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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
[ ] 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: 1-10643
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HALLWOOD REALTY PARTNERS, L.P.
(Exact name of registrant as specified in its charter)
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DELAWARE 75-2313955
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3710 RAWLINS
SUITE 1500
DALLAS, TEXAS 75219-4298
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 528-5588
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange on
Title of each class which registered
- ------------------------------------------------ ------------------------
UNITS REPRESENTING LIMITED PARTNERSHIP INTERESTS AMERICAN STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
----
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. X
---
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act): Yes X No
--- ---
The aggregate market value of units held by nonaffiliates of the registrant as
of June 28, 2002 was $86,860,000.
CLASS: UNITS REPRESENTING LIMITED PARTNERSHIP INTERESTS.
OUTSTANDING AT MARCH 14, 2003: 1,593,948 UNITS.
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Page 1 of 45
HALLWOOD REALTY PARTNERS, L.P.
FORM 10-K
TABLE OF CONTENTS
<Table>
<Caption>
Page
----
PART 1
Item 1 Business 3
Item 2 Properties 6
Item 3 Legal Proceedings 7
Item 4 Submission of Matters to a Vote of Security Holders 8
PART II
Item 5 Market for Registrant's Units and Related Security Holder Matters 8
Item 6 Selected Financial Data 9
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 7a Quantitative and Qualitative Disclosures about Market Risk 17
Item 8 Financial Statements and Supplemental Information 18
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures 39
PART III
Item 10 Directors and Executive Officers of the Registrant 40
Item 11 Executive Compensation 41
Item 12 Security Ownership of Certain Beneficial Owners and Management 43
Item 13 Certain Relationships and Related Transactions 44
Item 14 Controls and Procedures 44
PART IV
Item 15 Exhibits, Financial Statement Schedule and Reports on Form 8-K 44
</Table>
Page 2 of 45
PART I
ITEM 1. BUSINESS
DESCRIPTION OF THE BUSINESS
Hallwood Realty Partners, L.P. ("HRP"), a publicly traded Delaware limited
partnership, operates in the commercial real estate industry. HRP's activities
include the acquisition, ownership and operation of its commercial real estate
assets. Units representing limited partnership interests are traded on the
American Stock Exchange under the symbol "HRY".
As of December 31, 2002, HRP owned 14 real estate properties (the "Properties")
located in six states containing 5,199,000 net rentable square feet (for
additional information, see Item 2 - Properties). HRP seeks to maximize the
value of its real estate by making capital and tenant improvements, by executing
marketing programs to attract and retain tenants, and by controlling or
reducing, where possible, operating expenses.
Hallwood Realty, LLC ("Realty" or the "General Partner"), a Delaware limited
liability company and indirectly wholly-owned subsidiary of The Hallwood Group
Incorporated ("Hallwood"), is HRP's general partner and is responsible for asset
management of HRP and its Properties, including decision-making responsibility
for financing, refinancing, acquiring and disposing of properties. In addition,
Realty provides general operating and administrative services to HRP. Hallwood
Commercial Real Estate, LLC ("HCRE"), another indirectly wholly-owned subsidiary
of Hallwood, provides property management, leasing and construction supervision
services to the Properties.
RISKS, COMPETITION AND OTHER FACTORS
DETERIORATION IN ECONOMIC CONDITIONS AND THE REAL ESTATE MARKETS COULD HARM
HRP'S BUSINESS.
The commercial real estate industry is sensitive to a number of factors relating
to global, national, regional and local general and economic conditions,
including war, threat of war, inflation, interest rates, taxation policies,
availability of credit, employment levels, and wage and salary levels. A
negative trend in any of these conditions could adversely affect HRP's business.
If a substantial number of tenants default on their leases, choose not to renew,
or if rental rates decrease, HRP's financial position could be adversely
affected. Such effects could include a decline in acquisition, disposition and
leasing activity; a decline in the supply of capital invested in commercial real
estate; or a decline in the value of real estate.
HRP's cash flow would be adversely affected by decreases in the performance of
the properties it owns. Property performance typically depends upon the ability
to attract and retain creditworthy tenants; the ability to manage operating
expenses; the magnitude of defaults by tenants under their respective leases;
governmental regulations; the nature and extent of competitive properties;
financial and economic conditions generally and in the specific areas where
properties are located; and the real estate market generally. Expenses may
increase due to unexpected or higher repairs and maintenance costs, inflation,
services and costs required to retain tenants or to sign new tenants,
unsuccessful appeals of rising real estate taxes, changes in interest rates,
higher insurance costs, the outcome of existing or future litigation, as well as
other factors, many of which are beyond the control of HRP.
HRP MAY BE SENSITIVE TO CHANGES IN INTEREST RATES.
Because only one of its mortgage loans has a floating interest rate, HRP's
exposure to changes in market interest rates is limited to the difference
between the market rate in effect at the time a loan matures compared to its
existing loan rate. As of December 31, 2002, HRP had mortgage loans totaling
$172,552,000 with fixed interest rates from 6.97% to 8.7% (with an effective
average interest rate of 8.21%). These loans mature between 2005 and 2020. At
the time of loan maturity, a higher market interest rate compared to the
existing rate will have a negative impact on the amount of mortgage proceeds
secured from a refinancing, as well as a decrease in cash flow from future
operations due to the higher interest rate.
A $25,000,000 mortgage loan secured by Allfirst Building bears interest at LIBOR
plus 130 basis points, and therefore HRP's actual cash interest costs are
affected by changes in market interest rates. The interest rate for this loan
was 2.68% as of December 31, 2002. Assuming a 100 basis point, or 1%, change in
LIBOR, interest paid by HRP would increase or decrease by $250,000 on an annual
basis.
Page 3 of 45
RISKS, COMPETITION AND OTHER FACTORS (CONTINUED)
INSURANCE RISKS HAVE INCREASED AS A RESULT OF RECENT EVENTS.
Due in large part to the terrorist activities of September 11, 2001, insurance
companies have re-examined many aspects of their business and have taken certain
actions in the wake of these terrorist activities, including increasing
premiums, mandating higher self-insured retentions and deductibles, reducing
limits, restricting coverages, imposing exclusions (such as sabotage and
terrorism), and refusing to underwrite certain risks and classes of business.
Significantly increased premiums, mandated exclusions, or changes in limits,
coverages, terms and conditions could adversely affect HRP's ability to obtain
appropriate insurance coverages. However, at this time the only impact on HRP
has been an increase in premiums. HRP has $250,000,000 of terrorism insurance
coverage.
HRP MAY INCUR ENVIRONMENTAL LIABILITY IN ITS ROLE AS A PROPERTY OWNER.
Various national, state and local laws and regulations impose liability on real
property owners, such as HRP, for the cost of investigating, cleaning up or
removing contamination caused by hazardous or toxic substances. The liability
may be imposed even if the original actions were legal and HRP did not know of,
or was not responsible for, the presence of such hazardous or toxic substances.
HRP may also be solely responsible for the entire payment of the liability if it
is subject to joint and several liability with other responsible parties who are
unable to pay. HRP may be subject to additional liability if it fails to
disclose environmental issues to a buyer or lessee of property or if a third
party is damaged or injured as a result of environmental contamination emanating
from the site. HRP cannot be sure that any of such liabilities to which it may
become subject will not have a material adverse effect upon its business,
results of operations or financial condition.
Parklane Towers, as well as certain other properties to a lesser extent, are
known to contain asbestos. Removal of asbestos at HRP's properties is not
required because it is cementitious, it is not friable and because the
procedures in HRP's site environmental program Operations and Maintenance Manual
are performed as required.
HRP MAY HAVE DIFFICULTY DISPOSING OF ASSETS WHEN IT HAS TO DO SO.
HRP's basic investment strategy is to hold real estate assets until what it
believes to be an optimal time to sell them. Normally, this will be during
relatively strong real estate markets. However, factors beyond HRP's control
could make it necessary for HRP to dispose of real estate properties during weak
markets. Further, markets for real estate assets are not usually highly liquid,
which can make it particularly difficult to realize acceptable prices when
disposing assets during weak markets.
IF HRP DOES NOT GENERATE SUFFICIENT CASH FLOWS FROM OPERATIONS, IT MAY NEED
ADDITIONAL CAPITAL.
To date, HRP has financed its operations with cash from profitably operating its
established properties. If HRP does not generate enough cash from operations to
finance its business in the future, it will need to raise additional funds
through public or private financing or asset sales. If HRP borrows money, it may
be required to agree to restrictions limiting its operating flexibility. If HRP
requires additional funds and is not able to obtain such funds, it would have a
material adverse effect on its operations.
SOME OF HRP'S LOANS CONTAIN COVENANTS AND RESTRICTIONS, WHICH AFFECT
FLEXIBILITY.
HRP has two mortgage loans that require compliance with a loan covenant, which
if not met will trigger a default. The loans require the properties securing
each loan to maintain a liquidity ratio, specifically a debt service coverage
ratio. A debt service coverage ratio is the relationship of adjusted net
operating income (as defined in each loan agreement) for the previous 12 months
to the loan's annual debt service. The ratio, for a loan requiring a minimum
1.15 ratio, was 2.25, 2.35, and 2.19 for 2002, 2001, and 2000, respectively. The
ratio, for a loan requiring a minimum 1.10 ratio, was 2.39, 1.94, and 2.45 for
the same periods. Accordingly, HRP was in compliance with these loan covenants
for the three years ended December 31, 2002. As of December 31, 2002, the
outstanding balance of the loans is $111,553,000.
Additionally, these two mortgage loans contain restrictions that limit certain
actions. With respect to the properties encumbered by these loans, HRP cannot
incur additional debt. Also, HRP's ability to sell a property, or a portion
thereof, is limited because of the requirement to substitute collateral with
substantial penalty. These loans also, under certain circumstances, may restrict
the ability of HRP to merge, to consolidate or to liquidate.
Page 4 of 45
RISKS, COMPETITION AND OTHER FACTORS (CONTINUED)
HRP IS SUBJECT TO LITIGATION.
HRP is currently a party to certain litigation in Delaware state court, as
described more fully in Item 3 - Legal Proceedings. The trial court in that
matter ruled that the defendants other than HRP pay a judgment in the amount of
$3,417,423, plus pre-judgment interest from August 1995 to HRP. The plaintiff
and certain defendants have appealed that ruling. In October 2001, HRP received
the $3,417,423 judgment together with $2,987,576 of pre-judgment and
post-judgment interest, subject to an arrangement that it be returned in full or
part if the judgment is modified or reversed on appeal. If the appellate court
reverses the judgment, any subsequent ruling by the trial court on remand may be
more or less favorable to HRP.
HRP IS SUBJECT TO COMPETITION.
The Properties are subject to substantial competition from similar properties in
the vicinity in which they are located. In addition, there are numerous other
potential investors seeking to purchase improved real property and many property
holders seeking to dispose of real estate with which HRP will compete, including
companies substantially larger than HRP and with substantially greater
resources.
OTHER.
Realty and HCRE, on behalf of HRP, monitor compliance with the Americans with
Disabilities Act and are currently not aware of any material non-compliance
issues.
HRP does not directly employ any individuals. Currently, approximately 90
employees of Realty and/or HCRE render services on behalf of HRP and its
Properties.
The business of HRP involves only one industry segment. Accordingly, all
information required by Item 101(b) of Regulation S-K is included in the
Consolidated Financial Statements included in Item 8. HRP has no foreign
operations and its business is not seasonal.
OCCUPANCY AND MAJOR TENANT INFORMATION
For information regarding occupancy, percentages of square feet scheduled to
expire by calendar year, and major tenants, see "Liquidity and Capital
Resources" in Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Page 5 of 45
ITEM 2. PROPERTIES
As of December 31, 2002, HRP owned 14 properties located in six states with
5,199,000 net rentable square feet.
<Table>
<Caption>
NET
RENTABLE ACRES PERCENTAGE
YEAR(S) SQUARE OF LEASED AS OF
NAME AND LOCATION DESCRIPTION CONSTRUCTED FEET LAND 12/31/2002
- ------------------------------- -------------------------- ------------ --------- ----- ------------
AIRPORT PLAZA three story 1982 48,637 2 100%
San Diego, California office building
ALLFIRST BUILDING 22 story 1972 343,080 0.6 98%
Baltimore, Maryland office building
BELLEVUE CORPORATE PLAZA ten story 1980 242,861 3.6 74%
Bellevue, Washington office building
BRADSHAW BUSINESS PARKS 21 single story 1974 to 1980 452,838 31 95%
Sacramento and Rancho Cordova, office/warehouse buildings
California at four sites
CORPORATE SQUARE 10 one to seven story 1967 to 1973, 593,061 34 94%
Atlanta, Georgia office buildings 2000
EXECUTIVE PARK 26 one to six story 1965 to 1972, 1,019,615 70 88%
Atlanta, Georgia office buildings 2002
FAIRLANE COMMERCE PARK 11 single story buildings 1973 to 1990 416,056 35 100%
Dearborn, Michigan in office/industrial park
FOUNTAIN VIEW BUSINESS CENTER 3 three story 1980 89,432 4.3 96%
San Diego, California office buildings
GULLEY ROAD INDUSTRIAL PARK 5 single story buildings 1990 to 1993 154,360 11 83%
Dearborn, Michigan in an industrial park
MONTROSE OFFICE CENTER ten story 1980 147,337 3 99%
Rockville, Maryland office building
PARKLANE TOWERS twin fifteen story 1973 486,607 31.8 94%
Dearborn, Michigan office buildings
RAINTREE INDUSTRIAL PARK 14 single story buildings 1971 to 1979 795,198 49 84%
Solon, Ohio in office/industrial complex
RIVERBANK PLAZA 2 three story 1978 40,222 1.6 100%
San Diego, California office buildings
SEATTLE BUSINESS PARKS 17 single story 1972 to 1978, 369,248 23 87%
Kent and Tukwila, Washington buildings in two 1993
office/industrial parks
</Table>
Allfirst Bank, the principal tenant of Allfirst Building, has options to
purchase the building from HRP for $28,000,000 in either 2004 or 2006. For
information regarding this project as well as encumbrances to which any
properties are subject and the status of related mortgage loans, see "Liquidity
and Capital Resources" in Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations, as well as Note 6 to the
Consolidated Financial Statements and Schedule III in Item 8 - Financial
Statements and Supplemental Information.
OFFICE SPACE -
HRP leases and shares offices with Hallwood in Dallas, Texas under a lease which
expires November 30, 2008. HRP has a one-time option to terminate the lease
effective November 30, 2005. The annual minimum cash rental payments are
$315,000, of which HRP's portion is approximately $210,000 annually.
Page 6 of 45
ITEM 3. LEGAL PROCEEDINGS
On June 20, 1997, an action was filed against HRP, the General Partner, its
directors, and Hallwood by Gotham Partners, L.P. in the Court of Chancery of the
State of Delaware, styled Gotham Partners, L.P. v. Hallwood Realty Partners,
L.P., et al. (C.A. No. 15754). This action alleges claims of breach of fiduciary
duties, breach of HRP's partnership agreement, and fraud in connection with
certain transactions involving HRP's units in the mid 1990's. Hallwood is
alleged to have aided and abetted the alleged breaches. On June 21, 2000, after
completing fact discovery, all parties moved for summary judgment on several
issues. In September and October 2000, the Delaware court issued three separate
written opinions resolving the summary judgment motions. In the opinions, the
court ruled that trial would be required as to all issues, except that (i)
Gotham was found to have standing to pursue its derivative claims; (ii)
defendants were entitled to judgment dismissing the fraud claim; (iii) the
General Partner was entitled to judgment dismissing the breach of fiduciary duty
claims brought against it; and (iv) the General Partner's outside directors were
entitled to judgment dismissing all claims brought against them.
