Heartland Partners, L.P., a Delaware limited partnership (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 saleable real estate holdings with a view towards dissolving the partnership. The Company is undertaking to resolve its remaining liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidation of Assets and/or Bankruptcy." The Company has engaged a consultant and a law firm to advise it on procedures for dissolution and expects to begin that process in the second quarter of 2006. 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, if any, to the Company's Unitholders will depend on generation of cash from sales of real estate holdings and the resolution of liabilities and associated costs. The Company does not plan to distribute cash to Unitholders before entering dissolution.
CMC/Heartland Partners Holdings, Inc., a Delaware corporation and sole general partner of Heartland (the "General Partner" or "Holdings"), is owned by the four current members of Holdings board of directors. Previously, HTI Interests LLC, a Delaware limited liability company ("HTII"), was the sole general partner of the Company. HTII is owned 99.9% by Heartland Technology, Inc. ("HTI"), a Delaware corporation that filed for bankruptcy on June 15, 2005, and 0.1% by HTI Principals, Inc., a Delaware corporation owned by Lawrence S. Adelson, Richard Brandstatter, George Lightbourn, Thomas Power, Jr. and one former member of HTI's board of directors. HTII also owned 0.01% of CMC. On November 14, 2005, HTII transferred its general partnership interests in the Company and CMC to Holdings making Holdings the sole general partner of the Company. Lawrence S. Adelson, Richard Brandstatter, George Lightbourn and Thomas Power, Jr. each own 25% of Holdings, and each paid $25 for their interests.
CMC Heartland Partners, a Delaware general partnership ("CMC"), is an operating general partnership owned 99.99% by Heartland and 0.01% by Holdings.
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:
COMPANY DEVELOPMENT LOCATION OWNERSHIP ------- -------------------- ---------
HDC Not Applicable 100% (1) CMCIII Chicago, Illinois 100% (2)
(1) Stock wholly owned by Heartland. (2) Membership interest owned by CMC.
PARTNERSHIP AGREEMENT AND CASH DISTRIBUTIONS
Heartland's partnership agreement previously provided generally that Heartland's net income (loss) would 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"). Following the cancellation of the Class B Interest in connection with the settlement of claims by and against HTI (see "HTI Settlement" below), the partnership agreement was amended to provide that net income (loss) will be allocated 1% to the General Partner and 99% to the Unitholders. The partnership agreement provides that certain items of deduction, loss, income and gain may be specially allocated to the Unitholders or the General Partner. The Company has never made any special allocation of deduction, income, loss or gain and does not have any plan to do so. 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, 2005, the Unitholders' capital account balance was $424,000, 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 99% to the Unitholders 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 2005 or 2004.
HTI SETTLEMENT
Heartland Technology, Inc. ("HTI"), through a subsidiary, owned the general partner interests in Heartland and CMC and the Class B Interest in Heartland. In June 2005, HTI filed for liquidation under Chapter 11 of the federal bankruptcy law. On November 15, 2005, a settlement approved by the bankruptcy court was closed. CMC and Heartland made a payment to HTI and forgave outstanding claims against HTI. HTI transferred the general partner interests to CMC/Heartland Partners Holdings, Inc. HTI transferred the Class B Interest to Heartland and Heartland cancelled it. These transactions are discussed in more detail in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation" and the Notes to Financial Statements.
REAL ESTATE SALE ACTIVITIES
Property sales during 2005 totaled approximately $5,513,000. Major 2005 sales included Kinzie Station Phase II, Chicago, IL for $4,200,000, Lite Yard, Minneapolis, MN for $490,000 and Glendale Yard, Glendale, WI for $650,000. 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 appeal was settled in January 2006 with RACM making an additional payment of $3.25 million on March 2, 2006. The RACM settlement will be reflected in the Company's first quarter 2006 financial statements.
The Company also donated a property in Deer Lodge, Montana to a local government in 2005. The Company did not receive any cash for the donation, but the local government assumed responsibility for any environmental liabilities associated with the property. This property was carried at historical cost, as adjusted for net realizable value. The transaction resulted in the Company reducing the recorded environmental liability of $119,000 to $0.
The Company also realized $430,000 from the sale of 4,000 square feet of office space in Kinzie Station Phase I. The sale of the office space is treated as gain on sale of assets as it was formerly used by the Company for its offices.
The Company's remaining properties consist of approximately 3 acres located at Kinzie Station in Chicago, Illinois, along with associated air rights, and approximately 131 acres of land and easements scattered over 9 states.
