<PAGE> 1
LOGO
LONGLEAF PARTNERS FUNDS
QUARTERLY REPORT
at September 30, 1998
PARTNERS FUND
REALTY FUND
SMALL-CAP FUND
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MANAGED BY:
SOUTHEASTERN ASSET MANAGEMENT, INC.
Memphis, TN
<PAGE> 2
CONTENTS
<TABLE>
<S> <C>
Letter to Shareholders..................................... 2
Longleaf Partners Fund (Partners Fund)
Management Discussion.................................... 5
Performance History and Portfolio Summary*............... 7
Portfolio Investments.................................... 8
Longleaf Partners Realty Fund (Realty Fund)
Management Discussion.................................... 10
Performance History and Portfolio Summary*............... 11
Portfolio Investments.................................... 12
Longleaf Partners Small-Cap Fund (Small-Cap Fund)
Management Discussion.................................... 14
Performance History and Portfolio Summary*............... 15
Portfolio Investments.................................... 17
Service Directory.......................................... 20
Trustees and Officers...................................... 21
</TABLE>
* Average annual returns for all Funds and all indices except the Value-Line
Index are shown with all dividends and distributions reinvested; the
Value-Line Index is not available with reinvested dividends. The indices shown
are unmanaged. Past performance is no guarantee of future performance, and the
value of an investment when redeemed may be more or less than the purchase
price.
<PAGE> 3
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LONGLEAF PARTNERS FUNDS
LETTER TO SHAREHOLDERS
TO OUR SHAREHOLDERS:
Best Positioning in Eight Years
The third quarter of 1998 was a period of demarcation for equity investors.
Shareholders, lenders, currency speculators and hedge fund operators sought
liquidity and ended an eight year bull market for U.S. stocks. The unweighted
averages declined more than 30% peak to trough, IPO underwritings evaporated,
mutual fund owners withdrew assets, and bond returns dramatically decoupled from
equity results as capital preservation became a mantra. Market, business, and
credit risks worldwide were reestablished in the forefront of investors' minds.
While the purging of financial excesses may be difficult to appreciate because
of the resulting marked-to-market pain we have suffered, Longleaf owners reap
two very salutary benefits. For the first time since the Partners Fund closed in
September 1995 ALL THREE Longleaf Funds have sufficient undervalued and
qualified investment opportunities to become fully invested. This is a
significant change from our June report when cash reserves in the Small-Cap and
Partners Funds were 27% and 15%, respectively. Secondly, lower share prices and
our commitment of cash reserves to a number of very undervalued businesses have
reduced the composite price-to-value ratios for each Longleaf Fund to
historically low levels. Our partners today have larger margins of safety and
higher implied future returns than at any point since 1990. We encourage you to
read the report for each Longleaf Fund on the following pages.
Our Wonderful Partners
It is easy to be an investment partner when annual returns are 20+%. The test of
our relationship with shareholders comes in down markets such as the third
quarter. Over the last three months our partners have been more than supportive.
Unlike many funds that experienced net redemptions during the third quarter, all
three Longleaf Funds added new assets. Many of you have called to confirm that
this market has given us better bargains and to see if we can put additional
cash to work. This level of understanding of our discipline makes us proud to be
your partner, and, more importantly, benefits all shareholders. When investors
send new cash knowing we can buy very cheap businesses, we all receive better
long-term returns.
Because of the opportunities that the recent volatility has provided, we are
encouraging our partners to add to their stakes in all three Funds. In recent
2
<PAGE> 4
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LONGLEAF PARTNERS FUNDS
LETTER TO SHAREHOLDERS
months your partners at Southeastern have materially increased our investment
with you.
Re-opening Partners Fund
We closed Longleaf Partners Fund when cash exceeded our qualifying investment
opportunities. The reverse is now true. Cash inflows will enable the Fund to buy
more good businesses at depressed prices, and thereby lower the Fund's composite
price-to-value ratio. Because we have the opportunity to improve all
shareholders' positions with new cash, the Partners Fund will re-open to
investors on October 16.
Longleaf Partners International Fund Update
The number of undervalued businesses we are finding overseas is increasingly
compelling. We filed our registration statement for Longleaf International with
the SEC in early August and seeded it with our capital. It will be available to
the public at the end of October, and we will send all shareholders a Prospectus
with information on how to join us in the Fund.
1998 Distribution
Many of our partners, like ourselves, are taxable investors. You should be aware
of our distribution plan and our approach to tax efficient portfolio management.
Our investment decision to sell a holding occurs when its price approaches full
value or when we can substantially improve our price-to-value relationship. Once
we make a decision to sell, execution focuses on tax management. We generally
first sell the highest cost shares and those held more than one year.
The Funds will pay gains realized through October 31 this year. With three weeks
to go, we anticipate a sizable distribution, primarily of long-term gains from
sales in the Partners and Small-Cap Funds earlier this year when many holdings
reached fair value. The Realty Fund should have little or no realized gains to
distribute. The distribution should be paid approximately November 18. At the
end of December we will declare and distribute net income which is usually a
small amount for each Fund.
After gains have been distributed in November, shareholders will have a unique
opportunity to purchase all three Funds at one of the most tax advantageous
points in their history. Each Fund has little in unrealized gains. After the
distribution an investor will be purchasing a very small deferred tax liability
and a large opportunity for long-term appreciation.
