Forward-Looking Statements

In the interest of providing stockholders with certain information regarding the Company's and its subsidiaries' future plans and operations, certain statements set forth in this quarterly report on Form 10-Q relate to management's future plans, objectives and expectations. Such statements are forward-looking statements. Although any forward-looking statement expressed by or on behalf of Hallwood Group is, to the knowledge and in the judgment of the officers and directors, expected to prove true and come to pass, management is not able to predict the future with absolute certainty. Forward-looking statements involve known and unknown risks and uncertainties, which may cause Hallwood Group's actual performance and financial results in future periods to differ materially from any projection, estimate or forecasted result. Among others, these risks and uncertainties include those described in Hallwood Group's annual report on Form 10-K for the year ended December 31, 2011 in Item 1A - Risk Factors. These risks and uncertainties are difficult or impossible to predict accurately and many are beyond the control of Hallwood Group. Other risks and uncertainties may be described, from time to time, in Hallwood Group's periodic reports and filings with the Securities and Exchange Commission.

Overview

General. The Hallwood Group Incorporated (the "Company") (NYSE MKT:HWG) operates as a holding company. The Company operates its principal business in the textile products industry through its wholly owned subsidiary, Brookwood Companies Incorporated ("Brookwood"). Information contained herein includes references to the Company and its subsidiaries (collectively, the "Hallwood Group").

Textile Products. In 2012 and 2011, Hallwood Group derived all of its operating revenues from the textile activities of its Brookwood subsidiary; consequently, the Company's success is highly dependent upon Brookwood's success. Brookwood's success will be influenced in varying degrees by its ability to continue sales to existing customers, costs, availability of supplies, its response to competition and its ability to generate new markets. Although the textile activities of the Company and its subsidiaries have generated positive cash flow in recent years, there is no assurance that this trend will continue.

While Brookwood has enjoyed substantial revenues from its military business, there is no assurance that such revenues will continue. Brookwood's sales to the customers from whom it derives its military business have been volatile and difficult to predict, a trend management believes will continue. In recent years, orders from the military for goods generally were significantly affected by the increased activity of the U.S. military. As this activity changes, then orders from the military generally, including orders for Brookwood's products, may be similarly affected. The fluctuations in gross profit margin are attributed to varying levels of sales volume, changes in product mix and a more competitive pricing environment, primarily in the military market. Military sales of $12,924,000 and $54,155,000 for the 2012 third quarter and nine month periods, respectively, were 40.7% lower and 3.7% higher than the comparable periods in 2011 of $21,802,000 and $52,212,000.

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

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

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

Brookwood continues to identify new market niches. In addition to its existing products and proprietary technologies, Brookwood has developed advanced breathable, waterproof laminates and other materials, which have been well received by its customers. Continued development of these fabrics for military, industrial and consumer applications is a key element of Brookwood's business plan. The ongoing success of Brookwood is contingent on its ability to maintain its level of military business and adapt to the global textile industry. There can be no assurance that the positive results of the past can be sustained or that competitors will not aggressively seek to replace products developed by Brookwood.

The textile products business is not interdependent with the Company's other business operations. The Company does not guarantee the Brookwood bank facility and is not obligated to contribute additional capital. Conversely, Brookwood does not guarantee debts of the Company or any of the Company's other subsidiaries and is not obligated to contribute additional capital to the Company beyond preferred dividend payments and the tax sharing agreement.

Investments in Financial Instruments. In the 2011 first quarter, the Company opened an investment account with UBS AG, a global financial services firm, and intended to transfer a significant portion of the cash it holds from time to time to the UBS account to be placed in various financial instruments and to borrow additional amounts from UBS to invest on a leveraged basis. As of November 13, 2012, no funds have been transferred into the UBS account and currently the Company does not intend to transfer funds into the UBS account.

Presentation

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

Results of Operations

Hallwood Group reported a net loss of $1,063,000 for the 2012 third quarter, compared to net income of $350,000 in 2011. Revenue for the 2012 third quarter was $27,146,000, compared to $37,649,000 in 2011.

The net loss for the 2012 nine month period was $11,838,000, compared to a net loss of $4,173,000 in 2011. Revenue for the 2012 nine month period was $100,207,000, compared to $101,117,000 in 2011.

