Edgar Filing: HALLWOOD GROUP INC

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

Mark One
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

FOR THE TRANSITION PERIOD FROM TO

FOR THE YEAR ENDED DECEMBER 31, 2001 COMMISSION FILE NUMBER: 1-8303

THE HALLWOOD GROUP INCORPORATED
(Exact name of registrant as specified in its charter)

DELAWARE 51-0261339
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3710 RAWLINS, SUITE 1500, DALLAS, TEXAS 75219
(Address of principal executive offices) (Zip Code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(214) 528-5588

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

TITLE OF CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock ($.10 par value) American Stock Exchange
10% Collateralized Subordinated Debentures New York Stock Exchange
Due July 31, 2005

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

TITLE OF CLASS
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Series B Redeemable Preferred Stock

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in, definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

The aggregate market value of the Common Stock, $.10 par value per share,
held by non-affiliates of the registrant, based on the closing price of $6.00
per share on March 22, 2002 on the American Stock Exchange, was $3,803,000.

1,361,343 shares of Common Stock, $.10 par value per share, were outstanding
at March 22, 2002.

DOCUMENTS INCORPORATED BY REFERENCE

The information called for by Part III is incorporated by reference to the
definitive Proxy Statement for the Annual Meeting of Stockholders of the Company
to be filed with the Securities and Exchange Commission not later than 120 days
after December 31, 2001.
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FORM 10-K

TABLE OF CONTENTS

PAGE
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PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 8
Item 3. Legal Proceedings........................................... 9
Item 4. Submission of Matters to a Vote of Security Holders......... 9

PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 10
Item 6. Selected Financial Data..................................... 10
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 12
Item 7(A). Quantitative and Qualitative Disclosures About Market
Risk........................................................ 22
Item 8. Financial Statements and Supplementary Data................. 23
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 23

PART III
Item 10. Directors and Executive Officers of the Registrant.......... 23
Item 11. Executive Compensation...................................... 24
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 24
Item 13. Certain Relationships and Related Transactions.............. 24

PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 24

PART I

ITEM 1. BUSINESS

The Hallwood Group Incorporated ("Hallwood" or the "Company") (AMEX:HWG), a
Delaware corporation, is a holding company that classifies its continuing
operations into two business segments: real estate and textile products.
Financial information for each industry segment is set forth in Note 19 to the
consolidated financial statements. In March 2001, the Company announced the sale
of its energy business which closed in the second quarter of the year;
therefore, this former segment has been reported as a discontinued operation for
all years presented herein. In December 2000, the Company decided to dispose of
its hotel properties; therefore, apart from the one leasehold property it
retained and continues to operate, this former segment has also been
reclassified as a discontinued operation in the statement of operations and
hotels held for sale on the balance sheet. Operations of the remaining leased
hotel property are reported as other continuing operations in the statement of
operations and hotel held for use on the balance sheet.

Real Estate. Real estate operations are conducted primarily through the
Company's wholly owned subsidiaries, HWG, LLC, Hallwood Realty, LLC ("Hallwood
Realty") and Hallwood Commercial Real Estate, LLC ("HCRE"). Hallwood Realty is
the sole general partner of Hallwood Realty Partners, L.P. ("HRP"), a
publicly-traded, master limited partnership (AMEX:HRY). At December 31, 2001,
HRP owned fourteen real estate properties in six states containing 5,073,000 net
rentable square feet. The HRP Form 10-K for the year ended December 31, 2001 is
included elsewhere within this document.

Hallwood Realty owns a 1% general partner interest and HWG, LLC owns a 21%
limited partner interest in HRP. Hallwood Realty is responsible for asset
management of HRP and its properties, including the decisions regarding
financing, refinancing, acquiring and disposing of properties. It also provides
general operating and administrative services to HRP. HCRE is responsible for
on-site property management for all HRP properties, and properties it manages
for third parties, for which it receives management, leasing and construction
supervision fees. Hallwood Realty and HWG, LLC account for its ownership in HRP
using the equity method of accounting, recording its pro rata share of net
income (loss) and partners' capital transactions reported by HRP.

Real estate accounted for 10% of the Company's total revenues from
continuing operations in 2001, compared to 8% in 2000 and 10% in 1999.

Textile Products. Textile products operations are conducted through the
Company's wholly owned Brookwood Companies Incorporated ("Brookwood")
subsidiary. Brookwood is a complete textile service firm that develops and
produces innovative fabrics and related products through specialized finishing,
treating and coating processes.

Brookwood principally operates as a converter in the textile industry,
purchasing fabric from mills that is dyed and finished at its own plant, located
in Kenyon, Rhode Island, or by contracting with independent finishers. Upon
completion of the finishing process, the fabric is sold to customers. Brookwood
is one of the largest coaters of woven nylons in the United States and the only
converter that services multifaceted market segments including consumer,
industrial, medical and military products. Brookwood is known for its extensive,
in-house expertise in high-tech and high-fashion fabric development, and is a
major supplier of specialty fabric to the U.S. military.

The Brookwood Roll Goods Division serves manufacturers by maintaining an
extensive in-stock, short-lot service on woven nylon and polyester fabrics and
is able to provide shipment on a same day/next day basis. The First Performance
Fabric Division buys and sells short lots, remnants and mill seconds for a vast
assortment of coated and uncoated nylon products at discount prices.

Textile products accounted for 86% of the Company's total revenues from
continuing operations in 2001, compared to 90% in 2000 and 87% in 1999.

Other. Other revenues include hotel revenues, amortization of deferred
revenue, interest and other income and fee income from related party. In
December 2001, the Company determined that it would retain

its leasehold interest in the 112-room GuestHouse Suites Plus hotel in
Huntsville, Alabama and continues to operate the hotel. Results have been
reclassified to the other segment, and accounted for 2% of the Company's total
revenues from continuing operations for each of the three years presented
herein. Hotel assets have also been reclassified in the consolidated balance
sheet as held for use. Amortization of deferred revenue relates to the
noncompetition agreement entered into in June 2001, in connection with the
Company's sale of its energy investment. Interest and other income includes
interest earned on short-term investments and miscellaneous income. Fee income
from related party related to a consulting contract with a former energy
affiliate that was canceled in June 1999.

Other expenses include administrative, interest, hotel and cost from
separation agreement. Administrative expenses include consulting fees paid to
HSC Financial Corporation, as entity associated with the Company's chairman,
Anthony J. Gumbiner, and general costs of operating a public company. Interest
expense relates principally to the 10% Debentures, loans from principal
stockholder and the Company's obligation in connection with the separation
agreement among the Company, a former officer and director and a related trust.
Hotel expenses relate only to the leased property the Company retained and
continues to operate. The cost from separation agreement represents an increase
in the deferred purchase price for anticipated payments to the aforementioned
trust.

Discontinued Operations -- Energy. In March 2001, Hallwood Energy
Corporation ("Hallwood Energy") announced that it had signed a definitive merger
agreement pursuant to which Pure Resources II, Inc., an indirect wholly owned
subsidiary of Pure Resources, Inc., agreed to acquire all the outstanding common
stock of Hallwood Energy at a price of $12.50 per share and all the outstanding
shares of Series A Cumulative Preferred Stock of Hallwood Energy at a price of
$10.84 per share. The all-cash transaction was structured as a first step tender
offer followed by a cash merger to acquire all remaining shares of Hallwood
Energy. The Company also agreed to tender all of its shares of common stock in
the tender offer and granted to Pure an irrevocable proxy to vote in favor of
the merger, on the same terms as provided in the merger agreement. Pure
commenced its tender offer in April 2001, with an expiration date of May 8,
2001. On May 9, 2001, Pure announced that it had successfully completed its
tender offer, and had acquired approximately 85% of the Hallwood Energy common
stock and 78% of the Hallwood Energy preferred stock. The Company received
$18,000,000 for the tender of its 1,440,000 shares of common stock in May 2001
and received an additional $7,250,000, pursuant to the terms of a noncompetition
agreement that was paid by Pure upon the completion of the merger in June 2001.

Under the noncompetition agreement, the Company agreed to refrain from
taking certain actions (described below) without the prior written consent of
Pure and Hallwood Energy. These covenants were made by the Company in
consideration of the transactions contemplated by the merger agreement and the
payment by Pure to the Company. For a period of three years after the effective
date of the merger agreement, the Company will not, directly or indirectly,
engage in oil and gas activities in certain geographic areas without the prior
consent of Pure. Hallwood Energy was engaged in the development, exploration,
acquisition and production of oil and gas properties. Hallwood Energy owned
interests in properties primarily located in the San Juan Basin in New Mexico
and Colorado, South Texas, the Permian Basin in West Texas and onshore South
Louisiana. The Company has also agreed to keep Hallwood Energy's confidential
and proprietary information strictly confidential.

As a result of certain transactions completed in June 1999, the investment
in Hallwood Energy was accounted for under the equity method, as the Company
exercised significant influence over Hallwood Energy's operational and financial
policies. In accordance with the equity method of accounting, the Company
recorded its pro-rata share of Hallwood Energy's net income available to common
stockholders, its share of preferred dividends and any stockholders' equity
transactions.

Discontinued Operations -- Hotels. Hotel operations were conducted through
the Company's wholly owned, Hallwood Hotels, Inc. ("Hallwood Hotels") and Brock
Suite Hotels, Inc. ("Brock Hotels") subsidiaries. Hallwood Hotels held a
long-term leasehold interest in the Holiday Inn and Suites hotel, located in
Longboat Key, Florida and a fee interest in the Airport Embassy Suites hotel,
located in Oklahoma City, Oklahoma. Brock Hotels owned fee interests in two
GuestHouse Suites Plus properties located in Tulsa,

Oklahoma and Greenville, South Carolina, and holds a long-term leasehold
interest in a GuestHouse Suites Plus property located in Huntsville, Alabama.

In December 2000, the Company decided to dispose of its hotel segment,
principally by allowing its non-recourse debt holders to assume ownership of the
properties through foreclosures, or by selling or otherwise disposing of its
hotel properties. As part of the planned disposition, in December 2000, the
Company evaluated the operations and economic environment in which each of the
hotels operated and determined it was appropriate to record impairments of
$4,000,000 to reduce their carrying values to estimated fair market values.

In January 2001, a receiver was appointed to administer the disposition of
the GuestHouse Suites Plus hotel in Greenville, South Carolina. In February
2001, the Company signed an Agreement to Terminate Lease with the landlord of
the Holiday Inn and Suites hotel in Sarasota, Florida; however, the landlord has
since initiated a claim for approximately $750,000 under a parent company
guaranty which is presently in discovery. In March 2001, receivers were
appointed to administer the disposition of the GuestHouse Suites Plus hotel in
Tulsa, Oklahoma and the Airport Embassy Suites hotel in Oklahoma City, Oklahoma.
In June 2001, the Company entered into a settlement agreement with the mezzanine
lender whereby the Company transferred its capital stock ownership of Hallwood
Hotels -- OKC, Inc., the entity that owned the Embassy Suites hotel to the
mezzanine lender and obtained a release from its obligations under the first
mortgage and the mezzanine loan. The Company reported the transaction as a gain
from extinguishment of debt in the amount of $216,000, net of deferred tax
expense. However, the franchiser subsequently asserted a contract claim for
approximately $800,000 in liquidated damages which is presently in mediation. As
of December 31, 2001, the Company operated three remaining hotel properties and
recorded additional impairments of $935,000. The Company determined it would
retain its leasehold interest in the GuestHouse Suites Plus hotel located in
Huntsville, Alabama, the results of which have been reported in continuing
operations.

In January 2002, with assistance and consent of the mortgage lender, the
Company sold the GuestHouse Suites Plus hotel in Tulsa, Oklahoma. The Company
received no cash proceeds from the sale; however, concurrent with the sale, it
entered into a loan modification and assumption agreement which, among other
terms, included a release that discharged the Company from any further loan
obligations. It is anticipated that the Company will recognize a gain from
extinguishment of debt of approximately $1,600,000, net of deferred tax expense.
In February 2002, the lender for the GuestHouse Suites Plus hotel in Greenville,
South Carolina obtained a judgement of foreclosure of its non-recourse mortgage,
allowing for a sale of the property scheduled for May 2002, and waiving its
right to a deficiency judgement against the Company. It is anticipated that upon
completion of the foreclosure, the Company will recognize a gain from
extinguishment of debt of approximately $1,900,000, net of deferred tax expense.

RISKS, COMPETITION AND OTHER FACTORS

If the Company cannot generate sufficient cash flows from operations, it
may need additional capital. If the Company cannot generate enough cash flow
from operations to finance its business in the future, it will need to raise
additional capital through public or private financing or asset sales. If the
Company borrows money, it may be required to agree to restrictions limiting its
operating flexibility. If the Company requires additional capital but is not
able to obtain such capital, it would have a material adverse effect on its
operations.

Risk of Rising Interest Rates. A portion of the Company's indebtedness
bears interest at variable rates. In addition, the Company may incur
indebtedness in the future that also bears interest at a variable rate or may be
required to refinance its debt at higher rates. Increases in rates could
increase the Company's interest expense, which could adversely affect cash flow
from future operations.

Influence of Significant Stockholder. The Company's chairman, Anthony J.
Gumbiner, is also a significant stockholder. A trust with which Mr. Gumbiner is
associated owns 53% of the Company's outstanding common stock (56% including
stock options held by Mr. Gumbiner) as of December 31, 2001. Accordingly, Mr.
Gumbiner can exert substantial influence over the affairs of the Company.

Restrictions on Stock Transfers and Ownership Limits. The Company's Second
Restated Certificate of Incorporation contains a provision that restricts
transfers of the Company's common stock in order to protect certain federal
income tax benefits. The restriction prohibits any transfer of common stock to
any person that results in ownership in excess of 4.75% of the then outstanding
shares. The restrictions can be waived only with the approval of the Company's
board of directors.

Risk of Loan Covenant Violations or 10% Debenture Restrictions. The
Company's new Term Loan and Revolving Credit Facility acquired in March 2002,
and 10% Debentures require compliance with various loan covenants and financial
ratios, which, if not met, will trigger a default. The Term Loan and Revolving
Credit Facility requires a minimum debt service coverage ratio for each rolling
four quarter period, as defined, of 1.20 to 1.00, a senior leverage ratio, as
defined, of no greater than 2.50 to 1.00 and a minimum collateral value coverage
of 200% of the outstanding loan balance. The Company will be subject to such
requirements beginning with the quarter ending June 30, 2002. Additionally,
Brookwood's credit agreement requires compliance with various loan covenants and
financial ratios, principally a minimum debt service coverage ratio of 1.25 to
1.00 and a debt to equity ratio of 45%. The Indenture for the 10% Debentures
contains various covenants, which if violated, may result in a call of the
entire issue, principally the risk associated with a subsidiary commencing
receivership, bankruptcy or insolvency proceedings.

Risk of Litigation. The Company is currently a party to various litigation
matters, as described more fully in Item 3 -- Legal Proceedings. An unfavorable
decision on the matters could have an adverse effect on the Company. In
particular, the Company is a defendant in certain litigation in Delaware state
court. The trial court in that matter ruled that the Company pay a judgment in
the amount of $3,417,000 to HRP, plus pre-judgment interest of approximately
$2,891,000 to HRP. In October 2001, the Company paid $6,405,000, including
post-judgment interest of $97,000, subject to an arrangement that it be returned
in full or part if the judgment is modified or reversed on appeal. The plaintiff
and certain defendants have appealed the ruling. If the appellate court reverses
the judgment, any subsequent ruling by the trial court on remand may be more or
less favorable to the Company.

Real Estate. The Company's real estate operations, including its
investment in HRP, are subject to risk factors associated with the real estate
industry, including the following:

Concentration Risks. The Company's real estate subsidiaries receive a
substantial portion of their revenues from management, leasing and other
services provided to HRP. Any adverse effect on HRP's operations could effect
the Company through reduced fee income. Further, the early cancellation or non-
renewal of the management contracts between HRP and the Company's real estate
subsidiaries, which expire in June 2004, would have a material adverse effect on
the Company.

Deterioration in Economic Conditions and the Real Estate Markets Could
Impair HRP's Business. The commercial real estate industry depends on a number
of factors relating to general global, national, regional and local economic
conditions, including inflation, interest rates, taxation policies, availability
of credit, employment levels, and wage and salary levels. A negative trend in
any of these conditions could adversely affect HRP's business. If a substantial
number of tenants default on their leases, choose not to renew, or if rental
rates decrease, HRP's financial position could be adversely affected. Such
effects could include a decline in acquisition, disposition and leasing
activity; a decline in the supply of capital invested in commercial real estate;
or a decline in the value of real estate. HRP's cash flow would be adversely
affected by decreases in the performance of the properties it owns. Property
performance typically depends upon the ability to attract and retain
creditworthy tenants; the ability to manage operating expenses; the magnitude of
defaults by tenants under their respective leases; governmental regulations; the
nature and extent of competitive properties; financial and economic conditions
generally and in the specific areas where properties are located; and the real
estate market generally. Expenses may increase due to unexpected or higher
repairs and maintenance costs, inflation, services and costs required to retain
tenants or to sign new tenants, unsuccessfully appeals of rising real estate
taxes, changes in interest rates, higher insurance costs, the outcome of
existing or future litigation, as well as other factors, many of which are
beyond the control of HRP.

Interest Rate Risks. Because only one of its mortgage loans has a floating
interest rate, HRP's exposure to changes in market interest rates is limited to
the difference between the market rate in effect at the time a

loan matures compared to its existing loan rate. As of December 31, 2001, HRP
had mortgage loans totaling $176,224,000 with fixed interest rates from 6.97% to
8.7% (with an effective average interest rate of 8.21%). These loans mature
between 2005 and 2020. At the time of loan maturity, a higher market interest
rate compared to the existing rate will have a negative impact on the amount of
mortgage proceeds secured from a refinancing, as well as a decrease in cash flow
from future operations due to the higher interest rate.

Insurance Risks. Due in large part to the terrorist activities of
September 11, 2001, insurance companies are re-examining many aspects of their
business, and may consider taking certain actions in the wake of these terrorist
activities. Among such actions which insurance companies may take are increasing
premiums, mandating higher self-insured retention and deductibles, reducing
limits, restricting coverages, imposing exclusions (such as sabotage and
terrorism), and refusing to underwrite certain risks and classes of business.
Significantly increased premiums, mandated exclusions, or changes in limits,
coverages, terms and conditions could adversely affect HRP's ability to obtain
appropriate insurance coverages at reasonable costs.

Environmental Risks. Various national, state and local laws and
regulations impose liability on real property owners, such as HRP, for the cost
of investigating, cleaning up or removing contamination caused by hazardous or
toxic substances. The liability may be imposed even if the original actions were
legal and HRP did not know of, or was not responsible for, the presence of such
hazardous or toxic substances. HRP may also be solely responsible for the entire
payment of the liability if it is subject to joint and several liability with
other responsible parties who are unable to pay. Certain HRP properties are
known to contain asbestos. Removal of asbestos is not required, because, in all
cases, it is cementitious, it is not friable and the procedures in HRP's site
environmental program Operations and Maintenance Manual are performed as
required. HRP may be subject to additional liability if it fails to disclose
environmental issues to a buyer or lessee of property or if a third party is
damaged or injured as a result of environmental contamination emanating from the
site. HRP cannot be sure that any of such liabilities to which it may become
subject will not have a material adverse effect upon its business, results of
operations or financial condition.

Competition. HRP's properties are subject to substantial competition from
similar properties in the vicinity in which they are located. In addition, there
are numerous other potential investors seeking to purchase improved real
property and many property holders seeking to dispose of real estate with which
HRP will compete, including companies substantially larger than HRP and with
substantially greater resources.

Other. HRP's business is subject to other factors: (i) HRP normally would
sell properties during relatively strong real estate markets, factors beyond its
control could make it necessary for HRP to dispose of properties during weak
markets; (ii) HRP has financed its operations with cash flow from profitably
operating established properties which would be diminished in a weak rental
market, (iii) HRP were required to raise additional funds, it may be required to
agree to restrictions limiting its operating flexibility, (iv) HRP has certain
loans that require compliance with loan covenants and restrictions, which effect
is flexibility, and (iv) HRP is currently a party to certain litigation, the
outcome of which is uncertain.

Textile Products. Brookwood is subject to additional risk factors
including the following:

Supplier Risks. Brookwood purchases a significant amount of the fabric it
uses from a small number of suppliers. Brookwood believes that the loss of any
one or historically more of its suppliers would not have a long-term material
adverse effect on Brookwood, because other manufacturers with whom Brookwood
conducts business would be able to fulfill Brookwood's requirements. However,
the loss of certain of Brookwood's suppliers could, in the short term, adversely
affect Brookwood's business until alternative supply arrangements were secured.
In addition, there can be no assurance that any new supply arrangements would
have terms as favorable as those contained in current supply arrangements.
Brookwood has not experienced any significant disruptions in supply as a result
of shortages in the supply fabrics.

Environmental Risks. Brookwood is subject to a broad range of federal,
foreign, state and local laws and regulations relating to the pollution and
protection of the environment. Among the many environmental requirements
applicable to Brookwood are laws relating to air emissions, wastewater
discharges and the handling, disposal and release of solid and hazardous
substances and wastes. Based on continuing internal review and advice from
independent consultants, Brookwood believes that it is currently in substantial

compliance with applicable environmental requirements. Brookwood is also subject
to laws, such as CERCLA, that may impose liability retroactively and without
fault for releases or threatened releases of hazardous substances at on-site or
off-site locations. Brookwood is not aware of any releases for which it may be
liable under CERCLA or any analogous provision. Actions by federal, state and
local governments in the United States and abroad concerning environmental
matters could result in laws or regulations that could increase the cost of
producing the products manufactured by Brookwood or otherwise adversely affect
demand for its products. Widespread adoption of any prohibitions or restrictions
could adversely affect demand for Brookwood's products and thereby have a
material adverse effect upon Brookwood.

Brookwood does not currently anticipate any material adverse effect on its
operations, financial condition or competitive position as a result of its
efforts to comply with environmental requirements. Some risk of environmental
liability is inherent, however, in the nature of Brookwood's business, and there
can be no assurance that material environmental liabilities will not arise. It
is also possible that future developments in environmental regulation could lead
to material environmental compliance or cleanup costs.

Patent and Trademark Risks. Brookwood considers its patents and
trademarks, in the aggregate, to be important to its business and seeks to
protect this proprietary know-how in part through United States patent and
trademark registrations. Brookwood has a number of patent and trademark
applications pending, although no assurance can be given that patents or
trademarks will ever be issued from such applications or that any patents or
trademarks, if issued, will be determined to be valid. No assurance can be
given, however, that such protection will give Brookwood any material
competitive advantage. In addition, Brookwood maintains certain trade secrets
for which, in order to maintain the confidentiality of such trade secrets, has
not sought patent or trademark protection and therefore such patents and
trademarks could be infringed upon.

Risks Relating to Competition and Imports. Imports of foreign-made textile
and apparel products are a significant source of competition for most sectors of
the domestic textile industry. The U.S. government has attempted to regulate the
growth of certain textile and apparel imports through tariffs and bilateral
agreements, which establish quotas on imports from lesser-developed countries
that historically account for significant shares of U.S. imports. Despite these
efforts, imported apparel, which represents the area of heaviest import
penetration, represents in excess of 85% of the U.S. market.

The U.S. textile industry has been and continues to be negatively impacted
by existing worldwide trade practices. The establishment of the World Trade
Organization in 1995 has resulted in the phase out of quotas on textiles and
apparel through 2005. This phase out will gradually allow more low cost imports
to enter the U.S. and, apart from the September 11th terrorist attacks, was a
significant reason for the sales decline in 2001.

U.S. government policy on an overall basis has not been favorable to the
U.S. textile industry. Brookwood believes that the increasing flow of imports in
the United States is partly due to the U.S. government's strong dollar monetary
policy that allows foreign manufacturers to sell in the U.S. while a significant
portion of their production costs are denominated in devalued local currencies.
Further, Brookwood believes that as a result of the September 11, 2001 tragic
events, the U.S. government may grant trade concessions to textile producing
nations providing assistance in its war on terrorism. These trade concessions
would further harm the U.S. textile industry. There can be no assurance that the
impact of such trade agreements will not have a negative impact on Brookwood's
sales or that Brookwood will not lose customers to a foreign importer as a
result of such agreements.

Number of Employees. The Company had 546 and 764 employees as of February
28, 2002 and 2001, respectively, comprised as follows:

FEBRUARY 28,
-------------
2002 2001
----- -----

Continuing Operations
Hallwood.................................................. 5 5
Brookwood................................................. 401 409
HCRE...................................................... 75 73
Hotel..................................................... 28 28
Hallwood Realty........................................... 20 19
--- ---
Total................................................ 529 534
Discontinued Operations
Hotels.................................................... 17 230
--- ---
Total................................................ 546 764
=== ===

A substantial amount of the salaries and related costs for the employees of
HCRE and Hallwood Realty are reimbursed by HRP.

Brookwood's Kenyon Industries, Inc. subsidiary has entered into a
collective bargaining agreement with the Union of Needletrades, Industrial and
Textile Employees, representing approximately 236 employees at its Kenyon plant
facilities. The collective bargaining agreement expires on February 29, 2004.
Management believes that overall relations with employees are good.

ITEM 2. PROPERTIES

REAL PROPERTIES

The general character, location and nature of the significant real
properties owned by the Company and its subsidiaries and the encumbrances
against such properties are described below.

Cost of real estate owned by property type and geographic distribution (in
thousands of dollars):

DECEMBER 31, 2001
-------------------------------------------------
OPERATING NON-OPERATING
PROPERTY TYPE PROPERTIES PROPERTIES TOTAL PERCENTAGE
------------- ---------- ------------- ------- ----------

Textile Products
Dyeing and finishing plant -- Rhode
Island.............................. $ 4,815 $-- $ 4,815 41%
Hotels
GuestHouse Suites Plus -- South
Carolina(1)......................... 3,782 -- 3,782 32
GuestHouse Suites
Plus -- Oklahoma(1)................. 2,770 -- 2,770 23
GuestHouse Suites Plus -- Alabama(2)... 442 -- 442 4
------- --- ------- ----
Subtotal -- hotels............. 6,994 -- 6,994 59
Parking Lot -- Texas..................... -- 50 50 *
------- --- ------- ----
Total.......................... $11,809 $50 $11,859 100%
======= === ======= ====

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

* Less than 1%.

(1) Classified as held for sale on the consolidated balance sheet.

(2) Cost represents purchased leasehold interest and capital improvements and
classified as held for use on the consolidated balance sheet.

DECEMBER 31, 2001
----------------------------------
NUMBER OF
GEOGRAPHIC DISTRIBUTION INVESTMENTS AMOUNT PERCENTAGE
----------------------- ----------- ------- ----------

Textile Products
Rhode Island........................................ 1 $ 4,815 41%
Hotels
South Carolina...................................... 1 3,782 32
Oklahoma............................................ 1 2,770 23
Alabama............................................. 1 442 4
-- ------- ---
Subtotal.................................... 3 6,994 59
-- ------- ---
Parking Lot
Texas............................................... 1 50 *
-- ------- ---
Total....................................... 5 $11,859 100%
== ======= ===

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

* Less than 1%.

As of December 31, 2001 no real estate property constituted 10% or more of
consolidated assets.

The textile products' dyeing and finishing plant was custom-built and is a
multi-shift facility well-suited for that particular business. The development
of new products requires the plant to be constantly upgraded, along with various
levels of utilization. Brookwood's revolving credit agreement contains a
covenant to reasonably maintain property and equipment.

Hotel properties have been and will be operated until their disposition
under license and, as such, must meet and maintain standards established by the
licensor. At any time during the term of the license, the licensor may require
modernization, renovation and other upgrading of the hotel. During 1999,
renovations were completed to meet the new franchisor's standards for the
GuestHouse Suites Plus properties, and were funded by capital reserves, capital
lease facilities and working capital. The Company disposed of the GuestHouse
Suites Plus hotel in Tulsa, Oklahoma in January 2002, and anticipates the
disposition of the GuestHouse Suites Plus hotel in Greenville, South Carolina in
May 2002. The Company intends to continue operating the leased GuestHouse Suites
Plus hotel in Huntsville, Alabama. The Company does not plan to make any
additional significant investments in these properties.

ITEM 3. LEGAL PROCEEDINGS

The Company, certain of its affiliates and others have been named as
defendants in several lawsuits relating to various transactions in which it or
its affiliated entities participated. The Company and its affiliates intend to
defend, or in some cases negotiate to settle, the remaining actions and does not
currently anticipate that such actions will have a material adverse effect on
its financial condition, results of operations or cash flows of the Company. See
Note 18 to the Company's consolidated financial statements.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to vote of security holders during the period.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's shares of common stock, $.10 par value per share ("Common
Stock"), are traded on the American Stock Exchange under the symbol of HWG.
There were 797 stockholders of record as of March 22, 2002. Prior to June 22,
2000 the Common Stock had traded on the New York Stock Exchange.

The following table sets forth, for the periods indicated, a two-year
record of high and low closing prices on the American and New York Stock
Exchanges, as applicable.

YEARS ENDED DECEMBER 31,
------------------------------
2001 2000
------------- --------------
QUARTERS HIGH LOW HIGH LOW
-------- ----- ----- ------ -----

First................................................. $6.62 $4.00 $12.19 $8.63
Second................................................ 7.45 5.10 10.63 7.69
Third................................................. 7.40 4.85 8.00 5.00
Fourth................................................ 6.20 5.15 4.88 2.25

The Company did not pay cash dividends in 2001 or 2000 and, so long as the
Term Loan and Revolving Credit Facility remains outstanding, is restricted from
paying cash dividends on its Common Stock.

The closing price per share of the Common Stock on the American Stock
Exchange on March 22, 2002 was $6.00.

ITEM 6. SELECTED FINANCIAL DATA

YEARS ENDED DECEMBER 31,
-------------------------------------------------
2001 2000 1999 1998 1997
------- ------- -------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

REVENUES
Real estate................................ $ 8,394 $ 6,486 $ 9,503 $ 7,813 $ 7,206
Textile products........................... 69,579 73,852 80,704 80,343 91,552
Other...................................... 3,309 1,628 1,958 5,196 5,443
Associated company(a)...................... -- -- -- -- 19,416
------- ------- -------- ------- --------
81,282 81,966 92,165 93,352 123,617
EXPENSES
Real estate................................ 5,110 2,646 2,973 2,807 3,351
Textile products........................... 71,705 73,397 79,139 79,245 89,575
Other...................................... 6,592 7,768 7,541 7,675 8,977
Associated company(a)...................... -- -- -- -- 607
------- ------- -------- ------- --------
83,407 83,811 89,653 89,727 102,510
------- ------- -------- ------- --------
Income (loss) from continuing operations
before income taxes (benefit)............ (2,125) (1,845) 2,512 3,625 21,107
Income taxes (benefit)..................... 2,423 (1,210) (1,014) (3,069) 9,908
------- ------- -------- ------- --------
Income (loss) from continuing operations... (4,548) (635) 3,526 6,694 11,199

YEARS ENDED DECEMBER 31,
-------------------------------------------------
2001 2000 1999 1998 1997
------- ------- -------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

Income (loss) from discontinued operations
Income from discontinued operations --
energy(b)............................. 11,134 2,826 438 407 1,832
(Loss) from discontinued operations --
hotels(c)............................. (1,384) (6,973) (2,485) (1,515) (384)
------- ------- -------- ------- --------
9,750 (4,147) (2,047) (1,108) 1,448
------- ------- -------- ------- --------
Income (loss) before extraordinary gain
(loss) and cumulative effect of
accounting change........................ 5,202 (4,782) 1,479 5,586 12,647
Extraordinary gain (loss) from early
extinguishment of debt................... (917) (85) 240 1,481 200
(Loss) from cumulative effect of SFAS No.
133 adoption............................. (40) -- -- -- --
------- ------- -------- ------- --------
NET INCOME (LOSS).......................... $ 4,245 $(4,867) $ 1,719 $ 7,067 $ 12,847
======= ======= ======== ======= ========
INCOME (LOSS) PER COMMON SHARE FROM
CONTINUING OPERATIONS(d)
Basic.................................... $ (3.24) $ (0.48) $ 1.86 $ 3.53 $ 5.29
Assuming dilution........................ (3.24) (0.48) 1.83 3.41 5.09
NET INCOME (LOSS) PER COMMON SHARE
Basic.................................... $ 2.95 $ (3.45) $ 0.89 $ 3.73 $ 6.07
Assuming dilution........................ 2.95 (3.45) 0.88 3.60 5.84
DIVIDENDS PER COMMON SHARE................. -- -- -- -- --
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic.................................... 1,420 1,425 1,870 1,882 2,109
Assuming dilution........................ 1,420 1,425 1,899 1,947 2,190
FINANCIAL CONDITION
Total assets............................. $77,567 $95,923 $101,253 $96,586 $ 77,819
Loans payable............................ 30,750 61,628 61,463 42,521 26,319
Subordinated debentures.................. 6,677 6,725 6,768 21,535 24,292
Redeemable preferred stock............... 1,000 1,000 1,000 1,000 1,000
Common stockholders' equity.............. 15,883 11,814 17,058 20,938 14,171

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

(a) The Company sold its remaining investment in ShowBiz in 1997, which
constituted its associated company segment.

(b) In May 2001, the Company sold its investment in Hallwood Energy which has
been reclassified and reported as a discontinued operation for all periods
presented herein.

(c) The Company's hotel operations consisted of five hotel properties. In
December 2000, the Company decided to discontinue and dispose of its hotel
segment; however, the Company subsequently determined that it would retain
the leasehold interest in one of the hotels. Historical results of the four
hotels that have been or will be disposed of have been reclassified to
discontinued operations from continuing operations. The one leasehold
property that the Company retained has been reported as a continuing
operation.

(d) Per share amounts have been recast for the energy and hotel
reclassifications.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Results of Operations. The Company reported net income of $4,245,000 for
the year ended December 31, 2001, compared to a net loss of $4,867,000 for 2000,
and net income of $1,719,000 for 1999.

The Company reported a loss from continuing operations of $4,548,000 for
2001 and $635,000 for 2000 and income of $3,526,000 for 1999. Total revenue from
continuing operations was $81,282,000 for 2001, $81,966,000 for 2000 and
$92,165,000 for 1999.

Following is an analysis of the results of continuing operations for the
real estate and textile products business segments and the discontinued
operations for the energy and hotel business segments:

REAL ESTATE

Revenues. Real estate revenues of $8,394,000 for 2001, $6,486,000 for 2000
and $9,503,000 for 1999, include fee income and equity income (loss) from the
Company's investments in HRP.

Fee income of $6,558,000 for 2001 decreased by $90,000, or 1%, compared to
$6,648,000 in 2000. The 2000 fee income decreased by $2,443,000, or 27%,
compared to $9,091,000 in 1999. The decrease during 2000 was primarily due to a
substantial fee earned in 1999, in connection with the development and leasing
of a six-story, 151,000 square foot commercial office building owned by HRP. The
Company's Hallwood Realty subsidiary is the general partner of HRP and earns an
asset management fee and other fees from HRP properties, which amounted to
$609,000 for 2001, $655,000 for 2000 and $619,000 for 1999. The Company's HCRE
subsidiary is responsible for day-to-day on-site property management at all of
HRP's properties and other properties it manages for third parties, for which
HCRE receives management fees, leasing commissions and certain other fees, which
amounted to $5,949,000 for 2001, $5,993,000 for 2000 and $8,472,000 for 1999.

The equity income (loss) from investments in HRP represents the Company's
pro-rata share of the net income reported by HRP, adjusted for the elimination
of intercompany income and amortization of negative goodwill. The Company
recorded equity income of $1,836,000 in 2001, compared to a loss of $162,000 in
2000 and income of $412,000 in 1999. The 2001 increase resulted from gains from
property sales by HRP, improved operating performance and reduced administrative
costs. The 2001 equity income was exclusive of the Company's $117,000 pro-rata
share of HRP's $559,000 extraordinary loss from early extinguishment of debt and
its $40,000 pro-rata share of HRP's $192,000 loss from cumulative effect of
adopting SFAS No. 133, both of which are reported separately on the statement of
operations. The 2000 equity loss resulted from reduced income reported by HRP,
partially offset by reduced intercompany income adjustment related to leasing
and development fees from HRP, and was exclusive of the Company's $85,000
pro-rata share of HRP's $389,000 extraordinary loss from early extinguishment of
debt. The 1999 equity income resulted from higher income reported by HRP.

Expenses. Real estate expenses of $5,110,000 for 2001, $2,646,000 for 2000
and $2,973,000 for 1999, include litigation expense, administrative expenses and
depreciation and amortization.

Litigation expense of $2,360,000 was recorded in 2001. The Delaware Court
of Chancery rendered its opinion regarding certain litigation involving the
Company in July 2001. The court determined that the defendants should pay to HRP
a judgment of $3,417,000 plus pre-judgment interest of approximately $2,893,000.
The principal component of the judgment amount, which represented the court's
determination of an underpayment by the Company for certain limited partnership
units purchased by the Company in 1995 from HRP, was considered additional
purchase price and added to the Company's investment in the limited partnership
units. The interest component of the judgment amount has been recorded as an
expense, after elimination of the Company's $533,000 pro rata share of the
income that will be reported by HRP as a result of the payment. The Company paid
$6,405,000 (including post-judgment interest) to HRP in October 2001, subject to
an arrangement that it be returned in full or part if the judgment is modified
or reversed on appeal.

Administrative expenses increased by $104,000, or 5%, to $2,078,000 for
2001, compared to $1,974,000 for 2000. The 2000 expenses decreased by $327,000,
or 14%, compared to $2,301,000 for 1999.

Amortization expense of $672,000 for each of the three years 2001, 2000 and
1999 relates to Hallwood Realty's general partner interest in HRP to the extent
allocated to management rights.

TEXTILE PRODUCTS

Revenues. Textile revenues were $69,579,000 in 2001, $73,852,000 in 2000
and $80,704,000 in 1999.

Sales of $68,894,000 in 2001 decreased by $4,958,000, or 7%, compared to
$73,852,000 in 2000 and decreased by $6,852,000, or 9%, in 2000, compared to
$80,704,000 in 1999. The decreases were principally in the distribution business
as a result of lower overall demand, the continued trend of U.S. customers
moving production out of the country and the September 11th terrorist attacks
that adversely impacted luggage and outerwear business, partially offset by
increased revenues at the dying and finishing and laminating plants and revenues
from new customers and new production processes to diversify Brookwood's product
base.

During 2000, Brookwood formed a joint venture with an unrelated third party
that is also in a textile-related industry. The joint venture is 50%-owned by
Brookwood and 50%-owned by its joint venture partner with operating and
management decision making and venture profits and losses shared equally by both
parties. As Brookwood does not exercise control over the joint venture, the
investment is accounted for utilizing the equity method of accounting.
Brookwood's equity income from joint venture was $685,000 in 2001.

