UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 1-10520
HEARTLAND PARTNERS, L.P.
(Exact name of registrant as specified in its charter)
Delaware 36-3606475
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification no.)
330 North Jefferson Court, Chicago, Illinois 60661
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 312/575-0400
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Class A Limited Partnership Units American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [ ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [ ] No [X}
The aggregate market value of the Registrant's Class A Limited Partnership Units
held by non-affiliates of the Registrant, computed by reference to the last
reported sales price of the Registrant's units on the American Stock Exchange as
of March 24, 2003, was approximately $13,332,000. On that date there were
2,092,438 units outstanding. For the purposes of this computation, it is assumed
that non-affiliates of the Registrant are all holders other than directors and
officers of Heartland Technology, Inc., and managers of HTI Interests, LLC.
Exhibit index appears on Page 75.
1
Forward-Looking Statements
We caution you that certain statements in the Management's Discussion and
Analysis of Financial Condition and Results of Operations section, and elsewhere
in this Form 10-K are "forward-looking statements". Forward-looking statements
are not guarantees of future performance. They involve risks and uncertainties
that are difficult to predict. The Company's actual future results, performance
or achievement of results and the value of the partnership Units may differ
materially from what is forecast in forward-looking statements. We caution you
not to put undue reliance on any forward-looking statement in these documents.
The Company does not undertake any obligation to update or publicly release any
revisions to forward-looking statements to reflect events, circumstances or
changes in expectations after the date of this report.
PART I
ITEM 1. Business
Organization
Heartland Partners, L.P. ("Heartland" or the "Company"), a Delaware limited
partnership, was formed on October 6, 1988. Heartland's existence will continue
until December 31, 2065, unless extended or dissolved pursuant to the provisions
of Heartland's partnership agreement.
Heartland was organized to engage in the ownership, purchasing, development,
leasing, marketing, construction and sale of real estate properties. At December
31, 2002, CMC Heartland Partners ("CMC") is an operating general partnership
owned 99.99% by Heartland and .01% by HTI Interests, LLC ("HTII"). HTII is the
General Partner of Heartland, (in such capacity, the "General Partner"). HTII is
a Delaware limited liability company, owned 99.9% by Heartland Technology, Inc.
("HTI"), formerly known as Milwaukee Land Company and .1% by HTI Principals,
Inc., a Delaware corporation, owned by four former directors of HTI's Board of
Directors and a current director of HTI.
The following table sets forth various entities formed by the Company since its
inception, date and purpose of formation, development location and Ownership:
YEAR
COMPANY FORMED BUSINESS PURPOSE
- --------------------------------------------------- ------ ----------------------------------------------------------------
Heartland Development Corporation ("HDC") 1993 General Partner of CMC Heartland Partners I, Limited Partnership
CMC Heartland Partners I, Limited ("CMCLP") 1993 Owned Bloomfield development
Partnership
CMC Heartland Partners I, LLC ("CMCI") 1998 Owns Kinzie Station Phase II
CMC Heartland Partners II, LLC ("CMCII") 1997 Owned the Goose Island Industrial Park joint venture
CMC Heartland Partners III, LLC ("CMCIII") 1997 Owns Kinzie Station Phase I
CMC Heartland Partners IV, LLC ("CMCIV") 1998 Developing approximately 177 acres in Fife, Washington
CMC Heartland Partners V, LLC ("CMCV") 1996 Owned lots and homes in Osprey Cove
CMC Heartland Partners VI, LLC ("CMCVI") 1997 To acquire and hold future acquisitions
CMC Heartland Partners VII, LLC ("CMCVII") 1997 Owns lots and homes in the Longleaf Country Club
CMC Heartland Partners VIII, LLC ("CMCVIII") 1998 To acquire and hold future acquisitions
Lifestyle Construction Company,Inc. ("LCC") 1998 Serves as the general contractor in North Carolina
Lifestyle Communities, Ltd. ("LCL") 1996 Serves as the exclusive sales agent in the
Longleaf development
2
DEVELOPMENT
COMPANY LOCATION OWNERSHIP
- --------------------------------------------------- ------------------------------ ----------
Heartland Development Corporation ("HDC") Not applicable 100% (1)
CMC Heartland Partners I, Limited ("CMCLP") Rosemount, Minnesota 100% (2)
Partnership
CMC Heartland Partners I, LLC ("CMCI") Chicago,Illinois 100% (3)
CMC Heartland Partners II, LLC ("CMCII") Chicago,Illinois 100% (3)
CMC Heartland Partners III, LLC ("CMCIII") Chicago,Illinois 100% (3)
CMC Heartland Partners IV, LLC ("CMCIV") Fife,Washington 100% (3)
CMC Heartland Partners V, LLC ("CMCV") St. Marys,Georgia 100% (3)
CMC Heartland Partners VI, LLC ("CMCVI") Not Applicable 100% (3)
CMC Heartland Partners VII, LLC ("CMCVII") Southern Pines, North Carolina 100% (3)
CMC Heartland Partners VIII, LLC ("CMCVIII") Not Applicable 100% (3)
Lifestyle Construction Company,Inc. ("LCC") Not Applicable 100% (4)
Lifestyle Communities, Ltd. ("LCL") Not Applicable 100% (4)
(1) Stock wholly owned by Heartland.
(2) HDC owns a 1% General Partnership interest and CMC owns a 99% Limited
Partnership interest.
(3) Membership interest owned by CMC.
(4) Stock wholly owned by CMC.
Except as otherwise noted herein, references herein to "Heartland" or the
"Company" include CMC, HDC, CMCLP, CMCI, CMCII, CMCIII, CMCIV, CMCV, CMCVI,
CMCVII, CMCVIII, LCC and LCL. The consolidated financial statements include the
accounts of Heartland. All intercompany transactions have been eliminated in
consolidation.
Heartland's partnership agreement provides generally that Heartland's net income
(loss) will be allocated 1% to the General Partner, 98.5% to the Class A limited
partners (the "Unitholders") and 0.5% to the Class B limited partner ("Class B
Interest"). In addition, the partnership agreement provides that certain items
of deduction, loss, income and gain may be specially allocated to the
Unitholders, the Class B Interest or the General Partner. Also, the partnership
agreement provides that if an allocation of a net loss to a partner would cause
that partner to have a negative balance in its capital account at a time when
one or more partners would have a positive balance in their capital account such
net loss shall be allocated only among partners having positive balances in
their capital account.
Subject to the limitation described in the preceding paragraph, the General
Partner has the discretion to cause Heartland to make distributions of
Heartland's available cash in an amount equal to 98.5% to the Unitholders, 0.5%
to the Class B Interest and 1% to the General Partner. Liquidating
distributions, upon dissolution of the partnership, are made pro rata to each
partner in accordance with its positive capital account balance after certain
adjustments set out in the partnership agreement. There can be no assurance as
to the amount or timing of Heartland's cash distributions or whether the General
Partner will cause Heartland to make a cash distribution if cash is available.
On December 4, 1997, Heartland's partnership agreement was amended to allow the
General Partner in its discretion to establish a record date for distributions
on the last day of any calendar month.
On August 22, 2001, Heartland announced that it had been authorized by its
General Partner to purchase up to 50,000 of its outstanding Class A partnership
units. As of December 31, 2002 and 2001, the Company had repurchased 50,000 and
47,360 Class A partnership units at a total cost of $834,000 and $794,000,
respectively. These repurchases are shown as a reduction of Partners' Capital.
As of December 31, 2002 and 2001, Heartland and CMC had loaned HTI an aggregate
of $8,464,000 and $8,186,000, respectively. The loans are collateralized by a
security interest in the Class B Interest and bear interest at 13%. The Company
has also received as compensation for the loans a Series C Warrant that entitles
Heartland to purchase 320,000 shares of HTI common stock at an exercise price of
$1.05 per share. HTI's stock is now trading in the over-the-counter market (due
to being delisted from the American Stock Exchange) at less than $.01 per share
at December 31, 2002. The initial terms of the loan were based on the collateral
of the Class B Interest and prevailing borrowing rates. When HTI raised capital
through the issuance of subordinated debentures at 13% interest and the grant of
warrants, the loan terms were changed to reflect HTI's cost of capital.
3
At December 31, 2002 and 2001, HTI owed Heartland and CMC approximately
$8,464,000 and $8,186,000, respectively. On February 25, 2002, the Company and
CMC demanded immediate payment in full of all obligations due under the Line of
Credit Promissory Notes from HTI. Heartland has initiated steps to protect its
security interest in the Class B Interest (the "Collateral"). PG Oldco, Inc., a
creditor of HTI under notes aggregating $2,200,000 in principal amount, also has
a security interest in the Collateral and has commenced steps to protect its
interest. Under the Lien Subordination and Inter-Creditor Agreement
("Inter-Creditor Agreement") among Heartland, CMC, PG Oldco, Inc. and HTI,
Heartland and CMC have a first and prior security interest in the Collateral and
the proceeds thereof up to the Senior Debt Priority Amount (as defined in the
Inter-Creditor Agreement) and PG Oldco, Inc. has a first and prior security
interest in the Collateral and the proceeds thereof for all amounts in excess of
the Senior Debt Priority Amount. Because of the competing interests in the
Collateral, Heartland is negotiating with PG Oldco, Inc. a settlement of this
matter. The settlement is likely to involve CMC buying the PG Oldco, Inc. notes
for approximately $1,250,000. Heartland has recorded an allowance of
approximately $133,000 on the note receivable balance of $8,464,000 based on the
proposed terms of the settlement of approximately $1,250,000 and the December
31, 2002 Class B Interest capital account balance of $9,584,000.
Real Estate Development Activities
As of December 31, 2002, property designated for sale and development consisted
of 10 sites comprising approximately 518 acres. The book value of this land is
approximately $7,925,000 or an average of $15,300 per acre. Heartland reviews
these properties to determine whether to hold, develop, either solely or with a
third party joint venture or sell them. Heartland's objective for these
properties is to maximize Unitholder value over a period of years. At this time,
Heartland is focusing on raising cash by selling properties.
The real estate development business is highly competitive. Heartland is subject
to competition from a great number of real estate developers, including
developers with national operations, many of which have greater sales and
financial resources than the Company.
Kinzie Station
As of December 31, 2002, Heartland has a 2.68 acre site in the City of Chicago
known as Kinzie Station Phase I and II. Zoning approval for the construction of
381 residential units on this 2.68 acre site was received in 1997. On March 28,
2001, zoning approval to increase the total number of residential units from 381
to 442 units was received from the City of Chicago. In addition to the 2.68 acre
site, the Company owns approximately 8 acres of land and 4 acres of air rights
adjacent to Kinzie Station Phase I and II. Of the 8 acres, approximately 6 acres
are currently zoned for 1,700 residential units, a food store and a public park
("Kinzie Station North"). The Company closed the sale of approximately 3.4 acres
of Kinzie Station North to a consortium of residential developers on February
11, 2003 for $9,850,000. The buyer has the remaining Kinzie Station North
residential acreage under contract. The closing of that sale is contingent on
the vacation of a city street by the City of Chicago. Management believes that
this vacation could take place during the year 2003. The Company has an
agreement to sell the food store site to a retail developer. The closing of this
sale is contingent on certain governmental approvals, which could take place in
2003.
