**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the quarter ended June 30, 2003**

 

**Commission File Number 0-20449**

 

**PRICE LEGACY CORPORATION**

(Exact name of registrantas specified in its charter)

 

| **Maryland**                                                     |   | **33-0628740**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

**17140 Bernardo Center Drive, Suite 300, San Diego, California  92128**

(Address of principalexecutive offices) (Zip Code)

 

**(858) 675-9400**

(Registrant’s telephonenumber, 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 mark whether the registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2).  Yes ý   No o

 

The registrant had 36,963,756 shares of common stock, par value $.0001per share, outstanding at August 8, 2003.

 

 

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**PRICE LEGACY CORPORATION**

 

**INDEX TO FORM 10-Q**

 
| **PART I - FINANCIAL INFORMATION** |
|------------------------------------|
|                               |
|                               | **ITEM 1 - FINANCIAL STATEMENTS** |
|                               |   | CONSOLIDATED  BALANCE SHEETS |
|                               |   | CONSOLIDATED STATEMENTS  OF OPERATIONS |
|                               |   | CONSOLIDATED STATEMENTS OF  CASH FLOWS |
|                               |   | NOTES TO  CONSOLIDATED FINANCIAL STATEMENTS |
|                               |   |
|                               | **ITEM 2 - MANAGEMENT’S DISCUSSION  AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|                               |   |
|                               | **ITEM 3 - QUANTITATIVE AND QUALITATIVE  DISCLOSURES ABOUT MARKET RISK** |
|                               |   |
|                               | **ITEM 4 – CONTROLS AND PROCEDURES** |
|                               |   |
| **PART II - OTHER INFORMATION**    |
|                               |
|                               | **ITEM 1 – LEGAL PROCEEDINGS** |
|                               |   |
|                               | **ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K** |

 

2

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**PART I****- FINANCIALINFORMATION**

 

**ITEM 1****- FINANCIAL STATEMENTS**

 

**PRICELEGACY CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(in thousands, except share data)**

 
|                                                                                                                                                   |   | **June 30  2003** |          | **December  31  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------------|------------------------|--------|
|                                                                                                                                                   |   | **(unaudited)**   |          |                   |   |
| **ASSETS**                                                                                                                                             |   |              |          |                   |   |
|                                                                                                                                                   |   |              |          |                   |   |
| Real estate assets                                                                                                                                     |   |              |          |                   |   |
| Land and land improvements                                                                                                                             |   | **$**             | **435,525**   |                   | $      | 446,331 |   |
| Building and improvements                                                                                                                              |   | **682,443**       |          | 668,671                |   |
| Construction in progress                                                                                                                               |   | **27,781**        |          | 35,235                 |   |
|                                                                                                                                                   |   | **1,145,749**     |          | 1,150,237              |   |
| Less accumulated depreciation                                                                                                                          |   | **(43,640**       | **)**         | (34,617                | )      |
|                                                                                                                                                   |   | **1,102,109**     |          | 1,115,620              |   |
|                                                                                                                                                   |   |              | ** **    |                   |   |
| Investment in unconsolidated real estate joint ventures                                                                                                |   | **27,086**        | ** **    | 26,019                 |   |
| Cash and cash equivalents                                                                                                                              |   | **17,709**        | ** **    | 11,471                 |   |
| Restricted cash                                                                                                                                        |   | **11,289**        | ** **    | 8,787                  |   |
| Accounts receivable, net of allowance of $1,398 and $1,669                                                                                             |   | **7,436**         | ** **    | 6,036                  |   |
| Notes receivable                                                                                                                                       |   | **58,967**        | ** **    | 62,788                 |   |
| Interest receivable                                                                                                                                    |   | **14,930**        | ** **    | 16,032                 |   |
| Deferred rents                                                                                                                                         |   | **9,898**         | ** **    | 9,460                  |   |
| Other assets                                                                                                                                           |   | **15,675**        | ** **    | 16,805                 |   |
| Total assets                                                                                                                                           |   | **$**             | **1,265,099** | ** **             | $      | 1,273,018 |   |
|                                                                                                                                                   |   |              | ** **    |                   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                          |   |              | ** **    |                   |   |
|                                                                                                                                                   |   |              |          |                   |   |
| Liabilities                                                                                                                                            |   |              | ** **    |                   |   |
| Mortgages and notes payable                                                                                                                            |   | **$**             | **486,256**   | ** **             | $      | 487,811 |   |
| Revolving line of credit                                                                                                                               |   | **64,700**        | ** **    | 60,300                 |   |
| Accounts payable and other liabilities                                                                                                                 |   | **25,214**        | ** **    | 31,341                 |   |
| Total liabilities                                                                                                                                      |   | **576,170**       | ** **    | 579,452                |   |
|                                                                                                                                                   |   |              | ** **    |                   |   |
| Commitments                                                                                                                                            |   |              | ** **    |                   |   |
|                                                                                                                                                   |   |              | ** **    |                   |   |
| Minority interests                                                                                                                                     |   | **595**           | ** **    | 595                    |   |
|                                                                                                                                                   |   |              | ** **    |                   |   |
| Stockholders’ equity                                                                                                                              |   |              | ** **    |                   |   |
| Series A preferred stock, cumulative, redeemable, $0.0001 par value,  27,849,771 shares authorized, 27,434,166 shares issued and outstanding           |   | **399,615**       | ** **    | 399,615                |   |
| Series B preferred stock, junior, convertible, redeemable, $0.0001  par value, 27,458,855 shares authorized, 19,666,754 shares issued and  outstanding |   | **106,234**       | ** **    | 106,234                |   |
| Common stock, $0.0001 par value, 94,691,374 shares authorized,  36,963,756 and 37,255,748 issued and outstanding                                       |   | **4**             | ** **    | 4                      |   |
| Additional paid-in capital                                                                                                                             |   | **183,940**       | ** **    | 184,720                |   |
| Accumulated other comprehensive loss                                                                                                                   |   | **(2,107**        | **)**         | (921                   | )      |
| Retained earnings                                                                                                                                      |   | **648**           | ** **    | 3,319                  |   |
| Total stockholders’ equity                                                                                                                        |   | **688,334**       | ** **    | 692,971                |   |
| Total liabilities and stockholders’ equity                                                                                                        |   | **$**             | **1,265,099** | ** **             | $      | 1,273,018 |   |

 

*Seeaccompanying notes.*

 

3

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**PRICELEGACY CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(unaudited - amounts in thousands, except per share data)**

