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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 2002 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:
TITLE OF CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock ($0.10 par value) American Stock Exchange
10% Collateralized Subordinated New York Stock Exchange
Debentures Due July 31, 2005
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF CLASS
SERIES B REDEEMABLE PREFERRED STOCK
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
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 is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X].
The aggregate market value of the Common Stock, $0.10 par value per share,
held by non-affiliates of the registrant as of the last business day of June
2002, based on the closing price of $5.97 per share on the American Stock
Exchange, was $3,784,000.
1,361,343 shares of Common Stock, $0.10 par value per share, were
outstanding at March 28, 2003.
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, 2002.
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THE HALLWOOD GROUP INCORPORATED
FORM 10-K
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 13
Item 3. Legal Proceedings........................................... 14
Item 4. Submission of Matters to a Vote of Security Holders......... 14
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 14
Item 6. Selected Financial Data..................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 16
Item 7(A). Quantitative and Qualitative Disclosures About Market
Risk........................................................ 28
Item 8. Financial Statements and Supplementary Data................. 29
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 29
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 29
Item 11. Executive Compensation...................................... 29
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 30
Item 13. Certain Relationships and Related Transactions.............. 30
Item 14. Controls and Procedures..................................... 30
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 31
1
PART I
ITEM 1. BUSINESS
The Hallwood Group Incorporated ("Hallwood" or the "Company") (AMEX:HWG), a
Delaware corporation, is a holding company that classifies its primary
continuing business operations into two segments; real estate and textile
products. Financial information for each business segment is set forth in Note
19 to the consolidated financial statements. The Company's former energy and
hotel business segments were previously reclassified to discontinued operations.
Real Estate. Real estate operations 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, 2002,
HRP owned 14 real estate properties in six states containing 5,199,000 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. The HRP Form 10-K for the year ended December 31, 2002 is
included elsewhere within this document.
Hallwood Realty owns a 1% general partner interest and HWG, LLC owns a 21%
limited partner interest in HRP. Hallwood Realty is responsible for asset
management of HRP and its properties, including the decisions regarding
financing, refinancing, acquiring and disposing of properties. It also provides
general operating and administrative services to HRP. HCRE is responsible for
property management for all HRP properties, and properties it manages for third
parties, for which it receives management, leasing and construction supervision
fees. Hallwood Realty and HWG, LLC account for their ownership in HRP using the
equity method of accounting, recording their pro rata share of net income (loss)
and partners' capital transactions reported by HRP.
Real estate accounted for 7% of the Company's total revenues from
continuing operations in 2002, compared to 10% in 2001 and 8% in 2000.
Textile Products. Textile products operations are conducted through the
Company's wholly owned Brookwood Companies Incorporated subsidiary
("Brookwood"). Brookwood is an integrated textile service firm that develops and
produces innovative fabrics and related products through specialized finishing,
treating and coating processes.
Brookwood principally operates as a converter in the textile industry,
purchasing fabric from mills that is dyed and finished at its own plant, located
in Rhode Island, or by contracting with independent finishers. Upon completion
of the finishing process, the fabric is sold to customers. Brookwood, a large
textile converter of nylon and polyester fabrics, is one of the largest coaters
of woven nylons in the United States. Brookwood is known for its extensive,
in-house expertise in high-tech and high-fashion fabric development, and is a
major supplier of specialty fabric to U.S. military contractors. Brookwood
produces fabrics that meet standards and specifications set by both government
and private industry, which are used by consumers, military and industrial
customers.
The Brookwood Roll Goods Division serves manufacturers by maintaining an
extensive in-stock, short-lot service of woven nylon and polyester fabrics,
offering an expansive inventory in excess of two million yards stocked in a wide
array of colors. As speed is essential in this area, Brookwood Roll Goods has
positioned its sales and distribution facilities in southern California and
Rhode Island to allow shipment on a same day/next day basis.
The First Performance Fabric Division buys and sells short lots, remnants
and mill seconds for a vast assortment of coated and uncoated nylon products at
promotional prices. The products offered include nylon for consumer uses, such
as activewear, outerwear, swimwear as well as nylons used for balloons, luggage,
bags, flags and banners.
2
During 2000, Brookwood formed a joint venture, Strategic Technical
Alliance, LLC ("STA"), with an unrelated party that is also in a textile-related
industry. The business of STA is to produce advanced breathable, waterproof
laminate materials for military applications. STA was 50% owned by each party
with operating and management decision-making shared equally by both parties. In
September 2002, STA acquired the 50% ownership interest not owned by Brookwood,
effectively making STA a wholly owned Brookwood subsidiary. Since that date, the
financial results of STA have been fully consolidated. Prior to the acquisition,
Brookwood utilized the equity method of accounting.
The textile industry historically experiences seasonality swings. Brookwood
has partially offset the effect of those swings by diversifying its product
lines and business base. Brookwood enjoys a fairly steady stream of orders that
comprise its backlog. However, the seasonality swings and backlog are subject to
military contracts granted, from time to time, to its prime government
contractor customers. Management believes that Brookwood maintains a level of
inventory adequate to support its sales requirements and has historically
enjoyed a consistent turnover ratio.
In January 2003, Brookwood was granted a patent for its "breathable
waterproof laminate and method for making same", which is a critical process in
its production of speciality fabric for U.S. military contractors. Brookwood has
no other patents pending. Brookwood has ongoing programs of research and
development in all of its divisions adequate to maintain the exploration,
development and production of innovative products and technologies.
Textile products accounted for 88% of the Company's total revenues from
continuing operations in 2002, compared to 86% in 2001 and 90% in 2000.
Other. Other revenues include amortization of the Company's noncompetition
agreement fee received from the sale of its former energy investment in 2001,
revenue from a leased hotel property (a 112-room GuestHouse Suites Plus hotel in
Huntsville, Alabama), interest and other income and equity income (loss) from
its investment in a newly-formed, private energy company.
Other expenses include administrative, interest, hotel operating costs,
cost of Separation Agreement and loss from debt extinguishment. Administrative
expenses represent the general costs of operating a public company, including
consulting fees paid to HSC Financial Corporation, an entity associated with the
Company's chairman and principal stockholder, Anthony J. Gumbiner. Hotel
operating costs relate only to the leased hotel property the Company continues
to operate. Interest expense relates principally to the Term Loan and Revolving
Credit Facility, 10% Debentures, the Company's obligation in connection with the
Separation Agreement among the Company, a former officer and director and a
related trust (the "Separation Agreement"), a former Senior Secured Term Loan
and former loans from the Company's chairman and principal stockholder. The cost
of Separation Agreement represents an additional accrual of future cash payments
through December 2004 to the aforementioned trust. The loss from extinguishment
of debt relates to the write off of unamortized deferred loan costs associated
with the repayment of the former Senior Secured Term Loan in 2001.
New Energy Investment. During 2002, the Company invested $3,500,000 in a
newly-formed, private energy company -- Hallwood Energy Corporation ("HEC"). HEC
is presently in the developmental stage, having drilled seven test wells in the
Barnett Shale Formation of Johnson County, Texas. After constructing an
extensive gas gathering system, HEC commenced commercial production and sales
from three of the seven wells in February 2003. In March 2003, a fourth well was
placed in production, a fifth well was in the process of being completed and a
sixth well was nearing completion of drilling operations. These two wells are
expected to begin production in April 2003. One well, after numerous completion
attempts, has been temporarily abandoned. HEC anticipates that it will drill at
least six additional wells during the remainder of 2003. HEC holds oil and gas
leases covering 32,254 and 28,329 gross and net acres, respectively, in Johnson
and Hill Counties, Texas as of March 2003. The Company owns approximately 28% of
HEC and accounts for the investment using the equity method of accounting.
Certain of the Company's current officers and directors and certain officers and
directors of its former energy affiliate are investors in HEC.
3
Discontinued Operations -- Hotels. Hotel operations were conducted through
the Company's wholly owned, Hallwood Hotels, Inc. ("Hallwood Hotels") and Brock
Suite Hotels, Inc. ("Brock Hotels") subsidiaries. Hallwood Hotels held a
long-term leasehold interest in the Holiday Inn and Suites hotel, located in
Longboat Key, Florida and a fee interest in the Airport Embassy Suites hotel,
located in Oklahoma City, Oklahoma. Brock Hotels owned fee interests in two
GuestHouse Suites Plus properties located in Tulsa, Oklahoma and Greenville,
South Carolina, and holds a long-term leasehold interest in a GuestHouse Suites
Plus property located in Huntsville, Alabama.
In December 2000, the Company decided to dispose of its hotel segment,
principally by allowing its non-recourse debt holders to assume ownership of the
properties through foreclosures, or by selling or otherwise disposing of its
hotel properties. As part of the planned disposition, in December 2001 and 2000,
the Company evaluated the operations and economic environment in which each of
the hotels operated and determined it was appropriate to record impairments of
$935,000 and $4,000,000, respectively, to reduce their carrying values to
estimated fair market values.
In January 2001, a receiver was appointed to administer the disposition of
the GuestHouse Suites Plus hotel in Greenville, South Carolina. In February
2001, the Company signed an Agreement to Terminate Lease with the landlord of
the Holiday Inn and Suites hotel in Sarasota, Florida. In March 2001, receivers
were appointed to administer the disposition of the GuestHouse Suites Plus hotel
in Tulsa, Oklahoma and the Airport Embassy Suites hotel in Oklahoma City,
Oklahoma. In June 2001, the Company entered into a settlement agreement with the
mezzanine lender whereby the Company transferred all of its capital stock of
Hallwood Hotels-OKC, Inc., the entity that owned the Embassy Suites hotel, to
the mezzanine lender and obtained a release from its obligations under the first
mortgage and the mezzanine loan. The Company reported the transaction as a gain
from extinguishment of debt in the amount of $316,000, before a deferred tax
charge of $100,000.
During 2001, the Company determined it would retain its leasehold interest
in the GuestHouse Suites Plus hotel located in Huntsville, Alabama, the results
of which have been reported in continuing operations.
In January 2002, with assistance and consent of the lender, the Company
sold the GuestHouse Suites Plus hotel in Tulsa, Oklahoma for $3,000,000. The
Company received no cash proceeds from the sale; however, concurrently with the
sale, it entered into a loan modification and assumption agreement, which
included a release that discharged the Company from any further loan
obligations. The Company recognized a gain from extinguishment of debt of
$2,552,000, before a deferred tax charge of $875,000. In February 2002, the
lender for the GuestHouse Suites Plus hotel in Greenville, South Carolina
obtained a court judgement of foreclosure. In connection with the foreclosure,
the lender waived its right to a deficiency judgment against the Company. The
lender completed the foreclosure in June 2002 and the Company recognized a gain
from extinguishment of debt of $3,237,000, before a deferred tax charge of
$925,000.
The Company was a defendant in two lawsuits regarding guaranties of certain
obligations of the Embassy Suites and Holiday Inn hotels. In February 2003, the
Company settled both matters. The Company agreed (i) to pay $150,000 in cash and
to issue a non-interest bearing promissory note in the amount of $250,000
payable in equal monthly installments over eighteen months, in exchange for a
full release regarding the Embassy Suites hotel; and (ii) to pay $250,000 in
cash, in exchange for a full release regarding the Holiday Inn hotel. In
December 2002, the Company recorded an additional loss provision in the amount
of $247,000 to fully accrue for these two litigation matters.
Discontinued Operations -- Energy. In March 2001, Hallwood Energy
Corporation ("Hallwood Energy") announced that it had signed a definitive merger
agreement pursuant to which Pure Resources II, Inc., an indirect wholly owned
subsidiary of Pure Resources, Inc. ("Pure"), agreed to acquire all the
outstanding common stock of Hallwood Energy at a price of $12.50 per share and
all the outstanding shares of Series A Cumulative Preferred Stock of Hallwood
Energy at a price of $10.84 per share. The all-cash transaction was structured
as a first step tender offer followed by a cash merger to acquire all remaining
shares of Hallwood Energy. The Company also agreed to tender all of its shares
of common stock in the tender offer and granted to Pure an irrevocable proxy to
vote in favor of the merger, on the same terms as provided in the merger
agreement. Pure commenced its tender offer in April 2001, with an expiration
date of May 8, 2001. On May 9,
4
2001, Pure announced that it had successfully completed its tender offer, and
had acquired approximately 85% of the Hallwood Energy common stock and 78% of
the Hallwood Energy preferred stock. The Company received $18,000,000 for the
tender of its 1,440,000 shares of common stock in May 2001 and received an
additional $7,250,000, pursuant to the terms of a noncompetition agreement that
was paid by Pure upon the completion of the merger in June 2001.
Under the noncompetition agreement, the Company agreed to refrain from
taking certain actions (described below) without the prior written consent of
Pure and Hallwood Energy. These covenants were made by the Company in
consideration of the transactions contemplated by the merger agreement and the
payment by Pure to the Company. For a period of three years after the effective
date of the merger agreement, the Company will not, directly or indirectly,
engage in oil and gas activities in certain geographic areas without the prior
consent of Pure. Hallwood Energy was engaged in the development, exploration,
acquisition and production of oil and gas properties. Hallwood Energy owned
interests in properties primarily located in the San Juan Basin in New Mexico
and Colorado, South Texas, the Permian Basin in West Texas and onshore South
Louisiana. The Company also agreed to keep Hallwood Energy's confidential and
proprietary information strictly confidential.
COMPETITION, RISKS AND OTHER FACTORS
THE COMPANY
If the Company cannot generate sufficient cash flows from operations, it
may need additional capital. If the Company cannot generate enough cash flow
from operations to finance its business in the future, it will need to raise
additional capital through public or private financing or asset sales. If the
Company borrows money, it may be required to agree to restrictions limiting its
operating flexibility. If the Company requires additional capital but is not
able to obtain such capital, it would have a material adverse effect on its
operations and the Company's ability to service its debt.
Risk of Rising Interest Rates. A portion of the Company's indebtedness
bears interest at variable rates. In addition, the Company may incur
indebtedness in the future that also bears interest at a variable rate or may be
required to refinance its debt at higher rates. Accordingly, increases in
interest rates could increase the Company's interest expense, which could
adversely affect cash flow from future operations and the Company's ability to
service its debt.
Influence of Significant Stockholder. The Company's chairman, Anthony J.
Gumbiner, is also a significant stockholder of the Company. A trust, of which
Mr. Gumbiner and his family are beneficiaries, indirectly owns approximately 56%
of the Company's outstanding common stock (61% including currently exercisable
stock options held by Mr. Gumbiner) as of March 31, 2003. Accordingly, Mr.
Gumbiner can exert substantial influence over the affairs of the Company.
Competition for skilled personnel could increase our labor costs. The
Company competes with various other companies in attracting and retaining
qualified and skilled personnel. The Company depends on its ability to attract
and retain skilled management personnel who are responsible for the day-to-day
operations of the Company. Competitive pressures may require that the Company
enhance its pay and benefits package to compete effectively for such personnel.
If there is an increase in these costs or if the Company fails to attract and
retain qualified and skilled personnel, its business and operating results could
be adversely affected.
The Company is dependent on its key personnel whose continued service is
not guaranteed. The Company is dependent upon its executive officers for
strategic business direction and real estate experience. While the Company
believes that it could find replacements for these key personnel, loss of their
services could adversely affect the Company's operations.
Restrictions on Stock Transfers and Ownership Limits. 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. The restriction prohibits any transfer of common stock to
any person that results in ownership in excess of 4.75% of the then outstanding
shares. The restriction can be waived only with
5
the approval of the Company's board of directors. The restriction can impede a
third party from acquiring the Company, even if such an acquisition would be
beneficial to the Company's stockholders.
Risk of Loan Covenant Violations or 10% Debenture Restrictions. The
Company's Term Loan and Revolving Credit Facility and 10% Debentures require
compliance with various loan covenants and financial ratios, which, if not met,
will trigger a default. The Term Loan and Revolving Credit Facility requires a
minimum debt service coverage ratio for each rolling four quarter period, as
defined, of 1.20 to 1.00, a senior leverage ratio, as defined, of no greater
than 2.50 to 1.00 and a minimum collateral value coverage of 200% of the
outstanding loan balance. Additionally, Brookwood's credit agreement requires
compliance with various loan covenants and financial ratios, principally a
minimum debt service coverage ratio of 1.25 to 1.00, a debt to equity ratio of
50% and a minimum net income requirement both at the interim quarters, as well
as for the year ended December 31, 2002. Brookwood did not meet the minimum net
income requirement for the 2002 year, which caused an event of default as of
December 31, 2002. Brookwood received a waiver from its lender for the covenant
violation. The Indenture for the 10% Debentures contains various covenants,
principally the risk associated with a subsidiary commencing receivership,
bankruptcy or insolvency proceedings, which if violated, may result in a call of
the entire issue.
Risk of Litigation. The Company is currently a party to various litigation
matters, as described more fully in Item 3 -- Legal Proceedings and Note 18 to
the Company's consolidated financial statements. An unfavorable decision on the
matters could have an adverse effect on the Company. In particular, the Company
is a defendant in certain litigation in Delaware state court. The trial court in
that matter ruled that the Company pay a judgment in the amount of $3,417,000 to
HRP, plus pre-judgment interest of approximately $2,891,000 to HRP. In October
2001, the Company paid $6,405,000, including post-judgment interest of $97,000,
subject to an arrangement that it be returned in full or part if the judgment is
modified or reversed on appeal. The plaintiff and certain defendants appealed
the ruling. In August 2002, the Supreme Court of Delaware affirmed the judgment
of the trial court that the remaining defendants other than HRP are jointly and
severally liable to HRP. The Supreme Court reversed the trial court's
determination of damages, however, and remanded the case to the trial court to
fashion appropriate relief. A hearing on the remand proceedings was held before
the Delaware Court of Chancery in October 2002. A further hearing on the remand
is scheduled to take place in May 2003, with a decision by the Chancery Court to
follow. Since the appellate court reversed the judgment, any subsequent ruling
by the trial court on remand may be more or less favorable to the Company.
REAL ESTATE
Concentration Risks. The Company's real estate subsidiaries receive a
substantial portion of their revenues from management, leasing and other
services provided to HRP. Any adverse effect on HRP's operations could affect
the Company through reduced fee income. Further, the early cancellation or non-
renewal of the management contracts between HRP and the Company's real estate
subsidiaries, which expire in June 2004, would have a material adverse effect on
the Company.
Deterioration in Economic Conditions and the Real Estate Markets Could
Impair HRP's Business. The commercial real estate industry depends on a number
of factors relating to global, national, regional and local general and economic
conditions, including inflation, interest rates, taxation policies, availability
of credit, war, threat of war, employment levels, and wage and salary levels. A
negative trend in any of these conditions could adversely affect HRP's business.
If a substantial number of tenants default on their leases, choose not to renew,
or if rental rates decrease, HRP's financial position could be adversely
affected. Such effects could include: a decline in acquisition, disposition and
leasing activity; a decline in the supply of capital invested in commercial real
estate; or a decline in the value of real estate. HRP's cash flow would be
adversely affected by decreases in the performance of the properties it owns.
Property performance typically depends upon the ability to attract and retain
creditworthy tenants; the ability to manage operating expenses; the magnitude of
defaults by tenants under their respective leases; governmental regulations; the
nature and extent of competitive properties; financial and economic conditions
generally and in the specific areas where properties are located; and the real
estate market generally. Expenses may increase due to unexpected or higher
repairs and maintenance costs, inflation, services and costs required to retain
tenants or to sign new tenants,
6
unsuccessful appeals of rising real estate taxes, changes in interest rates,
higher insurance costs, the outcome of existing or future litigation, as well as
other factors, many of which are beyond the control of HRP.
Interest Rate Risks. Because only one of its mortgage loans, with a
$25,000,000 principal balance and interest at LIBOR plus 130 basis points, has a
floating interest rate, HRP's exposure to changes in market interest rates is
limited to the difference between the market rate in effect at the time a loan
matures compared to its existing interest rate. As of December 31, 2002, HRP had
mortgage loans totaling $172,552,000 with fixed interest rates from 6.97% to
8.7% (with an effective average interest rate of 8.21%). These loans mature
between 2005 and 2020. At the time of loan maturity, a higher market interest
rate, compared to the existing rate, will have a negative impact on the amount
of mortgage proceeds secured from a refinancing, as well as a decrease in cash
flow from future operations due to the higher interest rate.
Insurance Risks. Due in large part to the terrorist activities of
September 11, 2001, insurance companies have re-examined many aspects of their
business, and have taken certain actions in the wake of these terrorist
activities, including increasing premiums, mandating higher self-insured
retention and deductibles, reducing limits, restricting coverages, imposing
exclusions (such as sabotage and terrorism), and refusing to underwrite certain
risks and classes of business. Significantly increased premiums, mandated
exclusions, or changes in limits, coverages, terms and conditions could
adversely affect HRP's ability to obtain appropriate insurance coverages at
reasonable costs; however, at this time the only impact on HRP has been an
increase in premiums. HRP has $250,000,000 of terrorism insurance coverage.
Environmental Risks. Various national, state and local laws and
regulations impose liability on real property owners, such as HRP, for the cost
of investigating, cleaning up or removing contamination caused by hazardous or
toxic substances. The liability may be imposed even if the original actions were
legal and HRP did not know of, or was not responsible for, the presence of such
hazardous or toxic substances. HRP may also be solely responsible for the entire
payment of the liability if it is subject to joint and several liability with
other responsible parties who are unable to pay. HRP may be subject to
additional liability if it fails to disclose environmental issues to a buyer or
lessee of property or if a third party is damaged or injured as a result of
environmental contamination emanating from the site. HRP cannot be sure that any
of such liabilities to which it may become subject will not have a material
adverse effect upon its business, results of operations or financial condition.
Certain HRP properties are known to contain asbestos. Removal of asbestos at
HRP's properties is not required because it is cementitious, it is not friable
and because the procedures in HRP's site environmental program Operations and
Maintenance Manual are performed as required.
Competition. HRP's 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.
Other. HRP's business is subject to other factors: (i) HRP's basic
investment strategy is to hold real estate properties until what it believes to
be an optimal time to sell them. HRP normally would sell properties during
relatively strong real estate markets, however factors beyond HRP's control
could make it necessary for HRP to dispose of properties during weak markets.
Further, markets for real estate assets are not usually highly liquid, which can
make it particularly difficult to realize acceptable prices when disposing
assets during weak markets; (ii) HRP has financed its operations with cash flow
from profitably operating its established properties. If HRP does not generate
enough cash from operations to finance its business in the future, it will need
to raise additional funds through public or private financing or asset sales. If
HRP borrows additional funds, it may be required to agree to restrictions
limiting its operating flexibility. If HRP requires additional funds and is not
able to obtain such funds, it would have a material adverse effect on HRP's
operations; (iii) HRP has certain mortgage loans that require compliance with
loan covenants and restrictions, which if not met will trigger a default.
Additionally, these loans contain restrictions that limit certain actions; (iv)
HRP's properties are subject to the Americans with Disabilities Act. HRP and the
Company's real estate subsidiaries acting on behalf of HRP, monitor compliance
with the Americans with Disabilities Act and are currently not aware of any
material non-compliance issues; and (v) HRP is currently a party to certain
litigation, the outcome of which is uncertain.
7
TEXTILE PRODUCTS
Supplier Risks. Brookwood purchases a significant amount of the fabric it
uses from a small number of suppliers. Brookwood believes that the loss of any
one or more of its suppliers would not have a long-term material adverse effect
on Brookwood, because other manufacturers with which Brookwood conducts business
would be able to fulfill Brookwood's requirements. However, the loss of certain
of Brookwood's suppliers could, in the short term, adversely affect Brookwood's
business until alternative supply arrangements were secured. In addition, there
can be no assurance that any new supply arrangements would have terms as
favorable as those contained in current supply arrangements. Brookwood has not
experienced any significant disruptions in supply as a result of shortages in
the supply fabrics.
Concentration of Credit Risk. The financial instruments that potentially
subject Brookwood to concentration of credit risk consist principally of
accounts receivable. Brookwood grants credit to customers based on an evaluation
of the customer's financial condition. Exposure to losses on receivables is
principally dependent on each customer's financial condition. Brookwood manages
its exposure to credit risks through credit approvals, credit limits, monitoring
procedures and the use of factors.
The amount of receivables that Brookwood could factor is subject to certain
limitations as specified in individual factoring agreements. The factoring
agreements expose Brookwood to credit risk, if any of the factors fail to meet
their obligations. Brookwood seeks to manage this risk by conducting business
with a number of reputable factors and monitoring the factors' performance under
their agreements.
Risk of Loan Covenant Violations. Brookwood's credit agreement requires
compliance with various loan covenants and financial ratios, principally a
minimum debt service coverage ratio of 1.25 to 1.00, a debt to equity ratio of
50% and a minimum net income requirement at the interim quarters, as well as
$1,500,000 for the year ended December 31, 2002. Brookwood did not meet the
minimum net income requirement for the 2002 year, which caused an event of
default under the credit agreement as of December 31, 2002. Brookwood received a
waiver from its lender for the covenant violation.
Environmental Risks. Kenyon Industries, Inc. ("Kenyon") and Brookwood
Laminating, Inc. ("Brookwood Laminating") are wholly owned subsidiaries of
Brookwood. Kenyon and Brookwood Laminating are subject to a broad range of
federal, foreign, state and local laws and regulations relating to the pollution
and protection of the environment. Among the many environmental requirements
applicable to Kenyon and Brookwood Laminating are laws relating to air
emissions, ozone depletion, wastewater discharges and the handling, disposal and
release of solid and hazardous substances and wastes. Based on continuing
internal review and advice from independent consultants, Kenyon and Brookwood
Laminating believe that they are currently in substantial compliance with
applicable environmental requirements. Kenyon and Brookwood Laminating are also
subject to laws, such as The Comprehensive Environmental Response Compensation
and Liability Act ("CERCLA"), that may impose liability retroactively and
without fault for releases or threatened releases of hazardous substances at
on-site or off-site locations. Kenyon and Brookwood Laminating are not aware of
any releases for which they may be liable under CERCLA or any analogous
provision. Actions by federal, state and local governments in the United States
and abroad concerning environmental matters could result in laws or regulations
that could increase the cost of producing the products manufactured by Kenyon
and Brookwood Laminating or otherwise adversely affect demand for their
products. Widespread adoption of any prohibitions or restrictions could
adversely affect the cost and/or the ability to produce products and thereby
have a material adverse effect upon Kenyon, Brookwood Laminating or Brookwood.
Brookwood does not currently anticipate any material adverse effect on its
business, results of operations, financial condition or competitive position as
a result of its efforts to comply with environmental requirements. Some risk of
environmental liability is inherent, however, in the nature of Brookwood's
business, and there can be no assurance that material environmental liabilities
will not arise. It is also possible that future developments in environmental
regulation could lead to material environmental compliance or cleanup costs.
Patent and Trademark Risks. Brookwood considers its patents and
trademarks, in the aggregate, to be important to its business and seeks to
protect this proprietary know-how in part through United States patent and
trademark registrations. Brookwood has a number of trademark applications
pending, although no
8
assurance can be given that trademarks will ever be issued from such
applications or that any trademarks, if issued, will be determined to be valid.
No assurance can be given, however, that such protection will give Brookwood any
material competitive advantage. In addition, Brookwood maintains certain trade
secrets for which, in order to maintain the confidentiality of such trade
secrets, it has not sought patent or trademark protection and therefore such
trade secrets could be infringed upon and such infringement could have a
material adverse effect on its business, results of operations, financial
condition or competitive position.
Competition. The cyclical nature of the textile and apparel industries,
characterized by rapid shifts in fashion, consumer demand and competitive
pressures, results in both price and demand volatility. The demand for any
particular product varies from time to time based largely upon changes in
consumer preferences and general economic conditions affecting the textile and
apparel industries, such as consumer expenditures for non-durable goods. The
textile and apparel industries are also cyclical because the supply of
particular products changes as competitors enter or leave the market.
Brookwood sells primarily to domestic apparel manufacturers, some of which
operate offshore sewing operations. Some of Brookwood's customers have moved
their business offshore during the past few years. Brookwood has responded by
shipping fabric to Asia directly and also by supplying finished products and
garments directly to manufacturers. Brookwood competes with numerous domestic
and foreign fabric manufacturers, including companies larger in size and having
greater financial resources than Brookwood. The principal competitive factors in
the woven fabrics markets are price, service, delivery time, quality and
flexibility, with the relative importance of each factor depending upon the
needs of particular customers and the specific product offering. Brookwood's
management believes that Brookwood maintains its ability to compete effectively
by providing its customers with a broad array of high-quality fabrics at
competitive prices on a timely basis.
Brookwood's competitive position varies by product line. There are several
major domestic competitors in the synthetic fabrics business, none of which
dominates the market. Brookwood believes, however, that it has a strong
competitive position. In addition, Brookwood believes it is one of only three
finishers successful in printing camouflage on nylon for sale to apparel
suppliers of the U.S. government. Additional competitive strengths of Brookwood
include: knowledge of its customers' business needs; its ability to produce
special fabrics such as textured blends; state of the art fabric finishing
equipment at its facilities; substantial vertical integration; and its ability
to communicate electronically with its customers.
Risks Relating to Imports. Imports of foreign-made textile and apparel
products are a significant source of competition for most sectors of the
domestic textile industry. The U.S. government has attempted to regulate the
growth of certain textile and apparel imports through tariffs and bilateral
agreements, which establish quotas on imports from lesser-developed countries
that historically account for significant shares of U.S. imports. Despite these
efforts, imported apparel, which represents the area of heaviest import
penetration is estimated to represent in excess of 90% of the U.S. market.
The U.S. textile industry has been and continues to be negatively impacted
by existing worldwide trade practices. The establishment of the World Trade
Organization ("WTO") in 1995 has resulted in the phase out of quotas on textiles
and apparel through 2004. In addition, tariffs on textile and apparel products
will be reduced, but not eliminated, over the same ten-year period. After the
end of ten years, the textile and apparel trade would revert to regular WTO
rules that prohibit quotas and most other non-tariff barriers. Various other
proposals have been presented for WTO consideration, which could lead to further
significant changes in worldwide tariffs beyond those already anticipated.
U.S. government policy on an overall basis has not been favorable to the
U.S. textile industry. Brookwood believes that the increasing flow of imports in
the United States is partly due to the U.S. government's strong dollar monetary
policy that allows foreign manufacturers to sell in the U.S. while a significant
portion of their production costs are denominated in devalued local currencies.
Labor Relations. Brookwood's Kenyon Industries, Inc. subsidiary has
entered into a collective bargaining agreement with the Union of Needletrades,
Industrial and Textile Employees, representing approximately
9
239 employees at its Rhode Island plant facilities. The collective bargaining
agreement expires on February 29, 2004. Management believes that overall
relations with employees are good.
RELATED PARTY TRANSACTIONS
HRP. The Company's real estate subsidiaries earn asset management,
property management leasing and construction supervision fees for their
management of HRP's real estate properties. Hallwood Realty earns: (i) an asset
management fee equal to 1% of the net aggregate base rents of HRP's properties,
(ii) acquisition fees equal to 1% of the purchase price of newly acquired
properties and; (iii) disposition fees with respect to real estate investments,
other than the properties owned at the time of HRP's formation in 1990, equal to
10% of the amount by which the sales price of a property exceeds the purchase
price of such property. HCRE earns property management, leasing and construction
supervision fees. The management contracts with HRP expire on June 30, 2004 and
provide for: (i) a property management fee equal to 2.85% of cash receipts
collected from tenants; (ii) leasing fees equal to the current commission market
rate as applied to net aggregate rent (none exceeding 6% of the net aggregate
rent); and (iii) construction supervision fees for administering construction
projects equal to 5% of total construction or tenant improvement costs.
Hallwood Realty is also reimbursed for certain costs and expenses, at cost,
for administrative level salaries and bonuses, employee and director insurance
and allocated overhead costs. In addition, since HRP does not employ any
individuals, the compensation and other costs related to approximately 90
employees rendering services on behalf of HRP and its properties are reimbursed
to Hallwood Realty and HCRE by HRP.
A summary of the fees earned from HRP is detailed below (in thousands):
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
------ ------ ------
Leasing fees............................................... $2,151 $2,158 $2,601
Property management fees................................... 2,029 2,009 1,916
Asset management fees...................................... 618 609 581
Construction supervision fees.............................. 582 1,204 917
Acquisition fees........................................... -- 120 74
------ ------ ------
Total................................................. $5,380 $6,100 $6,089
====== ====== ======
HSC Financial Corporation. The Company has entered into a financial
consulting contract with HSC Financial Corporation ("HSC"), a corporation
associated with Mr. Anthony J. Gumbiner, the Company's chairman and principal
stockholder. The contract provides for HSC to furnish and perform international
consulting and advisory services to the Company and its subsidiaries, including
strategic planning and merger activities, at a rate of $795,000 per year
($495,000 prior to May 2001). HSC is also eligible for bonuses from the Company
or its subsidiaries, subject to approval by the Company's or its subsidiaries'
board of directors. Additionally, the Company reimburses HSC for reasonable and
necessary expenses of office space and administrative services. A summary of the
fees and expenses paid to HSC are detailed below (in thousands):
YEARS ENDED
DECEMBER 31,
------------------
2002 2001 2000
---- ---- ----
Consulting fees............................................. $795 $683 $495
Office space and administrative services.................... 98 86 117
Bonus....................................................... 33 33 --
---- ---- ----
Total.................................................. $926 $802 $612
==== ==== ====
In addition, HSC performs services for certain affiliated entities that are
not subsidiaries of the Company, for which it receives consulting fees, bonuses
or other forms of compensation and expenses. The Company recognizes a
proportionate share of such compensation and expenses, based upon its ownership
percentage in the affiliated entities, through the utilization of the equity
method of accounting.
10
Hallwood Investments Limited. During 2000 and 2001, the Company entered
into loan agreements totaling $4,000,000 with Hallwood Investments Limited, an
entity with which Mr. Gumbiner is associated. Several factors contributed to the
Company's cash flow needs at the time, including difficulties experienced by the
Company's hotel operations and restriction on the availability of distributions
and tax-sharing payments from Brookwood. The loans bore an interest rate of 10%
and were repaid in December 2001 and March 2002.
HEC. During 2002, the Company invested $3,500,000 in HEC, a newly-formed,
private energy company. The Company owns approximately 28% of HEC and accounts
for the investment using the equity method of accounting. Certain of the
Company's current officers and directors and certain officers and directors of
its former energy affiliate are investors in HEC.
Brookwood. During 2000, Brookwood formed STA with an unrelated party that
is also in a textile-related industry, principally to produce advanced,
breathable, waterproof laminate materials for military applications. In
September 2002, STA acquired the 50% ownership interest not owned by Brookwood
for $1,000,000 in cash, the issuance of a $596,000 note bearing interest at the
prime rate and royalty payments for three years based upon production under a
specified contract. Accordingly, STA became a wholly owned subsidiary of
Brookwood in September 2002. Brookwood reported sales to STA of $11,444,000,
$5,342,000 and $4,516,000 for the period through September 2002 and for the
years ended December 31, 2001 and 2000, respectively.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The Company and its subsidiaries have entered into various contractual
obligations and commercial commitments in the ordinary course of conducting its
business operations, which are provided below as of December 31, 2002 (in
thousands):
PAYMENTS DUE DURING THE YEAR ENDING DECEMBER 31,
--------------------------------------------------------------
2003 2004 2005 2006 2007 THEREAFTER TOTAL
------ ------- ------ ---- ---- ---------- -------
CONTRACTUAL OBLIGATIONS
Long term debt
Term Loan and Revolving Credit
Facility...................... $ 980 $ 1,052 $ 785 $ -- $ -- $ -- $ 2,817
10% Debentures.................. -- -- 6,468 -- -- -- 6,468
Loans payable (Brookwood)....... 824 11,763 383 180 97 -- 13,247
Capital lease obligations......... 522 544 -- -- -- -- 1,066
Separation Agreement.............. 500 3,500 -- -- -- -- 4,000
Operating leases.................. 1,121 1,076 834 653 538 1,614 5,836
------ ------- ------ ---- ---- ------ -------
Total......................... $3,947 $17,935 $8,470 $833 $635 $1,614 $33,434
====== ======= ====== ==== ==== ====== =======
AMOUNT OF COMMITMENT EXPIRATION
DURING THE YEAR ENDING DECEMBER 31,
------------------------------------------------------
2003 2004 2005 2006 2007 THEREAFTER TOTAL
---- ---- ---- ---- ---- ---------- ------
COMMERCIAL COMMITMENTS
Employment contracts.................... $400 $200 $50 -- -- -- $ 650
Letters of Credit....................... 393 -- -- -- -- -- 393
---- ---- --- -- -- -- ------
Total................................. $793 $200 $50 -- -- -- $1,043
==== ==== === == == == ======
The Company's Term Loan and Revolving Credit Facility and 10% Debentures
require compliance with various loan covenants and financial ratios, which, if
not met, will trigger a default. The Term Loan and Revolving Credit Facility
requires a minimum debt service coverage ratio, as defined, for each rolling
four quarter period, a senior leverage ratio, as defined, and a minimum
collateral value coverage. Additionally, Brookwood's credit agreement requires
compliance with various loan covenants and financial ratios, principally a
minimum net income and debt service coverage ratio and a debt to equity ratio.
11
The principal ratios, as defined in the respective agreements, as of the
end of the quarters in the year ended December 31, 2002 are provided below
(dollar amount in thousands):
DESCRIPTION REQUIRED AMOUNT DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
----------- --------------- ------------ ------------- -------- ---------
TERM LOAN AND REVOLVING
CREDIT FACILITY
Net cash flow, as defined must exceed $3,400........ $5,941 $4,756 $4,117 n/a
Debt service coverage must exceed 1.2 to 1.0.... 2.01 1.67 1.58 n/a
Senior leverage must be less than 2.5 to
1.0..................... 1.53 1.22 1.46 n/a
Collateral value coverage must exceed 200% of loan
balance................. 877% 1,035% 743% n/a
BROOKWOOD CREDIT AGREEMENT
Minimum net income, as defined must exceed:
$300 ytd 3/31/02........ $304
$750 ytd 6/30/02........ $ 770
$1,100 ytd 9/30/02...... $1,134
$1,500 ytd 12/31/02..... $1,436
Debt service coverage must exceed 1.25 to
1.00.................... 1.91 1.43 1.71 1.33
Debt to equity must be less than 50%..... 39% 43% 48% 40%
The Company was in compliance with its loan covenants under the Term Loan
and Revolving Credit Facility as of December 31, 2002 and for all interim
periods during 2002.
Brookwood was in compliance with its loan covenants for all interim periods
during 2002, except for the quarter ended December 31, 2002, when it did not
meet its minimum net income loan covenant. The covenant, which required for a
minimum net income of $1,500,000, was not met as Brookwood's net income for the
year ended December 31, 2002 was $1,436,000. Brookwood obtained a waiver for
this violation from the lender, and believes that it will be in compliance with
all of its covenants for 2003.
The Indenture for the 10% Debentures contains various covenants, which if
violated, may result in a call of the entire issue. The principal covenants
prohibit any subsidiary of the Company from commencing receivership, bankruptcy
or insolvency proceedings.
Number of Employees. The Company had 548 and 546 employees as of February
28, 2003 and 2002, respectively, comprised as follows:
FEBRUARY 28,
-------------
2003 2002
----- -----
Continuing Operations
Hallwood.................................................. 5 5
Brookwood................................................. 425 401
HCRE...................................................... 68 75
Hotel..................................................... 28 28
Hallwood Realty........................................... 22 20
--- ---
Sub-total.............................................. 548 529
Discontinued Operations
Hotels.................................................... -- 17
--- ---
Total.................................................. 548 546
=== ===
A substantial amount of the salaries and related costs for the employees of
HCRE and Hallwood Realty are reimbursed by HRP.
12
Brookwood's Kenyon Industries, Inc. subsidiary has entered into a
collective bargaining agreement with the Union of Needletrades, Industrial and
Textile Employees, representing approximately 239 employees at its Rhode Island
plant facilities. The collective bargaining agreement expires on February 29,
2004. Management believes that overall relations with employees are good.
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.