3
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LONGLEAF PARTNERS FUNDS
LETTER TO SHAREHOLDERS
The Calculus of Compounding
Four distinct variables determine an equity investor's long-term return and
guide our discipline: the price we pay for shares relative to their underlying
value today; the future growth of the business' value; the closing of the gap
between price and value; and, the bonus or penalty owners receive from
management's capital allocation decisions. The following example illustrates how
our discipline works. If we buy a company for half its value, if the value grows
12% per year through business operations, and if the share price rises to
reflect corporate worth in the fifth year, we will compound capital at 29% per
year.
Firmly understanding a company's intrinsic worth drives this dynamic. Volatile
markets which respond to the emotions of fear and greed do not change the value
of the businesses we own. Our valuations provide a rational guide for decision
making and are the lynchpin of our discipline. Our investment partners will be
rewarded because we have affiliated with many excellent companies and
outstanding managements at steeply discounted prices. We appreciate your
unwavering support and confidence.
Sincerely,
<TABLE>
<S> <C> <C>
/s/ O. Mason Hawkins, CFA /s/ G. Staley Cates, CFA /s/ C.T. Fitzpatrick, CFA
O. Mason Hawkins, CFA G. Staley Cates, CFA C.T. Fitzpatrick, CFA
Co-Portfolio Manager Co-Portfolio Manager Co-Portfolio Manager
</TABLE>
4
<PAGE> 6
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PARTNERS FUND - MANAGEMENT DISCUSSION
by Mason Hawkins and Staley Cates
In most business endeavors not much changes in a quarter. The investment world
for the Partners Fund, however, changed dramatically in three short months. Just
ninety days ago equity bargains were elusive, the Fund had 15% cash, and greed
was driving up an already overvalued market. Today, we have many compelling
investment ideas, the Fund is fully invested, and palpable fear has caused U.S.
stocks to fall precipitously from their highs.
We have made significant long-term progress in the third quarter, despite
nauseating short-term performance. The Fund fell 18% from June through
September. The Fund's composite price-to-value ratio (P/V) delineates the
attractiveness of our portfolio. Because the ratio compares today's stock price
to our appraisal of underlying corporate value, we think the Fund's P/V is the
single best indicator of our future performance. A lower ratio implies more
upside potential and a larger margin of safety in the portfolio. Exactly one
year ago the Fund's composite P/V was over 80%. Today it has improved to almost
50%. With the price-to-value ratio at its historic low our five-year return
expectations are much higher than they have been since 1990. While we do not
know if or when values will be recognized, we do know the following: a move to
100% of appraisal from 80% yields a 25% return; a move to full value from a 50%
P/V ratio produces a 100% gain. Thus, without the benefit of corporate value
growth factored into the compounding equation, our appreciation opportunity has
increased four-fold.
Some might assume their position has not improved because the lower price-to-
value ratio came with a 6% decline in Fund performance over the last year. While
the Fund's price did reduce the P/V (not the way we prefer it to happen!), three
quarters of the significant improvement came from better positioning of the
portfolio. We sold companies that reached full value earlier this year and
recently replaced them with more significantly undervalued securities. Our
corporate partners also have grown their businesses' intrinsic values. We
believe our improved long-term positioning will boost future performance by an
amount that far exceeds our short-term hit.
It may be surprising that new holdings or existing positions which we
significantly increased caused most of the damage to the quarter's performance.
In Longleaf's history, many of our biggest long-term winners began as short-term
disappointments. When a company has some kind of temporary or perceived problem
(otherwise it wouldn't be cheap) and already sells far below its highs,
statistically one has low odds of buying at the absolute bottom. Consequently,
stock prices of the companies we purchase often get worse before they get
better. It is usually well worth the wait. While we would love to be able to
time acquisitions better,
5
<PAGE> 7
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PARTNERS FUND - MANAGEMENT DISCUSSION
by Mason Hawkins and Staley Cates
the opportunity cost of staying out of that rare find is usually higher than the
short-term penalty.
Of the companies that have penalized our results the most since June, several
positions were established in the portfolio in the last six months. We purchased
new holdings such as Hilton, Pioneer Natural Resources, and UCAR International
after their prices had dropped significantly; their free falls continued after
we bought. We added heavily this quarter to existing positions in FDX and
Marriott after their stocks had declined; their price drops then resumed. We
knew these five were undervalued when we purchased them; the fears driving their
declines, however, became more pronounced and inflicted even more short-term
price damage. In all five cases the long-term free cash flows and asset values
are intact. These five are clearly more compelling at their current 40 (cents)
on the appraised dollar than they were 90 days ago at 60 (cents). Each has an
attractive business, and our partners such as Bill Marriott, Fred Smith, and
Steve Bollenbach have some of the best records in corporate America for building
shareholder value and getting it recognized.
We have recently increased our personal stake in the Partners Fund to seize this
rare and tremendous opportunity.
6
<PAGE> 8
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PARTNERS FUND - PERFORMANCE HISTORY AND
PORTFOLIO SUMMARY
AVERAGE ANNUAL RETURNS
FOR THE PERIODS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
Value-Line
Partners S&P 500 Geometric
Fund Index Index
-------- ------- ----------
<S> <C> <C> <C>
Year-to-Date (3.58)% 5.97% (15.65)%
One Year (6.13) 9.02 (17.99)
Three Years 14.89 22.59 5.01
Five Years 17.26 19.89 5.90
Ten Years 16.55 17.26 5.03
Since Inception 4/8/87 15.37 14.48 3.06
</TABLE>
FIVE LARGEST HOLDINGS
(REPRESENT 33.8% OF NET ASSETS)
FDX CORPORATION (FDX) 9.0%
Integrated air-ground transportation company providing time-definite delivery of
packages and documents worldwide.