Kinzie Station Phase I
Kinzie Station Phase I is situated on 1.23 acres. The construction of Kinzie
Station Phase I, which is complete, started on October 1, 1998. The Company
closed 162 Tower units and 24 Plaza units during the period May 1, 2000 to
December 31, 2002; 8 in 2002, 38 in 2001 and 140 in 2000.
Kinzie Station
Phase I
Unit Detail
As of December 31, 2002
Total Number Sale Contracts
Of Units To-Date
Tower Building 163 162
Plaza 24 24
------------ --------------
Total 187 186
============ ==============
On October 20, 1999, the Company executed loan documents with Bank One of
Illinois ("Bank One") for a loan of $5,250,000 to construct the Kinzie Station
Plaza building. On January 30, 2001, the final principal and interest payment
was made on the $5,250,000 Kinzie Station Plaza building loan. On February 23,
2001, the Company amended this loan agreement with Bank One, and borrowed an
additional $3,000,000 and changed the maturity date of the loan to February 23,
2002. The maturity date of this loan was extended to December 31, 2002. The loan
was paid in full on December 17, 2002. The loan's interest rate was the prime
rate (4.25% at December 31, 2002).
4
Kinzie Station Phase II
As of December 31, 2002, Heartland has a 1.45 acre site in the City of Chicago
known as Kinzie Station Phase II. The Company has zoning to construct a 267 unit
residential tower building. The Company has signed a letter of intent to sell
the property, subject to various contingencies.
Longleaf
In September, 1998, the Company signed a contract to be the exclusive
homebuilder and marketer for the Longleaf Country Club in Southern Pines, North
Carolina. Under the terms of the contract, CMCVII was entitled to sell and build
up to 244 homes on lots owned by Longleaf Associates Limited Partnership
("LALP"), an affiliate of General Investment & Development, an unrelated party.
Heartland assumed the day to day operations on April 1, 1998. On December 12,
2000, Heartland executed a purchase agreement whereby it purchased the remaining
207 lots owned by LALP, by the assumption of certain liabilities owed by LALP to
other unrelated parties and the payment of $250,000. The purchase price of
$2,459,000, which includes the $250,000 paid on December 12, 2000, for these 207
lots was determined by calculating the net present value of the payments to be
paid over a ten year period using a discount rate of 10%. Also, per the purchase
agreement, the Company is obligated to pay LALP 49% of the Net Cash Flow, as
defined, each year for the period January 1, 2001 to December 31, 2005. At
December 31, 2002, no payments of Net Cash Flow are owed or due to LALP. At
December 31, 2002, the Company owns 195 lots purchased for approximately
$2,173,000, an average of $11,100 per lot. These 195 lots comprising
approximately 65 acres of land, are also included in the aforementioned 518
acres.
In Longleaf, the Company has closed , as of December 31, 2002, a total of 46
contracts; 9 in 2002, 9 in 2001, 15 in 2000 and 13 in 1999. When the Company
assumed the day to day operations of Longleaf in April, 1998, there were a
number of homes under construction which were owned by the developer, as well as
resale homes, on the market. As of December 31, 2002, the Company has sold 52
homes and 5 lots for these owners since April 1, 1998.
Longleaf
Unit Inventory Detail
As of December 31, 2002
Model homes completed 2
Sold home under construction 1
Inventory homes completed and under construction 5
Lots owned 187
------------
Total unit inventory 195
============
On December 8, 2000, Heartland entered into an agreement for a $3,000,000
revolving line of credit for the construction of homes in Longleaf with Bank
One. Also, on December 8, 2000, Heartland executed loan documents borrowing an
additional $250,000 from Bank One to purchase the remaining lots owned by LALP.
This $250,000 was the first payment related to certain liabilities assumed by
the Company in accordance with a purchase agreement executed on December 12,
2000. The revolving line of credit and $250,000 loan mature April 12, 2003 and
bear interest at the prime rate (4.25% at December 31, 2002). At December 31,
2002, $932,000 had been advanced by Bank One to Heartland on the revolving line
of credit. The $250,000 was paid in full on October 4, 2002. The Company is
currently in negotiations with Bank One to extend the maturity date of the
revolving line of credit. While the Company has no reason to believe the
extension of the credit facility will not be approved by Bank One, there can be
no assurance the contemplated extension will be given. The consolidated
financial statements do not contain any adjustments to reflect the ultimate
outcome of this uncertainty.
CMCVII, per the Longleaf lot Purchase and Sale Agreement, dated December 12,
2000, was required on April 1, 2002 and November 1, 2002 to pay $135,000 and
$250,000, respectively, to Maples Properties, Inc. ("Maples"), the owner and
operator of the golf course and club house located at the Longleaf Country Club
in Southern Pines, North Carolina. Since the two payments were not made, this
constitutes an event of default under the agreement. The Company believes Maples
is in default of its obligations. In addition, the seller has not notified
CMCVII that it is in default. The seller would be entitled to seek specific
performance and/or other remedies as provided for in the contract. However, due
to its belief that Maples has breached the contract, CMCVII does not intend to
make these payments at this time.
5
Goose Island Joint Venture
Heartland, along with Colliers, Bennett and Kahnweiler, a Chicago based real
estate company, and Wooton Construction, formed a joint venture which developed
approximately 265,000 square feet of industrial space in the Goose Island
Industrial Park in Chicago, Illinois. As of December 31, 2002, the buildings had
been built and leases had been signed for all of the 265,000 square feet. The
Company sold its interest in the joint venture to its partners on October 22,
2002 for a price of $1,250,000 and the assumption by its partners of Heartland's
share of the joint venture liabilities. At the time of closing, Heartland
received $750,000 and is expected to receive the remaining $500,000 on October
22, 2003. As security for the $500,000 note, the remaining joint venture
partners have pledged their interests in the joint venture.
Fife, Washington
On December 1, 1998, the Company's 177 acre Fife property was annexed to the
City of Fife, Washington. A Local Improvement District (LID) has been approved
in order to support the improvement and extension of sewers and sewer capacity
for the site. The City of Fife has zoned the property for residential usage. The
Fife City Council approved the preliminary plat for the project on September 25,
2001.
On December 28, 2001, Heartland executed a construction management agreement
with Crab Apple Beach, L.L.C., an unrelated party, to assist in the management
of the development, in phases, of the Fife property. Development of the property
was started during the first quarter of the year 2002. This agreement was
terminated in the first quarter of the year 2003. Also, the Company anticipates
completing the engineering for the first phase of the development and submitting
to the City of Fife the final first phase plat for its approval in the second
quarter of the year 2003.
On August 22, 2002, Heartland executed documents for a loan of $4,000,000 from
Bank One. As collateral for this loan, the Company pledged the Fife, Washington
property. The loan bears interest at the prime rate plus 1% (5.25% at December
31, 2002), and matures May 1, 2003. From the $4,000,000 loan, the Company paid
LNB $1,500,000, which reduced the LNB line of credit principal balance from
$5,350,000 to $3,850,000. At that time, Bank One reserved $500,000 to pay future
environmental costs if needed. Also, on August 22, 2002, the Company cross
collateralized the Kinzie Station Phase I Bank One loan, which was paid in full
on December 17, 2002, with the Fife, Washington property. The outstanding loan
balance is $3,500,000 at December 31, 2002. The Company is currently in
negotiations with Bank One to extend the maturity date of the loan. While the
Company has no reason to believe the extension of the loan will not be approved
by Bank One, there can be no assurance the contemplated extension will be given.
The consolidated financial statements do not contain any adjustments to reflect
the ultimate outcome of this uncertainty.
In June, 1997, the Port of Tacoma ("Port") filed a complaint in the United
States District Court for the Western District of Washington alleging that the
Company was liable under Washington state law for the cost of the Port's
remediation of a railyard sold in 1980 by the bankruptcy trustee for the
Company's predecessor to the Port's predecessor in interest. On October 1, 1998,
the Company entered into a Settlement Agreement with the Port of Tacoma which
calls for the Company to either pay the Port of Tacoma $1,100,000 or transfer to
the Port of Tacoma real estate to be agreed upon at a later date. On December
19, 2002, the Company modified its October 1, 1998 settlement agreement with the
Port of Tacoma in which the Port of Tacoma released all claims against the
Company and the Company agreed either to, (a) pay $1,100,000 on or before
December 31, 2003 plus interest from January 1, 1999, or (b) convey real
property to be agreed upon at a later date. At December 31, 2002, interest owed
to the Port had been paid to date.
Menomonee Valley
The Company owns approximately 152 acres of property in the Menomonee River
Valley in Milwaukee, Wisconsin. The property is located next to Miller Park, the
home stadium of the Milwaukee Brewers baseball team. The Company has proposed a
mixed use development to include retail and entertainment uses complementary to
the baseball park as a recreational destination. The City of Milwaukee has
stated that it believes industrial development would be more appropriate for the
site and the Redevelopment Authority of the City of Milwaukee ("RACM") has
announced it will seek to acquire the property through eminent domain if
necessary. RACM is required to negotiate with the Company before it can file an
eminent domain proceeding. The Company may assert legal challenges to RACM's
authority if RACM does condemn the property. The outcomes of any eminent domain
proceeding or legal challenges to it are uncertain.
6
Osprey Cove
Osprey Cove in St. Marys, Georgia is a master-planned residential community with
a wide range of natural and recreation amenities, which includes a recreational
complex, lakes, a boat dock and a boat launch. In December, 1999, the Company
decided to cease operations at Osprey Cove. As of December 31, 2002, a total of
69 contracts have closed in Osprey Cove; 4 in 2002, 14 in 2001, 16 in 2000, 20
in 1999, 13 in 1998 and 2 in 1997. The First National Bank of St. Marys in
Georgia had made two loans totaling $405,000 to the Company. The interest rate
on these two loans was 7%. These two loans were paid in full during the first
quarter of the year 2002. The Company has no remaining interest in lots or homes
in Osprey Cove and has concluded its activities there.
Property Sales and Leasing Activities
Heartland's current inventory of land held for sale consists of approximately
13,789 acres located throughout 12 states. The book value of this inventory is
approximately $645,000. The majority of the land is former railroad
rights-of-way, long, narrow strips of land approximately 100 feet in width. Some
of Heartland's sites, located in small rural communities or outlying mid-cities,
are leased to third parties for agricultural use and these sites may be improved
with the lessee's structures.