A five-day trial was held in January 2001. On July 18, 2001, the Delaware Court
of Chancery rendered its opinion. In its decision, the court determined that an
option plan and a sale of units to Hallwood in connection with a reverse split
of units implemented by HRP in 1995 were in compliance with HRP's partnership
agreement. The court also found that the sale of units to Hallwood in connection
with a 1995 odd-lot offer by HRP did not comply with certain procedures required
by the HRP partnership agreement. The court ruled that the defendants other than
HRP pay a judgment to HRP in the amount of $3,417,423, plus pre-judgment
interest from August 1995. The judgment amount represents what the court
determined was an underpayment by Hallwood. In August 2001, plaintiff and
certain defendants appealed the Court of Chancery's judgment to the Delaware
Supreme Court. In October 2001, HRP received the $3,417,423 judgment together
with $2,987,576 of interest, subject to an arrangement that it be returned in
full or part if the judgment is modified or reversed on appeal. Oral arguments
were heard on February 12, 2002, and a rehearing en banc was held on March 26,
2002. On August 29, 2002, the Supreme Court affirmed the judgment of the trial
court that the remaining defendants other than HRP are jointly and severally
liable to HRP. The Supreme Court reversed the trial court's determination of
damages, and remanded the case to the trial court to fashion appropriate relief.
A hearing on the remand proceedings was held before the Court of Chancery on
October 25, 2002. A further hearing on the remand is scheduled to take place in
May or June 2003, with a decision by the Court of Chancery to follow. Since the
appellate court reversed the judgment, any subsequent ruling by the trial court
on remand may be more or less favorable to HRP. As a result of the uncertainty
of the litigation's outcome, HRP recorded the judgment and interest as "Deferred
Litigation Proceeds" on its balance sheet.
On February 15, 2000, HRP filed a lawsuit in the United States District Court
for the Southern District of New York styled Hallwood Realty Partners, L.P. v.
Gotham Partners L.P., et al. (Civ. No. 00 CV 1115) alleging violations of the
Securities Exchange Act of 1934 by certain purchasers of its units, including
Gotham Partners, L.P., Gotham Partners III, L.P., Private Management Group,
Inc., Interstate Properties, Steven Roth and EFO Realty, Inc., by virtue of
those purchasers' misrepresentations and/or omissions in connection with filings
required under the Securities Exchange Act of 1934. The complaint further
alleged that defendants, by acquiring more than 15% of the outstanding HRP
units, have triggered certain rights under its Unit Purchase Rights Agreement,
for which HRP was seeking declaratory relief. HRP sought various forms of
relief, including declaratory judgments, divestiture, corrective disclosures, a
"cooling-off" period and damages, including costs and disbursements. On November
16, 2000, the court granted HRP's motion to add as defendants Gotham Holdings
II, L.L.C., Hallwood Investors, L.P., Liberty Realty Partners, L.P. and
EFO/Liberty, Inc. and to remove EFO Realty, Inc. as a defendant. Discovery was
completed in December 2000 and trial was held in February 2001. On February 23,
2001, the court rendered a decision in favor of the defendants and on February
28, 2001, the court ordered the complaint dismissed. HRP filed a Notice of
Appeal on March 29, 2001. Oral argument was heard on March 4, 2002. On April 11,
2002, the U.S. Court of Appeals for the Second Circuit upheld the lower court's
ruling in favor of defendants. On April 25, 2002, HRP filed with the court a
Petition for Rehearing and Rehearing En Banc with respect to the April 11, 2002
decision. On June 3, 2002, the Second Circuit denied that petition. HRP has not
sought further appellate review and the determination in favor of defendants is
now final.
HRP is from time to time involved in various other legal proceedings and claims
which arise in the ordinary course of business. These matters are generally
covered by insurance. Management believes that the resolution of these matters
will not have a material adverse effect on HRP's financial position, cash flow
or operations.
Page 7 of 45
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders of HRP during the
fourth quarter of 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S UNITS AND RELATED SECURITY HOLDER MATTERS
HRP's units are traded on the American Stock Exchange under the symbol "HRY". As
of March 14, 2003, there were approximately 24,000 unitholders owning the
1,593,948 units outstanding. Each quarter Realty reviews HRP's capacity to make
cash distributions to its partners. HRP has not paid any cash distributions
since February, 1992.
The following table shows the high and low closing prices for the periods
indicated, as reported by the American Stock Exchange:
<Table>
<Caption>
CLOSING PRICES
--------------------
HIGH LOW
--------- ---------
2001 -
1st Quarter $ 71.75 $ 47.50
2nd Quarter 67.50 56.00
3rd Quarter 60.00 52.00
4th Quarter 71.02 52.75
2002 -
1st Quarter $ 72.25 $ 69.00
2nd Quarter 70.25 68.50
3rd Quarter 94.50 58.00
4th Quarter 87.95 80.50
</Table>
Page 8 of 45
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data regarding HRP's results
of operations and financial position as of the dates indicated. This information
should be read in conjunction with Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in Item 7 and the
Consolidated Financial Statements and notes thereto contained in Item 8.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
(in thousands except per unit amounts)
STATEMENTS OF OPERATIONS:
Total revenues(a) $ 73,739 $ 74,691 $ 69,901 $ 61,470 $ 58,056
Income (loss) before interest income, gain from
property sales, and cumulative effect of
SFAS No. 133 adoption 6,294 3,293 (1,267) 3,154 10,723
Income (loss) before cumulative effect
of SFAS No. 133 adoption 6,931 8,520 (299) 4,062 11,593
Net income (loss) 6,931 8,328 (299) 4,062 11,593
Income (loss) per unit and equivalent unit :
Basic -
Income (loss) before cumulative effect
of SFAS No. 133 adoption 4.32 5.31 (0.18) 2.40 6.86
Net income (loss) 4.32 5.19 (0.18) 2.40 6.86
Assuming dilution -
Income (loss) before cumulative effect
of SFAS No. 133 adoption 4.16 5.13 (0.18) 2.31 6.59
Net income (loss) 4.16 5.01 (0.18) 2.31 6.59
BALANCE SHEETS:
Real estate, net(b) $ 209,838 $ 213,574 $ 206,392 $ 192,814 $ 175,779
Total assets 274,420 269,875 254,504 230,386 214,023
Mortgages payable 197,552 201,224 200,096 171,312 162,078
Partners' capital(c) 60,675 54,022 44,490 48,696 44,634
</Table>
NOTES TO SELECTED FINANCIAL DATA:
(a) Reclassifications, including a gross-up for parking, construction and
tenant service expenses that were previously netted against revenues,
have been made in the prior year amounts to conform to the
classifications used in the current year. The reclassifications occurred
due to the adoption of EITF No. 01-14, "Income Statement
Characterization of Reimbursements Received for Out-of-Pocket Expenses
Incurred". The reclassifications had no effect on previously reported
net income or loss.
(b) Acquisition and development activity from 1999 to 2001 increased HRP's
real estate assets. These increases were partially offset by
depreciation and amortization. Prior to 1999, real estate assets
declined in each of the years, primarily due to depreciation and
amortization exceeding the additions of tenant and property
improvements.
(c) Partners' capital includes Accumulated Other Comprehensive Income of
$926,000 and $1,204,000 as of December 31, 2002 and 2001, respectively.
Partners' capital balance is allocated 99% to the limited partners and
1% to the General Partner.
Page 9 of 45
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This discussion should be read in conjunction with Item 6 - Selected Financial
Data and Item 8 - Financial Statements and Supplemental Information.
RESULTS OF OPERATIONS
2002 COMPARED TO 2001 -
REVENUE FROM PROPERTY OPERATIONS in 2002 increased $399,000, or 0.6%, compared
to 2001. The following table illustrates the components of the change, in
thousands:
<Table>
Rental income, net $ 830
Other property income (431)
-----
Net increase $ 399
=====
</Table>
Net rental income increased primarily due to an overall 5% increase in rental
rates offset by a decrease in average occupancy between periods from 90.9% to
87.3%. Average occupancy for 2002 was 89.0% excluding the new, but unoccupied,
building at Executive Park, which was completed in April 2002 - see Note 5 to
the Consolidated Financial Statements for more information. Other property
income decreased due to a reduction in tenant expense recoveries.
REVENUE FROM PARKING, CONSTRUCTION AND TENANT SERVICES for 2002 decreased
$1,351,000, or 16.7%, primarily as a result of a few major construction service
projects completed in 2001. By their nature, the demand for and size of
construction service projects can vary significantly from time to time.
PROPERTY OPERATING EXPENSES for 2002 increased $271,000, or 1.0%, compared to
2001. The change in expense includes non-specific, or general, increases in real
estate taxes, property and liability insurance premiums, and property level
salaries, partially offset by a general decrease in utilities and landscaping
costs.
PARKING, CONSTRUCTION AND TENANT SERVICES EXPENSE for 2002 decreased $787,000,
or 14.8%, primarily as a result of a few major construction service projects
completed in 2001. By their nature, the demand for and size of construction
service projects can vary significantly from time to time.
INTEREST EXPENSE for 2002 decreased $980,000, or 6.1%, compared to 2001, as a
result of a decrease in mortgage loan interest of $611,000 (primarily due to a
lower interest rate for HRP's only variable rate mortgage secured by Allfirst
Building), a decrease in capitalized interest of $230,000, and a decrease in
loan cost amortization and other interest costs of $40,000. (For more
information about the variable rate mortgage, see Item 7a - Quantitative and
Qualitative Disclosures About Market Risk.) Additionally, 2001 included $559,000
of prepayment penalties and other costs related to the early payoff of loans;
these costs were reclassified in the fourth quarter of 2002 from an
extraordinary item to current operations within interest expense as a result of
the adoption of Statement of Financial Accounting Standards ("SFAS") No. 145.
DEPRECIATION AND AMORTIZATION EXPENSE for 2002 increased $335,000, or 2.3%,
primarily due to depreciation for the newly completed building at Executive
Park.
GENERAL AND ADMINISTRATIVE EXPENSES for 2002 increased $239,000, or 5.5%,
compared to 2001, due to increases in certain professional fees, state franchise
taxes, director and officer liability insurance, and overhead costs.
LITIGATION COSTS were $777,000 and $3,808,000 for 2002 and 2001, respectively,
and are related to the lawsuits described in Item 3 - Legal Proceedings and Note
10 to the Consolidated Financial Statements.
INTEREST INCOME decreased by $406,000, or 38.9%, as a result of decreased
earnings on overnight cash investments due to significantly lower interest rates
available between years.
Page 10 of 45
RESULTS OF OPERATIONS (CONTINUED)
2001 COMPARED TO 2000 -
REVENUE FROM PROPERTY OPERATIONS in 2001 increased $2,929,000, or 4.6%, compared
to 2000. The following table illustrates the components of the change, in
thousands:
<Table>
Rental income, net $ 2,208
Other property income 721
---------
Net increase $ 2,929
=========
</Table>
Net rental income increased due to revenues generated from the addition and
completion of one development property at Corporate Square in mid-2000
($1,971,000), overall higher rental rates at most of HRP's real estate
properties, and an increase in average occupancy between years from 89.4% to
90.9%. As of December 31, 2001, HRP had leases executed and in place for
approximately 91% of the portfolio's net rentable square feet (excluding a
125,000 square foot development property at Executive Park). Other property
income increased primarily due to increases in tenant expense recoveries.
REVENUE FROM PARKING, CONSTRUCTION AND TENANT SERVICES for 2001 increased
$1,861,000, or 29.8%, primarily as a result of a few major construction service
projects completed in 2001. By their nature, the demand for and size of
construction service projects can vary significantly from time to time.
PROPERTY OPERATING EXPENSES for 2001 increased $641,000, or 2.4%, compared to
2000. The increase is comprised primarily of the following components:
o Operating costs with respect to the addition of the one
development property at Corporate Square completed in mid-2000
were $629,000 greater than in 2001.
o Professional fees decreased $705,000 primarily due to costs
incurred in 2000 for research and analysis of potential
property development projects.
o Combined, all other operating costs increased $717,000, or
about 2.7%, of which none are individually significant.
PARKING, CONSTRUCTION AND TENANT SERVICES EXPENSE for 2001 increased $1,757,000,
or 49.1%, primarily as a result of a few major construction service projects
completed in 2001. By their nature, the demand for and size of construction
service projects can vary significantly from time to time.
INTEREST EXPENSE for 2001 increased $313,000, or 2.0%, compared to 2000 as a
result of an increase in mortgage loan interest of $845,000 (due to a higher
average mortgage loan balance), partially offset by the capitalization of
$486,000 of interest for construction of the development project at Executive
Park (as described in Note 5 to the Consolidated Financial Statements), and a
decrease in loan cost amortization and other interest costs of $46,000.
DEPRECIATION AND AMORTIZATION EXPENSE was consistent between years and increased
$64,000, or 0.4%.
GENERAL AND ADMINISTRATIVE EXPENSES for 2001 decreased $690,000, or 13.7%,
compared to 2000 primarily due to $601,000 of non-qualified unit option
compensation in 2000.
LITIGATION COSTS were $3,808,000 and $5,663,000 for 2001 and 2000, respectively,
and are related to the lawsuits described in Item 3 - Legal Proceedings and Note
10 to the Consolidated Financial Statements.
GAIN FROM PROPERTY SALES of $4,184,000 in 2001 is comprised of the January sale
of one building at Seattle Business Parks for a gross selling price of
$3,287,000, resulting in a gain of $2,109,000; the January sale of one building
at Fairlane Commerce Park for a gross selling price of $575,000, resulting in a
gain of $153,000; and the March sale of Joy Road Distribution Center for a gross
selling price of $5,326,000, resulting in a gain of $1,922,000.
INTEREST INCOME increased by $75,000, or 7.7%, as a result of increased earnings
on overnight cash investments due to a higher average cash balance available for
investment, partially offset by lower interest rates.
Page 11 of 45
LIQUIDITY AND CAPITAL RESOURCES
GENERAL INFORMATION -
HRP operates in the commercial real estate industry. HRP's activities include
the acquisition, ownership and operation of its commercial real estate assets.
While it is the General Partner's intention to operate HRP's existing real
estate investments and to acquire and operate additional real estate
investments, Realty also continually evaluates each of HRP's real estate
investments in light of current economic trends, operations, and other factors
to determine if any should be considered for disposition.
As of December 31, 2002, HRP owned 14 real estate assets (the "Properties")
located in six states containing 5,199,000 net rentable square feet. HRP seeks
to maximize the value of its real estate by making capital and tenant
improvements, by executing marketing programs to attract and retain tenants, and
by controlling or reducing, where possible, operating expenses.
HRP fully consolidates into its financial statements majority owned entities.
For each of the three years in the period ended December 31, 2002, all entities
and Properties were fully owned. All significant intercompany balances and
transactions have been eliminated in consolidation.
HRP has, in three situations, created a Special Purpose Entity ("SPE"). These
SPEs were formed at the request of lenders for the express purpose of
strengthening the collateral for the loans by isolating (for Federal bankruptcy
law purposes) the assets and liabilities of the SPEs. In all cases and since
their various formation dates, the assets, liabilities and results of operations
of these wholly-owned entities have been fully consolidated into the financial
statements of HRP.
CASH SOURCES, CASH USES AND COMMITMENTS -
HRP's cash position increased $7,450,000 during 2002 to $32,363,000 as of
December 31, 2002. The source of cash during the year was $19,726,000 of cash
provided by operating activities,. The uses of cash were $6,617,000 for property
and tenant improvements, $1,977,000 for property development costs, $3,672,000
for scheduled mortgage principal payments, and $10,000 for loan fees.
For the foreseeable future, HRP anticipates that mortgage principal payments,
tenant and capital improvements, lease commissions and litigation costs will be
funded by net cash from operations. We believe that there will be sufficient
cash from operations to meet these needs because HRP has leases in place as of
December 31, 2002 to provide $54,963,000 of minimum rental payments during 2003
(see "Liquidity and Capital Resources - Lease Agreements and Major Tenant
Information"). For 2002, HRP had leases in place to provide $55,261,000 of
minimum rental payments (based on leases in place as of December 31, 2001),
however the actual rental payments recorded for 2002 were $61,481,000. Actual
rental payment results for 2002 were greater than the minimum rental payment
amount primarily due to our ability to attract and retain tenants. Our ability
to fund operations in the future will depend upon continued success in
maintaining current occupancy levels, retaining current tenants, and attracting
new tenants, as well as sustaining or increasing rental rates.
The primary sources of capital to fund any future acquisitions or developments
will be proceeds from the sale, financing or refinancing of one or more of our
properties. HRP has estimated and budgeted tenant and capital improvements of
$15,631,000 and lease commissions of $2,851,000 for 2003. Each quarter Realty
reviews HRP's capacity to make cash distributions. HRP has not made any cash
distributions since February, 1992.