Cost of real estate owned by property type and geographic distribution (in
thousands of dollars):
DECEMBER 31, 2002
------------------------------------------------
OPERATING NON-OPERATING
PROPERTY TYPE PROPERTIES PROPERTIES TOTAL PERCENTAGE
------------- ---------- ------------- ------ ----------
Dyeing and finishing plant -- Rhode
Island(1)............................... $4,919 $-- $4,919 91%
Hotel -- Alabama(2)....................... 442 -- 442 9
Parking Lot -- Texas(3)................... -- 50 50 *
------ --- ------ ---
Total................................ $5,361 $50 $5,411 100%
====== === ====== ===
---------------
* Less than 1%.
(1) Property pledged as collateral under loan agreement.
(2) Cost represents purchased leasehold interest and capital improvements.
Property pledged as collateral under bond indenture.
(3) Pledged in March 2003 in connection with settlement of hotel litigation
matter.
DECEMBER 31, 2002
---------------------------------
NUMBER OF
GEOGRAPHIC DISTRIBUTION INVESTMENTS AMOUNT PERCENTAGE
----------------------- ----------- ------ ----------
Rhode Island........................................... 1 $4,919 91%
Alabama................................................ 1 442 9
Texas.................................................. 1 50 *
-- ------ ---
Total............................................. 3 $5,411 100%
== ====== ===
---------------
* Less than 1%.
As of December 31, 2002 no real estate property constituted 10% or more of
consolidated assets.
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. Brookwood's revolving credit agreement contains a
covenant to reasonably maintain property and equipment.
The Company intends to continue operating the leased GuestHouse Suites Plus
hotel in Huntsville, Alabama under license and, as such, must meet and maintain
standards established by the licensor. The Company does not plan to make any
additional significant investment in property.
OFFICE SPACE
The Company shares offices with HRP in Dallas, Texas and pays a pro-rata
share of lease and other office-related costs. The lease for the office space
expires in November 2008 and contains a one-time option to terminate the lease
in November 2005.
13
Brookwood maintains its corporate headquarters in New York City and leases
its office space pursuant to a lease, which expires in August 2006.
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 and its affiliates intend 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 for a discussion of
such litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the period.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's shares of common stock, $0.10 par value per share ("Common
Stock"), are traded on the American Stock Exchange under the symbol of HWG.
There were 769 stockholders of record as of March 28, 2003.
The following table sets forth, for the periods indicated, a two-year
record of high and low closing prices on the American Stock Exchange.
YEARS ENDED DECEMBER 31,
-----------------------------
2002 2001
------------- -------------
QUARTERS HIGH LOW HIGH LOW
-------- ----- ----- ----- -----
First.................................................. $6.60 $6.00 $6.62 $4.00
Second................................................. 6.90 5.60 7.45 5.10
Third.................................................. 7.60 5.30 7.40 4.85
Fourth................................................. 7.26 6.50 6.20 5.15
The Company did not pay cash dividends in 2002 or 2001 and, so long as the
Term Loan and Revolving Credit Facility remains outstanding, is restricted from
paying cash dividends on its Common Stock.
The closing price per share of the Common Stock on the American Stock
Exchange on March 28, 2003 was $6.50.
14
ITEM 6. SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31,
------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
REVENUES
Real estate(a), (b)............................. $ 7,095 $ 8,514 $ 6,763 $ 10,358 $10,850
Textile products................................ 85,933 69,579 73,852 80,704 80,343
Other........................................... 4,128 3,309 1,628 2,198 5,303
------- ------- ------- -------- -------
97,156 81,402 82,243 93,260 96,496
EXPENSES
Real estate(a).................................. 2,491 5,347 3,008 3,828 4,470
Textile products................................ 83,266 71,705 73,397 79,139 79,245
Other........................................... 5,688 7,392 7,768 7,541 7,675
------- ------- ------- -------- -------
91,445 84,444 84,173 90,508 91,390
------- ------- ------- -------- -------
Income (loss) from continuing operations before
income taxes (benefit)(b)..................... 5,711 (3,042) (1,930) 2,752 5,106
Income taxes (benefit).......................... 2,319 2,423 (1,210) (1,014) (3,069)
------- ------- ------- -------- -------
Income (loss) from continuing operations........ 3,392 (5,465) (720) 3,766 8,175
Income (loss) from discontinued operations, net
of tax
Income (loss) from discontinued operations --
hotels(c).................................. 3,402 (1,384) (6,973) (2,485) (1,515)
Income from discontinued
operations -- energy(d).................... -- 11,134 2,826 438 407
------- ------- ------- -------- -------
3,402 9,750 (4,147) (2,047) (1,108)
------- ------- ------- -------- -------
Income (loss) before cumulative effect of
accounting changes............................ 6,794 4,285 (4,867) 1,719 7,067
Income (loss) from cumulative effect of
accounting changes(e)......................... 568 (40) -- -- --
------- ------- ------- -------- -------
Net Income (Loss)............................... $ 7,362 $ 4,245 $(4,867) $ 1,719 $ 7,067
======= ======= ======= ======== =======
INCOME (LOSS) PER COMMON SHARE FROM CONTINUING
OPERATIONS(f)
Basic......................................... $ 2.45 $ (3.89) $ (0.54) $ 1.99 $ 4.32
Assuming dilution............................. 2.38 (3.89) (0.54) 1.96 4.17
NET INCOME (LOSS) PER COMMON SHARE
Basic......................................... $ 5.37 $ 2.95 $ (3.45) $ 0.89 $ 3.73
Assuming dilution............................. 5.19 2.95 (3.45) 0.88 3.60
DIVIDENDS PER COMMON SHARE...................... -- -- -- -- --
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic......................................... 1,361 1,420 1,425 1,870 1,882
Assuming dilution............................. 1,415 1,420 1,425 1,899 1,947
FINANCIAL CONDITION
Total assets.................................. $69,548 $77,567 $95,923 $101,253 $96,586
Loans payable................................. 17,130 30,750 61,628 61,463 42,521
Subordinated debentures....................... 6,625 6,677 6,725 6,768 21,535
Redeemable preferred stock.................... 1,000 1,000 1,000 1,000 1,000
Common stockholders' equity................... 23,136 15,883 11,814 17,058 20,938
---------------
(a) Includes reclassification to gross-up certain construction and facilities
management expenses that were previously netted against revenues. The
reclassification occurred due to the adoption of
15
EITF No. 01-14 -- "Income Statement Characterization of Reimbursements
Received for Out-of-Pocket Expenses Incurred". The reclassifications had no
effect on previously reported net income.
(b) Includes amounts previously reported as extraordinary gain (loss) from
early extinguishment of debt under SFAS No. 145.
(c) The Company's hotel operations consisted of five hotel properties. In
December 2000, the Company decided to discontinue and dispose of its hotel
segment; however, the Company subsequently determined that it would retain
the leasehold interest in one of the hotels. Historical results of the four
hotels that have been disposed of have been reclassified to discontinued
operations from continuing operations. The one leasehold property that the
Company retained has been reported as a continuing operation.
(d) In May 2001, the Company sold its investment in Hallwood Energy which has
been reclassified and reported as a discontinued operation for all periods
presented herein.
(e) SFAS No. 142 became effective on January 1, 2002, which resulted in the
recording of income in 2002 of $568,000, which represented negative
goodwill associated with the Company's HRP investment. 2001 results
included a loss from adoption of SFAS No. 133.
(f) Per share amounts have been recast for discontinued hotel and energy
reclassifications and for previously reported extraordinary items.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations. The Company reported net income of $7,362,000 for
the year ended December 31, 2002, compared to net income of $4,245,000 for 2001,
and a net loss of $4,867,000 for 2000.
The Company reported income from continuing operations of $3,392,000 for
2002, compared to losses of $5,465,000 for 2001 and $720,000 for 2000. Revenue
from continuing operations was $97,156,000 for 2002, $81,402,000 for 2001 and
$82,243,000 for 2000.
Following is an analysis of the results of continuing operations for the
real estate and textile products business segments and the discontinued
operations for the energy and hotel business segments:
REAL ESTATE
Revenues. Real estate revenues of $7,095,000 for 2002, $8,514,000 for 2001
and $6,763,000 for 2000, include fee income and equity income (loss) from the
Company's investments in HRP.
Fee income of $5,667,000 for 2002 decreased by $1,128,000, or 17%, compared
to $6,795,000 for 2001. The 2001 fee income decreased by $215,000, or 3%,
compared to $7,010,000 for 2000. The decreases were principally due to lower
leasing and construction supervision fees, which are cyclical in nature. The
Company's Hallwood Realty subsidiary is the general partner of HRP and earns an
asset management fee and other fees from HRP properties, which amounted to
$618,000 for 2002, $729,000 for 2001 and $655,000 for 2000. 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, which
amounted to $4,762,000 for 2002, $5,371,000 for 2001 and $5,434,000 for 2000.
The equity income (loss) from investments in HRP represents the Company's
pro-rata share of the net income (loss) reported by HRP, adjusted for the
elimination of intercompany income and, prior to January 1, 2002, amortization
of negative goodwill. The Company recorded equity income of $1,428,000 for 2002,
compared to income of $1,719,000 in 2001 and a loss of $247,000 for 2000. The
2002 decrease resulted principally from gains from property sales by HRP in
2001, partially offset by decreased litigation costs for 2002. The 2001 increase
resulted from gains from property sales by HRP, improved operating performance
and reduced administrative and litigation costs. The 2001 equity income was
exclusive of the Company's $40,000 pro-rata share of HRP's $192,000 loss from
cumulative effect of adopting SFAS No. 133, which is reported separately on the
statement of operations. The 2000 equity loss resulted from reduced income
reported by HRP, partially offset by reduced intercompany income adjustment
related to leasing and development fees from HRP. In addition, the Company
adopted Statement of Financial Accounting Standards No. 142 -- Goodwill and
other Intangible Assets ("SFAS No. 142"), which resulted in the
16
recording of income from the cumulative effect of a change in accounting
principle in the amount of $568,000. This represented the unamortized amount of
negative goodwill associated with the Company's equity investment in HRP.
Expenses. Real estate expenses of $2,491,000 for 2002, $5,347,000 for 2001
and $3,008,000 for 2000, include administrative expenses, depreciation and
amortization and litigation expense.
Administrative expenses decreased by $496,000, or 21%, to $1,819,000 for
2002, compared to $2,315,000 for 2001. The 2001 expenses decreased by $21,000,
or 1%, compared to $2,336,000 for 2000. The decreases were primarily
attributable to the payments of commissions associated with leasing income and
fluctuations in construction and facilities management expenses, which can vary
significantly from year to year due to the transactional nature of the services.
Amortization expense of $672,000 for each of the three years 2002, 2001 and
2000 relates to Hallwood Realty's general partner interest in HRP to the extent
allocated to management rights, which is being amortized over a ten year period
ending in October 2003. At December 31, 2002, the unamortized cost remaining was
$560,000.
Litigation expense of $2,360,000 was recorded for 2001. The Delaware Court
of Chancery rendered its opinion regarding certain litigation involving the
Company in July 2001. The court determined that the defendants should pay to HRP
a judgment of $3,417,000 plus pre-judgment interest of approximately $2,893,000.
The principal component of the judgment amount, which represented the court's
determination of an underpayment by the Company for certain limited partnership
units purchased by the Company in 1995 from HRP, was considered additional
purchase price and added to the Company's investment in the limited partnership
units. The interest component of the judgment amount has been recorded as an
expense, after elimination of the Company's $533,000 pro rata share of the
income that will be reported by HRP as a result of the payment. The Company paid
$6,405,000 (including post-judgment interest) to HRP in October 2001, subject to
an arrangement that it be returned in full or part if the judgment is modified
or reversed on appeal.
TEXTILE PRODUCTS
Revenues. Textile revenues were $85,933,000 in 2002, $69,579,000 in 2001
and $73,852,000 in 2000.
Sales of $84,770,000 in 2002 increased by $15,876,000, or 23%, compared to
$68,894,000 in 2001 and decreased by $4,958,000, or 7%, in 2001, compared to
$73,852,000 in 2000. The 2002 increase was principally due to renewed activity
in the military business. The 2001 decrease was principally in the distribution
business as a result of lower overall demand, the continued trend of U.S.
customers moving production out of the country and the September 11th terrorist
attacks that adversely impacted the tourism industry, as well as luggage and
outerwear business, partially offset by increased revenues at the dyeing and
finishing and laminating plants and revenues from new customers and new
production processes to diversify Brookwood's product base. Brookwood had one
customer that accounted for more than 10% of its net sales during 2002. The
relationship with the customer is ongoing and Brookwood expects to maintain
comparable sales volumes with that customer in 2003. Sales to that customer were
$18,600,000, $3,800,000 and $42,000 in 2002, 2001 and 2000, respectively.
During 2000, Brookwood formed STA with an unrelated third party that is
also in a textile-related industry. STA acquired the 50% ownership interest not
owned by Brookwood in September 2002. Accordingly, STA became a wholly owned
subsidiary in September 2002. Prior to the acquisition, Brookwood utilized the
equity method of accounting. Brookwood's equity income from STA in 2002 was
$1,163,000 (prior to acquisition) and $685,000 in 2001.
Expenses. Total expenses increased $11,561,000, or 16%, to $83,266,000 in
2002. The 2001 expenses decreased $1,692,000 to $71,705,000 from $73,397,000 in
2000.
Cost of sales increased $13,096,000 to $71,481,000, or 22%, in 2002. The
2001 cost of sales of $58,385,000 decreased by $4,016,000, or 6%, compared to
$62,401,000 in 2000. The gross profit margin was 15.7%, 15.2% and 15.5% in 2002,
2001 and 2000, respectively.
17
Administrative and selling expenses of $11,243,000 for 2002 increased by
$487,000, or 5%, from the 2001 amount of $10,756,000, which increased $945,000,
or 10%, compared to the 2000 amount of $9,811,000. The increase in 2002 resulted
primarily from an increase in indirect and administrative payroll costs. The
increase in 2001 was attributable to costs related to the development of new
business products, costs incurred in a brief strike at the dyeing and finishing
plant and costs associated with the settlement of a contingent obligation in the
amount of $375,000.
Interest expense decreased by $576,000, or 52%, to $542,000 for 2002, and
increased by $67,000 for 2001 to $1,118,000 in 2001 from the 2000 amount of
$1,185,000. The 2002 decrease was principally due to lower interest rates, while
the 2001 decrease was the result of higher average borrowings and lower interest
rates.
In 2001, management conducted an analysis of the carrying values of certain
intangible assets related to acquisitions made in prior years by Brookwood and
determined that Brookwood suffered an impairment to those values due to adverse
economic trends and conditions. Accordingly, an impairment charge of $1,446,000
was recorded in December 2001.
OTHER
Revenues. Total revenues were $4,128,000 in 2002, $3,309,000 in 2001 and
$1,628,000 in 2000.
Fee revenue of $2,417,000 in 2002 and $1,410,000 in 2001 is attributable to
the amortization of deferred revenue from the noncompetition agreement
associated with the sale of the Company's investment in Hallwood Energy. Under
the noncompetition agreement, the Company agreed to refrain from taking certain
actions without prior consent, including, among other items, directly or
indirectly engaging in oil and gas activities in certain geographic areas, for
period of three years. The original $7,250,000 cash payment is being amortized
over a three year period which began June 2001.
Hotel revenue from the leased GuestHouse Suites Plus hotel in Huntsville,
Alabama was $1,576,000 in 2002, compared to $1,677,000 in 2001 and $1,540,000 in
2000. The $101,000 decrease, or 6%, in 2002 was due to decreased occupancy,
partially offset by an increased average daily rate. The 9% increase in 2001 was
attributable to increased occupancy, partially offset by a reduced average daily
rate. Revenues have been adversely impacted by a general downturn in the hotel
industry and increased competition in the Huntsville market.
Interest and other income in 2002 was $322,000, compared to the 2001 amount
of $222,000 and $88,000 in 2000. The 2002 increase was due to a gain of $296,000
on the exercise of an option and sale of a marketable security. The 2001
increase resulted from increased interest income on invested funds from the sale
of Hallwood Energy.
Equity loss of $187,000 in 2002 relates to the Company's pro rata share of
loss from HEC's operations, which commenced in 2002.
Expenses. Administrative expenses were $1,940,000 for 2002, compared to
$2,279,000 for 2001 and $1,837,000 for 2000. The decrease of $339,000, or 15%,
in 2002 and increase of $442,000, or 24%, in 2001 were primarily attributable to
fluctuating consulting and professional fees.
Hotel expenses include operating expenses, depreciation and interest costs
associated with the GuestHouse Suites Plus hotel in Huntsville, Alabama, which
the Company has retained and continues to operate. Hotel expenses increased by
$83,000, or 5%, to $1,898,000 in 2002, compared to $1,815,000 in 2001,
principally due to an increase in repairs and maintenance expense. 2001 expenses
decreased by $1,018,000, or 36%, from $2,833,000 in 2000 due to the recording of
an impairment of $680,000 in December 2000, reduced depreciation due to the
adjustment in basis from the impairment and lower operating expenses as a result
of improved cost controls.
In 1999, the Company entered into the Separation Agreement. The Separation
Agreement provided that a former officer and director and related trust exchange
their 24% stock ownership in the Company, for 20% of the Company's limited
partner interest in HRP, 20% of the Company's common stock interest in Hallwood
Energy, all of the Company's interest in its condominium hotel business and
future cash payments contingent
18
on the net cash flow from the Company's real estate management activities, that
being the lesser of 20% of the net cash flow from its real estate management
activities for the preceding quarter or $125,000. These future cash payments are
subject to termination or extinguishment in certain events. The additional cost
of the Separation Agreement recorded in 2002 and 2001 in the amounts of
$1,000,000 and $500,000, respectively, represent future cash payments to the
trust through the period ending December 2004. The Company has an option to
extinguish the future cash payments to the trust at any time prior to its
expiration in December 2004 upon the payment of $3,000,000.
Interest expense relates to the Company's Term Loan and Revolving Credit
Facility, 10% Collateralized Subordinated Debentures, former Senior Secured Term
Loan, stockholder loans and interest costs on contingent payments associated
with the Separation Agreement. Interest expense of $850,000 for 2002 decreased
by $1,148,000, or 57%, compared to 2001 interest of $1,998,000. The decrease was
primarily due to the payoff of the former Senior Secured Term Loan in May 2001,
partially offset by increased interest expense associated with the Term Loan and
Revolving Credit Facility obtained in March 2002. Interest expense for 2001
decreased $1,100,000, or 36%, to $1,998,000, compared to 2000 interest of
$3,098,000. The decrease was principally due to the principal amortization on
the former Senior Secured Term Loan prior to its payoff in May 2001, partially
offset by increased interest costs associated with the stockholder loans.
The loss from debt extinguishment of $800,000 in 2001 relates to the write
off of unamortized deferred loan costs associated with the repayment of the
former Senior Secured Term loan in May 2001. Previously, this loss was reported
as an extraordinary loss, but has been reclassified into continuing operations
in accordance with Statement of Financial Standards No. 145.
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 basis of assets and liabilities (approximately $49,793,000 at
December 31, 2002), tax net operating loss carryforwards ("NOLs") (approximately
$29,278,000 at December 31, 2002) and tax credit carryforwards (approximately
$2,228,000 at December 31, 2002), to the extent that realization of such
benefits is "more likely than not", as contemplated in Statement of Financial
Accounting Standards No. 109 -- Accounting for Income Taxes ("SFAS No. 109"). As
a result of the fluctuations in the anticipated gain on the sale of the HRP
limited partner units, the realization of a gain on the sale of Hallwood Energy,
and the projected income from operations, partially offset by the decline in
value and disposition of the Company's hotel properties, management has
determined that the deferred tax asset should be adjusted to reflect the
anticipated utilization of NOLs resulting from the expected income from these
assumptions. Accordingly the Company recorded a deferred tax expense of
$3,256,000 in 2002 and $949,000 in 2001, and deferred tax (benefit) of
$(1,205,000) in 2000, respectively, which resulted in the recognition of
deferred tax assets of $4,221,000 at December 31, 2002, $7,477,000 at December
31, 2001 and $8,426,000 at December 31, 2000. The portion of the deferred tax
expense (benefit) during the years ended December 31, 2002, 2001 and 2000
related to continuing operations was $1,456,000, $2,121,000 and $(1,546,000),
respectively, and the portion relating to discontinued operations was
$1,800,000, $(1,172,000) and $341,000, respectively.
The Company recorded a federal current charge of $50,000, $58,000 and
$46,000 from continuing operations in the three years ended December 31, 2002,
respectively, principally for the filing of separate returns of certain
subsidiaries not included in the Company's consolidated federal tax return. The
Company recorded state tax expense of $813,000 in 2002, $244,000 in 2001 and
$290,000 in 2000.
The Company's NOLs expire as follows: 2007 -- $7,083,000;
2008 -- $12,896,000; and 2009 to 2020 -- $9,299,000. 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 $12,415,000 of the NOLs prior to their
ultimate expiration in the year 2020.
19
Management believes that the Company has certain tax planning strategies
available, which include the potential sale of certain real estate investments,
that could be implemented, if necessary, to supplement income from operations to
fully realize the net recorded tax benefits before their expiration. Management
has considered such strategies in reaching its conclusion that, more likely than
not, taxable income will be sufficient to utilize a portion of the NOLs before
expiration; however, future levels of operating income and taxable gains are
dependent upon general economic conditions and other factors beyond the
Company's control. Accordingly, no assurance can be given that sufficient
taxable income will be generated for utilization of the NOLs. Management
periodically re-evaluates its tax planning strategies based upon changes in
facts and circumstances and, accordingly, considers potential adjustments to the
valuation allowance of the deferred tax asset.
Although the use of such carryforwards could, under certain circumstances
be limited, the Company is presently unaware of the occurrence of any event
which would result in such limitations. In addition, utilization of NOLs in the
future may be limited if changes in the Company's stock ownership create a
change of control, as provided in Section 382 of the Internal Revenue Code of
1986, as amended.
DISCONTINUED OPERATIONS -- HOTELS
Dispositions. In December 2000, the Company decided to discontinue its
hotel operations and dispose of its hotel segment, principally by allowing its
non-recourse debtholders to assume ownership of the properties through
foreclosures or by selling or otherwise disposing of its hotel properties. The
Company's former hotel segment consisted of three owned properties and two
leased properties. As part of the planned disposition, the Company evaluated the
operations and economic environment in which each of the hotels operated and in
December 2001 and December 2000 recorded impairments of $935,000 and $4,000,000
($3,320,000 for the hotels designated as held for sale and $680,000 for the
remaining hotel held for use), respectively, to reduce hotel carrying values to
estimated fair market values. Apart from the leasehold interest in the
GuestHouse Suites Plus hotel in Huntsville, Alabama that the Company continues
to operate and report as an asset held for use, hotel operations have been
segregated from the Company's continuing operations and reported as discontinued
hotel operations.
A summary of the discontinued hotel operations for each of the three years
in the period ended December 31, 2002 are presented below (in thousands):
YEARS ENDED DECEMBER 31,
--------------------------
2002 2001 2000
------ ------- -------
Revenue and Gain from Disposition
Gain from extinguishment of debt....................... $5,789 $ 316 $ --
Sales.................................................. 282 7,619 16,839
------ ------- -------
6,071 7,935 16,839
Expenses
Deferred federal income tax expense (benefit).......... 1,800 (500) 341
Operating expenses..................................... 324 6,822 14,746
Interest expense....................................... 183 1,848 2,607
Litigation and other disposition costs................. 362 214 115
Impairment............................................. -- 935 3,320
Depreciation and amortization.......................... -- -- 2,683
------ ------- -------
2,669 9,319 23,812
------ ------- -------
Income (loss) from discontinued hotel operations.... $3,402 $(1,384) $(6,973)
====== ======= =======
As of June 2002, the Company completed the disposition of all four hotel
properties it had previously designated as hotels held for sale.
20
The Company was a defendant in two lawsuits regarding guaranties of certain
obligations of the Holiday Inn and Embassy Suites hotels. In February 2003, the
Company settled both matters. The Company agreed (i) to pay $150,000 in cash and
to issue a non-interest bearing promissory note in the amount of $250,000
payable in equal monthly installments over eighteen months, in exchange for a
full release regarding the Embassy Suites hotel and (ii) to pay $250,000 in cash
in exchange for a full release regarding the Holiday Inn hotel. In December
2002, the Company recorded an additional loss provision in the amount of
$247,000 to fully accrue for these two litigation matters. Comparisons are
generally not meaningful due to the disposition of the Company's two
full-service hotel properties in 2001 and two limited service hotel properties
in 2002.
Revenues. In January 2002, with assistance and consent of the mortgage
lender, the Company sold the GuestHouse Suites hotel in Tulsa, Oklahoma for
$3,000,000. The Company received no cash proceeds from the sale. In connection
with the sale, the parties entered into a loan modification and assumption
agreement, which included a release that discharges the Company from any further
loan obligation associated with the Tulsa hotel. The Company recognized a gain
from extinguishment of debt of $2,552,000, before a deferred tax charge of
$875,000, in the 2002 first quarter. In February 2002, the mortgage lender for
the GuestHouse Suites hotel in Greenville, South Carolina obtained a court
judgement of foreclosure. In connection with the foreclosure, the lender waived
its right to a deficiency judgement against the Company and completed the
foreclosure in June 2002. The Company recognized a gain from extinguishment of
debt of $3,237,000, before a deferred tax charge of $925,000 in the 2002 second
quarter.
In June 2001, the Company entered into a settlement agreement with the
mezzanine lender whereby (i) the Company transferred to the lender the stock
ownership of Hallwood Hotels-OKC, Inc., the entity that owned the Embassy Suites
hotel and (ii) the mezzanine lender released the Company from its obligations
under the first mortgage and the mezzanine loan. The Company reported a gain
from extinguishment of debt of $316,000, before a deferred tax charge of
$100,000 in connection with the settlement agreement.
Sales of $282,000 in 2002 decreased by $7,337,000 from the 2001 amount of
$7,619,000 which decreased by $9,220,000, from the 2000 amount of $16,839,000,
due to the February 2001 termination of the lease for the Longboat Key Holiday
Inn and Suites hotel in Sarasota, Florida; and the dispositions of the Embassy
Suites hotel in Oklahoma City, Oklahoma in June 2001, the Tulsa GuestHouse
Suites hotel in January 2002, and the Greenville GuestHouse Suites hotel in June
2002.
Expenses. Hotel expenses were $2,669,000 for 2002, $9,319,000 for 2001,
and $23,812,000 for 2000.
Operating expenses of $324,000 for 2002 decreased by $6,498,000, or 95%,
from the 2001 amount of $6,822,000, which decreased by $7,924,000, or 54%, from
the 2000 amount of $14,746,000. The decreases were primarily due to the
aforementioned dispositions of the four hotels.
Interest expense of $183,000 for 2002 decreased by $1,665,000, or 90%, from
the 2001 amount of $1,848,000, which decreased by $759,000, or 29%, from the
2000 amount of $2,607,000. Again, the decreases were due to the aforementioned
dispositions.
The impairment of hotel assets of $935,000 in 2001 and $3,320,000 in 2000
were recorded to reduce the carrying values to their estimated fair values.
The litigation and other disposition costs principally relate to legal fees
and other expenses in connection with the dispositions and the resolution of the
two litigation matters discussed above, including a loss provision of $247,000
in the fourth quarter of 2002 for the settlement costs.
The deferred tax charge of $1,800,000 in 2002 is associated with the gains
from extinguishment of debt. The deferred income tax benefit of $500,000 (net of
the $100,000 deferred tax charge related to the disposition of the Embassy
Suites hotel) in 2001 increased the deferred tax asset associated with the
hotels held for sale to $1,800,000 in anticipation of debt extinguishment gains
in 2002. The deferred income tax expense of $341,000 in 2000 was the result of
the impairment charges in 2000.
Depreciation and amortization expense was not recorded in 2002 or 2001 due
to the impairment charges and classification of the hotels as a discontinued
operation. Depreciation and amortization expense was $2,683,000 for 2000.
21
DISCONTINUED OPERATIONS -- ENERGY
Revenues and Sale Transaction. In March 2001, the Company agreed to sell
its investment in its Hallwood Energy affiliate, which represented the Company's
energy operations, to Pure Resources II, an indirect subsidiary of Pure
Resources, Inc., subject to Hallwood Energy's shareholder approval which was
obtained in May 2001. The Company received $18,000,000 for the tender of its
1,440,000 shares of common stock of Hallwood Energy in May 2001 and recorded a
gain of $8,725,000 from this transaction. Accordingly, the former energy
operations have been segregated from the Company's continuing operations and
reported as a single line item -- income from discontinued energy operations. A
summary of its operations for each of the three years in the period ended
December 31, 2002 are presented below:
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
----- ------- ------
Revenues
Gain on sale of investment in Hallwood Energy............. $ -- $ 8,725 $ --
Equity income from investment in Hallwood Energy.......... -- 1,837 2,826
----- ------- ------
10,562 2,826
Expense
Deferred federal income tax benefit....................... -- (672) --
State income tax expense.................................. -- 100 --
----- ------- ------
-- (572) --
----- ------- ------
Income from discontinued energy operations............. $ -- $11,134 $2,826
===== ======= ======
The Company received an additional $7,250,000, pursuant to the terms of a
noncompetition agreement, that was paid by Pure upon the completion of the
merger in June 2001. The Company began amortizing the deferred revenue from the
noncompetition agreement over a three-year period commencing June 2001. The
amortization of $2,417,000 in 2002 and $1,410,000 in 2001 is reported in the
"other" section of the statement of operations.
Under the noncompetition agreement, the Company agreed to refrain from
taking certain actions without the prior written consent of Pure and Hallwood
Energy. These covenants were made by the Company in consideration of the
transactions contemplated by the merger agreement and the payment by Pure to the
Company. For a period of three years after the effective date of the merger
agreement, the Company will not, directly or indirectly, engage in oil and gas
activities in certain geographic areas without the prior consent of Pure.
Hallwood Energy was engaged in the development, exploration, acquisition and
production of oil and gas properties. The Company also agreed to keep Hallwood
Energy's confidential and proprietary information strictly confidential.
The equity income from the investment in Hallwood Energy represented the
Company's 15% pro rata share of income available to common stockholders and
amortization of negative goodwill. The 2001 amount reflects equity in Hallwood
Energy's earnings through the May 2001 sale date.
The Company accounted for its investment in Hallwood Energy using the
equity method of accounting, as the Company exercised significant influence over
Hallwood Energy's operational and financial policies. The Company recorded its
pro-rata share of Hallwood Energy's net income available to common stockholders,
preferred dividends and amortization of negative goodwill as a single line
item -- equity income from investments in Hallwood Energy.
Expenses. The Company recorded a net deferred federal income tax benefit
of $672,000 in 2001, principally due to the utilization of the Company's NOL's
associated with the gain on sale of its investment in Hallwood Energy, and state
income tax expense of $100,000.
22
CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES
SFAS No. 142 became effective January 1, 2002 and specifies that goodwill
and some intangible assets will no longer be amortized but instead will be
subject to periodic impairment testing. The effect of adopting SFAS No. 142 by
the Company resulted in the recording of income from the cumulative effect of a
change in accounting principle in the amount of $568,000, which represented the
unamortized amount of negative goodwill associated with the Company's equity
investment in HRP. In 2001, the Company recognized a loss from cumulative effect
of Statement of Financial Accounting Standard No. 133 -- Accounting for
Derivative Instruments and Hedging Activities ("SFAS No. 133"), in the amount of
$40,000, from the recognition of the Company's pro rata share of HRP's loss from
cumulative effect.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and judgments that affect the reported amounts of
certain assets, liabilities, revenues, expenses, and related disclosures. Actual
results may differ from these estimates under different assumptions or
conditions.
In December 2001, the SEC requested that registrants identify "critical
accounting policies" in Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations. The SEC indicated that a
"critical accounting policy" is one that is both important to the portrayal of
an entity's financial condition and results and requires management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain. The
Company believes that the following of its accounting policies fit this
description:
Revenue Recognition -- Fee income from real estate operations is recognized
as the services (e.g. management, leasing, acquisition, construction) are
performed in accordance with various service agreements. The Company records a
non-cash adjustment for the elimination of intercompany profits associated with
leasing and construction supervision fees earned from HRP to the extent of their
22% ownership interest in HRP. Such intercompany profits are deferred and
amortized to income over the term of the related leases and the depreciable
lives of property improvements as recorded by HRP.
Textile products sales are recognized upon shipment or release of product,
when title passes to the customer. Brookwood provides allowances for expected
cash discounts, returns, claims and doubtful accounts based upon historical bad
debt and claims experience and periodic evaluation of the aging of accounts
receivable. If the financial condition of Brookwood's customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances would be required.
On occasion, Brookwood receives written instructions from some of its
customers to finish fabric, invoice the full amount and hold the finished
inventory until the customer sends shipping instructions. In those cases,
Brookwood records the sale and sends the customer an invoice containing normal
and usual payment terms and segregates the inventory from Brookwood's inventory.
Equity Method of Accounting -- The Company accounts for its investments in
HRP and HEC, using the equity method of accounting. The Company owns
approximately 22% of HRP and 28% of HEC as of December 31, 2002, respectively.
The equity method is used because the Company has the ability to exercise
significant influence over the operating and financial policies of each entity.
The Company records its pro rata share of each entity's net income (loss)
adjusted for certain items, such as the elimination of intercompany profits, as
well as a pro rata share of partners' capital and stockholders' equity
transactions and comprehensive income.
Impairment of Long-Lived Assets -- 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. Unforeseen events and changes in circumstances and market
conditions could negatively affect the fair value of assets and result in an
impairment charge. In the event such indicators exist for assets held for use,
if undiscounted cash flows before interest charges are less than carrying value,
the asset is written down to estimated fair value. For assets held for sale,
these assets are carried at the lower of cost or estimated
23
sales price less costs of sale. Fair value is the amount at which the asset
could be bought or sold in a current transaction between willing parties and may
be estimated using a number of techniques, including quoted market prices or
valuations by third parties, present value techniques based on estimates of cash
flows, or multiples of earnings or revenues performance measures. The fair value
of the asset could be different using different estimates and assumptions in
these valuation techniques. Significant assumptions used in this process depend
upon the nature of the investment, but would include an evaluation of the future
business opportunities, sources of competition, advancement of technology and
its impact on patents and processes, future rental and occupancy rates, and the
level of expected operating expenses.
Inventories -- Inventories at the Brookwood subsidiary are valued at the
lower of cost (first-in, first-out or specific identification method) or market.
Inventories are reviewed and adjusted for changes in market value based on
assumptions related to future demand and worldwide and local market conditions.
If actual demand and market conditions vary from those projected by management,
adjustments to lower of cost or market value may be required.
The policies listed are not intended to be a comprehensive list of all of
our accounting policies. In most cases, the accounting treatment of a particular
transaction is specifically dictated by accounting principles generally accepted
in the United States of America, with no need for management's judgment in the
application. There are also areas in which management's judgment in selecting
any available alternative would not produce a materially different result than
those recorded and reported.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash position decreased by $1,629,000 during 2002 to
$1,377,000 as of December 31, 2002. The principal source of cash during the year
was $6,676,000 provided by operating activities. The principal uses of cash were
$3,500,000 for the HEC investment, $1,950,000 for textile products machinery,
equipment and capital items and $2,719,000 for net repayment of bank borrowings
and loans payable.
The Company principally operates in the real estate and textile products
business segments. During 2002, the Company reentered the energy business as a
minority owner in HEC.
The Company's real estate segment generates funds principally from its
property management and leasing activities without significant additional
capital costs. The Company has pledged 300,397 of its HRP limited partnership
units and the interest in its real estate subsidiaries to collateralize the Term
Loan and Revolving Credit Facility, described below, and the remaining 30,035
HRP units to secure all of the capital leases. Each quarter, Hallwood Realty
reviews HRP's capacity to make cash distributions to its partners. No
distributions were declared by HRP in 2002.
The Company's textile products segment generates funds from the dyeing and
finishing of fabrics and their sale to customers in the consumer, industrial,
medical and military markets. Brookwood maintains a revolving line of credit
facility and separate acquisition and equipment facilities. All facilities have
a maturity of January 2004. At December 31, 2002, Brookwood had $4,365,000 of
unused borrowing capacity on its revolving line of credit facility. In the years
ended December 31, 2002, 2001 and 2000, Brookwood paid to the Company, payments
of $250,000, $-0- and $200,000, respectively, under its tax sharing agreement
but no cash dividends. Future cash dividends and tax sharing payments to the
parent company are contingent upon Brookwood's compliance with the covenants
contained in the credit facility. Brookwood was in compliance with its loan
covenants for all interim periods in 2002, except for the quarter ended December
31, 2002, when it did not meet its minimum net income loan covenant. The
covenant, which required a minimum net income of $1,500,000, was not met as
Brookwood's net income was $1,436,000. Brookwood obtained a waiver for this
violation from the lender, and believes that it will be in compliance with all
of its covenants for 2003.
In March 2002, the Company and its HWG, LLC subsidiary entered into a
$7,000,000 credit agreement with First Bank & Trust, N.A. The facility is
comprised of a $3,000,000 term loan and a $4,000,000 revolving credit facility
(the "Term Loan and Revolving Credit Facility"). The term loan proceeds were
used in part to repay the aforementioned $1,500,000 convertible loan from
stockholder in March 2002, bears interest at a fixed rate of 7%, matures April
1, 2005 and is fully amortizing requiring a monthly payment of $92,631. The
24
revolving credit facility bears interest at the Company's option of one-half
percent over the prime rate, or Libor plus 3.25%, and matures April 1, 2005.
Collateral for the Term Loan and Revolving Credit Facility is 300,397 HRP
limited partner units. The credit agreement contains various financial and
non-financial covenants, including the maintenance of financial ratios,
restrictions on new indebtedness and the payment of dividends. The Company was
in compliance with the loan covenants for all periods during the year and as of
December 31, 2002. The Company borrowed $500,000 under this Revolving Credit
Facility in December 2002 and $800,000 in March 2003, and therefore has
$2,700,000 of unused borrowing capacity.
In July 2001, the Delaware Court of Chancery rendered its opinion regarding
certain litigation involving the Company. The court determined that the
defendants, including the Company, should pay to HRP a judgment of $3,417,000
plus pre-judgment interest of approximately $2,988,000. The court's judgment is
not final until all rehearings and appeals have been exhausted. In August 2001,
the plaintiff and certain defendants appealed the Court of Chancery's judgment
to the Delaware Supreme Court. In October 2001, with a portion of the proceeds
from the sale of its Hallwood Energy investment, the Company paid HRP
$6,405,000, including post-judgment interest, subject to an arrangement that it
be returned in full or part if the judgment is modified or reversed on appeal.
As further discussed in Note 18, the Supreme Court reversed the trial court's
determination of damages, and remanded the case to the trial court to fashion
appropriate relief. Preliminary hearings have been held and a further hearing on
the remand is scheduled for May 2003, with a decision by the Court of Chancery
to follow. Since the appellate court reversed the judgement, any subsequent
ruling by the trial court on remand may be more or less favorable to the
Company.
The Company tendered its 1,440,000 shares of common stock in Hallwood
Energy, pursuant to a tender offer and merger agreement with a subsidiary of
Pure announced in March 2001 and completed in May 2001. The Company received
$18,000,000 for the tender of its shares in May 2001 and received an additional
$7,250,000, pursuant to the terms of a noncompetition agreement upon completion
of the merger in June 2001. The former Senior Secured Term Loan, with a
remaining balance of $14,059,000, was fully repaid in May 2001 with a portion of
the proceeds from the sale.
In February 2000, Brookwood, through a wholly owned subsidiary, acquired
the assets of a company in a textile products-related industry. The purchase
price was $1,479,000 in cash plus contingent payments of up to $3,000,000, based
on specified levels of earnings over the next four years. Effective December 31,
2001, in consideration of thirty six monthly payments aggregating approximately
$375,000, the contingent obligation had been reduced to a percentage of cash
flow from the acquired subsidiaries, as defined, for the remaining years under
the agreement. As of December 31, 2002, no amounts have been paid or were owed
in relation to the contingency payments.
In accordance with the Separation Agreement, the Company has an obligation
to pay a trust related to a former officer and director 20% of the net cash flow
from the Company's real estate activities, up to $500,000 per year. These future
cash payments are subject to termination or extinguishment in certain events.
The Company has an option extinguish the future cash payments to the trust at
any time prior to its expiration in December 2004 upon the payment of
$3,000,000.
