10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

OR

¨ 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: 1-8303

The Hallwood Group Incorporated

(Exact name of registrant as specified in its charter)

Delaware	51-0261339
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
3710 Rawlins, Suite 1500, Dallas, Texas	75219
(Address of principal executive offices)	(Zip Code)

214-528-5588

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at April 30, 2012
Common Stock, $0.10 par value per share	1,525,166 shares

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

TABLE OF CONTENTS

ITEM NO.		PAGE
	PART I - FINANCIAL INFORMATION
1	Financial Statements (Unaudited):
	Condensed Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011		3
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2012 and 2011		4
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2012 and 2011		5
	Condensed Consolidated Statement of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2012		6
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011		7
	Notes to Condensed Consolidated Financial Statements		8
2	Management’s Discussion and Analysis of Financial Condition and Results of Operations		25
4	Controls and Procedures		35
	PART II - OTHER INFORMATION
1 thru 6	Other Information		36
	Signature Page		38
	Index to Exhibits		39

Page 2

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

(unaudited)

	March 31, 2012			December 31, 2011
ASSETS
Current Assets
Cash and cash equivalents	$	10,367		$	10,869
Accounts receivable, net
Factors		18,376			17,487
Trade and other		4,127			8,174
Related parties		42			42
Inventories		28,578			24,980
Deferred income tax, net		5,651			4,788
Prepaids, deposits and other assets		667			934
Prepaid income taxes		2,146			1,027
		69,954			68,301
Noncurrent Assets
Property, plant and equipment		20,199			20,442
Deferred income tax, net		1,881			—
Other assets		241			162
		22,321			20,604
Total Assets	$	92,275		$	88,905
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts payable	$	10,610		$	8,941
Accrued expenses and other current liabilities		6,078			5,096
Payable – Hallwood Energy matters
Litigation reserve		20,700			9,300
Contingent additional investment in Hallwood Energy		3,201			3,201
Income taxes payable		4			10
		40,593			26,548
Noncurrent Liabilities
Long term portion of loans payable		2,000			2,000
Deferred income tax		94			1,217
		2,094			3,217
Total Liabilities		42,687			29,765
Contingencies and Commitments (Note 13)
Stockholders’ Equity
Common stock, issued 2,396,105 shares for both periods; outstanding 1,525,166 shares for both periods		240			240
Additional paid-in capital		51,700			51,700
Retained earnings		11,052			20,604
Treasury stock, 870,939 shares for both periods; at cost		(13,404	)		(13,404	)
Total Stockholders’ Equity		49,588			59,140
Total Liabilities and Stockholders’ Equity	$	92,275		$	88,905

See accompanying notes to condensed consolidated financial statements.

Page 3

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

	Three Months Ended March 31,
	2012			2011
Revenues
Textile products sales	$	35,879		$	26,769
Expenses
Textile products cost of sales		30,149			23,194
Administrative and selling expenses		6,969			5,146
Litigation charge – Hallwood Energy matters		13,200			—
		50,318			28,340
Operating loss		(14,439	)		(1,571	)
Other Income (Loss)
Interest expense		(25	)		(26	)
Interest and other income		1			17
		(24	)		(9	)
Loss before income taxes		(14,463	)		(1,580	)
Income tax expense (benefit)		(4,911	)		(584	)
Net Loss	$	(9,552	)	$	(996	)
Net Loss Per Common Share
Basic	$	(6.26	)	$	(0.65	)
Diluted	$	(6.26	)	$	(0.65	)
Weighted Average Shares Outstanding
Basic		1,525			1,525
Diluted		1,525			1,525

See accompanying notes to condensed consolidated financial statements.

Page 4

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(unaudited)

	Three Months Ended March 31,
	2012			2011
Net Loss	$	(9,552	)	$	(996	)
Other Comprehensive Income (Loss)
None		—			—
Comprehensive Loss	$	(9,552	)	$	(996	)

See accompanying notes to condensed consolidated financial statements.

Page 5

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(in thousands)

(unaudited)

					Additional										Total
	Common Stock				Paid-In		Retained			Treasury Stock					Stockholders’
	Shares		Par Value		Capital		Earnings			Shares		Cost			Equity
Balance, January 1, 2012		2,396	$	240	$	51,700	$	20,604			871	$	(13,404	)	$	59,140
Net loss		—		—		—		(9,552	)		—		—			(9,552	)
Balance, March 31, 2012		2,396	$	240	$	51,700	$	11,052			871	$	(13,404	)	$	49,588

See accompanying notes to condensed consolidated financial statements.

Page 6

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended March 31,
	2012			2011
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	(9,552	)	$	(996	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Litigation charge – Hallwood Energy matters		13,200			—
Deferred tax expense (benefit)		(3,867	)		—
Depreciation, amortization and impairment		593			658
Provision (recovery) for obsolete inventory		154			(29	)
Provision (recovery) for doubtful accounts and factor dilution		8			(51	)
Changes in assets and liabilities:
(Increase) decrease in inventories		(3,752	)		(6,563	)
(Increase) decrease in accounts receivable		3,150			3,225
Partial payment of litigation reserve – Hallwood Energy matters		(1,800	)		—
Increase (decrease) in accounts payable		1,777			2,508
Increase (decrease) in accrued expenses and other current liabilities		982			(1,248	)
Net change in other assets and liabilities		188			(267	)
Net change in income taxes receivable/payable		(1,125	)		(672	)
Net cash provided by (used in) operating activities		(44	)		(3,435	)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from redemption of short-term investments		—			1,115
Proceeds from disposal of equipment		58			—
Investments in property, plant and equipment, net		(516	)		(555	)
Net cash provided by (used in) investing activities		(458	)		560
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from revolving credit facility		—			—
Repayments of revolving credit facility		—			—
Net cash provided by (used in) financing activities		—			—
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(502	)		(2,875	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		10,869			11,159
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	10,367		$	8,284

See accompanying notes to condensed consolidated financial statements.

Page 7

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Note 1 — Organization, Interim Condensed Consolidated Financial Statements and New Accounting Pronouncements

Organization. The Hallwood Group Incorporated (the “Company”) (NYSE Amex: HWG) was incorporated in Delaware in 1981. The Company 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”). The consolidated financial statements include the accounts of the Company and its subsidiaries (collectively, the “Hallwood Group”).

Interim Condensed Consolidated Financial Statements. The interim condensed consolidated financial statements of Hallwood Group have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America. Although condensed, in the opinion of management, all adjustments considered necessary for a fair presentation have been included. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related disclosures thereto included in Hallwood Group’s annual report on Form 10-K for the year ended December 31, 2011.

Textile Products. Textile products operations are conducted through Brookwood. Brookwood is an integrated textile firm that develops and produces innovative fabrics and related products through specialized finishing, treating and coating processes. Brookwood has two principal subsidiaries at March 31, 2012:

• Kenyon Industries, Inc. (“Kenyon”). Kenyon, located in Rhode Island, uses the latest technologies and processes in dyeing, finishing, coating and printing of woven synthetic products. Kenyon provides quality finishing services for fabrics used in a variety of markets, such as military, luggage and knapsacks, flag and banner, apparel, industrial and sailcloth.

• Brookwood Laminating Inc. (“Brookwood Laminating”). Brookwood Laminating, located in Connecticut, uses the latest in processing technology to provide quality laminating services for fabrics used in military clothing and equipment, sailcloth, medical equipment, industrial applications and consumer apparel. Up to five layers of textile materials can be processed using both wet and dry lamination techniques.

Textile products accounts for all of Hallwood Group’s operating revenues. See Note 4 for additional information on Brookwood.

Energy. Prior to October 2009, the Company held an investment in Hallwood Energy, L.P. (“Hallwood Energy”). Hallwood Energy was a privately held independent oil and gas limited partnership and operated as an upstream energy company engaged in the acquisition, development, exploration, production, and sale of hydrocarbons, with a primary focus on natural gas assets. The Company accounted for the investment in Hallwood Energy using the equity method of accounting, recording its pro rata share of Hallwood Energy’s net income (loss), partners’ capital transactions and comprehensive income (loss). As further discussed in Note 5, Hallwood Energy filed for bankruptcy in March 2009. In connection with the confirmation of Hallwood Energy’s bankruptcy in October 2009, the Company’s ownership interest in Hallwood Energy was extinguished and the Company no longer accounts for the investment in Hallwood Energy using the equity method of accounting.

Investments in Financial Instruments. In the 2011 first quarter, the Company opened an investment account with UBS AG, a global financial services firm, and intended to transfer a significant portion of the cash it holds from time to time to the UBS account to be placed in various financial instruments and to borrow additional amounts from UBS to invest on a leveraged basis. As of May 15, 2012, no funds have been transferred into the UBS account. The Company does not currently intend to transfer funds into the UBS account, but may consider doing so in the future.

Page 8

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Consolidation Policy. The Company’s Brookwood subsidiary operates on a 5-4-4 accounting cycle with its months always ending on a Saturday for accounting purposes, while the Company operates on a traditional fiscal month accounting cycle. For purposes of the year-end financial statements the Brookwood cycle always ends on December 31, however, quarterly interim financial statements may not correspond to the fiscal quarter-end. Hallwood Group’s condensed consolidated financial statements as of March 31, 2012 and 2011 include Brookwood’s operations through March 31, 2012 and April 2, 2011, respectively. Estimated operating results of Brookwood for the intervening periods to March 31, 2012 and 2011, respectively, are provided below (in thousands):

	Amounts in Intervening Periods
	Three Months Ended March 31,
	2012		2011
	(not applicable)		(two business days)
Textile products sales	$	—	$	711
Textile products costs of sales		—		628
Administrative and selling expenses		—		119

New Accounting Pronouncements. Accounting standard-setting organizations frequently issue new or revised accounting rules. Hallwood Group regularly reviews new pronouncements to determine their impact, if any, on Hallwood Group’s consolidated financial statements.

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, which requires a more uniform framework for fair value measurements and related disclosures between GAAP and International Financial Reporting Standards (“IFRS”). This guidance also requires additional disclosure (a) for Level 3 fair value measurements including quantitative information about unobservable inputs used, a description of the valuation processes used, by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (b) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use and the reason for the difference; (c) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (d) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. This guidance is effective for interim and annual periods beginning on or after December 15, 2011. Hallwood Group adopted this guidance prospectively as of January 1, 2012, the beginning of the 2012 fiscal year. The adoption of this guidance did not require any additional disclosure in the consolidated financial statements.

In September 2011, the FASB issued Accounting Standards Update No. 2011-09 (ASU 2011-09), Compensation – Retirement Benefits – Multiemployer Pans (Subtopic 715-80), Disclosures about an Employer’s Participation in a Multiemployer Plan. This standard requires an employer that participates in multiemployer pension plans to provide additional quantitative and qualitative disclosures in order to provide users with more detailed information about the employer’s involvement in multiemployer pension plans. In addition, this standard also includes changes in the disclosures required for multiemployer plans that provide postretirement benefits other than pensions. ASU 2011-09 is effective for Hallwood Group for the fiscal year ending after December 15, 2011. Hallwood Group adopted ASU 2011-09 in its annual financial statements for the year ended December 31, 2011. The adoption of ASU 2011-09 did not affect Hallwood Group’s financial position, results of operations or cash flows, although additional disclosures related to postretirement benefits have been included in the accompanying footnotes.

Page 9

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Note 2 — Cash and Cash Equivalents

Hallwood Group’s cash and cash equivalents are presented below (in thousands). Hallwood Group had no marketable securities as of March 31, 2012 or December 31, 2011.

	March 31, 2012
	Cost		Gross Unrealized Losses		Gross Unrealized Gains		Fair Value
Cash and Cash Equivalents
Cash	$	6,118	$	—	$	—	$	6,118
Available for-sale-securities:
Money market funds		4,249		—		—		4,249
Total cash and cash equivalents	$	10,367	$	—	$	—	$	10,367
	December 31, 2011
	Cost		Gross Unrealized Losses		Gross Unrealized Gains		Fair Value
Cash and Cash Equivalents
Cash	$	5,621	$	—	$	—	$	5,621
Available for-sale-securities:
Money market funds		5,248		—		—		5,248
Total cash and cash equivalents	$	10,869	$	—	$	—	$	10,869

Note 3 — Inventories

All inventories relate to Brookwood. Inventories as of the balance sheet dates were as follows (in thousands):

	March 31,		December 31,
	2012		2011
Raw materials	$	8,318	$	7,727
Work in progress		6,269		5,796
Finished goods		13,991		11,457
Total	$	28,578	$	24,980

Note 4 — Operations of Brookwood Companies Incorporated

Receivables. Brookwood maintains factoring agreements with several factors, which provide that receivables resulting from credit sales to customers, excluding the U.S. Government, may be sold to the factor, subject to a commission and the factor’s prior approval. Factored receivables were $18,376,000 and $17,487,000 at March 31, 2012 and December 31, 2011, which were net of a returned goods dilution allowance of $69,000 and $63,000, respectively.

Brookwood monitors its factors and their ability to fulfill their obligations to Brookwood in a timely manner. As of May 15, 2012, all of Brookwood’s factors were complying with payment terms in accordance with factor agreements.

Page 10

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Trade receivables were $3,815,000 and $8,031,000 at March 31, 2012 and December 31, 2011, which were net of an allowance for doubtful accounts of $120,000 and $118,000, respectively. The trade receivable balance at December 31, 2011 included approximately $1,643,000, which was the balance remaining related to fabric sold in two products to a Brookwood customer in the period from September 2008 to April 2009 that supplies the U.S. military for which payment had been delayed due to a compliance issue (see also Note 13). Brookwood received payment at full value of $1,643,000 in January 2012.

Sales Concentration. Brookwood has one customer who accounted for more than 10% of Brookwood’s sales. Sales to that Brookwood customer, Tennier Industries, Inc. (“Tennier”), accounted for more than 10% of Brookwood’s sales during the 2012 first quarter only. Brookwood’s relationship with Tennier is ongoing. Sales to Tennier, which are included in military sales, were $6,708,000 and $290,000 in the 2012 and 2011 first quarters, respectively. Sales to Tennier represented 18.7% and 1.1% of Brookwood’s net sales in the 2012 and 2011 first quarters, respectively.

Military sales accounted for $21,675,000 and $10,176,000 in the 2012 and 2011 first quarters, which represented 60.4% and 38.0% of Brookwood’s net sales in the 2012 and 2011 first quarters, respectively. 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.

Stockholders’ Equity. The Company is the holder of all of Brookwood’s outstanding $13,500,000 Series A, $13.50 annual dividend per share, redeemable preferred stock and all of its 10,000,000 outstanding shares of common stock. The preferred stock has a liquidation preference of $13,500,000 plus accrued but unpaid dividends. At March 31, 2012, cumulative dividends in arrears on the preferred stock amounted to approximately $456,000.

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 (the “2005 Long-Term Incentive Plan for Brookwood”) to encourage employees of Brookwood to increase the value of Brookwood and 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 (approximately $13,956,000 at March 31, 2012). 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 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 (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. No amounts have been accrued under this plan.

Note 5 — Investments in Hallwood Energy, L.P.

Hallwood Energy was a privately held independent oil and gas limited partnership and operated as an upstream energy company engaged in the acquisition, development, exploration, production, and sale of hydrocarbons, with a primary focus on natural gas assets. The Company had invested $75,401,000 in Hallwood Energy comprised of a general partnership interest, Class A and Class C limited partnership interests and convertible notes.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Prior to the confirmation of Hallwood Energy’s plan of reorganization in Bankruptcy Court in October 2009 (discussed below), the Company accounted for the investment in Hallwood Energy using the equity method of accounting and recorded its pro rata share of Hallwood Energy’s net income (loss), partner capital transactions and comprehensive income (loss), as appropriate. In connection with Hallwood Energy’s bankruptcy reorganization, the Company’s general and limited partnership interests in Hallwood Energy were extinguished and the Company no longer accounts for the investment in Hallwood Energy using the equity method of accounting.

Bankruptcy Reorganization by Hallwood Energy. In March 2009, Hallwood Energy, Hallwood Energy Management, LLC (the general partner of Hallwood Energy, “HEM”) and Hallwood Energy’s subsidiaries, filed petitions for relief under Chapter 11 of the United States Bankruptcy Code. The cases were adjudicated in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, in In re Hallwood Energy, L.P., et al Case No. 09-31253. The Company was only an investor in and creditor of Hallwood Energy. The bankruptcy filing did not include the Company or any other of its assets.

In October 2009, the Bankruptcy Court confirmed a plan of reorganization of the debtors that, among other things, extinguished Hallwood Energy’s general partnership and limited partnership interests, including those held by the Company. In addition, Hallwood Energy’s convertible notes, including those held by the Company, were subordinated to recovery in favor of Hall Phoenix/Inwood, Ltd. (“HPI”), the secured lender to and an investor in Hallwood Energy.

Litigation. In connection with Hallwood Energy’s bankruptcy proceeding, Hallwood Energy and other parties filed lawsuits and had threatened to assert additional claims against the Company and certain related parties alleging actual, compensatory and exemplary damages in excess of $200,000,000, based on purported breach of contract, fraud, breach of fiduciary duties, neglect, negligence and various misleading statements, omissions and misrepresentations. See Note 13.

In one of these matters, the Adversary Proceeding, on July 25, 2011, the Bankruptcy Court issued the Proposed Findings of Fact, Conclusions of Law and Judgment Awarding Various Monetary Damages (“the Proposed Findings”) proposing that damages be awarded against the Company totaling approximately $18,700,000 plus prejudgment and postjudgment interest and attorney’s fees as may be requested and awarded pursuant to a subsequent motion. As a result of the Proposed Findings and taking into consideration the Company’s objections to the Proposed Findings, during 2011 the Company recorded a charge of $7,500,000 in its statement of operations and its balance sheet as an accrual under Hallwood Energy matters – Litigation Reserve in the Adversary Proceeding, in addition to $3,201,000 that was previously recorded in connection with the Equity Support Agreement discussed below for a total reserve of $10,701,000 at December 31, 2011 for the Adversary Proceeding.

On April 24, 2012, the United States District Court entered a final judgment (the “Judgment”) substantially adopting the Proposed Findings. Based upon the monetary damages (including prejudgment and postjudgment interest, legal fees and court costs) awarded in the Judgment, the Company recorded an additional charge of $13,200,000 at March 31, 2012 in its statement of operations and balance sheet as an accrual under Hallwood Energy matters – Litigation Reserve. Accordingly, the total reserve at March 31, 2012 for the Adversary Proceeding was $23,901,000. The Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. In addition, the Company will be required to pay certain attorneys’ fees incurred by the plaintiffs. The amount and timing of the payment of these fees will be subsequently determined by the District Court, and are currently unresolved. See Note 6.

In the Hallwood Energy litigation matters, other than the Adversary Proceeding, effective February 14, 2012, the Company and certain other parties entered into a Confidential Settlement Agreement and Mutual Release of Claims (the “Settlement Agreement”). The Settlement Agreement effectively settles the claims by HPI, the Trustee of the Hallwood Energy I Creditors’ Trust, and their related parties (the “Plaintiffs”) against the Company and its related parties, other than the claims in the Adversary Proceeding, in which the District Court rendered the Judgment.

The terms of the Settlement Agreement included the payment by the Company of $1,800,000, in addition to payments by other defendants and the Company’s insurance carrier for its directors and officers’ liability insurance policy. Under the Settlement Agreement, the Plaintiffs release the Company, its current and former directors and officers, the former directors and officers of the general partner of Hallwood Energy, L.P. and various entities related to the foregoing persons from all claims asserted in or relating to (i) Hall Phoenix/Inwood Ltd. and Hall Performance Energy Partners 4, Ltd. v. The Hallwood Group Incorporated et al. in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03358; (ii) Ray Balestri,

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Trustee of the Hallwood Energy I Creditor’s Trust v. Anthony J. Gumbiner, et al. in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03263; and (iii) another suit in which the Company is not named as a party, and any other claims based on the facts alleged in the foregoing matters or that could have been alleged in the foregoing matters, other than the claims against the Company asserted in the Adversary Proceeding or any claims required to enforce any final judgment entered against the Company in the Adversary Proceeding. Similarly, the defendants release the Plaintiffs from all claims based on the facts alleged in the foregoing matters or that could have been alleged in the for foregoing matters, other than any claims or defenses the defendants may have in the Adversary Proceeding.

The parties entered into the Settlement Agreement for a number of reasons, including to save time and expense, to ensure available insurance proceeds could be used toward the settlement of the disputed claims rather than the payment of expenses and legal fees, and otherwise to resolve the litigation claims. The defendants continue to believe that the claims asserted against them in the lawsuits had no merit and their agreement to settle and compromise those claims should not be deemed as an admission of any liability, wrongdoing, or fault.

