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, 2004
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 (IRS Employer Indemnification No.)
of Incorporation or Organization)
53 West Jackson Blvd., Suite 1150
Chicago, Illinois 60604
----------------------------------------
(Address of Principal Executive Offices)
312-834-0592
----------------------------------------------------
(Registrant's telephone number, including area code)
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 June 30, 2004 was approximately $12,988,000. As of April 25, 2005, there were
2,092,438 units outstanding. For the purposes of this computation, the
registrant has assumed that non-affiliates of the registrant include all holders
of the Class A Limited Partnership Units other than directors and officers of
Heartland Technology, Inc. and managers of HTI Interests, LLC.
HEARTLAND PARTNERS, L.P.
FORM 10-K
TABLE OF CONTENTS
PART I
Page
Item 1. Business............................................................................. 3
Item 2. Properties........................................................................... 6
Item 3. Legal Proceedings.................................................................... 6
Item 4. Submission of Matters to a Vote of Security Holders.................................. 9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters and Issuer
Purchases of Equity Securities.................................................. 9
Item 6. Selected Financial Data.............................................................. 11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................................... 11
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................... 23
Item 8. Financial Statements and Supplementary Data.......................................... 23
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure............................................................ 23
Item 9A. Controls and Procedures.............................................................. 23
Item 9B. Other Information.................................................................... 24
PART III
Item 10. Directors and Executive Officers of the Company...................................... 25
Item 11. Executive Compensation............................................................... 26
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Unitholder Matters.............................................................. 29
Item 13. Certain Relationships and Related Transactions....................................... 30
Item 14. Principal Accountant Fees and Services............................................... 31
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................... 33
2
FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements intended to qualify for the safe
harbor from liability established by the Private Securities Litigation Reform
Act of 1995. These forward-looking statements generally can be identified by
phrases such as Heartland or the Company, as defined below, or its management
"believes," "expects," "anticipates," "foresees," "forecasts," "estimates," or
other words or phrases of similar import. Similarly, statements in this report
that describe the Company's plans, outlook, objectives, intentions or goals are
also 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, actions, performance or
achievement of results and the value of the partnership Units may differ
materially from what is forecasted in any 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 and Purpose; Recent Asset Sales
Heartland Partners, L.P. (together with its subsidiaries, "Heartland" or the
"Company") 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 originally organized to
engage in the ownership, purchasing, development, leasing, marketing,
construction and sale of real estate properties. Heartland is now attempting to
sell its remaining real estate holdings. It is pursuing a claim it has against a
local government unit in connection with the acquisition by condemnation of a
property in Milwaukee, Wisconsin. The Company plans to foreclose on the
Company's Class B Interest held by a wholly-owned subsidiary of Heartland
Technology, Inc., a Delaware corporation formerly known as Milwaukee Land
Company ("HTI"), that collateralizes outstanding loans due from HTI. The Company
is undertaking to resolve its remaining liabilities. Heartland's most
significant liabilities are environmental liabilities. Heartland is also a party
to litigation involving its former Chief Executive Officer. The amount and
timing of future cash distributions to the Company's Unitholders will depend on
generation of cash from sales and claims, resolution of liabilities and
associated costs. The Company's 2003 distributions were greater than in any past
year. The Company's Unitholders should not expect the same level of
distributions on an annual basis as occurred in 2003.
HTI Interests, LLC, a Delaware limited liability company and sole general
partner of Heartland (the "General Partner" or "HTII"), is owned 99.9% by HTI
and 0.1% by HTI Principals, Inc., a Delaware corporation owned by four current
members and one former member of HTI's board of directors. CMC Heartland
Partners, a Delaware general partnership ("CMC"), is an operating general
partnership owned 99.99% by Heartland and 0.01% by HTII.
The following table sets forth certain entities formed by Heartland or CMC since
their inception that currently hold real estate and other assets, the 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 III, LLC ("CMCIII") 1997 Previously owned Kinzie Station Phase I and Phase II
3
COMPANY DEVELOPMENT LOCATION OWNERSHIP
- ------- -------------------- ---------
HDC Not Applicable 100% (1)
CMCIII Chicago, Illinois 100% (2)
CMCIV Fife, Washington 100% (2)
CMCVII Southern Pines, North Carolina 100% (2)
(1) Stock wholly owned by Heartland.
(2) Membership interest owned by CMC.
Partnership Agreement and Cash Distributions
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 interest
(the "Class B Interest"). 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. 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 respective capital
accounts, such net loss shall be allocated only among partners having positive
balances in their respective capital accounts. Under the partnership agreement,
if a partner's capital account is reduced to zero and there are additional
losses allocable to that partner those additional losses will have to be made up
by subsequent gains allocable to that partner before gains will increase that
partner's capital account. As of December 31, 2004, the Unitholders' capital
account balance was $0, the Class B Interest's capital account balance was
$5,136,000, and the General Partner's capital account balance was $0.
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. Upon a dissolution
of the partnership, liquidating distributions will be made pro rata to each
partner in accordance with its positive capital account balance after certain
adjustments set forth in the partnership agreement. There can be no assurance as
to the amount or timing of any future cash distributions or whether the General
Partner will cause Heartland to make cash distributions in the future if cash is
available. The General Partner in its discretion may establish a record date for
distributions on the last day of any calendar month.
The Company did not make any cash distributions in 2004.
Notes Receivable From HTI
As of December 31, 2004 and 2003, HTI owes Heartland and CMC an aggregate of
$9,734,000 of which $8,464,000 relates to promissory notes issued in 2000 and
2001 (the "2000 Notes"). The notes are collateralized by a security interest in
the Class B Interest (the "Collateral") and bear interest at 13% per annum. The
Company also received as additional consideration for the 2000 Notes 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 was trading in the
over-the-counter market (after its delisting from the American Stock Exchange)
at less than $0.01 per share as of December 31, 2004. On February 25, 2002, the
Company and CMC demanded immediate payment in full of all obligations due under
the 2000 Notes from HTI.
PG Oldco, Inc., a creditor of HTI under notes in an aggregate principal amount
of $2,200,000 ("PG Oldco Notes"), also had a security interest in the Collateral
and had commenced steps to protect its interest. Under a Lien Subordination and
Inter-Creditor Agreement ("Inter-Creditor Agreement") by and among Heartland,
CMC, PG Oldco, Inc. and HTI, Heartland and CMC had 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). PG Oldco, Inc. had
a first and prior security interest in the Collateral and the proceeds thereof
for all amounts in excess of the Senior Debt Priority Amount. On May 23, 2003
Heartland purchased from PG Oldco, Inc. the PG Oldco Notes for approximately
$1,270,000. The purchase price consisted of $770,000 in cash paid on May 23,
2003 and a note payable for $500,000 due October 31, 2003. This note and accrued
interest were paid in full on October 31, 2003. The purchase price of $1,270,000
for the PG Oldco Notes was recorded as an increase in "Due from Affiliate" on
the Company's consolidated financial statements.
4
On April 16, 2004, the Company purchased the claims that an unrelated third
party maintained against HTI, the former general partner of Heartland, for
$70,000 which is included in general and administrative expense for the year
ended December 31, 2004. The claims include a $500,000 note (the "LZ debt
claim") and a "put" claim of approximately $13 million (the "LZ put claim"). HTI
disputes the validity of the LZ put claim. The Company purchased these claims
because it believes the value was reasonable and to preserve an orderly
liquidation of HTI given HTI's ownership of the limited liability companies
which hold the Company's Class B and General Partner interests.
Heartland has recorded an allowance for doubtful accounts of approximately
$7,234,000 and $5,133,000 on the 2000 Notes and PG Oldco Notes receivable
balance of $9,734,000 at December 31, 2004 and 2003, respectively. Heartland has
recorded an allowance for doubtful accounts against the 2000 Notes and PG Oldco
Notes because HTI has indicated to Heartland that it does not have the means to
repay the amounts owed under the 2000 Notes and PG Oldco Notes. A $5,000,000
allowance for doubtful accounts was recorded in the fourth quarter of 2003
following the sale of the Company's Fife, Washington property and the subsequent
cash distribution of $2.30 per Unit in December 2003 which reduced the estimated
amount of potential future distributions distributable to the Class B Interest.
An additional $2,101,000 was recorded in the fourth quarter of 2004 based on the
Company's continued operating losses, increased environmental expense and the
proposed settlement with HTI. Because Heartland intends to acquire the Class B
Interest from HTI either pursuant to a proposed settlement agreement between HTI
and certain of its creditors or upon a foreclosure of the Class B Interest, as
discussed below, Heartland has determined that the amount due from affiliate
should reflect the value of the Class B Interest based on the estimated amount
of potential future cash distributions distributable in respect of the Class B
Interest upon a liquidation of Heartland (assuming that the Class B Interest is
not cancelled and remains outstanding). In the event that the proposed
settlement agreement is not approved by HTI's other creditors, Heartland
anticipates that it will exercise its rights under the 2000 Notes, the PG Oldco
Notes, the related security agreements and applicable law to foreclose on the
Class B Interest. Upon either the acquisition of the Class B Interest pursuant
to the proposed settlement agreement or the foreclosure on the Class B Interest,
the receivable amount in respect of the 2000 Notes and the PG Oldco Notes
reflected in the "Due from Affiliate" account will be reduced to zero, and the
Class B Interest and the Class B Interest's capital account balance will be
cancelled. If cancelled, the Class B Interest will no longer be entitled to
receive any distributions of cash or other property from Heartland. Although
Heartland's management believes it is unlikely, there can be no assurance that
either the settlement agreement will be approved by HTI's creditors or that
Heartland will be able to foreclose on the Class B Interest. If the Class B
Interest is not foreclosed upon and cancelled, it will be entitled to receive
distributions in accordance with the terms of the partnership agreement.
Proposed Settlement with HTI
HTI has proposed a settlement under which CMC would pay HTI $669,000 and release
its claims (including the LZ put claim, the LZ debt claim, the PG Oldco Claim
and the CMC loan). CMC would get the Class B Interest and HTI would transfer the
General Partner interest and Management Agreement to an entity controlled by
CMC's Board of Managers. This settlement has been approved by a committee of
independent members of HTII's Board of Managers subject to approval by the other
major creditors of HTI.
Real Estate Sale Activities
Property sales during 2004 totaled $4,035,000. Significant sales included
approximately 2 acres of land in the Kinzie Station development in Chicago,
Illinois for $1,597,000, 6 acres of land at Petit Point located near Milwaukee,
Wisconsin for $1,155,000, approximately 28 acres of land in Rockford, Illinois
for $180,000, 7 acres of land in Fife, Washington for $200,000, approximately
11,777 acres of land scattered over 12 states for approximately $250,000 and
other land parcels for approximately $610,000.