 
|                                                           |   | **Second  Quarter  Three Months Ended  June 30** |       | **Year-to-Date  Six Months Ended  June 30** |       |
|----------------------------------------------------------------|--------|--------------------------------------------------|------------|---------------------------------------------|------------|
|                                                           |   | **2003**                                         |       | **2002**                                    |       | **2003** |   | **2002** |   |
|                                                           |   |                                             |       |                                        |       |   |   |   |   |
| Rental revenues                                                |   | **$**                                            | **32,197** |                                        | $          | 27,954 | ** ** | **$** | **63,902** | ** ** | $ | 54,857 |   |
|                                                           |   |                                             |       |                                        |       |   | ** ** |   |   |
| Expenses                                                       |   |                                             |       |                                        |       |   | ** ** |   |   |
| Operating and  maintenance                                     |   | **6,773**                                        |       | 5,081                                       | ** ** | **12,903** | ** ** | 10,022 |   |
| Property taxes                                                 |   | **3,894**                                        |       | 3,218                                       | ** ** | **7,623** | ** ** | 6,296 |   |
| Depreciation and  amortization                                 |   | **5,828**                                        |       | 3,945                                       | ** ** | **10,181** | ** ** | 7,987 |   |
| General and  administrative                                    |   | **1,830**                                        |       | 1,652                                       | ** ** | **3,813** | ** ** | 4,457 |   |
| Total expenses                                                 |   | **18,325**                                       |       | 13,896                                      | ** ** | **34,520** | ** ** | 28,762 |   |
|                                                           |   |                                             |       |                                        |       |   | ** ** |   |   |
| Operating income                                               |   | **13,872**                                       |       | 14,058                                      | ** ** | **29,382** | ** ** | 26,095 |   |
|                                                           |   |                                             |       |                                        |       |   | ** ** |   |   |
| Interest and  other                                            |   |                                             |       |                                        |       |   | ** ** |   |   |
| Interest expense                                               |   | **(6,659**                                       | **)**      | (5,646                                      | )          | **(13,269** | **)** | (11,888 | ) |
| Interest income                                                |   | **113**                                          | ** ** | 1,119                                       |       | **925** | ** ** | 2,388 |   |
| Equity in  earnings of joint ventures                          |   | **1,014**                                        | ** ** | 136                                         |       | **1,164** | ** ** | 314 |   |
| Total interest  and other                                      |   | **(5,532**                                       | **)**      | (4,391                                      | )          | **(11,180** | **)** | (9,186 | ) |
|                                                           |   |                                             | ** ** |                                        |       |   | ** ** |   |   |
| Income from  continuing operations                             |   | **8,340**                                        | ** ** | 9,667                                       |       | **18,202** | ** ** | 16,909 |   |
|                                                           |   |                                             | ** ** |                                        |       |   | ** ** |   |   |
| Discontinued  operations:                                      |   |                                             | ** ** |                                        |       |   | ** ** |   |   |
| Income from  operations                                        |   | **118**                                          | ** ** | 3,845                                       |       | **165** | ** ** | 5,477 |   |
| Provision for  asset impairment                                |   | **—**                                       | ** ** | (2,528                                      | )          | **—** | ** ** | (2,528 | ) |
| Net loss on sale  of real estate                               |   | **(2,314**                                       | **)**      | (843                                        | )          | **(2,521** | **)** | (843 | ) |
| (Loss) gain on  discontinued operations                        |   | **(2,196**                                       | **)**      | 474                                         |       | **(2,356** | **)** | 2,106 |   |
|                                                           |   |                                             | ** ** |                                        |       |   | ** ** |   |   |
| Net income  before gain on sale of real estate                 |   | **6,144**                                        | ** ** | 10,141                                      |       | **15,846** | ** ** | 19,015 |   |
|                                                           |   |                                             | ** ** |                                        |       |   | ** ** |   |   |
| Net gain on sale  of real estate                               |   | **—**                                       | ** ** | 3                                           |       | **687** | ** ** | 291 |   |
|                                                           |   |                                             | ** ** |                                        |       |   | ** ** |   |   |
| Net income                                                     |   | **6,144**                                        | ** ** | 10,144                                      |       | **16,533** | ** ** | 19,306 |   |
|                                                           |   |                                             | ** ** |                                        |       |   | ** ** |   |   |
| Dividends to  preferred stockholders                           |   | **(12,423**                                      | **)**      | (12,183                                     | )          | **(24,783** | **)** | (24,308 | ) |
|                                                           |   |                                             | ** ** |                                        |       |   | ** ** |   |   |
| Net loss  applicable to common stockholders                    |   | **$**                                            | **(6,279** | **)**                                       | $          | (2,039 | ) | **$** | **(8,250** | **)** | $ | (5,002 | ) |
|                                                           |   |                                             | ** ** |                                        |       |   | ** ** |   |   |
| Basic and  diluted net loss per common share                   |   | **$**                                            | **(.17**   | **)**                                       | $          | (.05 | ) | **$** | **(.22** | **)** | $ | (.12 | ) |
|                                                           |   |                                             | ** ** |                                        |       |   | ** ** |   |   |
| Weighted average  common shares outstanding  Basic and diluted |   | **36,995**                                       | ** ** | 40,727                                      | ** ** | **37,012** |   | 40,727 |   |
|                                                           |   |                                             | ** ** |                                        |       |   |   |   |   |
| Dividends per  preferred share                                 |   | **$**                                            | **.35**    |                                        | $          | .35 | ** ** | **$** | **.70** |   | $ | .70 |   |

 

*Seeaccompanying notes.*

 

4

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**PRICE LEGACY CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited - amounts in thousands)**

 
|                                                                               |   | **Year-to-Date  Six Months Ended  June 30** |       |
|------------------------------------------------------------------------------------|--------|---------------------------------------------|------------|
|                                                                               |   | **2003**                                    |       | **2002** |   |
| Operating activities                                                               |   |                                        |       |   |   |
| Net income                                                                         |   | **$**                                       | **16,533** | ** ** | $ | 19,306 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |   |                                        | ** ** |   |   |
| Depreciation and amortization                                                      |   | **10,258**                                  | ** ** | 8,748 |   |
| Deferred rents                                                                     |   | **(438**                                    | **)**      | (2,331 | ) |
| Provision for asset impairment                                                     |   | **—**                                  | ** ** | 2,528 |   |
| Equity in earnings of joint venture                                                |   | **(1,164**                                  | **)**      | (314 | ) |
| Net loss on sale of real estate assets                                             |   | **1,834**                                   | ** ** | 552 |   |
| Changes in operating assets and liabilities:                                       |   |                                        | ** ** |   |   |
| Accounts receivable and other assets                                               |   | **(1,140**                                  | **)**      | (2,524 | ) |
| Accounts payable and other liabilities                                             |   | **(6,054**                                  | **)**      | (2,177 | ) |
| Net cash provided by operating activities                                          |   | **22,109**                                  | ** ** | 23,788 |   |
|                                                                               |   |                                        | ** ** |   |   |
| Investing activities                                                               |   |                                        | ** ** |   |   |
| Increase to restricted cash                                                        |   | **(2,502**                                  | **)**      | (5,115 | ) |
| Additions to real estate assets                                                    |   | **(16,178**                                 | **)**      | (72,399 | ) |
| Proceeds from the sale of real estate assets                                       |   | **15,855**                                  | ** ** | 17,740 |   |
| Contributions to real estate joint ventures                                        |   | **(6**                                      | **)**      | (850 | ) |
| Distributions from real estate joint ventures                                      |   | **200**                                     | ** ** | 280 |   |
| Advances on notes receivable                                                       |   | **(14,466**                                 | **)**      | (1,578 | ) |
| Repayments on notes receivable                                                     |   | **17,585**                                  | ** ** | 3,283 |   |
| Net cash provided by (used in) investing activities                                |   | **488**                                     | ** ** | (58,639 | ) |
|                                                                               |   |                                        | ** ** |   |   |
| Financing activities                                                               |   |                                        | ** ** |   |   |
| Advances from revolving line of credit and notes payable                           |   | **68,713**                                  | ** ** | 63,213 |   |
| Repayments of revolving line of credit and notes payable                           |   | **(65,868**                                 | **)**      | (25,890 | ) |
| Dividends paid on Series A Preferred Stock                                         |   | **(19,204**                                 | **)**      | (19,204 | ) |
| Proceeds from exercise of stock options                                            |   | **—**                                  | ** ** | 303 |   |
| Net cash (used in) provided by financing activities                                |   | **(16,359**                                 | **)**      | 18,422 |   |
| Net increase (decrease) in cash and cash equivalents                               |   | **6,238**                                   | ** ** | (16,429 | ) |
|                                                                               |   |                                        | ** ** |   |   |
| Cash and cash equivalents at beginning of period                                   |   | **11,471**                                  | ** ** | 22,881 |   |
| Cash and cash equivalents at end of period                                         |   | **$**                                       | **17,709** | ** ** | $ | 6,452 |   |
|                                                                               |   |                                        | ** ** |   |   |
| Supplemental cash flow information:                                                |   |                                        | ** ** |   |   |
| Cash paid for interest                                                             |   | **$**                                       | **13,937** | ** ** | $ | 13,054 |   |
|                                                                               |   |                                        | ** ** |   |   |
| Supplemental schedule of noncash investing and financing activities:               |   |                                        | ** ** |   |   |
| Receipt of common shares in satisfaction of notes receivable                       |   | **779**                                     | ** ** | — |   |
| Assumption of loans to acquire real estate assets                                  |   | **—**                                  | ** ** | 5,787 |   |
| Reduction in note receivable to acquire real estate assets                         |   | **—**                                  | ** ** | 3,543 |   |
| Change in assets and liabilities related to the fair value of  interest rate swaps |   | **—**                                  | ** ** | 3,465 |   |

 

*See accompanying notes.*

 

5

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**PRICELEGACY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**June 30,2003**

 

**Note 1 – Organization and SignificantAccounting Policies**

 

***Organization***

Price Legacy Corporation (Price Legacy)operates as a real estate investment trust (REIT) incorporated in the state ofMaryland.  Our principal business is toacquire, operate, and develop real property, primarily open-air shoppingcenters.  On September 18, 2001, PriceLegacy completed a merger between Price Enterprises, Inc. (PEI) and ExcelLegacy Corporation (Excel Legacy) resulting in Excel Legacy becoming a whollyowned subsidiary of PEI (the Merger). The combined company operates as a REIT under the name Price LegacyCorporation.

 

Our subsidiaries include Excel Legacy Holdings, Inc., which has electedto be treated as a taxable REIT subsidiary (TRS).  Other than some activities related to lodging and health carefacilities, a TRS may generally engage in any business.  A TRS is subject to federal income tax andstate and local income tax, where applicable, as a regular C corporation.

 

***AccountingPrinciples***

We prepared the financial statements following the requirements of theSecurities and Exchange Commission (SEC) for interim reporting.  As permitted under those rules, certainfootnotes or other financial information that are normally required byaccounting principles generally accepted in the United States of America (GAAP)can be omitted.  Certain prior year datahave been reclassified to conform to the 2003 presentation.