At December 31, 2011, the Company recorded a charge of $1,800,000 in its statement of operations and balance sheet under Hallwood Energy matters – Litigation Reserve for the full value of the Company’s payment required by the Settlement Agreement. The Company paid the settlement amount of $1,800,000 to the plaintiffs on February 15, 2012.

Equity Support Agreement. In connection with the then ongoing efforts to complete an Acquisition and Farmout Agreement entered into between Hallwood Energy and FEI Shale, L.P. (“FEI”), the Company loaned Hallwood Energy $2,961,000 in May 2008. Concurrent with the completion of the Acquisition and Farmout Agreement in June 2008, the Company entered into an equity support agreement (the “Equity Support Agreement”) with Hallwood Energy under which the Company committed, under certain conditions, to contribute equity or debt capital to Hallwood Energy to maintain a reasonable liquidity position for Hallwood Energy or prevent or cure any default under Hallwood Energy’s credit facilities with respect to interest payments, up to a maximum of $12,500,000. The Company contributed $2,039,000 at the completion date (for a total amount of $5,000,000) to Hallwood Energy and committed to provide an additional amount of up to $7,500,000 in certain circumstances, under the terms of a $12,500,000 convertible subordinated note agreement (the “Second Convertible Note”) issued by Hallwood Energy in May 2008 and underwritten by the Company. In September 2008, the Company loaned $4,300,000 to Hallwood Energy pursuant to the Equity Support Agreement. An obligation and related additional equity loss were recorded in 2008 to the extent of the Company’s contingent commitment to provide additional financial support to Hallwood Energy pursuant to the Equity Support Agreement, in the amount of $3,201,000. The Company’s additional investments and contingent commitment to provide additional financial support resulted in the recording of an equity loss in the year ended December 31, 2008 of $12,120,000.

The Equity Support Agreement terminated not later than October 2009 in connection with the confirmation of Hallwood Energy’s plan of reorganization. The Equity Support Agreement is no longer in effect, although (as previously discussed) the obligation to pay the remaining unpaid contingent commitment under the Equity Support Agreement, which was subject to litigation in the Adversary Proceeding, was $3,201,000 and was paid on May 4, 2012.

Other. For further information on Hallwood Energy’s activities, including its bankruptcy reorganization, refer to Hallwood Group’s annual report on Form 10-K for the year ended December 31, 2011.

Page 13

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Note 6 — Loans Payable

Loans payable, all of which relate to Brookwood, at the balance sheet dates were as follows (in thousands):

	March 31,		December 31,
	2012		2011
Working Capital Revolving Credit Facility; repaid April 2012	$	2,000	$	2,000
New Revolving Credit Facility; due March 2014		—		—
		2,000		2,000
Current portion		—		—
Noncurrent portion	$	2,000	$	2,000

Working Capital Revolving Credit Facility. The Company’s Brookwood subsidiary had a revolving credit facility in an amount up to $25,000,000 with KeyBanc (the “Working Capital Revolving Credit Facility”). Borrowings were collateralized by accounts receivable, certain finished goods inventory, machinery and equipment and all of the issued and outstanding capital stock of Brookwood and its subsidiaries. The interest rate was a blended rate of 1.74% and 1.78% at March 31, 2012 and December 31, 2011, respectively. The outstanding balance was $2,000,000 at March 31, 2012, which was repaid on April 2, 2012 with proceeds from the New Revolving Credit Facility (discussed below).

Loan Covenants. The Working Capital Revolving Credit Facility contained various loan covenants including a covenant that provided for a maximum total debt to tangible net worth ratio of 1.50 and a covenant that Brookwood shall maintain a quarterly minimum income before taxes of not less than one dollar. In October 2009, an additional covenant was added that provided for a total funded debt to EBITDA (earnings before interest, taxes, depreciation and amortization) ratio, for the trailing four quarters, of not greater than 2.00 to be calculated on a quarterly basis.

As of March 31, 2012, December 31, 2011 and for the quarters ended September 30, 2011 and June 30, 2011, Brookwood was in compliance with its principal loan covenants for the Working Capital Revolving Credit Facility.

Due to a decline in military sales for quarter ended March 31, 2011, Brookwood was unable to meet the financial covenant that requires income before taxes of at least $1 in each quarter. Brookwood’s unaudited loss before taxes for the 2011 first quarter was $299,000. Accordingly, in May 2011, Brookwood requested and received a waiver from KeyBanc for the income covenant for the 2011 first quarter. Brookwood received an increased level of military orders in late March 2011 and into the subsequent 2011 periods, and reported income before taxes in the 2011 second quarter, third quarter and fourth quarter, respectively, and was in compliance with its loan covenants for the three remaining 2011 quarters.

New Revolving Credit Facility entered into in March 2012. On March 30, 2012, Brookwood and its subsidiaries entered into a loan agreement by and among Brookwood, its subsidiaries and Branch Banking and Trust Company (“BB&T”) (the “New Revolving Credit Facility”). The New Revolving Credit Facility replaces the Working Capital Revolving Credit Facility.

The New Revolving Credit Facility provides for borrowings of up to $25,000,000 and is secured by a first lien on substantially all of the assets of Brookwood. The New Revolving Credit Facility has a maturity date of March 30, 2014. On April 2, 2012, Brookwood borrowed $2,018,000 under this new facility to repay outstanding amounts due under the Working Capital Revolving Credit Facility, including accrued interest. On May 8, 2012, the Company requested a dividend of $8,000,000 from Brookwood, which obtained consent from BB&T for such payment. Accordingly, Brookwood borrowed $8,000,000 under the New Revolving Credit Facility and paid that amount as a dividend to the Company. The Company combined such funds with other available cash and the HFL Loan, discussed below, to satisfy the Judgment issued by the United States District Court. As of May 15, 2012, Brookwood had $14,891,000 of borrowing availability under this facility, which was net of a standby letter of credit for $91,000.

The interest rate payable on the New Revolving Credit Facility is dependent on a leverage ratio, as defined, and can vary from LIBOR plus 1.00% to 2.00%. If BB&T is not a primary factor of Brookwood, then the interest rates will be increased by 0.40%.

Page 14

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

The terms of the New Revolving Credit Facility provide that the facility may be used for refinancing existing indebtedness, providing for working capital and financing on-going capital expenditures.

The New Revolving Credit Facility contains customary representations, warranties and affirmative covenants on behalf of Brookwood and also contains negative covenants that, among other things, prohibit Brookwood from, without obtaining prior BB&T written consent and with certain exceptions: (i) permitting liens (other than customary liens) to exist on any of its properties; (ii) incurring other debt other than accounts payable to trade creditors incurred in the ordinary course of business and factors; (iii) making capital expenditures in excess of $5,000,000 in any year; (iv) purchasing substantially all the assets of another entity; (v) entering into new leases except operating leases for machinery and equipment that do not in the aggregate require payments in excess of $250,000 in any year and real estate leases in the ordinary course of business; (vi) paying dividends, or acquiring any of its stock, other than (a) annual payments to the Company for tax sharing obligations, and (b) annual discretionary dividends to the Company not to exceed 50% of Brookwood’s net income for such year; (vii) making loans or advances to, or guaranties for the benefit of, any person; and (viii) disposing of its assets or properties except in the ordinary course of its business.

The loan agreement also requires Brookwood to satisfy certain financial covenants on the last day of each fiscal quarter, including maintaining:

(i) a ratio of total current assets to the sum of total current liabilities and the outstanding loan balance of not less than 1.40 to 1.00.

(ii) a ratio of total liabilities to tangible net worth of not greater than 1.50 to 1.00. Tangible net worth is defined as net worth, plus obligations contractually subordinated to debts owed to BB&T, minus goodwill, contract rights, and assets representing claims on stockholders or affiliated entities.

(iii) a ratio of funded debt (as defined) to EBITDA (earnings before interest, taxes, depreciation and amortization) for the trailing four quarters of not greater than 2.75 to 1.00.

Brookwood was in compliance with such financial covenants at March 31, 2012. In order to maintain compliance with such covenants in the future, Brookwood may be required to limit aggregate borrowings under the New Revolving Credit Facility to less than $25,000,000 at the end of each fiscal quarter.

Payments of Dividends. During the term of the Working Capital Revolving Credit Facility, Brookwood submitted a quarterly loan compliance certificate to KeyBanc and concurrently requested the bank’s consent to pay cash dividends and tax sharing payments to the Company. Brookwood paid to the Company dividends of $1,000,000 in February 2012 and $4,000,000 during the year ended December 31, 2011. The New Revolving Credit Facility contains a restriction on the payment of any cash dividend or advance to the Company above the tax sharing payment and the permitted annual discretionary dividend not to exceed 50% of Brookwood’s net income. Brookwood has indicated that it would be required (pursuant to the terms of the New Revolving Credit Facility) to obtain consent from BB&T for such payments above the permitted amount.

In May 2012, following the Company’s request for an additional dividend, Brookwood requested BB&T to approve such dividend for $8,000,000. BB&T consented to the dividend, which was paid to the Company in May 2012. Any future 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.

Also in May 2012, to fund in part the payment of the Judgment, the Company borrowed from Hallwood Family (BVI) L.P., a limited partnership associated with its principal shareholder, the sum of $10,000,000 (the “HFL Loan”). The HFL Loan is secured by a pledge of all of the stock of Brookwood, subject to BB&T consent, and by the Company’s interest in the anticipated refunds of federal income taxes of approximate $5,000,000, which the Company expects to receive in 2012 and 2013. The HFL Loan is due in full on June 28, 2013 and bears interest at the rate of 6% per year, payable on a quarterly basis. The Company may prepay the HFL Loan at any time without penalty. The documents reflecting the HFL Loan contains representations, warranties and covenants that are typical for loans of this type.

Page 15

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Restricted Net Assets. Cash dividends and tax sharing payments by Brookwood to the Company are contingent upon compliance with the New Revolving Credit Facility loan covenants and/or consent from BB&T in certain circumstances. This limitation on the transferability of assets constitutes a restriction of Brookwood’s net assets, which were $58,995,000 and $59,970,000 at March 31, 2012 and December 31, 2011, respectively.

Note 7 — Stockholders’ Equity

Stock Options. At March 31, 2012, there were no outstanding stock options. The Company’s former stock option plan expired in 2005 and no stock options are available for issuance.

Note 8 — Income Taxes

Following is a schedule of the income tax expense (benefit) (in thousands):

	Three Months Ended
	March 31,
	2012			2011
Federal
Current	$	(1,055	)	$	(590	)
Deferred		(3,867	)		—
Sub-total		(4,922	)		(590	)
State
Current		11			6
Deferred		—			—
Sub-total		11			6
Total	$	(4,911	)	$	(584	)

The net deferred tax asset was $7,438,000 and $3,571,000 at March 31, 2012 and December 31, 2011, respectively. The net deferred tax asset at March 31, 2012 was comprised of temporary differences, including $7,038,000 related to loss reserves on litigation matters and $1,088,000 associated with the Company’s investment in Hallwood Energy. The net deferred tax asset at December 31, 2011 was comprised of temporary differences, including $3,162,000 related to loss reserves on litigation matters and $1,088,000 associated with the Company’s investment in Hallwood Energy. The federal tax rate was 34%, while state taxes were determined based upon taxable income apportioned to those states in which Hallwood Group does business at their respective tax rates.

Hallwood Group had a federal income tax receivable of $1,875,000 and $821,000 at March 31, 2012 and December 31, 2011, respectively, and net state tax receivable of $272,000 and $195,000, at March 31, 2012 and December 31, 2011, respectively. The federal income tax receivable is principally due to the carryback of the 2012 and 2011 federal net operating losses to 2010 and 2009, respectively.

Page 16

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Note 9 — Fair Value of Financial Instruments

The following table summarizes the valuation of Hallwood Group’s financial instruments based upon the inputs used to measure fair value in the three levels of the fair value hierarchy as of March 31, 2012 and December 31, 2011.

• Level 1 – Quoted market prices in active markets for identical assets or liabilities

• Level 2 – Quoted prices for similar assets or liabilities in active markets or inputs that are observable

• Level 3 – Inputs that are unobservable

	March 31, 2012
	Level 1		Level 2		Level 3
Cash Equivalents
Money market funds	$	4,249	$	—	$	—
	December 31, 2011
	Level 1		Level 2		Level 3
Cash Equivalents
Money market funds	$	5,248	$	—	$	—

Money market funds are classified as Level 1 instruments as they are traded in active markets with sufficient volume and frequency of transactions.

The fair value of financial instruments that are short-term or reprice frequently and have a history of negligible credit losses are considered to approximate their carrying value. These include cash, short term receivables, accounts payable, the revolving credit facility and other liabilities.

Note 10 — Supplemental Disclosures to the Condensed Consolidated Statements of Cash Flows

The following transactions affected recognized assets or liabilities but did not result in cash receipts or cash payments (in thousands):

Supplemental schedule of non-cash investing and financing activities:

	Three Months Ended
	March 31,
Description	2012		2011
Accrued capital expenditures in accounts payable and accrued expenses:
Amount at end of period	$	22	$	163

Supplemental disclosures of cash payments:

Income taxes paid	$	76	$	91
Interest paid		25		28

Page 17

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Note 11 — Computation of Income (Loss) Per Common Share

The following table reconciles weighted average shares outstanding from basic to diluted methods and reconciles net income (loss) used in the computation of income (loss) per share for the basic and diluted methods (in thousands):

	Three Months Ended
	March 31,
Description	2012			2011
Weighted Average Shares Outstanding
Basic and diluted		1,525			1,525
Net Income (Loss)
Basic and diluted	$	(9,552	)	$	(996	)

For the three months ended March 31, 2012 and 2011, there were no outstanding stock options. No shares were excluded from the calculation of diluted earnings per share.

Note 12 — Related Party Transactions

Hallwood Investments Limited. The Company has entered into a financial consulting contract with Hallwood Investments Limited (“HIL”), a corporation associated with Mr. Anthony J. Gumbiner, the Company’s chairman 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 contract and for travel and related expenses to 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 are detailed below (in thousands):

	Three Months Ended
	March 31,
	2012		2011
Consulting fees	$	249	$	249
Office space and administrative services		65		95
Travel and other expenses		17		13
Total	$	331	$	357

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 receive consulting fees, bonuses, stock options, profit interests or other forms of compensation and expenses. No such services were performed, or compensation earned, during 2012 or 2011. 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 office space for purposes unrelated to the Company’s business. The Company pays certain common general

Page 18

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

and administrative expenses for salaries, rent and other offices 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, 2012 and 2011, these companies reimbursed the Company $26,000 and $24,000, respectively, for such expenses.

In May 2012, to fund in part the payment of the Judgment, the Company entered into the HFL Loan with Hallwood Family (BVI) L.P., a limited partnership associated with Mr. Gumbiner. See Note 6.

Note 13 — Litigation, Contingencies and Commitments

Reference is made to Note 15 to the consolidated financial statements contained in the Company’s annual report on Form 10-K for the year ended December 31, 2011.

Litigation. From time to time, the Company, its subsidiaries, certain of its affiliates and others have been named as defendants in lawsuits relating to various transactions in which it or its affiliated entities participated. Although the Company does not believe that the results of any of these matters are likely to have a material adverse effect on its financial position, results of operations or cash flows, except as described below, it is possible that any of the matters could result in material liability. In addition, Hallwood Group has spent and may continue to spend significant amounts in professional fees and other associated costs in connection with certain of these matters. Hallwood Group expenses professional fees and other costs associated with litigation matters as incurred.

In July 2007, Nextec Applications, Inc. filed Nextec Applications, Inc. v. Brookwood Companies Incorporated and The Hallwood Group Incorporated in the United States District Court for the Southern District of New York (SDNY No. CV 07-6901) claiming that Brookwood infringed five United States patents pertaining to internally-coated webs. In October 2007, The Hallwood Group Incorporated was dismissed from the lawsuit. Nextec later added additional patents to the lawsuit. After a number of motions, only two patents remain in the action and are being asserted against the process and machine for making defendants’ Agility Storm-Tec X-Treme and Eclipse Storm-Tec X-Treme fabrics, which constitute two levels of the Military’s Extended Cold Weather Clothing System. Nextec is seeking a permanent injunction as well as damages in an amount to be determined at trial. Separately, Brookwood filed requests for reexamination by the United States Patent and Trademark Office of the remaining patent claims at issue in the litigation. The United States Patent and Trademark Office has granted the reexamination requests and issued first office actions rejecting all the reexamined patent claims as unpatentable over the prior art of record. Nextec will have an opportunity to respond to the Patent Office and eventually to appeal any final decision by the Patent Office. Brookwood intends to vigorously defend against all remaining claims. Trial on this matter began on April 30, 2012 and is ongoing. While Brookwood believes it possesses valid defenses to these claims, due to the nature of litigation, the ultimate outcome of this case is indeterminable at this time.

Hallwood Energy. In March 2009, Hallwood Energy, HEM (the general partner of Hallwood Energy) and Hallwood Energy’s subsidiaries, filed petitions for relief under Chapter 11 of the United States Bankruptcy Code. The cases were adjudicated in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, in In re Hallwood Energy, L.P., et al Case No. 09-31253. The Company was only an investor in and creditor of Hallwood Energy. The bankruptcy filing did not include the Company or Brookwood.

In October 2009, the Bankruptcy Court confirmed a plan of reorganization of the debtors that, among other things, extinguished the Company’s interest in Hallwood Energy’s general partnership and limited partnership interests. In addition, Hallwood Energy’s convertible notes, including those held by the Company, were subordinated to recovery in favor of Hall Phoenix/Inwood, Ltd (“HPI”), the secured lender to and an investor in Hallwood Energy.

The confirmed plan of reorganization in the Hallwood Energy bankruptcy proceeding also created a creditors’ trust that was authorized to pursue various claims against the Company, its officers, directors and affiliates and Hallwood Energy’s officers and directors, including claims assigned to the creditors’ trust by HPI.

Adversary Proceeding. On March 30, 2009, Hallwood Energy filed an adversary proceeding against the Company seeking a judgment for $3,200,000. The case was originally styled as Hallwood Energy, L.P. v. The Hallwood Group Incorporated, Adversary No. 09-03082, and was brought in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division. This dispute arose in connection with an Acquisition and Farmout Agreement entered into between Hallwood Energy and FEI Shale, L.P.

Page 19

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

(“FEI”), a subsidiary of Talisman Energy, Inc., in June 2008, The Company and Hallwood Energy entered into an Equity Support Agreement dated June 9, 2008 under which the Company agreed, under certain conditions, to contribute to Hallwood Energy up to $12,500,000, in consideration for which the Company would receive equity or debt securities of Hallwood Energy. As of February 25, 2009, the Company had contributed $9,300,000 to Hallwood Energy pursuant to the Equity Support Agreement. On that date, Hallwood Energy demanded that the Company fund the $3,200,000, which the Company did not do.

Following the commencement of litigation, HPI and FEI intervened in the lawsuit and filed their respective complaints in intervention. In their complaints, they alleged that the Company’s failure to fund $3,200,000 under the Equity Support Agreement damaged Hallwood Energy in an amount in excess of $3,200,000. FEI claimed that, in addition to not paying the $3,200,000, the Company defrauded FEI and tortiously interfered with its rights under the Acquisition and Farmout Agreement, and it sought approximately $38,000,000 in additional damages. In their second amended complaint, HPI and the trustee for the creditors’ trust contended that the additional damages were at least $20,000,000 based on the alleged failure of the Company to fund the $3,200,000, which allegedly caused FEI to not fund $20,000,000 due under the Farmout Agreement between Hallwood Energy and FEI. HPI and the trustee also asserted that the Company was liable for exemplary damages of $100,000,000 on account of its failure to fund the last $3,200,000 under the Equity Support Agreement. In the second amended complaint, HPI and the trustee had named as additional defendants Hallwood Family (BVI) L.P., Hallwood Investments Limited, Hallwood Company Limited, the Hallwood Trust, Hallwood Financial Limited and Brookwood Companies Incorporated contending that the additional defendants are liable to the plaintiffs under allegations requesting the remedy of substantive consolidation. On May 5, 2010, the Court dismissed with prejudice the substantive consolidation claim and abuse of the bankruptcy process against all parties, resulting in the Company remaining as the sole Defendant. In light of the Court’s disposition of the theories advanced in the second amended complaint, the adversary proceeding was now styled as Ray Balestri, Trustee of the Hallwood Energy I Creditors’ Trust, as successor in interest to Hallwood Energy, L.P., Plaintiffs and FEI Shale L.P. and Hall Phoenix/Inwood Ltd., Plaintiffs in Intervention vs. The Hallwood Group Incorporated, Defendant; Adversary No. 09-03082-SGJ (the “Adversary Proceeding”). The trial took place over a 13 day period from October 2010 to December 2010 and was followed with the Bankruptcy Court’s proposed findings in July 2011.

