1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10 - Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to For Quarter Ended September 30, 1998 Commission file number 1-7585 THE NEWHALL LAND AND FARMING COMPANY (A CALIFORNIA LIMITED PARTNERSHIP) (Exact name of Registrant as specified in its charter) California 95-3931727 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 23823 Valencia Boulevard, Valencia, CA 91355 (Address of principal executive offices) (Zip Code) (805) 255-4000 (Registrant's telephone number, including area code) 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 --- --- 2 Part I. Financial Information 2. Item 1. Financial Statements CONSOLIDATED STATEMENTS OF INCOME Unaudited Three Months Ended Nine months Ended In thousands, except per unit September 30 September 30 ----------------------------------------------------------------------------------- ------------------------- 1998 1997 1998 1997 -------------------------- ------------------------- REVENUES Real estate Residential home and land sales $ 19,261 $ 38,478 $ 63,377 $ 56,867 Industrial and commercial sales 42,549 13,743 145,471 38,754 Commercial operations Income-producing properties 8,788 8,510 28,264 24,342 Valencia Water Company 3,391 3,581 7,326 8,408 -------------------------- ------------------------- 73,989 64,312 244,438 128,371 -------------------------- ------------------------- Agriculture Operations 3,005 2,929 5,294 5,700 Ranch sales 1,067 62 1,390 17,962 -------------------------- ------------------------- 4,072 2,991 6,684 23,662 -------------------------- ------------------------- Total revenues $ 78,061 $ 67,303 $251,122 $152,033 ========================== ========================= CONTRIBUTION TO INCOME Real estate Residential home and land sales $ 5,054 $ 12,963 $ 23,799 $ 13,712 Industrial and commercial sales 13,748 1,116 44,221 15,018 Community development (2,625) (2,130) (6,856) (7,101) Commercial operations Income-producing properties 4,010 3,786 14,571 11,717 Valencia Water Company 1,003 1,080 1,734 2,330 -------------------------- ------------------------- 21,190 16,815 77,469 35,676 -------------------------- ------------------------- Agriculture Operations (1,371) 379 (516) 1,508 Ranch sales 775 45 1,098 16,995 -------------------------- ------------------------- (596) 424 582 18,503 -------------------------- ------------------------- Operating income 20,594 17,239 78,051 54,179 General and administrative expense (3,187) (2,088) (9,590) (6,219) Expense from unit ownership plans - (350) (400) (580) Interest and other, net (1,116) (2,262) (5,772) (7,137) -------------------------- ------------------------- Net income $ 16,291 $ 12,539 $ 62,289 $ 40,243 ========================== ========================= Net income per unit $ 0.48 $ 0.36 $ 1.81 $ 1.17 ========================== ========================= Net income per unit - diluted $ 0.47 $ 0.36 $ 1.79 $ 1.16 ========================== ========================= Number of units used in computing per unit amounts: Net income per unit 33,998 34,464 34,357 34,523 Net income per unit - diluted 34,382 34,809 34,781 34,758 Cash distributions per unit: Regular $ 0.10 $ 0.10 $ 0.30 $ 0.30 Special 0.12 0.08 3 Part I. Financial Information 3. Item 1. Financial Statements CONSOLIDATED BALANCE SHEETS September 30, December 31, In thousands 1998 1997 - ---------------------------------------------------------------- ------------------- ----------------- Unaudited ASSETS Cash and cash equivalents $ 3,589 $ 2,770 Accounts and notes receivable 29,550 19,027 Land under development 40,253 53,875 Land held for future development 30,678 32,551 Income-producing properties, net 237,050 227,203 Property and equipment, net 56,414 54,876 Other assets and deferred charges 13,579 13,630 ------------------- ----------------- $ 411,113 $ 403,932 =================== ================= LIABILITIES AND PARTNERS' CAPITAL Accounts payable $ 32,069 $ 18,529 Accrued expenses 43,779 39,635 Deferred revenues 17,170 3,152 Mortgage and other debt 117,424 156,946 Advances and contributions from developers for utility construction 23,832 18,845 Other liabilities 21,551 21,548 ------------------- ----------------- Total liabilities 255,825 258,655 Partners' capital 33,071 units outstanding, excluding 3,701 units in treasury, at September 30, 1998 and 34,527 units outstanding, excluding 2,245 units in treasury, at December 31, 1997 155,288 145,277 ------------------- ----------------- $ 411,113 $ 403,932 =================== ================= 4 Part I. Financial Information 4. Item 1. Financial Statements CONSOLIDATED STATEMENTS OF CASH FLOWS Unaudited Nine months Ended In thousands September 30 - ------------------------------------------------------------------------- ------------------------------------------- 1998 1997 ------------------ ------------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 62,289 $ 40,243 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 7,370 7,154 Increase in land under development (52,081) (47,045) Cost of sales and other inventory changes 65,703 50,589 (Increase) decrease in accounts and notes receivable (10,523) 7,538 Increase in accounts payable, accrued expenses and deferred revenues 31,702 11,682 Cost of property sold 67,478 14,707 Other adjustments, net 25 567 ------------------ ------------------ Net cash provided by operating activities 171,963 85,435 ------------------ ------------------ CASH FLOWS FROM INVESTING ACTIVITIES: Development of income-producing properties (78,148) (50,791) Purchase of property and equipment (5,985) (4,092) Investment in joint venture (198) (499) ------------------ ------------------ Net cash used in investing activities (84,331) (55,382) ------------------ ------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Distributions paid (14,509) (13,135) Decrease in mortgage and other debt (39,522) (14,429) Increase in advances and contributions from developers for utility construction 4,987 241 Purchase of partnership units (38,770) (5,746) Other, net 1,001 3,559 ------------------ ------------------ Net cash used in financing activities (86,813) (29,510) ------------------ ------------------ NET INCREASE IN CASH AND CASH EQUIVALENTS 819 543 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,770 2,412 ------------------ ------------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,589 $ 2,955 ================== ================== 5 Part I. Financial Information 5. Item 1. Financial Statements NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note 1. Accounting Policies The consolidated financial statements include the accounts of The Newhall Land and Farming Company and its subsidiaries, all of which are wholly-owned (collectively, "the Company"). All significant intercompany balances and transactions are eliminated. The Company's unaudited interim financial statements have been prepared substantially in conformity with generally accepted accounting principles used in the preparation of the Company's annual financial statements. In the opinion of the Company, all adjustments necessary for a fair statement of the results of operations for the three and nine months ended September 30, 1998 and 1997 have been made. Certain reclassifications have been made to prior periods' amounts to conform to the current period presentation. The interim statements are condensed and do not include some of the information necessary for a more complete understanding of the financial data. Accordingly, your attention is directed to the footnote disclosures found on pages 25 through 32 of the December 31, 1997 Annual Report to Partners and particularly to Note 2 which includes a summary of significant accounting policies. Interim financial information for the Company has substantial limitations as an indicator for the calendar year because: o Real estate sales occur irregularly and are recognized at the close of escrow or on the percentage of completion basis if the Company has an obligation to complete certain future improvements and provided profit recognition criteria are met. o Agricultural crops are on an annual cycle and income is recognized upon harvest. Most major crops are harvested during the fall and winter. o Sales of non-developable farm land occur irregularly and are recognized upon close of escrow provided profit recognition criteria are met. - -------------------------------------------------------------------------------- Note 2. Details of Land Under Development (In $000) September 30, December 31, 1998 1997 (Unaudited) Residential land development $ 257 $ 3,700 Industrial and commercial land development 25,505 38,190 Homes completed or under construction with venture partners 12,930 11,799 Agriculture 1,561 186 -------- -------- Total land under development $ 40,253 $ 53,875 ======== ======== - -------------------------------------------------------------------------------- Note 3. Amounts per Partnership Unit Unaudited Income Units Per Unit (in 000's except per unit) (numerator) (denominator) -------------------------------------------------------------------------------------------------------------- For three months ended September 30, 1998 NET INCOME PER UNIT Net income available to unitholders $ 16,291 33,998 $ .48 EFFECT OF DILUTIVE SECURITIES Unit options - 384 (.01) -------------------------------------------------------------------------------------------------------------- Net income per unit - diluted $ 16,291 34,382 $ .47 -------------------------------------------------------------------------------------------------------------- 6 Part I. Financial Information 6. Item 1. Financial Statements Note 3. Amounts per Partnership Unit (continued) For three months ended September 30, 1997 NET INCOME PER UNIT Net income available to unitholders $ 12,539 34,464 $ 0.36 EFFECT OF DILUTIVE SECURITIES Unit options - 345 - -------------------------------------------------------------------------------------------------------------- Net income per unit - diluted $ 12,539 34,809 $ 0.36 -------------------------------------------------------------------------------------------------------------- For nine months ended September 30, 1998 NET INCOME PER UNIT Net income available to unitholders $ 62,289 34,357 $ 1.81 EFFECT OF DILUTIVE SECURITIES Unit options - 424 (0.02) -------------------------------------------------------------------------------------------------------------- Net income per unit - diluted $ 62,289 34,781 $ 1.79 -------------------------------------------------------------------------------------------------------------- For nine months ended September 30, 1997 NET INCOME PER UNIT Net income available to unitholders $ 40,243 34,523 $ 1.17 EFFECT OF DILUTIVE SECURITIES Unit options - 235 (0.01) -------------------------------------------------------------------------------------------------------------- Net income per unit - diluted $ 40,243 34,758 $ 1.16 -------------------------------------------------------------------------------------------------------------- 7 Part I. Financial Information 7. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. RESULTS OF OPERATIONS Comparison of Third Quarter and Nine months of 1998 to Third Quarter and Nine months of 1997 Third Quarter Nine months ----------------------------------- ------------------------------------- Increase Increase Unaudited (Decrease) (Decrease) ----------------------------------------------------------------------------- Amount % Amount % ------------------ -------------- ----------------- ---------------- REVENUES Real Estate Residential home and land sales $ (19,217) -50% $ 6,510 11% Industrial and commercial sales 28,806 210% 106,717 275% Commercial operations Income-producing properties 278 3% 3,922 16% Valencia Water Company (190) -5% (1,082) -13% ----------------------------------- ------------------------------------- 9,677 15% 116,067 90% Agriculture Operations 76 3% (406) -7% Ranch sales 1621% (16,572) -92% 1,005 ------------------ -------------- ----------------- ---------------- Total revenues $ 10,758 16% $ 99,089 65% ================== ============== ================= ================ CONTRIBUTION TO INCOME Real Estate Residential home and land sales $ (7,909) -61% $ 10,087 74% Industrial and commercial sales 12,632 1132% 29,203 194% Community development (495) -23% 245 3% Commercial operations Income-producing properties 224 6% 2,854 24% Valencia Water Company (77) -7% (596) -26% ----------------------------------- ------------------------------------- 4,375 26% 41,793 117% Agriculture Operations (1,750) -462% (2,024) -134% Ranch sales 730 