Energy Corporation ("HEC") from 11%
to 53%, and thereafter, accounted for HEC as a consolidated subsidiary of the
Company. As a result of HEC's subsequent purchases of its own stock for treasury
and the Company's acquisition of additional HEC common stock, the Company's
effective percentage ownership increased to 82%, and after the Company's
November 1996 successful tender offer for the remaining minority shares, HEC was
merged into the Company. Certain energy assets acquired by the merger were
subsequently transferred to two wholly owned entities, HEPGP Ltd. ("HEPGP") and
Hallwood G.P., Inc. ("HGP"), the general partner of HEPGP.
The Company's energy operations are now conducted primarily through HEPGP,
and consist of the development, production and sale of oil and gas, and the
acquisition, exploration, development and operation of additional oil and gas
properties. HEPGP is the sole general partner of Hallwood Energy Partners, L.P.
("HEP"), a publicly-traded oil and gas master limited partnership (AMEX:HEP),
and conducts substantially all if its operations through HEP. HEPGP's general
partner interest in HEP entitles it to a share of net revenue derived from HEP's
properties ranging from 2% to 25%. At December 31, 1998, the Company also held
an approximate 6.5% ownership of HEP, consisting of 5.1% of HEP's Class A
limited partner units, 100% of HEP's Class B limited partner units and 1.8% of
the preferential Class C limited partner units.
HEP owns interests in approximately 1,600 wells, the most significant of
which are located in West Texas, South Louisiana, New Mexico and the Rocky
Mountain region. The Company and its subsidiaries account for their ownership of
HEP using the proportionate consolidation method, whereby it records a
proportional share of HEP's revenues and expenses, current assets, current
liabilities, noncurrent assets, long-term obligations and fixed assets.
2
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Proposed Consolidation Plan. In December, 1998, HEP and its affiliate,
Hallwood Consolidated Resources Corporation ("HCRC"), a publicly-traded oil and
gas company (NASDAQ: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. After the consolidation, the common
stock of Hallwood Energy Corporation will be owned 56% by the current Class A
unitholders of HEP, 26% by the current stockholders of HCRC and 18% by the
Company. HEP's current Class C unitholders will receive all of the redeemable
preferred stock in the new entity.
Because of the larger size of the new corporation, 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. Hallwood Energy Corporation will focus on reserve growth. A Joint Proxy
Statement/Prospectus for the consolidation was filed with the Securities and
Exchange Commission on December 30, 1998 and is proceeding through the usual SEC
comment process. It is presently anticipated that the Joint Proxy
Statement/Prospectus will be mailed to HEP unitholders and HCRC stockholders in
April and the consolidation will be concluded in May 1999. There can be no
assurance, however, that all conditions to the consolidation will be satisfied
by that time.
Energy accounted for 4% of the Company's total revenues in the year ended
December 31, 1998, compared to 4% in the year ended December 31, 1997 and 7% in
the year ended December 31, 1996.
See Note 14 to the Company's consolidated financial statements.
Operating Subsidiaries Division.
Textile Products. Textile products operations are conducted through the
Company's wholly owned Brookwood Companies Incorporated ("Brookwood")
subsidiary. Brookwood is a complete textile service firm that develops and
produces innovative fabrics and related products through specialized finishing,
treating and coating processes.
Textile products accounted for 69% of the Company's total revenues in the
year ended December 31, 1998, compared to 62% in the year ended December 31,
1997 and 67% in the year ended December 31, 1996.
See Note 15 to the Company's consolidated financial statements.
Hotels. Hotel operations are conducted through the Company's wholly owned,
Hallwood Hotels, Inc. ("Hallwood Hotels"), Brock Suite Hotels, Inc. ("Brock
Hotels") and Integra Resort Management, Inc. ("IRM") subsidiaries. Hallwood
Hotels holds a long-term leasehold interest in the Holiday Inn hotel, located in
Longboat Key, Florida and a fee interest in the Airport Embassy Suites hotel,
located in Oklahoma City, Oklahoma. Brock Hotels owns fee interests in Residence
Inns located in Tulsa, Oklahoma and Greenville, South Carolina, and a long-term
leasehold interest in a Residence Inn located in Huntsville, Alabama. IRM owns
315 owner's rental contracts and certain real estate at The Enclave Suites, a
resort condominium hotel located in Orlando, Florida. It manages the property
for individual unit owners for which it receives a management fee and other
consideration for the services it provides.
Hallwood Hotels and Brock Hotels properties are currently operated under
license agreements with Holiday Inns Franchising, Inc., Embassy Suites, Inc. and
Marriott International, Inc. The license agreements permit the licensor to
prescribe, at such times as it determines, standards for the operation and
maintenance of the various properties and their furnishings, equipment and
facilities. Substantial capital expenditures may be required from time to time
to comply with such standards. In April 1999, all of the Residence Inn
franchises will terminate by mutual agreement and are expected to become
GuestHouse franchises.
The hotel industry is, in some cases, affected by seasonal fluctuations in
demand. The Company's hotel properties as a whole do not experience significant
seasonal changes because many of the hotels primarily serve the business
traveler. The Holiday Inn hotel in Longboat Key , Florida, does, however,
experience some seasonal changes in occupancy, as occupancy levels tend to
increase during the winter months and decrease slightly during the rest of the
year.
Hotel revenues accounted for 18% of the Company's total revenues in the
year ended December 31, 1998, compared to 14% in the year ended December 31,
1997, and 18% in the year ended December 31, 1996.
3
<PAGE> 5
Associated Company. The Company is no longer engaged in the associated
company segment, as its remaining ShowBiz Pizza Time, Inc. ("ShowBiz")
investment was sold in March 1997, through a secondary public offering by
ShowBiz, for $41,285,000 in cash, resulting in an $18,277,000 gain. The Company
had accounted for its investment in ShowBiz on the equity method.
Associated company income accounted for 13% of the Company's total revenues
in the year ended December 31, 1997, compared to 4% in the year ended December
31, 1996.
See Note 2 to the Company's consolidated financial statements.
Competition. The Company's real estate operations are subject to
substantial competition from other entities which own similar properties in the
vicinity in which HRP's properties are located. In addition, there are numerous
other potential investors seeking to purchase improved real property and many
property holders seeking to dispose of real estate with which the Company and
HRP will compete, including companies substantially larger and with greater
resources. Furthermore, current economic conditions in each property's
respective real estate market are competitive and as such, competition for
tenants will continue to affect rental rates and revenue.
The Company and its energy affiliates encounter competition from other oil
and gas companies in all areas of their operations, including the acquisition of
exploratory prospects and proven properties. Competitors include major
integrated oil and gas companies and numerous independent oil and gas companies,
individuals and drilling and income programs. The market for oil and gas depends
on a number of factors, including the level of domestic production, pace of the
general economy, supply of imported oil and gas, actions of foreign
oil-producing nations and the extent of governmental regulation and taxation. In
addition, oil and gas must compete with coal, atomic energy, hydro-electric
power and other forms of energy. In response to volatility, the Company enters
into financial contracts for hedging the price of a portion of its oil and gas
production.
Textile products operations encounter competition in all regions in which
they are conducted. In the volume areas of the textile business, competition is
sometimes based on price, particularly during a weak economy.
Hotel operations are subject to competition from similar types of
properties in the vicinities in which they are located. The sale of hotels may
be impacted by the inability of prospective purchasers to obtain equity capital
or suitable financing.
Environmental Compliance. A number of jurisdictions in which the Company
operates have adopted laws and regulations relating to environmental matters.
Such laws and regulations may require the Company to secure governmental permits
and approvals and undertake measures to comply with the laws and regulations.
Compliance with the requirements imposed may be time-consuming and costly. While
environmental considerations, by themselves, have not significantly affected the
Company's business to date, it is possible that such considerations may have a
significant and adverse impact in the future. The Company actively monitors its
environmental compliance and while certain matters currently exist, management
is not aware of any compliance issues which will significantly impact the
financial position, operations or cash flows of the Company.
Number of Employees. The Company had 1,058 and 994 employees as of February
28, 1999 and 1998, respectively, comprised as follows:
<TABLE>
<CAPTION>
FEBRUARY 28,
-----------------------
1999 1998
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<S> <C> <C>
Hallwood.......................................................... 5 5
Brookwood......................................................... 353 387
Hotel subsidiaries................................................ 500 373
Hallwood Petroleum, Inc........................................... 108 123
HCRE.............................................................. 73 88
Hallwood Realty................................................... 19 18
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Total........................................................ 1,058 994
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</TABLE>
4
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A substantial amount of the salaries and related costs for the employees of
HCRE, Hallwood Realty and Hallwood Petroleum, Inc., an affiliate of HEPGP, are
reimbursed by the respective real estate and energy partnership affiliates.
ITEM 2. PROPERTIES
Real Properties
The general character, location and nature of the significant real
properties owned by the Company and its subsidiaries and the encumbrances
against such properties are described below and/or in Schedule III hereto.
Cost of real estate owned by property type and geographic distribution (in
thousands of dollars):
<TABLE>
<CAPTION>
DECEMBER 31, 1998
-----------------------------------------------
OPERATING NON-OPERATING
PROPERTY TYPE PROPERTIES PROPERTIES TOTAL PERCENTAGE
------------------- ---------- ------------- --------- ----------
<S> <C> <C> <C> <C>
Textile Products
Dyeing and finishing plant - Kenyon, RI (2)......... $ 4,724 $ -- $ 4,724 10 %
Hotels
Embassy Suites - Oklahoma City, OK (2).............. 20,590 -- 20,590 46
Residence Inn - Greenville, SC (2).................. 7,433 -- 7,433 17
Residence Inn - Tulsa, OK (2)...................... 5,813 -- 5,813 13
Holiday Inn - Longboat Key, FL (1) (2).............. 4,220 -- 4,220 10
Residence Inn - Huntsville, AL (1)................. 1,465 -- 1,465 3
Enclave Suites - Orlando, FL...................... 599 - 599 1
Parking lot - Irving, TX............................ -- 50 50 *
------- -- -------- ---
Subtotal....................................... 40,120 50 40,170 90
------- -- -------- ---
Total.......................................... $44,844 $ 50 $44,894 100 %
======= ==== ======= ===
</TABLE>
- -----------------------
* Less than 1%.
(1) Cost represents purchased leasehold interest in hotel property and capital
improvements.
(2) Property is pledged as collateral under loan or bond indenture agreements.
<TABLE>
<CAPTION>
DECEMBER 31, 1998
-----------------------------------
NUMBER OF
GEOGRAPHIC DISTRIBUTION INVESTMENTS AMOUNT PERCENTAGE
------------------------------- ----------- ------ ----------
<S> <C> <C> <C>
United States
Oklahoma........................................................ 2 $26,403 59 %
South Carolina.................................................. 1 7,433 17
Florida......................................................... 2 4,819 11
Rhode Island.................................................... 1 4,724 10
Alabama......................................................... 1 1,465 3
Texas........................................................... 1 50 *
- ------- ---
Total...................................................... 8 $44,894 100 %
= ======= ===
</TABLE>
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* Less than 1%.
As of December 31, 1998, the Company's Embassy Suites hotel in Oklahoma
City, Oklahoma was the only real estate property that constituted 10% or more of
the Company's consolidated assets.
5
<PAGE> 7
The textile products' dyeing and finishing plant was custom-built and is a
multi-shift facility well-suited for that particular business. The development
of new products requires the plant to be constantly upgraded, along with various
levels of utilization.
Hotel properties are operated under license and, as such, must meet and
maintain standards established by the licensor. At any time during the term of
the license, the licensor may require modernization, renovation and other
upgrading of the hotel. The Company has recently renovated the Longboat Key
Holiday Inn hotel with part of the financing provided by the owner. In April
1999, the Residence Inn by Marriott franchises will terminate by mutual
agreement and the properties will become GuestHouse franchises. Renovations to
meet the new franchiser's standards are expected to be funded from the Company's
capital reserves and equipment leasing facilities.
Oil and Gas Properties
Oil and gas properties consist primarily of the Company's and HEPGP's
indirect interest in properties owned through their investment in HEP.
Quantities and values presented in the financial statements attached hereto
related to HEP's properties, which are shown net to their interest in HEP. The
supplemental oil and gas reserve information appended to the consolidated
financial statements represents estimated quantities of proved oil and gas
reserves. These reserves are located principally in four regions within the
United States: the Greater Permian region of Texas and southeast New Mexico, the
Gulf Coast region of Louisiana and Texas, and the Rocky Mountain region. The
determination of oil and gas reserves is based on estimates which are highly
complex and interpretive. The estimates are subject to continuing change as
additional information becomes available.
See Note 14 to the Company's consolidated financial statements and
Supplemental Oil and Gas Reserve Information.
The following tables summarize certain oil and gas information related to
the Company's and HEPGP's direct interests and their share of HEP's oil and gas
activities (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
-------- ------
<S> <C> <C>
Net mineral interests, including $442 and $278, of unproved mineral
interests at December 31, 1998 and 1997, respectively .................. $11,479 $9,167
Net other property and equipment .......................................... -- 422
------- ------
Oil and gas properties, net ............................................... $11,479 $9,589
======= ======
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Property acquisition costs ........ $3,572 $ 354 $ 366
Development costs ................. 1,268 1,136 1,321
Exploration costs ................. 725 834 100
</TABLE>
ITEM 3. LEGAL PROCEEDINGS
The Company, certain of its affiliates and others have been named as
defendants in several lawsuits relating to various transactions in which it or
its affiliated entities participated. The Company intends to defend, or in some
cases negotiate to settle, the remaining actions and does not currently
anticipate that such actions will have a material adverse effect on its
financial condition, results of operations or cash flows of the Company. See
Note 18 to the Company's consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to vote of security holders during the period.
6
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's shares of common stock, $.10 par value per share ("Common
Stock"), are traded on the New York Stock Exchange under the symbol of HWG.
There were 963 stockholders of record as of March 19, 1999.
The following table sets forth, for the periods indicated, a two-year
record of high and low closing prices on the New York Stock Exchange.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------
1998 1997
------------------ ------------------
QUARTERS HIGH LOW HIGH LOW
- -------- -------- ------- ------- -------
<S> <C> <C> <C> <C>
First .................................. $37 1/2 $29 3/4 $28 3/4 $16 3/8
Second ................................. 37 1/4 32 1/2 27 3/4 24 3/8
Third .................................. 34 7/16 22 7/8 28 3/4 23 1/4
Fourth ................................. 22 3/4 16 5/8 40 1/2 29 1/8
</TABLE>
The Company did not pay cash dividends in 1998 or 1997 and does not intend
to pay cash dividends in the foreseeable future.
The closing price per share of the Common Stock on the New York Stock
Exchange on March 19, 1999 was $18.06.
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ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
FIVE MONTHS YEARS ENDED
YEARS ENDED DECEMBER 31, ENDED JULY 31,
----------------------------------- DECEMBER 31, ------------------------
1998 1997 1996 1995 1995 1994
-------- ------- --------- --------- --------- -----------
REVENUES ........................................ (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Asset Management
Real estate .................................. $ 7,813 $ 7,206 $ 3,947 $ 1,211 $ 4,595 $ 4,399
Energy (a) ................................... 5,216 6,350 7,515 3,149 5,359 6,234
Operating Subsidiaries
Textile products ............................. 80,343 91,552 77,583 28,229 77,808 71,624
Hotels (b) ................................... 21,130 21,038 20,948 8,073 24,898 20,896
Associated Companies (c) ........................ -- 19,416 4,448 (88) (171) 1,356
Other ........................................... 1,728 3,207 960 233 737 2,193
--------- -------- --------- --------- --------- ---------
116,230 148,769 115,401 40,807 113,226 106,702
EXPENSES
Asset Management
Real estate .................................. 2,807 3,351 2,329 1,343 3,244 4,287
Energy (a) ................................... 4,809 4,518 5,233 2,873 5,575 5,412
Operating Subsidiaries
Textile products ............................. 79,245 89,575 76,361 28,222 77,604 70,761
Hotels (b) ................................... 23,226 21,275 20,948 8,326 22,075 20,330
Associated Companies (c) ........................ -- 607 1,558 310 687 486
Other ........................................... 3,672 6,888 6,974 3,322 8,158 7,737
--------- -------- --------- --------- --------- ---------
113,759 126,214 113,403 44,396 117,343 109,013
--------- -------- --------- --------- --------- ---------
Income (loss) before income taxes
and extraordinary gain ....................... 2,471 22,555 1,998 (3,589) (4,117) (2,311)
Income taxes (benefit) .......................... (3,115) 9,908 (4,525) (299) 830 2,727
--------- -------- --------- --------- --------- ---------
Income (loss) before extraordinary gain ......... 5,586 12,647 6,523 (3,290) (4,947) (5,038)
Extraordinary gain from extinguishment of debt... 1,481 200 -- 25 143 648
--------- -------- --------- --------- --------- ---------
NET INCOME (LOSS) ............................... $ 7,067 $ 12,847 $ 6,523 $ (3,265) $ (4,804) $ (4,390)
========= ======== ========= ========= ========= =========
NET INCOME (LOSS) PER COMMON SHARE
Basic ........................................ $ 5.59 $ 9.10 $ 4.93 $ (2.45) $ (3.50) $ (3.20)
Assuming dilution ............................ 5.40 8.77 4.89 (2.45) (3.50) (3.20)
DIVIDENDS PER COMMON SHARE ...................... -- -- -- -- -- --
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic ........................................ 1,255 1,406 1,314 1,331 1,369 1,372
Assuming dilution ............................ 1,298 1,460 1,324 1,331 1,369 1,372
FINANCIAL CONDITION
Total assets ................................. $ 109,252 $ 89,758 $ 116,796 $ 98,223 $ 112,375 $ 127,325
Subordinated debentures ...................... 21,535 24,292 50,564 48,324 48,605 49,768
Loans payable ................................ 43,021 30,186 37,342 24,794 32,731 38,054
Redeemable preferred stock ................... 1,000 1,000 1,000 1,000 1,000 --
Common stockholders' equity (deficit) ........ 20,938 14,171 5,784 (391) 3,323 7,977
</TABLE>
(a) The Company's 53% majority interest in HEC was increased to 82% between May
1990 and October 1996 and, after a successful tender offer for the
remaining minority shares, HEC was merged into the Company.
(b) The Company's hotel operations commenced in December 1989, as a result of
the purchase of a fee interest, which was sold in January 1995, and the
purchase of three leasehold interests in June 1991, one of which was sold
in January 1993. Hotel operations were also increased by the March 1994
acquisition of a fee interest, two leasehold interests and two management
contracts. The two management contracts were sold during the fiscal year
ended July 31, 1995. The Company acquired the fee interest in the
Greenville, South Carolina and Oklahoma City, Oklahoma hotels in May 1996
and September 1998, respectively. Prior to the acquisitions, the Company
held leasehold interests. In July 1998, the Company acquired rental
contracts and certain real estate at The Enclave Suites, a resort
condominium hotel located in Orlando, Florida.
(c) The Company sold its remaining investment in ShowBiz in 1997, which
constituted its associated company segment.
8
<PAGE> 10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations. The Company reported net income of $7,067,000 for
the year ended December 31, 1998, compared to of $12,847,000 for the year ended
December 31, 1997, and $6,523,000 for the year ended December 31, 1996.
Total revenue for 1998 was $116,230,000, compared to $148,769,000 for 1997
and $115,401,000 for 1996.
Following is an analysis of the results of operations by asset management,
operating subsidiaries and associated company divisions and by the real estate,
energy, textile products, hotels and associated company business segments:
ASSET MANAGEMENT DIVISION. The reportable segments of the Company's asset
management division consist of real estate and energy.
REAL ESTATE
Revenues. Real estate revenues of $7,813,000 for 1998, $7,206,000 for 1997
and $3,947,000 for 1996, include fee income and equity income (loss) from the
Company's investments in HRP.
Fee income of $5,925,000 for 1998 decreased by 6%, compared to $6,306,000
in 1997. The 1997 fee income increased by 11%, compared to $5,678,000 in 1996.
The Company's Hallwood Realty subsidiary is the general partner of HRP and earns
an asset management fee and certain related fees from HRP properties, which
amounted to $495,000 for 1998, $465,000 for 1997 and $467,000 for 1996. The
Company's HCRE subsidiary is responsible for day-to-day on-site property
management at all of HRP's properties and other properties it manages for third
parties, for which HCRE receives management fees, leasing commissions and
certain other fees. HCRE revenue was $5,430,000 for 1998, $5,841,000 for 1997
and $5,205,000 for 1996. The 2% decrease during 1998 and the 7% increase during
1997 were primarily due to fluctuations in management and leasing fees earned
from third party contracts.
The equity income (loss) from investments in HRP represents the Company's
recognition of its pro-rata share of the income (loss) reported by HRP and
amortization of negative goodwill. The Company recorded equity income of
$1,888,000 in 1998 and equity income of $900,000 in 1997, compared to an equity
loss of $1,731,000 for 1996. The 1998 equity income is exclusive of the
Company's $1,374,000 pro-rata share of HRP's $5,347,000 net gain from early
extinguishment of debt, which is reported separately as an extraordinary item.
The improvement in 1998 was primarily due to HRP's 5.4% increase in rental
revenues accompanied by a 4.2% decrease in property operating expenses. The
improvement in 1997 resulted principally from HRP's substantially lower
depreciation expense, as a result of an extension of the useful economic lives
of certain building costs, effective from January 1, 1997. See Note 2 to the
Company's consolidated financial statements.
Expenses. Real estate expenses were $2,807,000 for 1998, compared to
$3,351,000 for 1997 and $2,329,000 for 1996. This category includes
administrative expenses, depreciation and amortization, interest and provision
for losses (recovery).
Administrative expenses declined 15% to $2,075,000 for 1998, compared to
$2,436,000 for 1997 and $1,396,000 for 1996. The fluctuations were primarily
attributable to the payments of leasing commissions to third party brokers
associated with leasing fee income and payments under HCRE's incentive plan.
Depreciation and amortization of $674,000 for 1998, compared to $674,000
for 1997 and $673,000 for 1996. Amortization expense of $672,000 for each of the
three years relates to Hallwood Realty's general partner interest in HRP to the
extent allocated to management rights.
Interest expense of $58,000 , $160,000 and $281,000 for 1998, 1997 and
1996, respectively, relates to a $500,000 promissory note secured by 89,269 HRP
limited partner units.
Provision for loss of $81,000 in 1997 was attributed to the
uncollectibility of a tenant receivable deposit from the prior sale of an
office-retail property. The recovery of $21,000 in 1996 relates to the
resolution of litigation over a defaulted mortgage.
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ENERGY
Revenues. Energy revenues were $5,216,000 for 1998, $6,350,000 for 1997 and
$7,515,000 for 1996.
After the Company's successful completion of the tender offer for the
minority shares of HEC and the subsequent merger of HEC in November 1996, it
effectively acquired ownership of the assets formerly held by HEC. Following the
merger, certain HEC assets were transferred to two wholly owned entities. The
two entities, in addition to other energy assets which remain with the Company,
constitute the Company's investment in the energy industry. The general partner
interest in HEP entitles the general partner to interests in HEP's properties
ranging from 2% to 25%. The Company also owns an approximate 6.5% interest in
HEP limited partner units. The Company and its energy subsidiaries account for
their ownership of HEP using the proportionate consolidation method of
accounting, whereby they record their proportional share of HEP's revenues and
expenses, current assets, current liabilities, noncurrent assets, long-term
obligations and fixed assets. HEP owns approximately 46% of its HCRC affiliate
and accounts for its investment in HCRC under the equity method.
Gas revenue of $3,652,000 for 1998 decreased by $368,000, or 9%, compared
to $4,020,000 for 1997 and the 1997 revenue decreased by $383,000, or 9%,
compared to $4,403,000 in 1996. The decrease in gas revenue for 1998 was due to
a decrease in the average gas price to $1.97 from $2.51 per mcf, partially
offset by an increase in production to 1,854,000 mcf from 1,602,000 mcf. The
decrease for 1997 was due to a decline in production from 1,728,000 mcf in 1996,
partially offset by an increase in the average gas price from $2.49 per mcf in
1996. The fluctuation in production volumes was caused by normal production
declines and the temporary shut-in of two wells in Louisiana during 1997 while
workover procedures were performed.
Oil revenue of $1,405,000 for 1998 decreased by $588,000, or 30%, compared
to $1,993,000 for 1997 and the 1997 revenue decreased by $670,000, or 25%,
compared to $2,663,000 in 1996. The decrease in oil revenue for 1998 was due to
a decrease in the average price per barrel to $13.13 from $19.93 in 1997,
partially offset by an increase in production to 107,000 barrels from 100,000
barrels in 1997. The decrease for 1997 was due to a decline in production from
125,000 barrels in 1996, and a decrease in the average price per barrel from
$20.64 in 1996. The fluctuation in production volumes was caused by normal
production declines and the temporary shut-in of two wells in Louisiana during
1997 while workover procedures were performed.
Other income of $159,000 for 1998, compares to $337,000 for 1997 and
$449,000 for 1996. The decrease in 1998 is primarily due to a decrease in HEP's
equity in earnings of affiliate, due to property impairments taken by HEP's
affiliate in 1998. The decrease in 1997 is due to a decrease in acquisition fee
income, partially offset by an increase in saltwater disposal income.
Expenses. Energy expenses of $4,809,000 for 1998, compares to $4,518,000
for 1997 and $5,233,000 for 1996.
Depreciation, depletion, amortization and impairment of properties
increased 27% in 1998 to $1,761,000 from $1,387,000 in 1997. The increase is due
to higher depletion resulting from the increased production discussed above, as
well as higher capitalized costs during 1998. The 9% decrease in 1997, compared
to $1,532,000 in 1996, is attributable to lower depletion in 1997 due to the
decline in production previously discussed.
Operating expenses, which are comprised of the costs of operating wells and
production-related taxes were $1,533,000 for 1998, which represents a $132,000
increase, or 9%, from the 1997 amount of $1,401,000, as a result of increased
production taxes from the increased production above. The 1997 expenses
decreased by $108,000, or 7%, from the 1996 amount of $1,509,000. The decrease
in 1997 is attributable to decreased production taxes due to the 15% decline in
oil and gas revenue during 1997.
Administrative expenses decreased 26% in 1998 to $968,000 from $1,317,000
in 1997. The decrease is due to reduced performance based compensation during
1998. The 1997 expenses were comparable to the 1996 amount of $1,314,000.
Interest expense increased by $134,000, or 32%, to $547,000 in 1998,
compared to $413,000 in 1997, due to an increase in the Company's term loan in
November 1997 and an increase in the pro-rata share of HEP's interest expense
due to HEP's higher outstanding debt in 1998. Interest expense in 1997 decreased
by $43,000, or 9%, from the 1996 amount of $456,000, due to a decrease in the
average outstanding debt balance and a decrease in its pro rata share of HEP's
interest expense resulting from a lower debt balance.
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Minority interest, which represented the interest of other common and
preferred shareholders in the net income of HEC was $422,000 for 1996. The
minority interest was eliminated in November 1996 as a result of the merger of
HEC into the Company.
OPERATING SUBSIDIARIES. The reportable segments of the Company's operating
subsidiaries division consist of textile products and hotels.
TEXTILE PRODUCTS
Revenues. Sales of $80,343,000 decreased by $11,209,000, or 12%, compared
to $91,552,000 in 1997. Sales by the distribution businesses were lower in 1998
due to decreased demand for textile products in consumer markets, partially
offset by increased sales of industrial products. This appears to be the result
of availability of lower priced Asian imports, a high level of U.S. consumer
spending on durable goods versus nondurable and unusual weather patterns
affecting outerwear sales. Sales increased by $13,969,000, or 18%, in 1997,
compared to $77,583,000 in 1996. The 1997 increase was attributable to higher
sales in all divisions, but principally in the distribution businesses. Demand
for Brookwood's products was much higher in 1997, compared to lower demand in
1996.
Expenses. Total expenses decreased to $79,245,000, or 12%, for 1998 from
$89,575,000 in 1997 and $76,361,000 in 1996. Cost of sales of $69,502,000
decreased by $9,971,000, or 13%, in 1998, principally due to the aforementioned
sales decrease. The gross profit margin was 13.5% in 1998 compared to 13.2% in
1997. Cost of sales of $79,473,000 increased $12,217,000, or 18%, for 1997 from
$67,256,000 in 1996, principally due to the increase in sales revenue. The gross
profit margin was 13.3% in 1996.
Administrative and selling expenses for 1998 of $8,805,000 decreased
$267,000, or 3%, compared to the 1997 amount of $9,072,000. The 1997 amount
increased $590,000, or 7%, compared to the 1996 amount of $8,482,000. The
fluctuations were attributable to operating expenses associated with the changes
in sales revenue for the respective years.
Interest expense decreased by $92,000 for 1998 to $938,000, from the 1997
amount of $1,030,000 and was the result of lower average borrowings and lower
interest rates. Interest expense increased by $407,000 in 1997, from $623,000 in
1996 as a result of higher average borrowings.
HOTELS
Revenues. Sales of $21,130,000 in 1998 increased by $92,000, or 0.4%, from
the 1997 amount of $21,038,000. The sales increase in 1998 was primarily due to
management fee revenues from The Enclave Suites, a resort condominium hotel
acquired in July 1998, partially offset by a decline in revenue at the Longboat
Key Holiday Inn and the Oklahoma City Embassy Suites properties. The Longboat
Key revenue decline was primarily due to an extensive renovation project, which
commenced in September 1997 and was finished in April 1998, and adverse weather
conditions. The Oklahoma City revenue decline was due to a substantial increase
in available rooms in the immediate market and low introductory rates offered by
the competition. The average daily rate and the average occupancy level for 1998
declined 1.4% and 2.8%, respectively, compared to 1997 amounts. Sales for 1997
increased by $90,000, or 0.4%, from the 1996 amount of $20,948,000. In 1997, the
hotel properties achieved a higher average daily rate of 3.4%, while occupancy
levels decreased by an average of 3.8%, compared to 1996. The 1997 sales were
negatively impacted by the renovation program at the Longboat Key hotel.
Expenses. Hotel expenses were $23,226,000 for 1998, $21,275,000 for 1997,
and $20,948,000 for 1996.
Operating expenses of $18,552,000 for 1998 were up $1,562,000, or 9.2%,
from the 1997 amount of $16,990,000. The increase was primarily attributable to
operating expenses at The Enclave Suites property. Operating expenses for 1998
at the remaining properties increased $237,000, or 1.4%, compared to 1997
expenses. Operating expenses for 1997 decreased by $147,000, or 0.9%, from the
1996 amount of $17,137,000. The decline is attributable to reduced rent for the
Greenville, South Carolina Residence Inn which was then a leasehold.
Depreciation and amortization expense of $3,184,000 for 1998 increased by
$343,000, or 12%, from the 1997 amount of $2,841,000. The increase was due to
the acquisition of The Enclave Suites and the fee interest in the Oklahoma City
Embassy Suites in September 1998. Depreciation and amortization expense for 1997
increased by
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<PAGE> 13
$184,000, or 7%, from the 1996 amount of $2,657,000. The increase is
attributable to additional depreciation resulting from the May 1996 purchase of
the fee interest in the Greenville Residence Inn and additional capital
expenditures at the remaining properties.
Interest expense of $1,490,000 for 1998 increased by $46,000, or 3.2%, from
the 1997 amount of $1,444,000. The increase was due to the September 1998 term
loans to acquire the Oklahoma City fee interest, offset by the refinancing of
the mortgage loans in the 1997 fourth quarter on the Residence Inn hotels in
Tulsa, Oklahoma and Greenville, South Carolina at more favorable interest rates.
Interest expense for 1997 increased by $290,000, or 25%, from the 1996 amount of
$1,154,000, due to the procurement of a term loan on the Greenville Residence
Inn hotel in May 1996, partially offset by the aforementioned refinancing of the
Residence Inn hotels in the 1997 fourth quarter.
ASSOCIATED COMPANY
The Company is no longer engaged in this segment, as its remaining ShowBiz
investment was sold in March 1997.
Revenues. Associated company income for 1997 was $19,416,000, compared to
the 1996 amount of $4,448,000. Results include the Company's pro-rata share of
ShowBiz' results using the equity method of accounting and gains from the sale
of ShowBiz shares. Revenue for 1997 includes equity income of $1,139,000 and a
gain of $18,277,000 from the March 1997 sale of the Company's remaining
investment in ShowBiz. The Company sold its 2,632,983 remaining ShowBiz shares
as part of a ShowBiz secondary common stock offering. The Company had determined
to sell its shares to repay debt, utilize expiring federal income tax loss
carryforwards and to focus on core investments. Revenue for 1996 included equity
income of $2,017,000 and a gain of $2,431,000 from the sale of 262,500 ShowBiz
shares.