On July 25, 2011, the Bankruptcy Court issued the Proposed Findings of Fact, Conclusions of Law and Judgment Awarding Various Monetary Damages (the “Proposed Findings”). The court proposed that the United States District Court award damages of $3,200,000 for the Company’s alleged breach of the Equity Support Agreement, to be allocated among the three plaintiffs and damages of $15,485,714 to FEI, for the Company’s alleged tortious interference with the Farmout Agreement, and, in the alternative, for the Company’s alleged fraud in failing to disclose to FEI that the Company allegedly did not intend to fund the remaining obligation under the Equity Support Agreement, plus prejudgment and postjudgment interest and attorneys’ fees as may be requested and awarded pursuant to subsequent motions and hearings. With respect to the issue of fraud by nondisclosure, the Bankruptcy Court proposed a finding that the Company (i) failed to disclose a belief that the Equity Support Agreement could legally be treated as terminated, (ii) failed to disclose its alleged intention not to fund the final $3,200,000 under the Equity Support Agreement and (iii) orchestrated an alleged misimpression that Hallwood Energy was not contemplating bankruptcy while planning Hallwood Energy’s bankruptcy and how to use FEI’s funding in a Hallwood Energy bankruptcy against FEI’s wishes. The court also proposed that the District Court reject HPI and the trustee’s claim that the Company’s failure to fund the $3,200,000 caused FEI to not fund $20,000,000 under the Farmout Agreement, that the District Court reject HPI and the trustee’s claim that the Company tortiously interfered with certain contractual rights, and that the District Court reject HPI and the trustee’s claim for exemplary or punitive damages.

As a result of Proposed Findings, taking into consideration the Company’s objections to the Proposed Findings, the Company recorded a litigation reserve charge for $7,500,000 at June 30, 2011. As no new information had become available regarding the outcome of the litigation, the Company did not believe the reserve related to the Adversary Proceeding should be changed at December 31, 2011. This accrued reserve of $7,500,000 was reported in the Company’s balance sheet under “Hallwood Energy matters — Litigation reserve” for those periods, in addition to the $3,201,000 that was previously recorded in connection with the Equity Support Agreement, for a total reserve of $10,701,000 at December 31, 2011 for the Adversary Proceeding. This reserve amount was established in consultation with the Company’s litigation counsel in the Hallwood Energy litigation, based on their best judgment of the probabilities of success related to, among other factors, the objections to be filed by the Company on its possible appeal of the District Court’s Judgment.

Page 20

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

On April 24, 2012, the United States District Court entered a final judgment (the “Judgment”) substantially adopting the Proposed Findings. Based upon the monetary damages (including prejudgment and postjudgment interest, legal fees and court costs) awarded in the Judgment, the Company, in consultation with the Company’s litigation counsel, recorded an additional charge of $13,200,000 at March 31, 2012 in its statement of operations and balance sheet as an accrual under Hallwood Energy matters – Litigation Reserve. Accordingly, the total reserve at March 31, 2012 for the Adversary Proceeding was $23,901,000. The Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. In addition, the Company will be required to pay certain attorneys’ fees incurred by the plaintiffs. The amount and timing of the payment of these fees will be subsequently determined by the District Court, and are currently unresolved.

Other Litigation Claims. On August 3, 2009, the Company was served with a complaint in Hall Phoenix/Inwood Ltd. and Hall Performance Energy Partners 4, Ltd. v. The Hallwood Group Incorporated, et al. filed in the 298^th District of Texas, No. 09-09551. The other defendants included Anthony J. Gumbiner, the Chairman and Chief Executive Officer of the Company, Bill Guzzetti, the President of the Company, certain affiliates of Mr. Gumbiner and certain officers of Hallwood Energy. The complaint alleged that the defendants defrauded plaintiffs in connection with plaintiffs acquiring interests in and providing loans to Hallwood Energy and sought unspecified actual and exemplary damages. On September 15, 2010, Ray Balestri, Trustee of the Hallwood Energy I Creditors Trust, intervened in this proceeding and added certain of the Company’s officers, directors, and an employee as defendants. The complaint alleged, among other things, claims against the defendants for breach of fiduciary duties, gross negligence and willful misconduct and sought indeterminable actual and exemplary damages. On November 5, 2010, this case was removed to the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03358. As discussed below, in February 2012, this claim was settled.

On July 30, 2010, Hallwood Energy’s trustee filed a complaint captioned Ray Balestri, Trustee of the Hallwood Energy I Creditor’s Trust v. Anthony J. Gumbiner, et al in the Dallas County Court at Law No. 4, No. CC-10-05212D. The other defendants include certain current and former directors, officers and employees of the Company, certain of Hallwood Energy’s former officers and directors, as well as outside legal counsel. The complaint alleged, among other things, claims against the defendants for breach of fiduciary duties, gross negligence and willful misconduct and sought unspecified actual and exemplary damages. This case was removed to the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03263. As discussed below, in February 2012, this claim was settled with respect to all parties except outside legal counsel.

Settlement in February 2012 of Litigation Claims other than Adversary Proceeding. Effective February 14, 2012, the Company and certain other parties entered into a Confidential Settlement Agreement and Mutual Release of Claims (the “Settlement Agreement”). The Settlement Agreement settles the claims by HPI, the Trustee of the Hallwood Energy I Creditors’ Trust, and their related parties (the “Plaintiffs”) against the Company and its related parties other than the Adversary Proceeding in which the Bankruptcy Court issued the Proposed Findings.

The terms of the Settlement Agreement include the payment by the Company of $1,800,000, in addition to payments by other defendants and the Company’s insurance carrier for its directors and officers liability insurance policy. Under the Settlement Agreement, the Plaintiffs released the Company, its current and former directors and officers, the former directors and officers of the general partner of Hallwood Energy, L.P. and various entities related to the foregoing persons from all claims asserted in or relating to (i) Hall Phoenix/Inwood Ltd. and Hall Performance Energy Partners 4, Ltd. v. The Hallwood Group Incorporated et al. in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03358; (ii) Ray Balestri, Trustee of the Hallwood Energy I Creditor’s Trust v. Anthony J. Gumbiner, et al. in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03263; and (iii) another suit in which the Company is not named as a party, and any other claims based on the facts alleged in the foregoing matters or that could have been alleged in the foregoing matters, other than the claims against the Company asserted in the Adversary Proceeding or any claims required to enforce any final judgment entered against the Company in the Adversary Proceeding. Similarly, the defendants released the Plaintiffs from all claims based on the facts alleged in the foregoing matters or that could have been alleged in the foregoing matters, other than any claims or defenses the defendants may have in the Adversary Proceeding.

The parties entered into the Settlement Agreement for a number of reasons, including to save time and expense, to ensure available insurance proceeds could be used toward the settlement of the disputed claims rather than the payment of expenses and legal fees, and otherwise to resolve the litigation claims. The defendants continue to believe that the claims asserted against them in the lawsuits had no merit and their agreement to settle and compromise those claims should not be deemed as an admission of any liability, wrongdoing, or fault.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

At December 31, 2011, the Company recorded a reserve of $1,800,000 in its statement of operations and balance sheet under Hallwood Energy matters – Litigation Reserve for the full value of the Company’s payments required by the Settlement Agreement. The Company paid the settlement amount of $1,800,000 to the Plaintiffs on February 15, 2012.

Claim Filed by Company with Insurance Carrier for Directors’ and Officers’ Liability Insurance Policy. Prior to entering into the Settlement Agreement, the Company incurred significant legal fees and associated costs in connection with these legal matters. The Company filed claims with the insurance carrier for the directors’ and officers’ liability insurance policies maintained by the Company for reimbursement of those legal fees and costs. The aggregate limit for each policy year under the Company’s policies has been $10,000,000. The insurance carrier has taken the position that all of the claims asserted in the Hallwood Energy litigation relate to the 2008 – 2009 policy year.

The Company received reimbursement of legal fees and associated costs of approximately $257,000 and $1,373,000 in the years ended December 31, 2011 and 2010, respectively, which were recorded as expense recoveries in administrative and selling expenses. Additionally, the insurance carrier paid legal fees and associated costs on behalf of other defendants in connection with the Hallwood Energy litigation matters other than the Adversary Proceeding. Significant additional costs in excess of insurance reimbursements have been incurred by the Company and on behalf of the other defendants.

In connection with the Settlement Agreement, the insurance carrier agreed to make a payment to the Plaintiffs and received a release and full discharge from any further payments for the Hallwood Energy litigation. Accordingly, the Company did not have insurance coverage available to satisfy the Judgment that was rendered in connection with the Adversary Proceeding. The insurance carrier is not reimbursing the Company for the legal fees and costs associated with the Adversary Proceeding.

Environmental Contingencies. A number of jurisdictions in which the Company or its subsidiaries operate 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 or its subsidiaries’ business to date, it is possible that such considerations may have a significant and adverse impact in the future. The Company and its subsidiaries actively monitor their environmental compliance and while certain matters currently exist, management is not aware of any compliance issues which will significantly impact the financial position, results of operations or cash flows of the Company or its subsidiaries.

The Company’s Brookwood subsidiary is subject to a number of environmental laws, regulations, licenses and permits and has ongoing discussions with environmental regulatory authorities, including the U.S. Environmental Protection Agency (the “EPA”), the Rhode Island Department of Health (“RIDOH”), the Rhode Island Department of Environmental Management (“RIDEM”) and the Connecticut Department of Energy and Environmental Protection (“CTDEEP”) on a number of matters, including compliance with safe drinking water rules and wastewater discharge and treatment regulations, the control of chemicals used in the companies’ coating operations that are classified as air pollutants, the presence of groundwater and soil contaminants at the companies’ facilities, the removal of underground storage tanks, and hazardous waste management

From time to time Brookwood and its subsidiaries have paid fines or penalties for alleged failure to comply with certain environmental requirements, which did not exceed $100,000 in the aggregate during the three years ended December 31, 2011 and the three months ended March 31, 2012. In addition, Brookwood and its subsidiaries have entered into various settlements and agreements with the regulatory authorities requiring the companies to perform certain tests, undertake certain studies, and install remedial facilities. Brookwood and its subsidiaries incurred capital expenditures to comply with environmental regulations of approximately $136,000 in the year ended December 31, 2011 and $37,000 during the three months ended March 31, 2012. In addition, Brookwood and its subsidiaries regularly incur expenses associated with various studies and tests to monitor and maintain compliance with diverse environmental requirements.

Other Contingencies. In May 2009, one of Brookwood’s suppliers advised Brookwood that shipments to Brookwood during the period from September 2008 to April 2009 of a quantity of greige fabric from the supplier incorporated some fiber that was not of domestic origin in some yarn from the vendor. The fabric in question was ordered to fill contracts in support of the United States military, was required to be domestic and is subject to the preference for domestic source required flow down provisions of the Department of Defense Supplement to the Federal Acquisition Regulations implementing the provisions of 10 USC 2533a.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

Brookwood’s suppliers had advised that the greige fabric containing the non-compliant yarn was supplied inadvertently to Brookwood in limited quantity. Brookwood determined that this yarn affected two of their greige products. Brookwood advised its affected customers and the United States military of this circumstance. Brookwood resolved the issue with respect to one of the products and received payment at full value in 2009. Additionally, resolution on the second product with one of the procurement entities was achieved in July 2010 and Brookwood received payment at full value of $3,242,000 in October 2010. Resolution with the final procurement entity was reached in the 2011 fourth quarter, and Brookwood received payment at full value of $1,643,000 in January 2012.

Note 14 — Segments and Related Information

The following represents Hallwood Group’s reportable segment operations for the three months ended March 31, 2012 and 2011, respectively (in thousands):

	Textile
	Products			Other			Consolidated
Three Months Ended March 31, 2012
Total revenue from external sources	$	35,879		$	—		$	35,879
Operating income (loss)	$	65		$	(14,504	)	$	(14,439	)
Other income (loss), net		(25	)		1			(24	)
Income (loss) before income taxes	$	40		$	(14,503	)	$	(14,463	)
Three months ended March 31, 2011
Total revenue from external sources	$	26,769		$	—		$	26,769
Operating income (loss)	$	(288	)	$	(1,283	)	$	(1,571	)
Other income (loss), net		(11	)		2			(9	)
Income (loss) before income taxes	$	(299	)	$	(1,281	)	$	(1,580	)

No differences have occurred in the basis or methodologies used in the preparation of this interim segment information from those used in the December 31, 2011 annual report. The total assets for Hallwood Group’s operating segments have not materially changed since the December 31, 2011 annual report.

Note 15 — Impact of Litigation on Liquidity

The Company and its subsidiaries are involved in a number of litigation matters, as described in Note 13, and have spent and may continue to spend significant amounts in professional fees in connection with the defense of its pending legal matters. As previously described, on April 24, 2012, the United States District Court in the Adversary Proceeding issued a Judgment awarding damages against the Company totaling approximately $18,700,000 plus prejudgment and postjudgment interest and attorneys’ fees as may be requested and awarded pursuant to a subsequent motion.

The Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. The amount and timing for the payment of legal fees to the plaintiff’s attorneys, which will be subsequently determined by the District Court, is currently unresolved.

In addition to its current available cash, to obtain additional funds to satisfy the Judgment, in May 2012, the Company received an $8,000,000 dividend from Brookwood and the $10,000,000 HFL Loan.

The Company’s ability to receive additional cash dividends or other advances from Brookwood above the permitted annual discretionary dividend not to exceed 50% of Brookwood’s net income to repay the HFL Loan or for other purposes, is dependent upon Brookwood’s obtaining consent from BB&T for such payments. Any such 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.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2012 and 2011

(unaudited)

The aforementioned circumstances raise substantial doubt about 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.

Note 16 — Subsequent Events

In completing the condensed consolidated financial statements and related notes thereto for the period ended March 31, 2012, Hallwood Group considered the following subsequent events:

• On April 24, 2012, the United States District Court issued the Judgment in the Adversary Proceeding, as further discussed in Note 13. An additional litigation charge of $13,200,000 related to the Adversary Proceeding has been included in the condensed consolidated financial statements for the period ended March 31, 2012.

• In May 2012, the Company received an $8,000,000 dividend from Brookwood and the $10,000,000 HFL Loan, as further discussed in Note 6 and Note 15, respectively.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

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

Forward-Looking Statements

In the interest of providing stockholders with certain information regarding the Company’s and its subsidiaries’ future plans and operations, certain statements set forth in this quarterly report on Form 10-Q 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 Hallwood Group 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 Hallwood Group’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 those described in Hallwood Group’s annual report on Form 10-K for the year ended December 31, 2011 in Item 1A – Risk Factors. These risks and uncertainties are difficult or impossible to predict accurately and many are beyond the control of Hallwood Group. Other risks and uncertainties may be described, from time to time, in Hallwood Group’s periodic reports and filings with the Securities and Exchange Commission.

Overview

General. The Hallwood Group Incorporated (the “Company”) (NYSE Amex:HWG) 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”).

Textile Products. In 2011 and 2012, 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. Although the textile activities of the Company and its subsidiaries (collectively, the “Hallwood Group”) have generated positive cash flow in recent years, there is no assurance that this trend will continue.

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. In recent years, orders from the military for goods generally were significantly affected by the increased activity of the U.S. military. If this activity changes, then orders from the military generally, including orders for Brookwood’s products, may be similarly affected. Military sales of $21,675,000 in the 2012 first quarter were 113% higher than the comparable period in 2011 of $10,176,000.

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 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 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 is 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 laminates 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

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

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

Brookwood’s business plan. The ongoing success of Brookwood is contingent on its ability to maintain its level of military business and adapt to the global textile industry. 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. 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 contribute additional capital to the Company beyond preferred dividend payments and the tax sharing agreement.

Investments in Financial Instruments. In the 2011 first quarter, the Company opened an investment account with UBS AG, a global financial services firm, and intended to transfer a significant portion of the cash it holds from time to time to the UBS account to be placed in various financial instruments and to borrow additional amounts from UBS to invest on a leveraged basis. As of May 15, 2012, no funds have been transferred into the UBS account. The Company does not currently intend to transfer funds into the UBS account, but may consider doing so in the future.

Energy. Hallwood Energy was a privately held independent oil and gas limited partnership and operated as an upstream energy company engaged in the acquisition, development, exploration, production, and sale of hydrocarbons, with a primary focus on natural gas assets.

In March 2009, Hallwood Energy, HEM (the general partner of Hallwood Energy) and Hallwood Energy’s subsidiaries, filed petitions for relief under Chapter 11 of the United States Bankruptcy Code. The cases were adjudicated in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, in In re Hallwood Energy, L.P., et al Case No. 09-31253. The Company was only an investor in and creditor of Hallwood Energy. The bankruptcy filing did not include the Company or any other of its assets. In October 2009, the Bankruptcy Court confirmed the plan of reorganization of the debtors.

Refer to the section “Investments in Hallwood Energy” for a further description of the Company’s former energy activities, including the bankruptcy case.

Presentation

The discussion of Hallwood Group’s financial condition and results of operations that follows 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 $9,552,000 for the 2012 first quarter, compared to a net loss of $996,000 in 2011. Revenue for the 2012 first quarter was $35,879,000, compared to $26,769,000 in 2011.

Revenues

Textile products sales of $35,879,000 increased by $9,110,000, or 34.0%, in the 2012 first quarter, compared to $26,769,000 in 2011. The increase in 2012 was principally due to an increase in sales of specialty fabric to U.S. military contractors as a result of increases in orders from the military to Brookwood’s customers, partially offset by reduced sales in its other market segments. Military sales accounted for $21,675,000 and $10,176,000 in the 2012 and 2011 first quarters, which represented 60.4% and 38.0% of Brookwood’s sales, respectively. 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 Concentration. Brookwood has one customer who accounted for more than 10% of Brookwood’s sales. Sales to that Brookwood customer, Tennier Industries, Inc. (“Tennier”), accounted for more than 10% of Brookwood’s sales during the 2012 first quarter only. Brookwood’s relationship with Tennier is ongoing. Sales to Tennier, which are included in military sales, were $6,708,000 in the 2012 first quarter, compared to $290,000 in 2011. Sales to Tennier represented 18.7% and 1.1% of Brookwood’s net sales in the 2012 and 2011 first quarters, respectively.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

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

Expenses

Textile products cost of sales of $30,149,000 for the 2012 first quarter increased by $6,955,000, or 30.0%, compared to $23,194,000 in 2011. The 2012 increase principally resulted from material and labor costs associated with the higher sales volume for the military segment, and from changes in product mix. 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 margin for the 2012 first quarter was 16.0%, compared to 13.4% for 2011. The higher gross profit margin was attributed to higher military sales volume and changes in product mix.

Administrative and selling expenses were comprised of the following (in thousands):

	Three Months Ended
	March 31,
	2012		2011
Brookwood	$	5,664	$	3,863
Company		1,305		1,283
Total	$	6,969	$	5,146

Brookwood’s administrative and selling expenses of $5,664,000 for the 2012 first quarter increased by $1,801,000, or 46.6%, from 2011. The increase for the 2012 first quarter compared to the 2011 quarter was primarily attributable to an increase in professional services of $1,687,000, principally legal fees.

The textile products administrative and selling expenses included items such as payroll, professional fees, sales commissions, factor 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 $206,000 and $140,000 in the 2012 and 2011 quarters, respectively.

The Company’s administrative expenses increased $22,000, or 1.7%, for the 2012 first quarter, compared to 2011. The increase was principally attributable to an increase in professional fees of $32,000.

In connection with the Hallwood Energy litigation matters discussed in Note 13, on July 25, 2011, the Bankruptcy Court issued Proposed Findings in the Adversary Proceeding, proposing that damages be awarded against the Company totaling approximately $18,700,000 plus prejudgment and post judgment interest and attorneys’ fees as may be requested and awarded pursuant to a subsequent motion.

On April 24, 2012, the United States District Court entered a final judgment (the “Judgment”) substantially adopting the Proposed Findings. Based upon the monetary damages (including prejudgment and postjudgment interest, legal fees and court costs) awarded in the Judgment, the Company recorded an additional charge of $13,200,000 at March 31, 2012 in its statement of operations and balance sheet as an accrual under Hallwood Energy matters – Litigation Reserve. Accordingly, the total reserve at March 31, 2012 for the Adversary Proceeding was $23,901,000. The Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. In addition, the Company will be required to pay certain attorneys’ fees incurred by the plaintiffs. The amount and timing of the payment of these fees will be subsequently determined by the District Court, and are currently unresolved.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

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

Other Income (Loss)

Interest expense of $25,000 in the 2012 first quarter and $26,000 for the 2011 first quarter relates to Brookwood’s revolving credit facility in an amount up to $25,000,000 with KeyBanc (the “Working Capital Revolving Credit Facility”).

Interest and other income was $1,000 in the 2012 first quarter, compared to $17,000 in 2011. The 2012 decreases were principally due to the redemption of marketable securities in 2011.