1622% (15,897) -94% ------------------ -------------- ----------------- ---------------- Operating income 3,355 19% 23,872 44% General and administrative expense (1,099) -53% (3,371) -54% Expense from unit ownership plans 350 100% 180 31% Interest and other, net 1,146 51% 1,365 19% ------------------ -------------- ----------------- ---------------- Net income $ 3,752 30% $ 22,046 55% ================== ============== ================= ================ Net income per unit $ 0.12 33% $ 0.64 55% ================== ============== ================= ================ Net income per unit - diluted $ 0.11 31% $ 0.63 54% ================== ============== ================= ================ Number of units used in computing per unit amounts: Net income per unit (466) -1% (166) 0% ================== ============== ================= ================ Net income per unit - diluted (427) -1% 23 0% ================== ============== ================= ================ 8 Part I. Financial Information 8. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. The increases and decreases in revenues and income for the three and nine months are attributable to the following: For the 1998 third quarter, revenues totaled $78.1 million and net income totaled $16.3 million compared to revenues for the 1997 third quarter of $67.3 million and net income of $12.5 million. For the nine months ended September 30, 1998, revenues totaled $251.1 million and net income totaled $62.3 million. This compares with revenues of $152.0 million and net income of $40.2 million for the nine months ended September 30, 1997. These increases in revenues and net income during the third quarter of 1998 compared to the same period in 1997 were due primarily to substantial increases in industrial and commercial sales and a stable earnings contribution from the Company's income portfolio, offset in part by reduced levels of residential lot sales. Industrial and commercial sales during the third quarter of 1998 included escrow closings on five industrial properties and two commercial properties. These results, along with the sale of Valencia Marketplace in the second quarter, have caused the revenues and net income per unit for the first nine months of 1998 to exceed any full year results in the Company's history. RESIDENTIAL HOME AND LAND SALES The Company generates revenues and income from Valencia residential projects by selling residential lots to merchant builders and home sales through joint ventures. Revenues and income are recorded by the Company on residential lot sales when title is transferred to the merchant builder, who, in turn, builds homes for sale. The Company also participates in home construction on lots it owns by establishing joint ventures with builders who have created innovative new home designs, targeting niche markets unmet by other merchant builders. In the joint-venture program, the Company records its portion of revenues and income upon close of escrow to the homebuyer. The Company's participation in joint ventures enables it to generate increased income as it receives a portion of the homebuilding profits in return for sharing in the risk of homebuilding, and in some cases, financing the construction costs. In a strong real estate market, the Company's strategy is to increase residential absorption by concentrating on lot sales to merchant builders with less emphasis on homebuilding joint ventures. As a result, in the current market, joint venture home closings will be lower compared to prior periods. During the 1998 third quarter, 132 new home sales were recorded in Valencia by merchant builders and the Company's joint ventures. This is below 1997 third quarter sales of 206 homes and 1998 second quarter sales of 160 homes due to temporary supply constraints in Valencia's new-home inventory. The number of housing product lines that will be actively selling in Valencia in 1999 will more than double from eight at the end of the 1998 third quarter. For both the 1998 and 1997 third quarters, Valencia captured a 40% share of all new homes sales in the Santa Clarita Valley. Merchant Builder Program In the 1998 third quarter, the sale of 168 lots for high-density housing closed escrow contributing $6.2 million to revenues and $3.8 million to income. This sale brings total residential lot sales for the first nine months of 1998 to 1,108 which added $40.8 million to revenues and $23.7 million to income. The Company does not anticipate any additional residential lot sales in the fourth quarter, nor are any residential lots currently in escrow. In the third quarter of 1997, residential lot sales in Valencia totaled 617 which added $27.3 million to revenues and $13.1 million to income. The largest transaction was the sale of 366 entitled, unimproved lots to Taylor Woodrow for $17 million contributing $10.1 million to income. In addition, escrow closed on 251 improved residential lots to three merchant builders contributing $10.3 million to revenues and $3.0 million to income under percentage of completion accounting. The 1997 nine-month period also included the sale of 94 residential lots which added $4.0 million to revenues and $1.2 million to income. At September 30, 1997, 43 residential lots were in escrow. Negotiations are currently underway with several merchant builders on the Company's next major project, Bridgeport (formerly referred to as Lago de Valencia), an approximately 700-home "lifestyle village" surrounding a lake. Grading of the 14-acre lake has started, with lot sales expected to begin in mid-1999. Other projects now being prepared for sale next year include 450 lots west of Valencia High School called Decoro South, 120 lots in the South River area, and the balance of the Company's Hasley Hills project just north of Valencia totaling 290 lots. 9 Part I. Financial Information 9. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Joint Venture Program During the 1998 third quarter, a total of 57 joint-venture homes in three projects closed escrow contributing $13.1 million to revenues and $1.4 million to income. At September 30, 1998, a total of 26 joint-venture homes were in escrow and an additional 53 homes were reserved, 47 of which were Cheyenne townhomes, the Company's 166-home joint venture with EPAC Communities, Inc. The remainder are at Avignon, a joint venture with EPAC for 76 luxury townhomes. Nouvelle, a joint venture with Warmington Homes for 72 single-family homes, is sold out with only 2 homes remaining to close escrow. All escrow closings are subject to market and other conditions A total of 90 joint-venture homes closed escrow during the 1998 nine-month period contributing $20.3 million to revenues and $2.2 million to income. With the Company's emphasis on lot sales to merchant builders, joint-venture home sales in 1998 will represent a smaller portion of total home sales compared to prior periods. In the 1997 third quarter, the Company's joint-venture homebuilding projects closed escrow on 51 homes contributing $11.2 million to revenues and $1.0 million to income. The 1997 nine-month period included 111 joint-venture home closings in six projects for $24.4 million adding $2.6 million to income. INDUSTRIAL AND COMMERCIAL SALES In the 1998 third quarter, escrow closed on five parcels totaling 59.1 industrial acres, including a building on 1.2 acres constructed as part of the Company's build-to-suit/lease program. These escrow closings contributed $33.7 million to third quarter revenues and $11.9 million to income. The largest sale during the quarter was for $20.4 million consisting of a 36.5-acre parcel for a 700,000-square-foot office complex to be developed on this parcel at the intersection of Interstate 5 and Highway 126. This is one of several parcels being sold for office development in Valencia's business parks and is significant because the Company believes that these types of projects tend to bring higher prices and more employment on a per-acre basis. During the first nine months of 1998, the Company closed escrow on a record 78.4 acres of industrial land, including four buildings constructed as part of its build-to-suit/lease program. These sales added $49.1 million to revenues and $13.8 million to income. In the first three quarters of 1998, more than one million square feet of space had been absorbed in Valencia's industrial properties, exceeding the amount for all of 1997. The Company's remaining unsold industrial land inventory is approximately 545 acres, which will support about 10 million square feet of building space. Additional industrial acreage is planned for the adjacent Newhall Ranch project. Also, during the 1998 third quarter, a 12.6-acre restricted-use site for a senior apartment project closed escrow for $1.8 million. In addition, the Company completed the sale of its remaining industrial building in Valencia Industrial Center consisting of a 29,000-square-foot building on 2.1 acres for $1.5 million. These two sales added $1.3 million to 1998 third quarter income. Results for the 1998 nine-month period also includes the sale of three small commercial parcels totaling 4.6 acres for $1.5 million adding $433,000 to income. Following the close of the third quarter, the Company's 56,800-square-foot Valley Business Center on approximately 15 acres closed escrow. This sale will contribute $7.3 million to revenues and $1.5 million to income in the fourth quarter. As previously reported, the 1998 second quarter sale of Valencia Marketplace is expected to generate future revenues and income in excess of the amounts recognized upon the close of escrow under percentage of completion accounting. Under this accounting method, revenues and income of $5.5 million and $2.1 million, respectively, were recorded in the third quarter. During the 1997 third quarter, three parcels in Valencia Commerce Center totaling 13.5 acres closed escrow which added $5.9 million to revenues and $1.1 million to income. Also in the 1997 third quarter, a 135,220-square-foot build-to-suit on 6.3 acres closed escrow for $7.9 million contributing $1.1 million to income. Results for the 1997 nine-month period also included sales of a 5.2-acre industrial parcel and 3.5 commercial acres which combined contributed $4.5 million to revenues and $2.5 million to income. Also included in the 1997 nine-month results are the sale of StoneCreek, a 208-unit apartment complex, for $18.3 million adding $12.9 million to income and the sale of Orchard Plaza, a 17,400-square-foot office building, for $2.2 million adding $618,000 to income. 10 Part I. Financial Information 10. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. At September 30, 1998, four sales of industrial land totaling 36.8 acres were in escrow for $16.0 million with closings scheduled before the end of 1998, and another 5.2-acre parcel with a 110,000 square foot build-to-suit was in escrow for $8.1 million with closing expected in 1999. Also in escrow is the Company's remaining property in Contra Costa County consisting of approximately 85 acres for $10.5 million with escrow expected to close in the first half of 1999. All escrow closings are subject to market and other conditions. At September 30, 1997, eight parcels totaling 12.2 industrial acres, 33.5 commercial acres and two build-to-suits in Valencia Commerce Center were in escrow for an aggregate of $18.9 million. Subsequently, escrows for 15.2 commercial acres were cancelled. COMMUNITY DEVELOPMENT The Company's community development activities are focused on securing the necessary governmental land use approvals as well as an intensified strategic marketing program to support the build-out of Valencia by 2005 and begin the development of Newhall Ranch, the next new town to be developed on the Company's 12,000 acres west of Valencia. The Company's ability to achieve its goals and increase the pace of development is contingent upon obtaining the necessary entitlements or governmental approvals. The Company has reached agreements with all school districts covering Newhall Ranch, as well as future development in Westridge and Valencia. The Los Angeles County Board of Supervisors reviewed the Specific Plan and zoning changes for Newhall Ranch, along with the Environmental Impact Report. Changes were suggested regarding land use pertaining to the environment and the Company is addressing those issues, which are scheduled for review by the Board of Supervisors. The October 27, 1998 meeting has been deferred in order to resolve the last remaining issues. A specific date has not been set for the continued hearing. Final approval for the approximately 22,000-home planned community is