Expenses. Interest expense for 1997 was $607,000, compared to the 1996
amount of $1,558,000. The $951,000 decline in 1997 is due to the repayment of a
$7,000,000 margin loan and a $4,000,000 promissory note, which had been
collateralized by the ShowBiz investment, and the resolution of litigation
involving a participation provision contained in the promissory note, for which
the Company recognized $419,000 of expense in 1997 and $755,000 in 1996.
OTHER
Revenues. Total revenues were $1,728,000 in 1998, $3,207,000 in 1997 and
$960,000 in 1996
During 1998, the Company favorably settled a 1996 litigation claim for
$1,025,000 involving its former merchant banking activities and it was reported
as revenue in the second quarter of 1998. In the third quarter of 1997, the
Company settled a 1992 insurance claim involving issues relating to directors
and officers liability coverage, and reported it as revenue of $1,508,000, net
of associated legal costs.
Fee income for 1998 of $550,000 was comparable with the 1997 amount of
$560,000. Fee income for 1997 increased by $135,000, or 32%, compared to the
1996 amount of $425,000. The fees were derived from financial consulting
contracts with an HEP affiliate and ShowBiz. A consulting contract with the HEP
affiliate, provided for a $300,000 annual fee until its termination on December
31, 1996. The Company entered into a new contract on similar terms, apart from
an increase to $550,000, effective December 31, 1996. The ShowBiz contract
provided for a $125,000 annual fee until its termination in March 1997.
Interest on short-term investments and other income in 1998 was $153,000,
compared to the 1997 amount of $1,139,000. The substantial decrease was
primarily 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. The interest and other income for 1997 increased $604,000
compared to the 1996 amount of $535,000. The increase was attributable to higher
cash and investment balances generated from the ShowBiz sale proceeds and higher
rental income from the aforementioned subleasing of executive office space.
Expenses. Interest expense for the three year period relates primarily to
the Company's 13.5% Subordinated Debentures, 7% Collateralized Senior
Subordinated Debentures and 10% Collateralized Subordinated Debentures.
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Interest expense for 1998 of $1,010,000 decreased by $2,587,000, or 72%,
compared to 1997 interest of $3,597,000. The decrease was primarily due to (i)
the repurchase of $12,875,000 of its 13.5% Debentures in a June 1997 self-tender
offer; (ii) the December 1997 redemption of the remaining $14,287,000 balance of
its outstanding 13.5% Debentures; (iii) the repurchase of 7% Debentures with a
face amount of $2,253,000 in January 1998 to satisfy the balance of a sinking
fund requirement; partially offset by the August 1998 Exchange Offer, whereby
$6,468,000 of 7% Debentures were exchanged for a new issue of 10% Debentures.
Interest expense in 1997 declined $661,000, or 16%, from the 1996 expense of
$4,258,000. The decrease was due to the aforementioned repurchase of $12,875,000
of its 13.5% Debentures, partially offset by increased interest costs associated
with the August 1996 and August 1997 issuance of additional 13.5% Debentures as
payment of annual interest in-kind. See Note 7 to the Company's consolidated
financial statements.
Administrative expenses of $2,662,000 for 1998 compares to $3,291,000 for
1997 and $2,716,000 for 1996. The decrease of $629,000, or 19%, in 1998,
compared to 1997, was primarily due to lower consulting and other professional
fees. The increase of $575,000, or 21%, in 1997, compared to 1996, was
attributable to higher consulting and other professional fees and shareholder
relations costs.
Income Taxes. The Company recognizes future tax benefits, measured by
enacted tax rates, attributable to net deductible temporary differences between
financial statement and income tax bases of assets and liabilities
(approximately $43,112,000 at December 31, 1998), tax net operating loss
carryforwards ("NOLs") (approximately $55,807,000 at December 31, 1998) and tax
credit carryforwards (approximately $2,994,000 at December 31, 1998), to the
extent that realization of such benefits is "more likely than not", as defined
in Statement of Financial Accounting Standards No. 109 - Accounting for Income
Taxes ("SFAS No. 109"). As a result of significant appreciation in the market
value of the Company's HRP limited partner units in 1997 and 1998, management
determined that the deferred tax asset should be increased to reflect the
substantial gain that would result from the sale of the HRP investment.
Accordingly the Company recorded a deferred tax benefit of $4,308,000 in 1998,
which increased the deferred tax asset to $6,348,000 at December 31, 1998.
During 1998, management completed a consolidation of the Company's real
estate assets. The assets were transferred at market value into a new structure
and, although the book basis of the assets was not changed, the consolidation
resulted in the recognition of a significant tax gain in 1998. Certain of the
Company's NOL carryforwards were utilized to reduce the related income tax
effect of the consolidation, although the Company recorded a current federal
charge for alternative minimum tax and state tax expense. The 1998 current
federal and state tax expenses were $745,000 and $448,000, respectively.
As a result of the appreciation in the market value of the Company's
investment in ShowBiz during 1996, management had determined that the deferred
tax asset should be increased at December 31, 1996 to reflect the anticipated
realization of future tax benefits. Accordingly, the deferred tax asset was
increased to $11,000,000 at December 31, 1996, from $5,929,000 at December 31,
1995, with a corresponding deferred tax benefit in 1996 of $5,071,000. In 1997,
concurrent with the sale of the ShowBiz investment, the Company recorded an
$8,960,000 non-cash federal deferred tax charge and a federal current charge of
$535,000 for alternative minimum tax. Additionally, the Company recorded current
federal and state tax expense of $117,000 and $296,000, respectively.
The Company's NOLs expire as follows: 2001 to 2004 - $1,240,000; and 2005
to 2010 - $54,567,000. SFAS No. 109 requires that the tax benefit of such NOLs
be recorded as an asset to the extent that management assesses the utilization
of such NOLs to be "more likely than not". 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 and
therefore, as of December 31, 1998, the deferred tax asset was $6,348,000.
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 net recorded tax benefits before
their expiration. Management has considered such strategies in reaching its
conclusion that, more likely than not, taxable income will be sufficient to
utilize a portion of the NOLs before expiration; however, future levels of
operating income and taxable gains are dependent upon general economic
conditions and other factors beyond the Company's control. Accordingly, no
assurance can be given that sufficient taxable income will be generated for
utilization of the NOLs. Management periodically re-evaluates its tax planning
strategies based upon changes in facts and circumstances
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<PAGE> 15
and, accordingly, considers potential adjustments to the valuation allowance of
the deferred tax asset. Although the use of such carryforwards could, under
certain circumstances be limited, the Company is presently unaware of the
occurrence of any event which would result in such limitations.
Extraordinary Gain from Early Extinguishment of Debt. The Company
recognized an extraordinary gain from early extinguishment of debt of $1,481,000
in 1998. The 1998 gain resulted from (i) the January 1998 repurchase of 7%
Debentures having a face amount of $2,253,000 for a discounted amount of
$2,146,000 resulting in a gain of $107,000; and (ii) a $1,374,000 gain from the
recognition of the Company's pro-rata share of a $5,347,000 extraordinary gain
from extinguishment of debt reported by HRP in 1998. In 1997, the Company
recorded a net extraordinary gain from debt extinguishment of $200,000. Of this
amount, $877,000 was attributable to the gain from the partial repurchase of
13.5% Debentures in June 1997, offset by $677,000 of losses from the refinancing
of the Company's Residence Inn hotels in Tulsa, Oklahoma and Greenville, South
Carolina.
LIQUIDITY AND CAPITAL RESOURCES.
The Company's unrestricted cash and cash equivalents at December 31, 1998
totaled $769,000.
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 113,300 of its HRP limited partnership
units as collateral for a loan and hotel lease obligations. In addition,
substantially all of the HRP limited partnership units are subject to a limited
negative pledge for the Company's energy term loan. If the Company pledges
designated HRP units, as defined, having a market value up to $2,000,000, the
negative pledge can be released. Each quarter Hallwood Realty reviews HRP's
capacity to make cash distributions to its partners. No distributions were
declared by HRP in 1998.
The Company's energy segment generates funds from its operating and
financing activities. Cash flow is subject to fluctuating oil and gas production
and prices. In accordance with the proportionate consolidation method of
accounting, the Company and its subsidiaries report their share of HEP's
long-term obligations totaling $5,306,000 at December 31, 1998. HEP's borrowings
are secured by a first lien on approximately 80% in value of HEP's oil and gas
properties. At December 31, 1998, HEP had a $49,700,000 revolving credit
agreement, which matures in May 2003. HEP's unused borrowing capacity under the
revolving credit agreement was $12,300,000 at February 28, 1999. The Company
does not provide any loan guarantees on HEP's borrowings.
In November 1997, HEPGP amended, restated and increased its energy term
loan to $4,000,000, which had a remaining balance of $2,267,000 at December 31,
1998. The term loan, which is collateralized by the Company's HEP general
partner and limited partner interests contains a provision which prohibits HEPGP
from making any distribution to the Company during the term of the loan which
matures in May 2000. Substantially all of the HRP limited partnership units are
subject to a limited negative pledge for the term loan.
During 1998, HEP declared distributions of $.52 per Class A unit and $1.00
per Class C unit to its unitholders. Distributions on Class B units are
suspended if the Class A units receive a distribution of less than $.20 per
Class A unit per calendar quarter. In any quarter for which distributions of
$.20 or more per unit are made on the Class A units, the Class B units are
entitled to be paid, in whole or in part, suspended distributions. The Class C
units have a distribution preference of $1.00 per year, payable quarterly. HEP
may not declare or make any cash distributions on the Class A or Class B units
unless all accrued and unpaid dividends on the Class C units have been paid. The
general partner is considering the distribution level for future quarters,
taking into account oil and gas prices, cash flows, long-term debt, borrowing
base levels and the capital needs of HEP.
In the years ended December 31, 1998, 1997 and 1996, the Company received
cash dividends of $784,000, $1,000,000, and $-0- respectively, from Brookwood. A
cash dividend for 1999, if any, is contingent upon Brookwood's compliance with
the covenants contained in its loan agreement. In addition, the Company received
$394,000, $638,000 and $409,000 under its tax sharing agreement with Brookwood
in the years ended December 31,1998, 1997 and 1996, respectively.
At December 31, 1998, Brookwood was not in compliance with two covenants
contained in its credit agreement, which requires a minimum consolidated
capital expenditure of $1,500,000 in a calendar year and a minimum ratio of
EBIDTA (earnings before interest, depreciation, taxes and amortization) to
consolidated fixed charges of 1.00 to 1.00 for four consecutive quarters. 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.
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<PAGE> 16
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, it may be impacted by the inability of prospective
purchasers to obtain equity capital or suitable financing. The Company completed
a renovation of the Longboat Key Holiday Inn hotel in April 1998, partly
financed by the owner in the form of higher lease payments. It is anticipated
that in April 1999 the Company will convert its three Residence Inn hotels to
GuestHouse franchises. Renovations to meet the new franchiser's standards are
expected to be funded from the Company's capital reserves and equipment lease
facilities.
Management believes that it will have sufficient funds for operations and
to satisfy its current obligations. Management is currently exploring
alternatives to refinance the 7% Debentures which mature in July 2000. See Notes
6 and 7 to the Company's consolidated financial statements for a further
discussion of the Company's loan and debenture obligations.
As described in Note 18 to the Company's consolidated financial statements,
the Company had outstanding contingencies and commitments of approximately
$13,118,000 (excluding operating lease commitments of $23,052,000).
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, which are generally more difficult to assess because they
often contain embedded 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 through the first part of 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 second 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 1999 at minimal cost. (4) Payroll -
HRP's payroll was processed in a non-compliant system through an outside payroll
vendor until Year 2000 compliant software was purchased and installed in the
fourth quarter of 1998 at minimal cost.
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<PAGE> 17
Additionally, HRP 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 HRP's business and
operations. This survey includes the identification of certain on-site,
non-information technology systems that may be Year 2000 sensitive. Once these
systems have been fully identified, HRP 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
gates, alarms, elevators, heating and air conditioning systems, irrigation
systems, security systems, thermostats, and utility meters and switches. HRP
anticipates finalizing its survey of service providers and vendors during the
second quarter of 1999.
HRP will utilize external and internal resources to reprogram, replace and
test its systems for Year 2000 modifications. HRP anticipates completing the
Year 2000 project, which includes repairing or replacing any vulnerable systems,
by June 30, 1999. Total costs, including information and non-information
technology systems, are not expected to exceed $100,000. In the event that a
system will not be Year 2000 compliant, HRP will assess the potential risk and,
to the extent it is feasible, transfer its business to an alternate vendor.
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 that might arise from matters not
previously considered. 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 (1) increased
time delays associated with posting of information, and (2) 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.
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 materially from those anticipated.
Energy. HEP's Year 2000 Plan has four phases: (i) assessment, (ii)
inventory, (iii) remediation, testing and implementation and (iv) contingency
plans. Approximately twelve months ago, HEP 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 HEP's IT systems that must be updated or replaced
in order to be Year 2000 compliant. In particular, the software used by HEP for
reservoir engineering must be updated or replaced. Remediation, testing and
implementation are scheduled to be completed by June 30, 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. HEP's
assessment of the readiness of third parties whose IT systems might have an
impact on HEP's business has thus far not indicated any material problems;
responses have been received to approximately 50% of the 172 inquiries made.
With regard to HEP's Non-IT systems, HEP believes that most of these
systems can be brought into compliance on schedule. HEP'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, HEP 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, HEP's preliminary estimate is that such
costs will not be material. To date, HEP has determined that its IT systems are
either compliant or can be made compliant for less than $150,000. 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 form 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 HEP's IT and Non IT systems, as well as
to the systems of third parties. Such failures could materially and adversely
affect HEP'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, HEP is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the HEP
results of operations, cash flow or financial condition. Although HEP 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 HEP. HEP 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. HEP 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.
HEP's Year 2000 plan is expected to significantly reduce HEP's level of
uncertainty about the compliance and readiness of these material third parties.
The evaluation of third party readiness will be followed by HEP's development of
contingency plans.
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<PAGE> 18
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 is currently
being 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 is not presently Year 2000 compliant, although it is
anticipated that updated software will be installed and tested by the 1999
second quarter at minimal cost. (3) Factory Production. To date Brookwood has
determined that substantially 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 second 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 (1) increased time delays associated with posting of
information , and (2) 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
installed and is currently testing a new software system that is Year 2000
compliant. It is anticipated that the software will be fully operational by the
1999 second 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 installed and
is currently testing a new software system that is Year 2000 compliant. It is
anticipated that the software will be fully operational by the 1999 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 second
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
17
<PAGE> 19
failure of information technology systems, the Company 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 (1) increased time delays associated with posting of
information, and (2) 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 75% complete. And that its remediation
is approximately 50% complete. As described earlier, the Company expects all of
its internal efforts will be completed by the second 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,
liquidity, 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.
18
<PAGE> 20
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, SFAS No. 130 - Reporting on Comprehensive Income ("SFAS No.
130") was issued. The Company had no items of other comprehensive income in the
years presented.
In June 1997, SFAS No. 131 - Disclosures about Segments of an Enterprise
and Related Information ("SFAS No. 131") was issued. The Company has adopted
SFAS No. 131 for purposes of its current financial statements. SFAS No. 131
redefines how operating segments are determined and requires disclosures of
certain financial and descriptive information about a company's operating
segments. The Company has evaluated and complied with the guidance under SFAS
No. 131.
In April 1998, Statement of Position 98-5 - Reporting on the Costs of
Start-up Activities ("SOP 98-5") was issued. SOP 98-5 concluded that costs of
start-up activities, including organization costs, should be expensed as
incurred. The Company's early adoption of this SOP had no significant effect on
the financial statements of the Company.
In June 1998, SFAS No. 133 - Accounting for Derivative Instruments and
Hedging Activities ("SFAS No. 133") was issued. The statement is effective for
all quarters for fiscal years beginning after June 15, 1999. SFAS No. 133
requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income depending on whether a
derivative is part of a hedge transaction, and if it is, the type of hedge
transaction. The Company currently has hedging contracts in its energy segment
as related to oil and gas activities and its real estate segment as related to
an interest rate swap agreement. The impact on the Company's results of
operations, financial position or cash flows will be dependent on the level and
type of derivative instruments the Company will have entered into at the time
SFAS No. 133 is implemented. The Company is not planning an early adoption of
SFAS No. 133 and has not had an opportunity to evaluate the impact of the
provisions of SFAS No. 133 on its consolidated financial statements relating to
future adoption.
INFLATION
Inflation did not have a significant impact on the Company in 1998, 1997
and 1996 and is not anticipated to have a material impact in 1999.
ITEM 7(a). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company does not directly have any derivative financial instruments in
place as of December 31, 1998, 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 HEP 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, HEP's deliverable volumes. HEP 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.
The Company's real estate division through its investment in HRP will
sometimes use derivative financial instruments to achieve a desired mix of fixed
versus floating rate debt. As of December 31, 1998, 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.
19
<PAGE> 21
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. The table below presents principal cash flows and related
weighted average interest rates of the Company's debt at December 31, 1998
(in thousands):
<TABLE>
<CAPTION>
EXPECTED MATURITY DATES AS OF DECEMBER 31, 1998
------------------------------------------------------------ FAIR
DEBT 1999 2000 2001 2002 2003 THEREAFTER TOTAL VALUE
---- ------ ------- ---- ---- ---- ---------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed Rate Debt $ 921 $14,542 $ 490 $ 528 $ 572 $33,077 50,130 $47,905
Average Interest Rate 7.81% 7.81% 8.14% 8.14% 8.15% 8.16%
Variable Rate Debt $5,624 $ 6,808 $ 161 $ 183 $ 209 $ 462 $13,447 13,440
Average Interest Rate 8.67% 8.21% 13.15% 13.15% 13.15% 13.15%
</TABLE>
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 a loss in income and cash flows of
approximately $1,271,000 during 1999, assuming that outstanding debt remained at
current levels.
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-K 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements, together with the
independent auditors' report, are included elsewhere herein. Reference is made
to Item 14, "Exhibits, Financial Statement Schedules, and Reports on Form 8-K".
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
20
<PAGE> 22
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain of the information required by this Item 10 is contained in the
definitive proxy statement of the Company for its Annual Meeting of Stockholders
( the "Proxy Statement") under the heading "Election of Directors," and such
information is incorporated herein by reference. The Proxy Statement will be
filed with the Securities and Exchange Commission not later than 120 days after
December 31, 1998.
In addition to certain directors of the Company who serve as executive
officers, the following individuals also serve as executive officers of the
Company:
William L. Guzzetti, age 55, has served as Executive Vice President of the
Company since October 1989. Mr. Guzzetti has served as President, Chief
Operating Officer and a Director of the general partner of HEP since February
1985 and as President, Chief Operating Officer and a Director of HCRC since May
1991. Prior to that, Mr. Guzzetti served as Senior Vice President, Secretary and
General Counsel of HEC from November 1980 until February 1985. Since November
1990 and May 1991, Mr. Guzzetti has served as the President, Chief Operating
Officer and a Director of Hallwood Realty and HCRE, respectively.
Melvin J. Melle, age 56, has served as Vice President and Chief Financial
Officer of the Company since December 1984 and as Secretary of the Company since
October 1987. Mr. Melle served as Assistant Secretary of the Company from
December 1984 to October 1987. Mr. Melle had served as Secretary and Principal
Financial and Accounting Officer of Alliance Bancorporation from April 1989
until its liquidation in February 1994. From June 1980 through June 1986, Mr.
Melle served as Chief Financial Officer of The Twenty Seven Trust. Mr. Melle is
a member of the American Institute of Certified Public Accountants and of the
Ohio Society of Certified Public Accountants.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is contained in the
Proxy Statement under the headings "Executive Compensation," " Compensation of
Directors" and "Certain Relationships and Related Transactions," and such
information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding ownership of certain of the Company's outstanding
securities is contained in the Proxy Statement under the heading "Security
Ownership of Certain Beneficial Owners and Management," and such information is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions is
contained in the Proxy Statement under the headings "Compensation Committee
Interlocks and Insider Participation" and "Certain Relationships and Related
Transactions," and such information is incorporated herein by reference.
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<PAGE> 23
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Reference is made to the "Index to Financial Statements and Schedules"
appearing after the signature page hereof.
1. Financial Statements.
Included in Part II, Item 8. of this report are the following:
Independent Auditors' Report
Consolidated Balance Sheets, December 31, 1998 and 1997
Consolidated Statements of Income, Years ended December 31,
1998, 1997 and 1996
Consolidated Statements of Changes in Stockholders' Equity,
Years ended December 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows, Years ended December
31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
Supplemental Oil and Gas Reserve Information (Unaudited)
2. Financial Statement Schedules.
Independent Auditors' Report on Schedules
I Condensed Financial Information of Registrant
II Valuation and Qualifying Accounts and Reserves
III Real Estate and Accumulated Depreciation
All other schedules are omitted since the required information is not
applicable or is included in the financial statements or related notes.
Financial Statements of Hallwood Realty Partners, L.P.
Form 10-K for the year ended December 31, 1998
3. Exhibits and Reports on Form 8-K.
(a) Exhibits.
3.1 -- Second Restated Certificate of Incorporation of
The Hallwood Group Incorporated, is incorporated
herein by reference to Exhibit 4.2 to the Company's
Form S-8 Registration Statement, File No. 33-63709.
3.2 -- Restated Bylaws of the Company is incorporated
herein by reference to Exhibit 3.2 to the Company's
Form 10-K for the year ended December 31, 1997,
File No. 1-8303.
4.1 -- Indenture Agreement, and related Pledge Agreement,
dated as of March 2, 1993, among Norwest Bank
Minnesota, National Association, Trustee, and the
Company, regarding 7% Collateralized Senior
Subordinated Debentures due July 31, 2000, is
incorporated herein by reference to Exhibit 4.2 to
the Company's Form 10-Q for the fiscal quarter
ended January 31, 1993, File No. 1-8303.
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<PAGE> 24
4.2 -- Indenture Agreement and related Pledge and
Security Agreement, dated as of August 31, 1998
among Bank One, N.A., a national banking
association, as Trustee and the Company, regarding
10% Collateralized Subordinated Debentures due July
31, 2005, is incorporated herein by reference to
Form T-3 filed June 2, 1998 and related T-3/A
amendments filed on June 17, 1998, August 4, 1998
and August 31, 1998, File No. 1-
8303.
10.3 -- Amended and Restated Agreement, dated March 30,
1990, between the Company and Stanwick Management
Company, Inc. (subsequently merged into its parent,
Stanwick Holdings, Inc.) concerning the allocation
of costs and expenses incurred in connection with
the operation and management of their common
offices is incorporated herein by reference to
Exhibit 10.30 to the Company's Form 10-Q for the
fiscal quarter ended April 30, 1990, File No.
1-8303.
* 10.4 -- Employment Agreement, dated January 1, 1994,
between the Company and Melvin John Melle, as
incorporated by reference to Exhibit 10.9 to the
Company's Form 10-K for the fiscal year ended July
31, 1994, File No. 1-8303.
10.6 -- Tax Sharing Agreement, dated as of March 15, 1989,
between the Company and Brookwood Companies
Incorporated is incorporated herein by reference to
Exhibit 10.25 to the Company's Form 10-K for the
fiscal year ended July 31, 1989, File No. 1-8303.
* 10.7 -- Amended Tax-Favored Savings Plan Agreement of the
Company, effective as of February 1, 1992, is
incorporated herein by reference to Exhibit 10.33
to the Company's Form 10-K for the fiscal year
ended July 31, 1992, File No. 1-8303.
* 10.8 -- Hallwood Special Bonus Agreement, dated as of
August 1, 1993, between the Company and all members
of its control group that now, or hereafter,
participate in the Hallwood Tax Favored Savings
Plan and its related trust, and those employees
who, during the plan year of reference are
highly-compensated employees of the Company, is
incorporated herein by reference to Exhibit 10.34
to the Company's Form 10-K for the fiscal year
ended July 31, 1994, File No. 1-8303.
* 10.18 -- 1995 Stock Option Plan for The Hallwood Group
Incorporated is incorporated herein by reference to
Exhibit 4.1 of the Company's Form S-8 Registration
Statement, File No. 33-63709.
10.20 -- Credit Agreement, dated as of December 10, 1996,
among HEPGP Ltd., as borrower, the Company, as a
guarantor, Hallwood G.P., Inc., as a guarantor, and
First Union National Bank of North Carolina, as
lender, is incorporated herein by reference to
Exhibit 10.20 to the Company's Form 10-K for the
year ended December 31, 1996, File No. 1-8303.
10.21 -- Credit Agreement, dated as of January 7, 1997,
among Brookwood Companies Incorporated, Kenyon
Industries, Inc. and Brookwood Laminating, Inc., as
borrower, and The Bank of New York, as Bank, is
incorporated herein by reference to Exhibit 10.21
to the Company's Form 10-K for the year ended
December 31, 1996, File No. 1-8303.
* 10.22 -- Financial Consulting Agreement, dated as of
December 31, 1996, between the Company and HSC
Financial Corporation, is incorporated herein by
reference to Exhibit 10.22 to the Company's Form
10-K for the year ended December 31, 1996, File No.
1-8303.
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<PAGE> 25
* 10.23 -- Financial Consulting Agreement, dated as of
December 31, 1996, between the Company and Hallwood
Petroleum, Inc., is incorporated herein by
reference to Exhibit 10.23 to the Company's Form
10-K for the year ended December 31, 1996, File No.
1-8303.
10.24 -- Amendment No. 1, dated as of April 1, 1997 to
Credit Agreement dated as of January 7, 1997, among
Brookwood Companies Incorporated, Kenyon
Industries, Inc., Brookwood Laminating, Inc., as
Borrowers, and The Bank of New York is incorporated
herein by reference to Exhibit 10.24 to the
Company's Form 10-Q for the quarter ended March 31,
1997, File No. 1-8303.
10.25 -- Amendment No. 2, dated as of May 23, 1997 to Credit
Agreement dated as of January 7, 1997, among
Brookwood Companies Incorporated, Kenyon
Industries, Inc., Brookwood Laminating, Inc., as
Borrowers, and The Bank of New York is incorporated
herein by reference to Exhibit 10.25 to the
Company's Form 10-Q for the quarter ended June 30,
1997, File No. 1-8303.
10.26 -- Amendment No. 3, dated as of June 25, 1997 to
Credit Agreement, dated as of January 7, 1997,
among Brookwood Companies Incorporated, Kenyon
Industries, Inc., Brookwood Laminating, Inc., as
Borrowers, and The Bank of New York is incorporated
herein by reference to Exhibit 10.26 to the
Company's Form 10-Q for the quarter ended June 30,
1997, File No. 1-8303.
10.27 -- Amendment No. 4, dated as of March 18, 1998, to
Credit Agreement, dated as of January 7, 1997,
among Brookwood Companies Incorporated, Kenyon
Industries, Inc., Brookwood Laminating, Inc., as
Borrowers, and The Bank of New York is incorporated
herein by reference to Exhibit 10.30 to the
Company's Form 10-Q for the quarter ended June 30,
1998, File No. 1-8303.
10.28 -- Amended and Restated Credit Agreement, dated as of
November 14, 1997, among HEPGP Ltd., as Borrower,
and The Hallwood Group Incorporated, as Parent
Guarantor, and Hallwood G.P., Inc., as Guarantor,
and First Union National Bank, as Lender, is
incorporated herein by reference to Exhibit 10.27
to the Company's Form 10-K for the year ended
December 31, 1997, File No. 1-8303.
10.29 -- Promissory note and related mortgage loan
agreement in the original amount of $5,280,000,
dated October 31, 1997, between Brock Suite Tulsa,
Inc., as Maker, and Credit Suisse First Boston
Mortgage Capital LLC, as Lender, is incorporated
herein by reference to Exhibit 10.28 to the
Company's Form 10-K for the year ended December 31,
1997, File No. 1-8303.
10.30 -- Promissory note and related mortgage loan agreement
in the original amount of $6,750,000, dated
December 24, 1997, between Brock Suite Greenville,
Inc., as Maker, and L.J. Melody & Company, as
Lender, is incorporated herein by reference to
Exhibit 10.29 to the Company's Form 10-K for the
year ended December 31, 1997, File No. 1- 8303.
10.31 -- Promissory note and related mortgage loan and
security agreement in the original amount of
$17,250,000, dated September 11, 1998, between
Hallwood Hotels - OKC, Inc., as Maker, and WMF
Capital Corporation, as Lender, is incorporated
herein by reference to Exhibit 10.31 to the
Company's Form 10-Q for the quarter ended September
30, 1998, File No. 1-8303.
10.32 -- Promissory note and related loan agreement in the
original amount of $1,300,000, dated September 11,
1998, between Hallwood Hotels - OKC Mezz, Inc., as
Maker, and Commercial Mortgage Investment Trust,
Inc., as Lender, is incorporated herein by
reference to Exhibit 10.32 to the Company's Form
10-Q for the quarter ended September 30, 1998, File
No. 1-8303.
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<PAGE> 26
21 -- Active Subsidiaries of the Registrant as of
February 28, 1999.
27 -- Financial Data Schedule.
(b) Reports on Form 8-K.
None.
- ------------------------------------
* Constitutes a compensation plan or agreement for executive officers.
25
<PAGE> 27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
By: /s/ MELVIN J. MELLE
-------------------
Melvin J. Melle
Vice President -- Finance
(Principal Financial and Accounting Officer)
Dated: March 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant on the 29th day of March 1999.
/s/ MELVIN J. MELLE Vice President -- Finance (Principal
-------------------- Financial and Accounting Officer)
(Melvin J. Melle)
/s/ ANTHONY J. GUMBINER Chairman of the Board and Director
------------------------ (Principal Executive Officer)
(Anthony J. Gumbiner)
/s/ BRIAN M. TROUP President and Director (Principal Operating
------------------- Officer)
(Brian M. Troup)
/s/ CHARLES A. CROCCO, JR. Director
- ---------------------------
(Charles A. Crocco, Jr.)
/s/ J. THOMAS TALBOT Director
---------------------
(J. Thomas Talbot)
26
<PAGE> 28
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report.............................................................................. 28
Financial Statements:
Consolidated Balance Sheets, December 31, 1998 and 1997............................................... 29
Consolidated Statements of Income, Years Ended December 31, 1998, 1997 and 1996....................... 31
Consolidated Statements of Changes in Stockholders' Equity, Years Ended December 31, 1996,
1997 and 1998...................................................................................... 33
Consolidated Statements of Cash Flows, Years Ended December 31, 1998, 1997 and 1996................... 34
Notes to Consolidated Financial Statements............................................................ 35
Supplemental Oil and Gas Reserve Information (Unaudited).............................................. 65
Independent Auditors' Report on Schedules................................................................. 68
Schedules:
I Condensed Financial Information of Registrant..................................................... 69
II Valuation and Qualifying Accounts and Reserves.................................................... 74
III Real Estate and Accumulated Depreciation.......................................................... 75
</TABLE>
All other schedules are omitted since the required information is not
applicable or is included in the financial statements or related notes.
Financial Statements of Hallwood Realty Partners, L.P.