Revenues

Textile products sales of $27,146,000 decreased by $10,503,000, or 27.9%, in the 2012 third quarter, compared to $37,649,000 in 2011. Sales for the 2012 nine month period of $100,207,000 decreased by $910,000, or 0.9%, compared to $101,117,000 in 2011. The decreases in 2012 were principally due to decreases in sales of specialty fabric to U.S. military contractors as a result of decreases in orders from the military to Brookwood's customers, as well as by reduced sales in its other market segments. Military sales accounted for $12,924,000 and $54,155,000 in the 2012 third quarter and nine month periods, compared to $21,802,000 and $52,212,000 in 2011, respectively. The military sales represented 47.6% and 57.9% of Brookwood's net sales in the 2012 and 2011 third quarters, respectively, and 54.0% and 51.6% in the 2012 and 2011 nine month periods, respectively. Generally, military sales represent sales of a product to a customer (prime and sub-prime contractors) that will be incorporated into an end product that will be used to fulfill a U.S. or international military contract.

Sales Concentration. Brookwood has one customer who accounted for more than 10% of Brookwood's sales. Sales to that Brookwood customer, Tennier Industries, Inc. ("Tennier"), accounted for more than 10% of Brookwood's sales during 2012 and 2011. Brookwood's relationship with Tennier is ongoing. Sales to Tennier, which are included in military sales, were $6,164,000 and $16,864,000 in the 2012 third quarter and nine month periods, respectively, compared to $5,061,000 and $11,456,000 in the 2011 comparable periods. Sales to Tennier represented 22.7% and 13.4% of Brookwood's net sales in the 2012 and 2011 third quarters, respectively, and 16.8% and 11.3% in the 2012 and 2011 nine month periods, respectively.

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

Expenses

Textile products cost of sales of $23,557,000 for the 2012 third quarter decreased by $6,559,000, or 21.8%, compared to $30,116,000 in 2011. For the nine month periods, textile products cost of sales of $85,970,000 for 2012 increased by $3,544,000, or 4.3%, compared to $82,426,000 in 2011. The third quarter decrease is primarily a result of lower textile product sales in a quarter to quarter comparison. The nine month increase principally resulted from material and labor costs associated with the higher sales volume for the military segment, and from changes in product mix. Cost of sales includes all costs associated with the manufacturing process, including but not limited to, materials, labor, utilities, royalties, depreciation on manufacturing equipment and all costs associated with the purchase, receipt and transportation of goods and materials to Brookwood's facilities, including inbound freight, purchasing and receiving costs, inspection costs, internal transfer costs and other costs of the distribution network. Brookwood believes that the reporting and composition of cost of sales and gross margin is comparable with similar companies in the textile converting and finishing industry.

The gross profit margin for the 2012 third quarter was 13.2%, compared to 20.0% for 2011 and for the 2012 nine month period, 14.2% versus 18.5%. The fluctuations in gross profit margin were attributed to varying levels of sales volume, changes in product mix and a more competitive pricing environment, primarily in the military market.

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

                              Three Months Ended          Nine Months Ended
                                 September 30,              September 30,
                               2012          2011         2012          2011
                Brookwood   $    3,790      $ 5,113     $  15,105     $ 13,244
                Company          1,225        1,768         3,583        4,114

                Total       $    5,015      $ 6,881     $  18,688     $ 17,358

Brookwood's administrative and selling expenses of $3,790,000 for the 2012 third quarter decreased by $1,323,000, or 25.9%, from 2011. For the 2012 nine months, administrative and selling expenses increased by $1,861,000, or 14.1%, compared to 2011. The nine month increase was primarily attributable to an increase in professional services of $1,356,000, principally legal fees. The principal component of the third quarter decrease was due to lower professional services, primarily legal fees of $1,373,000. Costs and expenses incurred by Brookwood in its successful defense of the Nextec litigation were $163,000 and $3,572,000 for the 2012 third quarter and nine month periods and $1,464,000 and $2,308,000 for the 2011 third quarter and nine month periods, respectively. The Court ruled from the bench on June 1, 2012 that, while Nextec's patents were valid, Brookwood had not infringed any of the patents in the lawsuit. Nextec has since filed a notice of appeal to the United States Court of Appeals for the Federal Circuit; Brookwood subsequently filed a notice of cross-appeal. For a further discussion on the Nextec litigation, see Note 13 in the accompanying condensed consolidated financial statements.

Brookwood's administrative and selling expenses included items such as payroll, professional fees, sales commissions, factor commissions, marketing, rent, insurance and travel. Brookwood conducts research and development activities related to the exploration, development and production of innovative products and technologies. Research and development costs were approximately $212,000 and $582,000 for the three and nine months ended September 30, 2012, respectively, compared to $149,000 and $486,000 for the comparable 2011 periods.

The Company's administrative expenses decreased $543,000, or 30.7%, for the 2012 third quarter, compared to 2011. For the 2012 nine months, the Company's administrative expenses decreased $531,000, or 12.9%, compared to 2011. The decreases were principally attributable to lower professional fees primarily associated with the defense in the Hallwood Energy litigation matters.

