News Column

HALLWOOD GROUP INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

May 13, 2014

Forward-Looking Statements

This Quarterly Report on Form 10-Q (this "Form 10-Q"), including but not limited to the section of this Form 10-Q entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations." information concerning the Company's business prospects or future financial performance, anticipated revenues, expenses, profitability or other financial items, including the outcome of pending litigation, and its strategies, plans and objectives, together with other statements that are not historical facts, includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements generally can be identified by the use of forward-looking terminology, such as "may," "might," "will," "would," "expect," "intend," "could," "estimate," "should," "anticipate," "doubt" or "believe." The Company intends that all forward-looking statements be subject to the safe harbors created by these laws. All statements other than statements of historical information provided herein are forward-looking and may contain information about financial results, economic conditions, trends, and known uncertainties. All forward-looking statements are based on current expectations regarding important risk factors. Many of these risks and uncertainties are beyond the Company's ability to control, and, in many cases, the Company cannot predict all of the risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. Actual results could differ materially from those expressed in the forward-looking statements, and readers should not regard those statements as a representation by the Company or any other person that the results expressed in the statements will be achieved. Important risk factors that could cause results or events to differ from current expectations are described in the Company's annual report on Form 10-K for the year ended December 31, 2013 under Item 1A - "Risk Factors". These factors are not intended to be an all-encompassing list of risks and uncertainties that may affect the operations, performance, development and results of the Company's business. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to release publicly the results of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof, including without limitation, changes in its business strategy or planned capital expenditures, growth plans, or to reflect the occurrence of unanticipated events, although other risks and uncertainties may be described, from time to time, in the Company's periodic reports and filings with the Securities and Exchange Commission (the "SEC").



Overview

General. The Hallwood Group Incorporated (the "Company") (NYSE MKT: HWG) was incorporated in Delaware in 1981 and operates as a holding company. The Company operates its principal business in the textile products industry through its wholly owned subsidiary, Brookwood Companies Incorporated ("Brookwood"). Information contained herein includes references to the Company and its subsidiaries (collectively, the "Hallwood Group"). Going Concern. As described in this quarterly report on Form 10-Q and in the Company's annual report on Form 10-K for the year ended December 31, 2013, (i) as a holding company, the Company is dependent upon Brookwood for cash, (ii) the Company does not currently have sufficient cash, either directly or through Brookwood, to fund its ongoing operating costs or obligations, including the HFL Loan, and (iii) Brookwood's ability to pay the Company a dividend or other advance is dependent upon circumstances that are outside of the Company's control. The Company can give no assurance that Brookwood will have the ability to satisfy the Company's cash flow needs, or that the Company would be able to obtain other sources of funding if needed, and therefore there is substantial doubt as to the Company's ability to continue as a going concern. The Company's audited consolidated financial statements for the fiscal year ended December 31, 2013, as included in its annual report on Form 10-K, contained an audit opinion from its independent registered public accounting firm which includes explanatory language related to going concern resulting from the uncertainty of the payment of dividends from its subsidiary to fund the Company's ongoing operations and obligations. Hallwood Financial Proposal and Merger Agreement - On November 6, 2012, the Company received a proposal (the "HFL Proposal") from Hallwood Financial Limited ("Parent" or "Hallwood Financial") to acquire all of the outstanding shares of the Company's common stock that Parent does not beneficially own at a cash purchase price of $10.00 per share. Parent is controlled by Anthony J. Gumbiner, Chairman and Chief Executive Officer of the Company and Parent currently owns 1,001,575, or 65.7%, of the issued and outstanding shares of common stock, par value $0.10 per share, of the Company (such outstanding shares, collectively, the "Company Common Stock," and, each, a "Share"). Page 21