Property sales in 2003 totaled $32,680,000. 2003 sales included 170 acres in
Fife Washington for $13,250,000, 3 acres of land in Kinzie Station North for
$9,850,000, 142 acres in the Menomonee Valley in Milwaukee, Wisconsin for
$3,550,000, 11 acres of land at Plankinton Yard located near Milwaukee,
Wisconsin for $819,000, and 7 units in Longleaf for $1,811,000.
5
At December 31, 2004 the Company had (i) approximately 4 acres of remaining
property at Kinzie Station in Chicago, Illinois, along with associated air
rights; (ii) approximately 25 acres of property in Rockford, Illinois; (iii) a 5
acre property in Minneapolis, Minnesota ("Lite Yard"); (iv) a 20 acre property
in Glendale, Wisconsin and (v) approximately 166 acres of land and easements
scattered over 9 states. Heartland also owns approximately 4,000 square feet of
office space in Chicago, Illinois. When the Company conveyed its property in
Menomonee Valley located in Milwaukee, Wisconsin to the Redevelopment Authority
of the City of Milwaukee ("RACM") in connection with a July 2003 condemnation
proceeding, it retained the right to appeal the purchase price and to seek
additional consideration. In April 2004, the Company filed suit against RACM in
the Milwaukee County Circuit Court appealing the amount paid by RACM.
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 two thirds of the
proceeds of any sale. The owner of the right of way receives the other third.
Other Activities
At December 31, 2004, the allowance for claims and liabilities established by
Heartland for environmental and other contingent liabilities totaled
approximately $4,228,000. 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 $4,228,000 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. "Legal Proceedings" and Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Regulatory and Environmental Matters
For a discussion of regulatory and environmental matters, see Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Employees
At December 31, 2004, Heartland employed 3 people, including Richard P.
Brandstatter who resigned his employment with the Company effective January 1,
2005.
ITEM 2. PROPERTIES.
A discussion of certain significant properties of the Company is included in
Item 1. "Business." Properties designated for sale include holdings that were
previously designated for development, and approximately 166 acres of scattered
land parcels. The Company's holdings are located in Illinois, Indiana, Iowa,
Michigan, Minnesota, Missouri, Montana, Washington, and Wisconsin. The Company
also owns certain air rights in Chicago, Illinois.
Heartland's headquarters occupies approximately 500 square feet of leased office
space located at 53 West Jackson Blvd, Suite 1150, Chicago, Illinois. The lease
for this office space expires May 31, 2005, and was prepaid in the amount of
$15,000.
ITEM 3. LEGAL PROCEEDINGS.
Krachtt Litigation
On September 21, 2004, the surviving spouse of an employee of a contractor
demolishing buildings on what was then Company owned property filed suit against
the Company, the contractor and the contractor's insurer in Milwaukee County,
Wisconsin Circuit Court alleging wrongful death of the employee and other
damages. The matter has been referred to the Company's insurer which has
accepted the defense of this litigation.
Southeast Wisconsin Professional Baseball District
In February 2002, the Company filed suit, which was amended on October 20, 2003,
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 the Company providing for the construction of a six lane bridge
to the Company's former Menomonee Valley project. On July 19, 2004, the Court
ruled in favor of the District's motion for summary judgment holding that the
claim ran with the land and was now held by the Redevelopment Authority of the
City of Milwaukee, to whom the Company had conveyed the property in lieu of
condemnation in July, 2003.
6
Maples
Under the terms of a lot agreement with the Longleaf Associates Limited
Partnership ("LALP"), CMCVII was required to pay $135,000, $250,000, $135,000
and $250,000 on April 1, 2002, November 1, 2002, April 1, 2003, and November 1,
2003, respectively, to Maples, the owner and operator of the golf course and
club house located at the Longleaf Country Club in Southern Pines, North
Carolina. The four payments totaling $770,000 were not made, which constituted
an event of default under the lot agreement. The Company believes Maples is in
default of its obligations under the golf membership agreements. In addition,
LALP, the seller of the Longleaf lots, did not notify CMCVII that it was in
default. LALP would have been entitled to seek specific performance and/or other
remedies as provided for in the membership agreement. However, due to its belief
that Maples had breached the membership agreement, CMCVII did not make these
payments. On June 19, 2003, Maples joined CMCVII as a defendant in a lawsuit
Maples filed against LALP in the North Carolina General Court of Justice
Superior Court Division of Moore County for breach of contract. Maples is
seeking $3,515,000 in compensatory damages from the defendants. CMCVII is
vigorously defending itself against this action and at this time the Company has
not recorded a loss contingency because the Company cannot determine (a) if it
is probable that a liability will be incurred and (b) the amount of any possible
liability. The Company's management is not able to express an opinion on whether
this action will adversely affect the Company's future financial condition or
results of operations. At this time, due to the sale of all of the assets of
CMCVII on December 31, 2003, and due to the release of CMCVII from any liability
related to the lot agreement by LALP, the Company is attempting to have CMCVII
removed as a defendant in the lawsuit.
Edwin Jacobson Lawsuit
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 managers of the General Partner. One of the lawsuits alleges CMC breached
the terms of his employment contract and that the officers and/or board members
wrongfully interfered with his contract. Jacobson is seeking compensatory and
punitive damages ($1,000,000 in salary and $11,000,000 in incentive
compensation). Jacobson asked the court to enforce his contract and enjoin the
Company from selling property or making distributions to the Unitholders until
the Company has appraised its properties and paid him according to the terms of
his employment contract. Jacobson's second lawsuit was for defamation. On
January 31, 2003, the Company filed motions to dismiss the amended lawsuits. On
May 29, 2003, the court dismissed, with prejudice, the defamation lawsuit
against the Company, CMC and certain officers and/or managers of the General
Partner. At the same time, the court dismissed, with prejudice, Jacobson's
motion to enjoin the Company from selling its real estate properties. Jacobson
also filed a motion for summary judgment on his contract claims which the court
denied. Jacobson filed a motion for reconsideration which was denied on April 8,
2005. CMC has filed a counterclaim alleging breach of fiduciary duty and a
motion to dismiss the claim for tortious interference with a contract. Jacobson
filed a motion for summary judgment on CMC's counterclaim alleging breach of
fiduciary duty which was denied on April 8, 2005.
On February 28, 2003, the Company filed suit against Jacobson in Delaware state
court to collect a note from Jacobson to the Company in the amount of $332,000,
which includes $16,000 of interest that has not been recorded in the Company's
consolidated financial statements. On July 8, 2003, the Delaware Court stayed
that action pending resolution of Jacobson's action against the Company.
CMC is vigorously defending itself against Jacobson's lawsuit and, in the
opinion of management, has valid defenses against the remaining lawsuit relating
to the Company's alleged breach of Jacobson's employment contract. At this time,
the probability that a liability will be incurred and the amount of any
potential liability cannot be determined. However, this litigation may not be
resolved in the Company's favor, and the Company may incur significant costs
associated therewith. If the Company is required to pay substantial amounts with
respect to the Jacobson litigation, the Company may not be left with any cash or
other property to distribute to the Unitholders. The parties have agreed to
voluntary, non-binding mediation.
7
RACM
On July 30, 2003, the Company conveyed 142 acres of property in Milwaukee,
Wisconsin to the Redevelopment Authority of the City of Milwaukee ("RACM") in
consideration of $3.55 million in lieu of condemnation. The Company reserved the
right to appeal the fair market value of the property and filed that appeal on
April 6, 2004, in Milwaukee County, Wisconsin Circuit court. The most recent
appraisal performed on behalf of the Company opines that the property had a fair
market value of $15 million. There is no assurance that a court will award that
amount at trial or that RACM would offer that amount to settle the litigation. A
court could find that the property was worth less than $3.55 million and order
the Company to return money to RACM. Any determination of fair market value and
award to the Company will be net of the $3.55 million which the Company has
already received. In the event of a court decision that determines the value of
the property to be more than 115% of $3.55 million, the Company will be entitled
to recover certain costs of the appeal.
Lite Yard
CMC owns a 5 acre site in Minneapolis, Minnesota that is impacted with arsenic
and lead ("Lite Yard"). On April 29, 2004, a Response Action Plan for the site
was approved by the Minnesota Department of Agriculture. The Company filed suit
against US Borax Inc. ("Borax") on July 23, 2003, in the United States District
Court for the District of Minnesota for contribution. Borax, which discontinued
operations in 1968, is a former operator of a pesticide/herbicide facility on
the property. This matter was settled pursuant to a Confidential Settlement
Agreement and Release dated September 27, 2004, between the Company and Borax.
Pursuant to the settlement agreement, Borax has agreed to pay a portion of the
Company's past and future response costs at the site. At December 31, 2004 and
2003, the Company's aggregate allowance for claims and liabilities for this site
was $1,588,000 and $3,415,000, respectively. Of this amount, $726,000 was
billed, but not yet paid, in respect of work related to the site through
December 31, 2004.
At December 31, 2004, the Company has recorded a $905,000 receivable for the
portion of these amounts due from Borax under the settlement agreement.
On September 3, 2004, the United States Environmental Protection Agency
("USEPA") issued an order ("Order") requiring the Company and Borax to remediate
arsenic in the soils of a nearby residential neighborhood on an emergency basis.
On January 24, 2005, the USEPA issued a general notice letter ("Letter) to the
Company and Borax requesting that the Company and Borax perform a remedial
investigation and feasibility study on the soils of the same nearby residential
neighborhood on a non-emergency basis for matters not covered by the Order.
Neither the Order nor the Letter are covered by the Confidential Settlement
Agreement and Release between the Company and Borax.
The Company offered the USEPA $300,000 to settle the Company's obligations under
the Order and Letter. The USEPA has not yet responded to the Company's offer.
The Company believes, based on USEPA publications, that the USEPA has provided
$1,500,000 for past and future remediation activities in the residential
neighborhood. This amount does not necessarily represent the entire cost of the
cleanup being under taken by the USEPA. The entire cost could be higher or
lower. The USEPA could seek substantial penalties against the Company in
addition to remediation costs. The Company engaged an environmental engineering
consultant to review information available regarding the possible scope and cost
of USEPA activities. The consultant projected a range of possible costs of
$2,841,000 to $3,833,000. However, this estimate was based on limited data
available to the consultant. The Company has reserved $1,196,000 in connection
with the Order and Letter. This reserve amount takes into consideration the
estimated range of possible costs and the allocation of costs among PRPs for the
on-site remediation at the Lite Yard.