 

We are responsible for the financial statements included in thisdocument.  The financial statementsinclude all normal and recurring adjustments that are considered necessary forthe fair presentation of our financial position and operating results.  You should also read the financialstatements and notes in our latest Annual Report on Form 10-K, as amended.

 

Revenues, expenses, assets and liabilities can vary during each quarterof the year.  Therefore, the results andtrends in these interim financial statements may not be the same as those forthe full year.

 

***Real Estate Assets and Depreciation***

We record real estate assets at historicalcosts and adjust them for recognition of impairment losses.  In following purchase accounting, weadjusted the historical costs of Excel Legacy’s real estate assets to fairvalue at the time of the Merger.  Ourconsolidated balance sheets at June 30, 2003 and December 31, 2002 reflect thenew basis of those real estate assets.

 

6

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We expense ordinary repairs and maintenance costs incurred, whichinclude building painting, parking lot repairs, etc.  We capitalize major replacements and betterments, which includeHVAC equipment, roofs, etc., and depreciate them over their estimated usefullives.

 

We compute real estate asset depreciation on a straight-line basis overtheir estimated useful lives, as follows:

 
| Land improvements         |   | 40 years                                |
|---------------------------|--------|-----------------------------------------|
| Building and improvements |   | 20 to 40 years                          |
| Tenant improvements       |   | Lesser of the term of lease or 10 years |
| Fixtures and equipment    |   | 3-7 years                               |

 

We review long-lived assets for impairmentwhen events or changes in business conditions indicate that their full carryingvalue may not be recovered.  We considerassets to be impaired and write them down to fair value if their expectedassociated future undiscounted cash flows are less than their carrying amounts.  Generally, we estimate fair value usingdiscounted cash flow, direct capitalization or market comparison analyses.  The process of evaluating for impairmentrequires estimates as to future events and conditions, which are subject tovarying market and economic factors.

 

We capitalize interest incurred during the construction period ofcertain assets and this interest is depreciated over the lives of thoseassets.  The following table showsinterest expense and the amount capitalized (amounts in thousands):

 
|                  |   | **Three Months Ended  June 30** |   | **Six Months  Ended  June 30** |   |
|-----------------------|--------|---------------------------------|--------|--------------------------------|--------|
|                  |   | **2003**                        |   | **2002**                       |   | **2003** |   | **2002** |   |
| Interest  incurred    |   | $                               | 7,137  |                           | $      | 6,362 |   | $ | 14,272 |   | $ | 13,371 |   |
| Interest  capitalized |   | (478                            | )      | (521                           | )      | (1,003 | ) | (1,093 | ) |
|                       |        |                                 |        |                                |        |  |  |  |  |  |  |  |  |

 

Pre-development costs that are directly related to specificconstruction projects are capitalized as incurred.  We expense these costs to the extent they are unrecoverable or itis determined that the related project will not be pursued.

 

***Cash and Cash Equivalents***

We consider all highly liquid investments with a maturity of less thanthree months when purchased to be cash and cash equivalents.

 

7

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We are required to maintain reserves with certain lenders for capitalexpenditures, insurance, real estate taxes and debt service.  As of June 30, 2003 and December 31, 2002,the aggregate amount of these reserves held by lenders was $11.3 million atJune 30, 2003 and $8.8 million at December 31, 2002, and is shown as restrictedcash on the Consolidated Balance Sheets.

 

Our restricted cash balances at June 30, 2003 and December 31, 2002also include $2.4 million of funds which represent proceeds from the sale ofvacant land at our property in Hollywood/Oakwood Plaza, FL.  The funds will be held by the propertylender until the debt is repaid in 2009.

 

***Investment in Securities***

Included in other assets on the ConsolidatedBalance Sheets are investments in securities. We review our investments in securities for possible impairment wheneverthe market value of the securities falls below cost and, in our opinion, suchdecline represents an other than temporary impairment.  Factors considered in this review include:

 

•      duration and extent, as well as reasonsfor which the market value has been less than cost

•                  financialcondition and near-term prospects of the investee, which includes considerationof proposed transactions known through Board of Directors participation

•                  our ability andintent to retain the investment for a period of time to allow for a recovery inmarket value.

 

When an other than temporary impairment loss on an individualinvestment is considered to have occurred, we write down the cost basis of thesecurity, and the charge is recorded in earnings.

 

***Comprehensive Income***

Statement of Financial Accounting Standard (SFAS) No. 130 “ReportingComprehensive Income” requires that all components of comprehensive income bereported in the financial statements in the period in which they arerecognized.  The components ofcomprehensive income at June 30, 2003 and 2002 are as follows:

 
|                                                 |   | **Three  Months Ended June 30** |   | **Six Months  Ended June 30** |   |
|------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                 |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
| Net income                                           |   | $                               | 6,144  |                          | $      | 10,144 |   | $ | 16,533 |   | $ | 19,306 |   |
| Unrealized loss  on derivative financial instruments |   | (458                            | )      | —                        |   | (1,183 | ) | — |   |
| Unrealized loss  on marketable securities            |   | —                          |   | (32                           | )      | (3 | ) | (17 | ) |
| Total comprehensive  income                          |   | $                               | 5,686  |                          | $      | 10,112 |   | $ | 15,347 |   | $ | 19,289 |   |

 

8

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***Use of Estimates***

Preparing financial statements in conformity with GAAP requires that wemake estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. We continually review our estimates and make adjustments as necessary,but actual results could differ from what we envisioned when we made theseestimates.

 

***Derivative Financial Instruments***

In January 2001, we adopted SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities.”  Inthe normal course of business, we may use derivative financial instruments tomanage or hedge interest rate risk. When entered into, we formally designate and document the financialinstrument as a hedge of a specific underlying exposure, as well as the riskmanagement objectives and strategies for undertaking the hedgetransactions.  We assess, both at theinception and at least quarterly thereafter, whether the financial instrumentsthat are used in hedging transactions are effective at offsetting changes ineither the fair value or cash flows of the related underlying exposure.  Because of the high degree of effectivenessbetween the hedging instrument and the underlying exposure being hedged,fluctuations in the value of the derivative instruments are generally offset bychanges in the fair value or cash flows of the underlying exposures beinghedged.  Any ineffective portion of afinancial instrument’s change in fair value is immediately recognized inearnings. Virtually all of our derivatives are straightforward over-the-counterinstruments with liquid markets.

 

To determine the fair values of derivative instruments, we use avariety of methods and assumptions that are based on market conditions andrisks existing at each balance sheet date. For the majority of financial instruments including most derivatives,long-term investments and long-term debt, standard market conventions andtechniques such as discounted cash flow analysis, option pricing models,replacement cost, and termination cost are used to determine fair value. Allmethods of assessing fair value result in a general approximation of value, andsuch value may never actually be realized.

 

***Asset Disposal***

In August 2001, the Financial Accounting Standards Board (FASB) issuedSFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets.”  SFAS No. 144 addressesfinancial accounting for the impairment or disposal of long-lived assets and iseffective in fiscal years beginning after December 15, 2001.  We have adopted this standard and reportoperations from properties sold in 2003 and 2002 as discontinued operations forthe quarter and year-to-date periods ended June 30, 2003 and 2002.

 

9

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***New Accounting Standards***

In December 2002, the FASB issued SFAS No. 148, “Accounting forStock-Based Compensation — Transition and Disclosure — an amendment of SFAS No.123.”  SFAS No. 148 addresses transitionprovisions for a voluntary change to the fair value method of accounting forstock-based employee compensation.  Inaddition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123.  This statement has not had a significantimpact on our consolidated financial statements.

 

We do not record compensation expense for stock option grants and wegranted no options in the first six months of 2003.  The following table summarizes results as if we had recordedcompensation expense under the provisions of SFAS No. 123, as amended by SFASNo. 148, for the 2002 option grants.

 
|                                                                               |   | **Three  Months Ended  June 30** |   | **Six  Months Ended  June 30** |   |
|------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                               |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
| Net loss  applicable to common stockholders:                                       |   |                             |   |                           |   |   |   |   |   |
| As reported                                                                        |   | $                                | (6,279 | )                              | $      | (2039 | ) | $ | (8,250 | ) | $ | (5,002 | ) |
| Deduct:  stock based compensation expense  determined under fair value method |   | —                           |   | (378                           | )      | — |   | (756 | ) |
| Pro forma                                                                          |   | $                                | (6,279 | )                              | $      | (2,417 | ) | $ | (8,250 | ) | $ | (5,758 | ) |
| Net loss per  share – basic and diluted:                                      |   |                             |   |                           |   |   |   |   |   |
| As reported                                                                        |   | (.17                             | )      | (.05                           | )      | (.22 | ) | (.12 | ) |
| Pro forma                                                                          |   | (.17                             | )      | (.06                           | )      | (.22 | ) | (.14 | ) |

 

We discuss our stock option plan further in Note 10.