Form 10-K for the Year Ended December 31, 1998
27
<PAGE> 29
INDEPENDENT AUDITORS' REPORT
To the Stockholders and Directors of
The Hallwood Group Incorporated
We have audited the accompanying consolidated balance sheets of The
Hallwood Group Incorporated and its subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of The Hallwood Group Incorporated
and its subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Dallas, Texas
March 26, 1999
28
<PAGE> 30
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1997
-------- -------
<S> <C> <C>
ASSET MANAGEMENT
REAL ESTATE
Investments in HRP .................................. $ 9,771 $ 7,197
Receivables and other assets ........................ 687 1,063
-------- -------
10,458 8,260
ENERGY
Oil and gas properties, net ......................... 11,479 9,589
Current assets of HEP ............................... 2,895 2,657
Noncurrent assets of HEP ............................ 1,219 1,859
Receivables and other assets ........................ 482 434
-------- -------
16,075 14,539
-------- -------
Total asset management assets .................... 26,533 22,799
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Inventories ......................................... 16,708 17,935
Receivables ......................................... 11,713 14,296
Property, plant and equipment, net .................. 8,738 9,057
Other ............................................... 889 938
-------- -------
38,048 42,226
HOTELS
Properties, net ..................................... 31,810 14,168
Receivables and other assets ........................ 3,845 1,742
-------- -------
35,655 15,910
-------- -------
Total operating subsidiaries assets .............. 73,703 58,136
OTHER
Deferred tax asset, net ............................. 6,348 2,040
Other ............................................... 1,191 1,557
Cash and cash equivalents ........................... 769 4,737
Restricted cash ..................................... 708 489
-------- -------
Total other assets ............................... 9,016 8,823
-------- -------
TOTAL ASSETS ..................................... $109,252 $89,758
======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
29
<PAGE> 31
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1998 1997
--------- --------
<S> <C> <C>
ASSET MANAGEMENT
REAL ESTATE
Loans payable ...................................................... $ 500 $ 500
Accounts payable and accrued expenses .............................. 775 1,295
--------- --------
1,275 1,795
ENERGY
Long-terms obligations of HEP ...................................... 5,306 4,731
Current liabilities of HEP ......................................... 3,949 2,793
Loan payable ....................................................... 2,267 3,867
Accounts payable and accrued expenses .............................. 1,144 548
--------- --------
12,666 11,939
--------- --------
Total asset management liabilities .............................. 13,941 13,734
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Loans payable ...................................................... 9,900 13,800
Accounts payable and accrued expenses .............................. 7,646 7,771
--------- --------
17,546 21,571
HOTELS
Loans payable ...................................................... 30,354 12,019
Accounts payable and accrued expenses .............................. 2,120 1,607
--------- --------
32,474 13,626
--------- --------
Total operating subsidiaries liabilities ........................ 50,020 35,197
OTHER
7% Collateralized Senior Subordinated Debentures ...................... 14,727 24,292
10% Collateralized Subordinated Debentures ............................ 6,808 --
Interest and other accrued expenses ................................... 1,818 1,364
--------- --------
Total other liabilities ......................................... 23,353 25,656
--------- --------
TOTAL LIABILITIES ............................................... 87,314 74,587
REDEEMABLE PREFERRED STOCK
Series B, $.10 par value; 250,000 shares issued and outstanding ....... 1,000 1,000
CONTINGENCIES AND COMMITMENTS
STOCKHOLDERS' EQUITY
Preferred stock, $.10 par value; authorized 500,000 shares;
250,000 shares issued and outstanding as Series B .................. -- --
Common stock, $.10 par value; authorized 10,000,000 shares;
issued 1,597,204 shares in both years;
outstanding 1,254,751 and 1,261,757 shares, respectively ........... 160 160
Additional paid-in capital ............................................ 54,823 54,823
Accumulated (deficit) ................................................. (24,676) (31,693)
Treasury stock, 342,453 and 335,447 shares, respectively; at cost ..... (9,369) (9,119)
--------- --------
TOTAL STOCKHOLDERS' EQUITY ...................................... 20,938 14,171
--------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ...................... $ 109,252 $ 89,758
========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
30
<PAGE> 32
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
------- ------- --------
<S> <C> <C> <C>
ASSET MANAGEMENT
REAL ESTATE
Fees .......................................................... $ 5,925 $ 6,306 $ 5,678
Equity income (loss) from investments in HRP .................. 1,888 900 (1,731)
------- ------- --------
7,813 7,206 3,947
Administrative expenses ....................................... 2,075 2,436 1,396
Depreciation and amortization ................................. 674 674 673
Interest ...................................................... 58 160 281
Provision for losses (recovery) ............................... -- 81 (21)
------- ------- --------
2,807 3,351 2,329
------- ------- --------
Income from real estate operations ............................ 5,006 3,855 1,618
ENERGY
Gas revenues .................................................. 3,652 4,020 4,403
Oil and gas revenues .......................................... 1,405 1,993 2,663
Other income .................................................. 159 337 449
------- ------- --------
5,216 6,350 7,515
Depreciation, depletion, amortization and impairment .......... 1,761 1,387 1,532
Operating expenses ............................................ 1,533 1,401 1,509
Administrative expenses ....................................... 968 1,317 1,314
Interest ...................................................... 547 413 456
Minority interest ............................................. -- -- 422
------- ------- --------
4,809 4,518 5,233
------- ------- --------
Income from energy operations .............................. 407 1,832 2,282
------- ------- --------
Income from asset management operations .................... 5,413 5,687 3,900
OPERATING SUBSIDIARIES
TEXTILE PRODUCTS
Sales ......................................................... 80,343 91,552 77,583
Cost of sales ................................................. 69,502 79,473 67,256
Administrative and selling expenses ........................... 8,805 9,072 8,482
Interest ...................................................... 938 1,030 623
------- ------- --------
79,245 89,575 76,361
------- ------- --------
Income from textile products operations .................... 1,098 1,977 1,222
</TABLE>
See accompanying notes to consolidated financial statements.
31
<PAGE> 33
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
OPERATING SUBSIDIARIES (CONTINUED) 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
HOTELS
Sales .................................................... $ 21,130 $ 21,038 $ 20,948
Operating expenses ....................................... 18,552 16,990 17,137
Depreciation and amortization ............................ 3,184 2,841 2,657
Interest ................................................. 1,490 1,444 1,154
-------- -------- --------
23,226 21,275 20,948
-------- -------- --------
Loss from hotel operations ............................ (2,096) (237) --
-------- -------- --------
Income (loss) from operating subsidiaries ............. (998) 1,740 1,222
ASSOCIATED COMPANY
Income from investment in ShowBiz ........................... -- 19,416 4,448
Interest .................................................... -- 607 1,558
-------- -------- --------
Income from associated company ........................ -- 18,809 2,890
OTHER
Litigation and insurance settlements ........................ 1,025 1,508 --
Fee income .................................................. 550 560 425
Interest on short-term investments and other income ......... 153 1,139 535
-------- -------- --------
1,728 3,207 960
Administrative expenses ..................................... 2,662 3,291 2,716
Interest .................................................... 1,010 3,597 4,258
-------- -------- --------
3,672 6,888 6,974
-------- -------- --------
Other loss, net ....................................... (1,944) (3,681) (6,014)
-------- -------- --------
Income before income taxes and extraordinary gain ........... 2,471 22,555 1,998
Income taxes (benefit) ...................................... (3,115) 9,908 (4,525)
-------- -------- --------
Income before extraordinary gain ............................ 5,586 12,647 6,523
Extraordinary gain from early extinguishment of debt ........ 1,481 200 --
-------- -------- --------
NET INCOME ...................................................... $ 7,067 $ 12,847 $ 6,523
======== ======== ========
PER COMMON SHARE
BASIC
Income before extraordinary gain ......................... $ 4.41 $ 8.96 $ 4.93
Extraordinary gain from extinguishment of debt ........... 1.18 0.14 --
-------- -------- --------
Net income ............................................ $ 5.59 $ 9.10 $ 4.93
======== ======== ========
ASSUMING DILUTION
Income before extraordinary gain ......................... $ 4.26 $ 8.63 $ 4.89
Extraordinary gain from extinguishment of debt ........... 1.14 0.14 --
-------- -------- --------
Net income ............................................ $ 5.40 $ 8.77 $ 4.89
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
32
<PAGE> 34
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TREASURY STOCK TOTAL
------------------ PAID-IN ACCUMULATED ---------------- STOCKHOLDERS'
SHARES PAR VALUE CAPITAL (DEFICIT) SHARES COST EQUITY
------ --------- ----------- ------------ ------ ------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1996.................... 1,597 $160 $57,210 $(50,963) 271 $(6,798) $ (391)
Net income.............................. 6,523 6,523
Purchase of treasury stock.............. 28 (394) (394)
Preferred stock dividends............... (50) (50)
Proportionate share of stockholders'
equity transactions of equity
investments.......................... 96 96
----- ---- ------- -------- ---- ------- -------
BALANCE, DECEMBER 31, 1996.................. 1,597 160 57,306 (44,490) 299 (7,192) 5,784
Net income.............................. 12,847 12,847
Purchase of treasury stock.............. 304 (8,373) (8,373)
Preferred stock dividends............... (50) (50)
Exchange of treasury stock for
ShowBiz shares....................... (2,626) (268) 6,446 3,820
Proportionate share of stockholders'
equity transactions of equity
investments.......................... 143 143
----- ---- ------- -------- ---- ------- -------
BALANCE, DECEMBER 31, 1997.................. 1,597 160 54,823 (31,693) 335 (9,119) 14,171
Net income ............................. 7,067 7,067
Purchase of treasury stock.............. 7 (250) (250)
Preferred stock dividends............... (50) (50)
----- ---- ------- -------- ---- ------- -------
BALANCE, DECEMBER 31, 1998.................. 1,597 $160 $54,823 $(24,676) 342 $(9,369) $20,938
===== ==== ======= ======== ==== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
33
<PAGE> 35
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................................... $ 7,067 $ 12,847 $ 6,523
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation, depletion, amortization and impairment ....... 7,006 6,142 5,953
Net change in deferred tax asset ........................... (4,308) 8,960 (5,071)
Equity in net (income) loss of HRP ......................... (1,888) (900) 1,731
Undistributed income from HEP .............................. (2,472) (3,826) (4,559)
Distributions from HEP ..................................... 2,199 2,135 2,562
Amortization of deferred gain from debenture exchanges ..... (504) (600) (577)
Extraordinary gain from extinguishment of debt ............. (1,481) (201) --
Gain from sale of investment in ShowBiz .................... -- (18,277) (2,431)
Equity in net (income) of ShowBiz .......................... -- (1,139) (2,017)
Accrued interest on 13.5% Debentures ....................... -- 1,069 2,656
Provision for losses ....................................... -- 81 2
Net change in textile products assets and liabilities ...... 3,675 (2,825) (3,517)
Net change in energy assets and liabilities ................ (228) 88 321
Net change in other assets and liabilities ................. 119 (299) (2,023)
-------- -------- --------
Net cash provided by (used in ) operating activities .... 9,185 3,255 (447)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of hotel properties and related assets ............... (21,845) (1,286) (7,761)
Investments in textile products property and equipment ........ (1,009) (1,440) (1,118)
Investments in energy property and equipment .................. (298) (223) (346)
Net change in restricted cash for investing activities ........ (219) (372) (102)
Investment in HEP by general partner .......................... (171) -- --
Proceeds from sale of investment in ShowBiz ................... -- 40,323 4,139
Purchase of minority shares of HEC ............................ -- (648) (1,750)
Investments in associated company/affiliate ................... -- -- (53)
Proceeds from sale of hotel properties and related assets ..... -- -- 23
-------- ------- --------
Net cash provided by (used in) investing activities ..... (23,542) 36,354 (6,968)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings and loans payable ............... 18,550 18,630 14,775
Repayment of bank borrowings and loans payable ................ (5,715) (25,411) (2,227)
Repurchase of 7% Debentures ................................... (2,146) -- --
Purchase of common stock for treasury ......................... (250) (8,373) (394)
Payment of preferred stock dividends .......................... (50) (50) (50)
Repurchase of 13.5% Debentures ................................ -- (27,163) --
Net change in restricted cash for financing activities ........ -- -- (375)
Purchase of capital stock by energy subsidiary for treasury ... -- -- (158)
-------- -------- --------
Net cash provided by (used in) financing activities ..... 10,389 (42,367) 11,571
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .............. (3,968) (2,758) 4,156
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ...................... 4,737 7,495 3,339
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR ............................ $ 769 $ 4,737 $ 7,495
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
34
<PAGE> 36
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- ACCOUNTING POLICIES
The significant accounting policies of the Company are as follows:
(a) Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its subsidiaries:
Brock Suite Greenville, Inc.
Brock Suite Hotels, Inc.
Brock Suite Huntsville, Inc.
Brock Suite Tulsa, Inc.
Brookwood Companies Incorporated
Brookwood Laminating, Inc.
C-34 Holdings, Inc.
Condo Hotel and Resort Management, Inc.
Enclave Resort, Inc.
HEPGP Ltd.
HWG, LLC
HWG 95 Advisors, Inc.
HWG 98 Advisors, Inc.
HWG Holding One, Inc.
HWG Holding Two, Inc.
HWG Realty Investors, Inc. (merged in 1998)
HWG Realty Investors, LLC
HSC Securities Corporation
Hallwood Commercial Real Estate, Inc. (merged in 1998)
Hallwood Commercial Realty, LLC
Hallwood Energy Corporation and subsidiaries (merged in 1996)
Hallwood G.P., Inc.
Hallwood Hotels, Inc.
Hallwood Hotels - OKC, Inc.
Hallwood Hotels - OKC Mezz, Inc
Hallwood-Integra Holding Company
Hallwood Investment Company
Hallwood-Kenyon Holding Company
Hallwood Realty, LLC
Hallwood Realty Corporation (merged in 1998)
Integra Resort Management, Inc.
Kenyon Industries, Inc.
The Company fully consolidates all subsidiaries and records a minority
interest in those less than wholly owned. All significant intercompany
balances and transactions have been eliminated in consolidation.
(b) Recognition of Income
Fee income from real estate operations is generally received in cash
and is recognized as the services (e.g. management, leasing,
acquisition, construction) are performed in accordance with various
service agreements.
Textile products sales are recognized upon shipment or release of
product or when title passes to the customer.
35
<PAGE> 37
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(c) Carrying Value of Investments
Common shares and other securities are recorded at fair value
determined as of the date acquired. Thereafter, equity accounting is
utilized where the Company is able to exercise significant influence
over the issuer's operating and financial policies.
During 1997, the Company's investee affiliate, Hallwood Realty
Partners, L.P. ("HRP"), completed a review of its real estate lives. In
light of recent improvements and actions taken to increase its
preventative maintenance programs, the estimated economic lives for
buildings were found to be generally longer than the useful lives being
used for depreciation purposes. Accordingly, effective January 1, 1997,
HRP extended the depreciable lives of certain building costs. The
effect of this change in estimate reduced depreciation and amortization
expense and improved the net operating results of HRP by approximately
$7,200,000 for the year ended December 31, 1997. The proportional
effect to the Company under equity accounting standards was an increase
in equity earnings from HRP in 1997 of approximately $1,800,000,
considering the Company's overall 25% ownership of HRP.
Real estate is carried at cost, including interest costs associated
with properties under development or renovation.
(d) Oil and Gas Properties
The Company and its energy subsidiaries and affiliates follow the full
cost method of accounting, whereby all costs related to the acquisition
and development of oil and gas properties are capitalized in a single
cost center ("full cost pool") and are amortized over the productive
life of the underlying proved reserves using the units of production
method. Proceeds from property sales are generally credited to the full
cost pool.
Capitalized costs of oil and gas properties may not exceed an amount
equal to the present value, discounted at 10%, of estimated future net
revenues from proved oil and gas reserves plus the cost, or estimated
fair market value, if lower, of unproved properties. Should capitalized
costs exceed this ceiling, an impairment is recognized. The present
value of estimated future net revenues is computed by applying current
prices of oil and gas to estimated future production of proved oil and
gas reserves as of year end, less estimated future expenditures to be
incurred in developing and producing the proved reserves assuming
continuation of existing economic conditions.
Costs are not accrued for future site restoration, dismantlement and
abandonment related to proved oil and gas properties, because the
Company and its energy affiliates estimate that such costs will be
offset by the salvage value of the equipment sold upon abandonment of
such properties. Estimates are based upon historical experience and
review of current properties and restoration obligations.
Unproved properties are withheld from the amortization base until such
time as they are either developed or abandoned. The properties are
evaluated periodically for impairment.
Hallwood Energy Partners, L.P. ("HEP") has entered into numerous
financial contracts to hedge the price of its oil and natural gas. The
purpose of the hedges is to provide protection against price decreases
and to provide a measure of stability in the volatile environment of
oil and natural gas spot pricing. The amounts received or paid upon
settlement of these contracts are recognized as oil or gas revenue at
the time the hedged volumes are sold. Management does not consider the
portion attributable to the Company to be significant in relation to
these derivative instruments.
(e) Investment in Energy Affiliate
The Company and its energy subsidiaries account for their ownership of
HEP using the proportionate consolidation method of accounting, whereby
the entities record their proportional share of HEP's revenues and
expenses, current assets, current liabilities, noncurrent assets,
long-term obligations and fixed assets.
36
<PAGE> 38
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(f) Purchase Price in Excess of Fair Value of Net Assets Acquired
The purchase price in excess of fair value of the net assets acquired
in business acquisitions is amortized over the expected period of
benefit. The excess of the Company's proportionate share of the
underlying equity in the net assets of HRP over its investment is
amortized on a straight line basis over a period of 10 years.
(g) Impairment
The Company's management routinely reviews its investments for
impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable.
(h) Depreciation and Amortization
Depreciation of fee-owned hotel properties is computed on the
straight-line method over a period of twenty years, five to twenty
years for improvements, and three to ten years for furniture and
equipment. Amortization of hotel leasehold interests is computed on the
straight-line method over the remaining lease term and varies from 6 to
10 years.
Expenditures for maintenance and repairs are charged to operations.
Renewals and betterments are capitalized and depreciated over the
estimated useful lives of the assets.
(i) Income Taxes
The Company files a consolidated federal income tax return. Deferred
tax assets and liabilities are recorded based on the difference between
the tax bases of assets and liabilities and their carrying amounts for
financial reporting purposes, referred to as temporary differences, net
operating loss carryforwards and tax credits reduced by a valuation
allowance. Provision is made for deferred taxes relating to temporary
differences in the recognition of income and expense for financial
reporting.
(j) Inventories
Inventories are valued at the lower of cost (first-in, first-out
method) or market.
(k) Statement of Cash Flows
The Company considers its holdings of highly liquid debt and money
market instruments to be cash equivalents if such securities mature
within ninety days from the date of acquisition.
(l) Environmental Remediation Costs
The Company accrues for losses associated with environmental
remediation obligations when such losses are probable and reasonably
estimable. Accruals for estimated losses from environmental remediation
obligations generally are recognized no later than completion of the
remedial feasibility study. Such accruals are adjusted as further
information develops or circumstances change. Recoveries of
environmental remediation costs from other parties are recorded as
assets when their receipt is deemed probable. Company management is not
aware of any environmental remediation obligations which would
significantly affect the operations, financial position or cash flow of
the Company.
(m) Common Stock
The Company's Second Restated Certificate of Incorporation contains a
provision that restricts transfers of the Company's common stock in
order to protect certain federal income tax benefits.
37
<PAGE> 39
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(n) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect reported amounts of certain assets,
liabilities, revenues and expenses as of and for the reporting periods.
Actual results may differ from such estimates.
(o) Computation of Earnings Per Common Share
Basic earnings per share is computed by dividing net income
attributable to the common stockholders' interests after preferred
dividend requirements by the weighted average number of common shares
outstanding. Earnings per share assuming dilution is computed by
dividing net income attributable to the common stockholders' interests
after preferred stock dividend requirements by the weighted average
number of equivalent shares outstanding. Stock options described in
Note 9 are considered to be equivalent shares. The number of equivalent
shares is computed using the "treasury stock method ," which assumes
that the increase in the number of shares is reduced by the number of
shares which could have been repurchased by the Company with the
proceeds from the exercise of the options.
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 assuming
dilution methods (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
DESCRIPTION 1998 1997 1996
---------------------------- ------ ------- ------
<S> <C> <C> <C>
NET INCOME
Net income, as reported .......................... $7,067 $12,847 $6,523
Less: Dividends on preferred stock ............... 50 50 50
------ ------- ------
Net income available to common stockholders ...... $7,017 $12,797 $6,473
====== ======= ======
AVERAGE SHARES OUTSTANDING
Average shares outstanding - basic ............... 1,255 1,406 1,314
Stock options .................................... 43 54 10
------ ------- ------
Outstanding shares -assuming dilution ............ 1,298 1,460 1,324
====== ======= ======
</TABLE>
(p) Reclassifications
Certain reclassifications have been made in the prior years' amounts
to conform to the classifications used in the current year. The
reclassifications had no effect on previously reported net income.
(q) New Accounting Pronouncements
In June 1997, SFAS No. 130 - Reporting on Comprehensive Income
("SFAS No. 130") was issued. The Company has adopted SFAS No. 130
effective January 1, 1998. The Company had no items of other
comprehensive income in the years presented.
In June 1997, SFAS No. 131 - Disclosures about Segments of an
Enterprise and Related Information ("SFAS No. 131") was issued. The
Company has adopted SFAS No. 131 for purposes of its current financial
statements, which redefines how operating segments are determined and
requires disclosures of certain financial and descriptive information
about a company's operating segments. The Company has evaluated and
complied with the guidance under SFAS No. 131.
38
<PAGE> 40
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In April 1998, Statement of Position 98-5 - Reporting on the Costs
of Start-up Activities ("SOP 98-5") was issued. SOP 98-5 concluded
that costs of start-up activities, including organization costs,
should be expensed as incurred. The Company's early adoption of
this SOP had no significant effect on the financial statements of
the Company.
In June 1998, SFAS No. 133 - Accounting for Derivative Instruments
and Hedging Activities ("SFAS No. 133") was issued. The statement
is effective for all quarters for fiscal years beginning after
June 15, 1999. SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period
in current earnings or other comprehensive income depending on
whether a derivative is part of a hedge transaction, and if it is,
the type of hedge transaction. The Company currently has hedging
contracts in its energy segment as related to oil and gas
activities and its real estate segment as related to an interest
rate swap agreement. The impact on the Company's results of
operations, financial position or cash flows will be dependent on
the level and type of derivative instruments the Company will have
entered into at the time SFAS No. 133 is implemented. The Company
is currently not planning an early adoption of SFAS No. 133, and
has not had an opportunity to evaluate the financial impact of
the provisions of SFAS No. 133 on its consolidated financial
statements.
39
<PAGE> 41
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 2 -- INVESTMENTS IN REAL ESTATE AFFILIATE AND ASSOCIATED COMPANY (DOLLAR
AMOUNTS IN THOUSANDS):
<TABLE>
<CAPTION>
DECEMBER 31, 1998
----------------- AMOUNT AT WHICH INCOME (LOSS) FOR
NUMBER CARRIED AT DECEMBER 31, YEARS ENDED DECEMBER 31,
BUSINESS SEGMENTS AND OF ---------------------- ---------------------------
DESCRIPTION OF INVESTMENTS UNITS COST 1998 1997 1998 1997 1996
- ------------------------------ ------- -------- ------ ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSET MANAGEMENT
REAL ESTATE AFFILIATE
HALLWOOD REALTY PARTNERS, L.P. (A)
-- General partner interest............ $ 8,650 $3,877 $ 4,435 $ 77 $ 29 $ (101)
-- Limited partner interest............ 413,040 5,377 5,894 2,762 1,811 871 (1,630)
------- ------ ------- ------- ------- --------
Totals....................... $14,027 $9,771 $ 7,197 $ 1,888 $ 900 $ (1,731)
======= ====== ======= ======= ======= ========
ASSOCIATED COMPANY
SHOWBIZ PIZZA TIME, INC. (B)
-- Common stock.......................
Equity in earnings............... $ 1,139 $ 2,017
Gain on sale of shares........... 18,277 2,431
------- --------
Totals....................... $19,416 $ 4,448
======= ========
</TABLE>
The ownership percentages reported below assume conversion/exercise of all
convertible securities owned by the Company but no conversion/exercise of any of
the convertible securities owned by any other holder of such securities.
(A) In November 1990, the Company, through its former wholly owned
subsidiary Hallwood Realty Corporation ("HRC"), acquired from Equitec
Financial Group, Inc. ("Equitec") the general partnership interests in
eight Equitec sponsored and managed limited partnerships for
$8,650,000 and consummated the consolidation of such limited
partnerships into Hallwood Realty Partners, L.P. ("HRP"). See Note 13.
The Company subsequently acquired additional limited partner units of
HRP in direct and open market purchases. The Company accounts for its
investment in HRP on the equity method of accounting. In addition to
recording its share of net income (loss), the Company also records its
pro rata share of various partner capital transactions reported by
HRP. The Company's proportionate share of the underlying equity in net
assets of HRP exceeds its investment by $6,236,000, which is being
amortized on the straight-line basis over a period of 10 years.
The carrying value of the Company's investment in the general partner
interest of HRP includes the value of intangible rights to provide
asset management and property management services. Equitec initially
retained the property management rights for a three-year period
following the November 1990 consolidation. Beginning November 1993,
the Company commenced amortization, over a ten-year period, of that
portion of the general partner interest ascribed to the management
rights and such amortization was $672,000 for each of the years ended
December 31, 1998, 1997 and 1996.
Between December 1990 and February 1995, the Company purchased 89,269
limited partner units (post reverse split basis) for $905,000 in
various transactions. In March 1995, HRP completed a one-for-five
reverse split of its limited partner units and the Company purchased
30,000 post reverse split units (estimated to be the number of
fractional units to be purchased by HRP) for $356,000. In June 1995,
HRP announced a commission-free program for its limited partner
unitholders to sell their less than round lot holdings of 99 or fewer
units. As a result of this program, which expired in July 1995, HRP
acquired 293,539 limited partner units. These units were resold to the
Company for $4,115,000, which was the same price that HRP paid for
such units. In subsequent incidental transactions, the Company
acquired 232 additional units.
The carrying value of the Company's investment in HRP includes
non-cash adjustments for its pro rata share of HRP's partner capital
transactions with corresponding adjustments to additional paid-in
capital. The cumulative amount of such adjustments, from the original
date of investment through December 31, 1998, resulted in a
40
<PAGE> 42
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
$49,000 decrease in the carrying value of the HRP investment. In 1998,
the Company also recognized an extraordinary gain of $1,374,000 from
the recognition of the company's pro-rata share of HRP's $5,347,000
extraordinary gain from early extinguishment of debt.
During 1998, management completed a consolidation of the Company's
real estate assets into a new structure. Following the completion of
the consolidation, the general partner interest is owned by Hallwood
Realty, LLC ("Hallwood Realty") and the limited partner interest is
owned by HWG, LLC. The consolidation did not effect the carrying value
of the investments.
The Company has pledged 89,269 HRP limited partner units to
collateralize a $500,000 promissory note. See Note 6.
The quoted market price per unit and the Company's carrying value per
unit of the limited partner units of HRP (Quotron symbol HRY) at
December 31, 1998 were $59.50 and $14.27, respectively. The general
partner interest in HRP is not publicly traded.
As of December 31, 1998, the Company owned a 1% general partner and a
25% limited partner interest in HRP.
The following table sets forth summarized (unaudited) financial data
of Hallwood Realty Partners, L.P. as of and for the years ended
December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Balance Sheet Data
Real estate property, net ..................................... $175,779 $179,028
Total assets .................................................. 214,023 207,134
Mortgages payable ............................................. 162,078 157,911
Total partners' capital ....................................... 44,634 33,041
Statement of Operations Data
Revenue ....................................................... $ 56,680 $ 53,899
Income before extraordinary gain .............................. 6,246 2,357
Net income .................................................... 11,593 2,357
</TABLE>
The data used to compile the above table was obtained from Securities and
Exchange Commission filings on Form 10-K.
(B) The Company acquired its investment in ShowBiz Pizza Time, Inc.
("ShowBiz") in 1988 as a result of (i) a spin-off of ShowBiz, formerly
a 90%-owned subsidiary of Integra-A Hotel and Restaurant Company
("Integra"), (ii) common stock warrants it received as consideration
for providing a subordinated loan to ShowBiz and for arranging and
guaranteeing a $10,000,000 five-year secured senior loan, and (iii)
common stock warrants it received in connection with the conversion of
its subordinated loan into a floating rate subordinated bond, which
was called in November 1993. A portion of the Company's investment in
Integra, which was based upon the average of the quoted market values
of Integra and ShowBiz following the spin-off, was ascribed to the
initial investment in ShowBiz.
The Company accounted for its investment in ShowBiz using the equity
method of accounting because the Company maintained significant
influence by virtue of having five of its directors sitting on the
nine-member board of ShowBiz. In addition to recording its share of
net income (loss), the Company also recorded its pro rata share of
various shareholders' equity transactions reported by ShowBiz.
Between 1990 and 1996, the Company acquired additional shares through
the exercise of common stock warrants and common stock splits and sold
a portion of its shares. During 1996, the Company sold 262,500 shares
of common stock for $4,139,000, at a net gain of $2,431,000.
41
<PAGE> 43
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In January 1997, the Board of Directors of the Company authorized the
issuance of 267,709 treasury shares in exchange for 219,194 common
shares of ShowBiz from the Alpha and Epsilon Trusts, which are
associated with Messrs. Anthony J. Gumbiner and Brian M. Troup,
chairman and president of the Company, respectively. For purposes of
the exchange, the shares of both companies were valued at their
average closing price for the month of December 1996. The completion
of the exchange was contingent upon regulatory approval which was
received in March 1997.
In February 1997, ShowBiz filed a registration statement with the
Securities and Exchange Commission covering a proposed public offering
of 3,200,000 shares of common stock (2,305,371 shares of which were to
be sold by the Company and 894,629 shares by the Alpha and Epsilon
Trusts). The underwriters were also granted, and did exercise, an
option to purchase an additional 454,746 shares of common stock from
the Company and the Trusts to cover over-allotments. The Company had
determined to sell its shares to repay debt, utilize expiring federal
income tax loss carryforwards and focus on core investments. In March
1997, the Company completed the sale of its entire 2,632,983 ShowBiz
shares at $15.68 per share, net of underwriting commissions. A portion
of the proceeds from the sale were used to repay the $7,000,000 MLBFS
line of credit and the $4,000,000 promissory note as discussed in Note
6. The Company realized a gain of $18,277,000 from the sale.
Concurrent with the sale, all five directors of the Company who were
also directors of ShowBiz resigned from the ShowBiz board.
42
<PAGE> 44
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 3 -- OIL AND GAS PROPERTIES
The following tables summarize certain oil and gas information by category
(full cost method), cost and unproved mineral interest (at cost). The tables
relate to all of HEPGP, the Company and its energy subsidiaries proportionate
share of HEP's oil and gas properties, (in thousands):
(a) Category:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1998 1997
--------- ---------
<S> <C> <C>
Proved mineral interests ............................................. $ 122,807 $ 118,898
Unproved mineral interests ........................................... 442 278
Other property and equipment ......................................... -- 422
--------- ---------
123,249 119,598
Less: Accumulated depreciation, depletion, amortization and
property impairment ............................................ (111,770) (110,009)
--------- ---------
Oil and gas properties, net .................................... $ 11,479 $ 9,589
========= =========
</TABLE>
(b) Cost:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Property acquisition - proved ............... $3,408 $ 233 $ 279
Property acquisition - unproved ............. 164 121 87
Development ................................. 1,268 1,136 1,321
Exploration ................................. 725 834 100
------ ------ ------
Total .................................... $5,565 $2,324 $1,787
====== ====== ======
</TABLE>
Depreciation, depletion, amortization and impairment per equivalent barrel
of production for the years ended 1998, 1997 and 1996, was $4.23, $3.78 and
$3.54, respectively.
(c) Unproved mineral interests (at cost):
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1998 1997
---- ----
<S> <C> <C>
Exploration acreage ......................... $401 $209
Other ....................................... 41 69
---- ----
Total ................................. $442 $278
==== ====
</TABLE>
43
<PAGE> 45
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 4 -- HOTEL PROPERTIES
The following table summarizes the cost and accumulated depreciation and
amortization of the hotel properties as of the balance sheet dates (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1998 1997
-------- --------
<S> <C> <C>
Building improvements and equipment ........................ $ 35,866 $ 16,670
Land and land improvements ................................. 2,903 1,797
Leasehold acquisition costs ................................ 1,401 6,501
-------- --------
40,170 24,968
Less: Accumulated depreciation and amortization ............ (8,360) (10,800)
-------- --------
Total ................................................ $ 31,810 $ 14,168
======== ========
</TABLE>
At December 31, 1998, hotel properties consisted of (i) fee interests in
one Embassy Suites and two Residence Inns; (ii) leasehold interests in one
Residence Inn and one Holiday Inn and; (iii) certain real estate related to the
resort condominium hotel. In April 1999, all of the Residence Inn franchises
will terminate by mutual agreement and are expected to become GuestHouse
franchises.
NOTE 5 -- CASH AND CASH EQUIVALENTS
Cash and cash equivalents as of the balance sheet dates are as follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1998 1997
---- ------
<S> <C> <C>
Cash ........................................ $488 $ 985
Cash equivalents ............................ 281 3,752
---- ------
Total ................................. $769 $4,737
==== ======
</TABLE>
44
<PAGE> 46
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 6 -- LOANS PAYABLE
Loans payable at the balance sheet dates are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
------- -------
<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 ............................. 2,267 3,867
Textile Products .....................................................
Revolving credit facility, prime + .25%, due January 2000 ......... 9,900 13,800
Hotels ...............................................................
Term loan, 7.5%, fixed, due October 2008 .......................... 17,198 --
Term loan, 7.86% fixed, due January 2008 .......................... 6,667 6,750
Term loan, 8.20% fixed, due November 2007 ......................... 5,209 5,269
Term loan, libor + 7.5%, due October 2005 ......................... 1,280 --
------- -------
30,354 12,019
Total ......................................................... $43,021 $30,186
======= =======
</TABLE>
Further information regarding loans payable is provided below:
Real Estate
Promissory note. In connection with the settlement of an obligation related
to Integra, 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"). The Company accrued the
full amount of $500,000 as a charge to interest expense, of which $50,000,
$120,000 and $230,000 were recorded in the years ended December 31, 1998, 1997
and 1996, respectively.