During 2003 debt obligations in the amount of $2,326,000 are due, primarily
composed of $824,000 debt at Brookwood and $980,000 from the Secured Term Loan
and Revolving Credit Facility. In January 2004, the Brookwood revolving and
acquisition facilities, with a balance of $11,000,000 at December 31, 2002,
mature. The Company intends to extend or refinance these facilities prior to
their maturity.
In accordance with its plan to dispose of its hotel segment, the Company
completed the disposition of its hotels held for sale in 2002 and did not
receive any amounts in excess of the debt outstanding on the properties;
however, all non-recourse debt associated with the properties has been
extinguished. At December 31, 2002, the Company continues to operate one leased
hotel, located in Huntsville, Alabama, which has been classified as hotel held
of use. The capital lease obligations are collateralized by 30,035 HRP units.
The lease payments are being made by the Company for the leases on the two
properties that were disposed of in 2002. Payments on the capital leases, which
expire in December 2004, are current.
25
The Company has outstanding contingencies and commitments of approximately
$18,954,000, principally associated with a $13,118,000 subscription obligation
of Hallwood Realty to HRP and operating lease commitments of $5,836,000.
The Company's ability to generate cash flow from operations sufficient to
make scheduled payments on its debts as they become due will depend on its
future performance and its ability to successfully implement business and growth
strategies. The Company's performance will also be affected by prevailing
economic conditions and the resolution of pending legal matters. Many of these
factors are beyond the Company's control. If future cash flows and capital
resources are insufficient to meet the Company's debt obligations and
commitments, it may be forced to reduce or delay activities and capital
expenditures, obtain additional equity capital beyond what is required under its
current credit facilities or restructure or refinance its debt. In the event
that the Company is unable to do so, it may be left without sufficient liquidity
and it may not be able to meet its debt service requirements. The Company
believes it can generate sufficient revenues and/or borrow on its credit
facilities to meet its liquidity needs. See Notes 5 and 6 to the Company's
consolidated financial statements for a further discussion of the Company's loan
and debenture obligations.
SPECIAL PURPOSE ENTITIES
The Company has, in certain situations, created a Special Purpose Entity
("SPE"). These SPE's were formed to hold title to specific assets and accomplish
various objectives. In 1998, the Company formed several SPEs to complete a
consolidation of its real estate assets into a new structure to facilitate
possible financing opportunities. In other situations, SPEs were formed at the
request of lenders for the express purpose of strengthening the collateral for
the loans by isolating (for Federal bankruptcy law purposes) the assets and
liabilities of the SPEs. In all cases and since their various formation dates,
these wholly-owned entities (including their assets, liabilities and results of
operations) have been fully consolidated into the financial statements of the
Company.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 142 -- Goodwill and Other
Intangible Assets ("SFAS No. 142") became effective January 1, 2002 and
specifies that goodwill and some intangible assets will no longer be amortized
but instead will be subject to periodic impairment testing. The effect of
adopting SFAS No. 142 had an impact on the Company's financial statements to the
extent that the unamortized amount of negative goodwill associated with the
Company's equity investment in HRP was accounted for as a cumulative effect
adjustment.
Statement of Financial Accounting Standards No. 143 -- Accounting for Asset
Retirement Obligations ("SFAS No. 143") was issued in June 2001, and was adopted
by the Company on January 1, 2003. This Statement addresses financial accounting
and reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The Company has no
such obligations as of December 31, 2002.
Statement of Financial Accounting Standards No. 144 -- Accounting for the
Impairment or Disposal of Long-lived Assets ("SFAS No. 144") was issued in
August 2001, and was adopted by the Company on January 1, 2002. This Statement
supersedes Statement of Financial Accounting Standards No. 121 -- Accounting for
the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of
("SFAS No. 121"), and the accounting and reporting provisions of APB Opinion No.
30, Reporting the Results of Operations -- Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions, for the disposal of a segment of a business (as
previously defined in that Opinion). This statement retains the requirements of
SFAS No. 121 to (a) recognize an impairment loss only if the carrying amount of
a long-lived asset is not recoverable from its undiscounted cash flows and (b)
measure an impairment loss as the difference between the carrying amount and
fair value of the asset. This statement requires that a long-lived asset to be
abandoned, exchanged for a similar productive asset, or distributed to owners in
a spinoff be considered held and used until it is disposed of. The accounting
model for long-lived assets to be disposed of by sale is used for all long-lived
assets, whether
26
previously held and used or newly acquired. The accounting model retains the
requirement of SFAS No. 121 to measure a long-lived asset classified as held for
sale at the lower of its carrying amount or fair value less cost to sell and to
cease depreciation. This statement requires that the current and historical
results of operations of disposed properties and assets classified as held for
sale, are classified as discontinued operations. This will result in the
reclassification of historical operations for property dispositions or assets
classified as held for sale that occur. The Company early adopted the
requirements of this statement and accordingly, the hotel assets disposed of or
to be disposed of were reclassified into discontinued operations for each of the
years presented.
Statement of Financial Accounting Standards No. 145 -- Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections ("SFAS No. 145") was issued in May 2002 and is effective for fiscal
years beginning and transactions occurring after May 15, 2002. This statement
rescinds certain authoritative pronouncements and amends, clarifies or describes
the applicability of others. One of its provisions requires the reclassification
of previously reported extraordinary gains (losses) from early extinguishment of
debt into continuing operations. The Company elected to early adopt SFAS No. 145
as of December 31, 2002, and, accordingly, has reclassified extraordinary gains
(losses) from debt extinguishment of debt into continuing operations. The
portion of the previously reported extraordinary gain (loss) which represented
the Company's pro-rata share of an extraordinary gain (loss) reported by HRP,
was reclassified to "Equity income (loss) from investments in HRP". The
remaining amount was reclassified to "Loss from debt extinguishment". The
reclassification had no effect on previously reported net income (loss).
Statement of Financial Accounting Standards No. 146 -- Accounting for Costs
Associated with Exit or Disposal Activities ("SFAS No. 146") was issued in June
2002, and will be effective for exit or disposal activities subsequent to
December 31, 2002. This statement addresses financial accounting and reporting
of costs associated with exit or disposal activities. The Company anticipates no
material impact on its financial statements from the adoption of SFAS No. 146
Statement of Financial Accounting Standards No. 148 -- Accounting for Stock
Based Compensation -- Transition and Disclosure, an Amendment of FASB Statement
("SFAS No. 148") was issued in December 2002. This statement provides new
transition methods if an entity adopts the fair value based method of valuing
stock-based compensation suggested in SFAS No. 123, as well as requiring
additional disclosures in interim and annual financial statements. At this time,
the Company expects that the impact will be limited to additional disclosure
requirements.
In November 2002, the Financial Accounting Standards Board issued
Interpretation No. 45 -- Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45").
FIN 45 requires that the guarantor recognize, at the inception of certain
guarantees, a liability for the fair value of the obligation undertaken in
issuing such guarantee. FIN 45 also requires additional disclosure about the
guarantor's obligations undertaken in issuing such guarantee. FIN 45 also
requires additional disclosure about the guarantor's obligations under certain
guarantees that it previously issued. As of December 31, 2002, the Company had
no such guarantees.
In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46 -- Consolidation of Variable Interest Entities ("FIN 46").
This interpretation of Accounting Research Bulletin No. 51, "Consolidated
Financial Statements," applies immediately to variable interest entities created
after January 31, 2003 and applies to the first period beginning after June 15,
2003 to entities acquired before February 1, 2003. While it has not fully
completed its process of determining the impact of the adoption of this
interpretation, FIN 46 requires the Company to disclose information about a
variable interest entity if it is reasonably possible that the Company will
consolidate or disclose information about the variable interest entity upon
adoption of the interpretation. The Company has two entities which are currently
accounted for utilizing the equity method of accounting, HRP and HEC.
Information including the relationship of the Company to HRP and HEC and certain
summarized financial information are described Notes 2 and 3.
27
INFLATION
Inflation did not have a significant impact on the Company in 2002, 2001
and 2000, and is not anticipated to have a material impact in 2003.
ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has no foreign operations, and it does not enter into financial
instrument transactions for trading or other speculative purposes.
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, 2002, HRP had an interest cap
agreement for one of its mortgage loans, which will limit HRP's exposure to
changing interest rates to a maximum of 10%. The Company's management does not
consider the portion attributable to the Company to be significant.
The Company is exposed to market risk due to fluctuations in interest
rates. The Company utilizes both fixed 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 fixed rate and variable rate debt at
December 31, 2002 (in thousands):
EXPECTED MATURITIES AS OF DECEMBER 31,
--------------------------------------------------- FAIR
DEBT CLASSIFICATION 2003 2004 2005 2006 2007 TOTAL VALUE
------------------- ------ ------- ------ ----- ----- ------- -------
Fixed Rate........................ $1,983 $ 2,106 $7,136 $ 180 $ 97 $11,502 $11,130
Average Interest Rate........... 9.05% 9.24% 9.55% 4.90% 4.78%
Variable Rate..................... $ 343 $11,253 $ 500 -- -- $12,096 $12,096
Average Interest Rate........... 4.56% 4.57% 4.75% -- --
There is inherent rollover risk for borrowings as they mature and are
renewed at current market rates. The extent of this risk is not quantifiable or
predictable because of the variability of future interest rates and the
Company's future financing requirements. A hypothetical increase in interest
rates of one percentage point would cause a loss in income and cash flows of
approximately $236,000 during 2003, assuming that outstanding debt remained at
current levels.
FORWARD-LOOKING STATEMENTS
In the interest of providing stockholders and debentureholders with certain
information regarding the Company's future plans and operations, certain
statements set forth in this Form 10-K relate to management's future plans,
objectives and expectations. Such statements are forward-looking statements.
Although any forward-looking statement expressed by or on behalf of the Company
is, to the knowledge and in the judgment of the officers and directors, expected
to prove true and come to pass, management is not able to predict the future
with absolute certainty. Forward-looking statements involve known and unknown
risks and uncertainties, which may cause the Company's actual performance and
financial results in future periods to differ materially from any projection,
estimate or forecasted result. Among others, these risks and uncertainties
include, the ability to obtain financing or refinance maturing debt; a potential
oversupply of commercial office buildings and industrial parks in the markets
served; fees for leasing, construction and acquisition of real estate
properties; lease and rental rates and occupancy levels obtained; the ability to
compete successfully with foreign textile production and the ability to generate
new products. These risks and uncertainties are difficult or impossible to
predict accurately and many are beyond the control of the Company. Other risks
and uncertainties are described in Item 1 and may be described, from time to
time, in the Company's periodic reports and filings with the Securities and
Exchange Commission.
28
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 15, "Exhibits, Financial Statement Schedules, and Reports on Form 8-K".
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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, 2002.
In addition to Anthony J. Gumbiner, age 58, who serves as Director,
Chairman and President, the following individuals also serve as executive
officers of the Company:
William L. Guzzetti, age 59, 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 Hallwood Energy from December 1998 until May
2001. He was President, Chief Operating Officer and a director of the general
partner of HEP from February 1985 until June 1999 and as President, Chief
Operating Officer and a Director of HCRC from May 1991 until June 1999. 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. He
is a member of the Florida Bar and the State Bar of Texas.
Melvin J. Melle, age 60, 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.
29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table provides information as of December 31, 2002 about the
Company's common stock that may be issued upon the exercise of options granted
pursuant to the Company's 1995 Stock Option Plan, as amended to date:
EQUITY COMPENSATION PLAN INFORMATION
----------------------------------------------------------------------------
NUMBER OF SECURITIES
AVAILABLE FOR FUTURE
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE ISSUANCE UNDER EQUITY
BE ISSUED UPON EXERCISE EXERCISE PRICE OF COMPENSATIONS PLANS,
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS(1)(2) WARRANTS AND RIGHTS REFLECTED IN FIRST COLUMN
------------- ------------------------- -------------------- -------------------------
Equity compensation plans
approved by stockholders...... 204,000 $12.23 --
Equity compensation plans not
approved by stockholders...... -- -- --
------- ------ ----
Total........................... 204,000 $12.23 --
======= ====== ====
---------------
(1) Reflects the three for two stock split effected by the Company in November
1999.
(2) The number of shares is subject to adjustment for changes resulting from
stock dividends, stock splits, recapitalizations and similar events. The
Committee administering the plan may, in its discretion, make adjustments as
appropriate in connection with any transaction.
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. Information regarding equity compensation
plans is contained in the Proxy Statement under the heading "Equity Compensation
Information."
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.
ITEM 14. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. It is the conclusion of
the Company's principal executive officer and principal financial officer that
the Company's disclosure controls (as defined in Exchange Act rules 13a-14 and
15d-14), based on their evaluation of these controls and procedures as of a date
within 90 days of the filing of this Annual Report, are effective in timely
alerting them to the material information relating to the Company required to be
included in its periodic filings with the Securities and Exchange Commission.
Management necessarily applied its judgment in assessing the costs and benefits
of such controls and procedures which, by their nature, can provide only
reasonable assurance regarding management's control objectives. The design of
any system of controls and procedures is based in part upon certain assumptions
about the likelihood of future events. There can be no assurance that any design
will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote.
Changes in internal controls. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation.
30
PART IV
ITEM 15. 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, 2002 and 2001
Consolidated Statements of Operations, Years ended December 31, 2002,
2001 and 2000
Consolidated Statements of Comprehensive Income (Loss), Years ended
December 31, 2002, 2001 and 2000
Consolidated Statements of Changes in Stockholders' Equity, Years
ended December 31, 2000, 2001 and 2002
Consolidated Statements of Cash Flows, Years ended December 31, 2002,
2001 and 2000
Notes to Consolidated Financial Statements
2. Financial Statement Schedules.
Independent Auditors' Report on Schedules
I Condensed Financial Information of Registrant
II Valuation and Qualifying Accounts and Reserves
All other schedules are omitted since the required information is not
applicable or is included in the consolidated financial statements or
related notes.
Hallwood Realty Partners, L.P. -- Form 10-K for the year ended
December 31, 2002
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 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.
*10.1 -- 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.
10.2 -- 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.
31
*10.3 -- 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.
*10.4 -- 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.
*10.5 -- 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.
10.6 -- Revolving credit loan and security agreement, related
revolving credit notes and stock pledge and security
agreements, all dated as of December 22, 1999, by and among
Brookwood Companies Incorporated, Kenyon Industries, Inc.,
Brookwood Laminating, Inc. and Key Bank National
Association, is incorporated herein by reference to Exhibit
10.7 to the Company's Form 10-K for the year ended December
31, 1999, File No. 1-8303.
*10.7 -- 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.
*10.8 -- Amendment to Financial Consulting Agreement, dated as of May
16, 2001, between the Company and HSC Financial Corporation,
is incorporated herein by reference to Exhibit 10.9 to the
Company's Form 10-K for the year ended December 31, 2001,
File No. 1-8303.
10.9 -- Agreement, as of May 5, 1999, among The Hallwood Group
Incorporated, Epsilon Trust and Brian Troup, is incorporated
herein by reference to Exhibit 10.34 to the Company's Form
10-Q for the quarter ended March 31, 1999, File No. 1-8303.
10.10 -- Amendment to Financial Consulting Agreement, dated as of
January 1, 2000, between the Company and HSC Financial
Corporation, is incorporated herein by refinance to Exhibit
10.15 to the Company's Form 10-Q for the quarter ended March
31, 2000, File No. 1-8303.
10.11 -- First Amendment to First Amended and Restated Revolving
Credit Loan and Security Agreement, dated as of October 23,
2000 by and among Key Bank National Association, Brookwood
Companies Incorporated and certain subsidiaries, is
incorporated herein by reference to Exhibit 10.19 to the
Company's Form 10-Q for the quarter ended September 30,
2000, File No. 1-8303.
10.12 -- Second Amendment to First Amended and Restated Revolving
Credit Loan and Security Agreement, dated as of January 2,
2001, by and among Key Bank National Association, Brookwood
Companies Incorporated and certain subsidiaries, is
incorporated herein by reference to Exhibit 10.20 to the
Company's Form 10-K for the year ended December 31, 2000,
File No. 1-8303.
10.13 -- Third Amendment to First Amended and Restated Revolving
Credit Loan and Security Agreement, dated as of May 13,
2002, by and among Key Bank National Association, Brookwood
Companies Incorporated and certain subsidiaries, is
incorporated herein by reference to Exhibit 10.17 to the
Company's Form 10-Q for the quarter ended March 31, 2002,
File No. 1-8303.
10.14 -- Promissory Note and Security Agreement regarding equipment
term loan in the amount of $1,000,000.00, dated as of
September 29, 2000, between Brookwood Companies
Incorporated, Kenyon Industries, Inc., Brookwood Laminating,
Inc., Ashford Bromely, Inc., Xtramile, Inc., and Land Ocean
III, Inc. and Key Leasing, a division of Key Corporate
Capital, Inc., fixed interest -- 9.37%, due September 29,
2005, is incorporated herein by reference to exhibit 10.19
to the Company's Form 10-Q for the quarter ended March 31,
2002, File No. 1-8303.
10.15 -- Promissory Note and Security Agreement regarding equipment
term loan in the amount of $541,976.24, dated as of February
25, 2002, between Brookwood Companies Incorporated, Kenyon
Industries, Inc., Brookwood Laminating, Inc., Ashford
Bromely, Inc., Xtramile, Inc., and Land Ocean III, Inc. and
Key Leasing, a division of Key Corporate Capital, Inc.,
Libor plus 325 basis points-floating, due February 25, 2007,
is incorporated herein by reference to exhibit 10.20 to the
Company's Form 10-Q for the quarter ended March 31, 2002,
File No. 1-8303.
32
10.16 -- Promissory Note and Security Agreement regarding equipment
term loan in the amount of $298,018, dated as of December
20, 2002, between Brookwood Companies Incorporated, Kenyon
Industries, Inc., Brookwood Laminating, Inc., Ashford
Bromely, Inc., Xtramile, Inc., Land Ocean III, Inc. and
Strategic Technical Alliance LLC and Key Leasing, a division
of Key Corporate Capital, Inc., fixed interest -- 4.67%, due
December 20, 2007, filed herewith.
10.17 -- Credit Agreement, dated as of March 21, 2002, among HWG,
LLC, as the Borrower, The Hallwood Group Incorporated, as
Parent Guarantor, First Bank & Trust, as Administrative
Agent and the Financial Institution Now or Hereafter Parties
Thereto, as the Lenders, regarding a $3,000,000 Term Loan
and a $4,000,000 Revolving Credit Facility, is incorporated
herein by reference to Exhibit 10.18 to the Company's Form
10-K for the year ended December 31, 2001, File No. 1-8303.
10.18 -- Subordinated Secured Promissory Note, dated September 28,
2002, Between Strategic Technical Alliance, LLC, as Maker,
and Burlington Industries, Inc., as Holder, in the amount of
$685,695, payable in eight quarterly installments beginning
January 31, 2003, filed herewith.
21. -- Active subsidiaries of the Registrant as of February 28,
2003, filed herewith.
99.1 -- Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
filed herewith.
---------------
* Constitutes a compensation plan or agreement for executive officers.
(b) Reports on Form 8-K. Dated November 14, 2002 -- Certification of
principal executive officer and principal financial officer, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, in connection with the
filing of Form 10-Q for the quarter ended September 30, 2002.
33
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: April 15, 2003
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 15th day of April 2003.
/s/ MELVIN J. MELLE Vice President -- Finance
--------------------------------------------- (Principal Financial and Accounting Officer)
(Melvin J. Melle)
/s/ ANTHONY J. GUMBINER Director, Chairman of the Board and President
--------------------------------------------- (Principal Executive and Operating Officer)
(Anthony J. Gumbiner)
/s/ CHARLES A. CROCCO, JR Director
---------------------------------------------
(Charles A. Crocco, Jr.)
/s/ J. THOMAS TALBOT Director
---------------------------------------------
(J. Thomas Talbot)
34
CERTIFICATION BY CHIEF EXECUTIVE OFFICER
I, Anthony J. Gumbiner, certify that:
1. I have reviewed this annual report on Form 10-K of The Hallwood Group
Incorporated (the "Registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Registrant as of, and for, the period presented in this annual report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to record,
process, summarize and report financial data and have identified for the
Registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
/s/ ANTHONY J. GUMBINER
--------------------------------------
By: Anthony J. Gumbiner
Title: Chief Executive Officer
Date: April 14, 2003
35
CERTIFICATION BY CHIEF FINANCIAL OFFICER
I, Melvin J. Melle, certify that:
1. I have reviewed this annual report on Form 10-K of The Hallwood Group
Incorporated (the "Registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Registrant as of, and for, the period presented in this annual report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to record,
process, summarize and report financial data and have identified for the
Registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
/s/ MELVIN J. MELLE
--------------------------------------
By: Melvin J. Melle
Title: Chief Financial Officer
Date: April 14, 2003
36
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
PAGE
----
Independent Auditors' Report................................ 38
Financial Statements:
Consolidated Balance Sheets, December 31, 2002 and 2001... 39
Consolidated Statements of Operations, Years Ended
December 31, 2002, 2001 and 2000....................... 40
Consolidated Statements of Comprehensive Income (Loss),
Years ended December 31, 2002, 2001 and 2000........... 41
Consolidated Statements of Changes in Stockholders'
Equity, Years Ended December 31, 2000, 2001 and 2002... 42
Consolidated Statements of Cash Flows, Years Ended
December 31, 2002, 2001 and 2000....................... 43
Notes to Consolidated Financial Statements................ 44
Independent Auditors' Report on Schedules................... 77
Schedules:
I Condensed Financial Information of Registrant (Parent
Company)............................................... 78
II Valuation and Qualifying Accounts and Reserves........ 85
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, 2002
37
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, 2002 and
2001, and the related consolidated statements of operations, comprehensive
income (loss), changes in stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2002. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based upon our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Note 1 to the consolidated financial statements under the
caption "Depreciation and Amortization", the Company changed its method of
accounting for goodwill in 2002 as required by Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets.
DELOITTE & TOUCHE LLP
Dallas, Texas
April 7, 2003 (April 15, 2003 as to
the last paragraph of Note 5
under the heading "Textile Products")
38
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
-------------------
2002 2001
-------- --------
ASSETS
REAL ESTATE
Investments in HRP......................................... $ 13,525 $ 12,261
Receivables and other assets
Related parties.......................................... 732 242
Other.................................................... 60 55
-------- --------
14,317 12,558
TEXTILE PRODUCTS
Receivables
Other.................................................... 15,743 11,896
Related parties.......................................... -- 5,217
Inventories................................................ 18,913 16,753
Property, plant and equipment, net......................... 9,315 9,426
Prepaids, deposits and other assets........................ 548 1,030
Investment in joint venture................................ -- 676
-------- --------
44,519 44,998
OTHER
Deferred tax asset, net.................................... 4,221 5,677
Investment in HEC.......................................... 3,313 --
Cash and cash equivalents.................................. 1,377 3,006
Restricted cash............................................ 982 966
Hotel assets held for use.................................. 362 448
Prepaids, deposits and other assets
Other.................................................... 317 240
Related parties.......................................... 140 168
-------- --------
10,712 10,505
DISCONTINUED OPERATIONS
Hotels held for sale
Properties, net.......................................... -- 6,602
Deferred tax asset, net.................................. -- 1,800
Receivables and other assets............................. -- 1,104
-------- --------
-- 9,506
-------- --------
TOTAL ASSETS............................................. $ 69,548 $ 77,567
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
REAL ESTATE
Accounts payable and accrued expenses...................... $ 1,306 $ 1,133
TEXTILE PRODUCTS
Loans payable.............................................. 13,247 16,255
Accounts payable and accrued expenses...................... 10,803 9,390
-------- --------
24,050 25,645
OTHER
10% Collateralized Subordinated Debentures................. 6,625 6,677
Separation Agreement obligations........................... 4,000 3,500
Deferred revenue -- noncompetition agreement............... 3,424 5,840
Loans payable.............................................. 2,817 --
Interest and other accrued expenses........................ 1,274 667
Capital lease obligations.................................. 1,066 1,386
Hotel accounts payable and accrued expenses................ 850 529
Convertible loan from stockholder.......................... -- 1,500
-------- --------
20,056 20,099
DISCONTINUED OPERATIONS
Hotels held for sale
Accounts payable and accrued expenses.................... -- 2,198
Loans payable............................................ -- 11,609
-------- --------
-- 13,807
-------- --------
TOTAL LIABILITIES........................................ 45,412 60,684
REDEEMABLE PREFERRED STOCK
Series B, $0.10 par value; 250,000 shares issued and
outstanding.............................................. 1,000 1,000
CONTINGENCIES AND COMMITMENTS
STOCKHOLDERS' EQUITY
Preferred stock, $0.10 par value; authorized 500,000
shares; 250,000 shares issued and outstanding as Series
B........................................................ -- --
Common stock, $0.10 par value; authorized 10,000,000
shares; issued 2,396,103 shares in both years;
outstanding 1,361,343 shares in both years............... 240 240
Additional paid-in capital................................. 54,452 54,452
Accumulated deficit........................................ (16,417) (23,729)
Accumulated other comprehensive income..................... 191 250
Treasury stock 1,034,760 shares in both years, at cost..... (15,330) (15,330)
-------- --------
TOTAL STOCKHOLDERS' EQUITY............................... 23,136 15,883
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............... $ 69,548 $ 77,567
======== ========
See accompanying notes to consolidated financial statements.
39
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
---------------------------
2002 2001 2000
------- ------- -------
REAL ESTATE
Fees
Related parties.......................................... $ 5,380 $ 6,100 $ 6,089
Other.................................................... 287 695 921
Equity income (loss) from investments in HRP............... 1,428 1,719 (247)
------- ------- -------
7,095 8,514 6,763
Administrative expenses.................................... 1,819 2,315 2,336
Depreciation and amortization.............................. 672 672 672
Litigation expense......................................... -- 2,360 --
------- ------- -------
2,491 5,347 3,008
------- ------- -------
Income from real estate operations....................... 4,604 3,167 3,755
TEXTILE PRODUCTS
Sales.................................................... 84,770 68,894 73,852
Equity income from joint venture........................... 1,163 685 --
------- ------- -------
85,933 69,579 73,852
Cost of sales.............................................. 71,481 58,385 62,401
Administrative and selling expenses........................ 11,243 10,756 9,811
Interest................................................... 542 1,118 1,185
Impairment of intangible assets............................ -- 1,446 --
------- ------- -------
83,266 71,705 73,397
------- ------- -------
Income (loss) from textile products operations........... 2,667 (2,126) 455
OTHER
Amortization of deferred revenue -- noncompetition
agreement................................................ 2,417 1,410 --
Hotel revenue.............................................. 1,576 1,677 1,540
Interest and other income.................................. 322 222 88
Equity loss from investment in HEC......................... (187) -- --
------- ------- -------
4,128 3,309 1,628
Administrative expenses.................................... 1,940 2,279 1,837
Hotel expenses............................................. 1,898 1,815 2,833
Cost of Separation Agreement............................... 1,000 500 --
Interest expense........................................... 850 1,998 3,098
Loss from debt extinguishment.............................. -- 800 --
------- ------- -------
5,688 7,392 7,768
------- ------- -------
Other loss, net.......................................... (1,560) (4,083) (6,140)
------- ------- -------
Income (loss) from continuing operations before income
taxes (benefit).......................................... 5,711 (3,042) (1,930)
Income taxes (benefit)..................................... 2,319 2,423 (1,210)
------- ------- -------
Income (loss) from continuing operations................... 3,392 (5,465) (720)
Income (loss) from discontinued operations, net of tax:
Income (loss) from discontinued operations -- hotels
(including gains from extinguishment of debt of $5,789
and $316 in 2002 and 2001, respectively)............... $ 3,402 $(1,384) $(6,973)
Income from discontinued operations -- energy (including
a gain on disposal of $8,725 in 2001).................. -- 11,134 2,826
------- ------- -------
3,402 9,750 (4,147)
------- ------- -------
Income (loss) before cumulative effect of changes in
accounting principles.................................... 6,794 4,285 (4,867)
Income (loss) from cumulative effect of changes in
accounting principles:
Income from SFAS No. 142 adoption........................ 568 -- --
Loss from SFAS No. 133 adoption.......................... -- (40) --
------- ------- -------
568 (40) --
------- ------- -------
NET INCOME (LOSS)........................................... 7,362 4,245 (4,867)
Cash dividend on preferred stock........................... (50) (50) (50)
------- ------- -------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS.......... $ 7,312 $ 4,195 $(4,917)
======= ======= =======
PER COMMON SHARE
BASIC
Income (loss) from continuing operations after preferred
dividends.............................................. $ 2.45 $ (3.89) $ (0.54)
Income (loss) from discontinued operations............... 2.50 6.87 (2.91)
Income (loss) from cumulative effect of changes in
accounting principles.................................. 0.42 (0.03) --
------- ------- -------
Net income (loss) available to common stockholders..... $ 5.37 $ 2.95 $ (3.45)
======= ======= =======
ASSUMING DILUTION
Income (loss) from continuing operations after preferred
dividends.............................................. $ 2.38 $ (3.89) $ (0.54)
Income (loss) from discontinued operations............... 2.41 6.87 (2.91)
Income (loss) from cumulative effect of changes in
accounting principles.................................. 0.40 (0.03) --
------- ------- -------
Net income (loss) available to common stockholders..... $ 5.19 $ 2.95 $ (3.45)
======= ======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING
BASIC...................................................... 1,361 1,420 1,425
======= ======= =======
ASSUMING DILUTION.......................................... 1,415 1,420 1,425
======= ======= =======
See accompanying notes to consolidated financial statements.
40
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31,
--------------------------
2002 2001 2000
------ ------- -------
(AMOUNTS IN THOUSANDS)
NET INCOME (LOSS)........................................... $7,362 $ 4,245 $(4,867)
Other Comprehensive Income (Loss)
Pro rata share of other comprehensive income from equity
investments
Adoption of SFAS No. 133
Cumulative effect.................................... -- (4,035) --
Realized upon disposition of Energy Investment....... -- 3,009 --
Change in fair value of derivatives.................. -- 1,302 --
Amortization of interest rate swap..................... (59) (26) --
------ ------- -------
(59) 250 --
------ ------- -------
COMPREHENSIVE INCOME (LOSS)................................. $7,303 $ 4,495 $(4,867)
====== ======= =======
See accompanying notes to consolidated financial statements.
41
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002
COMMON ACCUMULATED
STOCK OTHER
-------------- ADDITIONAL COMPRE- TREASURY STOCK TOTAL
PAR PAID-IN ACCUMULATED HENSIVE ----------------- STOCKHOLDERS'
SHARES VALUE CAPITAL DEFICIT INCOME SHARES COST EQUITY
------ ----- ---------- ----------- ----------- ------ -------- -------------
(AMOUNTS IN THOUSANDS)
BALANCE, JANUARY 1, 2000............ 2,396 $240 $54,743 $(23,007) $ -- 971 $(14,918) $17,058
Net loss.......................... (4,867) (4,867)
Pro rata share of stockholders'
equity transactions from equity
investments..................... (327) (327)
Cash dividend on preferred
stock........................... (50) (50)
----- ---- ------- -------- ------- ----- -------- -------
BALANCE, DECEMBER 31, 2000.......... 2,396 240 54,416 (27,924) -- 971 (14,918) 11,814
Net income........................ 4,245 4,245
Purchase of treasury stock........ 64 (412) (412)
Pro rata share of stockholders'
equity transactions from equity
investments.....................
Adoption of SFAS No. 133
Cumulative effect............. (4,035) (4,035)
Realized upon disposition of
Hallwood Energy............ 36 3,009 3,045
Change in fair value of
derivatives................ 1,302 1,302
Amortization of interest rate
swap.......................... (26) (26)
Cash dividend on preferred
stock........................... (50) (50)
----- ---- ------- -------- ------- ----- -------- -------
BALANCE, DECEMBER 31, 2001.......... 2,396 240 54,452 (23,729) 250 1,035 (15,330) 15,883
Net income........................ 7,362 7,362
Amortization of interest rate
swap............................ (59) (59)
Cash dividend on preferred
stock........................... (50) (50)
----- ---- ------- -------- ------- ----- -------- -------
BALANCE, DECEMBER 31, 2002.......... 2,396 $240 $54,452 $(16,417) $ 191 1,035 $(15,330) $23,136
===== ==== ======= ======== ======= ===== ======== =======
See accompanying notes to consolidated financial statements.
42
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
----------------------------
2002 2001 2000
------- -------- -------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)......................................... $ 7,362 $ 4,245 $(4,867)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities
Amortization of deferred revenue -- noncompetition
agreement............................................... (2,417) (1,410) --
Depreciation, amortization and impairment............... 2,162 3,661 2,071
Equity income from joint venture........................ (1,163) (685) --
Equity (income) loss from investments in HRP............ (1,428) (1,719) 247
Loss from extinguishment of debt........................ -- 800 --
Equity loss from investment in HEC...................... 187 -- --
Amortization of deferred gain from debenture
exchanges.............................................. (52) (48) (43)
(Increase) decrease in deferred tax asset............... 1,456 (344) (1,546)
Litigation expense...................................... -- (627) --
(Income) loss from cumulative effect of changes in
accounting principles.................................. (568) 40 --
Net change in textile products assets and liabilities... 4,228 (2,503) 300
Net change in other assets and liabilities.............. 408 1,281 2,070
Discontinued operations/Assets held for sale
Gain from extinguishment of hotel debt................ (5,789) -- --
Decrease in deferred tax asset........................ 1,800 1,193 341
Net change in other hotel and energy assets and
liabilities.......................................... 490 676 1,484
Gain on sale of investment in Hallwood Energy......... -- (8,725) --
Equity income from investments in Hallwood Energy..... -- (1,837) (2,826)
Hotel depreciation, amortization and impairments...... -- 935 7,010
------- -------- -------
Net cash provided by (used in) operating
activities....................................... 6,676 (5,067) 4,241
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in HEC common stock............................ (3,500) -- --
Investments in textile products property and equipment.... (950) (1,015) (1,735)
Payments for textile products business acquisition........ (1,000) -- (1,479)
Investment in HRP affiliate............................... -- (3,417) --
Investments in hotel held for use......................... -- (3) (3)
Discontinued operations/Assets held for sale
Proceeds from sale of Hallwood Energy stock............. -- 18,000 303
Proceeds from noncompetition agreement.................. -- 7,250 --
Purchase of minority shares in energy company........... -- -- (465)
Investments in hotel properties......................... -- -- (1,247)
Net change in restricted cash from investing
activities............................................. -- -- 281
------- -------- -------
Net cash provided by (used in) investing
activities....................................... (5,450) 20,815 (4,345)
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of bank borrowings and loans payable............ (7,433) (18,149) (3,541)
Proceeds from bank borrowings and loans payable........... 4,714 5,012 4,500
Payment of deferred loan costs............................ (86) -- --
Payment of cash dividend on preferred stock............... (50) (50) (50)
Purchase of common stock for treasury..................... -- (412) --
Net change in restricted cash from financing activities... -- (29) (36)
Discontinued operations/Assets held for sale
Repayment of bank borrowings and loan payable........... -- (15) (794)
------- -------- -------
Net cash provided by (used in) financing
activities....................................... (2,855) (13,643) 79
------- -------- -------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ (1,629) 2,105 (25)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 3,006 901 926
------- -------- -------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 1,377 $ 3,006 $ 901
======= ======== =======
See accompanying notes to consolidated financial statements.
43
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
The Hallwood Group Incorporated ("Hallwood" or the "Company") (AMEX:HWG), a
Delaware corporation, is a holding company and classifies its primary operations
into two business segments: real estate and textile products. Financial
information for each industry segment is set forth in Note 19 to the
consolidated financial statements. In May 2001, the Company decided to
discontinue and dispose of its energy segment, accordingly, this former business
segment was reclassified as a discontinued operation. The Company's energy
revenues consisted of its pro rata share of earnings of Hallwood Energy
Corporation ("Hallwood Energy"), a publicly traded oil and gas company, on the
equity method of accounting. In December 2000, the Company decided to
discontinue and dispose of its hotel segment, which at that time consisted of
five hotel properties. Accordingly, the Company's hotel operations were
reclassified as a discontinued operation. Two hotels were disposed of in 2001
and two hotels were disposed of in 2002. The Company determined in late 2001
that it would retain and continue to operate a leasehold interest in one hotel.
Balance sheet presentation for the two remaining hotels which were disposed of
in 2002 is "hotels held for sale" and for the leasehold interest is "hotel
assets held for use."
Real estate activities are conducted primarily through wholly-owned
subsidiaries. One of the subsidiaries serves as the general partner of Hallwood
Realty Partners, L.P. ("HRP"), a publicly traded master limited partnership.
Revenues are generated through the Company's pro rata share of earnings of HRP
on the equity method of accounting and the receipt of management fees, leasing
commissions and other fees from HRP and third parties.
Textile products operations are conducted through the Company's wholly
owned Brookwood Companies Incorporated ("Brookwood") subsidiary. Brookwood is an
integrated textile service firm that develops and produces innovative fabrics
and related products through specialized finishing, treating and coating
processes.
Significant accounting policies, which are in accordance with accounting
principles generally accepted in the United States of America, are as follows:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its subsidiaries:
Ashford Bromley, Inc.
Brock Suite Greenville, Inc.
Brock Suite Hotels, Inc.
Brock Suite Huntsville, Inc.
Brock Suite Tulsa, Inc.
Brookwood Companies Incorporated
Brookwood Laminating, Inc.
HCRE California, Inc.
HEPGP Ltd. (through May 2001)
HSC Securities Corporation
HWG, LLC
HWG 95 Advisors, Inc.
HWG 98 Advisors, Inc.
HWG Holding One, Inc.
HWG Holding Two, Inc.
HWG Realty Investors, LLC
Hallwood Commercial Real Estate, LLC
Hallwood G.P., Inc. (through May 2001)
Hallwood Hotels, Inc.
44
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Hallwood Hotels -- OKC, Inc. (through June 2001)
Hallwood Hotels -- OKC Mezz, Inc (through June 2001)
Hallwood-Integra Holding Company
Hallwood Investment Company
Hallwood-Kenyon Holding Company
Hallwood Realty, LLC
Kenyon Industries, Inc.
Land and Ocean III, Inc.
Strategic Technical Alliance, LLC (from September 2002)
XtraMile, 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.
RECOGNITION OF INCOME
Fee income from real estate operations is recognized as the services (e.g.
management, leasing, acquisition, construction) are performed in accordance with
various service agreements. The Company records a non-cash adjustment for the
elimination of intercompany profits associated with leasing and construction
supervision fees earned from HRP to the extent of their 22% ownership interest
in HRP. Such intercompany profits are deferred and amortized to income over the
depreciable term of the related leases and property improvements as recorded by
HRP.
Textile products sales are recognized upon shipment or release of product,
when title passes to the customer. Brookwood provides allowances for expected
cash discounts, returns, claims and doubtful accounts based upon historical bad
debt and claims experience and periodic evaluation of the aging of accounts
receivable. If the financial condition of Brookwood's customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
On occasion, Brookwood receives written instructions from some of its
customers to finish fabric, invoice the full amount and hold the finished
inventory until the customer sends shipping instructions. In those cases,
Brookwood records the sale and sends the customer an invoice containing normal
and usual payment terms and segregates the inventory from Brookwood's inventory.
Reclassifications, including a gross-up for construction and facilities
management expenses that were previously netted against revenues, have been made
in the prior-year amounts to conform to the classifications used in the current
year. The reclassifications occurred due to the adoption of EITF No.
01-14 -- "Income Statement Characterization of Reimbursements Received for
Out-of-Pocket Expenses Incurred. The reclassifications had no effect on
previously reported net income or loss.
CARRYING VALUE OF INVESTMENTS AND REAL ESTATE
Common shares and other securities are recorded at fair value determined as
of the date acquired. Thereafter, equity accounting is utilized where the
Company exercises significant influence over the issuer's operating and
financial policies.
Real estate is carried at cost, including interest costs associated with
properties under development or renovation.
INVESTMENT IN FORMER ENERGY AFFILIATE
The Company utilized the equity method of accounting for its former
Hallwood Energy affiliate, since the Company exercised significant influence
over the operations and financial policies of the entity.
45
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
IMPAIRMENT
The Company's management reviews its investments for impairment losses when
events and circumstances indicate that the carrying amount of an asset may not
be recoverable. In the event such indicators exist for assets held for use, and
if undiscounted cash flows before interest charges are less than carrying value,
the asset is written down to estimated fair value. Assets held for sale are
carried at the lower of cost or estimated sales price less costs of sale.
