**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10 - Q**

** **

**ý****QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

** **

**Forthe quarterly period ended June 30, 2003**

** **

**or**

** **

**o****TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

** **

**Forthe transition periodfrom         to         **

** **

**Commissionfile number 1-8885**

** **

**THE NEWHALLLAND AND FARMING COMPANY(a California Limited Partnership)**

(Exact name ofRegistrant as specified in its charter)

 

| **California**                                                   |   | **95-3931727**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **23823  Valencia Boulevard, Valencia, CA**                      |   | **91355**                             |
| (Address of  principal executive offices)                        |   | (Zip Code)                            |
|                                                             |
| **(661)  255-4000**                                              |
| (Registrant’s  telephone number, including area code)       |

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

YES  ý  NO  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).

 

YES  ý  NO  o

 

23,552,578partnership units outstanding at July 31, 2003

 

 

----

 

Part I. FinancialInformation

Item 1. FinancialStatements

 

**Consolidated Statements of Income**

*(Unaudited)*

*** ***
| **In  thousands except per unit**                                     |   | **Three  Months Ended  June 30,** |   | **Six  Months Ended  June 30,** |   |
|-----------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                                  |   | **2003**                          |   | **2002**                        |   | **2003** |   | **2002** |   |
| **Revenues**                                                          |   |                              |   |                            |   |   |   |   |   |
| Real estate                                                           |   |                              |   |                            |   |   |   |   |   |
| Residential land sales                                                |   | $                                 | 5,458  |                            | $      | 27,878 |   | $ | 50,757 |   | $ | 44,775 |   |
| Industrial and commercial sales                                       |   | 1,056                             |   | 9,802                           |   | 10,006 |   | 31,563 |   |
| Commercial operations                                                 |   |                              |   |                            |   |   |   |   |   |
| Income-producing properties                                           |   | 9,473                             |   | 9,742                           |   | 19,374 |   | 19,471 |   |
| Valencia Water Company                                                |   | 3,203                             |   | 3,480                           |   | 5,945 |   | 6,279 |   |
|                                                                  |   | 19,190                            |   | 50,902                          |   | 86,082 |   | 102,088 |   |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| Agriculture operations                                                |   | 1,258                             |   | 1,308                           |   | 1,910 |   | 1,931 |   |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| Total revenues                                                        |   | $                                 | 20,448 |                            | $      | 52,210 |   | $ | 87,992 |   | $ | 104,019 |   |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| **Contribution to income**                                            |   |                              |   |                            |   |   |   |   |   |
| Real estate                                                           |   |                              |   |                            |   |   |   |   |   |
| Residential land sales                                                |   | $                                 | 5,992  |                            | $      | 9,532 |   | $ | 22,072 |   | $ | 14,065 |   |
| Industrial and commercial sales                                       |   | (830                              | )      | 5,049                           |   | (204 | ) | 14,736 |   |
| Community development                                                 |   | (3,772                            | )      | (4,829                          | )      | (6,459 | ) | (7,719 | ) |
| Commercial operations                                                 |   |                              |   |                            |   |   |   |   |   |
| Income-producing properties                                           |   | 2,375                             |   | 3,139                           |   | 4,734 |   | 6,179 |   |
| Valencia Water Company                                                |   | 436                               |   | 734                             |   | 633 |   | 1,176 |   |
|                                                                  |   | 4,201                             |   | 13,625                          |   | 20,776 |   | 28,437 |   |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| Agriculture operations                                                |   | 290                               |   | (7                              | )      | 594 |   | 267 |   |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| General and administrative expense                                    |   | (2,534                            | )      | (3,529                          | )      | (7,037 | ) | (6,349 | ) |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| Operating income                                                      |   | 1,957                             |   | 10,089                          |   | 14,333 |   | 22,355 |   |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| Interest and other, net                                               |   | (610                              | )      | (714                            | )      | (1,209 | ) | (1,857 | ) |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| Net income                                                            |   | $                                 | 1,347  |                            | $      | 9,375 |   | $ | 13,124 |   | $ | 20,498 |   |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| Net income per unit                                                   |   | $                                 | 0.06   |                            | $      | 0.39 |   | $ | 0.56 |   | $ | 0.85 |   |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| Net income per unit - diluted                                         |   | $                                 | 0.06   |                            | $      | 0.38 |   | $ | 0.56 |   | $ | 0.83 |   |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| Weighted average number of units used in  computing per unit amounts: |   |                              |   |                            |   |   |   |   |   |
| Net income per unit                                                   |   | 23,357                            |   | 24,064                          |   | 23,280 |   | 24,144 |   |
| Net income per unit - diluted                                         |   | 23,665                            |   | 24,560                          |   | 23,583 |   | 24,589 |   |
|                                                                  |   |                              |   |                            |   |   |   |   |   |
| Cash distributions per unit:                                          |   |                              |   |                            |   |   |   |   |   |
| Regular                                                               |   | $                                 | 0.10   |                            | $      | 0.10 |   | $ | 0.20 |   | $ | 0.20 |   |
| Special                                                               |   | —                            |   | —                          |   | — |   | 0.13 |   |

 

*See notes to consolidated financial statements*

 

2

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**Consolidated Balance Sheets**

 
| **In thousands**                                                                                                                                                                                        |   | **June  30,  2003** |    | **December  31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|-------------------------|--------|
|                                                                                                                                                                                                    |   | **(Unaudited)**     |    |                    |   |
| **ASSETS**                                                                                                                                                                                              |   |                |    |                    |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Cash and cash equivalents                                                                                                                                                                               |   | $                   | 48,210  |                    | $      | 25,403 |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Accounts and notes receivable                                                                                                                                                                           |   | 8,766               |    | 6,131                   |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Land under development                                                                                                                                                                                  |   | 34,059              |    | 47,428                  |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Land held for future development                                                                                                                                                                        |   | 19,053              |    | 19,154                  |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Income-producing properties, net                                                                                                                                                                        |   | 168,561             |    | 159,971                 |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Property and equipment, net                                                                                                                                                                             |   | 78,114              |    | 76,449                  |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Investment in joint venture                                                                                                                                                                             |   | 1,372               |    | 1,199                   |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Other assets and deferred charges                                                                                                                                                                       |   | 27,169              |    | 23,890                  |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
|                                                                                                                                                                                                    |   | $                   | 385,304 |                    | $      | 359,625 |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| **LIABILITIES AND PARTNERS’ CAPITAL**                                                                                                                                                              |   |                |    |                    |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Accounts payable                                                                                                                                                                                        |   | $                   | 33,755  |                    | $      | 35,948 |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Accrued expenses                                                                                                                                                                                        |   | 54,305              |    | 43,119                  |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Deferred revenues                                                                                                                                                                                       |   | 31,670              |    | 22,696                  |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Mortgage and other debt                                                                                                                                                                                 |   | 65,233              |    | 60,037                  |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Advances and contributions from developers for utility construction                                                                                                                                     |   | 38,705              |    | 38,490                  |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Other liabilities                                                                                                                                                                                       |   | 24,012              |    | 23,639                  |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Total liabilities                                                                                                                                                                                       |   | 247,680             |    | 223,929                 |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Partners’ capital                                                                                                                                                                                  |   |                |    |                    |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| 23,304 units outstanding, excluding 13,468 units in treasury  (cost-$336,860), at June 30, 2003 and 23,518 units outstanding, excluding  13,254 units in treasury (cost-$330,358), at December 31, 2002 |   | 138,902             |    | 136,974                 |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
| Accumulated other comprehensive income                                                                                                                                                                  |   | (1,278              | )       | (1,278                  | )      |
|                                                                                                                                                                                                    |   |                |    |                    |   |
|                                                                                                                                                                                                    |   | 137,624             |    | 135,696                 |   |
|                                                                                                                                                                                                    |   |                |    |                    |   |
|                                                                                                                                                                                                    |   | $                   | 385,304 |                    | $      | 359,625 |   |

* *

*See notes to consolidated financial statements*

 

3

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**Consolidated Statements of CashFlow**

*(Unaudited)*

 
|                                                                               |   | **Six  Months Ended  June 30,** |   |
|------------------------------------------------------------------------------------|--------|---------------------------------|--------|
| **In thousands**                                                                   |   | **2003**                        |   | **2002** |   |
|                                                                               |   |                            |   |   |   |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                         |   |                            |   |   |   |
| Net income                                                                         |   | $                               | 13,124 |   | $ | 20,498 |   |
|                                                                               |   |                            |   |   |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |                            |   |   |   |
|                                                                               |   |                            |   |   |   |
| Depreciation and amortization                                                      |   | 5,870                           |   | 5,689 |   |
| Increase in land under development                                                 |   | (18,672                         | )      | (47,104 | ) |
| Cost of sales and other inventory changes                                          |   | 32,141                          |   | 44,376 |   |
| Decrease in accounts and notes receivable                                          |   | (2,635                          | )      | (10,530 | ) |
| Increase in accounts payable, accrued expenses  and deferred revenues              |   | 17,695                          |   | 16,138 |   |
| Cost of property sold                                                              |   | 1,738                           |   | 124 |   |
| Other adjustments, net                                                             |   | (2,958                          | )      | (1,482 | ) |
|                                                                               |   |                            |   |   |   |
| Net cash provided by operating activities                                          |   | 46,303                          |   | 27,709 |   |
|                                                                               |   |                            |   |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                         |   |                            |   |   |   |
|                                                                               |   |                            |   |   |   |
| Development of income-producing properties                                         |   | (14,379                         | )      | (5,798 | ) |
| Purchase of property and equipment                                                 |   | (3,430                          | )      | (4,131 | ) |
| Investment in joint venture                                                        |   | (173                            | )      | (315 | ) |
|                                                                               |   |                            |   |   |   |
| Net cash used in investing activities                                              |   | (17,982                         | )      | (10,244 | ) |
|                                                                               |   |                            |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                         |   |                            |   |   |   |
|                                                                               |   |                            |   |   |   |
| Distributions paid                                                                 |   | (4,695                          | )      | (7,999 | ) |
| Increase (decrease) in mortgage and other debt,  net                               |   | 5,196                           |   | (3,223 | ) |
| Increase in advances and contributions from  developers for utility construction   |   | 215                             |   | 3,353 |   |
| Purchase of partnership units                                                      |   | (8,514                          | )      | (12,703 | ) |
| Issuance of partnership units                                                      |   | 2,284                           |   | 2,122 |   |
|                                                                               |   |                            |   |   |   |
| Net cash used in financing activities                                              |   | (5,514                          | )      | (18,450 | ) |
|                                                                               |   |                            |   |   |   |
| **Net increase (decrease) in cash  and cash equivalents**                          |   | 22,807                          |   | (985 | ) |
|                                                                               |   |                            |   |   |   |
| **Cash and cash equivalents,  beginning of period**                                |   | 25,403                          |   | 3,050 |   |
|                                                                               |   |                            |   |   |   |
| **Cash and cash equivalents, end  of period**                                      |   | $                               | 48,210 |   | $ | 2,065 |   |
|                                                                               |   |                            |   |   |   |
| **Supplemental schedule of  non-cash investing and financing activites:**          |   |                            |   |   |   |
| Payable for unit repurchases                                                       |   | $                               | (273   | ) | $ | — |   |

 

*See notes to consolidatedfinancial statements*

 

4

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**Notes to Consolidated FinancialStatements**

** **

Note 1. Accounting Policies

 

The Newhall Land andFarming Company’s (“the Company”) unaudited interim financial statements havebeen prepared in conformity with generally accepted accounting principles usedin the preparation of the Company’s annual financial statements. In the opinionof the Company, all adjustments, consisting of normal and recurring items,necessary for a fair presentation of the results of operations for the threeand six months ended June 30, 2003 and 2002 have been made. The interimstatements are condensed and do not include some of the information necessaryfor a more complete understanding of the financial data.  Accordingly, your attention is directed tothe footnote disclosures found on pages 32 through 45 of the Company’s 2002Annual Report on Form 10-K.  Inaddition, a summary of the accounting policies that management considerssignificant in the preparation of the Company’s consolidated financialstatements is included below and in Item 2: Management’s Discussion and Analysis of Financial Condition and Resultsof Operations.