 

In January 2003, the FASB issued FIN 46,“Consolidation of Variable Interest Entities—an interpretation of ARB No.51.”  FIN 46 addresses consolidation bybusiness enterprises of variable interest entities, which have one or both ofthe following characteristics:  1) theequity investment at risk is not sufficient to permit the entity to finance itsactivities without additional subordinated financial support from otherparties, which is provided through other interests that will absorb some or allof the expected losses of the entity; and 2) the equity investors lack anessential characteristic of a controlling financial interest.  We are currently evaluating the effect FIN46 will have on our consolidated financial statements.  FIN 46 is effective in the first fiscal yearor interim period beginning after June 15, 2003.

 

10

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In April 2003, the FASB issued SFAS 149,“Amendment of Statement 133 on Derivative Instruments and Hedging Activities,”(SFAS 149).  SFAS 149 amends andclarifies financial accounting and reporting for derivative instruments and forhedging activities under SFAS 133, “Accounting for Derivative Instruments andHedging Activities.”  In particular, SFAS 149 (1) clarifies under whatcircumstances a contract with an initial net investment meets thecharacteristic of a derivative discussed in paragraph 6(b) of Statement 133, (2)clarifies when a derivative contains a financing component, (3) amends thedefinition of an underlying to conform it to language used in FASBInterpretation No. 45, Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others, and (4)amends certain other existing pronouncements. Those changes will result in moreconsistent reporting of contracts as either derivatives or hybrid instruments. SFAS 149 is effective for contracts entered into or modified after June30, 2003, except for certain provisions, and for hedging relationshipsdesignated after June 30, 2003.  We have determined that SFAS 149 will nothave a significant impact on our consolidated financial statements.

 

**Note 2 –Net Income Per Share**

 

SFAS No. 128, “Earnings Per Share,” requires presentation of twocalculations of earnings per common share. Basic earnings per common share equals net income applicable to commonstockholders divided by weighted average common shares outstanding during theperiod.  Diluted earnings per commonshare equals net income applicable to common stockholders divided by the sum ofweighted average common shares outstanding during the period plus dilutivepotential shares.  Dilutive potentialshares are shares assumed to be issued if outstanding stock options wereexercised.  The effect of common stockequivalents during the periods presented were anti-dilutive and therefore notpresented.

 

There were 19,666,754 shares of Series B Preferred Stock outstanding atJune 30, 2003 which may be exchanged on a one-to-one basis into common stock,subject to adjustment, starting in September 2003.  As of June 30, 2003, the Series B Preferred stockholders wereentitled to approximately 3.4 million additional Series B Preferred shares.

 

**Note 3 –Real Estate Assets**

 

Our real estate properties are generally leased under noncancelableleases with remaining terms ranging from 1 to 24 years.  Rental revenues include the following(amounts in thousands):

 

11

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|                                  |   | **Three  Months Ended June 30** |   | **Six Months  Ended June 30** |   |
|---------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                  |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
| Minimum rent                          |   | $                               | 23,060 |                          | $      | 19,677 |   | $ | 46,148 |   | $ | 39,019 |   |
| Straight-line  accrual of future rent |   | 694                             |   | 890                           |   | 1,208 |   | 2,196 |   |
| Expense reimbursements                |   | 6,182                           |   | 5,194                         |   | 12,952 |   | 10,130 |   |
| Percentage rent                       |   | 255                             |   | 515                           |   | 574 |   | 632 |   |
| Other revenues                        |   | 2,006                           |   | 1,678                         |   | 3,020 |   | 2,880 |   |
| Rental revenues                       |   | $                               | 32,197 |                          | $      | 27,954 |   | $ | 63,902 |   | $ | 54,857 |   |

 

***Acquisitions***

 

There were noacquisitions during the first six months of 2003.

 

During the first six months of 2002, we acquired the followingproperties:

 
| **Location**         |   | **Description** |   | **Date  Acquired** |   | **Purchase  Price** |             | **Mortgage  Assumed** |   |
|----------------------|--------|-----------------|--------|--------------------|--------|---------------------|------------------|-----------------------|--------|
|                 |   |            |   |               |   |                | **(000’s)** |                  |   | **(000’s)** |   |
| Ocala, FL            |   | Shopping Center |   | 5/3/02             |   | $                   | 7,163            |                  | $      | — |   |
| Fort Lauderdale,  FL |   | Pad             |   | 6/4/02             |   | 700                 |             | —                |   |
| Phoenix, AZ          |   | Shopping Center |   | 6/6/02             |   | 9,816               |             | 5,787                 |   |
| Columbia, SC         |   | Shopping Center |   | 6/7/02             |   | 8,035               |             | —                |   |
| Greenville, SC       |   | Shopping Center |   | 6/28/02            |   | 29,500              |             | —                |   |

 

We funded these acquisitions using proceeds from tax-deferred exchangetransactions on properties we sold in 2001 and 2002, by borrowing on ourunsecured line of credit, and assuming a mortgage.

 

***Dispositions***

 

During the first six months of 2003, we sold the following propertiesfor a net loss of $2.5 million:

 
| **Location**    |   | **Description**    |   | **Date  Sold** |   | **Sales  Price** |   |
|-----------------|--------|--------------------|--------|----------------|--------|------------------|--------|
|            |   |               |   |           |   | **(000’s)** |   |
| Scottsdale, AZ  |   | Land, Restaurant   |   | 3/31/03        |   | $                | 3,000  |   |
| Inglewood, CA   |   | Warehouse Building |   | 4/29/03        |   | 4,000            |   |
| New Britain, CT |   | Warehouse Building |   | 5/15/03        |   | 3,529            |   |
| Northridge, CA  |   | Shopping Center    |   | 6/27/03        |   | 5,850            |   |
|                 |        |                    |        |                |        |                  |        |  |

 

Also during 2003, we received payment on three notes receivable relatedto the sale of our self storage development properties in 2002.  We deferred the gain of $0.7 million on thesales until 2003, when we received payment on the notes.

 

12

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During the first six months of 2002, we sold the following propertiesfor a net loss of $0.6 million:

 
| **Location**                     |   | **Description**          |   | **Date  Sold** |   | **Sales  Price** |   |
|----------------------------------|--------|--------------------------|--------|----------------|--------|------------------|--------|
|                             |   |                     |   |           |   | **(000’s)** |   |
| Hollywood, FL                    |   | Land                     |   | 1/31/02        |   | $                | 1,410  |   |
| Tucson/Marana,  AZ               |   | Land                     |   | 1/31/02        |   | 684              |   |
| Hollywood, FL                    |   | Land                     |   | 4/19/02        |   | 1,028            |   |
| San  Diego/Pacific Beach, CA (1) |   | Self Storage Development |   | 6/1/02         |   | 11,632           |   |
| Walnut Creek, CA  (1)            |   | Self Storage Development |   | 6/1/02         |   | 7,708            |   |
| San Juan  Capistrano, CA (1)     |   | Self Storage Development |   | 6/1/02         |   | 6,918            |   |
| Glen Burnie, MD                  |   | Shopping Center          |   | 6/21/02        |   | 15,200           |   |
|                                  |        |                          |        |                |        |                  |        |  |

* *

----

*(1)    Our equity in the development was exchangedfor notes receivable with a participating interest*

 

**Note 4 –Provision for Asset Impairment**

 

We record real estate assets at historical costs and adjust them forrecognition of impairment losses. During the second quarter ended June 30, 2002, we recognized animpairment loss of $2.5 million on our Inglewood, CA property.  The tenant, House 2 Home, filed forbankruptcy and vacated, and the property was no longer generating income.  The loss was determined based on theestimated fair value of the property. The property was sold during the second quarter ended June 30, 2003.