WASTE MANAGEMENT, INC. (WMI) 7.5%
The world's largest solid waste collection and disposal company with
residential, commercial, and industrial customers throughout North America.
THE NEWS CORPORATION LIMITED (NWS) 6.1%
International media company which operates satellite television, owns Fox
Broadcasting and 20th Century Fox film operations, and publishes numerous
newspapers and magazines.
PHILIPS ELECTRONICS N.V. (PHG) 5.6%
A leading manufacturer of lighting systems, electronics products including
television and stereo equipment, appliances, and semiconductors.
MARRIOTT INTERNATIONAL, INC. (MAR) 5.6%
Owner of many of the strongest brand names in the lodging industry. Operates and
franchises over 300,000 rooms in hotels and resorts under the Marriott,
Courtyard, Residence Inn, Ritz-Carlton, and Renaissance names.
PORTFOLIO CHANGES
JANUARY 1, 1998 THROUGH SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
NEW HOLDINGS ELIMINATIONS
------------ ------------
<S> <C>
Agribrands International, Inc.* Agribrands International, Inc.*
Boston Properties, Inc. Alleghany Corp.
Canadian Pacific Limited Chicago Title Corporation*
Chicago Title Corporation* Kansas City Southern Industries,
Hilton Hotels Corporation Inc.
MediaOne Group, Inc.* The Quaker Oats Company
Pioneer Natural Resources Company The Ralston Purina Company
Sodexho Marriott Services, Inc.* Sodexho Marriott Services, Inc.*
Tricon Global Restaurants, Inc. Tricon Global Restaurants, Inc.
UCAR International, Inc. U S West, Inc.*
U S West, Inc.* The Union Corporation
United Healthcare Corporation
</TABLE>
* Acquired through merger/spin-off of existing position.
7
<PAGE> 9
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PARTNERS FUND - PORTFOLIO INVESTMENTS
AT SEPTEMBER 30, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- --------------
<S> <C> <C> <C> <C> <C>
Common Stock 97.4%
Beverages 4.8%
5,119,200 The Seagram Company Ltd. (Foreign) ........... $ 146,857,050
Broadcasting 6.1%
7,284,362 The News Corporation Limited (Foreign)........ 186,661,776
Cable 4.5%
3,108,100 * MediaOne Group, Inc........................... 138,116,194
Environmental Services 7.5%
4,748,750 Waste Management, Inc......................... 228,236,797
Health Care 5.5%
4,840,000 United Healthcare Corporation................. 169,400,000
Lodging 14.7%
8,249,500 Hilton Hotels Corporation..................... 140,757,094
10,763,800 * Host Marriott Corporation..................... 136,565,712
7,171,900 Marriott International, Inc................... 171,229,113
--------------
448,551,919
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Manufacturing 2.6%
4,450,000 * UCAR International, Inc....................... 80,100,000
Multi-Industry 6.6%
1,565,000 Alexander & Baldwin, Inc...................... 31,104,375
3,213,000 Philips Electronics N.V. (Foreign)............ 171,493,875
--------------
202,598,250
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Natural Resources 8.9%
1,237,700 The Pioneer Group, Inc........................ 20,422,050
9,755,000 Pioneer Natural Resources Company............. 137,179,687
2,900,000 Rayonier Inc.................................. 113,100,000
--------------
270,701,737
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Pharmaceuticals 1.2%
1,770,350 Mallinckrodt Inc. ............................ 35,960,234
Property & Casualty Insurance 6.2%
24,524,000 Mitsui Marine and Fire Insurance Company, Ltd.
(Foreign)................................... 100,892,154
8,673,000 The Nippon Fire & Marine Insurance Company,
Ltd. (Foreign).............................. 27,716,390
16,245,000 The Yasuda Fire and Marine Insurance Company,
Ltd. (Foreign).............................. 59,671,613
--------------
188,280,157
--------------
Publishing 4.6%
3,150,000 Knight Ridder, Inc............................ 140,175,000
</TABLE>
8
<PAGE> 10
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PARTNERS FUND - PORTFOLIO INVESTMENTS
AT SEPTEMBER 30, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- --------------
<S> <C> <C> <C> <C> <C>
Real Estate 5.6%
1,998,400 Boston Properties Inc......................... $ 56,954,400
6,038,591 TrizecHahn Corporation (Foreign).............. 113,223,581
--------------
170,177,981
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Telecommunications 4.9%
3,147,200 ALLTEL Corp (formerly 360 degrees
Communications Company)..................... 149,098,600
Transportation 13.7%
7,003,000 Canadian Pacific Limited (Foreign)............ 144,874,563
6,085,000 * FDX Corporation............................... 274,585,625
--------------
419,460,188
--------------
TOTAL COMMON STOCKS (COST $2,959,894,049)..... 2,974,375,883
Short-Term Obligations 1.9%
Repurchase Agreement with State Street Bank, 4.75% due 10-1-98..... 59,538,000
--------------
TOTAL INVESTMENTS (COST $3,019,432,049)(a).................. 99.3% 3,033,913,883
OTHER ASSETS AND LIABILITIES, NET........................... 0.7 22,285,181
----- --------------
NET ASSETS.................................................. 100.0% $3,056,199,064
===== ==============
NET ASSET VALUE PER SHARE.......................................... $25.05
==============
</TABLE>
* Non-income producing security
(a) Also represents aggregate cost for Federal income tax purposes.