 

Interimfinancial information for the Company has substantial limitations as anindicator for the calendar year because:

 

•                                          Landsales occur irregularly and are recognized at the close of escrow, providedprofit recognition criteria are met, or, if the Company has an obligation tocomplete certain future improvements, on the percentage of completion basis.

 

•                                          Salesof income properties and non-developable farmland occur irregularly and arerecognized upon close of escrow provided profit recognition criteria are met.

 

•                                          Agriculturalcrops are on an annual cycle and income is recognized upon harvest. Most majorcrops grown by the Company or its contractors are harvested during the fall andwinter.

 

*Basis of Consolidation:*Theconsolidated financial statements include the accounts of The Newhall Land andFarming Company and its subsidiaries, which are wholly-owned or controlled bythe Company (collectively, “the Company”). All significant intercompanybalances and transactions are eliminated.

 

*Reclassifications:** ***Certain reclassificationshave been made to prior years’ amounts to conform to the current yearpresentation.

 

*Joint Ventures:** ***The equity method is used to account for aninvestment in a joint venture with Hilton Inns, Inc., which is not controlledby the Company.

 

*Cash and Cash Equivalents: *The Company considers allhighly liquid investments with original maturity dates of 90 days or less to becash equivalents.

 

*Income-Producing Properties;Property and Equipment:** ***Propertyis stated at cost.  Depreciation isprovided on the straight-line basis over the estimated useful lives of thevarious assets without regard to salvage value. Lives used for calculatingdepreciation are as follows: buildings – 25 to 40 years; equipment – 3 to 10years; water supply systems, orchards and other – 5 to 75 years.

 

*Stock-based employeecompensation: *Stock-basedemployee compensation is accounted for using the intrinsic value method allowedunder APB Opinion No. 25, *Accounting for Stock Issued to Employees*.  No stock-based employee compensation expenseis reflected in net income, as options granted under the Company’s plans havean exercise price equal to the market value of the Company’s partnership unitson the date of grant.  The followingtable illustrates the effect on net income and net income per unit if theCompany had applied the fair value provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation* to stock-based employee compensation.

 

5

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|                                            |   | **Three  Months Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|-------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
| **In thousands, except per unit**               |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
| Net Income, as reported                         |   | $                                | 1,347  |                           | $      | 9,375 |   | $ | 13,124 |   | $ | 20,498 |   |
| Total stock-based employee compensation expense |   | (912                             | )      | (640                           | )      | (1,823 | ) | (1,280 | ) |
| Pro forma net income                            |   | $                                | 435    |                           | $      | 8,735 |   | $ | 11,301 |   | $ | 19,218 |   |
|                                            |   |                             |   |                           |   |   |   |   |   |
| Net income per unit                             |   |                             |   |                           |   |   |   |   |   |
| Basic - as reported                             |   | $                                | 0.06   |                           | $      | 0.39 |   | $ | 0.56 |   | $ | 0.85 |   |
| Basic - pro forma                               |   | 0.02                             |   | 0.36                           |   | 0.49 |   | 0.80 |   |
|                                            |   |                             |   |                           |   |   |   |   |   |
| Diluted - as reported                           |   | 0.06                             |   | 0.38                           |   | 0.56 |   | 0.83 |   |
| Diluted - pro forma                             |   | 0.02                             |   | 0.36                           |   | 0.48 |   | 0.78 |   |

 

*Management’s Estimates:** ***The preparationof financial statements in conformity with generally accepted accountingprinciples requires management to make certain estimates and assumptions. Theseaffect the reported amounts of assets and liabilities, the disclosure of anycontingent assets or liabilities and the reported amounts of revenues andexpenses during the reporting periods. Actual results could differ from theestimates made.

 

*Income Taxes:** ***The partnership is not a taxable entity;accordingly, no provision for income taxes has been made in the consolidatedfinancial statements. Partners are taxed on their allocable share of thePartnership’s earnings, which is reportable on their income tax returns.

 

Note 2. Details of Land Under Development

 
| **(In $000)**                               |   | **June 30,  2003** |   | **December  31,  2002** |   |
|---------------------------------------------|--------|--------------------|--------|-------------------------|--------|
|                                        |   |               |   |                    |   |
| Residential  development                    |   | $                  | 28,117 |                    | $      | 27,706 |   |
| Industrial  and commercial land development |   | 5,942              |   | 19,722                  |   |
|                                        |   |               |   |                    |   |
| Total  land under development               |   | $                  | 34,059 |                    | $      | 47,428 |   |

 

Note 3. Details for Earnings per Unit Calculation

 
| **(In 000’s except per unit)**   |   | **Income  (numerator)** |   | **Units  (denominator)** |   | **Per Unit** |   |
|---------------------------------------|--------|-------------------------|--------|--------------------------|--------|--------------|--------|
|                                  |   |                    |   |                     |   |         |   |
| For  three months ended June 30, 2003 |   |                    |   |                     |   |         |   |
| Net  income per unit                  |   |                    |   |                     |   |         |   |
| Net  income available to unitholders  |   | $                       | 1,347  |                     | 23,357 |         | $      | .06 |   |
| Effect  of dilutive securities        |   |                    |   |                     |   |         |   |
| Unit options                          |   | —                  |   | 308                      |   | —       |   |
| Net  income per unit - diluted        |   | $                       | 1,347  |                     | 23,665 |         | $      | .06 |   |
|                                  |   |                    |   |                     |   |         |   |
| For  three months ended June 30, 2002 |   |                    |   |                     |   |         |   |
| Net  income per unit                  |   |                    |   |                     |   |         |   |
| Net income  available to unitholders  |   | $                       | 9,375  |                     | 24,064 |         | $      | .39 |   |
| Effect  of dilutive securities        |   |                    |   |                     |   |         |   |
| Unit  options                         |   | —                  |   | 496                      |   | (.01         | )      |
| Net  income per unit - diluted        |   | $                       | 9,375  |                     | 24,560 |         | $      | .38 |   |

 

6

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| **(In 000’s  except per unit)** |   | **Income  (numerator)** |   | **Units  (denominator)** |   | **Per Unit** |   |
|--------------------------------------|--------|-------------------------|--------|--------------------------|--------|--------------|--------|
|                                 |   |                    |   |                     |   |         |   |
| For  six months ended June 30, 2003  |   |                    |   |                     |   |         |   |
| Net  income per unit                 |   |                    |   |                     |   |         |   |
| Net  income available to unitholders |   | $                       | 13,124 |                     | 23,280 |         | $      | .56 |   |
| Effect  of dilutive securities       |   |                    |   |                     |   |         |   |
| Unit options                         |   | —                  |   | 303                      |   | —       |   |
| Net  income per unit - diluted       |   | $                       | 13,124 |                     | 23,583 |         | $      | .56 |   |
|                                 |   |                    |   |                     |   |         |   |
| For  six months ended June 30, 2002  |   |                    |   |                     |   |         |   |
| Net  income per unit                 |   |                    |   |                     |   |         |   |
| Net  income available to unitholders |   | $                       | 20,498 |                     | 24,144 |         | $      | .85 |   |
| Effect  of dilutive securities       |   |                    |   |                     |   |         |   |
| Unit  options                        |   | —                  |   | 445                      |   | (.02         | )      |
| Net  income per unit - diluted       |   | $                       | 20,498 |                     | 24,589 |         | $      | .83 |   |

 

Note 4. Details ofIncome-Producing Properties, Income-Producing Properties Held for Sale andProperty and Equipment

 
| **(In $000s)**                |   | **June 30,  2003** |    | **December  31,  2002** |   |
|-------------------------------|--------|--------------------|---------|-------------------------|--------|
| Income-producing  properties  |   |               |    |                    |   |
| Land                          |   | $                  | 36,612  |                    | $      | 36,600 |   |
| Buildings                     |   | 142,563            |    | 134,002                 |   |
| Other                         |   | 11,647             |    | 9,655                   |   |
| Properties  under development |   | 24,078             |    | 23,741                  |   |
|                          |   | 214,899            |    | 203,998                 |   |
| Accumulated  depreciation     |   | (46,338            | )       | (44,027                 | )      |
|                          |   | $                  | 168,561 |                    | $      | 159,971 |   |

 
| **(In $000s)**                            |   | **June 30,  2003** |   | **December  31,  2002** |   |
|-------------------------------------------|--------|--------------------|--------|-------------------------|--------|
| Property  and equipment                   |   |               |   |                    |   |
| Land                                      |   | $                  | 3,760  |                    | $      | 3,760 |   |
| Buildings                                 |   | 6,403              |   | 6,034                   |   |
| Equipment                                 |   | 8,929              |   | 8,957                   |   |
| Water  supply systems, orchards and other |   | 95,764             |   | 91,465                  |   |
| Construction  in progress                 |   | 5,909              |   | 7,188                   |   |
|                                      |   | 120,765            |   | 117,404                 |   |
| Accumulated  depreciation                 |   | (42,651            | )      | (40,955                 | )      |
|                                      |   | $                  | 78,114 |                    | $      | 76,449 |   |

 

7

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Note 5. Disclosure about Certain Financial Statement Captions

 

*Cash and cash equivalents -*The Company had $48.2 million in cash andshort-term investments at June 30, 2003, representing a $22.8 million increasein cash and cash equivalents for the first half of 2003 compared to the Company’sending balance of cash and equivalents at December 31, 2002.  Cash generated from residential, commercialand industrial land sales totaled $67.0 million for the six months ended June30, 2003.  In June 2003, the Companyrefinanced a mortgage secured by the New Columbia Ranch.  The existing mortgage of $9.6 million wasrepaid and a new $15 million mortgage was executed.  (See additional discussion below on the Mortgage and other debtfinancial statement caption.)  At June30, 2003, with the exception of $20.0 million outstanding letters of credit,the Company had no outstanding balances on its available lines of credit.  Due to prepayment penalties, the Companyinvests its excess cash in short-term investments rather than pay down itsfixed rate debt.  (See the ConsolidatedStatements of Cash Flows and further discussion in Item 2:  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.)

 

*Land under development -*The $13.4 milliondecrease in land under development at June 30, 2003 compared to the prior yearend was primarily due to $32.0 million in cost allocations to residential lotsales and commercial and industrial land sales reported in the financialresults for the first half of 2003. This was partially offset by $18.7 million in project costs capitalizedduring the 2003 first and second quarters. (See definitions of project costs and cost allocations in the “CriticalAccounting Policies and Estimates” section of Item 2:  Management’s Discussion and Analysis of FinancialCondition and Results of Operations.)