 

**Note 5 –Discontinued Operations**

 

Included in the Consolidated Statements ofOperations are the discontinued operations of our properties at Scottsdale, AZ,Inglewood, CA, New Britain, CT, and Northridge, CA sold in 2003; and GlenBurnie, MD, and our self storage properties in San Diego/Murphy Canyon, CA,Solana Beach, CA and Azusa, CA which were sold in 2002.  Discontinued operations are summarized asfollows (amounts in thousands):

 

13

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|                                                |   | **Three  Months Ended  June 30** |   | **Six Months  Ended  June 30** |   |
|-----------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                                |   |                             |   |                           |   |   |   |   |   |
| Rental revenue                                      |   | $                                | 241    |                           | $      | 4,655 |   | $ | 512 |   | $ | 7,126 |   |
| Expenses                                            |   |                             |   |                           |   |   |   |   |   |
| Operating and  maintenance                          |   | 50                               |   | 104                            |   | 134 |   | 229 |   |
| Property taxes                                      |   | 45                               |   | 133                            |   | 135 |   | 269 |   |
| Depreciation and  amortization                      |   | 28                               |   | 378                            |   | 78 |   | 761 |   |
| Interest expense                                    |   | —                           |   | 195                            |   | — |   | 390 |   |
|                                                |   | 123                              |   | 810                            |   | 347 |   | 1,649 |   |
| Income from  operations                             |   | 118                              |   | 3,845                          |   | 165 |   | 5,477 |   |
| Provision for  asset impairment                     |   | —                           |   | (2,528                         | )      | — |   | (2,528 | ) |
| Net loss on sale  of real estate                    |   | (2,314                           | )      | (843                           | )      | (2,521 | ) | (843 | ) |
| Net (loss)  income                                  |   | $                                | (2,196 | )                              | $      | 474 |   | $ | (2,356 | ) | $ | 2,106 |   |
|                                                |   |                             |   |                           |   |   |   |   |   |
| (Loss) earnings  per common share Basic and diluted |   | $                                | (.06   | )                              | $      | .01 |   | $ | (.06 | ) | $ | .05 |   |

 

**Note 6 –Investments in Unconsolidated Real Estate Joint Ventures**

 

As of June 30, 2003 and December 31, 2002, we had the followinginvestments in unconsolidated joint ventures, which we account for under theequity method of accounting (amounts in thousands):

 
| **Joint  Venture**            |   | **Ownership %** |   | **June 30  2003** |   | **December 31  2002** |   |
|-------------------------------|--------|-----------------|--------|-------------------|--------|-----------------------|--------|
| Orlando Business  Park LLC    |   | 50              | %      | $                 | 17,074 |                  | $      | 16,020 |   |
| Old Mill  District Shops, LLC |   | 50              | %      | 3,979             |   | 3,999                 |   |
| 3017977 Nova  Scotia Company  |   | 55              | %      | 3,209             |   | 3,148                 |   |
| Blackstone  Ventures I        |   | 50              | %      | 2,512             |   | 2,546                 |   |
| Other                         |   | Various         |   | 312               |   | 306                   |   |
| Total                         |   |            |   | $                 | 27,086 |                  | $      | 26,019 |   |

 

Cash distributions and profits are typicallyallocated based on the above ownership percentages, adjusted for certainpreferred returns for capital contributions which are made in excess of eachpartners’ ownership percentages.  TheOrlando Business Park LLC assets consist primarily of land held for sale.  The other joint ventures are primarily inthe business of operating real estate. Their accounting principles are consistent with ours.

 

14

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Summarized unaudited financial informationfor the joint ventures is as follows (amounts in thousands):

 
|                          |   | **Total  Assets** |   | **Debt**               |   | **Total  Equity** |   |
|-------------------------------|--------|-------------------|--------|------------------------|--------|-------------------|--------|
| **As of  (Unaudited)**        |   | **June 30  2003** |   | **December  31  2002** |   | **June 30  2003** |   | **December  31  2002** |   | **June 30  2003** |   | **December  31  2002** |   |
|                          |   |              |   |                   |   |              |   |   |   |   |   |   |   |
| Orlando Business  Park LLC    |   | $                 | 28,182 |                   | $      | 26,069            |   | $ | 10,284 |   | $ | 11,162 |   | $ | 17,224 |   | $ | 16,024 |   |
| Old Mill  District Shops, LLC |   | 23,983            |   | 23,897                 |   | 17,470            |   | 17,356 |   | 6,273 |   | 6,314 |   |
| 3017977 Nova  Scotia Company  |   | 7,509             |   | 8,436                  |   | 5,982             |   | 5,131 |   | 3,209 |   | 3,148 |   |
| Blackstone  Ventures I        |   | 12,353            |   | 12,369                 |   | 9,918             |   | 9,982 |   | 2,044 |   | 2,071 |   |
| Other                         |   | 312               |   | 306                    |   | —            |   | — |   | 312 |   | 306 |   |
|                          |   | $                 | 72,339 |                   | $      | 71,077            |   | $ | 43,654 |   | $ | 43,631 |   | $ | 29,062 |   | $ | 27,863 |   |

** **
| **Quarter ended June 30**        |   | **Total  Revenues** |   | **Net Income  (Loss)** |   | **Company’s  Share of Net  Income (Loss)** |   |
|----------------------------------|--------|---------------------|--------|------------------------|--------|-------------------------------------------------|--------|
| **(Unaudited)**                  |   | **2003**            |   | **2002**               |   | **2003**                                        |   | **2002** |   | **2003** |   | **2002** |   |
|                             |   |                |   |                   |   |                                            |   |   |   |   |   |   |   |
| Orlando Business  Park LLC       |   | $                   | 1,200  |                   | $      | —                                          |   | $ | 1,200 |   | $ | — |   | $ | 1,055 |   | $ | — |   |
| Old Mill  District Shops, LLC    |   | 708                 |   | 805                    |   | (22                                             | )      | 211 |   | (11 | ) | 114 |   |
| 3017977 Nova  Scotia Company (1) |   | 417                 |   | 372                    |   | (60                                             | )      | (15 | ) | 2 |   | (3 | ) |
| Blackstone  Ventures I (1)       |   | 326                 |   | 322                    |   | 22                                              |   | 50 |   | 66 |   | 25 |   |
| Other                            |   | —              |   | —                 |   | —                                          |   | — |   | (98 | ) | — |   |
|                             |   | $                   | 2,651  |                   | $      | 1,499                                           |   | $ | 1,140 |   | $ | 246 |   | $ | 1,014 |   | $ | 136 |   |

* *

----

*(1)    Company’s share of net income includesadjustments for a prior period.*

 

**Note 7 –Notes Receivable**

 

We had $59.0million in principal amount of third party notes receivableoutstanding as of June 30, 2003 related to various real estate developments andrelated businesses.  Of this amount,$52.9 million relates to notes we assumed from Excel Legacy in the Merger.  The notes bear interest ranging from 2% to15% per annum.  The notes generally donot require cash payments of interest until specified future dates, typicallywhen developments are completed or sold. As of June 30, 2003, we had $14.9 million of accrued but unpaidinterest on these notes.  Of thisamount, we assumed $11.5 million from the Merger with Excel Legacy.  We typically do not recognize interestincome on non-recourse notes receivable related to development projects untilthe projects begin operations or the notes are repaid.

 

Of the $59.0million in notes receivable, as of June 30, 2003, the notesreceivable from companies owned by or affiliated with Steven Ellman (the EllmanCompanies) had an aggregate outstanding principal balance of approximately$57.5 million and the aggregate outstanding

 

15

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accrued interest on such notes receivable wasapproximately $14.9 million.  Notesreceivable of $12.2 million (principal amount and accrued interest) matured in2002.  We are in on-going negotiationswith the Ellman Companies to extend the maturity dates of these notesreceivable to up to December 31, 2004 under a signed letter agreement describedbelow.  The remainder of the notesreceivable mature at various dates in 2003 or 2004 or earlier if the relateddevelopment is sold.  Repayment of thenotes depends upon the completion of the various development projects or otherevents.  The notes receivable aregenerally non-recourse obligations, but are typically collateralized by eitherreal estate liens or pledges of ownership interests in the borrower oraffiliated entities.

 

The largest note receivable was made in 1996to enable the Ellman Companies to purchase real estate located in Scottsdale,Arizona.  The Ellman Companies currentlyplan to develop a shopping center on the Scottsdale property.  In July 2003, the City of Scottsdale enteredinto a development agreement with the Ellman Companies to govern the parties’actions going forward with respect to the development of such shopping centeron the Scottsdale property, however, the Ellman Companies have yet to resolvecertain occupancy and purchase agreement issues with the anticipated majortenants of such shopping center, and the Ellman Companies have yet to receive,among other things, the necessary government entitlements to commenceconstruction of such shopping center. In addition, we understand that a lawsuit has been filed by residents ofthe City of Scottsdale challenging certain actions by the City in approving andexecuting the development agreement, and such claims, as a practical matter,may need to be resolved to facilitate the financing and development of theproperty.  We are not in a position toassess the merits of such claims.  As ofJune 30, 2003, the outstanding principal balance on the note receivablerelating to the Scottsdale property was approximately $36.5 million and theoutstanding accrued interest on the note receivable was approximately $11.5****million. We did not accrue interest on this note in 2002 or 2003.  The note receivable currently matures on theearlier of the sale of the Scottsdale property or December 20, 2003.  The note currently is collateralized by apledge of the owners’ interests in the borrower.  In order, among other things, to facilitate the development ofthe Scottsdale property, we have engaged in negotiations with the EllmanCompanies  to extend the maturity dateof this note receivable to up to December 31, 2004, and in connection therewithto collateralize such note receivable with a second priority deed of trust onthe Scottsdale property.

 

In connection with prior development effortswith respect to the Scottsdale property, the Ellman Companies entity that ownsthe Scottsdale property obtained an additional loan from a third party

 

16

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lender. The loan is collateralized by a first priority deed of trust on theScottsdale property and was guaranteed by us. On February 27, 2003, one of our wholly owned subsidiaries purchased theloan from the lender for an aggregate purchase price of $13.0 million.  The loan matured on July 10, 2003.  We are in on-going negotiations with the EllmanCompanies to extend the maturity date of this loan under a signed letteragreement described below.