Note: Companies designated as "Foreign" are headquartered outside the U.S. and
represent 31% of Net Assets.
Open Forward Currency Contracts
<TABLE>
<CAPTION>
Currency
Currency Currency Sold and Market Unrealized
Units Sold Settlement Date Value Gain
- -------------- ---------------------------------- ------------ -----------
<C> <S> <C> <C>
14,552,730,000 Japanese Yen 1-28-99.............. $108,786,510 $14,578,148
6,265,172,522 Japanese Yen 2-26-99.............. 47,011,909 3,583,875
823,095,843 Japanese Yen 7-21-99.............. 6,290,867 (100,175)
------------ -----------
Total Forward Contracts........... $162,089,286 $18,061,848
============ ===========
</TABLE>
9
<PAGE> 11
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REALTY FUND - MANAGEMENT DISCUSSION
by C.T. Fitzpatrick, Mason Hawkins and Staley Cates
Publicly traded real estate indices have turned in their worst performance since
1974. The year-to-date decline exceeds that of all 1990. The Realty Fund, down
17.7% in the third quarter, has also suffered. Market prices contrast sharply
with conditions at the companies we own. Rents, cash flows, and profits have
risen and should continue to increase over the next few years at a much faster
rate than growth at most non-realty companies. The recent retrenchment in the
equity and debt markets should slow new supply and further improve the long-term
outlook for rents, occupancies, and earnings. Consequently, the Realty Fund's
price-to-value ratio is at an all-time low, investment ideas greatly exceed our
capital resources, and the implied returns over the next five years are at the
highest levels we have known.
Public markets have not differentiated between property or cash flow quality
among real estate companies. Traders and short-term investors have sold entire
sectors of the market with little regard for individual businesses and their
prices. The hotel industry, down over 50% this year, has suffered the most from
this lack of differentiation. The sell off in lodging has hurt the Fund's
performance but has offered companies with superior economics and outstanding
long-term prospects at mouth-watering prices. We have increased our stake in
Host Marriott and have added Hilton and Promus to the portfolio.
Hilton: In 1996 we purchased Hilton and sold it when the stock reached our
appraised value, roughly doubling our investment. Hilton is down 60% from
its high and currently sells for less than its price nearly three years ago.
Its same property revenues (RevPar) are up 19% since we last owned this
branded hotel company and our appraisal has risen to $40 per share from $25
three years ago. Hilton's properties are located primarily in supply
constrained markets, and its franchise fee stream is very well insulated
from new hotel supply. Steve Bollenbach, a superb corporate partner, is at
the helm, and insiders own 23% of the company.
Promus: The S&P 500 sells for 20 times free cash flow with a long-term
expected growth rate of 6%. Promus sells for less than 8 times after-tax
free cash flow which has grown at 30% annually over the last three years; we
are confident it will increase by over 20% in 1999. The stock has declined
53% from its high, the company is repurchasing shares, and insiders are
adding to their stakes. Promus derives two-thirds of its profits from
franchising and managing its strong brands including Embassy Suites, Hampton
Inns, and Doubletree. These stable fee streams should continue to grow
regardless of changes in new supply in the limited service hotel segment.
Our appraisal is over $50 per share.
The opportunity to acquire companies as superior as Hilton and Promus at prices
less than half of intrinsic worth is unusual. During the last three months our
returns were hurt by these two new holdings, as well as some of our highest
quality companies run by some of our most capable partners including Host
Marriott, Catellus, Forest City, and BayView. We gladly accept volatility and
its impact on short-term performance when we can team with superior managements
and own good businesses at depressed prices with an exceptional opportunity for
long-term return.
Now is the best time to be a long-term owner since the Realty Fund began
operations in January 1996. Prices are completely divorced from fundamentals.
This decoupling could last longer, causing consternation for investors with
short time horizons but presenting great opportunities for long-term intelligent
investors. We are fortunate to have the latter as our partners in Longleaf
Partners Realty Fund. Many of you recently have added to your position in the
Realty Fund, as have your partners here at Southeastern.
10
<PAGE> 12
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REALTY FUND - PERFORMANCE HISTORY AND
PORTFOLIO SUMMARY
AVERAGE ANNUAL RETURNS
FOR THE PERIODS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
Wilshire
Realty Real Estate NAREIT
Fund Securities Index Index
------ ---------------- ------
<S> <C> <C> <C>
Year-to-Date (20.69)% (16.62)% (15.50)%
One Year (23.14) (16.69) (14.61)
Since Inception 1/2/96 14.42 12.13 11.96
</TABLE>
FIVE LARGEST HOLDINGS
(REPRESENT 38.4% OF NET ASSETS)
EXCEL LEGACY CORPORATION (XELC) 10.7%
A C-Corp spun out of Excel Realty Trust and focused on development and re-
development of unique real estate projects throughout the U.S.
HOST MARRIOTT CORPORATION (HMT) 9.3%
Owner of 101 upscale and luxury full-service Marriott and Ritz Carlton hotels
and 31 assisted living centers, which are operated by Marriott International.
CATELLUS DEVELOPMENT CORPORATION (CDX) 7.3%
A diversified real estate company that owns, manages and develops industrial
warehouses, offices, apartments and residential communities. CDX has substantial
land holdings throughout the U.S.