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 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, HEPGP Ltd. ("HEPGP") amended, restated and
increased its credit agreement with First Union National Bank of North Carolina
("First Union"). The term loan in the original amount of $4,000,000 is
collateralized by the Company's HEP limited partner units and its investment in
HEPGP and Hallwood GP. HEPGP also pledged its direct interests in certain oil
and gas properties. Other significant terms include: (i) maturity date of May
15, 2000; (ii) monthly principal payments of $133,000, plus interest; (iii)
interest rate of LIBOR plus 3.5% (9.09% at December 31, 1998); (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. At December 31, 1998, the outstanding
balance was $2,267,000.
Long term obligations. Included in the consolidated balance sheets at
December 31, 1998 and 1997 are long-term obligations of HEP in the amount of
$5,306,000 and $4,731,000, respectively. These amounts represent the Company's
and its' subsidiaries share of HEP's outstanding long-term obligations which, at
December 31, 1998, consisted of a $49,700,000
45
<PAGE> 47
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
revolving credit agreement. HEP's borrowings are secured by a first lien on
approximately 80% in value of HEP's oil and gas properties.
Textile Products
In January 1997, Brookwood entered into a revolving credit facility in an
amount 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 facility expires on January 7, 2000 and bears interest, at Brookwood's
option, at one-quarter percent over prime (8.00% at December 31, 1998) 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 amount to $15,000,000 thereafter and to
change certain of the 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. As of
December 31, 1998, Brookwood had an additional $3,164,000 of borrowing base
availability. The facility contains covenants, which include maintenance of
certain financial ratios, restrictions on the amount of dividends and repayment
of debt or cash transfers to the Company. At December 31, 1998, the outstanding
balance was $9,900,000.
At December 31, 1998, Brookwood was not in compliance with two covenants
contained in the Credit Agreement, which requires a minimum consolidated capital
expenditure of $1,500,000 in a calendar year and a minimum ration of EBIDTA
(earnings before interest, depreciation, taxes and amortization) to consolidated
fixed charges of 1.00 to 1.00 for four consecutive quarters. 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."
Hotels
Term Loans. In September 1998, the Company formed two new 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
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. At
December 31, 1998, the outstanding balance was $17,198,000.
The mezzanine loan for $1,300,000 includes the following significant terms:
(i) interest rate of libor plus 7.5% (13.15% at December 31, 1998); (ii)
maturity date of October 2005; and (iii) prepayment permitted at any time
without penalty, upon 30-day notice to lender. At December 31, 1998, the
outstanding balance was $1,280,000.
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
Residence Inn 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 balance at December 31, 1998 was $6,667,000.
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
Residence Inn 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
46
<PAGE> 48
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
yield maintenance provisions and; (iv) various other financial and non-financial
covenants. The outstanding balance at December 31, 1998 was $5,209,000.
Associated Company
Line of credit. In April 1994, the Company obtained a line of credit from
Merrill Lynch Business Financial Services ("MLBFS") which replaced a former
margin loan. Significant terms of the line of credit were (i) interest rate --
prime plus 0.75%; (ii) collateral -- 2,159,047 shares of ShowBiz common stock;
and (iii) availability limited to 50% of the market value of the pledged shares
of ShowBiz. The maturity date was extended to April 30, 1997, and the maximum
commitment amount was increased to $7,000,000. The line of credit was repaid in
March 1997 from proceeds of sale of the Company's ShowBiz investment as
discussed in Note 2.
Promissory note. The Company issued a $4,000,000 promissory note to the
Integra Unsecured Creditors' Trust (the "Trust") in connection with the
consummation of the Integra Plan of Reorganization. Significant terms were (i)
maturity date - March 8, 1997; (ii) interest rate - 5% fixed; (iii) collateral -
517,242 shares of ShowBiz common stock; and (iv) the Trust was entitled to an
additional payment at the "Payment Date", as defined, in an amount equal to 100%
of the increase in the market value of the ShowBiz shares over the base amount
of $16.67 per share, the ("ShowBiz Participation Amount"). As the ShowBiz per
share price was $18.12 at December 31, 1996, the Company accrued $755,000 for
the ShowBiz Participation Amount as a charge to interest expense in the year
ended December 31, 1996. Although the Company had accrued the ShowBiz
Participation Amount, it contended that proper tender of payment and accrued
interest was made in October 1996, and therefore no ShowBiz Participation Amount
was owed. As the Trust contended that the promissory note did not provide for
prepayment, and that both the promissory note and ShowBiz Participation Amount
were owing, the Company filed suit to resolve the matter.
In connection with the disposition of the Company's entire ShowBiz
investment in March 1997, the Company and the Trust entered into an agreement
(the "Partial Compromise and Settlement Agreement"), whereby the Trust consented
to the sale of the 517,242 shares of ShowBiz in exchange for (i) the repayment
of the $4,000,000 principal amount of the note and accrued interest through
October 11, 1996 and (ii) the deposit of $2,513,000 (the "Full Escrowed Amount")
into an escrow account, which was a combination of the disputed ShowBiz
Participation Amount and the balance of accrued interest to the maturity date.
In July 1997 the Company entered into a Compromise and Settlement
Agreement, whereby (i) the parties agreed that the Full Escrowed Amount would be
equally divided between the Trust and the Company and (ii) mutual releases would
be executed, in respect to the civil action in the United States District Court,
Case No. 3-96CV309DG, for the Northern District of Texas, Dallas Division.
Accordingly, the Company received settlement proceeds of $1,256,500 plus accrued
interest on July 31, 1997.
Schedule of Maturities. Maturities of aggregate loans payable and
debentures for the next five years, are as follows (in thousands):
<TABLE>
<CAPTION>
BUSINESS SEGMENT
--------------------------------------------------------------
YEARS ENDED REAL TEXTILE
DECEMBER 31, ESTATE ENERGY (a) PRODUCTS HOTELS OTHER (b) TOTAL
------------ -------- ---------- ---------- --------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
1999 ................................... $ 500 $1,600 $3,900 $ 545 $ -- $ 6,545
2000 ................................... -- 667 6,000 595 14,088 21,350
2001 ................................... -- -- -- 651 -- 651
2002 ................................... -- -- -- 711 -- 711
2003 ................................... -- -- -- 781 -- 781
Thereafter ................................ -- -- -- 27,071 6,468 33,539
-------- ------ ------ ------- ------- -------
Total .............................. $ 500 $2,267 $9,900 $30,354 $20,556 $63,577
======== ====== ====== ======= ======= =======
</TABLE>
47
<PAGE> 49
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
- ------------------
(a) HEP's long-term indebtedness of $49,700,000 is not a direct obligation of
HEPGP or of the Company. HEP's debt maturities are as follows: $9,319,000
in 1999; $12,425,000 in 2000; $12,425,000 in 2001; $12,425,000 in 2002 and
$3,106,000 in 2003.
(b) Maturities for the 7% and 10% Debentures, excludes net unamortized gain
from exchange of $979,000 as discussed in Note 7.
48
<PAGE> 50
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 7 -- DEBENTURES
13.5% Subordinated Debentures. In May 1989, the Company distributed to its
stockholders $46,318,600 aggregate principal amount of a new issue of its 13.5%
Subordinated Debentures Due July 31, 2009 (the "13.5% Debentures"). The Company
had authorized the issuance of up to $100,000,000 aggregate principal amount of
13.5% Debentures. The 13.5% Debentures were subordinate to bank borrowings,
guarantees of the Company and other " Senior Indebtedness" (as defined in the
indenture relating to the 13.5% Debentures). Ten dollars principal amount of the
13.5% Debentures was distributed for each share of common stock of the Company
outstanding at the close of business on March 31, 1989.
Interest on the 13.5% Debentures was payable annually on August 15, and, at
the Company's option, up to two annual interest payments in any five-year period
could be paid in-kind by the issuance of additional 13.5% Debentures in lieu of
cash. The Company exercised this option and had paid the annual interest
payments in-kind for the 1991, 1992, 1996 and 1997 interest payments.
Tender Offer for and Redemption of 13.5% Debentures. In June 1997, pursuant
to a self-tender offer for up to $20,000,000 of its 13.5% Debentures,
debentureholders tendered and the Company repurchased $12,875,000 principal
value of 13.5% Debentures during the offer period. The offer price was $105 per
$100 principal amount, and aggregated $13,519,000 for all debentures properly
tendered. As no interest was paid to debentureholders accepting the offer, the
Company recognized an extraordinary gain from early debt extinguishment of
$877,000, attributable to the amount of accrued interest to the expiration of
the self-tender offer less the principal amount of premium.
In November 1997, the Company redeemed the $14,287,000 remaining balance of
its outstanding 13.5% Debentures. The redemption price was 100% of the principal
amount plus accrued interest to the redemption date of December 19, 1997.
7% Collateralized Senior Subordinated Debentures. In March 1993, the
Company completed an exchange offer (the "1993 Exchange Offer") whereby
$27,481,000 of its 13.5% Debentures were exchanged for a new issue of 7%
Collateralized Senior Subordinated Debentures due July 31, 2000 (the "7%
Debentures"), and purchased for cash $14,538,000 of its 13.5% Debentures at 80%
of face amount. Interest is payable quarterly in arrears in cash. The 7%
Debentures are secured by a pledge of the capital shares of the Brookwood and
Hallwood Hotels subsidiaries. The common and preferred stock of Brookwood are
also subject to a prior pledge in favor of BNY.
The Company accounted for the 1993 Exchange Offer in accordance with
Statement of Financial Accounting Standards No. 15 -- Accounting by Debtors and
Creditors for Troubled Debt Restructuring ("SFAS No. 15"). SFAS No. 15 requires
that concessions given the Company by 13.5% debentureholders should be accounted
for as a modification of an existing obligation and no current period gain
should be recognized. The amount of unrecognized gain was $4,220,000, and is
being amortized, using the constant effective interest rate method over the term
of the 7% Debentures. The total unrecognized gain was recorded as an increase to
the carrying value of the 7% Debentures, and is being amortized as a reduction
of interest expense. This amortization results in an effective interest rate of
approximately 4.2% for the 7% Debentures. The amortization of such unrecognized
gain was $492,000, $600,000 and $577,000 for the years ended December 31, 1998,
1997 and 1996, respectively.
Between 1994 and 1998, the Company repurchased 7% Debentures having a
principal value of $4,673,000, and completed an exchange offer for $6,467,830
principal amount. These repurchases satisfied the Company's obligation to retire
10% of the issue ($2,748,000) prior to March 1996 and partially satisfied the
Company's obligation to retire an additional 15% of the original issue prior to
March 1998. In January 1998, the Company repurchased 7% Debentures with a
principal amount of $2,253,000 for $2,146,000, to fully satisfy the balance of a
sinking fund requirement contained in the Indenture. The 1998 repurchase
resulted in an extraordinary gain from debt extinguishment of $107,000.
10% Subordinated Debentures. In June 1998, the Company announced a
commission-free exchange offer (the "1998 Exchange Offer") to all holders of 7%
Debentures. The Company offered to exchange 7% Debentures for a new issue of 10%
Collateralized Subordinated Debentures, due July 31, 2005, in the ratio of $100
principal amount of 10% Debentures for each $100 principal amount of 7%
Debentures tendered. Terms and conditions of the 1998 Exchange Offer were
described in an exchange offer circular, dated June 22, 1998, and a supplemental
modification letter dated July 31, 1998,
49
<PAGE> 51
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 1998 Exchange Offer.
The 10% Debentures were listed on The New York Stock Exchange and commenced
trading on Monday, 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 for financial
reporting 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 subordinated
and junior lien on the capital stock of the Brookwood and Hallwood Hotels, Inc.
subsidiaries which are also pledged to secure the 7% Debentures.
Balance sheet amounts for the 7% and 10% Debentures are detailed below (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
DESCRIPTION 1998 1997
----------- -------- --------
<S> <C> <C>
7% Debentures (face amount).......................................................... $14,088 $22,808
Unamortized gain from exchange, net of accumulated amortization...................... 639 1,484
------- -------
Totals........................................................................ $14,727 $24,292
======= =======
10% Debentures (face amount)......................................................... $ 6,468
Unamortized gain from exchange, net of accumulated amortization...................... 340
-------
Totals........................................................................ $ 6,808
=======
</TABLE>
NOTE 8 -- REDEEMABLE PREFERRED STOCK
In connection with the February 1995 settlement of certain related
lawsuits, the Company agreed to issue 250,000 shares of a newly-designated
series of preferred stock (the "Series B Preferred Stock") to the plaintiffs in
these lawsuits in exchange for the dismissal of all of these actions. The
holders of Series B Preferred Stock are entitled to dividends in an annual
amount of $0.20 per share (total amount of $50,000), which have been paid in
1996, 1997 and 1998. For the first five years, dividends are cumulative and the
payment of cash dividends on any common stock is prohibited before the full
payment of any accrued dividends. Thereafter, dividends will accrue and be
payable only if and when declared by the Board of Directors. The Series B
Preferred Stock also has dividend and liquidation preferences to the Company's
common stock. The shares are subject to mandatory redemption 15 years from the
date of issuance, at 100% of the liquidation preference of $4.00 per share plus
all accrued and unpaid dividends, and may be redeemed at any time on the same
terms at the option of the Company. The holders of the shares of Series B
Preferred Stock are not entitled to vote on matters brought before the Company's
stockholders, except as otherwise provided by law.
NOTE 9 -- STOCKHOLDERS' EQUITY
Common Stock. The number of outstanding shares of common stock does not
include treasury shares. See "Treasury Stock" below. The Company's Second
Restated Certificate of Incorporation contains a provision that restricts
transfers of the Company's common stock in order to protect certain federal
income tax benefits.
Preferred Stock. Under its Second Restated Certificate of Incorporation the
Company is authorized to issue 500,000 shares of preferred stock, par value $.10
per share, and did issue 250,000 shares of newly designated Series B Preferred
Stock, as discussed in Note 8.
50
<PAGE> 52
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Treasury Stock. Treasury stock consists of shares of common stock
repurchased by the Company. During 1998, the Company repurchased 7,006 shares of
its common stock from the estate of a former director at a cost of $250,000. As
of December 31, 1998 and 1997, the Company held 342,453 and 335,447 treasury
shares, respectively.
Commission-Free Offer to Purchase Common Stock. In June 1996, the Company
announced a commission-free offer (the "Offer") program for stockholders holding
99 or fewer shares of the Company's common stock as of the record date to sell
their shares to the Company. The Offer allowed eligible stockholders to sell
all, but not less than all, of their shares to the Company without incurring any
brokerage commission. The price paid by the Company was $14.00 per share, which
was higher than the average of the closing market prices of the shares for the
five trading days immediately preceding the Record Date, as reported by the Wall
Street Journal. In July 1996, the Offer terminated resulting in the Company's
purchase of 28,126 shares (1.76% of the total outstanding shares) from 1,590
stockholders at a total cost of $394,000 and are included in treasury shares.
Reissuance of Treasury Stock. In January 1997 the Board of Directors
authorized an exchange of 267,709 treasury shares acquired in the merger with
HEC for 219,194 shares of ShowBiz from the Alpha and Epsilon Trusts, as
discussed in Note 2.
Tender Offer for Common Stock. In June 1997, the Company conducted a
self-tender offer for up to 300,000 shares of its common stock at $27.50 per
share, terms and conditions of which were discussed in the offering document.
Stockholders tendered a total of 328,346 shares, of which the Company accepted
304,461 shares as permitted by the offering documents, for a total purchase
price of $8,373,000.
Stock Options. All options issued under the 1995 Stock Option Plan for The
Hallwood Group Incorporated Plan are nonqualified stock options. The exercise
prices of all options granted were at the fair market value of the Company's
common stock on the date of grant, expire ten years from date of grant and were
fully vested and exercisable on the date of grant. During 1998, the Company
reacquired 10,000 options from the estate of a former director at a cost of
$144,700 which was expensed.
Below is the status of 1995 Stock Option Plan as of December 31, 1998:
<TABLE>
<S> <C> <C>
Total options authorized................... 136,000
Less: Options granted, not exercised:
September 1997................... (63,000) Exercise price of $26.06, expiring September 2007
February 1997.................... (8,250) Exercise price of $22.50, expiring February 2007
September 1996................... (46,500) Exercise price of $11.75, expiring September 2006
June 1995........................ (8,250) Exercise price of $11.50, expiring June 2005
--------
Options available for grant................ 10,000
========
</TABLE>
51
<PAGE> 53
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 Accounting for Stock Based Compensation
("SFAS No. 123"). Accordingly, no compensation cost has been recognized for the
options. Had compensation costs for the options been determined based on the
fair value at the grant date for the awards under the 1995 Stock Option Plan
consistent with the provisions of SFAS No. 123, the Company's net income and net
income per share would have been the pro forma amounts indicated below (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1997 1996
---------- ----------
<S> <C> <C>
Net income - as reported............................................. $12,847 $6,523
Net income - pro forma............................................... 11,750 6,222
Net income per share - as reported
Basic............................................................. 9.10 4.93
Assuming dilution................................................. 8.77 4.89
Net income per share - pro forma....................................
Basic............................................................. 8.32 4.70
Assuming dilution................................................. 8.02 4.66
</TABLE>
The fair value of the options granted are estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions:
expected volatility of 55%, risk-free interest rate of 6.0%-6.7%, expected life
of 5 years and no distribution yield. The Company issued no options during 1998
and all options previously issued were fully vested at December 31, 1997.
NOTE 10 -- INCOME TAXES
The following is a summary of the income tax provision (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Federal
Deferred tax (benefit)........................ $(4,308) $8,960 $(5,071)
Current tax................................... 745 652 183
State .......................................... 448 296 363
------- ------ -------
Total..................................... $(3,115) $9,908 $(4,525)
======= ====== =======
</TABLE>
Reconciliations of the expected tax or (benefit) at the statutory tax rate
to the effective tax are as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Expected tax or (benefit) at the statutory tax rate ... $ 1,344 $ 7,737 $ 679
Expired NOLs .......................................... 3,309 6,813 --
Decrease in deferred tax asset valuation
allowance .......................................... (9,092) (5,694) (5,879)
Alternative minimum tax ............................... 745 652 183
State taxes ........................................... 296 196 240
Foreign loss not taxable .............................. (3) 59 190
Other ................................................. 286 145 62
------- ------- -------
Effective tax or (benefit) ............................ $(3,115) $ 9,908 $(4,525)
======= ======= =======
</TABLE>
52
<PAGE> 54
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
As a result of significant appreciation in the market value of the
Company's HRP limited partner units in 1997 and 1998, management determined that
the deferred tax asset should be increased to reflect the substantial gain that
would result from the sale of the HRP investment. Accordingly the Company
recorded a deferred tax benefit of $4,308,000 in 1998, which increased the
deferred tax asset to $6,348,000 at December 31, 1998.
During 1998, management completed a consolidation of the Company's real
estate assets. The assets were transferred at market value into a new structure
and, although the book basis of the assets was not changed, the consolidation
resulted in the recognition of a significant tax gain in 1998. Certain of the
Company's NOL carryforwards were utilized to reduce the related income tax
effect of the consolidation, although the Company recorded a current federal
charge for alternative minimum tax and state tax expense.
As a result of the appreciation in the market value of the Company's
investment in ShowBiz during 1996, management had determined that the deferred
tax asset should be increased at December 31, 1996 to reflect the anticipated
realization of future tax benefits. Accordingly, the deferred tax asset was
increased to $11,000,000 at December 31, 1996, from $5,929,000 at December 31,
1995, with a corresponding deferred tax benefit in 1996 of $5,071,000. In 1997,
concurrent with the sale of the ShowBiz investment, the Company recorded an
$8,960,000 non-cash federal deferred tax charge.
The Company incurred a federal alternative minimum tax of $745,000,
$682,000 and $146,000 for the years ended December 31, 1998, 1997 and 1996,
respectively, due to the utilization of net operating loss carryforwards
("NOLs") to offset taxable income. The accrued income tax payable of $887,000
and $113,000 at December 31, 1998 and 1997, respectively, is included in the
interest and other accrued expenses line item of the Company's balance sheet.
A schedule of the types and amounts of existing temporary differences and
NOL's, at the blended statutory tax rate of 34%, tax credits and valuation
allowance as of the balance sheet dates are as follows (in thousands):
<TABLE>
<CAPTION>
DEFERRED TAX
--------------------------------------------------------
DECEMBER 31, 1998 DECEMBER 31, 1997
-------------------------- -------------------------
ASSETS LIABILITIES ASSETS LIABILITIES
--------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Net operating loss carryforward ............................. $ 18,974 $ -- $35,086 $ --
Equity in earnings (losses) of unconsolidated
affiliates ............................................... 2,135 -- 3,325 (938)
Tax credits ................................................. 2,994 -- 2,216 --
Original issue discounts and cancellation of debt
income on debentures ..................................... 1,996 -- 2,102 --
Reserves recorded for financial statement purposes
and not for tax purposes ................................. 519 -- 466 --
Other temporary differences ................................. -- (86) 159 (185)
Depreciation and amortization ............................... -- (609) -- (720)
Basis differences ........................................... 10,703 -- -- --
-------- -------- ------- --------
Deferred tax assets and liabilities ......................... 37,321 $ (695) 43,354 $ (1,843)
======= ========
Less: Deferred tax liabilities .............................. (695) (1,843)
-------- -------
36,626 41,511
Less: Valuation allowance ................................... (30,278) (39,471)
-------- -------
Deferred tax asset, net .............................. $ 6,348 $ 2,040
======== ========
</TABLE>
53
<PAGE> 55
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Below is a schedule of expiring NOLs by year (in thousands):
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31, NOLs
------------ ----------
<S> <C>
2001...................................... $ 793
2004...................................... 447
2005...................................... 2,748
2006...................................... 22,144
2007...................................... 8,517
2008...................................... 12,896
2009...................................... 6,916
2010...................................... 1,346
---------
Total..................................... $ 55,807
=========
</TABLE>
In addition, the Company has approximately $2,178,000 of alternative
minimum tax credits which have no expiration date, a depletion carryforward of
approximately $6,311,000, which may be used to offset future taxable income
without an expiration limitation and an investment tax credit carryforward of
approximately $816,000, which expires in 2001.
Current tax laws and regulations relating to specified changes in ownership
may limit the Company's ability to utilize its NOLs and tax credit
carryforwards. As of December 31, 1998, management was not aware of any
ownership changes which would limit the utilization of the NOLs and tax credit
carryforwards.
NOTE 11 -- EXTRAORDINARY GAIN FROM EARLY EXTINGUISHMENT OF DEBT
The Company recognized an extraordinary gain from early extinguishment of
debt of $1,481,000 in the year ended December 31, 1998. The gain resulted from
(i) the January 1998 repurchase of 7% Debentures having a face amount of
$2,253,000 for a discounted amount of $2,146,000 resulting in a gain of
$107,000; and (ii) a $1,374,000 gain from the recognition of the Company's
pro-rata share of a $5,347,000 extraordinary gain from early extinguishment of
debt reported by HRP during 1998. In the year ended December 31, 1997, the
Company recorded a net extraordinary gain from debt extinguishment of $200,000.
Of this amount, $877,000 was attributable to the gain from the partial
repurchase of 13.5% Debentures in June 1997, offset by $677,000 of losses from
the refinancing of the Company's Residence Inn hotels in Tulsa, Oklahoma and
Greenville, South Carolina.
54
<PAGE> 56
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 12 -- SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS
Supplemental schedule of non-cash investing and financing activities. The
following transactions affected recognized assets or liabilities but did not
result in cash receipts or cash payments (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
DESCRIPTION 1998 1997 1996
------------------------ ------ ------ ------
<S> <C> <C> <C>
Exchange of 7% Debentures for a new issue of 10% Debentures ............. $6,821 $ -- $ --
Issuance of treasury stock in exchange for common shares of ShowBiz:
Investment in ShowBiz ................................................ -- 3,820 --
Reduction of additional paid-in capital .............................. -- 2,626 --
------ ------ ------
Reduction in treasury stock .......................................... -- 6,446 --
Payment in-kind of annual interest on 13.5% Debentures .................. -- 1,524 2,817
Repayment of note payable from funds held in restricted cash ............ -- 375 --
Recording of proportionate share of stockholders' equity/
partners' capital transactions of equity investments ................. -- 143 96
Supplemental disclosures of cash payments:
Interest paid ........................................................... $4,168 $7,244 $4,625
Income taxes paid ....................................................... 396 853 482
</TABLE>
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 13 -- ORGANIZATION AND OPERATIONS OF HALLWOOD REALTY PARTNERS, L.P.
Organization. In November 1990, the Company, through its former wholly
owned subsidiary Hallwood Realty Corporation, acquired from Equitec Financial
Group, Inc. ("Equitec"), the general partnership interests in eight Equitec
sponsored and managed limited partnerships for $8,650,000 and consummated the
consolidation of such partnerships into Hallwood Realty Partners, L.P. ("HRP").
The Company subsequently acquired additional limited partner units of HRP in
direct and open market purchases. During 1998, management completed a
consolidation of the Company's real estate assets into a new structure involving
several new wholly owned entities. Following the completion of the
consolidation, the general partner interest is owned by Hallwood Realty, LLC
("Hallwood Realty") and the limited partner interest is owned by HWG, LLC. The
consolidation did not effect the carrying value of the investments.
As general partner, Hallwood Realty earns an asset management fee and
related fees from HRP properties, which amounted to $495,000, $466,000 and
$467,000 for the years ended December 31, 1998 and 1997 and 1996, respectively.
The Company's Hallwood Commercial Real Estate, LLC ("HCRE") subsidiary is
responsible for day-to-day on-site property management at all of HRP's
properties for which HCRE receives management fees, leasing commissions and
other fees. HCRE earned fees and commissions from HRP and other third parties
aggregating $5,430,000, $5,841,000 and $5,205,000 during the years ended
December 31, 1998, 1997 and 1996, respectively.
NOTE 14 -- ORGANIZATION AND OPERATIONS OF HALLWOOD ENERGY CORPORATION AND HEPGP
LTD.
Organization. In May 1990, the Company acquired a majority interest in
Hallwood Energy Corporation ("HEC") through a step acquisition (as that concept
is referred to in Accounting Principles Bulletin No. 16). Prior to that date the
Company owned approximately 11% of HEC (38% assuming conversion of preferred
stock) and accounted for the investment under the equity method of accounting.
In May 1990, the Company converted its 44,846 shares of HEC's Series D preferred
stock into 17,938,400 shares of common stock. No consideration was paid by the
Company in connection with the conversion other than the surrender of its Series
D preferred stock. The Company also purchased 8,000,000 shares of HEC common
stock, in consideration for the cancellation of the principal amount of a
$1,500,000 note receivable from HEC,
55
<PAGE> 57
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
all pursuant to the terms of a letter agreement dated May 3, 1990. As a result
of (i) the stock issuance from these two transactions, (ii) additional purchases
of 37,312 HEC shares in 1995; (iii) a 1-for-50 reverse split; (iv) the
conversion of 356,000 shares of its Series E Preferred Stock for 356,000 shares
of common stock; and (v) subsequent purchases by HEC, between May 1990 and the
merger date, of its own common stock for treasury, the Company owned 633,917
shares of common stock of HEC (approximately 82%) prior to the tender offer and
merger discussed below.
Tender Offer for Minority Shares and Merger of HEC into the Company. In
October 1996, the Company and HEC announced that the two companies had entered
into a definitive merger agreement providing for the merger of HEC into the
Company. Prior to the merger, the Company agreed to commence a tender offer for
all of the 143,209 outstanding shares of HEC not currently owned by the Company,
at a price of $19.50 per share, subject to the terms and conditions of the
tender offer documents.
The Board of Directors of HEC and a special committee of the board of
directors of HEC unanimously approved the tender offer and merger and determined
that the terms of the tender offer and the merger were fair to and in the best
interest of the stockholders of HEC. The board of directors of HEC had
recommended that all stockholders of HEC accept the tender offer and tender
their shares. The completion of the transaction was conditioned upon, among
other things, the valid tender of a majority of the HEC shares not currently
held by the Company, which together with the shares currently held by the
Company, would constitute at least 90% of the issued and outstanding shares of
HEC.
The tender offer expired on November 22, 1996. The tendered shares
represented in excess of 10% of the remaining outstanding shares of HEC. As a
result of the tenders, the Company owned in excess of 92% of the total
outstanding shares of HEC and, on November 22, 1996, the merger of HEC into the
Company was consummated. At December 31, 1998 and 1997, the Company had included
$395,000 in accounts payable, representing the amount due the former HEC
shareholders who have yet to surrender their minority shares at $19.50 per
share.
Certain assets acquired by the Company from the merger were subsequently
transferred to two wholly owned entities, HEPGP and Hallwood G.P., Inc., the
general partner of HEPGP. The Company's energy operations are now conducted
primarily through HEPGP.
The $200,000 value of the net assets acquired in excess of the purchase
price was allocated to oil and gas properties and reduced the full cost pool,
and will be amortized over the productive life of the underlying proved reserves
using the units of production method. HEC's results of operations have been
included in the consolidated statements of operations since May 1990, including
recognition of the minority interest in net income (loss) to the merger date, in
the consolidated statement of operations.
As further discussed in Note 18, certain HEC minority shareholders filed
lawsuits in connection with the tender offer and subsequent merger. The Company
entered into a letter agreement in November 1998 to stipulate the tentative
terms of settlement for the lawsuits. In general, the settlement provides for
the payment of $24.00 per share for all 143,209 shares purchased by the Company
in the tender offer and subsequent merger. The settlement amount of $644,000 has
been accrued by HEPGP and added to the full cost pool at December 31, 1998 and
will be payable 30 days after entry of a final order approving the settlement.
Proposed Consolidation Plan. In December 1998, HEP and its affiliate,
Hallwood Consolidated Resources Corporation ("HCRC"), a publicly-traded oil and
gas company (NASDAQ: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. After the consolidation, the common
stock of Hallwood Energy Corporation will be owned 56% by the current Class A
unitholders of HEP, 26% by the current stockholders of HCRC and 18% by the
Company. HEP's current Class C unitholders will receive redeemable preferred
stock in the new entity.
Because of the larger size of the new corporation, 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. Hallwood Energy Corporation will focus on reserve growth. A Joint Proxy
Statement/Prospectus for the consolidation was filed with the Securities and
Exchange Commission on December 30,
56
<PAGE> 58
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
1998 and is proceeding through the usual SEC comment process. It is presently
anticipated that the Joint Proxy Statement/Prospectus will be mailed to HEP
unitholders and HCRC stockholders in April and the consolidation will be
concluded in May 1999. There can be no assurance, however, that all conditions
will be satisfied by that time.
Operations. The Company's HEP affiliate routinely enters into financial
contracts for hedging transactions of its crude oil and natural gas production.
Management does not consider the portion attributable to the Company to be
significant.
NOTE 15 -- ORGANIZATION AND OPERATIONS OF BROOKWOOD COMPANIES INCORPORATED
Organization. Brookwood Companies Incorporated, a wholly owned subsidiary
of the Company ("Brookwood"), was formed in March 1989 to acquire certain assets
and assume certain liabilities of a nylon textile converting and finishing
company. Brookwood is a complete textile service firm that develops and produces
innovative fabrics and related products through specialized finishing, treating
and coating processes.
Operations. Brookwood maintains factoring agreements which provide that
receivables resulting from credit sales to customers, excluding the U.S.
Government, may be sold to the factor without recourse, subject to a commission
of 0.7% and the factor's prior approval. Commissions paid to the factors were
approximately $417,000, $441,000 and $330,000 for the years ended December 31,
1998, 1997 and 1996, respectively.
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1997
------- --------
<S> <C> <C>
Raw materials............................................................ $ 3,387 $ 5,307
Work in process.......................................................... 4,555 3,239
Finished goods........................................................... 9,224 9,849
------- -------
17,166 18,395
Less: Obsolescence reserve............................................... (458) (460)
------- -------
Total................................................................. $16,708 $17,935
====== ======
</TABLE>
Property, plant and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1997
-------- --------
<S> <C> <C>
Land .................................................... $ 391 $ 391
Buildings and improvements .............................. 4,333 4,314
Leasehold improvements .................................. 133 121
Machinery and equipment ................................. 9,780 8,591
Office furniture and equipment .......................... 2,122 1,872
Construction in progress ................................ 834 1,297
-------- --------
17,593 16,586
Less: Accumulated depreciation .......................... (8,855) (7,529)
-------- --------
Total ................................................ $ 8,738 $ 9,057
======== ========
</TABLE>
NOTE 16 -- FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined using available
market information or other appropriate valuation methodologies that require
considerable judgment in interpreting market data and developing estimates.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts that the Company could realize in a current market exchange. The use
of different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts.
57
<PAGE> 59
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The fair value of financial instruments that are short-term or reprice
frequently and have a history of negligible credit losses are considered to
approximate their carrying value. These include cash and cash equivalents,
restricted cash, short term receivables, accounts payable and other liabilities.