The sale, management and leasing of the Company's non-development real estate
inventory is conducted by Heartland's Sales and Property Management Department.
The volume of the Company's sales has slowed over the last seven years due to
the less desirable characteristics of the remaining properties. The individual
parcels are held at a low book value and the Company anticipates that the sale
of its remaining parcels may extend beyond the year 2003. The Company is also
exploring the sale of these properties as a whole to a third pary.
The Company leases less than 1% of its total acreage under operating leases. The
number of leases declines each year as sales of properties are made to existing
lessees. The majority of the leases provide nominal rental income to Heartland.
The leases generally require the lessee to construct, maintain and remove any
improvements, pay property taxes, maintain insurance and maintain the condition
of the property. The majority of the leases are cancellable by either party upon
thirty to sixty days notice. Heartland's ability to terminate or modify certain
of its leases is restricted by applicable law and regulations.
Other Activities
At December 31, 2002, the allowance for claims and liabilities established by
Heartland for environmental and other contingent liabilities totaled
approximately $4,050,000. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Given the uncertainty inherent
in litigation, resolution of these matters could require funds greater or less
than the $4,050,000 allowance for claims and liabilities.
Heartland engages outside counsel to defend it in connection with most of these
claims. Significant claims are summarized in Item 3. and Item 8.
Regulation and Environmental Matters
For a discussion of regulation and environmental matters, see Item 8.
Employees and Website
At December 31, 2002, Heartland employed 17 people. The Company's website is
www.cmchp.com. Financial statements are available on the website.
7
Item 2. Properties
The Company has the right to sell easements for fiber optic lines along or
across 83 miles of rail right of way running from downtown Chicago west to Elgin
and Northwest to Fox Lake, Illinois. The Company receives 2/3 of the proceeds of
any sale.
A discussion of certain significant properties of the Company is included in
Item 1. In addition to the 518 acres designated for sale and development at
December 31, 2002, real estate holdings consisted of approximately 13,789 acres
of scattered land parcels. States in which large land holdings are located are
Illinois, Iowa, Minnesota, Montana, North Carolina, North Dakota, South Dakota,
Washington, and Wisconsin. The remaining acreage is located in Idaho, Indiana,
Michigan and Missouri. Most of the properties are former railroad rights-of-way,
located in rural areas, comprised of long strips of land approximately 100 feet
in width. Also included in these scattered land parcels are former station
grounds and rail yards. The Company owns certain air rights in the Chicago,
Illinois and Milwaukee, Wisconsin areas.
Other than land classified under Real Estate Development Activities in Item 1,
the land is typically unimproved. Some of the properties are improved with
structures (such as grain elevators and sheds) erected and owned by lessees.
Other properties are improved with Heartland-owned buildings that are of little
or no value.
Heartland's headquarters occupies approximately 4,000 square feet of owned
office space located at 330 North Jefferson Court, Suite 305, Chicago, Illinois.
This office space is in the Tower building of the Company's Kinzie Station Phase
I development.
Item 3. Legal Proceedings
In June, 1997, the Port of Tacoma ("Port") filed a complaint in the United
States District Court for the Western District of Washington alleging that the
Company was liable under Washington state law for the cost of the Port's
remediation of a railyard sold in 1980 by the bankruptcy trustee for the
Company's predecessor to the Port's predecessor in interest.
On October 1, 1998, the Company entered into a Settlement Agreement with the
Port of Tacoma which calls for the Company to either pay the Port of Tacoma
$1,100,000 or transfer to the Port of Tacoma real estate to be agreed upon at a
later date. On December 19, 2002, the Company modified its October 1, 1998
settlement agreement with the Port of Tacoma in which the Port of Tacoma
released all claims against the Company and the Company agreed either to, (a)
pay $1,100,000 on or before December 31, 2003 plus interest from January 1,
1999, or (b) convey real property to be agreed upon at a later date. At December
31, 2002, interest owed to the Port had been paid to date.
The Company will not make a claim on its insurance carriers in this matter
because the settlement amount does not exceed the self insured retention under
the applicable insurance policies.
On December 2, 2000, the Redevelopment Authority of the City of Milwaukee
("RACM") filed suit in Milwaukee County Circuit Court to obtain access to
appraise, survey and conduct environmental and geo-technical investigations on
certain property owned by the Company adjacent to the Milwaukee Brewers baseball
stadium in furtherance of RACM's efforts to acquire the property by
condemnation. The Company and RACM entered into an agreement under which RACM
would perform, at RACM's cost, limited investigations and provide the results to
Heartland. That work was concluded and the suit filed by RACM was dismissed
effective June 28, 2002.
In February, 2002, the Company filed suit against the Southeast Wisconsin
Professional Baseball District (the "District") in Milwaukee County Circuit
Court to enforce a provision of a contract between the District and Heartland
providing for the construction of an additional two lane bridge to the Company's
Menomonee Valley project.
8
On August 19, 2002, the former President and Chief Executive Officer of CMC,
Edwin Jacobson, filed two lawsuits against the Company, CMC and certain officers
and/or board members. One of the lawsuits alleges CMC violated the terms of his
employment contract and that the officers and/or board members interfered with
his contract. Mr. Jacobson is seeking compensatory and punitive damages. Mr.
Jacobson also asked the court to reinstate his contract and to enjoin the
Company from selling property or making distributions to Unitholders until it
has appraised its properties and paid him according to the terms of his
employment contract. Mr. Jacobson's second lawsuit is for defamation. He alleges
he was defamed by statements in a Company press release advising investors of
various pending business transactions and describing Heartland's termination of
his contract. He is seeking $1,000,000 in compensatory damages and $5,000,000 in
punitive damages. Edwin Jacobson v. CMC Heartland Partners et al., Case No. 02
CH 15160, consolidated with Case No. 02 L 010591, Circuit Court of Cook County,
Illinois. On October 24, 2002, the Company filed motions to dismiss the
lawsuits. On January 3, 2003, Mr. Jacobson filed amended complaints alleging the
same and seeking the same relief. On January 31, 2003, the Company filed motions
to dismiss the amended lawsuits. CMC is vigorously defending itself and, in the
opinion of management, has good defenses against the lawsuits as its actions
were consistent with its duties and in conformance with the law. The Company has
not recorded an allowance related to these actions because at this time it
cannot be determined if it is probable that a liability has been incurred and
the amount of any possible liability cannot be determined.
On February 28, 2003, in the Superior Court of the State of Delaware , the
Company filed suit against the former President and Chief Executive Officer of
CMC, Edwin Jacobson, to collect all principal and interest owed the Company,
approximately $332,000, related to money borrowed on October 17, 2000 that has
not been paid in accordance with the terms of the note.
CMCVII, per the Longleaf lot Purchase and Sale Agreement, dated December 12,
2000, was required on April 1, 2002 and November 1, 2002 to pay $135,000 and
$250,000, respectively, to Maples Properties, Inc. ("Maples"), the owner and
operator of the golf course and club house located at the Longleaf Country Club
in Southern Pines, North Carolina. Since the two payments were not made, this
constitutes an event of default under the agreement. The Company believes Maples
is in default of its obligations. In addition, the seller has not notified
CMCVII that it is in default. The seller would be entitled to seek specific
performance and/or other remedies as provided for in the contract. However, due
to its belief that Maples has breached the contract, CMCVII does not intend to
make these payments at this time.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of Unitholders of Heartland for the twelve
months ended December 31, 2002.
9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Units are listed and traded on the American Stock Exchange under the symbol
"HTL". The Units began trading on a "when issued" basis on June 20, 1990. The
following table sets forth the high and low sales prices per Unit by quarter for
the years ended December 31, 2002 and 2001.
2002 High Low
First quarter $ 15 7/8 $ 14
Second quarter 14 1/10 12 1/4
Third quarter 12 1/3 6 1/5
Fourth quarter 7 1/10 4 3/4
2001
First quarter $ 19 $ 17 1/2
Second quarter 17 1/2 14 1/4
Third quarter 15 1/2 13 3/5
Fourth quarter 17 1/4 14 5/6
Based on records maintained by Heartland's Unit transfer agent and registrar,
there were approximately 518 record holders of Heartland's Units as of March 15,
2003.
The amount of Heartland's cash available to be distributed to Unitholders, the
Class B Interest and the General Partner ("Available Cash Flow") will be
determined by the General Partner, in its sole discretion, after taking into
account all factors deemed relevant by the General Partner, including, without
limitation, general economic conditions and Heartland's financial condition,
results of operations and cash requirements, including (i) the servicing and
repayment of indebtedness, (ii) general and administrative charges, including
fees and expenses payable to HTII under management and other arrangements, (iii)
property and operating taxes, (iv) other costs and expenses, including legal and
accounting fees, and (v) reserves for future growth, commitments and
contingencies.
Heartland's Available Cash Flow will be derived from CMC, CMCI, CMCIII, CMCIV,
CMCVII and LCL. When available and appropriate, the General Partner expects to
cause Heartland to make distributions of Heartland's Available Cash Flow in an
amount equal to 98.5% to the Unitholders, 0.5% to the Class B Interest, and 1%
to the General Partner, although there can be no assurance as to the amount or
timing of Heartland's cash distributions or whether the General Partner will
cause Heartland to make a cash distribution if cash is available. Liquidating
distributions, upon dissolution of the partnership, are made pro rata to each
partner in accordance with its positive Capital Account balance after certain
adjustments set out in the Partnership agreement. Future lenders to Heartland
may impose restrictions on Heartland's ability to make distributions. In
addition, distributions may not be made to Unitholders until Heartland has paid
to HTII (or its assignee) all accrued and unpaid management fees pursuant to the
Management Agreement between Heartland and HTII. As of December 31, 2002 and
2001, there are no unpaid management fees. On December 4, 1997, Heartland's
partnership agreement was amended to allow the General Partner in its discretion
to establish a record date for distributions on the last day of any calendar
month.
On August 22, 2001, Heartland announced that it had been authorized by its
General Partner to purchase up to 50,000 of its outstanding Class A partnership
units. As of December 31, 2002 and 2001, the Company had repurchased 50,000 and
47,360 Class A partnership units at a total cost of $834,000 and $794,000,
respectively. These repurchases are shown as a reduction of Partners' Capital.
10
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with the
consolidated financial statements and the notes thereto contained herein in Item
8. Financial Statements and Supplementary Data, the information contained herein
in Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations and the information contained herein in Item 1. Business.
Historical results are not necessarily indicative of future results.