Expenses. Total expenses decreased $1,692,000, or 7%, to $71,705,000 in
2001. The 2000 expenses decreased $5,742,000 to $73,397,000 from $79,139,000 in
1999. Cost of sales decreased $4,016,000 to $58,385,000, or 6%, in 2001. The
2000 cost of sales of $62,401,000 decreased by $6,694,000, or 10%, compared to
$69,095,000 in 1999. The gross profit margin was 15.2%, 15.5% and 14.4% in 2001,
2000 and 1999, respectively. The lower margin in 2001 was due to lower volume
and lower margin business. The increased margin in 2000 resulted from higher
gross profit margins in the distribution business, attributable to a sales
decrease in low margin business and increased sales volume of products with
higher margins.

Administrative and selling expenses of $10,756,000 for 2001 increased by
$945,000, or 10%, from the 2000 amount of $9,811,000, which increased $687,000,
or 8%, compared to the 1999 amount of $9,124,000. The increase in 2001 was
attributable to costs related to the development of new business products and
costs incurred in a brief strike at the dying and finishing plant and costs
associated with the settlement of a contingent obligation in the amount of
$375,000. The increase in 2000 was due to expenses associated with new projects,
offset by reduced expenses in the distribution businesses.

Management conducted an analysis of the carrying values of certain
intangible assets related to acquisitions made in prior years and determined
that Brookwood has suffered an impairment to those values due to recent economic
trends and conditions. Accordingly, an impairment charge of $1,446,000 was
recorded in December 31, 2001.

Interest expense decreased by $67,000 to $1,118,000 for 2001, and increased
by $265,000 for 2000 to $1,185,000 in 2000 from the 1999 amount of $920,000. The
2001 decrease was principally due to lower interest rates partially offset by
higher average borrowings, while the 2000 increase was the result of higher
average borrowings and higher interest rates.

OTHER

Revenues. Total revenues were $3,309,000 in 2001, $1,628,000 in 2000 and
$1,958,000 in 1999.

Hotel revenue from the GuestHouse Suites Plus hotel in Huntsville, Alabama
was $1,677,000 in 2001, compared to $1,540,000 in 2000 and $1,614,000 in 1999.
The 9% increase in 2001 was attributable to increased occupancy, partially
offset by a reduced average daily rate. The 5% decrease in 2000 compared to
1999, was due to lower occupancy that resulted from substantial renovations
commenced in 1999 and completed in 2000.

Fee revenue of $1,410,000 in 2001 is attributable to the amortization of
deferred revenue from the noncompetition agreement received in connection with
the sale of the Company's investment in Hallwood Energy. The original $7,250,000
cash payment is being amortized over a three year period which began June 2001.

Interest and other income in 2001 was $222,000, compared to the 2000 amount
of $88,000. The 2001 increase resulted from increased interest income on
invested funds from the sale of Hallwood Energy. The 2000 decrease of $15,000,
compared to $103,000 in 1999, was attributable to rental income earned from the
subleasing of executive office space formerly occupied by an affiliated entity,
partially offset by a gain in 2000 on the sale of a miscellaneous investment.

Fee income of $241,000 for 1999 was attributable to a consulting contract
with the Company's former energy affiliate which was terminated in June 1999.

Expenses. Administrative expenses were $2,279,000 for 2001, compared to
$1,837,000 for 2000 and $2,442,000 for 1999. The increase of $442,000, or 23%,
in 2001 was primarily attributable to higher consulting and professional fees.
The decrease of $605,000, or 24%, in 2000, was primarily due to lower consulting
and professional fees, partially offset by the elimination of certain overhead
reimbursements from the Company's energy affiliate.

Interest expense relates to the Company's, 10% Collateralized Subordinated
Debentures, former Senior Secured Term Loan, former 7% Collateralized Senior
Subordinated Debentures, stockholder loans and interest costs on contingent
payments associated with a separation agreement with Mr. Brian M. Troup, the
Company's former president and director and a related trust (the "Separation
Agreement"). Interest expense of $1,998,000 for 2001 decreased by $1,100,000, or
36%, compared to 2000, interest of $3,098,000. The decrease was primarily due to
the principal amortization on the former Senior Secured Term Loan prior to its
payoff in May 2001, partially offset by increased interest costs associated with
the stockholder loans. Interest expense for 2000 increased $1,854,000, or 149%
to $3,098,000, compared to 1999 interest of $1,244,000. The increase was due to
(i) refinancing of the 7% Debentures in December 1999 from proceeds of the
Senior Secured Term Loan with a stated interest rate of 10.25% and an effective
interest rate of 12.75%, (ii) interest on the contingent payments associated
with the Separation Agreement, and (iii) stockholder loans with a fixed interest
rate of 10%.

Hotel expenses relate entirely to the GuestHouse Suites Plus hotel in
Huntsville, Alabama, which the Company has retained and continues to operate.
Operating expenses decreased by $117,000 in 2001 and by $163,000 in 2000 from
the previous years as a result of improved cost controls. Depreciation expense
for 2001 declined, due to the adjustment in the depreciable basis from the
impairment recorded in 2000. The interest expense is associated with the
$827,000 capital lease entered into in December 1999, to finance a substantial
renovation of the hotel. The effective interest on the five-year capital lease
is 12.75%. In December 2000, the Company evaluated the operations and economic
environment of the hotel and determined it was appropriate to record an
impairment of $680,000 to the estimated market value of its leasehold interest.

In 1999, the Company entered into a Separation Agreement with Mr. Brian M.
Troup, former president and director of the Company and a related trust. The
cost of Separation Agreement in 2001 in the amount of $500,000 represents an
increase in the deferred purchase price, in respect to the anticipated payments
to Epsilon Trust in 2002, for its 20% share of net cash flow from the Company's,
real estate management activities. The cost in 1999 was $1,769,000. Mr. Troup
and the Epsilon Trust exchanged their 24% stock ownership in the Company, for
20% of the Company's limited partner interest in HRP, 20% of the Company's
common stock interest in Hallwood Energy, all of the Company's interest in its
condominium hotel business and future cash payments contingent on the net cash
flow from the Company's real estate management activities.

Income Taxes. The Company recognizes future tax benefits, measured by
enacted tax rates, attributable to net deductible temporary differences between
financial statement and income tax basis of assets and liabilities
(approximately $54,812,000 at December 31, 2001), tax net operating loss
carryforwards ("NOLs") (approximately $37,467,000 at December 31, 2001) and tax
credit carryforwards (approximately $2,212,000 at December 31, 2001), to the
extent that realization of such benefits is "more likely than not", as defined
in Statement of Financial Accounting Standards No. 109 -- Accounting for Income
Taxes ("SFAS No. 109"). As a result of the fluctuations in the market value of
the HRP limited partner units, the realization of a gain on the sale of Hallwood
Energy, and the projected income from operations, partially offset by the
decline in value of the Company's hotel properties, management has determined
that the deferred tax asset should be adjusted

to reflect the impact of these changes on the anticipated utilization of NOLs
resulting from the assumed realization of the gains and projected income from
operations. Accordingly the Company recorded a deferred tax expense of $949,000
in 2001, and deferred tax (benefits) of $(1,205,000) in 2000 and $(873,000) in
1999, respectively, which resulted in the recognition of deferred tax assets of
$7,477,000 at December 31, 2001, $8,426,000 at December 31, 2000 and $7,221,000
at December 31, 1999.

The Company recorded a federal current charge of $58,000 in 2001 and
$46,000 in 2000, for the filing of separate returns of certain subsidiaries not
included in the Company's consolidated federal tax return, and a current charge
of $71,000 for alternative minimum tax in 1999. The Company recorded state tax
expense of $244,000 in 2001, $290,000 in 2000 and $233,000 in 1999.

The Company's NOLs expire as follows: 2006 -- $6,755,000;
2007 -- $8,517,000; 2008 -- $12,896,000; and 2009 to 2020 -- $9,299,000. SFAS
No. 109 requires that the tax benefit of such NOLs be recorded as an asset to
the extent that management assesses the utilization of such NOLs to be "more
likely than not". Based upon the Company's expectations and available tax
planning strategies, management has determined that taxable income will more
likely than not be sufficient to utilize approximately $21,990,000 of the NOLs
prior to their ultimate expiration in the year 2020.

Management believes that the Company has certain tax planning strategies
available, which include the potential sale of certain real estate investments,
that could be implemented, if necessary, to supplement income from operations to
fully realize the net recorded tax benefits before their expiration. Management
has considered such strategies in reaching its conclusion that, more likely than
not, taxable income will be sufficient to utilize a portion of the NOLs before
expiration; however, future levels of operating income and taxable gains are
dependent upon general economic conditions and other factors beyond the
Company's control. Accordingly, no assurance can be given that sufficient
taxable income will be generated for utilization of the NOLs. Management
periodically re-evaluates its tax planning strategies based upon changes in
facts and circumstances and, accordingly, considers potential adjustments to the
valuation allowance of the deferred tax asset. Although the use of such
carryforwards could, under certain circumstances be limited, the Company is
presently unaware of the occurrence of any event which would result in such
limitations.

DISCONTINUED OPERATIONS -- ENERGY

Revenues and Sale Transaction. In March 2001, the Company agreed to sell
its investment in its Hallwood Energy affiliate, which represented the Company's
energy operations, to Pure Resources II, an indirect subsidiary of Pure
Resources, Inc., subject to Hallwood Energy's shareholder approval which was
obtained in May 2001. The Company received $18,000,000 for the tender of its
1,440,000 shares of common stock of Hallwood Energy in May 2001 and recorded a
gain of $8,725,000 from this transaction. Accordingly, energy operations have
been segregated from the Company's continuing operations and reported as a
single line item -- income from discontinued energy operations. A summary of its
operations for the three years ended December 31, 2001 are presented below:

YEARS ENDED DECEMBER 31,
-------------------------
2001 2000 1999
------- ------ ------

Revenues
Gain on sale of investment in Hallwood Energy........... $ 8,725 $ -- $ --
Equity income from investment in Hallwood Energy........ 1,837 2,826 380
Oil and gas revenues and other income................... -- -- 2,515
------- ------ ------
10,562 2,826 2,895
Expense
Deferred federal income tax (benefit)................... (672) -- --
State income tax expense................................ 100 -- --
Interest expense........................................ -- -- 275
Depreciation, depletion and amortization................ -- -- 849
Operating and administrative expenses................... -- -- 1,333
------- ------ ------
(572) -- 2,457
------- ------ ------
Income from discontinued energy operations........... $11,134 $2,826 $ 438
======= ====== ======

The Company received an additional $7,250,000, pursuant to the terms of a
noncompetition agreement that was paid by Pure upon the completion of the merger
in June 2001. The Company began amortizing the deferred revenue from the
noncompetition agreement over a three-year period commencing June 2001. The
amortization of $1,410,000 in 2001 is reported in the "other" section of the
statement of operations.

The equity income from the investment in Hallwood Energy represented the
Company's 15% pro rata share of income available to common stockholders and
amortization of negative goodwill. The 2001 amount reflects equity in Hallwood
Energy's earnings through the sale date of May 11, 2001.

In June 1999, pursuant to the terms of a plan to consolidate certain former
energy affiliates and the energy interests of the Company into Hallwood Energy
(the "Energy Consolidation"), the Company received 1,800,000 shares of common
stock (18% of the total outstanding) and 43,816 shares of preferred stock (1.9%
of the total outstanding, which was sold in February 2000) in Hallwood Energy.
Subsequent to June 1999, the Company accounted for its investment in Hallwood
Energy using the equity method of accounting, as the Company exercised
significant influence over Hallwood Energy's operational and financial policies.
The Company recorded its pro-rata share of Hallwood Energy's net income
available to common stockholders, preferred dividends and amortization of
negative goodwill as a single line item -- equity income from investments in
Hallwood Energy.

Comparisons between years are not meaningful, due to the change in method
of accounting and sale of its energy investment. Gas revenue was $1,677,000 for
the 1999 period (through June 1999), consisting of 855,000 mcf at an average gas
of $1.96 per mcf. Oil revenue was $603,000 for the 1999 period (through June
1999) consisting of 46,000 barrels at an average price per barrel of $13.11.
Other income was $235,000 for the 1999 period.

Equity income of $1,837,000 in 2001, represents the Company's pro rata
share (18% ownership interest from June 1999 through December 1999, 15% average
thereafter through May 2001 disposition) of income available to common
stockholders and dividends on its preferred stock. The equity income increased
to $2,826,000 in 2000 from $380,000 in 1999.

Expenses. Energy expenses were $2,457,000 for 1999 and are comprised of
depreciation, depletion, amortization and impairment of properties in the amount
of $849,000, operating expenses, which are comprised of the costs of operating
wells and production-related taxes in the amount of $796,000, administrative
expenses of $537,000, and interest expense of $275,000.

The Company recorded a net deferred tax benefit of $672,000 in 2001,
principally due to the anticipated utilization of the Company's NOL's, relating
to the gain on sale of its investment in Hallwood Energy, and state income tax
expense of $100,000.

DISCONTINUED OPERATIONS -- HOTELS

In December 2000, the Company decided to discontinue its hotel operations
and dispose of its hotel segment, principally by allowing its non-recourse
debtholders to assume ownership of the properties through foreclosures or by
selling or otherwise disposing of its hotel properties. The Company's hotel
segment consisted of three owned properties and two leased properties. As part
of the planned disposition, in December 2000 and December 2001 the Company
evaluated the operations and economic environment in which each of the hotels
operated and determined it was appropriate to record an impairment of $4,000,000
($3,320,000 associated with the discontinued hotel operations) and $935,000,
respectively, to reduce their carrying value to estimated fair market values.
Except for the one leased hotel property the Company has decided to retain and
continues to operate, hotel operations have been segregated and reported as a
single line item -- loss from discontinued hotel operations. A summary of
operations for the three years ended December 31, 2001 are presented below (in
thousands):

YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------

Sales................................................... $ 7,619 $16,839 $20,280
Gain from extinguishment of debt........................ 216 -- --
------- ------- -------
7,835 16,839 20,280
Expenses
Operating expenses.................................... 6,822 14,746 17,117
Interest expense...................................... 1,848 2,607 2,495
Impairment............................................ 935 3,320 --
Deferred income taxes (benefit)....................... (600) 341 445
Other disposition costs............................... 214 115 --
Depreciation and amortization......................... -- 2,683 2,708
------- ------- -------
9,219 23,812 22,765
------- ------- -------
(Loss) from discontinued hotel operations.......... $(1,384) $(6,973) $(2,485)
======= ======= =======

Comparisons between 2001 and prior years are generally not meaningful due
to the disposition of the Company's two full-service hotel properties in 2001.

Revenues. Sales of $7,619,000 in 2001 decreased by $9,220,000, or 55%,
from the 2000 amount of $16,839,000, primarily due to the February 2001
termination of the lease for the Longboat Key Holiday Inn and Suites hotel in
Sarasota, Florida and the June 2001 transfer of the Embassy Suites hotel in
Oklahoma City, Oklahoma ownership to one of the lenders. Sales in 2000 decreased
by $3,441,000, compared to $20,280,000 in 1999, primarily due to reduced
management fees from certain assets distributed in December 1999 as part of the
Separation Agreement, and lower occupancy at the Company's three GuestHouse
hotels.

Expenses. Hotel expenses were $9,219,000 for 2001, $23,812,000 for 2000,
and $22,765,000 for 1999.

Operating expenses of $6,822,000 for 2001 decreased by $7,924,000, or 54%,
from the 2000 amount of $14,746,000, which decreased by $2,371,000, or 14%, from
the 1999 amount of $17,117,000. The 2001 decrease was primarily due to the
aforementioned disposition of the Longboat Key Holiday Inn and Embassy Suites
hotels. The 2000 decrease was attributable to reduced operating expenses related
to the December 1999 disposition of certain assets and lower occupancy at the
three GuestHouse properties due to the completion of substantial renovations.

Interest expense of $1,848,000 for 2001 decreased by $759,000, or 29%, from
the 2000 amount of $2,607,000, which increased by $112,000, or 4%, from the 1999
amount of $2,495,000. The 2001 decrease was due to the June 2001 disposition of
the Embassy Suites hotel. The 2000 increase was principally due to interest
expense associated with the three new capital leases.

The impairment of hotel assets of $935,000 in 2001 and $3,320,000 in 2000
were recorded to reduce the carrying values to their estimated fair values.

A deferred income taxes benefit of $600,000 was recorded in 2001, which
increased the deferred tax asset associated with the hotels held for sale to
$1,800,000. The Company anticipates the recording of significant gains from debt
extinguishment in 2002 as hotel dispositions are completed, partially offset by
the related deferred tax expense. The deferred income tax expenses of $341,000
and $445,000 in 2000 and 1999, respectively, were the result of the impairment
charges in 2000 and 1999.

Depreciation and amortization expense was not recorded in 2001 due to the
impairment charges and classification of the hotels as a discontinued operation.
Depreciation and amortization expense of $2,683,000 for 2000 decreased by
$25,000, or 9%, from the 1999 amount of $2,708,000. The 2000 decrease was due to
fewer depreciable assets as a result of certain disposals in late 1999 offset by
additional depreciation from capital leases at the three GuestHouse properties.
The five-year capital lease obligations commenced in January 2000.

EXTRAORDINARY GAIN (LOSS) FROM EARLY EXTINGUISHMENT OF DEBT

The Company recognized an extraordinary loss from early extinguishment of
debt of $917,000 in 2001, and $85,000 in 2000 and a gain of $240,000 in 1999,
respectively. The 2001 loss resulted from (i) an $800,000 write off of
unamortized loan costs associated with the payoff of the Senior Secured Term
Loan and (ii) a $117,000 loss from the Company's pro rata share of HRP's
extraordinary loss in 2001. The 2000 loss of $85,000 resulted from the
recognition of the Company's pro-rata share of an extraordinary loss from early
extinguishment of debt reported by HRP in 2000. The 1999 gain resulted from the
December 1999 redemption of the 7% Debentures at par value, to the extent of the
remaining unamortized gain.

CRITICAL ACCOUNTING POLICIES

In December 2001, the SEC requested that registrants identify "critical
accounting policies" in Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations. The SEC indicated that a
"critical accounting policy" is one that is both important to the portrayal of
an entity's financial condition and results and requires management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain. The
Company believes that the following of its accounting policies fit this
description:

Revenue Recognition -- Fee income from real estate operations is recognized
as the services (e.g. management, leasing, acquisition, construction) are
performed in accordance with various service agreements. Textile products sales
are recognized upon shipment or release of product, when title passes to the
customer.

Impairment of Long-Lived Assets -- The Company's management routinely
reviews its investments for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. In the event such indicators exist for assets held for use, if
undiscounted cash flows before interest charges are less than carrying value,
the asset is written down to estimated fair value. For assets held for sale,
these assets are carried at the lower of cost or estimated sales price less
costs of sale.

Inventories -- Inventories are valued at the lower of cost (first-in,
first-out or specific identification method) or market.

The policies listed are not intended to be a comprehensive list of all of
our accounting policies. In most cases, the accounting treatment of a particular
transaction is specifically dictated by accounting principles generally accepted
in the United States of America, with no need for management's judgment in the
application. There are also areas in which management's judgment in selecting
any available alternative would not produce a materially different result than
those recorded and reported.

Statement of Financial Accounting Standards No. 144 -- Accounting for the
Impairment or Disposal of Long-lived Assets ("SFAS No. 144") was issued in
August 2001, and was adopted by the Company on January 1, 2002. This Statement
supersedes SFAS No. 121, "Accounting for the Impairment of Long-lived Assets and
for Long-lived Assets to Be Disposed Of", and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of
Operations -- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for
the disposal of a segment of a business (as previously defined in that Opinion).
This statement retains the requirements of SFAS No. 121 to (a) recognize and
impairment loss only if the carrying amount of a long-lived asset is not
recoverable from its undiscounted cash flows and (b) measure an impairment loss
as the difference between the carrying amount and fair value of the asset. This
Statement requires that a long-lived asset to be abandoned, exchanged for a
similar productive asset, or distributed to owners in a spinoff be considered
held and used until it is disposed of. The accounting model for long-lived
assets to be disposed of by sale is used for all long-lived assets, whether
previously held and used or newly acquired. That accounting model retains the
requirement of SFAS No. 121 to measure a long-lived asset classified as held for
sale at the lower of its carrying amount or fair value less cost to sell and to
cease depreciation. This Statement requires that the current and historical
results of operations of disposed properties and assets classified as held for
sale, are classified as discontinued operations. This will result in the
reclassification of historical operations for property dispositions or assets
classified as held for sale that occur. The Company has elected to early adopt
the requirements of this Statement and accordingly, the hotel operations
disposed of or to be disposed of have been reclassified into discontinued
operations as of and for each of the periods presented.

LIQUIDITY AND CAPITAL RESOURCES

The Company's unrestricted cash and cash equivalents at December 31, 2001
totaled $3,006,000.

The Company tendered its 1,440,000 shares of common stock in Hallwood
Energy, pursuant to a tender offer and merger agreement announced in March 2001.
The Company received $18,000,000 for the tender of its shares in May 2001 and
received an additional $7,250,000, pursuant to the terms of a noncompetition
agreement upon completion of the merger in June 2001. The former Senior Secured
Term Loan, with a remaining balance of $14,059,000, was fully repaid in May 2001
with a portion of the proceeds from the sale.

During 2000, the Company borrowed a total of $2,500,000 from its chairman
and principal stockholder and an additional $1,500,000 in March 2001, all of
which have since been repaid. Several factors contributed to the Company's cash
flow needs at that time, including difficulties experienced by the Company's
hotel operations and restrictions on the availability of distributions and
payments from Brookwood. In response to these matters, management decided to
discontinue its hotel operations in December 2000 and sold its Hallwood Energy
investment during 2001.

In July 2001, the Delaware Court of Chancery rendered its opinion regarding
certain litigation involving the Company. The court determined that the
defendants, including the Company, should pay to HRP a judgment of $3,417,000
plus pre-judgment interest of approximately $2,988,000. The court's judgment is
not

final until all rehearings and appeals have been exhausted. In August 2001, the
plaintiff and certain defendants appealed the Court of Chancery's judgment to
the Delaware Supreme Court. Those appeals are pending. In October 2001, with a
portion of the proceeds from the sale of its Hallwood Energy investment, the
Company paid HRP $6,405,000, including post-judgment interest, subject to an
arrangement that it be returned in full or part if the judgment is modified or
reversed on appeal.

In March 2002, the Company and its HWG, LLC subsidiary entered into a
$7,000,000 credit agreement with First Bank & Trust , N.A. The facility is
comprised of a $3,000,000 term loan and a $4,000,000 revolving credit facility
(the "Term Loan and Revolving Credit Facility"). The term loan proceeds were
used in part to repay the aforementioned $1,500,000 convertible loan from
stockholder in March 2002, bears interest at a fixed rate of 7%, matures April
1, 2005 and is fully amortizing requiring a monthly payment of $92,631. The
revolving credit facility bears interest at the Company's option of one-half
percent over prime, or Libor plus 3.25%, and matures April 1, 2005. Collateral
for the Term Loan and Revolving Credit Facility is 300,397 HRP limited partner
units. The credit agreement contains various financial and non-financial
covenants, including the maintenance of financial ratios, restrictions on new
indebtedness and the payment of dividends. The Company has not drawn any funds
on the Revolving Credit Facility, and therefore has $4,000,000 of unused
borrowing capacity.

The Company's real estate segment generates funds principally from its
property management and leasing activities without significant additional
capital costs. Each quarter Hallwood Realty reviews HRP's capacity to make cash
distributions to its partners. No distributions were declared by HRP in 2001.

Brookwood maintains a revolving line of credit facility, which is
collateralized by accounts receivable, certain inventory and equipment, and also
maintains separate acquisition and equipment credit facilities. All facilities
have a maturity of December 2002. At December 31, 2001, Brookwood had $380,000
of unused borrowing capacity on its revolving line of credit. In the years ended
December 31, 2001, 2000 and 1999, Brookwood paid cash dividends of $-0-,
$400,000 and $400,000, and payments under its tax sharing agreement of $-0-,
$200,000 and $350,000, respectively. Future cash dividends and tax sharing
payments to the parent company are contingent upon Brookwood's compliance with
the covenants contained in the credit facility. Brookwood did not achieve its
cash flow coverage ratio covenant for the 2001 first quarter and in April 2001
obtained a waiver of this covenant violation. Brookwood was in compliance with
its covenants for the remainder of 2001 and as of December 31, 2001.

In February 2000, Brookwood, through a wholly owned subsidiary, acquired
the assets of a company in a textile products-related industry. The purchase
price was $1,450,000 in cash plus contingent payments of up to $3,000,000, based
on specified levels of earnings over the next four years. Effective December 31,
2001, in consideration of thirty six monthly payments aggregating approximately
$375,000, the contingent obligation had been reduced to a percentage of cash
flow from the acquired subsidiaries, as defined, for the remaining years under
the agreement.

During 2002 debt obligations in the amount of $17,530,000 are due,
primarily composed $15,632,000 non-recourse debt at Brookwood and $1,500,000
from a stockholder loan. The Company repaid the stockholder loan with available
funds and intends to extend or refinance its Brookwood debt before its December
2002 maturity.

The Company's hotel segment experienced cash flow difficulties during 2000,
due to weaker occupancy and average daily rates. In December 2000, the Company
decided to dispose of its hotel segment principally by allowing its non-recourse
debtholders to assume ownership of the properties through foreclosures or by
selling or otherwise disposing of its hotel properties. The Company subsequently
decided to retain its one remaining leased property located in Huntsville,
Alabama. The Company anticipates that in disposing of the hotels, it will not
receive any amounts in excess of the debt outstanding on the properties, but
that the non-recourse debt associated with the properties will be extinguished.
The capital lease obligations are collateralized by 30,035 HRP units and are
expected to be repaid by the sale of the leased property or other
considerations. Payments on the capital leases are current.

The Company had outstanding contingencies and commitments of approximately
$19,884,000, principally associated with a $13,118,000 subscription obligation
of Hallwood Realty to HRP and operating lease commitments of $6,766,000.

SPECIAL PURPOSE ENTITIES

The Company has, in certain situations, created a Special Purpose Entity
("SPE"). These SPE's were formed to hold title to specific assets and accomplish
various objectives. In 1998, the Company formed several SPEs to complete a
consolidation of its real estate assets into a new structure to facilitate
possible financing opportunities. In other situations, SPEs were formed at the
request of lenders for the express purpose of strengthening the collateral for
the loans by isolating (for Federal bankruptcy law purposes) the assets and
liabilities of the SPEs. In all cases and since their various formation dates,
these wholly-owned entities (including their assets, liabilities and results of
operations) have been fully consolidated into the financial statements of the
Company.

NEW ACCOUNTING PRONOUNCEMENTS

Statement of Financial Accounting Standards No. 141 -- Business
Combinations ("SFAS No. 141") is effective July 1, 2001 and prohibits
pooling-of-interests accounting for acquisitions. SFAS No. 142, "Goodwill and
Other Intangible Assets" is effective January 1, 2002 and specifies that
goodwill and some intangible assets will no longer be amortized but instead will
be subject to periodic impairment testing. The effect of adopting SFAS No. 142
will not have a material impact on the Company's financial statements.

Statement of Financial Accounting Standards No. 143 -- Accounting for Asset
Retirement Obligations ("SFAS No. 143") was issued in June 2001, and will be
adopted by the Company on January 1, 2003. This Statement addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. The
Company has not yet determined the effect adopting SFAS No. 143 will have on its
financial statements.

SFAS No. 144 -- Accounting for the Impairment or Disposal of Long-lived
Assets was issued in August 2001, and was adopted by the Company on January 1,
2002. This Statement supersedes SFAS No. 121, "Accounting for the Impairment of
Long-lived Assets and for Long-lived Assets to Be Disposed Of", and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations -- Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a segment of a business (as previously
defined in that Opinion). This statement retains the requirements of SFAS No.
121 to (a) recognize and impairment loss only if the carrying amount of a
long-lived asset in not recoverable from its undiscounted cash flows and (b)
measure an impairment loss as the difference between the carrying amount and
fair value of the asset. This statement requires that a long-lived asset to be
abandoned, exchanged for a similar productive asset, or distributed to owners in
a spinoff be considered held and used until it is disposed of. The accounting
model for long-lived assets to be disposed of by sale is used for all long-lived
assets, whether previously held and used or newly acquired. That accounting
model retains the requirement of SFAS No. 121 to measure a long-lived asset
classified as hld for sale at the lower of its carrying amount or fair value
less cost to sell and to cease depreciation. This statement requires that the
current and historical results of operations of disposed properties and assets
classified as held for sale, are classified as discontinued operations. This
will result in the reclassification of historical operations for property
dispositions or assets classified as held for sale that occur. The Company has
elected to early adopt the requirements of this statement and accordingly, the
hotel operations disposed of or to be disposed of have been reclassified into
discontinued operations as of and for each of the periods presented.

establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. All derivatives, whether designated in hedging relationships
or not, are required to be recorded on the balance sheet at fair value. If the
derivative is designated as a fair-value hedge, the changes in the fair value of
the derivative and the hedged item will be recognized in earnings. If the
derivative is designated as a cash flow hedge, changes in the fair value of the
derivative will be recorded in other comprehensive income and will be recognized
in the income statement when the hedged item affects earnings. These statements
define new requirements for designation and documentation of hedging
relationships as well as ongoing effectiveness assessments in order to use hedge
accounting. For a derivative that does not qualify as a hedge, changes in fair
value will be recognized in earnings.

The Company adopted these statements on January 1, 2001. In connection with
this adoption, all derivatives within the Company were identified pursuant to
SFAS No. 133 requirements. The Company determined it did not directly have any
derivative instruments, however HRP and Hallwood Energy do have such
instruments. Accordingly, the Company was required to record its pro-rata share
of any impact of these instruments in accordance with the equity method of
accounting.

HRP determined it had one derivative, an interest rate cap. Since this
derivative was designated as a cash flow hedge, changes in the fair value of the
derivative are recognized in other comprehensive income until the hedged item is
recognized in earnings. Hedge effectiveness will be measured based on the
relative changes in the fair value between the derivative contract and the
hedged item over time. Any changes in fair value resulting from ineffectiveness,
as defined by SFAS No. 133, will be recognized immediately in current earnings.
The interest rate cap is highly effective and, accordingly, the impact of the
adoption of these standards is the amount of the difference between the carrying
value and the fair value of the interest rate cap.

Hallwood Energy Corporation ("HEC") determined that all of its oil and gas
commodity swaps and collars, as well as its interest rate swaps should be
designated as cash flow hedges. Since HEC's derivatives are designated as cash
flow hedges, changes in the fair value of the derivatives are recognized in
other comprehensive income until the hedged item is recognized in earnings.
Hedge effectiveness was measured based on the relative changes in the fair value
between the derivative contract and the hedged item over time. Any changes in
fair value resulting from ineffectiveness, as defined by SFAS No. 133, were
recognized immediately in current earnings.

The adoption of SFAS No. 133 as of January 1, 2001 resulted in the
recognition of net reductions in the carrying value of its investments in
Hallwood Energy and HRP of $4,035,000.

The Company adopted Staff Accounting Bulletin No. 101 -- Revenue
Recognition in Financial Statements ("SAB No. 101"), in the fourth quarter of
2000. The adoption of SAB No. 101 had no impact on the financial position or
operations of the Company.

INFLATION

Inflation did not have a significant impact on the Company in 2001, 2000
and 1999, and is not anticipated to have a material impact in 2002.

ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company has no foreign operations, nor does it enter into financial
instrument transactions for trading or other speculative purposes.

The Company's real estate division through its investment in HRP will
sometimes use derivative financial instruments to achieve a desired mix of fixed
versus floating rate debt. As of December 31, 2001, HRP had an interest cap
agreement for one of its mortgage loans, which will limit HRP's exposure to
changing interest rates to a maximum of 10%. Management does not consider the
portion attributable to the Company to be significant.

The Company is exposed to market risk due to fluctuations in interest
rates. The Company utilizes both fixed and variable rate debt to finance its
operations. The table below presents principal cash flows and related weighted
average interest rates of the Company's debt at December 31, 2001, excluding
$11,609,000 of debt associated with its discontinued hotel operations (in
thousands):

EXPECTED MATURITIES AS OF DECEMBER 31, 2001
----------------------------------------------------- FAIR
DEBT CLASSIFICATION 2002 2003 2004 2005 2006 TOTAL VALUE
------------------- ------- ------ ------ ------ ------ ------- -------

Fixed Rate.............................. $ 2,081 $ 665 $ 745 $6,669 $ -- $10,160 $ 8,737
Average Interest Rate................. 10.32% 10.28% 10.21% 9.98% 10.00%
Variable Rate........................... $15,449 $ -- $ -- $ -- $ -- $15,449 $15,449
Average Interest Rate................. 5.05% -- -- -- --

There is inherent rollover risk for borrowings as they mature and are
renewed at current market rates. The extent of this risk is not quantifiable or
predictable because of the variability of future interest rates and the
Company's future financing requirements. A hypothetical increase in interest
rates of one percentage point would cause a loss in income and cash flows of
approximately $256,000 during 2002, assuming that outstanding debt remained at
current levels.

FORWARD-LOOKING STATEMENTS

In the interest of providing stockholders with certain information
regarding the Company's future plans and operations, certain statements set
forth in this Form 10-K are forward-looking statements. Although any
forward-looking statement expressed by or on behalf of the Company is, to the
knowledge and in the judgment of the officers and directors, expected to prove
true and come to pass, management is not able to predict the future with
absolute certainty. Forward-looking statements involve known and unknown risks
and uncertainties, which may cause the Company's actual performance and
financial results in future periods to differ materially from any projection,
estimate or forecasted result. Among others, these risks and uncertainties
include, the ability to obtain financing or refinance maturing debt; a potential
oversupply of commercial office buildings and industrial parks in the markets
served; fees for leasing, construction and acquisition of real estate
properties; lease and rental rates and occupancy levels obtained; the ability to
compete successfully with foreign textile production and the ability to generate
new products. These risks and uncertainties are difficult or impossible to
predict accurately and many are beyond the control of the Company. Other risks
and uncertainties may be described, from time to time, in the Company's periodic
reports and filings with the Securities and Exchange Commission.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Company's consolidated financial statements, together with the
independent auditors' report, are included elsewhere herein. Reference is made
to Item 14, "Exhibits, Financial Statement Schedules, and Reports on Form 8-K".

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Certain of the information required by this Item 10 is contained in the
definitive proxy statement of the Company for its Annual Meeting of Stockholders
( the "Proxy Statement") under the heading "Election of Directors," and such
information is incorporated herein by reference. The Proxy Statement will be
filed with the Securities and Exchange Commission not later than 120 days after
December 31, 2001.

In addition to Anthony J. Gumbiner, age 57, who serves as Director,
Chairman and President, the following individuals also serve as executive
officers of the Company:

William L. Guzzetti, age 58, has served as Executive Vice President of the
Company since October 1989. Mr. Guzzetti has served as President, Chief
Operating Officer and a Director of Hallwood Energy from December 1998 until May
2001. He was President, Chief Operating Officer and a director of the general
partner of HEP from February 1985 until June 1999 and as President, Chief
Operating Officer and a Director of HCRC from May 1991 until June 1999. Since
November 1990 and May 1991, Mr. Guzzetti has served as the President, Chief
Operating Officer and a Director of Hallwood Realty and HCRE, respectively. He
is a member of the Florida Bar and the State Bar of Texas.

Melvin J. Melle, age 59, has served as Vice President and Chief Financial
Officer of the Company since December 1984 and as Secretary of the Company since
October 1987. Mr. Melle served as Assistant Secretary of the Company from
December 1984 to October 1987. Mr. Melle had served as Secretary and Principal
Financial and Accounting Officer of Alliance Bancorporation from April 1989
until its liquidation in February 1994. From June 1980 through June 1986, Mr.
Melle served as Chief Financial Officer of The Twenty Seven Trust. Mr. Melle is
a member of the American Institute of Certified Public Accountants and of the
Ohio Society of Certified Public Accountants.

ITEM 11. EXECUTIVE COMPENSATION

Information with respect to executive compensation is contained in the
Proxy Statement under the headings "Executive Compensation," "Compensation of
Directors" and "Certain Relationships and Related Transactions," and such
information is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information regarding ownership of certain of the Company's outstanding
securities is contained in the Proxy Statement under the heading "Security
Ownership of Certain Beneficial Owners and Management," and such information is
incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding certain relationships and related transactions is
contained in the Proxy Statement under the headings "Compensation Committee
Interlocks and Insider Participation" and "Certain Relationships and Related
Transactions," and such information is incorporated herein by reference.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

Reference is made to the "Index to Financial Statements and Schedules"
appearing after the signature page hereof.

1. Financial Statements.

Included in Part II, Item 8. of this report are the
following
Independent Auditors' Report
Consolidated Balance Sheets, December 31, 2001 and 2000
Consolidated Statements of Operations, Years ended
December 31, 2001, 2000 and 1999
Consolidated Statements of Comprehensive Income (Loss),
Years ended December 31, 2001, 2000 and 1999
Consolidated Statements of Changes in Stockholders'
Equity, Years ended December 31, 1999, 2000 and 2001
Consolidated Statements of Cash Flows, Years ended
December 31, 2001, 2000 and 1999
Notes to Consolidated Financial Statements

2. Financial Statement Schedules.

Independent Auditors' Report on Schedules
I Condensed Financial Information of Registrant
II Valuation and Qualifying Accounts and Reserves

All other schedules are omitted since the required information is not
applicable or is included in the consolidated financial statements or related
notes.

Hallwood Realty Partners, L.P. -- Form 10-K for the year ended
December 31, 2001

3. Exhibits and Reports on Form 8-K.

(a) Exhibits.