A former consultant for the Company at the Lite Yard, Exponent, Inc., filed suit
against the Company in Minnesota state court on January 27, 2005. The complaint
alleges that the Company owes Exponent $361,000 in unpaid consultant fees. CMC
has disputed the reasonableness of Exponent's invoices.
8
Miles City Yard
By letter dated June 10, 2004, the Montana Department of Environmental Quality
("DEQ") demanded that the Company perform a remedial investigation of a railyard
in Miles City, Montana previously owned and operated by the Chicago, Milwaukee,
St. Paul and Pacific Railroad (the "Milwaukee Road"). The Company has, for many
years, been conducting a clean-up of a substantial diesel fuel release at this
site. On September 7, 2004, Trinity Railcar Repair, Inc. ("Trinity") filed suit
against the Company and CMC in Custer County, Montana state court, for
contribution under state environmental law, for indemnification under sale
agreements between the Company's predecessors-in-interest and Trinity's alleged
predecessors and for injunctive relief prohibiting the Company from dissolving
or making any distributions to its Unitholders. On September 14, 2004, Trinity
filed a motion for a preliminary injunction to prohibit the Company from
liquidating or making distributions to its Unitholders. On January 10, 2005, the
court held a hearing at which the Company's engineering witness testified that
the maximum cost of investigation and remediation could be as much as
$1,250,000. However, this estimate was not based on any direct investigation of
conditions at the site. On March 24, 2005, the court ordered the Company to
escrow cash, post a bond, or provide another guarantee, of $2,500,000 to cover
possible remediation and clean-up costs for the site. The court did not make a
determination as to the requirement for any remediation, the costs of
remediation or liability for any costs. The Company is considering an appeal of
this order and is negotiating a letter of credit to comply with the terms of
such order. The Company, based on current review of the site believes that the
range of costs of investigation and remediation, including the ongoing diesel
fuel clean-up could be between $618,000 and $1,740,000. At December 31, 2004,
the Company's aggregate allowance for claims and liabilities for this site
(including costs of investigation, remediation and legal fees relating to the
litigation) is $618,000.
Bozeman
In 2001 the Company sold a 14 acre property to the City of Bozeman, Montana that
was known to be contaminated with asbestos ore. As part of the sale, the City of
Bozeman released the Company from all environmental liability. The City of
Bozeman performed a clean-up of the north half of the property. In September
2003, the Company received a letter from the DEQ requesting an investigation of
possible asbestos ore on the south half of the property sold to the City of
Bozeman and a neighboring property. By letter dated November 3, 2004, the
Company was notified by the DEQ that the City of Bozeman, Montana had initiated
a proceeding under the Montana Controlled Allocation of Liability Act ("CALA")
with regard to the sold property. In the administrative proceeding, the DEQ will
allocate environmental liability among potentially liable parties. The Company
has projected that the total cost of the remediation already performed by the
City of Bozeman plus additional remediation which may be required for the south
half of the property is approximately within a range from $997,000 to
$1,645,000. The estimated range of costs for the neighboring property is
$120,000 to $219,000. The Company believes it has valid defenses to any CALA
allocated liability for the clean-up of the north half of the property and could
assert a claim against the City of Bozeman for liabilities for any clean-up of
the south half of the property. The Company has reserved an aggregate of
$332,000 for all claims and liabilities associated with this property and the
neighboring property. This reserve amount reflects the ranges of costs for both
on-site and off-site remediation and the Company's limited liability to the City
of Bozeman under the terms of the sale of the property to the City of Bozeman.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of Unitholders of Heartland during the year
ended December 31, 2004.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES.
Historical Trading Prices for Units
The Class A limited partnership 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, 2004 and 2003.
9
2004 High Low
First quarter $ 8.15 $ 6.55
Second quarter 7.95 6
Third quarter 6.69 4.10
Fourth quarter 5.21 3.99
2003
First quarter $ 7.10 $ 5.30
Second quarter 8.90 6.60
Third quarter 9 6
Fourth quarter 9.75 6.75
Based on records maintained by Heartland's transfer agent and registrar, there
were approximately 500 record holders of Heartland's units as of April 25, 2005.
Cash Distributions to Unitholders
The amount of Heartland's cash available to be distributed, if any, 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 contingencies
and environmental liabilities.
Heartland's Available Cash Flow will be derived from CMC and CMCIII. When, and
if, 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. If the partnership
were dissolved, liquidating distributions would be made pro rata to each partner
in accordance with its positive capital account balance after certain
adjustments set out in the partnership agreement. As of December 31, 2004, the
Unitholders' capital account balance was $0, the Class B Interest's capital
account balance was $5,136,000, and the General Partner's capital account
balance was $0. Future lenders to Heartland may impose restrictions on
Heartland's ability to make cash or other property 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, 2004 and
2003, there were 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.
No cash distributions were made during 2004 or 2002. During 2003, Heartland
declared and distributed cash distributions, in the aggregate, of approximately
$3.35 per unit. The Company's 2003 distributions were greater than in any past
year. Unitholders should not expect this level of distributions on an annual
basis.
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, 2004, 2003, 2002, 2001 and 2000 (amounts in
thousands except per Unit data):
Statement of Operations Data: 2004 2003 2002 2001 2000
- ----------------------------- ---- ---- ---- ---- ----
Property Sales $ 4,035 $ 32,680 $ 6,766 $ 30,471 $ 61,009
Operating (loss) income $ (4,524) $ (3,763) $ (2,455) $ 4,426 $ 8,436
Other income $ 169 1,408 1,397 932 1,408
----------- ----------- ----------- ----------- -----------
Net (loss) income $ (4,355) $ (2,355) $ (1,058) $ 5,358 $ 9,844
=========== =========== =========== =========== ===========
Net income (loss) allocated
to General Partner $ 2 $ -- $ (11) $ 54 $ 27
=========== =========== =========== =========== ===========
Net (loss) income allocated
to Class B Interest $ (4,357) $ (56) $ (5) $ 26 $ 3,911
=========== =========== =========== =========== ===========
Net (loss) income allocated
to Class A Units $ -- $ (2,299) $ (1,042) $ 5,278 $ 5,906
=========== =========== =========== =========== ===========
Net (loss) income per Class A Unit $ -- $ (1.10) $ (0.50) $ 2.48 $ 2.76
=========== =========== =========== =========== ===========
Cash distributions declared per Class A Unit $ -- $ 3.35 $ -- $ -- $ --
=========== =========== =========== =========== ===========
December 31, December 31, December 31, December 31, December 31,
Balance Sheet Data 2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Net Properties $ 6,416 $ 7,730 $ 28,699 $ 28,201 $ 38,916
Total assets 11,673 16,991 38,855 38,420 47,584
Allowance for claims
and liabilities 4,228 3,970 4,050 4,337 4,478
Total liabilities 6,537 7,500 19,893 18,360 32,088
Partners' capital 5,136 9,491 18,962 20,060 15,496
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Risk Factors
Real Estate Investment Risks; General Economic Conditions Affecting Real Estate
Industry
The Company faces risks associated with local real estate conditions in areas
where the Company owns properties. These risks include, but are not limited to:
liability for environmental hazards; changes in general or local economic
conditions; changes in real estate and zoning laws; changes in income taxes,
real estate taxes, or federal or local taxes; floods, earthquakes, and other
acts of nature; and other factors beyond the Company's control. The illiquidity
of real estate investments generally may impair the Company's ability to respond
promptly to changing circumstances. The inability of management to respond
promptly to changing circumstances could adversely affect the Company's
financial condition and ability to make distributions to the Unitholders.
The real estate industry generally 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. Sellers of real estate are
subject to various risks, many of which are outside the control of the seller,
including real estate market conditions, changing demographic conditions,
adverse weather conditions and natural disasters, such as hurricanes and
tornadoes, changes in government regulations or requirements and increases in
real estate taxes and other local government fees. The occurrence of any of the
foregoing could have a material adverse effect on the financial condition of
Heartland.
11
Environmental Liabilities
Under various federal, state and local laws, ordinances, and regulations, the
owner or operator of real property may be liable for the costs of removal or
remediation of hazardous or toxic substances located on or in, or emanating
from, such property, as well as costs of investigation and property damages.
Such laws often impose such liability without regard to whether the owner or
operator knew of, or was responsible for, the presence of such hazardous or
toxic substances. The presence of such substances, or the failure to properly
remediate such substances, may adversely affect the owner or operator's ability
to sell or lease a property or borrow using the property as collateral. Other
statutes may require the removal of underground storage tanks. Noncompliance
with these and other environmental, health or safety requirements may result in
substantial costs to us or may result in the need to cease or alter operations
on the property and may reduce the value of the property or our ability to sell
it.
In addition, the Company acquired its real estate portfolio from the successors
to the Chicago, Milwaukee, St. Paul and Pacific Railroad (the "Milwaukee Road")
under a Conveyance Agreement dated June 27, 1990, (the "Conveyance Agreement").
The Milwaukee Road emerged from reorganization in 1985. Under the Conveyance
Agreement, the Company agreed to assume certain environmental liabilities of the
Milwaukee Road which survived the Milwaukee Road's reorganization proceedings.
Environmental laws may impose liability on a previous owner or operator of a
property that owned or operated the property at a time when hazardous or toxic
substances were disposed on, or released from, the property. A conveyance of the
property, therefore, does not relieve the owner or operator from liability. The
Company cannot assure that environmental liability claims will not arise in the
future.
Heartland is subject to federal and state requirements for protection of the
environment, including those for discharge of hazardous materials and
remediation of contaminated sites. Heartland is in the process of assessing its
environmental exposure, including obligations and commitments for remediation of
contaminated sites and assessments of ranges and probabilities of recoveries
from other responsible parties. Because of the regulatory complexities and risk
of unidentified contaminants on its properties, the potential exists for
remediation costs to be materially different from the costs Heartland has
estimated. Some of the property owned by the Company consists of land formerly
used for railroad purposes. Other properties were leased to tenants that used
hazardous materials in their businesses. Any contamination of that property may
affect adversely the Company's ability to sell such property.
For a discussion of the amount and methodology used to determine the amount of
the Company's reserve for environmental liabilities and claims and certain risks
associated therewith, see "Summary of Significant Accounting Estimates - Reserve
for Environmental Liabilities".