BEACON CAPITAL PARTNERS, INC. (NOT LISTED) 5.6%
Private REIT that develops and owns office buildings throughout the U.S. and
mixed use properties such as developments that combine retail, research, office,
and entertainment space.
PRIME GROUP REALTY TRUST (PGE) 5.5%
Owner, operator, and developer of office buildings primarily in downtown Chicago
and its surrounding suburbs.
PORTFOLIO CHANGES
JANUARY 1, 1998 THROUGH SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
NEW HOLDINGS ELIMINATIONS
------------ ------------
<S> <C>
Beacon Capital Partners, Inc. Arden Realty, Inc.
Excel Legacy Corporation Common Horizon Group Properties, Inc.*
Excel Legacy Corporation - Series A Mariott International, Inc. Liquid
Liquidating Preference Convertible Yield Option Notes
Hilton Hotels Corporation Sodexho Marriott Services, Inc.*
Horizon Group Properties, Inc.* Sunburst Hospitality Corporation
Promus Hotel Corporation Wellsford Real Properties, Inc.
Sodexho Marriott Services, Inc.* White River Corporation
</TABLE>
* Acquired through merger/spin-off of existing position.
11
<PAGE> 13
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REALTY FUND - PORTFOLIO INVESTMENTS
AT SEPTEMBER 30, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- ------------
<S> <C> <C> <C> <C> <C>
Common Stock - 88.0%
Diversified Realty 15.1%
4,209,800 * Catellus Development Corporation................ $ 54,727,400
2,280,000 * Excel Legacy Corporation........................ 6,626,364
1,651,900 Forest City Enterprises, Inc. - Class A......... 34,689,900
135,200 Forest City Enterprises, Inc. - Class B......... 2,889,900
640,200 Sizeler Property Investors, Inc. (REIT)......... 5,761,800
440,600 TrizecHahn Corporation (Foreign)................ 8,261,250
------------
112,956,614
------------
Lodging 23.4%
1,750,000 Hilton Hotels Corporation....................... 29,859,375
5,470,200 * Host Marriott Corporation....................... 69,403,162
286,200 Marriott International, Inc. - Class A.......... 6,833,025
940,000 * Promus Hotel Corporation........................ 25,908,750
2,270,000 * Red Roof Inns, Inc.............................. 38,164,375
518,646 * Supertel Hospitality, Inc....................... 4,894,722
------------
175,063,409
------------
Mortgage Financing 2.7%
1,088,000 Bay View Capital Corp........................... 19,856,000
Natural Resources/Land 12.0%
1,393,800 * Castle & Cooke, Inc............................. 20,907,000
650,000 Deltic Timber Corporation....................... 11,700,000
650,000 The Pioneer Group, Inc.......................... 10,725,000
261,000 Rayonier Inc.................................... 10,179,000
6,950,000 TimberWest Timber Trust (Foreign)............... 35,747,281
------------
89,258,281
------------
Office 23.2%
892,400 Alexandria Real Estate Equities, Inc. (REIT).... 24,206,350
2,075,000 * Beacon Capital Partners, Inc.(b) (REIT)......... 41,500,000
1,280,400 Boston Properties Inc. (REIT)................... 36,491,400
1,090,900 Cousins Properties Incorporated (REIT).......... 30,613,381
2,443,300 Prime Group Realty Trust (REIT)................. 40,925,275
------------
173,736,406
------------
Retail 11.6%
1,223,800 Getty Realty Corp............................... 17,133,200
993,800 * IHOP Corp....................................... 36,646,375
3,371,400 Prime Retail, Inc. (REIT)....................... 33,081,863
------------
86,861,438
------------
TOTAL COMMON STOCKS (COST $780,522,377)......... 657,732,148
------------
</TABLE>
12
<PAGE> 14
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REALTY FUND - PORTFOLIO INVESTMENTS
AT SEPTEMBER 30, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- ------------
<S> <C> <C> <C> <C> <C>
Preferred Stock - 9.8%
Diversified Realty 9.8%
14,600,000 * Excel Legacy Corporation - Series A Liquidating
Preference Convertible(b)....................... $ 73,000,000
------------
TOTAL PREFERRED STOCK (COST $73,000,000)........ 73,000,000
------------
Options - 0.3%
CONTRACTS
----------
Put Options Written
5,494 Newhall Land and Farming Company, expiring
April '99 @ $20 (Premiums received
$1,076,268)..................................... (126,362)
2,967 Newhall Land and Farming Company, expiring
October '99 @ $25 (Premiums received
$709,919)....................................... (709,113)
Call Options Purchased
5,494 Newhall Land and Farming Company, expiring
April '99 @ $20 (Cost $1,761,493)............... 2,609,650
2,967 Newhall Land and Farming Company, expiring
October '99 @ $25 (Cost $1,225,243)............. 726,915
------------
2,501,090
------------
Short-Term Obligations 1.2%
Repurchase Agreement with State Street Bank, 4.75% due 10-1-98... 9,166,000
------------
TOTAL INVESTMENTS (COST $863,888,926)(a)...................... 99.3% 742,399,238
OTHER ASSETS AND LIABILITIES, NET............................. 0.7 5,327,279
----- ------------
NET ASSETS.................................................... 100.0% $747,726,517
===== ============
NET ASSET VALUE PER SHARE............................................ $13.76
======
</TABLE>
* Non-income producing security
(a) Also represents aggregate cost for Federal income tax purposes.
(b) Illiquid/restricted security.