CRITICAL ACCOUNTING POLICIES -
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and judgments that affect the reported amounts of certain assets,
liabilities, revenues, expenses, and related disclosures. Actual results may
differ from these estimates under different assumptions or conditions. In
December 2001, the SEC requested that registrants identify "critical accounting
policies" in Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations. The SEC indicated that a "critical
accounting policy" is one that is both important to the portrayal of an entity's
financial condition and results and requires management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain. HRP believes that the
following of its accounting policies fit this description:
Page 12 of 45
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Impairment of Long-Lived Assets - HRP reviews for impairment losses on its real
estate assets when events and circumstances indicate that the assets might be
impaired. If such indication is noted, an undiscounted cash flow analysis is
performed, and in the event undiscounted cash flow estimated to be generated by
an asset over the remaining depreciable life of that asset is less than its
carrying value, then the asset would be written down to its fair value. Cash
flow estimates are based on historical results adjusted to our best estimate of
future market and operating conditions. Significant assumptions used in this
process include an evaluation of leases in place, future rental and occupancy
rates, and the level of expected operating expenses. For the three years ended
December 31, 2002, HRP has not recorded a write-down or impairment of the
carrying value of any real estate property based on these calculations.
Assets Held for Sale - Should HRP decide to sell a property and actively
commence the disposal process, all of the assets, liabilities, income, and
expenses associated with such property will be segregated in the financial
statements. At such time, an evaluation for potential impairment will be made
using an estimate of the selling price less selling costs.
Revenue Recognition - SFAS No. 13 "Accounting for Leases" requires management to
estimate the economic life of lease payments. However, this does not require
subjective input by management, as rental income is recognized on a
straight-line basis over the lease term, as defined in each respective lease.
Adjustments to convert cash rental income (which may include free rent, reduced
rent, or periodic rental rate increases over the term of the lease) to
straight-line rental income increased revenues by $99,000, $256,000, and
$569,000 in 2002, 2001, and 2000, respectively.
Other accounting policies are described in Note 2 to the Consolidated Financials
Statements in Item 8. The policies listed are not intended to be a comprehensive
list of all of our accounting policies. In most cases, the accounting treatment
of a particular transaction is specifically dictated by accounting principles
generally accepted in the United States of America, with no need for
management's judgment in the application. There are also areas in which
management's judgment in selecting any available alternative would not produce a
materially different result than those recorded and reported.
RECENT ACCOUNTING PRONOUNCEMENTS -
SFAS No. 142 "Goodwill and Other Intangible Assets" was issued in June 2001 and
was adopted January 1, 2002. Among other things, SFAS No. 142 requires that in
conjunction with an acquisition of a property in the future all intangible
assets associated with such property will be separately evaluated and recorded.
SFAS No. 143 "Accounting for Asset Retirement Obligations" was adopted January
1, 2003. It establishes an accounting standard for recognition and measurement
of a liability for an asset retirement obligation and the associated asset
retirement cost. HRP has no such obligations as of December 31, 2002.
SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets"
was adopted January 1, 2002 and requires current, as well as historical, results
of operations for disposed properties and those properties held for sale that
occur subsequent to January 1, 2002 to be reclassified and presented separately
as discontinued operations.
SFAS No. 145 "Rescission of FASB Statements 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" was issued in April 2002 and was
adopted in the fourth quarter of 2002. Among other things, SFAS No. 145 limits
debt extinguishments that can be classified as extraordinary items. As a result,
HRP has reclassified previously recorded gains and losses from early
extinguishment of debt from an extraordinary item to current operations within
interest expense. Accordingly, the reclassifications had no effect on previously
reported net income or loss.
SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities"
was issued in June 2002 and will be effective for exit or disposal activities
subsequent to December 31, 2002. HRP anticipates no material impact on its
financial statements from the adoption of this accounting standard.
SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of FASB Statement No. 123" was issued in December 2002
and provides new transition methods if an entity adopts the fair value based
method of valuing stock-based compensation suggested in SFAS No. 123, as well as
requiring additional disclosures in interim and annual financial statements. At
this time, HRP expects that the impact will be limited to additional disclosure
requirements.
Page 13 of 45
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
In November 2002, the Financial Accounting Standards Board issued Interpretation
No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45
requires that the guarantor recognize, at the inception of certain guarantees, a
liability for the fair value of the obligation undertaken in issuing such
guarantee. FIN 45 also requires additional disclosure about the guarantor's
obligations under certain guarantees that it has issued. As of December 31, 2002
HRP had no such guarantees.
LEASE AGREEMENTS AND MAJOR TENANT INFORMATION -
Lease provisions generally require HRP's tenants to pay fixed rental amounts,
plus their proportionate share of certain building operating costs and real
property taxes. Revenue from expense recoveries, included in property
operations, was $3,755,000, $4,197,000, and $3,315,000 in 2002, 2001, and 2000,
respectively. In addition, certain leases include provisions for annual rental
adjustments. Some leases contain provisions to allow a tenant to terminate their
lease prior to its normal expiration. At December 31, 2002, the Properties, in
the aggregate, were 91% leased. The following table sets forth the minimum cash
rental payments to be received from leases in place as of December 31, 2002 (in
thousands):
<Table>
<Caption>
Payments Payments
from Leases from Leases
without Early with Early
Termination Termination
Rights Rights Total
--------------- --------------- ---------------
2003 $ 54,963 $ 651 $ 55,614
2004 48,306 413 48,719
2005 40,003 238 40,241
2006 27,928 1,837 29,765
2007 20,348 3,485 23,833
Thereafter 75,796 35,962 111,758
--------------- --------------- ---------------
Total $ 267,344 $ 42,586 $ 309,930
=============== =============== ===============
</Table>
Based on leases in place as of December 31, 2002, set forth below are the
percentages of leased square footage scheduled for lease expirations for each
calendar year, assuming that none of the tenants exercise early termination or
renewal options:
<Table>
2003 23%
2004 14%
2005 14%
2006 15%
2007 7%
Thereafter 27%
</Table>
During 2002 and 2001, two tenants leasing space contributed 10% or more of HRP's
revenues. Ford Motor Company and affiliates ("Ford") leases space in Parklane
Towers and Fairlane Commerce Park. Ford accounted for 11% and 12% of revenues in
2002 and 2001, respectively. The General Services Administration ("GSA") leases
space in Corporate Square and Executive Park. GSA accounted for 17% and 14% of
revenues in 2002 and 2001, respectively.
As of December 31, 2002, Ford leased 199,000 square feet of office space under
seven leases at Parklane Towers and 224,000 square feet of office, technical
laboratory and industrial space under seven leases at Fairlane Commerce Park.
These leases expire between 2003 and 2005 and most contain options providing for
one to ten year renewals. As of December 31, 2002, GSA leased 450,000 square
feet of office space at Executive Park (including 128,000 square feet associated
with a lease that begins in 2003 - see "Liquidity and Capital Resources -
Property Development at Executive Park") under seven leases which expire between
2003 and 2015. Also, as of December 31, 2002, GSA leased 310,000 square feet of
office space at Corporate Square under three leases which expire in 2004, 2013
(with a right to early terminate in 2008) and 2020. The remaining tenants are
not concentrated in any one industry, nor is HRP otherwise dependent on any
group of related tenants for 10% or more of its revenues.
Page 14 of 45
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
LITIGATION & JUDGMENT -
In July 2001, the Delaware Court of Chancery rendered its opinion for the action
styled Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., et al. (C.A. No.
15754). The court ruled that the defendants other than HRP pay a judgment to HRP
in the amount of $3,417,423, plus pre-judgment interest from August 1995. The
judgment amount represents what the court determined was an underpayment by
Hallwood. In August 2001, plaintiff and certain defendants appealed the Court of
Chancery's judgment to the Delaware Supreme Court. In October 2001, HRP received
the $3,417,423 judgment together with $2,987,576 of interest, subject to an
arrangement that it be returned in full or part if the judgment is modified or
reversed on appeal. Oral arguments were heard in February 2002 and a rehearing
en banc was held in March 2002. In August 2002, the Supreme Court affirmed the
judgment of the trial court that the remaining defendants other than HRP are
jointly and severally liable to HRP. The Supreme Court reversed the trial
court's determination of damages, and remanded the case to the trial court to
fashion appropriate relief. A hearing on the remand proceedings was held before
the Court of Chancery in October 2002. A further hearing on the remand is
scheduled to take place in May or June 2003, with a decision by the Court of
Chancery to follow. (For more information about this litigation, see Item 3 -
Legal Proceedings.) Since the appellate court reversed the judgment, any
subsequent ruling by the trial court on remand may be more or less favorable to
HRP. As a result of the uncertainty of the litigation's outcome, HRP recorded
the judgment and interest as "Deferred Litigation Proceeds" on its balance
sheet.
MORTGAGE LOANS -
Substantially all of the buildings in HRP's real estate properties were
encumbered and pledged as collateral by 11 non-recourse mortgage loans
aggregating $197,552,000 as of December 31, 2002. These mortgage loans have
interest rates varying from 2.68% to 8.70% (with an effective average interest
rate of 7.51%) and mature between 2005 and 2020. Other than Allfirst Building's
mortgage ($25,000,000), all mortgages have fixed interest rates. Most of the
mortgage loans require monthly principal payments with balloon payments due at
maturity. The following table shows for the years presented the principal and
balloon payments that are required (in thousands):
<Table>
<Caption>
Total
Mortgage
Principal Balloon Loan
Payments Payments Payments
-------------- -------------- --------------
2003 $ 3,998 $ -- $ 3,998
2004 4,310 -- 4,310
2005 4,167 74,515 78,682
2006 2,852 25,000 27,852
2007 3,079 -- 3,079
Thereafter 22,894 56,737 79,631
-------------- -------------- --------------
Total $ 41,300 $ 156,252 $ 197,552
============== ============== ==============
</Table>
Since August 2000, HRP has had available a $2,000,000 revolving line of credit,
which matures on July 29, 2003. The line of credit has a variable interest rate
of either prime plus 0.50% or LIBOR plus 3.0% and requires monthly interest
payments, but no principal amortization. HRP has not borrowed against this
facility.
HRP has two mortgage loans that require compliance with a loan covenant, which
if not met will trigger a default. The loans require the properties securing
each loan to maintain a liquidity ratio, specifically a debt service coverage
ratio. A debt service coverage ratio is the relationship of adjusted net
operating income (as defined in each loan agreement) for the previous 12 months
to the loan's annual debt service. The ratio, for a loan requiring a minimum
1.15 ratio, was 2.25, 2.35, and 2.19 for 2002, 2001, and 2000, respectively. The
ratio, for a loan requiring a minimum 1.10 ratio, was 2.39, 1.94, and 2.45 for
the same periods. Accordingly, HRP was in compliance with these loan covenants
for the three years ended December 31, 2002. As of December 31, 2002, the
outstanding balance of the loans is $111,553,000.
Additionally, these two mortgage loans contain restrictions that limit certain
actions. With respect to the properties encumbered by these loans, HRP cannot
incur additional debt. Also, HRP's ability to sell a property, or a portion
thereof, is limited because of the requirement to substitute collateral with
substantial penalty. These loans also, under certain circumstances, may restrict
the ability of HRP to merge, to consolidate or to liquidate.
Page 15 of 45
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
TRANSACTIONS WITH RELATED PARTIES -
Realty receives certain fees in connection with the ongoing management of HRP,
including an asset management fee, acquisition fees and disposition fees.
Specifically, Realty is entitled to receive an asset management fee equal to 1%
of the net aggregate base rents of the Properties, acquisition fees equal to 1%
of the purchase price of newly acquired properties, and disposition fees with
respect to real estate investments, other than the properties owned at the time
of HRP's formation in 1990, equal to 10% of the amount, by which the sales price
of a property exceeds the purchase price of such property.
HCRE receives compensation in connection with the management of the Properties,
which includes a property management fee, lease commissions and construction
supervision fees. The management contracts expire June 30, 2004 and provide for
basic compensation from a property management fee in an amount equal to 2.85% of
cash receipts collected from the Properties' tenants, lease commissions equal to
the current commission market rate as applied to the net aggregate rent (none
exceeding 6% of the net aggregate rent), and construction supervision fees for
administering all construction projects equal to 5% of the total contracted
costs of each capital expenditure or tenant improvement project.
Realty and HCRE are compensated for services provided to HRP and its Properties
as described above and are reimbursed, at cost, for certain costs and expenses.
In particular, since HRP does not directly employ any individuals, the
compensation and other costs related to approximately 90 employees rendering
services on behalf of HRP and its properties are reimbursed to Realty and HCRE
by HRP. The following table sets forth such compensation and reimbursements paid
by HRP (in thousands):
<Table>
<Caption>
Entity
Paid or
Reimbursed 2002 2001 2000
----------- ----------- ----------- -----------
Asset management fee Realty $ 618 $ 609 $ 581
Acquisition fee Realty -- -- 74
Disposition fee Realty -- 120 --
Reimbursement of costs(a) Realty 3,477 3,161 2,720
Property management fee HCRE 2,022 2,005 1,914
Lease commissions(b) HCRE 2,151 2,158 2,605
Construction fees HCRE 582 1,204 917
Reimbursement of costs(c) HCRE 3,916 3,826 3,521
</Table>
(a) These expenses are recorded as general and administrative
expenses and represent reimbursement, at cost, to Realty for
administrative level employee and director compensation,
officer and director liability insurance, and allocated
overhead costs. HRP pays its account balance with Realty on a
monthly basis.
(b) As of December 31, 2002, $567,000 of the 2002 lease
commissions are accrued and are scheduled to be paid in 2003.
(c) These costs are recorded as property operating expenses and
represent reimbursement to HCRE for property-level employee
compensation and related expenses.
In January 2001, HRP acquired a construction development consulting contract
from Hallwood regarding a project in Tulsa, Oklahoma with an unrelated third
party. In connection therewith, HRP reimbursed Hallwood for its actual costs
incurred related to the project of $281,000.
INFLATION -
Inflation did not have a significant impact on HRP during the three years ended
December 31, 2002 and is not anticipated to have a material impact in 2003.
RISKS, COMPETITION AND OTHER FACTORS -
For information about risks, see "Risks, Competition and Other Factors" in Item
1 - Business.
Page 16 of 45
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
PROPERTY DEVELOPMENT AT EXECUTIVE PARK -
In early 2001, HRP demolished a one-story office building at its Executive Park
property, which contained 18,000 net rentable square feet. In order to do so,
HRP obtained a release of the building from Executive Park's mortgage lien by
substituting for such collateral $608,000 of United States Treasury Bonds, which
have various maturity dates through December 2007. In February 2001, HRP began
constructing a five-story office building containing 128,000 net rentable square
feet. The building and its parking garage, excluding tenant finish-out, was
completed in April 2002. HRP incurred and capitalized $15,370,000 of
construction and development costs, which included all of the costs for the
building and its parking garage (excluding the existing land costs). A
seven-year lease for the entire building, with an option for five additional
years, with the General Services Administration was executed in September 2002
and will commence upon the completion of tenant improvements, estimated to be
sometime between May and August 2003. The lease commissions incurred were
$777,000, while the tenant improvements are estimated to be $4,500,000. All
development and leasing costs have been or will be paid from cash funds on hand;
however, it is anticipated that loan financing of $15,000,000 to $16,000,000
will be obtained in the second half of 2003.
FORWARD-LOOKING STATEMENTS -
In the interest of providing investors with certain information regarding HRP's
future plans and operations, certain statements set forth in this Form 10-K
relate to management's future plans, objectives and expectations. Such
statements are forward-looking statements. Although any forward-looking
statements contained in this Form 10-K or otherwise expressed by or on behalf of
HRP are, to the knowledge and in the judgment of the officers and directors of
the General Partner, expected to prove true and come to pass, management is not
able to predict the future with absolute certainty. Although HRP believes that
the assumptions underlying the forward-looking statements are reasonable, any of
the assumptions could be inaccurate and, therefore, there can be no assurance
that the forward-looking statements will prove to be accurate.