 

*Accrued expenses -*The $11.2 million increase in accrued expenses at June 30, 2003 comparedto December 31, 2002 primarily related to the collection of school fees frommerchant builders for residential lots sold. As monies are collected from merchant builders to fund the Company’sportion of future schools to be built in Valencia, the accrual account isincreased.  The Company reduces theaccrual as funding requests are paid by the Company to the school districts.

 

*Deferred revenues -*The $9.0 million net increase in deferredrevenues for the six months ended June 30, 2003 was primarily attributable to$16.7 million in deferred revenues for certain commercial land and residentiallot sales recorded under percentage of completion accounting in 2003, including$435,000 recorded in the 2003 second quarter. (See definition of percentage of completion in the “SignificantAccounting Policies and Estimates” section of Item 2:  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.)  This increase was partially offset by recognizing $8.1 million ofdeferred revenues earned in 2003 to date, including $919,000 of deferredrevenues recognized in the 2003 second quarter.

 

*Mortgage and other debt* - The $5.2 million increase in mortgage andother debt for the six months ended June 30, 2003 was primarily due to therefinancing of the New Columbia Ranch mortgage in June 2003.  The existing mortgage of $9.6 million wasrepaid and a new $15 million mortgage was executed.  The existing mortgage had an 8.45% interest rate and was tomature in November 2003.  The newmortgage has a term of 15 years and bears interest at 3.07% per annum for thefirst three years and converts to a variable rate, reset quarterly,thereafter.  (See further discussion inthe “Financial Condition” section of Item 2:  Management’s Discussion and Analysis of Financial Condition andResults of Operations.)

 

8

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Note 6. Business Segment Reporting 

 

The following tableprovides financial information regarding revenues from external customers,income and total assets for the Company’s business segments and also provides areconciliation to the Company’s consolidated totals:

 
|                         |   | **Three months ended June 30, 2003** |   |
|------------------------------|--------|--------------------------------------|--------|
| **(In $000s)**               |   | **Revenues**                         |   | **Contribution  to Income** |   | **Assets** |   |
| Real  Estate                 |   |                                 |   |   |   |   |   |
| Residential                  |   | $                                    | 5,458  |   | $ | 6,028 |   | $ | 34,075 |   |
| Industrial and commercial    |   | 1,056                                |   | (727 | ) | 23,854 |   |
| Community development        |   | —                               |   | (3,657 | ) | 34,499 |   |
| Income-producing  properties |   | 9,473                                |   | 2,391 |   | 157,076 |   |
| Valencia  Water Company      |   | 3,203                                |   | 453 |   | 79,266 |   |
| Agriculture                  |   | 1,258                                |   | 294 |   | 5,330 |   |
| Central  administration      |   | —                               |   | (2,325 | ) | 51,204 |   |
| All other                    |   | —                               |   | (500 | ) | — |   |
|                         |   | 20,448                               |   | 1,957 |   | 385,304 |   |
| Interest and other, net      |   | —                               |   | (610 | ) | — |   |
|                         |   | $                                    | 20,448 |   | $ | 1,347 |   | $ | 385,304 |   |

 
|                         |   | **Three months ended June 30, 2002** |   |
|------------------------------|--------|--------------------------------------|--------|
| **(In $000s)**               |   | **Revenues**                         |   | **Contribution  to Income** |   | **Assets** |   |
| Real  Estate                 |   |                                 |   |   |   |   |   |
| Residential                  |   | $                                    | 27,878 |   | $ | 9,634 |   | $ | 44,194 |   |
| Industrial and commercial    |   | 9,802                                |   | 5,237 |   | 55,978 |   |
| Community development        |   | —                               |   | (4,612 | ) | 34,726 |   |
| Income-producing  properties |   | 9,742                                |   | 3,171 |   | 150,354 |   |
| Valencia  Water Company      |   | 3,480                                |   | 781 |   | 75,706 |   |
| Agriculture                  |   | 1,308                                |   | 15 |   | 7,218 |   |
| Central  administration      |   | —                               |   | (3,037 | ) | 8,340 |   |
| All other                    |   | —                               |   | (1,100 | ) | — |   |
|                         |   | 52,210                               |   | 10,089 |   | 376,516 |   |
| Interest and other, net      |   | —                               |   | (714 | ) | — |   |
|                         |   | $                                    | 52,210 |   | $ | 9,375 |   | $ | 376,516 |   |

 
|                         |   | **Six months ended June 30, 2003** |   |
|------------------------------|--------|------------------------------------|--------|
| **(In $000s)**               |   | **Revenues**                       |   | **Contribution  to Income** |   | **Assets** |   |
| Real  Estate                 |   |                               |   |   |   |   |   |
| Residential                  |   | $                                  | 50,757 |   | $ | 22,227 |   | $ | 34,075 |   |
| Industrial and commercial    |   | 10,006                             |   | 108 |   | 23,854 |   |
| Community development        |   | —                             |   | (6,102 | ) | 34,499 |   |
| Income-producing  properties |   | 19,374                             |   | 4,787 |   | 157,076 |   |
| Valencia  Water Company      |   | 5,945                              |   | 706 |   | 79,266 |   |
| Agriculture                  |   | 1,910                              |   | 624 |   | 5,330 |   |
| Central  administration      |   | —                             |   | (6,267 | ) | 51,204 |   |
| All other                    |   | —                             |   | (1,750 | ) | — |   |
|                         |   | 87,992                             |   | 14,333 |   | 385,304 |   |
| Interest and other, net      |   | —                             |   | (1,209 | ) | — |   |
|                         |   | $                                  | 87,992 |   | $ | 13,124 |   | $ | 385,304 |   |

 

9

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|                         |   | **Six months ended June 30, 2002** |    |
|------------------------------|--------|------------------------------------|---------|
| **(In $000s)**               |   | **Revenues**                       |    | **Contribution  to Income** |   | **Assets** |   |
| Real  Estate                 |   |                               |    |   |   |   |   |
| Residential                  |   | $                                  | 44,775  |   | $ | 14,286 |   | $ | 44,194 |   |
| Industrial and commercial    |   | 31,563                             |    | 15,133 |   | 55,978 |   |
| Community development        |   | —                             |    | (7,259 | ) | 34,726 |   |
| Income-producing  properties |   | 19,471                             |    | 6,249 |   | 150,354 |   |
| Valencia  Water Company      |   | 6,279                              |    | 1,278 |   | 75,706 |   |
| Agriculture                  |   | 1,931                              |    | 315 |   | 7,218 |   |
| Central  administration      |   | —                             |    | (5,297 | ) | 8,340 |   |
| All other                    |   | —                             |    | (2,350 | ) | — |   |
|                         |   | 104,019                            |    | 22,355 |   | 376,516 |   |
| Interest and other, net      |   | —                             |    | (1,857 | ) | — |   |
|                         |   | $                                  | 104,019 |   | $ | 20,498 |   | $ | 376,516 |   |

 

Note 7.  NewAccounting Pronouncements

 

InApril 2003, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) No. 149, *Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities.* SFAS No. 149 amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments imbedded in other contracts and for hedging activitesunder SFAS No. 133, *Accounting forDerivative Instruments and Hedging Activities*.  The statement is generally effective forcontracts entered into or modified after June 30, 2003 and for hedgingrelationships designated after June 30, 2003. It is not anticipated that the adoption of this statement will have amaterial effect on the Company’s results of operations and financial conditionfor the year ending December 31, 2003.

 

In May 2003, the FASBissued SFAS No. 150, *Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity*.  SFAS No. 150 established standards for howan issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity.  The statement is effective for financial instruments entered intoor modified after May 31, 2003, and otherwise is effective at the beginning ofthe first interim period beginning after June 15, 2003.  It is not anticipated that the adoption of thisstatement will have a material effect on the Company’s results of operationsand financial condition for the year ending December 31, 2003.

 

Note 8. Subsequent Event

 

On July 21, 2003, theCompany entered into a merger agreement with Lennar Corporation (“Lennar”), aDelaware corporation, LNR Property Corporation (“LNR”), a Delaware corporation,NWHL Investment LLC, a Delaware limited liability company and NWHL Acquisition,L.P., a California limited partnership (“the Merger Agreement”).  Under the terms of the Merger Agreement, theCompany’s unitholders will receive $40.50 per partnership unit in cash, whichwill increase at a rate of 5% per annum commencing 270 days from the date ofthe Merger Agreement.  The totalpurchase consideration, after giving effect to the payment of employee options,will be approximately $990 million plus liabilities.  The transaction is subject to the approval of the CaliforniaPublic Utilities Commission, due to the change in control of Valencia WaterCompany that will result from the purchase, and customary closing conditions.The parties expect the transaction to close by the middle of 2004.

 

Fromthe effective date of the Merger Agreement, Lennar and LNR have 45 days toperform due diligence regarding the Company and its properties, and during thisperiod will have the right to terminate the Merger Agreement and forfeit a $5million deposit.  After the 45 day duediligence period, Lennar and LNR will deposit in total an additional $25million into escrow to secure their obligations under the Merger Agreement.

 

ACurrent Report on Form 8-K has been filed with the Securities and ExchangeCommission on this merger, which includes as exhibits the Merger Agreement andthe press release announcing the transaction.

 

10

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Part. I. FinancialInformation

Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

 

##### **CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

##### ** **

The Company’sconsolidated financial statements have been prepared in accordance with accountingprinciples generally accepted in the United States.  Inherent in the preparation of these financial statements arecertain estimates and assumptions that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities.  The Company evaluatesthese estimates and assumptions on a regular basis taking into accounthistorical experience and other relevant current factors.  Therefore, actual results may differ fromreported amounts under different assumptions or conditions.

 

The interim statementsare condensed and do not include some of the information necessary for a morecomplete understanding of the financial data. Accordingly, your attention is directed to the footnote disclosuresfound on pages 32 through 45 of the Company’s 2002 Annual Report on Form10-K.  The accounting policies used bythe Company in the preparation of its consolidated financial statements as theyrelate to its business segments are presented above in Note 1 to theconsolidated financial statements.  Asummary of the accounting policies management considers significant in thepreparation of the Company’s consolidated financial statements follows.  The Company’s audit committee has reviewedthe selection, application and disclosure of the Company’s critical accountingpolicies.

 

*Revenue recognition* – The majority ofrevenues for the Company result from land sales.  The Company follows the provisions in Statement of FinancialAccounting Standards (SFAS) No. 66, *Accounting for Sales of Real Estate*, torecord these sales.  SFAS No. 66provides specific sales recognition criteria to determine when land salesrevenues can be recorded.  For example,SFAS No. 66 requires a land sale must be consummated with a sufficient downpayment of the sales price depending upon the type and timeframe fordevelopment of the property sold, and that any receivable from the sale cannotbe subject to future subordination.  Theseller cannot retain any material continuing involvement in the property sold.

 

*Percentage of completion* – When theCompany has an obligation to complete development on sold property it utilizesthe percentage of completion method of accounting to record revenues andincome.  Under percentage of completionaccounting, the Company recognizes revenues and income based upon the ratio ofdevelopment cost completed to the estimated total cost of the property sold,provided required sales recognition criteria have been met.  Unearned revenues resulting from applyingpercentage of completion accounting are reported as deferred revenues in theliabilities section of the balance sheet. The Company estimates total project costs associated with the parcelsold.  Revisions in profit estimates andchanges in percentages complete are recorded in the consolidated statement ofincome in subsequent periods, as they become known and the developmentprogresses toward completion.