DEPRECIATION AND AMORTIZATION
Depreciation of fee-owned hotel properties was computed on the
straight-line method over a period of 20 to 25 years for buildings, 5 to 20
years for improvements, and 3 to 10 years for furniture and equipment. The
Company completed the disposition of its fee-owned hotels in 2002. Depreciation
and amortization of the hotels held for sale were discontinued in January 2001.
Amortization of hotel leasehold interests was computed on the straight-line
method over the remaining lease term and varies from 6 to 10 years. The one
remaining leasehold interest, which had earlier been written down to a new cost
basis at December 31, 2000, is being amortized on the straight line basis over 4
years.
The excess of the Company's share of the underlying equity in the net
assets of Hallwood Realty Partners, L.P. ("HRP") over its investment was
amortized on a straight line basis over a period of 19 years. Such amortization
was discontinued, effective January 1, 2002, upon the adoption of SFAS No. 142.
The effect of adopting SFAS No. 142 resulted in the recording of income from
cumulative effect of a change in accounting principle of $568,000, which
represented the unamortized amount of negative goodwill associated with the
Company's equity investment in HRP.
Depreciation of textile products buildings, equipment and improvements is
computed on the straight-line method. Buildings and improvements are depreciated
over a period of 15 to 20 years. Equipment is depreciated over a period of 3 to
10 years.
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
basis 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.
INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out or
specific identification method) or market.
CASH AND CASH EQUIVALENTS
The Company considers highly liquid investments with original maturities of
three months or less at the time of purchase to be cash equivalents.
ENVIRONMENTAL REMEDIATION COSTS
The Company accrues for losses associated with environmental remediation
obligations when such losses are probable and can be reasonably estimated.
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
46
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
management is not aware of any environmental remediation obligations which would
significantly affect the operations, financial position or cash flow of the
Company.
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.
EQUITY-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123 -- Accounting for
Stock-Based Compensations ("SFAS No. 123") establishes a method of accounting
whereby recognized option pricing models are used to estimate the fair value of
equity-based compensation, including options. The Company has adopted the
disclosure-only provisions of SFAS No. 123. Accordingly, no compensation cost
has been recognized for the options. Refer to Note 10 for a discussion of the
difference between the historical operations and pro forma operations for the
three years ended December 31, 2002, had the expense provisions of SFAS No. 123
been adopted.
COMPREHENSIVE INCOME
Comprehensive income items are revenues, expenses, gains and losses that
under accounting principles generally accepted in the United States of America
that are excluded from current period results and reflected as a component of
stockholders' equity. The Company recorded a pro-rata share of comprehensive
income items reported by its investments accounted for using the equity method
of accounting.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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.
CONCENTRATION OF CREDIT RISK
The financial instruments of its wholly-owned subsidiaries, which
potentially subject the Company to concentration of credit risk, consist
principally of accounts receivable. The Company grants credit to customers based
on an evaluation of the customer's financial condition. Exposure to losses on
receivables is principally dependent on each customer's financial condition. The
Company controls its exposure to credit risks through credit approvals, credit
limits and monitoring procedures and the use of factors.
DERIVATIVES
The Company accounts for derivative instruments in accordance with
Statement of Financial Accounting Standards No. 133 -- Accounting for Derivative
Instruments and Hedging Activities ("SFAS No. 133"). The Company does not
directly have any derivative instruments, however HRP does and Hallwood Energy
did have such instruments. Accordingly, the Company records its proportional
share of any impact of these instruments in accordance with the equity method of
accounting.
HRP has one derivative, an interest rate cap. Since this derivative was
designated as a cash flow hedge, changes in the fair value of the derivative,
are recognized in other comprehensive income until the hedged item is recognized
in earnings. Hedge effectiveness is measured based on the relative changes in
the fair value between the derivative contract and the hedged item over time.
Any changes in fair value resulting from ineffectiveness, as defined by SFAS No.
133, are recognized immediately in current earnings.
47
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Hallwood Energy determined that all of its oil and gas commodity swaps and
collars, as well as its interest rate swaps should be designated as cash flow
hedges. Since Hallwood Energy's derivatives were designated as cash flow hedges,
changes in the fair value of the derivatives were recognized in other
comprehensive income until the hedged item was recognized in earnings. Hedge
effectiveness was measured based on the relative changes in the fair value
between the derivative contract and the hedged item over time. Any changes in
fair value resulting from ineffectiveness, as defined by SFAS No. 133, were
recognized immediately in current earnings. The Company realized its pro-rata
share of Hallwood Energy's accumulated other comprehensive income upon the
disposition of its Hallwood Energy investment in May 2001.
COMPUTATION OF INCOME (LOSS) PER COMMON SHARE
Basic income (loss) per share was computed by dividing net income (loss)
available to common stockholders by the weighted average shares outstanding.
Income (loss) per common share assuming dilution was computed by dividing
net income (loss) available to common stockholders, adjusted for the interest
expense (net of tax) of the convertible loan, by the weighted average of shares
and potential shares outstanding.
Convertible loans are considered to be potential common shares when the
Company reports income from continuing operations. The number of potential
common shares from assumed loan conversion is computed using the "if-converted
method" for the period during which the loans are outstanding. Stock options are
considered to be potential common shares. The number of potential common shares
from assumed exercise of options is computed using the "treasury stock method."
The following table reconciles the Company's income (loss) from continuing
operations to income (loss) from continuing operations available to common
stockholders-assuming dilution, and the number of common shares used in the
calculation for the basic and assuming dilution methods (in thousands):
YEARS ENDED DECEMBER 31,
-------------------------
2002 2001 2000
------ ------- ------
INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS
Income (loss) from continuing operations.................. $3,392 $(5,465) $ (720)
Less dividend on preferred stock.......................... (50) (50) (50)
Interest expense (net of tax) of assumed loan
conversion.............................................. 28 -- --
------ ------- ------
Income (loss) from continuing operations available to
common stockholders -- assuming dilution................ $3,370 $(5,515) $ (770)
====== ======= ======
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic..................................................... 1,361 1,420 1,425
Potential shares from assumed loan conversion............. 54 -- --
------ ------- ------
Assuming dilution......................................... 1,415 1,420 1,425
====== ======= ======
Due to the loss from continuing operations in 2001 and 2000, potential
shares from assumed loan conversions of 456,000 and 155,000, respectively, were
anti-dilutive.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform
to the classifications used in the current year.
48
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 142 -- Goodwill and Other
Intangible Assets ("SFAS No. 142") became effective January 1, 2002 and
specifies that goodwill and some intangible assets will no longer be amortized
but instead will be subject to periodic impairment testing. The effect of
adopting SFAS No. 142 had an impact on the Company's financial statements to the
extent that the unamortized amount of negative goodwill associated with the
Company's equity investment in HRP was accounted for as a cumulative effect
adjustment.
Statement of Financial Accounting Standards No. 143 -- Accounting for Asset
Retirement Obligations ("SFAS No. 143") was issued in June 2001, and was adopted
by the Company on January 1, 2003. This Statement addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. The
Company has no such obligations as of December 31, 2002.
Statement of Financial Accounting Standards No. 144 -- Accounting for the
Impairment or Disposal of Long-lived Assets ("SFAS No. 144") was issued in
August 2001, and was adopted by the Company on January 1, 2002. This Statement
supersedes SFAS No. 121, "Accounting for the Impairment of Long-lived Assets and
for Long-lived Assets to Be Disposed Of", and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of
Operations -- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for
the disposal of a segment of a business (as previously defined in that Opinion).
This statement retains the requirements of SFAS No. 121 to (a) recognize an
impairment loss only if the carrying amount of a long-lived asset is not
recoverable from its undiscounted cash flows and (b) measure an impairment loss
as the difference between the carrying amount and fair value of the asset. This
statement requires that a long-lived asset to be abandoned, exchanged for a
similar productive asset, or distributed to owners in a spinoff be considered
held and used until it is disposed of. The accounting model for long-lived
assets to be disposed of by sale is used for all long-lived assets, whether
previously held and used or newly acquired. The accounting model retains the
requirement of SFAS No. 121 to measure a long-lived asset classified as held for
sale at the lower of its carrying amount or fair value less cost to sell and to
cease depreciation. This statement requires that the current and historical
results of operations of disposed properties and assets classified as held for
sale, are classified as discontinued operations. This will result in the
reclassification of historical operations for property dispositions or assets
classified as held for sale that occur. The Company early adopted the
requirements of this statement and accordingly, the hotel assets disposed of or
to be disposed of were reclassified into discontinued operations for each of the
years presented.
Statement of Financial Accounting Standards No. 145 -- Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections ("SFAS No. 145") was issued in May 2002 and is effective for fiscal
years beginning and transactions occurring after May 15, 2002. This statement
rescinds certain authoritative pronouncements and amends, clarifies or describes
the applicability of others. One of its provisions requires the reclassification
of previously reported extraordinary gains (losses) from early extinguishment of
debt into continuing operations. The Company elected to early adopt SFAS No. 145
as of December 31, 2002, and, accordingly, has reclassified extraordinary gains
(losses) from debt extinguishment of debt into continuing operations. The
portion of the previously reported extraordinary gain (loss) which represented
the Company's pro-rata share of an extraordinary gain (loss) reported by HRP,
was reclassified to "Equity income (loss) from investments in HRP". The
remaining amount was reclassified to "Loss from debt extinguishment". The
reclassification had no effect on previously reported net income (loss).
Statement of Financial Accounting Standards No. 146 -- Accounting for Costs
Associated with Exit or disposal Activities ("SFAS No. 146") was issued in June
2002, and will be effective for exit or disposal activities subsequent to
December 31, 2002. This statement addresses financial accounting and reporting
of costs associated with exit or disposal activities. The Company anticipates no
material impact on its financial statements from the adoption of SFAS No. 146.
49
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Statement of Financial Accounting Standards No. 148 -- Accounting for Stock
Based Compensation -- Transition and Disclosure, an Amendment of FASB Statement
("SFAS No. 148") was issued in December 2002. This statement provides new
transition methods if an entity adopts the fair value based method of valuing
stock-based compensation suggested in SFAS No. 123, as well as requiring
additional disclosures in interim and annual financial statements. At this time,
the Company expects that the impact of SFAS No. 148 will be limited to
additional disclosure requirements.
In November 2002, the Financial Accounting Standards Board issued
Interpretation No. 45 -- Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45").
FIN 45 requires that the guarantor recognize, at the inception of certain
guarantees, a liability for the fair value of the obligation undertaken in
issuing such guarantee. FIN 45 also requires additional disclosure about the
guarantor's obligations undertaken in issuing such guarantee. FIN 45 also
requires additional disclosure about the guarantor's obligations under certain
guarantees that it previously issued. As of December 31, 2002, the Company had
no such guarantees.
In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46 -- Consolidation of Variable Interest Entities ("FIN 46").
This interpretation of Accounting Research Bulletin No. 51, "Consolidated
Financial Statements," applies immediately to variable interest entities created
after January 31, 2003 and applies to the first period beginning after June 15,
2003 to entities acquired before February 1, 2003. While it has not fully
completed its process of determining the impact of the adoption of this
interpretation, FIN 46 requires the Company to disclose information about a
variable interest entity if it is reasonably possible that the Company will
consolidate or disclose information about the variable interest entity upon
adoption of the interpretation. The Company has two entities which are currently
accounted for utilizing the equity method of accounting, HRP and HEC.
Information including the relationship of the Company to HRP and HEC and certain
summarized financial information are described Notes 2 and 3.
NOTE 2 -- INVESTMENTS IN HRP (DOLLAR AMOUNTS IN THOUSANDS):
DECEMBER 31, 2002 AMOUNT AT
------------------- WHICH CARRIED AT INCOME (LOSS) FOR
COST OR DECEMBER 31, YEARS ENDED DECEMBER 31,
NUMBER ASCRIBED ----------------- --------------------------
DESCRIPTION OF INVESTMENT OF UNITS VALUE 2002 2001 2002 2001 2000
------------------------- -------- -------- ------- ------- ------- ------- ------
HALLWOOD REALTY PARTNERS, L.P.
-- General partner
interest................. $ 8,650 $ 1,350 $ 1,943 $ 81 $ 97 $ 11
-- Limited partner
interest................. 330,432 8,799 12,175 10,318 1,347 1,622 (258)
------- ------- ------- ------ ------ -----
Totals................... $17,449 $13,525 $12,261 $1,428 $1,719 $(247)
======= ======= ======= ====== ====== =====
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.
At December 31, 2002, the Hallwood Realty, LLC ("Hallwood Realty") and HWG,
LLC, wholly owned subsidiaries of the Company, owned a 1% general partner
interest and a 21% limited partner interest in its Hallwood Realty Partners,
L.P. ("HRP") affiliate, respectively.
In 1990, the Company, through a wholly owned subsidiary, 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 HRP. See Note
14. The Company subsequently acquired additional limited partner units of HRP in
direct and open market purchases. The Company accounts for its investment in HRP
using the equity method of accounting. In addition to recording its share of
HRP's net income (loss), the Company also records non-cash adjustments for the
elimination of intercompany profits with a corresponding adjustment to equity
income, its pro rata share of
50
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
HRP's partner capital transactions with corresponding adjustments to additional
paid-in capital and its pro rata share of HRP's comprehensive income. The
cumulative amount of such non-cash adjustments, from the original date of
investment through December 31, 2002, resulted in a $1,795,000 decrease in the
carrying value of the HRP investment. Prior to January 1, 2002, the Company
recorded amortization of the amount that the Company's share of the underlying
equity in net assets of HRP exceeded its investment on the straight line basis
over nineteen years, which was $568,000 as of January 1, 2002. In accordance
with SFAS No. 142, the unamortized amount of such "negative goodwill" was
recorded as income from cumulative effect of a change in accounting principle on
January 1, 2002. In 2001, the Company recognized a loss from cumulative effect
of SFAS No. 133 adoption of $40,000, from the recognition of the Company's
pro-rata share of HRP's loss from cumulative effect.
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. Beginning in 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, 2002, 2001 and 2000. At
December 31, 2002, the unamortized cost remaining was $560,000.
As further discussed in Note 18, the Delaware Court of Chancery rendered
its opinion regarding certain litigation involving the Company in July 2001. The
court determined that the defendants, including the Company, should pay to HRP a
judgment of $3,417,000 plus pre-judgment interest of approximately $2,893,000
from August 1995. The judgment amount, which represented the court's
determination of an underpayment by the Company for certain limited partnership
units purchased by the Company in 1995 from HRP, was considered additional
purchase price and was added to the Company's investment in the limited
partnership units. The interest component of the judgment was recorded as an
expense, net of the Company's pro rata share of the income that will be reported
by HRP. In October 2001, the Company paid $6,405,000, including post-judgment
interest, to HRP, subject to an arrangement that it be returned in full or part
if the judgment is modified or reversed on appeal.
The Company has pledged 300,397 HRP limited partner units to collateralize
the Term Loan and Revolving Credit facility and the remaining 30,035 units to
secure all of the capital leases.
The quoted market price per unit and the carrying value per limited partner
unit (AMEX:HRY) at December 31, 2002 were $82.20 and $36.85, respectively. The
general partner interest is not publicly traded.
The following table sets forth summarized financial data of Hallwood Realty
Partners, L.P., obtained from Securities and Exchange Commission filings on Form
10-K, as of and for each of the three years ended December 31, 2002 (in
thousands):
2002 2001 2000
-------- -------- --------
Balance Sheet Data
Real estate property, net.......................... $209,838 $213,574 $206,392
Total assets....................................... 274,420 269,875 254,504
Mortgages payable.................................. 197,552 201,224 200,096
Total partners' capital............................ 60,675 54,022 44,490
Statement of Operations Data
Revenue............................................ $ 73,739 $ 74,691 $ 69,901
Income (loss) before cumulative effect of SFAS No.
133 adoption.................................... 6,931 8,520 (299)
Net income (loss).................................. 6,931 8,328 (299)
51
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3 -- INVESTMENT IN HEC (DOLLAR AMOUNTS IN THOUSANDS):
DECEMBER 31, 2002 AMOUNT AT
--------------------- WHICH CARRIED AT INCOME (LOSS) FOR
COST OR DECEMBER 31, YEARS ENDED DECEMBER 31,
NUMBER ASCRIBED ---------------- ------------------------
DESCRIPTION OF INVESTMENT OF SHARES VALUE 2002 2001 2002 2001 2000
------------------------- --------- -------- ------- ----- ------ ----- -----
HALLWOOD ENERGY CORPORATION
Common stock....................... 1,750 $3,500 $3,313 -- $(187) -- --
====== ====== =====
The Company owns approximately 28% of HEC. It accounts for the investment
using the equity method of accounting and records its pro rata share of HEC's
net income (loss), its pro rata share of HEC's stockholder's equity transactions
and comprehensive income adjustments, if any.
During 2002, the Company invested $3,500,000 in a newly-formed, private
energy company -- Hallwood Energy Corporation ("HEC"). HEC is presently in the
developmental stage, having drilled seven test wells in the Barnett Shale
Formation of Johnson County, Texas. After constructing an extensive gas
gathering system, HEC commenced commercial production and sales from three of
the seven wells in February 2003. In March 2003, a fourth well was placed in
production, a fifth well was in the process of being completed and a sixth well
was nearing completion of drilling operations. These two wells are expected to
begin production in April 2003. One well, after numerous completion attempts,
has been temporarily abandoned. HEC anticipates that it will drill at least six
additional wells during the remainder of 2003. HEC holds oil and gas leases
covering 32,254 and 28,329 gross and net acres, respectively, in Johnson and
Hill Counties, Texas as of March 2003.
The following table sets forth summarized financial data of HEC as of and
for the year ended December 31, 2002 (in thousands):
Balance Sheet Data
Oil and gas properties, net............................... $ 7,524
Total assets.............................................. 11,994
Total liabilities......................................... 160
Stockholders' equity...................................... 11,834
Statement of Operations Data
Revenue................................................... $ 46
Net loss.................................................. (666)
Certain of the Company's current officers and directors and certain
officers and directors of its former energy affiliate are investors in HEC.
NOTE 4 -- RESTRICTED CASH
Restricted cash, of $982,000 and $966,000 at December 31, 2002 and 2001,
respectively, represents a deposit to secure a litigation claim, as discussed in
Note 18. On March 21, 2003, the parties submitted to the Delaware Court of
Chancery an agreed proposed Order and Judgment, which was signed by the Court
and terminated the litigation. The Order and Judgement provided for payment out
of the escrowed funds of approximately $547,000 to the noteholder and $437,000
to the Company. The Company received its share of the funds on March 31, 2003.
52
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5 -- LOANS PAYABLE
Loans payable at the balance sheet dates are as follows (in thousands):
DECEMBER 31,
-----------------
2002 2001
------- -------
TEXTILE PRODUCTS
Revolving credit facility, prime + .25% or Libor + 3.00%,
due January 2004....................................... $10,000 $14,449
Acquisition credit facility, prime + 1.00% or Libor
+3.25%, due January 2004............................... 1,000 1,000
Equipment term loan, 9.37% fixed, due October 2005........ 623 806
Subordinated secured promissory note, prime rate, due July
2004................................................... 596 --
Equipment term loan, 5.10% fixed, due March 2007.......... 469 --
Equipment term loan, 4.67% fixed, due December 2007....... 298 --
Subordinated secured promissory note, non-interest
bearing, due February 2005............................. 261 --
------- -------
13,247 16,255
------- -------
OTHER
Term loan, 7% fixed, due April 2005....................... 2,317 --
Revolving credit facility, prime + 0.50% or Libor + 3.25%,
due April 2005......................................... 500 --
Capital lease obligations, 12.18% fixed, due December
2004................................................... 1,066 1,386
Convertible loan from stockholder, 10% fixed, repaid March
2002................................................... -- 1,500
------- -------
3,883 2,886
------- -------
Total.................................................. $17,130 $19,141
======= =======
Further information regarding loans payable is provided below:
TEXTILE PRODUCTS
Revolving Credit Facility. The Company's Brookwood subsidiary has a
revolving credit facility in an amount up to $17,000,000 with Key Bank National
Association ("Key Credit Agreement"). Availability for direct borrowings and
letter of credit obligations under the Key Credit Agreement are limited to the
lesser of the facility amount or the borrowing base as defined in the agreement.
Borrowings are collateralized by accounts receivable, inventory imported under
trade letters of credit, certain finished goods inventory, machinery and
equipment and all of the issued and outstanding capital stock of Brookwood and
its subsidiaries.
The Key Credit Agreement has a maturity date of January 2, 2004, bears
interest at Brookwood's option of prime plus 0.25% (4.50% and 5.75% at December
31, 2002 and 2001, respectively) or Libor + 3.25%, contains various covenants,
including minimum net income levels by quarter, maintenance of certain financial
ratios, restrictions on dividends and repayment of debt or cash transfers to the
parent company. The outstanding balance at December 31, 2002 was $10,000,000.
Cash dividends and tax sharing payments to the parent company are
contingent upon Brookwood's compliance with the covenants contained in the loan
agreement. As of December 31, 2002, Brookwood had $4,365,000 of unused borrowing
capacity.
53
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Acquisition Credit Facility. The Key Credit Agreement provides for a
$2,000,000 acquisition revolving credit line. Brookwood borrowed $1,000,000
under this line during 2001. This facility bears interest at one percent over
the prime rate (5.25% and 5.75%, at December 31, 2002 and 2001, respectively).
The outstanding balance at December 31, 2002 was $1,000,000.
Subordinated Secured Promissory Note. Brookwood was a 50% partner in
Strategic Technical Alliance, LLC ("STA") with an unrelated third party until
September 2002. In September 2002, STA purchased the shares owned by the
unrelated third party partner, effectively making STA a wholly owned Brookwood
subsidiary, and gave the seller a promissory note in the amount of $596,000. The
note bears interest at the prime rate (4.25% at December 31, 2002), requires a
quarterly payment of approximately $85,000 and is due in July 2004. The
outstanding balance at December 31, 2002 was $596,000.
Equipment Credit Facility and Term Loans. The Key Credit Agreement
provides for a $2,000,000 equipment revolving credit line. The facility bears
interest at Libor plus 2.75 (4.13% and 4.18% at December 31, 2002 and 2001,
respectively). In May 2000, Brookwood borrowed $1,000,000 under this credit
line, which was converted into a term loan, at a fixed rate of 9.37%, with a
maturity date of October 2005. In February and December 2002, Brookwood borrowed
an additional $542,000 and $298,000 under this facility and converted those
amounts into term loans, at fixed rates of 5.10% and 4.67%, with maturities of
March and December 2007, respectively. Brookwood has $610,000 availability under
this facility. The outstanding balance at December 31, 2002 was $1,390,000.
Subordinated Promissory Note. As part of the purchase price related to the
acquisition of an entity in 2000, Brookwood gave the seller a $375,000
subordinated promissory note dated March 2002. The interest free note is fully
amortizing over 36 months and has a maturity date of February 2005. The
outstanding balance at December 31, 2002 was $261,000.
Loan Covenants. Brookwood was in compliance with its loan covenants for
all interim periods during 2002, except for the quarter ended December 31, 2002,
when it did not meet its minimum net income loan covenant. The covenant, which
required a minimum net income of $1,500,000, was not met as Brookwood's net
income for the year ended December 31, 2002 was $1,436,000. Brookwood obtained a
waiver for this violation from the lender, and believes that it will be in
compliance with all of its covenants for 2003.
OTHER
Term Loan and Revolving Credit Facility. In March 2002, the Company and
its HWG, LLC subsidiary entered into a $7,000,000 credit agreement with First
Bank & Trust, N.A. The facility is comprised of a $3,000,000 term loan and a
$4,000,000 revolving credit facility (the "Term Loan and Revolving Credit
Facility"). Term loan proceeds were used in part to repay the $1,500,000
convertible loan from stockholder discussed below. The term loan bears interest
at a fixed rate of 7%, matures April 2005 and is fully amortizing requiring
monthly payments of $92,631. The outstanding principal balance of the loan at
December 31, 2002 was $2,317,000.
The revolving credit facility bears interest at the Company's option of
one-half percent over prime, or Libor plus 3.25%, and matures April 2005. In
December 2002, the Company borrowed $500,000 under the facility, proceeds which
were principally used to invest in the Company's HEC affiliate. The interest
rate is 4.75% at December 31, 2002. The Company borrowed an additional $800,000
under the facility in March 2003 and therefore has $2,700,000 of unused
borrowing capacity.
Collateral for the Term Loan and Revolving Credit Facility is 300,397 HRP
limited partner units. The credit agreement contains various financial and
non-financial covenants, including the maintenance of certain financial ratios,
restrictions on certain new indebtedness and the payment of dividends.
54
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Loan Covenants. At December 31, 2002, and during the interim 2002 periods,
the Company was in compliance with its loan covenants under the Term Loan and
Revolving Credit Facility.
Capital Lease Obligations. During 1999, the Company's Brock Suite Hotels
subsidiaries entered into three separate five-year capital leasing agreements
for furniture, fixtures and building improvements at a cost of $2,085,000 for
three GuestHouse Suites Plus properties. The Company has pledged 30,035 HRP
limited partner units as additional collateral to secure the leases. The lease
terms commenced January 2000 and expire in December 2004. The combined monthly
lease payment is $46,570 and the effective interest rate is 12.18%. Interest
expense in the amount of $112,000, representing the full interest costs through
expiration of the capital leases associated with the two disposed hotels, was
accrued in the 2002 second quarter, as a reduction of gain from extinguishment
of debt. The outstanding balance at December 31, 2002 was $1,066,000.
Convertible Loans from Stockholder. In order to provide sufficient funds
to meet the Company's cash flow requirements and maintain compliance with the
loan covenants contained in the former Senior Secured Term Loan, the Company
entered into three loan agreements with an entity associated with its chairman
and principal stockholder, Anthony J. Gumbiner. Two loans were repaid in
December 2001 and the remaining loan was repaid in March 2002 in the amount of
$1,648,000, which represented principal of $1,500,000 and accrued interest of
$148,000.
Senior Secured Term Loan. In December 1999, the Company and its HWG, LLC
subsidiary entered into an $18,000,000 credit agreement with First Bank Texas,
N.A. and other financial institutions (the "Senior Secured Term Loan"). Proceeds
were used to repay the then outstanding 7% Debentures, a term loan and provide
working capital. The Senior Secured Term Loan bore interest at a fixed rate of
10.25%, was scheduled to mature in December 2004, was fully amortizing and
required a monthly payment of $385,000. The Senior Secured Term Loan was fully
repaid in May 2001 with a portion of the proceeds from the sale of the Company's
investment in Hallwood Energy.
Schedule of Maturities. Maturities of loans payable and 10% Debentures for
the next five years are presented below (in thousands):
TERM LOAN CAPITAL
YEARS ENDED TEXTILE AND REVOLVING LEASE 10%
DECEMBER 31, PRODUCTS CREDIT FACILITY OBLIGATIONS DEBENTURES TOTAL
------------ -------- --------------- ----------- ---------- -------
2003.......................... $ 824 $ 980 $ 522 $ -- $ 2,326
2004.......................... 11,763 1,052 544 -- 13,359
2005.......................... 383 785 -- 6,468(a) 7,636
2006.......................... 180 -- -- -- 180
2007.......................... 97 -- -- -- 97
------- ------ ------ ------ -------
Total.................... $13,247 $2,817 $1,066 $6,468 $23,598
======= ====== ====== ====== =======
---------------
(a) Face amount.
55
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6 -- 10% COLLATERALIZED SUBORDINATED DEBENTURES
The Company has outstanding an issue of 10% Collateralized Subordinated
Debentures ("10% Debentures"), due July 31, 2005. The 10% Debentures are listed
on The New York Stock Exchange. For financial reporting purposes, a pro rata
portion of an unamortized gain in the original amount of $353,000 was allocated
to the 10% Debentures from a previous debenture issue is being amortized over
its term using the effective interest method. As a result, the effective
interest rate is 8.9%. The 10% Debentures are secured by a junior lien on the
capital stock of Brookwood. Balance sheet amounts are presented below (in
thousands):
DECEMBER 31,
---------------
2002 2001
------ ------
10% Debentures (face amount)................................ $6,468 $6,468
Unamortized gain, net of accumulated amortization........... 157 209
------ ------
Total.................................................. $6,625 $6,677
====== ======
As a result of certain hotel properties of the Company being placed into
receivership, as further discussed in Note 7, the Company determined that a
technical default occurred under the terms of the Indenture for the 10%
Debentures. The Indenture provides that upon the occurrence of the default, the
principal and accrued interest on the 10% Debentures shall automatically become
due and payable. The trustee for the 10% Debentures, mailed a notice (the
"Notice") to debentureholders in July 2001, informing the holders of the
default. The Notice stated that the holders of a majority of the outstanding
principal amount of the 10% Debentures, on behalf of all holders, may waive the
default, rescind and annul the declaration of acceleration and its consequences.
In October 2001, the Company announced that a solicitation of its bondholders,
which began in September 2001, was completed and that bondholders consented to
grant the waiver and rescind and annul the acceleration. The overdue interest
was subsequently deposited with the Trustee and was paid in November 2001. The
payment consisted of interest that was to have been paid in July 2001 and
October 2001, which the Company was prohibited from paying by the Indenture
during the default, together with default interest on these amounts at the rate
of 10% per annum. The normal quarterly interest payments resumed in January
2002.
NOTE 7 -- DISCONTINUED OPERATIONS -- HOTELS
The Company's hotel segment experienced cash flow difficulties during 2000
due to weaker occupancy and average daily rates. In December 2000, the Company
decided to discontinue and dispose of its hotel segment, principally by allowing
its non-recourse debtholders to assume ownership of the properties through
foreclosure or by selling or otherwise disposing of its hotel properties. The
Company's former hotel segment consisted of three owned properties and two
leased properties.
The Company determined that it would retain ownership of the leasehold
interest in the GuestHouse Suites hotel in Huntsville, Alabama. The Company
continues to operate the hotel, subject to a lease concession from the owner.
Accordingly, this hotel has been classified as an asset held for use and
operating results are reported within continuing operations. The carrying value
of the leasehold interest was $221,000 and $331,000, at December 31, 2002 and
2001, respectively.
56
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of discontinued hotel operations is provided below (in
thousands):
YEARS ENDED DECEMBER 31,
--------------------------
2002 2001 2000
------ ------- -------
Revenue and Gain from Disposition
Gain from extinguishment of debt....................... $5,789 $ 316 $ --
Sales.................................................. 282 7,619 16,839
------ ------- -------
6,071 7,935 16,839
Expenses
Deferred federal income tax expense (benefit).......... 1,800 (500) 341
Operating expenses..................................... 324 6,822 14,746
Interest expense....................................... 183 1,848 2,607
Litigation and other disposition costs................. 362 214 115
Impairment............................................. -- 935 3,320
Depreciation and amortization.......................... -- -- 2,683
------ ------- -------
2,669 9,319 23,812
------ ------- -------
Income (loss) from discontinued hotel operations....... $3,402 $(1,384) $(6,973)
====== ======= =======
As of June 2002, the Company completed the disposition of all four hotel
properties it had previously designated as discontinued operations.
In January 2001, a receiver was appointed to administer the disposition of
the GuestHouse Suites hotel in Greenville, South Carolina. In February 2001, the
Company signed an Agreement to Terminate Lease with the landlord of the Holiday
Inn and Suites Hotel in Sarasota, Florida. In March 2001, receivers were
appointed to administer the disposition of the GuestHouse Suites Plus hotel in
Tulsa, Oklahoma and the Airport Embassy Suites Hotel in Oklahoma City, Oklahoma,
respectively.
In June 2001, the Company entered into a settlement agreement with the
mezzanine lender whereby the Company transferred all of its capital stock of
Hallwood Hotels -- OKC, Inc., the entity that owned the Embassy Suites hotel, to
the mezzanine lender and obtained a release from its obligations under the first
mortgage and the mezzanine loan. The Company reported a gain from extinguishment
of debt of $316,000 before a deferred tax charge of $100,000.
In January 2002, with assistance and consent of the mortgage lender, the
Company sold the GuestHouse Suites hotel in Tulsa, Oklahoma for $3,000,000. The
Company received no cash proceeds from the sale; however, concurrently with the
sale, it entered into a loan modification and assumption agreement, which
included a release that discharge the Company from any further loan obligations.
The Company recognized a gain from extinguishment of debt of $2,552,000, before
a deferred tax charge of $875,000 in the 2002 first quarter.
In February 2002, the lender for the GuestHouse Suites hotel in Greenville,
South Carolina obtained a court judgement of foreclosure. In connection with the
foreclosure, the lender waived its right to a deficiency judgement against the
Company and completed the foreclosure in June 2002. The Company recognized a
gain from extinguishment of debt of $3,237,000, before a deferred tax charge of
$925,000 in the 2002 second quarter.
57
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the non-recourse loans payable associated with the hotels held
for sale is detailed below (in thousands):
DECEMBER 31,
---------------
DESCRIPTION LOCATION 2002 2001
----------- -------------- ----- -------
Term loan, 7.86% fixed, extinguished June 2002....... Greenville, SC $ -- $ 6,514
Term loan, 8.20% fixed, extinguished January 2002.... Tulsa, OK -- 5,095
----- -------
Total........................................................... $ -- $11,609
===== =======
The Company was a defendant in two lawsuits regarding guaranties of certain
obligations of the Embassy Suites and Holiday Inn hotels. In February 2003, the
Company settled both matters. The Company agreed (i) to pay $150,000 in cash and
to issue a non-interest bearing promissory note in the amount of $250,000
payable in equal monthly installments over eighteen months, in exchange for a
full release regarding the Embassy Suites hotel and (ii) to pay $250,000 in cash
in exchange for a full release regarding the Holiday Inn hotel. In December
2002, the Company recorded an additional loss provision in the amount of
$247,000 to fully accrue for these two litigation matters.
NOTE 8 -- DISCONTINUED OPERATIONS -- ENERGY
In March 2001, the Company agreed to sell its investment in its Hallwood
Energy affiliate, which represented the Company's energy operations, to Pure
Resources II, Inc., an indirect subsidiary of Pure Resources, Inc., subject to
Hallwood Energy's shareholder approval which was obtained in May 2001. The
Company received $18,000,000 for the tender of its 1,440,000 shares of common
stock in May 2001 and received an additional amount of $7,250,000, pursuant to
the terms of a noncompetition agreement that was paid by Pure upon the
completion of the merger in June 2001.
Under the noncompetition agreement, the Company agreed to refrain from
taking certain actions without the prior written consent of Pure and Hallwood
Energy. These covenants were made by the Company in consideration of the
transactions contemplated by the merger agreement and the payment by Pure to the
Company. For a period of three years after the effective date of the merger
agreement, the Company will not, directly or indirectly, engage in oil and gas
activities in certain geographic areas without the prior consent of Pure. The
Company also agreed to keep Hallwood Energy's confidential and proprietary
information strictly confidential.
Accordingly, energy operations have been segregated from the Company's
continuing operations and reported as discontinued operations. A summary of the
income from discontinued energy operations is detailed below (in thousands):
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
----- ------- ------
Revenue
Gain on sale of investment in Hallwood Energy............. $ -- $ 8,725 $ --
Equity income from investment in Hallwood Energy.......... -- 1,837 2,826
----- ------- ------
10,562 2,826
Expenses
Deferred federal income tax benefit....................... -- (672) --
State income tax expense.................................. -- 100 --
----- ------- ------
-- (572) --
----- ------- ------
Income from discontinued energy operations............. $ -- $11,134 $2,826
===== ======= ======
58
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company began amortizing the deferred revenue from the noncompetition
agreement in the amount of $7,250,000, over a three-year period commencing June
2001. The amortization, which is reported in the "other" section of the
statement of operations, was $2,417,000 and $1,410,000 in the years ended
December 31, 2002 and 2001, respectively.
The Company accounted for its investment using the equity method of
accounting, as the Company exercised significant influence over Hallwood
Energy's operational and financial policies. The Company's share of the
underlying equity in net assets of Hallwood Energy exceeded its investment by
$4,391,000, which was being amortized at a rate which approximated the depletion
rate of Hallwood Energy's reserves. In addition to recording its share of
Hallwood Energy's net income available to common stockholders, the Company also
recorded its preferred dividends prior to the February 2000 sale of its
preferred stock. The Company also recorded its pro rata share of any capital
transactions and other comprehensive income.
NOTE 9 -- REDEEMABLE PREFERRED STOCK
The Company has outstanding 250,000 shares of preferred stock (the "Series
B Preferred Stock"). The holders of Series B Preferred Stock are entitled to
cash dividends in an annual amount of $0.20 per share (total annual amount of
$50,000), which have been paid in each of the years beginning in 1996 through
and including 2002. For the first five years, dividends were cumulative and the
payment of cash dividends on any common stock was prohibited before the full
payment of any accrued dividends. Beginning in 2001 dividends will accrue and be
payable only if and when declared by the Board of Directors. The Series B
Preferred Stock has dividend and liquidation preferences to the Company's common
stock. The shares are subject to mandatory redemption fifteen 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 10 -- STOCKHOLDERS' EQUITY
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.
Preferred Stock. Under its Second Restated Certificate of Incorporation
the Company is authorized to issue 500,000 shares of preferred stock, par value
$0.10 per share, and did issue 250,000 shares of Series B Preferred Stock.
Treasury Stock. During December 2001, the Company repurchased 63,400
shares of its common stock from its principal stockholder, Anthony J. Gumbiner
for $412,000, the same amount paid by Mr. Gumbiner, who purchased the shares in
October 2001 from an unrelated third party. As of December 31, 2002 and 2001,
the Company held 1,034,760 treasury shares.
Stock Options. All options under the 1995 Stock Option Plan for The
Hallwood Group Incorporated 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. In May 2000, the Board of Directors
granted the remaining 70,800 available options to purchase common stock under
the 1995 Stock Option Plan.
59
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of options granted and the changes therein during the three years
ended December 31, 2002 are presented below:
YEARS ENDED DECEMBER 31,
------------------------------------------------------------
2002 2001 2000
------------------ ------------------ ------------------
WEIGHTED WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------- -------- ------- -------- ------- --------
Outstanding, beginning of year.............. 204,000 $12.23 204,000 $12.23 133,200 $13.25
Granted..................................... -- -- -- -- 70,800 10.31
Exercised................................... -- -- -- -- -- --
Forfeited................................... -- -- -- -- -- --
Reacquired.................................. -- -- -- -- -- --
------- ------ ------- ------ ------- ------
Outstanding, end of year.................... 204,000 $12.23 204,000 $12.23 204,000 $12.23
======= ====== ======= ====== ======= ======
Options exercisable, at end of year......... 204,000 $12.23 204,000 $12.23 204,000 $12.23
======= ====== ======= ====== ======= ======
Below is the status of the 1995 Stock Option Plan as of December 31, 2002:
Total authorized....................... 204,000
Less: Number granted, not exercised:
May 2000............................. (70,800) Exercise price of $10.31, expiring May 2010
September 1997....................... (66,600) Exercise price of $17.37, expiring September
2007
February 1997........................ (12,375) Exercise price of $15.00, expiring February
2007
September 1996....................... (41,850) Exercise price of $7.83, expiring September
2006
June 1995............................ (12,375) Exercise price of $7.67, expiring June 2005
--------
Sub-total......................... (204,000)
--------
Total available........................ --
========
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 (loss) and net income (loss) per share for the year ended
December 31, 2000 would have been the pro forma amounts indicated below (in
thousands, except per share amounts):
Net income (loss) available to common stockholders -- as
reported.................................................. $(4,917)
Net income (loss) available to common stockholders -- pro
forma..................................................... (5,316)
Net income (loss) per common share -- as reported
Basic..................................................... $ (3.45)
Assuming dilution......................................... (3.45)
Net income (loss) per common share -- pro forma
Basic..................................................... $ (3.73)
Assuming dilution......................................... (3.73)
The fair value of 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%,
60
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
expected life of 5 years and no distribution yield. The Company issued options
for 70,800 shares of common stock in 2000 which vested immediately and did not
issue options during 2001 or 2002. The weighted average fair value of the
options granted during 2000 was $399,000. All options previously issued were
fully vested.