Note: Companies designated as "Foreign" are headquartered outside the U.S. and
represent 6% of Net Assets.
REITs comprise 28% of Net Assets.
13
<PAGE> 15
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SMALL-CAP FUND - MANAGEMENT DISCUSSION
by Mason Hawkins and Staley Cates
The composition of Longleaf Partners Small-Cap Fund changed dramatically over
the last three months. We used the $340 million we had in cash at June 30 plus
the proceeds from sales of five other companies to buy seven new businesses and
add to a number of existing holdings. Cash reserves are now at their lowest
level since we closed the Fund last summer, and our remaining liquidity is
allocated to several companies that our trading desk is buying.
Longleaf Partners Small-Cap Fund is ranked one of the top performing small cap
funds over the last one, three and five years by publications such as the Wall
Street Journal, Kiplinger's, Mutual Funds Magazine, and Investment News. The
Fund's long-term results have been rewarding. In the third quarter, however,
Small-Cap declined 13.4% while the Russell 2000 lost 20.2%. Although our short
and long-term relative returns are outstanding, relative performance does not
compound capital.
Several companies helped the Fund's performance during the third quarter. Both
Midas, our second largest holding, and Media One which we sold, appreciated
during the quarter. We also benefitted from our new position in Gulf Canada.
Most other holdings were flat or down over the last three months. Companies
whose declines most impacted the Fund such as BayView, newly acquired The
Carbide/Graphite Group, and Shaw Communications each have strong competitive
positions, solid free cash flows, great corporate partners at the helm, and are
selling at below 40% of corporate worth. This temporary mispricing affords us
the unique opportunity to buy more of these companies and others like them.
As significant owners we are very excited about the Fund's long-term prospects
based on the current price of the portfolio and its implications for future
returns. Small-Cap is at an all time low price-to-value ratio of 48%.
Many of you have inquired about plans to open Small-Cap. While our investment
opportunities finally do exceed our cash, the Fund will remain closed.
Concentration allows companies to have a meaningful impact on performance and
insures that we have a deep understanding of those businesses we own. If we
equally weight twenty businesses in a $1.1 billion fund, each stake must be
worth $55 million. Liquidity issues make us reluctant to own much more than 20%
of any one company. The math implies that a company must have at least a $300
million market cap to be in our universe. While we can own companies in the
range of the Russell 2000 (currently $5.9 million to $2.4 billion), we want to
remain flexible to invest in more than the upper end of that spectrum. Limiting
asset growth will benefit all existing partners.
14
<PAGE> 16
- --------------------------------------------------------------------------------
SMALL-CAP FUND - PERFORMANCE HISTORY AND
PORTFOLIO SUMMARY
AVERAGE ANNUAL RETURNS
FOR THE PERIODS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
Small-Cap Russell 2000 Value-Line
Fund Index Index
--------- ------------ ----------
<S> <C> <C> <C>
Year-to-Date (1.53)% (16.21)% (15.65)%
One Year 0.45 (19.02) (17.99)
Three Years 19.29 6.86 5.01
Five Years 16.66 9.09 5.90
</TABLE>
* The average annual returns for the Longleaf Partners Small-Cap Fund and the
Russell 2000 Index, from initial public offering on 2/21/89 through 9/30/98
were 11.33% and 10.97%, respectively. From inception through 3/31/91, the
Fund was managed by a different portfolio manager.
FIVE LARGEST HOLDINGS
(REPRESENT 29.3% OF NET ASSETS)
SHAW COMMUNICATIONS INC. (SCL) 9.8%
A Canadian cable television company which also provides high-speed Internet
access and digital audio services.
MIDAS INC. (MDS) 5.1%
One of the world's largest automotive service providers with over 1900
franchises in the U.S. and 800 locations overseas.
PROMUS HOTEL CORPORATION (PRH) 4.8%
Franchisor and/or manager of over 1100 hotels under the Doubletree, Embassy
Suites, Hampton Inn, and Homewood Suites brand names.
ORION CAPITAL CORPORATION (OC) 4.8%
A property/casualty insurer with business lines focusing on workers'
compensation, nonstandard auto, professional liability, and unique or highly
specialized situations.
CATELLUS DEVELOPMENT CORPORATION (CDX) 4.8%
A diversified real estate company that owns, manages, and develops industrial
warehouses, offices, apartments, and residential communities. CDX has
substantial land holdings, especially in the Western U.S.
15
<PAGE> 17
- --------------------------------------------------------------------------------
SMALL-CAP FUND - PORTFOLIO SUMMARY
PORTFOLIO CHANGES
JANUARY 1, 1998 THROUGH SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
NEW HOLDINGS ELIMINATIONS
------------ ------------
<S> <C>
Agribrands International, Inc. American Safety Razor Company
The Carbide/Graphite Group, Inc. Baker Fentress & Company
Carmike Cinemas, Inc. Celestial Seasonings, Inc.
Chicago Title Corporation* Chicago Title Corporation*
Fuji Fire and Marine Insurance Corecomm, Inc.
Company, Limited Dart Group Corporation
Genlyte Group Incorporated Duff & Phelps Credit Rating Co.
Gulf Canada Resources Limited Grey Advertising Inc. -
Kentucky Fried Chicken Japan Class A
Kerr-McGee Corporation Kerr-McGee Corporation
Kinseki, Ltd. Kuraya Corporation
Kuraya Corporation Lincoln Electric Holdings, Inc.