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

On April 24, 2012, the United States District Court entered a final judgment (the "Judgment") substantially adopting the Proposed Findings. Based upon the monetary damages (including prejudgment and postjudgment interest, legal fees and court costs) awarded in the Judgment, the Company recorded an additional charge of $13,200,000 at March 31, 2012 in its statement of operations and balance sheet as an accrual under Hallwood Energy matters - Litigation Reserve. Accordingly, the total reserve at

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

March 31, 2012 for the Adversary Proceeding was $23,901,000. The Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. In addition, the Company will be required to pay certain attorneys' fees incurred by the plaintiffs. At September 30, 2012, the litigation reserve for the Hallwood Energy matters is $2,079,000. The parties settled the amount of court costs for approximately $101,000, which was paid in August 2012. While the Company will be required to pay some additional amount of money to the plaintiffs as compensation for their attorney fees related to the breach of contract claim they prosecuted against the Company, the amount and timing of that payment are currently unresolved and will be determined by the court. The plaintiffs have alleged that they are entitled to approximately $4,000,000 for attorney fees while the Company contends that they should only recover a small fraction of that amount. In addition, the Company is in the process of appealing to the Fifth Circuit Court of Appeals the portions of the Judgment awarding a combined $17,947,000 on the plaintiffs' tort claims. On September 13, 2012, the Company filed its appellate brief in the Fifth Circuit. On November 15, 2012, FEI Shale, L.P. ("FEI"), the only appellee, will file its response, and the Company will then file a reply brief, completing the briefing process. It is difficult to determine or even approximate when the Fifth Circuit will rule on the Company's appeal, but it will likely be several months, if not longer.

Other Income (Loss)

Interest expense was $178,000 and $315,000 in the 2012 third quarter and nine month periods, respectively, compared to $25,000 and $74,000 for the 2011 third quarter and nine month periods. The interest expense primarily relates to Brookwood's revolving credit facilities and the HFL Loan, which was entered into in May 2012.

Interest and other income was $-0- and $2,000 in the 2012 third quarter and nine month periods, compared to $5,000 and $35,000 for the 2011 periods. The 2012 decreases were principally due to the redemption of marketable securities in 2011.

Income Taxes

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



                             Three Months Ended           Nine Months Ended
                                September 30,               September 30,
                             2012            2011         2012          2011
               Federal
               Current     $     (40 )      $  208      $    (48 )    $    398
               Deferred         (500 )         (13 )      (6,066 )      (2,638 )

               Sub-total        (540 )         195        (6,114 )      (2,240 )
               State
               Current            (1 )          87           (12 )         207
               Deferred           -             -             -             -

               Sub-total          (1 )          87           (12 )         207

               Total       $    (541 )      $  282      $ (6,126 )    $ (2,033 )

At September 30, 2012, the net deferred tax asset was attributable to temporary differences, that upon reversal, could be utilized to offset income from operations and the carryforward of 2012 taxable losses to future periods. The statutory federal tax rate in both periods was 34%, while state taxes were determined based upon taxable income apportioned to those states in which Hallwood Group does business at their respective tax rates.

Critical Accounting Policies

There have been no changes to the critical accounting policies identified and set forth in Hallwood Group's annual report on Form 10-K for the year ended December 31, 2011.

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

Related Party Transactions

Hallwood Investments Limited. The Company has entered into a financial consulting contract with Hallwood Investments Limited ("HIL"), a corporation associated with Mr. Anthony J. Gumbiner, the Company's chairman and principal stockholder. The contract provides for HIL to furnish and perform international consulting and advisory services to the Company and its subsidiaries, including strategic planning and merger activities, for annual compensation of $996,000. The annual amount is payable in monthly installments. The contract automatically renews for one-year periods if not terminated by the parties beforehand. Additionally, HIL and Mr. Gumbiner are also eligible for bonuses from the Company or its subsidiaries, subject to approval by the Company's or its subsidiaries' board of directors. The Company also reimburses HIL for reasonable expenses in providing office space and administrative services in Europe in connection with HIL's services to the Company pursuant to the financial consulting contract and for travel and related expenses between Europe and the Company's locations in the United States and health insurance premiums.

A summary of the fees and expenses related to HIL and Mr. Gumbiner are detailed below (in thousands):

                                                     Three Months Ended             Nine Months Ended
                                                        September 30,                 September 30,
                                                    2012            2011            2012          2011
Consulting fees                                   $     249       $     249      $      747      $   747
Office space and administrative services                 68              71             221          238
Travel and other expenses                                44              71              71          151
Interest expense on HFL loan                            136              -              216           -

Total                                             $     497       $     391      $    1,255      $ 1,136

In addition, from time to time, HIL and Mr. Gumbiner have performed services for certain affiliated entities that are not subsidiaries of the Company, for which they receive consulting fees, bonuses, stock options, profit interests or other forms of compensation and expenses. No such services were performed or compensation earned during 2012 or 2011. The Company recognizes a proportionate share of such compensation and expenses, based upon its ownership percentage in the affiliated entities, through the utilization of the equity method of accounting.