 

*Project costs* – Costs incurred by theCompany to record maps and develop specific real estate projects are capitalizedas a cost of that project and included as an asset in land under development onthe balance sheet.  Project litigationcosts are charged to expense when incurred. Indirect costs that do not clearly relate to projects under development,including general and administrative expenses, are charged to expense whenincurred.

 

*Cost allocations* – The Company generallyallocates onsite costs to individual parcels within a project on a square footbasis if the parcels in the project are of similar value.   In mixed-use projects, where there may beboth a residential and a commercial component with varying fair values, onsitecosts are allocated to the respective parcels using the relative sales valuemethod.  Under the relative sales valuemethod, each parcel in the project under development is allocated onsite costsin proportion to the estimated overall sales prices of the project such thateach parcel to be sold reflects the same gross profit margin.  Since this method requires the Company toestimate the expected sales prices for the entire project, the profit margin onsubsequent parcels sold will be impacted by both changes in the estimated totalrevenues as well as any changes in the estimated total costs of the project.

 

Offsite improvements withregional benefit, such as freeway on-ramps and off-ramps and water storagetanks, are referred to as infrastructure costs.  The Company estimates the total cost to develop theinfrastructure within a defined major development area and allocates this costto the land within the area.  Changes inthe estimated remaining infrastructure costs or changes in the remainingdevelopable acreage will impact the infrastructure cost allocation andcorresponding profit margin for unsold land within a major development area.

 

11

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*Stock-based employee compensation* – TheCompany accounts for stock-based employee compensation using the intrinsicvalue method allowed under APB Opinion No. 25, *Accounting for Stock Issued to Employees*.  No stock-based employee compensation expenseis reflected in net income, as options granted under the Company’s plans havean exercise price equal to the market value of the Company’s partnership unitson the date of grant.  Refer to Note 1to the consolidated financial statements for additional disclosures, includingthe pro forma effect for the fair value method of accounting (expensing) forstock-based employee compensation.

 

12

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**RESULTS OF OPERATIONS**

 

Comparisonof Second Quarter and Six Months of 2003 to Second Quarter and Six Months of2002

*Unaudited*

 

The amounts of increase or decrease inrevenues and income from the prior year second quarter and six months are asfollows (in 000s, except per unit):

 
|                                                                 |   | **Second  Quarter**      |    | **Six  Months**          |   |
|----------------------------------------------------------------------|--------|--------------------------|---------|--------------------------|--------|
|                                                                 |   | **Increase  (Decrease)** |    | **Increase  (Decrease)** |   |
|                                                                 |   | **Amount**               |    | **%**                    |   | **Amount** |   | **%** |   |
| **Revenues**                                                         |   |                     |    |                     |   |   |   |   |   |
| Real estate                                                          |   |                     |    |                     |   |   |   |   |   |
| Residential land sales                                               |   | $                        | (22,420 | )                        | -80    | % | $ | 5,982 |   | 13 | % |
| Industrial and commercial sales                                      |   | (8,746                   | )       | -89                      | %      | (21,557 | ) | -68 | % |
| Commercial operations                                                |   |                     |    |                     |   |   |   |   |   |
| Income-producing properties                                          |   | (269                     | )       | -3                       | %      | (97 | ) | 0 | % |
| Valencia Water Company                                               |   | (277                     | )       | -8                       | %      | (334 | ) | -5 | % |
|                                                                 |   | (31,712                  | )       | -62                      | %      | (16,006 | ) | -16 | % |
|                                                                 |   |                     |    |                     |   |   |   |   |   |
| Agriculture Operations                                               |   | (50                      | )       | -4                       | %      | (21 | ) | -1 | % |
|                                                                 |   |                     |    |                     |   |   |   |   |   |
| Total revenues                                                       |   | $                        | (31,762 | )                        | -61    | % | $ | (16,027 | ) | -15 | % |
|                                                                 |   |                     |    |                     |   |   |   |   |   |
| **Contribution to Income**                                           |   |                     |    |                     |   |   |   |   |   |
| Real estate                                                          |   |                     |    |                     |   |   |   |   |   |
| Residential land sales                                               |   | $                        | (3,540  | )                        | -37    | % | $ | 8,007 |   | 57 | % |
| Industrial and commercial sales                                      |   | (5,879                   | )       | -116                     | %      | (14,940 | ) | -101 | % |
| Community development                                                |   | 1,057                    |    | 22                       | %      | 1,260 |   | 16 | % |
| Commercial operations                                                |   |                     |    |                     |   |   |   |   |   |
| Income-producing properties                                          |   | (764                     | )       | -24                      | %      | (1,445 | ) | -23 | % |
| Valencia Water Company                                               |   | (298                     | )       | -41                      | %      | (543 | ) | -46 | % |
|                                                                 |   | (9,424                   | )       | -69                      | %      | (7,661 | ) | -27 | % |
|                                                                 |   |                     |    |                     |   |   |   |   |   |
| Agriculture Operations                                               |   | 297                      |    | 4243                     | %      | 327 |   | 122 | % |
|                                                                 |   |                     |    |                     |   |   |   |   |   |
| General and administrative expense                                   |   | 995                      |    | 28                       | %      | (688 | ) | -11 | % |
|                                                                 |   |                     |    |                     |   |   |   |   |   |
| Operating income                                                     |   | (8,132                   | )       | -81                      | %      | (8,022 | ) | -36 | % |
|                                                                 |   |                     |    |                     |   |   |   |   |   |
| Interest and other, net                                              |   | 104                      |    | 15                       | %      | 648 |   | 35 | % |
|                                                                 |   |                     |    |                     |   |   |   |   |   |
| Net income                                                           |   | $                        | (8,028  | )                        | -86    | % | $ | (7,374 | ) | -36 | % |
|                                                                 |   |                     |    |                     |   |   |   |   |   |
| Net income per unit                                                  |   | $                        | (0.33   | )                        | -85    | % | $ | (0.29 | ) | -34 | % |
| Net income per unit - diluted                                        |   | $                        | (0.32   | )                        | -85    | % | $ | (0.28 | ) | -33 | % |
|                                                                 |   |                     |    |                     |   |   |   |   |   |
| Weighted average number of units used in computing per unit amounts: |   |                     |    |                     |   |   |   |   |   |
| Net income per unit                                                  |   | (707                     | )       | -3                       | %      | (864 | ) | -4 | % |
| Net income per unit - diluted                                        |   | (895                     | )       | -4                       | %      | (1,006 | ) | -4 | % |

 

13

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The increases and decreases in revenues and income forthe three and six months are attributable to the following:

 

Forthe three months ended June 30, 2003, the Company reported revenues of $20.4million compared to $52.2 million for the three months ended June 30,2002.  Net income of $1.3 million, or$.06 per unit, was reported for the 2003 second quarter compared to net incomeof $9.4 million, or $.38 per unit, for the 2002 second quarter.

 

Theprimary contributors to the 2003 second quarter results were the sale of10 custom home sites in the Westridge golf course community, operations fromthe Company’s income-producing portfolio and the continued recognition ofrevenues and income under percentage of completion accounting from residentialland sales closed in previous periods. Combined, these activities contributed $13.9 million to revenues and$8.1 million to income in the second quarter 2003.

 

Majorcontributors to second quarter 2002 results were the sales of the entire 326entitled, unimproved residential lots in the community of Alta Vista, 95entitled, improved lots in Westridge and 16.7 acres of commercial land plannedfor an 185,000 square foot specialty retail center across from Valencia TownCenter regional shopping mall. Combined, these sales added $33.0 million to revenues and $14.3 millionto income in the 2002 second quarter.

 

For the three- and six-month periods ended June 30,2003, the sale of residential lots continued to be a major contributor to theCompany’s results from operations.  Forthe 2003 second quarter, 10 custom home sites in the Westridge golf coursecommunity closed escrow.  During the sixmonths ended June 30, 2003, escrows closed on the entire 759 residential lotsin the Company’s Creekside community, which completes the residential lots beingmarketed for sale to merchant builders in 2003.  Additionally, escrows closed on 14 custom estate lots in theWestridge community during this same six month period.  Home sales by merchant builders on lots previously purchased from theCompany continue to be strong with 505 homes sold during the first six monthsof 2003 compared to 696 new homes sold during the same period last year.  At June 30, 2003, merchant buildershad 553 homes in escrow and unsold inventory of 1,836 lots previously purchasedfrom the Company, compared to 457 homes in escrow and unsold inventory of 1,275lots at the end of the 2002 second quarter. While the Company does notparticipate directly in profits generated from escrow closings bymerchant builders, indirectly the Company generally shares with the merchantbuilders in the overall revenues and profits of home building projects aboveagreed upon thresholds.  The sale ofpreviously sold lots to homebuyers is also key to the Company’s future successin selling additional lots.

 

Revenuesfor the six months ended June 30, 2003 and 2002 totaled $88.0 million and$104.0 million, respectively. The Company reported net income of $13.1 millionand $20.5 million, respectively, for the six-month periods ended June 30, 2003and 2002.

 

The sales of all 759residential lots in the Company’s Creekside community, the sales of fourteencustom home sites in the Westridge golf course community, and continuingoperations from the Company’s income-producing portfolio were the primarycontributors to the Company’s results for the six months ended June 30, 2003.Combined, these contributed $61.9 million to revenues and $22.5 million to netincome.  In addition, the sale of 18.3acres of industrial and commercial land contributed $8.0 million to revenuesand $1.7 million to net income for the six months ended June 30, 2003.

 

Forthe six-months ended June 30, 2002, escrows closed on 407 lots in the Westridgecommunity in addition to the entire 326 lots in the community of AltaVista.  The Company also closed escrowon 55 acres of commercial land. Combined, these sales contributed $71.8 million to revenues and $31.0million to income for the period.

 

The Company’s 2003business plan anticipates that the majority of the Company’s revenues will begenerated from residential, commercial and industrial land sales and itsportfolio of income-producing properties. The entire community of Creekside, consisting of 759 entitled, improvedresidential lots, was sold to merchant builders during the first quarter of 2003.  These 759 lots complete the Company’sresidential lot sale offerings to merchant builders in 2003.  The Company’s residential focus for thebalance of 2003 is on selling custom, residential lots in Westridge.  As of June 30, 2003, fourteen of thesecustom home sites had closed escrow.  Asof July 28, 2003, escrows closed on an additional four custom estate lots,which will be reflected in the results for the 2003 third quarter.  Combined, the sales price of these 785residential lots is expected to total approximately $64 million.  The business plan for 2003 also includes thesale of 55 acres of industrial and commercial land with a combined expectedsales price of $44 million.  As of June30, 2003, escrows had closed on 18.3 acres of commercial and

 

14

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industrial land, and 35acres of commercial land were in escrow for closings later this year.  As of July 28, 2003, escrows closed on twoof these commercial parcels in escrow at the end of the 2003 second quarter, totalingapproximately 10 acres, for a combined sales value of approximately $12million, which will be reflected in the 2003 third quarter results.  The Company’s portfolio of income-producingproperties is expected to contribute approximately $9 million to income andgenerate net operating income of approximately $20 million, after accountingfor approximately $700,000 in projected start-up expenses for the TournamentPlayers ClubÒ at Valenciachampionship golf course, which commenced operations June 26, 2003 in theCompany’s Westridge community.  Netoperating income represents earnings from the income portfolio beforedeductions of $2 million for administrative expenses and $9 million fordepreciation, and is the industry-accepted performance measure for suchassets.  Based upon these assumptionsfor the current year, the Company expects income for 2003 to range from $1.15to $1.25 per unit.  These results do notinclude possible expense reimbursements resulting from the tentative settlementagreement in the Company initiatedlitigation against a gas and oil-field operator.  (See the “Community Development” section of Item2:  Management’s Discussion and Analysisof Financial Condition and Results of Operations below.)