--------------------------------------------------------------------------------

Table of Contents THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES



Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS In November 2012, the board of directors of the Company (the "Board") formed a special committee (the "Special Committee"), consisting of three independent directors of the Company, to evaluate the Merger (as defined below) and other alternatives available to the Company. On June 4, 2013, the Company announced that the Company, Parent, and HFL Merger Corporation, a Delaware corporation and a wholly owned subsidiary of the Parent ("Merger Sub"), entered into an Agreement and Plan of Merger (as amended by the Amendment to Agreement and Plan of Merger, dated as of July 11, 2013, and the Second Amendment to Agreement and Plan of Merger, dated as of February 7, 2014, the "Merger Agreement"). The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into the Company (the "Merger"), with the Company continuing as the surviving corporation and a wholly owned subsidiary of Parent. The Special Committee unanimously determined that the transactions contemplated by the Merger Agreement (as in effect on such date), including the Merger, are advisable and in the best interests of the Company and its stockholders (other than the persons and entities associated with Mr. Gumbiner), and unanimously recommended that the Board approve and declare advisable the Merger Agreement and the transactions contemplated thereby, including the Merger, and that the Company's stockholders vote for the adoption of the Merger Agreement (as in effect on such date). Based in part on that recommendation, the Board (other than Mr. Gumbiner, who did not participate due to his interest in the Merger) unanimously (i) determined that the transactions contemplated by the Merger Agreement, including the Merger, are advisable and in the best interests of the Company and its stockholders (other than the persons and entities associated with Mr. Gumbiner), (ii) approved and declared advisable the execution, delivery and performance of the Merger Agreement and the consummation of the transactions contemplated thereby, including the Merger and (iii) resolved to recommend that the Company's stockholders vote for the adoption of the Merger Agreement. Accordingly, the Board (without Mr. Gumbiner's participation) unanimously recommended that the stockholders of the Company adopt the Merger Agreement. On August 23, 2013, Gary L. Sample ("Plaintiff") filed a purported class and derivative action in the Court of Chancery of the State of Delaware (the "Delaware Court") against the parties to the Merger Agreement and certain directors and officers of the Company (collectively, the "Defendants"), asserting, among other things, that the original Merger Consideration (as defined below) was unfair and did not reflect the true value of the Company and all of its assets (the "Sample Litigation"). On February 7, 2014, Plaintiff and the Defendants (together, the "Parties") entered into a Stipulation of Settlement (the "Stipulation"), by and through their respective attorneys, whereby the Parties agreed that, in order to resolve the Sample Litigation, the parties to the Merger Agreement would, among other actions, amend the Merger Agreement to increase the Merger Consideration by $3.00 per share, from $10.00 per Share to $13.00 per Share, less any incentive fee and attorneys' fees awarded by the Delaware Court to Plaintiff and Plaintiff's counsel in accordance with the Stipulation (the "Increased Merger Consideration"). The Defendants specifically deny that they have engaged in any wrongdoing, deny that they committed any violation of law, deny that they breached any fiduciary duties, and deny liability of any kind to Plaintiff, the Company, or its stockholders. The Increased Merger Consideration will be paid if the Merger is consummated pursuant to the terms of the Merger Agreement as amended by the Second Amendment to the Merger Agreement, which was entered into by the Company, Parent, and Merger Sub as of February 7, 2014 (the "Second Amendment"). On March 25, 2014, the Delaware Court held a public hearing regarding the Settlement, during which it indicated its approval of the Settlement. On March 28, 2014, the Delaware Court entered a Final Order and Judgment approving the Settlement. The Delaware Court's order awarded a $10,000 incentive fee to the plaintiff and $310,000 in attorney's fees to the plaintiff's counsel. This means that the Merger Consideration will equal $12.39 per share. In addition to awarding in a $10,000 incentive fee and $310,000 in attorney's fees, the Delaware Court reserved judgment on a separate application for additional attorney's fees relating to disclosure by the Company of certain information, which resulted from the Settlement. The Company will not be responsible for payment of any such separate disclosure-based award of attorney's fees and, regardless of whether the Delaware Court grants such an award, the Merger Consideration will not decrease as a result. All known and unknown claims against the defendants relating to the Sample Litigation, the Merger, the Settlement, and investments in securities issued by the Company between November 6, 2012 and the date of the Merger, including derivative claims, have been released pursuant to the Delaware Court's approval of the Settlement. Pursuant to the Merger Agreement, Merger Sub will merge with and into the Company, with the Company continuing as the surviving corporation and a wholly owned subsidiary of Parent, and each share of Common Stock outstanding immediately prior to the effective time of the Merger (other than certain excluded and dissenting shares of Common Stock) will be cancelled and converted into the right to receive $12.39 in cash, without interest (the "Merger Consideration") based on the settlement of the Page 22