Forward-looking statements involve known and unknown risks and uncertainties,
which may cause HRP's actual performance and financial results in future periods
to differ materially from any projection, estimate or forecasted result. These
risks and uncertainties include the risks identified under "Risks, Competition
and Other Factors" in Item 1 - Business.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
On July 27, 2000, HRP sold its interest rate swap agreement for $1,597,000. HRP
had entered into the interest rate swap agreement in 1998 to reduce its exposure
to changes in interest rates for the loan secured by Allfirst Building. This
interest rate swap agreement effectively fixed the loan's cash interest rate at
6.78%, as opposed to the mortgage loan interest rate of LIBOR plus 1.30% (or
7.94% at the time of the swap agreement sale). The proceeds from the sale were
designated for general working capital purposes. For financial reporting
purposes, the proceeds are being amortized over the life of the loan as a
reduction to interest expense. During 2001, as the result of the adoption of
SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities", HRP
reclassified the remaining unamortized gain from liabilities to accumulated
other comprehensive income. The proceeds will continue to be amortized over the
life of Allfirst Building's mortgage payable as a reduction to interest expense.
As of December 31, 2002 and 2001, the unamortized balance, included on the
balance sheet as "Accumulated other comprehensive income", was $926,000 and
$1,204,000, respectively.
Also on July 27, 2000 and in connection with the sale of the swap agreement, HRP
purchased an interest rate cap for Allfirst Building's mortgage loan for
$288,000, which limits HRP's exposure to changing interest rates to a maximum of
10%. This interest rate cap, which has a notional amount of $25,000,000, has
terms consistent with Allfirst Building's mortgage loan. Allfirst Building's
cash interest rate was 2.68% and 3.44% as of December 31, 2002 and 2001,
respectively. The interest rate cap is a derivative and designated as a cash
flow hedge. Hedge effectiveness is measured based on using the intrinsic value
of the interest rate cap. All changes in the fair value of the time value of the
cap are recorded directly to earnings. With the January 1, 2001 adoption of SFAS
No. 133, HRP recorded the cumulative effect of the adoption as a reduction to
income of $192,000, or the amount of the difference between the carrying value
as of January 1, 2001 of $267,000 and the then estimated fair value of $75,000,
all of which represented change in time value. Thereafter, on a quarterly basis,
HRP has recorded changes in the estimated fair value of the cap in interest
expense. As of December 31, 2002 and 2001, the estimated fair value of the
interest rate cap was $55,000 and $68,000, respectively.
Other than Allfirst Building's mortgage ($25,000,000), all mortgages have fixed
interest rates. Accordingly, changes in LIBOR or the prime rate do not
significantly impact the amount of interest paid by HRP. Assuming a 100 basis
point, or 1%, change in LIBOR, interest paid by HRP would increase or decrease
by $250,000 on an annual basis.
Page 17 of 45
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL INFORMATION
ITEM 8 INDEX
<Table>
<Caption>
FINANCIAL STATEMENTS: Page
----
Independent Auditors' Report 19
Consolidated Balance Sheets as of December 31, 2002 and 2001 20
Consolidated Statements of Operations for the years
ended December 31, 2002, 2001 and 2000 21
Consolidated Statements of Comprehensive Income for the years
ended December 31, 2002, 2001 and 2000 22
Consolidated Statements of Partners' Capital for the years
ended December 31, 2002, 2001 and 2000 23
Consolidated Statements of Cash Flows for the years
ended December 31, 2002, 2001 and 2000 24
Notes to Consolidated Financial Statements 25
FINANCIAL STATEMENT SCHEDULE:
Schedule III - Real Estate and Accumulated Depreciation 38
All other schedules have been omitted because they are not
applicable, not required, or the required information is disclosed
in the Consolidated Financial Statements or notes thereto.
</Table>
Page 18 of 45
INDEPENDENT AUDITORS' REPORT
To the Partners of Hallwood Realty Partners, L.P.
We have audited the accompanying consolidated balance sheets of Hallwood Realty
Partners, L.P. and subsidiaries as of December 31, 2002 and 2001, and the
related consolidated statements of operations, comprehensive income, partners'
capital, and cash flows for each of the three years in the period ended December
31, 2002. Our audit for the year ended December 31, 2002 also included the
financial statement schedule listed in the Index at Item 8. These financial
statements and financial statement schedule are the responsibility of the
Partnership's management. Our responsibility is to express an opinion on the
financial statements and financial statement schedule based upon our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Hallwood Realty Partners, L.P. and
subsidiaries as of December 31, 2002 and 2001 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002 in conformity with accounting principles generally accepted in
the United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
DELOITTE & TOUCHE LLP
Dallas, Texas
March 6, 2003
Page 19 of 45
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT UNIT AMOUNTS)
<Table>
<Caption>
DECEMBER 31,
----------------------------------
2002 2001
-------------- --------------
ASSETS
Real estate:
Land $ 59,015 $ 59,015
Buildings and improvements 310,154 290,674
Tenant improvements 23,504 22,301
Construction in progress 836 18,303
-------------- --------------
393,509 390,293
Accumulated depreciation and amortization (183,671) (176,719)
-------------- --------------
Real estate, net 209,838 213,574
Cash and cash equivalents 32,363 24,913
Accounts receivable 2,315 2,315
Escrow deposits held by lenders 8,918 8,359
Effective rent receivable 4,729 4,630
Lease commissions, net 11,390 10,868
Loan costs, net 2,677 3,258
Prepaid expenses and other assets 2,190 1,958
-------------- --------------
Total assets $ 274,420 $ 269,875
============== ==============
LIABILITIES AND PARTNERS' CAPITAL
Liabilities:
Mortgages payable $ 197,552 $ 201,224
Accounts payable and accrued expenses 5,743 5,147
Prepaid rent, security deposits and other 3,533 3,061
Payable to affiliates 512 16
Deferred litigation proceeds 6,405 6,405
-------------- --------------
Total liabilities 213,745 215,853
-------------- --------------
Commitments and contingencies
Partners' capital:
Limited partners - 1,589,948 units outstanding 59,152 52,290
General partner 597 528
Accumulated other comprehensive income 926 1,204
-------------- --------------
Total partners' capital 60,675 54,022
-------------- --------------
Total liabilities and partners' capital $ 274,420 $ 269,875
============== ==============
</Table>
See notes to consolidated financial statements.
Page 20 of 45
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER UNIT AMOUNTS)
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------
2002 2001 2000
-------------- -------------- --------------
REVENUES:
Property operations $ 66,992 $ 66,593 $ 63,664
Parking, construction and tenant services 6,747 8,098 6,237
-------------- -------------- --------------
Total revenues 73,739 74,691 69,901
-------------- -------------- --------------
EXPENSES:
Property operations 27,464 27,193 26,552
Parking, construction and tenant services 4,547 5,334 3,577
Interest 15,165 16,145 15,832
Depreciation and amortization 14,897 14,562 14,498
General and administrative 4,595 4,356 5,046
Litigation costs 777 3,808 5,663
-------------- -------------- --------------
Total expenses 67,445 71,398 71,168
-------------- -------------- --------------
INCOME (LOSS) BEFORE INTEREST INCOME, GAIN FROM PROPERTY SALES,
AND CUMULATIVE EFFECT 6,294 3,293 (1,267)
Interest income 637 1,043 968
Gain from property sales -- 4,184 --
-------------- -------------- --------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT 6,931 8,520 (299)
Cumulative effect of SFAS No. 133 adoption -
valuation of interest rate cap -- (192) --
-------------- -------------- --------------
NET INCOME (LOSS) $ 6,931 $ 8,328 $ (299)
============== ============== ==============
ALLOCATION OF NET INCOME (LOSS):
Limited partners $ 6,862 $ 8,245 $ (296)
General partner 69 83 (3)
-------------- -------------- --------------
Total $ 6,931 $ 8,328 $ (299)
============== ============== ==============
NET INCOME (LOSS) PER UNIT AND POTENTIAL UNIT:
Earnings per unit - basic
Income (loss) before cumulative effect $ 4.32 $ 5.31 $ (0.18)
Cumulative effect of SFAS No. 133 adoption -- (0.12) --
-------------- -------------- --------------
Net income (loss) $ 4.32 $ 5.19 $ (0.18)
============== ============== ==============
Earnings per unit - assuming dilution
Income (loss) before cumulative effect $ 4.16 $ 5.13 $ (0.18)
Cumulative effect of SFAS No. 133 adoption -- (0.12) --
-------------- -------------- --------------
Net income (loss) $ 4.16 $ 5.01 $ (0.18)
============== ============== ==============
WEIGHTED AVERAGE UNITS USED IN COMPUTING NET INCOME (LOSS) PER
UNIT AND POTENTIAL UNIT:
Basic 1,590 1,590 1,620
============== ============== ==============
Assuming dilution 1,648 1,645 1,674
============== ============== ==============
</Table>
See notes to consolidated financial statements.
Page 21 of 45
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
<Table>
<Caption>
FOR THE YEARS ENDED
DECEMBER 31,
------------------------------------------------------
2002 2001 2000
-------------- -------------- --------------
NET INCOME (LOSS) $ 6,931 $ 8,328 $ (299)
Reclassification of cumulative effect of
SFAS No. 133 adoption - deferred gain
from sale of interest rate swap -- 1,481 --
Amortization of deferred gain
from sale of interest rate swap (278) (277) --
-------------- -------------- --------------
COMPREHENSIVE INCOME $ 6,653 $ 9,532 $ (299)
============== ============== ==============
</Table>
See notes to consolidated financial statements.
Page 22 of 45
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL
(IN THOUSANDS EXCEPT UNIT AMOUNTS)
<Table>
<Caption>
Accumulated Limited
Other Partnership
General Limited Comprehensive Units
Partner Partners Income Total Outstanding
----------- ----------- ------------- ----------- -----------
PARTNERS' CAPITAL, JANUARY 1, 2000 $ 487 $ 48,209 $ -- $ 48,696 1,672,556
Exercise and issuance of unit options 8 806 -- 814 17,200
Purchase of units (47) (4,674) -- (4,721) (99,808)
Net loss (3) (296) -- (299) --
----------- ----------- ----------- ----------- -----------
PARTNERS' CAPITAL, DECEMBER 31, 2000 445 44,045 -- 44,490 1,589,948
Reclassification of cumulative effect of
SFAS No. 133 adoption - deferred gain
from sale of interest rate swap -- -- 1,481 1,481 --
Amortization of deferred gain from
sale of interest rate swap -- -- (277) (277) --
Net income 83 8,245 -- 8,328 --
----------- ----------- ----------- ----------- -----------
PARTNERS' CAPITAL, DECEMBER 31, 2001 528 52,290 1,204 54,022 1,589,948
Amortization of deferred gain from
sale of interest rate swap -- -- (278) (278) --
Net income 69 6,862 -- 6,931 --
----------- ----------- ----------- ----------- -----------
PARTNERS' CAPITAL, DECEMBER 31, 2002 $ 597 $ 59,152 $ 926 $ 60,675 1,589,948
=========== =========== =========== =========== ===========
</Table>
See notes to consolidated financial statements.
Page 23 of 45
HALLWOOD REALTY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------
2002 2001 2000
------------- ------------- -------------
OPERATING ACTIVITIES:
Net income (loss) $ 6,931 $ 8,328 $ (299)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 14,897 14,562 14,498
Gain from property sales -- (4,184) --
Cumulative effect of SFAS No. 133 adoption -
valuation of interest rate cap -- 192 --
Non-qualified unit option compensation -- -- 601
Effective rent adjustments (99) (256) (569)
Changes in assets and liabilities:
Account receivable -- 896 (924)
Lease commission payments (2,951) (2,752) (5,043)
Prepaid expenses, escrow deposits and other assets (200) (174) 956
Accounts payable and other liabilities 1,148 (740) 3,660
------------- ------------- -------------
Net cash provided by operating activities 19,726 15,872 12,880
------------- ------------- -------------
INVESTING ACTIVITIES:
Property and tenant improvements (6,617) (9,417) (10,933)
Property development cost (1,977) (13,406) (8,811)
Property acquisitions -- -- (7,791)
Cash proceeds from property sales, net of selling costs -- 8,435 --
------------- ------------- -------------
Net cash used in investing activities (8,594) (14,388) (27,535)
------------- ------------- -------------
FINANCING ACTIVITIES:
Mortgage principal proceeds -- 10,000 50,623
Mortgage principal refinanced -- (2,760) (18,346)
Loan fees (10) (138) (1,210)
Mortgage principal early payoff -- (2,125) --
Mortgage prepayment penalties -- (423) (286)
Mortgage principal scheduled payments (3,672) (3,987) (3,493)
Exercise and issuance of unit options -- -- 213
Purchase of units -- -- (4,721)
Deferred litigation proceeds -- 6,405 --
------------- ------------- -------------
Net cash provided by (used in) financing activities (3,682) 6,972 22,780
------------- ------------- -------------
INCREASE IN CASH AND CASH EQUIVALENTS 7,450 8,456 8,125
BEGINNING CASH AND CASH EQUIVALENTS 24,913 16,457 8,332
------------- ------------- -------------
ENDING CASH AND CASH EQUIVALENTS $ 32,363 $ 24,913 $ 16,457
============= ============= =============
</Table>
See notes to consolidated financial statements.
Page 24 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
1 ORGANIZATION
Hallwood Realty Partners, L.P. ("HRP"), a publicly traded Delaware
limited partnership, operates in the commercial real estate industry.
HRP's activities include the acquisition, ownership and operation of
its commercial real estate assets. Units representing limited
partnership interests are traded on the American Stock Exchange under
the symbol "HRY". As of December 31, 2002 there were 1,589,948 units
outstanding.
As of December 31, 2002, HRP owned 14 real estate assets (the
"Properties") located in six states containing 5,199,000 net rentable
square feet. HRP seeks to maximize the value of its real estate by
making capital and tenant improvements, by executing marketing
programs to attract and retain tenants, and by controlling or
reducing, where possible, operating expenses.
Hallwood Realty, LLC ("Realty" or the "General Partner"), a Delaware
limited liability company and indirectly wholly-owned subsidiary of
The Hallwood Group Incorporated ("Hallwood"), is HRP's general partner
and is responsible for asset management of HRP and its Properties,
including decision-making responsibility for financing, refinancing,
acquiring and disposing of properties. In addition, Realty provides
general operating and administrative services to HRP. Hallwood
Commercial Real Estate, LLC ("HCRE"), another indirectly wholly-owned
subsidiary of Hallwood, provides property management, leasing and
construction supervision services to the Properties.
2 ACCOUNTING POLICIES
CONSOLIDATION
HRP fully consolidates into its financial statements majority owned
entities. For each of the three years in the period ended December 31,
2002, all entities and Properties were fully owned. All significant
intercompany balances and transactions have been eliminated in
consolidation.
HRP has, in three situations, created a Special Purpose Entity
("SPE"). These SPEs were formed at the request of lenders for the
express purpose of strengthening the collateral for the loans by
isolating (for Federal bankruptcy law purposes) the assets and
liabilities of the SPEs. In all cases and since their various
formation dates, the assets, liabilities and results of operations of
these wholly-owned entities have been fully consolidated into the
financial statements of HRP.
CASH AND CASH EQUIVALENTS
HRP considers highly liquid investments with original maturities of
three months or less at the time of purchase to be cash equivalents.
PROPERTY
Property is stated at cost. Renovations and improvements are
capitalized; maintenance and repairs are expensed. When an asset is
sold or otherwise disposed of, the related cost and accumulated
depreciation are removed from the accounts and any gain or any
previously unanticipated loss is recognized in the year of sale or
disposition. HRP reviews for impairment losses on its real estate
assets when events and circumstances indicate that the assets might be
impaired. If such indication is noted, an undiscounted cash flow
analysis is performed, and in the event undiscounted cash flow
estimated to be generated by an asset over the remaining depreciable
life of that asset is less than its carrying value, then the asset
would be written down to its fair value. Cash flow estimates are based
on historical results adjusted to our best estimate of future market
and operating conditions. Significant assumptions used in this process
include an evaluation of leases in place, future rental and occupancy
rates, and the level of expected operating expenses. For the three
years ended December 31, 2002, HRP has not recorded a write-down or
impairment of the carrying value of any real estate property based on
these calculations.
Page 25 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
2 ACCOUNTING POLICIES - (CONTINUED)
Should HRP decide to sell a property and actively commence the
disposal process, all of the assets, liabilities, income, and expenses
associated with such property will be segregated in the financial
statements. At such time, an evaluation for potential impairment will
be made using an estimate of the selling price less selling costs.