 

On March 9, 2003, we signed a letteragreement with the Ellman Companies which calls for, among other things, theestablishment of a schedule and budget with respect to the future developmentof the Scottsdale property and, upon our approval of same, the extension ofmaturity dates of the applicable notes receivable from the Ellman Companies.

 

We also have three notes receivable fromaffiliates of the Ellman Companies relating to the Ellman Companies’ ownershipin the Phoenix Coyotes hockey team. These loans were made at a time when the Ellman Companies intended torelocate the hockey team to an arena that was to be constructed on theScottsdale property.  As of June 30,2003, the aggregate outstanding principal balance of these three loans wasapproximately $19.3****million andthe aggregate outstanding accrued interest on these three loans wasapproximately $3.1 million.  Two of thethree notes receivable matured in December 2002 and the principal balance andoutstanding accrued interest on such loans is approximately $10.4 million and $2.1 million, respectively.  As noted above, we have engaged innegotiations with the Ellman Companies relating to an extension of the maturitydates of these notes receivable to up to December 31, 2004.

 

In February 2001, we entered into a letteragreement to govern the repayment of the loans described above relating to theScottsdale property and the acquisition of the Phoenix Coyotes by the EllmanCompanies.  Shortly thereafter and as aresult of delays at the Scottsdale property, the Ellman Companies elected topursue an alternative site for the hockey arena in Glendale, Arizona.  In December 2002, the Ellman Companies andthe other investors involved in the ownership of the Phoenix Coyotes enteredinto a series of transactions in which the Phoenix Coyotes hockey team, theproposed arena and related real estate development projects were consolidatedinto a single holding company for the purpose of assisting the combined entityin obtaining additional financing.  Itis unclear at this time the impact the structure will have on the repayment ofour loans made to the Ellman Companies in connection with their acquisition ofthe Phoenix Coyotes.  We stoppedaccruing interest on the loans when the development projects were consolidatedinto the holding company.  The sale ofequity interests in the holding company is expected to generate proceeds tohelp repay our notes.

 

17

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We also have two notes receivable from theEllman Companies relating to the Ellman Companies’ efforts to acquire andrefurbish an office building located in Phoenix, Arizona.  On March 9, 2003, we signed an agreementwith the Ellman Companies to acquire the Phoenix property via a deed in lieu offoreclosure agreement.  In the fourthquarter of 2002 we wrote down the value of the two notes to $1.0 million, whichwas the estimated fair value of the office building net of debt.  We have not accrued any interest on thesenotes.  One of the two notes receivablematured in December of 2002 and the second note receivable has a maturity dateof the earlier of the sale of the Phoenix property and May 28, 2004.  These notes receivable are non-recourseobligations, but are secured by a junior deed of trust on the Phoenixproperty.  In connection with thedevelopment of the Phoenix property, the borrower under these two notesreceivable obtained an additional loan from a third party lender.  The outstanding principal amount of the loanis approximately $4.5 million and the loan has a maturity date of April 5,2004, is secured by a first priority deed of trust on the Phoenix property andis guaranteed by us.

 

**Note 8 –Debt**

 

***Mortgages and Notes Payable***

We had the following mortgages and notes payable outstanding at June30, 2003 and December 31, 2002 (amounts in thousands):

** **
|                                                                                                                                                                                                                                          |   | **June 30  2003** |    | **December  31  2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|------------------------|--------|
| Mortgages on  five properties in Florida bearing interest ranging from 8.18% to 9.00%.  The loans are collateralized by the  properties and mature February 2009 and January 2010                                                        |   | $                 | 159,407 |                   | $      | 160,152 |   |
|                                                                                                                                                                                                                                          |   |              |    |                   |   |
| Mortgage payable  with GMAC Commercial Mortgage Corporation, bearing interest at LIBOR plus 98  basis points (2.10% at June 30, 2003).   The mortgage is collateralized by five of our properties and matures  June 2004                 |   | 121,375           |    | 121,375                |   |
|                                                                                                                                                                                                                                          |   |              |    |                   |   |
| Mortgages and  notes payable on nine properties bearing interest ranging from 3.17% to  8.45%.  The loans are collateralized  by the properties and mature on various dates between September 2003 and  February 2017                    |   | 96,113            |    | 101,948                |   |
|                                                                                                                                                                                                                                          |   |              |    |                   |   |
| Revolving $100.0  million credit facility bearing interest at LIBOR plus 150 to 200 basis  points (3.05% at June 30, 2003), maturing September 2004                                                                                           |   | 64,700            |    | 60,300                 |   |
|                                                                                                                                                                                                                                          |   |              |    |                   |   |
| Capital lease  arrangements with an individual on three properties.  The capital leases have effective interest  rates ranging from 4.02% to 7.36% and mature on various dates between August  2003 and June 2005                        |   | 34,084            |    | 34,052                 |   |
|                                                                                                                                                                                                                                          |   |              |    |                   |   |
| Construction  loan outstanding on a $46.0 million facility bearing interest at LIBOR plus  310 basis points (4.22% at June 30, 2003).   The loan is due March 2004 and is collateralized by a retail center in  Newport, KY (see below). |   | 28,500            |    | 38,500                 |   |
|                                                                                                                                                                                                                                          |   |              |    |                   |   |
| Mortgage on a  property in Orlando, FL bearing interest at LIBOR plus 130 basis points  (2.42% at June 30, 2003).  The loan is  collateralized by the property and matures June 2008                                                     |   | 22,100            |    | 21,888                 |   |
|                                                                                                                                                                                                                                          |   |              |    |                   |   |
| Construction  loan payable to a bank bearing interest at LIBOR plus 150 basis points (2.62%  at June 30, 2003).  The loan matures  November 2004 and is collateralized by the project                                                    |   | 16,354            |    | 5,159                  |   |
|                                                                                                                                                                                                                                          |   |              |    |                   |   |
| Note payable  outstanding on a $4.7 million facility related to Newport, KY (see below), bearing  interest at Prime plus 50 basis points (4.50% at June 30, 2003), matures  March 2004                                                        |   | 4,737             |    | 4,737                  |   |
|                                                                                                                                                                                                                                          |   |              |    |                   |   |
| Construction  loan payable to a bank bearing interest at LIBOR plus 185 basis points (2.97%  at June 30, 2003).  The loan matures  March 2005 and is collateralized by the project                                                       |   | 3,586             |    | —                 |   |
|                                                                                                                                                                                                                                          |   |              |    |                   |   |
| Total                                                                                                                                                                                                                                         |   | $                 | 550,956 |                   | $      | 548,111 |   |

 

18

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We were in compliance with all covenants onour credit facility at June 30, 2003. In 2003 we plan to use cash flow from operations to fund our recurringdebt service obligations.

 

We have a 65% interest in Newport on the Levee, LLC (Newport) that isdeveloping a retail project in Newport, KY. In addition to the $28.5 million and $4.7 million notes in the abovetable, the City of Newport has issued two series of public improvementbonds.  The Series 2000a tax exemptbonds total $44.2 million and are broken down as follows:  (a) $18.7 million maturing 2018 withinterest at 8.375%; (b) $20.5 million maturing 2027 with interest at 8.5%; and(c) $5.0 million maturing 2027 with interest at 8.375%.  The Series 2000b bonds are taxable and havea par amount of $11.6 million with interest at 11% due 2009.  The bonds are

 

19

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guaranteed by us, by Newport, and the third party co-developers of theproject.  Newport has drawn on $48.6million of the bonds at June 30, 2003.

 

Summarized debt information for ourunconsolidated joint ventures and the amount guaranteed by us at June 30, 2003is as follows:

 
| **Joint  Venture**            |   | **June 30  2003** |   | **Debt  Guaranteed** |   | **Maturity  Date** |   |
|-------------------------------|--------|-------------------|--------|----------------------|--------|--------------------|--------|
|                          |   |              |   |                 |   |               |   |
| Orlando Business  Park, LLC   |   | $                 | 10,284 |                 | $      | 10,284             |   | 6/1/04 |   |
| Old Mill  District Shops, LLC |   | 17,470            |   | 13,973               |   | 9/22/03            |   |
| Blackstone  Ventures I        |   | 9,918             |   | 3,098                |   | 10/1/04            |   |
| 3017977 Nova  Scotia Company  |   | 5,982             |   | —               |   | 6/15/04            |   |
|                          |   | $                 | 43,654 |                 | $      | 27,355             |   |   |   |

 

In addition, we have guaranteed a $4.5 million note payable to a thirdparty lender which matures in April 2004 relating to an office building inPhoenix, AZ on which we have notes receivable of $1.0 million in principalamount.