Notes Receivable from HTI
HTI owes Heartland, in the aggregate, approximately $9,734,000 of which
$8,464,000 relates to the 2000 Notes and the PG Oldco Notes, both of which are
secured by the Class B Interest. Heartland has recorded an allowance for
doubtful accounts of approximately $7,234,000 related thereto. Upon either the
acquisition of the Class B Interest pursuant to a proposed settlement agreement
or the foreclosure on the Class B Interest, the receivable amount in respect of
the 2000 Notes and the PG Oldco Notes reflected in the "Due from Affiliate"
account will be reduced to zero, and the Class B Interest and the Class B
Interest's capital account balance will be cancelled. If cancelled, the Class B
Interest will no longer be entitled to receive any distributions of cash or
other property from Heartland. Although Heartland's management believes it is
unlikely, there can be no assurance that either the settlement agreement will be
approved by HTI's creditors or that Heartland will be able to foreclose on the
Class B Interest. If the Class B Interest is not foreclosed upon and cancelled,
it will be entitled to receive distributions in accordance with the terms of the
Partnership Agreement. For additional information regarding these matters, see
"Item 1. Business - Notes Receivable from HTI."
12
Pending Litigation
The Jacobson litigation, as well as the other litigation disclosed in Item 3
above, may not be resolved in the Company's favor, and the Company may incur
significant costs associated therewith. If the Company is required to pay
substantial amounts with respect to the Jacobson, or other, litigation, the
Company may not be left with any cash or other property to distribute to the
Unitholders.
As discussed in "Item 3. Legal Proceedings--Miles City Yard", a state court in
Montana issued an order requiring the Company to escrow cash, post a bond, or
provide another guarantee, of $2,500,000 to cover possible remediation and
clean-up costs on land formerly owned by the Company, or its
predecessor-in-interest, in Miles City, Montana. The Company is considering an
appeal of this order and is negotiating a letter of credit to comply with the
terms of such order.
Access to Financing
As of December 31, 2004, Heartland's total consolidated debt was zero. There can
be no assurance that the amounts available from internally generated funds, cash
on hand and sale of assets will be sufficient to fund Heartland's anticipated
operations. Heartland may be required to seek additional capital in the form of
bank financing. 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
liquidation strategy and for other expenditures, properties might be sold for
far less than their market value. Any such discounted sale could adversely
affect Heartland's future results of operations and future cash flows. However,
the Company's management at this time does not anticipate selling the Company's
remaining properties at substantial discounts from their market value.
Period-to-Period Fluctuations
Heartland's sales activity varies from period to period, and the ultimate
success of this sales activity cannot always be determined from results in prior
periods. Thus, the timing and amount of revenues arising from this sales
activity 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 any future debt, and to meet working capital
requirements.
Potential Liquidation of Assets
The Company's management expects to sell to unrelated third parties the
remainder of its properties with a view towards eventually dissolving the
partnership within the next two years. If such sales do occur, the Company may
subsequently determine to liquidate the Company pursuant to the dissolution and
liquidation provisions of its partnership agreement. The Company might also
determine to liquidate in the context of a bankruptcy proceeding if the Company
believes that such a proceeding would likely serve to maximize value for the
Company's Unitholders by providing greater certainty with respect to the
satisfaction of, or provision for, the Company's known and contingent
liabilities. The Unitholders will not have control over the divestiture of the
Company's remaining assets or the liquidation process. The Company cannot make
any assurance that changes in its policies will serve fully the interests of all
Unitholders or that the Unitholders will receive any liquidating distributions
of cash or other property.
The Company is working to resolve its remaining liabilities which primarily
consist of environmental matters and Edwin Jacobson's claim against the Company.
In addition, the Company is pursuing recovery on the RACM claim it has against
local governmental units in Wisconsin and foreclosing on its Class B Partnership
Interest. Significant estimates are used in the preparation of financial
statements to value the Class B Interest which represents the collateral of the
HTI note receivable owed to the Company and CMC, the recoverability of the total
cost of properties and the Company's environmental liabilities. The amount and
timing of any future cash distributions will depend on generation of cash from
sales and claims and the resolution of liabilities. The Company has experienced
recurring operating losses for the years ended December 31, 2004, 2003, and 2002
and there can be no assurance that the amounts available from internally
generated funds, cash on hand, and sale of the remaining assets of the Company
will be sufficient to fund Heartland's anticipated operations and meet existing
and future liabilities. These losses, uncertainty as to the amount and timing of
additional compensation from the RACM claim, if any, and the uncertainty
surrounding such environmental liabilities and other claims, particularly the
Edwin Jacobson lawsuit, create uncertainties about the Company's ability to meet
existing and future liabilities as they become due. The Company has taken
certain steps, including the reduction of fixed overhead and conservation of
cash, in light of these uncertainties. The Company may be required to seek
additional capital in the form of bank financing, however, there is no assurance
that such bank financing will be available or, if available, will be on terms
favorable to the Company.
Risks Related to the Class A Units
The market value of the Class A units could decrease based on the Company's
performance, market perception and conditions. The market value of the Class A
units may be based primarily upon the market's perception of the Company's
growth potential and current and future cash distributions, and may be
secondarily based upon the real estate market value of the Company's underlying
assets. The market price of the Class A units may be influenced by the
distributions on the Class A units relative to market interest rates. Rising
interest rates may lead potential buyers of the Class A units to expect a higher
distribution rate, which would adversely affect the market price of the Class A
units. In addition, if the Company were to borrow, rising interest rates could
result in increased expense, thereby adversely affecting the cash flow and the
Company's ability to service its indebtedness and make distributions.
The Class A units have been traded since June 20, 1990. The Company believes
that factors such as (but not limited to) announcements of developments related
to the Company's business, fluctuations in the Company's quarterly or annual
operating results, failure to meet expectations, and general economic
conditions, could cause the price of the Company's units to fluctuate
substantially. In recent years the stock market has experienced extreme price
fluctuations, which have often been unrelated to the operating performance of
the underlying companies. Such fluctuations could adversely affect the market
price of the Class A units.
13
The Class A units are currently traded on the American Stock Exchange under the
symbol "HTL". The Class A units are thinly traded. There are no assurances that
the Company will maintain its listing on the exchange. If the Class A units
should be delisted from the exchange, it is likely that it could materially
and/or adversely affect any future liquidity in the Class A units.
Summary of Significant Accounting Estimates
The Company's most significant accounting estimates relate to the net realizable
value of assets, potential environmental liabilities, pending litigation and the
treatment of certain loans from Heartland to the General Partner.
Net Realizable Value of Assets
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. In the second quarter of 2004, an impairment
loss of $57,000 was recognized as a component of cost of sales.
Reserve for Environmental Liabilities
Estimation of Amount of Reserve for Environmental Claims and Liabilities:
The Company evaluates the environmental liabilities associated with its
properties on a regular basis. The Company records an allowance, or reserve, for
known potential environmental claims and liabilities, including remediation,
legal and consulting fees, to the extent it is probable that a liability has
been incurred and the amount of the liability can be reasonably estimated. The
reserve amount does not include any estimated amounts for unknown claims and
liabilities. The Company estimates its reserve for known environmental claims
and liabilities independent from any claims the Company may have for recovery
against third parties, including from governmental sponsored clean-up funds. If
the Company cannot reasonably estimate the amount of an environmental claim or
liability, but (i) the Company's management is able to determine that the amount
of the liability is likely to fall within a range and (ii) no amount within that
range can be determined to be a better estimate than any other amount, then the
Company records the reserve at the minimum amount of the range. At December 31,
2004, the Company recorded a receivable for the estimated amount due for future
costs at the Lite Yard under the Borax settlement agreement of $905,000. At
December 31, 2004, the reserve for environmental claims and liabilities was
$4,228,000, which represents the minimum amount of the range of the Company's
estimate of environmental claims and liabilities. The Company estimates the
upper range of the Company's environmental claims and liabilities to be
approximately $10,841,000.
Actual Costs Likely to Exceed Amount of Reserve:
If the Company were to use a different approach than that described above, the
amount of the reserve could be materially higher. Additionally, the Company
believes it is likely that the actual amount of the Company's environmental
claims and liabilities, when fully resolved or provided for, will be higher than
the reserve amount because it is unlikely that, as a whole, such claims and
liabilities will be less expensive to resolve than the amount of the low end of
such range. Also, as noted above, the Company does not include in the amount of
the reserve any estimated amounts for unknown claims and liabilities. This means
that as new claims arise the amount of the reserve will generally need to be
increased. For example, as the Company incurs environmental remediation and
other costs for new environmental claims, the Company pays for, and records as
an operating expense, the amount of such costs and accrues an environmental
reserve if necessary. However, because new environmental claims arise
periodically, the amount of the Company's reserve for environmental claims and
liabilities has not historically declined, but rather has remained flat or
increased over time.
The Company expects to sell to unrelated third parties its remaining properties
with a view towards eventually dissolving the partnership within the next two
years. If such sales do occur, the Company may then adopt a plan of dissolution.
Prior to any such dissolution, the Company will have to make a provision for all
of its potential environmental liabilities, including known liabilities and
unknown liabilities that are likely to arise or become known within at least ten
14
years after the date of dissolution. In connection with any future dissolution
of the Company, the Company may determine it to be in the best interests of the
Company and the Unitholders to purchase environmental liability insurance or to
pay a third party to assume the Company's environmental liabilities if it
appears that the cost to do so will likely be less than the cost of maintaining
the Company's overhead to resolve and manage the environmental claims and
remediation process going forward. The Company has had preliminary discussions
with environmental claims management firms regarding the potential cost at which
such firms would agree to assume the Company's known and unknown environmental
liabilities. Based on these preliminary discussions, the Company believes that
the cost associated with the assumption by a third party of such environmental
liabilities could be in excess of $10,000,000. At this time, however, the
Company has not yet determined whether it would be more cost effective to
undertake such an arrangement or to manage for its own account the environmental
claims and remediation process going forward.
In connection with the Company's efforts to obtain environmental insurance or
transfer its environmental claims and liabilities to third parties, the Company
engaged an outside consultant to estimate the potential environmental exposure
for claims (other than those related to the Wheeler Pit and Company owned
property at the Lite Yard) based on an "expected value" methodology. While an
expected value methodology is an accepted approach to valuation, it incorporates
certain assumptions, including estimates for unknown claims and liabilities,
and, as a result, is not recognized under generally accepted accounting
principles. The expected value for the Company's current portfolio estimated by
the outside consultant (which, as noted above, does not include estimates for
claims related to the Wheeler Pit or Company owned property at the Lite Yard) is
approximately $5,450,000, with an upper range of $9,410,000. At December 31,
2004, the Company estimates the range of the Company's environmental claims and
liabilities to be between $4,228,000 and $10,841,000.