Following is a summary of Heartland's selected financial data for the years
ended and as of December 31, 2002, 2001, 2000, 1999 and 1998 (amounts in
thousands except per Unit data):
Operating Statement Data: 2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Operating (loss) income $(2,455) $ 4,426 $ 8,436 $(5,010) $(6,998)
Other income 1,397 932 1,408 1,253 914
-------- -------- ------- -------- --------
Net (loss) income $(1,058) $ 5,358 $ 9,844 $(3,757) $(6,084)
======== ======== ======= ======== ========
Net (loss) income
allocated to General
Partner and Class B Interest $ (16) $ 80 $ 3,938 $(3,757) $ (182)
======== ======== ======= ======== ========
Net (loss) income allocated
to Class A Units $(1,042) $ 5,278 $ 5,906 $ -- $(5,902)
======== ======== ======= ======== ========
Net (loss) income per
Class A Unit $ (0.50) $ 2.48 $ 2.76 $ -- $ (2.76)
======== ======== ======= ======== ========
DECEMBER DECEMBER DECEMBER DECEMBER DECEMBER
Balance Sheet Data 31, 2002 31, 2001 31, 2000 31, 1999 31, 1998
-------- -------- -------- -------- --------
Net Properties $ 28,699 $ 28,201 $ 38,916 $ 50,751 $ 28,052
Total assets 38,855 38,420 47,584 57,256 33,231
Allowance for
claims and liabilities 4,050 4,337 4,478 2,804 2,762
Total liabilities 19,893 18,360 32,088 51,604 23,822
Partners' capital 18,962 20,060 15,496 5,652 9,409
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Forward-Looking Statements
We caution you that certain statements in the Management's Discussion and
Analysis of Financial Condition and Results of Operations section, and elsewhere
in this Form 10-K are "forward-looking statements". Forward-looking statements
are not guarantees of future performance. They involve risks and uncertainties
that are difficult to predict. The Company's actual future results, performance
or achievement of results and the value of the partnership Units may differ
materially from what is forecast in forward-looking statements. We caution you
not to put undue reliance on any forward-looking statement in these documents.
The Company does not undertake any obligation to update or publicly release any
revisions to forward-looking statements to reflect events, circumstances or
changes in expectations after the date of this report.
Summary of Significant Accounting Policies
Consolidation
The consolidated financial statements in Item 8. include the accounts of
Heartland; CMC, its 99.99% owned operating partnership; HDC, 100% owned by
Heartland; CMCLP, 1% general partnership interest owned by HDC and 99% owned by
CMC; CMCI, CMCII, CMCIII, CMCIV, CMCV, CMCVI, CMCVII, CMCVIII, LCC and LCL, each
100% owned by CMC. All intercompany transactions have been eliminated in
consolidation.
11
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents. The cash and cash
equivalents of the Company are held at two financial institutions.
Accounts Receivable
The Company provides an allowance for doubtful accounts against the portion of
accounts receivable which is estimated to be uncollectible. Accounts receivable
in the consolidated balance sheets are shown net of an allowance for doubtful
accounts of $316,000 and $0 as of December 31, 2002 and 2001, respectively.
Unearned Rents and Deferred Income
Unearned rents and deferred income are cash received from unrelated outside
parties for the rental of certain parcels of land or land easements owned by the
Company for periods of 20 to 25 years. The amounts received are being amortized
over each agreement's rental period.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, restricted cash, accounts
receivable, accounts payable and accrued expenses are reasonable estimates of
their fair values because of the short maturity of these financial instruments.
The carrying value of the Company's notes payable approximate fair value at
December 31, 2002 and 2001 due to the short duration and variable nature of the
financial instruments.
Revenue Recognition
Residential sales are recognized at closing when title to the home has passed to
the buyer. The Company's homes are generally offered for sale in advance of
their construction. To date, most of the Company's homes have been sold pursuant
to standard sales contracts entered into prior to commencement of construction.
The Company's standard sales contracts generally require the customer to make an
earnest money deposit. This deposit may range from 5% to 10% of the purchase
price for a buyer using conventional financing.
Land sales are recognized when the Company has received an adequate cash down
payment and all other conditions necessary for profit recognition have been
satisfied.
Investment in Joint Venture
Investment in joint venture represents recording of the Company's interest under
the equity method of accounting. Under the equity method of accounting, the
Company recorded its initial interest at cost and adjusts its investment
accounts for additional capital contributions, distributions and its share of
joint venture income or loss.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Significant estimates used in the preparation of the
financial statements include the value of the Class B Interest which represents
the collateral of the Heartland Technology, Inc. note receivable owed to the
Company and CMC, estimated costs to complete long term development projects, the
collectability of the Mr. Jacobson, former President and Chief Executive Officer
of CMC, note and interest receivable, estimated bad debt expense, the
recoverability of the total cost of properties and the estimates used in
determining the Company's environmental liabilities. Actual results could differ
from those estimates.
12
Income Taxes
A publicly-traded partnership generally is not liable for Federal income taxes,
provided that for each taxable year at least 90% of its gross income consists of
certain passive types of income. In such case, each partner includes its
proportionate share of partnership income or loss in its own tax return.
Accordingly, no provision for income taxes is reflected in Heartland's financial
statements.
Heartland's assets are carried at historical cost. At December 31, 2002 and
2001, the tax basis of the properties and improvements for Federal income tax
purposes was greater than their carrying value for financial reporting purposes.
Segment Reporting
The Company does not report by business segment since the land held for sale
revenues and expenses are not material to the Company's overall business
operations.
Property
Properties are carried at their historical cost. Expenditures which
significantly improve the values or extend useful lives of the properties are
capitalized. Predevelopment costs including real estate taxes that are directly
identified with a specific development project are capitalized. Interest and
related debt issuance costs are capitalized to qualifying real estate
inventories as incurred, in accordance with Statement of Financial Accounting
Standards No. 34, "Capitalization of Interest Costs", and charged to cost of
sales as revenue from residential and land sales are recognized. Repairs and
maintenance are charged to expense as incurred. Depreciation is provided for
financial statement purposes over the estimated useful life of the respective
assets ranging from 7 years for office equipment and fixtures to 40 years for
building and improvements using the straight-line method.
Properties held for development, including capitalized predevelopment costs, are
reviewed for impairment whenever events or changes in circumstances, such as a
condemnation proceeding being brought by a governmental agency against the
Company or the discovery of an environmental liability related to a particular
site, indicate that the carrying amount of the particular development property
may not be recoverable. If these events or changes in circumstances are present,
the Company estimates the sum of the expected future cash flows (undiscounted)
to result from the development operations and eventual disposition of the
particular development property, and if less than the carrying amount of the
development property, the Company will recognize an impairment loss based on
discounted cash flows. Upon recognition of any impairment loss, the Company
would measure that loss based on the amount by which the carrying amount of the
property exceeds the estimated fair value of the property. No event occurred
during the years 2002 and 2001 that resulted in an impairment loss being
recognized.
For properties held for sale, an impairment loss is recognized when the fair
value of the property, less the estimated cost to sell, is less than the
carrying amount of the property. No event occurred during the years 2002 and
2001 that resulted in an impairment loss being recognized.
Housing inventories (including completed model homes) consisting of land, land
development, direct and indirect construction costs and related interest, are
recorded at cost, which is not in excess of fair value. Land, land development
and indirect costs are allocated to cost of sales on the basis of units closed
in relation to the total anticipated units in the related development project;
such allocation approximates the relative sales value method. Direct
construction costs are allocated to the specific units closed for purposes of
determining costs of sales. Selling and marketing costs, not including those
costs incurred related to furnishing and developing the models and sales office,
are expensed in the period incurred. Costs incurred in the construction of the
model units and related furnishings are capitalized at cost. The Company intends
to offer these units for sale at the completion of a project and, accordingly,
no amortization of direct construction costs is provided. Housing inventories
are reviewed for impairment whenever events or circumstances indicate the fair
value less the cost to dispose of the inventories, is less than the capitalized
costs. If these events or changes in circumstances are present, the Company then
writes down the inventory to its fair value. No event occurred during the years
2002 and 2001 that resulted in an impairment loss being recognized.
13
Housing inventories consisted of the following at December 31, 2002 and 2001
(amounts in thousands):
2002 2001
---------- ----------
Land under development $ 3,118 $ 3,487
Direct construction costs 1,405 4,117
Capitalized project costs 3,148 3,243
---------- ----------
Total $ 7,671 10,847
========== ==========
Liquidity and Capital Resources
Cash flow for operating activities has been derived primarily from development
activities, proceeds of property sales, rental income and interest income. Cash
was $751,000 (including $42,000 of restricted cash) at December 31, 2002,
$1,299,000 (including $1,196,000 of restricted cash) at December 31, 2001 and
$2,849,000 (including $2,699,000 of restricted cash) at December 31, 2000. The
decrease in cash of $548,000 from December 31, 2001 to December 31, 2002, is
primarily due to the return to the Company on April 30, 2002 of the $1,150,000
interest reserve held by LNB as collateral for the LNB line of credit and the
subsequent use by the Company to reduce accounts payable. The decrease in cash
of $1,550,000 from December 31, 2000 to December 31, 2001, is primarily due to
the closing of 38 Kinzie Station Phase I units and the return of all of the
Kinzie Station Phase II purchasers' earnest money. (See the Consolidated
Statements of Cash Flows).
Net cash used in operating activities was $2,291,000 in 2002 compared to
$10,444,000 of net cash provided by operating activities in the year 2001. The
cash provided by operating activities from the year 2002 compared to the year
2001 decreased by $12,735,000. This is primarily due to housing inventories
decreasing $3,176,000 in 2002 compared to $9,507,000 in 2001, which is a
difference of $6,331,000. The difference is attributable to closing 8 units in
2002 in Kinzie Station Phase I compared to 38 units in 2001. Also, net additions
to capitalized predevelopment costs increased $3,817,000 in 2002 compared to
$487,000 in 2001, which is a difference of $3,330,000. This difference is
attributable to the Company not selling any development properties during the
year 2002. Net cash provided by operating activities was $10,444,000 in 2001,
compared to $16,364,000 in 2000. The cash provided by operating activities from
the year 2001 compared to the year 2000 decreased by $5,920,000. This is
primarily due to housing inventories decreasing $9,507,000 in 2001 compared to
$13,909,000 in 2000, which is a difference of $4,402,000. This difference is
attributable to closing 38 units in 2001 in Kinzie Station Phase I compared to
140 units in 2000. Also, the net cash used to reduce accounts payable and
accrued liabilities in 2001 was $4,642,000 as compared to 2000 of $3,063,000.
This is an increase of $1,579,000 in cash used in operating activities between
the years. (See the Consolidated Statements of Cash Flows).
During the year 2003, cash flows to pay development and homebuilding
construction costs will be provided by property sales proceeds and development,
construction and line of credit loans received from various sources.