NOTE 11 -- SEPARATION AGREEMENT
In 1999, the Company entered into the Separation Agreement. The Separation
Agreement provided that a former officer and director and related trust exchange
their 24% stock ownership in the Company, for 20% of the Company's limited
partner interest in HRP, 20% of the Company's common stock interest in Hallwood
Energy, all of the Company's interest in its condominium hotel business and
future cash payments contingent on the net cash flow from the Company's real
estate management activities, that being the lesser of 20% of the net cash flow
from its real estate management activities for the preceding quarter or
$125,000. These future cash payments are subject to termination or
extinguishment in certain events. The additional cost of the Separation
Agreement recorded in 2002 and 2001 in the amounts of $1,000,000 and $500,000,
respectively, represents an additional accrual of future cash payments to the
trust through the period ending December 2004. The Company has an option to
extinguish the future cash payments to the trust at any time prior to its
expiration in December 2004 upon the payment of $3,000,000.
NOTE 12 -- INCOME TAXES
The following is a schedule of the income tax expense (benefit) (in
thousands):
YEARS ENDED DECEMBER 31,
-------------------------
CONTINUING OPERATIONS 2002 2001 2000
--------------------- ------ ------ -------
Federal
Deferred................................................ $1,456 $2,121 $(1,546)
Current................................................. 50 58 46
------ ------ -------
Sub-total............................................ 1,506 2,179 (1,500)
State..................................................... 813 244 290
------ ------ -------
Total................................................ $2,319 $2,423 $(1,210)
====== ====== =======
YEARS ENDED DECEMBER 31,
--------------------------
DISCONTINUED OPERATIONS 2002 2001 2000
----------------------- ------- -------- -----
Federal
Deferred.................................................. $1,800 $(1,172) $341
Current................................................... -- -- --
------ ------- ----
Sub-total.............................................. 1,800 (1,172) 341
State....................................................... -- 100 --
------ ------- ----
Total.................................................. $1,800 $(1,072) $341
====== ======= ====
61
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reconciliations of the expected tax (or benefit) at the statutory tax rate
to the effective tax or (benefit) are as follows (in thousands):
YEARS ENDED DECEMBER 31,
---------------------------
2002 2001 2000
------- ------- -------
Expected tax (benefit) at the statutory tax rate........ $ 3,903 $ 1,930 $(1,949)
Increase (decrease) in deferred tax asset valuation
allowance............................................. (1,218) (1,489) 928
Other................................................... 884 562 (89)
State taxes............................................. 537 227 191
Foreign loss not taxable................................ 13 121 50
------- ------- -------
Effective tax or (benefit)............................ $ 4,119 $ 1,351 $ (869)
======= ======= =======
As a result of the expected gains from the Company's disposition of certain
hotels, the expected appreciation in the market value of the HRP limited partner
units and projected income from continuing operations, management determined
that the deferred tax asset should be adjusted to reflect the anticipated
utilization of net operating loss carryforwards ("NOLs") from assumed
realization of the gains and projected income from continuing operations.
Accordingly, the Company recorded a deferred tax expense of $3,256,000 and
$949,000 in 2002 and 2001, respectively, and a deferred tax benefit of
$1,205,000 in 2000, which adjusted the deferred tax asset to $4,221,000 at
December 31, 2002 from $7,477,000 ($1,800,000 attributable to hotels held for
sale) at December 31, 2001.
Although the Company reported significant taxable income in 2002 from
continuing operations and hotel dispositions and in 2001 from the sale of its
investment in Hallwood Energy, it incurred no federal alternative minimum tax
due to a change in the tax law affecting the calculation of the alternative
minimum tax, however current federal taxes of $50,000 and $58,000 were incurred
by subsidiaries in 2002 and 2001, respectively. For 2000, the Company incurred
no federal alternative minimum tax, due to federal tax losses, however $46,000
was incurred by subsidiaries. The accrued federal income tax payable
(receivable) was $33,000 and $(358,000), and state taxes payable were $460,000
and $157,000 at December 31, 2002 and 2001, respectively.
62
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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):
DEFERRED TAX ASSET, NET
-----------------------------------------------
DECEMBER 31, 2002 DECEMBER 31, 2001
---------------------- ----------------------
ASSETS LIABILITIES ASSETS LIABILITIES
-------- ----------- -------- -----------
Basis differences........................... $ 14,906 $ -- $ 12,999 $ --
Net operating loss carryforward............. 9,955 -- 12,739 --
Equity in earnings of unconsolidated
affiliates................................ 361 -- 3,540 --
Tax credits................................. 2,228 -- 2,212 --
Reserves recorded for financial statement
purposes and not for tax purposes......... 1,495 -- 2,093 --
Original issue discounts and cancellation of
debt income on debentures................. 194 -- 712 --
Depreciation and amortization............... -- 3,713 -- 475
Other temporary differences................. 3,687 -- -- 233
-------- ------ -------- ----
Deferred tax assets and liabilities......... 32,826 $3,713 34,295 $708
====== ====
Less: Deferred tax liabilities.............. (3,713) (708)
-------- --------
29,113 33,587
Less: Valuation allowance................... (24,892) (26,110)
-------- --------
Deferred tax asset, net................ $ 4,221(a) $ 7,477(b)
======== ========
---------------
(a) Full amount is attributable to continuing operations.
(b) $5,667 is attributable to continuing operations and $1,800 to hotels held
for sale.
Below is a schedule of expiring NOLs for tax purposes by year (in
thousands):
YEARS ENDING
DECEMBER 31, AMOUNT
------------ -------
2007........................................................ $ 7,083
2008........................................................ 12,896
2009........................................................ 6,916
2010........................................................ 1,346
2020........................................................ 1,037
-------
Total.................................................. $29,278
=======
In addition, the Company has approximately $2,228,000 of alternative
minimum tax credits, which have no expiration date, and a depletion carryforward
of approximately $6,323,000, which may be used to offset future taxable income
without an expiration limitation.
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, 2002, management was not aware of any
ownership changes which would limit the utilization of the NOLs and tax credit
carryforwards.
63
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13 -- 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):
YEARS ENDED DECEMBER 31,
---------------------------
2002 2001 2000
------- -------- ------
Recording of proportionate share of stockholders'
equity/partners' capital transactions of equity
investments
Adoption of SFAS No. 133:
Cumulative effect.................................. $ -- $ (4,035) $ --
Realized upon disposition of Hallwood Energy....... -- 3,009 --
Change in fair value of derivatives................ -- 1,302 --
Amortization of interest rate swap.................... (59) (26) --
------- -------- ------
Accumulated other comprehensive income............. $ (59) $ 250 --
======= ======== ======
Other
HRP................................................ $ -- $ -- $ 291
Hallwood Energy.................................... -- (36) 36
Hotel assets and liabilities relinquished in connection
with debt extinguishment:
Loans payable......................................... $11,609 $ 17,726 $ --
Other liabilities, net................................ 837 398 --
Hotel properties...................................... (6,552) (17,808) --
Deferred tax asset.................................... (1,800) (100) --
------- -------- ------
$ 4,094 $ 216 --
======= ======== ======
Supplemental disclosures of cash payments
Interest paid........................................... $ 1,606 $ 3,474 $6,143
Income taxes paid....................................... 168 738 397
NOTE 14 -- ORGANIZATION AND OPERATIONS OF HALLWOOD REALTY PARTNERS, L.P.
Organization. In 1990, the Company, through a wholly owned subsidiary,
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 affect the carrying value of the
investments.
Operations. The Company's real estate subsidiaries earn asset management,
property management leasing and construction supervision fees for their
management of HRP's real estate properties. Hallwood Realty earns: (i) an asset
management fee equal to 1% of the net aggregate base rents of HRP's properties,
(ii) acquisition fees equal to 1% of the purchase price of newly acquired
properties and; (iii) disposition fees with respect to real estate investments,
other than the properties owned at the time of HRP's formation in 1990, equal to
10% of the amount by which the sales price of a property exceeds the purchase
price of such
64
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
property. HCRE earns property management, leasing and construction supervision
fees. The management contracts with HRP expire on June 30, 2004 and provide for:
(i) a property management fee equal to 2.85% of cash receipts collected from
tenants; (ii) leasing fees equal to the current commission market rate as
applied to net aggregate rent (none exceeding 6% of the net aggregate rent); and
(iii) construction supervision fees for administering construction projects
equal to 5% of total construction or tenant improvement costs.
Hallwood Realty is also reimbursed for certain costs and expenses, at cost,
for administrative level salaries and bonuses, employee and director insurance
and allocated overhead costs. In addition, since HRP does not employ any
individuals, the compensation and other costs related to approximately 90
employees rendering services on behalf of HRP and its properties are reimbursed
to Hallwood Realty and HCRE by HRP.
A summary of the fees earned from HRP is detailed below (in thousands):
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
------ ------ ------
Leasing fees............................................... $2,151 $2,158 $2,601
Property management fees................................... 2,029 2,009 1,916
Asset management fees...................................... 618 609 581
Construction supervision fees.............................. 582 1,204 917
Acquisition fees........................................... -- 120 74
------ ------ ------
Total................................................. $5,380 $6,100 $6,089
====== ====== ======
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 an integrated 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 $297,000, $240,000 and $322,000 for the years ended December 31,
2002, 2001 and 2000, respectively. Brookwood had one customer that accounted for
more than 10% of its net sales during 2002. The relationship with the customer
is ongoing and Brookwood expects to maintain comparable sales volumes with that
customer in 2003. Sales to that customer were $18,600,000, $3,800,000 and
$42,000 in 2002, 2001 and 2000, respectively.
Inventories consist of the following (in thousands):
DECEMBER 31,
-----------------
2002 2001
------- -------
Finished goods.............................................. $10,316 $ 9,987
Work in process............................................. 4,904 2,851
Raw materials............................................... 4,266 4,336
------- -------
19,486 17,174
Less: Obsolescence reserve.................................. (573) (421)
------- -------
Total.................................................. $18,913 $16,753
======= =======
65
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Property, plant and equipment consists of the following (in thousands):
DECEMBER 31,
-------------------
2002 2001
-------- --------
Machinery and equipment..................................... $ 13,620 $ 12,187
Buildings and improvements.................................. 4,528 4,424
Office furniture and equipment.............................. 3,338 3,148
Construction in progress.................................... 862 1,401
Land........................................................ 391 391
Leasehold improvements...................................... 368 392
-------- --------
23,107 21,943
Less: Accumulated depreciation.............................. (13,792) (12,517)
-------- --------
Total.................................................. $ 9,315 $ 9,426
======== ========
In 2001, management conducted an analysis of the carrying values of certain
intangible assets related to acquisitions made in prior years and determined
that Brookwood suffered an impairment to those values due to adverse economic
trends and conditions. Accordingly, an impairment charge of $1,446,000 was
recorded in December 31, 2001.
During 2000, Brookwood formed a joint venture, Strategic Technical
Alliance, LLC ("STA"), with an unrelated third party that is also in a textile
related industry. The business of STA is to produce advanced breathable
waterproof laminate materials for military applications.
In September 2002, STA acquired the shares owned by the unrelated third
party, effectively making STA a wholly owned subsidiary, for $1,000,000 in cash,
the issuance of a $596,000 promissory note and royalty payments for three years
based upon production under a specified contract. For the first three quarters
of 2002, Brookwood accounted for its investment under the equity method of
accounting. Since that date, the results of STA have been fully consolidated.
The following table sets forth summarized financial data of STA as of and
for the years ended December 31, 2002 and 2001(in thousands):
DECEMBER 31,
----------------
2002 2001
------- ------
Balance Sheet Data
Total assets.............................................. -- $8,522
Total liabilities......................................... -- 7,288
Joint venture equity...................................... -- 1,234
Statement of Operations Data (through September 2002 only)
Revenue................................................... $15,380 $6,596
Net income................................................ 2,429 1,252
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.
66
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 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.
Management has reviewed the carrying value of its loans payable and 10%
Debentures in connection with interest rates currently available to the Company
for borrowings with similar characteristics and maturities. Loans payable
associated with the Company's assets held for sale and discontinued operations
have not been considered. Management has determined that the estimated fair
value of the loans payable would be approximately $17,243,000 and $19,141,000 at
December 31, 2002 and 2001, compared to the carrying value of $17,130,000 and
$19,141,000, respectively. The estimated fair value of the 10% Debentures is
$5,983,000 and $5,045,000, based on market prices on the New York Stock
Exchange, compared to the carrying values of $6,625,000 and $6,677,000 at
December 31, 2002 and 2001, respectively. The fair value of the Company's hotel
obligations approximated the carrying value given their proximity to expected
extinguishment, which occurred during 2001 and 2002.
The fair value information presented as of December 31, 2002 and 2001 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 January 1997, the compensation
committee approved a financial consulting contract with HSC Financial
Corporation ("HSC"), a corporation with which Mr. Gumbiner is and Mr. Troup was
associated, that 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,
excluding reimbursement for out-of-pocket and other reasonable expenses. 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 1998, however,
it automatically renews for one-year periods if not terminated by the parties
beforehand. The contract was amended to reduce the annual consulting fee to
$495,000 in January 2000 and amended to increase the fee to $795,000 in May
2001. In addition, the Board of Directors awarded a bonus to HSC in March 2003
and 2002, accrued into the prior year, in the amount of $33,000 from its HCRE
subsidiary.
Pursuant to the HSC financial consulting agreement, the Company reimburses
HSC for reasonable and necessary expenses in providing office space and
administrative services. The Company reimbursed HSC $392,000, $344,000 and
$304,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Of
the amounts paid, the Company incurred $98,000, $86,000 and $117,000 of expense
for the years ended December 31, 2002, 2001 and 2000, respectively. The
remainder was reimbursed by HRP and certain energy affiliates.
Hallwood Investments Limited. In March 2000, September 2000 and March
2001, the Company entered into loan agreements with an entity associated with
its chairman and principal stockholder, Anthony J. Gumbiner, in the amount of
$1,500,000, $1,000,000 and $1,500,000, respectively. Significant terms included:
(i) term of five years; (ii) fixed interest rate of 10%; (iii) interest and
principal payments deferred until maturity; (iv) unsecured; and (v) convertible
into common stock twelve months after date of issuance, if not previously
repaid, at a per share price which was 115% of the market price on the date each
of the loans was approved by the Company's independent board members. Two of the
loans were repaid in December 2001 in the amount of $2,881,000, which
represented principal of $2,500,000 and accrued interest of $381,000. The
remaining loan was repaid in March 2002 in the amount of $1,648,000, which
represented principal of $1,500,000 and accrued interest of $148,000.
67
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Hallwood Realty Partners, L.P. As previously discussed in Note 14, the
Company earns management fees, leasing commissions and other fees from HRP.
Stanwick. 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
$25,000 for each of the years ended December 31, 2002, 2001 and 2000,
respectively. Stanwick is a subsidiary of Luxembourg-based Hallwood Holdings
S.A. ("HHSA"). Anthony J. Gumbiner is a director of HHSA. Melvin J. Melle is
chief financial officer of HHSA and Stanwick.
Strategic Technical Alliance, LLC. In the normal course of business,
Brookwood sold inventory to STA, its joint venture investee. These sales
totalled $11,444,000, $5,342,000 and $67,000 for the period through September
2002 and for the years ended December 31, 2001 and 2000, respectively. In
September 2002, STA became a wholly owned Brookwood subsidiary. At December 31,
2001 STA owed $5,217,000 to Brookwood under this arrangement, and at December
31, 2002 the intercompany balance due has been eliminated in consolidation.
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.
In June 1997, an action was filed against the Company, HRP, the general
partner Hallwood Realty Corporation, a predecessor entity to Hallwood Realty,
LLC, and the directors of Hallwood Realty Corporation by Gotham Partners, L.P.
in the Delaware Court of Chancery, styled Gotham Partners, L.P. v. Hallwood
Realty Partners, L.P., et al (C.A. No. 15754). This action alleges claims of
breach of fiduciary duties, breach of HRP's partnership agreement and fraud in
connection with certain transactions involving HRP's limited partnership units
in the mid 1990's. The Company is alleged to have aided and abetted the alleged
breaches. In June 2000, after completing fact discovery, all parties moved for
summary judgment on several issues. In September and October 2000, the Delaware
court issued three separate written opinions resolving the summary judgment
motions. In the opinions, the court ruled that trial would be required as to all
issues, except that (i) Gotham was found to have standing to pursue its
derivative claims; (ii) defendants were entitled to judgment dismissing the
fraud claim; (iii) the general partner was entitled to judgment dismissing the
breach of fiduciary duty claims brought against it; and (iv) the general
partner's outside directors were entitled to judgment dismissing all claims
brought against them. A five-day trial was held in January 2001. In July 2001,
the Delaware Court of Chancery rendered its opinion. In its decision, the court
determined that an option plan and a sale of units to the Company in connection
with a reverse unit split implemented by HRP in 1995 were in compliance with
HRP's partnership agreement. The court also found that the sale of units to the
Company in connection with a 1995 odd-lot offer by HRP did not comply with
certain procedures required by the HRP partnership agreement. The court ruled
that the defendants other than HRP pay a judgment to HRP in the amount of
$3,417,000, plus pre-judgment interest of approximately $2,891,000 from August
1995. The judgment amount represents what the court determined was an
underpayment by the Company. In August 2001, the plaintiff and certain
defendants appealed the Court of Chancery's judgment to the Delaware Supreme
Court. In October 2001, the Company paid $6,405,000, including post judgment
interest, to HRP, subject to an arrangement that it be returned in full or part
if the judgment is modified or reversed on appeal. Oral arguments before the
Delaware Supreme Court were heard in February 2002, and a rehearing en banc was
held in March 2002. In August 2002, the Supreme Court affirmed the judgement of
the trial court that the remaining defendants other than HRP are jointly and
severally liable to HRP. The Supreme Court reversed the trial court's
determination of damages, and remanded the case to the trial court to fashion
68
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
appropriate relief. A hearing on the remand proceedings was held before the
Delaware Court of Chancery in October 2002. A further hearing on the remand is
scheduled to take place in May 2003, with a decision by the Court of Chancery to
follow. Since the appellate court reversed the judgment, any subsequent ruling
by the trial court on remand may be more or less favorable to the Company.
In February 2000, HRP filed a lawsuit in the United States District Court
for the Southern District of New York styled Hallwood Realty Partners, L.P. v.
Gotham Partners, L.P., et al (Civ. No. 00 CV 115) alleging violations of the
Securities Exchange Act of 1934 by certain purchasers of HRP's limited
partnership units, including Gotham Partners, L.P., Gotham Partners, III L.P.,
Private Management Group, Inc., Interstate Properties, Steven Roth and EFO
Realty, Inc., by virtue of those purchasers' misrepresentations and/or omissions
in connection with filings required under the Securities Exchange Act of 1934.
The complaint further alleged that the defendants, by acquiring more than 15% of
the outstanding HRP limited partnership units, have triggered certain rights
under its Unit Purchase Rights Agreement, for which HRP was seeking declaratory
relief. HRP sought various forms of relief, including declaratory judgments,
divestiture, corrective disclosures, a "cooling-off" period and damages,
including costs and disbursements. In November 2000, the court granted HRP's
motion to add as defendants Gotham Holdings II, LLC, Hallwood Investors, L.P.,
Liberty Realty Partners, L.P. and EFO/Liberty, Inc. and to remove EFO Realty,
Inc. as a defendant. Discovery was completed in December 2000 and trial was held
in February 2001. In February 2001, the court rendered a decision in favor of
the defendants and the court ordered the complaint dismissed. HRP filed a Notice
of Appeal in March 2001. Oral arguments were heard in March 2002. In April 2002,
the U.S. Court of Appeals for the Second Circuit upheld the lower court's ruling
in favor of the defendants. In April 2002, HRP filed with the court a Petition
for Rehearing en banc with respect to the April 2002 decision. In June 2002 the
Second Circuit denied the petition. HRP has not sought further appellate review
and the determination in favor of defendants is now final.
The Company was a party to certain litigation in the Delaware Court of
Chancery styled, Corporate Property Associates 6 and Corporate Property
Associates 7 v. The Hallwood Group Incorporated (C.A. 15661-NC), that involves a
four-year, $500,000 promissory note of the Company due March 1998. The note was
secured by a pledge of 89,269 HRP limited partner units. The agreement under
which the note was issued also provided that the pledgee ("CPA," or the
"Noteholder") had the right to receive up to an additional $500,000 based on the
increase in price of the HRP units (the "HRP Participation Amount"). In 1996,
the Company and CPA entered into an agreement under which the Company would pay
off the principal and interest on the note and all other obligations between the
parties would be ended. Subsequently, CPA refused to go forward with the
agreement and this litigation was instituted. In December 1999, the Company and
the Noteholder entered into an agreement, approved by the court, which provided
that (i) the Company pay the face amount of $500,000 plus $83,000 of accrued
interest to the Noteholder; (ii) the Company deposit $900,000 into an escrow
account to secure the maximum amount which could be payable by the Company,
including a potential claim of $400,000 for legal fees; and (iii) that the
noteholder release its collateral of 89,269 HRP units. The parties reserved
their rights to proceed with the litigation. Trial was held in June 2001 in the
Delaware Court of Chancery. In February 2002, the court rendered its decision in
favor of the Company. In March 2002, the court entered an order that provided
for the return of approximately $971,000, including accrued interest, to the
Company from the escrow account. The Noteholder filed an appeal in April 2002.
Oral arguments before the Delaware Supreme Court were heard in September 2002,
and a rehearing en banc was held in November 2002. In March 2003, the Delaware
Supreme Court issued its opinion reversing the finding of the Trial Court that
certain language in the letter agreement in question constituted a general
release of Hallwood's obligations. On March 21, 2003, the parties submitted to
the Chancery Court an agreed proposed Order and Judgment, which was signed by
the Court and terminated the litigation. The Order and Judgment provided for
payment out of the escrowed funds of approximately $547,000 to CPA and $437,000
to the Company. The Company received its share of the escrowed funds on March
31, 2003.
69
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company was a defendant in two lawsuits regarding guaranties of certain
obligations of the Embassy Suites and Holiday Inn hotels. In February 2003, the
Company settled both matters. The Company agreed to pay $150,000 in cash and
$250,000 in equal monthly installments over 18 months, in exchange for a full
release regarding the Embassy Suites hotel, and $250,000 in cash in exchange for
a full release regarding the Holiday Inn hotel. In December 2002, the Company
recorded an additional loss provision in the amount of $247,000 to fully accrue
for these two litigation matters.
The Company and its subsidiaries are from time to time involved in various
other legal proceedings in the ordinary course of their respective businesses.
Management believes that the resolution of the aforementioned litigation matters
will not have a material adverse effect on the financial condition, results of
operations or cash flows of the Company.
Contingencies. The Company has committed to make additional contributions
to the capital of Hallwood Realty, the general partner of HRP, upon demand, up
to a maximum aggregate amount of $13,118,000, subject to the terms of a
subscription agreement, to the extent Hallwood Realty has insufficient capital
to satisfy creditors of HRP. As of the date of this report no such demands have
been made.
In December 1999, the Company distributed certain assets and incurred a
contingent obligation, under the Separation Agreement discussed in Note 11. The
contingent obligation, in the amount of $4,000,000 at December 31, 2002 is the
estimated value of the remaining payments under the Separation Agreement and is
included in other accrued expenses. Interest on the contingent obligation was
imputed at 12.75% and amounted to $395,000 and $408,000 for the years ended
December 31, 2001 and 2000, respectively. In December 2001 the Company evaluated
the contingent obligation and accrued an additional $500,000 under this
agreement, which was paid in 2002. Similarly, the Company reevaluated the
obligation at December 2002, and determined that a further cost of $1,000,000
should be accrued, which is expected to be paid in 2003 and 2004.
In February 2000, Brookwood, through a wholly owned subsidiary, acquired
the assets of a company in a textile products-related industry. The purchase
price was $1,479,000 in cash plus contingent payments of up to $3,000,000, based
on specified levels of earnings over the next four years. Effective December 31,
2001, in consideration of thirty six monthly payments aggregating approximately
$375,000, the contingent obligation had been reduced to a percentage of cash
flow from the acquired subsidiaries, as defined, for the remaining years under
the agreement. As of December 31, 2002, no amounts have been paid or were owed
in relation to the contingency payments.
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 for noncancelable operating leases was
$1,518,000, $1,718,000 and $3,456,000 for the years ended December 31, 2002,
2001 and 2000, respectively. The Company leases certain textile manufacturing
equipment and certain hotel property, including land, buildings and equipment.
The leases generally require the Company to pay property taxes, insurance and
maintenance of the leased assets. The Company shares certain executive office
facilities with HRP and pays a proportionate share of the lease expense. Two
hotel leases (one of which was terminated in February 2001) required the payment
of contingent rent if revenue was in excess of a base amount. Contingent rent
was $-0-, $88,000 and $295,000 for the years ended December 31, 2002, 2001 and
2000, respectively.
70
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 2002 aggregate minimum annual rental commitments under
noncancelable operating leases having an initial or remaining term of more than
one year, were as follows (in thousands):
YEARS ENDING
DECEMBER 31, AMOUNT
------------ ------
2003........................................................ $1,121
2004........................................................ 1,076
2005........................................................ 834
2006........................................................ 653
2007........................................................ 538
Thereafter.................................................. 1,614
------
Total.................................................. $5,836
======
Employment Contracts. The Company's Brookwood subsidiary has employment
agreements that expire in 2003 and 2005. The approximate minimum annual
compensation due under this commitment are as follows (in thousands):
YEARS ENDING
DECEMBER 31, AMOUNT
------------ ------
2003........................................................ $400
2004........................................................ 200
2005........................................................ 50
2006........................................................ --
2007........................................................ --
----
Total..................................................... $650
====
NOTE 19 -- SEGMENT AND RELATED INFORMATION
The Company is a holding company and classifies its primary business
operations into two reportable segments; real estate and textile products. Both
segments have different management teams and infrastructures that engage in
different businesses and offer different services.
Real Estate. The real estate operations 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. At December 31, 2002, HRP
owned fourteen real estate properties in six states containing 5,199,000 net
rentable square feet. Hallwood Realty owns a 1% general partner interest and
HWG, LLC owns a 21% limited partner interest in HRP. Hallwood Realty is
responsible for asset management of HRP and its properties, including the
decisions regarding financing, refinancing, acquiring and disposing of
properties. It also provides general operating and administrative services to
HRP. HCRE is responsible for on-site property management for all HRP properties,
and properties it manages for third parties, for which it receives management,
leasing and construction supervision fees. The Company accounts for its
ownership in HRP using the equity method of accounting recording its pro-rata
share of net income (loss) and partners capital transactions reported by HRP.
Textile Products. The textile products operations are conducted through
the Company's wholly owned Brookwood subsidiaries. Brookwood is an integrated
textile service firm that develops and produces innovative fabrics and related
products through specialized finishing, treating and coating processes.
Discontinued Operations -- Energy. Hallwood Energy owned interests in oil
and gas properties, primarily located in the San Juan Basin in New Mexico and
Colorado, South Texas, the West Texas Permian Basin
71
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and onshore South Louisiana. The investment in Hallwood Energy was accounted for
using the equity method of accounting, as the Company exercised significant
influence over Hallwood Energy's operational and financial policies.
In May 2001, the Company sold its investment in Hallwood Energy.
Accordingly, the Company's former energy operations have been reclassified as
discontinued operations for all periods presented herein.
Discontinued Operations -- Hotels. Hotel operations were conducted through
the Company's wholly owned Hallwood Hotels and Brock Hotels subsidiaries.
Hallwood Hotels held 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 owned fee
interests in two GuestHouse Suites Plus properties located in Tulsa, Oklahoma
and Greenville, South Carolina, and a long-term leasehold interest in one
GuestHouse Suites Plus property located in Huntsville, Alabama.
In December 2000, the Company decided to discontinue and dispose of its
hotel segment, which consisted of five hotel properties at that time.
Accordingly, the Company's hotel operations which it intended to dispose of were
reclassified as discontinued operations. The Company subsequently determined
that it would retain a leasehold interest in one of the hotels which has been
reclassified as a continuing operation and is included in "other" within the
following schedule.
The following represents the Company's reportable amounts by segment,
including its discontinued operations, as of and for the years ended December
31, 2002, 2001 and 2000, respectively ( in thousands):
REAL TEXTILE DISCONTINUED
ESTATE PRODUCTS OTHER OPERATIONS CONSOLIDATED
------- -------- ------- ------------ ------------
YEAR ENDED DECEMBER 31, 2002
Total revenue from external
sources....................... $ 7,095 $85,933 $ 4,128 $97,156
======= ======= ======= =======
Operating income (loss)......... $ 4,604 $ 2,667 $ 7,271
======= =======
Unallocable expenses, net....... $(1,560) (1,560)
======= -------
Loss from continuing operations
before income taxes........... $ 5,711
=======
Income from discontinued
operations.................... $ 3,402 $ 3,402
======= =======
Identifiable assets, December
31, 2002...................... $14,317 $44,519 $58,836
Cash allocable to segment....... 119 869 1,371 2,359
------- ------- ------- -------
$14,436 $45,388 $ 1,371 61,195
======= ======= =======
Corporate assets................ $ 8,353 8,353
======= -------
Total assets, December 31,
2002.......................... $69,548
=======
Depreciation, amortization and
impairment.................... $ 672 $ 1,373 $ 117 $ 2,162
======= ======= ======= =======
Capital
expenditures/acquisitions..... $ 1,950 $ 1,950
======= =======
72
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
REAL TEXTILE DISCONTINUED
ESTATE PRODUCTS OTHER OPERATIONS CONSOLIDATED
------- -------- ------- ------------ ------------
YEAR ENDED DECEMBER 31, 2001
Total revenue from external
sources....................... $ 8,514 $69,579 $ 3,309 $81,402
======= ======= ======= =======
Operating income................ $ 3,167 $(2,126) $ 1,041
======= =======
Unallocable expenses, net....... $(4,083) (4,083)
======= -------
Loss from continuing operations
before income taxes........... $(3,042)
=======
Income from discontinued
operations.................... $ 9,750 $ 9,750
======= =======
Identifiable assets, December
31, 2001...................... $12,558 $44,998 $ -- $ 9,506 $67,062
Cash allocable to segment....... 97 323 3,552 -- 3,972
------- ------- ------- ------- -------
$12,655 $45,321 $ 3,552 $ 9,506 71,034
------- ======= ======= =======
Corporate assets................ $ 6,533 6,533
======= -------
Total assets, December 31,
2001.......................... $77,567
=======
Depreciation, amortization and
impairment.................... $ 672 $ 2,879 $ 110 $ 935 $ 4,596
======= ======= ======= ======= =======
Capital
expenditures/acquisitions..... $ 1,015 $ 3 $ 1,018
======= ======= =======
YEAR ENDED DECEMBER 31, 2000
Total revenue from external
sources....................... $ 6,763 $73,852 $ 1,628 $82,243
======= ======= ======= =======
Operating income................ $ 3,755 $ 455 $ 4,210
======= =======
Unallocable expenses, net....... $(6,140) (6,140)
======= -------
Loss from continuing operations
before income taxes........... $(1,930)
=======
Loss from discontinued
operations.................... $(4,147) $(4,147)
======= =======
Identifiable assets, December
31, 2000...................... $ 7,406 $41,479 $ -- $37,888 $86,773
Cash allocable to segment....... 283 211 1,344 -- 1,838
------- ------- ------- ------- -------
$ 7,689 $41,690 $ 1,344 $37,888 88,611
======= ======= ======= =======
Corporate assets................ $ 7,312 7,312
======= -------
Total assets, December 31,
2000.......................... $95,923
=======
Depreciation, amortization and
impairment.................... $ 672 $ 1,399 $ 1,007 $ 6,003 $ 9,081
======= ======= ======= ======= =======
Capital
expenditures/acquisitions..... $ 3,214 $ 3 $ 1,247 $ 4,464
======= ======= ======= =======
73
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 20 -- 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 plan provides that (i) eligible employees may contribute up to 15% of their
compensation to the plan; (ii) the Company's matching contribution is
discretionary, to be determined annually by the Company's Board of Directors;
(iii) excludes the Company's hotel hourly employees from a matching
contribution; and (iv) excludes highly compensated employees from a matching
contribution, although this group receives a compensatory bonus in lieu of such
contribution and diminution of related benefits. Amounts contributed by
employees are 100% vested and non-forfeitable. The Company's matching
contributions, which were 50% of its employees contributions up to the first 6%
contributed for each of the three years ended December 31, 2002, vest at a rate
of 20% per year of service and become fully vested after five years. Employees
of Hallwood Realty, HCRE and salaried hotel employees also participate in the
Company's 401(k) plan. Brookwood has a separate 401(k) plan which is similar to
the Company's plan. Brookwood did not provide a matching employer contribution
to its 401(k) plan in the three years ended December 31, 2002. Employer
contributions paid on behalf of Hallwood Realty employees were substantially
paid by HRP. The Company's contributions to the plans for the years ended
December 31, 2002, 2001 and 2000, respectively, excluding contributions from the
Hallwood Realty affiliate paid on behalf of HRP were $71,000, $62,000, and
$76,000, respectively.
Brookwood's union employees belong to a pension fund maintained by their
union. The Company contributes $90 per month per employee to the fund. Total
contributions for the years ended December 31, 2002, 2001 and 2000 were
$268,000, $245,000 and $222,000, respectively. At March 31, 2002, 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.
NOTE 21 -- CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES
SFAS No. 142 became effective January 1, 2002 and specifies that goodwill
and some intangible assets will no longer be amortized but instead will be
subject to periodic impairment testing. The effect of adopting SFAS No. 142 by
the Company resulted in the recording of income from the cumulative effect of a
change in accounting principle in the amount of $568,000, which represented the
unamortized amount of negative goodwill associated with the Company's equity
investment in HRP.
During 2001, management conducted an analysis of the carrying value of
certain intangible assets related to the textile products segment and recorded
an impairment charge of $1,446,000 as of December 31, 2001. The Company no
longer has any recorded goodwill or intangible assets that would be subject to
amortization or impairment testing.
74
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Had the provisions of SFAS No. 142 been applied retroactively, the
Company's net income (loss) and net income (loss) per share for each of the
three years ended December 31, 2002, would have been the pro forma amounts
indicated below (in thousands, except per share amounts):
YEARS ENDED DECEMBER 31,
-------------------------
2002 2001 2000
------ ------ -------
Net income(loss), as reported............................. $7,362 $4,245 $(4,867)
Add back amortization:
Real estate -- negative goodwill........................ -- (113) (226)
Textile products -- positive goodwill................... -- 59 122
Deduct cumulative effect of change in accounting
principle:
Real estate -- negative goodwill........................ (568) -- --
------ ------ -------
Net income (loss) -- pro forma............................ $6,794 $4,191 $(4,971)
====== ====== =======
Net income (loss) per common share -- assuming dilution,
as reported............................................. $ 5.19 $ 2.95 $ (3.45)
Adjustments............................................... (0.40) (.04) (.07)
------ ------ -------
Net income (loss) per common share -- assuming dilution,
pro forma............................................... $ 4.79 $ 2.91 $ (3.52)
====== ====== =======
NOTE 22 -- SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Results of operations by quarter for the years ended December 31, 2002 and
2001, are summarized below (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31, 2002
-----------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
Operating revenues(a)............................ $24,354 $25,887 $21,088 $25,827
Gross profit..................................... 5,325 5,641 5,168 4,579
Income (loss) from continuing operations......... 1,316 1,142 1,298 (364)
Income (loss) from discontinued operations....... 1,476 2,258 (15) (317)
Net income (loss)................................ 3,360 3,400 1,283 (681)
Comprehensive income (loss)...................... 3,346 3,385 1,268 (696)
Per Share Data:
Income (loss) from continuing operations
Basic.......................................... 0.97 0.80 0.95 (0.27)
Assuming dilution.............................. 0.85 0.80 0.95 (0.27)
Income (loss) from discontinued operations
Basic.......................................... 1.08 1.66 (0.01) (0.23)
Assuming dilution.............................. 0.93 1.66 (0.01) (0.23)
Net income (loss)
Basic.......................................... 2.47 2.46 0.94 (0.50)
Assuming dilution.............................. 2.15 2.46 0.94 (0.50)
75
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED DECEMBER 31, 2001
-----------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
Operating revenues(a)............................ $20,934 $21,222 $18,333 $20,913
Gross profit..................................... 4,130 1,868 4,329 1,981
Income (loss) from continuing operations(b)...... 342 (2,206) 338 (3,939)
Income (loss) from discontinued operations....... 4,950 5,794 (419) (575)
Net income (loss)................................ 5,252 3,588 (81) (4,514)
Comprehensive income (loss)...................... 2,519 6,597 (95) (4,526)
Per Share Data:
Income (loss) from continuing operations
Basic.......................................... 0.24 (1.58) 0.24 (2.80)
Assuming dilution.............................. 0.23 (1.58) 0.22 (2.80)
Income (loss) from discontinued operations
Basic.......................................... 3.47 4.07 (0.29) (0.41)
Assuming dilution.............................. 2.87 4.07 (0.29) (0.41)
Net income (loss)
Basic.......................................... 3.69 2.48 (0.06) (3.21)
Assuming dilution.............................. 3.07 2.48 (0.06) (3.21)
---------------
(a) Includes reclassification to gross-up certain construction and facilities
management expenses that were previously netted against revenues. The
reclassification occurred due to the adoption of EITF No. 01-14 -- "Income
Statement Characterization of Reimbursements Received for Out-of-pocket
Expenses Incurred". The reclassifications had no effect on previously
reported net income.
(b) Includes amounts previously reported as extraordinary gain (loss) from early
extinguishment of debt.
Year ended December 31, 2002. In January 2002, the Company sold the
GuestHouse Suites hotel in Tulsa, Oklahoma and recognized a gain from debt
extinguishment of $2,552,000, before a deferred tax charge of $875,000. In June
2002, the mortgage lender for the GuestHouse Suites hotel in Greenville, South
Carolina completed a foreclosure on the hotel and the Company recognized a gain
from debt extinguishment of $3,237,000, before a deferred tax charge of
$925,000. In December 2002, the Company recorded a loss provision of $247,000 to
fully accrue the settlement cost of two hotel litigation matters.
Year ended December 31, 2001. In May 2001, the Company sold its investment
in Hallwood Energy for a gain of $8,725,000. In June 2001, the Company recorded
a gain from extinguishment of debt from the disposition of one hotel property in
the amount of $216,000. In December 2001, the Brookwood subsidiary recorded an
impairment of its goodwill of $1,446,000. In December 2001, the Company recorded
an additional impairment of $935,000 relating to hotel assets held for sale.
76
INDEPENDENT AUDITORS' REPORT ON SCHEDULES
To the Stockholders and Directors of
The Hallwood Group Incorporated
We have audited the consolidated balance sheets of The Hallwood Group
Incorporated and its subsidiaries as of December 31, 2002 and 2001 and the
related consolidated statements of operations, comprehensive income (loss),
changes in stockholders' equity and cash flows for each of the three years in
the period ended December 31, 2002 and have issued our report thereon dated
April 7, 2003 (April 15, 2003 as to the last paragraph of Note 5 under the
heading "Textile Products"), which contained an explanatory paragraph referring
to the Company's change in its method of accounting for goodwill in 2002 as
required by Statement of Financial Accounting Standards No. 142, Goodwill and
Other Intangible Assets, and 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 15. 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
April 7, 2003
77
SCHEDULE I
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
BALANCE SHEETS
DECEMBER 31,
-------------------
2002 2001
-------- --------
(IN THOUSANDS)
ASSETS
Investments in subsidiaries -- continuing operations........ $ 31,361 $ 30,909
Deferred tax asset, net..................................... 4,221 5,677
Investment in HEC........................................... 3,313 --
Restricted cash............................................. 982 966
Receivables and other assets................................ 363 664
Cash and cash equivalents................................... 296 2,464
-------- --------
Total Assets.............................................. $ 40,536 $ 40,680
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
10% Collateralized Subordinated Debentures.................. $ 6,625 $ 6,677
Deferred cost -- Separation Agreement....................... 4,000 3,500
Deferred revenue -- noncompetition agreement................ 3,424 5,840
Accounts payable, accrued interest and other accrued
expenses.................................................. 1,285 2,093
Capital lease obligations................................... 1,066 1,386
Investment in subsidiaries -- discontinued hotels held for
sale...................................................... -- 4,301
-------- --------
Total Liabilities...................................... 16,400 23,797
Redeemable preferred stock.................................. 1,000 1,000
Common stock................................................ 240 240
Additional paid-in capital.................................. 54,452 54,452
Accumulated deficit......................................... (16,417) (23,729)
Accumulated other comprehensive income...................... 191 250
Treasury stock.............................................. (15,330) (15,330)
-------- --------
Total Stockholders' Equity............................. 23,136 15,883
-------- --------
Total Liabilities and Stockholders' Equity............. $ 40,536 $ 40,680
======== ========
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".