The Company also owns rights to lease or sell easements for fiber optics lines on a 70-mile commuter rail system in the Chicago area. The Company receives 2/3 of any consideration from such easements. The owner of the right of way receives the other third.
OTHER ACTIVITIES
At December 31, 2005, the allowance for claims and liabilities established by Heartland for environmental and other contingent liabilities totaled approximately $2,128,000. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." Given the uncertainty inherent in litigation and environmental remediation, resolution of these matters could require funds greater or less than the $2,128,000 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 1A. Risk Factors - Environmental Liabilities" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Summary of Significant Accounting Estimates - Reserve for Environmental Liabilities".
EMPLOYEES
At December 31, 2005, Heartland employed 2 people.
ITEM 1A. 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.
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 that 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 provide any assurance that additional 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 "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Summary of Significant Accounting Estimates - Reserve for Environmental Liabilities".
PENDING LITIGATION
The Jacobson litigation, as well as the other litigation disclosed in "Item 3. Legal Proceedings", 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 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 has posted a letter of credit to comply with the terms of such order.
ACCESS TO FINANCING
As of December 31, 2005, 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 and meet existing and future liabilities. 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.
The Company has obtained a $2.5 million letter of credit from LaSalle Bank, NA to comply with an order of a state court in Montana in connection with litigation over the Miles City Yard. See "Item 3. Legal Proceedings--Miles City Yard" for more information.
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 its cash flows from operations would have an adverse effect on its ability to service any future debt, and to meet working capital requirements.
LIQUIDATION OF ASSETS
The Company's management expects to sell to unrelated third parties the remainder of its saleable properties with a view towards dissolving the partnership. The Company has engaged a consultant and a law firm to advise it on procedures for dissolution and expects to begin the process in the second quarter of 2006. The Company may soon be required to use a liquidation basis of accounting in light of the foregoing. As part of any dissolution and liquidation, the Company will need to make reasonable provisions to pay all claims and obligations, which include contingent and conditional claims as well as unknown claims that may arise after dissolution. The consequence is that Unitholders may not receive any distributions, or if they do, the distributions may be lower than the true value of the Units. Because the amount of reserve required is uncertain, the Company may reserve a higher amount than necessary. The Company does not plan on distributing cash to Unitholders before entering dissolution. Its ability to make cash distributions during dissolution will depend on resolution of claims and liabilities. Alternatively, the Company may determine to dissolve and 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. However, even in the context of a bankruptcy proceeding, the Company will still face uncertainty, especially with respect to the environmental claims. Additionally, under any liquidation scenario, 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 under any liquidation scenario the Unitholders will receive any liquidating distributions of cash or other property, or if they do, that the distributions will reflect the true value of the Units.
The Company is working to resolve its remaining liabilities which primarily consist of environmental matters and Edwin Jacobson's claim against the Company. Significant estimates are used in the preparation of financial statements to value the Company's environmental liabilities. The amount and timing of future cash distributions, if any, to the Company's Unitholders will depend on generation of cash from sales of real estate holdings and the resolution of liabilities and associated costs. The Company has experienced recurring operating losses for the years ended December 31, 2005, 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, 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 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.
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.
CONFLICTS OF INTEREST OF GENERAL PARTNER AND ITS OFFICERS AND DIRECTORS
The officers and directors of CMC/Heartland Partners Holdings, Inc., including Lawrence S. Adelson, President and a director of CMC/Heartland Partners Holdings, Inc., will not devote their entire business time to the affairs of Heartland. The Heartland Partnership Agreement provides that (i) whenever a conflict of interest exists or arises between the General Partner or any of its affiliates, on the one hand, and Heartland or any Unitholder on the other hand, or (ii) whenever the Heartland Partnership Agreement or any other agreement contemplated therein provides that the General Partner shall act in a manner which is, or provide terms which are, fair and reasonable to Heartland, or any Unitholder, the General Partner shall resolve such conflict of interest, take such action or provide such terms, considering in each case the relative interests of each party (including its own interest) to such conflict, agreement, transaction or situation and the benefits and burdens relating to such interests, any customary or accepted industry practices, and any applicable generally accepted accounting practices or principles. Thus, unlike the strict duty of a fiduciary who must act solely in the best interests of his beneficiary, the Heartland Partnership Agreement permits the General Partner to consider the interests of all parties to a conflict of interest, including the General Partner. The Heartland Partnership Agreement also provides that, in certain circumstances, the General Partner will act in its sole discretion, in good faith or pursuant to other appropriate standards. The General Partner has sole authority over the timing and amount of distributions as well as dissolution of the partnership.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not Applicable.