--------------------------------------------------------------------------------

Table of Contents THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES



Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS Sample Litigation. The Sample Litigation is more fully described in Item 3 of our annual report on Form 10-K, "Legal Proceedings." The following excluded and dissenting shares of Common Stock will not be entitled to the Merger Consideration: (i) shares held by Parent, Merger Sub, the Company or any wholly owned subsidiary of the Company or held in the Company's treasury and (ii) shares outstanding immediately prior to the effective time of the Merger held by a stockholder who has neither voted in favor of the Merger nor consented thereto in writing and who has demanded properly in writing appraisal for such shares and otherwise properly perfected and not withdrawn or lost the right to an appraisal of such dissenting shares pursuant to Section 262 of the General Corporation Law of the State of Delaware. Consummation of the Merger is subject to certain other customary conditions, including, among others, (i) absence of any order or injunction prohibiting the consummation of the Merger, (ii) subject to certain exceptions, the accuracy of representations and warranties with respect to the business of the Company, (iii) each of the Company and Parent having performed their respective obligations pursuant to the Merger Agreement and (iv) the absence of a "Company Material Adverse Effect," which is defined in the Merger Agreement to include the occurrence of an "Event of Default" under that certain Loan Agreement, dated as of March 30, 2012, among Branch Banking and Trust Company, Brookwood Companies Incorporated, the Company and the other signatories thereto, filed with the SEC as Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended December 31, 2011. The Company's stockholders will be asked to consider and vote on a proposal to adopt the Merger Agreement at a special meeting of stockholders on May 15, 2014. In connection therewith, the Company has filed with the SEC and furnished to the Company's stockholders a proxy statement and other relevant documents. Before making any voting decision, the Company's stockholders are urged to read the proxy statement in its entirety when it becomes available and any other documents to be filed with the SEC in connection with the proposed Merger or incorporated by reference into the proxy statement because those documents will contain important information about the proposed Merger and the parties to the Merger. The Company's stockholders will be able to obtain a free copy of documents filed with the SEC at the SEC's website at http://www.sec.gov. In addition, the Company's stockholders may obtain a free copy of the Company's filings with the SEC from the Company's website at http://www.hallwood.com/hwg/SEC.php or by directing a request to: The Hallwood Group Incorporated, 3710 Rawlins, Suite 1500, Dallas, TX 75219; Attention: Investor Relations; Phone: (214) 528-5588 or (800) 225-0135. The foregoing information only describes certain terms of the Merger Agreement, as amended, and is not a complete description of all of the parties' rights and obligations under the Merger Agreement, as amended. For the complete terms, please read: (a) the Merger Agreement attached as Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on June 5, 2013; (b) the Amendment to Agreement and Plan of Merger, dated as of July 11, 2013, included as Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on July 12, 2013; and (c) the Second Amendment to Agreement and Plan of Merger, dated as of February 7, 2014, included as Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on February 10, 2014.



The Company's shares trade on the NYSE MKT stock exchange under the symbol of HWG and closed on November 5, 2012 (the day prior to the receipt of the HFL Proposal) at $6.00 per share. The Company's shares closed on May 6, 2014 at $12.29 per share.

Textile Products. In 2014 and 2013, Hallwood Group derived all of its operating revenues from the textile activities of its Brookwood subsidiary; consequently, the Company's success is highly dependent upon Brookwood's success. Brookwood's success will be influenced in varying degrees by its ability to continue sales to existing customers, costs, availability of supplies, its response to competition and its ability to generate new markets and products. While Brookwood has enjoyed substantial revenues from its military business, there is no assurance that such revenues will continue. Brookwood's sales to the customers from whom it derives its military business have been volatile and difficult to predict, a trend management believes will continue. Generally, military sales represent sales of a product to a customer (prime and sub-prime contractors) that will be incorporated into an end product that will be used to fulfill a U.S. or international military contract. In recent years, orders from the military for goods generally were significantly affected by the increased activity of the U.S. military. As this activity changes, then orders from the military generally, including orders for Brookwood's products, may be similarly affected. Military sales of $9,993,000 in the 2014 first quarter were 36.4% lower than the comparable period in 2013 of $15,714,000. Orders were weak in the fourth quarter of 2013 and through much of the first quarter of 2014 but have improved in March and into the second quarter of 2014 through the date of this quarterly report on Form 10-Q. We believe the reduction of sales and orders described is due at least in part to a reduction of deployed troops and continued debate in congress and the administration regarding federal spending and we are unable to know if the recent improvement in orders will continue. If such conditions persist, orders from the military, including orders for Brookwood's products, may experience further decline which could have a material adverse effect on Brookwood's operating results and financial condition. Page 23