78
SCHEDULE I
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
--------------------------
2002 2001 2000
------ ------- -------
(IN THOUSANDS)
INCOME
Intercompany income from subsidiaries
Interest income........................................ $3,065 $ 3,158 $ 3,294
Management fees........................................ 2,019 2,331 2,302
Dividends.............................................. -- -- 400
Amortization of deferred revenue -- noncompetition
agreement.............................................. 2,417 1,410 --
Equity in net income of subsidiaries -- continuing
operations............................................. 563 -- --
Interest and other income................................. 318 215 75
Equity loss from investment in HEC........................ (187) -- --
Fee income................................................ -- -- 237
------ ------- -------
Total income........................................... 8,195 7,114 6,308
EXPENSES
Administrative expenses................................... 1,930 2,266 2,055
Cost of Separation Agreement.............................. 1,000 500 --
Interest expense.......................................... 622 1,088 1,243
Intercompany interest expense............................. 156 559 1,710
Litigation expense........................................ -- 2,360 --
Equity in net loss of subsidiaries -- continuing
operations............................................. -- 2,023 3,485
Loss from debt extinguishment............................. -- 800 --
------ ------- -------
Total expenses......................................... 3,708 9,596 8,493
------ ------- -------
Income (loss) from continuing operations before income
taxes (benefit)........................................ 4,487 (2,482) (2,185)
Income taxes (benefit).................................... 527 3,023 (1,465)
------ ------- -------
Income (loss) from continuing operations.................. 3,960 (5,505) (720)
Income (loss) from discontinued operations, net of tax
Income (loss) from discontinued operations -- hotels
(includes gains from extinguishment of debt of $5,789
and $316 in 2002 and 2001, respectively)............. 3,402 (1,384) (6,973)
Income from discontinued operations -- energy.......... -- 11,134 2,826
------ ------- -------
3,402 9,750 (4,147)
------ ------- -------
NET INCOME (LOSS)........................................... 7,362 4,245 (4,867)
Cash dividend on preferred stock.......................... (50) (50) (50)
------ ------- -------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS.......... $7,312 $ 4,195 $(4,917)
====== ======= =======
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."
79
SCHEDULE I
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31,
--------------------------
2002 2001 2000
------ ------- -------
(IN THOUSANDS)
NET INCOME (LOSS)........................................... $7,362 $ 4,245 $(4,867)
Other Comprehensive Income (Loss)
Pro rata share of other comprehensive income from equity
investments
Adoption of SFAS No. 133
Cumulative effect.................................... -- (4,035) --
Realized upon disposition of Hallwood Energy......... -- 3,009 --
Change in fair value of derivatives.................. -- 1,302 --
Amortization of interest rate swap..................... (59) (26) --
------ ------- -------
(59) 250 --
------ ------- -------
COMPREHENSIVE INCOME (LOSS)................................. $7,303 $ 4,495 $(4,867)
====== ======= =======
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."
80
SCHEDULE I
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
----------------------------
2002 2001 2000
------- -------- -------
(IN THOUSANDS)
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES......... $ (317) $ (887) $ 1,844
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in HEC common stock............................ (3,500) -- --
Return of (additional) investment in subsidiaries......... 2,019 (21,350) (1,995)
Proceeds from sale of Hallwood Energy stock............... -- 18,000 303
Proceeds from noncompetition agreement.................... -- 7,250 --
Purchase of minority shares of Hallwood Energy............ -- -- (465)
------- -------- -------
Net cash provided by (used in) investing activities.... (1,481) 3,900 (2,157)
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of common stock for treasury..................... -- (412) --
Repayment of bank borrowings and loans payable............ (320) (388) --
Payment of cash dividend on preferred stock............... (50) (50) (50)
------- -------- -------
Net cash used in financing activities.................. (370) (879) (86)
------- -------- -------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ (2,168) 2,163 (363)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 2,464 301 664
------- -------- -------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 296 $ 2,464 $ 301
======= ======== =======
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."
81
SCHEDULE I
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
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):
YEARS ENDED DECEMBER 31,
------------------------
DESCRIPTION 2002 2001 2000
----------- ----- ------- ------
(IN THOUSANDS)
Proportionate share of stockholders' equity/partners'
capital transactions of equity investments
Adoption of SFAS No. 133:
Cumulative effect...................................... $ -- $(4,035) $ --
Realized upon disposition of Hallwood Energy........... -- 3,009 --
Change in fair value of derivatives.................... -- 1,302 --
Amortization of interest rate swap........................ (59) (26) --
----- ------- ------
$ (59) $ 250 --
===== ======= ======
Other
Hallwood Energy........................................ -- $ (36) $ 36
SUPPLEMENTAL DISCLOSURES OF CASH PAYMENTS
Interest paid............................................... $ 653 $ 1,607 $1,002
Income taxes paid (refunded)................................ (202) 517 156
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."
82
SCHEDULE I
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
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 accounting principles generally accepted in the
United States of America. 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 accounting principles
generally accepted in the United States of America. 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 -- 10% COLLATERALIZED SUBORDINATED DEBENTURES
As referenced in Note 6 in the Consolidated Financial Statements, the
Registrant's 10% Collateralized Subordinated Debentures due July 31, 2005, are
comprised of the following (in thousands):
DECEMBER 31,
---------------
2002 2001
------ ------
10% Debentures (face amount)................................ $6,468 $6,468
Unamortized gain, net of accumulated amortization........... 157 209
------ ------
Total.................................................. $6,625 $6,677
====== ======
NOTE 3 -- INCOME (LOSS) FROM DISCONTINUED OPERATIONS
In December 2000, the Company decided to discontinue and dispose of its
hotel segment, principally by allowing its non-recourse debt holders to assume
ownership of the properties through foreclosure or by selling or otherwise
disposing of its hotel properties. The Company's former hotel segment consisted
of three owned properties and two leased properties. As part of the planned
disposition, the Company evaluated the operations and economic environment in
which each of the hotels operated and in December 2001 and December 2000
recorded impairments of $935,000 and $4,000,000, respectively, to reduce hotel
carrying values to estimated fair market values, which is included in the equity
in net loss of hotel subsidiaries in the table below. Apart from the leasehold
interest in the GuestHouse Suites Plus hotel in Huntsville, Alabama that the
Company continues to operate and report as an asset held for use, hotel
operations have been segregated from the Company's continuing operations and
reported as discontinued hotel operations. The loss from discontinued operations
consists of the following (in thousands):
YEARS ENDED DECEMBER 31,
---------------------------
2002 2001 2000
------- ------- -------
Gain from extinguishment of debt........................ $ 5,789 $ 316 $ --
Deferred income tax (expense) benefit................... (1,800) 500 (341)
Equity in net loss of hotel subsidiaries................ (225) (1,986) (6,917)
Litigation and other disposition costs.................. (362) (214) (115)
Intercompany management fee............................. -- -- 400
------- ------- -------
Income (loss) from discontinued hotel operations...... $ 3,402 $(1,384) $(6,973)
======= ======= =======
83
SCHEDULE I
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
Energy operations have been segregated from the Company's continuing
operations and reported as a single line item -- income from discontinued energy
operations. A summary of its operations for each of the three years ended
December 31, 2002 are presented below:
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
----- ------- ------
Revenues
Gain on sale of investment in Hallwood Energy............. $ -- $ 8,725 $ --
Equity income from investment in Hallwood Energy.......... -- 1,837 2,826
----- ------- ------
-- 10,562 2,826
Expense
Deferred federal income tax (benefit)..................... -- (672) --
State income tax expense.................................. -- 100 --
----- ------- ------
-- (572) --
----- ------- ------
Income from discontinued energy operations............. $ -- $11,134 $2,826
===== ======= ======
NOTE 4 -- LITIGATION, CONTINGENCIES AND COMMITMENTS
See Note 18 to the consolidated financial statements.
The capital lease obligations associated with the Company's hotel
properties have been included as parent company liabilities, because the lease
obligations have been guaranteed by the parent company.
84
SCHEDULE II
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
CHARGED TO
BALANCE, (RECOVERY OF) CHARGED BALANCE,
BEGINNING COSTS AND TO OTHER END OF
OF YEAR EXPENSES ACCOUNTS DEDUCTIONS YEAR
--------- ------------- -------- ---------- --------
(IN THOUSANDS)
TEXTILE PRODUCTS
Allowance for losses -- accounts
receivable:
Year ended December 31, 2002........ $498 $181 -- $(369)(a) $310
Year ended December 31, 2001........ 375 147 -- (24)(a) 498
Year ended December 31, 2000........ 427 (13) $(10) (29)(a) 375
---------------
Notes:
(a) Write-offs, net of recoveries
85
THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.16 Promissory Note and Security Agreement regarding equipment
term loan in the amount of $298,018, dated as of December
20, 2002, between Brookwood Companies Incorporated, Kenyon
Industries, Inc., Brookwood Laminating, Inc., Ashford
Bromely, Inc., Xtramile, Inc., Land Ocean III, Inc. and
Strategic Technical Alliance LLC and Key Leasing, a division
of Key Corporate Capital, Inc., fixed interest -- 4.67%, due
December 20, 2007
10.18 Subordinated Secured Promissory Note, dated September 28,
2002, Between Strategic Technical Alliance, LLC, as Maker,
and Burlington Industries, Inc., as Holder, in the amount of
$685,695, payable in eight quarterly installments beginning
January 31, 2003
21. Active subsidiaries of the Registrant as of February 28,
2003
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
[ ] 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:
Name of each exchange on
Title of each class which registered
------------------------------------------------ ------------------------
UNITS REPRESENTING LIMITED PARTNERSHIP INTERESTS AMERICAN STOCK EXCHANGE
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
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act): Yes X No
--- ---
The aggregate market value of units held by nonaffiliates of the registrant as
of June 28, 2002 was $86,860,000.
CLASS: UNITS REPRESENTING LIMITED PARTNERSHIP INTERESTS.
OUTSTANDING AT MARCH 14, 2003: 1,593,948 UNITS.
================================================================================
Page 1 of 45
HALLWOOD REALTY PARTNERS, L.P.
FORM 10-K
TABLE OF CONTENTS
Page
----
PART 1
Item 1 Business 3
Item 2 Properties 6
Item 3 Legal Proceedings 7
Item 4 Submission of Matters to a Vote of Security Holders 8
PART II
Item 5 Market for Registrant's Units and Related Security Holder Matters 8
Item 6 Selected Financial Data 9
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 7a Quantitative and Qualitative Disclosures about Market Risk 17
Item 8 Financial Statements and Supplemental Information 18
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures 39
PART III
Item 10 Directors and Executive Officers of the Registrant 40
Item 11 Executive Compensation 41
Item 12 Security Ownership of Certain Beneficial Owners and Management 43
Item 13 Certain Relationships and Related Transactions 44
Item 14 Controls and Procedures 44
PART IV
Item 15 Exhibits, Financial Statement Schedule and Reports on Form 8-K 44
Page 2 of 45
PART I
ITEM 1. BUSINESS
DESCRIPTION OF THE BUSINESS
Hallwood Realty Partners, L.P. ("HRP"), a publicly traded Delaware limited
partnership, operates in the commercial real estate industry. HRP's activities
include the acquisition, ownership and operation of its commercial real estate
assets. Units representing limited partnership interests are traded on the
American Stock Exchange under the symbol "HRY".
As of December 31, 2002, HRP owned 14 real estate properties (the "Properties")
located in six states containing 5,199,000 net rentable square feet (for
additional information, see Item 2 - Properties). 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 ("Realty" or the "General Partner"), a Delaware limited
liability company and indirectly 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 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 ("HCRE"), another indirectly wholly-owned subsidiary
of Hallwood, provides property management, leasing and construction supervision
services to the Properties.
RISKS, COMPETITION AND OTHER FACTORS
DETERIORATION IN ECONOMIC CONDITIONS AND THE REAL ESTATE MARKETS COULD HARM
HRP'S BUSINESS.
The commercial real estate industry is sensitive to a number of factors relating
to global, national, regional and local general and economic conditions,
including war, threat of war, inflation, interest rates, taxation policies,
availability of credit, employment levels, and wage and salary levels. A
negative trend in any of these conditions could adversely affect HRP's business.
If a substantial number of tenants default on their leases, choose not to renew,
or if rental rates decrease, HRP's financial position could be adversely
affected. Such effects could include a decline in acquisition, disposition and
leasing activity; a decline in the supply of capital invested in commercial real
estate; or a decline in the value of real estate.
HRP's cash flow would be adversely affected by decreases in the performance of
the properties it owns. Property performance typically depends upon the ability
to attract and retain creditworthy tenants; the ability to manage operating
expenses; the magnitude of defaults by tenants under their respective leases;
governmental regulations; the nature and extent of competitive properties;
financial and economic conditions generally and in the specific areas where
properties are located; and the real estate market generally. Expenses may
increase due to unexpected or higher repairs and maintenance costs, inflation,
services and costs required to retain tenants or to sign new tenants,
unsuccessful appeals of rising real estate taxes, changes in interest rates,
higher insurance costs, the outcome of existing or future litigation, as well as
other factors, many of which are beyond the control of HRP.
HRP MAY BE SENSITIVE TO CHANGES IN INTEREST RATES.
Because only one of its mortgage loans has a floating interest rate, HRP's
exposure to changes in market interest rates is limited to the difference
between the market rate in effect at the time a loan matures compared to its
existing loan rate. As of December 31, 2002, HRP had mortgage loans totaling
$172,552,000 with fixed interest rates from 6.97% to 8.7% (with an effective
average interest rate of 8.21%). These loans mature between 2005 and 2020. At
the time of loan maturity, a higher market interest rate compared to the
existing rate will have a negative impact on the amount of mortgage proceeds
secured from a refinancing, as well as a decrease in cash flow from future
operations due to the higher interest rate.
A $25,000,000 mortgage loan secured by Allfirst Building bears interest at LIBOR
plus 130 basis points, and therefore HRP's actual cash interest costs are
affected by changes in market interest rates. The interest rate for this loan
was 2.68% as of December 31, 2002. Assuming a 100 basis point, or 1%, change in
LIBOR, interest paid by HRP would increase or decrease by $250,000 on an annual
basis.
Page 3 of 45
RISKS, COMPETITION AND OTHER FACTORS (CONTINUED)
INSURANCE RISKS HAVE INCREASED AS A RESULT OF RECENT EVENTS.
Due in large part to the terrorist activities of September 11, 2001, insurance
companies have re-examined many aspects of their business and have taken certain
actions in the wake of these terrorist activities, including increasing
premiums, mandating higher self-insured retentions and deductibles, reducing
limits, restricting coverages, imposing exclusions (such as sabotage and
terrorism), and refusing to underwrite certain risks and classes of business.
Significantly increased premiums, mandated exclusions, or changes in limits,
coverages, terms and conditions could adversely affect HRP's ability to obtain
appropriate insurance coverages. However, at this time the only impact on HRP
has been an increase in premiums. HRP has $250,000,000 of terrorism insurance
coverage.
HRP MAY INCUR ENVIRONMENTAL LIABILITY IN ITS ROLE AS A PROPERTY OWNER.
Various national, state and local laws and regulations impose liability on real
property owners, such as HRP, for the cost of investigating, cleaning up or
removing contamination caused by hazardous or toxic substances. The liability
may be imposed even if the original actions were legal and HRP did not know of,
or was not responsible for, the presence of such hazardous or toxic substances.
HRP may also be solely responsible for the entire payment of the liability if it
is subject to joint and several liability with other responsible parties who are
unable to pay. HRP may be subject to additional liability if it fails to
disclose environmental issues to a buyer or lessee of property or if a third
party is damaged or injured as a result of environmental contamination emanating
from the site. HRP cannot be sure that any of such liabilities to which it may
become subject will not have a material adverse effect upon its business,
results of operations or financial condition.
Parklane Towers, as well as certain other properties to a lesser extent, are
known to contain asbestos. Removal of asbestos at HRP's properties is not
required because it is cementitious, it is not friable and because the
procedures in HRP's site environmental program Operations and Maintenance Manual
are performed as required.
HRP MAY HAVE DIFFICULTY DISPOSING OF ASSETS WHEN IT HAS TO DO SO.
HRP's basic investment strategy is to hold real estate assets until what it
believes to be an optimal time to sell them. Normally, this will be during
relatively strong real estate markets. However, factors beyond HRP's control
could make it necessary for HRP to dispose of real estate properties during weak
markets. Further, markets for real estate assets are not usually highly liquid,
which can make it particularly difficult to realize acceptable prices when
disposing assets during weak markets.
IF HRP DOES NOT GENERATE SUFFICIENT CASH FLOWS FROM OPERATIONS, IT MAY NEED
ADDITIONAL CAPITAL.
To date, HRP has financed its operations with cash from profitably operating its
established properties. If HRP does not generate enough cash from operations to
finance its business in the future, it will need to raise additional funds
through public or private financing or asset sales. If HRP borrows money, it may
be required to agree to restrictions limiting its operating flexibility. If HRP
requires additional funds and is not able to obtain such funds, it would have a
material adverse effect on its operations.
SOME OF HRP'S LOANS CONTAIN COVENANTS AND RESTRICTIONS, WHICH AFFECT
FLEXIBILITY.
HRP has two mortgage loans that require compliance with a loan covenant, which
if not met will trigger a default. The loans require the properties securing
each loan to maintain a liquidity ratio, specifically a debt service coverage
ratio. A debt service coverage ratio is the relationship of adjusted net
operating income (as defined in each loan agreement) for the previous 12 months
to the loan's annual debt service. The ratio, for a loan requiring a minimum
1.15 ratio, was 2.25, 2.35, and 2.19 for 2002, 2001, and 2000, respectively. The
ratio, for a loan requiring a minimum 1.10 ratio, was 2.39, 1.94, and 2.45 for
the same periods. Accordingly, HRP was in compliance with these loan covenants
for the three years ended December 31, 2002. As of December 31, 2002, the
outstanding balance of the loans is $111,553,000.
Additionally, these two mortgage loans contain restrictions that limit certain
actions. With respect to the properties encumbered by these loans, HRP cannot
incur additional debt. Also, HRP's ability to sell a property, or a portion
thereof, is limited because of the requirement to substitute collateral with
substantial penalty. These loans also, under certain circumstances, may restrict
the ability of HRP to merge, to consolidate or to liquidate.
Page 4 of 45
RISKS, COMPETITION AND OTHER FACTORS (CONTINUED)
HRP IS SUBJECT TO LITIGATION.
HRP is currently a party to certain litigation in Delaware state court, as
described more fully in Item 3 - Legal Proceedings. The trial court in that
matter ruled that the defendants other than HRP pay a judgment in the amount of
$3,417,423, plus pre-judgment interest from August 1995 to HRP. The plaintiff
and certain defendants have appealed that ruling. In October 2001, HRP received
the $3,417,423 judgment together with $2,987,576 of pre-judgment and
post-judgment interest, subject to an arrangement that it be returned in full or
part if the judgment is modified or reversed on appeal. If the appellate court
reverses the judgment, any subsequent ruling by the trial court on remand may be
more or less favorable to HRP.
HRP IS SUBJECT TO COMPETITION.
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.
OTHER.
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. Currently, approximately 90
employees of Realty and/or HCRE render services on behalf of HRP and its
Properties.
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.
OCCUPANCY AND MAJOR TENANT INFORMATION
For information regarding occupancy, percentages of square feet scheduled to
expire by calendar year, and major tenants, see "Liquidity and Capital
Resources" in Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Page 5 of 45
ITEM 2. PROPERTIES
As of December 31, 2002, HRP owned 14 properties located in six states with
5,199,000 net rentable square feet.
NET
RENTABLE ACRES PERCENTAGE
YEAR(S) SQUARE OF LEASED AS OF
NAME AND LOCATION DESCRIPTION CONSTRUCTED FEET LAND 12/31/2002
------------------------------- -------------------------- ------------ --------- ----- ------------
AIRPORT PLAZA three story 1982 48,637 2 100%
San Diego, California office building
ALLFIRST BUILDING 22 story 1972 343,080 0.6 98%
Baltimore, Maryland office building
BELLEVUE CORPORATE PLAZA ten story 1980 242,861 3.6 74%
Bellevue, Washington office building
BRADSHAW BUSINESS PARKS 21 single story 1974 to 1980 452,838 31 95%
Sacramento and Rancho Cordova, office/warehouse buildings
California at four sites
CORPORATE SQUARE 10 one to seven story 1967 to 1973, 593,061 34 94%
Atlanta, Georgia office buildings 2000
EXECUTIVE PARK 26 one to six story 1965 to 1972, 1,019,615 70 88%
Atlanta, Georgia office buildings 2002
FAIRLANE COMMERCE PARK 11 single story buildings 1973 to 1990 416,056 35 100%
Dearborn, Michigan in office/industrial park
FOUNTAIN VIEW BUSINESS CENTER 3 three story 1980 89,432 4.3 96%
San Diego, California office buildings
GULLEY ROAD INDUSTRIAL PARK 5 single story buildings 1990 to 1993 154,360 11 83%
Dearborn, Michigan in an industrial park
MONTROSE OFFICE CENTER ten story 1980 147,337 3 99%
Rockville, Maryland office building
PARKLANE TOWERS twin fifteen story 1973 486,607 31.8 94%
Dearborn, Michigan office buildings
RAINTREE INDUSTRIAL PARK 14 single story buildings 1971 to 1979 795,198 49 84%
Solon, Ohio in office/industrial complex
RIVERBANK PLAZA 2 three story 1978 40,222 1.6 100%
San Diego, California office buildings
SEATTLE BUSINESS PARKS 17 single story 1972 to 1978, 369,248 23 87%
Kent and Tukwila, Washington buildings in two 1993
office/industrial parks
Allfirst Bank, the principal tenant of Allfirst Building, has options to
purchase the building from HRP for $28,000,000 in either 2004 or 2006. For
information regarding this project as well as encumbrances to which any
properties are subject and the status of related mortgage loans, see "Liquidity
and Capital Resources" in Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations, as well as Note 6 to the
Consolidated Financial Statements and Schedule III in Item 8 - Financial
Statements and Supplemental Information.
OFFICE SPACE -
HRP leases and shares offices with Hallwood in Dallas, Texas under a lease which
expires November 30, 2008. HRP has a one-time option to terminate the lease
effective November 30, 2005. The annual minimum cash rental payments are
$315,000, of which HRP's portion is approximately $210,000 annually.
Page 6 of 45
ITEM 3. LEGAL PROCEEDINGS
On June 20, 1997, an action was filed against HRP, the General Partner, its
directors, and Hallwood by Gotham Partners, L.P. in the Court of Chancery of the
State of Delaware, styled Gotham Partners, L.P. v. Hallwood Realty Partners,
L.P., et al. (C.A. No. 15754). This action alleges claims of breach of fiduciary
duties, breach of HRP's partnership agreement, and fraud in connection with
certain transactions involving HRP's units in the mid 1990's. Hallwood is
alleged to have aided and abetted the alleged breaches. On June 21, 2000, after
completing fact discovery, all parties moved for summary judgment on several
issues. In September and October 2000, the Delaware court issued three separate
written opinions resolving the summary judgment motions. In the opinions, the
court ruled that trial would be required as to all issues, except that (i)
Gotham was found to have standing to pursue its derivative claims; (ii)
defendants were entitled to judgment dismissing the fraud claim; (iii) the
General Partner was entitled to judgment dismissing the breach of fiduciary duty
claims brought against it; and (iv) the General Partner's outside directors were
entitled to judgment dismissing all claims brought against them.
A five-day trial was held in January 2001. On July 18, 2001, the Delaware Court
of Chancery rendered its opinion. In its decision, the court determined that an
option plan and a sale of units to Hallwood in connection with a reverse split
of units implemented by HRP in 1995 were in compliance with HRP's partnership
agreement. The court also found that the sale of units to Hallwood in connection
with a 1995 odd-lot offer by HRP did not comply with certain procedures required
by the HRP partnership agreement. The court ruled that the defendants other than
HRP pay a judgment to HRP in the amount of $3,417,423, plus pre-judgment
interest from August 1995. The judgment amount represents what the court
determined was an underpayment by Hallwood. In August 2001, plaintiff and
certain defendants appealed the Court of Chancery's judgment to the Delaware
Supreme Court. In October 2001, HRP received the $3,417,423 judgment together
with $2,987,576 of interest, subject to an arrangement that it be returned in
full or part if the judgment is modified or reversed on appeal. Oral arguments
were heard on February 12, 2002, and a rehearing en banc was held on March 26,
2002. On August 29, 2002, the Supreme Court affirmed the judgment of the trial
court that the remaining defendants other than HRP are jointly and severally
liable to HRP. The Supreme Court reversed the trial court's determination of
damages, and remanded the case to the trial court to fashion appropriate relief.
A hearing on the remand proceedings was held before the Court of Chancery on
October 25, 2002. A further hearing on the remand is scheduled to take place in
May or June 2003, with a decision by the Court of Chancery to follow. Since the
appellate court reversed the judgment, any subsequent ruling by the trial court
on remand may be more or less favorable to HRP. As a result of the uncertainty
of the litigation's outcome, HRP recorded the judgment and interest as "Deferred
Litigation Proceeds" on its balance sheet.
On February 15, 2000, HRP filed a lawsuit in the United States District Court
for the Southern District of New York styled Hallwood Realty Partners, L.P. v.
Gotham Partners L.P., et al. (Civ. No. 00 CV 1115) alleging violations of the
Securities Exchange Act of 1934 by certain purchasers of its units, including
Gotham Partners, L.P., Gotham Partners III, L.P., Private Management Group,
Inc., Interstate Properties, Steven Roth and EFO Realty, Inc., by virtue of
those purchasers' misrepresentations and/or omissions in connection with filings
required under the Securities Exchange Act of 1934. The complaint further
alleged that defendants, by acquiring more than 15% of the outstanding HRP
units, have triggered certain rights under its Unit Purchase Rights Agreement,
for which HRP was seeking declaratory relief. HRP sought various forms of
relief, including declaratory judgments, divestiture, corrective disclosures, a
"cooling-off" period and damages, including costs and disbursements. On November
16, 2000, the court granted HRP's motion to add as defendants Gotham Holdings
II, L.L.C., Hallwood Investors, L.P., Liberty Realty Partners, L.P. and
EFO/Liberty, Inc. and to remove EFO Realty, Inc. as a defendant. Discovery was
completed in December 2000 and trial was held in February 2001. On February 23,
2001, the court rendered a decision in favor of the defendants and on February
28, 2001, the court ordered the complaint dismissed. HRP filed a Notice of
Appeal on March 29, 2001. Oral argument was heard on March 4, 2002. On April 11,
2002, the U.S. Court of Appeals for the Second Circuit upheld the lower court's
ruling in favor of defendants. On April 25, 2002, HRP filed with the court a
Petition for Rehearing and Rehearing En Banc with respect to the April 11, 2002
decision. On June 3, 2002, the Second Circuit denied that petition. HRP has not
sought further appellate review and the determination in favor of defendants is
now final.
HRP is from time to time involved in various other 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.
Page 7 of 45
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 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S UNITS AND RELATED SECURITY HOLDER MATTERS
HRP's units are traded on the American Stock Exchange under the symbol "HRY". As
of March 14, 2003, there were approximately 24,000 unitholders owning the
1,593,948 units outstanding. Each quarter Realty reviews HRP's capacity to make
cash distributions to its partners. HRP has not paid any cash distributions
since February, 1992.
The following table shows the high and low closing prices for the periods
indicated, as reported by the American Stock Exchange:
CLOSING PRICES
--------------------
HIGH LOW
--------- ---------
2001 -
1st Quarter $ 71.75 $ 47.50
2nd Quarter 67.50 56.00
3rd Quarter 60.00 52.00
4th Quarter 71.02 52.75
2002 -
1st Quarter $ 72.25 $ 69.00
2nd Quarter 70.25 68.50
3rd Quarter 94.50 58.00
4th Quarter 87.95 80.50
Page 8 of 45
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data regarding HRP'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.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
(in thousands except per unit amounts)
STATEMENTS OF OPERATIONS:
Total revenues(a) $ 73,739 $ 74,691 $ 69,901 $ 61,470 $ 58,056
Income (loss) before interest income, gain from
property sales, and cumulative effect of
SFAS No. 133 adoption 6,294 3,293 (1,267) 3,154 10,723
Income (loss) before cumulative effect
of SFAS No. 133 adoption 6,931 8,520 (299) 4,062 11,593
Net income (loss) 6,931 8,328 (299) 4,062 11,593
Income (loss) per unit and equivalent unit :
Basic -
Income (loss) before cumulative effect
of SFAS No. 133 adoption 4.32 5.31 (0.18) 2.40 6.86
Net income (loss) 4.32 5.19 (0.18) 2.40 6.86
Assuming dilution -
Income (loss) before cumulative effect
of SFAS No. 133 adoption 4.16 5.13 (0.18) 2.31 6.59
Net income (loss) 4.16 5.01 (0.18) 2.31 6.59
BALANCE SHEETS:
Real estate, net(b) $ 209,838 $ 213,574 $ 206,392 $ 192,814 $ 175,779
Total assets 274,420 269,875 254,504 230,386 214,023
Mortgages payable 197,552 201,224 200,096 171,312 162,078
Partners' capital(c) 60,675 54,022 44,490 48,696 44,634
NOTES TO SELECTED FINANCIAL DATA:
(a) Reclassifications, including a gross-up for parking, construction and
tenant service expenses that were previously netted against revenues,
have been made in the prior year amounts to conform to the
classifications used in the current year. The reclassifications occurred
due to the adoption of EITF No. 01-14, "Income Statement
Characterization of Reimbursements Received for Out-of-Pocket Expenses
Incurred". The reclassifications had no effect on previously reported
net income or loss.
(b) Acquisition and development activity from 1999 to 2001 increased HRP's
real estate assets. These increases were partially offset by
depreciation and amortization. Prior to 1999, 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 includes Accumulated Other Comprehensive Income of
$926,000 and $1,204,000 as of December 31, 2002 and 2001, respectively.
Partners' capital balance is allocated 99% to the limited partners and
1% to the General Partner.
Page 9 of 45
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
2002 COMPARED TO 2001 -
REVENUE FROM PROPERTY OPERATIONS in 2002 increased $399,000, or 0.6%, compared
to 2001. The following table illustrates the components of the change, in
thousands:
Rental income, net $ 830
Other property income (431)
-----
Net increase $ 399
=====
Net rental income increased primarily due to an overall 5% increase in rental
rates offset by a decrease in average occupancy between periods from 90.9% to
87.3%. Average occupancy for 2002 was 89.0% excluding the new, but unoccupied,
building at Executive Park, which was completed in April 2002 - see Note 5 to
the Consolidated Financial Statements for more information. Other property
income decreased due to a reduction in tenant expense recoveries.
REVENUE FROM PARKING, CONSTRUCTION AND TENANT SERVICES for 2002 decreased
$1,351,000, or 16.7%, primarily as a result of a few major construction service
projects completed in 2001. By their nature, the demand for and size of
construction service projects can vary significantly from time to time.
PROPERTY OPERATING EXPENSES for 2002 increased $271,000, or 1.0%, compared to
2001. The change in expense includes non-specific, or general, increases in real
estate taxes, property and liability insurance premiums, and property level
salaries, partially offset by a general decrease in utilities and landscaping
costs.
PARKING, CONSTRUCTION AND TENANT SERVICES EXPENSE for 2002 decreased $787,000,
or 14.8%, primarily as a result of a few major construction service projects
completed in 2001. By their nature, the demand for and size of construction
service projects can vary significantly from time to time.
INTEREST EXPENSE for 2002 decreased $980,000, or 6.1%, compared to 2001, as a
result of a decrease in mortgage loan interest of $611,000 (primarily due to a
lower interest rate for HRP's only variable rate mortgage secured by Allfirst
Building), a decrease in capitalized interest of $230,000, and a decrease in
loan cost amortization and other interest costs of $40,000. (For more
information about the variable rate mortgage, see Item 7a - Quantitative and
Qualitative Disclosures About Market Risk.) Additionally, 2001 included $559,000
of prepayment penalties and other costs related to the early payoff of loans;
these costs were reclassified in the fourth quarter of 2002 from an
extraordinary item to current operations within interest expense as a result of
the adoption of Statement of Financial Accounting Standards ("SFAS") No. 145.
DEPRECIATION AND AMORTIZATION EXPENSE for 2002 increased $335,000, or 2.3%,
primarily due to depreciation for the newly completed building at Executive
Park.
GENERAL AND ADMINISTRATIVE EXPENSES for 2002 increased $239,000, or 5.5%,
compared to 2001, due to increases in certain professional fees, state franchise
taxes, director and officer liability insurance, and overhead costs.
LITIGATION COSTS were $777,000 and $3,808,000 for 2002 and 2001, respectively,
and are related to the lawsuits described in Item 3 - Legal Proceedings and Note
10 to the Consolidated Financial Statements.
INTEREST INCOME decreased by $406,000, or 38.9%, as a result of decreased
earnings on overnight cash investments due to significantly lower interest rates
available between years.
Page 10 of 45
RESULTS OF OPERATIONS (CONTINUED)
2001 COMPARED TO 2000 -
REVENUE FROM PROPERTY OPERATIONS in 2001 increased $2,929,000, or 4.6%, compared
to 2000. The following table illustrates the components of the change, in
thousands:
Rental income, net $ 2,208
Other property income 721
---------
Net increase $ 2,929
=========
Net rental income increased due to revenues generated from the addition and
completion of one development property at Corporate Square in mid-2000
($1,971,000), overall higher rental rates at most of HRP's real estate
properties, and an increase in average occupancy between years from 89.4% to
90.9%. As of December 31, 2001, HRP had leases executed and in place for
approximately 91% of the portfolio's net rentable square feet (excluding a
125,000 square foot development property at Executive Park). Other property
income increased primarily due to increases in tenant expense recoveries.
REVENUE FROM PARKING, CONSTRUCTION AND TENANT SERVICES for 2001 increased
$1,861,000, or 29.8%, primarily as a result of a few major construction service
projects completed in 2001. By their nature, the demand for and size of
construction service projects can vary significantly from time to time.
PROPERTY OPERATING EXPENSES for 2001 increased $641,000, or 2.4%, compared to
2000. The increase is comprised primarily of the following components:
o Operating costs with respect to the addition of the one
development property at Corporate Square completed in mid-2000
were $629,000 greater than in 2001.
o Professional fees decreased $705,000 primarily due to costs
incurred in 2000 for research and analysis of potential
property development projects.
o Combined, all other operating costs increased $717,000, or
about 2.7%, of which none are individually significant.
PARKING, CONSTRUCTION AND TENANT SERVICES EXPENSE for 2001 increased $1,757,000,
or 49.1%, primarily as a result of a few major construction service projects
completed in 2001. By their nature, the demand for and size of construction
service projects can vary significantly from time to time.
INTEREST EXPENSE for 2001 increased $313,000, or 2.0%, compared to 2000 as a
result of an increase in mortgage loan interest of $845,000 (due to a higher
average mortgage loan balance), partially offset by the capitalization of
$486,000 of interest for construction of the development project at Executive
Park (as described in Note 5 to the Consolidated Financial Statements), and a
decrease in loan cost amortization and other interest costs of $46,000.
DEPRECIATION AND AMORTIZATION EXPENSE was consistent between years and increased
$64,000, or 0.4%.
GENERAL AND ADMINISTRATIVE EXPENSES for 2001 decreased $690,000, or 13.7%,
compared to 2000 primarily due to $601,000 of non-qualified unit option
compensation in 2000.
LITIGATION COSTS were $3,808,000 and $5,663,000 for 2001 and 2000, respectively,
and are related to the lawsuits described in Item 3 - Legal Proceedings and Note
10 to the Consolidated Financial Statements.
GAIN FROM PROPERTY SALES of $4,184,000 in 2001 is comprised of the January sale
of one building at Seattle Business Parks for a gross selling price of
$3,287,000, resulting in a gain of $2,109,000; the January sale of one building
at Fairlane Commerce Park for a gross selling price of $575,000, resulting in a
gain of $153,000; and the March sale of Joy Road Distribution Center for a gross
selling price of $5,326,000, resulting in a gain of $1,922,000.
INTEREST INCOME increased by $75,000, or 7.7%, as a result of increased earnings
on overnight cash investments due to a higher average cash balance available for
investment, partially offset by lower interest rates.
Page 11 of 45
LIQUIDITY AND CAPITAL RESOURCES
GENERAL INFORMATION -
HRP operates in the commercial real estate industry. HRP's activities include
the acquisition, ownership and operation of its commercial real estate assets.
While it is the General Partner's 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, operations, and other factors
to determine if any should be considered for disposition.
As of December 31, 2002, HRP owned 14 real estate assets (the "Properties")
located in six states containing 5,199,000 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.
HRP fully consolidates into its financial statements majority owned entities.
For each of the three years in the period ended December 31, 2002, all entities
and Properties were fully owned. All significant intercompany balances and
transactions have been eliminated in consolidation.
HRP has, in three situations, created a Special Purpose Entity ("SPE"). These
SPEs were formed at the request of lenders for the express purpose of
strengthening the collateral for the loans by isolating (for Federal bankruptcy
law purposes) the assets and liabilities of the SPEs. In all cases and since
their various formation dates, the assets, liabilities and results of operations
of these wholly-owned entities have been fully consolidated into the financial
statements of HRP.
CASH SOURCES, CASH USES AND COMMITMENTS -
HRP's cash position increased $7,450,000 during 2002 to $32,363,000 as of
December 31, 2002. The source of cash during the year was $19,726,000 of cash
provided by operating activities,. The uses of cash were $6,617,000 for property
and tenant improvements, $1,977,000 for property development costs, $3,672,000
for scheduled mortgage principal payments, and $10,000 for loan fees.
For the foreseeable future, HRP anticipates that mortgage principal payments,
tenant and capital improvements, lease commissions and litigation costs will be
funded by net cash from operations. We believe that there will be sufficient
cash from operations to meet these needs because HRP has leases in place as of
December 31, 2002 to provide $54,963,000 of minimum rental payments during 2003
(see "Liquidity and Capital Resources - Lease Agreements and Major Tenant
Information"). For 2002, HRP had leases in place to provide $55,261,000 of
minimum rental payments (based on leases in place as of December 31, 2001),
however the actual rental payments recorded for 2002 were $61,481,000. Actual
rental payment results for 2002 were greater than the minimum rental payment
amount primarily due to our ability to attract and retain tenants. Our ability
to fund operations in the future will depend upon continued success in
maintaining current occupancy levels, retaining current tenants, and attracting
new tenants, as well as sustaining or increasing rental rates.
The primary sources of capital to fund any future acquisitions or developments
will be proceeds from the sale, financing or refinancing of one or more of our
properties. HRP has estimated and budgeted tenant and capital improvements of
$15,631,000 and lease commissions of $2,851,000 for 2003. Each quarter Realty
reviews HRP's capacity to make cash distributions. HRP has not made any cash
distributions since February, 1992.
CRITICAL ACCOUNTING POLICIES -
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and judgments that affect the reported amounts of certain assets,
liabilities, revenues, expenses, and related disclosures. Actual results may
differ from these estimates under different assumptions or conditions. In
December 2001, the SEC requested that registrants identify "critical accounting
policies" in Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations. The SEC indicated that a "critical
accounting policy" is one that is both important to the portrayal of an entity's
financial condition and results and requires management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain. HRP believes that the
following of its accounting policies fit this description:
Page 12 of 45
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Impairment of Long-Lived Assets - HRP reviews for impairment losses on its real
estate assets when events and circumstances indicate that the assets might be
impaired. If such indication is noted, an undiscounted cash flow analysis is
performed, and in the event undiscounted cash flow estimated to be generated by
an asset over the remaining depreciable life of that asset is less than its
carrying value, then the asset would be written down to its fair value. Cash
flow estimates are based on historical results adjusted to our best estimate of
future market and operating conditions. Significant assumptions used in this
process include an evaluation of leases in place, future rental and occupancy
rates, and the level of expected operating expenses. For the three years ended
December 31, 2002, HRP has not recorded a write-down or impairment of the
carrying value of any real estate property based on these calculations.