Factors and Properties Affecting the Amount of the Company's Environmental
Liabilities:
Under environmental laws, liability for hazardous substance contamination is
imposed on the current owners and operators of the contaminated site, as well as
the owner or the operator of the site at the time the hazardous substance was
disposed or otherwise released. In most cases, this liability is imposed without
regard to fault. Currently, the Company has known environmental liabilities
associated with certain of its properties arising out of the activities of the
Milwaukee Road or certain of the Milwaukee Road's lessees and may have further
material environmental liabilities as yet unknown. The majority of the Company's
known environmental liabilities stem from the use of petroleum products, such as
motor oil and diesel fuel, in the operation of a railroad or in operations
conducted by the Milwaukee Road's lessees.
From time to time contaminants are discovered on property the Company now owns.
Some of these may have resulted from the historical activities of the Milwaukee
Road. In other cases the property was leased to a tenant who released
contaminants onto the property. The Company's property may also be polluted by a
release or migration of contaminants onto the Company's property by unrelated
third parties. The Company has not investigated all of its properties and does
not know how many of them may be contaminated.
The Company's practice when it sells land is to sell the property "as is, where
is" without any representation or indemnification for environmental conditions.
The Company has one active site, however, Miles City, Montana, where the
Milwaukee Road and its successor may have issued certain limited indemnifies to
the buyer for specified environmental concerns. There are other cases in which
the Company has had a claim arising out of alleged contamination on sold
property. In some, but not all, of these instances, the Company has been
successful in asserting that such liabilities were discharged in the bankruptcy
proceedings of the Milwaukee Road.
The Company may be responsible for certain liabilities that arise from the
historical operations of the Milwaukee Road railroad that have nothing to do
with the ownership of property. The Company has been, for example, named as a
"potentially liable party" or had claims asserted by a private parties in
landfill-clean-up cases in which there is an allegation that the Milwaukee Road
generated or transported materials to the landfill. Additional claims may arise
in the future. In certain of these cases, the Company has asserted that such
liabilities were discharged in the bankruptcy proceedings of the Milwaukee Road.
The DEQ has asserted that the Company is liable for some or all of the
investigation and remediation of certain properties in Montana sold by the
Milwaukee Road's reorganization trustee prior to the consummation of its
reorganization. The Company has denied liability at certain of these sites based
on the reorganization bar of the Milwaukee Road. The Company's potential
liability for the investigation and remediation of these sites was discussed in
detail at a meeting with the DEQ in April 1997. While the DEQ has not formally
changed its position, the DEQ has not elected to file suit.
15
At two separate sites, the Company has been notified that releases arising out
of the operations of a lessee, former lessee or other third party have been
reported to government agencies. At each of these sites, the third party is
voluntarily cooperating with the appropriate agency by investigating the extent
of any such contamination and performing the appropriate remediation, if any.
Lite Yard
CMC owns a 5 acre site in Minneapolis, Minnesota that is impacted with arsenic
and lead ("Lite Yard"). On April 29, 2004, a Response Action Plan for the site
was approved by the Minnesota Department of Agriculture. The Company filed suit
against Borax on July 23, 2003, in the United States District Court for the
District of Minnesota for contribution. Borax, which discontinued operations in
1968, is a former operator of a pesticide/herbicide facility on the property.
This matter was settled pursuant to a Confidential Settlement Agreement and
Release dated September 27, 2004, between the Company and Borax. Pursuant to the
settlement agreement, Borax has agreed to pay a portion of the Company's past
and future response costs at the site. At December 31, 2004 and 2003, the
Company's aggregate allowance for claims and liabilities for this site was
$1,588,000 and $3,415,000, respectively. Of this amount, $726,000 was billed,
but not yet paid, in respect of work related to the site through December 31,
2004.
At December 31, 2004, the Company has recorded a $905,000 receivable for the
portion of these amounts due from Borax under the settlement agreement.
On September 3, 2004, the United States Environmental Protection Agency
("USEPA") issued an order ("Order") requiring the Company and Borax to remediate
arsenic in the soils of a nearby residential neighborhood on an emergency basis.
On January 24, 2005, the USEPA issued a general notice letter ("Letter) to the
Company and Borax requesting that the Company and Borax perform a remedial
investigation and feasibility study on the soils of the same nearby residential
neighborhood on a non-emergency basis for matters not covered by the Order.
Neither the Order nor the Letter are covered by the Confidential Settlement
Agreement and Release between the Company and Borax.
The Company offered the USEPA $300,000 to settle the Company's obligations under
the Order and Letter. The USEPA has not yet responded to the Company's offer.
The Company believes, based on USEPA publications, that the USEPA has provided
$1,500,000 for past and future remediation activities in the residential
neighborhood. This amount does not necessarily represent the entire cost of the
cleanup being under taken by the USEPA. The entire cost could be higher or
lower. The USEPA could seek substantial penalties against the Company in
addition to remediation costs. The Company engaged an environmental engineering
consultant to review information available regarding the possible scope and cost
of USEPA activities. The consultant projected a range of possible costs of
$2,841,000 to $3,833,000. However, this estimate was based on limited data
available to the consultant. The Company has reserved $1,196,000 in connection
with the Order and Letter. This reserve amount takes into consideration the
estimated range of possible costs and the allocation of costs among PRPs for the
on-site remediation at the Lite Yard.
A former consultant for the Company at the Lite Yard, Exponent, Inc., filed suit
against the Company in Minnesota state court on January 27, 2005. The complaint
alleges that the Company owes Exponent $361,000 in unpaid consultant fees. CMC
has disputed the reasonableness of Exponent's invoices.
Miles City Yard
By letter dated June 10, 2004, the DEQ demanded that the Company perform a
remedial investigation of a railyard in Miles City, Montana previously owned and
operated by the Milwaukee Road. The Company has, for many years, been conducting
a clean-up of a substantial diesel fuel release at this site. On September 7,
2004, Trinity filed suit against the Company and CMC in Custer County, Montana
state court, for contribution under state environmental law, for indemnification
under sale agreements between the Company's predecessors-in-interest and
Trinity's alleged predecessors and for injunctive relief prohibiting the Company
from dissolving or making any distributions to its Unitholders. On September 14,
16
2004, Trinity filed a motion for a preliminary injunction to prohibit the
Company from liquidating or making distributions to its Unitholders. On January
10, 2005, the court held a hearing at which the Company's engineering witness
testified that the maximum cost of investigation and remediation could be as
much as $1,250,000. However, this estimate was not based on any direct
investigation of conditions at the site. On March 24, 2005, the court ordered
the Company to escrow cash, post a bond, or provide another guarantee, of
$2,500,000 to cover possible remediation and clean-up costs for the site. The
court did not make a determination as to the requirement for any remediation,
the costs of remediation or liability for any costs. The Company is considering
an appeal of this order and is negotiating a letter of credit to comply with the
terms of such order. The Company, based on current review of the site believes
that the range of costs of investigation and remediation, including the ongoing
diesel fuel clean-up could be between $618,000 and $1,740,000. At December 31,
2004, the Company's aggregate allowance for claims and liabilities for this site
(including costs of investigation, remediation and legal fees relating to the
litigation) is $618,000.
Bozeman
In 2001 the Company sold a 14 acre property to the City of Bozeman, Montana that
was known to be contaminated with asbestos ore. As part of the sale, the City of
Bozeman released the Company from all environmental liability. The City of
Bozeman performed a clean-up of the north half of the property. In September
2003, the Company received a letter from the DEQ requesting an investigation of
possible asbestos ore on the south half of the property sold to the City of
Bozeman and a neighboring property. By letter dated November 3, 2004, the
Company was notified by the DEQ that the City of Bozeman, Montana had initiated
a proceeding under the Montana Controlled Allocation of Liability Act ("CALA")
with regard to the sold property. In the administrative proceeding, DEQ will
allocate environmental liability among potentially liable parties. The Company
has projected that the total cost of the remediation already performed by the
City of Bozeman plus additional remediation which may be required for the south
half of the property is approximately within a range from $997,000 to
$1,645,000. The estimated range of costs for the neighboring property is
$120,000 to $219,000. The Company believes it has valid defenses to any CALA
allocated liability for the clean-up of the north half of the property and could
assert a claim against the City of Bozeman for liabilities for any clean-up of
the south half of the property. The Company has reserved an aggregate of
$332,000 for all claims and liabilities associated with this property and the
neighboring property. This reserve amount reflects the ranges of costs for both
on-site and off-site remediation and the Company's limited liability to the City
of Bozeman under the terms of the sale of the property to the City of Bozeman.
Other
The Canadian Pacific Railroad, formerly known as the Soo Line Railroad Company,
has asserted that the Company is liable for, among other things, the remediation
of releases of petroleum or other regulated materials at six different sites
located in Iowa, Minnesota and Wisconsin that Canadian Pacific acquired from the
Company. The Company has denied liability based on the underlying sale
agreement. The environmental claims are all currently being handled by Canadian
Pacific, and the Company understands that Canadian Pacific has paid settlements
on certain of these claims. Because Canadian Pacific has been handling these
matters exclusively, the Company has made no determination as to the merits of
the claims and is unable to determine their materiality.
In November 1995, the Company settled a claim with respect to the so-called
"Wheeler Pit" site near Janesville, Wisconsin. The Company's only outstanding
obligation under the settlement is to pay 32% of the monitoring costs for
twenty-five years beginning in 1997. At December 31, 2004, Heartland's allowance
for claims and liabilities for this site is $191,000. By letter dated April 6,
2005, the lead PRP at this site offered to settle the Company's future
obligations for approximately $266,000. Additionally, the lead PRP at this site
previously made a demand for monitoring costs of $53,000 incurred through March
of 2004. The Company has not paid any amounts to the PRP in respect of
monitoring costs for this site to date.
In addition to the environmental matters set forth above, there may be other
properties with environmental liabilities not yet known to the Company, with
potential environmental liabilities for which the Company has no reasonable
basis to estimate, or for which the Company believes it is not reasonably likely
to ultimately bear responsibility for the liability but the investigation or
remediation of which may require future expenditures. Management is not able to
express an opinion at this time whether the environmental expenditures for these
properties will or will not be material.
17
The Company has given notice to insurers, which issued policies to the Milwaukee
Road of certain of the Company's environmental liabilities. Due to the high
deductibles on these policies, the Company has not yet demanded that any insurer
indemnify or defend the Company. Consequently, management has not formed an
opinion regarding the legal sufficiency of the Company's claims for insurance
coverage.
Treatment of Certain Loans from HTI to Heartland
As of December 31, 2004 and 2003, HTI owes Heartland and CMC an aggregate of
$9,734,000 of which $8,464,000 relates to promissory notes issued in 2000 and
2001 (the "2000 Notes"). The notes are collateralized by a security interest in
the Class B Interest (the "Collateral") and bear interest at 13% per annum. The
Company also received as additional consideration for the 2000 Notes 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 was trading in the
over-the-counter market (after its delisting from the American Stock Exchange)
at less than $0.01 per share as of December 31, 2004. On February 25, 2002, the
Company and CMC demanded immediate payment in full of all obligations due under
the 2000 Notes from HTI.