--------------------------------------------------------------------------------

Table of Contents THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES



Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS From time to time, the military limits orders for existing products and adopts revised specifications for new products to replace the products for which Brookwood's customers have been suppliers. The U.S. government released orders in recent years that include Brookwood's products, which resulted in significant military sales. Changes in specifications, procurement entity budgets, or orders present a potential opportunity for additional sales; however, it is a continuing challenge to adjust to changing specifications, budgetary and production requirements. Brookwood has regularly conducted research and development on various processes and products intended to comply with the revised specifications and it participates in the bidding process for new military products. However, to the extent Brookwood's products are not included in future purchases by the U.S. government for any reason, Brookwood's sales could be adversely affected. A provision of U.S. federal law, known as the Berry Amendment, generally requires the Department of Defense to give preference in procurement to domestically produced products, including textiles. Brookwood's sales of products to the U.S. military market are highly dependent upon the continuing application and enforcement of the Berry Amendment by the U.S. government. In addition, the U.S. government is releasing contracts for shorter periods than in the past. Management acknowledges the unpredictability in revenues and margins due to military sales and is unable at this time to predict future sales trends.



Unstable global nylon and chemical pricing and volatile domestic energy costs, coupled with a varying product mix, have continued to cause fluctuations in Brookwood's margins, a trend that will potentially continue.

Brookwood continues to identify new market niches. In addition to its existing products and proprietary technologies, Brookwood has developed advanced breathable, waterproof laminate and other materials, which have been well received by its customers. Continued development of these fabrics for military, industrial and consumer applications is a key element of Brookwood's business plan. The ongoing success of Brookwood is contingent on its ability to maintain its level of military business or expand its sales of its consumer and industrial product lines. While volatile, the significant opportunities for the military product line necessitate that it be a key focus of Brookwood's sales and marketing efforts; however, during this time of relative weakness of sales and orders of military products, Brookwood is aggressively seeking new customers and opportunities for our consumer and industrial product lines. There can be no assurance that the positive results of the past can be sustained or that competitors will not aggressively seek to replace products developed by Brookwood. The textile products business is not interdependent with the Company's other business operations, if any. The Company does not guarantee the Brookwood bank facility and is not obligated to contribute additional capital. Conversely, Brookwood does not guarantee debts of the Company or any of the Company's other subsidiaries and is not obligated to make payments to the Company beyond amounts potentially due under the tax sharing agreement. In addition to the limitations described in Note 5 in the accompanying condensed consolidated financial statements, any future dividend payments or advances would also be contingent upon the approval of Brookwood's board of directors and Brookwood's ability to meet the requirements of the Delaware corporate laws for the payment of dividends and compliance with other applicable laws and requirements.



Presentation

The discussion of Hallwood Group's financial condition and results of operations is intended to provide information that will assist in understanding its financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect its financial statements.



Results of Operations

Hallwood Group reported a net loss of $4,815,000 for the 2014 first quarter, compared to a net loss of $1,344,000 for the 2013 first quarter. Revenue was $24,122,000 and $31,283,000 for the 2014 and 2013 first quarters, respectively. Hallwood Group had an operating income (loss) of $(4,882,000) and $(1,144,000) for the first quarter of 2014 and 2013, respectively. Brookwood had operating income (loss) of $(3,751,000) and $94,000 for the 2014 and 2013 first quarters, respectively; whereas the Company had an operating income (loss) of $(1,131,000) and $(1,238,000) for the 2014 and 2013 first quarters, respectively. Page 24



--------------------------------------------------------------------------------

Table of Contents THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES



Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS Revenues Textile products sales of $24,122,000 decreased by $7,161,000, or 22.9%, in the 2014 first quarter, compared to $31,283,000 in the 2013 first quarter. The decrease in 2014 was principally due to fluctuations in sales of specialty fabric to U.S. military contractors as a result of changes to orders from the military to Brookwood's customers. Military sales accounted for $9,993,000 in the 2014 first quarter period, compared to $15,714,000 in the 2013 first quarter. Military sales represented 41.4% and 50.2% of Brookwood's net sales in the 2014 and 2013 first quarters, respectively. Orders were weak in the fourth quarter of 2013 and through much of the first quarter of 2014 but have improved in March and into the second quarter of 2014 through the date of this quarterly report on Form 10-Q. We believe the reduction of sales and orders described is due at least in part to a reduction of deployed troops and continued debate in congress and the administration regarding federal spending and we are unable to know if the recent improvement in orders will continue. Generally, military sales represent sales of a product to a customer (prime and sub-prime contractors) that will be incorporated into an end product that will be used to fulfill a U.S. or international military contract. Sales to one Brookwood customer, Tennier Industries, Inc. ("Tennier"), accounted for more than 10% of Brookwood's sales during the first quarter of 2013 and during the year 2013. Brookwood's relationship with Tennier is ongoing. Sales to Tennier, which are included in military sales, were $2,054,000 in the 2014 first quarter compared to $6,951,000 in the 2013 first quarter. Sales to Tennier in the first quarters of 2014 and 2013 represented 8.5% and 22.2%, respectively.