Assets Held for Sale - Should HRP decide to sell a property and actively
commence the disposal process, all of the assets, liabilities, income, and
expenses associated with such property will be segregated in the financial
statements. At such time, an evaluation for potential impairment will be made
using an estimate of the selling price less selling costs.
Revenue Recognition - SFAS No. 13 "Accounting for Leases" requires management to
estimate the economic life of lease payments. However, this does not require
subjective input by management, as rental income is recognized on a
straight-line basis over the lease term, as defined in each respective lease.
Adjustments to convert cash rental income (which may include free rent, reduced
rent, or periodic rental rate increases over the term of the lease) to
straight-line rental income increased revenues by $99,000, $256,000, and
$569,000 in 2002, 2001, and 2000, respectively.
Other accounting policies are described in Note 2 to the Consolidated Financials
Statements in Item 8. The policies listed are not intended to be a comprehensive
list of all of our accounting policies. In most cases, the accounting treatment
of a particular transaction is specifically dictated by accounting principles
generally accepted in the United States of America, with no need for
management's judgment in the application. There are also areas in which
management's judgment in selecting any available alternative would not produce a
materially different result than those recorded and reported.
RECENT ACCOUNTING PRONOUNCEMENTS -
SFAS No. 142 "Goodwill and Other Intangible Assets" was issued in June 2001 and
was adopted January 1, 2002. Among other things, SFAS No. 142 requires that in
conjunction with an acquisition of a property in the future all intangible
assets associated with such property will be separately evaluated and recorded.
SFAS No. 143 "Accounting for Asset Retirement Obligations" was adopted January
1, 2003. It establishes an accounting standard for recognition and measurement
of a liability for an asset retirement obligation and the associated asset
retirement cost. HRP has no such obligations as of December 31, 2002.
SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets"
was adopted January 1, 2002 and requires current, as well as historical, results
of operations for disposed properties and those properties held for sale that
occur subsequent to January 1, 2002 to be reclassified and presented separately
as discontinued operations.
SFAS No. 145 "Rescission of FASB Statements 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" was issued in April 2002 and was
adopted in the fourth quarter of 2002. Among other things, SFAS No. 145 limits
debt extinguishments that can be classified as extraordinary items. As a result,
HRP has reclassified previously recorded gains and losses from early
extinguishment of debt from an extraordinary item to current operations within
interest expense. Accordingly, the reclassifications had no effect on previously
reported net income or loss.
SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities"
was issued in June 2002 and will be effective for exit or disposal activities
subsequent to December 31, 2002. HRP anticipates no material impact on its
financial statements from the adoption of this accounting standard.
SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of FASB Statement No. 123" was issued in December 2002
and provides new transition methods if an entity adopts the fair value based
method of valuing stock-based compensation suggested in SFAS No. 123, as well as
requiring additional disclosures in interim and annual financial statements. At
this time, HRP expects that the impact will be limited to additional disclosure
requirements.
Page 13 of 45
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
In November 2002, the Financial Accounting Standards Board issued Interpretation
No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45
requires that the guarantor recognize, at the inception of certain guarantees, a
liability for the fair value of the obligation undertaken in issuing such
guarantee. FIN 45 also requires additional disclosure about the guarantor's
obligations under certain guarantees that it has issued. As of December 31, 2002
HRP had no such guarantees.
LEASE AGREEMENTS AND MAJOR TENANT INFORMATION -
Lease provisions generally require HRP's tenants to pay fixed rental amounts,
plus their proportionate share of certain building operating costs and real
property taxes. Revenue from expense recoveries, included in property
operations, was $3,755,000, $4,197,000, and $3,315,000 in 2002, 2001, and 2000,
respectively. In addition, certain leases include provisions for annual rental
adjustments. Some leases contain provisions to allow a tenant to terminate their
lease prior to its normal expiration. At December 31, 2002, the Properties, in
the aggregate, were 91% leased. The following table sets forth the minimum cash
rental payments to be received from leases in place as of December 31, 2002 (in
thousands):
Payments Payments
from Leases from Leases
without Early with Early
Termination Termination
Rights Rights Total
--------------- --------------- ---------------
2003 $ 54,963 $ 651 $ 55,614
2004 48,306 413 48,719
2005 40,003 238 40,241
2006 27,928 1,837 29,765
2007 20,348 3,485 23,833
Thereafter 75,796 35,962 111,758
--------------- --------------- ---------------
Total $ 267,344 $ 42,586 $ 309,930
=============== =============== ===============
Based on leases in place as of December 31, 2002, set forth below are the
percentages of leased square footage scheduled for lease expirations for each
calendar year, assuming that none of the tenants exercise early termination or
renewal options:
2003 23%
2004 14%
2005 14%
2006 15%
2007 7%
Thereafter 27%
During 2002 and 2001, two tenants leasing space contributed 10% or more of HRP's
revenues. Ford Motor Company and affiliates ("Ford") leases space in Parklane
Towers and Fairlane Commerce Park. Ford accounted for 11% and 12% of revenues in
2002 and 2001, respectively. The General Services Administration ("GSA") leases
space in Corporate Square and Executive Park. GSA accounted for 17% and 14% of
revenues in 2002 and 2001, respectively.
As of December 31, 2002, Ford leased 199,000 square feet of office space under
seven leases at Parklane Towers and 224,000 square feet of office, technical
laboratory and industrial space under seven leases at Fairlane Commerce Park.
These leases expire between 2003 and 2005 and most contain options providing for
one to ten year renewals. As of December 31, 2002, GSA leased 450,000 square
feet of office space at Executive Park (including 128,000 square feet associated
with a lease that begins in 2003 - see "Liquidity and Capital Resources -
Property Development at Executive Park") under seven leases which expire between
2003 and 2015. Also, as of December 31, 2002, GSA leased 310,000 square feet of
office space at Corporate Square under three leases which expire in 2004, 2013
(with a right to early terminate in 2008) and 2020. 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 14 of 45
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
LITIGATION & JUDGMENT -
In July 2001, the Delaware Court of Chancery rendered its opinion for the action
styled Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., et al. (C.A. No.
15754). The court ruled that the defendants other than HRP pay a judgment to HRP
in the amount of $3,417,423, plus pre-judgment interest from August 1995. The
judgment amount represents what the court determined was an underpayment by
Hallwood. In August 2001, plaintiff and certain defendants appealed the Court of
Chancery's judgment to the Delaware Supreme Court. In October 2001, HRP received
the $3,417,423 judgment together with $2,987,576 of interest, subject to an
arrangement that it be returned in full or part if the judgment is modified or
reversed on appeal. Oral arguments were heard in February 2002 and a rehearing
en banc was held in March 2002. In August 2002, the Supreme Court affirmed the
judgment of the trial court that the remaining defendants other than HRP are
jointly and severally liable to HRP. The Supreme Court reversed the trial
court's determination of damages, and remanded the case to the trial court to
fashion appropriate relief. A hearing on the remand proceedings was held before
the Court of Chancery in October 2002. A further hearing on the remand is
scheduled to take place in May or June 2003, with a decision by the Court of
Chancery to follow. (For more information about this litigation, see Item 3 -
Legal Proceedings.) Since the appellate court reversed the judgment, any
subsequent ruling by the trial court on remand may be more or less favorable to
HRP. As a result of the uncertainty of the litigation's outcome, HRP recorded
the judgment and interest as "Deferred Litigation Proceeds" on its balance
sheet.
MORTGAGE LOANS -
Substantially all of the buildings in HRP's real estate properties were
encumbered and pledged as collateral by 11 non-recourse mortgage loans
aggregating $197,552,000 as of December 31, 2002. These mortgage loans have
interest rates varying from 2.68% to 8.70% (with an effective average interest
rate of 7.51%) and mature between 2005 and 2020. Other than Allfirst Building's
mortgage ($25,000,000), all mortgages have fixed interest rates. Most of the
mortgage loans require monthly principal payments with balloon payments due at
maturity. The following table shows for the years presented the principal and
balloon payments that are required (in thousands):
Total
Mortgage
Principal Balloon Loan
Payments Payments Payments
-------------- -------------- --------------
2003 $ 3,998 $ -- $ 3,998
2004 4,310 -- 4,310
2005 4,167 74,515 78,682
2006 2,852 25,000 27,852
2007 3,079 -- 3,079
Thereafter 22,894 56,737 79,631
-------------- -------------- --------------
Total $ 41,300 $ 156,252 $ 197,552
============== ============== ==============
Since August 2000, HRP has had available a $2,000,000 revolving line of credit,
which matures on July 29, 2003. The line of credit has a variable interest rate
of either prime plus 0.50% or LIBOR plus 3.0% and requires monthly interest
payments, but no principal amortization. HRP has not borrowed against this
facility.
HRP has two mortgage loans that require compliance with a loan covenant, which
if not met will trigger a default. The loans require the properties securing
each loan to maintain a liquidity ratio, specifically a debt service coverage
ratio. A debt service coverage ratio is the relationship of adjusted net
operating income (as defined in each loan agreement) for the previous 12 months
to the loan's annual debt service. The ratio, for a loan requiring a minimum
1.15 ratio, was 2.25, 2.35, and 2.19 for 2002, 2001, and 2000, respectively. The
ratio, for a loan requiring a minimum 1.10 ratio, was 2.39, 1.94, and 2.45 for
the same periods. Accordingly, HRP was in compliance with these loan covenants
for the three years ended December 31, 2002. As of December 31, 2002, the
outstanding balance of the loans is $111,553,000.
Additionally, these two mortgage loans contain restrictions that limit certain
actions. With respect to the properties encumbered by these loans, HRP cannot
incur additional debt. Also, HRP's ability to sell a property, or a portion
thereof, is limited because of the requirement to substitute collateral with
substantial penalty. These loans also, under certain circumstances, may restrict
the ability of HRP to merge, to consolidate or to liquidate.
Page 15 of 45
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
TRANSACTIONS WITH RELATED PARTIES -
Realty receives certain fees in connection with the ongoing management of HRP,
including an asset management fee, acquisition fees and disposition fees.
Specifically, Realty is entitled to receive an asset management fee equal to 1%
of the net aggregate base rents of the Properties, acquisition fees equal to 1%
of the purchase price of newly acquired properties, and disposition fees with
respect to real estate investments, other than the properties owned at the time
of HRP's formation in 1990, equal to 10% of the amount, by which the sales price
of a property exceeds the purchase price of such property.
HCRE 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, 2004 and provide for
basic compensation from a property management fee in an amount equal to 2.85% of
cash receipts collected from the Properties' tenants, lease commissions equal to
the current commission market rate as applied to the net aggregate rent (none
exceeding 6% of the net aggregate rent), and 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 and are reimbursed, at cost, for certain costs and expenses.
In particular, since HRP does not directly employ any individuals, the
compensation and other costs related to approximately 90 employees rendering
services on behalf of HRP and its properties are reimbursed to Realty and HCRE
by HRP. The following table sets forth such compensation and reimbursements paid
by HRP (in thousands):
Entity
Paid or
Reimbursed 2002 2001 2000
----------- ----------- ----------- -----------
Asset management fee Realty $ 618 $ 609 $ 581
Acquisition fee Realty -- -- 74
Disposition fee Realty -- 120 --
Reimbursement of costs(a) Realty 3,477 3,161 2,720
Property management fee HCRE 2,022 2,005 1,914
Lease commissions(b) HCRE 2,151 2,158 2,605
Construction fees HCRE 582 1,204 917
Reimbursement of costs(c) HCRE 3,916 3,826 3,521
(a) These expenses are recorded as general and administrative
expenses and represent reimbursement, at cost, to Realty for
administrative level employee and director compensation,
officer and director liability insurance, and allocated
overhead costs. HRP pays its account balance with Realty on a
monthly basis.
(b) As of December 31, 2002, $567,000 of the 2002 lease
commissions are accrued and are scheduled to be paid in 2003.
(c) These costs are recorded as property operating expenses and
represent reimbursement to HCRE for property-level employee
compensation and related expenses.
In January 2001, HRP acquired a construction development consulting contract
from Hallwood regarding a project in Tulsa, Oklahoma with an unrelated third
party. In connection therewith, HRP reimbursed Hallwood for its actual costs
incurred related to the project of $281,000.
INFLATION -
Inflation did not have a significant impact on HRP during the three years ended
December 31, 2002 and is not anticipated to have a material impact in 2003.
RISKS, COMPETITION AND OTHER FACTORS -
For information about risks, see "Risks, Competition and Other Factors" in Item
1 - Business.
Page 16 of 45
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
PROPERTY DEVELOPMENT AT EXECUTIVE PARK -
In early 2001, HRP demolished a one-story office building at its Executive Park
property, which contained 18,000 net rentable square feet. In order to do so,
HRP obtained a release of the building from Executive Park's mortgage lien by
substituting for such collateral $608,000 of United States Treasury Bonds, which
have various maturity dates through December 2007. In February 2001, HRP began
constructing a five-story office building containing 128,000 net rentable square
feet. The building and its parking garage, excluding tenant finish-out, was
completed in April 2002. HRP incurred and capitalized $15,370,000 of
construction and development costs, which included all of the costs for the
building and its parking garage (excluding the existing land costs). A
seven-year lease for the entire building, with an option for five additional
years, with the General Services Administration was executed in September 2002
and will commence upon the completion of tenant improvements, estimated to be
sometime between May and August 2003. The lease commissions incurred were
$777,000, while the tenant improvements are estimated to be $4,500,000. All
development and leasing costs have been or will be paid from cash funds on hand;
however, it is anticipated that loan financing of $15,000,000 to $16,000,000
will be obtained in the second half of 2003.
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, objectives and expectations. 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 the risks identified under "Risks, Competition
and Other Factors" in Item 1 - Business.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
On July 27, 2000, HRP sold its interest rate swap agreement for $1,597,000. HRP
had entered into the interest rate swap agreement in 1998 to reduce its exposure
to changes in interest rates for the loan secured by Allfirst Building. This
interest rate swap agreement effectively fixed the loan's cash interest rate at
6.78%, as opposed to the mortgage loan interest rate of LIBOR plus 1.30% (or
7.94% at the time of the swap agreement sale). The proceeds from the sale were
designated for general working capital purposes. For financial reporting
purposes, the proceeds are being amortized over the life of the loan as a
reduction to interest expense. During 2001, as the result of the adoption of
SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities", HRP
reclassified the remaining unamortized gain from liabilities to accumulated
other comprehensive income. The proceeds will continue to be amortized over the
life of Allfirst Building's mortgage payable as a reduction to interest expense.
As of December 31, 2002 and 2001, the unamortized balance, included on the
balance sheet as "Accumulated other comprehensive income", was $926,000 and
$1,204,000, respectively.
Also on July 27, 2000 and in connection with the sale of the swap agreement, HRP
purchased an interest rate cap for Allfirst Building's mortgage loan for
$288,000, which limits HRP's exposure to changing interest rates to a maximum of
10%. This interest rate cap, which has a notional amount of $25,000,000, has
terms consistent with Allfirst Building's mortgage loan. Allfirst Building's
cash interest rate was 2.68% and 3.44% as of December 31, 2002 and 2001,
respectively. The interest rate cap is a derivative and designated as a cash
flow hedge. Hedge effectiveness is measured based on using the intrinsic value
of the interest rate cap. All changes in the fair value of the time value of the
cap are recorded directly to earnings. With the January 1, 2001 adoption of SFAS
No. 133, HRP recorded the cumulative effect of the adoption as a reduction to
income of $192,000, or the amount of the difference between the carrying value
as of January 1, 2001 of $267,000 and the then estimated fair value of $75,000,
all of which represented change in time value. Thereafter, on a quarterly basis,
HRP has recorded changes in the estimated fair value of the cap in interest
expense. As of December 31, 2002 and 2001, the estimated fair value of the
interest rate cap was $55,000 and $68,000, respectively.
Other than Allfirst Building's mortgage ($25,000,000), all mortgages have fixed
interest rates. Accordingly, changes in LIBOR or the prime rate do not
significantly impact the amount of interest paid by HRP. Assuming a 100 basis
point, or 1%, change in LIBOR, interest paid by HRP would increase or decrease
by $250,000 on an annual basis.
Page 17 of 45
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL INFORMATION
ITEM 8 INDEX
FINANCIAL STATEMENTS: Page
----
Independent Auditors' Report 19
Consolidated Balance Sheets as of December 31, 2002 and 2001 20
Consolidated Statements of Operations for the years
ended December 31, 2002, 2001 and 2000 21
Consolidated Statements of Comprehensive Income for the years
ended December 31, 2002, 2001 and 2000 22
Consolidated Statements of Partners' Capital for the years
ended December 31, 2002, 2001 and 2000 23
Consolidated Statements of Cash Flows for the years
ended December 31, 2002, 2001 and 2000 24
Notes to Consolidated Financial Statements 25
FINANCIAL STATEMENT SCHEDULE:
Schedule III - Real Estate and Accumulated Depreciation 38
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.
Page 18 of 45
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, 2002 and 2001, and the
related consolidated statements of operations, comprehensive income, partners'
capital, and cash flows for each of the three years in the period ended December
31, 2002. Our audit for the year ended December 31, 2002 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 auditing standards generally accepted
in the United States of America. 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, 2002 and 2001 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002 in conformity with accounting principles generally accepted in
the United States of America. 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
March 6, 2003
Page 19 of 45
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT UNIT AMOUNTS)
DECEMBER 31,
----------------------------------
2002 2001
-------------- --------------
ASSETS
Real estate:
Land $ 59,015 $ 59,015
Buildings and improvements 310,154 290,674
Tenant improvements 23,504 22,301
Construction in progress 836 18,303
-------------- --------------
393,509 390,293
Accumulated depreciation and amortization (183,671) (176,719)
-------------- --------------
Real estate, net 209,838 213,574
Cash and cash equivalents 32,363 24,913
Accounts receivable 2,315 2,315
Escrow deposits held by lenders 8,918 8,359
Effective rent receivable 4,729 4,630
Lease commissions, net 11,390 10,868
Loan costs, net 2,677 3,258
Prepaid expenses and other assets 2,190 1,958
-------------- --------------
Total assets $ 274,420 $ 269,875
============== ==============
LIABILITIES AND PARTNERS' CAPITAL
Liabilities:
Mortgages payable $ 197,552 $ 201,224
Accounts payable and accrued expenses 5,743 5,147
Prepaid rent, security deposits and other 3,533 3,061
Payable to affiliates 512 16
Deferred litigation proceeds 6,405 6,405
-------------- --------------
Total liabilities 213,745 215,853
-------------- --------------
Commitments and contingencies
Partners' capital:
Limited partners - 1,589,948 units outstanding 59,152 52,290
General partner 597 528
Accumulated other comprehensive income 926 1,204
-------------- --------------
Total partners' capital 60,675 54,022
-------------- --------------
Total liabilities and partners' capital $ 274,420 $ 269,875
============== ==============
See notes to consolidated financial statements.
Page 20 of 45
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER UNIT AMOUNTS)
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------
2002 2001 2000
-------------- -------------- --------------
REVENUES:
Property operations $ 66,992 $ 66,593 $ 63,664
Parking, construction and tenant services 6,747 8,098 6,237
-------------- -------------- --------------
Total revenues 73,739 74,691 69,901
-------------- -------------- --------------
EXPENSES:
Property operations 27,464 27,193 26,552
Parking, construction and tenant services 4,547 5,334 3,577
Interest 15,165 16,145 15,832
Depreciation and amortization 14,897 14,562 14,498
General and administrative 4,595 4,356 5,046
Litigation costs 777 3,808 5,663
-------------- -------------- --------------
Total expenses 67,445 71,398 71,168
-------------- -------------- --------------
INCOME (LOSS) BEFORE INTEREST INCOME, GAIN FROM PROPERTY SALES,
AND CUMULATIVE EFFECT 6,294 3,293 (1,267)
Interest income 637 1,043 968
Gain from property sales -- 4,184 --
-------------- -------------- --------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT 6,931 8,520 (299)
Cumulative effect of SFAS No. 133 adoption -
valuation of interest rate cap -- (192) --
-------------- -------------- --------------
NET INCOME (LOSS) $ 6,931 $ 8,328 $ (299)
============== ============== ==============
ALLOCATION OF NET INCOME (LOSS):
Limited partners $ 6,862 $ 8,245 $ (296)
General partner 69 83 (3)
-------------- -------------- --------------
Total $ 6,931 $ 8,328 $ (299)
============== ============== ==============
NET INCOME (LOSS) PER UNIT AND POTENTIAL UNIT:
Earnings per unit - basic
Income (loss) before cumulative effect $ 4.32 $ 5.31 $ (0.18)
Cumulative effect of SFAS No. 133 adoption -- (0.12) --
-------------- -------------- --------------
Net income (loss) $ 4.32 $ 5.19 $ (0.18)
============== ============== ==============
Earnings per unit - assuming dilution
Income (loss) before cumulative effect $ 4.16 $ 5.13 $ (0.18)
Cumulative effect of SFAS No. 133 adoption -- (0.12) --
-------------- -------------- --------------
Net income (loss) $ 4.16 $ 5.01 $ (0.18)
============== ============== ==============
WEIGHTED AVERAGE UNITS USED IN COMPUTING NET INCOME (LOSS) PER
UNIT AND POTENTIAL UNIT:
Basic 1,590 1,590 1,620
============== ============== ==============
Assuming dilution 1,648 1,645 1,674
============== ============== ==============
See notes to consolidated financial statements.
Page 21 of 45
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
FOR THE YEARS ENDED
DECEMBER 31,
------------------------------------------------------
2002 2001 2000
-------------- -------------- --------------
NET INCOME (LOSS) $ 6,931 $ 8,328 $ (299)
Reclassification of cumulative effect of
SFAS No. 133 adoption - deferred gain
from sale of interest rate swap -- 1,481 --
Amortization of deferred gain
from sale of interest rate swap (278) (277) --
-------------- -------------- --------------
COMPREHENSIVE INCOME $ 6,653 $ 9,532 $ (299)
============== ============== ==============
See notes to consolidated financial statements.
Page 22 of 45
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL
(IN THOUSANDS EXCEPT UNIT AMOUNTS)
Accumulated Limited
Other Partnership
General Limited Comprehensive Units
Partner Partners Income Total Outstanding
----------- ----------- ------------- ----------- -----------
PARTNERS' CAPITAL, JANUARY 1, 2000 $ 487 $ 48,209 $ -- $ 48,696 1,672,556
Exercise and issuance of unit options 8 806 -- 814 17,200
Purchase of units (47) (4,674) -- (4,721) (99,808)
Net loss (3) (296) -- (299) --
----------- ----------- ----------- ----------- -----------
PARTNERS' CAPITAL, DECEMBER 31, 2000 445 44,045 -- 44,490 1,589,948
Reclassification of cumulative effect of
SFAS No. 133 adoption - deferred gain
from sale of interest rate swap -- -- 1,481 1,481 --
Amortization of deferred gain from
sale of interest rate swap -- -- (277) (277) --
Net income 83 8,245 -- 8,328 --
----------- ----------- ----------- ----------- -----------
PARTNERS' CAPITAL, DECEMBER 31, 2001 528 52,290 1,204 54,022 1,589,948
Amortization of deferred gain from
sale of interest rate swap -- -- (278) (278) --
Net income 69 6,862 -- 6,931 --
----------- ----------- ----------- ----------- -----------
PARTNERS' CAPITAL, DECEMBER 31, 2002 $ 597 $ 59,152 $ 926 $ 60,675 1,589,948
=========== =========== =========== =========== ===========
See notes to consolidated financial statements.
Page 23 of 45
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------
2002 2001 2000
------------- ------------- -------------
OPERATING ACTIVITIES:
Net income (loss) $ 6,931 $ 8,328 $ (299)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 14,897 14,562 14,498
Gain from property sales -- (4,184) --
Cumulative effect of SFAS No. 133 adoption -
valuation of interest rate cap -- 192 --
Non-qualified unit option compensation -- -- 601
Effective rent adjustments (99) (256) (569)
Changes in assets and liabilities:
Account receivable -- 896 (924)
Lease commission payments (2,951) (2,752) (5,043)
Prepaid expenses, escrow deposits and other assets (200) (174) 956
Accounts payable and other liabilities 1,148 (740) 3,660
------------- ------------- -------------
Net cash provided by operating activities 19,726 15,872 12,880
------------- ------------- -------------
INVESTING ACTIVITIES:
Property and tenant improvements (6,617) (9,417) (10,933)
Property development cost (1,977) (13,406) (8,811)
Property acquisitions -- -- (7,791)
Cash proceeds from property sales, net of selling costs -- 8,435 --
------------- ------------- -------------
Net cash used in investing activities (8,594) (14,388) (27,535)
------------- ------------- -------------
FINANCING ACTIVITIES:
Mortgage principal proceeds -- 10,000 50,623
Mortgage principal refinanced -- (2,760) (18,346)
Loan fees (10) (138) (1,210)
Mortgage principal early payoff -- (2,125) --
Mortgage prepayment penalties -- (423) (286)
Mortgage principal scheduled payments (3,672) (3,987) (3,493)
Exercise and issuance of unit options -- -- 213
Purchase of units -- -- (4,721)
Deferred litigation proceeds -- 6,405 --
------------- ------------- -------------
Net cash provided by (used in) financing activities (3,682) 6,972 22,780
------------- ------------- -------------
INCREASE IN CASH AND CASH EQUIVALENTS 7,450 8,456 8,125
BEGINNING CASH AND CASH EQUIVALENTS 24,913 16,457 8,332
------------- ------------- -------------
ENDING CASH AND CASH EQUIVALENTS $ 32,363 $ 24,913 $ 16,457
============= ============= =============
See notes to consolidated financial statements.
Page 24 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
1 ORGANIZATION
Hallwood Realty Partners, L.P. ("HRP"), a publicly traded Delaware
limited partnership, operates in the commercial real estate industry.
HRP's activities include the acquisition, ownership and operation of
its commercial real estate assets. Units representing limited
partnership interests are traded on the American Stock Exchange under
the symbol "HRY". As of December 31, 2002 there were 1,589,948 units
outstanding.
As of December 31, 2002, HRP owned 14 real estate assets (the
"Properties") located in six states containing 5,199,000 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 ("Realty" or the "General Partner"), a Delaware
limited liability company and indirectly 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 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 ("HCRE"), another indirectly wholly-owned
subsidiary of Hallwood, provides property management, leasing and
construction supervision services to the Properties.
2 ACCOUNTING POLICIES
CONSOLIDATION
HRP fully consolidates into its financial statements majority owned
entities. For each of the three years in the period ended December 31,
2002, all entities and Properties were fully owned. All significant
intercompany balances and transactions have been eliminated in
consolidation.
HRP has, in three situations, created a Special Purpose Entity
("SPE"). These SPEs were formed at the request of lenders for the
express purpose of strengthening the collateral for the loans by
isolating (for Federal bankruptcy law purposes) the assets and
liabilities of the SPEs. In all cases and since their various
formation dates, the assets, liabilities and results of operations of
these wholly-owned entities have been fully consolidated into the
financial statements of HRP.
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 reviews for impairment losses on its real estate
assets when events and circumstances indicate that the assets might be
impaired. If such indication is noted, an undiscounted cash flow
analysis is performed, and in the event undiscounted cash flow
estimated to be generated by an asset over the remaining depreciable
life of that asset is less than its carrying value, then the asset
would be written down to its fair value. Cash flow estimates are based
on historical results adjusted to our best estimate of future market
and operating conditions. Significant assumptions used in this process
include an evaluation of leases in place, future rental and occupancy
rates, and the level of expected operating expenses. For the three
years ended December 31, 2002, HRP has not recorded a write-down or
impairment of the carrying value of any real estate property based on
these calculations.
Page 25 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
2 ACCOUNTING POLICIES - (CONTINUED)
Should HRP decide to sell a property and actively commence the
disposal process, all of the assets, liabilities, income, and expenses
associated with such property will be segregated in the financial
statements. At such time, an evaluation for potential impairment will
be made using an estimate of the selling price less selling costs.
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
or useful life, if shorter.
HRP capitalizes all costs related to the development and construction
of its projects, including interest of $256,000, $486,000, and
$493,000 in 2002, 2001, and 2000, respectively. The development period
of a project is considered to have begun when activities related to
the construction of the project or a portion thereof has commenced.
All costs for construction are capitalized and allocated to each
building. Capitalization of such costs is discontinued when the
building is available for occupancy.
HRP would accrue for losses associated with environmental remediation
obligations if such losses were probable and reasonably estimable.
Accruals for estimated losses from environmental remediation
obligations would generally be recognized no later than completion of
a remedial feasibility study. Such accruals would be adjusted as
further information developed or circumstances changed. Costs of
future expenditures for environmental remediation obligations would
not be 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 2003 to 2020.
Loan costs are amortized over the terms of the respective loans. The
loans mature between 2005 and 2020. Amortization of lease commissions,
included in depreciation and amortization expense, was $2,817,000,
$2,889,000, and $3,180,000 in 2002, 2001, and 2000, respectively.
Amortization of loan costs, included in interest expense, was
$591,000, $624,000, and $855,000 in 2002, 2001, and 2000,
respectively. The caption "Prepaid expenses and other assets" on the
Consolidated Balance Sheets 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. Amortization of effective rent
income adjustments, included in property operations revenues, was
$99,000, $256,000, and $569,000 in 2002, 2001, and 2000, respectively.
Lease provisions generally require tenants to pay their proportionate
share of certain building operating costs and real property taxes.
Revenue from these expense recoveries, included in property
operations, are recorded as earned and was $3,755,000, $4,197,000, and
$3,315,000 in 2002, 2001, and 2000, respectively.
Revenues and expenses from short-term construction and tenant service
projects are recorded at the time of project completion. Revenues and
expenses from long-term construction projects are accounted for using
the percentage-of-completion method. Reclassifications, including a
gross-up for parking, construction and tenant service expenses that
were previously netted against revenues, have been made in the prior
year amounts to conform to the classifications used in the current
year. The reclassifications occurred due to the adoption of EITF No.
01-14, "Income Statement Characterization of Reimbursements Received
for Out-of-Pocket Expenses Incurred". The reclassifications had no
effect on previously reported net income or loss.
Page 26 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
2 ACCOUNTING POLICIES - (CONTINUED)
INTEREST RATE AGREEMENTS
HRP has used an interest rate swap as a hedge against interest
exposure of variable rate debt. HRP's only interest rate swap was sold
in July 2000. Differences between amounts paid or received in this
interest rate agreement, which was designated as a hedge, were
included in interest expense as the payments were made or received.
HRP was exposed to credit-related gains or losses in the event of
non-performance by counterparties, however none of the counterparties
failed to meet their obligations during the term of the agreement. In
July 2000, in connection with the sale of the interest rate swap, HRP
purchased an interest rate cap derivative that limits its interest
rate exposure on its mortgage for Allfirst Building (see Notes 6 and 9
for more information).
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 $280,000, $178,000, and $182,000 in 2002, 2001, and
2000, 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.
EQUITY-BASED COMPENSATION
Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation" establishes a method of
accounting whereby recognized option pricing models are used to
estimate the fair value of equity-based compensation, including
options. HRP has elected, as provided by SFAS No. 123, not to
recognize employee equity-based compensation expense as calculated
under SFAS No. 123, but has recognized such expense in accordance with
the provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". As the only options of HRP
fully vested in 1997, there is no difference between the historical
operations and pro forma operations for each of the three years ended
December 31, 2002 had the expense provisions of SFAS No. 123 been
adopted.
COMPUTATION OF NET INCOME (LOSS) PER UNIT
Basic earnings per unit is computed by dividing results attributable
to the limited partners' interests by the weighted average number of
units outstanding. Earnings per unit assuming dilution is computed by
dividing results 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 following table illustrates the amounts used to calculate
the weighted average number of units outstanding:
2002 2001 2000
----------- ----------- -----------
Weighted average units outstanding - basic 1,590 1,590 1,620
Potential weighted average units issued from options 69 69 75
Potential repurchase of units from unit option proceeds (11) (14) (21)
----------- ----------- -----------
Potential weighted average units outstanding - assuming 1,648 1,645 1,674
=========== =========== ===========
COMPREHENSIVE INCOME
Comprehensive income items are revenues, expenses, gains and losses
that under accounting principles generally accepted accounting
principles are excluded from current period results and reflected as a
component of equity. HRP recorded comprehensive income related to its
unrealized gain from the sale of an interest rate swap.
Page 27 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
2 ACCOUNTING POLICIES - (CONTINUED)
SEGMENT REPORTING
Operating segments are defined as components of an entity for which
separate financial information is available that is evaluated by the
chief operating decision-maker in deciding how to allocate resources
and in assessing performance. Management believes that HRP operates in
only one business segment, real estate.
RECENT ACCOUNTING PRONOUNCEMENTS AND OTHER
SFAS No. 142 "Goodwill and Other Intangible Assets" was issued in June
2001 and was adopted January 1, 2002. Among other things, SFAS No. 142
requires that in conjunction with an acquisition of a property in the
future all intangible assets associated with such property will be
separately evaluated and recorded.
SFAS No. 143 "Accounting for Asset Retirement Obligations" was adopted
January 1, 2003. It establishes an accounting standard for recognition
and measurement of a liability for an asset retirement obligation and
the associated asset retirement cost. HRP has no such obligations as
of December 31, 2002.
SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets" was adopted January 1, 2002 and requires current, as well as
historical, results of operations for disposed properties and those
properties held for sale that occur subsequent to January 1, 2002 to
be reclassified and presented separately as discontinued operations.
SFAS No. 145 "Rescission of FASB Statements 4, 44 and 64, Amendment of
FASB Statement No. 13, and Technical Corrections" was issued in April
2002 and was adopted in the fourth quarter of 2002. Among other
things, SFAS No. 145 limits debt extinguishments that can be
classified as extraordinary items. As a result, HRP has reclassified
previously recorded gains and losses from early extinguishment of debt
from an extraordinary item to current operations within interest
expense. Accordingly, the reclassifications had no effect on
previously reported net income or loss.
SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal
Activities" was issued in June 2002 and will be effective for exit or
disposal activities subsequent to December 31, 2002. HRP anticipates
no material impact on its financial statements from the adoption of
this accounting standard.
SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of FASB Statement No. 123" was issued in
December 2002 and provides new transition methods if an entity adopts
the fair value based method of valuing stock-based compensation
suggested in SFAS No. 123, as well as requiring additional disclosures
in interim and annual financial statements. At this time, HRP expects
that the impact will be limited to additional disclosure requirements.
In November 2002, the Financial Accounting Standards Board issued
Interpretation No. 45 "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires that the guarantor
recognize, at the inception of certain guarantees, a liability for the
fair value of the obligation undertaken in issuing such guarantee. FIN
45 also requires additional disclosure about the guarantor's
obligations under certain guarantees that it has issued. As of
December 31, 2002 HRP had no such guarantees.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of certain assets, liabilities, revenues, expenses, and
related disclosures, as of and for the reporting periods. Actual
results may differ from these estimates under different assumptions or
conditions.
The policies listed are not intended to be a comprehensive list of all
of our accounting policies. In many cases, the accounting treatment of
a particular transaction is specifically dictated by accounting
principles generally accepted in the United States of America, with no
need for management's judgment in the application. There are also
areas in which management's judgment in selecting any available
alternative would not produce a materially different results.
Page 28 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
3 STATEMENTS OF CASH FLOWS
Cash interest payments were $14,602,000 (net of capitalized interest
of $256,000), $14,947,000 (net of capitalized interest of $486,000),
and $13,831,000 (net of capitalized interest of $523,000) in 2002,
2001, and 2000, respectively.
Supplemental disclosure of noncash investing and financing activities
are as follows -
As of December 31, 2001, HRP had a construction payable for
property development at Executive Park of $250,000.
4 TRANSACTIONS WITH RELATED PARTIES
Realty receives certain fees in connection with the ongoing management
of HRP, including an asset management fee, acquisition fees and
disposition fees. Specifically, Realty is entitled to receive an asset
management fee equal to 1% of the net aggregate base rents of the
Properties, acquisition fees equal to 1% of the purchase price of
newly acquired properties, and disposition fees with respect to real
estate investments, other than the properties owned at the time of
HRP's formation in 1990, equal to 10% of the amount, by which the
sales price of a property exceeds the purchase price of such property.
HCRE 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, 2004 and provide for basic compensation from
a property management fee in an amount equal to 2.85% of cash receipts
collected from the Properties' tenants, lease commissions equal to the
current commission market rate as applied to the net aggregate rent
(none exceeding 6% of the net aggregate rent), and 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 and are reimbursed, at cost, for certain
costs and expenses. In particular, since HRP does not directly employ
any individuals, the compensation and other costs related to
approximately 90 employees rendering services on behalf of HRP and its
properties are reimbursed to Realty and HCRE by HRP. The following
table sets forth such compensation and reimbursements paid by HRP (in
thousands):
ENTITY
PAID OR
REIMBURSED 2002 2001 2000
---------- ----------- ----------- -----------
Asset management fee Realty $ 618 $ 609 $ 581
Acquisition fee Realty -- -- 74
Disposition fee Realty -- 120 --
Reimbursement of costs(a) Realty 3,477 3,161 2,720
Property management fee HCRE 2,022 2,005 1,914
Lease commissions(b) HCRE 2,151 2,158 2,605
Construction fees HCRE 582 1,204 917
Reimbursement of costs(c) HCRE 3,916 3,826 3,521
(a) These expenses are recorded as general and administrative expenses and
represent reimbursement, at cost, to Realty for administrative level
employee and director compensation, officer and director liability
insurance, and allocated overhead costs. HRP pays its account balance
with Realty on a monthly basis.
(b) As of December 31, 2002, $567,000 of the 2002 lease commissions are
accrued and are scheduled to be paid in 2003.
(c) These costs are recorded as property operating expenses and represent
reimbursement to HCRE for property-level employee compensation and
related expenses.
In January 2001, HRP acquired a construction development consulting
contract from Hallwood regarding a project in Tulsa, Oklahoma with an
unrelated third party. In connection therewith, HRP reimbursed
Hallwood for its actual costs incurred related to the project of
$281,000.
Page 29 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
5 PROPERTY TRANSACTIONS
PROPERTY DEVELOPMENT AT EXECUTIVE PARK
In early 2001, HRP demolished a one-story office building at its
Executive Park property in Atlanta, Georgia, which contained 18,000
net rentable square feet. In order to do so, HRP obtained a release of
the building from Executive Park's mortgage lien by substituting for
such collateral $608,000 of United States Treasury Bonds, which have
various maturity dates through December 2007. In February 2001, HRP
began constructing a five-story office building containing 128,000 net
rentable square feet. The building and its parking garage, excluding
tenant finish-out, was completed in April 2002. HRP incurred and
capitalized $15,370,000 of construction and development costs, which
included all of the costs for the building and its parking garage
(excluding the existing land costs). A seven-year lease for the entire
building, with an option for five additional years, with the General
Services Administration was executed in September 2002 and will
commence upon the completion of tenant improvements, estimated to be
sometime between May and August 2003. The lease commissions incurred
were $777,000, while the tenant improvements are estimated to be
$4,500,000. All development and leasing costs have been or will be
paid from cash funds on hand; however, it is anticipated that loan
financing of $15,000,000 to $16,000,000 will be obtained in the second
half of 2003.
PROPERTY DEVELOPMENT AT CORPORATE SQUARE
During the second quarter of 2000, HRP completed new construction of a
6-story office building containing approximately 151,000 net rentable
square feet that was commenced in the second quarter of 1999. It was
constructed on undeveloped land within the Corporate Square complex in
Atlanta, Georgia. A 20-year lease with the General Services
Administration for the entire building was executed in 1999 and the
tenant began paying rent August 2000.
The building construction, tenant improvements, lease commissions and
loan costs totaled $18,779,000 (excluding the original land cost). In
1999, HRP incurred, in connection with the leasing of the entire
project, $2,982,000 of lease commissions.
An interim-construction loan was secured in August 1999 that funded
$12,621,000 of the costs ($6,998,000 in 1999 and $5,623,000 in 2000).
On August 31, 2000, HRP secured permanent financing of $21,500,000.
The loan's monthly payment is based on a twenty-year amortization
period and matures August 15, 2020 and has a fixed interest rate of
7.97%. The loan proceeds repaid the interim-construction loan and
replenished working capital for the completed project.
ACQUISITION
On January 26, 2000, HRP acquired three 3-story office buildings in
San Diego, California (Fountain View Business Center) containing
approximately 89,000 net rentable square feet on 4.3 acres of land.