PG Oldco, Inc., a creditor of HTI under notes in an aggregate principal amount
of $2,200,000 ("PG Oldco Notes"), also had a security interest in the Collateral
and had commenced steps to protect its interest. Under a Lien Subordination and
Inter-Creditor Agreement ("Inter-Creditor Agreement") by and among Heartland,
CMC, PG Oldco, Inc. and HTI, Heartland and CMC had 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). PG Oldco, Inc. had
a first and prior security interest in the Collateral and the proceeds thereof
for all amounts in excess of the Senior Debt Priority Amount. On May 23, 2003
Heartland purchased from PG Oldco, Inc. the PG Oldco Notes for approximately
$1,270,000. The purchase price consisted of $770,000 in cash paid on May 23,
2003 and a note payable for $500,000 due October 31, 2003. This note and accrued
interest were paid in full on October 31, 2003. The purchase price of $1,270,000
for the PG Oldco Notes was recorded as an increase in "Due from Affiliate" on
the Company's consolidated financial statements.
On April 16, 2004, the Company purchased the claims that an unrelated third
party maintained against HTI, the former general partner of Heartland, for
$70,000 which is included in general and administrative expense for the year
ended December 31, 2004. The claims include a $500,000 note (the "LZ debt
claim") and a "put" claim of approximately $13 million (the "LZ put claim"). HTI
disputes the validity of the LZ put claim. The Company purchased these claims
because it believes the value was reasonable and to preserve an orderly
liquidation of HTI given HTI's ownership of the limited liability companies
which hold the Company's Class B and General Partner interests.
Heartland has recorded an allowance for doubtful accounts of approximately
$7,234,000 and $5,133,000 on the 2000 Notes and PG Oldco Notes receivable
balance of $9,734,000 at December 31, 2004 and 2003, respectively. Heartland has
recorded an allowance for doubtful accounts against the 2000 Notes and PG Oldco
Notes because HTI has indicated to Heartland that it does not have the means to
repay the amounts owed under the 2000 Notes and PG Oldco Notes. A $5,000,000
allowance for doubtful accounts was recorded in the fourth quarter of 2003
following the sale of the Company's Fife, Washington property and the subsequent
cash distribution of $2.30 per Unit in December 2003 which reduced the estimated
amount of potential future distributions distributable to the Class B Interest.
An additional $2,101,000 was recorded in the fourth quarter of 2004 based on the
Company's continued operating losses, increased environmental expense and the
proposed settlement with HTI. Because Heartland intends to acquire the Class B
Interest from HTI either pursuant to a proposed settlement agreement between HTI
and certain of its creditors or upon a foreclosure of the Class B Interest, as
discussed below, Heartland has determined that the amount due from affiliate
should reflect the value of the Class B Interest based on the estimated amount
of potential future cash distributions distributable in respect of the Class B
Interest upon a liquidation of Heartland (assuming that the Class B Interest is
not cancelled and remains outstanding). In the event that the proposed
settlement agreement is not approved by HTI's other creditors, Heartland
anticipates that it will exercise its rights under the 2000 Notes, the PG Oldco
Notes, the related security agreements and applicable law to foreclose on the
Class B Interest. Upon either the acquisition of the Class B Interest pursuant
to the proposed settlement agreement or the foreclosure on the Class B Interest,
the receivable amount in respect of the 2000 Notes and the PG Oldco Notes
reflected in the "Due from Affiliate" account will be reduced to zero, and the
Class B Interest and the Class B Interest's capital account balance will be
cancelled. If cancelled, the Class B Interest will no longer be entitled to
receive any distributions of cash or other property from Heartland. Although
Heartland's management believes it is unlikely, there can be no assurance that
either the settlement agreement will be approved by HTI's creditors or that
Heartland will be able to foreclose on the Class B Interest. If the Class B
Interest is not foreclosed upon and cancelled, it will be entitled to receive
distributions in accordance with the terms of the partnership agreement.
18
HTI has proposed a settlement under which CMC would pay HTI $669,000 and release
its claims (including the LZ put claim, the LZ debt claim, the PG Oldco Claim
and the CMC loan). CMC would get the Class B Interest and HTI would transfer the
General Partner interest and Management Agreement to an entity controlled by
CMC's Board of Managers. This settlement has been approved by a committee of
independent members of HTII's Board of Managers subject to approval by the other
major creditors of HTI.
Jacobson Litigation
Edwin Jacobson, the former President and C.E.O. of CMC, has sued the Company
claiming that it owes him additional salary and incentive compensation based on
the terms of his employment contract. He has demanded $12,000,000 ($1,000,000
salary and $11,000,000 incentive compensation) in damages. The Company has
denied Mr. Jacobson's claims and has countersued to recover past payments made
to him and to collect $332,000 in principal and interest under a note Jacobson
made to the Company. The Company offered to settle the lawsuits in exchange for
forgiving Jacobson's debt to the Company. When it made the offer, the Company
established an allowance against the Note Receivable of $316,000. CMC has made
no other provision for this potential liability.
Critical Accounting Policies
The following section is a summary of critical accounting policies that require
management estimates and judgments.
o The Company provides an allowance for doubtful accounts against the
portion of accounts receivable that is estimated to be uncollectible.
Accounts receivable in the consolidated balance sheets are shown net
of an allowance for doubtful accounts of $354,000 as of December 31,
2004. Due from affiliate on the consolidated balance sheets are shown
net of an allowance for doubtful accounts of $7,234,000 as of December
31, 2004. The value of the Class B Interest, held as collateral for
the 2000 Notes and PG Oldco Notes, involve significant estimates by
the Company.
o Heartland evaluates environmental liabilities associated with its
properties on a regular basis. An allowance is provided with regard to
potential environmental liabilities, including remediation, legal and
consulting fees, 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 evaluated independently from any claim
the Company may have 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 a better estimate
than any other amount, then an allowance in the minimum amount of the
range is established.
o 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.
Results of Operations
Operations for the year ended December 31, 2004 resulted in a net loss of
($4,355,000). The loss was allocated to the Class B Interest in accordance with
the relevant provisions of the Partnership Agreement. For the year ended
December 31, 2003, operations resulted in a net loss of ($2,355,000) or ($1.10)
per Class A Unit. Operations for the year ended December 31, 2002 resulted in a
net loss of ($1,058,000) or ($0.50) per Class A Unit.
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Property Sales. Property sales decreased $28,645,000, or 88% to $4,035,000 for
year ended December 31, 2004 from $32,680,000 for the year ended December 31,
2003. There were several large sales that closed in 2003 including 3 acres of
land in Kinzie Station North for $9,850,000, 170 acres of land in Fife,
Washington for $13,250,000 and the conveyance of title to approximately 142
acres of land in Milwaukee, Wisconsin for $3,550,000. Property sales that closed
in 2004 include 2 acres of industrial land in Kinzie Station, Chicago, Il for
approximately $1,597,000, 6 acres in Milwaukee, WI for approximately $1,155,000,
21 acres in Rockford, Il. for approximately $180,000 and 11,777 acres of
non-contiguous land in 12 states for $250,000.
19
Cost of Property Sales. Cost of property sales decreased $22,388,000, or 94% to
$1,321,000 for year ended December 31, 2004 from $23,709,000 for year ended
December 31, 2003. This decrease was primarily the result of lower property
sales in 2004.
Gross Profit on Property Sales. Gross profit on property decreased $6,257,000,
or 70% to $2,714,000 for year ended December 31, 2004 from $8,971,000 for year
ended December 31, 2003. This decrease was primarily the result of lower
property sales in 2004 partly offset by a book loss of $4,000,000 on the
disposition of the Menomonee Valley property in Milwaukee, WI in 2003.
Selling Expenses. Selling expenses decreased $1,126,000, or 61% to $721,000 for
year ended December 31, 2004 from $1,847,000 for year ended December 31, 2003.
This decrease reflected lower sales activity in 2004 and the elimination of
sales expense from the Longleaf development which was sold in 2003.
General and Administrative Expenses. General and administrative expenses
decreased $42,000, or 1% to $3,391,000 for year ended December 31, 2004 from
$3,433,000 for year ended December 31, 2003. The decrease was primarily due to
slightly lower legal and consulting fees. The Company also had incurred large
payments in 2003 and 2004 under a Partnership Insurance program. These payments
will not recur in future years.
Interest Expense. Interest expense decreased $328,000, or 91% to $33,000 for
year ended December 31, 2004 from $361,000 for year ended December 31, 2003.
This decrease was primarily the result of the Company having no outstanding debt
during 2004. The $33,000 of interest expense in 2004 relates to fees payable in
connection with a line of credit.
Bad Debt Expense. Bad debt expense decreased $2,861,000, or 57% to $2,139,000
for year ended December 31, 2004 from $5,000,000, for year ended December 31,
2003. This decrease was primarily the result of the recording of an allowance
for doubtful accounts on the HTI note receivable of $2,101,000 in 2004 compared
to $5,000,000 recorded in 2003.
Real Estate Taxes. Real Estate taxes decreased $353,000, or 80% to $91,000 for
year ended December 31, 2004 from $444,000 for year ended December 31, 2003.
This decrease was the result of fewer properties being owned by the Company
during 2004, and the assumption of accrued real estate taxes by the buyer of
11,777 acres of Heartland's properties in 2004.
Environmental Expenses and Other Charges. Environmental expenses and other
charges decreased $786,000 or 48% to $863,000 for the year ended December 31,
2004 from $1,649,000 for the year ended December 31, 2003. Heartland spent
significant amounts on environmental remediation in 2004, but had reserved for
these expenditures in prior years. The Company also got the benefit of payments
from Borax for costs relating to remediation of the Lite Yard that had been
expensed in prior years.
Other Income and (Expenses). Total other income decreased $1,239,000, or 88% to
$169,000 for year ended December 31, 2004 from $1,408,000 for year ended
December 31, 2003. Other income for 2003 had included a gain on the
extinguishment of $1,500,000 of debt in connection with the sale of Longleaf in
North Carolina.
Net (loss) Income. Net loss increased $2,000,000 or 85% to $(4,355,000) for year
ended December 31, 2004 from $(2,355,000) for year ended December 31, 2003. The
increase was primarily due to lower property sales not being offset by lower
operating costs as well as an additional allowance of $2,101,000 for doubtful
accounts related to the HTI note receivable.