Expenses

Textile products cost of sales of $24,327,000 for the 2014 first quarter decreased by $3,132,000, or 11.4%, compared to $27,459,000 in the 2013 first quarter. The 2014 decrease is primarily a result of the fluctuations in textile product sales, principally from variances in military sales, and changes in overall product mix in a quarter to quarter comparison. Cost of sales includes all costs associated with the manufacturing process, including but not limited to, materials, labor, utilities, royalties, depreciation on manufacturing equipment and all costs associated with the purchase, receipt and transportation of goods and materials to Brookwood's facilities, including inbound freight, purchasing and receiving costs, inspection costs, internal transfer costs and other costs of the distribution network. Brookwood believes that the reporting and composition of cost of sales and gross margin is comparable with similar companies in the textile converting and finishing industry. The gross profit (loss) margin for the 2014 first quarter was (0.8)%, compared to 12.2% for the 2013 first quarter. The decrease in gross profit margin was attributed to varying levels of sales volume (principally a 36.4% reduction in military sales in the 2014 first quarter, as compared to the 2013 first quarter), changes in product mix, increased energy costs and a more competitive pricing environment, primarily in the military market. Administrative and selling expenses were comprised of the following (in thousands): Three Months Ended March 31, 2014 2013 Brookwood $ 3,546$ 3,730 Company 1,131 1,238 Total $ 4,677$ 4,968 Brookwood's administrative and selling expenses of $3,546,000 for the 2014 first quarter decreased by $184,000, or 4.9% from the same period in 2013. Brookwood's administrative and selling expenses included items such as payroll, professional fees, sales commissions, marketing, rent, insurance and travel. Brookwood conducts research and development activities related to the exploration, development and production of innovative products and technologies. Research and development costs were approximately $248,000 and $169,000 for the 2014 and 2013 first quarters, respectively. Page 25



--------------------------------------------------------------------------------

Table of Contents THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES



Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS The Company's administrative expenses decreased $107,000, or 8.6%, for the 2014 first quarter, compared to the 2013 first quarter. The decrease was attributable to a reduction in certain professional fees.



Other Income (Expense)

Interest expense was comprised of the following (in thousands):

Three Months Ended March 31, 2014 2013 Brookwood $ 30$ 62 Company 83 131 Total $ 113$ 193



Brookwood's interest expense principally relates to its revolving credit facility. The Company's interest expense substantially relates to the HFL Loan, which was entered into in May 2012.

Income Taxes

Following is a schedule of the Company's income tax expense (benefit) (in thousands): Three Months Ended March 31, 2014 2013 Federal Current $ - $ - Deferred - - Sub-total - - State Current (180 ) 7 Deferred - - Sub-total (180 ) 7 Total $ (180 )$ 7



The Company recorded no federal deferred tax benefit for the three months ended March 31, 2014 and 2013 since the deferred tax asset resulting from the estimated tax loss for the same periods in the amounts of $1,637,000 and $491,000, respectively was offset by a full valuation allowance.

The net deferred tax asset (liability) for the Company was ($75,000) and ($75,000) at March 31, 2014 and December 31, 2013, respectively.

At March 31, 2014, the deferred tax assets, before valuation allowance, was comprised principally of $7,581,000 related to the anticipated carryforward of taxable losses; $667,000 of tax credits; and offset by other deferred tax liabilities of $315,000. Due to continuing uncertainty related to taxable income to be reported in future periods (after consideration of historical results, current business trends, and other objectively verifiable information), the Company recorded an additional valuation allowance at March 31, 2014 in the amount of $1,637,000 and continues to record a valuation allowance on all of its deferred tax assets at March 31, 2014. The total valuation allowance at March 31, 2014 was $8,008,000. Page 26



--------------------------------------------------------------------------------

Table of Contents THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES



Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS



Critical Accounting Policies

There have been no changes to the critical accounting policies identified and set forth in Hallwood Group's annual report on Form 10-K for the year ended December 31, 2013.