Income Taxes

Following is a schedule of income tax expense (benefit) (in thousands):

	Three Months Ended
	March 31,
	2012			2011
Federal
Current	$	(1,055	)	$	(590	)
Deferred		(3,867	)		—
Sub-total		(4,922	)		(590	)
State
Current		11			6
Deferred		—			—
Sub-total		11			6
Total	$	(4,911	)	$	(584	)

At March 31, 2012, the net deferred tax asset was attributable to temporary differences, that upon reversal, could be utilized to offset income from operations. The statutory federal tax rate in both periods was 34%, while state taxes were determined based upon taxable income apportioned to those states in which Hallwood Group does business at their respective tax rates.

Investments in Hallwood Energy

Hallwood Energy was a privately held independent oil and gas limited partnership and operated as an upstream energy company engaged in the acquisition, development, exploration, production, and sale of hydrocarbons, with a primary focus on natural gas assets.

Prior to the confirmation of Hallwood Energy’s plan of reorganization by Hallwood Energy (discussed below) in October 2009, the Company had invested $61,481,000 in Hallwood Energy’s general partnership interest and Class A and Class C limited partnership interests. In addition, the Company loaned Hallwood Energy $13,920,000 in the form of convertible notes issued by Hallwood Energy. The Company accounted for the investment in Hallwood Energy using the equity method of accounting and recorded its pro rata share of Hallwood Energy’s net income (loss), partners’ capital transactions, and comprehensive income (loss), as appropriate. In connection with Hallwood Energy’s bankruptcy reorganization, the Company’s general and limited partnership interests in Hallwood Energy were extinguished and the Company no longer accounts for the investment in Hallwood Energy using the equity method of accounting.

Bankruptcy Reorganization by Hallwood Energy. In March 2009, Hallwood Energy, HEM (the general partner of Hallwood Energy) and Hallwood Energy’s subsidiaries, filed petitions for relief under Chapter 11 of the United States Bankruptcy Code. The cases were adjudicated in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, in In re Hallwood Energy, L.P., et al Case No. 09-31253. The Company was only an investor in and creditor of Hallwood Energy. The bankruptcy filing did not include the Company or any other of its assets.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

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

In October 2009, the Bankruptcy Court confirmed a plan of reorganization of the debtors that, among other things, extinguished Hallwood Energy’s general partnership and limited partnership interests, including those held by the Company. In addition, Hallwood Energy’s convertible notes, including those held by the Company, were subordinated to recovery in favor of Hall Phoenix/Inwood, Ltd. (“HPI”), the secured lender to and an investor in Hallwood Energy.

Litigation. In connection with Hallwood Energy’s bankruptcy proceeding, Hallwood Energy and other parties filed lawsuits and had threatened to assert additional claims against the Company and certain related parties alleging actual, compensatory and exemplary damages in excess of $200,000,000, based on purported breach of contract, fraud, breach of fiduciary duties, neglect, negligence and various misleading statements, omissions and misrepresentations. See Note 13.

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, 2011.

Related Party Transactions

Hallwood Investments Limited. The Company has entered into a financial consulting contract with Hallwood Investments Limited (“HIL”), a corporation associated with Mr. Anthony J. Gumbiner, the Company’s chairman 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 contract 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 are detailed below (in thousands):

	Three Months Ended
	March 31,
	2012		2011
Consulting fees	$	249	$	249
Office space and administrative services		65		95
Travel and other expenses		17		13
Total	$	331	$	357

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 receive consulting fees, bonuses, stock options, profit interests or other forms of compensation and expenses. No such services were performed or compensation earned during 2012 or 2011. 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 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, 2012 and 2011, these companies reimbursed the Company $26,000 and $24,000, respectively, for such expenses.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

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

In addition, in May 2012, to fund in part the payment of the Judgment, the Company entered into the HFL Loan with Hallwood Family (BVI) L.P., a limited partnership associated with Mr. Gumbiner, as described below under “Liquidity and Capital Resources”.

Litigation

Refer to Note 13 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, 2012 (in thousands):

	Payments Due During the Year Ending December 31,
	2012*		2013		2014		2015		2016		Thereafter		Total
Contractual Obligations
Long term debt	$	—	$	—	$	2,000	$	—	$	—	$	—	$	2,000
Operating leases		555		542		462		396		212		—		2,167
Total	$	555	$	542	$	2,462	$	396	$	212	$	—	$	4,167

* For the nine months ending December 31, 2012.

At March 31, 2012, the Company did not have any interest bearing debt. Interest costs associated with Brookwood’s debt, which bears interest at variable rates, are not a material component of the Company’s expenses. Estimated interest payments, based on the current principal balances and weighted average interest rates, assuming the renewal of the revolving credit facility at its loan balance as of March 31, 2012, are $26,000 for the nine months ending December 31, 2012 and $35,000 for each of the years ending December 31, 2013 through December 31, 2016, respectively.

In connection with the payment of the Judgment in the Adversary Proceeding in May 2012, Brookwood borrowed $8,000,000 under the New Revolving Credit Facility, which was paid as a dividend to the Company, and the Company entered into the HFL Loan for $10,000,000. The additional borrowings are not reflected in the above table.

Payments in Adversary Proceeding. In May 2012, the Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. In addition, the Company will be required to pay certain attorneys’ fees incurred by the plaintiffs. The amount and timing of the payment of these fees will be subsequently determined by the District Court, and are currently unresolved.

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 (approximately $13,956,000 at March 31, 2012). The base amount will fluctuate in accordance with a formula that increases by the annual amount of the dividend on the preferred stock accrued, currently $1,823,000, and decreases by the amount of the cash dividends actually paid. 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.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

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

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, 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 (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. No amounts have been accrued under the plan.

Off-Balance Sheet Arrangements

Hallwood Group has no off-balance sheet arrangements.

Financial Covenants

The principal ratios required to be maintained under Brookwood’s former Working Capital Revolving Credit Facility for the last four quarters are provided below:

		Quarters Ended
		March 31,		December 31,		September,		June 30,
Description	Requirement	2012		2011		2011		2011
Total debt to tangible net worth	must be less than ratio of 1.50		0.34		0.30		0.34		0.31
Total funded debt to EBITDA	must be less than ratio of 2.00		0.24		0.25		0.21		0.28
Income before income taxes	must exceed $1		Yes		Yes		Yes		Yes

Brookwood was in compliance with its loan covenants under the Working Capital Revolving Credit Facility as of March 31, 2012, December 31, 2011 and for the 2011 second and third quarter interim periods.

Due to a decline in military sales for the 2011 first quarter, Brookwood was unable to meet the financial covenant that requires income before taxes of at least $1 in each quarter. Brookwood’s unaudited loss before taxes for the 2011 first quarter was $299,000. Accordingly, in May 2011, Brookwood requested and received a waiver from KeyBanc for the income covenant for the 2011 first quarter. Brookwood received an increased level of military orders in late March and into the subsequent 2011 periods and reported income before taxes in excess of $1 in the 2011 second quarter, third quarter and fourth quarter, respectively, and was in compliance with its loan covenants for the three remaining 2011 quarters.

The principal financial ratios under Brookwood’s New Revolving Credit Facility were as follows:

		March 31,
Description	Requirement	2012
Current assets to current liabilities plus funded debt	must be greater than ratio of 1.40		3.17
Total liabilities to tangible net worth	must be less than ratio of 1.50		0.34
Total funded debt to EBITDA	must be less than ratio of 2.75		0.24

Brookwood was in compliance with its loan covenants under the New Revolving Credit Facility at March 31, 2012. Following the $8,000,000 borrowing on the New Revolving Credit Facility in May 2012, Brookwood remained in compliance with its loan covenants. In order to maintain compliance with such covenants in the future, Brookwood may be required to limit aggregate borrowings under the New Revolving Credit Facility to less than $25,000,000 at the end of each fiscal quarter.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

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

Cash dividends and tax sharing payments by Brookwood to the Company are contingent upon compliance with the loan covenants in the New Revolving Credit Facility and/or consent from BB&T in certain circumstances. This limitation on the transferability of assets constitutes a restriction of Brookwood’s net assets, which were $58,995,000 and $59,970,000 as of March 31, 2012 and December 31, 2011, respectively.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

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

Liquidity and Capital Resources

General. The Company, through its Brookwood subsidiary, principally operates in the textile products segment. The Hallwood Group’s cash position decreased by $502,000 during the 2012 three month period to $10,367,000 as of March 31, 2012. The principal uses of cash were $44,000 used in operations (which includes the payment of $1,800,000 in February 2012 for the settlement of Hallwood Energy litigation matters, other than the Adversary Proceeding) and $516,000 for property, plant and equipment, principally at Brookwood. The amount outstanding under the Working Capital Revolving Credit Facility was $2,000,000 at March 31, 2012 and December 31, 2011.

In May 2012, to fund in part the payment of the Judgment in the Adversary Proceeding, as further discussed below, the Company obtained an $8,000,000 dividend from Brookwood. Also in May 2012, to fund in part the payment of the Judgment, the Company borrowed from Hallwood Family (BVI) L.P., a limited partnership associated with its principal shareholder, the sum of $10,000,000 (the “HFL Loan”). The HFL Loan is secured by a pledge of all of the stock of Brookwood, subject to BB&T consent, and by the Company’s interest in the anticipated refunds of federal income taxes of approximately $5,000,000, which the Company expects to receive in 2012 and 2013. The HFL Loan is due in full on June 28, 2013 and bears interest at the rate of 6% per year, payable on a quarterly basis. The Company may prepay the HFL Loan at any time without penalty. The documents reflecting the HFL Loan contain representations, warranties and covenants that are typical for loans of this type.

The Company is dependent on fees, dividends and advances from Brookwood for its liquidity requirements. Brookwood’s ability to generate cash flow from operations will depend on its future performance, including the level and timing of military sales, and its ability to successfully implement business and growth strategies.

Textiles. Hallwood Group’s textile products segment generates funds from the dyeing, laminating and finishing of fabrics and their sales to customers in the military, consumer, industrial and medical markets. Brookwood maintains a $25,000,000 New Revolving Credit Facility with BB&T that replaced its former Working Capital Revolving Credit Facility. The New Revolving Credit Facility has a maturity date of March 30, 2014. At May 15, 2012, Brookwood had approximately $14,891,000 of unused borrowing capacity on its New Revolving Credit Facility.

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, subject to a commission and the factor’s prior approval. Brookwood monitors its factors and their ability to fulfill their obligations to Brookwood in a timely manner. As of May 15, 2012, all of Brookwood’s factors were complying with payment terms in accordance with factor agreements.

Brookwood paid cash dividends to the Company of $1,000,000 in the 2012 first quarter and $4,000,000 for all of 2011. In addition, Brookwood made tax sharing payments to the Company of $-0- in the 2012 first quarter and $2,992,000 for all of 2011 under its tax sharing agreement. The New Revolving Credit Facility contains a restriction on the payment of any cash dividend or advance to the Company above the permitted annual discretionary dividend not to exceed 50% of Brookwood’s net income. Brookwood has indicated that it would be required (pursuant to the terms of the New Revolving Credit Facility) to obtain consent from BB&T for such payments above the permitted amount. In May 2012, following the Company’s request for an additional dividend, Brookwood requested BB&T to approve such dividend for $8,000,000. BB&T consented to the dividend, which was paid to the Company in May 2012. Any future payments or advances would also be contingent the upon the approval of Broowkood’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. Future cash dividends and tax sharing payments are contingent upon Brookwood’s continued compliance with its loan covenants contained in the New Revolving Credit Facility.

Brookwood continuously evaluates opportunities to reduce production costs and expand its manufacturing capacity and portfolio of products. Accordingly, Brookwood incurs capital expenditures to pursue such opportunities, as well as for environmental and safety compliance, building upgrades, energy efficiencies, and various strategic objectives. In the 2012 first quarter period and for all of 2011, Brookwood met its capital expenditure and equipment maintenance requirements from its operating cash flows and availability under its former Working Capital Revolving Credit Facility. There were no material capital commitments as of March 31, 2012. It is anticipated that Brookwood’s future capital expenditure projects will be funded from operations and, if necessary, availability under its New Revolving Credit Facility. Brookwood estimates its 2012 capital expenditures will be within a range of $2,000,000 to $3,000,000.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

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

Impact of Litigation on the Company’s Liquidity. The Company and its subsidiaries are involved in a number of litigation matters, as described in Note 13, and have spent and may continue to spend significant amounts in professional fees in connection with the defense of its pending legal matters. As previously described, on April 24, 2012, the United States District Court in the Adversary Proceeding issued a Judgment awarding damages against the Company totaling approximately $18,700,000 plus prejudgment and postjudgment interest and attorneys’ fees as may be requested and awarded pursuant to a subsequent motion.

The Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. In addition, the Company will be required to pay certain attorneys’ fees incurred by the plaintiffs. The amount and timing of the payment of these fees will be subsequently determined by the District Court, and are currently unresolved.

In addition to its current available cash, to obtain additional funds to satisfy the Judgment, in May 2012, the Company received an $8,000,000 dividend from Brookwood and the $10,000,000 HFL Loan.

The Company’s ability to receive additional cash dividends or other advances from Brookwood above the permitted approval discretionary dividend not to exceed 50% of Brookwood’s net income to repay the HFL Loan or for other purposes, is dependent upon the approval of Brookwood’s board of directors and Brookwood’s obtaining consent from BB&T for such payments. Any such payments or advances would also be contingent upon 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.

The aforementioned circumstances raise substantial doubt about 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.

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

Item 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports filed or submitted under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

An evaluation was performed under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this quarterly report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosures controls and procedures were effective.

Changes in Internal Control over Financial Reporting.

There were no changes in the Company’s internal control over financial reporting that occurred during the quarterly period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Page 35

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

PART II — OTHER INFORMATION

Item
1	Legal Proceedings
	Reference is made to Note 13 to the Company’s condensed consolidated financial statements included within this quarterly report on Form 10-Q.
1A	Risk Factors	N/A
2	Unregistered Sales of Equity Securities and Use of Proceeds	None

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THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

PART II—OTHER INFORMATION (continued)

3	Defaults upon Senior Securities		None
4	(Removed and Reserved)
5	Other Information		None
6	Exhibits
	10.1	Promissory Note for $10,000,000 loan from Hallwood Family (BVI), L.P., dated as of May 9, 2012.
	10.2	Security Agreement dated as of May 9, 2012 between the Company and Hallwood Family (BVI), L.P.
	31.1	Certification of the Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of the Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Chief Executive Officer and Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	101.INS	XBRL Instance Document*
	101.SCH	XBRL Taxonomy Extension Schema*
	101.CAL	XBRL Taxonomy Extension Calculation Linkbase*
	101.DEF	XBRL Additional Taxonomy Extension Definition Linkbase*
	101.LAB	XBRL Taxonomy Extension Label Linkbase*
	101.PRE	XBRL Taxonomy Extension Presentation Linkbase*

* Furnished electronically herewith. XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

Page 37

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	THE HALLWOOD GROUP INCORPORATED
Dated: May 15, 2012	By:	/s/ Richard Kelley
		Richard Kelley, Vice President
		(Duly Authorized Officer and
		Principal Financial and
		Accounting Officer)

Page 38

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

INDEX TO EXHIBITS

Exhibit Number	Description
10.1	Promissory Note for $10,000,000 loan from Hallwood Family (BVI), L.P., dated as of May 9, 2012.
10.2	Security Agreement dated as of May 9, 2012 between the Company and Hallwood Family (BVI), L.P.
31.1	Certification of the Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of the Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer and Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS	XBRL Instance Document*
101.SCH	XBRL Taxonomy Extension Schema*
101.CAL	XBRL Taxonomy Extension Calculation Linkbase*
101.DEF	XBRL Additional Taxonomy Extension Definition Linkbase*
101.LAB	XBRL Taxonomy Extension Label Linkbase*
101.PRE	XBRL Taxonomy Extension Presentation Linkbase*

* Furnished electronically herewith. XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

Page 39

EX-10.1

Exhibit 10.1

PROMISSORY NOTE

Date: May 9, 2012 Principal Amount: $10,000,000

FOR VALUE RECEIVED, the undersigned maker, The Hallwood Group Incorporated, a Delaware corporation (“Maker”), hereby unconditionally promises to pay to the order of Hallwood Family (BVI), L.P., a British Virgin Islands limited partnership (“Holder”), at 3710 Rawlins, Suite 1500, Dallas, Texas 75218, in lawful money of the United States of America, the principal amount shown above, together with interest.

1. Principal Payments. The outstanding principal amount of this promissory note (“Note”), together with all unpaid accrued interest, shall be payable on June 28, 2013.

2. Interest. Interest on the principal balance outstanding from time to time shall accrue from the date of this Note at the lesser of (a) six percent (6.0%) per annum, compounded quarterly, or (b) the Maximum Lawful Rate (as defined herein). Interest on the indebtedness evidenced by this Note shall be computed on the basis of a year of 365 days. Such interest shall be payable on the last day of each calendar quarter, with the first payment to be paid on or before June 30, 2012 and the final payment to be paid on June 28, 2013.

3. Charges and Maximum Lawful Rate. As used herein, the term “Maximum Lawful Rate” shall mean the maximum lawful rate of interest which may be contracted for, charged, taken, received or reserved by Holder in accordance with the applicable laws of the State of Texas (or applicable United States federal law to the extent that it permits Holder to contract for, charge, take, receive or reserve a greater amount of interest than under Texas law), taking into account all Charges (as herein defined) made in connection with the transaction evidenced by this Note and any other documents executed in connection herewith. As used herein, the term “Charges” shall mean all fees, charges and/or any other things of value, if any, contracted for, charged, received, taken or reserved by Holder in connection with the transactions relating to this Note that are treated as interest under applicable law.

4. Prepayment of Principal. This Note may be prepaid, in whole or in part, at any time without premium or penalty. All prepayment shall be applied first to accrued interest and then to principal.

5. Security Interest. To secure all of the obligations of Maker pursuant to this Note, Maker hereby grants to Holder a security interest in (i) all of the common and preferred stock of Brookwood Companies Incorporated (“Brookwood”), all of which is held by Maker; and (ii) the interest in Maker in any federal tax refund Maker receives in 2012 or 2013 (the items described in clauses (i) and (ii) being the “Collateral”), but only to the extent that Maker is not prohibited by law or any agreements with third parties from granting such a security interest. The security interests will be further evidenced by a Security Agreement and a Pledge and Security Agreement between Maker and Holder, each dated the same date as this Note. The Security Agreement, the Pledge and Security Agreement (the “Pledge Agreement”) and this Note, together with any other documents entered into relating to this Note constitute the “Loan Documents”.

6. Further Assurances. Maker agrees to use its good faith commercially reasonable efforts to take or cause to be taken all appropriate action, and do or cause to be done all things necessary, proper or advisable, including to execute and deliver a more specific security agreement reflecting the security interest granted in this Note, and such other documents and papers, as may be required to carry out the provisions of this Note or as may be necessary or desirable in order to consummate or implement expeditiously the transactions contemplated by this Note. Maker further authorizes Holder to take any action that Holder determines in good faith to be necessary or appropriate to reflect or perfect the security interest granted in this Note, including the filing of any financing statements with government authorities.

7. Waiver of Notice. Maker and each surety, guarantor, endorser, and other party ever liable for payment of any sums of money payable on this Note jointly and severally waive notice, presentment, demand for payment, protest, notice of protest and non-payment or dishonor, notice of acceleration, notice of intent to accelerate, notice of intent to demand, diligence in collecting, grace, and all other formalities of any kind, and consent to all extensions without notice for any period or periods of time and partial payments, before or after maturity, and any impairment of any collateral securing this Note, all without prejudice to Holder. Holder shall similarly have the right to deal in any way, at any time, with one or more of the foregoing parties without notice to any other party, and to grant any such party any extensions of time for payment of any of said indebtedness, or to release or substitute part or all of the collateral securing this Note, or to grant any other indulgences or forbearances whatsoever, without notice to any other party and without in any way affecting the personal liability of any party hereunder.

8. Affirmative Covenants. Maker covenants and agrees that from the date hereof and until payment in full of all indebtedness and performance of all obligations owed under this Note, Maker shall:

(a) Maintain Existence and Current Legal Form of Business: (i) Maintain its existence and good standing in the state of its incorporation or organization, (ii) maintain its current legal form of business indicated above, and, (iii), as applicable, qualify and remain qualified as a foreign corporation in each jurisdiction in which the failure to be so qualified would have a material adverse effect.

(b) Maintain Records: Keep adequate records and books of account, in which complete entries will be made in accordance with generally accepted accounting principles consistently applied, reflecting all financial transactions of Maker.

(c) Notice of Default: Promptly upon discovery or knowledge thereof, notice of the existence of any Event of Default (as defined herein).