3.1 -- Second Restated Certificate of Incorporation of The Hallwood
Group Incorporated, is incorporated herein by reference to
Exhibit 4.2 to the Company's Form S-8 Registration
Statement, File No. 33-63709.
3.2 -- Restated Bylaws of the Company is incorporated herein by
reference to Exhibit 3.2 to the Company's Form 10-K for the
year ended December 31, 1997, File No. 1-8303.
4.1 -- Indenture Agreement and related Pledge and Security
Agreement, dated as of August 31, 1998 among Bank One, N.A.,
a national banking association, as Trustee and the Company,
regarding 10% Collateralized Subordinated Debentures due
July 31, 2005, is incorporated herein by reference to Form
T-3 filed June 2, 1998 and related T-3/A amendments filed on
June 17, 1998, August 4, 1998 and August 31, 1998, File No.
1-8303.
10.1 -- Amended and Restated Agreement, dated March 30, 1990,
between the Company and Stanwick Management Company, Inc.
(subsequently merged into its parent, Stanwick Holdings,
Inc.) concerning the allocation of costs and expenses
incurred in connection with the operation and management of
their common offices is incorporated herein by reference to
Exhibit 10.30 to the Company's Form 10-Q for the fiscal
quarter ended April 30, 1990, File No. 1-8303.
*10.2 -- Employment Agreement, dated January 1, 1994, between the
Company and Melvin John Melle, as incorporated by reference
to Exhibit 10.9 to the Company's Form 10-K for the fiscal
year ended July 31, 1994, File No. 1-8303.
10.3 -- Tax Sharing Agreement, dated as of March 15, 1989, between
the Company and Brookwood Companies Incorporated is
incorporated herein by reference to Exhibit 10.25 to the
Company's Form 10-K for the fiscal year ended July 31, 1989,
File No. 1-8303.
*10.4 -- Amended Tax-Favored Savings Plan Agreement of the Company,
effective as of February 1, 1992, is incorporated herein by
reference to Exhibit 10.33 to the Company's Form 10-K for
the fiscal year ended July 31, 1992, File No. 1-8303.
*10.5 -- Hallwood Special Bonus Agreement, dated as of August 1,
1993, between the Company and all members of its control
group that now, or hereafter, participate in the Hallwood
Tax Favored Savings Plan and its related trust, and those
employees who, during the plan year of reference are
highly-compensated employees of the Company, is incorporated
herein by reference to Exhibit 10.34 to the Company's Form
10-K for the fiscal year ended July 31, 1994, File No.
1-8303.
*10.6 -- 1995 Stock Option Plan for The Hallwood Group Incorporated
is incorporated herein by reference to Exhibit 4.1 of the
Company's Form S-8 Registration Statement, File No.
33-63709.
10.7 -- Revolving credit loan and security agreement, related
revolving credit notes and stock pledge and security
agreements, all dated as of December 22, 1999, by and among
Brookwood Companies Incorporated, Kenyon Industries, Inc.,
Brookwood Laminating, Inc. and Key Bank National
Association, is incorporated herein by reference to Exhibit
10.7 to the Company's Form 10-K for the year ended December
31, 1999, File No. 1-8303.
*10.8 -- Financial Consulting Agreement, dated as of December 31,
1996, between the Company and HSC Financial Corporation, is
incorporated herein by reference to Exhibit 10.22 to the
Company's Form 10-K for the year ended December 31, 1996,
File No. 1-8303.
*10.9 -- Amendment to Financial Consulting Agreement, dated as of May
16, 2001, between the Company and HSC Financial Corporation,
filed herewith.

10.10 -- Promissory note and related mortgage loan agreement in the
original amount of $6,750,000, dated December 24, 1997,
between Brock Suite Greenville, Inc., as Maker, and L.J.
Melody & Company, as Lender, is incorporated herein by
reference to Exhibit 10.29 to the Company's Form 10-K for
the year ended December 31, 1997, File No. 1-8303.
10.11 -- Agreement, as of May 5, 1999, among The Hallwood Group
Incorporated, Epsilon Trust and Brian Troup, is incorporated
herein by reference to Exhibit 10.34 to the Company's Form
10-Q for the quarter ended March 31, 1999, File No. 1-8303.
10.12 -- Amendment to Financial Consulting Agreement, dated as of
January 1, 2000, between the Company and HSC Financial
Corporation, is incorporated herein by refinance to Exhibit
10.15 to the Company's Form 10-Q for the quarter ended March
31, 2000, File No. 1-8303.
10.13 -- Convertible Unsecured Promissory Note in the amount of
$1,000,000, dated as of September 15, 2000, between Hallwood
Investment Company and Hallwood Investments Limited, is
incorporated herein by reference to Exhibit 10.18 to the
Company's Form 10-Q for the quarter ended September 30,
2000, File No. 1-8303.
10.14 -- Convertible Unsecured Promissory Note in the amount of
$1,500,000, dated as of March 30, 2001, between Hallwood
Investment Company and Hallwood Investments Limited, is
incorporated herein by reference to Exhibit 10.22 to the
Company's Form 10-Q for the quarter ended March 31, 2001,
File No. 1-8303.
10.15 -- First Amendment to First Amended and Restated Revolving
Credit Loan and Security Agreement, dated as of October 23,
2000 by and among Key Bank National Association, Brookwood
Companies Incorporated and certain subsidiaries, is
incorporated herein by reference to Exhibit 10.19 to the
Company's Form 10-Q for the quarter ended September 30,
2000, File No. 1-8303.
10.16 -- Second Amendment to First Amended and Restated Revolving
Credit Loan and Security Agreement, dated as of January 2,
2001, by and among Key Bank National Association, Brookwood
Companies Incorporated and certain subsidiaries, is
incorporated herein by reference to Exhibit 10.20 to the
Company's Form 10-K for the year ended December 31, 2000,
File No. 1-8303.
10.18 -- Credit Agreement, dated as of March 21, 2002, among HWG,
LLC, as the Borrower, The Hallwood Group Incorporated, as
Parent Guarantor, First Bank & Trust, as Administrative
Agent and the Financial Institution Now or Hereafter Parties
Thereto, as the Lenders, regarding a $3,000,000 Term Loan
and a $4,000,000 Revolving Credit Facility, filed herewith.
21. -- Active subsidiaries of the Registrant as of February 28,
2002.

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

* Constitutes a compensation plan or agreement for executive officers.

(b) Reports on Form 8-K.

None.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

THE HALLWOOD GROUP INCORPORATED

By: /s/ MELVIN J. MELLE
------------------------------------
Melvin J. Melle
Vice President -- Finance
(Principal Financial and Accounting
Officer)

Dated: April 15, 2002

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant on the 15th day of April 2002.

SIGNATURES TITLE
---------- -----

/s/ MELVIN J. MELLE Vice President -- Finance (Principal Financial and
------------------------------------------------ Accounting Officer)
(Melvin J. Melle)

/s/ ANTHONY J. GUMBINER Director, Chairman of the Board and President
------------------------------------------------ (Principal Executive and Operating Officer)
(Anthony J. Gumbiner)

/s/ CHARLES A. CROCCO, JR. Director
------------------------------------------------
(Charles A. Crocco, Jr.)

/s/ J. THOMAS TALBOT Director
------------------------------------------------
(J. Thomas Talbot)

INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

PAGE
----

Independent Auditors' Report................................ 29
Financial Statements:
Consolidated Balance Sheets, December 31, 2001 and 2000... 30
Consolidated Statements of Operations, Years Ended
December 31, 2001, 2000 and 1999....................... 32
Consolidated Statements of Comprehensive Income (Loss),
Years Ended December 31, 2001, 2000 and 1999........... 34
Consolidated Statements of Changes in Stockholders'
Equity, Years Ended December 31, 1999, 2000 and 2001... 35
Consolidated Statements of Cash Flows, Years Ended
December 31, 2001, 2000 and 1999....................... 36
Notes to Consolidated Financial Statements................ 37
Independent Auditors' Report on Schedules................... 69
Schedules:
I Condensed Financial Information of Registrant (Parent
Company)............................................... 70
II Valuation and Qualifying Accounts and Reserves......... 77

All other schedules are omitted since the required
information is not applicable or is included in the
financial statements or related notes

Financial Statements of Hallwood Realty Partners, L.P.
Form 10-K for the Year Ended December 31, 2001

INDEPENDENT AUDITORS' REPORT

To the Stockholders and Directors of
The Hallwood Group Incorporated

We have audited the accompanying consolidated balance sheets of The
Hallwood Group Incorporated and its subsidiaries as of December 31, 2001 and
2000, and the related consolidated statements of operations, comprehensive
income (loss), changes in stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2001. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of The Hallwood Group Incorporated
and its subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States of America.

DELOITTE & TOUCHE LLP

Dallas, Texas
April 11, 2002

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31,
-------------------------
2001 2000
---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)

ASSETS
REAL ESTATE
Investments in HRP........................................ $ 12,261 $ 6,973
Receivables and other assets
Related parties........................................ 242 165
Other.................................................. 55 268
-------- --------
12,558 7,406
TEXTILE PRODUCTS
Receivables
Other.................................................. 11,896 13,170
Related parties........................................ 5,217 --
Inventories............................................... 16,753 16,413
Property, plant and equipment, net........................ 9,426 9,785
Prepaids, deposits and other assets....................... 1,030 2,111
Investment in joint venture............................... 676 --
-------- --------
44,998 41,479
OTHER
Deferred tax asset, net................................... 5,677 5,333
Cash and cash equivalents................................. 3,006 901
Restricted cash........................................... 966 937
Hotel assets held for use................................. 448 555
Prepaids, deposits and other assets....................... 408 1,424
-------- --------
10,505 9,150
DISCONTINUED OPERATIONS
Hotels held for sale
Properties, net........................................ 6,602 25,345
Deferred tax asset, net................................ 1,800 1,300
Receivables and other assets........................... 1,104 2,047
-------- --------
9,506 28,692
Energy
Investment in Hallwood Energy............................. -- 9,196
-------- --------

TOTAL ASSETS........................................... $ 77,567 $ 95,923
======== ========

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS -- (CONTINUED)

DECEMBER 31,
-------------------------
2001 2000
---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)

LIABILITIES AND STOCKHOLDERS' EQUITY
REAL ESTATE
Accounts payable and accrued expenses..................... $ 1,133 $ 777
TEXTILE PRODUCTS
Loans payable............................................. 16,255 12,910
Accounts payable and accrued expenses..................... 9,390 7,195
-------- --------
25,645 20,105
OTHER
10% Collateralized Subordinated Debentures................ 6,677 6,725
Deferred revenue -- noncompetition agreement.............. 5,840 --
Interest and other accrued expenses....................... 4,167 3,820
Convertible loan from stockholder......................... 1,500 2,500
Capital lease obligations................................. 1,386 1,774
Hotel accounts payable and accrued expenses............... 529 316
Senior Secured Term Loan.................................. -- 15,094
-------- --------
20,099 30,229
DISCONTINUED OPERATIONS
Hotels held for sale
Loans payable.......................................... 11,609 29,350
Accounts payable and accrued expenses.................. 2,198 2,648
-------- --------
13,807 31,998
-------- --------
TOTAL LIABILITIES...................................... 60,684 83,109
REDEEMABLE PREFERRED STOCK
Series B, $.10 par value; 250,000 shares issued and
outstanding............................................ 1,000 1,000
CONTINGENCIES AND COMMITMENTS
STOCKHOLDERS' EQUITY
Preferred stock, $.10 par value; authorized 500,000
shares; 250,000 shares issued and outstanding as Series
B...................................................... -- --
Common stock, $.10 par value; authorized 10,000,000
shares; issued 2,396,103 shares in both years;
outstanding 1,361,343 and 1,424,789 shares,
respectively........................................... 240 240
Additional paid-in capital................................ 54,452 54,416
Accumulated deficit....................................... (23,729) (27,924)
Accumulated other comprehensive income.................... 250 --
Treasury stock 1,034,760 and 971,360 shares, respectively,
at cost................................................ (15,330) (14,918)
-------- --------
TOTAL STOCKHOLDERS' EQUITY............................. 15,883 11,814
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............. $ 77,567 $ 95,923
======== ========

See accompanying notes to consolidated financial statements.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------

REAL ESTATE
Fees
Related parties........................................ $ 6,100 $ 6,089 $ 8,110
Other.................................................. 458 559 981
Equity income (loss) from investments in HRP.............. 1,836 (162) 412
------- ------- -------
8,394 6,486 9,503
Litigation expense........................................ 2,360 -- --
Administrative expenses................................... 2,078 1,974 2,301
Depreciation and amortization............................. 672 672 672
------- ------- -------
5,110 2,646 2,973
------- ------- -------
Income from real estate operations................ 3,284 3,840 6,530
TEXTILE PRODUCTS
Sales..................................................... 68,894 73,852 80,704
Equity income from joint venture.......................... 685 -- --
------- ------- -------
69,579 73,852 80,704
Cost of sales............................................. 58,385 62,401 69,095
Administrative and selling expenses....................... 10,756 9,811 9,124
Impairment of intangible assets........................... 1,446 -- --
Interest.................................................. 1,118 1,185 920
------- ------- -------
71,705 73,397 79,139
------- ------- -------
Income (loss) from textile products operations.... (2,126) 455 1,565
OTHER
Hotel revenue............................................. 1,677 1,540 1,614
Amortization of deferred revenue -- noncompete
agreement.............................................. 1,410 -- --
Interest and other income................................. 222 88 103
Fee income from related parties........................... -- -- 241
------- ------- -------
3,309 1,628 1,958
Administrative expenses................................... 2,279 1,837 2,442
Interest expense.......................................... 1,998 3,098 1,244
Hotel expenses............................................ 1,815 2,833 2,086
Cost of separation agreement.............................. 500 -- 1,769
------- ------- -------
6,592 7,768 7,541
------- ------- -------
Other loss, net................................... (3,283) (6,140) (5,583)
------- ------- -------
Income (loss) from continuing operations before income
taxes (benefit)........................................ (2,125) (1,845) 2,512
Income taxes (benefit).................................... 2,423 (1,210) (1,014)
------- ------- -------
Income (loss) from continuing operations.................. (4,548) (635) 3,526
------- ------- -------

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS -- (CONTINUED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------

Income (loss) from discontinued operations, net of tax
Income from discontinued operations -- energy
(including a gain on disposal of $8,725)............. 11,134 2,826 438
(Loss) from discontinued operations -- hotels
(including a gain on extinguishment of debt on
disposal of $216,000)................................ (1,384) (6,973) (2,485)
------- ------- -------
9,750 (4,147) (2,047)
------- ------- -------
Income (loss) before extraordinary gain (loss) and
cumulative effect of SFAS No. 133 adoption............. 5,202 (4,782) 1,479
Extraordinary gain (loss) from early extinguishment of
debt................................................... (917) (85) 240
------- ------- -------
Income (loss) before cumulative effect of SFAS No. 133
adoption............................................... 4,285 (4,867) 1,719
Loss from cumulative effect of SFAS No. 133 adoption...... (40) -- --
------- ------- -------
NET INCOME (LOSS)........................................... 4,245 (4,867) 1,719
Cash dividend on preferred stock.......................... (50) (50) (50)
------- ------- -------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS.......... $ 4,195 $(4,917) $ 1,669
======= ======= =======
PER COMMON SHARE
BASIC
Income (loss) from continuing operations to common
stockholders......................................... $ (3.24) $ (0.48) $ 1.86
Income (loss) from discontinued operations............. 6.87 (2.91) (1.10)
Extraordinary gain (loss) from early extinguishment of
debt................................................. (0.65) (0.06) 0.13
Loss from cumulative effect of SFAS No. 133 adoption... (0.03) -- --
------- ------- -------
Net income (loss) available to common
stockholders.................................... $ 2.95 $ (3.45) $ 0.89
======= ======= =======
ASSUMING DILUTION
Income (loss) from continuing operations to common
stockholders......................................... $ (3.24) $ (0.48) $ 1.83
Income (loss) from discontinued operations............. 6.87 (2.91) (1.08)
Extraordinary gain (loss) from early extinguishment of
debt................................................. (0.65) (0.06) 0.13
Loss from cumulative effect of SFAS No. 133 adoption... (0.03) -- --
------- ------- -------
Net income (loss) available to common
stockholders.................................... $ 2.95 $ (3.45) $ 0.88
======= ======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING
BASIC..................................................... 1,420 1,425 1,870
======= ======= =======
ASSUMING DILUTION......................................... 1,420 1,425 1,899
======= ======= =======

See accompanying notes to consolidated financial statements.
33

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(AMOUNTS IN THOUSANDS)

YEARS ENDED DECEMBER 31,
-------------------------
2001 2000 1999
------ ------- ------

Net Income (Loss)........................................... $4,245 $(4,867) $1,719

Other Comprehensive Income (Loss)
Pro rata share of other comprehensive income from equity
investments
Adoption of SFAS No. 133
Cumulative effect.................................... (4,035) -- --
Realized upon disposition of Hallwood Energy......... 3,009 -- --
Change in fair value of derivatives.................. 1,302 -- --
Amortization of interest rate swap................... (26) -- --
------ ------- ------
Other Comprehensive Income (Loss)........................... 250 -- --
------ ------- ------
Comprehensive Income (Loss)................................. $4,495 $(4,867) $1,719
====== ======= ======

See accompanying notes to consolidated financial statements.
34

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001
(IN THOUSANDS)

COMMON STOCK ACCUMULATED
-------------- ADDITIONAL OTHER TREASURY STOCK TOTAL
PAR PAID-IN ACCUMULATED COMPREHENSIVE ----------------- STOCKHOLDERS'
SHARES VALUE CAPITAL DEFICIT INCOME SHARES COST EQUITY
------ ----- ---------- ----------- ------------- ------ -------- -------------

BALANCE, JANUARY 1, 1999.......... 2,396 $240 $54,743 $(24,676) $ -- 513 $ (9,369) $20,938
Net income...................... 1,719 1,719
Purchase of treasury stock...... 458 (5,549) (5,549)
Preferred stock dividend........ (50) (50)
----- ---- ------- -------- ------- ----- -------- -------
BALANCE, DECEMBER 31, 1999........ 2,396 240 54,743 (23,007) -- 971 (14,918) 17,058
Net loss........................ (4,867) (4,867)
Pro rata share of stockholders'
equity transactions from
equity investments............ (327) (327)
Preferred stock dividend........ (50) (50)
----- ---- ------- -------- ------- ----- -------- -------
BALANCE, DECEMBER 31, 2000........ 2,396 240 54,416 (27,924) -- 971 (14,918) 11,814
Net income...................... 4,245 4,245
Purchase of treasury stock...... 64 (412) (412)
Pro rata share of stockholders'
equity transactions from
equity investments............
Adoption of SFAS No. 133:
Cumulative effect............. (4,035) (4,035)
Realized upon disposition of
Hallwood Energy............. 36 3,009 3,045
Change in fair value of
derivatives................. 1,302 1,302
Amortization of interest rate
swap........................ (26) (26)
Preferred stock dividend........ (50) (50)
----- ---- ------- -------- ------- ----- -------- -------
BALANCE, DECEMBER 31, 2001........ 2,396 $240 $54,452 $(23,729) $ 250 1,035 $(15,330) $15,883
===== ==== ======= ======== ======= ===== ======== =======

See accompanying notes to consolidated financial statements.
35

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

YEARS ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- ------- --------

CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)......................................... $ 4,245 $(4,867) $ 1,719
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities
Depreciation, depletion, amortization and impairment.... 3,661 2,071 2,716
Equity (income) loss from investments in HRP............ (1,836) 162 (412)
Amortization of deferred revenue -- noncompetition
agreement............................................. (1,410) -- --
(Increase) decrease in deferred tax asset............... (344) (1,546) (1,318)
Extraordinary (gain) loss from early extinguishment of
debt.................................................. 917 85 (240)
Equity income from joint venture........................ (685) -- --
Litigation expense...................................... (627) -- --
Cost of separation agreement............................ 500 -- 1,769
Amortization of deferred gain from debenture
exchanges............................................. (48) (43) (439)
Loss from cumulative effect of SFAS No. 133 adoption.... 40 -- --
Net change in textile products assets and liabilities... (2,503) 300 (2,186)
Net change in other assets and liabilities.............. 781 2,070 (2,104)
Discontinued operations/Assets held for sale
Gain on sale of investment in Hallwood Energy......... (8,725) -- --
Equity income from investments in Hallwood Energy..... (1,837) (2,826) (380)
(Increase) decrease in deferred tax asset............. 1,193 341 445
Hotel impairments..................................... 935 4,000 --
Depreciation and amortization......................... -- 3,010 2,896
Net change in other hotel assets and liabilities...... 676 1,473 282
Net change in energy assets and liabilities........... -- 11 (328)
-------- ------- --------
Net cash provided by (used in) operating
activities....................................... (5,067) 4,241 2,420
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in HRP affiliate............................... (3,417) -- --
Investments in textile products property and equipment.... (1,015) (1,735) (1,377)
Investments in hotel held for use......................... (3) (3) (54)
Payments for textile products business acquisition........ -- (1,479) --
Discontinued operations/Assets held for sale
Proceeds from sale of Hallwood Energy stock............. 18,000 303 --
Proceeds from noncompetition agreement.................. 7,250 -- --
Purchase of minority shares of HEC...................... -- (465) --
Investments in energy assets............................ -- -- (58)
Investments in hotel properties......................... -- (1,247) (807)
Net change in restricted cash from investing
activities............................................ -- 281 (274)
-------- ------- --------
Net cash provided by (used in) investing activities... 20,815 (4,345) (2,570)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings and loans payable........... 5,012 4,500 29,545
Repayment of bank borrowings and loans payable............ (18,149) (3,541) (12,667)
Purchase of common stock for treasury..................... (412) -- --
Payment of preferred stock dividend....................... (50) (50) (50)
Net change in restricted cash from financing activities... (29) (36) (901)
Redemption of 7% Debentures............................... -- -- (14,088)
Payment of deferred loan costs............................ -- -- (1,011)
Discontinued operations/Assets held for sale Repayment of
bank borrowings and loan payable........................ (15) (794) (521)
-------- ------- --------
Net cash provided by (used in) financing activities... (13,643) 79 307
-------- ------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ 2,105 (25) 157
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 901 926 769
-------- ------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 3,006 $ 901 $ 926
======== ======= ========

See accompanying notes to consolidated financial statements.
36

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

The Hallwood Group Incorporated ("Hallwood" or the "Company") (AMEX:HWG), a
Delaware corporation, is a holding company and classifies its operations into
two business segments: real estate and textile products. Financial information
for each industry segment is set forth in Note 19 to the consolidated financial
statements. In May 2001, the Company decided to discontinue and dispose of its
energy segment, accordingly, this former business segment has been reclassified
as a discontinued operation. The Company's energy revenues consisted of its pro
rata share of earnings of Hallwood Energy Corporation ("Hallwood Energy"), a
publicly traded oil and gas company, on the equity method of accounting. In
December 2000, the Company decided to discontinue and dispose of its hotel
segment, which at that time consisted of five hotel properties. Accordingly, the
Company's hotel operations were reclassified as a discontinued operation. Two
hotels were disposed of in 2001, one hotel was sold in January 2002 and one
hotel is planned for disposition in May 2002. The Company determined in late
2001 that it would retain and continue to operate a leasehold interest in one
hotel. Balance sheet presentation for the two remaining hotels which are
expected to be disposed of in 2002 "hotels held for sale" and for the leasehold
interest is "hotel assets held for use."

The Company's continuing real estate activities are conducted primarily
through wholly-owned subsidiaries. One of the subsidiaries serves as the general
partner of Hallwood Realty Partners, L.P. ("HRP"), a publicly traded master
limited partnership. Revenues are generated through the Company's pro rata share
of earnings of HRP on the equity method of accounting and the receipt of
management fees, leasing commissions and other fees from HRP and third parties.

The continuing textile products operations are conducted through the
Company's wholly owned Brookwood Companies Incorporated ("Brookwood")
subsidiary. Brookwood is a complete textile service firm that develops and
produces innovative fabrics and related products through specialized finishing,
treating and coating processes.

The significant accounting policies of the Company, which are in accordance
with accounting principles generally accepted in the United States of America,
are as follows:

(a) PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company
and its subsidiaries:

Ashford Bromley, Inc.
Brock Suite Greenville, Inc.
Brock Suite Hotels, Inc.
Brock Suite Huntsville, Inc.
Brock Suite Tulsa, Inc.
Brookwood Companies Incorporated
Brookwood Laminating, Inc.
HCRE California, Inc.
HEPGP Ltd. (through May 2001)
HWG, LLC
HWG 95 Advisors, Inc.
HWG 98 Advisors, Inc.
HWG Holding One, Inc.
HWG Holding Two, Inc.
HWG Realty Investors, LLC
HSC Securities Corporation
Hallwood Commercial Real Estate, LLC
Hallwood G.P., Inc. (through May 2001)

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Hallwood Hotels, Inc.
Hallwood Hotels -- OKC, Inc. (through June 2001)
Hallwood Hotels -- OKC Mezz, Inc (through June 2001)
Hallwood-Integra Holding Company
Hallwood Investment Company
Hallwood-Kenyon Holding Company
Hallwood Realty, LLC
Kenyon Industries, Inc.
Land and Ocean III, Inc.
XtraMile, Inc.

The Company fully consolidates all subsidiaries and records a minority
interest in those less than wholly owned. All significant intercompany balances
and transactions have been eliminated in consolidation.

(b) RECOGNITION OF INCOME

Fee income from real estate operations is recognized as the services (e.g.
management, leasing, acquisition, construction) are performed in accordance with
various service agreements.

Textile products sales are recognized upon shipment or release of product,
when title passes to the customer.

Common shares and other securities are recorded at fair value determined as
of the date acquired. Thereafter, equity accounting is utilized where the
Company exercises significant influence over the issuer's operating and
financial policies.

Real estate is carried at cost, including interest costs associated with
properties under development or renovation.

(d) INVESTMENT IN ENERGY AFFILIATE

Prior to the June 1999 Energy Consolidation, the Company consolidated its
energy operations. Subsequently, it utilized the equity method of accounting,
since the Company exercised significant influence over the operations and
financial policies of its energy affiliate.

(e) PURCHASE PRICE IN EXCESS OF FAIR VALUE OF NET ASSETS ACQUIRED

The purchase price in excess of fair value of net assets acquired in
business acquisitions is amortized over the expected period of benefit.

(f) IMPAIRMENT

The Company's management routinely reviews its investments for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. In the event such indicators exist for assets
held for use, and if undiscounted cash flows before interest charges are less
than carrying value, the asset is written down to estimated fair value. Assets
held for sale are carried at the lower of cost or estimated sales price less
costs of sale.

(g) DEPRECIATION AND AMORTIZATION

Depreciation of fee-owned hotel properties is computed on the straight-line
method over a period of twenty to twenty-five years for buildings, 5 to 20 years
for improvements, and three to ten years for furniture

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

and equipment. The excess of the Company's share of the underlying equity in the
net assets of Hallwood Realty Partners, L.P. ("HRP") over its investment is
amortized on a straight line basis over a period of 19 years. Amortization of
hotel leasehold interests is computed on the straight-line method over the
remaining lease term and varies from 6 to 10 years. Depreciation and
amortization of the hotels held for sale were discontinued in January 2001.

Depreciation of textile products buildings, equipment and improvements is
computed on the straight-line method. Buildings and improvements are depreciated
over a period of 15 to 20 years. Equipment is depreciated over a period of 3 to
10 years.

Expenditures for maintenance and repairs are charged to operations.
Renewals and betterments are capitalized and depreciated over the estimated
useful lives of the assets.

(h) INCOME TAXES

The Company files a consolidated federal income tax return. Deferred tax
assets and liabilities are recorded based on the difference between the tax
basis of assets and liabilities and their carrying amounts for financial
reporting purposes, referred to as temporary differences, net operating loss
carryforwards and tax credits reduced by a valuation allowance. Provision is
made for deferred taxes relating to temporary differences in the recognition of
income and expense for financial reporting.

(i) INVENTORIES

Inventories are valued at the lower of cost (first-in, first-out or
specific identification method) or market.

(j) STATEMENT OF CASH FLOWS

The Company considers its holdings of highly liquid debt and money market
instruments to be cash equivalents if such securities mature within ninety days
from the date of purchase.

(k) ENVIRONMENTAL REMEDIATION COSTS

The Company accrues for losses associated with environmental remediation
obligations when such losses are probable and can be reasonably estimated.
Accruals for estimated losses from environmental remediation obligations
generally are recognized no later than completion of the remedial feasibility
study. Such accruals are adjusted as further information develops or
circumstances change. Recoveries of environmental remediation costs from other
parties are recorded as assets when their receipt is deemed probable. Company
management is not aware of any environmental remediation obligations which would
significantly affect the operations, financial position or cash flow of the
Company.

(l) COMMON STOCK

The Company's Second Restated Certificate of Incorporation contains a
provision that restricts transfers of the Company's common stock in order to
protect certain federal income tax benefits.

(m) USE OF ESTIMATES

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(n) CONCENTRATION OF CREDIT RISK

The financial instruments of its wholly-owned subsidiaries which
potentially subject the Company to concentration of credit risk consist
principally of accounts receivable. The Company grants credit to customers based
on an evaluation of the customer's financial condition. Exposure to losses on
receivables is principally dependent on each customer's financial condition. The
Company controls its exposure to credit risks through credit approvals, credit
limits and monitoring procedures, and establishes allowances for anticipated
losses. Reserves are established for anticipated uncollectible amounts.

(o) COMPUTATION OF INCOME (LOSS) PER COMMON SHARE

Basic income (loss) per share is computed by dividing net income (loss)
available to common stockholders by the weighted average shares outstanding.

Income (loss) per common share assuming dilution is computed by dividing
net income (loss) available to common stockholders, adjusted for the impact of
convertible loans, by the weighted average of shares and potential shares
outstanding.

Convertible loans are considered to be potential common shares when the
Company reports income from continuing operations. The number of potential
common shares from assumed loan conversion is computed using the "if-converted
method" for the period during which the loans are outstanding. Stock options are
considered to be potential common shares. The number of potential common shares
from assumed exercise of options is computed using the "treasury stock method ."

(p) RECLASSIFICATIONS

Certain reclassifications have been made to prior year amounts to conform
to the classifications used in the current year.

(q) NEW ACCOUNTING PRONOUNCEMENTS

Statement of Financial Accounting Standards No. 143 -- Accounting for Asset
Retirement Obligations ("SFAS No. 143") was issued in June 2001, and will be
adopted by the Company on January 1, 2003. This Statement address financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. The
Company has not yet determined the effect adopting SFAS No. 143 will have on its
financial statements.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

abandoned, exchanged for a similar productive asset, or distributed to owners in
a spinoff be considered held and used until it is disposed of. The accounting
model for long-lived assets to be disposed of by sale is used for all long-lived
assets, whether previously held and used or newly acquired. The accounting model
retains the requirement of SFAS No. 121 to measure a long-lived asset classified
as held for sale at the lower of its carrying amount or fair value less cost to
sell and to cease depreciation. This statement requires that the current and
historical results of operations of disposed properties and assets classified as
held for sale, are classified as discontinued operations. This will result in
the reclassification of historical operations for property dispositions or
assets classified as held for sale that occur. The Company has elected to early
adopt the requirements of this statement and accordingly, the hotel assets
disposed of or to be disposed of have been reclassified into discontinued
operations as of and for each of the periods presented.

Statement of Financial Accounting Standards No. 133 -- Accounting for
Derivative Instruments and Hedging Activities ("SFAS No. 133") is effective for
all fiscal years beginning after June 15, 2000. SFAS No. 133 (as amended by SFAS
No. 137 -- Accounting for Derivative Instruments and Hedging Activities --
Deferral of the Effective Date of FASB Statement No. 133 and SFAS No.
138 -- Accounting for Certain Derivative Instruments and Certain Hedging
Activities (an amendment of FASB Statement No. 133), establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. All
derivatives, whether designated in hedging relationships or not, will be
required to be recorded on the balance sheet at fair value. If the derivative is
designated as a fair-value hedge, the changes in the fair value of the
derivative and the hedged item will be recognized in earnings. If the derivative
is designated as a cash flow hedge, changes in the fair value of the derivative
will be recorded in other comprehensive income and will be recognized in the
income statement when the hedged item affects earnings. These statements define
new requirements for designation and documentation of hedging relationships as
well as ongoing effectiveness assessments in order to use hedge accounting. For
a derivative that does not qualify as a hedge, changes in fair value will be
recognized in earnings.

The Company adopted these statements on January 1, 2001. In connection with
this adoption, all derivatives within the Company were identified pursuant to
SFAS No. 133 requirements. The Company determined it did not directly have any
derivative instruments, however HRP and Hallwood Energy do have such
instruments. Accordingly, the Company will be required to record its
proportional share of any impact of these instruments in accordance with the
equity method of accounting..

HRP determined it had one derivative, an interest rate cap. Since this
derivative was designated as a cash flow hedge, changes in the fair value of the
derivative, will be recognized in other comprehensive income until the hedged
item is recognized in earnings. Hedge effectiveness will be measured based on
the relative changes in the fair value between the derivative contract and the
hedged item over time. Any changes in fair value resulting from ineffectiveness,
as defined by SFAS No. 133, will be recognized immediately in current earnings.
The interest rate cap is highly effective and, accordingly, the impact of the
adoption of these standards is the amount of the difference between the carrying
value and the fair value of the interest rate cap.

Hallwood Energy determined that all of its oil and gas commodity swaps and
collars, as well as its interest rate swaps should be designated as cash flow
hedges. Since Hallwood Energy's derivatives were designated as cash flow hedges,
changes in the fair value of the derivatives were recognized in other
comprehensive income until the hedged item is recognized in earnings. Hedge
effectiveness was measured based on the relative changes in the fair value
between the derivative contract and the hedged item over time. Any changes in
fair value resulting from ineffectiveness, as defined by SFAS No. 133, were
recognized immediately in current earnings.

The adoption of SFAS No. 133 as of January 1, 2001 on the Company's
financial statements resulted in the recognition of net reductions in the
carrying value of its investments in Hallwood Energy and HRP, net-of-tax
cumulative effect adjustment of $4,035,000.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 2 -- INVESTMENTS IN REAL ESTATE AFFILIATE (DOLLAR AMOUNTS IN THOUSANDS):

DECEMBER 31, 2001 AMOUNT AT WHICH
------------------- CARRIED AT INCOME (LOSS) FOR YEARS
COST OR DECEMBER 31, ENDED DECEMBER 31,
BUSINESS SEGMENTS AND NUMBER ASCRIBED ---------------- ------------------------
DESCRIPTION OF INVESTMENTS OF UNITS VALUE 2001 2000 2001 2000 1999
-------------------------- -------- -------- ------- ------ ------- ------ -----

REAL ESTATE AFFILIATE
HALLWOOD REALTY PARTNERS, L.P.
-- General partner interest............ $ 8,650 $ 1,943 $2,529 $ 97 $ 11 $ 51
-- Limited partner interest............ 330,432 8,799 10,318 4,444 1,739 (173) 361
------- ------- ------ ------ ----- ----
Totals................................ $17,449 $12,261 $6,973 $1,836 $(162) $412
======= ======= ====== ====== ===== ====

The ownership percentages reported below assume conversion/exercise of all
convertible securities owned by the Company, but no conversion/exercise of any
of the convertible securities owned by any other holder of such securities.

(A) At December 31, 2001, the Hallwood Realty, LLC ("Hallwood Realty") and
HWG, LLC, wholly owned subsidiaries of the Company, owned a 1% general partner
interest and a 21% limited partner interest in its Hallwood Realty Partners,
L.P. ("HRP") affiliate, respectively.

In 1990, the Company, through a wholly owned subsidiary, acquired from
Equitec Financial Group, Inc. ("Equitec") the general partnership interests in
eight Equitec sponsored and managed limited partnerships for $8,650,000 and
consummated the consolidation of such limited partnerships into HRP. See Note
14. The Company subsequently acquired additional limited partner units of HRP in
direct and open market purchases. The Company accounts for its investment in HRP
using the equity method of accounting. In addition to recording its share of
HRP's net income (loss), the Company also records amortization of the amount
that the Company's share of the underlying equity in net assets of HRP exceeded
its investment on the straight line basis over 19 years, the carrying value of
which is $568,000 at December 31, 2001. The Company also records non-cash
adjustments for the elimination of intercompany profits with a corresponding
adjustment to equity income, its pro rata share of HRP's partner capital
transactions with corresponding adjustments to additional paid-in capital and
its pro rata share of HRP's comprehensive income. The cumulative amount of such
non-cash adjustments, from the original date of investment through December 31,
2001, resulted in a $1,658,000 decrease in the carrying value of the HRP
investment. In 2001 and 2000, the Company recognized an extraordinary loss of
$117,000 and $85,000, respectively, from the recognition of the Company's
pro-rata share of HRP's extraordinary losses from early extinguishment of debt
in each of those years. In 2001, the Company also recognized a loss from
cumulative effect of SFAS No. 133 adoption, from the recognition of the
Company's pro-rata share of HRP's loss from cumulative effect.

As further discussed in Note 18, the Delaware Court of Chancery rendered
its opinion regarding certain litigation involving the Company in July 2001. The
court determined that the defendants, including the Company, should pay to HRP a
judgment of $3,417,000 plus pre-judgment interest of approximately $2,891,000
from August 1995. The judgment amount, which represented the court's
determination of an underpayment by the Company for certain limited partnership
units purchased by the Company in 1995 from HRP, was considered additional
purchase price and was added to the Company's investment in the limited
partnership units. The interest component of the judgment was recorded as an
expense, net of the Company's pro rata share of the income that will be reported
by HRP. In October 2001, the Company paid $6,405,000,

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

including post-judgment interest, to HRP, subject to an arrangement that it be
returned in full or part if the judgment is modified or reversed on appeal.

The carrying value of the Company's investment in the general partner
interest of HRP includes the value of intangible rights to provide asset
management and property management services. Beginning in November 1993, the
Company commenced amortization, over a ten-year period, of that portion of the
general partner interest ascribed to the management rights and such amortization
was $672,000 for each of the years ended December 31, 2001, 2000 and 1999.

In December 1999, the Company distributed 82,608 HRP limited partner units
in connection with the separation agreement, associated with a former officer
and director of the Company discussed in Note 10. The Company has pledged 30,035
HRP limited partner units to secure all of the capital leases.

The quoted market price per unit and the carrying value per limited partner
unit (AMEX:HRY) at December 31, 2001 were $70.50 and $31.22, respectively. The
general partner interest is not publicly traded.

The following table sets forth summarized financial data of Hallwood Realty
Partners, L.P., obtained from Securities and Exchange Commission filings on Form
10-K, as of and for the three years ended December 31, 2001 (in thousands):

2001 2000 1999
-------- -------- --------

Balance Sheet Data
Real estate property, net.......................... $213,574 $206,392 $192,814
Total assets....................................... 269,875 254,504 230,386
Mortgages payable.................................. 201,224 200,096 171,312
Total partners' capital............................ 54,022 44,490 48,696
Statement of Operations Data
Revenue............................................ $ 74,584 $ 67,292 $ 59,645
Income before extraordinary loss and cumulative
effect of SFAS No. 133 adoption................. 9,079 90 4,062
Net income (loss).................................. 8,328 (299) 4,062

NOTE 3 -- RESTRICTED CASH

Restricted cash, of $966,000 and $937,000 at December 31, 2001 and 2000,
respectively, represents a deposit to secure a litigation claim.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4 -- LOANS PAYABLE

Loans payable at the balance sheet dates are as follows (in thousands):

DECEMBER 31,
-----------------
2001 2000
------- -------

Textile Products
Revolving credit facility, prime + .25% or Libor + 3.00%,
due December 2002...................................... $14,449 $10,937
Acquisition credit facility, prime + 1.00% Libor +3.25%,
due December 2002...................................... 1,000 1,000
Equipment term loan, 9.30% fixed rate, due October 2005... 806 973
Equipment credit facility, prime +.25% or Libor +2.75%,
due December 2002...................................... -- --
------- -------
16,255 12,910
Other
Convertible loan from stockholder, 10% fixed, repaid March
2002................................................... 1,500 2,500
Capital lease obligations, 12.18% fixed, due December
2004................................................... 1,386 1,774
Senior Secured Term Loan, 10.25% fixed, repaid June
2001................................................... -- 15,094
------- -------
2,886 19,368
------- -------
Total.................................................. $19,141 $32,278
======= =======

Further information regarding loans payable is provided below:

TEXTILE PRODUCTS

Revolving Credit Facility. In December 1999, the Company's Brookwood
subsidiary entered into a revolving credit facility in an amount up to
$17,000,000 with Key Bank National Association ("Key Credit Agreement") to
replace its former credit facility. Availability for direct borrowings and
letter of credit obligations under the Key Credit Agreement are limited to the
lesser of the facility amount or the borrowing base as defined in the agreement.
As of December 31, 2001, Brookwood had an additional $380,000 of borrowing base
availability. Borrowings are collateralized by accounts receivable, inventory
imported under trade letters of credit, certain finished goods inventory,
machinery and equipment and all of the issued and outstanding capital stock of
Brookwood and its subsidiaries. The loan agreement contains covenants, which
include maintenance of certain financial ratios, restrictions on dividends and
repayment of debt or cash transfers to the parent company. The outstanding
balance at December 31, 2001 was $14,449,000.