20
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Property Sales. Property sales increased $25,914,000, or 383% to $32,680,000 for
year ended December 31, 2003 from $6,766,000 for the year ended December 31,
2002. This increase was primarily the result of sales in 2003 consisting
primarily of approximately 3 acres of land in Kinzie Station North for
$9,850,000, 170 acres of land in Fife, Washington for $13,250,000 and the
conveyance of title to approximately 142 acres of land in Milwaukee, Wisconsin
for $3,550,000.
Cost of Property Sales. Cost of property sales increased $18,194,000, or 330% to
$23,709,000 for year ended December 31, 2003 from $5,515,000 for year ended
December 31, 2002. This increase was primarily the result of an increase in the
cost of property sales related to the above described three sales which totaled
approximately $17,500,000.
Gross Profit on Property Sales. Gross profit on property increased $7,720,000,
or 617% to $8,971,000 for year ended December 31, 2003 from $1,251,000 for year
ended December 31, 2002. This increase was primarily the result of an increase
in the gross profit recognized of approximately $9,150,000 on the above
described three sales.
Selling Expenses. Selling expenses increased $670,000, or 57% to $1,847,000 for
year ended December 31, 2003 from $1,177,000 for year ended December 31, 2002.
This increase was primarily the result of an increase in broker sales
commissions of $173,000 because of increased sales revenues, an increase in the
sales department legal fees of $174,000 because of the Company's decision in
2003 to sell several properties, and an increase of $348,000 in consulting,
security, architecture and surveying expenses that in 2002 had been capitalized
to development properties being expensed starting in 2003 because these
properties had been designated as held for sale.
General and Administrative Expenses. General and administrative expenses
increased $1,311,000, or 62% to $3,433,000 for year ended December 31, 2003 from
$2,122,000 for year ended December 31, 2002. This increase was primarily the
result of an increase in legal fees of $615,000 due to several lawsuits,
continuing legal matters such as the Edwin Jacobson, former C.E.O. and President
of the Company, and the RACM lawsuits and legal advice concerning the options
for the dissolution of the partnership, an increase in insurance expense of
$284,000 because of the Partnership Liability Insurance policy premium cost
increasing substantially and an increase in salary expense of $415,000 due to
the accrual by the Company of the Phantom Unit bonus expense to the four
officers covered by the Company's bonus plans in the amount of approximately
$436,000.
Interest Expense. Interest expense increased $322,000, or 826% to $361,000 for
year ended December 31, 2003 from $39,000 for year ended December 31, 2002. This
increase was primarily the result of the Company's decision in 2003 to sell
several properties, which resulted in interest that was capitalized in prior
years to development properties being expensed starting in 2003.
Bad Debt Expense. Bad debt expense increased $4,551,000, or 1,014% to
$5,000,000, for year ended December 31, 2003 from $449,000, for year ended
December 31, 2002. This increase was the result of the recording of an allowance
for doubtful accounts on the HTI note receivable of $5,000,000 see "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Summary of Significant Accounting Estimates-Treatment of certain
loans from HTI to Heartland".
Real Estate Taxes. Real Estate taxes increased $287,000, or 183% to $444,000 for
year ended December 31, 2003 from $157,000 for year ended December 31, 2002.
This increase was primarily the result of the Company's decision in 2003 to sell
several properties, which resulted in property taxes that were capitalized in
prior years to development properties being expensed starting in 2003.
Environmental Expenses and Other Charges. Environmental expenses and other
charges increased $1,887,000 to $1,649,000 for year ended December 31, 2003 from
$(238,000) for year ended December 31, 2002. This increase was primarily the
result of an increase in the amount of costs that will be incurred in the
environmental remediation of the Lite Yard site located in Minneapolis, MN.
Other Income and (Expenses). Total other income increased $11,000, or 0.8% to
$1,408,000 for year ended December 31, 2003 from $1,397,000 for year ended
December 31, 2002. This increase was primarily the result of the $1,500,000 gain
on the extinguishment of the LALP debt related to the sale of the CMCVII assets
on December 31, 2003 to NC One compared to the $1,137,000 gain recognized by the
Company on the sale of its interest in the Goose Island joint venture in 2002.
21
Net (loss) Income. Net loss increased $1,297,000 to $(2,355,000) for year ended
December 31, 2003 from $(1,058,000) for year ended December 31, 2002. This
increase was primarily the result of an increase in property sale revenues from
the sale of former development properties in 2003 compared to 2002 when none
were sold reduced by the $5,000,000 allowance for doubtful accounts recorded
related to the HTI note receivable balance in 2003 and the increase in
environmental expenses and other charges of $1,887,000.
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 $1,450,000 at December 31, 2004 compared to $3,926,000 as of December 31,
2003 and $751,000 (including $42,000 of restricted cash) as of December 31,
2002. The decrease in cash of $2,476,000 from December 31, 2003 to December 31,
2004 was primarily due to less cash generated from land sales during 2004
compared to 2003 which was not completely offset by lower cash costs and
expenses. The increase in cash of $3,175,000 from December 31, 2002 to December
31, 2003 was due to the Company retaining a part of the proceeds of the sale of
land a Fife, Washington for working capital. (See the Consolidated Statements of
Cash Flows).
Net cash used in operating activities was $2,476,000 for the year ended December
31, 2004 compared to $19,138,000 of net cash provided by operating activities
for the year ended December 31, 2003. Cash provided by operating activities from
2004 compared to 2003 decreased by $21,614,000 as a result of significantly
lower sales in 2004 that were not offset by lower costs. Cash provided by
operating activities in 2003 compared to 2002 increased by $21,429,000. This was
primarily due to housing inventories decreasing $7,671,000 in 2003 compared to
$3,176,000 in 2002, a difference of $4,495,000. The difference was attributable
to selling all the assets of CMCVII on December 31, 2003 to NC One and closing
10 home sales in Longleaf during 2003. Also, land held for sale decreased a
total of $12,281,000 in 2003 compared to an increase in land held for
development and sale of $3,739,000 in 2002, a difference of $16,020,000 (a
decrease in costs). The difference was attributable to having closed no sales of
land held for sale in 2002 compared to having closed the Fife, Washington
property (170 acres), 2 parcels in Kinzie Station North located in Chicago,
Illinois and the deeding of the Menomonee Valley property located in Milwaukee,
Wisconsin (142 acres) in 2003. (See the Consolidated Statements of Cash Flows).
The Company did not make any cash distributions to the Unitholders in 2004. On
August 11, 2003, Heartland declared a cash distribution of $1.05 per unit. On
September 15, 2003, it distributed approximately $2,231,000 in cash, which was
allocated 98.5%, to the Unitholders of record as of August 29, 2003, 1% to the
General Partner and 0.5% to the Class B Interest. On November 14, 2003,
Heartland declared another cash distribution of $2.30 per unit. On December 9,
2003, it distributed approximately $4,885,000 in cash, which was allocated 98.5%
to the Unitholders of record as of November 28, 2003, 1% to the General Partner
and 0.5% to the Class B Interest. The Company's 2003 distributions were greater
than in any past year. Unitholders should not expect the 2003 level of
distributions on an annual basis.
Gross proceeds from property sales provided cash flow of $4,035,000 in 2004,
$32,680,000 in 2003 and $6,766,000 in 2002. During the years 2005 and 2006, the
Company expects proceeds from property sales to consist primarily of the sale of
the remaining Kinzie Station North acreage, Kinzie Station Phase II property,
three remaining sites in Illinois, Wisconsin and Minnesota (one in each state)
and 166 acres of scattered land parcels located in 9 states, fiber optics rights
and additional compensation from the appeal of the RACM condemnation of property
in Milwaukee, Wisconsin.
The cost of property sales in 2004 was $1,321,000 or 33% of sales proceeds;
$23,709,000 or 73% of sales proceeds in 2003 and in 2002 $5,515,000 or 82% of
sales proceeds. Future cost of sales ratios for the remaining real estate sales
may vary from ratios experienced in the prior three years depending on which
sales close. The balance of Heartland's real estate is former development
properties as were the major property sales that took place during the years
2004, 2003 and 2002.
Portfolio income is derived principally from interest earned on certificates of
deposit and investment of cash not required for operating activities in
overnight investments. Portfolio income for 2004 was $27,000, compared to
$30,000 for 2003 and $308,000 for 2002. The decrease in portfolio income from
2002 to the year 2003 of $278,000 is mainly attributable to a decrease in
interest earned on the HTI note receivable of $270,000. Heartland stopped
accruing interest on the HTI note receivable April 1, 2002 due to the
uncertainty regarding the collectibility of the HTI note receivable.
22
As of December 31, 2004, Heartland had designated 4 sites, or approximately 50
acres with a book value of approximately $5,912,000, for sale. These properties
are located in Illinois, Wisconsin and Minnesota, and 166 acres are scattered
land parcels throughout 9 states. The Company intends to dispose of land held
for sale in an orderly fashion; however, the Company anticipates that the
disposal of such properties may extend beyond the year 2005.
In March 2004, the Company obtained a $2,000,000 line of credit with LaSalle
National Bank ("LNB"). The line of credit matured December 1, 2004 and bore
interest at the prime rate plus 1.5% (7.25% at December 31, 2004). The LNB line
of credit was secured by the Kinzie Station North and Kinzie Station Phase II
properties that are located in Chicago, Illinois. LNB also required the Company
to maintain net worth (defined as assets minus liabilities) of $5,500,000,
maintain net income of $1,000,000 during any fiscal year beginning with the year
ending December 31, 2003, can not make any advances or distributions to
Unitholders or members from funds borrowed under the line of credit, and various
other covenants described in the Secured Revolving Note document. The Company
did not draw on the LNB line of credit.
The Company's management intends to sell to unrelated third parties the
remainder of its properties with a view towards eventually dissolving the
partnership within the next two years. The Unitholders will not have control
over the divestiture of the Company's remaining assets or, if the partnership is
dissolved, the liquidation process. The Company cannot make any assurance that
changes in its policies will serve fully the interests of all Unitholders or
that the Unitholders will receive any liquidating distributions of cash or other
property. The Company is working to resolve its remaining liabilities which
primarily consist of environmental matters and Edwin Jacobson's claim against
the Company. In addition, the Company is pursuing recovery on the RACM claim it
has against local governmental units in Wisconsin and foreclosing on its Class B
Partnership Interest. Significant estimates are used in the preparation of
financial statements to value the Class B Interest which represents the
collateral of the HTI note receivable owed to the Company and CMC, the
recoverability of the total cost of properties and the Company's environmental
liabilities. The amount and timing of any future cash distributions will depend
on generation of cash from sales and claims and the resolution of liabilities.