Proceeds from property sales provided cash flow of $6,766,000 in 2002,
$30,471,000 in 2001 and $61,009,000 in 2000. Sales in 2002 consists primarily of
8 units in Kinzie Station Phase I for $2,715,000, 9 units in Longleaf for
$2,226,000 and various land held for sale parcels for $1,199,000. Sales in 2001
consists primarily of 38 units in Kinzie Station Phase I for $11,903,000, 9
units in Longleaf for $2,395,000, 235 acres of land in Rosemount, Minnesota for
$9,275,000, 14 acres of land in Bozeman, Montana for $2,150,000 and 1.2 acres of
land in Kinzie Station Phase II for $2,937,000. Sales in 2000 consists primarily
of 140 units in Kinzie Phase I for $33,637,000, 16 units in Osprey Cove for
$2,477,000, 15 units in Longleaf for $3,839,000, 21 units and developed acreage
in Rosemount for $8,249,000, 67 acres at Galewood in Chicago, Illinois for
$7,160,000 and 2 acres at Kinzie Station in Chicago, Illinois for $2,457,000.
14
During the year 2003, proceeds from property sales will consist primarily of the
sale of Longleaf homes, development properties and land held for sale acreage.
The cost of property sales for 2002 was $5,515,000 or 82% of sales proceeds, for
2001 was $19,908,000 or 65% of sales proceeds and for 2000 was $45,612,000 or
75% of sales proceeds.
It is not expected that future cost of sales ratios for real estate other than
development projects and home sales will change materially from ratios
experienced in prior years, as the balance of Heartland's real estate other than
development projects consists primarily of railroad properties acquired over the
past 150 years at values far lower than current fair values.
Portfolio income is derived principally from the interest earned on the HTI note
receivable, interest earned on certificates of deposit and investment of cash
not required for operating activities in overnight investments. Portfolio income
for 2002 was $308,000, compared to $1,176,000 for 2001 and $390,000 for 2000.
The decrease in portfolio income from 2002 to the year 2001 of $868,000 is
mainly attributable to a decrease in interest earned on the HTI note receivable
of $611,000. Heartland stopped accruing interest on the HTI note receivable
April 1, 2002 due to the uncertainty regarding the collectibility of the HTI
note receivable. The increase in portfolio income from the year 2000 to the year
2001 of $786,000 is mainly attributable to additional interest earned on the HTI
note receivable of $588,000 and interest earned of $162,000 on the delayed
closing of the 113 acres in Rosemount, Minnesota.
As of December 31, 2002, Heartland had designated 10 sites, or approximately 518
acres with a book value of approximately $7,925,000, for sale and development.
Capitalized expenditures at these sites were $6,083,000 in 2002, $9,891,000 in
2001 and $30,250,000 in 2000. At December 31, 2002 and 2001, capitalized costs
on development properties including housing inventories totaled $18,635,000 and
$17,626,000, respectively. Expenditures which significantly increase the value
and are directly identified with a specific project are capitalized.
At December 31, 2002, land held for sale consists of 13,789 acres with a book
value of $645,000. Land held for sale will be disposed of in an orderly fashion,
however, it is anticipated that the disposal of such properties may extend
beyond the year 2003. The Company is also exploring the sale of these properties
as a whole to a third party.
It is the Company's practice to evaluate environmental liabilities associated
with the Company's properties. Heartland monitors the potential exposure to
environmental costs on a regular basis and has recorded a liability in the
amount of $4,000,000 at December 31, 2002 and $4,066,000 at December 31, 2001
for possible environmental liabilities, including remediation, legal and
consulting fees. A reserve is established with regard to potential environmental
liabilities when it is probable that a liability has been incurred and the
amount of the liability can be reasonably estimated. The amount of any liability
is determined independently from any claim for recovery. If the amount of the
liability cannot be reasonably estimated, but management is able to determine
that the amount of the liability is likely to fall within a range, and no amount
within that range can be determined to be the better estimate, then a reserve in
the minimum amount of the range is accrued. If the Company were to use a
different approach, the reserve could be materially higher. Estimates can be
affected by various uncertainties including future changes in technology,
changes in regulations or requirements of local governmental authorities, third
party claims, the scope and cost to be performed at each site, the portion of
costs that may be shared and the timing of the remediation work. At December 31,
2002, there is not sufficient information to reasonably estimate all the
environmental liabilities of which management is aware. Accordingly, management
is unable to determine whether environmental liabilities which management is
unable to reasonably estimate will or will not have a material effect on
Heartland's results of operations or financial condition. As additional
information becomes available, the Company will reassess its reserves which may
then be modified and related charges/credits against earnings may then be made.
15
In addition, Heartland has established an allowance for resolution of
non-environmental claims of $50,000 and $271,000 at December 31, 2002 and 2001,
respectively, related to certain unresolved claims that were transferred to CMC
as part of a conveyance of certain real properties at the time of formation of
the partnership.
Heartland does not at this time anticipate that these claims or assessments will
have a material effect on the Company's liquidity, financial position and
results of operations beyond the reserve which the Company has established for
such claims and assessments. In making this evaluation, the Company has assumed
that the Company will continue to be able to assert the bankruptcy bar arising
from the reorganization of its predecessor and that resolution of current
pending and threatened claims and assessments will be consistent with the
Company's experience with similar previously asserted claims and assessments.
While the timing of the payment of environmental claims has not significantly
adversely effected the Company's cash flow or liquidity in the past, management
is not able to reasonably anticipate whether future payments may or may not have
a significant adverse effect in the future.
Notwithstanding, at December 31, 2002, there is not sufficient information to
reasonably estimate all the environmental liabilities of which management is
aware. Accordingly, management is unable to determine whether environmental
liabilities which management is unable to reasonably estimate will or will not
have a material effect on Heartland's results of operations or financial
condition.
At December 31, 2002, HTI owed Heartland and CMC approximately $8,464,000. On
February 25, 2002, the Company and CMC demanded immediate payment in full of all
obligations due under the Line of Credit Promissory Notes from HTI. Heartland
has initiated steps to protect its security interest in the Class B Interest
(the "Collateral"). PG Oldco, Inc., a creditor of HTI under notes aggregating
$2,200,000 in principal amount, also has a security interest in the Collateral
and has commenced steps to protect its interest. Under the Lien Subordination
and Inter-Creditor Agreement ("Inter-Creditor Agreement") among Heartland, CMC,
PG Oldco, Inc. and HTI, Heartland and CMC have a first and prior security
interest in the Collateral and the proceeds thereof up to the Senior Debt
Priority Amount (as defined in the Inter-Creditor Agreement) and PG Oldco, Inc.
has a first and prior security interest in the Collateral and the proceeds
thereof for all amounts in excess of the Senior Debt Priority Amount. Because of
the competing interests in the Collateral, Heartland is negotiating with PG
Oldco, Inc. a settlement of this matter. The settlement is likely to involve CMC
buying the PG Oldco, Inc. notes for approximately $1,250,000. Heartland has
recorded an allowance of approximately $133,000 on the note receivable balance
of $8,464,000 based on the proposed terms of the settlement of approximately
$1,250,000 and the December 31, 2002 Class B Interest capital account balance of
$9,584,000.
Heartland's management believes it will have sufficient funds available for
operating expenses, but anticipates the necessity of utilizing outside financing
to fund development projects. As of December 31, 2002, the Company has a line of
credit with LaSalle National Bank ("LNB") in the amount of $3,850,000. Heartland
has also granted LNB, as collateral for the line of credit, a first lien on
certain parcels of land in Chicago, Illinois. The net worth requirement for the
line of credit is $5,500,000. Advances against the line of credit bear interest
at the prime rate of LNB plus 1.5% (5.75% at December 31, 2002). The line of
credit will mature on March 31, 2003. At December 31, 2002 and 2001, $3,850,000
and $3,500,000, respectively, had been advanced to Heartland by LNB against the
line of credit. On February 11, 2003, the Company closed on the sale of
approximately 3.4 acres of land in Chicago, Illinois at a price of $9,850,000.
At that time the outstanding LNB line of credit balance of $3,850,000 was paid
in full.
If Heartland is not successful in obtaining sufficient capital to fund the
implementation of its business strategy and other expenditures, development
projects may be delayed or abandoned. No assurance can be given that such
financing will be available or, if available, will be on terms favorable to
Heartland. The consolidated financial statements do not contain any adjustments
to reflect the ultimate outcome of this uncertainty.
16
At December 31, 2002 the Company had capital and operating lease obligations of
the following:
2003 2004 2005 Total
---------- ---------- ---------- ----------
Capital leases $ 25,000 $ -- $ -- $ 25,000
Operating leases 20,000 9,000 3,000 32,000
Model home rent - two
officers of Heartland 79,000 20,000 -- 99,000
---------- ---------- ---------- ----------
Total $ 124,000 $ 29,000 $ 3,000 $ 156,000
========== ========== ========== ==========
Results of Operations
For the year ended December 31, 2002, operations resulted in a net loss of
($1,058,000) or ($0.50) per Class A Unit. Operations for the years ended
December 31, 2001 and 2000 resulted in a net income of $5,358,000 and $9,844,000
or $2.48 and $2.76 per Class A Unit, respectively.
The differences in net loss in 2002 compared to the net income in 2001 and in
net income in 2001 compared to the net income in 2000 of $6,416,000 and
$4,486,000, respectively, are primarily due to a decrease in sales volume for
those years.
Total operating expenses for 2002 were $3,706,000 compared to $6,137,000 for
2001 and $6,961,000 for 2000. The decrease of $2,431,000 in 2002 compared to
2001 is primarily due to decreased selling expenses of $2,744,000 offset by an
increase in bad debt expense of $449,000. The decrease of $824,000 in 2001
compared to 2000 is primarily due to decreased general and administrative
expenses of $471,000.
Economic and Other Conditions Generally
The real estate industry is highly cyclical and is affected by changes in
national, global and local economic conditions and events, such as employment
levels, availability of financing, interest rates, consumer confidence and the
demand for housing and other types of construction. Real estate developers are
subject to various risks, many of which are outside the control of the
developer, including real estate market conditions, changing demographic
conditions, adverse weather conditions and natural disasters, such as hurricanes
and tornadoes, delays in construction schedules, cost overruns, changes in
government regulations or requirements, increases in real estate taxes and other
local government fees and availability and cost of land, materials and labor.
The occurrence of any of the foregoing could have a material adverse effect on
the financial condition of Heartland.
17
Access to Financing
The real estate business is capital intensive and requires expenditures for land
and infrastructure development, housing construction and working capital.