At June 30, 2000 and September 30, 2000, Brookwood was not in compliance
with a coverage ratio covenant contained in the Key Credit Agreement and
subsequently obtained waivers of the violations. The waivers provided for an
increase of 0.50% in interest rates on the revolving credit facility and the
acquisition credit facility, effective October 2000, restrictions on the
payments to the parent company and certain other restrictive provisions. Cash
dividends and tax sharing payments to the parent company are contingent upon
Brookwood's compliance with the covenants contained in the loan agreement. At
December 31, 2000, Brookwood was in compliance with its coverage ratio covenant,
however, Brookwood did not achieve its coverage ratio for the first quarter of
2001 and obtained a waiver. Brookwood was in compliance with its coverage ratio
covenant for the remainder of 2001.

Acquisition Credit Facility. The Key Credit Agreement provides for a
$2,000,000 acquisition revolving credit line. Brookwood borrowed $1,000,000
under this line during the year ended December 31, 2001. This

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

facility bears interest at one percent over the prime rate (5.75% and 10.50%, at
December 31, 2001 and 2000, respectively). The outstanding balance at December
31, 2001 was $1,000,000.

Equipment Credit Facility. The Key Credit Agreement provides for a
$2,000,000 equipment revolving credit line. Brookwood borrowed $1,000,000 under
this credit line. The facility bears interest at Libor plus 2.75 (4.18% and
9.37% at December 31, 2001 and 2000, respectively). In 2000 the $1,000,000
borrowing was converted into a term loan, at fixed rate of 9.37%, with a
maturity date of October 2005 and requires a monthly principal and interest
payment of $20,938. The outstanding balance at December 31, 2001 was $806,000.

The Company intends to extend or refinance their three revolving credit
facilities prior to its maturity in December 2002.

OTHER

Senior Secured Term Loan. In December 1999, the Company and its HWG, LLC
subsidiary entered into an $18,000,000 credit agreement with First Bank Texas,
N.A. and other financial institutions (the "Senior Secured Term Loan"). Proceeds
were used to repay the then outstanding 7% Debentures, a term loan and provide
working capital. The Senior Secured Term Loan bore interest at a fixed rate of
10.25%, was scheduled to mature in December 2004, was fully amortizing and
required a monthly payment of $385,000. Collateral was comprised of (i) 300,397
HRP limited partner units; (ii) 1,440,000 shares of Hallwood Energy common
stock; (iii) a senior lien on the capital stock of the Hallwood Hotels, Inc.
subsidiary; and (iv) a senior lien on the capital stock of the Brock Suite
Hotels, Inc. subsidiary. The Senior Secured Term Loan contained various
financial and non-financial covenants. The Senior Secured Term Loan was fully
repaid in May 2001 with a portion of the proceeds from the sale of the Company's
investment in Hallwood Energy.

Convertible Loans from Stockholder. In order to provide sufficient funds
to meet the Company's cash flow requirements and maintain compliance with the
loan covenants contained in the Senior Secured Term Loan, the Company entered
into three loan agreements with an entity associated with its chairman and
principal stockholder, Anthony J. Gumbiner. Loans payable at the balance sheet
dates are as follows (amounts in thousands, except conversion prices):

DECEMBER 31,
ORIGINAL CONVERSION ---------------
LOAN DATE LOAN AMOUNT PRICE REPAYMENT DATE 2001 2000
--------- ----------- ---------- -------------- ------ ------

March 2001...................... $1,500 $6.12 March 2002 $1,500 $ --
September 2000.................. 1,000 6.47 December 2001 -- 1,000
March 2000...................... 1,500 10.13 December 2001 -- 1,500
------ ------ ------
$4,000 $1,500 $2,500
====== ====== ======

Significant terms included: (i) term of five years; (ii) fixed interest
rate of 10%; (iii) interest and principal payments deferred until maturity; (iv)
unsecured; and (v) convertible into common stock after a one-year period from
the date of issuance at a conversion price equal to 115% of the market price on
the date each of the loans was approved by the Company's independent board
members. Two loans were repaid in December 2001 in the amount of $2,881,000,
which represented principal of $2,500,000 and accrued interest of $381,000. The
remaining loan was repaid in March 2002 in the amount of $1,648,000, which
represented principal of $1,500,000 and accrued interest of $148,000.

Capital Lease Obligations. During 1999, the Company's Brock Suite Hotels
subsidiaries entered into three separate five-year capital leasing agreements
for furniture, fixtures and building improvements at a cost of $2,085,000 for
three GuestHouse Suites Plus properties. The Company has pledged 30,035 HRP
limited partner units as additional collateral to secure the leases. The lease
terms commenced January 2000 and

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

expire in December 2004. The combined monthly lease payment is $46,570 and the
effective interest rate is 12.18%. The outstanding balance at December 31, 2001
was $1,386,000.

In March 2002, the Company and its HWG, LLC subsidiary entered into a
$7,000,000 credit agreement with First Bank & Trust , N.A. (the "Term Loan and
Revolving Credit Facility"). The facility is comprised of a $3,000,000 term loan
and a $4,000,000 revolving credit facility. The term loan proceeds were used in
part to repay the aforementioned $1,500,000 convertible loan from stockholder in
March 2002, bears interest at a fixed rate of 7%, matures April 1, 2005 and is
fully amortizing requiring a monthly payment of $92,631. The revolving credit
facility bears interest at the Company's option of one-half percent over prime,
or Libor plus 3.25%, and matures April 1, 2005. Collateral for the Term Loan and
Revolving Credit Facility is 300,397 HRP limited partner units. The credit
agreement contains various financial and non-financial covenants, including the
maintenance of certain financial ratios, restrictions on certain new
indebtedness and the payment of dividends. The Company has not drawn any funds
on the revolving credit facility, and therefore has $4,000,000 of unused
borrowing capacity.

Schedule of Maturities. Maturities of loans payable and 10% Debentures for
the next five years are presented below (in thousands):

CAPITAL
YEARS ENDED TEXTILE STOCKHOLDER LEASE 10%
DECEMBER 31, PRODUCTS LOANS OBLIGATIONS DEBENTURES TOTAL
------------ -------- ----------- ----------- ---------- -------

2002............................. $15,632 $1,500 $ 398 $ -- $17,530
2003............................. 201 -- 464 -- 665
2004............................. 221 -- 524 -- 745
2005............................. 201 -- -- 6,468 6,669
2006............................. -- -- -- -- --
------- ------ ------ ------ -------
Total....................... $16,255 $1,500 $1,386 $6,468(a) $25,609(b)
======= ====== ====== ====== =======

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

(a) Maturity of 10% Debentures excludes unamortized gain of $209,000.

(b) Excludes $11,609,000 of debt associated with the Company's discontinued
hotel segment, which is considered currently payable due to the existing
loan defaults.

NOTE 5 -- DEBENTURES

10% Subordinated Debentures. The Company has outstanding an issue of 10%
Collateralized Subordinated Debentures ("10% Debentures"), due July 31, 2005.
The 10% Debentures are listed on The New York Stock Exchange. For accounting
purposes, a pro rata portion of an unamortized gain in the original amount of
$353,000 is being amortized over its term using the effective interest method.
As a result, the effective interest rate for financial reporting is 8.9%. The
10% Debentures are secured by a junior lien on the capital stock of the
Brookwood subsidiary and certain hotel subsidiaries. Balance sheet amounts for
the 10% Debentures are detailed below (in thousands):

DECEMBER 31,
---------------
2001 2000
------ ------

10% Debentures (face amount)................................ $6,468 $6,468
Unamortized gain, net of accumulated amortization........... 209 257
------ ------
Total..................................................... $6,677 $6,725
====== ======

As a result of certain hotel properties of the Company being placed into
receivership, as further discussed in Note 6, the Company determined that a
technical default occurred under the terms of the Indenture for the

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10% Debentures. The Indenture provides that upon the occurrence of the default,
the principal and accrued interest on the 10% Debentures shall automatically
become due and payable. The trustee for the 10% Debentures, mailed a notice (the
"Notice") to debentureholders on July 27, 2001, informing the holders of the
default. The Notice stated that the holders of a majority of the outstanding
principal amount of the 10% Debentures, on behalf of all holders, may waive the
default, rescind and annul the declaration of acceleration and its consequences.
On October 22, 2001, the Company announced that a solicitation of its
bondholders, which began on September 24, 2001, was completed and that
bondholders consented to grant the waiver and rescind and annul the
acceleration. The overdue interest was subsequently deposited with the Trustee
and was paid on November 30, 2001 to holders of record on November 20, 2001. The
payment consisted of interest that was to have been paid on July 31, 2001 and
October 31, 2001, which the Company was prohibited from paying by the Indenture
during the default, together with default interest on these amounts at the rate
of 10% per annum. The normal quarterly interest payments resumed on January 31,
2002.

7% Collateralized Senior Subordinated Debentures. In March 1993, the
Company completed an exchange offer whereby $27,481,000 of its then outstanding
13.5% Debentures were exchanged for a new issue of 7% Collateralized Senior
Subordinated Debentures due July 31, 2000 (the "7% Debentures"), and purchased
for cash $14,538,000 of its 13.5% Debentures at 80% of face amount. Concessions
given the Company from the 13.5% debentureholders in the 1993 exchange offer
were accounted for as a modification of an existing obligation and no current
period gain was recognized. The unrecognized gain of $4,220,000, was amortized,
using the constant effective interest rate method over the term of the 7%
Debentures. The total unrecognized gain was recorded as an increase to the
carrying value of the 7% Debentures, and was amortized as a reduction of
interest expense. This amortization resulted in an effective interest rate of
approximately 4.2% for the 7% Debentures. The amortization of such unrecognized
gain was $399,000 for the year ended December 31, 1999.

In December 1999, the Company announced the full redemption (the
"Redemption") of its outstanding 7% Debentures of $14,088,000, which occurred in
January 2000 (the "Redemption Date"). The redemption price was 100% of the face
amount plus accrued and unpaid interest to the Redemption Date. Funding for the
Redemption was provided by proceeds from the new Senior Secured Term Loan. In
accordance with the terms of the indenture, the funds were irrevocably
transferred to the trustee in December 1999, and the obligation was effectively
extinguished and collateral released. The Redemption was actually completed by
the trustee in January 2000, at which time the 7% Debentures were retired and
canceled. The Company recognized an extraordinary gain from debt extinguishment
of $240,000 during 1999 from the Redemption, representing the remaining balance
of the unrecognized gain at that date.

NOTE 6 -- DISCONTINUED OPERATIONS -- HOTEL ASSETS HELD FOR SALE

The Company's hotel segment experienced cash flow difficulties during 2000
due to weaker occupancy and average daily rates. In December 2000, the Company
decided to discontinue and dispose of its hotel segment, principally by allowing
its non-recourse debtholders to assume ownership of the properties through
foreclosure or by selling or otherwise disposing of its hotel properties. The
Company's hotel segment consisted of three owned properties and two leased
properties. The capital lease obligations will be repaid by the sale of leased
property or other considerations.

The Company determined that it would retain ownership of the leasehold
interest in the GuestHouse Suites hotel in Huntsville, Alabama. The Company
continues to operate the hotel, subject to significant lease concessions by the
landlord. Accordingly, this hotel has been classified as an asset held for use.
Prior year operating results for the hotel have been reclassified to continuing
operations in the "other" segment. The carrying value the hotel held for use was
$331,000 and $438,000, at December 31, 2001 and 2000, respectively.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A summary of the loss from hotel operations held for sale are detailed
below (in thousands):

YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------

Sales................................................... $ 7,619 $16,839 $20,280
Gain from extinguishment of debt........................ 216 -- --
------- ------- -------
7,835 16,839 20,280
------- ------- -------
Expenses
Operating expenses.................................... 6,822 14,746 17,117
Interest expense...................................... 1,848 2,607 2,495
Impairment............................................ 935 3,320 --
Deferred income taxes (benefit)....................... (600) 341 445
Other disposition costs............................... 214 115 --
Depreciation and amortization......................... -- 2,683 2,708
------- ------- -------
9,219 23,812 22,765
------- ------- -------
(Loss) from discontinued hotel operations............. $(1,384) $(6,973) $(2,485)
======= ======= =======

In January 2001, a receiver was appointed to administer the disposition of
the GuestHouse Suites hotel in Greenville, South Carolina. In February 2001, the
Company signed an Agreement to Terminate Lease with the landlord of the Holiday
Inn and Suites Hotel in Sarasota, Florida. In March 2001, receivers were
appointed to administer the disposition of the GuestHouse Suites Plus hotel in
Tulsa, Oklahoma and the Airport Embassy Suites Hotel in Oklahoma City, Oklahoma,
respectively.

In June 2001, the Company entered into a settlement agreement with the
mezzanine lender whereby 1) the Company transferred to the lender the stock
ownership of Hallwood Hotels -- OKC, Inc., the entity that owned the Embassy
Suites hotel and 2) the mezzanine lender released the Company from its
obligations under the first mortgage and the mezzanine loan. The Company
continues to have certain contingent obligations with respect to limited matters
such as environmental contamination, but management is not aware of any
circumstances which would initiate a claim. The Company reported the transaction
as an extinguishment of debt and recorded a gain $216,000 (net of $100,000
deferred tax expense).

In January 2002, with assistance and consent of the mortgage lender, the
Company sold the GuestHouse Suites hotel in Tulsa, Oklahoma for $3,000,000. The
Company received no cash proceeds from the sale. In connection with the sale,
the parties entered into a loan modification and assumption agreement which,
among other terms, included a release that discharges the Company from any
further loan obligation associated with the Tulsa hotel. It is anticipated that
the Company will recognize a gain from extinguishment of debt of approximately
$1,600,000, net of tax, in 2002.

In February 2002, the mortgage lender for the GuestHouse Suites hotel in
Greenville, South Carolina obtained a court judgement of foreclosure on its
mortgage. A foreclosure sale is scheduled for May 2002. In connection with the
foreclosure, the lender has waived its right to a deficiency judgement against
the Company. It is anticipated that the Company will recognize a gain from
extinguishment of debt of approximately $1,900,000, net of tax, in 2002.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A summary of the non-recourse loans payable associated with the hotels held
for sale is detailed below (in thousands):

DECEMBER 31,
-----------------
DESCRIPTION LOCATION 2001 2000
----------- ----------------- ------- -------

Term loan, 7.86% fixed, due January 2008..... Greenville, SC $ 6,514 $ 6,512
Term loan, 8.20% fixed, due November 2007.... Tulsa, OK 5,095 5,093
Term loan, 7.5%, fixed, due October 2008..... Oklahoma City, OK -- 16,742
Term loan, Libor + 7.5%, due October 2005.... Oklahoma City, OK -- 1,003
------- -------
Total...................................... $11,609 $29,350
======= =======

The Company has been released from all its mortgage obligations. However,
the owner of the Longboat Key Holiday Inn hotel has made a claim against the
Company under a guaranty which is in discovery, and the franchiser of the
Embassy Suites hotel has made a claim for liquidated damages under a franchise
contract which is in mediation.

NOTE 7 -- DISCONTINUED OPERATIONS -- ENERGY

In March 2001, the Company agreed to sell its investment in its Hallwood
Energy affiliate, which represented the Company's energy operations to Pure
Resources II, Inc., an indirect wholly owned subsidiary of Pure Resources, Inc.,
subject to Hallwood Energy's shareholder approval which was obtained in May
2001. The all-cash transaction was structured as a first step tender offer
followed by a cash merger to acquire all remaining shares of Hallwood Energy.
Pure commenced its tender offer in April 2001, with an expiration date of May 8,
2001. On May 9, 2001, Pure announced that it had successfully completed its
tender offer, and had acquired approximately 85% of the Hallwood Energy common
stock and 78% of the Hallwood Energy preferred stock. The Company received
$18,000,000 for the tender of its 1,440,000 shares of common stock in May 2001
and received an additional amount of $7,250,000, pursuant to the terms of a
noncompetition agreement that was paid by Pure upon the completion of the merger
in June 2001.

Under the noncompetition agreement, the Company agreed to refrain from
taking certain actions without the prior written consent of Pure and Hallwood
Energy. These covenants were made by the Company in consideration of the
transactions contemplated by the merger agreement and the payment by Pure to the
Company. For a period of three years after the effective date of the merger
agreement, the Company will not, directly or indirectly, engage in oil and gas
activities in certain geographic areas without the prior consent of Pure. The
Company has also agreed to keep Hallwood Energy's confidential and proprietary
information strictly confidential.

Accordingly, energy operations have been segregated from the Company's
continuing operations and reported as a single line item -- Income from
Discontinued Operations. A summary of the net assets as of the balance sheet
dates and income from discontinued energy operation, are detailed below (in
thousands):

DECEMBER 31,
--------------
2001 2000
----- ------

Investment in Hallwood Energy............................... $ -- $7,403
Deferred tax asset.......................................... -- 1,793
----- ------
Net assets of discontinued energy operations.............. $ -- $9,196
===== ======

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

YEARS ENDED DECEMBER 31,
-------------------------
2001 2000 1999
------- ------ ------

Revenue
Gain on sale of investment in Hallwood Energy........... $ 8,725 $ -- $ --
Equity income from investment in Hallwood Energy........ 1,837 2,826 380
Oil and gas revenues and other income................... -- -- 2,515
------- ------ ------
10,562 2,826 2,895
Expenses
Deferred federal income tax (benefit)................... (672) -- --
State income tax expense................................ 100 -- --
Interest expense........................................ -- -- 275
Depreciation depletion and amortization................. -- -- 849
Operating and administrative expenses................... -- -- 1,333
------- ------ ------
(572) -- 2,457
------- ------ ------
Income from discontinued energy operations........... $11,134 $2,826 $ 438
======= ====== ======

The Company began amortizing the deferred revenue from the noncompetition
agreement in the amount of $7,250,000, over a three-year period commencing June
2001. The amortization is being reported in the "other" section of the statement
of operations.

In June 1999, Hallwood Energy Corporation, a new publicly traded entity
("Hallwood Energy"), completed a consolidation of its affiliated Hallwood Energy
Partners, L.P. ("HEP") and Hallwood Consolidated Resources Corporation ("HCRC")
and the energy interests of the Company (the "Energy Consolidation"). The
Company received 1,800,000 shares of common stock (18% of the total outstanding)
and 43,816 shares of preferred stock (1.9% of the total outstanding) in Hallwood
Energy, in exchange for the contribution its energy interests. In December 1999,
the Company distributed 360,000 shares of Hallwood Energy common stock in
connection with the Separation Agreement, and in February 2000, sold all of its
preferred stock to Hallwood Energy at its carrying value. As of the June 1999,
the Company no longer consolidated its energy business.

The Company subsequently accounted for its investment using the equity
method of accounting, as the Company exercised significant influence over
Hallwood Energy's operational and financial policies. The Company's share of the
underlying equity in net assets of Hallwood Energy exceeded its investment by
$4,391,000, which was being amortized at a rate which approximated the depletion
rate of Hallwood Energy's reserves. In addition to recording its share of
Hallwood Energy's net income available to common stockholders, the Company also
recorded its preferred dividends prior to the February 2000 sale of its
preferred stock. The Company also recorded its pro rata share of any capital
transactions and other comprehensive income.

NOTE 8 -- REDEEMABLE PREFERRED STOCK

The Company has outstanding 250,000 shares of preferred stock (the "Series
B Preferred Stock"). The holders of Series B Preferred Stock are entitled to
dividends in an annual amount of $0.20 per share (total annual amount of
$50,000), which have been paid in each of the years between 1996 and 2001. For
the first five years, dividends were cumulative and the payment of cash
dividends on any common stock was prohibited before the full payment of any
accrued dividends. Beginning in 2001 dividends will accrue and be payable only
if and when declared by the Board of Directors. The Series B Preferred Stock
also has dividend and liquidation preferences to the Company's common stock. The
shares are subject to mandatory redemp-

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

tion 15 years from the date of issuance, at 100% of the liquidation preference
of $4.00 per share plus all accrued and unpaid dividends, and may be redeemed at
any time on the same terms at the option of the Company. The holders of the
shares of Series B Preferred Stock are not entitled to vote on matters brought
before the Company's stockholders, except as otherwise provided by law.

NOTE 9 -- STOCKHOLDERS' EQUITY

Common Stock. The Company's Second Restated Certificate of Incorporation
contains a provision that restricts transfers of the Company's common stock in
order to protect certain federal income tax benefits.

Preferred Stock. Under its Second Restated Certificate of Incorporation
the Company is authorized to issue 500,000 shares of preferred stock, par value
$.10 per share, and did issue 250,000 shares of Series B Preferred Stock.

Treasury Stock. During December 2001, the Company repurchased 63,400
shares of its common stock from its principal stockholder, Anthony J. Gumbiner
for $412,000, the same amount paid by the stockholder to purchase the shares in
October 2001 from an unrelated third party. During 1999, the Company redeemed
457,794 shares of common stock in connection with the separation agreement
discussed in Note 10. As of December 31, 2001 and 2000, the Company held
1,034,760 and 971,360 treasury shares, respectively.

Stock Options. All options under the 1995 Stock Option Plan for The
Hallwood Group Incorporated are nonqualified stock options. The exercise prices
of all options granted were at the fair market value of the Company's common
stock on the date of grant, expire ten years from date of grant and were fully
vested and exercisable on the date of grant. In May 2000, the Board of Directors
granted the remaining 70,800 available options to purchase common stock under
the 1995 Stock Option Plan. During 1999, the Company reacquired 55,800 options
from its former president, pursuant to the separation agreement.

A summary of options granted and the changes therein during the three years
ended December 31, 2001 are presented below:

YEARS ENDED DECEMBER 31,
------------------------------------------------------------
2001 2000 1999
------------------ ------------------ ------------------
WEIGHTED WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------- -------- ------- -------- ------- --------

Outstanding, beginning of
year...................... 204,000 $12.23 133,200 $13.25 189,000 $13.06
Granted..................... -- -- 70,800 10.31 -- --
Exercised................... -- -- -- -- -- --
Forfeited................... -- -- -- -- -- --
Reacquired.................. -- -- -- -- (55,800) 12.60
------- ------ ------- ------ ------- ------
Outstanding, end of year.... 204,000 $12.23 204,000 $12.23 133,200 $13.25
======= ====== ======= ====== ======= ======
Options exercisable, at end
of year................... 204,000 $12.23 204,000 $12.23 133,200 $13.25
======= ====== ======= ====== ======= ======

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Below is the status of the 1995 Stock Option Plan as of December 31, 2001:

Total authorized.................... 204,000
Less: Number granted, not exercised:
May 2000....................... (70,800) Exercise price of $10.31, expiring
May 2010
September 1997................. (66,600) Exercise price of $17.37, expiring
September 2007
February 1997.................. (12,375) Exercise price of $15.00, expiring
February 2007
September 1996................. (41,850) Exercise price of $7.83, expiring
September 2006
June 1995...................... (12,375) Exercise price of $7.67, expiring
June 2005
--------
Sub-total................. (204,000)
--------
Total available..................... --
========

The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 -- Accounting for Stock Based
Compensation ("SFAS No. 123"). Accordingly, no compensation cost has been
recognized for the options. Had compensation costs for the options been
determined, based on the fair value at the grant date, for the awards under the
1995 Stock Option Plan consistent with the provisions of SFAS No. 123, the
Company's net income (loss) and net income (loss) per share for the year ended
December 31, 2000 would have been the pro forma amounts indicated below (in
thousands, except per share amounts):

Net income (loss) available to common stockholders -- as
reported.................................................. $(4,917)
Net income (loss) available to common stockholders -- pro
forma..................................................... $(5,316)
Net income (loss) per common share -- as reported
Basic..................................................... (3.45)
Assuming dilution......................................... (3.45)
Net income (loss) per common share -- pro forma
Basic..................................................... (3.73)
Assuming dilution......................................... (3.73)

The fair value of options granted are estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions: expected
volatility of 55%, risk-free interest rate of 6.0%-6.7%, expected life of 5
years and no distribution yield. The Company issued options for 70,800 shares of
common stock in 2000 which vested immediately and did not issue options during
2001 or 1999. The weighted average fair value of the options granted during 2000
was $399,000. All options previously issued were fully vested.

Income (Loss) Per Common Share. The following table reconciles the
Company's income (loss) from continuing operations to income (loss) from
continuing operations available to common stockholders

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

assuming dilution, and the number of common shares used in the calculation for
the basic and assuming dilution methods (in thousands):

YEARS ENDED DECEMBER 31,
------------------------
2001 2000 1999
------- ----- ------

INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS
Income (loss) from continuing operations................... $(4,548) $(635) $3,526
Less dividend on preferred stock........................... (50) (50) (50)
------- ----- ------
Income (loss) from continuing operations available to
common stockholders -- basic............................. $(4,598) $(685) $3,476
======= ===== ======
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic...................................................... 1,420 1,425 1,870
Assumed issuance of shares from exercise of stock
options.................................................. -- -- 82
Assumed repurchase of shares from stock options proceeds... -- -- (53)
------- ----- ------
Assuming dilution.......................................... 1,420 1,425 1,899
======= ===== ======

Due to the loss from continuing operations in 2001 and 2000, all common
stock equivalents are anti-dilutive.

NOTE 10 -- COST OF SEPARATION AGREEMENT

In 2001, the Company recorded an additional loss of $500,000, which
represents an increase in the deferred purchase price for anticipated payments
to Epsilon Trust in 2002, applicable to its 20% share of net cash flow from the
Company's real estate management activities.

In May 1999, the Company announced that it had reached an agreement with
Mr. Brian M. Troup, former president and director of the Company, regarding a
separation of their interests (the "Separation Agreement"). In exchange for
stock and options of the Company held by Mr. Troup and Epsilon Trust, the
Company transferred certain assets to the trust or Mr. Troup resulting in a loss
of $1,769,000 in 1999. In addition, the Company agreed to pay quarterly to Mr.
Troup the lesser of 20% of the net cash flow from its real estate management
activities for the preceding quarter or $125,000, subject to termination in
certain events.

NOTE 11 -- INCOME TAXES

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

YEARS ENDED DECEMBER 31,
--------------------------
CONTINUING OPERATIONS 2001 2000 1999
--------------------- ------ ------- -------

Federal
Deferred............................................... $2,121 $(1,546) $(1,318)
Current................................................ 58 46 71
------ ------- -------
Sub-total........................................... 2,179 (1,500) (1,247)
State.................................................... 244 290 233
------ ------- -------
Total............................................... $2,423 $(1,210) $(1,014)
====== ======= =======

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

YEARS ENDED DECEMBER 31,
---------------------------
DISCONTINUED OPERATIONS 2001 2000 1999
----------------------- ------- ------- -------

Federal
Deferred.............................................. $(1,272) $ 341 $ 445
Current............................................... -- -- --
------- ------- -------
Sub-total............................................. (1,272) 341 445
State................................................... 100 -- --
------- ------- -------
Total................................................. $(1,172) $ 341 $ 445
======= ======= =======

YEARS ENDED DECEMBER 31,
---------------------------
EXTRAORDINARY ITEMS 2001 2000 1999
------------------- ------- ------- -------

Federal
Deferred.............................................. $ 100 $ -- $ --
======= ======= =======

Reconciliations of the expected tax (or benefit) at the statutory tax rate
to the effective tax or (benefit) are as follows (in thousands):

YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------

Expected tax (benefit) at the statutory tax rate........ $ 1,930 $(1,949) $ 391
Increase (decrease) in deferred tax asset valuation
allowance............................................. (1,489) 928 (3,607)
State taxes............................................. 227 191 154
Foreign loss not taxable................................ 121 50 3
Redemption of treasury stock............................ -- -- 2,639
Alternative minimum tax................................. -- -- 71
Other................................................... 562 (89) (220)
------- ------- -------
Effective tax or (benefit)............................ $ 1,351 $ (869) $ (569)
======= ======= =======

As a result of the expected gains from the Company's plan to dispose of
certain hotels, the appreciation in the market value of the HRP limited partner
units and projected income from continuing operations, management has determined
that the deferred tax asset should be adjusted to reflect the anticipated
utilization of net operating loss carryforwards ("NOLs") from assumed
realization of the gains and projected income from continuing operations.
Accordingly, the Company recorded a deferred tax expense of $949,000 in 2001,
and a deferred tax benefit of $1,205,000 in 2000 and $873,000 in 1999, which
adjusted the deferred tax asset to $7,477,000 ($1,800,000 attributable to hotels
held for sale) at December 31, 2001 from $8,426,000 ($1,300,000 attributable to
hotels held for sale and $1,793,000 to discontinued energy operations) at
December 31, 2000, and increased it to $7,221,000 ($1,641,000 attributable to
discontinued operations) at December 31, 1999 from $6,348,000 at December 31,
1998.

Although the Company reported significant taxable income in 2001 as a
result of the sale of its investment in Hallwood Energy, it incurred no federal
alternative minimum tax due to a change in the tax law affecting the calculation
of the alternative minimum tax, however current federal taxes of $58,000 were
incurred by subsidiaries. For 2000, the Company incurred no federal alternative
minimum tax, due to federal tax losses, however $46,000 was incurred by
subsidiaries. The Company incurred a federal alternative minimum tax of $71,000
in 1999, due to utilization of NOLs to offset taxable income. The accrued
federal

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

income tax (receivable) payable was $(358,000) and $98,000, and for state taxes
was $210,000 and $125,000 at December 31, 2001 and 2000, respectively.

A schedule of the types and amounts of existing temporary differences and
NOL's, at the blended statutory tax rate of 34%, tax credits and valuation
allowance as of the balance sheet dates are as follows (in thousands):

DEFERRED TAX ASSET, NET
-----------------------------------------------
DECEMBER 31, 2001 DECEMBER 31, 2000
---------------------- ----------------------
ASSETS LIABILITIES ASSETS LIABILITIES
-------- ----------- -------- -----------

Basis differences........................... $ 12,999 $ -- $ 13,563 $ --
Net operating loss carryforward............. 12,739 -- 17,175 --
Equity in earnings of unconsolidated
affiliates................................ 3,540 -- 1,086
Tax credits................................. 2,212 -- 3,044 --
Reserves recorded for financial statement
purposes and not for tax purposes......... 2,093 -- 1,905 --
Original issue discounts and cancellation of
debt income on debentures................. 712 -- 708 --
Depreciation and amortization............... -- 475 619 --
Other temporary differences................. -- 233 97 --
-------- ---- -------- ------
Deferred tax assets and liabilities......... 34,295 $708 37,111 $1,086
==== ======
Less: Deferred tax liabilities.............. (708) (1,086)
-------- --------
33,587 36,025
Less: Valuation allowance................... (26,110) (27,599)
-------- --------
Deferred tax asset, net................ $ 7,477(a) $8,426(b)
======== ========

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

(a) $5,667,000 is attributable to continuing operations and $1,800,000 to
hotels held for sale.

(b) $5,333,000 is attributable to continuing operations, $1,300,000
attributable to hotels held for sale and $1,793,000 attributable to
discontinued energy operations.

Below is a schedule of expiring NOLs for tax purposes by year (in
thousands):

YEARS ENDING
DECEMBER 31, AMOUNT
------------ -------

2006........................................................ $ 6,755
2007........................................................ 8,517
2008........................................................ 12,896
2009........................................................ 6,916
2010........................................................ 1,346
2020........................................................ 1,037
-------
Total.................................................. $37,467
=======

In addition, the Company has approximately $2,212,000 of alternative
minimum tax credits, which have no expiration date, and a depletion carryforward
of approximately $6,323,000, which may be used to offset future taxable income
without an expiration limitation.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Current tax laws and regulations relating to specified changes in ownership
may limit the Company's ability to utilize its NOLs and tax credit
carryforwards. As of December 31, 2001, management was not aware of any
ownership changes which would limit the utilization of the NOLs and tax credit
carryforwards.

NOTE 12 -- EXTRAORDINARY GAIN (LOSS) FROM EARLY EXTINGUISHMENT OF DEBT

In the year ended December 31, 2001, the Company recognized an
extraordinary loss from early extinguishment of debt of $917,000. The loss
resulted from (i) the write off of $800,000 in unamortized deferred loan costs
associated with the repayment of the Senior Secured Term Loan, and (ii) a
$117,000 loss from of the Company's pro rata share of a $559,000 extraordinary
loss reported by HRP during 2001.

In the year ended December 31, 2000, the Company recognized an
extraordinary loss from early extinguishment of debt of $85,000, which
represented the Company's pro-rata share of an extraordinary loss from early
extinguishment of debt reported by HRP. In the year ended December 31, 1999, the
Company recognized an extraordinary gain from early debt extinguishment of
$240,000 from the redemption of the 7% Debentures.

NOTE 13 -- SUPPLEMENTAL DISCLOSURES TO THE CONSOLIDATED STATEMENTS OF CASH FLOWS

Supplemental schedule of non-cash investing and financing activities. The
following transactions affected recognized assets or liabilities but did not
result in cash receipts or cash payments (in thousands):

YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
-------- ------ -------

Recording of proportionate share of stockholders'
equity/partners' capital transactions of equity
investments
Adoption of SFAS No. 133
Cumulative effect.................................. $ (4,035) -- --
Realized upon disposition of Hallwood Energy....... 3,009 -- --
Change in fair value of derivatives................ 1,302 -- --
Amortization of interest rate swap................. (26) -- --
-------- ------ -------
Accumulated other comprehensive income............. $ 250 -- --
======== ====== =======
Other
HRP................................................ $ -- $ 291 $ --
Hallwood Energy.................................... (36) 36 --

Hotel assets and liabilities relinquished in connection
with debt extinguishment
Loans payable......................................... $ 17,726 $ -- $ --
Other liabilities, net................................ 398 -- --
Hotel properties...................................... (17,808) -- --
Deferred tax asset.................................... (100) -- --
-------- ------ -------
$ 216 -- --
======== ====== =======

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
-------- ------ -------

Assets exchanged in connection with the separation
agreement
Investment in HRP..................................... -- -- $ 4,172
Investment in Hallwood Energy......................... -- -- 1,665
Interest in all condominium hotel assets.............. -- -- 1,723
Present value of future cash payments................. -- -- 3,197
-------- ------ -------
-- -- $10,757
======== ====== =======
Conversion of energy investment to equity method
Oil and gas properties................................ -- -- $10,809
Current assets of HEP................................. -- -- 3,267
Noncurrent assets of HEP.............................. -- -- 1,194
Receivables and other assets.......................... -- -- 64
Long-term obligations of HEP.......................... -- -- (6,872)
Current liabilities of HEP............................ -- -- (2,160)
Accounts payable and accrued expenses................. -- -- (602)
-------- ------ -------
-- -- $ 5,700
======== ====== =======
Hotel furniture, fixtures and improvements acquired by
capital lease......................................... -- -- $ 2,085

Supplemental disclosures of cash payments.
Interest paid........................................... $ 3,474 $6,143 $ 5,620
Income taxes paid....................................... 738 397 965

NOTE 14 -- ORGANIZATION AND OPERATIONS OF HALLWOOD REALTY PARTNERS, L.P.

Organization. In 1990, the Company, through a wholly owned subsidiary,
acquired from Equitec Financial Group, Inc. ("Equitec"), the general partnership
interests in eight Equitec sponsored and managed limited partnerships for
$8,650,000 and consummated the consolidation of such partnerships into Hallwood
Realty Partners, L.P. ("HRP"). The Company subsequently acquired additional
limited partner units of HRP in direct and open market purchases. During 1998,
management completed a consolidation of the Company's real estate assets into a
new structure involving several new wholly owned entities. Following the
completion of the consolidation, the general partner interest is owned by
Hallwood Realty, LLC ("Hallwood Realty") and the limited partner interest is
owned by HWG, LLC. The consolidation did not affect the carrying value of the
investments.

Operations. As general partner, Hallwood Realty earns an asset management
fee and related fees from HRP properties, which amounted to $609,000, $655,000
and $619,000 for the years ended December 31, 2001, 2000 and 1999, respectively.

The Company's Hallwood Commercial Real Estate, LLC ("HCRE") subsidiary is
responsible for day-to-day on-site property management at all of HRP's
properties for which HCRE receives management fees, leasing commissions and
other fees. HCRE earned fees and commissions from HRP and other third parties
aggregating $5,949,000, $5,993,000 and $8,472,000 during the years ended
December 31, 2001, 2000 and 1999, respectively.

Other. In accordance with the terms of the Separation Agreement, the
Company distributed 82,608 HRP limited partner units to the Epsilon Trust in
December 1999, all of which were repurchased by HRP in

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

May 2000. As of December 31, 2001, the Company owns 330,432 HRP limited partner
units (21% of the total outstanding).

NOTE 15 -- ORGANIZATION AND OPERATIONS OF BROOKWOOD COMPANIES INCORPORATED

Organization. Brookwood Companies Incorporated, a wholly owned subsidiary
of the Company ("Brookwood"), was formed in March 1989 to acquire certain assets
and assume certain liabilities of a nylon textile converting and finishing
company. Brookwood is a complete textile service firm that develops and produces
innovative fabrics and related products through specialized finishing, treating
and coating processes.

Operations. Brookwood maintains factoring agreements which provide that
receivables, resulting from credit sales to customers, excluding the U.S.
Government, may be sold to the factor without recourse, subject to a commission
of 0.7% and the factor's prior approval. Commissions paid to the factors were
approximately $240,000, $322,000 and $379,000 for the years ended December 31,
2001, 2000 and 1999, respectively.

Inventories consist of the following (in thousands):

DECEMBER 31,
-----------------
2001 2000
------- -------

Raw materials............................................... $ 4,336 $ 3,805
Work in process............................................. 2,851 2,702
Finished goods.............................................. 9,987 10,271
------- -------
17,174 16,778
Less: Obsolescence reserve.................................. (421) (365)
------- -------
Total.................................................. $16,753 $16,413
======= =======

Property, plant and equipment consists of the following (in thousands):

DECEMBER 31,
-------------------
2001 2000
-------- --------

Land........................................................ $ 391 $ 391
Buildings and improvements.................................. 4,424 4,372
Leasehold improvements...................................... 392 392
Machinery and equipment..................................... 12,187 11,466
Office furniture and equipment.............................. 3,148 3,034
Construction in progress.................................... 1,401 1,273
-------- --------
21,943 20,928
Less: Accumulated depreciation.............................. (12,517) (11,143)
-------- --------
Total.................................................. $ 9,426 $ 9,785
======== ========

During 2000, Brookwood formed a joint venture with an unrelated third party
that is also in a textile related industry. The joint venture is 50%-owned by
its joint venture partner with operating and management decision making, and
venture profits and losses shared equally by both partners. As Brookwood does
not

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

exercise control over the joint venture, the investment is accounted for
utilizing the equity method of accounting.