Investments accounted for under the equity method, hotel and real estate
properties and other assets consist of nonfinancial instruments, which are
excluded from the scope of the applicable accounting pronouncement.
Management has reviewed the carrying value of its loans payable, 7%
Debentures and 10% Debentures in connection with interest rates currently
available to the Company for borrowings with similar characteristics and
maturities. Management has determined that the estimated fair value of the loans
payable would be approximately $42,339,000 and $30,186,000 at December 31, 1998
and 1997, compared to the carrying value of $43,021,000 and $30,186,000,
respectively. The estimated fair value of the 7% and 10% Debenture issues is
$19,006,000 and $21,468,000, based on market prices on the New York Bond
Exchange, compared to the carrying values of $21,535,000 and $24,292,000 at
December 31, 1998 and 1997, respectively.
As of December 31, 1998 and 1997, the fair value information presented
herein is based on pertinent information available to management. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore current estimates of fair value may differ significantly from the
amounts presented herein.
NOTE 17 -- RELATED PARTY TRANSACTIONS
HSC Financial Corporation. Effective August 1, 1994, the Company entered
into a consulting agreement with HSC Financial Corporation ("HSC"), a
corporation with which Messrs. Gumbiner and Troup are associated, pursuant to
which HSC agreed to provide international consulting and advisory services to
the Company and its affiliates for an annual fee of $350,000, excluding
reimbursement for out-of-pocket and other reasonable expenses. This consulting
agreement was terminated effective December 31, 1996.
Effective December 31, 1996, the compensation committee approved a
financial consulting contract with HSC, which provides for HSC to furnish and
perform international consulting and advisory services to the Company and its
subsidiaries, including strategic planning and merger activities, for annual
compensation of $825,000. The annual amount is payable in monthly installments,
as a retainer to secure the availability of HSC to perform such services as and
when required by the Company. This contract had an original termination date of
July 31, 1998, however, it automatically renews for one year periods if not
terminated by the parties beforehand. In addition, the Board of Directors
awarded bonuses to HSC in March 1997 in the amount of $100,000 from the Company
and $139,000 from its HCRE subsidiary, and in March 1998 in the amount of
$500,000 from the Company and $323,000 from its HCRE subsidiary.
Hallwood Petroleum, Inc. Effective August 1, 1994, Hallwood Petroleum, Inc.
("HPI"), a wholly owned subsidiary of HEP, entered into a compensation agreement
with Mr. Gumbiner, pursuant to which Mr. Gumbiner is to consult with and assist
HPI and its energy affiliates in connection with their present and future
international activities. HPI paid Mr. Gumbiner annual compensation of $250,000.
This compensation agreement was terminated effective December 31, 1996.
The Company entered into a financial consulting agreement with HPI, dated
as of June 30, 1994, which provided that the Company or its agent provide
consulting services to HPI for compensation at the rate of $300,000 per year.
The Board of Directors compensation committee determined that these services
would be most appropriately provided by HSC, acting as the Company's agent,
through the services of Mr. Gumbiner and Mr. Troup, and that as consideration
for these services the Company would pay to HSC the fee to which the Company is
entitled under the agreement. Of the $300,000 payment made in June 1996,
approximately $9,000, was paid by HEC, and the remainder by HEP and other
affiliates of HEP. This financial consulting agreement was terminated effective
December 31, 1996, and replaced by a new financial consulting agreement, dated
as of December 31, 1996 on substantially the same terms and conditions, apart
from an increase in amount of compensation to $550,000 per annum. Approximately
$13,000 of such fees paid in 1998 and 1997 were paid by HEPGP, and the remainder
by HEP and other affiliates of HEP.
Expenses. Pursuant to an existing agreement, the Company reimburses HSC for
reasonable and necessary expenses in providing office space and administrative
services. The Company paid HSC $325,000, $299,000 and $307,000 for the years
58
<PAGE> 60
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
ended December 31, 1998, 1997 and 1996, respectively. Of the amounts paid, the
Company incurred $65,000, $60,000 and $58,000 of expense for the years ended
December 31, 1998, 1997 and 1996, respectively. The remainder was reimbursed by
HRP, HEPGP, HEP and other affiliates of HEP.
Exchange. On January 3, 1997, the Board of Directors of the Company
authorized the issuance of 267,709 common shares of the Company (formerly owned
by HEC, and considered treasury shares) in exchange for 219,194 common shares of
ShowBiz from the Alpha and Epsilon Trust, which are associated with Messrs.
Anthony J. Gumbiner and Brian M. Troup, respectively. For purposes of the
exchange, the shares of both companies were valued at their average closing
price for the month of December 1996. The completion of the exchange was
contingent upon regulatory approval, which was received on March 12, 1997.
Other. As described in Note 18, the Board of Directors authorized the
Company to loan Mr. Gumbiner the amount needed to satisfy the personal
assessment due the Securities and Exchange Commission in accordance with the
terms of a settlement agreement of its claims. The original amount of the
promissory note, dated July 25, 1996, was $477,000 and the outstanding balance
at December 31, 1997 was $366,000. The remaining balance of the promissory note
was paid in full in March 1998.
The Company shares common offices, facilities and staff with Stanwick
Holdings, Inc. ("Stanwick"). The Company pays the common general and
administrative expenses of the two entities and charges Stanwick a management
fee for its allocable share of the expenses. Stanwick reimbursed the Company
$37,000, $6,000 and $25,000 for the years ended December 31, 1998, 1997 and
1996, respectively. Stanwick is a subsidiary of Luxembourg-based Hallwood
Holdings S.A. ("HHSA"). Anthony J. Gumbiner and Brian M. Troup are directors of
HHSA. Melvin J. Melle is chief financial officer of HHSA and Stanwick.
During 1998, the Company repurchased 7,006 shares of common stock and
10,000 options to purchase shares of common stock from the estate of former
director, Robert L. Lynch, at a cost of $250,000 and $144,700, respectively.
NOTE 18 -- LITIGATION, CONTINGENCIES AND COMMITMENTS
Litigation. The Company, certain of its affiliates and others have been
named as defendants in several lawsuits relating to various transactions in
which it or its affiliated entities participated. The Company intends to defend,
or in some cases negotiate to settle, the remaining actions and does not
currently anticipate that such actions will have a material adverse effect on
its financial condition, results of operations or cash flows of the Company.
In July 1997, the Company entered into a Compromise and Settlement
Agreement, whereby the Company and the Integra Unsecured Creditors' Trust agreed
to equally divide a $2,513,000 escrow account which had been established in
connection with the Company's sale of its ShowBiz investment. See Note 6.
In February 1997, a lawsuit was filed in the Chancery Court for New Castle
County, Delaware, styled Gotham Partners, L.P. v. Hallwood Realty Partners, L.P.
and Hallwood Realty Corporation (C.A. No.15578). The complaint sought access to
certain books and records of HRP, a list of the limited partners and
reimbursement of the plaintiff's expenses. On June 20, 1997, Gotham Partners,
L.P. filed a separate complaint in the Chancery Court for New Castle County,
Delaware, styled Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., et al
(C.A. No.15754), against the Company, HRP, HRC and the directors of HRC,
alleging claims of breach of fiduciary duties, breach of HRP's partnership
agreement, fraud, and as to the Company, aiding and abetting these alleged
breaches. At the same time as the filing of this complaint, plaintiff filed a
motion to amend its complaint in the earlier action to allege the same facts and
demand the same relief as plaintiff sought in the separate complaint. On June
27, 1997, the parties entered into a Stipulation and Order under which HRP
provided to plaintiff copies of certain of the documents requested. The other
claims in the two actions remain outstanding. On August 27, 1997, defendants
moved to dismiss the complaint in the separate action for plaintiff's failure
either to make a demand on HRC to bring suit or to allege adequately that such a
demand was futile. On February 6, 1998, the court granted defendants' motion to
dismiss but gave plaintiff thirty days to file an amended complaint. Plaintiffs
filed an amended complaint on March 6, 1998, which defendants again moved to
dismiss. This motion was denied and the parties are proceeding with discovery.
Management believes that the claims are without merit and intend to defend the
cases vigorously, but because of their early stages, cannot predict the outcome
of the claims or any possible effect any adverse outcome might have.
59
<PAGE> 61
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In November 1996, a lawsuit was filed in United States District Court for
the District of Colorado styled The Ravenswood Investment Company, L.P. v.
Hallwood Energy Corporation, Hallwood Group Inc., et al. The case alleges that
in connection with the tender offer to the shareholders of HEC and the
subsequent merger of HEC into the Company, the defendants failed to disclose
certain matters in the tender offer documents, breached their fiduciary duty to
the shareholders of HEC, and committed certain fraudulent acts. The plaintiff
seeks rescission or rescissionary damages of an unspecified amount. The
plaintiff also seeks class certification to represent similarly situated former
shareholders of HEC. In a related case filed by the plaintiff in March 1997 in
the District Court of Dallas County, Texas, plaintiff is also demanding an
appraisal of the fair value of the HEC shares owned by plaintiff. The defendants
believe that they fully considered and disclosed all material information in
connection with the tender offer and merger and that the price paid for the HEC
shares was fair, and that both cases are without merit. In May 1997, a case was
filed in the United States District Court for the District of Colorado styled
Wayland E. Noland v. Hallwood Energy Corporation, The Hallwood Group
Incorporated, et al, (C.A. No. 96-WM-2665). In September 1997, this case was
consolidated with the Ravenswood Investment Company, L.P. vs. Hallwood Energy
Corporation, Hallwood Group, Inc. case discussed below. Unlike the plaintiff in
the Ravenswood case, the plaintiff in the Noland case tendered his shares
pursuant to the tender offer made by the Company to the shareholders of HEC, but
the allegations are substantially identical as those made in the Ravenswood
case. The plaintiff in the Noland case seeks damages of an unspecified amount,
and seeks class certification to represent similarly situated former
shareholders of HEC. The defendants believe that they fully considered and
disclosed all material information in connection with the tender offer and
merger and that the price paid for the HEC shares was fair, and that the Noland
case, like the Ravenswood case, is without merit. Certain non-tendering
plaintiffs in the Ravenswood case have also filed a lawsuit styled Cede &
Company, et al, vs. Hallwood Group Inc. for appraisal rights under the Texas
statute. The Company entered into a letter agreement in November 1998 to
stipulate the tentative terms of settlement for all three of these lawsuits.
Definitive settlement documents will be prepared for presentation to the
respective courts. In general, the settlement provides for the payment of $24.00
per share to the former HEC shareholders for all 143,209 shares purchased by the
Company in the HEC tender offer and subsequent merger, compared to the original
tender offer price of $19.50 per share. The settlement amount of $644,000 has
been accrued at December 31, 1998 and will be payable 30 days after entry of a
final order approving the settlement. In addition, the Company will pay a
nominal amount of additional costs to obtain final approval of the settlement.
In connection with the Demand for Arbitration filed by Arcadia Exploration
and Production Company ("Arcadia") with the American Arbitration Association
against HEP, HCRC, E.M. Nominee Partnership Company and Hallwood Consolidated
Partners, L.P. (collectively referred to as "Hallwood Energy"), the arbitrators
ruled that the original agreement entered into in August 1997 to purchase oil
and gas properties should proceed, with a reduction to the total purchase price
of approximately $2,500,000 for title defects. The arbitrators also ruled that
Arcadia was not entitled to enforce its claim that Hallwood Energy was required
to purchase an additional $8,000,000 worth of properties and denied Arcadia's
claim for attorneys fees. Arcadia's claim for interest on the adjusted purchase
price is still pending. In October 1998, HEP and HCRC closed the acquisition of
oil and gas properties from Arcadia, including interests in approximately 570
wells, numerous proven and unproven drilling locations, exploration acreage, and
3-D seismic data. HEP's share of the purchase price was $8,200,000.
In July 1996, the Company announced that it agreed to a settlement of a
claim by the Securities and Exchange Commission ("SEC") arising from the sale of
a small portion of its holdings in the stock of ShowBiz during a four-day period
in June 1993. These and other similar sales were made by the Company pursuant to
a pre-planned, long-term selling program begun in December 1992. The SEC
asserted that some, but not all, of the Company's June 1993 sales were improper
because, before the sales program was completed, the Company was alleged to have
received non-public information about ShowBiz. In connection with the
settlement, the Company paid approximately $953,000, representing the loss that
the SEC alleged the Company avoided by selling during the four-day period, plus
interest of $240,000. This money was deposited into a fund for the benefit of
those who bought ShowBiz stock from the Company during the four-day period. The
Company has also agreed to be subject to an injunction against any future
violations of certain federal securities laws. In addition, the SEC alleged that
Anthony J. Gumbiner failed to take appropriate action to discontinue the
Company's sales of the ShowBiz shares during the four days in question. Mr.
Gumbiner did not directly conduct the sales, nor did he sell any shares for his
own account or for the account of any trust for which he has the power to
designate the trustee. Although the sales were made solely by the Company, the
SEC assessed a civil penalty of $477,000 against Mr. Gumbiner, as a "control
person" for the Company. Mr. Gumbiner, however, is not subject to any separate
injunction concerning his future personal activities. As provided in the
settlement, neither the Company nor Mr. Gumbiner admitted or denied the
allegations made by
60
<PAGE> 62
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
the SEC, and both entered into the settlement to avoid the extraordinary time
and expense that would be involved in protracted litigation with the government.
The Company believes that the SEC's legal theories in any such litigation would
have been novel, but felt that this settlement was in its best interests and
fair to the shareholders who were affected by the Company's sales. As the
settlement had been anticipated and estimated amounts previously accrued, the
Company's contribution, including interest, did not result in an additional
charge against operations in the year ended December 31, 1996. The Company had
established reserves of $250,000 in the five months ended December 31, 1995 and
$500,000 in each of the years ended July 31, 1995 and 1994, respectively. In
approving the terms of the settlement, the Board of Directors of the Company
also authorized the Company to loan Mr. Gumbiner the amount needed to satisfy
his personal assessment. Significant terms of the promissory note from Mr.
Gumbiner include: (i) principal amount of $477,000; (ii) interest rate of prime
plus 0.75%; and (iii) quarterly principal and interest payments totaling
$31,250.
The Company and its subsidiaries are from time to time involved in various
other legal proceedings in the ordinary course of their respective businesses.
Management believes that the resolution of the aforementioned litigation matters
will not have a material adverse effect on the financial condition, results of
operations or cash flows of the Company.
Contingencies. The Company has committed to make additional contributions
to the capital of Hallwood Realty, the general partner of HRP, upon demand, up
to a maximum aggregate amount of $13,118,000, subject to the terms of a
subscription agreement, to the extent Hallwood Realty has insufficient capital
to satisfy creditors of HRP. As of the date of this report no such demands have
been made.
Environmental Compliance. A number of jurisdictions in which the Company
operates have adopted laws and regulations relating to environmental matters.
Such laws and regulations may require the Company to secure governmental permits
and approvals and undertake measures to comply therewith. Compliance with the
requirements imposed may be time-consuming and costly. While environmental
considerations, by themselves, have not significantly affected the Company's
business to date, it is possible that such considerations may have a significant
and adverse impact in the future. The Company actively monitors its
environmental compliance and while certain matters currently exist, management
is not aware of any compliance issues which will significantly impact the
financial position, operations or cash flows of the Company.
Commitments. Total lease expense was $4,126,000, $4,479,000 and $4,575,000
for the years ended December 31, 1998, 1997 and 1996, respectively. The Company
leases certain hotel property, including land, buildings and equipment,
executive office facilities at several locations, and certain textile
manufacturing equipment. The leases generally require the Company to pay
property taxes, insurance and maintenance of the leased assets. Lease expense on
certain office facilities is incurred on behalf of partnerships, of which the
Company is general partner and is substantially reimbursed by such partnerships.
Certain of the hotel property leases require the payment of rent contingent upon
hotel revenue. Contingent rent was $140,000, $439,000 and $473,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
At December 31, 1998, aggregate net minimum annual rental commitments under
noncancelable operating leases having an initial or remaining term of more that
one year, were as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31, AMOUNT
------------- -------
<S> <C>
1999........................................................................ $ 2,911
2000........................................................................ 2,762
2001........................................................................ 2,436
2002........................................................................ 2,309
2003........................................................................ 2,309
Thereafter.................................................................. 10,325
-------
Total....................................................................... $23,052
=======
</TABLE>
61
<PAGE> 63
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 19 -- SEGMENT AND RELATED INFORMATION
The Company is a diversified holding company and classifies its current
operations into four reportable segments, each having different management
teams and infrastructures that engage in different businesses and offer
different services. The accounting policies are the same as those described in
Note 1 and the Company evaluates performance based upon operating income (loss):
Real Estate. Real estate activities are conducted primarily through the
Company's wholly owned subsidiaries, HWG, LLC, Hallwood Realty and HCRE.
Hallwood Realty is the sole general partner of HRP, a publicly-traded, real
estate master limited partnership. At December 31, 1998, HRP owned twelve real
estate properties in six states. Hallwood Realty owns a 1% general partner
interest and HWG, LLC owns a 25% limited partner interest in HRP. Hallwood
Realty is responsible for asset management of HRP and its properties, including
the decisions regarding financing, acquiring and disposing of properties. It
also provides general operating and administrative services to HRP. HCRE is
responsible for on-site property management at all HRP properties, and
properties it manages for third parties, for which it receives managing, leasing
and construction supervision fees. The Company accounts for its ownership in HRP
using the equity method of accounting. See Note 13.
Energy. The Company's energy operations are conducted primarily through
HEPGP, and consists of the development, production and sale of oil and gas, and
the acquisition, exploration, development and operation of additional oil and
gas properties. HEPGP is the sole general partner of HEP, a publicly-traded oil
and gas master limited partnership, and conducts substantially all of its
operations through HEP. HEP owns interests in approximately 1,600 wells, the
most significant of which are located in West Texas, South Louisiana, New
Mexico and the Rocky Mountain region. The Company and its subsidiaries account
for their ownership of HEP using the proportionate consolidation method,
whereby it records a proportional share of HEP's revenue and expenses, current
assets, current liabilities, noncurrent assets, long-term obligations and fixed
assets. See Note 14.
Textile Products. Textile products operations are conducted through the
Company's wholly owned Brookwood subsidiary. Brookwood is a complete textile
service firm that develops and produces innovative fabrics and related products
through specialized finishing, treating and coating processes. See Note 15.
Hotels. Hotel operations are conducted through the Company's wholly owned,
Hallwood Hotels, Brock Hotels and IRM subsidiaries. Hallwood Hotels holds a
long-term leasehold interest in the Holiday Inn hotel, located in Longboat Key,
Florida and a fee interest in the Airport Embassy Suites hotel, located in
Oklahoma City, Oklahoma. Brock Hotels owns fee interest in Residence Inns
located in Tulsa, Oklahoma and Greenville, South Carolina, and a long-term
leasehold interest in a Residence Inn located in Huntsville, Alabama. IRM owns
315 owners' rental contracts and certain real estate at The Enclave Suites, a
resort condominium hotel located in Orlando, Florida. It manages the property
for individual unit owners for which it receives a management fee and other
consideration for the services it provides.
Associated Company. The Company is no longer engaged in the associated
company segment, as its remaining ShowBiz investment was sold in March 1977,
through a secondary public offering by ShowBiz. The Company had accounted for
its investment in ShowBiz on the equity method.
The following represents the Company's reportable segment position as of
and for the years ended December 31, 1998, 1997 and 1996, respectively (in
thousands):
<TABLE>
<CAPTION>
REAL TEXTILE ASSOCIATED
ESTATE ENERGY PRODUCTS HOTELS COMPANY OTHER CONSOLIDATED
------ ------ -------- ------- ---------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998
Total revenue from external sources........ $ 7,813 $ 5,216 $80,343 $ 21,130 $ -- $ 1,728 $ 116,230
======= ======= ======= ======== ========== ======= =========
Operating income (loss).................... $ 5,006 $ 407 $ 1,098 $ (2,096) $ -- $ -- $ 4,415
======= ======= ======= ======== ========== =======
Unallocable expenses, net.................. $(1,944) (1,944)
======= ---------
Income before income taxes................. $ 2,471
=========
Extraordinary gain (loss) from
Early extinguishment of debt........... $ 1,374 $ -- $ -- $ -- $ -- $ 107 $ 1,481
======= ======= ======= ======== ========== ======= =========
Identifiable assets, December 31, 1998..... $10,458 $16,075 $38,048 $ 35,655 $ -- $ -- $ 100,236
Cash allocable with segment................ 114 87 42 944 -- 290 1,477
------- ------- ------- -------- ---------- ------- ---------
$10,572 $16,162 $38,090 $ 36,599 $ -- $ 290 101,713
======= ======= ======= ======== ========== =======
Corporate assets........................... $ 7,539 7,539
======= ---------
Total assets, December 31, 1998............ $ 109,252
=========
Depreciation, depletion, amortization
and impairment......................... $ 674 $ 1,761 $ 1,387 $ 3,184 $ -- $ -- $ 7,006
======= ======= ======= ======== ========== ======= =========
Capital expenditures/acquisitions.......... $ -- $ 298 $ 1,009 $ 21,845 $ -- $ -- $ 23,152
======= ======= ======= ======== ========== ======= =========
YEAR ENDED DECEMBER 31, 1997
Total revenue from external sources........ $ 7,206 $ 6,350 $91,552 $ 21,038 $ 19,416 $ 3,207 $ 148,769
======= ======= ======= ======== ========== ======= =========
Operating income (loss).................... $ 3,855 $ 1,832 $ 1,977 $ (237) $ 18,809 $ -- $ 26,236
======= ======= ======= ======== ========== =======
Unallocable expenses, net.................. $(3,681) (3,681)
======= =========
Income before income taxes................. $ 22,555
Extraordinary gain (loss) from =========
Early extinguishment of debt........... $ -- $ -- $ -- $ (677) $ -- $ 877 $ 200
======= ======= ======= ======== ========== ======= =========
Identifiable assets, December 31, 1997..... $ 8,260 $14,539 $42,226 $ 15,910 $ -- $ -- $ 80,935
Cash allocable with segment................ 186 31 44 396 -- 4,569 5,226
------- ------- ------- -------- ---------- ------- ---------
$ 8,446 $14,570 $42,270 $ 16,306 $ -- $ 4,569 86,161
======= ======= ======= ======== ========== =======
Corporate assets........................... $ 3,597 3,597
======= ---------
Total assets, December 31, 1997............ $ 89,758
=========
Depreciation, depletion, amortization
and impairment......................... $ 674 $ 1,387 $ 1,240 $ 2,841 $ -- $ -- $ 6,142
======= ======= ======= ======== ========== ======= =========
Capital expenditures/acquisitions.......... $ -- $ 223 $ 1,440 $ 1,286 $ -- $ -- $ 2,949
======= ======= ======= ======== ========== ======= =========
YEAR ENDED DECEMBER 31, 1996
Total revenue from external sources........ $ 3,947 $ 7,515 $77,583 $ 20,948 $ 4,448 $ 960 $ 115,401
======= ======= ======= ======== ========== ======= =========
Operating income........................... $ 1,618 $ 2,282 $ 1,222 $ -- $ 2,890 $ -- $ 8,012
======= ======= ======= ======== ========== =======
Unallocable expenses, net.................. $(6,014) (6,014)
======= ---------
Income before income taxes................. $ 1,998
=========
Identifiable assets, December 31, 1996..... $ 8,227 $13,566 $40,110 $ 17,644 $ 16,945 $ -- $ 96,492
Cash allocable with segment................ 436 182 90 916 -- 6,444 8,068
------- ------- ------- -------- ---------- ------- ---------
$ 8,663 $13,748 $40,200 $ 18,560 $ 16,945 $ 6,444 104,560
======= ======= ======= ======== ========== =======
Corporate assets........................... $12,236 12,236
======= ---------
Total assets, December 31, 1996............ $ 116,796
=========
Depreciation, depletion, amortization
and impairment......................... $ 673 $ 1,532 $ 1,091 $ 2,657 $ -- $ -- $ 5,953
======= ======= ======= ======== ========== ======= =========
Capital expenditures/acquisitions.......... $ 40 $ 346 $ 1,118 $ 7,721 $ -- $ -- $ 9,225
======= ======= ======= ======== ========== ======= =========
</TABLE>
62
<PAGE> 64
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 20 -- SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The results of operations by quarter for the years ended December 31, 1998
and 1997, are summarized below (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Operating revenues............................ $31,100 $32,025 $26,843 $26,262
Gross profit.................................. 3,940 5,762 3,758 3,521
Net income.................................... 344 1,905 191 4,627
Net income per share - basic.................. 0.27 1.48 0.15 3.69
Net income per share - assuming dilution...... 0.26 1.42 0.15 3.62
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
---------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Operating revenues............................ $51,815 $36,258 $28,113 $32,583
Gross profit.................................. 21,687 6,421 3,554 7,009
Net income.................................... 8,381 3,221 55 1,190
Net income per share - basic.................. 5.37 2.05 0.04 0.94
Net income per share - assuming dilution...... 5.27 2.01 0.04 0.90
</TABLE>
Year ended December 31, 1998. In May 1998, the Company reported
revenue of $1,025,000 from the favorable settlement of a litigation claim
involving its former merchant banking activities. In December 1998, the Company
recognized a deferred income tax benefit of $4,308,000 from assumed utilization
of NOL's, and an extraordinary gain of $1,374,000 from the recognition of the
Company's pro-rata share of a $5,347,000 extraordinary gain from early
extinguishment of debt reported by HRP.
Year ended December 31, 1997. In March 1997, the Company sold its
ShowBiz investment and realized a gain of $18,277,000 from the sale. Pursuant to
a self-tender offer the Company repurchased 13.5% Debentures in the face amount
of $12,875,000 in June 1997 and subsequently redeemed the remaining balance of
the 13.5% Debentures in the face amount of $14,287,000 in December 1997.
NOTE 21 -- EMPLOYEE BENEFIT RETIREMENT PLANS
In August 1989, the Company established a contributory, tax-deferred 401(k)
tax favored savings plan covering substantially all of its non-union employees.
The original plan provided that eligible employees may contribute up to 15% of
their compensation to the plan, and the Company would match 50% of its
employees' contributions up to the first 6% contributed. Amounts contributed by
employees are 100% vested and non-forfeitable. The plan was amended on February
1, 1992 and August 1, 1993 to (i) modify eligibility requirements: (ii) make the
Company's matching contribution discretionary, to be determined annually by the
Company's Board of Directors; (iii) exclude the Company's hotel hourly employees
from a matching contribution; (iv) exclude highly compensated employees from a
matching contribution, although this group receives a compensatory bonus in lieu
of such contribution and diminution of related benefits; and (v) spin-out
Brookwood employees into a separate plan. The Company's matching contributions
vest at a rate of 20% per year of service and become fully vested after five
years. Employees of HRC, HCRE and salaried hotel employees also participate in
the Company's 401(k) plan. HPI has a separate 401(k) plan which is similar to
the Company's plan. Employer contributions paid on behalf of HRC and HPI
employees are substantially paid by the respective real estate and energy master
limited partnerships. The Company's contributions to the plan for the years
ended December 31, 1998, 1997 and 1996, respectively, excluding contributions
from the HRC and HPI affiliates to the extent paid by the master limited
partnership, were $215,000, $212,000, and $220,000, respectively.
Brookwood's union employees belong to a pension fund maintained by their
union. The Company contributes $84 per month per employee to the fund. Total
contributions for the years ended December 31, 1998, 1997 and 1996 were
$210,000, $217,000 and $207,000, respectively. At September 30, 1998, the date
of the latest actuarial valuation, Brookwood was not subject to a withdrawal
liability upon termination of the pension plan because it was fully funded.
63
<PAGE> 65
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION
DECEMBER 31, 1998
(UNAUDITED)
The following reserve quantity and future net cash flow information for the
oil and gas properties for the Company, its energy subsidiaries and HEP (the
"Energy Interests") represents proved reserves which are located in the United
States. The determination of oil and gas reserves is based on estimates which
are highly complex and interpretive. The estimates are subject to continuing
change as additional information becomes available.
The standardized measure of discounted future net cash flows provides a
comparison of the Energy Interests proved oil and gas reserves from year to
year. No consideration has been given to future income taxes since the tax basis
and net operating loss carryforwards for the Energy Interests exceed future net
cash flows. Under the guidelines set forth by the Securities and Exchange
Commission, the calculation is performed using year-end prices. At December 31,
1998, oil and gas prices averaged $10.00 per barrel of oil and $2.00 per mcf of
gas for the Energy Interests, including its interest in HEP. Future production
costs are based on year-end costs and include severance taxes. This standardized
measure is not necessarily representative of the market value of the properties.
The standardized measure of discounted future net cash flows for the Energy
Interests has been increased by $232,000 at December 31, 1998 for the effect of
HEP's hedge contracts. This amount represents the difference between year-end
prices and the hedge contract prices multiplied by the quantities subject to
contract, discounted at 10%.
64
<PAGE> 66
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
RESERVE QUANTITIES
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
GAS OIL
MCF BBLS
--- ----
<S> <C> <C>
PROVED RESERVES:
Balance, January 1, 1996................................ 11,637 994
Extensions and discoveries.............................. 263 107
Revision of previous estimates.......................... 1,083 28
Sales of reserves in place.............................. (374) (54)
Purchases of reserves in place ......................... 1,169 2
Production.............................................. (1,728) (125)
------- ----
Balance, December 31, 1996.............................. 12,050 952
Extensions and discoveries.............................. 531 123
Revision of previous estimates.......................... 1,403 (231)
Sales of reserves in place.............................. (13) (2)
Purchases of reserves in place ......................... 62 12
Production.............................................. (1,602) (100)
------- ----
Balance, December 31, 1997.............................. 12,431 754
Extensions and discoveries.............................. 332 65
Revision of previous estimates.......................... (1,324) (174)
Sales of reserves in place.............................. (27) (4)
Purchases of reserves in place.......................... 2,964 60
Production.............................................. (1,854) (107)
------ ----
Balance, December 31, 1998.............................. 12,522 594
====== ===
PROVED DEVELOPED RESERVES:
Balance, December 31, 1996.............................. 11,768 904
====== ====
Balance, December 31, 1997.............................. 12,092 691
====== ====
Balance, December 31, 1998.............................. 12,090 503
====== ===
</TABLE>
65
<PAGE> 67
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
DESCRIPTION 1998 1997 1996
----------- -------- -------- --------
<S> <C> <C> <C>
Future cash flows ............................................... $ 33,000 $ 40,000 $ 70,000
Future production and development costs ......................... (12,000) (14,000) (21,000)
-------- -------- --------
Future net cash flows before discount ........................... 21,000 26,000 49,000
10% discount to present value ................................... (6,000) (7,000) (18,000)
-------- -------- --------
Standardized measure of discounted future net cash flows ........ $ 15,000 $ 19,000 $ 31,000
======== ======== ========
</TABLE>
CHANGES IN THE STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
DESCRIPTION 1998 1997 1996
----------- -------- -------- --------
<S> <C> <C> <C>
Standardized measure of discounted future net cash
at beginning of year ......................................... $ 19,000 $ 31,000 $ 19,000
Sales of oil and gas produced, net of production costs .......... (3,524) (4,611) (5,557)
Net changes in prices and production costs ...................... (3,643) (11,722) 11,583
Extensions, discoveries and other additions, net of future
production costs ............................................. 694 1,496 1,582
Changes in estimated future development costs ................... (1,402) (1,358) (1,125)
Development costs incurred ...................................... 1,268 1,136 1,321
Revisions of previous quantity estimates ........................ (2,275) 20 2,186
Purchases of reserves in place .................................. 3,193 158 2,064
Sales of reserves in place ...................................... (49) (29) (1,220)
Accretion of discount ........................................... 1,900 3,100 1,900
Changes in production rates and other ........................... (162) (190) (734)
-------- -------- --------
Standardized measure of discounted future net cash flows
at the end of year ........................................... $ 15,000 $ 19,000 $ 31,000
======== ======== ========
</TABLE>
66
<PAGE> 68
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
INDEPENDENT AUDITORS' REPORT ON SCHEDULES
We have audited the consolidated balance sheets of The Hallwood Group
Incorporated and its subsidiaries as of December 31, 1998 and 1997 and the
related consolidated statements of income, changes in stockholders' equity
and cash flows for each of the three years in the period ended December 31,
1998, and have issued our report thereon dated March 26, 1999, which report is
included elsewhere in this Form 10-K. Our audits also included the financial
statement schedules of The Hallwood Group Incorporated and its subsidiaries,
listed in the accompanying index at Item 14(a)2. These financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion based on our audits. In our opinion, such financial
statement schedules, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
DELOITTE & TOUCHE LLP
Dallas, Texas
March 26, 1999
67
<PAGE> 69
SCHEDULE I
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
ASSETS -----------------------------
1998 1997
---------- --------
<S> <C> <C>
Investments in subsidiaries............................................ $ 35,015 $ 27,560
Energy division
Oil and gas properties, net........................................ 6,759 5,457
Current assets of HEP.............................................. 1,524 1,409
Noncurrent assets of HEP........................................... 647 964
Deferred tax asset, net................................................ 6,348 2,040
Receivables and other assets........................................... 1,147 1,608
Cash and cash equivalents.............................................. 127 4,358
Investment in HRP...................................................... -- 2,762
--------- --------
Total Assets....................................................... $ 51,567 $ 46,158
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
7% Collateralized Senior Subordinated Debentures....................... $ 14,727 $ 24,292
10% Collateralized Subordinated Debentures............................. 6,808 --
Energy division
Long-term obligations of HEP....................................... 2,817 2,511
Current liabilities of HEP......................................... 2,054 1,472
Accounts payable and accrued expenses.............................. 395 395
Accounts payable, accrued interest and other accrued expenses.......... 2,328 1,817
Loans payable.......................................................... 500 500
--------- --------
Total Liabilities.................................................. 29,629 30,987
Redeemable preferred stock............................................. 1,000 1,000
Common stock........................................................... 160 160
Additional paid-in capital............................................. 54,823 54,823
Accumulated (deficit).................................................. (24,676) (31,693)
Treasury stock......................................................... (9,369) (9,119)
--------- --------
Total Stockholders' Equity......................................... 20,938 14,171
--------- --------
Total Liabilities and Stockholders' Equity......................... $ 51,567 $ 46,158
========= ========
</TABLE>
The "Notes to Consolidated Financial Statements of The Hallwood Group
Incorporated and Subsidiaries" are an integral part of these statements.