Accordingly, Heartland anticipates incurring additional indebtedness to fund
their real estate development activities. As of December 31, 2002, Heartland's
total consolidated indebtedness was $8,282,000. This amount is due within one
year from January 1, 2003. There can be no assurance that the amounts available
from internally generated funds, cash on hand, Heartland's existing credit
facilities and sale of non-strategic assets will be sufficient to fund
Heartland's anticipated operations. Heartland may be required to seek additional
capital in the form of equity or debt financing from a variety of potential
sources, including additional bank financing and sales of debt or equity
securities. No assurance can be given that such financing will be available or,
if available, will be on terms favorable to Heartland. If Heartland is not
successful in obtaining sufficient capital to fund the implementation of its
business strategy and other expenditures, development projects may be delayed or
abandoned. Any such delay or abandonment could result in a reduction in sales
and would adversely affect Heartland's future results of operations. Management
does not have any intention to abandon any projects.
Period-to-Period Fluctuations
Heartland's real estate projects are long-term in nature. Sales activity varies
from period to period, and the ultimate success of any development cannot always
be determined from results in any particular period or periods. Thus, the timing
and amount of revenues arising from capital expenditures are subject to
considerable uncertainty. The inability of Heartland to manage effectively their
cash flows from operations would have an adverse effect on their ability to
service debt, and to meet working capital requirements.
Interest Rate Sensitivity
The Company's total consolidated indebtedness at December 31, 2002 is
$8,282,000. The Company pays interest on its outstanding borrowings under
revolving credit facilities and fixed loan amounts at prime or the prime rate
plus 1.50% and at a fixed rate of 7.5%. (See Note 4 to the Consolidated
Financial Statements.) An adverse change of 1.00% in the prime rate would
increase the yearly interest incurred by approximately $83,000.
The Company does not have any other financial instruments for which there is a
significant exposure to interest rate changes.
Item 7A: Quantitative and Qualitative Disclosures about Market Risk
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Economic and Other Conditions Generally", "Access to Financing"
and "Interest Rate Sensitivity".
18
PART II
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT ACCOUNTANTS
To the Partners and Unitholders of Heartland Partners, L.P.:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) on page 75, present fairly, in all material
respects, the financial position of Heartland Partners, L.P. and its
subsidiaries at December 31, 2002 and 2001, and the results of their operations
and their cash flows for the years ended December 31, 2002 and 2001 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedules listed
in the index appearing under Item 15(a)(2) on page 75, present fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedules are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedules based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Chicago, Illinois
March 5, 2003
19
HEARTLAND PARTNERS, L.P.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
December 31, December 31,
2002 2001
----------------- -----------------
Assets:
Cash $ 709 $ 103
Restricted cash 42 1,196
Accounts receivable (net of allowance of $316 and $0
at December 31, 2002 and 2001) 696 430
Due from affiliate (net of allowance of $133 and $0 at
December 31, 2002 and 2001) 8,331 8,186
Prepaid and other assets 378 138
Investment in joint venture -- 166
----------------- -----------------
Total 10,156 10,219
----------------- -----------------
Property:
Land 1,072 1,072
Buildings and improvements 634 1,630
Less accumulated depreciation 213 1,144
----------------- -----------------
Net land, buildings and improvements 1,493 1,558
Land held for sale 645 723
Housing inventories 7,671 10,847
Land held for development 4,807 4,807
Capitalized predevelopment costs 14,083 10,266
----------------- -----------------
Net properties 28,699 28,201
----------------- -----------------
Total assets $ 38,855 $ 38,420
================= =================
Liabilities:
Notes payable $ 8,282 $ 6,746
Accounts payable and accrued
expenses 3,193 2,625
Cash overdraft -- 278
Accrued real estate taxes 789 817
Allowance for claims and liabilities 4,050 4,337
Unearned rents and deferred income 1,429 1,530
Other liabilities 2,150 2,027
----------------- -----------------
Total liabilities 19,893 18,360
----------------- -----------------
Partners' capital:
General Partner 70 81
Class A Limited Partners - 2,142 units
authorized and issued and 2,092 outstanding at
December 31, 2002 and 2,095 at December 31, 2001 9,308 10,390
Class B Limited Partner 9,584 9,589
----------------- -----------------
Total partners' capital 18,962 20,060
----------------- -----------------
Total liabilities and partners' capital $ 38,855 $ 38,420
================= =================
See accompanying notes to Consolidated Financial Statements.
20
HEARTLAND PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except for per unit data)
For the Years Ended December 31,
2002 2001
---------- ----------
Income:
Property sales $ 6,766 $ 30,471
Less: Cost of property sales 5,515 19,908
---------- ----------
Gross profit on property sales 1,251 10,563
---------- ----------
Operating Expenses:
Selling expenses 1,177 3,921
General and administrative
expenses 2,161 1,888
Bad debt expense 449 --
Real estate taxes 157 225
Environmental expenses and other charges (238) 103
---------- ----------
Total operating expenses 3,706 6,137
---------- ----------
Operating (loss) income (2,455) 4,426
Other Income and (Expenses):
Portfolio income 308 1,176
Rental income 368 378
Other income 1,199 122
Depreciation (65) (319)
Management fee (413) (425)
---------- ----------
Total other income 1,397 932
---------- ----------
Net (loss) income $ (1,058) $ 5,358
========== ==========
Net (loss) income allocated to
General partner $ (11) $ 54
========== ==========
Net (loss) income allocated to
Class B limited partner $ (5) $ 26
========== ==========
Net (loss) income allocated to
Class A limited partners $ (1,042) $ 5,278
========== ==========
Net (loss) income per Class A
Limited partnership unit $ (0.50) $ 2.48
========== ==========
Weighted average number of Class A limited
partnership units outstanding 2,093 2,127
========== ==========
See accompanying notes to Consolidated Financial Statements.
21
HEARTLAND PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL
(amounts in thousands)
For the Years ended December 31, 2002 and 2001
Class A Class B
General Limited Limited
Partner Partners Partner Total
---------- ---------- ---------- ----------
Balance at December 31, 2000 $ 27 $ 5,906 $ 9,563 $ 15,496
Net income 54 5,278 26 5,358
Redemption of Class A Limited Partners units -- (794) -- (794)
---------- ---------- ---------- ----------
Balance at December 31, 2001 81 10,390 9,589 20,060
---------- ---------- ---------- ----------
Net loss (11) (1,042) (5) (1,058)
Redemption of Class A Limited Partners units -- (40) -- (40)
---------- ---------- ---------- ----------
Balance at December 31, 2002 $ 70 $ 9,308 $ 9,584 $ 18,962
========== ========== ========== ==========
See accompanying notes to Consolidated Financial Statements.
22
HEARTLAND PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
For the Years Ended
December 31,
2002 2001
---------- ----------
Cash Flow from Operating Activities:
Net (loss) income $ (1,058) $ 5,358
Adjustments reconciling net (loss) income to net cash (used in) provided by
operating activities:
Allowances for bad debts 449 --
Equity in loss of joint venture -- 136
Gain on sale of joint venture (1,137) --
Write off of Kinzie Station fixed assets -- 688
Depreciation 65 319
Net change in allowance for claims and liabilities (287) (141)
Net change in assets and liabilities:
(Increase) decrease in accounts receivable (582) 152
Decrease in housing inventories, net 3,176 9,507
Decrease in land held for sale 78 17
Decrease in land held for development -- 690
Increase in capitalized predevelopment costs, net (3,817) (487)
Increase (decrease) in accounts payable and accrued liabilities 568 (4,642)
Net change in other assets and liabilities 254 (1,153)
---------- ----------
Net cash (used in) provided by operating activities (2,291) 10,444
---------- ----------
Cash Flow from Investing Activities:
Additions to land, building and other, net -- (19)
Increase in note receivable from affiliate (278) (3,605)
Distributions received from joint venture 158 75
Proceeds from sale of joint venture, net 645 --
---------- ----------
Net cash provided by (used in) investing activities 525 (3,549)
---------- ----------
Cash Flow from Financing Activities:
Advances on notes payable 6,521 7,500
Payoffs on notes payable (4,985) (15,429)
Redemption of Class A Limited Partner units (40) (794)
Decrease in restricted cash 1,154 1,503
(Decrease) increase in cash overdraft (278) 278
---------- ----------
Net cash provided by (used in) financing activities 2,372 (6,942)
---------- ----------
Net increase (decrease) in cash 606 (47)
Cash at beginning of period 103 150
---------- ----------
Cash at end of period $ 709 $ 103
========== ==========
Non-cash Activities:
Write off of buildings and improvements and the related
accumulated depreciation $ 996 $ --
========== ==========
Note received from sale of joint venture $ 500 $ --
========== ==========
See accompanying notes to Consolidated Financial Statements.
23
Heartland Partners, L.P.
Notes to Consolidated Financial Statements
For the year ended December 31, 2002
1. Organization
Heartland Partners, L.P. ("Heartland" or the "Company"), a Delaware limited
partnership, was formed on October 6, 1988. Heartland's existence will continue
until December 31, 2065, unless extended or dissolved pursuant to the provisions
of Heartland's partnership agreement.
Heartland was organized to engage in the ownership, purchasing, development,
leasing, marketing, construction and sale of real estate properties. At December
31, 2002, CMC Heartland Partners ("CMC") is an operating general partnership
owned 99.99% by Heartland and .01% by HTI Interests, LLC ("HTII"). HTII is the
General Partner of Heartland, (in such capacity, the "General Partner"). HTII is
a Delaware limited liability company, owned 99.9% by Heartland Technology, Inc.
("HTI"), formerly known as Milwaukee Land Company and .1% by HTI Principals,
Inc., a Delaware corporation, owned by four former directors of HTI's Board of
Directors and a current director of HTI.
The following table sets forth various entities formed by the Company since its
inception, date and purpose of formation, development location and Ownership:
YEAR
COMPANY FORMED BUSINESS PURPOSE
- --------------------------------------------------- ------ ----------------------------------------------------------------
Heartland Development Corporation ("HDC") 1993 General Partner of CMC Heartland Partners I, Limited Partnership
CMC Heartland Partners I, Limited ("CMCLP") 1993 Owned Bloomfield development
Partnership
CMC Heartland Partners I, LLC ("CMCI") 1998 Owns Kinzie Station Phase II
CMC Heartland Partners II, LLC ("CMCII") 1997 Owned the Goose Island Industrial Park joint venture
CMC Heartland Partners III, LLC ("CMCIII") 1997 Owns Kinzie Station Phase I
CMC Heartland Partners IV, LLC ("CMCIV") 1998 Developing approximately 177 acres in Fife, Washington
CMC Heartland Partners V, LLC ("CMCV") 1996 Owned lots and homes in Osprey Cove
CMC Heartland Partners VI, LLC ("CMCVI") 1997 To acquire and hold future acquisitions
CMC Heartland Partners VII, LLC ("CMCVII") 1997 Owns lots and homes in the Longleaf Country Club
CMC Heartland Partners VIII, LLC ("CMCVIII") 1998 To acquire and hold future acquisitions
Lifestyle Construction Company,Inc. ("LCC") 1998 Serves as the general contractor in North Carolina
Lifestyle Communities, Ltd. ("LCL") 1996 Serves as the exclusive sales agent in the
Longleaf development
24
Heartland Partners, L.P.