The following table sets forth summarized financial data of the joint
venture as of and for the year ended December 31, 2001(in thousands):

Balance Sheet Data
Total assets.............................................. $8,522
Total liabilities......................................... 7,288
Joint venture capital..................................... 1,234
Statement of Operations Data
Revenue................................................... $6,596
Net income................................................ 1,252

NOTE 16 -- FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair value amounts have been determined using available
market information or other appropriate valuation methodologies that require
considerable judgment in interpreting market data and developing estimates.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts that the Company could realize in a current market exchange. The use
of different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts.

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

Management has reviewed the carrying value of its loans payable and 10%
Debentures in connection with interest rates currently available to the Company
for borrowings with similar characteristics and maturities. Loans payable
associated with the Company's assets held for sale and discontinued operations
have not been considered. Management has determined that the estimated fair
value of the loans payable would be approximately $19,141,000 and $30,223,000 at
December 31, 2001 and 2000, compared to the carrying value of $19,141,000 and
$30,504,000, respectively. The estimated fair value of the 10% Debentures is
$5,045,000 and $5,692,000, based on market prices on the New York Stock
Exchange, compared to the carrying values of $6,677,000 and $6,725,000 at
December 31, 2001 and 2000, respectively. The fair value of the Company's hotel
obligations approximates the carrying value given its proximity to expected
extinguishment.

The fair value information presented as of December 31, 2001 and 2000 is
based on pertinent information available to management. Although management is
not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since that date and, therefore current estimates
of fair value may differ significantly from the amounts presented herein.

NOTE 17 -- RELATED PARTY TRANSACTIONS

HSC Financial Corporation. Effective January 1997, the compensation
committee approved a financial consulting contract with HSC Financial
Corporation ("HSC"), a corporation with which Mr. Gumbiner is and Mr. Troup was
associated, that provides for HSC to furnish and perform international
consulting and advisory services to the Company and its subsidiaries, including
strategic planning and merger activities, for annual compensation of $825,000,
excluding reimbursement for out-of-pocket and other reasonable expenses. The
annual amount is payable in monthly installments, as a retainer to secure the
availability of HSC to perform such services as and when required by the
Company. This contract had an original termination date of July 1998, however,
it automatically renews for one-year periods if not terminated by the parties
beforehand.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The contract was amended to reduce the annual consulting fee to $495,000 in
January 2000 and amended to increase the fee to $795,000 in May 2001. In
addition, the Board of Directors awarded a bonus to HSC in March 2002 in the
amount of $33,000 from its HCRE subsidiary.

Pursuant to the HSC financial consulting agreement, the Company reimburses
HSC for reasonable and necessary expenses in providing office space and
administrative services. The Company paid HSC $344,000, $304,000 and $313,000
for the years ended December 31, 2001, 2000 and 1999, respectively. Of the
amounts paid, the Company incurred $86,000, $117,000 and $107,000 of expense for
the years ended December 31, 2001, 2000 and 1999, respectively. The remainder
was reimbursed by HRP, HEPGP, HEP and other affiliates of HEP.

Hallwood Investments Limited. In March 2000, September 2000 and March
2001, the Company entered into loan agreements with an entity associated with
its chairman and principal stockholder, Anthony J. Gumbiner, in the amount of
$1,500,000, $1,000,000 and $1,500,000, respectively. Significant terms included:
(i) term of five years; (ii) fixed interest rate of 10%; (iii) interest and
principal payments deferred until maturity; (iv) unsecured; and (v) convertible
into common stock twelve months after date of issuance, if not previously
repaid, at $10.13 per share (March 2000 loan) $6.47 per share (September 2001
loan), which was 115% of the market price on the date each of the loans was
approved by the Company's independent board members. Two of the loans were
repaid in December 2001 in the amount of $2,881,000, which represented principal
of $2,500,000 and accrued interest of $381,000. The remaining loan was repaid in
March 2002 in the amount of $1,648,000, which represented principal of
$1,500,000 and accrued interest of $148,000.

Hallwood Realty Partners, L.P. As previously discussed in Note 14, the
Company earns management fees, leasing commissions and other fees from HRP.

Stanwick. The Company shares common offices, facilities and staff with
Stanwick Holdings, Inc. ("Stanwick"). The Company pays the common general and
administrative expenses of the two entities and charges Stanwick a management
fee for its allocable share of the expenses. Stanwick reimbursed the Company
$25,000 for each of the years ended December 31, 2001, 2000 and 1999,
respectively. Stanwick is a subsidiary of Luxembourg-based Hallwood Holdings
S.A. ("HHSA"). Anthony J. Gumbiner is a director of HHSA. Melvin J. Melle is
chief financial officer of HHSA and Stanwick.

Strategic Technical Alliance -- Joint Venture. In the normal course of
business, Brookwood sells inventory to its joint venture investee. At December
31, 2001 the joint venture owed $5,216,000 to Brookwood under this arrangement.

NOTE 18 -- LITIGATION, CONTINGENCIES AND COMMITMENTS

Litigation. The Company, certain of its affiliates and others have been
named as defendants in several lawsuits relating to various transactions in
which it or its affiliated entities participated. The Company intends to defend,
or in some cases negotiate to settle, the remaining actions and does not
currently anticipate that such actions will have a material adverse effect on
its financial condition, results of operations or cash flows of the Company.

Beginning in 1997, the Company and its HRP affiliate have been defendants
in two lawsuits that were brought by Gotham Partners, L.P. in the Delaware Court
of Chancery. The first suit filed in February 1997, styled Gotham Partners, L.P.
v. Hallwood Realty Partners, L.P. and Hallwood Realty Corporation (C.A.
No.15578), sought access to certain books and records of HRP and was
subsequently settled, allowing certain access. The suit was dismissed in April
2001. The second action, filed in June 1997, styled Gotham Partners, L.P. v.
Hallwood Realty Partners, L.P., et al (C.A. No.15754), against the Company, HRP,
HRC and the directors of HRC, alleges claims of breach of fiduciary duties,
breach of HRP's partnership agreement and fraud in connection with certain
transactions involving HRP's limited partnership units in the mid 1990's. The
Company is alleged to have aided and abetted the alleged breaches. In June 2000,
after completing fact

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

discovery, all parties moved for summary judgment on several issues. In
September and October 2000, the Delaware court issued three separate written
opinions resolving the summary judgment motions. In the opinions, the court
ruled that trial would be required as to all issues, except that (i) Gotham was
found to have standing to pursue its derivative claims; (ii) defendants were
entitled to judgment dismissing the fraud claim; (iii) the general partner was
entitled to judgment dismissing the breach of fiduciary duty claims brought
against it; and (iv) the general partner's outside directors were entitled to
judgment dismissing all claims brought against them. A five-day trial was held
in January 2001. In July 2001, the Delaware Court of Chancery rendered its
opinion. In its decision, the court determined that an option plan and a sale of
units to the Company in connection with a reverse unit split implemented by HRP
in 1995 were in compliance with HRP's partnership agreement. The court also
found that the sale of units to the Company in connection with a 1995 odd-lot
offer by HRP did not comply with certain procedures required by the HRP
partnership agreement. The court ruled that the defendants other than HRP pay a
judgment in the amount of $3,417,000, plus pre-judgment interest of
approximately $2,891,000 from August 1995 to HRP. The amount represents what the
court determined was an underpayment by the Company. The court's judgment is not
final until all rehearings and appeals have been exhausted. In August 2001, the
plaintiff and certain defendants appealed the Court of Chancery's judgment to
the Delaware Supreme Court. Those appeals are pending. Oral arguments were heard
on February 12, 2002 and a rehearing en banc was held on March 26, 2002. In
October 2001, the Company paid $6,405,000, including post judgment interest, to
HRP, subject to an arrangement that it be returned in full or part if the
judgment is modified or reversed on appeal. If the appellate court reverses the
judgment, any subsequent ruling by the trial court on remand may be more or less
favorable to the Company.

In February 2000, HRP filed a lawsuit in the United States District Court
for the Southern District of New York styled Hallwood Realty Partners, L.P. v.
Gotham Partners, L.P., et al (Civ. No. 00 CV 115) alleging violations of the
Securities Exchange Act of 1934 by certain purchasers of HRP's limited
partnership units, including Gotham Partners, L.P., Gotham Partners, III L.P.,
Private Management Group, Inc., Interstate Properties, Steven Roth and EFO
Realty, Inc., by virtue of those purchasers' misrepresentations and/or omissions
in connection with filings required under the Securities Exchange Act of 1934.
The complaint further alleged that the defendants, by acquiring more than 15% of
the outstanding HRP limited partnership units, have triggered certain rights
under its Unit Purchase Rights Agreement, for which HRP was seeking declaratory
relief. HRP sought various forms of relief, including declaratory judgments,
divestiture, corrective disclosures, a "cooling-off" period and damages,
including costs and disbursements. Discovery was completed in December 2000 and
trial was held in February 2001. In February 2001, the court rendered a decision
in favor of the defendants and the court ordered the complaint dismissed. HRP
appealed certain of the trial court's rulings to the U.S. Second Circuit Court
of Appeals. The appellate court affirmed the rulings of the trial court on April
11, 2002.

In connection with the settlement of an obligation related to a matter
involving the Company's former affiliate Integra -- A Hotel and Restaurant
Company, the Company issued a four-year, $500,000 promissory note due March
1998. The note was secured by a pledge of 89,269 HRP limited partner units. The
settlement agreement also provided that the pledgee had the right to receive an
additional payment in an amount equal to 25% of the increase in the value of the
HRP units over the base amount of $8.44 per unit, but in no event more than an
additional $500,000 (the "HRP Participation Amount"). The Company tendered full
payment, including the HRP Participation Amount, totaling $1,000,000 in March
1998, although it reserved its rights to litigate the validity of an earlier
tender that was rejected by the noteholder. The noteholder refused acceptance of
the March 1998 tendered payment and instituted litigation in the State of
Delaware. In December 1999, the Company and the noteholder entered into an
agreement, approved by the court, which provided that (i) the Company pay the
face amount of $500,000 plus $83,000 of accrued interest to the noteholder; (ii)
the Company pay $900,000 into an escrow account to secure the maximum amount
which could be payable by the Company, including a potential claim of $400,000
for legal fees; and (iii) that the noteholder release its collateral of 89,269
HRP units. The parties complied with the terms of the Agreement and the units
were

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

released. The trial was held in June 2001 in the Delaware Court of Chancery. The
parties submitted post-trial briefings in September 2001. In February 2002, the
court rendered its decision in favor of the Company. On March 22, 2002, the
court entered an order that provides for the return of approximately $971,000,
including accrued interest, to the Company from the escrow account. The
noteholder has thirty days form the entry date to file an appeal, if any.

The Company is currently a defendant in two lawsuits in connection with the
disposition of two hotel properties. Plaintiffs allege violations of franchise
and lease agreements and seek damages of approximately $1,500,000. Management
believes that the claims are without merit and intends to vigorously defend the
cases.

The Company and its subsidiaries are from time to time involved in various
other legal proceedings in the ordinary course of their respective businesses.
Management believes that the resolution of the aforementioned litigation matters
will not have a material adverse effect on the financial condition, results of
operations or cash flows of the Company.

Contingencies. The Company has committed to make additional contributions
to the capital of Hallwood Realty, the general partner of HRP, upon demand, up
to a maximum aggregate amount of $13,118,000, subject to the terms of a
subscription agreement, to the extent Hallwood Realty has insufficient capital
to satisfy creditors of HRP. As of the date of this report no such demands have
been made.

In December 1999, the Company distributed certain assets and incurred a
contingent obligation, under the Separation Agreement discussed in Note 10. The
contingent obligation, in the amount of $3,500,000 at December 31, 2001 is the
present value of the remaining payments under the Separation Agreement and is
included in other accrued expenses. Interest on the contingent obligation has
been imputed at 12.75% and amounted to $395,000 and $408,000 for the years ended
December 31, 2001 and 2000, respectively. During 2001, the Company accrued an
additional $500,000 under this agreement, which is expected to be paid in 2002.

A number of jurisdictions in which the Company operates have adopted laws
and regulations relating to environmental matters. Such laws and regulations may
require the Company to secure governmental permits and approvals and undertake
measures to comply therewith. Compliance with the requirements imposed may be
time-consuming and costly. While environmental considerations, by themselves,
have not significantly affected the Company's business to date, it is possible
that such considerations may have a significant and adverse impact in the
future. The Company actively monitors its environmental compliance and while
certain matters currently exist, management is not aware of any compliance
issues which will significantly impact the financial position, operations or
cash flows of the Company.

Commitments. Total lease expense for noncancelable operating leases was
$1,751,000, $3,456,000 and $3,452,000 for the years ended December 31, 2001,
2000 and 1999, respectively. The Company leases certain textile manufacturing
equipment and certain hotel property, including land, buildings and equipment.
The leases generally require the Company to pay property taxes, insurance and
maintenance of the leased assets. The Company shares certain executive office
facilities with HRP and pays a proportionate share of the lease expense. Two
hotel leases (one of which was terminated in February 2001) required the payment
of contingent rent if revenue was excess of a base amount. Contingent rent was
$88,000, $295,000 and $187,000 for the years ended December 31, 2001, 2000 and
1999, respectively.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

At December 31, 2001, aggregate net minimum annual rental commitments under
noncancelable operating leases having an initial or remaining term of more than
one year, were as follows (in thousands):

YEARS ENDING
DECEMBER 31, AMOUNT
------------ ------

2002........................................................ $1,140
2003........................................................ 990
2004........................................................ 944
2005........................................................ 905
2006........................................................ 635
Thereafter.................................................. 2,152
------
Total..................................................... $6,766
======

Employment Contracts. The Company's Brookwood subsidiary has employment
agreements which expire at various dates with a corporate officer and certain
key employees. The approximate minimum annual compensation due under these
commitments were as follows (in thousands):

YEARS ENDING
DECEMBER 31, AMOUNT
------------ --------

2002........................................................ $315,000
2003........................................................ --
2004........................................................ --
2005........................................................ --
2006........................................................ --
--------
Total..................................................... $315,000
========

NOTE 19 -- SEGMENT AND RELATED INFORMATION

The Company is a holding company and classifies its business operations
into two reportable segments; real estate and textile products. Both segments
have different management teams and infrastructures that engage in different
businesses and offer different services.

Real Estate. The continuing real estate operations are conducted primarily
through the Company's wholly owned subsidiaries, HWG, LLC, Hallwood Realty and
HCRE. Hallwood Realty is the sole general partner of HRP. At December 31, 2001,
HRP owned fourteen real estate properties in six states containing 5,073,000 net
rentable square feet. Hallwood Realty owns a 1% general partner interest and
HWG, LLC owns a 21% limited partner interest in HRP. Hallwood Realty is
responsible for asset management of HRP and its properties, including the
decisions regarding financing, refinancing, acquiring and disposing of
properties. It also provides general operating and administrative services to
HRP. HCRE is responsible for on-site property management for all HRP properties,
and properties it manages for third parties, for which it receives management,
leasing and construction supervision fees. The Company accounts for its
ownership in HRP using the equity method of accounting recording its pro-rata
share of net income (loss) and partners capital transactions reported by HRP.

Textile Products. The continuing textile products operations are conducted
through the Company's wholly owned Brookwood subsidiary. Brookwood is a complete
textile service firm that develops and produces innovative fabrics and related
products through specialized finishing, treating and coating processes.

Discontinued Operations -- Energy. Hallwood Energy owned interests in oil
and gas properties, primarily located in the San Juan Basin in New Mexico and
Colorado, South Texas, the West Texas Permian Basin

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

and onshore South Louisiana. Prior to the June 1999 Energy Consolidation, the
Company consolidated the operations of HEP. Subsequently, the investment in
Hallwood Energy was accounted for using the equity method of accounting, as the
Company exercised significant influence over Hallwood Energy's operational and
financial policies.

In May 2001, the Company sold its investment in Hallwood Energy. The
Company no longer operates in the energy business. Accordingly, the Company's
energy operations have been reclassified as discontinued operations for all
periods presented herein.

Discontinued Operations -- Hotels. Hotel operations were conducted through
the Company's wholly owned Hallwood Hotels and Brock Hotels subsidiaries.
Hallwood Hotels held a long-term leasehold interest in the Holiday Inn hotel,
located in Longboat Key , Florida and a fee interest in the Airport Embassy
Suites hotel, located in Oklahoma City, Oklahoma. Brock Hotels owned fee
interests in two GuestHouse Suites Plus properties located in Tulsa, Oklahoma
and Greenville, South Carolina, and a long-term leasehold interest in one
GuestHouse Suites Plus property located in Huntsville, Alabama.

In December 2000, the Company decided to discontinue and dispose of its
hotel segment, which consisted of five hotel properties at that time.
Accordingly, the Company's hotel operations which it intends to dispose of have
been reclassified as discontinued operations. The Company subsequently
determined that it would retain a leasehold interest in one of the hotels which
has been reclassified as a continuing operation and is included in "other"
within the following schedule. The balance sheet presentation for hotel
operations have been reclassified to reflect the two hotels which are expected
to be disposed of in 2002 as held for sale and the hotel which the Company
intends to operate as held for use.

Prior to its disposition in December 1999, the Company also conducted hotel
operations through its wholly owned IRM subsidiary. It managed the property for
individual unit owners for which it received a management fee and other
consideration for the services it provided.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following represents the Company's reportable amounts by segment,
including its discontinued operations, as of and for the years ended December
31, 2001, 2000 and 1999, respectively ( in thousands):

REAL TEXTILE DISCONTINUED
ESTATE PRODUCTS OTHER OPERATIONS CONSOLIDATED
------- -------- ------- ------------ ------------

YEAR ENDED DECEMBER 31, 2001
Total revenue from external
sources....................... $ 8,394 $69,579 $ 3,309 $ 81,282
======= ======= ======= ========
Operating income (loss)......... $ 3,284 $(2,126) $ 1,158
======= =======
Unallocable expenses, net....... $(3,283) (3,283)
======= --------
Loss from continuing operations
before income taxes........... $ (2,125)
========
Income from discontinued
operations.................... $ 9,750 $ 9,750
======= ========
Extraordinary gain (loss)....... $ (117) $ (800) $ (917)
======= ======= ========
Identifiable assets, December
31, 2001...................... $12,558 $44,998 $ -- $ 9,506 $ 67,062
Cash allocable with segment..... 97 323 3,552 -- 3,972
------- ------- ------- ------- --------
$12,655 $45,321 $ 3,552 $ 9,506 71,034
======= ======= ======= =======
Corporate assets................ $ 6,533 6,533
======= --------
Total assets, December 31,
2001.......................... $ 77,567
========
Depreciation, amortization and
impairment.................... $ 672 $ 2,879 $ 110 $ 935 $ 4,596
======= ======= ======= ======= ========
Capital
expenditures/acquisitions..... $ 1,015 $ 3 $ 1,018
======= ======= ========

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

REAL TEXTILE DISCONTINUED
ESTATE PRODUCTS OTHER OPERATIONS CONSOLIDATED
------- -------- ------- ------------ ------------

YEAR ENDED DECEMBER 31, 2000
Total revenue from external
sources....................... $ 6,486 $73,852 $ 1,628 $ 81,966
======= ======= ======= ========
Operating income................ $ 3,840 $ 455 $ 4,295
======= =======
Unallocable expenses, net....... $(6,140) (6,140)
======= --------
Loss from continuing operations
before income taxes........... $ (1,845)
========
Loss from discontinued
operations.................... $(4,147) $ (4,147)
======= ========
Extraordinary loss.............. $ (85) $ (85)
======= ========
Identifiable assets, December
31, 2000...................... $ 7,406 $41,479 $ -- $37,888 $ 86,773
Cash allocable with segment..... 283 211 1,344 -- 1,838
------- ------- ------- ------- --------
$ 7,689 $41,690 $ 1,344 $37,888 88,611
======= ======= ======= =======
Corporate assets................ $ 7,312 7,312
======= --------
Total assets, December 31,
2000.......................... $ 95,923
========
Depreciation, amortization and
impairment.................... $ 672 $ 1,399 $ 1,007 $ 6,003 $ 9,081
======= ======= ======= ======= ========
Capital
expenditures/acquisitions..... $ 3,214 $ 3 $ 1,247 $ 4,464
======= ======= ======= ========
YEAR ENDED DECEMBER 31, 1999
Total revenue from external
sources....................... $ 9,503 $80,704 $ 1,958 $ 92,165
======= ======= ======= ========
Operating income................ $ 6,530 $ 1,565 $ 8,095
======= =======
Unallocable expenses, net....... $(5,583) (5,583)
======= --------
Income from continuing
operations before income
taxes......................... $ 2,512
========
Loss from discontinued
operations.................... $(2,047) $ (2,047)
======= ========
Extraordinary gain.............. $ 240 $ 240
======= ========
Identifiable assets, December
31, 1999...................... $10,159 $41,276 $ -- $36,875 $ 88,310
Cash allocable with segment..... 104 37 1,686 -- 1,827
------- ------- ------- ------- --------
$10,263 $41,313 $ 1,686 $36,875 90,137
======= ======= ======= =======
Corporate assets................ $11,116 11,116
======= --------
Total assets, December 31,
1999.......................... $101,253
========
Depreciation, depletion,
amortization and impairment... $ 672 $ 1,195 $ 188 $ 3,557 $ 5,612
======= ======= ======= ======= ========
Capital
expenditures/acquisitions..... $ 1,377 $ 881 $ 2,073 $ 4,331
======= ======= ======= ========

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 20 -- SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Results of operations by quarter for the years ended December 31, 2001 and
2000, are summarized below (in thousands, except per share amounts):

YEAR ENDED DECEMBER 31, 2001
-----------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------- ---------- --------------- --------------

Operating revenues....................... $20,878 $21,176 $18,339 $20,889
Gross profit............................. 4,075 2,622 4,335 1,956
Income (loss) from continuing
operations............................. 352 (1,406) 437 (3,931)
Income (loss) from discontinued
operations............................. 4,950 6,010 (635) (575)
Net income (loss)........................ 5,252 3,588 (81) (4,514)
Comprehensive income (loss).............. 2,519 6,597 (95) (4,526)
Per Share Data:
Income (loss) from continuing operations
Basic.................................. 0.25 (1.02) 0.31 (2.79)
Assuming dilution...................... 0.23 (1.02) 0.27 (2.79)
Income (loss) from discontinued
operations
Basic.................................. 3.47 4.07 (0.45) (0.41)
Assuming dilution...................... 2.87 4.07 (0.32) (0.41)
Net income (loss)
Basic.................................. 3.69 2.48 (0.06) (3.21)
Assuming dilution...................... 3.07 2.48 (0.00) (3.21)

YEAR ENDED DECEMBER 31, 2000
-----------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------- ---------- --------------- --------------

Operating revenues....................... $22,129 $21,406 $18,443 $19,988
Gross profit............................. 3,589 3,269 2,463 2,456
Income (loss) from continuing
operations............................. 136 (77) (820) 126
Income (loss) from discontinued
operations............................. 191 7 187 (4,532)
Net income (loss) and comprehensive
income (loss).......................... 327 (70) (633) (4,491)
Per Share Data:
Income (loss) from continuing operations
Basic.................................. 0.10 (0.09) (0.58) 0.09
Assuming dilution...................... 0.10 (0.09) (0.58) 0.09
Income (loss) from discontinued operation
Basic.................................. 0.13 -- 0.13 (3.18)
Assuming dilution...................... 0.13 -- 0.13 (3.18)
Net income (loss)
Basic.................................. 0.23 (0.08) (0.44) (3.15)
Assuming dilution...................... 0.23 (0.08) (0.44) (3.15)

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

The above amounts have been adjusted for the reclassification to continuing
operations of one leased hotel property which the Company continues to operate.

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Year ended December 31, 2001. In May 2001, the Company sold its investment
in Hallwood Energy for a gain of $8,725,000. In June 2001, the Company recorded
a gain from extinguishment of debt from the disposition of one hotel property in
the amount of $216,000. In December 2001, the Brookwood subsidiary recorded an
impairment of its goodwill of $1,446,000. In December 2001, the Company recorded
an additional impairment of $935,000 relating to hotel assets held for sale.

Year ended December 31, 2000. In December 2000, the Company decided to
discontinue and dispose of its hotel segment. In connection with the planned
disposition, the Company recorded an impairment of $4,000,000 to reduce the
carrying values to their estimated fair market values. In December 2000, the
Company recognized an extraordinary loss of $85,000 from early extinguishment of
debt, which represented the Company's pro-rata share of an extraordinary loss
from early extinguishment of debt reported by HRP.

NOTE 21 -- EMPLOYEE BENEFIT RETIREMENT PLANS

In August 1989, the Company established a contributory, tax-deferred 401(k)
tax favored savings plan covering substantially all of its non-union employees.
The plan provides that (i) eligible employees may contribute up to 15% of their
compensation to the plan; (ii) the Company's matching contribution is
discretionary, to be determined annually by the Company's Board of Directors;
(iii) excludes the Company's hotel hourly employees from a matching
contribution; and (iv) excludes highly compensated employees from a matching
contribution, although this group receives a compensatory bonus in lieu of such
contribution and diminution of related benefits. Amounts contributed by
employees are 100% vested and non-forfeitable. The Company's matching
contributions, which were 50% of its employees contributions up to the first 6%
contributed for each of the three years ended December 31, 2001, vest at a rate
of 20% per year of service and become fully vested after five years. Employees
of Hallwood Realty, HCRE and salaried hotel employees also participate in the
Company's 401(k) plan. Hallwood Energy and Brookwood have separate 401(k) plans
which are similar to the Company's plan. Brookwood did not provide a matching
employer contribution to its 401(k) plan in the years ended December 31, 2001
and 2000. Employer contributions paid on behalf of Hallwood Realty and Hallwood
Energy employees were substantially paid by HRP and Hallwood Energy (HEP prior
to the Energy Consolidation), respectively. The Company's contributions to the
plans for the years ended December 31, 2001, 2000 and 1999, respectively,
excluding contributions from the Hallwood Realty and Hallwood Energy affiliates
were $62,000, $76,000, and $299,000, respectively.

Brookwood's union employees belong to a pension fund maintained by their
union. The Company contributes $90 per month per employee to the fund. Total
contributions for the years ended December 31, 2001, 2000 and 1999 were
$245,000, $222,000 and $212,000, respectively. At March 31, 2001, the date of
the latest actuarial valuation, Brookwood was not subject to a withdrawal
liability upon termination of the pension plan because it was fully funded.

NOTE 22 -- SUBSEQUENT EVENT

In January 2002, the Company invested $1,500,000 in a newly-formed, private
energy company. The Company owns approximately 25% of this entity, anticipates
using the equity method of accounting and has no future funding obligations.

INDEPENDENT AUDITORS' REPORT ON SCHEDULES

To the Stockholders and Directors of
The Hallwood Group Incorporated

We have audited the consolidated balance sheets of The Hallwood Group
Incorporated and its subsidiaries as of December 31, 2001 and 2000 and the
related consolidated statements of operations, comprehensive income (loss),
changes in stockholders' equity and cash flows for each of the three years in
the period ended December 31, 2001 and have issued our report thereon dated
April 11, 2002, which report is included elsewhere in this Form 10-K. Our audits
also included the financial statement schedules of The Hallwood Group
Incorporated and its subsidiaries, listed in the accompanying index at Item
14(a)2. These financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly in all material respects the information set forth therein.

DELOITTE & TOUCHE LLP

Dallas, Texas
April 11, 2002

SCHEDULE I

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY)
BALANCE SHEETS
(IN THOUSANDS)

DECEMBER 31,
-------------------
2001 2000
-------- --------

ASSETS
Investments in subsidiaries
Continuing operations..................................... $ 30,909 $ 11,721
Discontinued operations -- energy......................... -- 9,196
Deferred tax asset, net..................................... 5,677 5,333
Cash and cash equivalents................................... 2,464 301
Restricted cash............................................. 966 937
Receivables and other assets................................ 664 1,460
-------- --------
Total Assets........................................... $ 40,680 $ 28,948
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
10% Collateralized Subordinated Debentures.................. $ 6,677 $ 6,725
Deferred revenue -- noncompetition agreement................ 5,840 --
Accounts payable, accrued interest and other accrued
expenses.................................................. 5,593 4,329
Investment in subsidiaries -- discontinued hotels held for
sale...................................................... 4,301 3,306
Capital lease obligations................................... 1,386 1,774
-------- --------
Total Liabilities...................................... 23,797 16,134
Redeemable preferred stock.................................. 1,000 1,000
Common stock................................................ 240 240
Additional paid-in capital.................................. 54,452 54,416
Accumulated deficit......................................... (23,729) (27,924)
Accumulated other comprehensive income...................... 250 --
Treasury stock.............................................. (15,330) (14,918)
-------- --------
Total Stockholders' Equity............................. 15,883 11,814
-------- --------
Total Liabilities and Stockholders' Equity............. $ 40,680 $ 28,948
======== ========

The "Notes to Consolidated Financial Statements of The Hallwood Group
Incorporated and Subsidiaries" are an integral part of these statements.

See accompanying "Notes to Condensed Financial Information of Registrant".

SCHEDULE I

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)

STATEMENTS OF OPERATIONS
(IN THOUSANDS)

YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------

INCOME
Intercompany income from subsidiaries
Interest income........................................ $ 3,158 $ 3,294 $ 3,731
Management fees........................................ 2,331 2,302 3,387
Dividends.............................................. -- 400 400
Amortization of deferred revenue.......................... 1,410 -- --
Interest and other income................................. 215 75 90
Fee income................................................ -- 237 241
------- ------- -------
Total income......................................... 7,114 6,308 7,849
EXPENSES
Litigation expense........................................ 2,360 -- --
Administrative expenses................................... 2,266 2,055 2,433
Equity in net loss (income) of subsidiaries -- continuing
operations............................................. 2,023 3,485 (2,282)
Interest expense.......................................... 1,088 1,243 1,191
Intercompany interest expense............................. 559 1,710 51
Cost of separation agreement.............................. 500 -- 4,675
------- ------- -------
Total expenses....................................... 8,796 8,493 6,068
------- ------- -------
Income (loss) from continuing operations.................. (1,682) (2,185) 1,781
Income taxes (benefit).................................... 3,023 (1,465) (1,745)
------- ------- -------
Income (loss) from continuing operations before
extraordinary gain..................................... (4,705) (720) 3,526
Income (loss) from discontinued operations, net of tax
Income from discontinued operations -- energy.......... 11,134 2,826 438
Loss from discontinued operations -- hotels (includes
extraordinary gain from extinguishment of debt of
$216 in 2001)........................................ (1,384) (6,973) (2,485)
------- ------- -------
9,750 (4,147) (2,047)
------- ------- -------
Income (loss) before extraordinary gain (loss)............ 5,045 (4,867) 1,479
Extraordinary gain (loss) from early extinguishment of
debt................................................... (800) -- 240
------- ------- -------
NET INCOME (LOSS)........................................... 4,245 (4,867) 1,719
Cash dividend on preferred stock.......................... (50) (50) (50)
------- ------- -------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS.......... $ 4,195 $(4,917) $ 1,669
======= ======= =======

The "Notes to Consolidated Financial Statements of The Hallwood Group
Incorporated and Subsidiaries" are an integral part of these statements.

See accompanying "Notes to Condensed Financial Information of Registrant."

SCHEDULE I

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)

STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS)

YEARS ENDED DECEMBER 31,
-------------------------
2001 2000 1999
------ ------- ------

Net Income (Loss)........................................... $4,245 $(4,867) $1,719
Other Comprehensive Income (Loss)
Pro rata share of other comprehensive income from equity
investments
Adoption of SFAS No. 133
Cumulative effect.................................... (4,035) -- --
Realized upon disposition of Hallwood Energy......... 3,009 -- --
Changes in fair value of derivatives................. 1,302 -- --
Amortization of interest rate swap................... (26) -- --
------ ------- ------
Other Comprehensive Income (Loss)........................... 250 -- --
------ ------- ------
Comprehensive Income (Loss)................................. $4,495 $(4,867) $1,719
====== ======= ======

The "Notes to Consolidated Financial Statements of the Hallwood Group
Incorporated and Subsidiaries" are an integral part of these statements.

See accompanying "Notes to Condensed Financial Information of Registrant".
72

SCHEDULE I

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)

STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

YEARS ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- ------- --------

NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES...................................... $ (858) $ 1,880 $ 2,914
CASH FLOWS FROM INVESTING ACTIVITIES
Return of (additional) investment in subsidiaries......... (21,350) (1,995) 13,162
Proceeds from sale of Hallwood Energy stock............... 18,000 303 --
Proceeds from noncompetition agreement.................... 7,250 -- --
Purchase of minority shares of Hallwood Energy............ -- (465) --
-------- ------- --------
Net cash provided by (used in) investing activities.... 3,900 (2,157) 13,162
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of common stock for treasury..................... (412) -- --
Repayment of bank borrowings and loans payable............ (388) -- (500)
Payment of preferred stock dividend....................... (50) (50) (50)
Net change in restricted cash for financing activities.... (29) (36) (901)
Redemption of 7% Debentures............................... -- -- (14,088)
-------- ------- --------
Net cash used in financing activities.................. (879) (86) (15,539)
-------- ------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................................... 2,163 (363) 537
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 301 664 127
-------- ------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 2,464 $ 301 $ 664
======== ======= ========

The "Notes to Consolidated Financial Statements of The Hallwood Group
Incorporated and Subsidiaries" are an integral part of these statements.

See accompanying "Notes to Condensed Financial Information of Registrant".

SCHEDULE I

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)

STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

YEARS ENDED DECEMBER 31,
--------------------------
DESCRIPTION 2001 2000 1999
----------- ------- ------ -------

Proportionate share of stockholders' equity/partners'
capital transactions of equity investments
Adoption of SFAS No. 133:
Cumulative effect................................... $(4,035) $ -- $ --
Realized upon disposition of Hallwood Energy........ 3,009 -- --
Change in fair value of derivatives................. 1,302 -- --
Amortization of interest rate swap.................. (26) -- --
------- ------ -------
Accumulated other comprehensive income.............. $ 250 -- --
======= ====== =======
Other
Hallwood Energy..................................... $ (36) $ 36 $ --
Assets exchanged for redemption of treasury stock
Assets owned by subsidiaries........................... -- -- 5,895
Present value of future cash payments.................. -- -- 3,197
Investment in Hallwood Energy.......................... -- -- 1,665
-------
$10,757
=======
Conversion of energy investment to equity method
Oil and gas properties................................. -- -- $ 6,548
Current assets of HEP.................................. -- -- 1,722
Noncurrent assets of HEP............................... -- -- 634
Receivables and other assets........................... -- -- 53
Long-term obligations of HEP........................... -- -- (3,648)
Current liabilities of HEP............................. -- -- (1,056)
-------
$ 4,253
=======
Supplemental disclosures of cash payments
Interest paid............................................ $ 1,607 $1,002 $ 2,027
Income taxes paid........................................ 517 156 837

The "Notes to Consolidated Financial Statements of The Hallwood Group
Incorporated and Subsidiaries" are an integral part of these statements.

See accompanying "Notes to Condensed Financial Information of Registrant."
74

SCHEDULE I

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY)

NOTE 1 -- BASIS OF PRESENTATION

Pursuant to the rules and regulations of the Securities and Exchange
Commission, the condensed financial statements of the Registrant do not include
all of the information and notes normally included with financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America. In addition, for purposes of this schedule, the
investments in majority owned subsidiaries are accounted for using the equity
method of accounting which is not in accordance with accounting principles
generally accepted in the United States of America. It is, therefore suggested
that these condensed financial statements be read in conjunction with the
consolidated financial statements and notes thereto included in the Registrant's
annual report as referenced in Form 10-K, Part II, Item 8.

NOTE 2 -- 10% COLLATERALIZED SUBORDINATED DEBENTURES

As referenced in Note 5 in the Consolidated Financial Statements, the
Registrant's 10% Collateralized Subordinated Debentures due July 31, 2005, are
comprised of the following (in thousands):

DECEMBER 31,
---------------
2001 2000
------ ------

NOTE 3 -- LOSS FROM DISCONTINUED OPERATIONS

In December 2000, the Company decided to discontinue and dispose of its
hotel segment, principally allowing its non-recourse debt holders to assume
ownership of the properties through foreclosure or by selling or otherwise
disposing of its hotel properties. The Company's hotel segment consisted of
three owned properties and two leased properties. As part of the planned
disposition in the Company evaluated the operations and economic environment in
which each of the hotels operated and determined it was appropriate to record an
impairment of $4,000,000 and $935,000, respectively to reduce their carrying
value to estimated fair market value, which is included in the equity in net
loss of hotel subsidiaries in the table below. The loss from discontinued
operations consists of the following (in thousands):

YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------

Equity in net loss of hotel subsidiaries................ $ 1,986 $ 6,917 $ 2,540
Deferred income taxes (benefit)......................... (600) 341 445
Other hotel disposition costs........................... 214 115 --
Extraordinary gain from extinguishment of debt.......... (216) -- --
Less:
Intercompany management fee........................... -- (400) (500)
------- ------- -------
(Loss) from discontinued hotel operations............. $(1,384) $(6,973) $(2,485)
======= ======= =======

SCHEDULE I

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY) -- (CONTINUED)

Energy operations have been segregated from the Company's continuing
operations and reported as a single line item -- income from discontinued energy
operations. A summary of its operations for the three years ended December 31,
2001 are presented below:

YEARS ENDED DECEMBER 31,
-------------------------
2001 2000 1999
------- ------ ------

NOTE 4 -- LITIGATION, CONTINGENCIES AND COMMITMENTS

See Note 18 to the consolidated financial statements.

The capital lease obligations associated with the Company's hotel
properties have been included as parent company liabilities, because the lease
obligations will not necessarily be assumed or extinguished as the hotels are
disposed of and repayment has been guaranteed by the parent company.

SCHEDULE II

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)

CHARGED TO
BALANCE, (RECOVERY OF) CHARGED BALANCE,
BEGINNING COSTS AND TO OTHER END OF
OF YEAR EXPENSES ACCOUNTS DEDUCTIONS YEAR
--------- ------------- -------- ---------- --------

TEXTILE PRODUCTS
Allowance for losses -- accounts
receivable:
Year ended December 31, 2001......... $375 $147 $ -- $(24)(a) $498
Year ended December 31, 2000......... 427 (13) (10) (29)(a) 375
Year ended December 31, 1999......... 418 42 -- (33)(a) 427

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

Notes:

(a) Write-off, net of recoveries

THE HALLWOOD GROUP INCORPORATED AND SUBSIDIARIES

INDEX TO EXHIBITS

EXHIBIT
NUMBER DESCRIPTION
------- -----------

10.9 Amendment to Financial Consulting Agreement, dated as of May
16, 2001, between the Company and HSC Financial Corporation.

10.18 Credit Agreement, dated as of March 21, 2002, among HWG,
LLC, as the Borrower, The Hallwood Group Incorporated, as
Parent Guarantor, First Bank & Trust, as Administrative
Agent and the Financial Institution Now or Hereafter Parties
Thereto, as the Lenders, regarding a $3,000,000 Term Loan
and a $4,000,000 Revolving Credit Facility, filed herewith.