The acquisition cost was $7,791,000.
DISPOSITIONS
In March 2001, HRP sold Joy Road Distribution Center that contained
442,000 net rentable square feet on 21 acres for a gross selling price
of $5,326,000. The carrying value of the assets was $2,994,000. The
sale resulted in $4,916,000 of net proceeds to HRP and a net gain of
$1,922,000. The net sale proceeds were used to pay the outstanding
mortgage principal balance of $2,125,000, to pay a prepayment penalty
of $14,000 to the lender, and to add $2,777,000 to general working
capital. The prepayment penalty along with the writeoff of $31,000 of
unamortized loan costs associated with the retired loan were expensed
and are included in the Consolidated Statements of Operations as
interest expense.
In January 2001, HRP sold one of the warehouse buildings at Seattle
Business Parks that contained 63,000 net rentable square feet on 3.9
acres for a gross selling price of $3,287,000. The carrying value of
the assets was $885,000. The sale resulted in $2,994,000 of net
proceeds, which were added to HRP's working capital, and a net gain of
$2,109,000.
Also in January 2001, HRP sold one building at Fairlane Commerce Park
that contained less than 2,000 net rentable square feet on 0.5 acres
for a gross selling price of $575,000. The carrying value of the
assets was $372,000. The sale resulted in $525,000 of net proceeds,
which were added to HRP's working capital, and a net gain of $153,000.
Page 30 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
6 MORTGAGES PAYABLE
Substantially all of the buildings in HRP's real estate properties
were encumbered and pledged as collateral by 11 non-recourse mortgage
loans aggregating $197,552,000 as of December 31, 2002 and
$201,224,000 as of December 31, 2001. These mortgage loans have
interest rates varying from 2.68% to 8.70% (with an effective average
interest rate of 7.51% as of December 31, 2002) and mature between
2005 and 2020. Other than Allfirst Building's mortgage ($25,000,000),
all mortgages have fixed interest rates. Most of the mortgage loans
require monthly principal payments with balloon payments due at
maturity. The following table sets forth, by real estate property,
mortgages payable balances as of December 31, 2002 and 2001 (in
thousands), maturity dates, and interest rates:
Mortgages Mortgages Interest
Payable as of Payable as of Maturity Rate as of
12-31-2002 12-31-2001 Date 12-31-2002
-------------- -------------- ---------- ----------
Airport Plaza $ 721 $ 735 10-11-2005 8.70%
Allfirst Building 25,000 25,000 4-30-2006 2.68%(a)
Bellevue Corporate Plaza 14,414 14,701 10-11-2005 8.70%
Bradshaw Business Parks 11,980 12,261 12-31-2020 8.10%(b)
Corporate Square 7,838 7,993 10-11-2005 8.70%
Corporate Square 9,782 9,944 8-11-2011 7.70%
Corporate Square 20,468 20,970 8-15-2020 7.97%
Executive Park 31,915 32,427 4-11-2008 7.32%
Fairlane Commerce Park 19,099 19,479 10-11-2005 8.70%
Fountain View Business Center 5,151 5,284 2-10-2010 8.17%
Gulley Road Industrial Park 4,144 4,487 5-11-2011 7.375%
Montrose Office Center 5,856 5,972 10-11-2005 8.70%
Parklane Towers 21,621 22,051 10-11-2005 8.70%
Raintree Industrial Park 10,090 10,291 10-11-2005 8.70%
Riverbank Plaza 2,364 2,422 2-10-2010 8.29%
Seattle Business Parks 7,109 7,207 6-7-2008 6.97%
-------------- --------------
Total $ 197,552 $ 201,224
============== ==============
(a) Variable interest rate. LIBOR plus 1.30%. Rate was 3.44% as of December 31, 2001.
(b) Call options exercisable by lender on 2-1-2011 and 2-1-2016.
The following table shows for the years presented the principal and
balloon payments that are required (in thousands):
Total
Mortgage
Principal Balloon Loan
Payments Payments Payments
---------------- ---------------- ----------------
2003 $ 3,998 $ -- $ 3,998
2004 4,310 -- 4,310
2005 4,167 74,515 78,682
2006 2,852 25,000 27,852
2007 3,079 -- 3,079
Thereafter 22,894 56,737 79,631
---------------- ---------------- ----------------
Total $ 41,300 $ 156,252 $ 197,552
================ ================ ================
Page 31 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
6 MORTGAGES PAYABLE - (CONTINUED)
The following discussions pertain to financing and refinancing
activities during the three years ended December 31, 2002.
ALLFIRST BUILDING
On July 27, 2000, HRP sold its interest rate swap agreement for
$1,597,000. HRP had entered into the interest rate swap agreement in
1998 to reduce its exposure to changes in interest rates for the loan
secured by Allfirst Building. This interest rate swap agreement
effectively fixed the loan's cash interest rate at 6.78%, as opposed to
the mortgage loan interest rate of LIBOR plus 1.30% (or 7.94% at the
time of the swap agreement sale). The proceeds from the sale were
designated for general working capital purposes. For financial reporting
purposes, the proceeds are being amortized over the life of the loan as
a reduction to interest expense. During 2001, as the result of the
adoption of SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities", HRP reclassified the remaining unamortized gain
from liabilities to accumulated other comprehensive income. The proceeds
will continue to be amortized over the life of Allfirst Building's
mortgage payable as a reduction to interest expense. As of December 31,
2002 and 2001, the unamortized balance, included on the balance sheet as
"Accumulated other comprehensive income", was $926,000 and $1,204,000,
respectively.
Also on July 27, 2000 and in connection with the sale of the swap
agreement, HRP purchased an interest rate cap for Allfirst Building's
mortgage loan for $288,000, which limits HRP's exposure to changing
interest rates to a maximum of 10%. This interest rate cap, which has a
notional amount of $25,000,000, has terms consistent with Allfirst
Building's mortgage loan. Allfirst Building's cash interest rate was
2.68% and 3.44% as of December 31, 2002 and 2001, respectively. The
interest rate cap is a derivative and designated as a cash flow hedge.
Hedge effectiveness is measured based on using the intrinsic value of
the interest rate cap. All changes in the fair value of the time value
of the cap are recorded directly to earnings. With the January 1, 2001
adoption of SFAS No. 133, HRP recorded the cumulative effect of the
adoption as a reduction to income of $192,000, or the amount of the
difference between the carrying value as of January 1, 2001 of $267,000
and the then estimated fair value of $75,000, all of which represented
change in time value. Thereafter, on a quarterly basis, HRP has recorded
changes in the estimated fair value of the cap in interest expense. As
of December 31, 2002 and 2001, the estimated fair value of the interest
rate cap was $55,000 and $68,000, respectively.
BRADSHAW BUSINESS PARKS
In December 2000, HRP refinanced Bradshaw Business Park's existing loan
with a new lender. The interest rate was reduced to 8.1% from 8.5% and
the maturity date was extended by 17 years, subject to two call options
exercisable by the lender on February 1, 2011 and February 1, 2016. The
monthly principal payments amortize the loan over 20 years. The loan
proceeds of $12,500,000 were used (i) to pay the outstanding principal
balance of $5,724,000 with the former lender, (ii) to pay transaction
costs of $267,000, (iii) to pay a prepayment penalty of $286,000, (iv)
to fund $288,000 of loan reserves, and (v) to add $5,935,000 to general
working capital. The prepayment penalty along with the writeoff of
$103,000 of unamortized loan costs associated with the retired loan were
expensed and are included in the Consolidated Statements of Operations
as interest expense.
CORPORATE SQUARE
On August 7, 2001, HRP refinanced a mortgage loan secured by a portion
of Corporate Square with a new lender. The interest rate was reduced to
7.7% from 8.625% and the maturity date was extended six years to August
2011. The monthly principal payments amortize the loan over 22.5 years.
The loan proceeds of $10,000,000 were used to pay the outstanding
mortgage principal balance of $2,760,000 with the former lender, to pay
a prepayment penalty of $409,000, to pay transaction costs of $142,000,
and for general working capital. The prepayment penalty along with the
writeoff of $105,000 of unamortized loan costs associated with the
retired loan were expensed and are included in the Consolidated
Statements of Operations as an interest expense.
FOUNTAIN VIEW
In January 2000, HRP obtained financing of $5,500,000 in connection with
the acquisition of Fountain View Business Center (three 3-story office
buildings in San Diego, California). The loan has a monthly payment
based on a twenty-year amortization, matures in ten years and has a
fixed interest rate of 8.17%.
Page 32 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
6 MORTGAGES PAYABLE - (CONTINUED)
JOY ROAD DISTRIBUTION CENTER
In August 2000, HRP received $3,000,000 of loan proceeds from a
promissory term note secured by Joy Road Distribution Center in Detroit,
Michigan. The loan proceeds were for general working capital purposes.
The loan was scheduled to mature July 31, 2002, however it was paid off
in March 2001 when Joy Road Distribution Center was sold. The loan had a
variable interest rate of LIBOR plus 3.0%.
LINE OF CREDIT
Since August 2000, HRP has had available a $2,000,000 revolving line of
credit, which matures on July 29, 2003. The line of credit has a
variable interest rate of either prime plus 0.50% or LIBOR plus 3.0% and
requires monthly interest payments, but no principal amortization. HRP
has not borrowed against this facility.
RIVERBANK PLAZA
In May 2000, HRP closed on a new mortgage generating $2,500,000 of loan
proceeds, which is secured by Riverbank Plaza (acquired in August 1999
in a cash transaction). The loan's monthly payment is based on a
twenty-year amortization, matures in ten years and has a fixed interest
rate of 8.29%. The loan proceeds were for general working capital
purposes.
7 LEASE AGREEMENTS AND MAJOR TENANT INFORMATION
HRP leases and shares offices with Hallwood in Dallas, Texas under a
lease which expires November 30, 2008. HRP has a one-time option to
terminate the lease effective November 30, 2005. The annual minimum cash
rental payments are $315,000, of which HRP's portion is approximately
$210,000 annually.
Lease provisions generally require HRP's tenants to pay fixed rental
amounts, plus their proportionate share of certain building operating
costs and real property taxes. Revenue from expense recoveries, included
in property operations, was $3,755,000, $4,197,000, and $3,315,000 in
2002, 2001, and 2000, respectively. In addition, certain leases include
provisions for annual rental adjustments. Some leases contain provisions
to allow a tenant to terminate their lease prior to its normal
expiration. At December 31, 2002, the Properties, in the aggregate, were
91% leased. The following table sets forth the minimum cash rental
payments to be received from leases in place as of December 31, 2002 (in
thousands):
Payments Payments
from Leases from Leases
without Early with Early
Termination Termination
Rights Rights Total
---------------- ---------------- ----------------
2003 $ 54,963 $ 651 $ 55,614
2004 48,306 413 48,719
2005 40,003 238 40,241
2006 27,928 1,837 29,765
2007 20,348 3,485 23,833
Thereafter 75,796 35,962 111,758
---------------- ---------------- ----------------
Total $ 267,344 $ 42,586 $ 309,930
================ ================ ================
During 2002 and 2001, two tenants leasing space contributed 10% or more
of HRP's revenues. Ford Motor Company and affiliates ("Ford") leases
space in Parklane Towers and Fairlane Commerce Park. Ford accounted for
11% and 12% of revenues in 2002 and 2001, respectively. The General
Services Administration ("GSA") leases space in Corporate Square and
Executive Park. GSA accounted for 17% and 14% of revenues in 2002 and
2001, respectively.
Page 33 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
7 LEASE AGREEMENTS AND MAJOR TENANT INFORMATION - (CONTINUED)
As of December 31, 2002, Ford leased 199,000 square feet of office space
under seven leases at Parklane Towers and 224,000 square feet of office,
technical laboratory and industrial space under seven leases at Fairlane
Commerce Park. These leases expire between 2003 and 2005 and most
contain options providing for one to ten year renewals. As of December
31, 2002, GSA leased 450,000 square feet of office space at Executive
Park (including 128,000 square feet associated with a lease that begins
in 2003 - see Note 5) under seven leases which expire between 2003 and
2015. Also, as of December 31, 2002, GSA leased 310,000 square feet of
office space at Corporate Square under three leases which expire in
2004, 2013 (with a right to early terminate in 2008) and 2020. 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.
8 PARTNERS' CAPITAL
In 1995, HRP issued options totaling 86,000 units to certain executives
of Realty and HCRE with an exercise price of $11.875 per unit. The
options were vested over a three year period ending in 1997 and they
expire on February 27, 2005. As of December 31, 2002, 17,200 options had
been exercised (all during 2000), none have been canceled and 68,800
options remained exercisable. In February 2003, options for 4,000 units
were exercised by the estate of a deceased HCRE executive. No options
have been granted since 1995.
As part of the resignation of Brian Troup as an officer and director of
Hallwood and HRP's general partner on December 21, 1999, Hallwood
transferred 82,608 units of HRP that it owned to a trust controlled by
Mr. Troup. On May 12, 2000, Mr. Troup exercised his unit options to
purchase 17,200 HRP units at the option plan's exercise price of $11.875
per unit, which generated $601,000 of non-cash compensation. Also on May
12, 2000, HRP purchased and retired all of Mr. Troup's above-mentioned
99,808 units at $46.825 per unit (the average of the closing market
prices of the units for the twenty trading days prior to the purchase).
9 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 HRP 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 are not considered financial
instruments.
Management has reviewed the fair values of its mortgages payable in
connection with interest rates currently available to HRP for borrowing
with similar characteristics and maturities (approximately 7.5% as of
December 31, 2002 and 2001). Based on those interest rates, management
has determined that the estimated fair values of HRP's mortgages payable
as of December 31, 2002 and 2001 would equal approximately $199,383,000
and $204,158,000, respectively, as compared to the carrying values of
$197,552,000 and $201,224,000, respectively.
The estimated fair value of HRP's interest rate cap as of December 31,
2002 and 2001 was $55,000 and $68,000, respectively, based on quotes
obtained from the issuer of the cap agreement (see Note 6 for more
information). The carrying value of HRP's interest rate cap as of
December 31, 2002 and 2001 was $55,000 and $68,000, respectively.
The fair value information presented herein is based on pertinent
information available to management as of December 31, 2002. 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.
Page 34 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
10 COMMITMENTS AND CONTINGENCIES
LITIGATION
On June 20, 1997, an action was filed against HRP, the General Partner,
its directors, and Hallwood by Gotham Partners, L.P. in the Court of
Chancery of the State of Delaware, styled Gotham Partners, L.P. v.
Hallwood Realty Partners, L.P., et al. (C.A. No. 15754). This action
alleges claims of breach of fiduciary duties, breach of HRP's
partnership agreement, and fraud in connection with certain transactions
involving HRP's units in the mid 1990's. Hallwood is alleged to have
aided and abetted the alleged breaches. On June 21, 2000, after
completing fact discovery, all parties moved for summary judgment on
several issues. In September and October 2000, the Delaware court issued
three separate written opinions resolving the summary judgment motions.
In the opinions, the court ruled that trial would be required as to all
issues, except that (i) Gotham was found to have standing to pursue its
derivative claims; (ii) defendants were entitled to judgment dismissing
the fraud claim; (iii) the General Partner was entitled to judgment
dismissing the breach of fiduciary duty claims brought against it; and
(iv) the General Partner's outside directors were entitled to judgment
dismissing all claims brought against them.
A five-day trial was held in January 2001. On July 18, 2001, the
Delaware Court of Chancery rendered its opinion. In its decision, the
court determined that an option plan and a sale of units to Hallwood in
connection with a reverse split of units implemented by HRP in 1995 were
in compliance with HRP's partnership agreement. The court also found
that the sale of units to Hallwood in connection with a 1995 odd-lot
offer by HRP did not comply with certain procedures required by the HRP
partnership agreement. The court ruled that the defendants other than
HRP pay a judgment to HRP in the amount of $3,417,423, plus pre-judgment
interest from August 1995. The judgment amount represents what the court
determined was an underpayment by Hallwood. In August 2001, plaintiff
and certain defendants appealed the Court of Chancery's judgment to the
Delaware Supreme Court. In October 2001, HRP received the $3,417,423
judgment together with $2,987,576 of interest, subject to an arrangement
that it be returned in full or part if the judgment is modified or
reversed on appeal. Oral arguments were heard on February 12, 2002, and
a rehearing en banc was held on March 26, 2002. On August 29, 2002, the
Supreme Court affirmed the judgment of the trial court that the
remaining defendants other than HRP are jointly and severally liable to
HRP. The Supreme Court reversed the trial court's determination of
damages, and remanded the case to the trial court to fashion appropriate
relief. A hearing on the remand proceedings was held before the Court of
Chancery on October 25, 2002. A further hearing on the remand is
scheduled to take place in May or June 2003, with a decision by the
Court of Chancery to follow. Since the appellate court reversed the
judgment, any subsequent ruling by the trial court on remand may be more
or less favorable to HRP. As a result of the uncertainty of the
litigation's outcome, HRP recorded the judgment and interest as
"Deferred Litigation Proceeds" on its balance sheet.
On February 15, 2000, HRP filed a lawsuit in the United States District
Court for the Southern District of New York styled Hallwood Realty
Partners, L.P. v. Gotham Partners L.P., et al. (Civ. No. 00 CV 1115)
alleging violations of the Securities Exchange Act of 1934 by certain
purchasers of its units, including Gotham Partners, L.P., Gotham
Partners III, L.P., Private Management Group, Inc., Interstate
Properties, Steven Roth and EFO Realty, Inc., by virtue of those
purchasers' misrepresentations and/or omissions in connection with
filings required under the Securities Exchange Act of 1934. The
complaint further alleged that defendants, by acquiring more than 15% of
the outstanding HRP units, have triggered certain rights under its Unit
Purchase Rights Agreement, for which HRP was seeking declaratory relief.
HRP sought various forms of relief, including declaratory judgments,
divestiture, corrective disclosures, a "cooling-off" period and damages,
including costs and disbursements. On November 16, 2000, the court
granted HRP's motion to add as defendants Gotham Holdings II, L.L.C.,
Hallwood Investors, L.P., Liberty Realty Partners, L.P. and EFO/Liberty,
Inc. and to remove EFO Realty, Inc. as a defendant. Discovery was
completed in December 2000 and trial was held in February 2001. On
February 23, 2001, the court rendered a decision in favor of the
defendants and on February 28, 2001, the court ordered the complaint
dismissed. HRP filed a Notice of Appeal on March 29, 2001. Oral argument
was heard on March 4, 2002. On April 11, 2002, the U.S. Court of Appeals
for the Second Circuit upheld the lower court's ruling in favor of
defendants. On April 25, 2002, HRP filed with the court a Petition for
Rehearing and Rehearing En Banc with respect to the April 11, 2002
decision. On June 3, 2002, the Second Circuit denied that petition. HRP
has not sought further appellate review and the determination in favor
of defendants is now final.
HRP is from time to time involved in various other 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.
Page 35 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
10 COMMITMENTS AND CONTINGENCIES - (CONTINUED)
ASBESTOS
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 HRP's properties is not
required because it is cementitious, it is not friable and because the
procedures in HRP's site environmental program Operations and
Maintenance Manual are performed as required.
RIGHTS PLAN
HRP has a Unit Purchase Rights Agreement ("Rights Plan") that provides
for a distribution of one right for each unit of HRP to holders of
record at the close of business as of December 10, 1990. The rights will
not trade separately from the units until, and will become exercisable
only in the event, with certain exceptions, an acquiring party
accumulates 15 percent or more of HRP'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. 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 HRP 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. Unless and until a triggering event under the Rights Plan
occurs, there is one right for each outstanding unit, the rights do not
trade separately from the units, and the rights are not currently
exercisable.
OTHER
HRP has estimated and budgeted tenant and capital improvements of
$15,631,000 and lease commissions of $2,851,000 for 2003.
Page 36 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
11 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Set forth below is selected quarterly financial data for the years ended
December 31, 2002 and 2001 (in thousands except per unit amounts) :
Quarter Ending
------------------------------------------------------------------------
March 31 June 30 September 30 December 31
-------------- -------------- -------------- --------------
2002
Total revenues(a) $ 18,067 $ 19,153 $ 17,781 $ 18,738
Property operations revenues less property
operations expenses, general and administrative
expenses and litigation costs(a)(b) 8,979 8,935 8,599 7,643
Net income(b) 2,474 1,942 1,843 672
Earnings per unit - basic
Net income(b) 1.54 1.21 1.15 0.42
Earnings per unit - assuming dilution
Net income(b) 1.49 1.17 1.11 0.40
2001
Total revenues(a) $ 18,876 $ 18,979 $ 18,742 $ 18,094
Property operations revenues less property
operations expenses, general and administrative
expenses and litigation costs(a)(b) 5,943 8,994 8,662 7,637
Income before cumulative effect of
SFAS No. 133 adoption(b) 3,411 2,371 1,840 898
Net income(b) 3,219 2,371 1,840 898
Earnings per unit - basic
Income before cumulative effect of
SFAS No. 133 adoption 2.12 1.48 1.15 0.56
Cumulative effect of SFAS No. 133 adoption (0.12) -- -- --
Net income(b) 2.00 1.48 1.15 0.56
Earnings per unit - assuming dilution
Income before cumulative effect of
SFAS No. 133 adoption 2.05 1.43 1.11 0.54
Cumulative effect of SFAS No. 133 adoption (0.11) -- -- --
Net income(b) 1.94 1.43 1.11 0.54
(a) Reclassifications, including a gross-up for parking, construction
and tenant service expenses that were previously netted against
revenues, have been made in the prior year amounts to conform to
the classifications used in the current year. The reclassifications
occurred due to the adoption of EITF No. 01-14, "Income Statement
Characterization of Reimbursements Received for Out-of-Pocket
Expenses Incurred". The reclassifications had no effect on
previously reported net income or loss.
(b) Litigation costs were $217, $148, $106 and $306 in the first,
second, third, and fourth quarters of 2002, respectively.
Litigation costs were $2,690, $639, $206 and $273 in the first,
second, third, and fourth quarters of 2001, respectively. (See Note
10 to the Consolidated Financial Statements for more information.)
Page 37 of 45
HALLWOOD REALTY PARTNERS, L.P.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2002
(IN THOUSANDS)
Costs
Capitalized
Subsequent To
Initial Cost Acquisition
--------------------------------------- -----------------
Buildings Buildings
And And
Description(A) Encumbrances Land Improvements Improvements
------------------------------ ----------------- ----------------- ----------------- -----------------
Airport Plaza $ 721 $ 300 $ 4,013 $ 655
Allfirst Building 25,000 2,100 43,772 3,225
Bellevue Corporate Plaza 14,414 7,428 17,617 2,298
Bradshaw Business Parks 11,980 5,018 15,563 5,709
Corporate Square 38,088 6,142 14,112 24,620
Executive Park 31,915 15,243 34,982 29,790
Fairlane Commerce Park 19,099 4,883 17,894 6,684
Fountain View Business Center 5,151 1,858 5,933 677
Gulley Road Industrial Park 4,144 1,227 7,022 316
Montrose Office Center 5,856 5,096 15,754 3,518
Parklane Towers 21,621 3,420 37,592 7,410
Raintree Industrial Park 10,090 1,191 18,208 1,701
Riverbank Plaza 2,364 710 1,644 1,823
Seattle Business Parks 7,109 4,399 7,608 4,170
Corporate office - FF&E -- -- -- 184
----------------- ----------------- ----------------- -----------------
TOTAL $ 197,552 $ 59,015 $ 241,714 $ 92,780
================= ================= ================= =================
Gross Amount At Which
Carried At Close Of Period
---------------------------------------------------------- -----------------
Buildings Accumulated
And Depreciation Date(s)
Description(A) Land Improvements Total (B) (B)(C) Acquired
------------------------------ ---------------- ----------------- ----------------- ----------------- -----------------
Airport Plaza $ 300 $ 4,668 $ 4,968 $ 4,239 4/30/87
Allfirst Building 2,100 46,997 49,097 31,051 6/29/84
Bellevue Corporate Plaza 7,428 19,915 27,343 7,057 6/30/88
Bradshaw Business Parks 5,018 21,272 26,290 13,183 9/24/85
Corporate Square 6,142 38,732 44,874 17,909 8/2/85 & 10/1/92
Executive Park 15,243 64,772 80,015 32,936 12/19/85
Fairlane Commerce Park 4,883 24,578 29,461 13,342 12/30/86 & 7/1/87
Fountain View Business Center 1,858 6,610 8,468 888 1/26/00
Gulley Road Industrial Park 1,227 7,338 8,565 1,159 10/29/99
Montrose Office Center 5,096 19,272 24,368 9,551 1/8/88
Parklane Towers 3,420 45,002 48,422 31,683 12/16/84
Raintree Industrial Park 1,191 19,909 21,100 11,757 7/17/86
Riverbank Plaza 710 3,467 4,177 1,125 8/19/99
Seattle Business Parks 4,399 11,778 16,177 7,690 4/24/86
Corporate office - FF&E -- 184 184 101 various
---------------- ----------------- ----------------- -----------------
TOTAL $ 59,015 $ 334,494 $ 393,509 $ 183,671
================ ================= ================= =================
See notes to Schedule III on following page.
Page 38 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO SCHEDULE III
DECEMBER 31, 2002
(IN THOUSANDS)
(A) PROPERTY LOCATIONS ARE AS FOLLOWS:
Airport Plaza San Diego, California
Allfirst Building Baltimore, Maryland
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
Fountain View Business Center San Diego, California
Gulley Road Industrial Park Dearborn, Michigan
Montrose Office Center Rockville, Maryland
Parklane Towers Dearborn, Michigan
Raintree Industrial Park Solon, Ohio
Riverbank Plaza San Diego, California
Seattle Business Parks Kent and Tukwila, Washington
(B) RECONCILIATION OF CARRYING COSTS (in thousands):
Accumulated
Cost Depreciation
--------------- ---------------
Balance, January 1, 2000$ 358,315 $ 165,501
Additions 24,896 11,318
Retirements (5,949) (5,949)
--------------- ---------------
Balance, December 31, 2000 377,262 170,870
Additions 23,073 11,674
Retirements and dispositions (10,042) (5,825)
--------------- ---------------
Balance, December 31, 2001 390,293 176,719
Additions 8,344 12,080
Retirements (5,128) (5,128)
--------------- ---------------
Balance, December 31, 2002 $ 393,509 $ 183,671
=============== ===============
(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
or useful life, if shorter.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
Page 39 of 45
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
HRP has no officers or directors. Realty, as general partner, performs functions
generally performed by officers and directors. Realty was formed in Delaware as
a corporation in January 1990 and became a limited liability company in December
1998.
BUSINESS EXPERIENCE OF DIRECTORS AND OFFICERS OF REALTY -
ANTHONY J. GUMBINER, 58, CHAIRMAN OF THE BOARD AND DIRECTOR OF REALTY
Mr. Gumbiner has served as director and Chairman of the Board of
Realty since January 1990. He has served as a director and Chairman of
the Board since 1981 and Chief Executive Officer since 1984 of
Hallwood. He has also served as Hallwood's President and Chief
Operating Officer since December 21, 1999. Formerly, he served as
Chairman of the Board and Chief Executive Officer of Hallwood Energy
Corporation and its predecessors ("HEC") from 1987 until HEC was sold
in 2001. Mr. Gumbiner is also a solicitor of the Supreme Court of
Judicature of England.
WILLIAM L. GUZZETTI, 59, PRESIDENT AND DIRECTOR OF REALTY
Mr. Guzzetti has been President, Chief Operating Officer and a
director of Realty since January 1990. He has served as Executive-Vice
President of Hallwood since October 1989 and in that capacity may
devote a portion of his time to the activities of Hallwood, including
the management of real estate investments, acquisitions and
restructurings of entities controlled by Hallwood. He also served as
President, Chief Operating Officer and a director of HEC from 1985
until HEC was sold in 2001 and in that capacity devoted a portion of
his time to the activities of HEC. He is a member of The Florida Bar
and the State Bar of Texas.
JOHN G. TUTHILL, 59, EXECUTIVE VICE PRESIDENT AND SECRETARY
Mr. Tuthill has been an Executive Vice President and Secretary of
Realty since January 1990. He 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, 55, SENIOR VICE PRESIDENT
Mr. Walther has been a Senior Vice President of Realty since November
1998. Mr. Walther was a member of the Board of Directors of Realty
from June 1994 to November 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, 55, VICE PRESIDENT - FINANCE
Mr. Gent joined Hallwood in March 1990 as the Vice President-Finance.
He 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, 61, 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 and British companies. He is a
Fellow of the Royal Institution of Chartered Surveyors and holds a
B.A. (Hons) Degree and is a Master of Literature from Oxford
University.
WILLIAM F. FORSYTH, 53, 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.
EDWARD T. STORY, 59, 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.
Page 40 of 45
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - (continued)
Section 16(a) of the Securities and Exchange Act of 1934 requires the officers
and directors of Hallwood Realty, LLC and persons who own more than ten percent
of HRP's units to file reports of ownership and changes in ownership with the
Securities and Exchange Commission (the "SEC"). Officers, directors and greater
than ten percent owners 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 from certain
reporting persons that no forms were required of those persons, HRP believes
that during the period January 1, 2002 to December 31, 2002, all officers and
directors of Hallwood Realty, LLC and ten percent owners complied with
applicable filing requirements.
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 2002, Messrs. Gumbiner and
Guzzetti served on the Board of Directors of Realty. Mr. Gumbiner is also Chief
Executive Officer of Hallwood and Realty, and a member of the Board of Directors
of Hallwood, which serves as the compensation committee for Hallwood. Mr.
Guzzetti is also President and Chief Operating Officer of Realty, and Executive
Vice President of Hallwood. Messrs. Forsyth, Crisp, and Story were each paid
$25,000 in 2002, 2001, and 2000, respectively, for director fees.
Realty receives certain fees in connection with the ongoing management of HRP,
including an asset management fee, acquisition fees and disposition fees.
Specifically, Realty is entitled to receive an asset management fee equal to 1%
of the net aggregate base rents of the Properties, acquisition fees equal to 1%
of the purchase price of newly acquired properties, and disposition fees with
respect to real estate investments, other than the properties owned at the time
of HRP's formation in 1990, equal to 10% of the amount, by which the sales price
of a property exceeds the purchase price of such property.
HCRE 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, 2004 and provide for
basic compensation from a property management fee in an amount equal to 2.85% of
cash receipts collected from the Properties' tenants, lease commissions equal to
the current commission market rate as applied to the net aggregate rent (none
exceeding 6% of the net aggregate rent), and 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 and are reimbursed, at cost, for certain costs and expenses.
In particular, since HRP does not directly employ any individuals, the
compensation and other costs related to approximately 90 employees rendering
services on behalf of HRP and its properties are reimbursed to Realty and HCRE
by HRP. The following table sets forth such compensation and reimbursements paid
by HRP (in thousands):
Entity
Paid or
Reimbursed 2002 2001 2000
---------- ------------ ------------ ------------
Asset management fee Realty $ 618 $ 609 $ 581
Acquisition fee Realty -- -- 74
Disposition fee Realty -- 120 --
Reimbursement of costs(a) Realty 3,477 3,161 2,720
Property management fee HCRE 2,022 2,005 1,914
Lease commissions(b) HCRE 2,151 2,158 2,605
Construction fees HCRE 582 1,204 917
Reimbursement of costs(c) HCRE 3,916 3,826 3,521
(a) These expenses are recorded as general and administrative expenses and
represent reimbursement, at cost, to Realty for administrative level
employee and director compensation, officer and director liability
insurance, and allocated overhead costs. HRP pays its account balance
with Realty on a monthly basis.
(b) As of December 31, 2002, $567,000 of the 2002 lease commissions are
accrued and are scheduled to be paid in 2003.
(c) These costs are recorded as property operating expenses and represent
reimbursement to HCRE for property-level employee compensation and
related expenses.
Page 41 of 45
ITEM 11. EXECUTIVE COMPENSATION - (CONTINUED)
CASH COMPENSATION OF EXECUTIVE OFFICERS
HRP has no executive officers, however, employees of Realty (general partner of
HRP) perform all functions ordinarily performed by executive officers. The
following table sets forth the compensation paid for services performed for HRP
to the Chief Executive Officer and the four other executive officers. Bonuses
are with respect to years presented and are usually paid in the following year.
SUMMARY COMPENSATION TABLE
Annual Compensation
--------------------------------------------------------------------
Other Annual
Name and Principal Position Year Salary(a) Bonus Compensation(b)
--------------------------- ---- --------------- ----------------- ---------------
Anthony J. Gumbiner 2002 $ -- $ 150,000 $ --
Chairman of the Board and 2001 -- 150,000 --
Chief Executive Officer 2000 -- 150,000 --
William L. Guzzetti 2002 200,000 32,333 --
President and Chief 2001 200,000 32,333 --
Operating Officer 2000 200,000 32,333 --
John G. Tuthill 2002 150,360 68,265 7,643
Executive Vice President 2001 150,360 68,265 7,895
and Secretary 2000 150,360 68,265 7,923
Udo H. Walther 2002 150,000 68,250 7,643
Senior Vice President 2001 150,000 68,250 7,895
2000 150,000 68,250 --
Jeffrey D. Gent 2002 129,203 20,075 6,308
Vice President - Finance 2001 120,750 19,547 6,245
2000 115,000 19,471 6,206
----------
(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.
In 1995, HRP issued options totaling 86,000 units to certain executives of
Realty and HCRE with an exercise price of $11.875 per unit. The options were
vested over a three year period ending in 1997 and they expire on February 27,
2005. As of December 31, 2002, 17,200 options had been exercised (all during
2000), none have been canceled and 68,800 options remained exercisable. In
February 2003, options for 4,000 units were exercised by the estate of a
deceased HCRE executive. The following table discloses for each of the executive
officers of Realty the number of these options held by each of the executive
officers and the potential realizable values for their options at December 31,
2002. None of the executive officers exercised any options during the year ended
December 31, 2002 and HRP has not granted SARs.
AGGREGATED OPTION/SAR EXERCISES IN 2002
AND OPTION/SAR VALUES AT DECEMBER 31, 2002
Value of Unexercised
Number of Unexercised In-the-Money
Options at Options at
Units December 31, 2002 December 31, 2002
Acquired ------------------------------ ---------------------------
Name on Exercise Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ----------- ------------- ----------- -------------
Anthony J. Gumbiner 0 25,800 0 $ 1,814,385 $ 0
William L. Guzzetti 0 15,000 0 1,054,875 0
John G. Tuthill 0 13,000 0 914,225 0
Jeffrey D. Gent 0 7,000 0 492,275 0
Page 42 of 45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of March 14, 2003 concerning the
number of HRP 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:
Amount Percent
Name and Address of Beneficially of
Beneficial Owner Owned(a) Class
------------------------------------ ---------------- -----------
HWG, LLC 330,432 20.7%
c/o The Hallwood Group Incorporated
3710 Rawlins, Suite 1500
Dallas, Texas 75219
High River Limited Partnership 235,000 14.7%
c/o Icahn Associates Corp.
767 Fifth Avenue, 47th Floor
New York, NY 10153
Interstate Properties 160,200 10.1%
Park 80 West, Plaza II
Saddle Brook, NJ 07662
Alan G. Crisp(b) -- --
William F. Forsyth(b) -- --
Anthony J. Gumbiner(b) 25,800(c) 1.6%(c)
William L. Guzzetti(b) 15,100(d) 0.9%(d)
Edward T. Story(b) -- --
All directors and executive officers
as a group (8 persons) 60,900(e) 3.7%(e)
----------
(a) Unless otherwise indicated, each of the persons named has sole voting
and investment.
(b) Represented by the following address: c/o Hallwood Realty, LLC, 3710
Rawlins, Suite 1500, Dallas, Texas, 75219.
(c) Comprised of currently exercisable options to purchase 25,800 units.
(d) Includes currently exercisable options to purchase 15,000 units.
(e) Includes currently exercisable options to purchase 60,800 units.
EQUITY COMPENSATION PLAN INFORMATION
In 1995, HRP issued options totaling 86,000 units to certain executives of
Realty and HCRE with an exercise price of $11.875 per unit. The options were
vested over a three year period ending in 1997 and they expire on February 27,
2005. As of December 31, 2002, 17,200 options had been exercised (all during
2000), none have been canceled and 68,800 options remained exercisable. In
February 2003, options for 4,000 units were exercised by the estate of a
deceased HCRE executive.
As part of the resignation of Brian Troup as an officer and director of Hallwood
and HRP's general partner on December 21, 1999, Hallwood transferred 82,608
units of HRP that it owned to a trust controlled by Mr. Troup. On May 12, 2000,
Mr. Troup exercised his unit options to purchase 17,200 HRP units at the option
plan's exercise price of $11.875 per unit, which generated $601,000 of non-cash
compensation. Also on May 12, 2000, HRP purchased and retired all of Mr. Troup's
above-mentioned 99,808 units at $46.825 per unit (the average of the closing
market prices of the units for the twenty trading days prior to the purchase).
Page 43 of 45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -
(CONTINUED)
The following table provides information as of December 31, 2002 about HRP's
units that may be issued upon the exercise of options granted pursuant to HRP's
1995 Unit Option Plan, as amended to date.
A B C
Number of units to be Weighted-average Number of units remaining available for
issued upon exercise of exercise price of future issuance under equity compensation
Plan category outstanding options outstanding options plans (excluding units reflected in column A)
------------- ------------------------ ------------------- ---------------------------------------------
Equity compensation plans
approved by unitholders None n/a None
Equity compensation plans
not approved by unitholders 68,800(1) $11.875 None
(1) HRP is a partnership and, as such, does not hold meetings of its
unitholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See Note 4 to the Consolidated Financial Statements included in Item 8 for
information covered by this item.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. It is the conclusion
of the registrant's principal executive officer and principal
financial officer that the registrant's disclosure controls (as
defined in Exchange Act rules 13a-14 and 15d-14), based on their
evaluation of these controls and procedures as of a date within 90
days of the filing of this annual report on Form 10-K, are effective.
(b) Changes in internal controls. There were no significant changes in the
registrant's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their
evaluation.
PART IV
ITEM 15. 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.
HRP filed a report on Form 8-K, dated November 13, 2002, to
report that its Form 10-Q for the period ended September 30,
2002 was accompanied by a written statement of each of the
Principal Executive Officer and the Principal Financial
Officer. This statement was furnished in Item 9 of said Form
8-K pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(3) Exhibits.
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 44 of 45
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 18, 2003 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, 2002, has been signed below
by the following persons on behalf of the Registrant in the capacities and on
the date indicated.
Signature Capacity Date
------------------------ ----------------------------------- --------------
/s/ ANTHONY J. GUMBINER Chairman of the Board and Director, March 18, 2003
------------------------ Hallwood Realty, LLC --------------
Anthony J. Gumbiner (Chief Executive Officer)
/s/ WILLIAM L. GUZZETTI President and Director, March 18, 2003
------------------------ Hallwood Realty, LLC --------------
William L. Guzzetti (Chief Operating Officer)
/s/ JEFFREY D. GENT Vice President-Finance, March 18, 2003
------------------------ Hallwood Realty, LLC --------------
Jeffrey D. Gent (Chief Accounting Officer)
/s/ ALAN G. CRISP Director, March 18, 2003
------------------------ Hallwood Realty, LLC --------------
Alan G. Crisp
/s/ WILLIAM F. FORSYTH Director, March 18, 2003
------------------------ Hallwood Realty, LLC --------------
William F. Forsyth
/s/ EDWARD T. STORY Director, March 18, 2003
------------------------ Hallwood Realty, LLC --------------
Edward T. Story
Page 45 of 45
HALLWOOD REALTY PARTNERS, L.P.
CERTIFICATION FOR ANNUAL REPORTS ON FORM 10-K
I, Anthony J. Gumbiner, certify that:
1. I have reviewed this annual report on Form 10-K of Hallwood Realty
Partners, L.P.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation
Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 18, 2003 /s/ Anthony J. Gumbiner
-------------- -----------------------
Anthony J. Gumbiner
Chief Executive Officer
HALLWOOD REALTY PARTNERS, L.P.
CERTIFICATION FOR ANNUAL REPORTS ON FORM 10-K
I, Jeffrey D. Gent, certify that:
1. I have reviewed this annual report on Form 10-K of Hallwood Realty
Partners, L.P.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation
Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 18, 2003 /s/ Jeffrey D. Gent
-------------- --------------------------------------------
Jeffrey D. Gent
Vice President - Finance
(Principal Financial and Accounting Officer)