See accompanying "Notes to Condensed Financial Information of Registrant".
68
<PAGE> 70
SCHEDULE I (CONTINUED)
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
STATEMENTS OF INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
INCOME
Equity in net income (loss) of subsidiaries......................... $(2,749) $(1,561) $ 1,431
Intercompany income from subsidiaries
Management fees.................................................. 2,660 2,834 2,598
Dividends........................................................ 1,724 2,800 1,100
Interest income.................................................. 465 278 524
Energy division - oil and gas revenues and other income............. 2,218 2,742 251
Income (loss) from investment in HRP................................ 1,728 871 (1,630)
Litigation and insurance settlements................................ 1,025 1,508 -
Fee income.......................................................... 550 560 425
Interest on short-term investments.................................. 121 922 175
Other income........................................................ 9 202 215
Income from investment in ShowBiz................................... -- 19,416 4,448
------- ------- -------
Total income.................................................. 7,751 30,572 9,537
EXPENSES
Administrative expenses............................................. 2,654 3,196 2,183
Energy division - oil and gas expenses.............................. 2,076 1,845 152
Interest expense.................................................... 1,067 4,364 6,097
Depreciation and amortization....................................... 2 152 --
Provision for losses (recovery)..................................... -- -- (29)
------- ------- -------
Total expenses................................................ 5,799 9,557 8,403
------- ------- -------
Income before income taxes and extraordinary gain................... 1,952 21,015 1,134
Income taxes (benefit).............................................. (3,688) 9,045 (5,389)
------ ------- -------
Income before extraordinary gain.................................... 5,640 11,970 6,523
Extraordinary gain from early extinguishment of debt................ 1,427 877 --
------- ------- -------
NET INCOME .......................................................... $ 7,067 $12,847 $ 6,523
======= ======= =======
</TABLE>
The "Notes to Consolidated Financial Statements of The Hallwood Group
Incorporated and Subsidiaries" are an integral part of these statements.
See accompanying "Notes to Condensed Financial Information of Registrant."
69
<PAGE> 71
SCHEDULE I (CONTINUED)
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------
1998 1997 1996
--------- --------- --------
<S> <C> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES............................... $ 2,609 $ 873 $ 523
CASH FLOWS FROM INVESTING ACTIVITIES
Return of (additional) investment in subsidiaries................... (4,394) 4,108 2,176
Proceeds from sale of investment in ShowBiz......................... -- 40,323 4,139
Purchase of minority shares of HEC.................................. -- (648) (1,750)
Capital acquisition of real estate.................................. -- -- (40)
Investment in HRP................................................... -- -- (4)
--------- --------- --------
Net cash provided by (used in) investing activities.............. (4,394) 43,783 4,521
CASH FLOWS FROM FINANCING ACTIVITIES
Repurchase of 7% Debentures......................................... (2,146) -- --
Purchase of common stock for treasury............................... (250) (8,373) (394)
Payment of dividends to Series B preferred stockholders............. (50) (50) (50)
Repurchase of 13.5% Debentures...................................... -- (27,163) -
Repayment of bank borrowings and loans payable...................... -- (11,000) (437)
Proceeds from bank borrowings and loans payable..................... -- -- 2,000
--------- --------- --------
Net cash provided by (used in) financing activities.............. (2,446) (46,586) 1,119
--------- --------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS......................................................... (4,231) (1,930) 6,163
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR............................ 4,358 6,288 125
--------- --------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR.................................. $ 127 $ 4,358 $ 6,288
========= ========= =========
</TABLE>
The "Notes to Consolidated Financial Statements of The Hallwood Group
Incorporated and Subsidiaries" are an integral part of these statements.
See accompanying "Notes to Condensed Financial Information of Registrant."
70
<PAGE> 72
SCHEDULE I (CONTINUED)
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Supplemental schedule of non-cash investing and financing activities. The
following transactions affected recognized assets or liabilities but did not
result in cash receipts or cash payments (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
DESCRIPTION 1998 1997 1996
--------------------- ------ ------ ------
<S> <C> <C> <C>
Exchange of 7% Debentures for new issue of 10%Debentures .................. $6,821 $ -- $ --
Issuance of treasury stock in exchange for common shares of ShowBiz:
Investment in ShowBiz ................................................ -- 3,820 --
Reduction of additional paid-in capital .............................. -- 2,626 --
------ ------ ------
Reduction in treasury stock .......................................... -- 6,446 --
Payment in-kind of annual interest on 13.5% Debentures .................... -- 1,524 2,817
Recording of proportionate share of stockholders' equity/
partners' capital transactions of equity investments ................. -- 143 96
Supplemental disclosures of cash payments:
Interest paid ............................................................. $1,508 $5,522 $2,659
Income taxes paid ......................................................... 241 600 322
====== ====== ======
</TABLE>
The "Notes to Consolidated Financial Statements of The Hallwood Group
Incorporated and Subsidiaries" are an integral part of these statements.
See accompanying "Notes to Condensed Financial Information of Registrant."
71
<PAGE> 73
SCHEDULE I (CONTINUED)
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
NOTE 1 -- BASIS OF PRESENTATION
Pursuant to the rules and regulations of the Securities and Exchange
Commission, the condensed financial statements of the Registrant do not include
all of the information and notes normally included with financial statements
prepared in accordance with generally accepted accounting principles. In
addition, for purposes of this schedule, the investments in majority owned
subsidiaries are accounted for using the equity method of accounting which is
not in accordance with generally accepted accounting principles. It is,
therefore suggested that these condensed financial statements be read in
conjunction with the consolidated financial statements and notes thereto
included in the Registrant's annual report as referenced in Form 10-K, Part II,
Item 8.
NOTE 2 -- DEBENTURE ISSUES AND LOAN PAYABLE
As referenced in Notes 6 and 7 in the Consolidated Financial Statements,
the Registrant's debentures and loans payable are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
DESCRIPTION 1998 1997
---------------------------- ------- -------
<S> <C> C>
Debentures
7% Debentures (including deferred gain of $639 and $1,484, respectively).......... $14,727 $24,292
10% Debentures (including deferred gain of $340).................................. 6,808 --
------- -------
Totals....................................................................... $21,535 $24,292
======= =======
Loan Payable - real estate............................................................ $ 500 $ 500
======= =======
</TABLE>
Maturities over the next five years are as follows (in thousands): 1999--
$500; 2000-- $14,088; 2001-- $-0-; 2002-- $-0- and 2003-- $-0-.
NOTE 3 -- LITIGATION, CONTINGENCIES AND COMMITMENTS
See Note 18 to the consolidated financial statements.
72
<PAGE> 74
SCHEDULE II
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE, CHARGED TO CHARGED BALANCE,
BEGINNING COSTS AND TO OTHER END OF
OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
--------- --------- -------- ---------- --------
<S> <C> <C> <C> <C> <C>
TEXTILE PRODUCTS
Allowance for losses - accounts receivable:
Year ended December 31, 1998.............. $407 $47 $-- $(36) (a) $418
Year ended December 31, 1997.............. 455 31 -- (79) (a) 407
Year ended December 31, 1996.............. 534 35 -- (114) (a) 455
</TABLE>
- ------------------------
Notes:
(a) Write-off, net of recoveries
73
<PAGE> 75
SCHEDULE III
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
GROSS AMOUNT WHICH
INITIAL COST CARRIED AT CLOSE
TO COMPANY COSTS CAPI- OF PERIOD
-------------- TALIZED SUB- ------------------------
BUILD- SEQUENT TO BUILD- ACCUMU- DEPRE-
INGS AND ACQUISITION INGS AND ULATED CIABLE
ENCUM- IMPROVE (IMPROVE- IMPROVE- DEPRECIA- DATE LIFE IN
BRANCES LAND MENTS MENTS) LAND MENTS TOTAL TION ACQUIRED YEARS
------- ----- ------- ------ ----- ------ ------ -------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
TEXTILE PRODUCTS
Industrial plant
Kenyon, Rhode Island (b)...... $ -- $ 391 $ 2,355 $ 1,978 $ 391 $ 4,333 $ 4,724 $ 1,825 3/89 20
HOTELS
Oklahoma City, Oklahoma (b)...... 18,478 -- -- 20,590 1,102 19,488 20,590 1,666 6/91 20
Greenville, South Carolina (b)... 6,667 -- 459 6,974 830 6,603 7,433 1,603 3/94 15
Tulsa, Oklahoma (b).............. 5,209 909 4,285 619 919 4,894 5,813 2,452 3/94 10
Longboat Key, Florida (a)(b)..... -- -- -- 4,220 -- 4,220 4,220 1,899 6/91 7
Huntsville, Alabama (a)(b)....... -- -- 942 523 -- 1,465 1,465 721 3/94 10
Orlando, Florida................. -- -- 599 -- -- 599 599 19 7/98 15
Irving, Texas.................... -- 50 -- -- 50 -- 50 -- 3/94
------- ----- ------- ------ ----- ------ ------ --------
Subtotal................... 30,354 959 6,285 32,926 2,901 37,269 40,170 8,360
------ ----- ------- ------ ----- ------ ------ --------
Totals..................... $30,354 $1,350 $8,640 $34,904 $3,292 $41,602 $44,894 $10,185
======= ====== ====== ======= ====== ======= ======= =======
</TABLE>
Changes in real estate owned and accumulated depreciation for the years
ended December 31, 1998, 1997 and 1996 are summarized below (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------ ----------------------- -----------------------
REAL ACCUMULATED REAL ACCUMULATED REAL ACCUMULATED
ESTATE DEPRECIATION ESTATE DEPRECIATION ESTATE DEPRECIATION
------- ------------- ------- ------------- ------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, BEGINNING OF YEAR................ $29,673 $12,412 $29,913 $11,038 $22,141 $ 8,168
Additions during the year
Costs capitalized................... 20,321 -- 1,285 -- 7,772 --
Depreciation........................ -- 2,873 -- 2,899 -- 2,870
Fully depreciated assets............ (5,100) (5,100) (1,525) (1,525) -- --
Deductions during the year
Sales............................... -- -- -- -- -- --
------- ------- ------- ------- ------- -------
BALANCE, END OF YEAR...................... $44,894 $10,185 $29,673 $12,412 $29,913 $11,038
======= ======= ======= ======= ======= =======
</TABLE>
- ------------------------
See Note 1 (g) to the Company's consolidated financial statements. The
aggregate cost basis of real estate owned for federal income tax purposes was
approximately $1.9 million higher than the basis for financial reporting
purposes.
(a) Leasehold interest. Cost represents price paid for leasehold interest,
plus furnishings and equipment.
(b) The stock of the subsidiary which holds this asset is pledged as
collateral for the 7% or 10% Debentures as described in Note 7 to the
Company's consolidated financial statements.
74
<PAGE> 76
===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-K
MARK ONE
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD - FROM TO
------------------- -----------------
COMMISSION FILE NUMBER: 1-10643
------------------
HALLWOOD REALTY PARTNERS, L.P.
(Exact name of registrant as specified in its charter)
---------------------
DELAWARE 75-2313955
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3710 RAWLINS
SUITE 1500
DALLAS, TEXAS 75219-4298
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 528-5588
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
<CAPTION>
Name of each exchange on
Title of each class which registered
------------------- ------------------------
<S> <C>
UNITS REPRESENTING LIMITED PARTNERSHIP INTERESTS AMERICAN STOCK EXCHANGE
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
-----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]
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 [ ]
The aggregate market value of units held by nonaffiliates of the registrant as
of March 5, 1999 was $70,527,000.
CLASS: UNITS REPRESENTING LIMITED PARTNERSHIP INTERESTS.
OUTSTANDING AT MARCH 5, 1999: 1,672,556 UNITS.
===============================================================================
Page 1 of 38
<PAGE> 77
HALLWOOD REALTY PARTNERS, L.P.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
PART I ----
<S> <C> <C>
Item 1. Business 3
Item 2. Properties 4
Item 3. Legal Proceedings 6
Item 4. Submission of Matters to a Vote of
Security Holders 6
PART II
Item 5. Market for Registrant's units and Related
Security Holder Matters 7
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Item 8. Financial Statements and Supplemental Information 15
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures 32
PART III
Item 10. Directors and Executive Officers of the
Registrant 33
Item 11. Executive Compensation 34
Item 12. Security Ownership of Certain Beneficial Owners
and Management 36
Item 13. Certain Relationships and Related Transactions 36
PART IV
Item 14. Exhibits, Financial Statement Schedule and
Reports on Form 8-K. 37
</TABLE>
Page 2 of 38
<PAGE> 78
PART I
ITEM 1. BUSINESS
DESCRIPTION OF THE BUSINESS
Hallwood Realty Partners, L.P. ("HRP" or the "Partnership"), a publicly traded
Delaware limited partnership, is engaged in the acquisition, ownership and
operation of commercial real estate assets. The limited partners' interests, or
units, are traded on the American Stock Exchange under the symbol "HRY".
As of December 31, 1998, HRP owned twelve real estate properties (the
"Properties") located in six states (see Item 2 Properties) containing
5,150,000 net rentable square feet. HRP seeks to maximize the value of its real
estate by making capital and tenant improvements, by executing marketing
programs to attract and retain tenants, and by controlling or reducing, where
possible, operating expenses.
Hallwood Realty, LLC, formerly Hallwood Realty Corporation, ("Realty" or the
"General Partner"), a Delaware limited liability company and wholly-owned
subsidiary of The Hallwood Group Incorporated ("Hallwood") is HRP's general
partner and is responsible for asset management of HRP and its Properties,
including the decision making responsibility for financing, refinancing,
acquiring and disposing of properties. In addition, Realty provides general
operating and administrative services to HRP. Hallwood Commercial Real Estate,
LLC, formerly Hallwood Commercial Real Estate, Inc., ("HCRE"), another
wholly-owned subsidiary of Hallwood, provides property management services to
the Properties.
OCCUPANCY/MAJOR TENANT INFORMATION
In the aggregate, the Properties were 93% occupied at December 31, 1998. Set
forth below are the percentages of square feet represented by scheduled lease
expirations for each calendar year, assuming that none of the tenants exercise
early termination or renewal options:
<TABLE>
<S> <C>
1999 14%
2000 20%
2001 22%
2002 16%
2003 10%
Thereafter 18%
</TABLE>
During 1998, one tenant contributed more than 10% of the total revenues of the
Partnership. During 1997, two tenants leasing space each contributed more than
10% of the total revenues of the Partnership. Ford Motor Company and affiliates
("Ford") leases space in Parklane Towers and Fairlane Commerce Park and
contributed 13% and 15% of revenues in 1998 and 1997, respectively. The Centers
for Disease Control and Prevention ("CDC"), an agency of the U.S. Department of
Health and Human Services, leases space in Corporate Square and Executive Park
and contributed 9% and 10% of the revenues in 1998 and 1997, respectively.
As of December 31, 1998, Ford occupied 233,000 square feet of office space
under 9 separate leases at Parklane Towers and 255,000 square feet of office,
technical laboratory and industrial space under 9 separate leases at Fairlane
Commerce Park. These leases expire between 1999 and 2003 and most contain
renewal options, providing for one to ten year renewals. As of December 31,
1998, CDC occupied 218,000 square feet of office space at Executive Park under
5 leases which expire between 2001 and 2003 and 158,000 square feet of office
space at Corporate Square under a lease which expires in 2013.
The remaining tenants are not concentrated in any one industry, nor is HRP
otherwise dependent on any group of related tenants for 10% or more of its
revenues.
Page 3 of 38
<PAGE> 79
COMPETITION AND OTHER FACTORS
The Properties are subject to substantial competition from similar properties
in the vicinity in which they are located. In addition, there are numerous
other potential investors seeking to purchase improved real property and many
property holders seeking to dispose of real estate with which HRP will compete,
including companies substantially larger than HRP and with substantially
greater resources. Furthermore, current economic conditions in each property's
respective real estate market are competitive and as such, competition for
tenants will continue to affect rental rates and revenue.
The environmental laws of the federal government and of certain state and local
governments impose liability on current property owners for the cleanup of
hazardous and toxic substances discharged on such property. This liability may
be imposed without regard to the timing, cause or person responsible for the
release of such substances onto the property. HRP could be subject to
additional liability in the event that it owns properties having such
environmental problems. Parklane Towers, as well as certain other properties to
a lesser extent, are known to contain asbestos. Removal of asbestos at Parklane
Towers is estimated to cost approximately $1,700,000; however, it is not
required to be removed because it is not friable and HRP has an Operations and
Maintenance Program in place.
Realty and HCRE, on behalf of HRP, monitor compliance with the Americans with
Disabilities Act and are currently not aware of any material non-compliance
issues.
HRP does not directly employ any individuals. All 90 employees rendering
services on behalf of HRP and its Properties are employees of Realty and/or
HCRE.
The business of HRP involves only one industry segment. Accordingly, all
information required by Item 101(b) of Regulation S-K is included in the
Consolidated Financial Statements included in Item 8. HRP has no foreign
operations and its business is not seasonal.
ITEM 2. PROPERTIES
As of December 31, 1998, HRP owned twelve properties in six states with
5,150,000 net rentable square feet.
<TABLE>
<CAPTION>
NAME AND LOCATION GENERAL DESCRIPTION OF THE PROPERTY
- ----------------- -----------------------------------
<S> <C>
Airport Plaza Fee simple interest in a 3-story office building constructed in
San Diego, California 1982 containing 48,853 net rentable square feet of space located
on 2 acres of land. The property was 94% occupied at December 31,
1998.
Bellevue Corporate Plaza Fee simple interest in a 10-story office building constructed in
Bellevue, Washington 1980 containing 234,880 net rentable square feet of space located
on 3.6 acres of land. The property was 99% occupied at December
31, 1998.
Bradshaw Business Parks Fee simple interest in 21 single-story buildings located at four
Sacramento and separate sites containing an aggregate of 452,838 net rentable
Rancho Cordova, California square feet of office/warehouse space on 31 acres of land and
constructed between 1973 and 1981. At December 31, 1998, the
property was 94% occupied.
Corporate Square Fee simple interest in an 8-building office complex ranging from
Atlanta, Georgia one to seven stories, constructed between 1968 and 1973,
containing an aggregate of 443,117 net rentable square feet of
space located on 32 acres of land. The property was 90% occupied
at December 31, 1998.
</TABLE>
Page 4 of 38
<PAGE> 80
<TABLE>
<CAPTION>
NAME AND LOCATION GENERAL DESCRIPTION OF THE PROPERTY
- ----------------- -----------------------------------
<S> <C>
Executive Park Fee simple interest in 26 buildings ranging from one to six
Atlanta, Georgia stories, constructed between 1965 and 1972, containing a total of
908,445 net rentable square feet of space located on 70 acres of
land. The property was 92% occupied at December 31, 1998.
Fairlane Commerce Park Fee simple interest in a portion of an office/industrial park
Dearborn, Michigan consisting of 12 single-story buildings constructed between 1974
and 1990. The property consists of 417,922 net rentable square
feet of space on 35 acres of land. The property was 97% occupied
at December 31, 1998.
First Maryland Building Fee simple interest in a 22-story office building constructed in
Baltimore, Maryland 1972 containing 344,224 net rentable square feet of office space
on 0.6 acres of land. At December 31, 1998, the property was 96%
occupied.
Joy Road Distribution Center Fee simple interest in a 442,201 square foot warehouse situated
Detroit, Michigan on 21 acres and originally constructed in the early 1940's. The
property was 95% occupied at December 31, 1998.
Montrose Office Center Fee simple interest in a 10-story office building constructed in
Rockville, Maryland 1980 containing 147,658 net rentable square feet of space on 3
acres of land. The property was 99% occupied at December 31,
1998.
Parklane Towers
Dearborn, Michigan Fee simple interest in twin 15-story office buildings constructed
in 1973 containing 482,668 net rentable square feet of space on
31.8 acres of land. The property was 94% occupied at December 31,
1998.
Raintree Industrial Park Fee simple interest in an office/industrial complex constructed
Solon, Ohio between 1971 and 1978 containing 794,953 net rentable square feet
of space in 14 buildings on 49 acres of land. The property was
87% occupied at December 31, 1998.
Seattle Business Parks Fee simple interest in office/industrial parks located at two
Kent and Tukwila, Washington separate sites. The buildings were completed between 1972 and
1993 and contain an aggregate of 432,467 net rentable square feet
of space in 18 buildings on 27 acres of land. At December 31,
1998, the property was 97% occupied.
</TABLE>
For information regarding the encumbrances to which the properties are subject
and the status of the related mortgage loans, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources" contained in Item 7 and Note 5 to the Consolidated Financial
Statements and Schedule III contained in Item 8.
Page 5 of 38
<PAGE> 81
ITEM 3. LEGAL PROCEEDINGS
On February 27, 1997, a lawsuit was filed in the Chancery Court for New Castle
County, Delaware, styled Gotham Partners, L.P. v. Hallwood Realty Partners,
L.P. and Hallwood Realty Corporation (C.A. No. 15578). The complaint sought
access to certain books and records of HRP, a list of the limited partners and
reimbursement of the plaintiff's expenses.
On June 20, 1997, Gotham Partners, L.P. filed a separate complaint in the
Chancery Court for New Castle County, Delaware, styled Gotham Partners, L.P. v.
Hallwood Realty Partners, L.P., et al. (C.A. No. 15754), against Hallwood, HRP,
Realty, and the directors of Realty, alleging claims of breach of fiduciary
duties, breach of HRP's partnership agreement, fraud, and as to Hallwood,
aiding and abetting these alleged breaches. At the same time as the filing of
this complaint, plaintiff filed a motion to amend its complaint in the earlier
action to allege the same facts and demand the same relief as plaintiff sought
in the separate complaint.
On June 27, 1997, the parties entered into a Stipulation and Order under which
HRP provided to plaintiff copies of certain of the documents requested. The
other claims in the two actions remain outstanding.
On August 27, 1997, defendants moved to dismiss the complaint in the separate
action for plaintiff's failure either to make a demand on the general partner
to bring suit or to allege adequately that such a demand was futile. On
February 6, 1998, the Court granted defendants' motion to dismiss but gave
plaintiff thirty days to file an amended complaint. Plaintiffs filed an amended
complaint on March 6, 1998, which defendants again moved to dismiss. This
motion was denied and the parties are proceeding with discovery.
HRP's management believes that the claims are without merit and intend to
defend the cases vigorously, but because of their early stages, cannot predict
the outcome of the claims or any possible effect an adverse outcome might have.
HRP is from time to time involved in various legal proceedings and claims which
arise in the ordinary course of business. These matters are generally covered
by insurance. Management believes that the resolution of these matters will not
have a material adverse effect on HRP's financial position, cash flow or
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders of HRP during the
fourth quarter of 1998.
Page 6 of 38
<PAGE> 82
PART II
ITEM 5. MARKET FOR REGISTRANT'S UNITS AND RELATED SECURITY
HOLDER MATTERS
The Partnership's units are traded on the American Stock Exchange under the
symbol "HRY". As of March 5, 1999, there were approximately 31,100 unitholders
of record of the 1,672,556 units outstanding. HRP has not paid any cash
distributions since February, 1992. Each quarter Realty reviews HRP's capacity
to make cash distributions to its partners.
The following table shows the range of sales prices for the periods indicated,
as reported by the American Stock Exchange:
<TABLE>
<CAPTION>
Trading Ranges
------------------------
High Low
-------- -------
<S> <C> <C>
1997 -
1st Quarter $ 27.625 $ 24.50
2nd Quarter 29.75 24.50
3rd Quarter 55.50 29.50
4th Quarter 54.75 47.375
1998 -
1st Quarter $ 66.00 $ 46.00
2nd Quarter 70.00 64.25
3rd Quarter 70.00 53.50
4th Quarter 64.25 44.50
</TABLE>
Page 7 of 38
<PAGE> 83
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data regarding the
Partnership's results of operations and financial position as of the dates
indicated. This information should be read in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in Item 7 and the Consolidated Financial Statements and notes thereto
contained in Item 8.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
---- ------ ------ ------ ------
(in thousands except per unit amounts)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS:
Total revenues $ 56,680 $ 53,899 $ 49,612 $ 50,829 $ 48,615
Income (loss) before extraordinary item 6,246 2,357 (9,428) (9,024) (18,161)
Net income (loss) 11,593 2,357 (9,428) (9,789) (18,161)
Income (loss) per unit and equivalent unit :
Basic -
Income (loss) before extraordinary item 3.70 1.40 (5.50) (5.55) (10.38) (a)
Net income (loss) 6.86 1.40 (5.50) (5.55) (10.38) (a)
Assuming dilution -
Income (loss) before extraordinary item 3.55 1.35 (5.50) (5.55) (10.38) (a)
Net income (loss) per unit 6.59 1.35 (5.50) (5.55) (10.38) (a)
BALANCE SHEETS:
Real estate, net (b) $ 175,779 $ 179,028 $ 182,877 $ 192,266 $ 205,212
Total assets 214,023 207,134 210,214 225,359 225,418
Mortgages payable 162,078 157,911 160,732 166,675 160,296
Partners' capital (c) 44,634 33,041 30,684 41,917 51,522
</TABLE>
Notes to Selected Financial Data:
(a) The per unit amounts for 1994 were adjusted to reflect the effect of
a 1-for-5 reverse split of the outstanding units effective as of the
close of business on March 3, 1995.
(b) Real estate assets declined in each of the years, primarily due to
depreciation and amortization exceeding the additions of tenant and
property improvements.
(c) Partners' capital is allocated 99% to the limited partners and 1% to
the general partner.
Page 8 of 38
<PAGE> 84
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This discussion should be read in conjunction with Item 6 - Selected Financial
Data and Item 8 - Financial Statements and Supplemental Information.
RESULTS OF OPERATIONS:
1998 VERSUS 1997 -
REVENUE FROM PROPERTY OPERATIONS in 1998 increased $2,864,000, or 5.4%, as
compared to 1997. The following table illustrates the components of the change:
<TABLE>
<S> <C>
Rental income, net $ 2,771,000
Expense recoveries 30,000
Other property income 63,000
-----------
Net increase $ 2,864,000
===========
</TABLE>
Rental income increased largely due to rental rate increases at a number of
properties and to a lesser degree due to a rise in average occupancy to 93.5%
in 1998 from 93.1% in 1997. As of December 31, 1998, HRP had leases executed
and in place for 93.3% of the portfolio's net rentable square feet.
INTEREST INCOME increased $311,000 as a result of additional earnings on
overnight investments due to higher average cash balances available for
investment.
PROPERTY OPERATING EXPENSES for 1998 decreased $987,000, or 4.2%, compared to
1997. The decrease is comprised of the following components:
o Real estate taxes decreased $603,000 primarily due to tax refunds
received in 1998 for tax years 1993 to 1997 for Parklane Towers and
Raintree Industrial Park.
o Repairs and Maintenance Costs decreased $450,000 primarily due to
exterior window glazing costs performed in 1997 at Parklane Towers.
o Management fees rose $121,000 due to the increase in net rental
income and occupancy mentioned above.
o Janitorial costs increased $129,000 principally due to the increase
in occupancy.
o Combined, all other operating costs decreased $184,000, or 0.8%,
between the years.
INTEREST EXPENSE diminished $164,000, or 1.3%, due to lower principal balances
as a result of scheduled principal payments and due to lower interest rates
from the refinancing of loans secured by Executive Park and Seattle Business
Parks during 1998 (see Note 5 to the Consolidated Financial Statements for more
information about refinancing of loans).
DEPRECIATION AND AMORTIZATION EXPENSE increased $59,000 primarily due to an
increase in lease commission amortization of $131,000 as a result of new leases
executed during 1997 which have increased the portfolio's occupancy, partially
offset by a decrease in building cost depreciation.
GENERAL AND ADMINISTRATIVE EXPENSES decreased $16,000 for 1998 compared to
1997, due to lower insurance premiums for director and officer coverage and
lower investor mailing costs, partially offset by an increase in state
franchise taxes for the state of Michigan.
NET GAIN FROM EARLY EXTINGUISHMENTS OF DEBT of $5,347,000 in 1998 is comprised
of the following transactions and is further discussed in Note 5 to the
Consolidated Financial Statements:
o a gain of $7,223,000 from the early payoff of the loan secured by
First Maryland Building comprised of $7,441,000 of unamortized loan
forgiveness, net of a $200,000 prepayment penalty and $18,000 of
unamortized loan costs, all associated with the retired loan.
o a loss of $1,611,000 from the early payoff of the loan secured by
Executive Park comprised of a prepayment penalty of $1,465,000 and
the writeoff of $146,000 of unamortized loan costs associated with
the retired loan.
o a loss of $265,000 from the early payoff of the loan secured by
Seattle Business Park comprised of a prepayment penalty of $190,000
and the writeoff of $75,000 of unamortized loan costs associated
with the retired loan.
Page 9 of 38
<PAGE> 85
RESULTS OF OPERATIONS (CONTINUED) -
1997 VERSUS 1996 -
REVENUE FROM PROPERTY OPERATIONS in 1997 increased $4,099,000, or 8.4%,
compared to 1996. The following table illustrates the components of the change:
<TABLE>
<S> <C>
Rental income, net $ 3,651,000
Expense recoveries 145,000
Other property income 303,000
-----------
Net increase $ 4,099,000
===========
</TABLE>
Rental income increased primarily as the result of a rise in average occupancy
to 93.1% in 1997 from 87.8% in 1996. As of December 31, 1997, HRP had leases
executed and in place for 94.4% of the portfolio's net rentable square feet.
GAIN FROM PROPERTY SALE of $394,000 in 1997 represents the sale of one building
in Fairlane Commerce Park containing 3,500 net rentable square feet and
approximately 0.5 acres for $510,000 before expenses of $8,000.
INTEREST INCOME decreased $206,000 primarily as a result of decreased earnings
on overnight investments due to lower average cash balances.
PROPERTY OPERATING EXPENSES for 1997 increased $213,000, or 0.9%, compared to
1996. The increase is comprised of the following components:
o Janitorial costs increased $144,000 and security costs increased
$64,000 principally due to the increase in occupancy mentioned
above.
o Personnel costs increased $145,000, or 4.1%.
o Management fees were $100,000 more due to the increase in net rental
income and occupancy mentioned above.
o Property insurance costs decreased $119,000 due to lower premiums.
o Combined, all other operating costs decreased $121,000, or 0.05%,
between the years.
INTEREST EXPENSE decreased $577,000, or 4.3%, due to loan
modifications/renewals for First Maryland Building and Executive Park in 1996.
First Maryland's costs dropped $92,000 and is comprised of a $112,000 reduction
in cash interest paid to the lender and a $20,000 decrease in amortization of
mortgage principal forgiveness. Executive Park's costs decreased $313,000 due
to the reduction in its interest rate by slightly more than 1%. All other
interest costs fell $172,000 due to a reduction in debt levels as a result of
monthly principal amortization payments.
DEPRECIATION AND AMORTIZATION EXPENSE decreased $6,958,000 primarily due to an
extension of depreciable lives of certain building costs effective January 1,
1997 (see Note 2 to the Consolidated Financial Statements in Item 8).