 

The ability of the Company to complete sales projectedin 2003 will be dependent upon a variety of factors including, but not limitedto, identification of suitable buyers for its land, reaching agreement with thebuyers on definitive terms, the successful completion of the due diligence workby buyers, the availability of financing to suitable buyers, satisfactoryresolution of regulatory and legal issues, and market and general economic andother conditions, the timing and outcome of which may be beyond the control ofthe Company.  Generally, revenues andincome from land sales are recorded under the percentage of completion methodof accounting.  Accordingly, certainrevenues and income from land sales in the current year may be deferred tofuture periods when the Company has an obligation to complete development on aproperty sold.

 

# **Residential Land Sales**

# ** **

The Company primarilysells lots to merchant builders who, in turn, build homes for sale.  Revenues and income are recorded when titleis transferred to the merchant builder. Generally, residential lot sale agreements contain a provision wherebythe Company will receive from the merchant builder a portion of the home salesprices above an agreed upon base price (price participation) and/or in theoverall profitability of the home building project after the merchant builderhas received an agreed upon return (profit participation).  If home prices and/or project profitabilityfall short of the participation thresholds, the Company receives no additionalrevenues or income and has no financial obligation to the builder.

 

In the 2003 second quarter, 10 custom home sitesclosed escrow in the Company’s Westridge golf course community, contributing$3.5 million to revenues and $2.2 million to income under percentage ofcompletion accounting.  Additionally,revenues of $852,000 were recognized under percentage of completion accountingon lots previously sold by the Company, which, when combined with revisedestimates to complete the land development on the sold lots, generated $3.5million in income for the 2003 quarter.

 

Results for the six monthperiod ended June 30, 2003 included the sale of the entire 759 lots in theCreekside community to merchant builders and the sale of 14 custom home sitesin the Westridge community.  The sale ofthese 773 lots contributed a combined total of $42.5 million to revenues and$17.8 million to income under the percentage of completion method of accountingthrough June 30, 2003.  In addition,results for the six-month period ended June 30, 2003 included $6.1 million inrevenues recognized under percentage of completion accounting on lotspreviously sold by the Company, which, when combined with revised estimates tocomplete the land development on the sold lots, generated $4.7 million inincome for the six month period.  Also,$2.2 million in revenues and income were recognized in the six month periodended June 30, 2003 from cash payments received by the Company under price andprofit participation agreements related to prior year lot sales.

 

In the 2002 second quarter,421 residential lots closed escrow.  Thesale of the entire inventory of 326 entitled, unimproved residential lots inthe community of Alta Vista and of 95 entitled, improved lots in the Westridgegolf course community contributed a total of $25.5 million to revenues and $9.4million to income under percentage of completion accounting.  For the six months ended June 30, 2002, theCompany closed escrows on 407 residential lots in the Westridge community andthe 326 lots in Alta Vista, for a total of 733 residential lots sold, which combinedcontributed $41.4 million to revenues and $13.9 million to income.

 

15

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No residential lots were inescrow to merchant builders at the end of the 2003 second quarter.  As of July 28, 2003, escrows closedon four additional custom lots for a combined sales price of $2.4 million,which will be reflected in the results for the third quarter 2003.  At June 30, 2002, the entire 275 residential lots in the community ofHidden Creek and 278 residential lots in Valencia Westridge were in escrow,with closings recorded in the second half of 2002.

 

# **Industrial and Commercial Sales**

# ** **

Industrial and commercialland sales have been minimal for the Company for the first six months of 2003,resulting in a $204,000 loss for the division for the six months ended June 30,2003.  For the six month period endedJune 30, 2003, escrows closed on 5 parcels totaling approximately 18 acres.

 

## **IndustrialLand Sales**

## ** **

Industrial land sales activity remained slow duringthe 2003 second quarter as the market continued to absorb space on the marketas a result of significant land sales in previous years.  At June 30, 2003, the Company had 365 netacres of entitled industrial land remaining in Valencia.  There are indications the local market forindustrial property is strengthening as the industrial vacancy rate in Valenciawas less than 11% at June 30, 2003 compared to 12% at December 31, 2002.

 

No industrial land was sold during the quarters endedJune 30, 2003 or 2002.  Results for the sixmonths ended June 30, 2003 included one 5.7-acre industrial parcel,contributing $2.8 million to revenues and $409,000 to income.  No industrial land sales closed escrow inthe six-month period ended June 30, 2002.

 

The Company expects to market for sale approximately14 acres of industrial land in 2003, including the 5.7-acre parcel which closedin the 2003 first quarter.  Noindustrial land was in escrow at June 30, 2003.  The ability to complete sales in 2003 will be dependent upon avariety of factors including, but not limited to, identification of suitablebuyers, agreement with the buyers on definitive terms, successful completion ofthe due diligence work by buyers, availability of financing to suitable buyers,regulatory and legal issues, market and other conditions.

 

## **CommercialLand Sales**

## ** **

No commercial land wassold during the 2003 second quarter. Results for the quarter included the recognition under percentage ofcompletion accounting of $975,000 in revenues and $318,000 in income from prioryear sales.  For the six-month periodended June 30, 2003, escrows closed on four commercial parcels totaling 12.6acres.  These sales, combined,contributed $5.2 million to revenues and $1.3 million to income underpercentage of completion accounting.  Inaddition, revenues of $1.9 million and income of $1.0 million were recognizedunder percentage of completion accounting from prior year land sales.

 

In the 2002 second quarter,escrow closed on a 16.7-acre commercial parcel located across from Valencia TownCenter regional mall on which an 185,000 square foot retail center anchored byKohl’s department store has been constructed. This sale contributed $7.4million to revenues and $5.0 million to income under the percentage ofcompletion method of accounting.  Theresults for the quarter also included $2.3 million in revenues and $1.6 millionin income recorded under percentage of completion accounting.  For the six-months ended June 30, 2002, theCompany closed escrows on 55.5 acres of commercial land, contributing $30.5million to revenues and $17.2 million to income.  In addition to the 16.7 acres sold in the 2002 second quarter,the 55.5 acres included 22.3 acres in the Westridge golf course community fortwo commercial sites and an apartment site, which contributed $17.3 million torevenues and $9.3 million to income.

 

At June 30, 2003, fivecommercial parcels totaling approximately 35 acres were in escrow for about $32million with closings expected later in 2003. Subsequent to the end of the 2003 second quarter, two of these escrowsclosed on a total of 10 acres, including one parcel planned for 188 apartmentunits, for a combined sales price of approximately $12 million, which will bereflected in the results for the 2003 third quarter.  At June30, 2002, one commercial parcel totaling 4.6 acres was in escrow.  This escrow closed during the 2003first quarter and is

 

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reflected in the resultsfor the six-months ended June 30, 2003. All escrow closings are subject tomarket and other conditions that may be beyond the control of the Company.

 

## **CommunityDevelopment**

## ** **

Communitydevelopment expenses decreased 22% for the three-month period and 16% for thesix-month period ended June 30, 2003 compared to the same 2002 periodsprimarily due to the Company’s reduction in corporate marketing expensesas a result of the Company’s streamlining of its administration, sales andmarketing efforts and a decrease in costs related to certain legal challenges. Community development expenses for 2003 are expected to decrease about30% from the 2002 level due to the Company’s anticipated reduction inmarketing expenses and a decrease in costs related to legal challenges.  These expense reductions are anticipated tobe partially offset by continuing expenses related to obtaining entitlementsand planning for the completion of the projected sellout of Valenciaresidential land, and positioning Newhall Ranch to commence development.

 

In early 2001, the Companyinitiated litigation against a gas and oil-field operator to seek to enforcecontractual provisions requiring the operator to perform adequate restorationof the leased properties.  On May 20,2003, the Los Angeles County Superior Court granted a stay of the case to allowthe parties time to document the details of a tentative settlement which hadbeen reached and execute a definitive settlement agreement.  At this time, the definitive settlementagreement is not complete.  However,discussions between the Company and the defendants are on going.

 

On May 27, 2003, the LosAngeles County Board of Supervisors approved the General-Plan and Sub-PlanAmendment, Zone Change, Conditional Use Permit and the Final EnvironmentalImpact report relating to the Newhall Ranch Specific Plan.  The next step in the process will be ahearing by the Kern County Superior Court, which is expected to occur inOctober 2003.  At this hearing the judgeis expected to determine whether the final documents meet the requirements setout in the court order that returned the project to the Los Angeles CountyBoard of Supervisors.  Meanwhile, theCompany continues to work on developing subdivision maps and applications forpermits, which need to be approved before development can occur.  Initial development is currently expected tobegin in 2006.  The length of timenecessary to obtain completion of governmental review and approvals necessaryfor the project, and the timing of any judicial processes that may result, aredifficult to predict and actual commencement of development may be delayedbeyond the target date.

 

## **Income-Producing Properties**

## ** **

Forthe three-month period ended June 30, 2003, revenues and income were down 3%and 24%, respectively, over the same period in 2002.  Revenues for the six-month period ended June 30, 2003 werecomparable with revenues for the six months ended June 30, 2002 while incomewas down 23% over the prior year.  Thedecrease in revenues was primarily due to a reduction in ancillary charges onthe Valencia Town Center mall and a slight reduction in revenues at the HyattValencia hotel.  The decrease inincome for both the three and six month periods ended June 30, 2003 wasprimarily due to higher operating expenses at the existing properties and topre-opening and marketing expenses for the Tournament Players ClubÒat Valencia championship golf course, which opened on June 26, 2003.

 

Netoperating income represents earnings from the income portfolio beforedeductions for administrative expenses and depreciation, and is the industry-acceptedperformance measure for such assets. Net operating income for the second quarter 2003 and the six-monthperiod ended June 30, 2003 decreased 10% and 8%, respectively, over the sameperiods in 2002 primarily due to higher operating expenses at theexisting properties.

 

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**Income-producing Properties**

 

***(Dollars inthousands)***

 
| **Net Operating Income**     |   | **Three Months Ended********June 30,** |   | **Six Months Ended********June 30,** |   |
|------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                         |   | **2003**                               |   | **2002**                             |   | **2003** |   | **2002** |   |
| Retained Properties(1)       |   | $                                      | 5,035  |                                 | $      | 5,589 |   | $ | 10,165 |   | $ | 11,037 |   |
| Properties Held for Sale(2)  |   | —                                 |   | (6                                   | )      | — |   | (12 | ) |
| Sold Properties              |   | —                                 |   | —                               |   | — |   | — |   |
|                         |   |                                   |   |                                 |   |   |   |   |   |
| Net Operating Income(3)      |   | 5,035                                  |   | 5,583                                |   | 10,165 |   | 11,025 |   |
| Admin/Depreciation           |   | (2,661                                 | )      | (2,444                               | )      | (5,431 | ) | (4,846 | ) |
| Total Contribution to Income |   | $                                      | 2,374  |                                 | $      | 3,139 |   | $ | 4,734 |   | $ | 6,179 |   |

 

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(1)     Includes NorthPark Village Square and RiverOaks shopping centers, Valencia Town Center regional mall and entertainmentcenter, retail along Town Center Drive, Hyatt Valencia and Valencia Hiltonhotels, restaurants, leases, etc.