Lincoln Electric Holdings, Inc. MediaOne Group Inc.
MediaOne Group, Inc.* Nippon Shoji Kaisha Ltd.
Midas Inc. Showboat, Inc.
Nippon Broadcasting System The Union Corporation
Nippon Shinyaku Co., Ltd. U S West, Inc.*
Nippon Shoji Kaisha Ltd. White River Corporation
Perrigo Company Zurn Industries, Inc.
Promus Hotel Corporation
Robbins & Myers, Inc.
Ryoyo Electro Corp.
Sangetsu Co., Ltd.
Shaw Communications Inc. - Class A
Showa Pharmaceutical Co. Ltd.
U.S. Industries, Inc.
U S West, Inc*
</TABLE>
* Acquired through merger/spin-off of existing position.
16
<PAGE> 18
- --------------------------------------------------------------------------------
SMALL-CAP FUND - PORTFOLIO INVESTMENTS
AT SEPTEMBER 30, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- --------------
<S> <C> <C> <C> <C> <C>
Common Stock 90.3%
Agriculture 2.1%
1,015,400 *Agribrands International, Inc.................. $ 23,988,825
Broadcasting 1.2%
367,000 Nippon Broadcasting System (Foreign)........... 13,049,368
Building Materials 0.4%
405,000 Sangetsu Co., Ltd (Foreign).................... 4,656,369
Business Services 1.4%
1,104,400 *Pinkerton's, Inc............................... 15,254,525
Cable 9.8%
100,000 Shaw Communications Inc. - Class A (Foreign)... 1,670,816
6,479,800 Shaw Communications Inc. - Class B (Foreign)... 108,265,562
--------------
109,936,378
--------------
Commercial Lighting 1.8%
872,600 *Genlyte Group Incorporated..................... 17,888,300
137,350 Thomas Industries, Inc......................... 2,944,441
--------------
20,832,741
--------------
Electronics 0.8%
194,000 Kinseki, Ltd.(Foreign)......................... 792,418
1,105,000 Ryoyo Electro Corp. (Foreign).................. 7,833,713
--------------
8,626,131
--------------
Entertainment 2.4%
1,470,000 *Carmike Cinemas, Inc. -- Class A............... 27,011,250
Investment Management Companies 1.0%
524,100 United Asset Management Corporation............ 11,268,150
Lodging 4.8%
1,961,500 *Promus Hotel Corporation....................... 54,063,844
Manufacturing 6.7%
203,100 AMETEK, Inc.................................... 3,503,475
1,740,000 *The Carbide/Graphite Group, Inc................ 19,357,500
688,400 Robbins & Myers, Inc........................... 14,585,475
2,471,700 U.S. Industries, Inc........................... 37,229,981
--------------
74,676,431
--------------
Mortgage Financing 2.5%
1,518,600 Bay View Capital Corp.......................... 27,714,450
Natural Resources 11.5%
845,000 Deltic Timber Corporation...................... 15,210,000
3,349,996 Gendis Inc. - Class A (Foreign)................ 14,267,445
12,100,900 *Gulf Canada Resources Limited (Foreign)........ 49,916,213
865,000 The Pioneer Group, Inc......................... 14,272,500
6,950,000 TimberWest Timber Trust (Foreign).............. 35,747,281
--------------
129,413,439
--------------
</TABLE>
17
<PAGE> 19
- --------------------------------------------------------------------------------
SMALL-CAP FUND - PORTFOLIO INVESTMENTS
AT SEPTEMBER 30, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
SHARES MARKET VALUE
---------- --------------
<S> <C> <C> <C> <C> <C>
Pharmaceuticals 0.8%
697,000 Nippon Shinyaku Co., Ltd. (Foreign)............ $ 2,826,506
608,900 *Perrigo Company................................ 5,556,213
95,000 Showa Pharmaceutical Co. Ltd (Foreign)......... 481,560
--------------
8,864,279
--------------
Property & Casualty Insurance 16.8%
239,101 *Alleghany Corporation.......................... 44,711,887
5,717,000 The Chiyoda Fire and Marine Insurance Company,
Ltd. (Foreign)............................... 16,841,882
3,840,000 The Dai-Tokyo Fire and Marine Insurance
Company, Ltd. (Foreign)...................... 10,945,636
3,910,000 Fuji Fire and Marine Insurance Company, Limited
(Foreign).................................... 7,152,439
1,777,400 Hilb, Rogal and Hamilton Company............... 33,548,425
199,000 The Koa Fire and Marine Insurance Company, Ltd.