Depreciation of buildings is computed using the straight-line method
over estimated useful lives ranging from 15 to 43 years. Equipment and
other improvements are depreciated on the straight-line method over
estimated useful lives ranging from 3 to 23 years. Tenant improvements
are capitalized and amortized over the terms of the respective leases
or useful life, if shorter.
HRP capitalizes all costs related to the development and construction
of its projects, including interest of $256,000, $486,000, and
$493,000 in 2002, 2001, and 2000, respectively. The development period
of a project is considered to have begun when activities related to
the construction of the project or a portion thereof has commenced.
All costs for construction are capitalized and allocated to each
building. Capitalization of such costs is discontinued when the
building is available for occupancy.
HRP would accrue for losses associated with environmental remediation
obligations if such losses were probable and reasonably estimable.
Accruals for estimated losses from environmental remediation
obligations would generally be recognized no later than completion of
a remedial feasibility study. Such accruals would be adjusted as
further information developed or circumstances changed. Costs of
future expenditures for environmental remediation obligations would
not be discounted to their present value. Recoveries of environmental
remediation costs from other parties are recorded as assets when their
receipt is deemed probable. HRP's management is not aware of any
environmental remediation obligations which would materially affect
the operations, financial position or cash flows of HRP and therefore
has made no loss accruals.
OTHER ASSETS
Lease concessions and commissions are amortized over the terms of the
respective leases. Leases at the Properties expire from 2003 to 2020.
Loan costs are amortized over the terms of the respective loans. The
loans mature between 2005 and 2020. Amortization of lease commissions,
included in depreciation and amortization expense, was $2,817,000,
$2,889,000, and $3,180,000 in 2002, 2001, and 2000, respectively.
Amortization of loan costs, included in interest expense, was
$591,000, $624,000, and $855,000 in 2002, 2001, and 2000,
respectively. The caption "Prepaid expenses and other assets" on the
Consolidated Balance Sheets includes prepaid real estate taxes,
prepaid insurance and other miscellaneous deposits and prepaid
expenses.
REVENUE RECOGNITION
Rental income is recognized as earned on a straight-line basis over
the terms of the respective leases. Amortization of effective rent
income adjustments, included in property operations revenues, was
$99,000, $256,000, and $569,000 in 2002, 2001, and 2000, respectively.
Lease provisions generally require tenants to pay their proportionate
share of certain building operating costs and real property taxes.
Revenue from these expense recoveries, included in property
operations, are recorded as earned and was $3,755,000, $4,197,000, and
$3,315,000 in 2002, 2001, and 2000, respectively.
Revenues and expenses from short-term construction and tenant service
projects are recorded at the time of project completion. Revenues and
expenses from long-term construction projects are accounted for using
the percentage-of-completion method. Reclassifications, including a
gross-up for parking, construction and tenant service expenses that
were previously netted against revenues, have been made in the prior
year amounts to conform to the classifications used in the current
year. The reclassifications occurred due to the adoption of EITF No.
01-14, "Income Statement Characterization of Reimbursements Received
for Out-of-Pocket Expenses Incurred". The reclassifications had no
effect on previously reported net income or loss.
Page 26 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
2 ACCOUNTING POLICIES - (CONTINUED)
INTEREST RATE AGREEMENTS
HRP has used an interest rate swap as a hedge against interest
exposure of variable rate debt. HRP's only interest rate swap was sold
in July 2000. Differences between amounts paid or received in this
interest rate agreement, which was designated as a hedge, were
included in interest expense as the payments were made or received.
HRP was exposed to credit-related gains or losses in the event of
non-performance by counterparties, however none of the counterparties
failed to meet their obligations during the term of the agreement. In
July 2000, in connection with the sale of the interest rate swap, HRP
purchased an interest rate cap derivative that limits its interest
rate exposure on its mortgage for Allfirst Building (see Notes 6 and 9
for more information).
INCOME TAXES
Currently, HRP is a non-taxable entity. Federal and state income
taxes, if any, are the responsibility of the individual partners.
Accordingly, the Consolidated Financial Statements do not include a
provision for income taxes. However, certain business and franchise
taxes are the responsibility of HRP and subsidiary entities. These
business and franchise taxes, included in general and administrative
expenses, were $280,000, $178,000, and $182,000 in 2002, 2001, and
2000, respectively. HRP's tax returns are subject to examination by
federal and state taxing authorities. If HRP's amounts are ultimately
changed by the taxing authorities, the tax liability of the partners
could be changed accordingly. Additionally, no assurance can be given
that the federal or state governments will not pass legislation that
will characterize HRP as an association taxable as a corporation for
federal income tax purposes. Such classification may have an adverse
effect on HRP.
EQUITY-BASED COMPENSATION
Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation" establishes a method of
accounting whereby recognized option pricing models are used to
estimate the fair value of equity-based compensation, including
options. HRP has elected, as provided by SFAS No. 123, not to
recognize employee equity-based compensation expense as calculated
under SFAS No. 123, but has recognized such expense in accordance with
the provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". As the only options of HRP
fully vested in 1997, there is no difference between the historical
operations and pro forma operations for each of the three years ended
December 31, 2002 had the expense provisions of SFAS No. 123 been
adopted.
COMPUTATION OF NET INCOME (LOSS) PER UNIT
Basic earnings per unit is computed by dividing results attributable
to the limited partners' interests by the weighted average number of
units outstanding. Earnings per unit assuming dilution is computed by
dividing results attributable to the limited partners' interests by
the weighted average number of units and potential units outstanding.
Options to acquire units were issued during 1995 and are considered to
be potential units. The number of potential units is computed using
the treasury stock method which assumes that the increase in the
number of units is reduced by the number of units which could have
been repurchased by HRP with the proceeds from the exercise of these
options. The following table illustrates the amounts used to calculate
the weighted average number of units outstanding:
<Table>
<Caption>
2002 2001 2000
----------- ----------- -----------
Weighted average units outstanding - basic 1,590 1,590 1,620
Potential weighted average units issued from options 69 69 75
Potential repurchase of units from unit option proceeds (11) (14) (21)
----------- ----------- -----------
Potential weighted average units outstanding - assuming 1,648 1,645 1,674
=========== =========== ===========
</Table>
COMPREHENSIVE INCOME
Comprehensive income items are revenues, expenses, gains and losses
that under accounting principles generally accepted accounting
principles are excluded from current period results and reflected as a
component of equity. HRP recorded comprehensive income related to its
unrealized gain from the sale of an interest rate swap.
Page 27 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
2 ACCOUNTING POLICIES - (CONTINUED)
SEGMENT REPORTING
Operating segments are defined as components of an entity for which
separate financial information is available that is evaluated by the
chief operating decision-maker in deciding how to allocate resources
and in assessing performance. Management believes that HRP operates in
only one business segment, real estate.
RECENT ACCOUNTING PRONOUNCEMENTS AND OTHER
SFAS No. 142 "Goodwill and Other Intangible Assets" was issued in June
2001 and was adopted January 1, 2002. Among other things, SFAS No. 142
requires that in conjunction with an acquisition of a property in the
future all intangible assets associated with such property will be
separately evaluated and recorded.
SFAS No. 143 "Accounting for Asset Retirement Obligations" was adopted
January 1, 2003. It establishes an accounting standard for recognition
and measurement of a liability for an asset retirement obligation and
the associated asset retirement cost. HRP has no such obligations as
of December 31, 2002.
SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets" was adopted January 1, 2002 and requires current, as well as
historical, results of operations for disposed properties and those
properties held for sale that occur subsequent to January 1, 2002 to
be reclassified and presented separately as discontinued operations.
SFAS No. 145 "Rescission of FASB Statements 4, 44 and 64, Amendment of
FASB Statement No. 13, and Technical Corrections" was issued in April
2002 and was adopted in the fourth quarter of 2002. Among other
things, SFAS No. 145 limits debt extinguishments that can be
classified as extraordinary items. As a result, HRP has reclassified
previously recorded gains and losses from early extinguishment of debt
from an extraordinary item to current operations within interest
expense. Accordingly, the reclassifications had no effect on
previously reported net income or loss.
SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal
Activities" was issued in June 2002 and will be effective for exit or
disposal activities subsequent to December 31, 2002. HRP anticipates
no material impact on its financial statements from the adoption of
this accounting standard.
SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of FASB Statement No. 123" was issued in
December 2002 and provides new transition methods if an entity adopts
the fair value based method of valuing stock-based compensation
suggested in SFAS No. 123, as well as requiring additional disclosures
in interim and annual financial statements. At this time, HRP expects
that the impact will be limited to additional disclosure requirements.
In November 2002, the Financial Accounting Standards Board issued
Interpretation No. 45 "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires that the guarantor
recognize, at the inception of certain guarantees, a liability for the
fair value of the obligation undertaken in issuing such guarantee. FIN
45 also requires additional disclosure about the guarantor's
obligations under certain guarantees that it has issued. As of
December 31, 2002 HRP had no such guarantees.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of certain assets, liabilities, revenues, expenses, and
related disclosures, as of and for the reporting periods. Actual
results may differ from these estimates under different assumptions or
conditions.
The policies listed are not intended to be a comprehensive list of all
of our accounting policies. In many cases, the accounting treatment of
a particular transaction is specifically dictated by accounting
principles generally accepted in the United States of America, with no
need for management's judgment in the application. There are also
areas in which management's judgment in selecting any available
alternative would not produce a materially different results.
Page 28 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
3 STATEMENTS OF CASH FLOWS
Cash interest payments were $14,602,000 (net of capitalized interest
of $256,000), $14,947,000 (net of capitalized interest of $486,000),
and $13,831,000 (net of capitalized interest of $523,000) in 2002,
2001, and 2000, respectively.
Supplemental disclosure of noncash investing and financing activities
are as follows -
As of December 31, 2001, HRP had a construction payable for
property development at Executive Park of $250,000.
4 TRANSACTIONS WITH RELATED PARTIES
Realty receives certain fees in connection with the ongoing management
of HRP, including an asset management fee, acquisition fees and
disposition fees. Specifically, Realty is entitled to receive an asset
management fee equal to 1% of the net aggregate base rents of the
Properties, acquisition fees equal to 1% of the purchase price of
newly acquired properties, and disposition fees with respect to real
estate investments, other than the properties owned at the time of
HRP's formation in 1990, equal to 10% of the amount, by which the
sales price of a property exceeds the purchase price of such property.
HCRE receives compensation in connection with the management of the
Properties, which includes a property management fee, lease
commissions and construction supervision fees. The management
contracts expire June 30, 2004 and provide for basic compensation from
a property management fee in an amount equal to 2.85% of cash receipts
collected from the Properties' tenants, lease commissions equal to the
current commission market rate as applied to the net aggregate rent
(none exceeding 6% of the net aggregate rent), and construction
supervision fees for administering all construction projects equal to
5% of the total contracted costs of each capital expenditure or tenant
improvement project.
Realty and HCRE are compensated for services provided to HRP and its
Properties as described above and are reimbursed, at cost, for certain
costs and expenses. In particular, since HRP does not directly employ
any individuals, the compensation and other costs related to
approximately 90 employees rendering services on behalf of HRP and its
properties are reimbursed to Realty and HCRE by HRP. The following
table sets forth such compensation and reimbursements paid by HRP (in
thousands):
<Table>
<Caption>
ENTITY
PAID OR
REIMBURSED 2002 2001 2000
---------- ----------- ----------- -----------
Asset management fee Realty $ 618 $ 609 $ 581
Acquisition fee Realty -- -- 74
Disposition fee Realty -- 120 --
Reimbursement of costs(a) Realty 3,477 3,161 2,720
Property management fee HCRE 2,022 2,005 1,914
Lease commissions(b) HCRE 2,151 2,158 2,605
Construction fees HCRE 582 1,204 917
Reimbursement of costs(c) HCRE 3,916 3,826 3,521
</Table>
(a) These expenses are recorded as general and administrative expenses and
represent reimbursement, at cost, to Realty for administrative level
employee and director compensation, officer and director liability
insurance, and allocated overhead costs. HRP pays its account balance
with Realty on a monthly basis.
(b) As of December 31, 2002, $567,000 of the 2002 lease commissions are
accrued and are scheduled to be paid in 2003.
(c) These costs are recorded as property operating expenses and represent
reimbursement to HCRE for property-level employee compensation and
related expenses.
In January 2001, HRP acquired a construction development consulting
contract from Hallwood regarding a project in Tulsa, Oklahoma with an
unrelated third party. In connection therewith, HRP reimbursed
Hallwood for its actual costs incurred related to the project of
$281,000.
Page 29 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
5 PROPERTY TRANSACTIONS
PROPERTY DEVELOPMENT AT EXECUTIVE PARK
In early 2001, HRP demolished a one-story office building at its
Executive Park property in Atlanta, Georgia, which contained 18,000
net rentable square feet. In order to do so, HRP obtained a release of
the building from Executive Park's mortgage lien by substituting for
such collateral $608,000 of United States Treasury Bonds, which have
various maturity dates through December 2007. In February 2001, HRP
began constructing a five-story office building containing 128,000 net
rentable square feet. The building and its parking garage, excluding
tenant finish-out, was completed in April 2002. HRP incurred and
capitalized $15,370,000 of construction and development costs, which
included all of the costs for the building and its parking garage
(excluding the existing land costs). A seven-year lease for the entire
building, with an option for five additional years, with the General
Services Administration was executed in September 2002 and will
commence upon the completion of tenant improvements, estimated to be
sometime between May and August 2003. The lease commissions incurred
were $777,000, while the tenant improvements are estimated to be
$4,500,000. All development and leasing costs have been or will be
paid from cash funds on hand; however, it is anticipated that loan
financing of $15,000,000 to $16,000,000 will be obtained in the second
half of 2003.
PROPERTY DEVELOPMENT AT CORPORATE SQUARE
During the second quarter of 2000, HRP completed new construction of a
6-story office building containing approximately 151,000 net rentable
square feet that was commenced in the second quarter of 1999. It was
constructed on undeveloped land within the Corporate Square complex in
Atlanta, Georgia. A 20-year lease with the General Services
Administration for the entire building was executed in 1999 and the
tenant began paying rent August 2000.
The building construction, tenant improvements, lease commissions and
loan costs totaled $18,779,000 (excluding the original land cost). In
1999, HRP incurred, in connection with the leasing of the entire
project, $2,982,000 of lease commissions.
An interim-construction loan was secured in August 1999 that funded
$12,621,000 of the costs ($6,998,000 in 1999 and $5,623,000 in 2000).
On August 31, 2000, HRP secured permanent financing of $21,500,000.
The loan's monthly payment is based on a twenty-year amortization
period and matures August 15, 2020 and has a fixed interest rate of
7.97%. The loan proceeds repaid the interim-construction loan and
replenished working capital for the completed project.
ACQUISITION
On January 26, 2000, HRP acquired three 3-story office buildings in
San Diego, California (Fountain View Business Center) containing
approximately 89,000 net rentable square feet on 4.3 acres of land.
The acquisition cost was $7,791,000.
DISPOSITIONS
In March 2001, HRP sold Joy Road Distribution Center that contained
442,000 net rentable square feet on 21 acres for a gross selling price
of $5,326,000. The carrying value of the assets was $2,994,000. The
sale resulted in $4,916,000 of net proceeds to HRP and a net gain of
$1,922,000. The net sale proceeds were used to pay the outstanding
mortgage principal balance of $2,125,000, to pay a prepayment penalty
of $14,000 to the lender, and to add $2,777,000 to general working
capital. The prepayment penalty along with the writeoff of $31,000 of
unamortized loan costs associated with the retired loan were expensed
and are included in the Consolidated Statements of Operations as
interest expense.
In January 2001, HRP sold one of the warehouse buildings at Seattle
Business Parks that contained 63,000 net rentable square feet on 3.9
acres for a gross selling price of $3,287,000. The carrying value of
the assets was $885,000. The sale resulted in $2,994,000 of net
proceeds, which were added to HRP's working capital, and a net gain of
$2,109,000.
Also in January 2001, HRP sold one building at Fairlane Commerce Park
that contained less than 2,000 net rentable square feet on 0.5 acres
for a gross selling price of $575,000. The carrying value of the
assets was $372,000. The sale resulted in $525,000 of net proceeds,
which were added to HRP's working capital, and a net gain of $153,000.