(2)     Consists of a 35,310 sq. ft. buildinglocated in Valencia Commerce Center that was sold in the 4th quarterof 2002.

(3)     Before administration expenses, depreciation andinterest.  Maintenance costs areexpensed as incurred.

 

Occupancy rates at theCompany’s various income-producing properties were as follows at June 30, 2003and 2002:

 
| **Occupancy  Rates*:**                 |   | **June 30, 2003** |   | **June 30, 2002** |   |
|----------------------------------------|--------|-------------------|--------|-------------------|--------|
| Valencia Town Center  Mall**           |   | 82                | %      | 82                | %      |
| Entertainment Center***                |   | 94                | %      | 97                | %      |
| Valencia Town Center  Master Lease**** |   | 79                | %      | 80                | %      |
| NorthPark/River Oaks  Shopping Centers |   | 100               | %      | 99                | %      |
| Hotels                                 |   | 75                | %      | 75                | %      |

 

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*                                         Includes signed lease space and leases toshort-term tenants.

**                                  Includes 334,661 sq. ft. of leasable retailspace in the mall and along Town Center Drive, and 8,431 sq. ft. of officespace.

***                           Includes 128,745 sq. ft. of leasable space.

****                    Includes 51,019 sq. ft. of retail space froma 12-1/2 year lease-back agreement that was part of the sale of four officebuildings along Town Center Drive that closed escrow in early December 2000.

 

The primary contributorto the vacancy at Valencia Town Center regional shopping mall was theapproximately 12% of non-anchor gross leasable area that was not available foroccupancy due to the construction related to the second phase of the remodelproject underway at the property.  Thefirst phase of the remodel involved relocating an expanded food court to the west end of the shopping mall where Edwards Theaters was previouslylocated. This was complete in February 2003. The second phase of the remodel in progress is to create newretail space in the former food court location and is expected to be open laterthis year.

 

Results for the 2002second quarter and the six months ended June 30, 2002 included the favorableeffect of the cessation of depreciation totaling $17,000 and $36,000,respectively, on income-producing properties held for sale.  One minor income property was sold in the2002 fourth quarter.  There were noproperties held for sale at June 30, 2003 or during the six month period thenended.

 

The Company’s portfolio ofincome-producing properties is expected to contribute approximately $9 millionto income in 2003 and generate net operating income of approximately $20 million,after accounting for approximately $700,000 in projected start-up costs for theTournament Players ClubÒ at Valencia championship golf course, whichopened on June 26, 2003.  These amountsreflect a decrease from the previously reported estimates of approximately $22million in net operating income and $10 million in income for 2003.  The change primarily is due to revisedoccupancy forecasts at Valencia Town Center regional shopping center and theEntertainment Center combined with higher operating expenses.

 

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# **Valencia Water Company**

# ** **

ValenciaWater Company is a regulated utility serving approximately 25,000 meteredconnections and is a wholly-owned subsidiary of the Company.  Second quarter 2003 revenues decreased 8%and income decreased 41% from the same period in the prior year.  For the first six months of 2003, ValenciaWater Company recorded a decrease of 5% in revenues and a 46% decrease inincome over the six-month period ended June 30, 2002.  The decrease in revenues for the three- and six-month periodsended June 30, 2003 was primarily due to reduced water sales resulting from generally wetter weatherconditions in 2003 than in 2002.  Thiswas partially offset by a 5% increase in the water company’s meteredconnections.  The decrease in income forthe three- and six-month periods ended June 30, 2003 was primarily due tohigher administrative expenses and expenses related to legal proceedings inwhich Valencia Water Company is involved.

 

In January 2002, ValenciaWater Company was notified by the California Public Utilities Commission (CPUC)of the Commission’s desire to perform a review of the utility’s authorized rateof return based upon its approved rate structure.  The review was completed in February 2002 and resulted in a 4.85%reduction in Valencia Water Company’s authorized water billing rates.  In March 2002, Valencia Water Company fileda general rate case with the CPUC.  Afinal decision received from the CPUC in May 2003 resulted in a 1.12% increaseto the water company’s authorized revenues over current revenues.

 

# **Agricultural Operations**

# ** **

The Company’s remainingagricultural properties include the 14,000-acre New Columbia Ranch in MaderaCounty and the 1,250-acre Newhall Orchard in Ventura County.  In prior years, most of the remaining 14,750acres in Ventura County owned by the Company has been leased for cattlegrazing.  At June 30, 2003, there was nolessee for this land.  The Company iscurrently seeking a new lessee.  TheCompany has leased out a majority of the New Columbia Ranch to farming tenantsin 2003 to minimize the Company’s fixed overhead costs and its exposure to cropcommodity price fluctuations.

 

For the three- andsix-month periods ended June 30, 2003, agriculture revenues, including theCompany’s energy operations, decreased 4% and 1%, respectively, compared torevenues for the same periods in 2002. The decrease in revenues was primarily due to discontinuation of asubstantial portion of the Company’s farming operations at New Columbia Ranchand reduced prices on citrus, partially offset by increased land rents at NewColumbia Ranch combined with higher oil and gas prices.

 

For both the three- andsix-month periods ended June 30, 2003, income from agriculture operations, including the Company’senergy operations, increased in excess of 100% compared to the same periods in2002.  The increase in income wasprimarily due to the increased land rent revenues, together with a reduction inoverhead costs related to the leasing of land to farming tenants at NewColumbia Ranch and a reduction in costsassociated with acreage being converted to idle farmland.  This was partially offset by the recordingin the 2003 second quarter of a crop loss reserve for citrus.

 

# **General and Administrative Expense**

# ** **

General and administrative expenses for the 2003second quarter decreased 28% over 2002 second quarter general andadministrative expenses, while expenses for the six months ended June 30, 2003increased 11% from the same periods in 2002. The decrease in the 2003 second quarter was primarily due to reduced levels ofincentive-based compensation expense accrual resulting from lower earnings forthe 2003 second quarter.  The increasefor the six months ended June 30, 2003 compared to the same period inthe prior year was primarily due to one time expenses associated withseparation pay and related charges connected with the Company’s streamlining ofits administration, sales and marketing efforts during the 2003 first quarterto better align the Company with its strategic direction.  This was partially offset by reduced levelsof incentive-based compensation expense. However, for all of 2003, general and administrative expenses areexpected to remain comparable to 2002 levels.

 

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# **Interest and Other, net**

# ** **

Interest and other, netdecreased 15% and 35% for the 2003 second quarter and the six-months ended June30, 2003, respectively, as compared to the same periods in 2002.  The decreases were primarily due tolower interest expense on lines of credit due to lower outstanding balances, anincrease in interest capitalized to the Company’s active construction projectsand interest income received from an escrow account related to a freeway interchangeinfrastructure improvement. These were partially offset by a decrease ininterest income from promissory notes accepted by the Company in conjunctionwith certain commercial land and residential lot sales and a pre-payment penalty incurred in relationwith the early payment of the $9.6 million New Columbia Ranch mortgage.Interest expense in 2003 is expected to be approximately 10% lower than amountsreported in 2002.

 

**FINANCIALCONDITION**

 

**Liquidity and Capital Resources**

 

At June 30, 2003, the Company had cash and cashequivalents of $48.2 million and $162.0 million in available lines of credit,net of $20.0 million in outstanding letters of credit.  At that date, there were no borrowingsoutstanding on unsecured lines of credit or a revolving mortgage facility.  The Company had fixed rate debt outstandingtotaling $65.2 million.  In June 2003, a$2 million unsecured line of credit with Union Bank of California expired and maynot be replaced.  The Company believesit has adequate sources of cash from operations and debt capacity, combinedwith proceeds from anticipated land sales, to finance future operations on botha short- and long-term basis and to fund unit repurchases.  (See additional information on the unitrepurchase program below.)  The Companyutilizes its available debt capacity to fund ongoing operations, as well as tofund administration and legal costs to bring future projects online over thelonger term in order to enable the Company to complete the development ofValencia and to begin development of Newhall Ranch.  As a guideline, the Company targets total debt not to exceed 60%of the appraised value of the income portfolio.  The Company ended the 2003 second quarter with a conservativedebt to income portfolio value ratio of 22%, which the Company believes willprovide adequate debt capacity to fund operations and continue unitrepurchases.  At June 30, 2003, therewas no debt secured by the Company’s raw land or land under developmentinventories.

 

In May 2001, the Board ofDirectors authorized a unit repurchase program of up to 2,520,000 units, or 10%of the then outstanding units.  Inaccordance with the program, the Company repurchases units from time to time atprevailing market prices and, depending on market conditions, either throughthe open market, or unsolicited negotiated transactions.  Repurchases are generally funded from cashflow generated from normal business operations.  As of June 30, 2003, a total of 2,259,415 partnership units hadbeen repurchased under this program for $65.4 million, or an average unit priceof $28.95.  Of this total, 302,230 unitswere repurchased during the first six months of 2003 for $8.8 million, or anaverage unit price of $29.07.  A totalof 260,585 units remained to be repurchased under this program at June 30,2003.  As a result of the mergeragreement announced on July21, 2003, the Company has suspended the repurchase program.  (See Note 8 of Part 1 Item 2:  Financial Statements for additionalinformation on the merger agreement.)

 

For the six months endedJune 30, 2003, the Company invested approximately $4.5 million (before $8.2million in fee reimbursements received from the Valencia Bridge and MajorThoroughfare District) in major roads and freeway infrastructure improvementsprimarily within Valencia, which amounts are included in land under developmenton the accompanying balance sheet.  Inaddition, the Company invested approximately $5 million in the remodel of theformer Edwards Theatres’ space in Valencia Town Center regional mall torelocate the existing food court and create retail space, and approximately $8million on the completion of the construction of Tournament Players ClubÒat Valencia championship golf course, in the Company’s Westridge community,which amounts are included in income-producing properties on the accompanyingbalance sheet.  For the remainder of2003, the Company expects to invest approximately $13 million in major roadsand freeway infrastructure improvements to enable the Company to continue itsland sales program in Valencia.  Inaddition, approximately $7 million is expected to be invested in Valencia TownCenter regional mall to complete the relocation of the existing food court andthe creation of new retail space.  TheCompany expects to invest another approximately $3 million on the completion ofthe golf course and clubhouse.  At June30, 2003, there were no other material commitments for capital expenditures.

 

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*The following discussion relates to principal items in theConsolidated Statements of Cash Flow*:

 

# **Operating Activities**

# ** **

Netcash provided by operating activities totaled $46.3 million for the first sixmonths of 2003 versus $27.7 million for the six months ended June 30,2002.  Cash generated from operatingactivities included the sales of the entire 759 residential lots in theCompany’s Creekside community, fourteen custom home sites in the Westridge golfcourse community, and approximately 18 acres of commercial and industrial land.  Together with revenue from the Company’sportfolio of income-producing properties, these sources contributed $69.9million to revenues.  This wasoffset by the acceptance by the Company of $2.0 million in promissory notes inconjunction with the terms of certain commercial land sales during thesix-month period.  These notes havematurity dates prior to December 31, 2003. Cash used in operatingactivities included the use of approximately $19 million for land developmentexpenditures, primarily related to land preparation and infrastructureimprovements to ready land for development or sale.  Additional uses of cash included payment of the Company’s generaland administrative expenses and interest expense.