HIL and certain of its affiliates in which Mr. Gumbiner has an indirect financial interest share common offices, facilities and certain staff in the Company's Dallas office for which these companies reimburse the Company. Certain individuals employed by the Company, in addition to their services provided to the Company, perform services on behalf of the HIL-related affiliates. In addition, HIL utilizes some of the office space for purposes unrelated to the Company's business. The Company pays certain common general and administrative expenses for salaries, rent and other office expenses and charges the HIL-related companies an overhead reimbursement fee for the share of the expenses allocable to these companies. For the three months ended September 30, 2012 and 2011, these companies reimbursed the Company $27,000 and $25,000, respectively, for such expenses. For the nine months ended September 30, 2012 and 2011, these companies reimbursed the Company $80,000 and $72,000, respectively, for such expenses.

In May 2012, to fund in part the payment of the Judgment, the Company entered into the HFL Loan with Hallwood Family (BVI) L.P., a limited partnership associated with Mr. Gumbiner, as described below under "Liquidity and Capital Resources". The interest expense payable on the HFL Loan was $136,000 and $-0- at September 30, 2012 and December 31, 2011, respectively.

Litigation

Refer to Note 13 in the accompanying condensed consolidated financial statements for a discussion of litigation matters.

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

Contractual Obligations and Commercial Commitments

The Company and its subsidiaries have entered into various contractual
obligations and commercial commitments in the ordinary course of conducting its
business operations, which are provided below as of September 30, 2012 (in
thousands):



                                                         Payments Due During the Year Ending December 31,
                                          2012*       2013        2014       2015      2016       Thereafter       Total
Contractual Obligations
Loans payable                            $    78     $ 9,106     $ 3,850     $  -      $  -      $         -      $ 13,034
Operating leases                             189         683         594       397       212               -         2,075

Total                                    $   267     $ 9,789     $ 4,444     $ 397     $ 212     $         -      $ 15,109

* For the three months ending December 31, 2012.

At September 30, 2012, the Company's debt was comprised of the HFL Loan, which bears interest at a 6% annual fixed rate. Brookwood's debt consisted of the New Revolving Credit Facility, which bears interest at variable rates. Estimated interest payments, based on the current principal balances and weighted average interest rates, assuming the repayment of the HFL Loan at its June 2013 maturity date and renewal of the revolving credit facility at its loan balance as of September 30, 2012, are $147,000 for the three months ending December 31, 2012 and $317,000, $47,000, $47,000, and $47,000 for each of the years ending December 31, 2013 through December 31, 2016, respectively.

Payments in Adversary Proceeding. In May 2012, the Company satisfied the Judgment, including prejudgment and postjudgment interest, in two payments; $3,774,000 on May 4, 2012 and $17,947,000 on May 9, 2012. In addition, the Company will be required to pay certain attorneys' fees incurred by the plaintiffs. The parties settled the amount of court costs for approximately $101,000, which was paid in August 2012. While the Company will be required to pay some additional amount of money to the plaintiffs as compensation for their attorney fees related to the breach of contract claim they prosecuted against the Company, the amount and timing of that payment are currently unresolved and will be determined by the court. The plaintiffs have alleged that they are entitled to approximately $4,000,000 for attorney fees while the Company contends that they should only recover a small fraction of that amount. In addition, the Company is in the process of appealing to the Fifth Circuit Court of Appeals the portions of the Judgment awarding a combined $17,947,000 on the plaintiffs' tort claims. On September 13, 2012, the Company filed its appellate brief in the Fifth Circuit. On November 15, 2012, FEI, the only appellee, will file its response, and the Company will then file a reply brief, completing the briefing process. It is difficult to determine or even approximate when the Fifth Circuit will rule on the Company's appeal, but it will likely be several months, if not longer.

Employment Contracts. The Company and its Brookwood subsidiary have compensation agreements with various personnel and consultants. Generally, the agreements extend for one-year terms and are renewable annually.

2005 Long-Term Incentive Plan for Brookwood. In December 2005, the Company adopted The Hallwood Group Incorporated 2005 Long-Term Incentive Plan for Brookwood Companies Incorporated ("2005 Long-Term Incentive Plan for Brookwood") to encourage employees of Brookwood to increase the value of Brookwood and to continue to be employed by Brookwood. The terms of the incentive plan provide . . .