21 Active subsidiaries of the Registrant as of February 28,
2002.

================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

----------

FORM 10-K

MARK ONE
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD - FROM TO
-------------- --------------

COMMISSION FILE NUMBER: 1-10643

----------

HALLWOOD REALTY PARTNERS, L.P.
(Exact name of registrant as specified in its charter)

----------

DELAWARE 75-2313955
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

3710 RAWLINS
SUITE 1500
DALLAS, TEXAS 75219-4298
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (214) 528-5588

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Name of each exchange on
Title of each class which registered
------------------- ------------------------

UNITS REPRESENTING LIMITED PARTNERSHIP INTERESTS AMERICAN STOCK EXCHANGE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
-----

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
------ ------

The aggregate market value of units held by nonaffiliates of the registrant
as of March 22, 2002 was $88,159,000.

CLASS: UNITS REPRESENTING LIMITED PARTNERSHIP INTERESTS.
OUTSTANDING AT MARCH 22, 2002: 1,589,948 UNITS.

================================================================================

PAGE 1 OF 45

HALLWOOD REALTY PARTNERS, L.P.

TABLE OF CONTENTS

Page
----

PART I

Item 1. Business 3

Item 2. Properties 6

Item 3. Legal Proceedings 8

Item 4. Submission of Matters to a Vote of
Security Holders 9

PART II

Item 5. Market for Registrant's Units and Related
Security Holder Matters 9

Item 6. Selected Financial Data 10

Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11

Item 7a. Quantitative and Qualitative Disclosures about Market Risk 18

Item 8. Financial Statements and Supplemental Information 19

Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures 39

PART III

Item 10. Directors and Executive Officers of the Registrant 40

Item 11. Executive Compensation 41

Item 12. Security Ownership of Certain Beneficial Owners
and Management 43

Item 13. Certain Relationships and Related Transactions 43

PART IV

Item 14. Exhibits, Financial Statement Schedule and
Reports on Form 8-K. 44

PAGE 2 of 45

PART I

ITEM 1. BUSINESS

DESCRIPTION OF THE BUSINESS

Hallwood Realty Partners, L.P. ("HRP"), a publicly traded Delaware limited
partnership, operates in the commercial real estate segment. HRP's activities
include the acquisition, ownership and operation of its commercial real estate
assets. Units representing limited partnership interests are traded on the
American Stock Exchange under the symbol "HRY".

As of December 31, 2001, HRP owned fourteen real estate properties (the
"Properties") located in six states containing 5,073,000 net rentable square
feet (for additional information, see Item 2 - Properties). HRP seeks to
maximize the value of its real estate by making capital and tenant improvements,
by executing marketing programs to attract and retain tenants, and by
controlling or reducing, where possible, operating expenses.

Hallwood Realty, LLC ("Realty" or the "General Partner"), a Delaware limited
liability company and indirectly wholly-owned subsidiary of The Hallwood Group
Incorporated ("Hallwood"), is HRP's general partner and is responsible for asset
management of HRP and its Properties, including decision-making responsibility
for financing, refinancing, acquiring and disposing of properties. In addition,
Realty provides general operating and administrative services to HRP. Hallwood
Commercial Real Estate, LLC ("HCRE"), another indirectly wholly-owned subsidiary
of Hallwood, provides property management, leasing and construction supervision
services to the Properties.

RISKS, COMPETITION AND OTHER FACTORS

DETERIORATION IN ECONOMIC CONDITIONS AND THE REAL ESTATE MARKETS COULD HARM
HRP'S BUSINESS.

The commercial real estate industry depends on a number of factors relating to
general global, national, regional and local economic conditions, including
inflation, interest rates, taxation policies, availability of credit, employment
levels, and wage and salary levels. A negative trend in any of these conditions
could adversely affect HRP's business. If a substantial number of tenants
default on their leases, choose not to renew, or if rental rates decrease, HRP's
financial position could be adversely affected. Such effects could include a
decline in acquisition, disposition and leasing activity; a decline in the
supply of capital invested in commercial real estate; or a decline in the value
of real estate.

HRP's cash flow would be adversely affected by decreases in the performance of
the properties it owns. Property performance typically depends upon the ability
to attract and retain creditworthy tenants; the ability to manage operating
expenses; the magnitude of defaults by tenants under their respective leases;
governmental regulations; the nature and extent of competitive properties;
financial and economic conditions generally and in the specific areas where
properties are located; and the real estate market generally. Expenses may
increase due to unexpected or higher repairs and maintenance costs, inflation,
services and costs required to retain tenants or to sign new tenants,
unsuccessful appeals of rising real estate taxes, changes in interest rates,
higher insurance costs, the outcome of existing or future litigation, as well as
other factors, many of which are beyond the control of HRP.

HRP MAYBE SENSITIVE TO CHANGES IN INTEREST RATES.

Because only one of its mortgage loans has a floating interest rate, HRP's
exposure to changes in market interest rates is limited to the difference
between the market rate in effect at the time a loan matures compared to its
existing loan rate. As of December 31, 2001, HRP had mortgage loans totaling
$176,224,000 with fixed interest rates from 6.97% to 8.7% (with an effective
average interest rate of 8.21%). These loans mature between 2005 and 2020. At
the time of loan maturity, a higher market interest rate compared to the
existing rate will have a negative impact on the amount of mortgage proceeds
secured from a refinancing, as well as a decrease in cash flow from future
operations due to the higher interest rate.

HRP's $25,000,000 mortgage loan secured by Allfirst Building bears interest at
LIBOR plus 130 basis points, and therefore HRP's actual cash interest costs are
affected by changes in market interest rates. The interest rate for this loan
was 3.44% as of December 31, 2001. Assuming a 100 basis point, or 1%, change in
LIBOR, interest paid by HRP would increase or decrease by approximately $250,000
on an annual basis.

PAGE 3 of 45

RISKS, COMPETITION AND OTHER FACTORS (CONTINUED)

INSURANCE RISKS HAVE INCREASED AS A RESULT OF RECENT EVENTS.

Due in large part to the terrorist activities of September 11, 2001, HRP
believes that insurance companies are re-examining many aspects of their
business, and may consider taking certain actions in the wake of these terrorist
activities. Among such actions which insurance companies may take are increasing
premiums, mandating higher self-insured retentions and deductibles, reducing
limits, restricting coverages, imposing exclusions (such as sabotage and
terrorism), and refusing to underwrite certain risks and classes of business.
Significantly increased premiums, mandated exclusions, or changes in limits,
coverages, terms and conditions could adversely affect HRP's ability to obtain
appropriate insurance coverages at reasonable costs.

HRP MAY INCUR ENVIRONMENTAL LIABILITY IN ITS ROLE AS A PROPERTY OWNER.

Various national, state and local laws and regulations impose liability on real
property owners, such as HRP, for the cost of investigating, cleaning up or
removing contamination caused by hazardous or toxic substances. The liability
may be imposed even if the original actions were legal and HRP did not know of,
or was not responsible for, the presence of such hazardous or toxic substances.
HRP may also be solely responsible for the entire payment of the liability if it
is subject to joint and several liability with other responsible parties who are
unable to pay. HRP may be subject to additional liability if it fails to
disclose environmental issues to a buyer or lessee of property or if a third
party is damaged or injured as a result of environmental contamination emanating
from the site. HRP cannot be sure that any of such liabilities to which it may
become subject will not have a material adverse effect upon its business,
results of operations or financial condition.

Parklane Towers, as well as certain other properties to a lesser extent, are
known to contain asbestos. Removal of asbestos at Parklane Towers is not
required because it is cementitious, it is not friable and because the
procedures in HRP's site environmental program Operations and Maintenance Manual
are performed as required.

HRP MAY HAVE DIFFICULTY DISPOSING OF ASSETS WHEN IT HAS TO DO SO.

HRP's basic investment strategy is to hold real estate assets until what it
believes to be an optimal time to sell them. Normally, this will be during
relatively strong real estate markets. However, factors beyond HRP's control
could make it necessary for HRP to dispose of real estate properties during weak
markets. Following a period when the market value of HRP's assets fell
significantly, it could be required to sell assets at a time when it may be very
inopportune to do so. Further, markets for real estate assets are not usually
highly liquid, which can make it particularly difficult to realize acceptable
prices when disposing assets during weak markets.

IF HRP DOES NOT GENERATE SUFFICIENT CASH FLOWS FROM OPERATIONS, IT MAY NEED
ADDITIONAL CAPITAL.

To date, HRP has financed its operations with cash from profitably operating its
established properties. If HRP does not generate enough cash from operations to
finance its business in the future, it will need to raise additional funds
through public or private financing or asset sales. If HRP borrows money, it may
be required to agree to restrictions limiting its operating flexibility. If HRP
requires additional funds and is not able to obtain such funds, it would have a
material adverse effect on its operations.

SOME OF HRP'S LOANS CONTAIN COVENANTS AND RESTRICTIONS, WHICH AFFECT
FLEXIBILITY.

HRP has two mortgage loans that require compliance with a loan covenant, which
if not met will trigger a default. The loans require the properties securing
each loan to maintain a liquidity ratio, specifically a debt service coverage
ratio. Debt service coverage ratio is the relationship of adjusted net operating
income (as defined in each loan agreement) for the previous twelve months to the
loan's annual debt service. The ratio, for the loan requiring a minimum 1.15
ratio, was 2.35, 2.19, and 1.91 for 2001, 2000, and 1999, respectively. The
ratio, for the loan requiring a minimum 1.10 ratio, was 1.94, 2.45, and 2.24 for
the same periods. Accordingly, HRP was in compliance with its loans' covenants
for the three years ended December 31, 2001. As of December 31, 2001, the
outstanding balance of the loans is $113,649,000.

Additionally, these two mortgage loans contain restrictions that limit certain
actions. With respect to the properties encumbered by these loans, HRP cannot
incur additional debt. Also, its ability to sell a property, or a portion
thereof, is limited because of the requirement to substitute collateral at a
currently cost-prohibitive rate. These loans also, under certain circumstances,
may restrict the ability of HRP to merge, to consolidate or to liquidate.

PAGE 4 of 45

RISKS, COMPETITION AND OTHER FACTORS (CONTINUED)

HRP IS SUBJECT TO LITIGATION.

HRP is currently a party to certain litigation in Delaware state court, as
described more fully in Item 3 - Legal Proceedings. The trial court in that
matter ruled that the defendants other than HRP pay a judgment in the amount of
$3,417,423, plus pre-judgment interest from August 1995 to HRP. The plaintiff
and certain defendants have appealed that ruling. In October 2001, HRP received
the $3,417,423 judgment together with $2,987,576 of pre-judgment and
post-judgment interest, subject to an arrangement that it be returned in full or
part if the judgment is modified or reversed on appeal. If the appellate court
reverses the judgment, any subsequent ruling by the trial court on remand may be
more or less favorable to HRP.

HRP IS SUBJECT TO COMPETITION.

The Properties are subject to substantial competition from similar properties in
the vicinity in which they are located. In addition, there are numerous other
potential investors seeking to purchase improved real property and many property
holders seeking to dispose of real estate with which HRP will compete, including
companies substantially larger than HRP and with substantially greater
resources.

OTHER RISKS.

Realty and HCRE, on behalf of HRP, monitor compliance with the Americans with
Disabilities Act and are currently not aware of any material non-compliance
issues.

HRP does not directly employ any individuals. All 95 employees rendering
services on behalf of HRP and its Properties are employees of Realty and/or
HCRE.

Allfirst Bank, the principal tenant of Allfirst Building, has options to
purchase the building from HRP in either 2004 or 2006.

The business of HRP involves only one industry segment. Accordingly, all
information required by Item 101(b) of Regulation S-K is included in the
Consolidated Financial Statements included in Item 8. HRP has no foreign
operations and its business is not seasonal.

OCCUPANCY AND MAJOR TENANT INFORMATION

For information regarding occupancy, percentages of square feet scheduled to
expire by calendar year, and major tenants, see "Liquidity and Capital
Resources" in Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations.

PAGE 5 of 45

ITEM 2. PROPERTIES

As of December 31, 2001, HRP owned fourteen properties in six states with
5,073,000 net rentable square feet.

NAME AND LOCATION GENERAL DESCRIPTION OF THE PROPERTY
----------------- -----------------------------------

Airport Plaza Fee simple interest in a 3-story office building constructed in 1982 containing
San Diego, California 48,853 net rentable square feet of space located on 2 acres of land. The
property was 80% occupied at December 31, 2001.

Allfirst Building Fee simple interest in a 22-story office building constructed in 1972 containing
Baltimore, Maryland 345,172 net rentable square feet of office space on 0.6 acres of land. At
December 31, 2001, the property was 97% occupied. Allfirst Bank, the principal
tenant of Allfirst Building, has options to purchase the building from HRP for
$28,000,000 in either 2004 or 2006.

Bellevue Corporate Plaza Fee simple interest in a 10-story office building constructed in 1980 containing
Bellevue, Washington 242,939 net rentable square feet of space located on 3.6 acres of land. The
property was 80% occupied at December 31, 2001.

Bradshaw Business Parks Fee simple interest in 21 single-story buildings located at four separate sites
Sacramento and containing an aggregate of 452,838 net rentable square feet of office/warehouse
Rancho Cordova, California space on 31 acres of land and constructed between 1974 and 1980. At December 31,
2001, the property was 92% occupied.

Corporate Square Fee simple interest in a 10-building office complex ranging from one to seven
Atlanta, Georgia stories, constructed between 1967 and 2000, containing an aggregate of 592,769
net rentable square feet of space located on 34 acres of land. The property was
98% occupied at December 31, 2001.

Executive Park Fee simple interest in 25 office buildings ranging from one to six stories,
Atlanta, Georgia constructed between 1965 and 1972, containing a total of 891,615 net rentable
square feet of space located on 70 acres of land. The property was 81% occupied
at December 31, 2001. In 2001, HRP began constructing (on another previously
owned 3 acres of land) a 5-story building which will contain 125,000 net
rentable square feet. (For additional information regarding this project, see
"Liquidity and Capital Resources" in Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations.)

Fairlane Commerce Park Fee simple interest in a portion of an office/industrial park consisting of 11
Dearborn, Michigan single-story buildings constructed between 1973 and 1990. The property consists
of 416,056 net rentable square feet of space on about 35 acres of land. The
property was 100% occupied at December 31, 2001.

PAGE 6 of 45

NAME AND LOCATION GENERAL DESCRIPTION OF THE PROPERTY
----------------- -----------------------------------

Fountain View Business Center Fee simple interest in three 3-story office buildings constructed in 1980
San Diego, California containing 89,432 net rentable square feet of space located on 4.3 acres of
land. As of December 31, 2001, the property was 98% occupied.

Gulley Road Industrial Park Fee simple interest in an industrial park consisting of 5 single-story buildings
Dearborn, Michigan constructed between 1990 and 1993 containing 154,360 net rentable square feet on
11 acres of land. The property was 88% occupied at December 31, 2001.

Montrose Office Center Fee simple interest in a 10-story office building constructed in 1980 containing
Rockville, Maryland 147,658 net rentable square feet of space on 3 acres of land. The property was
93% occupied at December 31, 2001.

Parklane Towers Fee simple interest in twin 15-story office buildings constructed in 1973
Dearborn, Michigan containing 486,542 net rentable square feet of space on 31.8 acres of land. The
property was 97% occupied at December 31, 2001.

Raintree Industrial Park Fee simple interest in an office/industrial complex constructed between 1971 and
Solon, Ohio 1979 containing 795,198 net rentable square feet of space in 14 single-story
buildings on 49 acres of land. The property was 87% occupied at December 31,
2001.

Riverbank Plaza Fee simple interest in two 3-story office buildings constructed in 1978
San Diego, California containing 40,222 net rentable square feet of space located on 1.6 acres of
land. As of December 31, 2001, the property was 90% occupied.

Seattle Business Parks Fee simple interest in office/industrial parks located at two separate sites.
Kent and Tukwila, Washington The single-story buildings were completed between 1972 and 1993 and contain an
aggregate of 369,222 net rentable square feet of space in 17 buildings on 23
acres of land. At December 31, 2001, the property was 95% occupied.

For information regarding encumbrances to which the properties are subject and
the status of related mortgage loans, see "Liquidity and Capital Resources" in
Item 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations, as well as Note 6 to the Consolidated Financial Statements and
Schedule III in Item 8 - Financial Statements and Supplemental Information.

OFFICE SPACE -

HRP leases and shares offices with Hallwood in Dallas, Texas under a lease which
expires November 30, 2008. HRP has a one-time option to terminate the lease
effective November 30, 2005. The minimum cash rental payments are $149,000,
$315,000, and $315,000 for 2002, 2003 and 2004, respectively, of which HRP's
portion is approximately $100,000, $210,000 and $210,000 for 2002, 2003 and
2004, respectively.

PAGE 7 of 45

ITEM 3. LEGAL PROCEEDINGS

Beginning in 1997, HRP has been a defendant in two lawsuits that were brought by
Gotham Partners, L.P. in the Delaware Court of Chancery.

The first suit was filed on February 27, 1997 in the Court of Chancery for New
Castle County, Delaware, styled Gotham Partners, L.P. v. Hallwood Realty
Partners, L.P. and Hallwood Realty Corporation (C.A. No. 15578), and it sought
access to certain books and records of HRP and was subsequently settled,
allowing certain access. On April 9, 2001 the case was dismissed.

The second action was filed on June 20, 1997 in a separate complaint in the
Court of Chancery for New Castle County, Delaware, styled Gotham Partners, L.P.
v. Hallwood Realty Partners, L.P., et al. (C.A. No. 15754). This action alleges
claims of breach of fiduciary duties, breach of HRP's partnership agreement, and
fraud in connection with certain transactions involving HRP's units in the mid
1990's. Hallwood is alleged to have aided and abetted the alleged breaches. On
June 21, 2000, after completing fact discovery, all parties moved for summary
judgment on several issues. In September and October, 2000, the Delaware court
issued three separate written opinions resolving the summary judgment motions.
In the opinions, the court ruled that trial would be required as to all issues,
except that (i) Gotham was found to have standing to pursue its derivative
claims; (ii) defendants were entitled to judgment dismissing the fraud claim;
(iii) the General Partner was entitled to judgment dismissing the breach of
fiduciary duty claims brought against it; and (iv) the General Partner's outside
directors were entitled to judgment dismissing all claims brought against them.

A five-day trial was held in January 2001. On July 18, 2001, the Delaware Court
of Chancery rendered its opinion. In its decision, the court determined that an
option plan and a sale of units to Hallwood in connection with a reverse unit
split implemented by HRP in 1995 were in compliance with HRP's partnership
agreement. The court also found that the sale of units to Hallwood in connection
with a 1995 odd-lot offer by HRP did not comply with certain procedures required
by the HRP partnership agreement. The court ruled that the defendants other than
HRP pay a judgment in the amount of $3,417,423, plus pre-judgment interest from
August 1995 to HRP. The judgment amount represents what the court determined was
an underpayment by Hallwood. The court's judgment is not final until all
rehearings and appeals have been exhausted. In August 2001, plaintiff and
certain defendants appealed the Court of Chancery's judgment to the Delaware
Supreme Court. Those appeals are pending. Oral arguments were heard on February
12, 2002, and a rehearing en banc was held on March 26, 2002. In October 2001,
HRP received the $3,417,423 judgment together with $2,987,576 of pre-judgment
and post-judgment interest, subject to an arrangement that it be returned in
full or part if the judgment is modified or reversed on appeal. If the appellate
court reverses the judgment, any subsequent ruling by the trial court on remand
may be more or less favorable to HRP. As a result of the appeals and the
uncertainty of their outcome, HRP recorded the judgment and interest as
"Deferred Litigation Proceeds" on its balance sheet.

On February 15, 2000, HRP filed a lawsuit in the United States District Court
for the Southern District of New York styled Hallwood Realty Partners, L.P. v.
Gotham Partners L.P., et al. (Civ. No. 00 CV 1115) alleging violations of the
Securities Exchange Act of 1934 by certain purchasers of its units, including
Gotham Partners, L.P., Gotham Partners III, L.P., Private Management Group,
Inc., Interstate Properties, Steven Roth and EFO Realty, Inc., by virtue of
those purchasers' misrepresentations and/or omissions in connection with filings
required under the Securities Exchange Act of 1934. The complaint further
alleged that defendants, by acquiring more than 15% of the outstanding HRP
units, have triggered certain rights under its Unit Purchase Rights Agreement,
for which HRP was seeking declaratory relief. HRP sought various forms of
relief, including declaratory judgments, divestiture, corrective disclosures, a
"cooling-off" period and damages, including costs and disbursements. On November
16, 2000, the court granted HRP's motion to add as defendants Gotham Holdings
II, L.L.C., Hallwood Investors, L.P., Liberty Realty Partners, L.P. and
EFO/Liberty, Inc. and to remove EFO Realty, Inc. as a defendant.

Discovery was completed in December 2000 and trial was held in February 2001. On
February 23, 2001, the court rendered a decision in favor of the defendants and
on February 28, 2001, the court ordered the complaint dismissed. HRP filed a
Notice of Appeal on March 29, 2001 with respect to the February 28, 2001
dismissal of the complaint and other matters. All parties filed briefs with the
Second Circuit. Oral arguments were heard on March 4, 2002.

HRP is from time to time involved in various other legal proceedings and claims
which arise in the ordinary course of business. These matters are generally
covered by insurance. Management believes that the resolution of these matters
will not have a material adverse effect on HRP's financial position, cash flow
or operations.

PAGE 8 of 45

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the security holders of HRP during the
fourth quarter of 2001.

PART II

ITEM 5. MARKET FOR REGISTRANT'S UNITS AND RELATED SECURITY HOLDER MATTERS

HRP's units are traded on the American Stock Exchange under the symbol "HRY". As
of March 22, 2002, there were approximately 26,000 unitholders owning the
1,589,948 units outstanding. HRP has not paid any cash distributions since
February, 1992. Each quarter Realty reviews HRP's capacity to make cash
distributions to its partners.

The following table shows the range of sales prices for the periods indicated,
as reported by the American Stock Exchange:

Trading Ranges
--------------------
High Low
------- -------

2000 -
1st Quarter $ 50.75 $ 41.88

2nd Quarter 48.00 34.25

3rd Quarter 46.50 33.25

4th Quarter 46.25 40.00

2001 -

1st Quarter $ 71.75 $ 47.50

2nd Quarter 67.50 56.00

3rd Quarter 60.00 52.00

4th Quarter 71.02 52.75

PAGE 9 of 45

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial data regarding HRP's results
of operations and financial position as of the dates indicated. This information
should be read in conjunction with Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in Item 7 and the
Consolidated Financial Statements and notes thereto contained in Item 8.

Year Ended December 31,
---------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(in thousands except per unit amounts)

STATEMENTS OF OPERATIONS:

Total revenues $ 74,584 $ 67,292 $ 59,645 $ 56,680 $ 53,899
Income before extraordinary item and
cumulative effect of SFAS No. 133 adoption 9,079 90 4,062 6,246 2,357
Net income (loss) 8,328 (299) 4,062 11,593 2,357

Income (loss) per unit and equivalent unit:
Basic -
Income before extraordinary item and
cumulative effect of SFAS No. 133 adoption 5.66 0.06 2.40 3.70 1.40
Net income (loss) 5.19 (0.18) 2.40 6.86 1.40
Assuming dilution -
Income before extraordinary item and
cumulative effect of SFAS No. 133 adoption 5.47 0.05 2.31 3.55 1.35

Net income (loss) per unit 5.01 (0.18) 2.31 6.59 1.35

BALANCE SHEETS:

Real estate, net (a) $ 213,574 $ 206,392 $ 192,814 $ 175,779 $ 179,028

Total assets 269,875 254,504 230,386 214,023 207,134

Mortgages payable 201,224 200,096 171,312 162,078 157,911

Partners' capital (b) 54,022 44,490 48,696 44,634 33,041

NOTES TO SELECTED FINANCIAL DATA:

(a) Acquisition and development activity from 1999 to 2001 increased HRP's
real estate assets. These increases were partially offset by
depreciation and amortization. Prior to 1999, real estate assets
declined in each of the years, primarily due to depreciation and
amortization exceeding the additions of tenant and property
improvements.

(b) Partners' capital includes Accumulated Other Comprehensive Income of
$1,204,000 as of December 31, 2001. Partners' capital balance is
allocated 99% to the limited partners and 1% to the General Partner.

PAGE 10 of 45

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

This discussion should be read in conjunction with Item 6 - Selected Financial
Data and Item 8 - Financial Statements and Supplemental Information.

RESULTS OF OPERATIONS:

2001 VERSUS 2000 -

REVENUE FROM PROPERTY OPERATIONS in 2001 increased $3,033,000, or 4.6%, compared
to 2000. The following table illustrates the components of the change:

Rental income, net $ 2,208,000
Other property income 825,000
-----------
Net increase $ 3,033,000
===========

Net rental income increased due to revenues generated from the addition and
completion of one development property at Corporate Square in mid-2000
($1,971,000), overall higher rental rates at most of HRP's real estate
properties, and an increase in average occupancy between years from 89.4% to
90.9%. As of December 31, 2001, HRP had leases executed and in place for
approximately 91% of the portfolio's net rentable square feet (excluding a
125,000 square foot development property at Executive Park). Other property
income increased primarily due to increases in tenant expense recoveries.

GAIN FROM PROPERTY SALES of $4,184,000 in 2001 is comprised of the January sale
of one building at Seattle Business Parks for a gross selling price of
$3,287,000, resulting in a gain of $2,109,000; the January sale of one building
at Fairlane Commerce Park for a gross selling price of $575,000, resulting in a
gain of $153,000; and the March sale of Joy Road Distribution Center for a gross
selling price of $5,326,000, resulting in a gain of $1,922,000.

INTEREST INCOME increased by $75,000, or 7.7%, as a result of increased earnings
on overnight investments due to a higher average cash balance available for
investment, partially offset by lower interest rates.

PROPERTY OPERATING EXPENSES for 2001 increased $641,000, or 2.4%, compared to
2000. The increase is comprised primarily of the following components:

o Operating costs with respect to the addition of the one development
property at Corporate Square completed in mid-2000 were $629,000 greater
than in 2001.

o Professional fees decreased $705,000 primarily due to costs incurred in
2000 for research and analysis of potential property development
projects.

o Combined, all other operating costs increased $717,000, or about 2.7%,
of which none are individually significant.

INTEREST EXPENSE for 2001 increased $143,000, or 0.9%, compared to 2000 as a
result of an increase in mortgage loan interest of $845,000 (due to a higher
average mortgage loan balance), partially offset by the capitalization of
$486,000 of interest for construction of the development project at Executive
Park (as described in Note 5 to the Consolidated Financial Statements), and a
decrease in loan cost amortization and other interest costs of $216,000.

DEPRECIATION AND AMORTIZATION EXPENSE was consistent between years and increased
$64,000, or 0.4%.

GENERAL AND ADMINISTRATIVE EXPENSES for 2001 decreased $690,000, or 13.7%,
compared to 2000 primarily due to $601,000 of non-qualified unit option
compensation in 2000.

LITIGATION COSTS were $3,808,000 and $5,663,000 for 2001 and 2000, respectively,
and are related to the lawsuits described in Item 3 - Legal Proceedings and Note
11 to the Consolidated Financial Statements.

PAGE 11 of 45

RESULTS OF OPERATIONS (CONTINUED) -

LOSS ON EARLY EXTINGUISHMENT OF DEBT of $559,000 in 2001 is from the early
payoff of the loan secured by Joy Road Distribution Center and the refinancing
of a loan secured by a portion of Corporate Square and is comprised of
prepayment penalties of $423,000 and the writeoff of $136,000 of unamortized
loan costs associated with the retired loans.

2000 VERSUS 1999 -

REVENUE FROM PROPERTY OPERATIONS in 2000 increased $7,587,000, or 12.9%,
compared to 1999. The following table illustrates the components of the change:

Rental income, net $ 6,638,000
Other property income 949,000
------------
Net increase $ 7,587,000
============

Net rental income increased as the result of overall higher rental rates, the
August 1999 to January 2000 acquisitions of Riverbank Plaza, Gulley Road
Industrial Park, and Fountain View Business Center ($2,532,000), and the
completion of a new building at Corporate Square in mid-2000 ($1,402,000).
Collectively these four properties are referred as "New Properties". These
increases to rental income were partially offset by a decline in average
occupancy, in the aggregate, between years from 93.1% to 89.4%. The decrease in
average occupancy was primarily due to Joy Road Distribution Center's drop from
98% occupancy at year-end 1999 to 28% occupancy at year-end 2000. As of December
31, 2000, HRP had leases executed and in place for approximately 90% of the
portfolio's net rentable square feet. Other property income increased primarily
due to increases in tenant expense recoveries.

INTEREST INCOME increased $60,000 as a result of additional earnings on
overnight investments due to slightly higher interest rates, partially offset by
lower average cash balances available for investment.

PROPERTY OPERATING EXPENSES for 2000 increased $2,590,000, or 10.8%, compared to
1999. The increase is comprised primarily of the following components:

o Operating costs with respect to the New Properties contributed
$1,362,000 towards the overall increase.

o Professional fees increased primarily due to $539,000 of costs for
research and analysis of potential property development projects.

o Combined, all other operating costs increased $689,000, or 2.9%, between
the years.

INTEREST EXPENSE for 2000 increased $1,742,000, or 12.7%, compared to 1999 as a
result of an increase in mortgage loan interest of $1,442,000 (including
$1,453,000 for the New Properties) due to a higher average mortgage loan
balance, in the aggregate and, due to a lesser extent, an increase in loan cost
amortization and other interest of $300,000.

DEPRECIATION AND AMORTIZATION EXPENSE increased $2,500,000, or 20.8%, due to
$1,137,000 of depreciation for the New Properties and increases of $584,000 of
depreciation and $779,000 of lease commission amortization for comparable
properties.

GENERAL AND ADMINISTRATIVE EXPENSES for 2000 increased $1,229,000, or 32.2%,
compared to 1999, as a result of $601,000 of non-cash compensation generated
from the exercise of unit options in May 2000, (see Note 8 to the Consolidated
Financial Statements), $414,000 of higher professional fees incurred with
proposed acquisitions, and $284,000 of increases to travel, insurance and
miscellaneous costs and expenses.

LITIGATION COSTS were $5,663,000 and $2,105,000 for 2000 and 1999, respectively,
and are related to the lawsuits described in Item 3 - Legal Proceedings and Note
11 to the Consolidated Financial Statements.

LOSS ON EARLY EXTINGUISHMENT OF DEBT of $389,000 in 2000 is from the early
payoff of the loan secured by Bradshaw Business Parks and is comprised of a
prepayment penalty of $286,000 and the writeoff of $103,000 of unamortized loan
costs associated with the retired loan.

PAGE 12 of 45

LIQUIDITY AND CAPITAL RESOURCES

GENERAL INFORMATION -

HRP operates in the commercial real estate industry. HRP's activities include
the acquisition, ownership and operation of its commercial real estate assets.
While it is the General Partner's intention to operate HRP's existing real
estate investments and to acquire and operate additional real estate
investments, Realty also continually evaluates each of HRP's real estate
investments in light of current economic trends, operations, and other factors
to determine if any should be considered for disposal.

As of December 31, 2001, HRP owned fourteen real estate assets (the
"Properties"), located in six states containing 5,073,000 net rentable square
feet. HRP seeks to maximize the value of its real estate by making capital and
tenant improvements, by executing marketing programs to attract and retain
tenants, and by controlling or reducing, where possible, operating expenses.

HRP fully consolidates into its financial statements majority owned entities.
For each of the three years in the period ended December 31, 2001, all entities
and Properties were fully owned. All significant intercompany balances and
transactions have been eliminated in consolidation.

HRP has, in three situations, created a Special Purpose Entity ("SPE"). These
SPEs were formed at the request of lenders for the express purpose of
strengthening the collateral for the loans by isolating (for Federal bankruptcy
law purposes) the assets and liabilities of the SPEs. In all cases and since
their various formation dates, these wholly-owned entities (including their
assets, liabilities and results of operations) have been fully consolidated into
the financial statements of HRP.

CRITICAL ACCOUNTING POLICIES -

In December 2001, the SEC requested that registrants identify "critical
accounting policies" in Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations. The SEC indicated that a
"critical accounting policy" is one that is both important to the portrayal of
an entity's financial condition and results and requires management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain. HRP
believes that the following of its accounting policies fit this description:

Revenue Recognition - Statement of Financial Accounting Standards ("SFAS") No.
13 "Accounting for Leases" requires management to estimate the economic life of
lease payments. However, this does not require subjective input by management,
as rental income is recognized on a straight-line basis over the lease term, as
defined in each respective lease. These adjustments to convert cash rental
income (which may include free rent and periodic rental rate increases over the
term of the lease) to straight-line rental income increased revenues by
$256,000, $569,000, and $778,000 in 2001, 2000, and 1999, respectively.

Impairment of Long-Lived Assets - HRP records impairment losses on its real
estate assets when events and circumstances indicate that the assets might be
impaired or the undiscounted cash flows estimated to be generated by those
assets are less than the carrying value of that asset. In such cases, an
impaired asset would be written down to its fair value. Our cash flow estimates
are based on historical results adjusted to our best estimate of future market
and operating conditions. For the three years ended December 31, 2001, HRP has
not recorded a write-down, or impairment of the carrying value of any real
estate property, based on these calculations.

PAGE 13 of 45

LIQUIDITY AND CAPITAL RESOURCES - (CONTINUED)

Significant and other accounting policies are described in Note 2 to the
Consolidated Financials Statements in Item 8. The policies listed are not
intended to be a comprehensive list of all of our accounting policies. In most
cases, the accounting treatment of a particular transaction is specifically
dictated by accounting principles generally accepted in the United States of
America, with no need for management's judgment in the application. There are
also areas in which management's judgment in selecting any available alternative
would not produce a materially different result than those recorded and
reported.

CASH SOURCES, CASH USES AND COMMITMENTS -

HRP's cash position increased $8,456,000 during 2001 to $24,913,000 as of
December 31, 2001. The sources of cash during the year were $15,872,000 of cash
provided by operating activities, $10,000,000 of mortgage principal proceeds,
$8,435,000 of net cash proceeds from property sales, and $6,405,000 of
litigation judgment and interest described in Item 3 - Legal Proceedings. The
uses of cash were $9,417,000 for property and tenant improvements, $13,406,000
for property development costs, $3,987,000 for scheduled mortgage principal
payments, $2,760,000 of mortgage principal repayments from mortgage refinance
proceeds, $2,125,000 for the early payoff of mortgage principal in conjunction
with a property sale, $423,000 for mortgage prepayment penalties, and $138,000
for loan fees and expenses.

For the foreseeable future, HRP anticipates that mortgage principal payments,
tenant and capital improvements, lease commissions and litigation costs will be
funded by net cash from operations. We believe that there will be sufficient
cash from operations to meet these needs because HRP has leases in place as of
December 31, 2001 to provide $55,261,000 of minimum rental payments during 2002
(see "Lease Agreements and Major Tenant Information" discussed within Item 7 and
Note 7 to the Consolidated Financial Statements). HRP had $54,443,000 of minimum
rental payments estimated for 2001 (based on leases in place as of December 31,
2000), however the actual rental payments recorded for 2001 were $60,494,000.
Our ability to fund operations in the future will depend upon continued success
in maintaining current occupancy levels, retaining current tenants, and
attracting new tenants. The primary sources of capital to fund any future
acquisitions or developments will be proceeds from the sale, financing or
refinancing of one or more of its Properties.

Each quarter Realty reviews HRP's capacity to make cash distributions. HRP has
not made any cash distributions since February, 1992. In addition to the
commitment described below with regards to the development project at Executive
Park, HRP has estimated and budgeted tenant and capital improvements of
$10,852,000 and lease commissions of $2,261,000 for 2002.

PROPERTY DEVELOPMENT AT EXECUTIVE PARK -

In early 2001, HRP demolished a 1-story office building at its Executive Park
property in Atlanta, Georgia that contained 18,000 net rentable square feet. In
order to do so, HRP had to obtain a release of the building from Executive
Park's mortgage lien by substituting for such collateral $608,000 of United
States Treasury Bonds, which have various maturity dates through December 2007.
In February 2001, HRP began constructing a 5-story office building containing
125,000 net rentable square feet. The estimated construction and development
costs for the building and its parking garage (excluding the existing land
costs, lease commissions and tenant improvements to be spent after a lease is
executed, and loan fees once financing is secured) are approximately
$15,650,000. As of December 31, 2001, HRP had incurred and capitalized
$13,656,000 of construction and development costs. The building and its parking
garage, excluding tenant finish-out, is estimated to be completed by the end of
March, 2002. All development costs have been and are estimated to continue to be
from existing cash funds until the property is substantially leased, at which
time it is anticipated that loan financing will be secured. Costs for lease
commissions, tenant improvements and loan fees are dependant upon the terms of
each lease agreement and yet to be determined, as no pre-leasing has been done.
HRP anticipates leasing substantially all of the building by late 2002.

RISKS, COMPETITION AND OTHER FACTORS -

For information about risks, see "Risks, Competition and Other Factors" in Item
1 - Business.

PAGE 14 of 45

LIQUIDITY AND CAPITAL RESOURCES - (CONTINUED)

LEASE AGREEMENTS AND MAJOR TENANT INFORMATION -

Lease provisions generally require HRP's tenants to pay fixed rental amounts
plus their proportionate share of certain building operating costs and real
property taxes. In addition, certain leases include provisions for annual rental
adjustments. Revenue from expense recoveries, included in property operations,
was $4,197,000, $3,315,000, and $2,539,000 in 2001, 2000, and 1999,
respectively. At December 31, 2001, the Properties, in the aggregate, were 91%
occupied (excluding a 125,000 square foot development property at Executive
Park). The following table sets forth the minimum cash rental payments to be
received from leases in place as of December 31, 2001 (in thousands):

Payments Payments
from Leases from Leases
without Early with Early
Termination Termination
Rights Rights Total
------------- ----------- -----

2002 $ 55,261 $ 2,720 $ 57,981
2003 45,577 2,437 48,014
2004 36,574 1,777 38,351
2005 29,210 1,335 30,545
2006 19,066 2,218 21,284
Thereafter 73,340 21,730 95,070
--------- -------- ---------
Total $ 259,028 $ 32,217 $ 291,245
========= ======== =========

Based on leases in place as of December 31, 2001, set forth below are the
percentages of square feet scheduled for lease expirations for each calendar
year, assuming that none of the tenants exercise early termination or renewal
options:

2002 22%
2003 17%
2004 11%
2005 12%
2006 16%
Thereafter 22%

During 2001 and 2000, two tenants leasing space contributed 10% or more of HRP's
revenues. Ford Motor Company and affiliates ("Ford") leases space in Parklane
Towers and Fairlane Commerce Park. Ford accounted for 12% and 11% of revenues in
2001 and 2000, respectively. The General Services Administration ("GSA") leases
space in Corporate Square and Executive Park. GSA accounted for 14% and 12% of
revenues in 2001 and 2000, respectively.