Notes to Consolidated Financial Statements (Continued)
DEVELOPMENT
COMPANY LOCATION OWNERSHIP
- --------------------------------------------------- ------------------------------ ----------
Heartland Development Corporation ("HDC") Not applicable 100% (1)
CMC Heartland Partners I, Limited ("CMCLP") Rosemount, Minnesota 100% (2)
Partnership
CMC Heartland Partners I, LLC ("CMCI") Chicago,Illinois 100% (3)
CMC Heartland Partners II, LLC ("CMCII") Chicago,Illinois 100% (3)
CMC Heartland Partners III, LLC ("CMCIII") Chicago,Illinois 100% (3)
CMC Heartland Partners IV, LLC ("CMCIV") Fife,Washington 100% (3)
CMC Heartland Partners V, LLC ("CMCV") St. Marys,Georgia 100% (3)
CMC Heartland Partners VI, LLC ("CMCVI") Not Applicable 100% (3)
CMC Heartland Partners VII, LLC ("CMCVII") Southern Pines, North Carolina 100% (3)
CMC Heartland Partners VIII, LLC ("CMCVIII") Not Applicable 100% (3)
Lifestyle Construction Company,Inc. ("LCC") Not Applicable 100% (4)
Lifestyle Communities, Ltd. ("LCL") Not Applicable 100% (4)
(1) Stock wholly owned by Heartland.
(2) HDC owns a 1% General Partnership interest and CMC owns a 99% Limited
Partnership interest.
(3) Membership interest owned by CMC.
(4) Stock wholly owned by CMC.
25
Heartland Partners, L.P.
Notes to Consolidated Financial Statements (Continued)
Except as otherwise noted herein, references herein to "Heartland" or the
"Company" include CMC, HDC, CMCLP, CMCI, CMCII, CMCIII, CMCIV, CMCV, CMCVI,
CMCVII, CMCVIII, LCC and LCL. The consolidated financial statements include the
accounts of Heartland. All intercompany transactions have been eliminated in
consolidation.
Heartland's partnership agreement provides generally that Heartland's net income
(loss) will be allocated 1% to the General Partner, 98.5% to the Class A limited
partners (the "Unitholders") and 0.5% to the Class B limited partner ("Class B
Interest"). In addition, the partnership agreement provides that certain items
of deduction, loss, income and gain may be specially allocated to the
Unitholders, the Class B Interest or the General Partner. Also, the partnership
agreement provides that if an allocation of a net loss to a partner would cause
that partner to have a negative balance in its capital account at a time when
one or more partners would have a positive balance in their capital account such
net loss shall be allocated only among partners having positive balances in
their capital account.
Subject to the limitations described in the preceding paragraph, the General
Partner has the discretion to cause Heartland to make distributions of
Heartland's available cash in an amount equal to 98.5% to the Unitholders, 0.5%
to the Class B Interest and 1% to the General Partner. Liquidating
distributions, upon dissolution of the partnership, are made pro rata to each
partner in accordance with its positive Capital Account balance after certain
adjustments set out in the Partnership agreement. There can be no assurance as
to the amount or timing of Heartland's cash distributions or whether the General
Partner will cause Heartland to make a cash distribution if cash is available.
On December 4, 1997, Heartland's partnership agreement was amended to allow the
General Partner in its discretion to establish a record date for distributions
on the last day of any calendar month. No cash distributions were made in 2002
or 2001.
On August 22, 2001, Heartland announced that it had been authorized by its
General Partner to purchase up to 50,000 of its outstanding Class A partnership
units. As of December 31, 2002 and 2001, the Company had repurchased 50,000 and
47,360 Class A partnership units at a total cost of $834,000 and $794,000,
respectively. These repurchases are shown as a reduction of Partners' Capital.
As of December 31, 2002 and 2001, Heartland and CMC had loaned HTI an aggregate
of $8,464,000 and $8,186,000, respectively. The loans are collateralized by a
security interest in the Class B Interest and bear interest at 13%. The Company
has also received as compensation for the loans a Series C Warrant that entitles
Heartland to purchase 320,000 shares of HTI common stock at an exercise price of
$1.05 per share. HTI's stock is now trading in the over-the-counter market (due
to being delisted from the American Stock Exchange) at less than $.01 per share
at December 31, 2002. The initial terms of the loan were based on the collateral
of the Class B Interest and prevailing borrowing rates. When HTI raised capital
through the issuance of subordinated debentures at 13% interest and the grant of
warrants, the loan terms were changed to reflect HTI's cost of capital.
At December 31, 2002 and 2001, HTI owed Heartland and CMC approximately
$8,464,000 and $8,186,000, respectively. On February 25, 2002, the Company and
CMC demanded immediate payment in full of all obligations due under the Line of
Credit Promissory Notes from HTI. Heartland has initiated steps to protect its
security interest in the Class B Interest (the "Collateral"). PG Oldco, Inc., a
creditor of HTI under notes aggregating $2,200,000 in principal amount, also has
a security interest in the Collateral and has commenced steps to protect its
interest. Under the Lien Subordination and Inter-Creditor Agreement
("Inter-Creditor Agreement") among Heartland, CMC, PG Oldco, Inc. and HTI,
Heartland and CMC have a first and prior security interest in the Collateral and
the proceeds thereof up to the Senior Debt Priority Amount (as defined in the
Inter-Creditor Agreement) and PG Oldco, Inc. has a first and prior security
interest in the Collateral and the proceeds thereof for all amounts in excess of
the Senior Debt Priority Amount. Because of the competing interests in the
Collateral, Heartland is negotiating with PG Oldco, Inc. a settlement of this
matter. The settlement is likely to involve CMC buying the PG Oldco, Inc. notes
for approximately $1,250,000. Heartland has recorded an allowance of
approximately $133,000 on the note receivable balance of $8,464,000 based on the
proposed terms of the settlement of approximately $1,250,000 and the December
31, 2002 Class B Interest capital account balance of $9,584,000.
26
Heartland Partners, L.P.
Notes to Consolidated Financial Statements (Continued)
At December 31, 2002, land held for sale consisted of approximately 13,789 acres
of scattered land parcels. The book value of this inventory is approximately
$645,000. States in which large land holdings are located are Illinois, Iowa,
Minnesota, Montana, North Dakota, South Dakota, Washington, and Wisconsin. The
remaining acreage is located in Idaho, Indiana, Michigan and Missouri. Most of
the properties are former railroad rights-of-way, located in rural areas,
comprised of long strips of land approximately 100 feet in width. Also included
in these scattered land parcels are former station grounds and rail yards. The
land is typically unimproved. Some of the properties are improved with
structures (such as grain elevators and sheds) erected and owned by lessees.
Other properties are improved with Heartland-owned buildings that are of little
or no value. The Company has the right to sell easements for fiber optic lines
along or across 83 miles of rail right of way running from downtown Chicago west
to Elgin and northwest to Fox Lake, Illinois. The Company receives 2/3 of the
proceeds of any sale.
At December 31, 2002, property available for sale and development, including
housing inventories, consisted of 10 sites comprising approximately 518 acres.
The book value of this land is approximately $7,925,000 or an average of $15,300
per acre. Heartland reviews these properties to determine whether to hold,
develop, either solely or with a third party joint venture or sell them.
Heartland's objective for these properties is to maximize Unitholder value over
a period of years.
Heartland has a 1.23 acre site in Chicago, Illinois known as Kinzie Station
Phase I that is complete. Phase I consists of 163 units in a Tower and 24 units
in a Plaza Building. Kinzie Station Phase II is a 1.45 acre site adjacent to
Phase I on which the Company has zoning to construct a 267 unit residential
tower building. Heartland is also selling and building single family homes in
the Longleaf Country Club in Southern Pines, North Carolina.
2. Summary of Significant Accounting Policies
Consolidation
The consolidated financial statements include the accounts of Heartland; CMC,
its 99.99% owned operating partnership; HDC, 100% owned by Heartland; CMCLP, 1%
general partnership interest owned by HDC and 99% owned by CMC; CMCI, CMCII,
CMCIII, CMCIV, CMCV, CMCVI, CMCVII, CMCVIII, LCC and LCL, each 100% owned by
CMC. All intercompany transactions have been eliminated in consolidation.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents. The cash and cash
equivalents of the Company are held at two financial institutions.
Accounts Receivable
The Company provides an allowance for doubtful accounts against the portion of
accounts receivable which is estimated to be uncollectible. Accounts receivable
in the consolidated balance sheets are shown net of an allowance for doubtful
accounts of $316,000 and $0 as of December 31, 2002 and 2001, respectively.
27
Heartland Partners, L.P.
Notes to Consolidated Financial Statements (Continued)
Unearned Rents and Deferred Income
Unearned rents and deferred income are cash received from unrelated outside
parties for the rental of certain parcels of land or land easements owned by the
Company for periods of 20 to 25 years. The amounts received are being amortized
over each agreement's rental period.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, restricted cash, accounts
receivable, accounts payable and accrued expenses are reasonable estimates of
their fair values because of the short maturity of these financial instruments.
The carrying value of the Company's notes payable approximate fair value at
December 31, 2002 and 2001 due to the short duration and variable nature of the
financial instruments.
Revenue Recognition
Residential sales are recognized at closing when title to the home has passed to
the buyer. The Company's homes are generally offered for sale in advance of
their construction. To date, most of the Company's homes have been sold pursuant
to standard sales contracts entered into prior to commencement of construction.
The Company's standard sales contracts generally require the customer to make an
earnest money deposit. This deposit may range from 5% to 10% of the purchase
price for a buyer using conventional financing.
Land sales are recognized when the Company has received an adequate cash down
payment and all other conditions necessary for profit recognition have been
satisfied.
Investment in Joint Venture
Investment in joint venture represents recording of the Company's interest under
the equity method of accounting. Under the equity method of accounting, the
Company recorded its initial interest at cost and adjusts its investment
accounts for additional capital contributions, distributions and its share of
joint venture income or loss.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Significant estimates used in the preparation of the
financial statements include the value of the Class B Interest which represents
the collateral of the Heartland Technology, Inc. note receivable owed to the
Company and CMC, estimated costs to complete long term development projects, the
collectability of the Mr. Jacobson, former President and Chief Executive Officer
of CMC, note and interest receivable, estimated bad debt expense, the
recoverability of the total cost of properties and the estimates used in
determining the Company's environmental liabilities. Actual results could differ
from those estimates.
Income Taxes
A publicly-traded partnership generally is not liable for Federal income taxes,
provided that for each taxable year at least 90% of its gross income consists of
certain passive types of income. In such case, each partner includes its
proportionate share of partnership income or loss in its own tax return.