Page 30 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
6 MORTGAGES PAYABLE
Substantially all of the buildings in HRP's real estate properties
were encumbered and pledged as collateral by 11 non-recourse mortgage
loans aggregating $197,552,000 as of December 31, 2002 and
$201,224,000 as of December 31, 2001. These mortgage loans have
interest rates varying from 2.68% to 8.70% (with an effective average
interest rate of 7.51% as of December 31, 2002) and mature between
2005 and 2020. Other than Allfirst Building's mortgage ($25,000,000),
all mortgages have fixed interest rates. Most of the mortgage loans
require monthly principal payments with balloon payments due at
maturity. The following table sets forth, by real estate property,
mortgages payable balances as of December 31, 2002 and 2001 (in
thousands), maturity dates, and interest rates:
<Table>
<Caption>
Mortgages Mortgages Interest
Payable as of Payable as of Maturity Rate as of
12-31-2002 12-31-2001 Date 12-31-2002
-------------- -------------- ---------- ----------
Airport Plaza $ 721 $ 735 10-11-2005 8.70%
Allfirst Building 25,000 25,000 4-30-2006 2.68%(a)
Bellevue Corporate Plaza 14,414 14,701 10-11-2005 8.70%
Bradshaw Business Parks 11,980 12,261 12-31-2020 8.10%(b)
Corporate Square 7,838 7,993 10-11-2005 8.70%
Corporate Square 9,782 9,944 8-11-2011 7.70%
Corporate Square 20,468 20,970 8-15-2020 7.97%
Executive Park 31,915 32,427 4-11-2008 7.32%
Fairlane Commerce Park 19,099 19,479 10-11-2005 8.70%
Fountain View Business Center 5,151 5,284 2-10-2010 8.17%
Gulley Road Industrial Park 4,144 4,487 5-11-2011 7.375%
Montrose Office Center 5,856 5,972 10-11-2005 8.70%
Parklane Towers 21,621 22,051 10-11-2005 8.70%
Raintree Industrial Park 10,090 10,291 10-11-2005 8.70%
Riverbank Plaza 2,364 2,422 2-10-2010 8.29%
Seattle Business Parks 7,109 7,207 6-7-2008 6.97%
-------------- --------------
Total $ 197,552 $ 201,224
============== ==============
(a) Variable interest rate. LIBOR plus 1.30%. Rate was 3.44% as of December 31, 2001.
(b) Call options exercisable by lender on 2-1-2011 and 2-1-2016.
</Table>
The following table shows for the years presented the principal and
balloon payments that are required (in thousands):
<Table>
<Caption>
Total
Mortgage
Principal Balloon Loan
Payments Payments Payments
---------------- ---------------- ----------------
2003 $ 3,998 $ -- $ 3,998
2004 4,310 -- 4,310
2005 4,167 74,515 78,682
2006 2,852 25,000 27,852
2007 3,079 -- 3,079
Thereafter 22,894 56,737 79,631
---------------- ---------------- ----------------
Total $ 41,300 $ 156,252 $ 197,552
================ ================ ================
</Table>
Page 31 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
6 MORTGAGES PAYABLE - (CONTINUED)
The following discussions pertain to financing and refinancing
activities during the three years ended December 31, 2002.
ALLFIRST BUILDING
On July 27, 2000, HRP sold its interest rate swap agreement for
$1,597,000. HRP had entered into the interest rate swap agreement in
1998 to reduce its exposure to changes in interest rates for the loan
secured by Allfirst Building. This interest rate swap agreement
effectively fixed the loan's cash interest rate at 6.78%, as opposed to
the mortgage loan interest rate of LIBOR plus 1.30% (or 7.94% at the
time of the swap agreement sale). The proceeds from the sale were
designated for general working capital purposes. For financial reporting
purposes, the proceeds are being amortized over the life of the loan as
a reduction to interest expense. During 2001, as the result of the
adoption of SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities", HRP reclassified the remaining unamortized gain
from liabilities to accumulated other comprehensive income. The proceeds
will continue to be amortized over the life of Allfirst Building's
mortgage payable as a reduction to interest expense. As of December 31,
2002 and 2001, the unamortized balance, included on the balance sheet as
"Accumulated other comprehensive income", was $926,000 and $1,204,000,
respectively.
Also on July 27, 2000 and in connection with the sale of the swap
agreement, HRP purchased an interest rate cap for Allfirst Building's
mortgage loan for $288,000, which limits HRP's exposure to changing
interest rates to a maximum of 10%. This interest rate cap, which has a
notional amount of $25,000,000, has terms consistent with Allfirst
Building's mortgage loan. Allfirst Building's cash interest rate was
2.68% and 3.44% as of December 31, 2002 and 2001, respectively. The
interest rate cap is a derivative and designated as a cash flow hedge.
Hedge effectiveness is measured based on using the intrinsic value of
the interest rate cap. All changes in the fair value of the time value
of the cap are recorded directly to earnings. With the January 1, 2001
adoption of SFAS No. 133, HRP recorded the cumulative effect of the
adoption as a reduction to income of $192,000, or the amount of the
difference between the carrying value as of January 1, 2001 of $267,000
and the then estimated fair value of $75,000, all of which represented
change in time value. Thereafter, on a quarterly basis, HRP has recorded
changes in the estimated fair value of the cap in interest expense. As
of December 31, 2002 and 2001, the estimated fair value of the interest
rate cap was $55,000 and $68,000, respectively.
BRADSHAW BUSINESS PARKS
In December 2000, HRP refinanced Bradshaw Business Park's existing loan
with a new lender. The interest rate was reduced to 8.1% from 8.5% and
the maturity date was extended by 17 years, subject to two call options
exercisable by the lender on February 1, 2011 and February 1, 2016. The
monthly principal payments amortize the loan over 20 years. The loan
proceeds of $12,500,000 were used (i) to pay the outstanding principal
balance of $5,724,000 with the former lender, (ii) to pay transaction
costs of $267,000, (iii) to pay a prepayment penalty of $286,000, (iv)
to fund $288,000 of loan reserves, and (v) to add $5,935,000 to general
working capital. The prepayment penalty along with the writeoff of
$103,000 of unamortized loan costs associated with the retired loan were
expensed and are included in the Consolidated Statements of Operations
as interest expense.
CORPORATE SQUARE
On August 7, 2001, HRP refinanced a mortgage loan secured by a portion
of Corporate Square with a new lender. The interest rate was reduced to
7.7% from 8.625% and the maturity date was extended six years to August
2011. The monthly principal payments amortize the loan over 22.5 years.
The loan proceeds of $10,000,000 were used to pay the outstanding
mortgage principal balance of $2,760,000 with the former lender, to pay
a prepayment penalty of $409,000, to pay transaction costs of $142,000,
and for general working capital. The prepayment penalty along with the
writeoff of $105,000 of unamortized loan costs associated with the
retired loan were expensed and are included in the Consolidated
Statements of Operations as an interest expense.
FOUNTAIN VIEW
In January 2000, HRP obtained financing of $5,500,000 in connection with
the acquisition of Fountain View Business Center (three 3-story office
buildings in San Diego, California). The loan has a monthly payment
based on a twenty-year amortization, matures in ten years and has a
fixed interest rate of 8.17%.
Page 32 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
6 MORTGAGES PAYABLE - (CONTINUED)
JOY ROAD DISTRIBUTION CENTER
In August 2000, HRP received $3,000,000 of loan proceeds from a
promissory term note secured by Joy Road Distribution Center in Detroit,
Michigan. The loan proceeds were for general working capital purposes.
The loan was scheduled to mature July 31, 2002, however it was paid off
in March 2001 when Joy Road Distribution Center was sold. The loan had a
variable interest rate of LIBOR plus 3.0%.
LINE OF CREDIT
Since August 2000, HRP has had available a $2,000,000 revolving line of
credit, which matures on July 29, 2003. The line of credit has a
variable interest rate of either prime plus 0.50% or LIBOR plus 3.0% and
requires monthly interest payments, but no principal amortization. HRP
has not borrowed against this facility.
RIVERBANK PLAZA
In May 2000, HRP closed on a new mortgage generating $2,500,000 of loan
proceeds, which is secured by Riverbank Plaza (acquired in August 1999
in a cash transaction). The loan's monthly payment is based on a
twenty-year amortization, matures in ten years and has a fixed interest
rate of 8.29%. The loan proceeds were for general working capital
purposes.
7 LEASE AGREEMENTS AND MAJOR TENANT INFORMATION
HRP leases and shares offices with Hallwood in Dallas, Texas under a
lease which expires November 30, 2008. HRP has a one-time option to
terminate the lease effective November 30, 2005. The annual minimum cash
rental payments are $315,000, of which HRP's portion is approximately
$210,000 annually.
Lease provisions generally require HRP's tenants to pay fixed rental
amounts, plus their proportionate share of certain building operating
costs and real property taxes. Revenue from expense recoveries, included
in property operations, was $3,755,000, $4,197,000, and $3,315,000 in
2002, 2001, and 2000, respectively. In addition, certain leases include
provisions for annual rental adjustments. Some leases contain provisions
to allow a tenant to terminate their lease prior to its normal
expiration. At December 31, 2002, the Properties, in the aggregate, were
91% leased. The following table sets forth the minimum cash rental
payments to be received from leases in place as of December 31, 2002 (in
thousands):
<Table>
<Caption>
Payments Payments
from Leases from Leases
without Early with Early
Termination Termination
Rights Rights Total
---------------- ---------------- ----------------
2003 $ 54,963 $ 651 $ 55,614
2004 48,306 413 48,719
2005 40,003 238 40,241
2006 27,928 1,837 29,765
2007 20,348 3,485 23,833
Thereafter 75,796 35,962 111,758
---------------- ---------------- ----------------
Total $ 267,344 $ 42,586 $ 309,930
================ ================ ================
</Table>
During 2002 and 2001, two tenants leasing space contributed 10% or more
of HRP's revenues. Ford Motor Company and affiliates ("Ford") leases
space in Parklane Towers and Fairlane Commerce Park. Ford accounted for
11% and 12% of revenues in 2002 and 2001, respectively. The General
Services Administration ("GSA") leases space in Corporate Square and
Executive Park. GSA accounted for 17% and 14% of revenues in 2002 and
2001, respectively.
Page 33 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
7 LEASE AGREEMENTS AND MAJOR TENANT INFORMATION - (CONTINUED)
As of December 31, 2002, Ford leased 199,000 square feet of office space
under seven leases at Parklane Towers and 224,000 square feet of office,
technical laboratory and industrial space under seven leases at Fairlane
Commerce Park. These leases expire between 2003 and 2005 and most
contain options providing for one to ten year renewals. As of December
31, 2002, GSA leased 450,000 square feet of office space at Executive
Park (including 128,000 square feet associated with a lease that begins
in 2003 - see Note 5) under seven leases which expire between 2003 and
2015. Also, as of December 31, 2002, GSA leased 310,000 square feet of
office space at Corporate Square under three leases which expire in
2004, 2013 (with a right to early terminate in 2008) and 2020. The
remaining tenants are not concentrated in any one industry, nor is HRP
otherwise dependent on any group of related tenants for 10% or more of
its revenues.
8 PARTNERS' CAPITAL
In 1995, HRP issued options totaling 86,000 units to certain executives
of Realty and HCRE with an exercise price of $11.875 per unit. The
options were vested over a three year period ending in 1997 and they
expire on February 27, 2005. As of December 31, 2002, 17,200 options had
been exercised (all during 2000), none have been canceled and 68,800
options remained exercisable. In February 2003, options for 4,000 units
were exercised by the estate of a deceased HCRE executive. No options
have been granted since 1995.
As part of the resignation of Brian Troup as an officer and director of
Hallwood and HRP's general partner on December 21, 1999, Hallwood
transferred 82,608 units of HRP that it owned to a trust controlled by
Mr. Troup. On May 12, 2000, Mr. Troup exercised his unit options to
purchase 17,200 HRP units at the option plan's exercise price of $11.875
per unit, which generated $601,000 of non-cash compensation. Also on May
12, 2000, HRP purchased and retired all of Mr. Troup's above-mentioned
99,808 units at $46.825 per unit (the average of the closing market
prices of the units for the twenty trading days prior to the purchase).
9 ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
Estimated fair value amounts of certain financial instruments have been
determined using available market information based upon negotiations
held by Realty with potential lenders or other appropriate valuation
methodologies that require considerable judgment in interpreting market
data and developing estimates. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts that HRP could
realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect
on the estimated fair value amounts.
The fair value of financial instruments that are short-term or re-price
frequently and have a history of negligible credit losses is considered
to approximate their carrying value. These include cash and cash
equivalents, short term receivables, accounts payable and other
liabilities. Real estate and other assets are not considered financial
instruments.
Management has reviewed the fair values of its mortgages payable in
connection with interest rates currently available to HRP for borrowing
with similar characteristics and maturities (approximately 7.5% as of
December 31, 2002 and 2001). Based on those interest rates, management
has determined that the estimated fair values of HRP's mortgages payable
as of December 31, 2002 and 2001 would equal approximately $199,383,000
and $204,158,000, respectively, as compared to the carrying values of
$197,552,000 and $201,224,000, respectively.
The estimated fair value of HRP's interest rate cap as of December 31,
2002 and 2001 was $55,000 and $68,000, respectively, based on quotes
obtained from the issuer of the cap agreement (see Note 6 for more
information). The carrying value of HRP's interest rate cap as of
December 31, 2002 and 2001 was $55,000 and $68,000, respectively.
The fair value information presented herein is based on pertinent
information available to management as of December 31, 2002. Although
management is not aware of any factors that would significantly affect
the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statements
since that date and, therefore current estimates of fair value may
differ significantly from the amounts presented herein.
Page 34 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
10 COMMITMENTS AND CONTINGENCIES
LITIGATION
On June 20, 1997, an action was filed against HRP, the General Partner,
its directors, and Hallwood by Gotham Partners, L.P. in the Court of
Chancery of the State of Delaware, styled Gotham Partners, L.P. v.
Hallwood Realty Partners, L.P., et al. (C.A. No. 15754). This action
alleges claims of breach of fiduciary duties, breach of HRP's
partnership agreement, and fraud in connection with certain transactions
involving HRP's units in the mid 1990's. Hallwood is alleged to have
aided and abetted the alleged breaches. On June 21, 2000, after
completing fact discovery, all parties moved for summary judgment on
several issues. In September and October 2000, the Delaware court issued
three separate written opinions resolving the summary judgment motions.
In the opinions, the court ruled that trial would be required as to all
issues, except that (i) Gotham was found to have standing to pursue its
derivative claims; (ii) defendants were entitled to judgment dismissing
the fraud claim; (iii) the General Partner was entitled to judgment
dismissing the breach of fiduciary duty claims brought against it; and
(iv) the General Partner's outside directors were entitled to judgment
dismissing all claims brought against them.
A five-day trial was held in January 2001. On July 18, 2001, the
Delaware Court of Chancery rendered its opinion. In its decision, the
court determined that an option plan and a sale of units to Hallwood in
connection with a reverse split of units implemented by HRP in 1995 were
in compliance with HRP's partnership agreement. The court also found
that the sale of units to Hallwood in connection with a 1995 odd-lot
offer by HRP did not comply with certain procedures required by the HRP
partnership agreement. The court ruled that the defendants other than
HRP pay a judgment to HRP in the amount of $3,417,423, plus pre-judgment
interest from August 1995. The judgment amount represents what the court
determined was an underpayment by Hallwood. In August 2001, plaintiff
and certain defendants appealed the Court of Chancery's judgment to the
Delaware Supreme Court. In October 2001, HRP received the $3,417,423
judgment together with $2,987,576 of interest, subject to an arrangement
that it be returned in full or part if the judgment is modified or
reversed on appeal. Oral arguments were heard on February 12, 2002, and
a rehearing en banc was held on March 26, 2002. On August 29, 2002, the
Supreme Court affirmed the judgment of the trial court that the
remaining defendants other than HRP are jointly and severally liable to
HRP. The Supreme Court reversed the trial court's determination of
damages, and remanded the case to the trial court to fashion appropriate
relief. A hearing on the remand proceedings was held before the Court of
Chancery on October 25, 2002. A further hearing on the remand is
scheduled to take place in May or June 2003, with a decision by the
Court of Chancery to follow. Since the appellate court reversed the
judgment, any subsequent ruling by the trial court on remand may be more
or less favorable to HRP. As a result of the uncertainty of the
litigation's outcome, HRP recorded the judgment and interest as
"Deferred Litigation Proceeds" on its balance sheet.