 

Forthe six months ended June 30, 2002, cash generated from operating activitiesincluded the sale of 733 residential lots, the sale of approximately 56commercial acres and revenue from the Company’s portfolio of income-producingproperties, combined for a total of $91.3 million.  This was offset by the Company’s acceptance in the 2002 firstquarter of $18.7 million in promissory notes in conjunction with the terms ofcertain commercial land and residential lot sales.  These notes matured prior to December 31, 2002.  One of these notes in the amount of $3million was collected in the 2002 second quarter.  In addition, $5.5 million of notes receivables outstanding atDecember 31, 2001 were collected in the 2002 second quarter. Cash used inoperating activities also included the use of approximately $47 million for landunder development expenditures mostly related to land preparation andinfrastructure improvements to ready the land for development or sale.  Additional uses of cash included theCompany’s general and administrative expenses and interest expense.

 

# **Investing Activities**

# ** **

For the six months endedJune 30, 2003 and June 30, 2002, expenditures for development ofincome-producing properties totaled $14.4 million and $5.8 million,respectively, and, for both periods were primarily for the Valencia Town Centerfood court remodel and expansion, and construction of Tournament Players ClubÒat Valencia championship golf course, in the Company’s Westridge community.

 

Purchase of property andequipment totaled $3.4 million for the six-month period ended June 30, 2003 comparedto $4.1 million for the same 2002 period. Investments in both periods were primarily for water utilityconstruction.

 

# **Financing Activities**

# ** **

Distributions to unitholders totaling $4.7 million and$8.0 million were made in the six months ended June 30, 2003 and June 30, 2002,respectively, consisting of two regular quarterly distributions of $.10 perunit in each year and a $.13 per unit special distribution in 2002.  No special distribution was made in 2003.  The Company declared a regular quarterly distribution of $.10 per unit,payable September 8, 2003 to unitholders of record on August 11, 2003.  The Company’s usual practice is toprovide sufficient distributions, including special distributions, to pay thetaxes associated with Company earnings. The declaration of distributions and the amount declared, are determinedby the Board of Directors on a quarterly basis taking into account theCompany’s earnings, financial condition and prospects.

 

AtJune 30, 2003, the Company had outstanding balances in mortgage and other debtof $65.2 million versus $82.3 million at June 30, 2002.  The $17.1 million decrease was primarily dueto the absence of any outstanding borrowings on the Company’s available linesof credit at June 30, 2003 versus $23.3 million outstanding at June 30,2002.  The reduced borrowings on thelines of credit were due to strong operating cash flow, primarily fromresidential lot sales, and a reduced pace of repurchases of partnership unitscompared to the six months ended June 30, 2002.  This decrease was partially offset by the refinancing of the $9.6million mortgage secured by the New Columbia Ranch, which was to mature onNovember 1, 2003.  On June 26, 2003, theCompany closed the

 

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refinanceon the new 15-year mortgage for $15 million, with a fixed interest rate of3.07% for the first three years.  Theremaining activity was due to principal payments on the Company’s outstandingfixed rate debt based on contractual terms partially offset by an increase inthe outstanding principal on community facilities bonds due to the refinance ofthe bonds in October 2002.  TheCompany’s lines of credit are available to fund recurring operations, distributionsand repurchases of partnership units.

 

Duringthe six months ended June 30, 2003, the Company repurchased 302,230 partnershipunits for $8.8 million, or an average unit price of $29.07.  During the six months ended June 30, 2002,415,935 partnership units were repurchased for $12.7 million, or an averageprice of $30.54.

 

# **New Accounting Pronouncements**

# ** **

InApril 2003, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) No. 149, *Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities.* SFAS No. 149 amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments imbedded in other contracts and for hedging activitesunder SFAS No. 133, *Accounting forDerivative Instruments and Hedging Activities*.  The statement is generally effective forcontracts entered into or modified after June 30, 2003 and for hedgingrelationships designated after June 30, 2003. The adoption of this statement will not have a material effect on theCompany’s results of operations and financial condition for the year endingDecember 31, 2003.

 

In May 2003, the FASBissued SFAS No. 150, *Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity*.  SFAS No. 150 established standards for howan issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity.  The statement is effective for financial instruments entered intoor modified after May 31, 2003, and otherwise is effective at the beginning ofthe first interim period beginning after June 15, 2003.  The adoption of this statement will not havea material effect on the Company’s results of operations and financialcondition for the year ending December 31, 2003.

 

# **FORWARD-LOOKING INFORMATION AND RISK FACTORS**

# ** **

Except for historicalmatters, the matters discussed in this report are forward-looking statementsthat involve inherent risks and uncertainties. We have tried, wherever practical, to identify these forward-lookingstatements by using words like “anticipate,” “believe,” “estimate,” “target,”“project,” “expect,” “plan,” and similar expressions.  Forward-looking statements include, but are not limited to,statements about plans; opportunities; anticipated regulatory approvals oractions; potential litigation outcomes; negotiations; market and economicconditions; development, construction, and sales activities; and availabilityof financing.

 

We caution you not toplace undue reliance on these forward-looking statements, which reflect ourcurrent beliefs and are based on information currently available to us.  We expressly undertake no obligationpublicly to revise or update these forward-looking statements to reflect futureevents or changes in circumstances.

 

These forward-lookingstatements are subject to risks and uncertainties that could cause our actualresults, performance, or achievements to differ from those expressed in orimplied by these statements.  See our riskfactors below.

 

*Sales of Real Estate:*The majority of theCompany’s revenues is generated by its real estate operations. The ability ofthe Company to consummate sales of real estate is dependent on various factorsincluding, but not limited to, availability of financing to the buyer, agreementwith buyers on definitive terms, regulatory and legal issues, and successfulcompletion of the buyer’s due diligence. The fact that a real estatetransaction has entered escrow does not necessarily mean that the transactionultimately will close. Therefore, the timing of sales may differ from thatanticipated by the Company and some anticipated sales may not occur. Theinability to close sales as anticipated could adversely impact the recognitionof revenue in any specific period.

 

*Economic Conditions:* Development ofresidential, industrial and commercial real estate can be significantlyimpacted by general and local economic conditions, which are beyond the controlof the Company. The Company’s real estate operations are concentrated in northLos Angeles County. The southern California economy is profoundly affected bythe entertainment, technology and defense industries and certain other businesssegments. Consequently, all sectors of the Company’s real estate operationstend to be cyclical. The

 

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regional, state andnational economies have slowed.  Therecan be no assurances that the slowdown will not worsen or the economy willrecover in the near future.

 

*Inflation*: The Company believes it is wellpositioned against the effects of inflation. Historically, during periods ofinflation, the Company has been able to increase selling prices of propertiesto offset rising costs of land development and construction.  A portion of the commercial income portfoliois protected from inflation since percentage rent clauses and Consumer PriceIndex increases in the Company’s leases tend to adjust rental receipts forinflation, while the underlying value of commercial properties has tended torise over the long term.  However, therecan be no assurance that the Company will continue to be able to offset theimpacts of inflation through increases in the selling prices of its propertiesin future periods.

 

*Interest Rates and Financing*: Fluctuationsin interest rates and the availability of financing have an important impact onthe Company’s performance. Sales of the Company’s properties could be adverselyimpacted by the inability of buyers to obtain adequate financing at ratesacceptable to them. Further, the Company’s real estate development activitiesare dependent on the availability of adequate sources of capital. Certain ofthe Company’s credit facilities bear interest at variable rates and would benegatively impacted by increasing interest rates.

 

*Competition*: The sale and leasing ofresidential, industrial and commercial real estate is highly competitive, withcompetition coming from numerous and varied sources. The degree of competitionis affected by such factors as the supply of real estate available comparableto that sold and leased by the Company and the level of demand for such realestate. Currently, the residential market in the Santa Clarita Valley,including Valencia, remains strong and has been capturing an increasing portionof Los Angeles County’s new home sales. However, there is no assurance that this trend will continue.  Although there are indications the localmarket for industrial property is strengthening, the industrial market inValencia is experiencing limited demand and vacancy rates remain high since thenational and regional economies have slowed. In addition, local competition has intensified as other business parkswithin the area have opened or are in the planning stages.

 

*Geographic Concentration*: The Company’sreal estate development activities are focused on the 18,100 acres that it ownsin north Los Angeles County. The Company’s entire commercial real estate incomeportfolio is located in the Valencia area. Therefore, any economic or otherfactors affecting that concentrated area, such as changes in the housingmarket, economic conditions and environmental factors, which cannot bepredicted with certainty, could affect future results.

 

*Exposure to Natural Occurrences and Acts of Terror:*TheCompany’s assets and real estate operations may be adversely affected bynatural occurrences such as earthquakes and weather conditions, and acts ofterrorism or armed conflict that may cause damage to assets, delay progress andincrease the costs of infrastructure construction and land development, impactthe economy generally or locally, and affect the pace of sales.

 

*Government Regulation and Entitlement Risks*:In developing its projects, the Company must obtain the approval of numerousgovernmental authorities regulating such matters as permitted land uses,density and traffic, and the provision of utility services such as electricity,water and waste disposal. In addition, the Company is subject to a variety offederal, state and local laws and regulations concerning protection of healthand the environment. This government regulation affects the types of projects,which can be pursued by the Company and increases the cost of development andownership. The Company devotes substantial financial and managerial resourcesto comply with these requirements. To varying degrees, certain permits andapprovals will be required to complete the developments currently beingundertaken or planned by the Company. Furthermore, the timing, cost and scopeof planned projects may be subject to legal challenges. (See following“Litigation” discussion.) In addition, the continued effectiveness of permitsalready granted may be subject to factors such as changes in policies, rulesand regulations and their interpretation and application. The ability to obtainnecessary approvals and permits for its projects may be beyond the Company’scontrol and could restrict, delay or prevent development of new projects. TheCompany’s results of operations in any period will be affected by the amount ofentitled properties the Company has in inventory.

 

*Litigation*: The land use approvalprocesses the Company must follow ultimately to develop its projects havebecome increasingly complex. Moreover, the statutes, regulations and ordinancesgoverning the approval processes provide third parties opportunities tochallenge the proposed plans and approvals. As a result, the prospect of, andactual, third-party challenges to planned real estate developments haveprovided additional uncertainties in real estate development planning and entitlementactivities. Third-party challenges in the form of litigation will, by theirnature, adversely affect the length of time required to obtain the necessaryapprovals. In addition, adverse decisions arising from any litigation increasethe costs and may adversely affect the design, scope, plans and profitabilityof a project.

 

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*Environmental Remediation andEndangered Species*: The Company owns or formerly owned properties with respect to which theCompany may be required to remediate environmental effects of prior releases ofcontamination.  Future environmentalcosts are difficult to estimate because of factors such as, but not limited to,the unknown magnitude of possible contamination, the unknown timing and extentof remediative actions that may be required, the determination of the Company’spotential liability, and the extent to which such costs are recoverable fromthird parties or from applicable insurance coverages.  In addition, the length of time to perform any requiredremediation or the successful pursuit of responsible third parties is difficultto predict. The ability to, or length of time required to, remediate anyproperty could increase the costs of, and restrict, prevent or delay the developmentof a new project.  Additionally, thepresence of endangered species on the Company’s property could delay andincrease the cost of development, and, in limited circumstances, could preventthe development of some properties.