 

**Note 9 –Financial Instruments: Derivatives and Hedging**

 

In the normal course of business, we areexposed to the effect of changes in interest rates.  We limit these risks by following established risk managementpolicies and procedures including the use of derivatives.  For interest rate exposures, derivatives areused primarily to manage the cost of borrowing obligations.

 

We have a policy of only entering intoderivative contracts with major financial institutions based upon their creditratings and other factors.  When viewedin conjunction with the underlying and offsetting exposure that the derivativesare designed to hedge, we do not anticipate any material adverse effect on ournet income,  financial position, or cashflows in the future from the use of derivatives.

 

To manage interest rate risk, we may employoptions, forwards, swaps, caps and floors, or a combination thereof, dependingon the underlying exposure.  Weundertake a variety of borrowings from lines of credit to medium and long-termfinancings.  To manage overall costs, wecurrently use derivative instruments to cap our exposure to variability ininterest rates or to convert a portion of our variable-rate debt to fixed-ratedebt.  In July 2002, we paid $3.4million for forward-starting, LIBOR-based interest rate caps with a combinednotional value of $152

 

20

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million and a strike of 7.0% to cap ourexposure to interest rate variability on anticipated floating-rate debt.  The interest rate caps are effective July 1,2004, and continue through 2009 to 2010.

 

We also use derivatives to protect the fairvalue of existing or anticipated fixed-rate debt.  During 2002, we had five amortizing swaps with approximately $161million current notional value protecting the fair value of approximately $161million fixed-rate debt from changes in value attributable to interest ratemovement.  InOctober 2002, we sold our five Interest Rate Swap Agreements back to thecounter party for a $13.8 million gain and will amortize the gain over thefixed-rate debt’s remaining life through 2009 to 2010.  The interest rate caps are included withother assets on the consolidated balance sheets.

 

Hedges that are designated as fair valuehedges mitigate risk on changes in the fair value of fixed-rate debt.  The unrealized gains/losses in the fairvalue of these hedges are reported in earnings with an offsetting adjustmentthrough earnings to the carrying value of the hedged debt.  Adjustments to the carrying value of thehedged debt are amortized to earnings beginning no later than when the hedgeddebt ceases to be adjusted for changes in its fair value attributable to theinterest rate risk being hedged.

 

Cash flow hedges hedge the future cashoutflows of current or forecasted debt. The interest rate caps described above protect against variability ininterest cash outflows above the cap strike rate.  The changes in the fair value of these hedges are reported on thebalance sheet with a corresponding adjustment to either Accumulated OtherComprehensive Income or in earnings, depending on the hedgingrelationship.  Unrealized gains andlosses held in Accumulated Other Comprehensive Income will be reclassified toearnings in the same period or periods that the hedged cash flows affectearnings.  As of June 30, 2003, thebalance in Accumulated Other Comprehensive Loss relating to derivatives was$2.0 million.  Within the next twelvemonths, we do not expect to reclassify any of this balance to earnings as thecaps are forward starting and take effect July 1, 2004.

 

We hedge our exposure to the variability infuture cash flows for forecasted transactions other than interest-related cashflows over a maximum period of 12 months. During the forecasted period, unrealized gains and losses in the hedginginstrument will be reported in Accumulated

 

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Other Comprehensive Income.  Once the hedged transaction takes place, thehedge gains and losses will be reported in earnings during the same period inwhich the hedged item is recognized in earnings.  We are not currently hedging exposure to variability in futurecash flows for forecasted transactions other than interest-related cash flowson future anticipated debt.

 

**Note 10– Stock Option Plan**

 

In 2001, we established a Stock Option and Incentive Plan (the Plan)and we may grant stock options to any employee or director under thisplan.  As of June 30, 2003, we reserved3,630,000 shares for issuance under the Plan. Options generally vest over three years and expire ten years after thegrant date.  Once exercisable, theemployee or director can purchase shares of our stock at the market price onthe date we granted the option.

 

In connection with the Merger, each outstanding option to purchaseExcel Legacy common stock automatically became an option to purchase our commonstock.  The number of shares of ourcommon stock which may be purchased with these options and the exercise pricewas adjusted to reflect the exchange ratio.

 

As we stated in Note 1, we follow the provisions for APB No. 25,“Accounting for Stock Issued to Employees.” We implemented the disclosure provisions required by SFAS No. 123,“Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting forStock-Based Compensation –Transition and Disclosure –an amendment of SFASNo.123,” respectively, for our stock option plans.  SFAS No. 123 requires pro forma net income and earnings per shareinformation, which is calculated assuming we had accounted for our stock optionplans under the “fair value” method described in that statement.  We estimated the fair value of the 2002options grants using the Black-Scholes option pricing model, modified fordividends and using the following assumptions:

 
|                                    |   | **2002** |   |
|-----------------------------------------|--------|----------|--------|
| Risk free  interest rate                |   | 3.98     | %      |
| Annual dividend  rate                   |   | 0.00     | %      |
| Volatility  factor of the stock price   |   | 40.15    | %      |
| Weighted average  expected life (years) |   | 10       |   |

 

We do not record compensation expense for stock option grants, and nooptions were granted in the first six months of 2003.  The table in Note 1 summarizes results as if we had recordedcompensation expense for the 2002 option grants.

 

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**Note 11– Series B Preferred Stock**

 

In 2001, PEI entered into a Securities Purchase Agreement with Warburg,Pincus Equity Partners, L.P. and certain of its affiliates (Warburg Pincus),pursuant to which PEI agreed to sell to Warburg Pincus for an aggregatepurchase price of $100,000,000:

•                  17,985,612shares of a new class of preferred stock, 9% Series B Junior ConvertibleRedeemable Preferred Stock, par value $0.0001 per share (the Series B PreferredStock) at $5.56 per share

•                  awarrant to purchase an aggregate of 2.5 million shares of common stock at anexercise price of $8.25 per share (the Warburg Investment)

 

Also in 2001, PEI and Sol Price, a significant stockholder of PEI andExcel Legacy through various trusts, agreed to convert an existing Excel Legacyloan payable to a trust controlled by Sol Price of approximately $9.3 millioninto 1,681,142 shares of the Series B Preferred Stock and a warrant to purchase233,679 shares of our common stock at an exercise price of $8.25 per share.

 

Price Legacy issued the Series B Preferred Stock and warrants toWarburg Pincus and Sol Price concurrently with the completion of the Merger.

 

The Series B Preferred Stock is junior to the Series A Preferred Stockwith respect to dividend, liquidation and other rights, and is convertible undercertain conditions into Price Legacy common stock at a one-to-one ratio, whichmay be adjusted under certain circumstances, starting in September 2003.  The 9% coupon will be paid with additionalshares of Series B Preferred Stock at $5.56 per share for the first 45 monthsfrom issuance (until June 2005), at which time the coupon will increase to 10%payable in cash thereafter.  While noadditional shares of Series B Preferred Stock have been issued, 3,389,300 shareshave accumulated through June 30, 2003. These shares will be issued in the future.

 

**Note 12– Subsequent Event**

 

In August 2003, we agreed to sell 1,875,000 common shares of MACESecurity Int’l Inc. for $1.5 million.  Aloss of $1.6 million will be recognized on the sale.

 

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**ITEM 2****- MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

***Introduction***

 

This report on Form 10-Q contains certain “forward-looking” statementswithin the meaning of the Private Securities Litigation Reform Act of 1995which provides a “safe harbor” for these types of statements.  You can identify these forward-lookingstatements by forward-looking words such as “believe,” “may,” “could,” “will,”“estimate,” “continue,” “anticipate,” “intend,” “seek,” “plan,” “expect,”“should,” “would” and similar expressions in this report on Form 10-Q.  These forward-looking statements are subjectto a number of risks, uncertainties and assumptions about Price Legacy,including, among other things:

•                  theeffect of economic, credit and capital market conditions in general and on realestate companies in particular, including changes in interest rates

•                  ourability to compete effectively

•                  developmentsin the retail industry

•                  thefinancial stability of our tenants, including our reliance on major tenants

•                  ourability to successfully complete real estate acquisitions, developments anddispositions

•                  thefinancial performance of our properties, joint ventures and investments

•                  governmentapprovals, actions and initiatives, including the need for compliance withenvironmental requirements

•                  ourability to continue to qualify as a real estate investment trust, or REIT

 

The factors identified above are believed to be some, but not all, ofthe important factors that could cause actual events and results to besignificantly different from those that may be expressed or implied in anyforward-looking statements.  Anyforward-looking statements should also be considered in light of theinformation provided in “Factors That May Affect Future Performance” located inour Form 10-K filing for the 2002 fiscal year. We assume no obligation to publicly update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise.You are advised, however, to consult any further disclosures we make on relatedsubjects in our reports on Forms 10-K, 10-Q and 8-K filed with the SEC.  Our Form 10-K filing for the 2002 fiscalyear listed various important factors that could cause actual results to differmaterially from expected and historic results.