Related Party Transactions

Hallwood Investments Limited. The Company has entered into a financial consulting contract with Hallwood Investments Limited ("HIL"), an entity associated with Mr. Anthony J. Gumbiner, the Company's chairman, Chief Executive Officer and principal stockholder. The contract provides for HIL to furnish and perform international consulting and advisory services to the Company and its subsidiaries, including strategic planning and merger activities, for annual compensation of $996,000. The annual amount is payable in monthly installments. The contract automatically renews for one-year periods if not terminated by the parties beforehand. Additionally, HIL and Mr. Gumbiner are also eligible for bonuses from the Company or its subsidiaries, subject to approval by the Company's or its subsidiaries' board of directors. The Company also reimburses HIL for reasonable expenses in providing office space and administrative services in Europe in connection with HIL's services to the Company pursuant to the financial consulting agreement and for travel and related expenses between Europe and the Company's locations in the United States and health insurance premiums. A summary of the fees and expenses related to HIL and Mr. Gumbiner is detailed below (in thousands): Three Months Ended March 31, 2014 2013 Consulting fees $ 249$ 249 Interest expense on HFL loan 83 130 Office space and administrative services 57 70 Travel and other expenses 17 15 Total $ 406$ 464 In May 2012, to fund in part the payment of a judgment in a legal matter related to its investment in Hallwood Energy, L.P., the Company entered into the HFL Loan with Hallwood Family (BVI) L.P., a limited partnership associated with Mr. Gumbiner. The interest expense payable on the HFL Loan was $357,000 and $275,000 at March 31, 2014 and December 31, 2013 respectively. See Note 5 for more information. In addition, from time to time, HIL and Mr. Gumbiner have performed services for certain affiliated entities that are not subsidiaries of the Company, for which they have received consulting fees, bonuses, stock options, profit interests or other forms of compensation and expenses. No such services were performed, or compensation earned, during 2014 or 2013. 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. HIL and certain of its affiliates in which Mr. Gumbiner has an indirect financial interest share common offices, facilities and certain staff in the Company's Dallas office for which these companies reimburse the Company. Certain individuals employed by the Company, in addition to their services provided to the Company, perform services on behalf of the HIL-related affiliates. In addition, HIL utilizes some of the Dallas office space for purposes unrelated to the Company's business. The Company pays certain common general and administrative expenses for salaries, rent and other office expenses and charges the HIL-related companies an overhead reimbursement fee for the share of the expenses allocable to these companies. For the three months ended March 31, 2014 and 2013, these companies reimbursed the Company $26,000 and $30,000, respectively, for such expenses. Page 27



--------------------------------------------------------------------------------

Table of Contents THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES



Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS Litigation



Refer to Note 11 in the accompanying condensed consolidated financial statements for a discussion of litigation matters.

Contractual Obligations and Commercial Commitments

The Company and its subsidiaries have entered into various contractual obligations and commercial commitments in the ordinary course of conducting its business operations, which are provided below as of March 31, 2014 (in thousands):

Payments Due



During the Years Ending December 31,

2014* 2015 2016 2017 2018 Thereafter Total Contractual Obligations Revolving Credit Facility $ - $ - $ 3,925 $ - $ - $ - $ 3,925 HFL Loan - 5,411 - - - - 5,411 Operating leases 562 583 212 - - - 1,357 Total $ 562$ 5,994$ 4,137 $ - $ - $ - $ 10,693



* For the nine months ending December 31, 2014.