(d) Pledge of Equity Interests: Cause, at all times, 100% of the equity interests of Brookwood to be pledged to Holder pursuant to a Pledge and Security Agreement in form and substance reasonably acceptable to Holder.

9. Events of Default. Subject to the Opportunity to Cure Non-Monetary Default set forth below, each of the following shall be “Events of Default” under this Note:

(a) The failure to make prompt payment of principal or interest on the Note when due or payable.

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(b) Should a custodian be appointed for or take possession of any or all of the assets of Maker or Brookwood, or should Maker or Brookwood either voluntarily or involuntarily become subject to any insolvency proceeding, including becoming a debtor under the United States Bankruptcy Code, any proceeding to dissolve Maker or Brookwood, any proceeding to have a receiver appointed, or should Maker or Brookwood make an assignment for the benefit of creditors, or should there be an attachment, execution, or other judicial seizure of all or any portion of Maker’s or Brookwood’s assets, and such seizure is not discharged within 60 days.

(c) Should final judgment for the payment of money in excess of $2,000,000 be rendered against Maker or Brookwood which is not covered by insurance and shall remain undischarged for a period of 30 days unless such judgment or execution thereon be effectively stayed.

(d) Should there be any transfer or disposition of any of the Collateral, except as permitted by the Security Agreement, the Pledge Agreement or this Note;

(e) Should there be any attachment, execution or levy on any of the Collateral;

(f) Should any lien or security interest granted to Holder to secure payment of the Note terminate, fail for any reason to have the priority agreed to by Holder on the date granted, or become unperfected or invalid for any reason;

(g) Should there be an Event of Default under that certain Loan Agreement between Brookwood and Branch Banking and Trust Company dated as of March 30, 2012.

The term “Opportunity to Cure Non-Monetary Default” as used in this Note shall mean the right of Maker to cure a pending Event of Default under this Note or other Loan Document, other than the failure to pay money, within ten (10) days after the occurrence of such pending default; provided, however, that if such default cannot reasonably be cured within such ten (10) day period, there shall be no Event of Default if Maker commences to cure such default during such ten (10) day period and completes such cure within thirty (30) days after the occurrence of such Event of Default.

10. Default Costs. Should an Event of Default occur, Maker will pay to Holder all costs incurred by Holder for the purpose of enforcing its rights hereunder, including:

(a) costs of foreclosure;

(b) costs of obtaining money damages; and

(c) a reasonable fee for the service of attorneys employed by Holder for any purpose related to the Loan Documents, including without limitation consultation, drafting documents, sending notices or instituting, prosecuting or defending litigation or arbitration.

11. Remedies Upon Default. Upon the occurrence of any of the above listed Events of Default, Holder may at any time thereafter, at its option, take any or all of the following actions, at the same or at different times:

(a) Declare the balance of the Note to be immediately due and payable, both as to principal and interest, late fees, and all other amounts/expenditures without presentment, demand, protest, or notice of any kind, all of which are hereby expressly waived by the Maker;

3

(b) Require the Maker to pledge additional collateral to Holder from Makers’ assets and properties, the acceptability and sufficiency of such collateral to be determined in Holder’s sole discretion;

(c) Take immediate possession of and foreclose upon any or all collateral which may be granted to Holder as security for the indebtedness and obligations of the Maker under the Loan Documents;

(d) Exercise any and all other rights and remedies available to Holder under the terms of the Loan Documents and applicable law, including the Texas Uniform Commercial Code;

(e) All obligations, if any, of Holder under the Loan Documents shall immediately cease and terminate unless and until Holder shall reinstate such obligation in writing.

12. No Waiver. No delay or omission on the part of Holder in exercising any rights hereunder shall operate as a waiver of such right or of any other right of such Holder.

13. Collection. If Holder expends any effort in any attempt to enforce payment of all or any part or installment of any sum due Holder hereunder, or if this Note is placed in the hands of an attorney for collection, or if it is collected through any legal proceedings, Maker agrees to pay all reasonable collection costs and fees incurred by Holder, including reasonable attorneys’ fees.

14. Jury Waiver. Holder (by its acceptance hereof) and Maker hereby voluntarily, knowingly, irrevocably and unconditionally waive any right to have a jury participate in resolving any dispute (whether based upon contract, tort or otherwise) between or among Holder and Maker arising out of or in any way related to this Note, any other related document, or any relationship between Holder and Maker. This provision is a material inducement to Holder to provide the financing evidenced by this Note.

15. Usury. Notwithstanding anything to the contrary contained herein, no provisions of this Note shall require the payment or permit the collection of interest in excess of the Maximum Lawful Rate. If any excess of interest in such respect is herein provided for, or shall be adjudicated to be so provided, in this Note or otherwise in connection with this loan transaction, the provisions of this paragraph shall govern and prevail, and neither Maker nor the sureties, guarantors, successors or assigns of Maker shall be obligated to pay the excess amount of such interest, or any other excess sum paid for the use, forbearance or detention of sums loaned pursuant hereto. If for any reason interest in excess of the Maximum Lawful Rate shall be deemed charged, required or permitted by any court of competent jurisdiction, any such excess shall be applied as a payment and reduction of the principal of indebtedness evidenced by this Note; and, if the principal amount hereof has been paid in full, any remaining excess shall forthwith be paid to Maker. In determining whether or not the interest paid or payable exceeds the Maximum Lawful Rate, Maker and Holder shall, to the extent permitted by applicable law, (a) characterize any non-principal payment as an expense, fee, or premium rather than as interest, (b) exclude voluntary prepayments and the effects thereof, and (c) amortize, prorate, allocate, and spread in equal or unequal parts the total amount of interest throughout the entire contemplated term of the indebtedness evidenced by this Note so that the interest for the entire term does not exceed the Maximum Lawful Rate.

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16. Governing Law. Notwithstanding conflicts of law principles, this Note shall be governed by and construed in accordance with the laws of the State of Texas and the applicable laws of the United States of America. This Note is performable in Dallas County, Texas. Any action or proceeding under or in connection with this Note against Maker or any other party ever liable for payment of any sums of money payable on this Note may be brought in any state or federal court in Dallas County, Texas. Maker and each such other party hereby irrevocably (a) submits to the nonexclusive jurisdiction of such courts, and (b) waives any objection he or it may now or hereafter have as to the venue of any such action or proceeding brought in such court or that such court is an inconvenient forum. Nothing herein shall affect the right of Holder to bring any action or proceeding against Maker or any other party liable hereunder or with respect to any collateral in any state or federal court in any other jurisdiction. Any action or proceeding by Maker or any other party liable hereunder against Holder shall be brought only in a court located in Dallas County, Texas.

17. Addresses for Notices. All communications, notices and disclosures required or permitted by the Loan Documents shall be in writing and shall be deemed to have been given at the earlier of the time when actually delivered to a party or an officer of the party to which notice is to be given or when sent by facsimile transmission, overnight courier service or by certified or registered first-class mail, postage prepaid, return receipt requested, addressed as follows, unless and until any party notifies the other party in accordance with this section of a change of address:

Maker’s Address for Notices:

The Hallwood Group Incorporated

3710 Rawlins

Suite 1500

Dallas, Texas 75218

Attn: President

Holder’s Address for Notices:

Hallwood Family (BVI) L.P.

3710 Rawlins

Suite 1500

Dallas, Texas 75218

Attn: General Partner

18. ENTIRE AGREEMENT. THIS NOTE AND ALL OTHER INSTRUMENTS, DOCUMENTS AND AGREEMENTS EXECUTED AND DELIVERED BY MAKER IN CONNECTION WITH THE INDEBTEDNESS EVIDENCED BY THIS NOTE EMBODY THE FINAL, ENTIRE AGREEMENT OF MAKER AND HOLDER WITH RESPECT TO THE INDEBTEDNESS EVIDENCED BY THIS NOTE AND SUPERSEDE ANY AND ALL PRIOR COMMITMENTS, AGREEMENTS, REPRESENTATIONS AND UNDERSTANDINGS, WHETHER WRITTEN OR ORAL, RELATING TO THE INDEBTEDNESS EVIDENCED BY THIS NOTE AND MAY NOT BE CONTRADICTED OR VARIED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OR DISCUSSIONS OF MAKER AND HOLDER. THERE ARE NO ORAL AGREEMENTS BETWEEN MAKER AND HOLDER.

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19. Severability. If any provisions of this Note or any payments pursuant to the terms hereof shall be invalid or unenforceable to any extent, the remainder of this Note and any other payments hereunder shall not be affected thereby and shall be enforceable to the greatest extent permitted by law.

20. Time of the Essence. Time is of the essence with respect to all of the Maker’s obligations and agreements under this Note.

MAKER:

THE HALLWOOD GROUP INCORPORATED

By:

Name:

Title:

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EX-10.2

Exhibit 10.2

City: Dallas, TX

SECURITY AGREEMENT

This Security Agreement (“Security Agreement”), is made as of May 9, 2012, between The Hallwood Group Incorporated, a Delaware corporation (“Debtor”), and Hallwood Family (BVI), L.P., a British Virgin Islands limited partnership (“Secured Party”).

This Security Agreement is entered into in connection with a promissory note dated of even date herewith (including all extensions, renewals, modifications and substitutions thereof, the “Note”) of Debtor, in the principal amount of $10,000,000 and any advances under the Note (collectively, the “Loan”).

Secured Party and Debtor agree as follows:

I. DEFINITIONS.

1.1 Collateral. The “Collateral” shall consist of all of Debtor’s interest in all federal income tax refunds and all proceeds (cash and non-cash) and products of the foregoing.

1.2 Obligations. This Security Agreement secures the following (collectively, the “Obligations”):

(i) Debtor’s obligations under the Note, this Security Agreement and the Pledge and Security Agreement (the “Pledge Agreement”) between Debtor and Secured Party dated as of May 9, 2012;

(ii) all of Debtor’s present and future indebtedness and obligations to Secured Party.

(iii) the repayment of (a) any amounts that Secured Party may advance or spend under this Security Agreement, the Note or the Pledge Agreement for the maintenance or preservation of the Collateral and (b) any other expenditures that Secured Party may make under the provisions of the Note, this Security Agreement or the Pledge Agreement for the benefit of Debtor;

(iv) all amounts owed under any modifications, renewals, extensions or substitutions of any of the foregoing obligations;

(v) all Default Costs, as defined in Paragraph VIII of this Security Agreement; and

(vi) any of the foregoing that may arise after the filing of a petition by or against Debtor under the United States Bankruptcy Code, even if the obligations do not accrue because of the automatic stay under Bankruptcy Code § 362 or otherwise.

1.3 UCC. Each capitalized term as defined in Article 9 of the Texas Uniform Commercial Code (“UCC”).

II. GRANT OF SECURITY INTEREST.

Debtor grants a security interest in the Collateral to Secured Party to secure the payment and performance of the Obligations.

III. PERFECTION OF SECURITY INTERESTS.

3.1 Filing of Security Interests.

(i) Debtor authorizes Secured Party to execute on Debtor’s behalf and file any financing statement (the ‘Financing Statement’) describing the Collateral in any location deemed necessary and appropriate by Secured Party.

(ii) Debtor authorizes Secured Party to file a Financing Statement describing any agricultural liens or other statutory liens held by Secured Party.

3.2 Possession.

(i) Debtor shall have the right to maintain possession of the Collateral, except where expressly otherwise provided in this Security Agreement.

(ii) Where Collateral is in the possession of a third party, Debtor will join with Secured Party in notifying the third party of Secured Party’s security interest and obtaining an acknowledgment from the third party that it is holding the Collateral for the benefit of Secured Party.

IV. POST-CLOSING COVENANTS AND RIGHTS CONCERNING THE COLLATERAL.

4.1 Inspection. The parties to this Security Agreement may inspect any Collateral in the other party’s possession, at any time upon reasonable notice.

4.2 Secured Party’s Collection Rights. Secured Party shall have the right at any time after an Event of Default (as defined in the Note), subject to Debtor’s required Opportunity to Cure Non-Monetary Default (as defined in the Note), to enforce Debtor’s rights against any account debtors and obligors.

4.3 Limitations on Obligations Concerning Maintenance of Collateral.

(i) Risk of Loss. Debtor has the risk of loss of the Collateral.

(ii) No Collection Obligation. Secured Party has no duty to collect any income accruing on the Collateral or to preserve any rights relating to the Collateral.

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4.4 No Disposition of Collateral. Secured Party does not authorize, and Debtor agrees not to:

(i) make any sales or leases of any of the Collateral other than in the ordinary course of business; or

(ii) grant any other security interest in any of the Collateral.

4.5 Power of Attorney. Debtor hereby irrevocably appoints, effective upon and during the continuation of an Event of Default, Secured Party as Debtor’s attorney-in-fact, such power of attorney being coupled with an interest, with full authority in the place and stead of Debtor and in the name of Debtor or otherwise to take any action and to execute any instrument which Secured Party may deem necessary or appropriate to accomplish the purposes of this Security Agreement, including without limitation: (i) to demand, collect, sue for, recover, compound, receive and give acquittance and receipts for moneys due and to become due under or in respect of the Collateral; (ii) to receive, endorse and collect any drafts or other instruments, documents and chattel paper in connection with clause (i) above; and (iii) to file any claims or take any action or institute any proceedings which Secured Party may deem necessary or appropriate for the collection and/or preservation of the Collateral or otherwise to enforce the rights of Secure Party with respect to the Collateral.

V. FORECLOSURE PROCEDURES.

5.1 No Waiver. No delay or omission by Secured Party to exercise any right or remedy accruing upon any Event of Default shall (i) impair any right or remedy, (ii) waive any default or operate as an acquiescence to the Event of Default, or (iii) affect any subsequent default of the same or of a different nature.

5.2 Notices. Secured Party shall give Debtor such notice of any private or public sale as may be required by the UCC.

5.3 Condition of Collateral. Secured Party has no obligation to repair, clean-up or otherwise prepare the Collateral for sale.

5.4 No Obligation to Pursue Others. Secured Party has no obligation to attempt to satisfy the Obligations by collecting them from any other person liable for them and Secured Party may release, modify or waive any collateral provided by any other person to secure any of the Obligations, all without affecting Secured Party’s rights against Debtor. Debtor waives any right it may have to require Secured Party to pursue any third person for any of the Obligations.

5.5 Compliance With Other Laws. Secured Party may comply with any applicable state or federal law requirements in connection with a disposition of the Collateral and compliance will not be considered adversely to affect the commercial reasonableness of any sale of the Collateral.

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5.6 Warranties. Secured Party may sell the Collateral without giving any warranties as to the Collateral and may specifically disclaim any warranties of title or the like. This procedure will not be considered adversely to affect the commercial reasonableness of any sale of the Collateral.

5.7 Sales on Credit. If Secured Party sells any of the Collateral upon credit, Debtor will be credited only with payments actually made by the purchaser and received by Secured Party. In the event the purchaser fails to pay for the Collateral, Secured Party may resell the Collateral and Debtor shall be credited with the proceeds of the sale as and when received, less expenses.

5.8 Purchases by Secured Party. In the event Secured Party purchases any of the Collateral being sold, Secured Party may pay for the Collateral by crediting some or all of the Obligations of Debtor.

5.9 No Marshalling. Secured Party has no obligation to marshal any assets in favor of Debtor, or against or in payment of:

(i) the Note,

(ii) any of the other Obligations, or

(iii) any other obligation owed to Secured Party, Debtor or any other person.

VI. MISCELLANEOUS.

6.1 Assignment.

(i) Binds Assignees. This Security Agreement shall bind and shall inure to the benefit of the successors and assigns of Secured Party, and shall bind all successors and permitted assigns of Debtor.

(ii) No Assignments by Debtor. Secured Party does not consent to any assignment by Debtor except as expressly provided in this Security Agreement.

(iii) Secured Party Assignments. Secured Party may assign its rights and interests under this Security Agreement to any subsequent holder of the Note. If an assignment is made, Debtor shall render performance under this Security Agreement to the assignee. Debtor waives and will not assert against any assignee of Secured Party any claims, defenses or set-offs which Debtor could assert against Secured Party except defenses which cannot be waived; provided, however, that Debtor is not waiving such rights with respect to the original Secured Party.

6.2 Severability. Should any provision of this Security Agreement be found to be void, invalid or unenforceable by a court or panel of arbitrators of competent jurisdiction, that finding shall only affect the provisions found to be void, invalid or unenforceable and shall not affect the remaining provisions of this Security Agreement.

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6.3 Notices. All notices and other communications provided for hereunder shall be furnished in accordance with the terms of the Note.

6.4 Headings. Section headings used in this Security Agreement are for convenience only. They are not a part of this Security Agreement and shall not be used in construing it.

6.5 Governing Law. This Security Agreement is being executed and delivered and is intended to be performed in the State of Texas and shall be construed and enforced in accordance with the laws of the State of Texas, except to the extent that the UCC provides for the application of the law of the Debtor State.

6.6 Rules of Construction.

(i) No reference to ‘proceeds’ in this Security Agreement authorizes any sale, transfer, or other disposition of the Collateral by Debtor except in the ordinary course of business or as permitted by the Note.

(ii) “Includes” and “including” are not limiting.

(iii) “Or” is not exclusive.

(iv) “All” includes “any” and “any” includes “all”.

6.7 Integration and Modifications.

(i) This Security Agreement and the Note constitute the entire agreement of Debtor and Secured Party concerning their subject matter.

(ii) Any modification to this Security Agreement must be made in writing and signed by the party adversely affected.

6.8 Waiver. Any party to this Security Agreement may waive the enforcement of any provision to the extent the provision is for its benefit.

6.9 Further Assurances. Debtor agrees to execute any further documents, and to take any further actions, reasonably requested by Secured Party to evidence or perfect the security interest granted herein or to effectuate the rights granted to Secured Party herein.

6.10 Stamps and Fees. Debtor shall pay all federal or state stamps, taxes, or other fees or charges, if any are payable or are determined to be payable by reason of the execution, delivery, or issuance of the Note or this Security Agreement or any security granted to Secured Party; and Debtor agrees to indemnify and hold harmless Secured Party against any and all liability in respect thereof.

6.11 Attorneys’ Fees. Debtor shall pay the fees and expenses of counsel to Secured Party in connection with entering into this Security Agreement and any other document related thereto and any amendment thereto or waiver thereof. In the event Debtor shall default in any of its obligations hereunder and Secured Party believes it necessary to employ an attorney to assist

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in the enforcement or collection of the indebtedness of Debtor to Secured Party, to enforce the terms and provisions of the Note and this Security Agreement, to modify the Note or this Security Agreement, or in the event Secured Party voluntarily or otherwise should become a party to any suit or legal proceeding (including a proceeding conducted under the Bankruptcy Code) relating to Debtor or concerning the subject matter of the Note or this Security Agreement, Debtor agrees to pay the reasonable attorneys’ fees of Secured Party and all related costs of collection or enforcement that may be incurred by Secured Party. Debtor shall be liable for such attorneys’ fees and costs whether or not any suit or proceeding is actually commenced.

6.12 Secured Party Making Required Payments. In the event Debtor shall fail to maintain insurance, pay taxes or assessments, costs and expenses which Debtor is, under any of the terms the Note or this Security Agreement, required to pay, or fail to keep any of the properties and assets constituting Collateral free from new security interests, liens, or encumbrances, except as permitted herein, Secured Party may at its election make expenditures for any or all such purposes and the amounts expended together with interest thereon at the Default Rate, shall become immediately due and payable to Secured Party, and shall have benefit of and be secured by the Collateral; provided, however, Secured Party shall be under no duty or obligation to make any such payments or expenditures.

6.13 Right of Offset. Any indebtedness owing from Secured Party to Debtor may be set off and applied by Secured Party on any indebtedness or liability of Debtor to Secured Party, at any time and from time to time after maturity, whether by acceleration or otherwise, and without demand or notice to Debtor. Secured Party may sell participations in or make assignments of any Loan made under this Security Agreement, and Debtor agrees that any such participant or assignee shall have the same right of setoff as is granted to Secured Party herein.

6.14 UCC Authorization. Debtor authorizes Secured Party to file such UCC Financing Statements describing the Collateral in any location deemed necessary and appropriate by Secured Party.

6.15 Modification and Renewal Fees. Secured Party may, at its option, charge any fees for modification, renewal, extension, or amendment of any terms of the Note(s) not prohibited by applicable law.

6.16 Conflicting Provisions. If provisions of this Security Agreement shall conflict with any terms or provisions of any of the Note or other Loan Documents or any schedule attached hereto, the provisions of such Note or Loan Document or any schedule attached hereto, as appropriate, shall take priority over any provisions in this Security Agreement.