projected for early 1999. Hearings were held this summer before the Los Angeles County Regional Planning Commission on the Environmental Impact Report for the Westridge Golf Course Community. The project received approval from the Planning Commission on November 2, 1998 and is expected to go before the Los Angeles County Board of Supervisors in early 1999. Community development expenses increased 23% from the prior year three-month period primarily due to expenses relating to evaluation of development opportunities outside of Valencia. The impact of these expenditures was offset in the nine-month comparisons due to higher entitlement expenditures in the prior year relating to final approvals for several projects in Valencia. The Company will continue to focus on obtaining residential entitlements to meet the accelerated pace of development to support forecasted demand. Community development expenses in 1998 are expected to be approximately the same as in 1997. INCOME-PRODUCING PROPERTIES The Company's income-producing property portfolio is a relatively stable source of earnings and cash flow that also provides debt capacity to grow the Company and working capital for continuing operations. For the third quarter of 1998, revenues from this commercial portfolio increased 3% and income increased 6% and, for the nine-month period, revenues increased 16% and income increased 24%. High occupancy rates and favorable rents throughout the portfolio more than offset the second quarter sale of Valencia Marketplace and contributed to the increases from the corresponding prior year periods. In Valencia Town Center along Town Center Drive, the Company's 244-room Hyatt Valencia Hotel and Santa Clarita Conference Center opened in August and the six-story building for Princess Cruises will be ready for occupancy in November. The 194,000 square feet of retail space along Town Center Drive is currently 71% pre-leased, with approximately 54,000 square feet expected to be open for the holiday shopping season. The 130,000-square-foot entertainment complex which will include an IMAX 3-D Theatre, 11 additional movie screens and a Borders bookstore, is under construction with completion scheduled for mid-1999. The complex also will include new restaurants and other retail space. 11 Part I. Financial Information 11. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. The three apartment complexes in the income portfolio have occupancy rates above 97% and, during the past 12 months, rents for new tenants have increased approximately 20%. To meet growing demand, eight additional apartment projects totaling more than 2,500 units are planned during the build-out of Valencia. The first project, Montecito, a 210-unit apartment complex in Valencia Town Center adjacent to Valencia Country Club, is under construction with units expected to be available in the spring of 1999. Valencia Town Center shopping mall space and the Company's neighborhood shopping centers continue to show strong results. Remodeling at River Oaks will be completed this fall and is expected to have a positive impact on re-leasing space in the center. Construction is on schedule for the 16,700-square-foot Rite-Aid drug store and 5,600 square feet of additional retail space at NorthPark Village Square, the Company's latest neighborhood shopping center. Plaza del Rancho, a 53,000-square-foot, mixed-use project in Valencia Industrial Center that opened last summer, is 90% leased. The portfolio's office building next to Company headquarters is fully leased, and the three-story office building in Valencia Town Center is 79% leased. When current projects under construction in Valencia Town Center are complete, about $12 to $13 million in incremental net operating income annually is expected to be generated as the projects reach stabilization, more than offsetting the loss of income from strategic asset sales such as Valencia Marketplace. The Company's investment in the continued expansion of the portfolio will exceed $100 million in 1998. Income from the commercial portfolio for the full year of 1998 is expected to increase approximately 15% over 1997 due to the completion of several new commercial properties in 1998, along with high occupancy rates and increased rents from existing portfolio projects. VALENCIA WATER COMPANY Valencia Water Company is a regulated public utility and a wholly-owned subsidiary of the Company serving over 19,000 metered customers in the Valencia area. Reduced demand due to heavy rainfall during the winter and spring resulted in lower revenues and income for the 1998 third quarter and nine months from Valencia Water Company. Revenues declined 5% and income declined 7% for the 1998 third quarter. For the 1998 nine-month period, revenues and income declined 13% and 26%, respectively. By year-end the declines are expected to be partially offset by increased demand due to increases in the water utility's customer base. AGRICULTURAL OPERATIONS Income from agriculture, including the Company's energy operations, for the 1998 third quarter and nine-month periods was below year earlier levels. The primary contributor to the decreases was a $1.9 million non-cash, write-off of mineral rights associated with previously sold ranch land based on an independent valuation performed during in the current year quarter. Additionally, lower oil and gas prices negatively impacted results for both the third quarter and first nine months of 1998. RANCH SALES In the 1998 third quarter, a 970-acre parcel of the Merced Ranch closed escrow for $1.1 million, contributing $775,000 to income. The sale is part of the Company's strategy of selling farm land not suitable for development. No other sales of farm land have taken place in 1998. Results for the nine-month period includes $323,000 recognized from the 1996 sale of 539 acres of row crop land at the Suey Ranch. The Company continues to market three remaining parcels, containing an aggregate of 2,970 acres, at Merced Ranch which are being leased while awaiting sale. The sale of a small remaining parcel in northern California was completed during the 1997 third quarter for $62,000 adding $45,000 to income. Results for the 1997 nine-month period also includes the sale of 1,674 acres of vineyard and undeveloped land at the 38,000-acre Suey Ranch for $17.9 million adding $17.0 million to income. 