As of December 31, 2001, Ford occupied 206,000 square feet of office space under
8 leases at Parklane Towers and 291,000 square feet of office, technical
laboratory and industrial space under 10 leases at Fairlane Commerce Park. These
leases expire between 2002 and 2010 and most contain renewal options, providing
for one to ten year renewals. As of December 31, 2001, GSA occupied 327,000
square feet of office space at Executive Park under 5 leases which expire
between 2002 and 2011 and 309,000 square feet of office space at Corporate
Square under 2 leases which expire in 2013 (with a right to early terminate in
2008) and 2020. The remaining tenants are not concentrated in any one industry,
nor is HRP otherwise dependent on any group of related tenants for 10% or more
of its revenues.

ACCOUNTING STANDARDS -

In August 2001, SFAS No. 144 "Accounting for the Impairment or Disposal of
Long-Lived Assets" was issued. The provisions of this statement are effective
for HRP beginning on January 1, 2002. HRP believes that the impact of adopting
SFAS No. 144 will be limited to the requirement that the results of operations
of disposed properties, for current and historical presentation, be classified
as discontinued operations. This will result in the reclassification of
historical operations for property dispositions that occur in current periods.

PAGE 15 of 45

LIQUIDITY AND CAPITAL RESOURCES - (CONTINUED)

LITIGATION & JUDGMENT -

On July 18, 2001, the Delaware Court of Chancery rendered it opinion for the
action styled Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., et al.
(C.A. No. 15754). The court ruled that the defendants other than HRP pay a
judgment in the amount of $3,417,423, plus pre-judgment interest from August
1995 to HRP. The judgment amount represents what the court determined was an
underpayment by Hallwood. The court's judgment is not final until all rehearings
and appeals have been exhausted. In August 2001, plaintiff and certain
defendants appealed the Court of Chancery's judgment to the Delaware Supreme
Court. Those appeals are pending. (For more information about this litigation
and the lawsuit filed in United States District Court of the Southern District
of New York, see Item 3 - Legal Proceedings and Note 11 to the Consolidated
Financial Statements.)

In October 2001, HRP received the $3,417,423 judgment together with $2,987,576
of pre-judgment and post-judgment interest, subject to an arrangement that it be
returned in full or part if the judgment is modified or reversed on appeal. As a
result of the appeals and the uncertainty of their outcome, HRP recorded the
judgment and interest as "Deferred Litigation Proceeds" on its balance sheet.

MORTGAGE LOANS -

Substantially all of the buildings in HRP's real estate properties were
encumbered and pledged as collateral by eleven non-recourse mortgage loans
aggregating $201,224,000 as of December 31, 2001. These mortgage loans have
interest rates varying from 3.44% to 8.70% (with an effective average interest
rate of 7.6%) and mature between 2005 and 2020. Other than Allfirst Building's
mortgage ($25,000,000), all mortgages have fixed interest rates. Most of the
mortgage loans require monthly principal payments with balloon payments due at
maturity. The following table shows for the years presented the principal and
balloon payments that are required (in thousands):

Total
Mortgage
Principal Balloon Loan
Payments Payments Payments
--------- -------- --------

2002 $ 3,672 $ -- $ 3,672
2003 3,998 -- 3,998
2004 4,310 -- 4,310
2005 4,167 74,515 78,682
2006 2,852 25,000 27,852
Thereafter 25,973 56,737 82,710
-------- --------- ---------
Total $ 44,972 $ 156,252 $ 201,224
======== ========= =========

Since August 2000, HRP has had available a $2,000,000 revolving line of credit,
which now matures on July 29, 2002. The line of credit has a variable interest
rate of either prime plus 0.50% or LIBOR plus 3.0% and requires monthly interest
payments, but no principal amortization. HRP has not borrowed against this
facility.

On August 7, 2001, HRP refinanced a mortgage loan secured by a portion of
Corporate Square with a new lender. The interest rate was reduced to 7.7% from
8.625% and the maturity date was extended six years to August 2011. The monthly
principal payments amortize the loan over 22.5 years. The loan proceeds of
$10,000,000 were used to pay the outstanding mortgage principal balance of
$2,760,000 with the former lender, to pay a prepayment penalty of $409,000, to
pay transaction costs of $142,000, and for general working capital. The
prepayment penalty along with the writeoff of $105,000 of unamortized loan costs
associated with the retired loan were expensed and are included in the
Consolidated Statements of Operations as an extraordinary item.

PAGE 16 of 45

LIQUIDITY AND CAPITAL RESOURCES - (CONTINUED)

PROPERTY DISPOSITIONS -

In March 2001, HRP sold Joy Road Distribution Center that contained 442,000 net
rentable square feet on 21 acres for a gross selling price of $5,326,000. The
carrying value of the assets was $2,994,000. The sale resulted in $4,916,000 of
net proceeds to HRP and a net gain of $1,922,000. The net sale proceeds were
used to pay the outstanding mortgage principal balance of $2,125,000, to pay a
prepayment penalty of $14,000 to the lender, and to add $2,777,000 to general
working capital. The prepayment penalty along with the writeoff of $31,000 of
unamortized loan costs associated with the retired loan were expensed and are
included in the Consolidated Statements of Operations as an extraordinary item.

In January 2001, HRP sold one of the warehouse buildings at Seattle Business
Parks that contained 63,000 net rentable square feet on 3.9 acres for a gross
selling price of $3,287,000. The carrying value of the assets was $885,000. The
sale resulted in $2,994,000 of net proceeds, which were added to HRP's working
capital, and a net gain of $2,109,000.

Also in January 2001, HRP sold one building at Fairlane Commerce Park that
contained less than 2,000 net rentable square feet on 0.5 acres for a gross
selling price of $575,000. The carrying value of the assets was $372,000. The
sale resulted in $525,000 of net proceeds, which were added to HRP's working
capital, and a net gain of $153,000.

TRANSACTIONS WITH RELATED PARTIES -

Realty receives certain fees in connection with the ongoing management of HRP,
including an asset management fee, acquisition fees and disposition fees.
Specifically, Realty is entitled to receive an asset management fee equal to 1%
of the net aggregate base rents of the Properties, acquisition fees equal to 1%
of the purchase price of newly acquired properties, and disposition fees with
respect to real estate investments, other than the properties owned at the time
of HRP's formation in 1990, equal to 10% of the amount, by which the sales price
of a property exceeds the purchase price of such property.

HCRE receives compensation in connection with the management of the Properties,
which includes a property management fee, lease commissions and construction
supervision fees. The management contracts expire June 30, 2004 and provide for
basic compensation from a property management fee in an amount equal to 2.85% of
cash receipts collected from the Properties' tenants, lease commissions equal to
the current commission market rate as applied to the net aggregate rent (none
exceeding 6% of the net aggregate rent), and construction supervision fees for
administering all construction projects equal to 5% of the total contracted
costs of each capital expenditure or tenant improvement project.

Realty and HCRE are compensated for services provided to HRP and its Properties
as described above. The following table sets forth such compensation and
reimbursements paid by HRP (in thousands):

Entity
Paid or
Reimbursed 2001 2000 1999
---------- ------ ------ ------

Asset management fee Realty $ 609 $ 581 $ 514
Acquisition fee Realty -- 74 105
Disposition fee Realty 120 -- --
Reimbursement of costs (a) Realty 3,297 2,974 2,941
Property management fee HCRE 2,005 1,914 1,693
Lease commissions HCRE 2,158 2,605 4,933
Construction fees HCRE 1,204 917 891

(a) These costs are mostly recorded as general and administrative expenses
and represent reimbursement to Realty, at cost, for administrative level
salaries and compensation, bonuses, employee and director insurance, and
allocated overhead costs. HRP pays its account balance with Realty on a
monthly basis.

In January 2001, HRP acquired a construction development consulting contract
from Hallwood regarding a project in Tulsa, Oklahoma with an unrelated third
party. In connection therewith, HRP reimbursed Hallwood for its actual costs
incurred of $281,000.

PAGE 17 of 45

LIQUIDITY AND CAPITAL RESOURCES - (CONTINUED)

INFLATION -

Inflation did not have a significant impact on HRP during the three years ended
December 31, 2001 and is not anticipated to have a material impact in 2002.

FORWARD-LOOKING STATEMENTS -

In the interest of providing investors with certain information regarding HRP's
future plans and operations, certain statements set forth in this Form 10-K
relate to management's future plans, objectives and expectations. Such
statements are forward-looking statements. Although any forward-looking
statements contained in this Form 10-K or otherwise expressed by or on behalf of
HRP are, to the knowledge and in the judgment of the officers and directors of
the General Partner, expected to prove true and come to pass, management is not
able to predict the future with absolute certainty. Although HRP believes that
the assumptions underlying the forward-looking statements are reasonable, any of
the assumptions could be inaccurate and, therefore, there can be no assurance
that the forward-looking statements will prove to be accurate.

Forward-looking statements involve known and unknown risks and uncertainties,
which may cause HRP's actual performance and financial results in future periods
to differ materially from any projection, estimate or forecasted result. These
risks and uncertainties include the risks identified under "Risks, Competition
and Other Factors" in Item 1 - Business.

ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

On July 27, 2000, HRP sold its interest rate swap agreement for $1,597,000. HRP
had entered into the interest rate swap agreement in 1998 to reduce its exposure
to changes in interest rates for the loan secured by Allfirst Building. This
interest rate swap agreement effectively fixed the loan's cash interest rate at
6.78%, as opposed to the mortgage loan interest rate of LIBOR plus 1.30% (or
7.94% at the time of the swap agreement sale). The proceeds from the sale were
designated for general working capital purposes. For financial reporting
purposes, the proceeds are being amortized over the life of the loan as a
reduction to interest expense. As of December 31, 2000, the unamortized balance,
included on the balance sheet in "Prepaid rent, security deposits and other",
was $1,481,000. During 2001, as the result of the adoption of SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities" HRP reclassified
the remaining unamortized gain from liabilities to accumulated other
comprehensive income. The proceeds will continue to be amortized over the life
of Allfirst Building's mortgage payable as a reduction to interest expense. As
of December 31, 2001, the unamortized balance, included on the balance sheet as
"Accumulated other comprehensive income", was $1,204,000.

Also on July 27, 2000 and in connection with the sale of the swap agreement, HRP
purchased an interest rate cap for Allfirst Building's mortgage loan for
$288,000, which limits HRP's exposure to changing interest rates to a maximum of
10%. This interest rate cap, which has a notional amount of $25,000,000, has
terms consistent with Allfirst Building's mortgage loan. Allfirst Building's
cash interest rate was 3.44% and 8.12% as of December 31, 2001 and 2000,
respectively. The interest rate cap is a derivative and designated as a cash
flow hedge. Hedge effectiveness is measured based on using the intrinsic value
of the interest rate cap. All changes in the fair value of the time value of the
cap are recorded directly to earnings. With the January 1, 2001 adoption SFAS
No. 133, HRP recorded the cumulative effect of the adoption as a reduction to
income of $192,000, or the amount of the difference between the carrying value
as of January 1, 2001 of $267,000 and the then estimated fair value of $75,000,
all of which represented change in time value. Thereafter, on a quarterly basis,
HRP has recorded changes in the estimated fair value of the cap in interest
expense. As of December 31, 2001, the estimated fair value of the interest rate
cap was $68,000.

Other than Allfirst Building's mortgage ($25,000,000), all mortgages have fixed
interest rates. Accordingly, changes in LIBOR or the prime rate do not
significantly impact the amount of interest paid by HRP. Assuming a 100 basis
point, or 1%, change in LIBOR, interest paid by HRP would increase or decrease
by approximately $250,000 on an annual basis.

PAGE 18 of 45

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL INFORMATION

INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL INFORMATION

FINANCIAL STATEMENTS: Page
----

Independent Auditors' Report 20

Consolidated Balance Sheets as of December 31, 2001 and 2000 21

Consolidated Statements of Operations for the years
ended December 31, 2001, 2000 and 1999 22

Consolidated Statements of Partners' Capital for the years
ended December 31, 2001, 2000 and 1999 23

Consolidated Statements of Cash Flows for the years
ended December 31, 2001, 2000 and 1999 24

Notes to Consolidated Financial Statements 25

FINANCIAL STATEMENT SCHEDULE:

Schedule III - Real Estate and Accumulated Depreciation 38

All other schedules have been omitted because they are not applicable,
not required, or the required information is disclosed in the
Consolidated Financial Statements or notes thereto.

PAGE 19 of 45

INDEPENDENT AUDITORS' REPORT

To the Partners of Hallwood Realty Partners, L.P.

We have audited the accompanying consolidated balance sheets of Hallwood Realty
Partners, L.P. and subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of operations, partners' capital and cash flows
for each of the three years in the period ended December 31, 2001. Our audit for
the year ended December 31, 2001 also included the financial statement schedule
listed in the Index at Item 8. These financial statements and financial
statement schedule are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on the financial statements and
financial statement schedule based upon our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Hallwood Realty Partners, L.P. and
subsidiaries as of December 31, 2001 and 2000 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

DELOITTE & TOUCHE LLP

Dallas, Texas
February 15, 2002

PAGE 20 of 45

HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT UNIT AMOUNTS)

DECEMBER 31,
------------------------
2001 2000
---------- ----------

ASSETS

Real estate:
Land $ 59,015 $ 60,236
Buildings and improvements 290,674 291,474
Tenant improvements 22,301 21,797
Construction in progress 18,303 3,755
---------- ----------
390,293 377,262
Accumulated depreciation and amortization (176,719) (170,870)
---------- ----------
Real estate, net 213,574 206,392

Cash and cash equivalents 24,913 16,457
Accounts receivable 2,315 3,211
Lease commissions, net 10,868 11,035
Loan reserves and escrows 8,359 7,109
Loan costs, net 3,258 3,879
Prepaid expenses and other assets 6,588 6,421
---------- ----------

Total assets $ 269,875 $ 254,504
========== ==========

LIABILITIES AND PARTNERS' CAPITAL

Liabilities:
Mortgages payable $ 201,224 $ 200,096
Accounts payable and accrued expenses 5,147 5,570
Prepaid rent, security deposits and other 3,061 4,192
Deferred litigation proceeds 6,405 --
Payable to affiliates, net 16 156
---------- ----------
Total liabilities 215,853 210,014
---------- ----------
Commitments and contingencies
Partners' capital:
Limited partners -
1,589,948 units outstanding 52,290 44,045
General partner 528 445
Accumulated other comprehensive income 1,204 --
---------- ----------
Total partners' capital 54,022 44,490
---------- ----------
Total liabilities and partners' capital $ 269,875 $ 254,504
========== ==========

See notes to consolidated financial statements.

PAGE 21 of 45

HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER UNIT AMOUNTS)

FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------

REVENUES:
Property operations $ 69,357 $ 66,324 $ 58,737
Gain from property sales 4,184 -- --
Interest 1,043 968 908
---------- ---------- ----------
Total revenues 74,584 67,292 59,645
---------- ---------- ----------

EXPENSES:
Property operations 27,193 26,552 23,962
Interest 15,586 15,443 13,701
Depreciation and amortization 14,562 14,498 11,998
General and administrative 4,356 5,046 3,817
Litigation costs 3,808 5,663 2,105
---------- ---------- ----------
Total expenses 65,505 67,202 55,583
---------- ---------- ----------
INCOME BEFORE EXTRAORDINARY LOSS AND CUMULATIVE EFFECT OF SFAS NO. 133
ADOPTION 9,079 90 4,062

Extraordinary loss from early extinguishment of debt (559) (389) --
---------- ---------- ----------

INCOME BEFORE CUMULATIVE EFFECT
OF SFAS NO. 133 ADOPTION 8,520 (299) 4,062

Cumulative effect of SFAS No. 133 adoption -
valuation of interest rate cap (192) -- --
---------- ---------- ----------

NET INCOME (LOSS) $ 8,328 $ (299) $ 4,062
========== ========== ==========

ALLOCATION OF NET INCOME (LOSS):
Limited partners $ 8,245 $ (296) $ 4,021
General partner 83 (3) 41
---------- ---------- ----------
Total $ 8,328 $ (299) $ 4,062
========== ========== ==========

NET INCOME (LOSS) PER UNIT AND POTENTIAL UNIT:

Earnings per unit - basic
Income before extraordinary loss and cumulative effect of SFAS No. 133
adoption $ 5.66 $ 0.06 $ 2.40
Loss from early extinguishment of debt (0.35) (0.24) --
Cumulative effect of SFAS No. 133 adoption (0.12) -- --
---------- ---------- ----------
Net income (loss) $ 5.19 $ (0.18) $ 2.40
========== ========== ==========
Earnings per unit - assuming dilution
Income before extraordinary loss and cumulative effect of SFAS No. 133
adoption $ 5.47 $ 0.05 $ 2.31
Loss from early extinguishment of debt (0.34) (0.23) --
Cumulative effect of SFAS No. 133 adoption (0.12) -- --
---------- ---------- ----------
Net income (loss) $ 5.01 $ (0.18) $ 2.31
========== ========== ==========

WEIGHTED AVERAGE UNITS USED IN COMPUTING NET INCOME (LOSS) PER UNIT
AND POTENTIAL UNIT:

Basic 1,590 1,620 1,673
========== ========== ==========

Assuming dilution 1,645 1,674 1,740
========== ========== ==========

See notes to consolidated financial statements.

PAGE 22 of 45

HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL
(IN THOUSANDS EXCEPT UNIT AMOUNTS)

Accumulated Limited
Other Partnership
General Limited Comprehensive Units
Partner Partners Income Total Outstanding
--------- ---------- ------------- ----------- ------------

PARTNERS' CAPITAL, JANUARY 1, 1999 $ 446 $ 44,188 $ -- $ 44,634 1,672,556

Net income 41 4,021 -- 4,062 --
--------- ---------- ------------ ----------- ------------
PARTNERS' CAPITAL, DECEMBER 31, 1999 487 48,209 -- 48,696 1,672,556

Exercise and issuance of unit options 8 806 -- 814 17,200

Purchase of units (47) (4,674) -- (4,721) (99,808)

Net loss (3) (296) -- (299) --
--------- ---------- ------------ ----------- ------------

PARTNERS' CAPITAL, DECEMBER 31, 2000 445 44,045 -- 44,490 1,589,948

Reclassification of cumulative effect of
SFAS No. 133 adoption - deferred gain
from sale of interest rate swap -- -- 1,342 1,342 --

Amortization of deferred gain from
sale of interest rate swap -- -- (138) (138) --

Net income 83 8,245 -- 8,328 --
--------- ---------- ------------ ----------- ------------

PARTNERS' CAPITAL, DECEMBER 31, 2001 $ 528 $ 52,290 $ 1,204 $ 54,022 1,589,948
========= ========== ============ =========== ============

See notes to consolidated financial statements.

PAGE 23 of 45

HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------

OPERATING ACTIVITIES:

Net income (loss) $ 8,328 $ (299) $ 4,062

Adjustments to reconcile net income (loss)
to net cash provided by operating activities:

Depreciation and amortization 14,562 14,476 11,998

Effective rent adjustments (256) (569) (778)

Non-qualified unit option compensation -- 601 --

Gain from property sales (4,184) -- --

Loss from early extinguishment of debt 559 389 --

Cumulative effect of SFAS No. 133 adoption -
valuation of interest rate cap 192 -- --

Changes in assets and liabilities:

Receivables 896 (924) (831)

Lease commission payments (2,752) (5,043) (4,272)

Prepaid expenses, loan reserves and other assets (733) 589 (250)

Accounts payable and other liabilities (740) 3,660 (1,055)
---------- ---------- ----------
Net cash provided by operating activities 15,872 12,880 8,874
---------- ---------- ----------
INVESTING ACTIVITIES:

Property and tenant improvements (9,417) (10,933) (7,024)

Property development costs (13,406) (8,811) (6,427)

Property acquisitions -- (7,791) (5,454)

Cash proceeds from property sales, net of selling costs 8,435 -- --
---------- ---------- ----------
Net cash used in investing activities (14,388) (27,535) (18,905)
---------- ---------- ----------
FINANCING ACTIVITIES:

Mortgage principal proceeds 10,000 50,623 6,998

Mortgage principal refinanced (2,760) (18,346) --

Mortgage prepayment penalty (423) (286) --

Mortgage principal scheduled payments (3,987) (3,493) (2,913)

Mortgage principal early payoff (2,125) -- --

Loan fees and expenses (138) (1,210) (219)

Deferred litigation proceeds 6,405 -- --

Exercise and issuance of unit options -- 213 --

Purchase of units -- (4,721) --
---------- ---------- ----------
Net cash provided by financing activities 6,972 22,780 3,866
---------- ---------- ----------

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 8,456 8,125 (6,165)

BEGINNING CASH AND CASH EQUIVALENTS 16,457 8,332 14,497
---------- ---------- ----------

ENDING CASH AND CASH EQUIVALENTS $ 24,913 $ 16,457 $ 8,332
========== ========== ==========

See notes to consolidated financial statements.

PAGE 24 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

1. ORGANIZATION

Hallwood Realty Partners, L.P. ("HRP"), a publicly traded Delaware limited
partnership, operates in the commercial real estate industry. HRP's
activities include the acquisition, ownership and operation of its
commercial real estate assets. Units representing limited partnership
interests are traded on the American Stock Exchange under the symbol "HRY".
As of December 31, 2001, there were 1,589,948 units outstanding.

As of December 31, 2001, HRP owned fourteen real estate assets (the
"Properties"), located in six states containing 5,073,000 net rentable
square feet. HRP seeks to maximize the value of its real estate by making
capital and tenant improvements, by executing marketing programs to attract
and retain tenants, and by controlling or reducing, where possible,
operating expenses.

Hallwood Realty, LLC ("Realty" or the "General Partner"), a Delaware limited
liability company and indirectly wholly-owned subsidiary of The Hallwood
Group Incorporated ("Hallwood"), is HRP's general partner and is responsible
for asset management of HRP and its Properties, including decision-making
responsibility for financing, refinancing, acquiring and disposing of
properties. In addition, Realty provides general operating and
administrative services to HRP. Hallwood Commercial Real Estate, LLC
("HCRE"), another indirectly wholly-owned subsidiary of Hallwood, provides
property management, leasing and construction supervision services to the
Properties.

2. ACCOUNTING POLICIES

CONSOLIDATION

HRP fully consolidates into its financial statements majority owned
entities. For each of the three years in the period ended December 31, 2001,
all entities and Properties were fully owned. All significant intercompany
balances and transactions have been eliminated in consolidation.

HRP has, in three situations, created a Special Purpose Entity ("SPE").
These SPEs were formed at the request of lenders for the express purpose of
strengthening the collateral for the loans by isolating (for Federal
bankruptcy law purposes) the assets and liabilities of the SPEs. In all
cases and since their various formation dates, these wholly-owned entities
(including their assets, liabilities and results of operations) have been
fully consolidated into the financial statements of HRP.

CASH AND CASH EQUIVALENTS

HRP considers highly liquid investments with original maturities of three
months or less at the time of purchase to be cash equivalents.

PROPERTY

Property is stated at cost. Renovations and improvements are capitalized;
maintenance and repairs are expensed. When an asset is sold or otherwise
disposed of, the related cost and accumulated depreciation are removed from
the accounts and any gain or any previously unanticipated loss is recognized
in the year of sale or disposition. HRP records impairment losses on its
real estate assets when events and circumstances indicate that the assets
might be impaired or the undiscounted cash flows estimated to be generated
by those assets are less than the carrying value of that asset. In such
cases, an impaired asset would be written down to its fair value. Our cash
flow estimates are based on historical results adjusted to our best estimate
of future market and operating conditions. For the three years ended
December 31, 2001, HRP has not recorded a write-down, or impairment of the
carrying value of any real estate property, based on these calculations.

Depreciation of buildings is computed using the straight-line method over
estimated useful lives ranging from 15 to 43 years. Equipment and other
improvements are depreciated on the straight-line method over estimated
useful lives ranging from 3 to 23 years. Tenant improvements are capitalized
and amortized over the terms of the respective leases or useful life, if
shorter.

PAGE 25 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

2. ACCOUNTING POLICIES - (CONTINUED)

HRP capitalizes all costs related to the development and construction of its
projects, including interest of $486,000, $493,000, and $124,000 in 2001,
2000, and 1999, respectively. The development period of a project is
considered to have begun when activities related to the construction of the
project or a portion thereof have commenced. All costs for construction are
capitalized and allocated to each building; capitalization of such costs is
discontinued when the building is available for occupancy.

HRP would accrue for losses associated with environmental remediation
obligations if such losses were probable and reasonably estimable. Accruals
for estimated losses from environmental remediation obligations would
generally be recognized no later than completion of a remedial feasibility
study. Such accruals would be adjusted as further information developed or
circumstances changed. Costs of future expenditures for environmental
remediation obligations would not be discounted to their present value.
Recoveries of environmental remediation costs from other parties are
recorded as assets when their receipt is deemed probable. HRP's management
is not aware of any environmental remediation obligations which would
materially affect the operations, financial position or cash flows of HRP
and therefore has made no loss accruals.

OTHER ASSETS

Lease concessions and commissions are amortized over the terms of the
respective leases. Leases at the Properties expire from 2002 to 2020. Loan
costs are amortized over the terms of the respective loans. The loans mature
between 2005 and 2020. Amortization of lease commissions, included in
depreciation and amortization expense, was $2,889.000, $3,180,000, and
$2,286,000 in 2001, 2000, and 1999, respectively. Amortization of loan
costs, included in interest expense, was $624,000, $855,000, and $536,000 in
2001, 2000, and 1999, respectively. The caption "Prepaid expenses and other
assets" on the Consolidated Balance Sheets includes unamortized effective
rent adjustments, prepaid real estate taxes, prepaid insurance and other
miscellaneous deposits and prepaid expenses.

REVENUE RECOGNITION

Rental income is recognized as earned on a straight-line basis over the
terms of the respective leases. Amortization of effective rent income
adjustments, included in property operations revenues, was $256,000,
$569,000, and $778,000 in 2001, 2000, and 1999, respectively. Lease
provisions generally require tenants to pay their proportionate share of
certain building operating costs and real property taxes. Revenue from these
expense recoveries, included in property operations, are recorded as earned
and was $4,197,000, $3,315,000, and $2,539,000 in 2001, 2000, and 1999,
respectively.

INTEREST RATE AGREEMENTS

HRP has used an interest rate swap as a hedge against interest exposure of
variable rate debt. HRP's only interest rate swap was sold in July 2000.
Differences between amounts paid or received in this interest rate
agreement, which was designated as a hedge, were included in interest
expense as the payments were made or received. HRP was exposed to
credit-related gains or losses in the event of non-performance by
counterparties, however none of the counterparties failed to meet their
obligations during the term of the agreement. In July 2000, in connection
with the sale of the interest rate swap, HRP purchased an interest rate cap
derivative that limits its interest rate exposure on its mortgage for
Allfirst Building (see Notes 6 and 9 for more information).

INCOME TAXES

Currently, HRP is a non-taxable entity. Federal and state income taxes, if
any, are the responsibility of the individual partners. Accordingly, the
Consolidated Financial Statements do not include a provision for income
taxes. However, certain business and franchise taxes are the responsibility
of HRP and subsidiary entities. These business and franchise taxes, included
in general and administrative expenses, were $178,000, $182,000, and
$243,000 in 2001, 2000, and 1999, respectively. HRP's tax returns are
subject to examination by federal and state taxing authorities. If HRP's
amounts are ultimately changed by the taxing authorities, the tax liability
of the partners could be changed accordingly. Additionally, no assurance can
be given that the federal or state governments will not pass legislation
that will characterize HRP as an association taxable as a corporation for
federal income tax purposes. Such classification may have an adverse effect
on HRP.

PAGE 26 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

2. ACCOUNTING POLICIES - (CONTINUED)

COMPUTATION OF NET INCOME (LOSS) PER UNIT

Basic earnings per unit is computed by dividing results attributable to the
limited partners' interests by the weighted average number of units
outstanding. Earnings per unit assuming dilution is computed by dividing
results attributable to the limited partners' interests by the weighted
average number of units and potential units outstanding. Options to acquire
units were issued during 1995 and are considered to be potential units. The
number of potential units is computed using the treasury stock method which
assumes that the increase in the number of units is reduced by the number of
units which could have been repurchased by HRP with the proceeds from the
exercise of these options. The following table illustrates the amounts used
to calculate the weighted average number of units outstanding:

2001 2000 1999
-------- -------- --------

Weighted average units outstanding - basic 1,590 1,620 1,673

Potential weighted average units issued from options 69 75 86

Potential repurchase of units from unit option proceeds (14) (21) (19)
-------- -------- --------
Potential weighted average units outstanding - assuming dilution 1,645 1,674 1,740
======== ======== ========

ACCOUNTING PRONOUNCEMENTS AND OTHER

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of certain assets, liabilities, revenues, expenses, and related
disclosures, as of and for the reporting periods. Actual results may differ
from these estimates under different assumptions or conditions. Certain
reclassifications have been made in the prior year amounts to conform to the
classifications used in the current year. The reclassifications had no
effect on previously reported results.

The policies listed are not intended to be a comprehensive list of all of
our accounting policies. In many cases, the accounting treatment of a
particular transaction is specifically dictated by accounting principles
generally accepted in the United States of America, with no need for
management's judgment in the application. There are also areas in which
management's judgment in selecting any available alternative would not
produce a materially different results.

Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for
Derivative Instruments and Hedging Activities" [as amended by SFAS No. 137
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of FASB Statement No. 133" and SFAS No. 138 "Accounting
for Certain Derivative Instruments and Certain Hedging Activities (an
amendment of FASB Statement No. 133)] establishes accounting and reporting
standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. All
derivatives, whether designated in hedging relationships or not, are
required to be recorded on the balance sheet at fair value. HRP adopted
these statements on January 1, 2001. In connection with this adoption, HRP
determined it had one derivative, an interest rate cap (see Notes 6 and 9
for more information).

In August 2001, SFAS No. 144 "Accounting for the Impairment or Disposal of
Long-Lived Assets" was issued. The provisions of this statement are
effective beginning on January 1, 2002. HRP believes that the impact of
adopting SFAS No. 144 will be limited to the requirement that the results of
operations of disposed properties, for current and historical presentation,
be classified as discontinued operations. This will result in the
reclassification of historical operations for property dispositions that
occur in current periods.

PAGE 27 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

3. TRANSACTIONS WITH RELATED PARTIES

Realty receives certain fees in connection with the ongoing management of
HRP, including an asset management fee, acquisition fees and disposition
fees. Specifically, Realty is entitled to receive an asset management fee
equal to 1% of the net aggregate base rents of the Properties, acquisition
fees equal to 1% of the purchase price of newly acquired properties, and
disposition fees with respect to real estate investments, other than the
properties owned at the time of HRP's formation in 1990, equal to 10% of the
amount, by which the sales price of a property exceeds the purchase price of
such property.

HCRE receives compensation in connection with the management of the
Properties, which includes a property management fee, lease commissions and
construction supervision fees. The management contracts expire June 30, 2004
and provide for basic compensation from a property management fee in an
amount equal to 2.85% of cash receipts collected from the Properties'
tenants, lease commissions equal to the current commission market rate as
applied to the net aggregate rent (none exceeding 6% of the net aggregate
rent), and construction supervision fees for administering all construction
projects equal to 5% of the total contracted costs of each capital
expenditure or tenant improvement project.

Realty and HCRE are compensated for services provided to HRP and its
Properties as described above. The following table sets forth such
compensation and reimbursements paid by HRP (in thousands):

Entity
Paid or
Reimbursed 2001 2000 1999
---------- ------- ------- ------

4. STATEMENTS OF CASH FLOWS

Cash interest payments were $14,947,000 (net of capitalized interest of
$486,000), $13,831,000 (net of capitalized interest of $523,000),
$13,114,000 (net of capitalized interest of $94,000) in 2001, 2000, and
1999, respectively.

Supplemental disclosure of noncash investing and financing activities are as
follows -

As of December 31, 2001, HRP had a construction payable for property
development costs at Executive Park of $250,000.

In October 1999, HRP acquired Gulley Road Industrial Park for $8,249,000
including the assumption of an outstanding mortgage of $5,149,000.

PAGE 28 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

5. PROPERTY TRANSACTIONS

PROPERTY DEVELOPMENT AT EXECUTIVE PARK -

In early 2001, HRP demolished a 1-story office building at its Executive
Park property in Atlanta, Georgia that contained 18,000 net rentable square
feet. In order to do so, HRP had to obtain a release of the building from
Executive Park's mortgage lien by substituting for such collateral $608,000
of United States Treasury Bonds, which have various maturity dates through
December 2007. In February 2001, HRP began constructing a 5-story office
building containing 125,000 net rentable square feet. The estimated
construction and development costs for the building and its parking garage
(excluding the existing land costs, lease commissions and tenant
improvements to be spent after a lease is executed, and loan fees once
financing is secured) are approximately $15,650,000. As of December 31,
2001, HRP had incurred and capitalized $13,656,000 of construction and
development costs. The building and its parking garage, excluding tenant
finish-out, is estimated to be completed by the end of March, 2002. All
development costs have been and are estimated to continue to be from
existing cash funds until the property is substantially leased, at which
time it is anticipated that loan financing will be secured. Costs for lease
commissions, tenant improvements and loan fees are dependant upon the terms
of each lease agreement and yet to be determined, as no pre-leasing has been
done. HRP anticipates leasing substantially all of the building by late
2002.

PROPERTY DEVELOPMENT AT CORPORATE SQUARE -

During the second quarter of 2000, HRP completed new construction of a
6-story office building containing approximately 151,000 net rentable square
feet that was commenced in the second quarter of 1999. It was constructed on
undeveloped land within the Corporate Square complex in Atlanta, Georgia. A
20-year lease with the General Services Administration for the entire
building was executed in 1999 and the tenant began paying rent August 2000.

The building construction, tenant improvements, lease commissions and loan
costs totaled $18,779,000 (excluding the original land cost). In 1999, HRP
incurred, in connection with the leasing of the entire project, $2,982,000
of lease commissions.

An interim-construction loan was secured in August 1999 that funded
$12,621,000 of the costs ($6,998,000 in 1999 and $5,623,000 in 2000). On
August 31, 2000, HRP secured permanent financing of $21,500,000. The loan's
monthly payment is based on a twenty-year amortization period and matures
August 15, 2020 and has a fixed interest rate of 7.97%. The loan proceeds
repaid the interim-construction loan and replenished working capital for the
completed project.

ACQUISITIONS -

On January 26, 2000, HRP acquired three 3-story office buildings in San
Diego, California (Fountain View Business Center) containing approximately
89,000 net rentable square feet on 4.3 acres of land. The acquisition cost
was $7,791,000.

In October 1999, HRP acquired a 5-building industrial park in Dearborn,
Michigan (Gulley Road Industrial Park) containing approximately 154,000 net
rentable square feet on 11 acres of land. The acquisition costs of
$8,249,000 included the assumption of a then outstanding mortgage loan of
$5,149,000.

In August 1999, HRP acquired two 3-story office buildings in San Diego,
California (Riverbank Plaza) containing approximately 40,000 net rentable
square feet on 1.6 acres of land for $2,354,000 in cash. The property was
unoccupied from December 1999 through April 2000 during a $1,765,000
property and tenant improvement renovation.

PAGE 29 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

5. PROPERTY TRANSACTIONS - (CONTINUED)

DISPOSITIONS -

In March 2001, HRP sold Joy Road Distribution Center that contained 442,000
net rentable square feet on 21 acres for a gross selling price of
$5,326,000. The carrying value of the assets was $2,994,000. The sale
resulted in $4,916,000 of net proceeds to HRP and a net gain of $1,922,000.
The net sale proceeds were used to pay the outstanding mortgage principal
balance of $2,125,000, to pay a prepayment penalty of $14,000 to the lender,
and to add $2,777,000 to general working capital. The prepayment penalty
along with the writeoff of $31,000 of unamortized loan costs associated with
the retired loan were expensed and are included in the Consolidated
Statements of Operations as an extraordinary item.

In January 2001, HRP sold one of the warehouse buildings at Seattle Business
Parks that contained 63,000 net rentable square feet on 3.9 acres for a
gross selling price of $3,287,000. The carrying value of the assets was
$885,000. The sale resulted in $2,994,000 of net proceeds, which were added
to HRP's working capital, and a net gain of $2,109,000.

Also in January 2001, HRP sold one building at Fairlane Commerce Park that
contained less than 2,000 net rentable square feet on 0.5 acres for a gross
selling price of $575,000. The carrying value of the assets was $372,000.
The sale resulted in $525,000 of net proceeds, which were added to HRP's
working capital, and a net gain of $153,000.

6. MORTGAGES PAYABLE

Substantially all of the buildings in HRP's real estate properties were
encumbered and pledged as collateral by eleven non-recourse mortgage loans
aggregating $201,224,000 as of December 31, 2001 and $200,096,000 as of
December 31, 2000. These mortgage loans have interest rates varying from
3.44% to 8.70% (with an effective average interest rate of 7.6%) and mature
between 2005 and 2020. Other than Allfirst Building's mortgage, all
mortgages have fixed interest rates. Most of the mortgage loans require
monthly principal payments with balloon payments due at maturity. The
following table sets forth, by real estate property, the mortgages payable
balances, maturity dates, and interest rates as of December 31, 2001 (in
thousands):

Mortgages Maturity Interest
Payable Date Rate
--------- -------- --------

Airport Plaza $ 735 10-11-2005 8.70%
Allfirst Building 25,000 4-30-2006 3.44% (a)
Bellevue Corporate Plaza 14,701 10-11-2005 8.70%
Bradshaw Business Parks 12,261 1-1-2021 8.10% (b)
Corporate Square 7,993 10-11-2005 8.70%
Corporate Square 9,944 8-11-2011 7.70%
Corporate Square 20,970 8-15-2020 7.97%
Executive Park 32,427 4-11-2008 7.32%
Fairlane Commerce Park 19,479 10-11-2005 8.70%
Fountain View Business Center 5,284 2-10-2010 8.17%
Gulley Road Industrial Park 4,487 5-11-2011 7.375%
Montrose Office Center 5,972 10-11-2005 8.70%
Parklane Towers 22,051 10-11-2005 8.70%
Raintree Industrial Park 10,291 10-11-2005 8.70%
Riverbank Plaza 2,422 2-10-2010 8.29%
Seattle Business Parks 7,207 6-7-2008 6.97%
---------
Total $ 201,224
=========

(a) Variable interest rate. LIBOR plus 1.30%.

(b) Call options exercisable by lender on 2-1-2011 and 2-1-2016.

PAGE 30 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

6. MORTGAGES PAYABLE - (continued)

The following table shows for the years presented the principal and balloon
payments that are required (in thousands):

Total
Mortgage
Principal Balloon Loan
Payments Payments Payments
--------- -------- ---------

2002 $ 3,672 $ - $ 3,672
2003 3,998 - 3,998
2004 4,310 - 4,310
2005 4,167 74,515 78,682
2006 2,852 25,000 27,852
Thereafter 25,973 56,737 82,710
-------- --------- ---------
Total $ 44,972 $ 156,252 $ 201,224
======== ========= =========

The following discussions pertain to financing and refinancing activities of
HRP during the three years ended December 31, 2001.