6.17 Consent to Jurisdiction. Debtor hereby irrevocably agrees that any legal action or proceeding arising out of or relating to this Security Agreement may be instituted in the District Court in Dallas County, Texas, or the United States District Court for the Northern District of Texas or in such other appropriate court and venue as Secured Party may choose in its sole discretion. Secured Party and Debtor each consent to the jurisdiction of such courts and waives any objection relating to the basis for personal or in rem jurisdiction or to venue which Secured Party or Debtor may now or hereafter have in any such legal action or proceedings.

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6.18 Counterparts. This Security Agreement may be executed by one or more parties on any number of separate counterparts and all of such counterparts taken together shall be deemed to constitute one and the same instrument.

6.19 Indemnification. Debtor hereby agrees to and does hereby indemnify and defend Secured Party, its affiliates, their successors and assigns and their respective directors, officer, employees and shareholders, and do hereby hold each of them harmless from and against, any loss, liability, lawsuit, proceeding, cost expense or damage (including reasonable in-house and outside counsel fees, whether suit is brought or not) arising from or otherwise relating to the closing, disbursement, administration, or repayment of the Obligations, including without limitation: (i) the failure to make any payment to Secured Party promptly when due, whether under the Note evidencing the Loan or otherwise; (ii) the breach of any representations or warranties to Secured Party contained in this Security Agreement or in any other documents now or hereafter executed in connection with the Obligations; or (iii) the violation of any covenants or agreements made for the benefit of Secured Party and contained in any of the documents; provided, however, that the foregoing indemnification shall not be deemed to cover any loss which is finally determined by a court of competent jurisdiction to result solely from Secured Party’s gross negligence or willful misconduct.

6.20 WAIVER OF TRIAL BY JURY. UNLESS EXPRESSLY PROHIBITED BY APPLICABLE LAW, EACH PARTY HERETO HEREBY WAIVES THE RIGHT TO TRIAL BY JURY OF ANY MATTERS OR CLAIMS ARISING OUT OF THIS SECURITY AGREEMENT OR THE NOTE OR OUT OF THE CONDUCT OF THE RELATIONSHIP BETWEEN DEBTOR AND SECURED PARTY. THIS PROVISION IS A MATERIAL INDUCEMENT FOR SECURED PARTY TO ENTER INTO THIS SECURITY AGREEMENT AND THE NOTE. FURTHER, EACH PARTY HERETO HEREBY CERTIFIES THAT NO PARTY’S REPRESENTATIVE, AGENT OR COUNSEL, HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH PARTY WOULD NOT SEEK TO ENFORCE THIS WAIVER OR RIGHT TO JURY TRIAL PROVISION IN THE EVENT OF LITIGATION. NO PARTY’S REPRESENTATIVE, AGENT OR COUNSEL, HAS THE AUTHORITY TO WAIVE, CONDITION OR MODIFY THIS PROVISION.

SIGNATURES ON THE FOLLOWING PAGE

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The parties have signed this Security Agreement as of the day and year first above written.

	THE HALLWOOD GROUP INCORPORATED
By:
Name:
Title:

	HALLWOOD FAMILY (BVI), L.P. By: Hallwood G.P. (BVI) Limited, General Partner
By:
Name:
Title:	Director

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EX-31.1

Exhibit 31.1

Certification by Chief Executive Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Anthony J. Gumbiner, certify that:

1. I have reviewed this quarterly report on Form 10-Q of The Hallwood Group Incorporated;

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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 – 15(e) and 15d – 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 15, 2012	/s/ Anthony J. Gumbiner
	By: Anthony J. Gumbiner
	Title: Chief Executive Officer

EX-31.2

Exhibit 31.2

Certification by Chief Financial Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Richard Kelley, certify that:

1. I have reviewed this quarterly report on Form 10-Q of The Hallwood Group Incorporated;

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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 – 15(e) and 15d – 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 15, 2012	/s/ Richard Kelley
	By: Richard Kelley
	Title: Chief Financial Officer

EX-32.1

Exhibit 32.1

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the filing of the Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 (the “Report”) by The Hallwood Group Incorporated (the “Registrant”), each of the undersigned hereby certifies that:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

Dated: May 15, 2012	/s/ Anthony J. Gumbiner
	Anthony J. Gumbiner
	Chief Executive Officer
Dated: May 15, 2012	/s/ Richard Kelley
	Richard Kelley
	Chief Financial Officer

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Cash and Cash Equivalents

3 Months Ended

Mar. 31, 2012

Cash and Cash Equivalents [Abstract]

Cash and Cash Equivalents

Note 2 — Cash and Cash Equivalents

Hallwood Group’s cash and cash equivalents are presented below (in thousands). Hallwood Group had no marketable securities as of March 31, 2012 or December 31, 2011.

	March 31, 2012
	Cost		Gross Unrealized Losses		Gross Unrealized Gains		Fair Value
Cash and Cash Equivalents
Cash	$	6,118	$	—	$	—	$	6,118
Available for-sale-securities:
Money market funds		4,249		—		—		4,249
Total cash and cash equivalents	$	10,367	$	—	$	—	$	10,367
	December 31, 2011
	Cost		Gross Unrealized Losses		Gross Unrealized Gains		Fair Value
Cash and Cash Equivalents
Cash	$	5,621	$	—	$	—	$	5,621
Available for-sale-securities:
Money market funds		5,248		—		—		5,248
Total cash and cash equivalents	$	10,869	$	—	$	—	$	10,869

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Organization, Interim Condensed Consolidated Financial Statements and New Accounting Pronouncements

3 Months Ended

Mar. 31, 2012

Organization, Interim Condensed Consolidated Financial Statements and New Accounting Pronouncements [Abstract]

Organization, Interim Condensed Consolidated Financial Statements and New Accounting Pronouncements

Note 1 — Organization, Interim Condensed Consolidated Financial Statements and New Accounting Pronouncements

Organization. The Hallwood Group Incorporated (the “Company”) (NYSE Amex: HWG) was incorporated in Delaware in 1981. The Company 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”). The consolidated financial statements include the accounts of the Company and its subsidiaries (collectively, the “Hallwood Group”).

Interim Condensed Consolidated Financial Statements. The interim condensed consolidated financial statements of Hallwood Group have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America. Although condensed, in the opinion of management, all adjustments considered necessary for a fair presentation have been included. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related disclosures thereto included in Hallwood Group’s annual report on Form 10-K for the year ended December 31, 2011.

Textile Products. Textile products operations are conducted through Brookwood. Brookwood is an integrated textile firm that develops and produces innovative fabrics and related products through specialized finishing, treating and coating processes. Brookwood has two principal subsidiaries at March 31, 2012:

• Kenyon Industries, Inc. (“Kenyon”). Kenyon, located in Rhode Island, uses the latest technologies and processes in dyeing, finishing, coating and printing of woven synthetic products. Kenyon provides quality finishing services for fabrics used in a variety of markets, such as military, luggage and knapsacks, flag and banner, apparel, industrial and sailcloth.

• Brookwood Laminating Inc. (“Brookwood Laminating”). Brookwood Laminating, located in Connecticut, uses the latest in processing technology to provide quality laminating services for fabrics used in military clothing and equipment, sailcloth, medical equipment, industrial applications and consumer apparel. Up to five layers of textile materials can be processed using both wet and dry lamination techniques.

Textile products accounts for all of Hallwood Group’s operating revenues. See Note 4 for additional information on Brookwood.

Energy. Prior to October 2009, the Company held an investment in Hallwood Energy, L.P. (“Hallwood Energy”). Hallwood Energy was a privately held independent oil and gas limited partnership and operated as an upstream energy company engaged in the acquisition, development, exploration, production, and sale of hydrocarbons, with a primary focus on natural gas assets. The Company accounted for the investment in Hallwood Energy using the equity method of accounting, recording its pro rata share of Hallwood Energy’s net income (loss), partners’ capital transactions and comprehensive income (loss). As further discussed in Note 5, Hallwood Energy filed for bankruptcy in March 2009. In connection with the confirmation of Hallwood Energy’s bankruptcy in October 2009, the Company’s ownership interest in Hallwood Energy was extinguished and the Company no longer accounts for the investment in Hallwood Energy using the equity method of accounting.

Investments in Financial Instruments. In the 2011 first quarter, the Company opened an investment account with UBS AG, a global financial services firm, and intended to transfer a significant portion of the cash it holds from time to time to the UBS account to be placed in various financial instruments and to borrow additional amounts from UBS to invest on a leveraged basis. As of May 15, 2012, no funds have been transferred into the UBS account. The Company does not currently intend to transfer funds into the UBS account, but may consider doing so in the future.

Consolidation Policy. The Company’s Brookwood subsidiary operates on a 5-4-4 accounting cycle with its months always ending on a Saturday for accounting purposes, while the Company operates on a traditional fiscal month accounting cycle. For purposes of the year-end financial statements the Brookwood cycle always ends on December 31, however, quarterly interim financial statements may not correspond to the fiscal quarter-end. Hallwood Group’s condensed consolidated financial statements as of March 31, 2012 and 2011 include Brookwood’s operations through March 31, 2012 and April 2, 2011, respectively. Estimated operating results of Brookwood for the intervening periods to March 31, 2012 and 2011, respectively, are provided below (in thousands):

	Amounts in Intervening Periods
	Three Months Ended March 31,
	2012		2011
	(not applicable)		(two business days)
Textile products sales	$	—	$	711
Textile products costs of sales		—		628
Administrative and selling expenses		—		119

New Accounting Pronouncements. Accounting standard-setting organizations frequently issue new or revised accounting rules. Hallwood Group regularly reviews new pronouncements to determine their impact, if any, on Hallwood Group’s consolidated financial statements.

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, which requires a more uniform framework for fair value measurements and related disclosures between GAAP and International Financial Reporting Standards (“IFRS”). This guidance also requires additional disclosure (a) for Level 3 fair value measurements including quantitative information about unobservable inputs used, a description of the valuation processes used, by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (b) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use and the reason for the difference; (c) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (d) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. This guidance is effective for interim and annual periods beginning on or after December 15, 2011. Hallwood Group adopted this guidance prospectively as of January 1, 2012, the beginning of the 2012 fiscal year. The adoption of this guidance did not require any additional disclosure in the consolidated financial statements.

In September 2011, the FASB issued Accounting Standards Update No. 2011-09 (ASU 2011-09), Compensation – Retirement Benefits – Multiemployer Pans (Subtopic 715-80), Disclosures about an Employer’s Participation in a Multiemployer Plan. This standard requires an employer that participates in multiemployer pension plans to provide additional quantitative and qualitative disclosures in order to provide users with more detailed information about the employer’s involvement in multiemployer pension plans. In addition, this standard also includes changes in the disclosures required for multiemployer plans that provide postretirement benefits other than pensions. ASU 2011-09 is effective for Hallwood Group for the fiscal year ending after December 15, 2011. Hallwood Group adopted ASU 2011-09 in its annual financial statements for the year ended December 31, 2011. The adoption of ASU 2011-09 did not affect Hallwood Group’s financial position, results of operations or cash flows, although additional disclosures related to postretirement benefits have been included in the accompanying footnotes.

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Condensed Consolidated Balance Sheets (Unaudited) (USD $) In Thousands, unless otherwise specified	Mar. 31, 2012	Dec. 31, 2011
Current Assets
Cash and cash equivalents	$ 10,367	$ 10,869
Accounts receivable, net
Factors	18,376	17,487
Trade and other	4,127	8,174
Related parties	42	42
Inventories	28,578	24,980
Deferred income tax, net	5,651	4,788
Prepaids, deposits and other assets	667	934
Prepaid income taxes	2,146	1,027
Total currents assets	69,954	68,301
Noncurrent Assets
Property, plant and equipment	20,199	20,442
Deferred income tax, net	1,881	0
Other assets	241	162
Total noncurrent assets	22,321	20,604
Total Assets	92,275	88,905
Current Liabilities
Accounts payable	10,610	8,941
Accrued expenses and other current liabilities	6,078	5,096
Payable - Hallwood Energy matters
Litigation reserve	20,700	9,300
Contingent additional investment in Hallwood Energy	3,201	3,201
Income taxes payable	4	10
Total current liabilities	40,593	26,548
Noncurrent Liabilities
Long term portion of loans payable	2,000	2,000
Deferred income tax	94	1,217
Total noncurrent liabilities	2,094	3,217
Total Liabilities	42,687	29,765
Contingencies and Commitments (Note 13)
Stockholders' Equity
Common stock, issued 2,396,105 shares for both periods; outstanding 1,525,166 shares for both periods	240	240
Additional paid-in capital	51,700	51,700
Retained earnings	11,052	20,604
Treasury stock, 870,939 shares for both periods; at cost	(13,404)	(13,404)
Total Stockholders' Equity	49,588	59,140
Total Liabilities and Stockholders' Equity	$ 92,275	$ 88,905

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Condensed Consolidated Statement of Changes in Stockholders' Equity (Unaudited) (USD $) In Thousands	Total	Common Stock	Additional Paid-In Capital	Retained Earnings	Treasury Stock
Beginning balance at Dec. 31, 2011	$ 59,140	$ 240	$ 51,700	$ 20,604	$ (13,404)
Beginning balance, shares at Dec. 31, 2011		2,396			871
Net Loss	(9,552)			(9,552)
Ending balance at Mar. 31, 2012	$ 49,588	$ 240	$ 51,700	$ 11,052	$ (13,404)
Ending balance, shares at Mar. 31, 2012		2,396			871

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Impact of Litigation on Liquidity

3 Months Ended

Mar. 31, 2012

Impact of Litigation on Liquidity [Abstract]

Impact of Litigation on Liquidity

Note 15 — Impact of Litigation on Liquidity

The Company and its subsidiaries are involved in a number of litigation matters, as described in Note 13, and have spent and may continue to spend significant amounts in professional fees in connection with the defense of its pending legal matters. As previously described, on April 24, 2012, the United States District Court in the Adversary Proceeding issued a Judgment awarding damages against the Company totaling approximately $18,700,000 plus prejudgment and postjudgment interest and attorneys’ fees as may be requested and awarded pursuant to a subsequent motion.

The Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. The amount and timing for the payment of legal fees to the plaintiff’s attorneys, which will be subsequently determined by the District Court, is currently unresolved.

In addition to its current available cash, to obtain additional funds to satisfy the Judgment, in May 2012, the Company received an $8,000,000 dividend from Brookwood and the $10,000,000 HFL Loan.

The Company’s ability to receive additional cash dividends or other advances from Brookwood above the permitted annual discretionary dividend not to exceed 50% of Brookwood’s net income to repay the HFL Loan or for other purposes, is dependent upon Brookwood’s obtaining consent from BB&T for such payments. Any such 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.

The aforementioned circumstances raise substantial doubt about 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.

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Condensed Consolidated Statements of Cash Flows (Unaudited) (USD $) In Thousands, unless otherwise specified	3 Months Ended
	Mar. 31, 2012	Mar. 31, 2011
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$ (9,552)	$ (996)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Litigation charge - Hallwood Energy matters	13,200
Deferred tax expense (benefit)	(3,867)
Depreciation, amortization and impairment	593	658
Provision (recovery) for obsolete inventory	154	(29)
Provision (recovery) for doubtful accounts and factor dilution	8	(51)
Changes in assets and liabilities:
(Increase) decrease in inventories	(3,752)	(6,563)
(Increase) decrease in accounts receivable	3,150	3,225
Partial payment of litigation reserve - Hallwood Energy matters	(1,800)
Increase (decrease) in accounts payable	1,777	2,508
Increase (decrease) in accrued expenses and other current liabilities	982	(1,248)
Net change in other assets and liabilities	188	(267)
Net change in income taxes receivable/payable	(1,125)	(672)
Net cash provided by (used in) operating activities	(44)	(3,435)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from redemption of short-term investments		1,115
Proceeds from disposal of equipment	58
Investments in property, plant and equipment, net	(516)	(555)
Net cash provided by (used in) investing activities	(458)	560
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from revolving credit facility
Repayments of revolving credit facility
Net cash provided by (used in) financing activities
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	(502)	(2,875)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	10,869	11,159
CASH AND CASH EQUIVALENTS, END OF PERIOD	$ 10,367	$ 8,284

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Condensed Consolidated Balance Sheets (Unaudited) (Parenthetical)	Mar. 31, 2012	Dec. 31, 2011
Condensed Consolidated Balance Sheets [Abstract]
Common stock, shares issued	2,396,105	2,396,105
Common stock, shares outstanding	1,525,166	1,525,166
Treasury stock, shares	870,939	870,939

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Supplemental Disclosures to the Condensed Consolidated Statements of Cash Flows

3 Months Ended

Mar. 31, 2012

Supplemental Disclosures to the Condensed Consolidated Statements of Cash Flows [Abstract]

Supplemental Disclosures to the Condensed Consolidated Statements of Cash Flows

Note 10 — Supplemental Disclosures to the Condensed Consolidated Statements of Cash Flows

The following transactions affected recognized assets or liabilities but did not result in cash receipts or cash payments (in thousands):

Supplemental schedule of non-cash investing and financing activities:

	Three Months Ended
	March 31,
Description	2012		2011
Accrued capital expenditures in accounts payable and accrued expenses:
Amount at end of period	$	22	$	163

Supplemental disclosures of cash payments:

Income taxes paid	$	76	$	91
Interest paid		25		28

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Document and Entity Information	3 Months Ended
	Mar. 31, 2012	Apr. 30, 2012
Document and Entity Information [Abstract]
Entity Registrant Name	Hallwood Group Inc
Entity Central Index Key	0000355766
Document Type	10-Q
Document Period End Date	Mar. 31, 2012
Amendment Flag	false
Document Fiscal Year Focus	2012
Document Fiscal Period Focus	Q1
Current Fiscal Year End Date	--12-31
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding		1,525,166

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Computation of Income (Loss) Per Common Share

3 Months Ended

Mar. 31, 2012

Computation of Income (Loss) Per Common Share [Abstract]

Computation of Income (Loss) Per Common Share

Note 11 — Computation of Income (Loss) Per Common Share

The following table reconciles weighted average shares outstanding from basic to diluted methods and reconciles net income (loss) used in the computation of income (loss) per share for the basic and diluted methods (in thousands):

	Three Months Ended
	March 31,
Description	2012			2011
Weighted Average Shares Outstanding
Basic and diluted		1,525			1,525
Net Income (Loss)
Basic and diluted	$	(9,552	)	$	(996	)

For the three months ended March 31, 2012 and 2011, there were no outstanding stock options. No shares were excluded from the calculation of diluted earnings per share.

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Condensed Consolidated Statements of Operations (Unaudited) (USD $) In Thousands, except Per Share data, unless otherwise specified	3 Months Ended
	Mar. 31, 2012	Mar. 31, 2011
Revenues
Textile products sales	$ 35,879	$ 26,769
Expenses
Textile products cost of sales	30,149	23,194
Administrative and selling expenses	6,969	5,146
Litigation charge - Hallwood Energy matters	13,200
Total expenses	50,318	28,340
Operating loss	(14,439)	(1,571)
Other Income (Loss)
Interest expense	(25)	(26)
Interest and other income	1	17
Total other income (loss)	(24)	(9)
Loss before income taxes	(14,463)	(1,580)
Income tax expense (benefit)	(4,911)	(584)
Net Loss	$ (9,552)	$ (996)
Net Loss Per Common Share
Basic	$ (6.26)	$ (0.65)
Diluted	$ (6.26)	$ (0.65)
Weighted Average Shares Outstanding
Basic	1,525	1,525
Diluted	1,525	1,525

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Investments in Hallwood Energy, L.P.

3 Months Ended

Mar. 31, 2012

Investments in Hallwood Energy, L.P. [Abstract]

Investments in Hallwood Energy, L.P.

Note 5 — Investments in Hallwood Energy, L.P.

Hallwood Energy was a privately held independent oil and gas limited partnership and operated as an upstream energy company engaged in the acquisition, development, exploration, production, and sale of hydrocarbons, with a primary focus on natural gas assets. The Company had invested $75,401,000 in Hallwood Energy comprised of a general partnership interest, Class A and Class C limited partnership interests and convertible notes.

Prior to the confirmation of Hallwood Energy’s plan of reorganization in Bankruptcy Court in October 2009 (discussed below), the Company accounted for the investment in Hallwood Energy using the equity method of accounting and recorded its pro rata share of Hallwood Energy’s net income (loss), partner capital transactions and comprehensive income (loss), as appropriate. In connection with Hallwood Energy’s bankruptcy reorganization, the Company’s general and limited partnership interests in Hallwood Energy were extinguished and the Company no longer accounts for the investment in Hallwood Energy using the equity method of accounting.

Bankruptcy Reorganization by Hallwood Energy. In March 2009, Hallwood Energy, Hallwood Energy Management, LLC (the general partner of Hallwood Energy, “HEM”) and Hallwood Energy’s subsidiaries, filed petitions for relief under Chapter 11 of the United States Bankruptcy Code. The cases were adjudicated in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, in In re Hallwood Energy, L.P., et al Case No. 09-31253. The Company was only an investor in and creditor of Hallwood Energy. The bankruptcy filing did not include the Company or any other of its assets.