12 Part I. Financial Information 12. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expenses increased 53% and 54%, respectively, for the third quarter and nine months of 1998. The increases were primarily due to consulting fees relating to expanded marketing programs and improved business conditions, and non-capitalized expenses in connection with replacement and upgrading of the Company's accounting system and Year 2000 repairs. General and administrative expenses are expected to be lower in 1999. EXPENSE FROM UNIT OWNERSHIP PLANS In the 1998 first quarter, an expense of $400,000 was recorded in connection with appreciation rights on outstanding, non-qualified options granted prior to 1992 due to increases in the market price of partnership units. No expense was recorded in the second or third quarters of 1998. Results for the 1997 three- and nine-month periods included option appreciation expense of $350,000 and $580,000, respectively. INTEREST AND OTHER, NET Reduction in debt due to receipt of $111 million cash upon the sale of Valencia Marketplace in June 1998 and an increase in interest capitalized to portfolio projects contributed to decreases of 51% for the three-month period and 19% for the nine-month period in Interest and Other, net, compared to comparable 1997 periods. Interest income from increased cash available for investment was offset by a reduction in interest income due to collection of notes from prior land sales for both the three and nine-month periods. FINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES At September 30, 1998, the Company had cash and cash equivalents of $3.6 million and $162.4 million in available lines of credit and a revolving mortgage facility to fund development activities. The Company believes it has adequate sources of cash from operations and debt capacity, including lines of credit, to finance future operations and take advantage of new development opportunities. At September 30, 1998, there was no debt against raw land or land under development inventories. On August 14, 1998, the Board of Directors authorized the repurchase of one million units and, on September 9, 1998, the Board of Directors authorized an additional one million units for repurchase. In addition, the Company had 181,385 units authorized for repurchase from a prior repurchase program. During the quarter, the Company repurchased a total of 1,497,489 units for $38.8 million leaving a balance of 683,896 units authorized. The unit repurchases are being made because management and the Board of Directors believe that the current market price of the Company's partnership units does not reflect the Company's current performance and outlook. The Company intends to continue buying units into 1999 depending upon market conditions. Changes to the Company's business plan for next year are being evaluated in order to expand the current repurchase program, including accelerating certain land sales, reducing capital spending, and evaluating the sale of more non-strategic assets, including ranches. The goal is to add about 2 million more units to the current program in 1999, assuming the business plan for the coming year is met. There are no material commitments for capital expenditures other than the Company's plans in the ordinary course of business to develop its portfolio of income-producing properties. The Company expects to invest over $100 million in its commercial portfolio in 1998. For additional information on income-producing properties under development see the Investing Activities section. 13 Part I. Financial Information 13. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. OPERATING ACTIVITIES Net cash provided by operating activities for the nine months ended September 30, 1998 totaled $172.0 million and included the sale of Valencia Marketplace for $111 million cash. Also, sales of 1,198 residential lots and homes, 78.4 acres of industrial land including four industrial buildings, 17.2 acres of commercial land and a 29,000-square-foot building on 2.1 acres in Valencia Industrial Center combined provided $105.3 million cash and $15.3 million in notes. In addition, notes totaling $3.3 million from land sales in prior years were collected during the period. Expenditures for land under development inventories and home construction totaled $52.1 million during the first nine months of 1998, which was more than offset by $65.7 million of cost of sales relief. Inventory expenditures were related to land preparation and infrastructure to ready land for development or sale and home construction advances for the Company's homebuilding partnerships. The Company's net investment in homebuilding partnerships totaled $12.9 million at September 30, 1998. INVESTING ACTIVITIES Expenditures for development of income-producing properties in Valencia totaled $78.1 million for the nine months ended September 30, 1998. Major expenditures included $25.3 million for the Hyatt Valencia Hotel and Conference Center; $8.6 million for a six-story office building to be occupied by Princess Cruises; $4.1 million for a 210-unit apartment complex in Valencia Town Center; $3.9 million for industrial buildings under the build-to-suit/lease program; and $21.6 million for various retail/office/ entertainment projects in Valencia Town Center including parking structures. Also included is $10.7 million for Valencia Marketplace which was sold in June 1998. The Company is obligated to complete the construction and leasing of the center and the sale is being recognized under percentage of completion accounting. Property and equipment expenditures were primarily related to water utility construction costs. FINANCING ACTIVITIES Distributions totaling $14.5 million have been paid as of September 30, 1998 consisting of three quarterly distributions of $.10 per unit and a special distribution of $.12 per unit. The declaration of distributions, and the amount declared, are determined by the Board of Directors on a quarterly basis taking into account the Company's earnings, financial condition and prospects. The next quarterly distribution will be considered by the Board of Directors on November 18, 1998. Upon sale of Valencia Marketplace on June 5, 1998 for $111 million cash, the Company paid off