GENERAL AND ADMINISTRATIVE EXPENSES in 1997 decreased $176,000, or 5.1%, as the
result of a net decrease in professional fees and services as compared to 1996,
including certain due diligence costs for a potential acquisition in 1996,
partially offset by an increase in legal costs in 1997 as a result of the legal
proceeding described in Note 9 to the Consolidated Financial Statements in Item
8.
Page 10 of 38
<PAGE> 86
LIQUIDITY AND CAPITAL RESOURCES
HRP is engaged in the acquisition, ownership and operation of commercial real
estate assets. While it is the General Partner's primary intention to operate
HRP's existing real estate investments and to acquire and operate additional
real estate investments, Realty also continually evaluates each of HRP's real
estate investments in light of current economic trends and operations to
determine if any should be considered for disposal.
HRP's cash position increased $7,832,000 during 1998 from $6,665,000 as of
December 31, 1997 to $14,497,000 as of December 31, 1998. The sources of cash
for 1998 were $66,500,000 of mortgage principal proceeds and $14,078,000 of
cash provided by operating activities. Uses of cash for 1998 were $59,577,000
of mortgage principal repayments from refinancing proceeds, $6,603,000 of
property and tenant improvements, $1,855,000 of mortgage prepayment penalties,
$2,756,000 of scheduled mortgage principal payments, $1,405,000 of loan fees,
and $550,000 of net loan reserve requirements.
As of December 31, 1998, HRP had remaining commitments for current construction
projects of about $1,570,000. Additionally, HRP has estimated and budgeted for
1999 tenant and capital improvements (including the aforementioned commitments)
of $7,300,000 and lease commissions of about $2,130,000.
For the foreseeable future, HRP anticipates that mortgage principal payments,
tenant and capital improvements, and lease commissions will be funded by net
cash from operations. The primary sources of capital to fund any future
acquisitions will be proceeds from the sale or financing of one or more of its
Properties.
Each quarter Realty reviews HRP's capacity to make cash distributions. HRP has
not made any cash distributions since February, 1992.
MORTGAGES AND LOAN REFINANCING -
Substantially all of the buildings in eleven of HRP's Properties were
encumbered by and pledged as collateral under non-recourse mortgages as of
December 31, 1998. HRP has no mortgage loans maturing or requiring balloon
principal payments until the year 2003. Based upon loan amortization's in
effect, HRP is required to pay $2,470,000 of principal payments in 1999.
On November 16, 1998, HRP refinanced First Maryland Building's loan with a new
lender. The interest rate was reduced to LIBOR plus 1.30% from LIBOR plus 3.25%
and the maturity date was extended three years to April 30, 2006. The new loan
does not require any principal amortization. In connection with the
refinancing, HRP entered into an interest rate swap agreement to reduce its
exposure to changes in interest rates, which as been designated as a hedge
against HRP's variable interest exposure relating to the loan with a notional
amount of $25,000,000 terminating on April 30, 2006. This agreement, which is
settled monthly, effectively fixes the loan's interest rate at 6.78% compared
to the previous rate of 8.47% as of November 1998.
The loan proceeds of $25,000,000 plus $15,000 of cash were used (i) to pay the
outstanding principal balance of $24,531,000 with the former lender, (ii) to
pay transaction costs of $284,000, and (iii) to pay a prepayment penalty of
$200,000.
The remaining unamortized debt forgiveness of $7,441,000 less the prepayment
penalty of $200,000 and unamortized loan costs of $18,000, all associated with
the retired loan, resulted in a gain from early extinguishment of debt of
$7,223,000 included in the Statement of Operations as an extraordinary item.
NEW ACCOUNTING STANDARDS -
HRP has adopted Statements of Financial Accounting Standards ("SFAS") No. 130
"Reporting on Comprehensive Income" effective January 1, 1998. HRP had no items
of other comprehensive income in the years presented.
Page 11 of 38
<PAGE> 87
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) -
SFAS No. 131 "Disclosures about Segments of an Enterprise and Related
Information" redefines how operating segments are determined and requires
disclosure of certain financial and descriptive information about a company's
operating segments. HRP has evaluated the guidance under SFAS No. 131 and
determined that it operates in only one segment.
SFAS No. 133 "Accounting of Derivative Instruments and Hedging Activities" was
issued in June 1998 and is effective for periods beginning after June 15, 1999.
It requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in the fair value of the derivatives are recorded
each period in current earnings of other comprehensive income depending on
whether a derivative is designated as part of a hedge transaction, and if it
is, the type of hedge transaction. The impact on HRP's results of operation,
financial position, or cash flows will be dependent on the level and types of
derivative instruments that HRP will have entered into at the time SFAS No. 133
is implemented. HRP is currently not planning on early adoption of SFAS No. 133
and has not had an opportunity to evaluate the impact of the provisions of SFAS
No. 133 on its consolidated financial statements relating to future adoption.
Statement of Position ("SOP") 98-5 "Reporting on the Costs of Start-up
Activities" was issued in April 1998. SOP 98-5 concluded that costs of start-up
activities, including organization costs, should be expensed as incurred. HRP's
early adoption of this SOP did not have a significant effect on the financial
statements.
YEAR 2000 PLAN -
HRP 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.
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 1999 at minimal cost. (4) Payroll -
The General Partner processed payroll in a non-compliant system through an
outside payroll vendor until Year 2000 compliant software was purchased and
installed in the fourth quarter of 1998 at minimal cost.
Additionally, HRP 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 HRP's business and
operations. This survey includes the identification of certain on-site,
non-information technology systems that may be Year 2000 sensitive. Once these
systems have been fully identified , we 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 gates, alarms, elevators, heating and air conditioning systems,
irrigation systems, security systems, thermostats, and utility meters and
switches. HRP anticipates finalizing its survey of service providers and
vendors during the second quarter of 1999.
HRP will utilize external and internal resources to reprogram, replace and test
its systems for Year 2000 modifications. HRP anticipates completing the Year
2000 project, which includes repairing or replacing any vulnerable systems, by
June 30, 1999. Total costs, including information and non-information
technology systems, are not expected to exceed $100,000. In the event that a
system will not be Year 2000 compliant, HRP will assess the potential risk and,
to the extent it is feasible, transfer its business to an alternate vendor.
Page 12 of 38
<PAGE> 88
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) -
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 that might arise from matters not
previously considered. 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 (1) increased
time delays associated with posting of information, and (2) 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.
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 materially from those anticipated.
FORWARD-LOOKING STATEMENTS -
In the interest of providing investors with certain information regarding HRP's
future plans and operations, certain statements set forth in this Form 10-K
relate to management's future plans and objectives. Such statements are
forward- looking statements. Although any forward-looking statements contained
in this Form 10-K or otherwise expressed by or on behalf of HRP are, to the
knowledge and in the judgment of the officers and directors of the General
Partner, expected to prove true and come to pass, management is not able to
predict the future with absolute certainty. Although HRP believes that the
assumptions underlying the forward-looking statements are reasonable, any of
the assumptions could be inaccurate and, therefore, there can be no assurance
that the forward-looking statements will prove to be accurate.
Forward-looking statements involve known and unknown risks and uncertainties,
which may cause HRP's actual performance and financial results in future
periods to differ materially from any projection, estimate or forecasted
result. These risks and uncertainties include, among other things, future
economic, competitive and market conditions and future business decisions, all
of which are difficult or impossible to predict accurately and many of which
are beyond the control of HRP; other risks and uncertainties may be described,
from time to time, in HRP's periodic reports and filings with the Securities
and Exchange Commission.
In addition, the dates for completion of HRP's Year 2000 plan are based on its
best estimates, which were derived using numerous assumptions of future events.
Due to the general uncertainty inherent in the Year 2000 problem, resulting in
part from the uncertainty of the Year 2000 readiness of third-parties and the
interconnection of computer systems, HRP cannot ensure its ability to timely
and cost-effectively resolve problems associated with the Year 2000 issue that
may affect its operations and business. Accordingly, partners and potential
investors are cautioned that certain events or circumstances could cause actual
results to differ materially from those projected, estimated or predicted.
Page 13 of 38
<PAGE> 89
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As part of HRP's financing activity, derivative securities are sometimes used to
achieve the desired mix of fixed versus floating rate debt. HRP does not hold or
issue derivative financial instruments for trading. HRP's derivative instrument,
which is matched directly against an outstanding borrowing is a "pay
fixed/receive variable" interest rate swap with highly rated counterparties in
which the interest payments are calculated on a notional amount. The notional
amount does not represent amounts exchanged by the parties and thus are not a
measure of exposure to HRP through its use of the derivative. HRP is exposed to
credit-related gains or losses in the event of non-performance by counterparties
to this financial instrument; however, HRP does not expect any counterparties to
fail to meet their obligations. The interest rate swap is described as follows
(in thousands):
<TABLE>
<CAPTION>
Variable Rate as of December 31, 1998
--------------------------------------------
Fair Value
Notional Amount Maturity Date Fixed Rate % % Based On of Swap (a)
- --------------- -------------- ------------ ------- ------------ --------------
<S> <C> <C> <C> <C> <C>
$25,000 April 30, 2006 6.78% 6.85% 30 day LIBOR $366
</TABLE>
(a) The estimated amount that HRP would have to pay to terminate the interest
rate swap agreement (used to hedge against exposure to interest rate
fluctuations) as of December 31, 1998 was based on a quote received from
the lender.
Page 14 of 38
<PAGE> 90
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL INFORMATION
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL INFORMATION
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS: Page
----
<S> <C>
Independent Auditors' Report 16
Consolidated Balance Sheets as of December 31, 1998 and 1997 17
Consolidated Statements of Operations for the years
ended December 31, 1998, 1997 and 1996 18
Consolidated Statements of Partners' Capital for the years
ended December 31, 1998, 1997 and 1996 19
Consolidated Statements of Cash Flows for the years
ended December 31, 1998, 1997 and 1996 20
Notes to Consolidated Financial Statements 21
FINANCIAL STATEMENT SCHEDULE:
Schedule III - Real Estate and Accumulated Depreciation 31
All other schedules have been omitted because they are not applicable,
not required, or the required information is disclosed in the
consolidated financial statements or notes thereto.
</TABLE>
Page 15 of 38
<PAGE> 91
INDEPENDENT AUDITORS' REPORT
To the Partners of Hallwood Realty Partners, L.P.
We have audited the accompanying consolidated balance sheets of Hallwood Realty
Partners, L.P. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, partners' capital and cash flows
for each of the three years in the period ended December 31, 1998. Our audits
also included the financial statement schedule listed in the Index at Item 8.
These financial statements and financial statement schedule are the
responsibility of the Partnership's management. Our responsibility is to
express an opinion on the financial statements and financial statement schedule
based upon our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Hallwood Realty Partners, L.P. and
subsidiaries as of December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Dallas, Texas
February 5, 1999
Page 16 of 38
<PAGE> 92
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT UNIT AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1997
---- ----
ASSETS
<S> <C> <C>
Real estate:
Land $ 56,441 $ 56,441
Buildings and improvements 262,588 259,220
Tenant improvements 17,692 18,734
--------- ---------
336,721 334,395
Accumulated depreciation and amortization (160,942) (155,367)
--------- ---------
Real estate, net 175,779 179,028
Cash and cash equivalents 14,497 6,665
Accounts receivable 1,456 1,162
Prepaid lease commissions, net 7,186 7,049
Lease concessions 2,955 2,511
Loan reserves and escrows 6,986 6,215
Loan costs, net 3,923 3,213
Prepaid expenses and other assets, net 1,241 1,291
--------- ---------
Total assets $ 214,023 $ 207,134
========= =========
LIABILITIES AND PARTNERS' CAPITAL
Liabilities:
Mortgages payable $ 162,078 $ 157,911
Unamortized mortgage payable forgiveness -- 8,926
Accounts payable and accrued expenses 4,435 4,157
Prepaid rent and security deposits 2,703 2,764
Payable to affiliates 173 335
--------- ---------
Total liabilities 169,389 174,093
--------- ---------
COMMITMENTS AND CONTINGENCIES
Partners' capital:
Limited partners - 1,672,556 units outstanding 44,188 32,711
General partner 446 330
--------- ---------
Total partners' capital 44,634 33,041
--------- ---------
Total liabilities and partners' capital $ 214,023 $ 207,134
========= =========
</TABLE>
See notes to consolidated financial statements.
Page 17 of 38
<PAGE> 93
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER UNIT AMOUNTS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
REVENUES:
Property operations $ 55,810 $ 52,946 $ 48,847
Gain from property sale -- 394 --
Interest and other 870 559 765
-------- -------- --------
Total revenues 56,680 53,899 49,612
-------- -------- --------
EXPENSES:
Property operations 22,261 23,248 23,035
Interest 12,781 12,945 13,522
Depreciation and amortization 12,114 12,055 19,013
General and administrative 3,278 3,294 3,470
-------- -------- --------
Total expenses 50,434 51,542 59,040
-------- -------- --------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM 6,246 2,357 (9,428)
Extraordinary item -
Net gain on early extinguishments of debt 5,347 -- --
-------- -------- --------
NET INCOME (LOSS) $ 11,593 $ 2,357 $ (9,428)
======== ======== ========
ALLOCATION OF NET INCOME (LOSS):
Limited partners $ 11,477 $ 2,334 $ (9,334)
General partner 116 23 (94)
-------- -------- --------
Total $ 11,593 $ 2,357 $ (9,428)
======== ======== ========
INCOME (LOSS) PER UNIT AND EQUIVALENT UNIT:
Basic -
Income (loss) before extraordinary item $ 3.70 $ 1.40 $ (5.50)
Net gain on early extinguishments of debt 3.16 -- --
-------- -------- --------
Net income (loss) $ 6.86 $ 1.40 $ (5.50)
======== ======== ========
Assuming dilution -
Income (loss) before extraordinary item $ 3.55 $ 1.35 $ (5.50)
Net gain on early extinguishments of debt 3.04 -- --
-------- -------- --------
Net income (loss) $ 6.59 $ 1.35 $ (5.50)
======== ======== ========
WEIGHTED AVERAGE UNITS
USED IN COMPUTING NET INCOME
(LOSS) PER UNIT AND EQUIVALENT UNIT:
Basic 1,673 1,673 1,698
======== ======== ========
Assuming dilution 1,741 1,730 1,698
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
Page 18 of 38
<PAGE> 94
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL
(IN THOUSANDS EXCEPT UNIT AMOUNTS)
<TABLE>
<CAPTION>
Limited
Partner
General Limited Units
Partner Partners Total Outstanding
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
PARTNERS' CAPITAL, JANUARY 1, 1996 $ 419 $ 41,498 $ 41,917 1,747,765
Purchase of units (18) (1,787) (1,805) (75,209)
Net loss (94) (9,334) (9,428) --
---------- ---------- ---------- ----------
PARTNERS' CAPITAL, DECEMBER 31, 1996 307 30,377 30,684 1,672,556
Net income 23 2,334 2,357 --
---------- ---------- ---------- ----------
PARTNERS' CAPITAL, DECEMBER 31, 1997 330 32,711 33,041 1,672,556
Net income 116 11,477 11,593 --
---------- ---------- ---------- ----------
PARTNERS' CAPITAL, DECEMBER 31, 1998 $ 446 $ 44,188 $ 44,634 1,672,556
========== ========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
Page 19 of 38
<PAGE> 95
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 11,593 $ 2,357 $ (9,428)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 12,114 12,055 19,013
Net gain on early extinguishments of debt (5,347) -- --
Amortization of mortgage principal forgiveness (1,485) (1,674) (1,693)
Gain from property sale -- (394) --
Lease concessions (444) (157) 144
Changes in assets and liabilities:
Receivables (294) 444 (526)
Prepaid lease commissions, net (2,369) (2,191) (4,338)
Prepaid expenses and other assets, net 255 510 (62)
Accounts payable and other liabilities 55 (1,086) 487
-------- -------- --------
Net cash provided by operating activities 14,078 9,864 3,597
-------- -------- --------
INVESTING ACTIVITIES:
Property and tenant improvements (6,603) (5,534) (5,998)
Tenant improvement escrow -- 1,532 (1,532)
Property acquisition -- (649) (1,699)
Cash proceeds from property sale, net of selling costs -- 502 --
Mortgage receivable principal payments -- 46 86
-------- -------- --------
Net cash used in investing activities (6,603) (4,103) (9,143)
-------- -------- --------
FINANCING ACTIVITIES:
Mortgage principal proceeds 66,500 549 --
Mortgage principal refinanced (59,577) -- --
Mortgage prepayment penalties (1,855) -- --
Mortgage principal payments (2,756) (3,226) (2,706)
Loan reserves (550) -- (450)
Purchase of units -- -- (1,805)
Loan fees (1,405) 25 (239)
-------- -------- --------
Net cash provided by (used in) financing activities 357 (2,652) (5,200)
-------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 7,832 3,109 (10,746)
BEGINNING CASH AND CASH EQUIVALENTS 6,665 3,556 14,302
-------- -------- --------
ENDING CASH AND CASH EQUIVALENTS $ 14,497 $ 6,665 $ 3,556
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
Page 20 of 38
<PAGE> 96
HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1998
1. ORGANIZATION
Hallwood Realty Partners, L.P. ("HRP" or the "Partnership"), a
publicly traded Delaware limited partnership, is engaged in the
acquisition, ownership and operation of commercial real estate assets.
The limited partners' interests, or units, are traded on the American
Stock Exchange under the symbol "HRY". As of December 31, 1998, there
were 1,672,556 units outstanding.
As of December 31, 1998, HRP owned twelve real estate assets (the
"Properties"), located in six states containing 5,150,000 net rentable
square feet. HRP seeks to maximize the value of its real estate by
making capital and tenant improvements, by executing marketing
programs to attract and retain tenants, and by controlling or
reducing, where possible, operating expenses.
Hallwood Realty, LLC, formerly Hallwood Realty Corporation, ("Realty"
or the "General Partner"), a Delaware limited liability company and
wholly-owned subsidiary of The Hallwood Group Incorporated
("Hallwood") is HRP's general partner and is responsible for asset
management of HRP and its Properties, including the decision making
responsibility for financing, refinancing, acquiring and disposing of
properties. In addition, Realty provides general operating and
administrative services to HRP. Hallwood Commercial Real Estate, LLC,
formerly Hallwood Commercial Real Estate, Inc., ("HCRE"), another
wholly-owned subsidiary of Hallwood, provides property management
services to the Properties.
2. ACCOUNTING POLICIES
CONSOLIDATION
HRP fully consolidates into its financial statements majority owned
entities and reflects a minority interest for those entities not fully
owned. For each of the three years in the period ended December 31,
1998, all entities and Properties were fully owned. All significant
intercompany balances and transactions have been eliminated in
consolidation.
CASH AND CASH EQUIVALENTS
HRP considers highly liquid investments with original maturities of
three months or less at the time of purchase to be cash equivalents.
PROPERTY
Property is stated at cost. Renovations and improvements are
capitalized; maintenance and repairs are expensed. When an asset is
sold or otherwise disposed of, the related cost and accumulated
depreciation are removed from the accounts and any gain or any
previously unanticipated loss is recognized in the year of sale or
disposition. HRP's management routinely reviews its investments for
impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable.
Depreciation of buildings is computed using the straight-line method
over estimated useful lives ranging from 15 to 43 years. Equipment and
other improvements are depreciated on the straight-line method over
estimated useful lives ranging from 3 to 23 years. Tenant improvements
are capitalized and amortized over the terms of the respective leases.
During 1997, HRP completed a review of its real estate lives. In light
of recent improvements and actions taken to increase its preventative
maintenance programs, the estimated economic lives for buildings were
found to be generally longer than the useful lives being used for
depreciation purposes. Accordingly, effective January 1, 1997, HRP
extended the depreciable lives of certain building costs. The effect
of this change in estimate reduced depreciation and amortization
expense and improved the net operating results by $7,200,000 ($4.26
per unit) for the year ended December 31, 1997.
Page 21 of 38
<PAGE> 97
HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1998
2. ACCOUNTING POLICIES - (CONTINUED)
HRP accrues for losses associated with environmental remediation
obligations when such losses are probable and reasonably estimable.
Accruals for estimated losses from environmental remediation
obligations generally are recognized no later than completion of a
remedial feasibility study. Such accruals are adjusted as further
information develops or circumstances change. Costs of future
expenditures for environmental remediation obligations are not
discounted to their present value. Recoveries of environmental
remediation costs from other parties are recorded as assets when their
receipt is deemed probable. HRP's management is not aware of any
environmental remediation obligations which would materially affect
the operations, financial position or cash flows of HRP and therefore
has made no loss accruals.
OTHER ASSETS
Lease concessions and commissions are amortized over the terms of the
respective leases. Leases at the Properties expire from 1999 to 2013.
Loan costs are amortized over the terms of the respective loans. The
loans mature between 2003 and 2008. Amortization of lease concessions
income, included in property operations revenues, was $444,000 and
$157,000 in 1998 and 1997, respectively. Amortization of lease
concessions expense, included in property operations revenues, was
$144,000 in 1996. Amortization of lease commissions, included in
depreciation and amortization expense, was $2,232,000, $2,101,000, and
$1,897,000 in 1998, 1997 and 1996, respectively. Amortization of loan
costs, included in interest expense, was $456,000, $453,000, and
$453,000 in 1998, 1997 and 1996, respectively. The caption "Other
assets" on the Consolidated Balance Sheet includes prepaid real estate
taxes, prepaid insurance and other miscellaneous deposits and prepaid
expenses.
REVENUE RECOGNITION
Rental income is recognized as earned on a straight-line basis over
the terms of the respective leases.
INTEREST RATE AGREEMENTS
Interest rate swaps are entered into as a hedge against interest
exposure of variable rate debt. Differences between amounts to be paid
or received on these interest rate agreements designated as hedges are
included in interest expense as the payments are made or received. HRP
is exposed to credit-related gains or losses in the event of
non-performance by counterparties; however, HRP does not expect any
counterparties to fail to meet their obligations.
INCOME TAXES
Currently, HRP is a non-taxable entity. Federal and state income
taxes, if any, are the responsibility of the individual partners.
Accordingly, the Consolidated Financial Statements do not include a
provision for income taxes. However, certain business and franchise
taxes are the responsibility of HRP and subsidiary entities. These
business and franchise taxes, included in general and administrative
expenses, were $248,000, $117,000, and $206,000, in 1998, 1997, and
1996, respectively. HRP's tax returns are subject to examination by
federal and state taxing authorities. If HRP's amounts are ultimately
changed by the taxing authorities, the tax liability of the partners
could be changed accordingly. Additionally, no assurance can be given
that the federal or state governments will not pass legislation that
will characterize HRP as an association taxable as a corporation for
federal income tax purposes. Such classification may have an adverse
effect on HRP.
Page 22 of 38
<PAGE> 98
HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1998
2. ACCOUNTING POLICIES - (CONTINUED)
COMPUTATION OF NET INCOME (LOSS) PER UNIT
Basic earnings per unit is computed by dividing net income
attributable to the limited partners' interests by the weighted
average number of units outstanding. Earnings per unit assuming
dilution is computed by dividing net income attributable to the
limited partners' interests by the weighted average number of units
and potential units outstanding. Options to acquire units were issued
during 1995 and are considered to be potential units. The number of
potential units is computed using the treasury stock method which
assumes that the increase in the number of units is reduced by the
number of units which could have been repurchased by HRP with the
proceeds from the exercise of these options. The options are
considered antidilutive in 1996 and therefore are not taken into
consideration in the computation of earnings per unit assuming
dilution. The following table illustrates the amounts used to
calculate the weighted average number of units outstanding:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Weighted average units outstanding - basic 1,673 1,673
Issuance of units from options 86 86
Repurchase of units from unit option proceeds (18) (29)
------ ------
Weighted average units outstanding - assuming dilution 1,741 1,730
====== ======
</TABLE>
FINANCIAL STATEMENTS AND OTHER
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of certain assets,
liabilities, revenues, and expenses as of and for the reporting
periods. Actual results may differ from these estimates.
HRP has adopted Statements of Financial Accounting Standards ("SFAS")
No. 130 "Reporting on Comprehensive Income" effective January 1, 1998.
HRP had no items of other comprehensive income in the years presented.
SFAS No. 131 "Disclosures about Segments of an Enterprise and Related
Information" redefined how operating segments are determined and
requires disclosure of certain financial and descriptive information
about a company's operating segments. HRP has evaluated the guidance
under SFAS No. 131 and determined that it operates in only one
segment.
SFAS No. 133 "Accounting of Derivative Instruments and Hedging
Activities" was issued in June 1998 and is effective for periods
beginning after June 15, 1999. It requires that all derivative
instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of the derivatives are recorded each period
in current earnings of other comprehensive income depending on whether
a derivative is designated as part of a hedge transaction, and if it
is, the type of hedge transaction. The impact on HRP's results of
operation, financial position, or cash flows will be dependent on the
level and types of derivative instruments that HRP will have entered
into at the time SFAS No. 133 is implemented. HRP is currently not
planning on early adoption of SFAS No. 133 and has not had an
opportunity to evaluate the impact of the provisions of SFAS No. 133
on its consolidated financial statements relating to future adoption.
Statement of Position ("SOP") 98-5 "Reporting on the Costs of Start-up
Activities" was issued in April 1998. SOP 98-5 concluded that costs of
start-up activities, including organization costs, should be expensed
as incurred. HRP's early adoption of this SOP did not have a
significant effect on the financial statements.
Page 23 of 38
<PAGE> 99
HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1998
3. TRANSACTIONS WITH RELATED PARTIES
Realty receives certain fees in connection with the ongoing management
of HRP, including an asset management fee, acquisition fees and
incentive disposition fees. Specifically, Realty is entitled to
receive (i) an asset management fee equal to 1% of the net aggregate
base rents of the Properties, (ii) acquisition fees equal to 1% of the
purchase price of newly acquired properties, and (iii) incentive fees
for performing disposition services with respect to real estate
investments, other than the properties owned at the time of HRP's
formation on November 1, 1990, equal to 10% of the amount, by which
the sales price of a property disposed of exceeds the purchase price
of such property.
HCRE receives compensation in connection with the management of the
Properties, which includes a property management fee, lease
commissions and construction supervision fees. The management
contracts have been extended and expire June 30, 2004 and provide for
(i) basic compensation from a property management fee which is an
amount equal to 2.85% of cash receipts collected from the Properties'
tenants, (ii) lease commissions equal to the current market rate as
applied to the net aggregate rent, not to exceed 6% of the net
aggregate rent, and (iii) construction supervision fees for
administering all construction projects equal to 5% of the total
contracted costs of each capital expenditure or tenant improvement
project.
Realty and HCRE are compensated for services provided to HRP and its
Properties as described above. The following table sets forth such
compensation and reimbursement paid by HRP for the periods presented
(in thousands):
<TABLE>
<CAPTION>
Entity
Paid or
Reimbursed 1998 1997 1996
---------- ---- ---- ----
<S> <C> <C> <C> <C>
Asset management fee Realty $ 495 $ 458 $ 450
Acquisition fee Realty -- 7 17
Reimbursement of costs (a) Realty 2,320 2,316 2,321
Property management fee HCRE 1,608 1,524 1,433
Lease commissions HCRE 1,964 1,425 2,888
Construction fees HCRE 314 353 382
</TABLE>
(a) These costs are mostly recorded as General and
Administrative Expenses and represent reimbursement to
Realty, at cost, for partnership level salaries, employee
and director insurance and certain overhead costs. HRP
pays, on a monthly basis, the balance of its account with
Realty.
4. PROPERTY ACQUISITION AND PROPERTY SALE
In May 1997, HRP acquired 6.2 acres of land at the Corporate Square
office complex of which about half is a parking lot and the other half
is wooded land for a purchase price of $725,000, plus about $25,000 of
miscellaneous costs. The purchase price consisted of a $75,000 cash
down payment and a $650,000 seven year, fully-amortizing non-recourse
mortgage note with 0% interest the first year; 4% interest in years
two and three; 6% interest in years four and five; and 8% interest in
years six and seven. For financial reporting purposes, the carrying
values of the mortgage note and land were reduced by $101,000 in order
to reflect an imputed market interest rate of 8% for the mortgage
note.
In October 1997, HRP sold one building in Fairlane Commerce Park
containing 3,500 net rentable square feet on approximately 0.5 acres
for $510,000 in cash before closing expenses of $8,000. HRP recorded a
$394,000 gain from the property sale.
Page 24 of 38
<PAGE> 100
HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1998
5. MORTGAGES PAYABLE
Substantially all of the buildings in eleven of HRP's Properties were
encumbered and pledged as collateral by eight non-recourse mortgages
aggregating $162,078,000 as of December 31, 1998. These mortgages have
interest rates varying from 6.78% to 8.7% (with an effective average
interest rate of 8.1%) and mature between 2003 and 2008. Cash interest
payments were $13,934,000, $14,177,000, and $14,947,000, in 1998, 1997
and 1996, respectively.
Most of the mortgages require monthly principal payments with balloon
payments due at maturity. The following table shows for the periods
presented the principal and balloon payments that are required (in
thousands):
<TABLE>
<CAPTION>
Total
Principal Balloon Mortgage
Payments Payments Payments
-------- -------- --------
<S> <C> <C> <C>
1999 $ 2,470 $ -- $ 2,470
2000 2,669 -- 2,669
2001 2,930 -- 2,930
2002 3,183 -- 3,183
2003 3,430 4,900 8,330
Thereafter 8,021 134,475 142,496
-------- -------- --------
Total $ 22,703 $139,375 $162,078
======== ======== ========
</TABLE>
EXECUTIVE PARK -
On February 27, 1998, HRP entered into an agreement to refinance the
mortgage loan secured by Executive Park that became effective March
20, 1998. The new loan reduces the interest rate from 8.87% to an
effective interest rate of 7.32% and extends the amortization period
from fifteen years to twenty-seven years with a maturity date of April
11, 2008. The loan proceeds of $34,000,000 were used (i) to pay the
outstanding principal balance of $28,707,000 with the former lender,
(ii) to pay transaction costs of $901,000, (iii) to pay a prepayment
penalty of $1,465,000, (iv) to pay $550,000 of net loan reserves, and
(v) for general working capital. The prepayment penalty along with the
writeoff of $146,000 of unamortized loan costs associated with the
retired loan were expensed and are included in the Statement of
Operations as an extraordinary item.
SEATTLE BUSINESS PARKS -
On June 1, 1998, HRP refinanced the mortgage loan secured by Seattle
Business Parks into two new loans which reduced the interest rate from
9.25% to 6.97%. The new loans lengthen the amortization period from
twenty-two years to thirty years and the maturity date was extended by
seven years to June 7, 2008. The loan proceeds of $7,500,000 were used
(i) to pay the outstanding principal balance of $6,339,000 with the
former lender, (ii) to pay transaction costs of $220,000, (iii) to pay
a prepayment penalty of $190,000, and (iv) for general working
capital. The prepayment penalty along with the writeoff of $75,000 of
unamortized loan costs associated with the retired loan were expensed
and are included in the Statement of Operations as an extraordinary
item.
FIRST MARYLAND BUILDING -
Effective May 1, 1996, the lender for First Maryland Building extended
the loan to April 30, 2003 with an interest rate of LIBOR plus 3.25%
and forgave $3,237,000 of the principal balance in addition to the
$9,250,000 of forgiveness granted in September 1995. The extension
required 49.9% of the property's net cash flow to be used to amortize
the loan's principal balance. During 1997, an additional $144,000 of
forgiveness was recorded.
Page 25 of 38
<PAGE> 101
HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1998
5. MORTGAGES PAYABLE - (CONTINUED)
For financial reporting purposes, the mortgage principal forgiveness
was treated as a troubled debt restructuring and accordingly, HRP did
not recognize a gain. Instead, the mortgage principal forgiveness
remained on the balance sheet and was being amortized over the life of
the loan. Interest expense was computed in such a way that a constant
effective interest rate (equal to approximately 1.19% as of November
1998) was applied to the carrying amount of the loan.
On November 16, 1998, HRP refinanced First Maryland Building's loan
with a new lender. The interest rate was reduced to LIBOR plus 1.30%
from LIBOR plus 3.25% and the maturity date was extended three years
to April 30, 2006. The new loan does not require any principal
amortization. In connection with the refinancing, HRP entered into an
interest rate swap agreement to reduce its exposure to changes in
interest rates, which as been designated as a hedge against HRP's
variable interest exposure relating to the loan with a notional amount
of $25,000,000 terminating on April 30, 2006. This agreement, which is
settled monthly, effectively fixes the loan's interest rate at 6.78%
compared to the previous loan's rate of 8.47% as of November 1998.
The loan proceeds of $25,000,000 plus $15,000 of cash were used (i) to
pay the outstanding principal balance of $24,531,000 with the former
lender, (ii) to pay transaction costs of $284,000, and (iii) to pay a
prepayment penalty of $200,000.