(Foreign).................................... 584,778
7,670,000 The Nissan Fire & Marine Insurance Company,
Ltd. (Foreign)............................... 20,679,474
1,494,600 Orion Capital Corporation...................... 53,338,537
--------------
187,803,058
--------------
Real Estate 12.0%
4,100,100 *Catellus Development Corporation............... 53,301,300
1,135,400 Cousins Properties Incorporated................ 31,862,163
552,900 *IHOP Corp...................................... 20,388,187
1,520,000 TrizecHahn Corporation (Foreign)............... 28,500,000
--------------
134,051,650
--------------
Restaurants 1.3%
114,000 Kentucky Fried Chicken Japan (Foreign)......... 896,121
982,400 *VICORP Restaurants, Inc........................ 13,323,800
--------------
14,219,921
--------------
Retail 5.1%
2,333,400 Midas Inc...................................... 56,584,950
Telecommunications 3.5%
2,078,009 *Vanguard Cellular Systems, Inc. -- Class A..... 39,482,171
Transportation 4.4%
1,105,000 *FDX Corporation................................ 49,863,125
--------------
TOTAL COMMON STOCKS (COST $1,077,640,640)............... 1,011,361,055
--------------
</TABLE>
18
<PAGE> 20
- --------------------------------------------------------------------------------
SMALL-CAP FUND - PORTFOLIO INVESTMENTS
AT SEPTEMBER 30, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
MARKET VALUE
--------------
<S> <C> <C> <C> <C> <C>
Short-Term Obligations 8.3%
Federal Home Loan Mortgage Corporation, 5.22% due 10-2-98........... $ 49,992,847
Repurchase Agreement with State Street Bank, 4.75% due 10-1-98...... 42,900,000
--------------
92,892,847
--------------
TOTAL INVESTMENTS (COST $1,170,533,487)(a)................... 98.6% 1,104,253,902
OTHER ASSETS AND LIABILITIES, NET............................ 1.4 15,813,814
----- --------------
NET ASSETS................................................... 100.0% $1,120,067,716
===== ==============
NET ASSET VALUE PER SHARE........................................... $21.84
</TABLE>
* Non-income producing security
(a) Also represents aggregate cost for Federal income tax purposes.
Note: Companies designated as "Foreign" are headquartered outside the U.S. and
represent 29% of Net Assets.
Open Forward Currency Contracts
<TABLE>
<CAPTION>
Currency Currency Sold and Currency Unrealized
Units Sold Settlement Date Market Value Gain
- ------------- ---------------------------------- ------------ -----------
<C> <S> <C> <C>
150,608,700 Canadian Dollars 10-28-98......... $98,676,118 $ 8,698,712
57,000,000 Canadian Dollars 4-1-99........... 37,335,185 1,403,431
3,830,551,260 Japanese Yen 4-2-99............... 28,874,018 1,625,269
8,312,155,852 Japanese Yen 5-13-99.............. 62,981,212 1,153,453
------------ -----------
Total Forward Contracts........... $227,866,533 $12,880,865
============ ===========
</TABLE>
19
<PAGE> 21
- --------------------------------------------------------------------------------
SERVICE DIRECTORY
FUND INFORMATION (800) 445-9469
To request a prospectus, financial report, application or other Fund information
call (800) 445-9469 from 8:00 a.m. to 8:00 p.m. Eastern time, seven days a week.
EXISTING SHAREHOLDER INQUIRIES (800) 488-4191
To request action on your existing account contact the transfer agent, NFDS, at
(800) 488-4191 from 9:00 a.m. to 6:00 p.m. Eastern time, Monday through Friday.
<TABLE>
<S> <C>
Mail correspondence to: Overnight address:
Longleaf Partners Funds Longleaf Partners Funds
c/o NFDS c/o NFDS
P.O. Box 419929 330 W. 9th Street
Kansas City, MO 64141-6929 Kansas City, MO 64105
(816) 843-8468
</TABLE>
24-HOUR AUTOMATED INFORMATION (800) 378-3788
For automated reporting of daily prices, account balances and transaction
activity call (800) 378-3788, 24-hours a day, seven days a week. Please have
your Fund number (see below) and account number ready to access your investment
information.
SERVICES FOR FINANCIAL ADVISORS (800) 761-2509
Please contact Lee Harper or Mary Williamson for additional information.
PUBLISHED DAILY PRICE QUOTATIONS
Daily net asset value per share of each Fund is reported in mutual fund
quotations tables of major newspapers in alphabetical order under the bold
heading LONGLEAF PARTNERS as follows:
<TABLE>
<CAPTION>
TRANSFER AGENT
ABBREVIATION SYMBOL CUSIP FUND NUMBER
- ------------ ------ --------- --------------
<C> <S> <C> <C>
Partners LLPFX 543069108 133
Realty LLREX 543069306 135
Sm-Cap LLSCX 543069207 134
</TABLE>
20
<PAGE> 22
- --------------------------------------------------------------------------------
TRUSTEES AND OFFICERS
Trustees
O. Mason Hawkins, Chairman
Chadwick H. Carpenter, Jr.
Daniel W. Connell, Jr.
Steven N. Melnyk
C. Barham Ray
W. Reid Sanders
Officers
O. Mason Hawkins, Co-Portfolio Manager and Chief Executive Officer
W. Reid Sanders, President
G. Staley Cates, Co-Portfolio Manager and Vice President - Investments
C. T. Fitzpatrick, Co-Portfolio Manager of the Realty Fund
and Vice-President - Investments
Charles D. Reaves, Executive Vice President and General Counsel
Julie M. Douglas, Executive Vice President - Operations and Treasurer
Lee B. Harper, Executive Vice President - Marketing
Frank N. Stanley III, Vice President - Investments
John B. Buford, Vice President - Investments
Randy D. Holt, Vice President and Secretary
Transfer Agent
National Financial Data Services
Kansas City, Missouri
Custodian
State Street Bank & Trust Company
Boston, Massachusetts
Special Legal Counsel
Dechert Price & Rhodes
Washington D.C.
Independent Public Accountants
PricewaterhouseCoopers LLP
Boston, Massachusetts
21
<PAGE> 23
Longleaf Partners Funds
c/o NFDS
P.O. Box 419929
Kansas City, MO 64141-6929
Fund Information Requests
(800) 445-9469
Shareholder Account Inquiries
(800) 488-4191