all outstanding borrowings against unsecured lines of credit and a revolving mortgage facility. At September 30, 1998, $6.1 million was outstanding against unsecured lines of credit and $10 million was outstanding against a revolving mortgage facility. By the end of 1998, the Company expects total debt to be above the 1997 year-end level of $48.1 million. A total of 1,497,489 partnership units have been repurchased for an aggregate of $38.8 million during the nine months ended September 30, 1998. YEAR 2000 ISSUE The Year 2000 issue concerns the possibility that computer programs with date-sensitive software may recognize a date using "00" as the year 1900, rather than as the year 2000, because the programs were written using two digits rather than four to define the applicable year. This could result in a system failure or miscalculations causing disruptions of operations such as, among others, a temporary inability to process transactions or engage in similar normal business activities. Readiness: The Company's Year 2000 remediation efforts are progressing appropriately. At the end of 1997, a Year 2000 Task Force was formed to coordinate Company-wide efforts to be Year 2000 compliant. To date, the Company has inventoried its internal systems as well as identified systems and applications outside of the Company that may include imbedded computer technology that could be impacted by the Year 2000 Issue. 14 Part I. Financial Information 14. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. As a result of the Company's comprehensive review of its internal systems in 1997, and for other strategic reasons, the Company is in the process of replacing its computerized accounting system. This is scheduled to be completed by the end of 1998, except for payroll and human resources functionality which the Company projects will be completed by April, 1999. The Company is dependent upon this accounting system replacement to conduct its day-to-day business operations and to manage its real estate projects. The Company has made significant progress in modifying existing software to be retained to be Year 2000 compliant. Completion of these system changes is planned for the first quarter of 1999, which will allow adequate time for testing. Significant vendors, consultants, suppliers and governmental agencies (collectively, "business partners") were sent a questionnaire on their Year 2000 compliance efforts. Nearly 75% have responded to this request. The Company is in the process of completing selected site visits before the end of 1998 to assess the Year 2000 compliance efforts of these business partners. Costs: The Company estimates the total cost of its compliance efforts in connection with the Year 2000 Issue will be approximately $400,000 and will be expensed as incurred. As of September 30, 1998, $95,000 had been expensed for this project. The majority of the expenditures in the future is expected to be for third party computer analysts to complete the modification and testing of existing software for Year 2000 compliance. In addition, the cost of the new accounting system is approximately $1 million and is being capitalized and amortized over its useful life. The cost of the Year 2000 Issue and the estimated completion dates are based on management's best estimates, which were derived utilizing assumptions of future events, including the continued availability of certain resources, third-party modification plans and other factors. There can be no guarantee that these estimates will prove accurate and actual results could differ from those estimated. Risks: The Company believes the worst-case scenario for the Year 2000 Issue would be for the Company or a significant number of its business partners to fail to successfully complete their respective Year 2000 remediation efforts by December 31, 1999. Under this scenario, the Company's operations would most likely be disrupted which would result in a material adverse effect on its business, operating results and financial condition. Contingency Plans: The Company has in place a contingency plan in the event the accounting system replacement cannot be accomplished in the specified timeframe. This includes, among other things, retrofitting its existing accounting software to be Year 2000 compliant. The Company expects also to develop by June 1999 contingency plans for business partners that do not indicate Year 2000 compliance. There can be no assurance that any contingency plans developed by the Company will prevent any service interruption on the part of one or more of the Company's business partners or that any such service interruption would not have a material adverse effect upon the Company's business, operating results or financial condition. A failure of the accounting systems of a significant number of the Company's customers or business partners, or any of their financial institutions or lenders, would likely have a material adverse effect on the Company's business, operating results and financial condition. INFLATION, RISKS AND RELATED FACTORS AFFECTING FORWARD-LOOKING INFORMATION This report and other published reports contain forward-looking statements regarding the status of proposed or pending sales and rental activity, future planned development, plus the long-term growth goals of the Company. These forward-looking statements made in this report are based on present trends the Company is experiencing in residential, industrial and commercial markets. Also, the Company's success in obtaining entitlements, governmental and environmental regulations, timing of escrow closings, expansion of its income portfolio and marketplace acceptance of its business strategies are among the factors that could affect results. The following risks and related factors, among others, should be taken into consideration in evaluating the future prospects for the Company. Actual results may materially differ from those predicted. Sales of Real Estate: The majority of the Company's revenues are generated by its real estate operations. The ability of the Company to consummate sales of real estate is dependent on various factors, including but not limited to availability of financing to the buyer, regulatory and legal issues and successful completion of the buyer's due diligence. The fact that a real estate transaction has entered escrow does not necessarily mean that the 15 Part I. Financial Information 15. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. transaction will ultimately close. Therefore, the timing of sales may differ from that anticipated by the Company. The inability to close sales as anticipated could adversely impact the recognition of revenue in any specific period. Economic Conditions: Real estate development is significantly impacted by general and local economic conditions which are beyond the control of the Company. The Company's real estate operations are concentrated in Southern California. The regional economy is profoundly affected by the entertainment, technology and certain other segments, which have been known to affect the region's demographics. Consequently, all sectors of real estate development for the Company tend to be cyclical. While the economy of Southern California has shown improvements recently, there can be no assurances that present trends will continue. Interest Rates and Financing: Fluctuations in interest rates and the availability of financing have an important impact on the Company's performance. Sales of the Company's projects could be adversely impacted by the inability of buyers to obtain adequate financing. Further, the Company's real estate development activities are dependent on the availability of adequate sources of capital. Certain of the Company's credit facilities bear interest at variable rates and would be negatively impacted by increasing interest rates. Competition: The sale and leasing of residential, industrial and commercial real estate is highly competitive, with competition coming from numerous and varied sources. The degree of competition is affected by such factors as the supply of real estate available which is comparable to that sold and leased by the Company and the level of demand for such real estate. While the Company recently has continued to increase its market share at both the local and the county level, new competition is expected to deliver competing projects in the future that could reverse this trend. Geographic Concentration: The Company's real estate development activities are focused on its 20,000 acres in Los Angeles County, 30 miles north of Los Angeles. The Company's entire commercial income portfolio is located in the Valencia area. Therefore, any factors affecting that concentrated area, such as changes in the housing market or environmental factors, including seismic activity, which cannot be predicted with certainty, could affect future results. Government Regulation and Entitlement Risks: In developing its projects, the Company must obtain the approval of numerous governmental authorities regulating such matters as permitted land uses, density and traffic, and the providing of utility services such as electricity, water and waste disposal. In addition, the Company is subject to a variety of federal, state and local laws and regulations concerning protection of health and the environment. This government regulation affects the types of projects which can be pursued by the Company and increases the cost of development and ownership. The Company devotes substantial financial and managerial resources to complying with these requirements. To varying degrees, certain permits and approvals will be required to complete the developments currently being undertaken, or planned by the Company. Furthermore, the timing, cost and scope of planned projects may be subject to legal challenges, particularly large projects with regional impacts. In addition, the continued effectiveness of permits already granted is subject to factors such as changes in policies, rules and regulations and their interpretation and application. The ability to obtain necessary approvals and permits for its projects can be beyond the Company's control and could restrict or prevent development of otherwise desirable new properties. The Company's results of operations in any period will be affected by the amount of entitled properties the Company has in inventory. Inflation: The Company believes it is well positioned against the effects of inflation. Historically, during periods of inflation, the Company has been able to increase selling prices of properties to offset rising costs of land development and construction. Recently, land values have been increasing at a faster rate than costs. However, there are no assurances that this trend will continue. A portion of the commercial income portfolio is protected from inflation since percentage rent clauses in the Company's leases tend to adjust rental receipts for inflation, while the underlying value of commercial properties has tended to rise over the long term. 16 16. Part II. Other Information Item 6. Exhibits and Reports on Form 8-K (a) Exhibits (listed by numbers corresponding to the Exhibit Table of Item 601 in Regulation S-K): 10(a) Amendment No. 3 to The Newhall Land and Farming Company Retirement Plan dated July 15, 1998 10(b) Amendment No. 2 to The Newhall Land and Farming Company Savings Plan dated July 15, 1998 10(c) The Newhall Land and Farming Company Pension Restoration Plan (as amended through July 15, 1998) 10(d) The Newhall Land and Farming Company Employee Savings Restoration Plan As Amended Effective January 1, 1999 27 Financial Data Schedule (b) No report was filed on Form 8-K in the third quarter ended September 30, 1998. 17 17. SIGNATURES Pursuant to the requirements 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. THE NEWHALL LAND AND FARMING COMPANY (a California Limited Partnership) Registrant By Newhall Management Limited Partnership, Managing General Partner By Newhall Management Corporation, Managing General Partner Date: November 9, 1998 By /s/ THOMAS L. LEE -------------------------- Thomas L. Lee, Chairman and Chief Executive Officer of Newhall Management Corporation (Principal Executive Officer) Date: November 9, 1998 By /s/ STUART R. MORK -------------------------- Stuart R. Mork, Senior Vice President and Chief Financial Officer of Newhall Management Corporation (Principal Financial Officer) Date: November 9, 1998 By /s/ DONALD L. KIMBALL -------------------------- Donald L. Kimball, Vice President - Finance and Controller of Newhall Management Corporation (Principal Accounting Officer)