On February 15, 2000, HRP filed a lawsuit in the United States District
Court for the Southern District of New York styled Hallwood Realty
Partners, L.P. v. Gotham Partners L.P., et al. (Civ. No. 00 CV 1115)
alleging violations of the Securities Exchange Act of 1934 by certain
purchasers of its units, including Gotham Partners, L.P., Gotham
Partners III, L.P., Private Management Group, Inc., Interstate
Properties, Steven Roth and EFO Realty, Inc., by virtue of those
purchasers' misrepresentations and/or omissions in connection with
filings required under the Securities Exchange Act of 1934. The
complaint further alleged that defendants, by acquiring more than 15% of
the outstanding HRP units, have triggered certain rights under its Unit
Purchase Rights Agreement, for which HRP was seeking declaratory relief.
HRP sought various forms of relief, including declaratory judgments,
divestiture, corrective disclosures, a "cooling-off" period and damages,
including costs and disbursements. On November 16, 2000, the court
granted HRP's motion to add as defendants Gotham Holdings II, L.L.C.,
Hallwood Investors, L.P., Liberty Realty Partners, L.P. and EFO/Liberty,
Inc. and to remove EFO Realty, Inc. as a defendant. Discovery was
completed in December 2000 and trial was held in February 2001. On
February 23, 2001, the court rendered a decision in favor of the
defendants and on February 28, 2001, the court ordered the complaint
dismissed. HRP filed a Notice of Appeal on March 29, 2001. Oral argument
was heard on March 4, 2002. On April 11, 2002, the U.S. Court of Appeals
for the Second Circuit upheld the lower court's ruling in favor of
defendants. On April 25, 2002, HRP filed with the court a Petition for
Rehearing and Rehearing En Banc with respect to the April 11, 2002
decision. On June 3, 2002, the Second Circuit denied that petition. HRP
has not sought further appellate review and the determination in favor
of defendants is now final.
HRP is from time to time involved in various other legal proceedings and
claims which arise in the ordinary course of business. These matters are
generally covered by insurance. Management believes that the resolution
of these matters will not have a material adverse effect on HRP's
financial position, cash flow or operations.
Page 35 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
10 COMMITMENTS AND CONTINGENCIES - (CONTINUED)
ASBESTOS
The environmental laws of the federal government and of certain state
and local governments impose liability on current property owners for
the cleanup of hazardous and toxic substances discharged on such
property. This liability may be imposed without regard to the timing,
cause or person responsible for the release of such substances onto the
property. HRP could be subject to additional liability in the event that
it owns properties having such environmental problems. Parklane Towers,
as well as certain other properties to a lesser extent, are known to
contain asbestos. Removal of asbestos at HRP's properties is not
required because it is cementitious, it is not friable and because the
procedures in HRP's site environmental program Operations and
Maintenance Manual are performed as required.
RIGHTS PLAN
HRP has a Unit Purchase Rights Agreement ("Rights Plan") that provides
for a distribution of one right for each unit of HRP to holders of
record at the close of business as of December 10, 1990. The rights will
not trade separately from the units until, and will become exercisable
only in the event, with certain exceptions, an acquiring party
accumulates 15 percent or more of HRP's units, or if a party commences
or announces an intent to commence a tender offer or exchange offer to
acquire 30 percent or more of such units. Each right will entitle the
holder to buy one additional unit at a price of $250. In addition, upon
the occurrence of certain events, holders of the rights will be
entitled to purchase either HRP units or shares in an "acquiring
entity" at half of market value. HRP will generally be entitled to
redeem the rights at $.01 per right at any time on or prior to the
tenth day following the acquisition of a 15 percent or greater interest
in its units. Unless and until a triggering event under the Rights Plan
occurs, there is one right for each outstanding unit, the rights do not
trade separately from the units, and the rights are not currently
exercisable.
OTHER
HRP has estimated and budgeted tenant and capital improvements of
$15,631,000 and lease commissions of $2,851,000 for 2003.
Page 36 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2002
11 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Set forth below is selected quarterly financial data for the years ended
December 31, 2002 and 2001 (in thousands except per unit amounts) :
<Table>
<Caption>
Quarter Ending
------------------------------------------------------------------------
March 31 June 30 September 30 December 31
-------------- -------------- -------------- --------------
2002
Total revenues(a) $ 18,067 $ 19,153 $ 17,781 $ 18,738
Property operations revenues less property
operations expenses, general and administrative
expenses and litigation costs(a)(b) 8,979 8,935 8,599 7,643
Net income(b) 2,474 1,942 1,843 672
Earnings per unit - basic
Net income(b) 1.54 1.21 1.15 0.42
Earnings per unit - assuming dilution
Net income(b) 1.49 1.17 1.11 0.40
2001
Total revenues(a) $ 18,876 $ 18,979 $ 18,742 $ 18,094
Property operations revenues less property
operations expenses, general and administrative
expenses and litigation costs(a)(b) 5,943 8,994 8,662 7,637
Income before cumulative effect of
SFAS No. 133 adoption(b) 3,411 2,371 1,840 898
Net income(b) 3,219 2,371 1,840 898
Earnings per unit - basic
Income before cumulative effect of
SFAS No. 133 adoption 2.12 1.48 1.15 0.56
Cumulative effect of SFAS No. 133 adoption (0.12) -- -- --
Net income(b) 2.00 1.48 1.15 0.56
Earnings per unit - assuming dilution
Income before cumulative effect of
SFAS No. 133 adoption 2.05 1.43 1.11 0.54
Cumulative effect of SFAS No. 133 adoption (0.11) -- -- --
Net income(b) 1.94 1.43 1.11 0.54
</Table>
(a) Reclassifications, including a gross-up for parking, construction
and tenant service expenses that were previously netted against
revenues, have been made in the prior year amounts to conform to
the classifications used in the current year. The reclassifications
occurred due to the adoption of EITF No. 01-14, "Income Statement
Characterization of Reimbursements Received for Out-of-Pocket
Expenses Incurred". The reclassifications had no effect on
previously reported net income or loss.
(b) Litigation costs were $217, $148, $106 and $306 in the first,
second, third, and fourth quarters of 2002, respectively.
Litigation costs were $2,690, $639, $206 and $273 in the first,
second, third, and fourth quarters of 2001, respectively. (See Note
10 to the Consolidated Financial Statements for more information.)
Page 37 of 45
HALLWOOD REALTY PARTNERS, L.P.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2002
(IN THOUSANDS)
<Table>
<Caption>
Costs
Capitalized
Subsequent To
Initial Cost Acquisition
--------------------------------------- -----------------
Buildings Buildings
And And
Description(A) Encumbrances Land Improvements Improvements
- ------------------------------ ----------------- ----------------- ----------------- -----------------
Airport Plaza $ 721 $ 300 $ 4,013 $ 655
Allfirst Building 25,000 2,100 43,772 3,225
Bellevue Corporate Plaza 14,414 7,428 17,617 2,298
Bradshaw Business Parks 11,980 5,018 15,563 5,709
Corporate Square 38,088 6,142 14,112 24,620
Executive Park 31,915 15,243 34,982 29,790
Fairlane Commerce Park 19,099 4,883 17,894 6,684
Fountain View Business Center 5,151 1,858 5,933 677
Gulley Road Industrial Park 4,144 1,227 7,022 316
Montrose Office Center 5,856 5,096 15,754 3,518
Parklane Towers 21,621 3,420 37,592 7,410
Raintree Industrial Park 10,090 1,191 18,208 1,701
Riverbank Plaza 2,364 710 1,644 1,823
Seattle Business Parks 7,109 4,399 7,608 4,170
Corporate office - FF&E -- -- -- 184
----------------- ----------------- ----------------- -----------------
TOTAL $ 197,552 $ 59,015 $ 241,714 $ 92,780
================= ================= ================= =================
<caption>
Gross Amount At Which
Carried At Close Of Period
---------------------------------------------------------- -----------------
Buildings Accumulated
And Depreciation Date(s)
Description(A) Land Improvements Total (B) (B)(C) Acquired
- ------------------------------ ---------------- ----------------- ----------------- ----------------- -----------------
Airport Plaza $ 300 $ 4,668 $ 4,968 $ 4,239 4/30/87
Allfirst Building 2,100 46,997 49,097 31,051 6/29/84
Bellevue Corporate Plaza 7,428 19,915 27,343 7,057 6/30/88
Bradshaw Business Parks 5,018 21,272 26,290 13,183 9/24/85
Corporate Square 6,142 38,732 44,874 17,909 8/2/85 & 10/1/92
Executive Park 15,243 64,772 80,015 32,936 12/19/85
Fairlane Commerce Park 4,883 24,578 29,461 13,342 12/30/86 & 7/1/87
Fountain View Business Center 1,858 6,610 8,468 888 1/26/00
Gulley Road Industrial Park 1,227 7,338 8,565 1,159 10/29/99
Montrose Office Center 5,096 19,272 24,368 9,551 1/8/88
Parklane Towers 3,420 45,002 48,422 31,683 12/16/84
Raintree Industrial Park 1,191 19,909 21,100 11,757 7/17/86
Riverbank Plaza 710 3,467 4,177 1,125 8/19/99
Seattle Business Parks 4,399 11,778 16,177 7,690 4/24/86
Corporate office - FF&E -- 184 184 101 various
---------------- ----------------- ----------------- -----------------
TOTAL $ 59,015 $ 334,494 $ 393,509 $ 183,671
================ ================= ================= =================
</Table>
See notes to Schedule III on following page.
Page 38 of 45
HALLWOOD REALTY PARTNERS, L.P.
NOTES TO SCHEDULE III
DECEMBER 31, 2002
(IN THOUSANDS)
(A) PROPERTY LOCATIONS ARE AS FOLLOWS:
<Table>
Airport Plaza San Diego, California
Allfirst Building Baltimore, Maryland
Bellevue Corporate Plaza Bellevue, Washington
Bradshaw Business Parks Sacramento and Rancho Cordova, California
Corporate Square Atlanta, Georgia
Executive Park Atlanta, Georgia
Fairlane Commerce Park Dearborn, Michigan
Fountain View Business Center San Diego, California
Gulley Road Industrial Park Dearborn, Michigan
Montrose Office Center Rockville, Maryland
Parklane Towers Dearborn, Michigan
Raintree Industrial Park Solon, Ohio
Riverbank Plaza San Diego, California
Seattle Business Parks Kent and Tukwila, Washington
</Table>
(B) RECONCILIATION OF CARRYING COSTS (in thousands):
<Table>
<Caption>
Accumulated
Cost Depreciation
--------------- ---------------
Balance, January 1, 2000$ 358,315 $ 165,501
Additions 24,896 11,318
Retirements (5,949) (5,949)
--------------- ---------------
Balance, December 31, 2000 377,262 170,870
Additions 23,073 11,674
Retirements and dispositions (10,042) (5,825)
--------------- ---------------
Balance, December 31, 2001 390,293 176,719
Additions 8,344 12,080
Retirements (5,128) (5,128)
--------------- ---------------
Balance, December 31, 2002 $ 393,509 $ 183,671
=============== ===============
</Table>
(C) COMPUTATION OF DEPRECIATION:
Depreciation of buildings is computed using the straight-line method
over estimated useful lives ranging from 15 to 43 years. Equipment and
other improvements are depreciated on the straight-line method over
estimated useful lives ranging from 3 to 23 years. Tenant improvements
are capitalized and amortized over the term of the respective leases
or useful life, if shorter.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
Page 39 of 45
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
HRP has no officers or directors. Realty, as general partner, performs functions
generally performed by officers and directors. Realty was formed in Delaware as
a corporation in January 1990 and became a limited liability company in December
1998.
BUSINESS EXPERIENCE OF DIRECTORS AND OFFICERS OF REALTY -
ANTHONY J. GUMBINER, 58, CHAIRMAN OF THE BOARD AND DIRECTOR OF REALTY
Mr. Gumbiner has served as director and Chairman of the Board of
Realty since January 1990. He has served as a director and Chairman of
the Board since 1981 and Chief Executive Officer since 1984 of
Hallwood. He has also served as Hallwood's President and Chief
Operating Officer since December 21, 1999. Formerly, he served as
Chairman of the Board and Chief Executive Officer of Hallwood Energy
Corporation and its predecessors ("HEC") from 1987 until HEC was sold
in 2001. Mr. Gumbiner is also a solicitor of the Supreme Court of
Judicature of England.
WILLIAM L. GUZZETTI, 59, PRESIDENT AND DIRECTOR OF REALTY
Mr. Guzzetti has been President, Chief Operating Officer and a
director of Realty since January 1990. He has served as Executive-Vice
President of Hallwood since October 1989 and in that capacity may
devote a portion of his time to the activities of Hallwood, including
the management of real estate investments, acquisitions and
restructurings of entities controlled by Hallwood. He also served as
President, Chief Operating Officer and a director of HEC from 1985
until HEC was sold in 2001 and in that capacity devoted a portion of
his time to the activities of HEC. He is a member of The Florida Bar
and the State Bar of Texas.
JOHN G. TUTHILL, 59, EXECUTIVE VICE PRESIDENT AND SECRETARY
Mr. Tuthill has been an Executive Vice President and Secretary of
Realty since January 1990. He joined Hallwood in October 1989 to head
all property management functions, having previously served as
President of Southmark Commercial Management since November 1986,
where he was responsible for a diversified real estate portfolio of
over 18,000,000 square feet.
UDO H. WALTHER, 55, SENIOR VICE PRESIDENT
Mr. Walther has been a Senior Vice President of Realty since November
1998. Mr. Walther was a member of the Board of Directors of Realty
from June 1994 to November 1998. Mr. Walther had been President and
Chief Executive Officer of Walther Group, Inc., a full service design
and construction consultancy, and President of Precept Builders, Inc.
from 1991 to 1998. Previously, Mr. Walther was a Partner at Trammell
Crow Company, Project Manager with HCB Contractors and Marketing Vice
President for Researched Investments, Ltd.
JEFFREY D. GENT, 55, VICE PRESIDENT - FINANCE
Mr. Gent joined Hallwood in March 1990 as the Vice President-Finance.
He previously served as Vice President-Finance of Southmark Commercial
Management since September 1984, where he was responsible for the
financial functions of a diversified real estate portfolio of over
18,000,000 square feet.
ALAN G. CRISP, 61, DIRECTOR OF REALTY
Mr. Crisp was Chairman and Chief Executive Officer of Atlantic
Metropolitan Holdings (U.K.) plc from 1979 until 1988, when he joined
Interallianz Bank Zurich AG. From 1988 to 1993, he was General Manager
of the London Office of the Bank. Since 1994, Mr. Crisp has been a
consultant for various international and British companies. He is a
Fellow of the Royal Institution of Chartered Surveyors and holds a
B.A. (Hons) Degree and is a Master of Literature from Oxford
University.
WILLIAM F. FORSYTH, 53, DIRECTOR OF REALTY
Mr. Forsyth has been Chairman of Kildalton & Co., an investment
management consultancy based in Edinburgh, Scotland since 1992. He
graduated in law at Edinburgh University in 1971, and is a member of
the Society of Investment Analysts in the United Kingdom.
EDWARD T. STORY, 59, DIRECTOR OF REALTY
Mr. Story has been President and Chief Executive Officer of SOCO
International, plc, an oil and gas company, since September, 1991.
Prior to September 1991, he was Founder and Chairman of Thaitex
Petroleum Company, Co-founder and Chief Financial Officer of Conquest
Exploration Company, the Chief Financial Officer for Superior Oil
Company, and Exploration and Production Controller with Exxon
Corporation.