In October 2009, the Bankruptcy Court confirmed a plan of reorganization of the debtors that, among other things, extinguished Hallwood Energy’s general partnership and limited partnership interests, including those held by the Company. In addition, Hallwood Energy’s convertible notes, including those held by the Company, were subordinated to recovery in favor of Hall Phoenix/Inwood, Ltd. (“HPI”), the secured lender to and an investor in Hallwood Energy.

Litigation. In connection with Hallwood Energy’s bankruptcy proceeding, Hallwood Energy and other parties filed lawsuits and had threatened to assert additional claims against the Company and certain related parties alleging actual, compensatory and exemplary damages in excess of $200,000,000, based on purported breach of contract, fraud, breach of fiduciary duties, neglect, negligence and various misleading statements, omissions and misrepresentations. See Note 13.

In one of these matters, the Adversary Proceeding, on July 25, 2011, the Bankruptcy Court issued the Proposed Findings of Fact, Conclusions of Law and Judgment Awarding Various Monetary Damages (“the Proposed Findings”) proposing that damages be awarded against the Company totaling approximately $18,700,000 plus prejudgment and postjudgment interest and attorney’s fees as may be requested and awarded pursuant to a subsequent motion. As a result of the Proposed Findings and taking into consideration the Company’s objections to the Proposed Findings, during 2011 the Company recorded a charge of $7,500,000 in its statement of operations and its balance sheet as an accrual under Hallwood Energy matters – Litigation Reserve in the Adversary Proceeding, in addition to $3,201,000 that was previously recorded in connection with the Equity Support Agreement discussed below for a total reserve of $10,701,000 at December 31, 2011 for the Adversary Proceeding.

On April 24, 2012, the United States District Court entered a final judgment (the “Judgment”) substantially adopting the Proposed Findings. Based upon the monetary damages (including prejudgment and postjudgment interest, legal fees and court costs) awarded in the Judgment, the Company recorded an additional charge of $13,200,000 at March 31, 2012 in its statement of operations and balance sheet as an accrual under Hallwood Energy matters – Litigation Reserve. Accordingly, the total reserve at March 31, 2012 for the Adversary Proceeding was $23,901,000. The Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. In addition, the Company will be required to pay certain attorneys’ fees incurred by the plaintiffs. The amount and timing of the payment of these fees will be subsequently determined by the District Court, and are currently unresolved. See Note 6.

In the Hallwood Energy litigation matters, other than the Adversary Proceeding, effective February 14, 2012, the Company and certain other parties entered into a Confidential Settlement Agreement and Mutual Release of Claims (the “Settlement Agreement”). The Settlement Agreement effectively settles the claims by HPI, the Trustee of the Hallwood Energy I Creditors’ Trust, and their related parties (the “Plaintiffs”) against the Company and its related parties, other than the claims in the Adversary Proceeding, in which the District Court rendered the Judgment.

The terms of the Settlement Agreement included the payment by the Company of $1,800,000, in addition to payments by other defendants and the Company’s insurance carrier for its directors and officers’ liability insurance policy. Under the Settlement Agreement, the Plaintiffs release the Company, its current and former directors and officers, the former directors and officers of the general partner of Hallwood Energy, L.P. and various entities related to the foregoing persons from all claims asserted in or relating to (i) Hall Phoenix/Inwood Ltd. and Hall Performance Energy Partners 4, Ltd. v. The Hallwood Group Incorporated et al. in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03358; (ii) Ray Balestri,

Trustee of the Hallwood Energy I Creditor’s Trust v. Anthony J. Gumbiner, et al. in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03263; and (iii) another suit in which the Company is not named as a party, and any other claims based on the facts alleged in the foregoing matters or that could have been alleged in the foregoing matters, other than the claims against the Company asserted in the Adversary Proceeding or any claims required to enforce any final judgment entered against the Company in the Adversary Proceeding. Similarly, the defendants release the Plaintiffs from all claims based on the facts alleged in the foregoing matters or that could have been alleged in the for foregoing matters, other than any claims or defenses the defendants may have in the Adversary Proceeding.

The parties entered into the Settlement Agreement for a number of reasons, including to save time and expense, to ensure available insurance proceeds could be used toward the settlement of the disputed claims rather than the payment of expenses and legal fees, and otherwise to resolve the litigation claims. The defendants continue to believe that the claims asserted against them in the lawsuits had no merit and their agreement to settle and compromise those claims should not be deemed as an admission of any liability, wrongdoing, or fault.

At December 31, 2011, the Company recorded a charge of $1,800,000 in its statement of operations and balance sheet under Hallwood Energy matters – Litigation Reserve for the full value of the Company’s payment required by the Settlement Agreement. The Company paid the settlement amount of $1,800,000 to the plaintiffs on February 15, 2012.

Equity Support Agreement. In connection with the then ongoing efforts to complete an Acquisition and Farmout Agreement entered into between Hallwood Energy and FEI Shale, L.P. (“FEI”), the Company loaned Hallwood Energy $2,961,000 in May 2008. Concurrent with the completion of the Acquisition and Farmout Agreement in June 2008, the Company entered into an equity support agreement (the “Equity Support Agreement”) with Hallwood Energy under which the Company committed, under certain conditions, to contribute equity or debt capital to Hallwood Energy to maintain a reasonable liquidity position for Hallwood Energy or prevent or cure any default under Hallwood Energy’s credit facilities with respect to interest payments, up to a maximum of $12,500,000. The Company contributed $2,039,000 at the completion date (for a total amount of $5,000,000) to Hallwood Energy and committed to provide an additional amount of up to $7,500,000 in certain circumstances, under the terms of a $12,500,000 convertible subordinated note agreement (the “Second Convertible Note”) issued by Hallwood Energy in May 2008 and underwritten by the Company. In September 2008, the Company loaned $4,300,000 to Hallwood Energy pursuant to the Equity Support Agreement. An obligation and related additional equity loss were recorded in 2008 to the extent of the Company’s contingent commitment to provide additional financial support to Hallwood Energy pursuant to the Equity Support Agreement, in the amount of $3,201,000. The Company’s additional investments and contingent commitment to provide additional financial support resulted in the recording of an equity loss in the year ended December 31, 2008 of $12,120,000.

The Equity Support Agreement terminated not later than October 2009 in connection with the confirmation of Hallwood Energy’s plan of reorganization. The Equity Support Agreement is no longer in effect, although (as previously discussed) the obligation to pay the remaining unpaid contingent commitment under the Equity Support Agreement, which was subject to litigation in the Adversary Proceeding, was $3,201,000 and was paid on May 4, 2012.

Other. For further information on Hallwood Energy’s activities, including its bankruptcy reorganization, refer to Hallwood Group’s annual report on Form 10-K for the year ended December 31, 2011.

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Operations of Brookwood Companies Incorporated

3 Months Ended

Mar. 31, 2012

Operations of Brookwood Companies Incorporated [Abstract]

Operations of Brookwood Companies Incorporated

Note 4 — Operations of Brookwood Companies Incorporated

Receivables. Brookwood maintains factoring agreements with several factors, which provide that receivables resulting from credit sales to customers, excluding the U.S. Government, may be sold to the factor, subject to a commission and the factor’s prior approval. Factored receivables were $18,376,000 and $17,487,000 at March 31, 2012 and December 31, 2011, which were net of a returned goods dilution allowance of $69,000 and $63,000, respectively.

Brookwood monitors its factors and their ability to fulfill their obligations to Brookwood in a timely manner. As of May 15, 2012, all of Brookwood’s factors were complying with payment terms in accordance with factor agreements.

Trade receivables were $3,815,000 and $8,031,000 at March 31, 2012 and December 31, 2011, which were net of an allowance for doubtful accounts of $120,000 and $118,000, respectively. The trade receivable balance at December 31, 2011 included approximately $1,643,000, which was the balance remaining related to fabric sold in two products to a Brookwood customer in the period from September 2008 to April 2009 that supplies the U.S. military for which payment had been delayed due to a compliance issue (see also Note 13). Brookwood received payment at full value of $1,643,000 in January 2012.

Sales Concentration. Brookwood has one customer who accounted for more than 10% of Brookwood’s sales. Sales to that Brookwood customer, Tennier Industries, Inc. (“Tennier”), accounted for more than 10% of Brookwood’s sales during the 2012 first quarter only. Brookwood’s relationship with Tennier is ongoing. Sales to Tennier, which are included in military sales, were $6,708,000 and $290,000 in the 2012 and 2011 first quarters, respectively. Sales to Tennier represented 18.7% and 1.1% of Brookwood’s net sales in the 2012 and 2011 first quarters, respectively.

Military sales accounted for $21,675,000 and $10,176,000 in the 2012 and 2011 first quarters, which represented 60.4% and 38.0% of Brookwood’s net sales in the 2012 and 2011 first quarters, respectively. 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.

Stockholders’ Equity. The Company is the holder of all of Brookwood’s outstanding $13,500,000 Series A, $13.50 annual dividend per share, redeemable preferred stock and all of its 10,000,000 outstanding shares of common stock. The preferred stock has a liquidation preference of $13,500,000 plus accrued but unpaid dividends. At March 31, 2012, cumulative dividends in arrears on the preferred stock amounted to approximately $456,000.

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 (the “2005 Long-Term Incentive Plan for Brookwood”) to encourage employees of Brookwood to increase the value of Brookwood and 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 (approximately $13,956,000 at March 31, 2012). 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 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 (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. No amounts have been accrued under this plan.

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Subsequent Events

3 Months Ended

Mar. 31, 2012

Subsequent Events [Abstract]

Subsequent Events

Note 16 — Subsequent Events

In completing the condensed consolidated financial statements and related notes thereto for the period ended March 31, 2012, Hallwood Group considered the following subsequent events:

• On April 24, 2012, the United States District Court issued the Judgment in the Adversary Proceeding, as further discussed in Note 13. An additional litigation charge of $13,200,000 related to the Adversary Proceeding has been included in the condensed consolidated financial statements for the period ended March 31, 2012.

• In May 2012, the Company received an $8,000,000 dividend from Brookwood and the $10,000,000 HFL Loan, as further discussed in Note 6 and Note 15, respectively.

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Related Party Transactions

3 Months Ended

Mar. 31, 2012

Related Party Transactions [Abstract]

Related Party Transactions

Note 12 — Related Party Transactions

Hallwood Investments Limited. The Company has entered into a financial consulting contract with Hallwood Investments Limited (“HIL”), a corporation associated with Mr. Anthony J. Gumbiner, the Company’s chairman 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 contract and for travel and related expenses to 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 are detailed below (in thousands):

	Three Months Ended
	March 31,
	2012		2011
Consulting fees	$	249	$	249
Office space and administrative services		65		95
Travel and other expenses		17		13
Total	$	331	$	357

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 receive consulting fees, bonuses, stock options, profit interests or other forms of compensation and expenses. No such services were performed, or compensation earned, during 2012 or 2011. 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 office space for purposes unrelated to the Company’s business. The Company pays certain common general and administrative expenses for salaries, rent and other offices 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, 2012 and 2011, these companies reimbursed the Company $26,000 and $24,000, respectively, for such expenses.

In May 2012, to fund in part the payment of the Judgment, the Company entered into the HFL Loan with Hallwood Family (BVI) L.P., a limited partnership associated with Mr. Gumbiner. See Note 6.

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Income Taxes

3 Months Ended

Mar. 31, 2012

Income Taxes [Abstract]

Income Taxes

Note 8 — Income Taxes

Following is a schedule of the income tax expense (benefit) (in thousands):

	Three Months Ended
	March 31,
	2012			2011
Federal
Current	$	(1,055	)	$	(590	)
Deferred		(3,867	)		—
Sub-total		(4,922	)		(590	)
State
Current		11			6
Deferred		—			—
Sub-total		11			6
Total	$	(4,911	)	$	(584	)

The net deferred tax asset was $7,438,000 and $3,571,000 at March 31, 2012 and December 31, 2011, respectively. The net deferred tax asset at March 31, 2012 was comprised of temporary differences, including $7,038,000 related to loss reserves on litigation matters and $1,088,000 associated with the Company’s investment in Hallwood Energy. The net deferred tax asset at December 31, 2011 was comprised of temporary differences, including $3,162,000 related to loss reserves on litigation matters and $1,088,000 associated with the Company’s investment in Hallwood Energy. The federal tax rate was 34%, while state taxes were determined based upon taxable income apportioned to those states in which Hallwood Group does business at their respective tax rates.

Hallwood Group had a federal income tax receivable of $1,875,000 and $821,000 at March 31, 2012 and December 31, 2011, respectively, and net state tax receivable of $272,000 and $195,000, at March 31, 2012 and December 31, 2011, respectively. The federal income tax receivable is principally due to the carryback of the 2012 and 2011 federal net operating losses to 2010 and 2009, respectively.

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Loans Payable

3 Months Ended

Mar. 31, 2012

Loans Payable [Abstract]

Loans Payable

Note 6 — Loans Payable

Loans payable, all of which relate to Brookwood, at the balance sheet dates were as follows (in thousands):

	March 31,		December 31,
	2012		2011
Working Capital Revolving Credit Facility; repaid April 2012	$	2,000	$	2,000
New Revolving Credit Facility; due March 2014		—		—
		2,000		2,000
Current portion		—		—
Noncurrent portion	$	2,000	$	2,000

Working Capital Revolving Credit Facility. The Company’s Brookwood subsidiary had a revolving credit facility in an amount up to $25,000,000 with KeyBanc (the “Working Capital Revolving Credit Facility”). Borrowings were collateralized by accounts receivable, certain finished goods inventory, machinery and equipment and all of the issued and outstanding capital stock of Brookwood and its subsidiaries. The interest rate was a blended rate of 1.74% and 1.78% at March 31, 2012 and December 31, 2011, respectively. The outstanding balance was $2,000,000 at March 31, 2012, which was repaid on April 2, 2012 with proceeds from the New Revolving Credit Facility (discussed below).

Loan Covenants. The Working Capital Revolving Credit Facility contained various loan covenants including a covenant that provided for a maximum total debt to tangible net worth ratio of 1.50 and a covenant that Brookwood shall maintain a quarterly minimum income before taxes of not less than one dollar. In October 2009, an additional covenant was added that provided for a total funded debt to EBITDA (earnings before interest, taxes, depreciation and amortization) ratio, for the trailing four quarters, of not greater than 2.00 to be calculated on a quarterly basis.

As of March 31, 2012, December 31, 2011 and for the quarters ended September 30, 2011 and June 30, 2011, Brookwood was in compliance with its principal loan covenants for the Working Capital Revolving Credit Facility.

Due to a decline in military sales for quarter ended March 31, 2011, Brookwood was unable to meet the financial covenant that requires income before taxes of at least $1 in each quarter. Brookwood’s unaudited loss before taxes for the 2011 first quarter was $299,000. Accordingly, in May 2011, Brookwood requested and received a waiver from KeyBanc for the income covenant for the 2011 first quarter. Brookwood received an increased level of military orders in late March 2011 and into the subsequent 2011 periods, and reported income before taxes in the 2011 second quarter, third quarter and fourth quarter, respectively, and was in compliance with its loan covenants for the three remaining 2011 quarters.

New Revolving Credit Facility entered into in March 2012. On March 30, 2012, Brookwood and its subsidiaries entered into a loan agreement by and among Brookwood, its subsidiaries and Branch Banking and Trust Company (“BB&T”) (the “New Revolving Credit Facility”). The New Revolving Credit Facility replaces the Working Capital Revolving Credit Facility.

The New Revolving Credit Facility provides for borrowings of up to $25,000,000 and is secured by a first lien on substantially all of the assets of Brookwood. The New Revolving Credit Facility has a maturity date of March 30, 2014. On April 2, 2012, Brookwood borrowed $2,018,000 under this new facility to repay outstanding amounts due under the Working Capital Revolving Credit Facility, including accrued interest. On May 8, 2012, the Company requested a dividend of $8,000,000 from Brookwood, which obtained consent from BB&T for such payment. Accordingly, Brookwood borrowed $8,000,000 under the New Revolving Credit Facility and paid that amount as a dividend to the Company. The Company combined such funds with other available cash and the HFL Loan, discussed below, to satisfy the Judgment issued by the United States District Court. As of May 15, 2012, Brookwood had $14,891,000 of borrowing availability under this facility, which was net of a standby letter of credit for $91,000.

The interest rate payable on the New Revolving Credit Facility is dependent on a leverage ratio, as defined, and can vary from LIBOR plus 1.00% to 2.00%. If BB&T is not a primary factor of Brookwood, then the interest rates will be increased by 0.40%.

The terms of the New Revolving Credit Facility provide that the facility may be used for refinancing existing indebtedness, providing for working capital and financing on-going capital expenditures.

The New Revolving Credit Facility contains customary representations, warranties and affirmative covenants on behalf of Brookwood and also contains negative covenants that, among other things, prohibit Brookwood from, without obtaining prior BB&T written consent and with certain exceptions: (i) permitting liens (other than customary liens) to exist on any of its properties; (ii) incurring other debt other than accounts payable to trade creditors incurred in the ordinary course of business and factors; (iii) making capital expenditures in excess of $5,000,000 in any year; (iv) purchasing substantially all the assets of another entity; (v) entering into new leases except operating leases for machinery and equipment that do not in the aggregate require payments in excess of $250,000 in any year and real estate leases in the ordinary course of business; (vi) paying dividends, or acquiring any of its stock, other than (a) annual payments to the Company for tax sharing obligations, and (b) annual discretionary dividends to the Company not to exceed 50% of Brookwood’s net income for such year; (vii) making loans or advances to, or guaranties for the benefit of, any person; and (viii) disposing of its assets or properties except in the ordinary course of its business.

The loan agreement also requires Brookwood to satisfy certain financial covenants on the last day of each fiscal quarter, including maintaining:

(i) a ratio of total current assets to the sum of total current liabilities and the outstanding loan balance of not less than 1.40 to 1.00.

(ii) a ratio of total liabilities to tangible net worth of not greater than 1.50 to 1.00. Tangible net worth is defined as net worth, plus obligations contractually subordinated to debts owed to BB&T, minus goodwill, contract rights, and assets representing claims on stockholders or affiliated entities.

(iii) a ratio of funded debt (as defined) to EBITDA (earnings before interest, taxes, depreciation and amortization) for the trailing four quarters of not greater than 2.75 to 1.00.

Brookwood was in compliance with such financial covenants at March 31, 2012. In order to maintain compliance with such covenants in the future, Brookwood may be required to limit aggregate borrowings under the New Revolving Credit Facility to less than $25,000,000 at the end of each fiscal quarter.

Payments of Dividends. During the term of the Working Capital Revolving Credit Facility, Brookwood submitted a quarterly loan compliance certificate to KeyBanc and concurrently requested the bank’s consent to pay cash dividends and tax sharing payments to the Company. Brookwood paid to the Company dividends of $1,000,000 in February 2012 and $4,000,000 during the year ended December 31, 2011. The New Revolving Credit Facility contains a restriction on the payment of any cash dividend or advance to the Company above the tax sharing payment and the permitted annual discretionary dividend not to exceed 50% of Brookwood’s net income. Brookwood has indicated that it would be required (pursuant to the terms of the New Revolving Credit Facility) to obtain consent from BB&T for such payments above the permitted amount.

In May 2012, following the Company’s request for an additional dividend, Brookwood requested BB&T to approve such dividend for $8,000,000. BB&T consented to the dividend, which was paid to the Company in May 2012. Any future 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.

Also in May 2012, to fund in part the payment of the Judgment, the Company borrowed from Hallwood Family (BVI) L.P., a limited partnership associated with its principal shareholder, the sum of $10,000,000 (the “HFL Loan”). The HFL Loan is secured by a pledge of all of the stock of Brookwood, subject to BB&T consent, and by the Company’s interest in the anticipated refunds of federal income taxes of approximate $5,000,000, which the Company expects to receive in 2012 and 2013. The HFL Loan is due in full on June 28, 2013 and bears interest at the rate of 6% per year, payable on a quarterly basis. The Company may prepay the HFL Loan at any time without penalty. The documents reflecting the HFL Loan contains representations, warranties and covenants that are typical for loans of this type.

Restricted Net Assets. Cash dividends and tax sharing payments by Brookwood to the Company are contingent upon compliance with the New Revolving Credit Facility loan covenants and/or consent from BB&T in certain circumstances. This limitation on the transferability of assets constitutes a restriction of Brookwood’s net assets, which were $58,995,000 and $59,970,000 at March 31, 2012 and December 31, 2011, respectively.

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Stockholders' Equity

3 Months Ended

Mar. 31, 2012

Stockholders' Equity [Abstract]

Stockholders' Equity

Note 7 — Stockholders’ Equity

Stock Options. At March 31, 2012, there were no outstanding stock options. The Company’s former stock option plan expired in 2005 and no stock options are available for issuance.