 

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Item 1. FinancialInformation

Item 3. Quantitative andQualitative Disclosures about Market Risk.

 

TheCompany is exposed to market risk primarily due to fluctuations in interestrates. The Company utilizes both fixed rate and variable rate debt. At June 30,2003, the Company had no outstanding variable rate debt and $65.2 million ofoutstanding fixed rate debt with interest rates ranging from 3.07% to 8.00%.

 

Thetable below presents principal cash flows and related weighted average interestrates of the Company’s long-term fixed rate and variable rate debt at June 30,2003 by expected maturity dates:

 
| **Dollars  in thousands**      |   | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   | **Fair  Value** |   |
|--------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|-----------|--------|-----------------|--------|
|                           |   |     |   |     |   |     |   |     |   |     |   |           |   |      |   |            |   |
| Mortgage and Other Debt        |   |     |   |     |   |     |   |     |   |     |   |           |   |      |   |            |   |
| Fixed Rate Debt (3)            |   | $        | 231    |     | $      | 499      |   | $        | 557    |     | $      | 22,314         |   | $         | 75     |            | $      | 41,556 |   | $ | 65,232 |   | $ | 70,481 | (2) |
| Weighted Average Interest Rate |   | 7.44     | %      | 7.41     | %      | 7.35     | %      | 7.44     | %      | 5.76     | %      | 5.38           | %      | 6.12      | %      |            |   |
|                           |   |     |   |     |   |     |   |     |   |     |   |           |   |      |   |            |   |
| Variable Rate Debt (1)         |   |     |   |     |   |     |   |     |   |     |   |           |   | $         | — |            | $      | — |   |
| Weighted Average Interest Rate |   |     |   |     |   |     |   |     |   |     |   |           |   |      |   |            |   |
|                                |        |          |        |          |        |          |        |          |        |          |        |                |        |           |        |                 |        |  |  |  |  |  |  |  |  |

 

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(1)               The Company has a$50 million revolving mortgage facility which bears interest at LIBOR plus1.40% against which  no borrowings wereoutstanding at June 30, 2003. The Company also has unsecured lines of creditconsisting of a $130 million line on which the interest rate is LIBOR plus1.40%, against which no borrowings were outstanding at June 30, 2003. A $2million line on which the interest rate was LIBOR plus 1.25% expired in June2003 and may not be replaced.

 

(2)               The fair values ofthe Company’s fixed rate debt either approximate carrying value or areestimated using discounted cash flow analyses based on the Company’s currentincremental borrowing arrangments ranging from 3.07% to 5.65%.

 

(3)               Amounts include a$15 million mortgage secured by New Columbia Ranch. The mortgage bears interestat 3.07% per annum for the first three years and resets to a variable rate,reset quarterly, thereafter.

 

The table belowpresents principal cash flows and related weighted average interest rates ofthe Company’s long-term fixed rate and variable rate debt at December 31, 2002by expected maturity dates:

 
| **Dollars  in thousands**      |   | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   | **Fair  Value** |   |
|--------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|-----------|--------|-----------------|--------|
|                           |   |     |   |     |   |     |   |     |   |     |   |           |   |      |   |            |   |
| Mortgage and Other Debt        |   |     |   |     |   |     |   |     |   |     |   |           |   |      |   |            |   |
| Fixed Rate Debt                |   | $        | 10,055 |     | $      | 499      |   | $        | 557    |     | $      | 22,314         |   | $         | 75     |            | $      | 26,537 |   | $ | 60,037 |   | $ | 64,045 |   |
| Weighted Average Interest Rate |   | 8.40     | %      | 7.41     | %      | 7.35     | %      | 7.44     | %      | 5.76     | %      | 6.69           | %      | 7.26      | %      |            |   |
|                           |   |     |   |     |   |     |   |     |   |     |   |           |   |      |   |            |   |
| Variable Rate Debt (1)         |   |     |   |     |   |     |   |     |   |     |   |           |   | $         | — |            | $      | — |   |
| Weighted Average Interest Rate |   |     |   |     |   |     |   |     |   |     |   |           |   |      |   |            |   |
|                                |        |          |        |          |        |          |        |          |        |          |        |                |        |           |        |                 |        |  |  |  |  |  |  |  |  |

 

Thereis inherent rollover risk for borrowings as they mature and are renewed atcurrent market rates.The extent of this risk is not quantifiable or predictablebecause of the variability of future interest rates and the Company’s futurefinancing requirements. The Company manages its interest rate risk bymaintaining a conservative ratio of fixed rate, long-term debt to total debt inorder to maintain variable rate exposure at an acceptable level and by takingadvantage of favorable market conditions for long-term debt. In addition, theCompany’s guideline for total debt is not to exceed 60% of the appraised valueof the income portfolio. As of June 30, 2003, the Company’s debt to incomeportfolio value ratio was 22%.

 

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**Part 1. Financial Information**

Item 4.  Controls and Procedures.

 

Within 90 days prior tothe filing date of this report, an evaluation was performed under thesupervision and with the participation of the Company’s management, includingthe Chief Executive Officer and Chief Financial Officer, of the effectivenessof the Company’s disclosure controls and procedures.  Based on thatevaluation, the Company’s management, including the Chief Executive Officer andChief Financial Officer, concluded that the Company’s disclosure controls andprocedures were effective.  There have been no significant changes in theCompany’s internal controls or in other factors that could significantly affectinternal controls subsequent to the date of their evaluation.

 

**Part II. Other Information**

Item 1.  Legal Proceedings.

 

Please refer to“Community Development” under Part I, Item 2. – “Management’s Discussion andAnalysis of Financial Condition and Results of Operations”.

 

Item 5.  Other Information.

 

OnJuly 21, 2003, the Company entered into a merger agreement with LennarCorporation, a Delaware corporation, LNR Property Corporation, a Delawarecorporation, NWHL Investment LLC, a Delaware limited liability company and NWHLAcquisition, L.P., a California limited partnership.  Please refer to “Note 8 – Subsequent Event” under PartI, Item 1. – “Financial Statements”.

 

The Company's electronicfilings with the Securities and Exchange Commission, including its AnnualReport on Form 10-K, Quarterly Reports on Form 10-Q and CurrentReports on Form 8-K, and amendments to each, are available free of chargethrough a link on the Company's website as soon as reasonably practicable aftersuch material is electronically filed with the Commission. The Company'swebsite address is www.newhall.com.

 

### Item 6. Exhibits andReports on Form 8-K

 

(a)                                  Exhibits (listed by numbers corresponding tothe Exhibit Table of Item 601 in Regulation S-K):

 

**10 (a)**                   The Newhall Land andFarming Company Retirement Plan (Restatement effective January 1, 2002)Amendment No. 1

** **

10(b)                  The Newhall Land and Farming 2002 EquityCompensation Plan Amendment No. 1

 

**31(a)**                      Certification of QuarterlyReport by Principal Executive Officer Pursuant to Exchange Act Rules 13a-14 and15d-14

 

**31(b)**                     Certification of Quarterly Report byPrincipal Financial Officer Pursuant to Exchange Act Rules 13a-14 and 15d-14

 

32(a)                      Certification of Principal Executive OfficerPursuant to 18 U.S.C. Section 1350*

 

32(b)                     Certification of Principal Financial OfficerPursuant to 18 U.S.C. Section 1350*

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*Exhibits 32(a) and 32(b) are to be treated as “furnished” rather than “filed”as part of the report.

 

(b)                                 The following reports on Form 8-K were filedin the second quarter ended June 30, 2003:

 
| **Item Reported**                                                                                                                                                                                          |   | **Date of Report** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|
|                                                                                                                                                                                                       |   |               |
| A news release issued by  the Company on April 2, 2003 announcing that first quarter earnings were  expected to be approximately $0.48 to $0.52 per unit and the Newhall Ranch  public hearing was closed. |   | April 2, 2003      |

 

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Part II . Other Information

Item 6. Exhibits and Reports on Form 8-K

 
| **Item Reported**                                                                                                                                                                                                                                                                                              |   | **Date of Report** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|
|                                                                                                                                                                                                                                                                                                           |   |               |
| Two news releases issued by the Company on April 15, 2003.  One announced the promotions of Donald L.  Kimball to Vice President and Chief Financial Officer and Vicki M. Stiller to  Controller.  The second news release  declared a regular quarterly distribution of $0.10 per partnership unit. |   | April 15, 2003     |
|                                                                                                                                                                                                                                                                                                           |   |               |
| A news release issued by the Company on May 28, 2003 announcing that Newhall Ranch Specific Plan was approved  and that the Company has reached a  tentative settlement agreement to resolve pending litigation initiated by the  Company.                                                                     |   | May 28, 2003       |
|                                                                                                                                                                                                                                                                                                           |   |               |
| A news release issued by the Company on June 26, 2003 announcing that  second quarter earnings were expected to be approximately $0.03 to $0.06 per  unit.                                                                                                                                                     |   | June 26, 2003      |

 

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SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
| 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: August 4, 2003                  | By: | / S / GARY M. CUSUMANO |
|                                  |   |   Gary M.  Cusumano, President and Chief Executive Officer    of Newhall Management Corporation |
|                                  |   |   (Principal  Executive Officer) |
|                                  |   |   |
| Date: August 4, 2003                  | By: | / S / DONALD L. KIMBALL |
|                                  |   |   Donald L.  Kimball, Vice President and Chief Financial    Officer of Newhall Management Corporation |
|                                  |   |   (Principal  Financial Officer) |
|                                  |   |   |
| Date: August 4, 2003                  | By: | / S / VICKI M. STILLER |
|                                  |   |   Vicki M.  Stiller, Controller of Newhall Management    Corporation |
|                                  |   |   (Principal  Accounting Officer) |
|                                       |  |  |  |  |  |  |  |  |  |

 

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THE NEWHALL LAND ANDFARMING COMPANY

 

INDEX TO EXHIBITS

 

 
| **Exhibit  Number** |   | **Description**                                                                                                    |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                               |
| **10 (a)**          |   | **The  Newhall Land and Farming Company Retirement Plan (Restatement effective  January 1, 2002) Amendment No. 1** |
|                |   |                                                                                                               |
| 10 (b)              |   | The Newhall Land and Farming 2002 Equity  Compensation Plan  Amendment No. 1                                  |
|                |   |                                                                                                               |
| 31(a)               |   | Certification of Quarterly Report By Principal Executive Officer  Pursuant to Exchange Act Rules 13a-14 and 15d-14 |
|                |   |                                                                                                               |
| 31(b)               |   | Certification of Quarterly Report By Principal Financial Officer  Pursuant to Exchange Act Rules 13a-14 and 15d-14 |
|                |   |                                                                                                               |
| 32(a)               |   | Certification of Principal Executive Officer Pursuant to 18 U.S.C.  Section 1350                                   |
|                |   |                                                                                                               |
| 32(b)               |   | Certification of Principal Financial Officer Pursuant to 18 U.S.C.  Section 1350                                   |

 

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