The Company has experienced recurring operating losses for the years ended
December 31, 2004, 2003, and 2002 and there can be no assurance that the amounts
available from internally generated funds, cash on hand, and sale of the
remaining assets of the Company will be sufficient to fund Heartland's
anticipated operations and meet existing and future liabilities. These losses,
uncertainty as to the amount and timing of additional compensation from the RACM
claim, if any, and the uncertainty surrounding such environmental liabilities
and other claims, particularly the Edwin Jacobson lawsuit, create uncertainties
about the Company's ability to meet existing and future liabilities as they
become due. The Company has taken certain steps, including the reduction of
fixed overhead and conservation of cash, in light of these uncertainties. The
Company may be required to seek additional capital in the form of bank
financing, however, there is no assurance that such bank financing will be
available or, if available, will be on terms favorable to the Company.
Interest Rate Sensitivity
The Company's total consolidated indebtedness at December 31, 2004 was zero.
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".
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements of the Company and the related notes,
together with the Report of Independent Registered Accounting Firm thereon, are
set forth beginning on page 52 of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
Heartland's Chief Executive Officer has evaluated the Company's disclosure
controls and procedures as of the end of the period covered by this report and
they have concluded that these controls and procedures are adequate to ensure
that information required to be disclosed by Heartland in the reports that it
files or submits under the Securities and Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported, within the time periods specified
in the Securities and Exchange Commission's rules and forms.
Changes in Internal Control over Financial Reporting
In the fourth quarter of 2004, the Company's Chief Financial Officer resigned
and the Company engaged RSM McGladrey to perform accounting services. Although
the Company has experienced delays in the compilation of its financial
statements for 2004 due to this transition, there have been no changes in
internal control over financial reporting that occurred during the fourth
quarter of 2004 that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
23
ITEM 9B. OTHER INFORMATION.
In December 2004, the Company extended the term of the Company's 2002 Incentive
Plan until December 31, 2006. The same employees continue to be covered under
the plan.
In December 2004, the Company granted its President, Richard Brandstatter, a
$45,000 bonus for certain tasks completed during the year and approved the terms
of a consulting agreement, pursuant to which Mr. Brandstatter (following his
resignation effective January 1, 2005) will receive an annual consulting fee of
$100,000 for consulting services and will be eligible to receive up to an
additional $30,000 upon the completion of certain identified tasks.
24
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Heartland does not have a Board of Directors.
Set forth below is information for each director of HTI, each manager of HTI
Interests, LLC and each executive officer of HTI and Heartland. Directors of HTI
and managers of HTII are not compensated by Heartland.
Principal Occupation, Business
Name and Age Experience and Directorships
------------ ----------------------------
Lawrence S. Adelson, 55........ Chief Executive Officer of the Company since February, 2002; Manager of HTI
Interests, LLC since February, 2002; Chairman of the Board and Chief
Executive Officer of HTI since February, 2002; Director of HTI since
February, 2002; Vice President and General Counsel of the Company (June, 1990
- February, 2002); Vice President and General Counsel of HTI (October, 1988 -
February, 2002).
Richard P. Brandstatter, 49.... Former President of the Company from March 2003 to December 2004; Chief
Financial Officer of the Company from November 2004 to December 2004; Vice
President - Finance, Treasurer and Secretary of HTI since February, 1999;
Director of HTI since June, 2002, Vice President - Finance, Treasurer and
Secretary of the Company (August, 1995-March, 2003).
Daniel L. Bernardi, 50......... Former Chief Financial Officer of the Company from March 2003 to November
2004. Controller of the Company (September, 1998-March, 2003)
Charles J. Harrison, 47........ Vice President Real Estate, General Counsel and Secretary of the Company
since March, 2002. President of Power Mart Real Estate Corporation August,
2001, to February, 2002. General Counsel and prior positions with the
Company October 1990 to July 2001.
Thomas F. Power, 64............ Manager of HTI Interests, LLC since July 2003; Member of the Audit Committee
of HTII since July 2003. Trustee, Mexrail Independent Voting Trust. Former
President and CEO and Director of Wisconsin Central Transportation
Corporation (1999-2001).
George Lightbourn, 53.......... Manager of HTI Interests, LLC and Member of the Audit Committee of HTII since
2004. Currently President of Gaming Informatics, LLC; Senior Fellow with the
Wisconsin Policy Research Institute. Served as Secretary of the Wisconsin
Department of Administration (January 2000-January 2003). Deputy Secretary
of the Department of Administration (1995-1999). Currently serving on board
of Madison Cultural Arts District Board, the Monona Economic Development
Committee and SpaceMetrics.
Ezra K. Zilkha, 79............. Manager of HTI Interests, LLC and Member of the Audit Committee of HTII since
2002. Former Director of HTI (Class II) (October, 1988-June, 2002); Retired
as Chairman of the Board of the Company on February 25, 2002; Former chairman
of the compensation committee of HTI; Manager of HTI Interests, LLC;
President and Director (since 1956), Zilkha & Sons, Inc. (private
investments), New York, New York. Mr. Zilkha formerly served as a director
of the Newhall Land and Farming Company.
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Resignations
Daniel L. Bernardi, Chief Financial Officer, resigned on December 30, 2004.
Richard P. Brandstatter, resigned as President of the Company effective January
1, 2005. Mr. Brandstatter remains a member of the Board of Managers of the
Company and will have a consulting relationship with the Company as described
above. Neither of these positions will be replaced in light of the continuing
wind down of the Company's operations.
Identification of the Audit Committee
The General Partner's board of managers has designated a standing audit
committee for the Company consisting of Ezra Zilkha, Thomas F. Power and George
Lightbourn. Ezra Zilkha and Thomas Power have been designated as the audit
committee financial experts serving on the Company's audit committee. Refer to
Item 10. above for Mr. Power's, and Mr. Zilkha's qualifications.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires certain officers
and directors of Heartland Technology, Inc., managers of HTI Interests, LLC and
any persons who own more than ten-percent of the Units to file forms reporting
their initial beneficial ownership of Units and subsequent changes in that
ownership with the Securities and Exchange Commission and the American Stock
Exchange. Officers and directors of Heartland Technology, Inc., managers of HTI
Interests, LLC and greater than ten-percent beneficial owners are also required
to furnish the Company with copies of all such Section 16(a) forms they file.
Based solely on a review of the copies of the forms furnished to the Company, or
written representations from certain reporting persons that no Forms 4 or 5 were
required, the Company believes that during the 2004 fiscal year all section
16(a) filing requirements were complied with.
Code of Ethics
The Company has adopted a code of ethics, which is attached as an exhibit to
this Form 10-K, that applies to each of the Company's executive officers.
ITEM 11. EXECUTIVE COMPENSATION.
The following information is furnished as to all compensation awarded to, earned
by or paid to the Chief Executive Officer of CMC and the three other executive
officers 2004 compensation greater than $100,000.
Name And Annual Compensation All Other
Principal Position Year Salary Bonus Compensation (1)
------------------ ---- ------ ----- ----------------
Lawrence S. Adelson 2004 $ 200,000 $ -- $ 3,250
Chief Executive Officer 2003 200,000 545,000 (2) 2,400
2002 194,000 -- 2,000
Richard P. Brandstatter 2004 $ 168,400 $ 76,600 (3) $ 14,050 (4)
Former President 2003 134,000 655,000 (5) 13,800 (6)
2002 121,000 12,900 (7) 2,500
Daniel L. Bernardi 2004 $ 88,389 $ 30,000 (8) $ 2,030
Former Chief Financial Officer 2003 100,000 10,000 (9) 3,000
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Charles J. Harrison 2004 $ 152,000 $ 25,600 (10) $ 3,000
Vice President Real Estate, 2003 $ 150,000 $ 205,000 (11) $ 3,000
General Counsel and Secretary 2002 109,000 21,900 (12) 2,800
__________________________
(1) Unless otherwise noted, "All Other Compensation" is comprised of CMC's
contribution on behalf of the officers to a salary reduction plan qualified
under Sections 401(a) and (k) of the Internal Revenue Code of 1986. Columns
for "Other Annual Compensation", "Restricted Stock Awards", "Options/SARS"
and "Payout-LTIP Payout" are omitted since there was no compensation
awarded to, earned by or paid to any of the above named executives required
to be reported in such columns in any fiscal year covered by the table.
(2) Includes $335,000 payable in respect of 100,000 "phantom" units, or the
economic (but not tax) equivalent of 100,000 Units, awarded under Mr.
Adelson's employment agreement, and $210,000 payable in respect of the CMC
Plan.
(3) Represents $45,000 of special compensation bonus approved by the managers
of the Company's general partner, $25,600 related to the 2002 CMC Plan and
6,000 other bonus income.
(4) Includes $10,800 for an automobile allowance.
(5) Includes $621,500 payable in respect of the CMC Plan, the 2002 CMC Plan and
individual merit bonuses, and $33,500 in respect of 10,000 "phantom" units,
or the economic (but not tax) equivalent of 10,000 Units awarded under the
2002 CMC Plan.
(6) Includes $10,800 for an automobile allowance.
(7) Includes $12,900 payable in respect of the CMC Plan.
(8) Includes a $30,000 severance payment.
(9) Includes a $10,000 performance bonus.
(10) Amounts due under 2002 CMC Plan.
(11) Includes $171,500 payable in respect of the 2002 CMC Plan and $33,500 in
respect of 10,000 "phantom" units, or the economic (but not tax) equivalent
of 10,000 Units, awarded under the 2002 CMC Plan.
(12) Includes amounts payable in respect of the 2002 CMC Plan.
Under a deferred salary arrangement available to all employees, Mr. Adelson
deferred approximately $27,000 of his 2001 salary into 2002 and $17,000 of his
2003 salary into 2004. Also, Mr. Adelson, Mr. Brandstatter, Ms. Susan
Tjarksen-Roussos and Mr. Harrison deferred payment of accrued bonuses from 2003
to 2004 in the amounts of $417,000, $432,000, $265,000 and $42,000,
respectively.
Effective March 1, 2002, an employment agreement with Lawrence S. Adelson, Chief
Executive Officer of CMC, was approved by the HTII Board of Managers. The term
of the employment agreement is from March 1, 2002 to June 27, 2005 and his
salary is $200,000 per year. His incentive compensation is the economic (but not
tax) equivalent of ownership of 100,000 (non-voting) Heartland Class A
Partnership Units and is payable at the time of any distributions to the
Unitholders. These "phantom" Units are accounted for in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and related Interpretations. Compensation expense is recognized when
the amount of the underlying distribution is probable and estimable.
Heartland does not maintain any p