Accordingly, no provision for income taxes is reflected in Heartland's financial
statements.
Heartland's assets are carried at historical cost. At December 31, 2002 and
2001, the tax basis of the properties and improvements for Federal income tax
purposes was greater than their carrying value for financial reporting purposes.
28
Heartland Partners, L.P.
Notes to Consolidated Financial Statements (Continued)
Segment Reporting
The Company does not report by business segment since the land held for sale
revenues and expenses are not material to the Company's overall business
operations.
Property
Properties are carried at their historical cost. Expenditures which
significantly improve the values or extend useful lives of the properties are
capitalized. Predevelopment costs including real estate taxes that are directly
identified with a specific development project are capitalized. Interest and
related debt issuance costs are capitalized to qualifying real estate
inventories as incurred, in accordance with Statement of Financial Accounting
Standards No. 34, "Capitalization of Interest Costs", and charged to cost of
sales as revenue from residential and land sales are recognized. Repairs and
maintenance are charged to expense as incurred. Depreciation is provided for
financial statement purposes over the estimated useful life of the respective
assets ranging from 7 years for office equipment and fixtures to 40 years for
building and improvements using the straight-line method.
Properties held for development, including capitalized predevelopment costs, are
reviewed for impairment whenever events or changes in circumstances, such as a
condemnation proceeding being brought by a governmental agency against the
Company or the discovery of an environmental liability related to a particular
site, indicate that the carrying amount of the particular development property
may not be recoverable. If these events or changes in circumstances are present,
the Company estimates the sum of the expected future cash flows (undiscounted)
to result from the development operations and eventual disposition of the
particular development property, and if less than the carrying amount of the
development property, the Company will recognize an impairment loss based on
discounted cash flows. Upon recognition of any impairment loss, the Company
would measure that loss based on the amount by which the carrying amount of the
property exceeds the estimated fair value of the property. No event occurred
during the years 2002 and 2001 that resulted in an impairment loss being
recognized.
For properties held for sale, an impairment loss is recognized when the fair
value of the property, less the estimated cost to sell, is less than the
carrying amount of the property. No event occurred during the years 2002 and
2001 that resulted in an impairment loss being recognized.
Housing inventories (including completed model homes) consisting of land, land
development, direct and indirect construction costs and related interest, are
recorded at cost, which is not in excess of fair value. Land, land development
and indirect costs are allocated to cost of sales on the basis of units closed
in relation to the total anticipated units in the related development project;
such allocation approximates the relative sales value method. Direct
construction costs are allocated to the specific units closed for purposes of
determining costs of sales. Selling and marketing costs, not including those
costs incurred related to furnishing and developing the models and sales office,
are expensed in the period incurred. Costs incurred in the construction of the
model units and related furnishings are capitalized at cost. The Company intends
to offer these units for sale at the completion of a project and, accordingly,
no amortization of direct construction costs is provided. Housing inventories
are reviewed for impairment whenever events or circumstances indicate the fair
value less the cost to dispose of the inventories, is less than the capitalized
costs. If these events or changes in circumstances are present, the Company then
writes down the inventory to its fair value. No event occurred during the years
2002 and 2001 that resulted in an impairment loss being recognized.
29
Heartland Partners, L.P.
Notes to Consolidated Financial Statements (Continued)
Housing inventories consisted of the following at December 31, 2002 and 2001
(amounts in thousands):
2002 2001
---------- ----------
Land under development $ 3,118 $ 3,487
Direct construction costs 1,405 4,117
Capitalized project costs 3,148 3,243
---------- ----------
Total $ 7,671 $ 10,847
========== ==========
3. Restricted Cash
The total restricted cash at December 31, 2002 and 2001 was $42,000 and
$1,196,000, respectively. At December 31, 2002 and 2001, CMC has a line of
credit agreement in the amount of $3,850,000 and $5,000,000, respectively, with
LaSalle National Bank ("LNB") pursuant to which CMC had pledged cash in the
amount of $1,150,000 as an interest reserve. This interest reserve was released
to the Company on April 30, 2002. Restricted cash also includes purchasers'
earnest money escrow deposits of $42,000 and $46,000 at December 31, 2002 and
2001, respectively.
4. Investment in Joint Venture
Heartland, along with Colliers, Bennett and Kahnweiler, a Chicago based real
estate company, and Wooton Construction, formed a joint venture which developed
approximately 265,000 square feet of industrial space in the Goose Island
Industrial Park in Chicago, Illinois. As of December 31, 2002 and 2001, the
buildings had been built and leases had been signed for all of the 265,000
square feet. The investment had a carrying value of $166,000 as of December 31,
2001. The Company sold its interest in the joint venture to its partners on
October 22, 2002 for a price of $1,250,000 and the assumption by its partners of
Heartland's share of the joint venture liabilities. At the time of closing,
Heartland received $750,000 and is expected to receive the remaining $500,000 on
October 22, 2003. As security for the $500,000 note, the remaining joint venture
partners have pledged their interests in the joint venture.
5. Notes Payable
At December 31, 2002, CMC has a line of credit agreement in the amount of
$3,850,000 with LNB. The net worth requirement per the line of credit agreement
is $5,500,000. Heartland, as collateral, has granted LNB a first lien on certain
parcels of land in Chicago, Illinois which have a carry value of $5,304,000 at
December 31, 2002. At December 31, 2001, CMC had a line of credit agreement in
the amount of $5,000,000 with LNB, pursuant to which CMC pledged cash in the
amount of $1,150,000 as an interest reserve. Heartland had pledged as additional
collateral its interest in the Goose Island Joint Venture which had a carrying
value of $166,000 as of December 31, 2001. Also, at December 31, 2001, pursuant
to the line of credit agreement, Heartland had granted LNB a first lien on
certain parcels of land in Chicago, Illinois, Milwaukee, Wisconsin and Fife,
Washington which had carrying values of $4,594,000, $5,799,000 and $5,063,000,
respectively. Advances against the line of credit bear interest at the prime
rate of LNB plus 1.5% (5.75% at December 31, 2002). The line of credit matures
March 31, 2003. At December 31, 2002 and 2001, $3,850,000 and $3,500,000,
respectively, had been advanced to the Company by LNB against the line of
credit. On February 11, 2003, the Company closed on the sale of approximately
3.4 acres of land in Chicago, Illinois at a price of $9,850,000. At that time
the outstanding LNB line of credit balance of $3,850,000 was paid in full.
At Osprey Cove in St. Marys, Georgia, the First National Bank of St. Marys in
Georgia had made two loans on two homes totaling $388,000 to the Company. The
carrying value of these two homes was $512,000 at December 31, 2001. The loans
would have matured on November 7, 2002 and July 5, 2002, respectively. The loans
interest rate was 7%. At December 31, 2001, $388,000 had been advanced to
Heartland on the two loans. As of March 19, 2002, these two loans were paid in
full.
30
Heartland Partners, L.P.
Notes to Consolidated Financial Statements (Continued)
As of December 8, 2000, Heartland had obtained an agreement for a $3,000,000
revolving line of credit for the construction of homes in Longleaf with Bank One
of Illinois ("Bank One"). Also, on December 8, 2000, Heartland executed loan
documents borrowing an additional $250,000 to purchase the remaining lots owned
by the developer of Longleaf. This $250,000 was the first payment related to
certain liabilities assumed by the Company in accordance with a purchase
agreement executed on December 12, 2000. The revolving line of credit and
$250,000 loan mature April 12, 2003 and bear interest at the prime rate (4.25%
at December 31, 2002). At December 31, 2002, $932,000 had been advanced by Bank
One to Heartland on the revolving line of credit. The $250,000 loan was paid in
full on October 4, 2002. The carrying value of the collateral for the revolving
line of credit is $2,290,000 at December 31, 2002. At December 31, 2001,
$1,358,000 had been advanced by Bank One to Heartland on these two loans. The
carrying value of the collateral for both these loans at December 31, 2001 was
$2,938,000. The Company is currently in negotiations with Bank One to extend the
maturity date of the revolving line of credit.
On October 20, 1999, the Company executed loan documents with Bank One for a
loan of $5,250,000 to construct the Kinzie Station Plaza building. The loan was
collateralized by real estate contained in the project. On January 30, 2001, the
final principal and interest payment was made on the $5,250,000 Kinzie Station
Plaza building loan. On February 23, 2001, the Company amended this loan
agreement with Bank One, and borrowed an additional $3,000,000, of which
$1,500,000 was outstanding at December 31, 2001, and changed the maturity date
of the loan to February 23, 2002. The maturity date of this loan was extended to
December 31, 2002. This loan was paid in full on December 17, 2002. The loan's
interest rate was the prime rate (4.25% at December 31, 2002).
On August 22, 2002, Heartland executed documents for a loan of $4,000,000 from
Bank One. As collateral for this loan, the Company pledged the Fife, Washington
property. The loan bears interest at the prime rate plus 1% (5.25% at December
31, 2002), and matures May 1, 2003. From the $4,000,000 loan, the Company paid
LNB $1,500,000, which reduced the LNB line of credit principal balance from
$5,350,000 to $3,850,000. At that time, Bank One reserved $500,000 to pay future
environmental costs if needed. Also, on August 22, 2002, the Company cross
collateralized the Kinzie Station Phase I Bank One loan, which was paid in full
on December 17, 2002, with the Fife, Washington property. The outstanding loan
balance is $3,500,000 at December 31, 2002. The Company is currently in
negotiations with Bank One to extend the maturity date of the loan.
During the years ended December 31, 2002 and 2001, the Company incurred and paid
interest on loans in the amount of $542,000 and $1,028,000, of which $542,000
and $837,000 was capitalized, respectively.
As of December 31, 2002 and 2001, Heartland's total consolidated indebtedness
was $8,282,000 and $6,746,000, respectively. These amounts are due within one
year from January 1, 2003 and 2002, respectively. There can be no assurance that
the amounts available from internally generated funds, cash on hand, Heartland's
existing credit facilities and sale of non-strategic assets will be sufficient
to fund Heartland's anticipated operations. Heartland may be required to seek
additional capital in the form of equity or debt financing from a variety of
potential sources, including additional bank financing and sales of debt or
equity securities. No assurance can be given that such financing will be
available or, if available, will be on terms favorable to Heartland. If
Heartland is not successful in obtaining sufficient capital to fund the
implementation of its business strategy and other expenditures, development
projects may be delayed or abandoned. Any such delay or abandonment could result
in a reduction in sales and would adversely affect Heartland's future financial
condition and results of operations. Management does not intend to abandon any
projects.
31
Heartland Partners, L.P.
Notes to Consolidated Financial Statements (Continued)
6. Recognition and Measurement of Environmental Liabilities
It is Heartland's practice to evaluate environmental liabilities associated with
its properties on a regular basis. An allowance is provided wit