The remaining unamortized debt forgiveness of $7,441,000 less the
prepayment penalty of $200,000 and unamortized loan costs of $18,000,
all associated with the retired loan, resulted in a gain from early
extinguishment of debt of $7,223,000 included in the Statements of
Operations as an extraordinary item.
For federal income tax purposes, debt forgiveness of $12,487,000 was
reported as a 1996 gain to the partners of HRP.
6. LEASE AGREEMENTS
The lease provisions generally require tenants to pay fixed rental
amounts plus their proportionate share of certain building operating
costs and real property taxes. In addition, certain leases include
provisions for annual rental adjustments. Revenue from expense
recoveries, included in property operations, was $2,591,000,
$2,561,000, and $2,416,000 in 1998, 1997 and 1996, respectively. At
December 31, 1998, the Properties, in the aggregate, were 93% occupied
and minimum cash rental payments to be received under non-cancelable
leases with tenants were as follows (in thousands):
<TABLE>
<S> <C>
1999 $ 46,154
2000 39,262
2001 29,097
2002 22,089
2003 14,259
Thereafter 39,355
---------
Total $ 190,216
=========
</TABLE>
During 1998, one tenant contributed more than 10% of the total
revenues of the Partnership. During 1997, two tenants leasing space
each contributed more than 10% of the total revenues of the
Partnership. Ford Motor Company and affiliates ("Ford") leases space
in Parklane Towers and Fairlane Commerce Park and contributed 13% and
15% of revenues in 1998 and 1997, respectively. The Centers for
Disease Control and Prevention ("CDC"), an agency of the U.S.
Department of Health and Human Services, leases space in Corporate
Square and Executive Park and contributed 9% and 10% of the revenues
in 1998 and 1997, respectively.
Page 26 of 38
<PAGE> 102
HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1998
6. LEASE AGREEMENTS - (CONTINUED)
As of December 31, 1998, Ford occupied 233,000 square feet of office
space under 9 separate leases at Parklane Towers and 255,000 square
feet of office, technical laboratory and industrial space under 9
separate leases at Fairlane Commerce Park. These leases expire between
1999 and 2003 and most contain renewal options, providing for one to
ten year renewals. As of December 31, 1998, CDC occupied 218,000
square feet of office space at Executive Park under 5 leases which
expire between 2001 and 2003 and 158,000 square feet of office space
at Corporate Square under a lease which expires in 2013.
The remaining tenants are not concentrated in any one industry, nor is
HRP otherwise dependent on any group of related tenants for 10% or
more of its revenues.
7. PARTNERS' CAPITAL
HRP has adopted the disclosure-only provisions of SFAS No. 123 -
"Accounting for Stock Based Compensation". Accordingly, no
compensation cost has been recognized for the options. HRP issued
options in 1995, which were vested over a three year period ending in
1997, and accordingly had no effect to 1998. Had compensation costs
for the Options been determined based on the fair value at the grant
date for the awards in 1995 consistent with the provisions of SFAS No.
123, HRP's net loss and net loss per unit for 1997 and 1996 would have
been the pro forma amounts indicated below (in thousands except per
unit amounts):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Net income (loss) - as reported $ 2,357 $ (9,428)
Net income (loss) - pro forma 2,325 (9,623)
Net income (loss) per unit:
As reported -
Basic 1.40 (5.50)
Assuming dilution 1.35 (5.50)
Pro forma -
Basic 1.38 (5.61)
Assuming dilution 1.33 (5.61)
</TABLE>
The fair value of the option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following
assumptions used: expected volatility of 57.8%, risk-free interest
rate of 7.1%, expected life of 5 years and no distribution yield.
UNIT PURCHASES - 1996
HRP purchased, in private transactions, 74,760 units for $1,775,000 in
May 1996 and 449 units for $12,000 in July 1996. Accordingly, HRP's
outstanding units decreased from 1,747,765 Units to 1,672,556 units.
In addition, the General Partner's capital account was adjusted by
$18,000 in order to maintain its 1% general partner interest, in
accordance with HRP's Partnership Agreement.
Page 27 of 38
<PAGE> 103
HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1998
8. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
Estimated fair value amounts of certain financial instruments have
been determined using available market information based upon
negotiations held by Realty with potential lenders or other
appropriate valuation methodologies that require considerable judgment
in interpreting market data and developing estimates. Accordingly, the
estimates presented herein are not necessarily indicative of the
amounts that the Partnership could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value
amounts.
The fair value of financial instruments that are short-term or
re-price frequently and have a history of negligible credit losses is
considered to approximate their carrying value. These include cash and
cash equivalents, short term receivables, accounts payable and other
liabilities. Real estate and other assets consist of nonfinancial
instruments.
Management has reviewed the carrying values of its mortgages payable
in connection with interest rates currently available to the
Partnership for borrowing with similar characteristics and maturities
(approximately 7.25% and 7.75% as of December 31, 1998 and 1997,
respectively) and has determined that they would equal approximately
$171,921,000 and $166,871,000 (excluding the unamortized mortgage
payable forgiveness at December 31, 1997 discussed in Note 4) of
estimated fair value as of December 31, 1998 and 1997, respectively.
The fair value of HRP's interest rate swap agreement (used to hedge
against exposure to interest rate fluctuations) is $366,000, the
estimated amount that HRP would have to pay to terminate the agreement
as of December 31, 1998. The amount was determined based on a quote
received from its lender.
As of December 31, 1998 and 1997, the fair value information presented
herein is based on pertinent information available to management.
Although management is not aware of any factors that would
significantly affect the estimated fair value amounts, such amounts
have not been comprehensively revalued for purposes of these financial
statements since that date and, therefore current estimates of fair
value may differ significantly from the amounts presented herein.
9. COMMITMENTS AND CONTINGENCIES
LITIGATION
On February 27, 1997, a lawsuit was filed in the Chancery Court for
New Castle County, Delaware, styled Gotham Partners, L.P. v. Hallwood
Realty Partners, L.P. and Hallwood Realty Corporation (C.A. No.
15578). The complaint sought access to certain books and records of
HRP, a list of the limited partners and reimbursement of the
plaintiff's expenses.
On June 20, 1997, Gotham Partners, L.P. filed a separate complaint in
the Chancery Court for New Castle County, Delaware, styled Gotham
Partners, L.P. v. Hallwood Realty Partners, L.P., et al. (C.A. No.
15754), against Hallwood, HRP, Realty, and the directors of Realty,
alleging claims of breach of fiduciary duties, breach of HRP's
partnership agreement, fraud, and as to Hallwood, aiding and abetting
these alleged breaches. At the same time as the filing of this
complaint, plaintiff filed a motion to amend its complaint in the
earlier action to allege the same facts and demand the same relief as
plaintiff sought in the separate complaint.
On June 27, 1997, the parties entered into a Stipulation and Order
under which HRP provided to plaintiff copies of certain of the
documents requested. The other claims in the two actions remain
outstanding.
On August 27, 1997, defendants moved to dismiss the complaint in the
separate action for plaintiff's failure either to make a demand on the
general partner to bring suit or to allege adequately that such a
demand was futile. On February 6, 1998, the Court granted defendants'
motion to dismiss but gave plaintiff thirty days to file an amended
complaint. Plaintiffs filed an amended complaint on March 6, 1998,
which defendants again moved to dismiss. This motion was denied and
the parties are proceeding with discovery.
Page 28 of 38
<PAGE> 104
HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1998
9. COMMITMENTS AND CONTINGENCIES - (CONTINUED)
HRP's management believes that the claims are without merit and intend
to defend the cases vigorously, but because of their early stages,
cannot predict the outcome of the claims or any possible effect an
adverse outcome might have.
HRP is from time to time involved in various legal proceedings and
claims which arise in the ordinary course of business. These matters
are generally covered by insurance. Management believes that the
resolution of these matters will not have a material adverse effect on
HRP's financial position, cash flow or operations.
ASBESTOS
Parklane Towers, as well as certain other properties to a lesser
extent, are known to contain asbestos. Removal of the asbestos at
Parklane Towers is estimated to cost approximately $1,700,000;
however, it is not required to be removed since it is not friable and
the Partnership has an Operations and Maintenance Program in place.
Federal and state environmental legislation or regulations may have an
impact on the future operations of Parklane Towers or certain other
properties if such legislation or regulations require the immediate
expenditure of funds to comply with applicable restrictions or
requirements.
RIGHTS PLAN
HRP has a Unit Purchase Rights Agreement ("Rights Plan") that provides
for a distribution of one right for each unit of the Partnership to
holders of record at the close of business as of December 10, 1990.
The rights will become exercisable only in the event, with certain
exceptions, an acquiring party accumulates 15 percent or more of the
Partnership's units, or if a party commences or announces an intent to
commence a tender offer or exchange offer to acquire 30 percent or
more of such units. The rights will expire on November 30, 2000. Each
right will entitle the holder to buy one additional unit at a price of
$250. In addition, upon the occurrence of certain events, holders of
the rights will be entitled to purchase either Partnership units or
shares in an "acquiring entity" at half of market value. HRP will
generally be entitled to redeem the rights at $.01 per right at any
time on or prior to the tenth day following the acquisition of a 15
percent or greater interest in its units.
OTHER
As of December 31, 1998, HRP had remaining commitments for current
construction projects of about $1,570,000. Additionally, HRP has
estimated and budgeted for 1999 tenant and capital improvements
(including the aforementioned commitments) of $7,300,000 and lease
commissions of about $2,130,000.
Page 29 of 38
<PAGE> 105
HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 1998
11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Set forth below is selected quarterly financial data for the years
ended December 31, 1998 and 1997.
<TABLE>
<CAPTION>
Quarter Ending
---------------------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
(in thousands except per unit amounts)
1998
----
<S> <C> <C> <C> <C>
Total revenues $ 13,823 $ 13,771 $ 14,515 $ 14,571
Property operations revenues less property
operations expenses and general
and administrative expenses 7,183 7,581 7,674 7,833
Net income (loss) (a) (542) 1,390 1,727 9,018
Net income (loss) per unit - basic (.32) .82 1.02 5.34
Net income (loss) per unit - assuming dilution (.31) .79 .98 5.13
1997
----
Total revenues (b) $ 12,908 $ 13,443 $ 13,533 $ 14,015
Property operations revenues less property
operations expenses and general
and administrative expenses 6,135 7,054 6,693 6,522
Net income 68 936 569 784
Net income per unit - basic .04 .55 .34 .47
Net income per unit - assuming dilution .04 .54 .33 .45
</TABLE>
(a) Net income (loss) for the first and second quarter of 1998
includes losses on early extinguishments of debt of
$1,611,000 and $265,000, respectively. Net income for the
fourth quarter of 1998 includes a gain on early
extinguishment of debt of $7,223,000. (See Note 5 to the
Consolidated Financial Statements for more information about
the refinancing of mortgage loans during 1998).
(b) Total revenues in the fourth quarter of 1997 include $394,000
of gain from the sale of a property.
Page 30 of 38
<PAGE> 106
HALLWOOD REALTY PARTNERS, L.P.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
Costs
capitalized
subsequent to
Initial cost acquisition
--------------------- -------------
Buildings Buildings
and and
Description (A) Encumbrances Land improvements improvements
- --------------- ------------ ---- ------------ -------------
<S> <C> <C> <C> <C>
Airport Plaza $ 771 $ 300 $ 4,013 $ 309
Bellevue Corporate Plaza 15,421 7,428 17,617 2,673
Bradshaw Business Parks 6,152 5,018 15,563 4,418
Corporate Square 12,901 6,142 14,112 8,056
Executive Park 33,747 15,243 34,982 9,910
Fairlane Commerce Park 20,433 5,191 18,080 5,807
First Maryland Building 25,000 2,100 43,772 3,693
Joy Road Distribution Center -- 359 1,340 1,704
Montrose Office Center 6,265 5,096 15,754 3,645
Parklane Towers 23,131 3,420 37,592 4,543
Raintree Industrial Park 10,795 1,191 18,208 1,405
Seattle Business Parks 7,462 4,953 8,730 4,260
Corporate office equipment -- -- -- 94
-------- -------- -------- --------
TOTAL $162,078 $ 56,441 $229,763 $ 50,517
======== ======== ======== ========
<CAPTION>
Gross amount at which
carried at close of period
---------------------------------
Buildings Accumulated
and depreciation Date
Description (A) Land improvements Total (B) (B)(C) acquired
--------------- ---- ------------ --------- ------------- --------
<S> <C> <C> <C> <C> <C> <C>
Airport Plaza $ 300 $ 4,322 $ 4,622 $ 3,761 4/30/87
Bellevue Corporate Plaza 7,428 20,290 27,718 5,494 6/30/88
Bradshaw Business Parks 5,018 19,981 24,999 11,287 9/24/85
Corporate Square 6,142 22,168 28,310 14,221 8/2/85 & 10/1/92
Executive Park 15,243 44,892 60,135 32,668 12/19/85
Fairlane Commerce Park 5,191 23,887 29,078 10,841 12/30/86 & 7/1/87
First Maryland Building 2,100 47,465 49,565 26,943 6/29/84
Joy Road Distribution Center 359 3,044 3,403 416 2/14/96
Montrose Office Center 5,096 19,399 24,495 8,028 1/8/88
Parklane Towers 3,420 42,135 45,555 29,008 12/16/84
Raintree Industrial Park 1,191 19,613 20,804 10,439 7/17/86
Seattle Business Parks 4,953 12,990 17,943 7,796 4/24/86
Corporate office equipment -- 94 94 40 various
-------- -------- -------- --------
TOTAL $ 56,441 $280,280 $336,721 $160,942
======== ======== ======== ========
</TABLE>
See notes to Schedule III on following page.
Page 31 of 38
<PAGE> 107
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO SCHEDULE III
DECEMBER 31, 1998
(IN THOUSANDS)
(A) PROPERTY LOCATIONS ARE AS FOLLOWS:
<TABLE>
<S> <C>
Airport Plaza San Diego, California
Bellevue Corporate Plaza Bellevue, Washington
Bradshaw Business Parks Sacramento and Rancho Cordova, California
Corporate Square Atlanta, Georgia
Executive Park Atlanta, Georgia
Fairlane Commerce Park Dearborn, Michigan
First Maryland Building Baltimore, Maryland
Joy Road Distribution Center Detroit, Michigan
Montrose Office Center Rockville, Maryland
Parklane Towers Dearborn, Michigan
Raintree Industrial Park Solon, Ohio
Seattle Business Parks Kent and Tukwila, Washington
</TABLE>
(B) RECONCILIATION OF CARRYING COSTS (in thousands):
<TABLE>
<CAPTION>
Accumulated
Cost Depreciation
---- ------------
<S> <C> <C>
Balance, January 1, 1996 $ 330,478 $ 138,212
Additions 7,697 17,086
Retirements (5,784) (5,784)
--------- ---------
Balance, December 31, 1996 332,391 149,514
Additions 6,183 9,924
Retirements and disposition (4,179) (4,071)
--------- ---------
Balance, December 31, 1997 334,395 155,367
Additions 6,603 9,852
Retirements (4,277) (4,277)
--------- ---------
Balance, December 31, 1998 $ 336,721 $ 160,942
========= =========
</TABLE>
(C) COMPUTATION OF DEPRECIATION:
Depreciation of buildings is computed using the straight-line method over
estimated useful lives ranging from 15 to 43 years. Equipment and other
improvements are depreciated on the straight-line method over estimated
useful lives ranging from 3 to 23 years. Tenant improvements are
capitalized and amortized over the term of the respective leases.
Accumulated depreciation also includes loss reserves established for
anticipated losses on future dispositions.
During 1997, HRP completed a review of its real estate lives. In light of
recent improvements and actions taken to increase its preventative
maintenance programs, the estimated economic lives for buildings were found
to be generally longer than the useful lives being used for depreciation
purposes. Accordingly, effective January 1, 1997, HRP extended the
depreciable lives of certain building costs. The effect of this change in
estimate reduced depreciation and amortization expense by $7,200,000.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURES
None.
Page 32 of 38
<PAGE> 108
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Partnership has no officers or directors. Realty, as general partner of
the Partnership, performs all functions ordinarily performed by officers and
directors. Realty was originally incorporated in Delaware in January 1990 and
became a limited liability company formed in Delaware in December 1998.
BUSINESS EXPERIENCE OF DIRECTORS AND OFFICERS OF REALTY -
ANTHONY J. GUMBINER, 54, CHAIRMAN OF THE BOARD AND DIRECTOR OF REALTY
Mr. Gumbiner has served as Chairman of the Board of Directors of
Hallwood since 1981 and as its Chief Executive Officer since April
1984. He has served as Chairman of the Board of Directors since May
1984 and Chief Executive Officer since February 1987 of the general
partner of Hallwood Energy Partners, L.P. ("HEP"). He has also served
as the managing director of Hallwood Holdings S.A. ("HHSA") since
March 1984; as a director of Realty since 1990; and as a director of
Hallwood Consolidated Resources Corporation ("HCRC") since 1992. Mr.
Gumbiner is also a Solicitor of the Supreme Court of Judicature of
England.
BRIAN M. TROUP, 51, DIRECTOR OF REALTY
Mr. Troup has served as a director of Hallwood since 1981 and as
President and Chief Operating Officer of Hallwood since April 1986.
Mr. Troup has served as a director of the general partner of HEP since
May 1984. He also has served as a director of HCRC since 1992; as a
director of HHSA since March 1984; and as a director of Realty since
1990. He is an associate of the Institute of Bankers in Scotland and a
member of the Society of Investment Analysts in the United Kingdom.
WILLIAM L. GUZZETTI, 55, PRESIDENT AND DIRECTOR OF REALTY
Mr. Guzzetti has been President and a director of Realty since January
1990. He has served as Executive-Vice President of Hallwood since
October 1989 and as President and a director of HCRC since 1992. Mr.
Guzzetti has been President and a director of the general partner of
HEP since February 1985.
JOHN G. TUTHILL, 55, EXECUTIVE VICE PRESIDENT AND SECRETARY
Mr. Tuthill has been an Executive Vice President and Secretary of
Realty since January 1990. Mr. Tuthill joined Hallwood in October 1989
to head all property management functions, having previously served as
President of Southmark Commercial Management since November 1986,
where he was responsible for a diversified real estate portfolio of
over 18,000,000 square feet.
UDO H. WALTHER, 50, EXECUTIVE VICE PRESIDENT
Mr. Walther has been an Executive Vice President of Realty since
November 1, 1998. Mr. Walther was a member of the Board of Directors
of Realty from June 17, 1994 to November 1, 1998. Mr. Walther had been
President and Chief Executive Officer of Walther Group, Inc., a full
service design and construction consultancy, and President of Precept
Builders, Inc. from 1991 to 1998. Previously, Mr. Walther was a
Partner at Trammell Crow Company, Project Manager with HCB Contractors
and Marketing Vice President for Researched Investments, Ltd.
JEFFREY D. GENT, 51, VICE PRESIDENT - FINANCE
Mr. Gent has been the Vice President-Finance of Realty since March
1990, having previously served as Vice President Finance of Southmark
Commercial Management since September 1984, where he was responsible
for the financial functions of a diversified real estate portfolio of
over 18,000,000 square feet.
ALAN G. CRISP, 57, DIRECTOR OF REALTY
Mr. Crisp was Chairman and Chief Executive Officer of Atlantic
Metropolitan Holdings (U.K.) plc from 1979 until 1988, when he joined
Interallianz Bank Zurich AG. From 1988 to 1993, he was General Manager
of the London Office of the Bank. Since 1994, Mr. Crisp has been a
consultant for various international companies. He is a Fellow of the
Royal Institution of Chartered Surveyors and holds a B.A. (Hons)
Degree.
WILLIAM F. FORSYTH, 49, DIRECTOR OF REALTY
Mr. Forsyth has been Chairman of Kildalton & Co., an investment
management consultancy based in Edinburgh, Scotland since 1992. He
graduated in law at Edinburgh University in 1971, and is a member of
the Society of Investment Analysts in the United Kingdom.
Page 33 of 38
<PAGE> 109
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - (CONTINUED)
EDWARD T. STORY, 55, DIRECTOR OF REALTY
Mr. Story has been President and Chief Executive Officer of SOCO
International, plc, an oil and gas company, since September, 1991.
Prior to September 1991, he was Founder and Chairman of Thaitex
Petroleum Company, Co-founder and Chief Financial Officer of Conquest
Exploration Company, the Chief Financial Officer for Superior Oil
Company and Exploration and Production Controller with Exxon
Corporation.
Section 16(a) of the Securities and Exchange Act of 1934 requires a
registrant's officers and directors, if any, and persons who own more than ten
percent of a registered class of HRP's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
(the "SEC") and the American Stock Exchange. Officers, directors and greater
than ten percent shareholders are required by the SEC regulations to furnish
HRP with copies of all Section 16(a) forms they file. Based solely on a review
of the copies of such forms furnished to HRP, or written representations that
no Forms 5 were required, HRP believes that during the period January 1, 1998
to December 31, 1998, all Section 16(a) filing requirements applicable to its
officers and directors were complied with.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION COMMITTEE INTERLOCKS, INSIDER PARTICIPATION AND COMPENSATION OF
DIRECTORS
Realty does not have a compensation committee and compensation decisions are
made by the Board of Directors of Realty. During 1998, Messrs. Gumbiner, Troup
and Guzzetti served on the Board of Directors of Realty and the compensation
committee of Hallwood Energy. Mr. Gumbiner is also Chief Executive Officer of
Hallwood, Realty and the general partner of HEP. Mr. Troup is also President
and Chief Operating Officer of Hallwood. Mr. Guzzetti is also President and
Chief Operating Officer of Realty, Chief Operating Officer and President of the
general partner of HEP, and Executive Vice President of Hallwood. Messrs.
Forsyth, Crisp, Story and Walther were each paid $20,000 in each of the three
years ended December 31, 1998 for director fees.
Realty receives certain fees in connection with the ongoing management of HRP,
including an asset management fee, acquisition fees and incentive disposition
fees. Specifically, Realty is entitled to receive (i) an asset management fee
equal to 1% of the net aggregate base rents of the Properties, (ii) acquisition
fees equal to 1% of the purchase price of newly acquired properties, and (iii)
incentive fees for performing disposition services with respect to real estate
investments, other than the properties owned at the time of HRP's formation on
November 1, 1990, equal to 10% of the amount, by which the sales price of a
property disposed of exceeds the purchase price of such property.
HCRE receives compensation in connection with the management of the Properties,
which includes a property management fee, lease commissions and construction
supervision fees. The management contracts expire June 30, 1999 and provide for
(i) basic compensation from a property management fee which is an amount equal
to 2.85% of cash receipts collected from the Properties' tenants, (ii) lease
commissions equal to the current market rate as applied to the net aggregate
rent, not to exceed 6% of the net aggregate rent, and (iii) construction
supervision fees for administering all construction projects equal to 5% of the
total contracted costs of each capital expenditure or tenant improvement
project.
Realty and HCRE are compensated for services provided to HRP and its Properties
as described above. The following table sets forth such compensation and
reimbursement paid by HRP for the periods presented (in thousands):
<TABLE>
<CAPTION>
Entity
Paid or
Reimbursed 1998 1997 1996
---------- ---- ---- ----
<S> <C> <C> <C> <C>
Asset management fee Realty $ 495 $ 458 $ 450
Acquisition fee Realty - 7 17
Reimbursement of costs (a) Realty 2,320 2,316 2,321
Property management fee HCRE 1,608 1,524 1,433
Lease commissions HCRE 1,964 1,425 2,888
Construction fees HCRE 314 353 382
</TABLE>
(a) These costs are mostly recorded as General and
Administrative Expenses and represent reimbursement to
Realty, at cost, for partnership level salaries, employee
and director insurance and certain overhead costs. HRP
pays, on a monthly basis, the balance of its account with
Realty.
Page 34 of 38
<PAGE> 110
ITEM 11. EXECUTIVE COMPENSATION - (CONTINUED)
CASH COMPENSATION OF EXECUTIVE OFFICERS
The Partnership has no executive officers, however, employees of Realty
(general partner of the Partnership) perform all functions ordinarily performed
by executive officers. The following table sets forth annual compensation
information for the Chief Executive Officer and the three other executive
officers with earnings that exceeded $100,000 for the year ended December 31,
1998.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
--------------------------
Annual Compensation
-------------------------------------------------
Other Annual
Name and Principal Position Year Salary (a) Bonus Compensation (b)
- --------------------------- ---- ---------- ----- ----------------
<S> <C> <C> <C> <C>
Anthony J. Gumbiner 1998 $ -- $ -- $ --
Chairman of the Board and 1997 -- -- --
Chief Executive Officer 1996 -- -- --
William L. Guzzetti 1998 200,000 15,833 --
President and Chief 1997 200,000 17,583 --
Operating Officer 1996 200,000 8,333 --
John G. Tuthill 1998 150,360 57,265 8,212
Executive Vice President 1997 150,360 46,265 8,256
and Secretary 1996 150,360 46,265 3,345
Jeffrey D. Gent 1998 104,366 27,523 5,984
Vice President - Finance 1997 99,396 11,212 6,385
1996 90,360 15,648 2,317
</TABLE>
-----------------
(a) Represents executive officers' gross salary before contributions
to the qualified 401(k) Tax Favored Savings Plan. .
(b) Represents employer matching contributions to the 401(k) Tax
Favored Savings Plan or payments in lieu thereof . made under a
special bonus arrangement.
The following table discloses for each of the executive officers of Realty, who
have been granted options to purchase securities . of HRP the number of such
options held by each of the executive officers and the potential realizable
values for their options at December 31, 1998. None of the executive officers
exercised any options during the year ended December 31, 1998 and HRP has not
granted SARs.
AGGREGATED OPTION/SAR EXERCISES IN 1998
AND OPTION/SAR VALUES AT DECEMBER 31, 1998
<TABLE>
<CAPTION>
Value of Unexercised
Number of Unexercised In-the-Money
Options at Options at
Units December 31, 1998 December 31, 1998
Acquired -------------------------------- -----------------------------------
Name on Exercise Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Anthony J. Gumbiner 0 25,800 0 $ 1,228,725 $ 0
William L. Guzzetti 0 15,000 0 714,375 0
John G. Tuthill 0 13,000 0 619,125 0
Jeffrey D. Gent 0 7,000 0 333,375 0
</TABLE>
Page 35 of 38
<PAGE> 111
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of March 5, 1999 concerning the
number of Partnership units owned beneficially by (l) the persons who, to the
knowledge of the management, beneficially owned more than 5% of the units
outstanding on such date, (2) each director and (3) the present directors and
executive officers of Realty as a group:
<TABLE>
<CAPTION>
Amount Percent
Name and Address of Beneficially of
Beneficial Owner Owned (a) Class
- ------------------- ------------- --------
<S> <C> <C>
HWG, LLC
c/o The Hallwood Group Incorporated
3710 Rawlins, Suite 1500
Dallas, Texas 75219 413,040 24.7%
Gotham Partners, L.P. and
Gotham Partners, L.P. III
237 Park Avenue, 9th Floor
New York, NY 10017 247,994 14.8%
Private Management Group, Inc. ("PMG")
20 Corporate Park, Suite 400
Irvine, CA 92606 (b) 102,615 6.1%
Interstate Properties
Park 80 West, Plaza II
Saddle Brook, NJ 07662 98,600 5.9%
Alan G. Crisp (c) -- --
William F. Forsyth (c) -- --
Anthony J. Gumbiner (c) 25,800 (d) 1.5% (d)
William L. Guzzetti (c) 15,100 (e) 0.9% (e)
Edward T. Story (c) -- --
Brian M. Troup (c) 17,200 (f) 1.0% (f)
All directors and executive officers
as a group (9 persons) 78,100 (g) 4.5% (g)
</TABLE>
- --------------------
(a) Unless otherwise indicated, each of the persons named has sole
voting and investment power with respect to the units reported.
(b) PMG is an Investment Advisor registered under Section 203 of the
Investment Advisers Act of 1940 with sole power to vote or direct
the vote of all the units, including their directly-owned 840
units. PMG also has sole power to dispose or direct the disposition
of all of the units.
(c) Represents the following address: c/o Hallwood Realty, LLC, 3710
Rawlins, Suite 1500, Dallas, Texas, 75219.
(d) Comprised of currently exercisable options to purchase 25,800
units.
(e) Includes currently exercisable options to purchase 15,000 units.
(f) Comprised of currently exercisable options to purchase 17,200
units.
(g) Includes currently exercisable options to purchase 78,000 units.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information covered by this item, see Note 3 to the Registrant's
financial statements included in Item 8 hereof.
Page 36 of 38
<PAGE> 112
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(1) Financial Statements.
See Index contained in Item 8.
(2) Reports on Form 8-K.
No reports on Form 8-K were filed during the fourth quarter of 1998 or in
1999 prior to the filing of this Form 10-K for the year ended December
31, 1998.
(3) Exhibits and Reports on Form 8-K.
The response to this portion of Item 14 is incorporated by reference as
detailed in the Exhibit Index.
(4) Financial Statement Schedules.
See Index contained in Item 8.
Page 37 of 38
<PAGE> 113
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
HALLWOOD REALTY PARTNERS, L.P.
BY: HALLWOOD REALTY, LLC
GENERAL PARTNER
DATE: March 10, 1999 BY: /s/ WILLIAM L. GUZZETTI
-------------- --------------------------------------
William L. Guzzetti
President and Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K for the year ended December 31, 1998, has been
signed below by the following persons on behalf of the Registrant in the
capacities and on the date indicated.
<TABLE>
<CAPTION>
Signature Capacity Date
--------- -------- ----
<S> <C> <C>
/s/ ANTHONY J. GUMBINER Chairman of the Board and Director, March 10, 1999
- -------------------------------------------------- Hallwood Realty, LLC --------------
Anthony J. Gumbiner (Chief Executive Officer)
/s/ WILLIAM L. GUZZETTI President and Director, March 10, 1999
- -------------------------------------------------- Hallwood Realty, LLC --------------
William L. Guzzetti (Chief Operating Officer)
/s/ JEFFREY D. GENT Vice President - Finance, March 10, 1999
- -------------------------------------------------- Hallwood Realty, LLC --------------
Jeffrey D. Gent (Chief Accounting Officer)
/s/ALAN G. CRISP Director, March 10, 1999
- -------------------------------------------------- Hallwood Realty, LLC --------------
Alan G. Crisp
/s/ WILLIAM F. FORSYTH Director, March 10, 1999
- -------------------------------------------------- Hallwood Realty, LLC --------------
William F. Forsyth
Director,
- -------------------------------------------------- Hallwood Realty, LLC --------------
Edward T. Story
/s/ BRIAN M. TROUP Director, March 10, 1999
- -------------------------------------------------- Hallwood Realty, LLC --------------
Brian M. Troup
</TABLE>
<PAGE> 114
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
21 Active subsidiaries of the Registrant as of February 28, 1999
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 21
ACTIVE SUBSIDIARIES OF THE REGISTRANT
AS OF FEBRUARY 28, 1999
<TABLE>
<CAPTION>
NAME STATE OR COUNTRY
------------------------------ ----------------
<S> <C>
Brock Suite Hotels, Inc. and subsidiaries....................................... Delaware
Brookwood Companies Incorporated and subsidiaries............................... Delaware
Condo Hotel and Resort Management, Inc.......................................... Delaware
HEPGP Ltd....................................................................... Colorado
HSC Securities Corporation...................................................... Delaware
HWG, LLC........................................................................ Delaware
HWG Holding One, Inc............................................................ Delaware
HWG Holding Two, Inc............................................................ Delaware
HWG Realty Investors, LLC and subsidiaries...................................... Delaware
Hallwood Commercial Real Estate, LLC............................................ Delaware
Hallwood G.P., Inc.............................................................. Delaware
Hallwood Hotels, Inc. and subsidiaries.......................................... Delaware
Hallwood Investment Company..................................................... Grand Cayman Island
Hallwood Realty, LLC............................................................ Delaware
Integra Resort Management, Inc. and subsidiaries................................ Delaware
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 769
<SECURITIES> 9,771
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 16,708
<CURRENT-ASSETS> 0
<PP&E> 181,012
<DEPRECIATION> 128,985
<TOTAL-ASSETS> 109,252
<CURRENT-LIABILITIES> 0
<BONDS> 21,535
1,000
0
<COMMON> 160
<OTHER-SE> 20,778
<TOTAL-LIABILITY-AND-EQUITY> 109,252
<SALES> 0
<TOTAL-REVENUES> 116,230
<CGS> 0
<TOTAL-COSTS> 109,716
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,043
<INCOME-PRETAX> 2,471
<INCOME-TAX> (3,115)
<INCOME-CONTINUING> 5,586
<DISCONTINUED> 0
<EXTRAORDINARY> 1,481
<CHANGES> 0
<NET-INCOME> 7,067
<EPS-PRIMARY> 5.59
<EPS-DILUTED> 5.40
</TABLE>