Interest costs associated with Brookwood's Revolving Credit Facility, which bears interest at variable rates, are not a material component of the Company's consolidated expenses. Estimated interest payments, based on the principal balance as of March 31, 2014, average principal balances during 2014, and weighted average interest rates are approximately $126,000 on an annual basis. Estimated interest payments associated with the Company's HFL Loan, based on the principal balance as of March 31, 2014, are approximately $320,000 per year. Employment Contracts. The Company and its Brookwood subsidiary have compensation agreements with various personnel and consultants. Generally, the agreements extend for one-year terms and are renewable annually. 2005 Long-Term Incentive Plan for Brookwood. In December 2005, the Company adopted The Hallwood Group Incorporated 2005 Long-Term Incentive Plan for Brookwood Companies Incorporated ("2005 Long-Term Incentive Plan for Brookwood") to encourage employees of Brookwood to increase the value of Brookwood and to continue to be employed by Brookwood. The terms of the incentive plan provide for a total award amount to participants equal to 15% of the fair market value of consideration received by the Company in a change of control transaction, as defined, in excess of the sum of the liquidation preference plus accrued unpaid dividends on the Brookwood preferred stock ($14,411,000 at March 31, 2014). The base amount will fluctuate in accordance with a formula that increases by the amount of the annual dividend on the preferred stock, currently $1,823,000, and decreases by the amount of the actual preferred dividends paid by Brookwood to the Company. The plan generally defines a change of control transaction as a transaction approved by the Company's board of directors or by the holders of at least 50% of the voting capital stock of the Company that results in: (i) a change in beneficial ownership of the Company or Brookwood of 50% or more of the combined voting power, (ii) the sale of all or substantially all of the assets of Brookwood, or (iii) any other transaction that, in the Company's board of directors discretion, has substantially the same effect of item (i) or (ii). Certain transfers, generally among existing stockholders and their related parties, are exempted from the definition. However, if the Company's board of directors determines that certain specified Brookwood officers, or other persons performing similar functions do not have, prior to the change of control transaction, in the aggregate an equity or debt interest of at least two percent in the entity with whom the change of control transaction is completed, then the minimum amount to be awarded under the plan shall be $2,000,000. In addition, the Company agreed that, if members of Brookwood's senior management do not have, prior to a change of control transaction is completed in the aggregate an equity or debt interest of at least two percent in the entity with whom the change of control transaction (exclusive of any such interest any such individual receives with respect to his or her employment following the change of control transaction), then the Company will be obligated to pay an additional $2,600,000. As of March 31, 2014, no amounts have been accrued or paid under the Long-Term Incentive Plan for Brookwood. The Merger will not constitute a change of control transaction under the plan. Page 28



--------------------------------------------------------------------------------

Table of Contents THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES



Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS



Off-Balance Sheet Arrangements

Hallwood Group has no off-balance sheet arrangements.

Financial Covenants

Brookwood.The Revolving Credit Facility, as amended, required Brookwood to satisfy certain financial covenants on the last day of each fiscal quarter. For each of the quarterly periods during 2013, Brookwood was in compliance with loan covenants of the Revolving Credit Facility. The principal financial ratios required under Brookwood's Revolving Credit Facility were as follows: Quarters Ended in 2013 Description Requirement Dec 31, Sept 30, June 30, Mar 31, Current ratio must be greater than ratio of 1.40 2.67 2.60 2.62 2.54 Total liabilities to must be less than tangible net worth ratio of 1.50 0.39 0.42 0.41 0.43 Total funded debt to must be less than EBITDA ratio of 4.00 0.27 0.26 0.43 1.53 On March 28, 2014, Brookwood and its subsidiaries executed an amended and restated credit agreement with BB&T (the "Amended and Restated Credit Facility"). The Amended and Restated Credit Facility contains a minimum fixed charge coverage ratio covenant and a minimum excess availability covenant, each as defined in the Amended and Restated Credit Facility. The minimum fixed charge coverage ratio is 1.10 to 1.00 and will be measured quarterly beginning with the quarter ended September 30, 2014. The minimum excess availability covenant is measured monthly. As of March 31, 2014, subject to the provisions of the Amended and Restated Credit Facility and borrowings of $3,925,000, Brookwood had unused borrowing availability of approximately $4.6 million under this credit facility. Brookwood was in compliance with loan covenants of the Amended and Restated Credit Facility as of March 31, 2014. Pursuant to the March 2014 amendment, in order to maintain compliance with such covenants in the future, Brookwood may be required to limit aggregate borrowings under the Amended and Restated Credit Facility to less than $25,000,000 at the end of each fiscal quarter. For more information about the Amended and Restated Credit Facility, see Note 5 in the accompanying condensed consolidated financial statements. Cash dividends and tax sharing payments by Brookwood to the Company are limited by the terms of the Amended and Restated Credit Facility and are contingent upon compliance with the loan covenants therein. This limitation on the transferability of assets constitutes a restriction of Brookwood's net assets, which were $42,650,000 and $45,033,000 as of March 31, 2014 and December 31, 2013, respectively.