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Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2012

Fair Value of Financial Instruments [Abstract]

Fair Value of Financial Instruments

Note 9 — Fair Value of Financial Instruments

The following table summarizes the valuation of Hallwood Group’s financial instruments based upon the inputs used to measure fair value in the three levels of the fair value hierarchy as of March 31, 2012 and December 31, 2011.

• Level 1 – Quoted market prices in active markets for identical assets or liabilities

• Level 2 – Quoted prices for similar assets or liabilities in active markets or inputs that are observable

• Level 3 – Inputs that are unobservable

	March 31, 2012
	Level 1		Level 2		Level 3
Cash Equivalents
Money market funds	$	4,249	$	—	$	—
	December 31, 2011
	Level 1		Level 2		Level 3
Cash Equivalents
Money market funds	$	5,248	$	—	$	—

Money market funds are classified as Level 1 instruments as they are traded in active markets with sufficient volume and frequency of transactions.

The fair value of financial instruments that are short-term or reprice frequently and have a history of negligible credit losses are considered to approximate their carrying value. These include cash, short term receivables, accounts payable, the revolving credit facility and other liabilities.

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Segments and Related Information

3 Months Ended

Mar. 31, 2012

Segments and Related Information [Abstract]

Segments and Related Information

Note 14 — Segments and Related Information

The following represents Hallwood Group’s reportable segment operations for the three months ended March 31, 2012 and 2011, respectively (in thousands):

	Textile
	Products			Other			Consolidated
Three Months Ended March 31, 2012
Total revenue from external sources	$	35,879		$	—		$	35,879
Operating income (loss)	$	65		$	(14,504	)	$	(14,439	)
Other income (loss), net		(25	)		1			(24	)
Income (loss) before income taxes	$	40		$	(14,503	)	$	(14,463	)
Three months ended March 31, 2011
Total revenue from external sources	$	26,769		$	—		$	26,769
Operating income (loss)	$	(288	)	$	(1,283	)	$	(1,571	)
Other income (loss), net		(11	)		2			(9	)
Income (loss) before income taxes	$	(299	)	$	(1,281	)	$	(1,580	)

No differences have occurred in the basis or methodologies used in the preparation of this interim segment information from those used in the December 31, 2011 annual report. The total assets for Hallwood Group’s operating segments have not materially changed since the December 31, 2011 annual report.

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Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited) (USD $) In Thousands, unless otherwise specified	3 Months Ended
	Mar. 31, 2012	Mar. 31, 2011
Condensed Consolidated Statements of Comprehensive Income (Loss) [Abstract]
Net Loss	$ (9,552)	$ (996)
Other Comprehensive Income (Loss)
None
Comprehensive Loss	$ (9,552)	$ (996)

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Inventories

3 Months Ended

Mar. 31, 2012

Inventories [Abstract]

Inventories

Note 3 — Inventories

All inventories relate to Brookwood. Inventories as of the balance sheet dates were as follows (in thousands):

	March 31,		December 31,
	2012		2011
Raw materials	$	8,318	$	7,727
Work in progress		6,269		5,796
Finished goods		13,991		11,457
Total	$	28,578	$	24,980

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Litigation, Contingencies and Commitments

3 Months Ended

Mar. 31, 2012

Litigation, Contingencies and Commitments [Abstract]

Litigation, Contingencies and Commitments

Note 13 — Litigation, Contingencies and Commitments

Reference is made to Note 15 to the consolidated financial statements contained in the Company’s annual report on Form 10-K for the year ended December 31, 2011.

Litigation. From time to time, the Company, its subsidiaries, certain of its affiliates and others have been named as defendants in lawsuits relating to various transactions in which it or its affiliated entities participated. Although the Company does not believe that the results of any of these matters are likely to have a material adverse effect on its financial position, results of operations or cash flows, except as described below, it is possible that any of the matters could result in material liability. In addition, Hallwood Group has spent and may continue to spend significant amounts in professional fees and other associated costs in connection with certain of these matters. Hallwood Group expenses professional fees and other costs associated with litigation matters as incurred.

In July 2007, Nextec Applications, Inc. filed Nextec Applications, Inc. v. Brookwood Companies Incorporated and The Hallwood Group Incorporated in the United States District Court for the Southern District of New York (SDNY No. CV 07-6901) claiming that Brookwood infringed five United States patents pertaining to internally-coated webs. In October 2007, The Hallwood Group Incorporated was dismissed from the lawsuit. Nextec later added additional patents to the lawsuit. After a number of motions, only two patents remain in the action and are being asserted against the process and machine for making defendants’ Agility Storm-Tec X-Treme and Eclipse Storm-Tec X-Treme fabrics, which constitute two levels of the Military’s Extended Cold Weather Clothing System. Nextec is seeking a permanent injunction as well as damages in an amount to be determined at trial. Separately, Brookwood filed requests for reexamination by the United States Patent and Trademark Office of the remaining patent claims at issue in the litigation. The United States Patent and Trademark Office has granted the reexamination requests and issued first office actions rejecting all the reexamined patent claims as unpatentable over the prior art of record. Nextec will have an opportunity to respond to the Patent Office and eventually to appeal any final decision by the Patent Office. Brookwood intends to vigorously defend against all remaining claims. Trial on this matter began on April 30, 2012 and is ongoing. While Brookwood believes it possesses valid defenses to these claims, due to the nature of litigation, the ultimate outcome of this case is indeterminable at this time.

Hallwood Energy. In March 2009, Hallwood Energy, HEM (the general partner of Hallwood Energy) and Hallwood Energy’s subsidiaries, filed petitions for relief under Chapter 11 of the United States Bankruptcy Code. The cases were adjudicated in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, in In re Hallwood Energy, L.P., et al Case No. 09-31253. The Company was only an investor in and creditor of Hallwood Energy. The bankruptcy filing did not include the Company or Brookwood.

In October 2009, the Bankruptcy Court confirmed a plan of reorganization of the debtors that, among other things, extinguished the Company’s interest in Hallwood Energy’s general partnership and limited partnership interests. In addition, Hallwood Energy’s convertible notes, including those held by the Company, were subordinated to recovery in favor of Hall Phoenix/Inwood, Ltd (“HPI”), the secured lender to and an investor in Hallwood Energy.

The confirmed plan of reorganization in the Hallwood Energy bankruptcy proceeding also created a creditors’ trust that was authorized to pursue various claims against the Company, its officers, directors and affiliates and Hallwood Energy’s officers and directors, including claims assigned to the creditors’ trust by HPI.

Adversary Proceeding. On March 30, 2009, Hallwood Energy filed an adversary proceeding against the Company seeking a judgment for $3,200,000. The case was originally styled as Hallwood Energy, L.P. v. The Hallwood Group Incorporated, Adversary No. 09-03082, and was brought in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division. This dispute arose in connection with an Acquisition and Farmout Agreement entered into between Hallwood Energy and FEI Shale, L.P. (“FEI”), a subsidiary of Talisman Energy, Inc., in June 2008, The Company and Hallwood Energy entered into an Equity Support Agreement dated June 9, 2008 under which the Company agreed, under certain conditions, to contribute to Hallwood Energy up to $12,500,000, in consideration for which the Company would receive equity or debt securities of Hallwood Energy. As of February 25, 2009, the Company had contributed $9,300,000 to Hallwood Energy pursuant to the Equity Support Agreement. On that date, Hallwood Energy demanded that the Company fund the $3,200,000, which the Company did not do.

Following the commencement of litigation, HPI and FEI intervened in the lawsuit and filed their respective complaints in intervention. In their complaints, they alleged that the Company’s failure to fund $3,200,000 under the Equity Support Agreement damaged Hallwood Energy in an amount in excess of $3,200,000. FEI claimed that, in addition to not paying the $3,200,000, the Company defrauded FEI and tortiously interfered with its rights under the Acquisition and Farmout Agreement, and it sought approximately $38,000,000 in additional damages. In their second amended complaint, HPI and the trustee for the creditors’ trust contended that the additional damages were at least $20,000,000 based on the alleged failure of the Company to fund the $3,200,000, which allegedly caused FEI to not fund $20,000,000 due under the Farmout Agreement between Hallwood Energy and FEI. HPI and the trustee also asserted that the Company was liable for exemplary damages of $100,000,000 on account of its failure to fund the last $3,200,000 under the Equity Support Agreement. In the second amended complaint, HPI and the trustee had named as additional defendants Hallwood Family (BVI) L.P., Hallwood Investments Limited, Hallwood Company Limited, the Hallwood Trust, Hallwood Financial Limited and Brookwood Companies Incorporated contending that the additional defendants are liable to the plaintiffs under allegations requesting the remedy of substantive consolidation. On May 5, 2010, the Court dismissed with prejudice the substantive consolidation claim and abuse of the bankruptcy process against all parties, resulting in the Company remaining as the sole Defendant. In light of the Court’s disposition of the theories advanced in the second amended complaint, the adversary proceeding was now styled as Ray Balestri, Trustee of the Hallwood Energy I Creditors’ Trust, as successor in interest to Hallwood Energy, L.P., Plaintiffs and FEI Shale L.P. and Hall Phoenix/Inwood Ltd., Plaintiffs in Intervention vs. The Hallwood Group Incorporated, Defendant; Adversary No. 09-03082-SGJ (the “Adversary Proceeding”). The trial took place over a 13 day period from October 2010 to December 2010 and was followed with the Bankruptcy Court’s proposed findings in July 2011.

On July 25, 2011, the Bankruptcy Court issued the Proposed Findings of Fact, Conclusions of Law and Judgment Awarding Various Monetary Damages (the “Proposed Findings”). The court proposed that the United States District Court award damages of $3,200,000 for the Company’s alleged breach of the Equity Support Agreement, to be allocated among the three plaintiffs and damages of $15,485,714 to FEI, for the Company’s alleged tortious interference with the Farmout Agreement, and, in the alternative, for the Company’s alleged fraud in failing to disclose to FEI that the Company allegedly did not intend to fund the remaining obligation under the Equity Support Agreement, plus prejudgment and postjudgment interest and attorneys’ fees as may be requested and awarded pursuant to subsequent motions and hearings. With respect to the issue of fraud by nondisclosure, the Bankruptcy Court proposed a finding that the Company (i) failed to disclose a belief that the Equity Support Agreement could legally be treated as terminated, (ii) failed to disclose its alleged intention not to fund the final $3,200,000 under the Equity Support Agreement and (iii) orchestrated an alleged misimpression that Hallwood Energy was not contemplating bankruptcy while planning Hallwood Energy’s bankruptcy and how to use FEI’s funding in a Hallwood Energy bankruptcy against FEI’s wishes. The court also proposed that the District Court reject HPI and the trustee’s claim that the Company’s failure to fund the $3,200,000 caused FEI to not fund $20,000,000 under the Farmout Agreement, that the District Court reject HPI and the trustee’s claim that the Company tortiously interfered with certain contractual rights, and that the District Court reject HPI and the trustee’s claim for exemplary or punitive damages.

As a result of Proposed Findings, taking into consideration the Company’s objections to the Proposed Findings, the Company recorded a litigation reserve charge for $7,500,000 at June 30, 2011. As no new information had become available regarding the outcome of the litigation, the Company did not believe the reserve related to the Adversary Proceeding should be changed at December 31, 2011. This accrued reserve of $7,500,000 was reported in the Company’s balance sheet under “Hallwood Energy matters — Litigation reserve” for those periods, in addition to the $3,201,000 that was previously recorded in connection with the Equity Support Agreement, for a total reserve of $10,701,000 at December 31, 2011 for the Adversary Proceeding. This reserve amount was established in consultation with the Company’s litigation counsel in the Hallwood Energy litigation, based on their best judgment of the probabilities of success related to, among other factors, the objections to be filed by the Company on its possible appeal of the District Court’s Judgment.

On April 24, 2012, the United States District Court entered a final judgment (the “Judgment”) substantially adopting the Proposed Findings. Based upon the monetary damages (including prejudgment and postjudgment interest, legal fees and court costs) awarded in the Judgment, the Company, in consultation with the Company’s litigation counsel, recorded an additional charge of $13,200,000 at March 31, 2012 in its statement of operations and balance sheet as an accrual under Hallwood Energy matters – Litigation Reserve. Accordingly, the total reserve at March 31, 2012 for the Adversary Proceeding was $23,901,000. The Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. In addition, the Company will be required to pay certain attorneys’ fees incurred by the plaintiffs. The amount and timing of the payment of these fees will be subsequently determined by the District Court, and are currently unresolved.

Other Litigation Claims. On August 3, 2009, the Company was served with a complaint in Hall Phoenix/Inwood Ltd. and Hall Performance Energy Partners 4, Ltd. v. The Hallwood Group Incorporated, et al. filed in the 298 ^th District of Texas, No. 09-09551. The other defendants included Anthony J. Gumbiner, the Chairman and Chief Executive Officer of the Company, Bill Guzzetti, the President of the Company, certain affiliates of Mr. Gumbiner and certain officers of Hallwood Energy. The complaint alleged that the defendants defrauded plaintiffs in connection with plaintiffs acquiring interests in and providing loans to Hallwood Energy and sought unspecified actual and exemplary damages. On September 15, 2010, Ray Balestri, Trustee of the Hallwood Energy I Creditors Trust, intervened in this proceeding and added certain of the Company’s officers, directors, and an employee as defendants. The complaint alleged, among other things, claims against the defendants for breach of fiduciary duties, gross negligence and willful misconduct and sought indeterminable actual and exemplary damages. On November 5, 2010, this case was removed to the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03358. As discussed below, in February 2012, this claim was settled.

On July 30, 2010, Hallwood Energy’s trustee filed a complaint captioned Ray Balestri, Trustee of the Hallwood Energy I Creditor’s Trust v. Anthony J. Gumbiner, et al in the Dallas County Court at Law No. 4, No. CC-10-05212D. The other defendants include certain current and former directors, officers and employees of the Company, certain of Hallwood Energy’s former officers and directors, as well as outside legal counsel. The complaint alleged, among other things, claims against the defendants for breach of fiduciary duties, gross negligence and willful misconduct and sought unspecified actual and exemplary damages. This case was removed to the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03263. As discussed below, in February 2012, this claim was settled with respect to all parties except outside legal counsel.

Settlement in February 2012 of Litigation Claims other than Adversary Proceeding. Effective February 14, 2012, the Company and certain other parties entered into a Confidential Settlement Agreement and Mutual Release of Claims (the “Settlement Agreement”). The Settlement Agreement settles the claims by HPI, the Trustee of the Hallwood Energy I Creditors’ Trust, and their related parties (the “Plaintiffs”) against the Company and its related parties other than the Adversary Proceeding in which the Bankruptcy Court issued the Proposed Findings.

The terms of the Settlement Agreement include the payment by the Company of $1,800,000, in addition to payments by other defendants and the Company’s insurance carrier for its directors and officers liability insurance policy. Under the Settlement Agreement, the Plaintiffs released the Company, its current and former directors and officers, the former directors and officers of the general partner of Hallwood Energy, L.P. and various entities related to the foregoing persons from all claims asserted in or relating to (i) Hall Phoenix/Inwood Ltd. and Hall Performance Energy Partners 4, Ltd. v. The Hallwood Group Incorporated et al. in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03358; (ii) Ray Balestri, Trustee of the Hallwood Energy I Creditor’s Trust v. Anthony J. Gumbiner, et al. in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division, Adversary No. 10-03263; and (iii) another suit in which the Company is not named as a party, and any other claims based on the facts alleged in the foregoing matters or that could have been alleged in the foregoing matters, other than the claims against the Company asserted in the Adversary Proceeding or any claims required to enforce any final judgment entered against the Company in the Adversary Proceeding. Similarly, the defendants released the Plaintiffs from all claims based on the facts alleged in the foregoing matters or that could have been alleged in the foregoing matters, other than any claims or defenses the defendants may have in the Adversary Proceeding.

The parties entered into the Settlement Agreement for a number of reasons, including to save time and expense, to ensure available insurance proceeds could be used toward the settlement of the disputed claims rather than the payment of expenses and legal fees, and otherwise to resolve the litigation claims. The defendants continue to believe that the claims asserted against them in the lawsuits had no merit and their agreement to settle and compromise those claims should not be deemed as an admission of any liability, wrongdoing, or fault.

At December 31, 2011, the Company recorded a reserve of $1,800,000 in its statement of operations and balance sheet under Hallwood Energy matters – Litigation Reserve for the full value of the Company’s payments required by the Settlement Agreement. The Company paid the settlement amount of $1,800,000 to the Plaintiffs on February 15, 2012.

Claim Filed by Company with Insurance Carrier for Directors’ and Officers’ Liability Insurance Policy. Prior to entering into the Settlement Agreement, the Company incurred significant legal fees and associated costs in connection with these legal matters. The Company filed claims with the insurance carrier for the directors’ and officers’ liability insurance policies maintained by the Company for reimbursement of those legal fees and costs. The aggregate limit for each policy year under the Company’s policies has been $10,000,000. The insurance carrier has taken the position that all of the claims asserted in the Hallwood Energy litigation relate to the 2008 – 2009 policy year.

The Company received reimbursement of legal fees and associated costs of approximately $257,000 and $1,373,000 in the years ended December 31, 2011 and 2010, respectively, which were recorded as expense recoveries in administrative and selling expenses. Additionally, the insurance carrier paid legal fees and associated costs on behalf of other defendants in connection with the Hallwood Energy litigation matters other than the Adversary Proceeding. Significant additional costs in excess of insurance reimbursements have been incurred by the Company and on behalf of the other defendants.

In connection with the Settlement Agreement, the insurance carrier agreed to make a payment to the Plaintiffs and received a release and full discharge from any further payments for the Hallwood Energy litigation. Accordingly, the Company did not have insurance coverage available to satisfy the Judgment that was rendered in connection with the Adversary Proceeding. The insurance carrier is not reimbursing the Company for the legal fees and costs associated with the Adversary Proceeding.

Environmental Contingencies. A number of jurisdictions in which the Company or its subsidiaries operate 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 or its subsidiaries’ business to date, it is possible that such considerations may have a significant and adverse impact in the future. The Company and its subsidiaries actively monitor their environmental compliance and while certain matters currently exist, management is not aware of any compliance issues which will significantly impact the financial position, results of operations or cash flows of the Company or its subsidiaries.

The Company’s Brookwood subsidiary is subject to a number of environmental laws, regulations, licenses and permits and has ongoing discussions with environmental regulatory authorities, including the U.S. Environmental Protection Agency (the “EPA”), the Rhode Island Department of Health (“RIDOH”), the Rhode Island Department of Environmental Management (“RIDEM”) and the Connecticut Department of Energy and Environmental Protection (“CTDEEP”) on a number of matters, including compliance with safe drinking water rules and wastewater discharge and treatment regulations, the control of chemicals used in the companies’ coating operations that are classified as air pollutants, the presence of groundwater and soil contaminants at the companies’ facilities, the removal of underground storage tanks, and hazardous waste management

From time to time Brookwood and its subsidiaries have paid fines or penalties for alleged failure to comply with certain environmental requirements, which did not exceed $100,000 in the aggregate during the three years ended December 31, 2011 and the three months ended March 31, 2012. In addition, Brookwood and its subsidiaries have entered into various settlements and agreements with the regulatory authorities requiring the companies to perform certain tests, undertake certain studies, and install remedial facilities. Brookwood and its subsidiaries incurred capital expenditures to comply with environmental regulations of approximately $136,000 in the year ended December 31, 2011 and $37,000 during the three months ended March 31, 2012. In addition, Brookwood and its subsidiaries regularly incur expenses associated with various studies and tests to monitor and maintain compliance with diverse environmental requirements.

Other Contingencies. In May 2009, one of Brookwood’s suppliers advised Brookwood that shipments to Brookwood during the period from September 2008 to April 2009 of a quantity of greige fabric from the supplier incorporated some fiber that was not of domestic origin in some yarn from the vendor. The fabric in question was ordered to fill contracts in support of the United States military, was required to be domestic and is subject to the preference for domestic source required flow down provisions of the Department of Defense Supplement to the Federal Acquisition Regulations implementing the provisions of 10 USC 2533a. Brookwood’s suppliers had advised that the greige fabric containing the non-compliant yarn was supplied inadvertently to Brookwood in limited quantity. Brookwood determined that this yarn affected two of their greige products. Brookwood advised its affected customers and the United States military of this circumstance. Brookwood resolved the issue with respect to one of the products and received payment at full value in 2009. Additionally, resolution on the second product with one of the procurement entities was achieved in July 2010 and Brookwood received payment at full value of $3,242,000 in October 2010. Resolution with the final procurement entity was reached in the 2011 fourth quarter, and Brookwood received payment at full value of $1,643,000 in January 2012.