ALLFIRST BUILDING -

On July 27, 2000, HRP sold its interest rate swap agreement for $1,597,000.
HRP had entered into the interest rate swap agreement in 1998 to reduce its
exposure to changes in interest rates for the loan secured by Allfirst
Building. This interest rate swap agreement effectively fixed the loan's
cash interest rate at 6.78%, as opposed to the mortgage loan interest rate
of LIBOR plus 1.30% (or 7.94% at the time of the swap agreement sale). The
proceeds from the sale were designated for general working capital purposes.
For financial reporting purposes, the proceeds are being amortized over the
life of the loan as a reduction to interest expense. As of December 31,
2000, the unamortized balance, included on the balance sheet in "Prepaid
rent, security deposits and other", was $1,481,000. During 2001, as the
result of the adoption of SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities", HRP reclassified the remaining
unamortized gain from liabilities to accumulated other comprehensive income.
The proceeds will continue to be amortized over the life of Allfirst
Building's mortgage payable as a reduction to interest expense. As of
December 31, 2001, the unamortized balance, included on the balance sheet as
"Accumulated other comprehensive income", was $1,204,000.

Also on July 27, 2000 and in connection with the sale of the swap agreement,
HRP purchased an interest rate cap for Allfirst Building's mortgage loan for
$288,000, which limits HRP's exposure to changing interest rates to a
maximum of 10%. This interest rate cap, which has a notional amount of
$25,000,000, has terms consistent with Allfirst Building's mortgage loan.
Allfirst Building's cash interest rate was 3.44% and 8.12% as of December
31, 2001 and 2000, respectively. The interest rate cap is a derivative and
designated as a cash flow hedge. Hedge effectiveness is measured based on
using the intrinsic value of the interest rate cap. All changes in the fair
value of the time value of the cap are recorded directly to earnings. With
the January 1, 2001 adoption of SFAS No. 133, HRP recorded the cumulative
effect of the adoption as a reduction to income of $192,000, or the amount
of the difference between the carrying value as of January 1, 2001 of
$267,000 and the then estimated fair value of $75,000, all of which
represented change in time value. Thereafter, on a quarterly basis, HRP has
recorded changes in the estimated fair value of the cap in interest expense.
As of December 31, 2001, the estimated fair value of the interest rate cap
was $68,000.

BRADSHAW BUSINESS PARKS -

In December 2000, HRP refinanced Bradshaw Business Park's existing loan with
a new lender. The interest rate was reduced to 8.1% from 8.5% and the
maturity date was extended over ten years to a call option date in February
2011. The monthly principal payments amortize the loan over 20 years. The
loan proceeds of $12,500,000 were used (i) to pay the outstanding principal
balance of $5,724,000 with the former lender, (ii) to pay transaction costs
of $267,000, (iii) to pay a prepayment penalty of $286,000, (iv) to fund
$288,000 of loan reserves, and (v) to add $5,935,000 to general working
capital. The prepayment penalty along with the writeoff of $103,000 of
unamortized loan costs associated with the retired loan were expensed and
are included in the Consolidated Statements of Operations as an
extraordinary item.

PAGE 31 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

6. MORTGAGES PAYABLE - (CONTINUED)

CORPORATE SQUARE -

On August 7, 2001, HRP refinanced a mortgage loan secured by a portion of
Corporate Square with a new lender. The interest rate was reduced to 7.7%
from 8.625% and the maturity date was extended six years to August 2011. The
monthly principal payments amortize the loan over 22.5 years. The loan
proceeds of $10,000,000 were used to pay the outstanding mortgage principal
balance of $2,760,000 with the former lender, to pay a prepayment penalty of
$409,000, to pay transaction costs of $142,000, and for general working
capital. The prepayment penalty along with the writeoff of $105,000 of
unamortized loan costs associated with the retired loan were expensed and
are included in the Consolidated Statements of Operations as an
extraordinary item.

An interim-construction loan was secured in August 1999 that funded
$12,621,000 of a development project at Corporate Square (see Note 5 for
further information). The loan provided $6,998,000 in 1999 and $5,623,000
in 2000. On August 31, 2000, HRP secured permanent financing of $21,500,000.
The loan's monthly payment is based on a twenty-year amortization period and
matures August 15, 2020 and has a fixed interest rate of 7.97%. The loan
proceeds repaid the interim-construction loan and replenished working
capital for the completed project.

FOUNTAIN VIEW -

In January 2000, HRP obtained financing of $5,500,000 in connection with the
acquisition of Fountain View Business Center (three 3-story office buildings
in San Diego, California). The loan has a monthly payment based on a
twenty-year amortization, matures in ten years and has a fixed interest rate
of 8.17%.

JOY ROAD DISTRIBUTION CENTER -

In August 2000, HRP received $3,000,000 of loan proceeds from a promissory
term note secured by Joy Road Distribution Center in Detroit, Michigan. The
loan proceeds were for general working capital purposes. The loan was
scheduled to mature July 31, 2002, however it was paid off in March 2001
when Joy Road Distribution Center was sold. The loan had a variable interest
rate of either prime plus 0.50% or LIBOR plus 3.0%.

LINE OF CREDIT -

Since August 2000, HRP has had available a $2,000,000 revolving line of
credit, which now matures on July 29, 2002. The line of credit has a
variable interest rate of either prime plus 0.50% or LIBOR plus 3.0% and
requires monthly interest payments, but no principal amortization. HRP has
not borrowed against this facility.

RIVERBANK PLAZA -

In May 2000, HRP closed on a new mortgage generating $2,500,000 of loan
proceeds and is secured by Riverbank Plaza, which was acquired in August
1999 in a cash transaction. The loan's monthly payment is based on a
twenty-year amortization, matures in ten years and has a fixed interest rate
of 8.29%. The loan proceeds were for general working capital purposes.

PAGE 32 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

7. LEASE AGREEMENTS AND MAJOR TENANT INFORMATION

Lease provisions generally require HRP's tenants to pay fixed rental amounts
plus their proportionate share of certain building operating costs and real
property taxes. In addition, certain leases include provisions for annual
rental adjustments. Revenue from expense recoveries, included in property
operations, was $4,197,000, $3,315,000, and $2,539,000 in 2001, 2000, and
1999, respectively. At December 31, 2001, the Properties, in the aggregate,
were 91% occupied (excluding a 125,000 square foot development property at
Executive Park). The following table sets forth the minimum cash rental
payments to be received from leases in place as of December 31, 2001 (in
thousands):

Payments Payments
from Leases from Leases
without Early with Early
Termination Termination
Rights Rights Total
------------- ----------- ---------

2002 $55,261 $ 2,720 $ 57,981
2003 45,577 2,437 48,014
2004 36,574 1,777 38,351
2005 29,210 1,335 30,545
2006 19,066 2,218 21,284
Thereafter 73,340 21,730 95,070
--------- -------- ---------
Total $ 259,028 $ 32,217 $ 291,245
========= ======== =========

During 2001 and 2000, two tenants leasing space contributed 10% or more of
HRP's revenues. Ford Motor Company and affiliates ("Ford") leases space in
Parklane Towers and Fairlane Commerce Park. Ford accounted for 12% and 11%
of revenues in 2001 and 2000, respectively. The General Services
Administration ("GSA") leases space in Corporate Square and Executive Park.
GSA accounted for 14% and 12% of revenues in 2001 and 2000, respectively.

As of December 31, 2001, Ford occupied 206,000 square feet of office space
under 8 leases at Parklane Towers and 291,000 square feet of office,
technical laboratory and industrial space under 10 leases at Fairlane
Commerce Park. These leases expire between 2002 and 2010 and most contain
renewal options, providing for one to ten year renewals. As of December 31,
2001, GSA occupied 327,000 square feet of office space at Executive Park
under 5 leases which expire between 2002 and 2011 and 309,000 square feet of
office space at Corporate Square under 2 leases which expire in 2013 (with a
right to early terminate in 2008) and 2020. The remaining tenants are not
concentrated in any one industry, nor is HRP otherwise dependent on any
group of related tenants for 10% or more of its revenues.

HRP leases and shares offices with Hallwood in Dallas, Texas under a lease
which expires November 30, 2008. HRP has a one-time option to terminate the
lease effective November 30, 2005. The minimum cash rental payments are
$149,000, $315,000, and $315,000 for 2002, 2003 and 2004, respectively, of
which HRP's portion is approximately $100,000, $210,000 and $210,000 for
2002, 2003 and 2004, respectively.

8. PARTNERS' CAPITAL

In 1995, HRP issued options totaling 86,000 units to certain executives of
Realty and HCRE with an exercise price of $11.875 per unit. The options were
vested over a three year period ending in 1997. The options expire on
February 27, 2005 and generally, the optionees may borrow the amounts
necessary to exercise the options from HRP. As of December 31, 2001, 17,200
options had been exercised (all during 2000), none have been canceled and
68,800 options remained exercisable. No options have been granted since the
adoption of the disclosure only provisions of SFAS No. 123 - "Accounting for
Stock Based Compensation".

As part of the resignation of Brian Troup as an officer and director of
Hallwood and HRP's general partner on December 21, 1999, Hallwood
transferred 82,608 units of HRP that it owned to a trust controlled by Mr.
Troup. On May 12, 2000, Mr. Troup exercised his unit options to purchase
17,200 HRP units at the option plan's exercise price of $11.875 per unit,
which generated $601,000 of non-cash compensation. Also on May 12, 2000, HRP
purchased and retired all of Mr. Troup's above-mentioned 99,808 units at
$46.825 per unit (the average of the closing market prices of the units for
the twenty trading days prior to the purchase). As a result of these
transactions, HRP's outstanding units decreased from 1,672,556 to 1,589,948.

PAGE 33 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

9. COMPREHENSIVE INCOME

The components of other comprehensive income for the three years ended
December 31, 2001 are shown as follows (in thousands):

2001 2000 1999
-------- -------- --------

Net income (loss) $ 8,328 $ (299) $ 4,062
Reclassification of cumulative effect of SFAS No
133 adoption - deferred gain from sale of
interest rate swap 1,342 -- --

Other Comprehensive Income -
Amortization of deferred gain
from sale of interest rate swap (138) -- --
-------- -------- --------

Comprehensive income $ 9,532 $ (299) $ 4,062
======== ======== ========

10. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

Estimated fair value amounts of certain financial instruments have been
determined using available market information based upon negotiations held
by Realty with potential lenders or other appropriate valuation
methodologies that require considerable judgment in interpreting market data
and developing estimates. Accordingly, the estimates presented herein are
not necessarily indicative of the amounts that HRP could realize in a
current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair
value amounts.

The fair value of financial instruments that are short-term or re-price
frequently and have a history of negligible credit losses is considered to
approximate their carrying value. These include cash and cash equivalents,
short term receivables, accounts payable and other liabilities. Real estate
and other assets are not considered financial instruments.

Management has reviewed the fair values of its mortgages payable in
connection with interest rates currently available to HRP for borrowing with
similar characteristics and maturities (approximately 7.5% and 8.0% as of
December 31, 2001 and 2000, respectively). Based on those interest rates,
management has determined that the estimated fair values of HRP's mortgages
payable as of December 31, 2001 and 2000 would equal approximately
$204,158,000 and $200,564,000, respectively, as compared to the carrying
values of $201,224,000 and $200,096,000, respectively.

The estimated fair value of HRP's interest rate cap as of December 31, 2001
and 2000 was $68,000 and $75,000, respectively, based on quotes obtained
from the issuer of the cap agreement (see Note 6 for more information). The
carrying value of HRP's interest rate cap as of December 31, 2001 and 2000
was $68,000 and $267,000, respectively.

As of December 31, 2001 and 2000, the fair value information presented
herein is based on pertinent information available to management. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore current estimates of fair value may differ significantly from the
amounts presented herein.

PAGE 34 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

11. COMMITMENTS AND CONTINGENCIES

LITIGATION

Beginning in 1997, HRP has been a defendant in two lawsuits that were
brought by Gotham Partners, L.P. in the Delaware Court of Chancery.

The first suit was filed on February 27, 1997 in the Court of Chancery for
New Castle County, Delaware, styled Gotham Partners, L.P. v. Hallwood Realty
Partners, L.P. and Hallwood Realty Corporation (C.A. No. 15578), and it
sought access to certain books and records of HRP and was subsequently
settled, allowing certain access. On April 9, 2001 the case was dismissed.

The second action was filed on June 20, 1997 in a separate complaint in the
Court of Chancery for New Castle County, Delaware, styled Gotham Partners,
L.P. v. Hallwood Realty Partners, L.P., et al. (C.A. No. 15754). This action
alleges claims of breach of fiduciary duties, breach of HRP's partnership
agreement, and fraud in connection with certain transactions involving HRP's
units in the mid 1990's. Hallwood is alleged to have aided and abetted the
alleged breaches. On June 21, 2000, after completing fact discovery, all
parties moved for summary judgment on several issues. In September and
October, 2000, the Delaware court issued three separate written opinions
resolving the summary judgment motions. In the opinions, the court ruled
that trial would be required as to all issues, except that (i) Gotham was
found to have standing to pursue its derivative claims; (ii) defendants were
entitled to judgment dismissing the fraud claim; (iii) the General Partner
was entitled to judgment dismissing the breach of fiduciary duty claims
brought against it; and (iv) the General Partner's outside directors were
entitled to judgment dismissing all claims brought against them.

A five-day trial was held in January 2001. On July 18, 2001, the Delaware
Court of Chancery rendered its opinion. In its decision, the court
determined that an option plan and a sale of units to Hallwood in connection
with a reverse unit split implemented by HRP in 1995 were in compliance with
HRP's partnership agreement. The court also found that the sale of units to
Hallwood in connection with a 1995 odd-lot offer by HRP did not comply with
certain procedures required by the HRP partnership agreement. The court
ruled that the defendants other than HRP pay a judgment in the amount of
$3,417,423, plus pre-judgment interest from August 1995 to HRP. The judgment
amount represents what the court determined was an underpayment by Hallwood.
The court's judgment is not final until all rehearings and appeals have been
exhausted. In August 2001, plaintiff and certain defendants appealed the
Court of Chancery's judgment to the Delaware Supreme Court. Those appeals
are pending. Oral arguments were heard on February 12, 2002, and a rehearing
en banc was held on March 26, 2002. In October 2001, HRP received the
$3,417,423 judgment together with $2,987,576 of pre-judgment and
post-judgment interest, subject to an arrangement that it be returned in
full or part if the judgment is modified or reversed on appeal. If the
appellate court reverses the judgment, any subsequent ruling by the trial
court on remand may be more or less favorable to HRP. As a result of the
appeals and the uncertainty of their outcome, HRP recorded the judgment and
interest as "Deferred Litigation Proceeds" on its balance sheet.

On February 15, 2000, HRP filed a lawsuit in the United States District
Court for the Southern District of New York styled Hallwood Realty Partners,
L.P. v. Gotham Partners L.P., et al. (Civ. No. 00 CV 1115) alleging
violations of the Securities Exchange Act of 1934 by certain purchasers of
its units, including Gotham Partners, L.P., Gotham Partners III, L.P.,
Private Management Group, Inc., Interstate Properties, Steven Roth and EFO
Realty, Inc., by virtue of those purchasers' misrepresentations and/or
omissions in connection with filings required under the Securities Exchange
Act of 1934. The complaint further alleged that defendants, by acquiring
more than 15% of the outstanding HRP units, have triggered certain rights
under its Unit Purchase Rights Agreement, for which HRP was seeking
declaratory relief. HRP sought various forms of relief, including
declaratory judgments, divestiture, corrective disclosures, a "cooling-off"
period and damages, including costs and disbursements. On November 16, 2000,
the court granted HRP's motion to add as defendants Gotham Holdings II,
L.L.C., Hallwood Investors, L.P., Liberty Realty Partners, L.P. and
EFO/Liberty, Inc. and to remove EFO Realty, Inc. as a defendant.

Discovery was completed in December 2000 and trial was held in February
2001. On February 23, 2001, the court rendered a decision in favor of the
defendants and on February 28, 2001, the court ordered the complaint
dismissed. HRP filed a Notice of Appeal on March 29, 2001 with respect to
the February 28, 2001 dismissal of the complaint and other matters. All
parties filed briefs with the Second Circuit. Oral arguments were heard on
March 4, 2002.

PAGE 35 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

11. COMMITMENTS AND CONTINGENCIES - (CONTINUED)

HRP is from time to time involved in various other legal proceedings and
claims which arise in the ordinary course of business. These matters are
generally covered by insurance. Management believes that the resolution of
these matters will not have a material adverse effect on HRP's financial
position, cash flow or operations.

ASBESTOS

The environmental laws of the federal government and of certain state and
local governments impose liability on current property owners for the
cleanup of hazardous and toxic substances discharged on such property. This
liability may be imposed without regard to the timing, cause or person
responsible for the release of such substances onto the property. HRP could
be subject to additional liability in the event that it owns properties
having such environmental problems. Parklane Towers, as well as certain
other properties to a lesser extent, are known to contain asbestos. Removal
of asbestos at Parklane Towers is not required because it is cementitious,
it is not friable and because the procedures in HRP's site environmental
program Operations and Maintenance Manual are performed as required.

RIGHTS PLAN

HRP has a Unit Purchase Rights Agreement ("Rights Plan") that provides for a
distribution of one right for each unit of HRP to holders of record at the
close of business as of December 10, 1990. The rights will become
exercisable only in the event, with certain exceptions, an acquiring party
accumulates 15 percent or more of HRP's units, or if a party commences or
announces an intent to commence a tender offer or exchange offer to acquire
30 percent or more of such units. Each right will entitle the holder to buy
one additional unit at a price of $250. In addition, upon the occurrence of
certain events, holders of the rights will be entitled to purchase either
HRP units or shares in an "acquiring entity" at half of market value. HRP
will generally be entitled to redeem the rights at $.01 per right at any
time on or prior to the tenth day following the acquisition of a 15 percent
or greater interest in its units.

Although it is HRP's position in the litigation filed in the Southern
District of New York that certain holders of HRP's units have become an
"Acquiring Person" under the Rights Plan by virtue of obtaining dispositive
power over more than 15% of the outstanding units, a final determination of
this issue will be made by the court. As a result, the General Partner has
amended the Rights Plan, among other things, to postpone the "Distribution
Date" under the Rights Plan based on the General Partner's current
understanding of the facts. By taking such action, the rights will become
exercisable, if at all, only after the final resolution by a court that an
"Acquiring Person" exists for the purposes of the Rights Plan. Additionally,
the expiration of the redemption period under the Rights Plan has also been
extended pending litigation. However, if additional facts come to the
General Partner's attention or the status or unit ownership of any
unitholder change in any respect, the General Partner will review the
circumstances at that time and may change its conclusions. HRP has also
amended the Rights Plan to extend the expiration period of the rights until
one year after entry of an order, which is final and not subject to appeal,
resolving the above-mentioned lawsuit.

OTHER

In addition to the commitment previously described in Note 5 with regards to
Executive Park, HRP has estimated and budgeted tenant and capital
improvements of $10,852,000 and lease commissions of $2,261,000 for 2002.

PAGE 36 of 45

HALLWOOD REALTY PARTNERS, L. P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED DECEMBER 31, 2001

12. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

Set forth below is selected quarterly financial data for the years ended
December 31, 2001 and 2000 (in thousands except per unit amounts):

Quarter Ending
-----------------------------------------------------------
March 31 June 30 September 30 December 31
------------ ------------ ------------ ------------

2001
Total revenues $ 22,090 $ 17,925 $ 17,660 $ 16,909
Property operations revenues less property
operations expenses, general and administrative
expenses and litigation costs (a) 6,653 9,706 9,345 8,296
Income before extraordinary loss and cumulative effect
of SFAS No. 133 adoption (a) 3,456 2,371 2,354 898
Net income (a) 3,219 2,371 1,840 898
Earnings per unit - basic
Income before extraordinary loss and cumulative
effect of SFAS No. 133 adoption 2.15 1.48 1.47 0.56
Extinguishment of debt (0.03) -- (0.32) --
Cumulative effect of SFAS No. 133 adoption (0.12) -- -- --
Net income (a) 2.00 1.48 1.15 0.56
Earnings per unit - assuming dilution
Income before extraordinary loss and cumulative
effect of SFAS No. 133 adoption 2.08 1.43 1.42 0.54
Extinguishment of debt (0.03) -- (0.31) --
Cumulative effect of SFAS No. 133 adoption (0.11) -- -- --
Net income (a) 1.94 1.43 1.11 0.54

2000
Total revenues $ 16,169 $ 16,203 $ 17,171 $ 17,749

Property operations revenues less property
operations expenses, general and administrative
expenses and litigation costs (a) 8,041 7,125 7,712 6,163
Income (loss) before extraordinary item (a) 1,450 533 659 (2,552)
Net income (loss) (a) 1,450 533 659 (2,941)
Earnings per unit - basic
Income (loss) before extraordinary loss .86 .32 .41 (1.59)
Extinguishment of debt -- -- -- (.24)
Net income (loss) (a) .86 .32 .41 (1.83)
Earnings per unit - assuming dilution (b)
Income (loss) before extraordinary loss .83 .31 .40 (1.59)
Extinguishment of debt -- -- -- (.24)
Net income (loss) (a) .83 .31 .40 (1.83)

(a) Litigation costs were $2,690, $639, $206 and $273 in the first, second,
third, and fourth quarters of 2001, respectively. Litigation costs were
$616, $1,292, $1,359 and $2,396 in the first, second, third, and fourth
quarters of 2000, respectively. (See Note 11 to the Consolidated Financial
Statements for more information.)

(b) Unit options are considered antidilutive in the fourth quarter of 2000 and
therefore are not taken into consideration in the computation of earnings
per unit assuming dilution.

PAGE 37 of 45

HALLWOOD REALTY PARTNERS, L.P.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2001
(IN THOUSANDS)

Costs
capitalized
subsequent to Gross amount at which
Initial cost acquisition carried at close of period
--------------------- ------------- ----------------------------------
Buildings Buildings Buildings
and and and
Description (A) Encumbrances Land improvements improvements Land improvements Total (B)
--------------- ------------ ---- ------------ ------------- ---- ------------ ---------

Airport Plaza $ 735 $ 300 $ 4,013 $ 460 $ 300 $ 4,473 $ 4,773
Allfirst Building 25,000 2,100 43,772 3,865 2,100 47,637 49,737
Bellevue Corporate Plaza 14,701 7,428 17,617 2,473 7,428 20,090 27,518
Bradshaw Business Parks 12,261 5,018 15,563 5,618 5,018 21,181 26,199
Corporate Square 38,907 6,142 14,112 24,543 6,142 38,655 44,797
Executive Park 32,427 15,243 34,982 25,889 15,243 60,871 76,114
Fairlane Commerce Park 19,479 4,883 17,894 6,494 4,883 24,388 29,271
Fountain View Business Center 5,284 1,858 5,933 674 1,858 6,607 8,465
Gulley Road Industrial Park 4,487 1,227 7,022 304 1,227 7,326 8,553
Montrose Office Center 5,972 5,096 15,754 3,402 5,096 19,156 24,252
Parklane Towers 22,051 3,420 37,592 8,023 3,420 45,615 49,035
Raintree Industrial Park 10,291 1,191 18,208 1,531 1,191 19,739 20,930
Riverbank Plaza 2,422 710 1,644 1,698 710 3,342 4,052
Seattle Business Parks 7,207 4,399 7,608 4,298 4,399 11,906 16,305
Corporate office - FF&E -- -- -- 292 -- 292 292
------------ ----------- ----------- ----------- ---------- ------------ -----------
TOTAL $ 201,224 $ 59,015 $ 241,714 $ 89,564 $ 59,015 $ 331,278 $ 390,293
============ =========== =========== =========== ========== ============ ===========

Accumulated
depreciation Date
Description (A) (B)(C) acquired
--------------- ------------ --------

Airport Plaza $ 4,039 4/30/87
Allfirst Building 30,761 6/29/84
Bellevue Corporate Plaza 6,601 6/30/88
Bradshaw Business Parks 12,604 9/24/85
Corporate Square 16,650 8/2/85 & 10/1/92
Executive Park 32,125 12/19/85
Fairlane Commerce Park 12,416 12/30/86 & 7/1/87
Fountain View Business Center 564 1/26/00
Gulley Road Industrial Park 775 10/29/99
Montrose Office Center 9,054 1/8/88
Parklane Towers 31,326 12/16/84
Raintree Industrial Park 11,254 7/17/86
Riverbank Plaza 708 8/19/99
Seattle Business Parks 7,664 4/24/86
Corporate office - FF&E 178 various
-----------
TOTAL $ 176,719
===========

See notes to Schedule III on following page.

PAGE 38 of 45

HALLWOOD REALTY PARTNERS, L.P.
NOTES TO SCHEDULE III
DECEMBER 31, 2001
(IN THOUSANDS)

(A) PROPERTY LOCATIONS ARE AS FOLLOWS:

Airport Plaza San Diego, California
Allfirst Building Baltimore, Maryland
Bellevue Corporate Plaza Bellevue, Washington
Bradshaw Business Parks Sacramento and Rancho Cordova, California
Corporate Square Atlanta, Georgia
Executive Park Atlanta, Georgia
Fairlane Commerce Park Dearborn, Michigan
Fountain View Business Center San Diego, California
Gulley Road Industrial Park Dearborn, Michigan
Montrose Office Center Rockville, Maryland
Parklane Towers Dearborn, Michigan
Raintree Industrial Park Solon, Ohio
Riverbank Plaza San Diego, California
Seattle Business Parks Kent and Tukwila, Washington

(B) RECONCILIATION OF CARRYING COSTS (in thousands):

Accumulated
Cost Depreciation
---------- ------------

Balance, January 1, 1999 $ 336,721 $ 160,942

Additions 26,694 9,659
Retirements (5,100) (5,100)
---------- ----------

Balance, December 31, 1999 358,315 165,501

Additions 24,896 11,318
Retirements (5,949) (5,949)
---------- ----------

Balance, December 31, 2000 377,262 170,870

Additions 23,073 11,674
Retirements and dispositions (10,042) (5,825)
---------- ----------

Balance, December 31, 2001 $ 390,293 $ 176,719
========== ==========

Depreciation of buildings is computed using the straight-line method
over estimated useful lives ranging from 15 to 43 years. Equipment and
other improvements are depreciated on the straight-line method over
estimated useful lives ranging from 3 to 23 years. Tenant improvements
are capitalized and amortized over the term of the respective leases or
useful life, if shorter.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES

None.

PAGE 39 of 45

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

HRP has no officers or directors. Realty, as general partner, performs functions
generally performed by officers and directors. Realty was formed in Delaware as
a corporation in January 1990 and became a limited liability company in December
1998.

BUSINESS EXPERIENCE OF DIRECTORS AND OFFICERS OF REALTY -

ANTHONY J. GUMBINER, 57, CHAIRMAN OF THE BOARD AND DIRECTOR OF REALTY
Mr. Gumbiner has served as director and Chairman of the Board of Realty
since January 1990. He has served as a director and Chairman of the
Board since 1981 and Chief Executive Officer since 1984 of Hallwood. He
has also served as Hallwood's President and Chief Operating Officer
since December 21, 1999. He has served as a director of Hallwood
Holdings S.A. since 1984. Formerly, he served as Chairman of the Board
and Chief Executive Officer of Hallwood Energy Corporation and its
predecessors ("HEC") from 1987 until HEC was sold in 2001. Mr. Gumbiner
is also a solicitor of the Supreme Court of Judicature of England.

WILLIAM L. GUZZETTI, 58, PRESIDENT AND DIRECTOR OF REALTY
Mr. Guzzetti has been President, Chief Operating Officer and a director
of Realty since January 1990. He has served as Executive-Vice President
of Hallwood since October 1989 and in that capacity may devote a portion
of his time to the activities of Hallwood, including the management of
real estate investments, acquisitions and restructurings of entities
controlled by Hallwood. He also served as President, Chief Operating
Officer and a director of HEC from 1985 until HEC was sold in 2001 and
in that capacity devoted a portion of his time to the activities of HEC.
He is a member of The Florida Bar and the State Bar of Texas.

JOHN G. TUTHILL, 58, EXECUTIVE VICE PRESIDENT AND SECRETARY
Mr. Tuthill has been an Executive Vice President and Secretary of Realty
since January 1990. He joined Hallwood in October 1989 to head all
property management functions, having previously served as President of
Southmark Commercial Management since November 1986, where he was
responsible for a diversified real estate portfolio of over 18,000,000
square feet.

UDO H. WALTHER, 54, SENIOR VICE PRESIDENT
Mr. Walther has been a Senior Vice President of Realty since November
1998. Mr. Walther was a member of the Board of Directors of Realty from
June 1994 to November 1998. Mr. Walther had been President and Chief
Executive Officer of Walther Group, Inc., a full service design and
construction consultancy, and President of Precept Builders, Inc. from
1991 to 1998. Previously, Mr. Walther was a Partner at Trammell Crow
Company, Project Manager with HCB Contractors and Marketing Vice
President for Researched Investments, Ltd.

JEFFREY D. GENT, 54, VICE PRESIDENT - FINANCE
Mr. Gent joined Hallwood in March 1990 as the Vice President-Finance. He
previously served as Vice President-Finance of Southmark Commercial
Management since September 1984, where he was responsible for the
financial functions of a diversified real estate portfolio of over
18,000,000 square feet.

ALAN G. CRISP, 60, DIRECTOR OF REALTY
Mr. Crisp was Chairman and Chief Executive Officer of Atlantic
Metropolitan Holdings (U.K.) plc from 1979 until 1988, when he joined
Interallianz Bank Zurich AG. From 1988 to 1993, he was General Manager
of the London Office of the Bank. Since 1994, Mr. Crisp has been a
consultant for various international companies. He is a Fellow of the
Royal Institution of Chartered Surveyors and holds a B.A. (Hons) Degree
and is a Master of Literature from Oxford University.

WILLIAM F. FORSYTH, 52, DIRECTOR OF REALTY
Mr. Forsyth has been Chairman of Kildalton & Co., an investment
management consultancy based in Edinburgh, Scotland since 1992. He
graduated in law at Edinburgh University in 1971, and is a member of the
Society of Investment Analysts in the United Kingdom.

EDWARD T. STORY, 58, DIRECTOR OF REALTY
Mr. Story has been President and Chief Executive Officer of SOCO
International, plc, an oil and gas company, since September, 1991. Prior
to September 1991, he was Founder and Chairman of Thaitex Petroleum
Company, Co-founder and Chief Financial Officer of Conquest Exploration
Company, the Chief Financial Officer for Superior Oil Company and
Exploration and Production Controller with Exxon Corporation.

PAGE 40 of 45

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - (CONTINUED)

Section 16(a) of the Securities and Exchange Act of 1934 requires the officers
and directors of Hallwood Realty, LLC and persons who own more than ten percent
of HRP's units to file reports of ownership and changes in ownership with the
Securities and Exchange Commission (the "SEC"). Officers, directors and greater
than ten percent owners are required by the SEC regulations to furnish HRP with
copies of all Section 16(a) forms they file. Based solely on a review of the
copies of such forms furnished to HRP, or written representations from certain
reporting persons that no forms were required of those persons, HRP believes
that during the period January 1, 2001 to December 31, 2001, all officers and
directors of Hallwood Realty, LLC and ten percent owners complied with
applicable filing requirements, except that, as alleged in litigation filed in
the Southern District of New York, HRP believes that certain holders of HRP's
units have obtained dispositive power over more than 15% of the outstanding
units, which has not been properly disclosed. A final determination of this
issue will be made by the court.

ITEM 11. EXECUTIVE COMPENSATION

COMPENSATION COMMITTEE INTERLOCKS, INSIDER PARTICIPATION AND COMPENSATION OF
DIRECTORS

Realty does not have a compensation committee and compensation decisions are
made by the Board of Directors of Realty. During 2001, Messrs. Gumbiner and
Guzzetti served on the Board of Directors of Realty. Mr. Gumbiner is also Chief
Executive Officer of Hallwood and Realty, and a member of the Board of Directors
of Hallwood, which serves as the compensation committee for Hallwood. Mr.
Guzzetti is also President and Chief Operating Officer of Realty, and Executive
Vice President of Hallwood. Messrs. Forsyth, Crisp, and Story were each paid
$25,000, $25,000, and $20,000 in 2001, 2000, and 1999, respectively, for
director fees.

Realty and HCRE are compensated for services provided to HRP and its Properties
as described above. The following table sets forth such compensation and
reimbursements paid by HRP (in thousands):

Entity
Paid or
Reimbursed 2001 2000 1999
---------- ---- ---- ----

(a) These costs are mostly recorded as general and administrative
expenses and represent reimbursement to Realty, at cost, for
administrative level salaries and compensation, bonuses, employee
and director insurance, and allocated overhead costs. HRP pays its
account balance with Realty on a monthly basis.

PAGE 41 of 45

ITEM 11. EXECUTIVE COMPENSATION - (CONTINUED)

CASH COMPENSATION OF EXECUTIVE OFFICERS

HRP has no executive officers, however, employees of Realty (general partner of
HRP) perform all functions ordinarily performed by executive officers. The
following table sets forth the compensation paid for services performed for HRP
to the Chief Executive Officer and the four other executive officers with
earnings that exceeded $100,000 for the year ended December 31, 2001. Bonuses
and other annual compensation are with respect to years presented and are
usually paid in the following year.

SUMMARY COMPENSATION TABLE
---------------------------------------------------
Annual Compensation
---------------------------------------------------
Other Annual
Name and Principal Position Year Salary (a) Bonus Compensation (b)
--------------------------- ---- ---------- ----- ----------------

Anthony J. Gumbiner 2001 $ -- $ 150,000 $ --
Chairman of the Board and 2000 -- 150,000 --
Chief Executive Officer 1999 -- 150,000 --

William L. Guzzetti 2001 200,000 32,333 --
President and Chief 2000 200,000 32,333 --
Operating Officer 1999 200,000 32,333 --

John G. Tuthill 2001 150,360 68,265 7,140
Executive Vice President 2000 150,360 68,265 7,895
and Secretary 1999 150,360 68,265 7,923

Udo H. Walther 2001 150,000 68,250 7,140
Senior Vice President 2000 150,000 68,250 7,895
1999 150,000 68,250 --

Jeffrey D. Gent 2001 120,750 19,547 5,893
Vice President - Finance 2000 115,000 19,471 6,245
1999 108,541 18,784 6,206

----------

(a) Represents executive officers' gross salary before contributions to
the qualified 401(k) Tax Favored Savings Plan.

(b) Represents employer matching contributions to the 401(k) Tax Favored
Savings Plan or payments in lieu thereof made under a special bonus
arrangement.

In 1995, HRP issued options totaling 86,000 units to certain executives of
Realty and HCRE with an exercise price of $11.875 per unit. The following table
discloses for each of the executive officers of Realty the number of these
options held by each of the executive officers and the potential realizable
values for their options at December 31, 2001. None of the executive officers
exercised any options during the year ended December 31, 2001 and HRP has not
granted SARs.

AGGREGATED OPTION/SAR EXERCISES IN 2001
AND OPTION/SAR VALUES AT DECEMBER 31, 2001

Value of Unexercised
Number of Unexercised In-the-Money
Options at Options at
Units December 31, 2001 December 31, 2001
Acquired ----------------------------- -----------------------------
Name on Exercise Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ----------- ------------- ----------- -------------

Anthony J. Gumbiner 0 25,800 0 $ 1,512,525 $ 0

William L. Guzzetti 0 15,000 0 879,375 0

John G. Tuthill 0 13,000 0 762,125 0

Jeffrey D. Gent 0 7,000 0 410,375 0

PAGE 42 of 45

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information as of March 22, 2002 concerning the
number of HRP units owned beneficially by (l) the persons who, to the knowledge
of the management, beneficially owned more than 5% of the units outstanding on
such date, (2) each director and (3) the present directors and executive
officers of Realty as a group:

Amount Percent
Name and Address of Beneficially of
Beneficial Owner Owned (a) Class
------------------- ------------ -------

HWG, LLC 330,432 20.8%
c/o The Hallwood Group Incorporated
3710 Rawlins, Suite 1500
Dallas, Texas 75219

Gotham Partners, L.P. and 247,994 15.6%
Gotham Partners, L.P. III
237 Park Avenue, 9th Floor
New York, NY 10017 (b)

Interstate Properties 171,500 10.8%
Park 80 West, Plaza II
Saddle Brook, NJ 07662 (b)

Alan G. Crisp (c) -- --

William F. Forsyth (c) -- --

Anthony J. Gumbiner (c) 25,800 (d) 1.6% (d)

William L. Guzzetti (c) 15,100 (e) 0.9% (e)

Edward T. Story (c) -- --

All directors and executive officers
as a group (8 persons) 60,900 (f) 3.7% (f)

(a) Unless otherwise indicated, each of the persons named has sole
voting and investment power with respect to the units reported.

(b) See discussion in Item 3 regarding certain litigation filed in the
Southern District of New York.

(d) Comprised of currently exercisable options to purchase 25,800 units.

(e) Includes currently exercisable options to purchase 15,000 units.

(f) Includes currently exercisable options to purchase 60,800 units.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

See Note 3 to the Consolidated Financial Statements included in Item 8 for
information covered by this item.

PAGE 43 of 45

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(1) Financial Statements.

See Index contained in Item 8.

(2) Reports on Form 8-K.

No reports on Form 8-K were filed during the fourth quarter of 2001 or in
2002 prior to the filing of this Form 10-K for the year ended December 31,
2001.

(3) Exhibits.

The response to this portion of Item 14 is incorporated by reference as
detailed in the Exhibit Index.

(4) Financial Statement Schedules.

See Index contained in Item 8.

PAGE 44 of 45

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

HALLWOOD REALTY PARTNERS, L.P.
BY: HALLWOOD REALTY, LLC
GENERAL PARTNER

DATE: March 22, 2002 BY: /s/ WILLIAM L. GUZZETTI
-------------- -------------------------------------
William L. Guzzetti
President and Chief Operating Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report on Form 10-K for the year ended December 31, 2001, has been signed below
by the following persons on behalf of the Registrant in the capacities and on
the date indicated.

Signature Capacity Date
--------- -------- ----

/s/ ANTHONY J. GUMBINER Chairman of the Board and Director, March 22, 2002
------------------------------------- Hallwood Realty, LLC
Anthony J. Gumbiner (Chief Executive Officer)

/s/ WILLIAM L. GUZZETTI President and Director, March 22, 2002
------------------------------------- Hallwood Realty, LLC
William L. Guzzetti (Chief Operating Officer)

/s/ JEFFREY D. GENT Vice President-Finance, March 22, 2002
------------------------------------- Hallwood Realty, LLC
Jeffrey D. Gent (Chief Accounting Officer)

/s/ ALAN G. CRISP Director, March 22, 2002
------------------------------------- Hallwood Realty, LLC
Alan G. Crisp

/s/ WILLIAM F. FORSYTH Director, March 22, 2002
------------------------------------- Hallwood Realty, LLC
William F. Forsyth

/s/ EDWARD T. STORY Director, March 22, 2002
------------------------------------- Hallwood Realty, LLC
Edward T. Story

PAGE 45 of 45