Liquidity and Capital Resources

General. The Company, through its Brookwood subsidiary, principally operates in the textile products segment. Hallwood Group's cash position decreased by $844,000 during the 2014 three month period to $209,000 as of March 31, 2014. The principal source of cash in the 2014 three month period was $2,750,000 of net borrowings of the Revolving Credit Facility, as amended in March 2014. The primary uses of cash were $3,017,000 used by operating activities and $577,000 for property, plant and equipment, principally at Brookwood. The amounts outstanding under the Amended and Restated Credit Facility and HFL Loan were $3,925,000 and $5,411,000, respectively, at March 31, 2014. Page 29



--------------------------------------------------------------------------------

Table of Contents THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES



Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS As further discussed under Item 1A, "Risk Factors" of the Company's annual report on Form 10-K for the year ended December 31, 2013, (i) as a holding company, the Company is dependent upon Brookwood for cash, (ii) the Company does not currently earn sufficient cash, directly or through Brookwood, to fund its ongoing operating costs or obligations, including the HFL Loan, and (iii) Brookwood's ability to pay the Company a dividend or other advance is dependent upon circumstances that are outside of the Company's control. The Company can give no assurance that Brookwood will have the ability to satisfy the Company's cash flow needs, or that the Company would be able to obtain other sources of funding in such a circumstance (other than the HFL Loan, which was amended on March 26, 2014 to provide up to $3,000,000 of liquidity in 2014), and therefore there is substantial doubt as to the Company's ability to continue as a going concern.



The Company's audited consolidated financial statements for the fiscal year ended December 31, 2013, included in the Company's annual report on Form 10-K, contains an audit report from its independent public accounting firm which included explanatory language related to going concern resulting from the uncertainty of the payment of dividends from its subsidiary to fund the Company's ongoing operations and obligations.

As a holding company, the Company is dependent on Brookwood to receive the cash necessary to fund its ongoing operations and its obligations. Brookwood paid $3,900,000 of dividends during 2013 to the Company, and as of May 13, 2014, Brookwood has not paid any dividends to the Company during 2014. At March 31, 2014 and December 31, 2013, the Company had approximately $155,000 and $972,000, respectively, of cash and cash equivalents. If for any reason Brookwood is unable to pay a cash dividend or other advance to the Company, the Company would be required to seek alternative sources of funding. The Company has not yet determined what, if any, sources would be available to it (other than the HFL Loan, which was amended on March 26, 2014 to provide up to $3,000,000 of liquidity in 2014, and is discussed in Note 5 of the accompanying condensed consolidated financial statements), but will consider such alternatives as an additional or new facility or term loan and potential sales of assets or additional securities. No assurance can be given that any such additional sources of funding will be available to the Company, which could result in the Company not being able to continue as a going concern. Any failure to receive from Brookwood cash required by the Company could have a material adverse effect on the Company's financial position, results of operations and cash flows and could substantially impair the Company's ability to continue as a going concern. The consolidated financial statements have been prepared assuming the Company will continue as a going concern and do not include any adjustments that might result should the Company be unable to continue as a going concern. The Company believes that it will satisfy its recurring and normal operating costs, or general and administrative expenses, for 2014 with its cash on hand and the funds available to the Company through the extension of the revolving credit facility associated with the HFL Loan. On March 28, 2014 Brookwood executed an Amended and Restated Credit Agreement, as defined and discussed Note 5 of the accompanying condensed consolidated financial statements. Although Brookwood expects to have sufficient borrowing capacity in 2014, dividends and other distributions to Hallwood in 2014 are limited to $750,000 payable after September 30, 2014. In subsequent periods, Brookwood may make dividends and distributions to Hallwood as long as Brookwood is in compliance with both the minimum fixed charge coverage ratio and minimum excess availability covenants. The Company was advanced $175,000 in April 2013 and $200,000 in May 2014, prior to the filing of this Quarterly Report on Form 10-Q, under HFL Loan's revolving credit facility. Additionally, any payment of a dividend or advance by Brookwood to the Company is dependent on a number of other factors including compliance with the loan covenants in Brookwood's Amended and Restated Credit Facility, as amended, with Branch Banking & Trust, the approval of Brookwood's board of directors, Brookwood's ability to meet the requirements of the Delaware corporate laws for payment of dividends, and compliance with other applicable laws and requirements. As a result, no assurance can be given that these amounts will be available when required. Page 30



--------------------------------------------------------------------------------

Table of Contents

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters