<PAGE>   1
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

MARK ONE

[X]      QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

                  FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001

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

                          COMMISSION FILE NUMBER 0-9579

                                   ----------

                           HALLWOOD ENERGY CORPORATION
             (Exact name of registrant as specified in its charter)

                                   ----------

           DELAWARE                                       84-1489099
(State or other jurisdiction of                        (I.R.S. Employer
incorporation or organization)                      Identification Number)

         4610 SOUTH ULSTER STREET
                SUITE 200
             DENVER, COLORADO                               80237
(Address of principal executive offices)                 (Zip Code)

       Registrant's telephone number, including area code: (303) 850-7373

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  [  ]

Number of shares outstanding as of May 7, 2001

Common Stock                                                9,659,239
Series A Cumulative Preferred Stock                         2,263,573




                                  Page 1 of 22
<PAGE>   2



PART I.  FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

                           HALLWOOD ENERGY CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)
                                 (In thousands)


<TABLE>
<CAPTION>

                                                  March 31,      December 31,
                                                    2001             2000
                                                ------------    ------------

<S>                                             <C>             <C>
CURRENT ASSETS
   Cash and cash equivalents                    $     12,108    $      4,334
   Accounts receivable:
     Oil and gas revenues                             20,519          20,618
     Trade                                             9,594           3,911
   Due from affiliates                                 2,478             685
   Prepaid expenses and other current assets           2,740           1,927
                                                ------------    ------------
         Total                                        47,439          31,475
                                                ------------    ------------

PROPERTY, PLANT AND EQUIPMENT, at cost
   Oil and gas properties (full cost method):
     Proved mineral interests                        780,691         765,262
     Unproved mineral interests                        6,715           6,557
   Furniture, fixtures and other                       1,287           1,249
                                                ------------    ------------
         Total                                       788,693         773,068

   Less accumulated depreciation, depletion,
     amortization and property impairment           (613,651)       (608,563)
                                                ------------    ------------
         Total                                       175,042         164,505
                                                ------------    ------------

OTHER ASSETS
   Derivatives, at fair value                            101
   Deferred expenses and other assets                  1,060           1,107
   Deferred tax asset                                 10,770             680
                                                ------------    ------------
         Total                                        11,931           1,787
                                                ------------    ------------

TOTAL ASSETS                                    $    234,412    $    197,767
                                                ============    ============
</TABLE>



                        (Continued on the following page)



                                     - 2 -
<PAGE>   3



                           HALLWOOD ENERGY CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)
                          (In thousands except shares)


<TABLE>
<CAPTION>

                                                           March 31,   December 31,
                                                              2001         2000
                                                           ---------   ------------

<S>                                                        <C>          <C>
CURRENT LIABILITIES
   Accounts payable and accrued liabilities                $  43,400    $  28,082
   Derivatives, at fair value                                 23,510
                                                           ---------    ---------
         Total                                                66,910       28,082
                                                           ---------    ---------

NONCURRENT LIABILITIES
   Long-term debt                                             81,449       79,387
   Derivatives, at fair value                                  7,733
   Deferred liabilities                                          946        1,037
                                                           ---------    ---------
         Total                                                90,128       80,424
                                                           ---------    ---------

           Total liabilities                                 157,038      108 506
                                                           ---------    ---------

COMMITMENTS AND CONTINGENCIES (NOTE 6)

STOCKHOLDERS' EQUITY
   Series A Cumulative Preferred Stock; 5,000,000 shares
     authorized; 2,263,573 shares issued and outstanding      20,873       20,873
   Common Stock par value $.01 per share; 25,000,000
     shares authorized; 10,423,693 shares issued and
     9,659,239 outstanding                                       104          104
   Additional paid-in capital                                 70,085       70,085
   Retained earnings                                          11,110        2,809
   Accumulated other comprehensive loss                      (20,188)
   Less cost of treasury stock of 764,454 common shares       (4,610)      (4,610)
                                                           ---------    ---------
         Stockholders' equity - net                           77,374       89,261
                                                           ---------    ---------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                 $ 234,412    $ 197,767
                                                           =========    =========
</TABLE>



    The accompanying notes are an integral part of the financial statements.


                                     - 3 -
<PAGE>   4


                           HALLWOOD ENERGY CORPORATION
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)
                      (In thousands except per share data)


<TABLE>
<CAPTION>

                                                        For the Three Months Ended
                                                                March 31,
                                                       ----------------------------
                                                           2001            2000
                                                       ------------    ------------
<S>                                                    <C>             <C>
REVENUES:
   Gas revenue                                         $     19,218    $     13,845
   Oil revenue                                                3,836           6,145
   Pipeline, facilities and other                             2,169           1,666
   Interest                                                     161             153
                                                       ------------    ------------
                                                             25,384          21,809
                                                       ------------    ------------

EXPENSES:
   Production operating                                       6,109           5,482
   Ineffectiveness of oil and gas derivatives                   554
   General and administrative                                 2,660           1,801
   Depreciation, depletion and amortization                   5,048           6,434
   Interest                                                   1,808           2,395
                                                       ------------    ------------
                                                             16,179          16,112
                                                       ------------    ------------

OTHER INCOME (EXPENSES):
   Minority interest in net income of affiliates                               (127)
   Litigation                                                    27            (617)
                                                       ------------    ------------
                                                                 27            (744)
                                                       ------------    ------------

INCOME BEFORE INCOME TAXES                                    9,232           4,953
                                                       ------------    ------------

PROVISION FOR INCOME TAXES:
   Current                                                       55             548
   Deferred                                                     310
                                                       ------------    ------------
                                                                365             548
                                                       ------------    ------------

NET INCOME                                                    8,867           4,405

PREFERRED DIVIDENDS                                             566             573
                                                       ------------    ------------

   NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS
                                                       $      8,301    $      3,832
                                                       ============    ============

   NET INCOME PER SHARE - BASIC                        $        .86    $        .38
                                                       ============    ============

   NET INCOME PER SHARE - DILUTED                      $        .83    $        .38
                                                       ============    ============

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - BASIC
                                                              9,659          10,000
                                                       ============    ============

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - DILUTED
                                                             10,012          10,000
                                                       ============    ============
</TABLE>

     The accompanying notes are an integral part of the financial statements



                                     - 4 -
<PAGE>   5


                           HALLWOOD ENERGY CORPORATION
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                                 (In thousands)


<TABLE>
<CAPTION>

                                                                               For the Three Months Ended
                                                                                        March 31,
                                                                              ----------------------------
                                                                                  2001            2000
                                                                              ------------    ------------

<S>                                                                           <C>             <C>
OPERATING ACTIVITIES:
    Net income                                                                $      8,867    $      4,405
    Adjustments to reconcile net income to net cash provided
       by operating activities:
          Depreciation, depletion and amortization                                   5,048           6,434
          Depreciation charged to affiliates                                            40              50
          Amortization of deferred loan costs and debt discount                        109             110
          Ineffectiveness of oil and gas derivatives                                   554
          Deferred tax expense                                                         310
          Minority interest in net income of affiliates                                                127
          Recoupment of take-or-pay liability                                                          (52)


    Changes in operating assets and liabilities provided (used) cash net of
       noncash activity:
          Oil and gas revenues receivable                                               99          (1,299)
          Trade receivables                                                         (5,683)         (2,030)
          Due from affiliates                                                       (1,793)           (134)
          Prepaid expenses and other current assets                                   (813)             15
          Accounts payable and accrued liabilities                                  15,318            (757)
          Deferred liabilities                                                         (91)
                                                                              ------------    ------------
                Net cash provided by operating activities                           21,965           6,869
                                                                              ------------    ------------

INVESTING ACTIVITIES:
    Additions to property, plant and equipment                                      (5,114)         (1,182)
    Exploration and development costs incurred                                     (10,712)         (4,296)
    Proceeds from sales of property, plant and equipment                               201          11,503
                                                                              ------------    ------------
                Net cash provided by (used in) investing activities                (15,625)          6,025
                                                                              ------------    ------------

FINANCING ACTIVITIES:
    Proceeds from long-term debt                                                     2,000
    Payments of long-term debt                                                                      (7,000)
    Dividends paid                                                                    (566)           (573)
    Purchase and cancellation of preferred shares                                                     (303)
                                                                              ------------    ------------
                Net cash provided by (used in) financing activities                  1,434          (7,876)
                                                                              ------------    ------------

NET INCREASE IN CASH AND CASH EQUIVALENTS                                            7,774           5,018

CASH AND CASH EQUIVALENTS:

BEGINNING OF PERIOD                                                                  4,334          10,480
                                                                              ------------    ------------

END OF PERIOD                                                                 $     12,108    $     15,498
                                                                              ============    ============
</TABLE>



    The accompanying notes are an integral part of the financial statements.


                                     - 5 -
<PAGE>   6


                           HALLWOOD ENERGY CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)



NOTE 1    -  GENERAL

Hallwood Energy Corporation ("Hallwood" or the "Company") is a Delaware
corporation engaged in the development, exploration, acquisition and production
of oil and gas properties. Hallwood began operations June 8, 1999, in connection
with the consolidation ("Consolidation") of Hallwood Energy Partners, L.P.
("HEP") and Hallwood Consolidated Resources Corporation ("HCRC") and the
acquisition of the direct energy interests of The Hallwood Group Incorporated
("Hallwood Group"). The Company's properties are primarily located in the Rocky
Mountain, Greater Permian and Gulf Coast regions of the United States.

On March 29, 2001, Hallwood and Pure Resources II, Inc. ("Pure"), a wholly owned
subsidiary of Pure Resources, Inc. signed an agreement and plan of merger
pursuant to which Pure has offered to purchase for cash all outstanding shares
of Hallwood common and preferred stock for $12.50 per share and $10.84 per
share, respectively.

The offer is conditioned on, among other things, there being validly tendered
and not properly withdrawn prior to the expiration of the offer a number of
shares that would constitute at least a majority of all outstanding shares of
common stock (with shares of common stock issuable upon the exercise of
outstanding warrants being deemed outstanding for this purpose) and at least a
majority of all outstanding shares of Series A Cumulative Preferred Stock on the
date of purchase. The offer is further conditioned upon the execution of
cancellation agreements between the Company and the holders of the Company's
options pursuant to the agreement and plan of merger. Therefore, shares
underlying the options are not included in the calculation of the shares of
outstanding common stock for purposes of Pure's offer.

The Board of Directors of Hallwood has approved the transaction and the merger
agreement and the transactions contemplated by the merger agreement including
the offer and the merger, and determined that the terms of the offer, the merger
and the other transactions contemplated by the merger agreement are advisable
and fair to and in the best interests of Hallwood and its stockholders.

The interim financial data are unaudited; however, in the opinion of management,
the interim data include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the results for the interim
periods. Quarterly results might not be indicative of the actual annual results.
These financial statements should be read in conjunction with the financial
statements and accompanying notes included in Hallwood's 2000 Annual Report on
Form 10-K.

ACCOUNTING POLICIES

CONSOLIDATION

Hallwood fully consolidates entities in which it owns a greater than 50% equity
interest and reflects a minority interest in the consolidated financial
statements. The accompanying financial statements include the majority owned
affiliates, the May Limited Partnerships 1984-1, 1984-2 and 1984-3 through March
31, 2000 when they were liquidated.




                                     - 6 -
<PAGE>   7
COMPUTATION OF NET INCOME PER SHARE

Basic income per share is computed by dividing net income attributable to the
common shareholders by the weighted average number of common shares outstanding
during the periods. Diluted income per common share includes the potential
dilution that could occur upon exercise of options or warrants to acquire common
stock, computed using the treasury stock method which assumes that the increase
in the number of shares is reduced by the number of shares which could have been
repurchased by the Company with the proceeds from the exercise of the options or
warrants (which were assumed to have been made at the average market price of
the common shares during the reporting period). The warrants described in Note 2
and all of the Company's outstanding stock options described in Note 4 have been
ignored during the three months ended March 31, 2000, and the stock options
issued in January 2001 have been ignored during the three months ended March 31,
2001, in the computation of diluted net income per share because their inclusion
would be antidilutive.

The following table reconciles the number of shares outstanding used in the
calculation of basic and diluted income per share.

<TABLE>
<CAPTION>

                                                      Income
                                                     to Common
                                                    Shareholders   Shares   Per Share
                                                    ------------   ------   ----------
                                                   (In thousands except per share data)

<S>                                                 <C>             <C>     <C>
FOR THE THREE MONTHS ENDED MARCH 31, 2001
  Net income per share - basic                      $      8,301    9,659   $      .86
                                                                            ==========
  Effect of options and warrants                                      353
                                                    ------------   ------
  Net income per share - diluted                    $      8,301   10,012   $      .83
                                                    ============   ======   ==========

FOR THE THREE MONTHS ENDED MARCH 31, 2000
  Net income per share- basic                       $      3,832   10,000   $      .38
                                                    ------------   ------   ==========
  Net income per share- diluted                     $      3,832   10,000   $      .38
                                                    ============   ======   ==========
</TABLE>

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Statement of Financial Accounting Standards No. 133 "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), is effective for all fiscal
years beginning after June 15, 2000. SFAS 133, as amended and interpreted,
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. SFAS
133 defines 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 SFAS 133 on January 1, 2001. In connection with the adoption
of SFAS 133, all derivatives within the Company were identified pursuant to SFAS
133 requirements. The Company 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 the Company'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 is measured based on the relative changes in the fair value
between the derivative contract and the hedged item over time. Any changes in
fair value resulting from ineffectiveness, as defined by SFAS 133, are
recognized immediately in current earnings.



                                     - 7 -
<PAGE>   8


OTHER COMPREHENSIVE INCOME (LOSS)

The components of other comprehensive income (loss) and related tax effects for
the three months ended March 31, 2001 are shown as follows:

<TABLE>
<CAPTION>

                                                                 Tax          Net of
                                                   Gross        Effect         Tax
                                                ----------    ----------    ----------
                                                            (In thousands)

<S>                                             <C>           <C>           <C>
Cumulative effect of accounting change          $  (43,816)   $   14,897    $  (28,919)
Reclassification adjustments                        13,228        (4,497)        8,731
                                                ----------    ----------    ----------
Accumulated other comprehensive income (loss)   $  (30,588)   $   10,400    $  (20,188)
                                                ==========    ==========    ==========
</TABLE>

The reclassification adjustments above represent the changes in the fair values
of the Company's derivatives resulting from the settlement of these derivatives
during the first quarter of 2001.

RECLASSIFICATIONS

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

NOTE 2 - DEBT

Hallwood's long-term debt at March 31, 2001 and December 31, 2000 consisted of
the following:

<TABLE>
<CAPTION>

                         March 31, 2001    December 31, 2000
                         --------------    -----------------
                                   (In thousands)

<S>                      <C>               <C>
Credit Agreement         $       58,000    $          56,000
Note Agreement                   25,000               25,000
Debt discount                    (1,551)              (1,613)
                         --------------    -----------------
  Total long-term debt   $       81,449    $          79,387
                         ==============    =================
</TABLE>

On June 8, 1999, Hallwood and its lenders entered into an Amended and Restated
Credit Agreement (as amended, the "Credit Agreement") to extend the term date of
its line of credit to May 31, 2002. The lenders were Morgan Guaranty Trust
Company, First Union National Bank and Bank of America. Effective June 30, 2000,
Wells Fargo Bank replaced Bank of America as one of Hallwood's lenders under its
Credit Agreement and Hallwood's Credit Agreement was amended to reduce
Hallwood's borrowing base to $70,000,000. Hallwood's unused borrowing base was
$12,000,000 as of March 31, 2001.

Borrowings against the Credit Agreement bear interest at the lower of the
Certificate of Deposit rate plus from 1.375% to 2.125%, prime plus .5% plus from
 .25% to 1% or the Euro-Dollar rate plus from 1.25% to 2.0%. The applicable
interest rate was approximately 6.7% at March 31, 2001. Interest is payable
monthly. Quarterly principal payments of $8,286,000 are scheduled to commence
May 31, 2002.

The borrowing base for the Credit Agreement is typically redetermined
semiannually, although the lenders have the right to make a redetermination at
anytime. The Credit Agreement is secured by a first lien on approximately 80% in
value of Hallwood's oil and gas properties. Additionally, aggregate dividends
paid and stock repurchased by Hallwood in any 12 month period are limited to 50%
of cash flow from operations before working capital changes and distributions
received from affiliates, if the principal amount of debt of Hallwood is 50% or
more of the borrowing base. Aggregate dividends paid and stock repurchased by
Hallwood are limited to 65% of cash flow from operations before working capital
changes and distributions received from affiliates, if the principal amount of
debt is less than 50% of the borrowing base.



                                     - 8 -
<PAGE>   9



Hallwood has $25,000,000 of 10.32% Senior Subordinated Notes ("Subordinated
Notes") due December 23, 2007 and warrants to purchase common stock under its
Amended and Restated Subordinated Note and Warrant Purchase Agreement (the "Note
Agreement"). The Note Agreement was amended on June 8, 1999 to issue warrants to
The Prudential Insurance Company of America to purchase 309,278 shares of
Hallwood's common stock at an exercise price of $7.00 per share. The terms of
the Note Agreement were further amended on June 30, 2000 to exclude certain
hedging transactions of the subsidiaries of Hallwood from the calculation of
indebtedness. The Subordinated Notes bear interest at the rate of 10.32% per
annum on the unpaid balance, payable quarterly. Annual principal payments of
$5,000,000 are due December 23, 2003 through December 23, 2007.

Hallwood recorded the Subordinated Notes and the warrants based upon the
relative fair values of the Subordinated Notes without the warrants and of the
warrants themselves at the time of Consolidation. The allocated value of the
warrants of $1,956,000 was recorded as additional paid-in-capital. The discount
on the Subordinated Notes is being amortized over the term of the Subordinated
Notes using the interest method of amortization.

As part of its risk management strategy, Hallwood enters into financial
contracts to hedge the interest rate payments under its Credit Agreement.
Hallwood does not use the hedges for trading purposes, but rather to protect
against the volatility of the cash flows under its Credit Agreement, which has a
floating interest rate. The amounts received or paid upon settlement of these
transactions are recognized as interest expense at the time the interest
payments are due.

All contracts are interest rate swaps with fixed rates. As of March 31, 2001,
Hallwood was a party to eight contracts with three different counterparties.

The following table provides a summary of Hallwood's financial contracts.

<TABLE>
<CAPTION>

                                                                    Average
                                             Amount of              Contract
               Period                       Debt Hedged            Floor Rate
               ------                       -----------            ----------

<S>                                         <C>                    <C>
     Last nine months of 2001               $36,000,000                5.23%
     2002                                    37,500,000                5.23
     2003                                    37,500,000                5.23
     2004                                     6,000,000                5.23

</TABLE>

NOTE 3 - STATEMENTS OF CASH FLOWS

Cash paid for interest during the three months ended March 31, 2001 and 2000 was
$1,741,000 and $2,285,000, respectively. There was no cash paid for income taxes
during the three months ended March 31, 2001 and 2000.


NOTE 4 - DERIVATIVES

As part of its risk management strategy, Hallwood enters into financial
contracts to hedge the price of its oil and natural gas. Hallwood does not use
these hedges for trading purposes, but rather for the purpose of providing
protection against price decreases and to provide a measure of stability in the
volatile environment of oil and natural gas spot pricing. The amounts received
or paid upon settlement of these contracts is recognized as oil or gas revenue
at the time the hedged volumes are sold.

The financial contracts used by Hallwood to hedge the price of its oil and
natural gas production are swaps and collars. Under the swap contracts, Hallwood
sells its oil and gas production at spot market prices and receives or makes
payments based on the differential between the contract price and a floating
price which is based on spot market indices. Under the collar agreements,
Hallwood will receive the contract price if the spot price is lower than the
contract price, the cap price if the spot price is higher than the cap price,
and the spot price if that price is between the contract price and the cap
price.




                                     - 9 -
<PAGE>   10

The adoption of SFAS 133 as of January 1, 2001 resulted in the recognition of a
current asset of $163,000, a noncurrent asset of $316,000, a current liability
of $36,228,000 and a noncurrent liability of $8,067,000, with a net-of-tax
cumulative effect adjustment reducing other comprehensive income by $28,919,000.

During the first quarter of 2001, $554,000, representing the ineffective portion
of the Company's cash flow hedges was included in earnings. As of March 31,
2001, the fair values of the Company's cash flow hedges consisted of a
noncurrent asset of $101,000, a current liability of $23,510,000, a noncurrent
liability of $7,733,000 and a net of tax balance in other comprehensive loss of
$20,188,000.

The Company expects that $23,510,000 of losses under the Company's cash flow
hedges, will be reclassified from other comprehensive loss to earnings during
the next twelve months.

In the event of nonperformance by the counterparties to the financial contracts,
Hallwood is exposed to credit loss, but has no off-balance sheet risk of
accounting loss. The Company anticipates that the counterparties will be able to
satisfy their obligations under the contracts because the counterparties consist
of well-established banking and financial institutions which have been in
operation for many years. Certain of Hallwood's hedges are secured by the lien
on Hallwood's oil and gas properties, which also secures Hallwood's Credit
Agreement described in Note 2.

NOTE 5 -  STOCK OPTIONS

On January 31, 2001, the Compensation Committee of Hallwood granted options to
purchase 398,867 shares of common stock at an exercise price of $9.875 per share
which was equal to the fair market value of the common stock on the date of
grant. The options expire on January 31, 2008, unless sooner terminated pursuant
to the provisions of the plan. One-third of the options vested on the grant date
and the remainder vest one-third on January 31, 2002 and one-third on January
31, 2003.

On January 28, 2000, the Compensation Committee of Hallwood granted options to
purchase 238,500 shares of common stock at an exercise price of $4.625 per share
which was equal to the fair market value of the common stock on the date of
grant. The options expire on January 28, 2007, unless sooner terminated pursuant
to the provisions of the plan. One-third of the options vested on the grant
date, one-third vested on January 28, 2001 and the remaining one-third will vest
on January 28, 2002. During the year ended December 31, 2000, 6,533 of these
options were exercised, 19,600 of these options expired and 3,267 of these
options were cancelled.

On June 9, 1999, the Compensation Committee of Hallwood granted options to
purchase 600,000 shares of common stock at an exercise price of $7.00 per share
which was equal to the fair market value on the date of grant. On November 22,
1999, Hallwood granted an additional 61,500 options to purchase common stock at
an exercise price of $7.00 per share which was greater than the fair market
value of the common stock on the date of the grant. The options expire on June
9, 2006, unless sooner terminated pursuant to the provisions of the plan.
One-third of the options vested on the grant date, and the remainder vest
one-third on June 8, 2000 and one-third on June 8, 2001. During the year ended
December 31, 2000, 27,000 of these options expired and 54,000 of these options
were cancelled.

Pursuant to the terms of the plan under which the options were granted, all of
the outstanding options vest upon a change of control, as defined.

NOTE 6 - LEGAL SETTLEMENTS

In connection with the Consolidation, Hallwood assumed the liability for two
lawsuits filed against Hallwood Group and certain individuals and related to the
direct energy interests acquired from Hallwood Group. These lawsuits, both filed
in federal court in Denver, Colorado, have been settled and dismissed. During
February 2000, Hallwood paid approximately $673,000 in connection with these
lawsuits. During May 2000, the Company received a settlement offer from its
insurance company to reimburse approximately $419,000 of the costs paid in
connection with these lawsuits. This amount was received by the Company during
the third quarter of 2000 and recognized as litigation income during that
quarter.


                                     - 10 -
<PAGE>   11

In connection with the 1995 closing of the Jakarta, Indonesia office of HEP and
HCRC, three former employees filed a lawsuit against those entities, primarily
based on allegations that their employment contracts had been breached. The case
was tried in 1997, and after appeals, a final judgment of approximately $488,000
plus interest was awarded to the plaintiffs. The amount due was accrued as of
March 31, 2000, and was paid to the plaintiffs in the second quarter of 2000.

In addition to the litigation noted above, the Company and its subsidiaries are
from time to time subject to routine litigation and claims incidental to their
business, which the Company believes will be resolved without material effect on
the Company's financial condition, cash flows or operations.

ITEM 2    -  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
             RESULTS OF OPERATIONS

On March 29, 2001, Hallwood and Pure Resources II, Inc., a wholly owned
subsidiary of Pure Resources, Inc. signed an agreement and plan of merger
pursuant to which Pure Resources II, Inc. has offered to purchase for cash all
outstanding shares of Hallwood common and preferred stock for $12.50 per share
and $10.84 per share, respectively.

The offer is conditioned on, among other things, there being validly tendered
and not properly withdrawn prior to the expiration of the offer a number of
shares that would constitute at least a majority of all outstanding shares of
common stock (with shares of common stock issuable upon the exercise of
outstanding warrants being deemed outstanding for this purpose) and at least a
majority of all outstanding shares of Series A Cumulative Preferred Stock on the
date of purchase. The offer is further conditioned upon the execution of
cancellation agreements between the Company and the holders of the Company's
options pursuant to the agreement and plan of merger. Therefore, shares
underlying the options are not included in the calculation of the shares of
outstanding common stock for purposes of Pure's offer.

The Board of Directors of Hallwood has approved the transaction and the merger
agreement and the transactions contemplated by the merger agreement including
the offer and the merger, and determined that the terms of the offer, the merger
and the other transactions contemplated by the merger agreement are advisable
and fair to and in the best interests of Hallwood and its stockholders.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOW

Hallwood had $21,965,000 of cash flow from operating activities during the first
three months of 2001.

Primary cash inflows were:

     o  Proceeds from long-term debt of $2,000,000; and

     o  Proceeds from the sale of properties of $201,000.

Cash was used primarily for:

     o  Additions to property and development costs incurred of $15,826,000;
        and

     o  Dividends to preferred shareholders of $566,000.

When combined with miscellaneous other cash activity during the period, the
result was an increase of $7,774,000 in Hallwood's cash from $4,334,000 at
December 31, 2000 to $12,108,000 at March 31, 2001.



                                     - 11 -
<PAGE>   12



EXPLORATION AND DEVELOPMENT PROJECTS AND ACQUISITIONS

Through March 31, 2001, Hallwood incurred $15,826,000 in cash for property
additions, development, exploitation, and exploration costs. The costs were
comprised of $5,114,000 for property additions and approximately $10,712,000 for
domestic exploration and development. Hallwood's capital budget for 2001 is
$50,000,000, with $30,000,000 targeted for exploration, exploitation, and
development. The remaining $20,000,000 is available for acquisitions, debt
reduction, stock repurchases, and other capital projects. The significant
capital expenditures through March 31, 2001 are as follows.

GULF COAST REGION

During the first three months of 2001, Hallwood expended approximately
$6,447,000 (40%) of its capital budget in the Gulf Coast Region in Louisiana and
South and East Texas. The following are major projects within the region.

LOUISIANA. In the first quarter of 2001, Hallwood began drilling a 15,250 foot
Klump well that is a test of sands that are productive in a nearby field. Total
depth of the well is expected to be reached in the second quarter of 2001.
Additionally, a 12,830 foot Marg Tex exploration well is currently being
completed. The well is anticipated to begin producing in mid-May. Hallwood will
have an approximate 28% working interest in the Klump well and a 35% working
interest in the Marg Tex well. Total costs for both wells during the first
quarter of 2001, were approximately $3,580,000.

SOUTH TEXAS. Hallwood began drilling a 10,850 foot sand development well in
Chambers County, Texas in March 2001. The well is part of an August 2000
property acquisition and Hallwood owns an approximate 97% working interest. The
well is currently being completed. Total costs during the first quarter of 2001
were $1,878,000. A second well in the area is anticipated later this year.

ROCKY MOUNTAIN REGION

During the first quarter of 2001, Hallwood expended approximately $1,384,000
(9%) of its capital budget in the Rocky Mountain Region located in Colorado and
Northwest New Mexico.

SAN JUAN BASIN PROJECT - COLORADO AND NEW MEXICO. Hallwood incurred
approximately $1,288,000 for costs associated with recompleting two Colorado
Fruitland Coal infill wells in the first quarter of 2001 and for two additional
wells to be completed in the second quarter of 2001. During the fourth quarter
of 2000, two wells were completed and there are an additional 12 locations,
which still remain. As many as nine of the additional locations could be drilled
this year. All of the wells relate to the application made by Hallwood, and
other industry partners, to the Colorado Oil and Gas Commission for field wide
infill drilling in the Fruitland Coal formation. The application was to reduce
the present 320-acre spacing units to 160 acres, because the existing spacing
units cannot be adequately drained by a single well. Approval was granted in
July 2000, and could result in as many as 18 locations on the acreage in which
the Company has an indirect interest through its special purpose tax credit
vehicle. In addition to the Colorado locations, Hallwood has the potential for
12 similar locations in New Mexico if infill drilling is permitted there. It is
estimated that at current pricing these additional locations would add
approximately 25 net Bcfe in reserve volumes. Hallwood has not made application
for infill drilling locations in New Mexico.

During the first quarter of 2001, Hallwood more than doubled the compression
horsepower at its Southeast Durango central delivery point. The increase in
compression was necessary to accommodate the increased production from the new
wells associated with the infill drilling program and it will also increase
production on the existing wells. In addition, Hallwood is currently working on
an improvement plan to add lines, loop lines, and lower pressure connections
which will result in increased production and will yield additional recoverable
reserves. The project will be completed in mid-May.

GREATER PERMIAN REGION

In the Greater Permian Region, Hallwood's capital expenditures incurred during
the first quarter of 2001 were approximately $6,470,000 (41%).





                                     - 12 -
<PAGE>   13

SPRABERRY. The majority of the costs incurred in the Greater Permian Region
primarily relate to the 20 well Spraberry infill drilling program that began in
the fourth quarter of 2000. To date, 19 of the wells have been successfully
drilled and completed or spud. First quarter of 2001 costs related to the
drilling program were approximately $5,310,000. Hallwood will begin drilling the
final well in the second quarter of 2001.

OTHER

The remaining $1,525,000 (10%) of Hallwood's capital expenditures in the first
quarter of 2001 was devoted to the following projects.

In January 2001, Hallwood spud a 13,265 foot stacked lateral well in the James
Lime formation located in Nacogdoches County, Texas. The well was completed in
April. Hallwood owns a 45% working interest in the well, which will be brought
on line in May 2001. Total costs for the well during 2001 were approximately
$841,000.

The remaining capital expenditures relate to technical general and
administrative expenditures and numerous projects, which were completed or are
underway and are individually less significant.

DIVIDENDS

On March 20, 2001, Hallwood declared a quarterly dividend of $.25 per Series A
Cumulative Preferred share, payable on May 15, 2001 to shareholders of record on
March 31, 2001. This amount was accrued as of March 31, 2001.

The Series A Cumulative Preferred Stock has a dividend preference of $1.00 per
share per year. Hallwood may not declare or pay dividends to common shareholders
unless full cumulative dividends have been paid on the preferred stock.

FINANCING

Hallwood's long-term debt at March 31, 2001 and December 31, 2000 consisted of
the following:

<TABLE>
<CAPTION>

                         March 31, 2001    December 31, 2000
                         --------------    -----------------
                                               (In thousands)

<S>                      <C>               <C>
Credit Agreement         $       58,000    $          56,000
Note Agreement                   25,000               25,000
Debt discount                    (1,551)              (1,613)
                         --------------    -----------------
  Total long-term debt   $       81,449    $          79,387
                         ==============    =================
</TABLE>

On June 8, 1999, Hallwood and its lenders entered into an Amended and Restated
Credit Agreement (as amended, the "Credit Agreement") to extend the term date of
its line of credit to May 31, 2002. The lenders were Morgan Guaranty Trust
Company, First Union National Bank and Bank of America. Effective June 30, 2000,
Wells Fargo Bank replaced Bank of America as one of Hallwood's lenders under its
Credit Agreement, and Hallwood's Credit Agreement was amended to reduce
Hallwood's borrowing base to $70,000,000. Hallwood's unused borrowing base was
$12,000,000 as of March 31, 2001.

Borrowings against the Credit Agreement bear interest at the lower of the
Certificate of Deposit rate plus from 1.375% to 2.125%, prime plus .5% plus from
 .25% to 1% or the Euro-Dollar rate plus from 1.25% to 2.0%. The applicable
interest rate was approximately 6.7% at September 30, 2000. Interest is payable
monthly. Quarterly principal payments of $8,286,000 are scheduled to commence
May 31, 2002.


                                     - 13 -
<PAGE>   14



The borrowing base for the Credit Agreement is typically redetermined
semiannually, although the lenders have the right to make a redetermination at
anytime. The Credit Agreement is secured by a first lien on approximately 80% in
value of Hallwood's oil and gas properties. Additionally, aggregate dividends
paid and stock repurchased by Hallwood in any 12 month period are limited to 50%
of cash flow from operations before working capital changes and distributions
received from affiliates, if the principal amount of debt of Hallwood is 50% or
more of the borrowing base. Aggregate dividends paid and stock repurchased by
Hallwood are limited to 65% of cash flow from operations before working capital
changes and distributions received from affiliates, if the principal amount of
debt is less than 50% of the borrowing base.

Hallwood has $25,000,000 of 10.32% Senior Subordinated Notes ("Subordinated
Notes") due December 23, 2007 and warrants to purchase common stock under its
Amended and Restated Subordinated Note and Warrant Purchase Agreement (the "Note
Agreement"). The Note Agreement was amended on June 8, 1999 to issue warrants to
The Prudential Insurance Company of America to purchase 309,278 shares of
Hallwood's common stock at an exercise price of $7.00 per share. The terms of
the Note Agreement were further amended on June 30, 2000 to exclude certain
hedging transactions of the subsidiaries of Hallwood from the calculation of
indebtedness. The Subordinated Notes bear interest at the rate of 10.32% per
annum on the unpaid balance, payable quarterly. Annual principal payments of
$5,000,000 are due December 23, 2003 through December 23, 2007.

Hallwood recorded the Subordinated Notes and the warrants based upon the
relative fair values of the Subordinated Notes without the warrants and of the
warrants themselves at the time of Consolidation. The allocated value of the
warrants of $1,956,000 was recorded as additional paid-in-capital. The discount
on the Subordinated Notes is being amortized over the term of the Subordinated
Notes using the interest method of amortization.

As part of its risk management strategy, Hallwood enters into financial
contracts to hedge the interest rate payments under its Credit Agreement.
Hallwood does not use the hedges for trading purposes, but rather to protect
against the volatility of the cash flows under its Credit Agreement, which has a
floating interest rate. The amounts received or paid upon settlement of these
transactions are recognized as interest expense at the time the interest
payments are due.

All contracts are interest rate swaps with fixed rates. As of March 31, 2001,
Hallwood was a party to eight contracts with three different counterparties.

The following table provides a summary of Hallwood's financial contracts.

<TABLE>
<CAPTION>

                                                                    Average
                                             Amount of              Contract
               Period                       Debt Hedged            Floor Rate
               ------                       -----------            ----------

<S>                                         <C>                    <C>
     Last nine months of 2001               $36,000,000                5.23%
     2002                                    37,500,000                5.23
     2003                                    37,500,000                5.23
     2004                                     6,000,000                5.23

</TABLE>



                                     - 14 -
<PAGE>   15


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

In the interest of providing the shareholders with certain information regarding
the Company's future plans and operations, certain statements set forth in this
Form 10-Q relate to management's future plans, objectives and expectations. Such
statements are forward-looking statements within the meanings of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Although any forward-looking statements
contained in this Form 10-Q or otherwise expressed by or on behalf of the
Company are, to the knowledge and in the judgment of the officers and directors
of the Company, 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. Please refer to the
Company's Annual Report on Form 10-K for additional statements concerning
important factors that could cause actual results to differ materially from the
Company's expectations. These risks and uncertainties include, among other
things, volatility of oil and gas prices, competition, risks inherent in the
Company's oil and gas operations, risk of mechanical failure, the inexact nature
of interpretation of seismic and other geological and geophysical data,
imprecision of reserve estimates, the availability of capital, the Company's
ability to replace and expand oil and gas reserves, and such other risks and
uncertainties described from time to time in the Company's periodic reports and
filings with the Securities and Exchange Commission. Accordingly, shareholders
and potential investors are cautioned that certain events or circumstances could
cause actual results to differ materially from those projected, estimated or
predicted.

INFLATION AND CHANGING PRICES

PRICES

Prices obtained for oil and gas production depend upon numerous factors that are
beyond the control of Hallwood, including the extent of domestic and foreign
production, imports of foreign oil, market demand, domestic and worldwide
economic and political conditions, and government regulations and tax laws. The
following table presents the weighted average prices received each quarter by
Hallwood and the effects of the hedging transactions discussed below.

<TABLE>
<CAPTION>

                                      Oil                   Oil                    Gas                    Gas
                                (excluding the         (including the        (excluding the         (including the
                                  effects of             effects of            effects of             effects of
                                    hedging               hedging                hedging                hedging
                                 transactions)         transactions)          transactions)          transactions)
                                --------------         -------------          -------------          -------------
                                   (per bbl)             (per bbl)              (per mcf)              (per mcf)

<S>                              <C>                   <C>                    <C>                    <C>
First quarter - 2000                 $27.26                $24.19                 $2.29                  $2.19
Second quarter - 2000                 29.42                 23.35                  3.22                   2.70
Third quarter - 2000                  30.69                 23.51                  3.77                   2.84
Fourth quarter - 2000                 30.45                 23.09                  4.74                   3.10
First quarter - 2001                  28.20                 26.10                  6.57                   4.06
</TABLE>

As part of its risk management strategy, Hallwood enters into financial
contracts to hedge the price of its oil and natural gas. The purpose of the
hedges is to provide protection against price decreases and to provide a measure
of stability in the volatile environment of oil and natural gas spot pricing.
The amounts received or paid upon settlement of hedge contracts are recognized
as oil or gas revenue at the time the hedged volumes are sold.

Hallwood's philosophy is to use derivatives to provide a measure of stability in
the volatile price environment of oil and gas, and to furnish an element of
predictability in the cash flow of the Company. In general, the Company is
authorized to hedge up to 50%, on a total equivalent volume basis, of its oil
and gas production for the next two forward years, and 30% for each of the three
years thereafter. The Company does not ordinarily intend to hedge more than 65%
of any one commodity. In addition, Hallwood will, in most cases, enter into
transactions with minimum fixed prices for the production subject to the
contracts. This philosophy may be modified as circumstances require.





                                     - 15 -
<PAGE>   16

The financial contracts used by Hallwood to hedge the price of its oil and
natural gas production are swaps and collars. Under the swap contracts, Hallwood
sells its oil and gas production at spot market prices and receives or makes
payments based on the differential between the contract price and a floating
price which is based on spot market indices. As of March 31, 2001, Hallwood was
a party to 22 financial contracts with three different counterparties.

The following tables provide a summary of Hallwood's outstanding financial
contracts:

<TABLE>
<CAPTION>

                                          Oil
                                  ---------------------           Contract
                                  Percent of Production           Delivered
            Period                       Hedged                     Price
            ------                ---------------------           ---------
                                                                  (per bbl)

<S>                               <C>                              <C>
Last nine months of 2001                     30%                    $23.14
2002                                          9                      23.10
</TABLE>


<TABLE>
<CAPTION>

                                          Gas
                                  ---------------------           Contract
                                  Percent of Production           Delivered
            Period                       Hedged                     Price
            ------                ---------------------           ---------
                                                                  (per mcf)
<S>                               <C>                              <C>
Last nine months of 2001                     55%                    $2.24
2002                                         25                      2.09
</TABLE>

Between 9% and 12% of the gas volumes hedged in each year are subject to a
collar agreement under which Hallwood will receive the contract price if the
spot price is lower than the contract price, the cap price if the spot price is
higher than the cap price, and the spot price if that price is between the
contract price and the cap price. The cap prices range from $2.62 per mcf to
$2.77 per mcf.

During the second quarter through April 25, 2001, the weighted average oil price
(for barrels not hedged) was approximately $26.65 per barrel. The weighted
average price of natural gas (for mcf not hedged) during that period was
approximately $4.85 per mcf.

INFLATION

Inflation did not have a material impact on Hallwood in 2000. However,
substantial drilling, completion and operational cost increases were experienced
throughout the industry and became evident in the latter half of 2000. Hallwood
expects to experience continued inflationary pressure for oil field goods and
services during 2001.

RESULTS OF OPERATIONS

FIRST QUARTER OF 2001 COMPARED TO THE FIRST QUARTER OF 2000

The following table is presented to contrast Hallwood's oil and gas price and
production for discussion purposes. Significant fluctuations are discussed in
the accompanying narrative.

<TABLE>
<CAPTION>

                                            2001              2000
                                            ----              ----
                                          (In thousands except price)

<S>                                       <C>               <C>
Gas
  Production (mcf)                          4,736             6,323
  Price (per mcf)                           $4.06           $  2.19

Oil
  Production (bbl)                            147               254
  Price (per bbl)                          $26.10            $24.19
</TABLE>


                                     - 16 -
<PAGE>   17


GAS REVENUE

Gas revenue increased $5,373,000 during the first quarter of 2001 compared with
the first quarter of 2000. The increase is the result of an increase in the
average gas price from $2.19 per mcf in 2000 to $4.06 per mcf in 2001, partially
offset by a decrease in production from 6,323,000 mcf in 2000 to 4,736,000 in
2001. The decrease in production is primarily due to declining production rates
on the Lavaca County properties and the property sales during the first and
second quarters of 2000.

The effect of Hallwood's hedging transactions as described under "Inflation and
Changing Prices," during the first quarter of 2001, was to decrease Hallwood's
average gas price from $6.57 per mcf to $4.06 per mcf, representing a
$11,887,000 decrease in revenue from hedging transactions.

OIL REVENUE

Oil revenue decreased $2,309,000 during the first quarter of 2001 compared with
the first quarter of 2000. The decrease is the result of a decrease in
production from 254,000 barrels in 2000 to 147,000 barrels in 2001, partially
offset by an increase in the average oil price from $24.19 per barrel in 2000 to
$26.10 per barrel in 2001. The production decrease is primarily due to property
sales during the first and second quarters of 2000.

The effect of Hallwood's hedging transactions during the first quarter of 2001
was to decrease Hallwood's average oil price from $28.20 per barrel to $26.10
per barrel, resulting in a $309,000 decrease in revenue from hedging
transactions.

PIPELINE, FACILITIES AND OTHER

Pipeline, facilities and other revenue consists primarily of facilities income
from two gathering systems located in New Mexico, revenues derived from salt
water disposal and Section 29 tax credit payments related to certain wells in
San Juan County, New Mexico and LaPlata County, Colorado. Pipeline, facilities
and other revenue increased $503,000 during the first quarter of 2001 compared
with the first quarter of 2000. The increase is primarily due to an increase in
Section 29 tax credit payments resulting from an increase in the contractual
inflation rate used in the calculation of the payments and a one-time downward
adjustment to salt water disposal income during 2000, which related to a change
in the operating agreement associated with one of the Company's significant salt
water disposal wells.

PRODUCTION OPERATING

Production operating expense increased $627,000 during the first quarter of 2001
compared with the first quarter of 2000. The increase is the result of increased
production taxes resulting from the higher oil and gas prices discussed above as
well as operational cost increases experienced throughout the industry,
partially offset by decreased operating costs due to property sales during the
first and second quarters of 2000.

INEFFECTIVENESS OF OIL AND GAS DERIVATIVES

As described in Notes 1 and 4 of the accompanying financial statements, the
Company adopted SFAS 133 on January 1, 2001. The adoption resulted in a $554,000
charge to income representing the ineffectiveness of the Company's derivatives
during the first quarter of 2001.

GENERAL AND ADMINISTRATIVE EXPENSE

General and administrative expense includes costs incurred for direct
administrative services such as legal, audit and reserve reports, as well as
allocated internal overhead incurred by the operating company on behalf of
Hallwood. These expenses increased $859,000 during 2001 compared with 2000
primarily due to an increase in bad debt expense during the first quarter of
2001.



                                     - 17 -
<PAGE>   18

DEPRECIATION, DEPLETION AND AMORTIZATION EXPENSE

Depreciation, depletion and amortization expense decreased $1,386,000 during the
first quarter of 2001 compared with the first quarter of 2000. The decrease is
primarily the result of lower depletion rate during 2001 due to the decrease in
production discussed above.

INTEREST

Interest expense decreased $587,000 during the first quarter of 2001 compared
with the first quarter of 2000 due to a lower average outstanding debt balance
during 2001.

PROVISION FOR INCOME TAXES

The current provision for income taxes during the first quarter of 2001 is
comprised of a provision for both federal and state income taxes. The deferred
tax provision represents the effect of adjusting the Company's valuation
allowance to result in a $370,000 net deferred tax asset, which represent the
Company's estimated realizable portion of its net deferred tax assets before
consideration of the taxes associated with the accumulated other comprehensive
loss resulting from the derivatives. The effective tax rate during 2001 is lower
than the statutory rate primarily because of the use of net operating loss
carryforwards.

MINORITY INTEREST IN NET INCOME OF AFFILIATES

Minority interest in net income of affiliates during 2000 represents
unaffiliated partners' interest in the net income of the May Partnerships. The
zero balance during the first quarter of 2001 reflects the liquidation of the
remaining three May Partnerships in April 2000.

LITIGATION

Litigation expense during the first quarter of 2000 is comprised of the costs
related to the settlement of the employment litigation described in Note 6 of
the accompanying financial statements. The litigation income during 2001
represents an adjustment relating to the amounts paid during 2000 in connection
with the employment litigation discussed above.


                                     - 18 -
<PAGE>   19



ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Hallwood's primary market risks relate to changes in interest rates and in the
prices received from sales of oil and natural gas. Hallwood's primary risk
management strategy is to partially mitigate the risk of adverse changes in its
cash flows caused by increases in interest rates on its variable rate debt and
decreases in oil and natural gas prices, by entering into derivative financial
and commodity instruments, including swaps and collars. By hedging only a
portion of its market risk exposures, Hallwood is able to participate in the
increased earnings and cash flows associated with decreases in interest rates
and increases in oil and natural gas prices; however, it is exposed to risk on
the unhedged portion of its variable rate debt and oil and natural gas
production.

Historically, Hallwood has attempted to hedge the exposure related to its
variable rate debt and its forecasted oil and natural gas production in amounts
which it believes are prudent based on the prices of available derivatives and,
in the case of production hedges, the Company's deliverable volumes. Hallwood
attempts to manage the exposure to adverse changes in the fair value of its
fixed rate debt agreements by issuing fixed rate debt only when business
conditions and market conditions are favorable.

Hallwood does not use or hold derivative instruments for trading purposes nor
does it use derivative instruments with leveraged features. Hallwood's
derivative instruments are designated and effective as hedges against its
identified risks, and do not of themselves expose Hallwood to market risk
because any adverse change in the cash flows associated with the derivative
instrument is accompanied by an offsetting change in the cash flows of the
hedged transaction.

All derivative activity is carried out by personnel who have appropriate skills,
experience and supervision. The personnel involved in derivative activity must
follow prescribed trading limits and parameters that are regularly reviewed by
the Board of Directors and by senior management. Hallwood uses only well-known,
conventional derivative instruments and attempts to manage its credit risk by
entering into financial contracts with reputable financial institutions.

Following are disclosures regarding Hallwood's market risk sensitive instruments
by major category. Investors and other users are cautioned to avoid simplistic
use of these disclosures. Users should realize that the actual impact of future
interest rate and commodity price movements will likely differ from the amounts
disclosed below due to ongoing changes in risk exposure levels and concurrent
adjustments to hedging positions. It is not possible to accurately predict
future movements in interest rates and oil and natural gas prices.

Commodity Price Risk (non-trading) - Hallwood hedges a portion of the price risk
associated with the sale of its oil and natural gas production through the use
of derivative commodity instruments, which consist of swaps and collars. These
instruments reduce Hallwood's exposure to decreases in oil and natural gas
prices on the hedged portion of its production by enabling it to effectively
receive a fixed price on its oil and gas sales or a price that only fluctuates
between a predetermined floor and ceiling. As of March 31, 2001, Hallwood has
entered into derivative commodity hedges covering an aggregate of 287,000
barrels of oil and 13,241,000 mcf of gas that extend through 2002. As of
December 31, 2000 these hedges covered an aggregate of 358,000 barrels of oil
and 15,929,000 mcf of gas. Under these contracts, Hallwood sells its oil and
natural gas production at spot market prices and receives or makes payments
based on the differential between the contract price and a floating price which
is based on spot market indices. The amount received or paid upon settlement of
these contracts is recognized as oil or natural gas revenues at the time the
hedged volumes are sold. A hypothetical decrease in oil and natural gas prices
of 10% from the prices in effect as of March 31, 2001 would cause a loss in
income and cash flows of $8,226,000 during the remaining nine months of 2001,
assuming that oil and gas production remain at projected levels. This loss in
income and cash flows would be offset by a $3,949,000 increase in income and
cash flows associated with the oil and natural gas derivative contracts that are
in effect for the remaining nine months of 2001. As of December 31, 2000, a
hypothetical decrease in oil and natural gas prices of 10% would have caused a
loss of income and cash flows of $20,380,000 during the year ended December 31,
2001. This loss would have been offset by a $9,676,000 increase in income and
cash flows from the derivatives that were in effect as of December 31, 2000.


                                     - 19 -
<PAGE>   20


Interest Rate Risks (non-trading) - Hallwood uses both fixed and variable rate
debt to partially finance operations and capital expenditures. As of March 31,
2001, Hallwood's debt consisted of $58,000,000 in borrowings under its Credit
Agreement which bears interest at a variable rate, and $25,000,000 in borrowings
under its 10.32% Senior Subordinated Notes which bear interest at a fixed rate.
Hallwood hedges a portion of the risk associated with this variable rate debt
through derivative instruments, which consist of interest rate swaps and
collars. Under the swap contracts, Hallwood makes interest payments on its
Credit Agreement as scheduled and receives or makes payments based on the
differential between the fixed rate of the swap and a floating rate plus a
defined differential. These instruments reduce Hallwood's exposure to increases
in interest rates on the hedged portion of its debt by enabling it to
effectively pay a fixed rate of interest or a rate which only fluctuates within
a predetermined ceiling and floor. A hypothetical increase in interest rates of
two percentage points would cause a loss in income and cash flows of $870,000
during the remaining nine months of 2001, assuming that outstanding borrowings
under the Credit Agreement remain at current levels. This loss in income and
cash flows would be offset by a $540,000 increase in income and cash flows
associated with the interest rate swap and collar agreements that are in effect
for the remaining nine months of 2001. As of December 31, 2000, a hypothetical
increase of 2% would have caused a loss of income and cash flows of $1,120,000
during 2001. This loss in income and cash flows would have been offset by a
$720,000 increase in income and cash flows associated with the interest rate
derivatives that were in effect as of December 31, 2000.



                                     - 20 -
<PAGE>   21


PART II  -    OTHER INFORMATION


ITEM 1     -  LEGAL PROCEEDINGS

              Reference is made to Item 8 - Notes 13 and 14 of Form 10-K for the
              year ended December 31, 2000 and Note 6 of this Form 10-Q.


ITEM 2     -  CHANGES IN SECURITIES

              None.


ITEM 3     -  DEFAULTS UPON SENIOR SECURITIES

              None.


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

              None.


ITEM 5     -  OTHER INFORMATION

              None.


ITEM 6     -  EXHIBITS AND REPORTS ON FORM 8-K

              a)   Exhibits

                   10.18  Amendment No. 6 to credit Agreement, dated June 8,
                          1999

              b)   Reports on Form 8-K

                   None.


                                     - 21 -
<PAGE>   22


SIGNATURE

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

                                      HALLWOOD ENERGY CORPORATION



Date:  May 7, 2001                    By: /s/ William J. Baumgartner
     ----------------------               -------------------------------
                                          William J. Baumgartner, Vice President
                                          (Chief Financial Officer)



                                     - 22 -
<PAGE>   23


                                INDEX TO EXHIBITS

<TABLE>
<CAPTION>

EXHIBIT
NUMBER         DESCRIPTION
-------        -----------
<S>            <C>

10.18          Amendment No. 6 to credit Agreement, dated June 8, 1999
</TABLE>