Page 40 of 45
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - (continued)
Section 16(a) of the Securities and Exchange Act of 1934 requires the officers
and directors of Hallwood Realty, LLC and persons who own more than ten percent
of HRP's units to file reports of ownership and changes in ownership with the
Securities and Exchange Commission (the "SEC"). Officers, directors and greater
than ten percent owners are required by the SEC regulations to furnish HRP with
copies of all Section 16(a) forms they file. Based solely on a review of the
copies of such forms furnished to HRP, or written representations from certain
reporting persons that no forms were required of those persons, HRP believes
that during the period January 1, 2002 to December 31, 2002, all officers and
directors of Hallwood Realty, LLC and ten percent owners complied with
applicable filing requirements.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION COMMITTEE INTERLOCKS, INSIDER PARTICIPATION AND COMPENSATION OF
DIRECTORS
Realty does not have a compensation committee and compensation decisions are
made by the Board of Directors of Realty. During 2002, Messrs. Gumbiner and
Guzzetti served on the Board of Directors of Realty. Mr. Gumbiner is also Chief
Executive Officer of Hallwood and Realty, and a member of the Board of Directors
of Hallwood, which serves as the compensation committee for Hallwood. Mr.
Guzzetti is also President and Chief Operating Officer of Realty, and Executive
Vice President of Hallwood. Messrs. Forsyth, Crisp, and Story were each paid
$25,000 in 2002, 2001, and 2000, respectively, for director fees.
Realty receives certain fees in connection with the ongoing management of HRP,
including an asset management fee, acquisition fees and disposition fees.
Specifically, Realty is entitled to receive an asset management fee equal to 1%
of the net aggregate base rents of the Properties, acquisition fees equal to 1%
of the purchase price of newly acquired properties, and disposition fees with
respect to real estate investments, other than the properties owned at the time
of HRP's formation in 1990, equal to 10% of the amount, by which the sales price
of a property exceeds the purchase price of such property.
HCRE receives compensation in connection with the management of the Properties,
which includes a property management fee, lease commissions and construction
supervision fees. The management contracts expire June 30, 2004 and provide for
basic compensation from a property management fee in an amount equal to 2.85% of
cash receipts collected from the Properties' tenants, lease commissions equal to
the current commission market rate as applied to the net aggregate rent (none
exceeding 6% of the net aggregate rent), and construction supervision fees for
administering all construction projects equal to 5% of the total contracted
costs of each capital expenditure or tenant improvement project.
Realty and HCRE are compensated for services provided to HRP and its Properties
as described above and are reimbursed, at cost, for certain costs and expenses.
In particular, since HRP does not directly employ any individuals, the
compensation and other costs related to approximately 90 employees rendering
services on behalf of HRP and its properties are reimbursed to Realty and HCRE
by HRP. The following table sets forth such compensation and reimbursements paid
by HRP (in thousands):
<Table>
<Caption>
Entity
Paid or
Reimbursed 2002 2001 2000
---------- ------------ ------------ ------------
Asset management fee Realty $ 618 $ 609 $ 581
Acquisition fee Realty -- -- 74
Disposition fee Realty -- 120 --
Reimbursement of costs(a) Realty 3,477 3,161 2,720
Property management fee HCRE 2,022 2,005 1,914
Lease commissions(b) HCRE 2,151 2,158 2,605
Construction fees HCRE 582 1,204 917
Reimbursement of costs(c) HCRE 3,916 3,826 3,521
</Table>
(a) These expenses are recorded as general and administrative expenses and
represent reimbursement, at cost, to Realty for administrative level
employee and director compensation, officer and director liability
insurance, and allocated overhead costs. HRP pays its account balance
with Realty on a monthly basis.
(b) As of December 31, 2002, $567,000 of the 2002 lease commissions are
accrued and are scheduled to be paid in 2003.
(c) These costs are recorded as property operating expenses and represent
reimbursement to HCRE for property-level employee compensation and
related expenses.
Page 41 of 45
ITEM 11. EXECUTIVE COMPENSATION - (CONTINUED)
CASH COMPENSATION OF EXECUTIVE OFFICERS
HRP has no executive officers, however, employees of Realty (general partner of
HRP) perform all functions ordinarily performed by executive officers. The
following table sets forth the compensation paid for services performed for HRP
to the Chief Executive Officer and the four other executive officers. Bonuses
are with respect to years presented and are usually paid in the following year.
SUMMARY COMPENSATION TABLE
<Table>
<Caption>
Annual Compensation
--------------------------------------------------------------------
Other Annual
Name and Principal Position Year Salary(a) Bonus Compensation(b)
- --------------------------- ---- --------------- ----------------- ---------------
Anthony J. Gumbiner 2002 $ -- $ 150,000 $ --
Chairman of the Board and 2001 -- 150,000 --
Chief Executive Officer 2000 -- 150,000 --
William L. Guzzetti 2002 200,000 32,333 --
President and Chief 2001 200,000 32,333 --
Operating Officer 2000 200,000 32,333 --
John G. Tuthill 2002 150,360 68,265 7,643
Executive Vice President 2001 150,360 68,265 7,895
and Secretary 2000 150,360 68,265 7,923
Udo H. Walther 2002 150,000 68,250 7,643
Senior Vice President 2001 150,000 68,250 7,895
2000 150,000 68,250 --
Jeffrey D. Gent 2002 129,203 20,075 6,308
Vice President - Finance 2001 120,750 19,547 6,245
2000 115,000 19,471 6,206
</Table>
- ----------
(a) Represents executive officers' gross salary before contributions to the
qualified 401(k) Tax Favored Savings Plan.
(b) Represents employer matching contributions to the 401(k) Tax Favored
Savings Plan or payments in lieu thereof made under a special bonus
arrangement.
In 1995, HRP issued options totaling 86,000 units to certain executives of
Realty and HCRE with an exercise price of $11.875 per unit. The options were
vested over a three year period ending in 1997 and they expire on February 27,
2005. As of December 31, 2002, 17,200 options had been exercised (all during
2000), none have been canceled and 68,800 options remained exercisable. In
February 2003, options for 4,000 units were exercised by the estate of a
deceased HCRE executive. The following table discloses for each of the executive
officers of Realty the number of these options held by each of the executive
officers and the potential realizable values for their options at December 31,
2002. None of the executive officers exercised any options during the year ended
December 31, 2002 and HRP has not granted SARs.
AGGREGATED OPTION/SAR EXERCISES IN 2002
AND OPTION/SAR VALUES AT DECEMBER 31, 2002
<Table>
<Caption>
Value of Unexercised
Number of Unexercised In-the-Money
Options at Options at
Units December 31, 2002 December 31, 2002
Acquired ------------------------------ ---------------------------
Name on Exercise Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ----------- ------------- ----------- -------------
Anthony J. Gumbiner 0 25,800 0 $ 1,814,385 $ 0
William L. Guzzetti 0 15,000 0 1,054,875 0
John G. Tuthill 0 13,000 0 914,225 0
Jeffrey D. Gent 0 7,000 0 492,275 0
</Table>
Page 42 of 45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of March 14, 2003 concerning the
number of HRP units owned beneficially by (l) the persons who, to the knowledge
of the management, beneficially owned more than 5% of the units outstanding on
such date, (2) each director and (3) the present directors and executive
officers of Realty as a group:
<Table>
<Caption>
Amount Percent
Name and Address of Beneficially of
Beneficial Owner Owned(a) Class
- ------------------------------------ ---------------- -----------
HWG, LLC 330,432 20.7%
c/o The Hallwood Group Incorporated
3710 Rawlins, Suite 1500
Dallas, Texas 75219
High River Limited Partnership 235,000 14.7%
c/o Icahn Associates Corp.
767 Fifth Avenue, 47th Floor
New York, NY 10153
Interstate Properties 160,200 10.1%
Park 80 West, Plaza II
Saddle Brook, NJ 07662
Alan G. Crisp(b) -- --
William F. Forsyth(b) -- --
Anthony J. Gumbiner(b) 25,800(c) 1.6%(c)
William L. Guzzetti(b) 15,100(d) 0.9%(d)
Edward T. Story(b) -- --
All directors and executive officers
as a group (8 persons) 60,900(e) 3.7%(e)
</Table>
- ----------
(a) Unless otherwise indicated, each of the persons named has sole voting
and investment.
(b) Represented by the following address: c/o Hallwood Realty, LLC, 3710
Rawlins, Suite 1500, Dallas, Texas, 75219.
(c) Comprised of currently exercisable options to purchase 25,800 units.
(d) Includes currently exercisable options to purchase 15,000 units.
(e) Includes currently exercisable options to purchase 60,800 units.
EQUITY COMPENSATION PLAN INFORMATION
In 1995, HRP issued options totaling 86,000 units to certain executives of
Realty and HCRE with an exercise price of $11.875 per unit. The options were
vested over a three year period ending in 1997 and they expire on February 27,
2005. As of December 31, 2002, 17,200 options had been exercised (all during
2000), none have been canceled and 68,800 options remained exercisable. In
February 2003, options for 4,000 units were exercised by the estate of a
deceased HCRE executive.
As part of the resignation of Brian Troup as an officer and director of Hallwood
and HRP's general partner on December 21, 1999, Hallwood transferred 82,608
units of HRP that it owned to a trust controlled by Mr. Troup. On May 12, 2000,
Mr. Troup exercised his unit options to purchase 17,200 HRP units at the option
plan's exercise price of $11.875 per unit, which generated $601,000 of non-cash
compensation. Also on May 12, 2000, HRP purchased and retired all of Mr. Troup's
above-mentioned 99,808 units at $46.825 per unit (the average of the closing
market prices of the units for the twenty trading days prior to the purchase).
Page 43 of 45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -
(CONTINUED)
The following table provides information as of December 31, 2002 about HRP's
units that may be issued upon the exercise of options granted pursuant to HRP's
1995 Unit Option Plan, as amended to date.
<Table>
<Caption>
A B C
Number of units to be Weighted-average Number of units remaining available for
issued upon exercise of exercise price of future issuance under equity compensation
Plan category outstanding options outstanding options plans (excluding units reflected in column A)
- ------------- ------------------------ ------------------- ---------------------------------------------
Equity compensation plans
approved by unitholders None n/a None
Equity compensation plans
not approved by unitholders 68,800(1) $11.875 None
</Table>
(1) HRP is a partnership and, as such, does not hold meetings of its
unitholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See Note 4 to the Consolidated Financial Statements included in Item 8 for
information covered by this item.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. It is the conclusion
of the registrant's principal executive officer and principal
financial officer that the registrant's disclosure controls (as
defined in Exchange Act rules 13a-14 and 15d-14), based on their
evaluation of these controls and procedures as of a date within 90
days of the filing of this annual report on Form 10-K, are effective.
(b) Changes in internal controls. There were no significant changes in the
registrant's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their
evaluation.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(1) Financial Statements.
See Index contained in Item 8.
(2) Reports on Form 8-K.
HRP filed a report on Form 8-K, dated November 13, 2002, to
report that its Form 10-Q for the period ended September 30,
2002 was accompanied by a written statement of each of the
Principal Executive Officer and the Principal Financial
Officer. This statement was furnished in Item 9 of said Form
8-K pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(3) Exhibits.
The response to this portion of Item 14 is incorporated by
reference as detailed in the Exhibit Index.
(4) Financial Statement Schedules.
See Index contained in Item 8.
Page 44 of 45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HALLWOOD REALTY PARTNERS, L.P.
BY: HALLWOOD REALTY, LLC
GENERAL PARTNER
DATE: March 18, 2003 BY: /s/ WILLIAM L. GUZZETTI
-------------- -------------------------------------
William L. Guzzetti
President and Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report on Form 10-K for the year ended December 31, 2002, has been signed below
by the following persons on behalf of the Registrant in the capacities and on
the date indicated.
<Table>
<Caption>
Signature Capacity Date
- ------------------------ ----------------------------------- --------------
/s/ ANTHONY J. GUMBINER Chairman of the Board and Director, March 18, 2003
- ------------------------ Hallwood Realty, LLC --------------
Anthony J. Gumbiner (Chief Executive Officer)
/s/ WILLIAM L. GUZZETTI President and Director, March 18, 2003
- ------------------------ Hallwood Realty, LLC --------------
William L. Guzzetti (Chief Operating Officer)
/s/ JEFFREY D. GENT Vice President-Finance, March 18, 2003
- ------------------------ Hallwood Realty, LLC --------------
Jeffrey D. Gent (Chief Accounting Officer)
/s/ ALAN G. CRISP Director, March 18, 2003
- ------------------------ Hallwood Realty, LLC --------------
Alan G. Crisp
/s/ WILLIAM F. FORSYTH Director, March 18, 2003
- ------------------------ Hallwood Realty, LLC --------------
William F. Forsyth
/s/ EDWARD T. STORY Director, March 18, 2003
- ------------------------ Hallwood Realty, LLC --------------
Edward T. Story
</Table>
Page 45 of 45
HALLWOOD REALTY PARTNERS, L.P.
CERTIFICATION FOR ANNUAL REPORTS ON FORM 10-K
I, Anthony J. Gumbiner, certify that:
1. I have reviewed this annual report on Form 10-K of Hallwood Realty
Partners, L.P.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation
Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 18, 2003 /s/ Anthony J. Gumbiner
-------------- -----------------------
Anthony J. Gumbiner
Chief Executive Officer
HALLWOOD REALTY PARTNERS, L.P.
CERTIFICATION FOR ANNUAL REPORTS ON FORM 10-K
I, Jeffrey D. Gent, certify that:
1. I have reviewed this annual report on Form 10-K of Hallwood Realty
Partners, L.P.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation
Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 18, 2003 /s/ Jeffrey D. Gent
-------------- --------------------------------------------
Jeffrey D. Gent
Vice President - Finance
(Principal Financial and Accounting Officer)
HALLWOOD REALTY PARTNERS, L.P.
EXHIBIT INDEX
<Table>
<Caption>
Exhibit
Number Exhibit
- ------- -------
3.1 Certificate of Limited Partnership of Hallwood Realty Partners, L.P., dated January 10, 1990. (Filed as an Exhibit
to Registration Statement No. 33-35621 on Form S-4 of the Partnership, filed with the Commission on June 28, 1990,
as amended, on June 29, 1990 and incorporated herein by reference.)
3.2 Amended and Restated Agreement of Limited Partnership of Hallwood Realty Partners, L.P., dated June 7, 1990.
(Filed as an Exhibit to Registration Statement No. 33-35621 on Form S-4 of the Partnership, filed with the
Commission on June 28, 1990, as amended, on June 29, 1990 and incorporated herein by reference.)
4.1 Unit Purchase Rights Agreement, dated as of November 30, 1990, between the Partnership and The First National Bank
of Boston, as Rights Agent (Filed as part of Exhibit 1 to Current Report of Form 8-K, dated November 30, 1990, and
which is incorporated herein by reference - File No. 1-10643). (Incorporated by reference from exhibit 4.1 filed
with Annual Report on Form 10-K for the fiscal year ended December 31, 1999.)
4.2 Amendment No. 1 to Unit Purchase Rights Agreement dated February 14, 2000 (Incorporated by reference from exhibit
4.2 filed with Annual Report on Form 10-K for the fiscal year ended December 31, 1999.)
10.1* 1995 Unit Option Plan for Hallwood Realty Partners, L.P. (Incorporated by reference as the exhibit indicated and
filed with Annual Report on Form 10-K for the fiscal year ended December 31, 1994.)
10.2* 1995 Unit Option Plan Loan Program for Hallwood Realty Partners, L.P. (Incorporated by reference as the exhibit
indicated and filed with Annual Report on Form 10-K for the fiscal year ended December 31, 1994.)
10.3 Loan Agreement between Hallwood 95, L.P. and Nomura Asset Capital Corporation. (Incorporated by reference from
exhibit 2.1 filed with Current Report on Form 8-K dated September 29, 1995.)
10.4 Amended and Restated Agreement of Limited Partnership of Hallwood 95, L.P. (Incorporated by reference from exhibit
10.17 filed with Annual Report on Form 10-K for the fiscal year ended December 31, 1995.)
10.5 Management Agreement between Hallwood Real Estate Investors Fund XV and Hallwood Commercial Real Estate, LLC dated
July 1, 1999. (Agreement is representative of each individual management agreement for real estate properties
owned by Hallwood Realty Partners, L.P. Differences in the individual agreements include, but not limited to,
owners' name, property name, and legal description. Exhibit D to this item is a schedule reflecting the economic
differences in leasing fee compensation.) (Incorporated by reference from exhibit 10.5 filed with Annual Report on
Form 10-K for the fiscal year ended December 31, 1999.)
</Table>
* Constitutes a management compensation plan.