 

In Management’s Discussion and Analysis we explain our generalfinancial condition and results of operations including:

•                  whyrevenues, costs and earnings changed from the prior period

•                  fundsfrom operations (FFO)

•                  howwe used cash for capital projects and dividends and how we expect to use cashin the remainder of 2003

•                  wherewe plan on obtaining cash for future dividend payments and future capitalexpenditures

 

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**Critical Accounting Policies andEstimates**

 

***General***

Our discussion and analysis of our financial condition and results ofoperations are based upon our consolidated financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States of America (GAAP). Preparation of our financial statements in accordance with GAAP requiresmanagement to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses and the related notes.  We believe that the following accountingpolicies are critical because they affect the more significant judgments andestimates used in the preparation of our consolidated financialstatements.  Actual results may differfrom these estimates under different assumptions or conditions.  For a detailed discussion on the applicationof these and other accounting policies, see Note 1 in the Notes to theConsolidated Financial Statements in Item 8 of our Annual Report on Form 10-K,as amended, for the 2002 fiscal year.

 

***Consolidation***

We combine our financial statements with those of our wholly-ownedsubsidiaries as well as all affiliates in which we have control and presentthem on a consolidated basis.  Theconsolidated financial statements do not include the results of transactionsbetween us and our subsidiaries or among our subsidiaries.

 

***Revenue Recognition***

Recognition of revenue is dependent upon the quality and ability of ourtenants to pay their rent in a timely manner. Rental revenues include: (1) minimum annual rentals, adjusted for thestraight-line method for recognition of fixed future increases; (2) additionalrentals, including recovery of property operating expenses, and certain otherexpenses which we accrue in the period in which the related expense occurs; and(3) percentage rents based on the level of sales achieved by the lessee, whichwe recognize when earned.

 

Gain or loss on sale of real estate is recognized when the salescontract is executed, title has passed, payment is received, and we no longerhave continuing involvement in the asset.

 

***Real Estate Assets and Depreciation***

We record real estate assets at historical costs and adjust them forrecognition of impairment losses.  Infollowing purchase accounting, we adjusted the historical costs of ExcelLegacy’s real estate assets to fair value at the time of the Merger.  Our consolidated balance sheets at June 30,2003 and December 31, 2002 reflect the new basis of those real estate assets.

 

We expense as incurred ordinary repairs and maintenance costs, whichinclude building painting, parking lot repairs, etc.  We capitalize major replacements and betterments, which includeHVAC equipment, roofs, etc., and depreciate them over their estimated useful lives.

 

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We compute real estate asset depreciation on a straight-line basis overtheir estimated useful lives, as follows:

 
| Land improvements         |   | 40 years                                |
|---------------------------|--------|-----------------------------------------|
| Building and improvements |   | 20 to 40 years                          |
| Tenant improvements       |   | Lesser of the term of lease or 10 years |
| Fixtures and equipment    |   | 3-7 years                               |

 

We review long-lived assets for impairment when events or changes inbusiness conditions indicate that their full carrying value may not berecovered.  We consider assets to beimpaired and write them down to fair value if their expected associated futureundiscounted cash flows are less than their carrying amounts.

 

We capitalize interest incurred during the construction period ofcertain assets and this interest is depreciated over the lives of those assets.

 

Pre-development costs that are directly related to specificconstruction projects are capitalized as incurred.  We expense these costs to the extent they are unrecoverable or itis determined that the related project will not be pursued.

 

***Derivative Instruments and HedgingActivities***

 

We follow the provisions of SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities.”  In the normal course of business, we may usederivative financial instruments to manage or hedge interest rate risk.  When entered into, we formally designate anddocument the financial instrument as a hedge of a specific underlying exposure,as well as the risk management objectives and strategies for undertaking thehedge transactions.  We assess, both atthe inception and at least quarterly thereafter, whether the financialinstruments that are used in hedging transactions are effective at offsettingchanges in either the fair value or cash flows of the related underlying exposure.  Because of the high degree of effectivenessbetween the hedging instrument and the underlying exposure being hedged,fluctuations in the value of the derivative instruments are generally offset bychanges in the fair value or cash flows of the underlying exposures beinghedged.  Any ineffective portion of afinancial instrument’s change in fair value is immediately recognized inearnings. Virtually all of our derivatives are straightforward over-the-counterinstruments with liquid markets.

 

To determine the fair values of derivative instruments, we use avariety of methods and assumptions that are based on market conditions andrisks existing at each balance sheet date. For the majority of financial instruments including most derivatives,long-term investments and long-term debt, standard market conventions andtechniques such as discounted cash flow analysis, option pricing models,replacement cost, and termination cost are used to determine fair value. Allmethods of assessing fair value result in a general approximation of value, andsuch value may never actually be realized.

 

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***Asset Disposal***

In August 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses financial accounting for the impairment ordisposal of long-lived assets and is effective in fiscal years beginning afterDecember 15, 2001.  We have adopted thisstatement and report discontinued operations for the quarter and six monthperiods ended June 30, 2003 and June 30, 2002.

 

***Rental Revenues***

 
|               |   | **Amount** |   | **Change** |   | **Percent  Change** |   |
|--------------------|--------|------------|--------|------------|--------|---------------------|--------|
| 2nd Quarter 2003   |   | $          | 32,197 |       | $      | 4,243               |   | 15 | % |
| 2nd Quarter 2002   |   | 27,954     |   | —     |   | —              |   |
|               |   |       |   |       |   |                |   |
| Year-to-Date  2003 |   | 63,902     |   | 9,045      |   | 16                  | %      |
| Year-to-Date  2002 |   | 54,857     |   | —     |   | —              |   |
|                    |        |            |        |            |        |                     |        |  |  |

 

Revenues increased $4.2 million to $32.2 million in the second quarterof 2003 compared to the same period in 2002 primarily because:

 

•                  propertieswe acquired during 2002 generated $3.7 million of additional revenues

•                  propertieswe owned both years generated $0.5 million of additional revenues, primarilydue to additional leasing activity at our Newport, KY and Moorestown, NJproperties and the opening of our Temecula, CA property.  These increases were partially offset byvacancies at our Westbury, NY property due to Kmart’s bankruptcy  and our Wayne, NJ property due to Today’sMan and The Wiz bankruptcies

 

Revenues increased $9.0 million to $63.9 million in the six monthyear-to-date period of 2003 compared to the same period in 2002 primarilybecause:

 

•                  propertieswe acquired during 2002 generated $7.7 million of additional revenues

•                  propertieswe owned both years generated $1.3 million of additional revenues, primarilydue to additional leasing activity at our Newport, KY and Moorestown, NJlocations and the opening of our Temecula, CA property.  These increases were partially offset byvacancies at our Westbury, NY, Wayne, NJ, and Miami, FL properties due to thebankruptcies of Kmart, Today’s Man, and The Wiz.

 

***Expenses***

 
|               |   | **Amount** |   | **Change** |   | **Percent  Change** |   |
|--------------------|--------|------------|--------|------------|--------|---------------------|--------|
| 2nd Quarter 2003   |   | $          | 18,325 |       | $      | 4,429               |   | 32 | % |
| 2nd Quarter 2002   |   | 13,896     |   | —     |   | —              |   |
|               |   |       |   |       |   |                |   |
| Year-to-Date  2003 |   | 34,520     |   | 5,758      |   | 20                  | %      |
| Year-to-Date  2002 |   | 28,762     |   | —     |   | —              |   |
|                    |        |            |        |            |        |                     |        |  |  |

 

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Expenses increased $4.4 million to $18.3 million in the second quarterof 2003 compared to 2002 primarily because:

 

•                  expenseson properties we owned both years increased $2.9 million, primarily due toincreased depreciation at our Newport, KY location and increased bad debtexpense at our Wayne, NJ property due to the bankruptcies of Today’s Man andThe Wiz

•                  expenseson properties we acquired in 2002 generated $1.3 million of additional expensesin 2003

•                  generaland administrative expense increased $0.2 million, primarily due to additionallegal expenses

 

Expenses increased $5.8 million to $34.5 million for the year-to-dateperiod ended June 30, 2003 compared to 2002 primarily because:

 

•                  expensesfrom properties we owned in both years increased by $3.7 million, primarily dueto increased depreciation expense at our Newport, KY location and increased baddebt expense at our Wayne, NJ property due to the bankruptcies of Today’s Manand The Wiz

•                  expenseson properties we acquired in 2002 generated $2.6 million of additional expensesin 2003

•                  theseincreases to expenses were partially offset by a decrease to general andadministrative expenses of $0.6 million due to higher legal costs in the firstquarter of 2002 related to our investment in Destination Villages, LLC

 

***Operating Income***

 
|               |   | **Amount** |   | **Change** |   | **Percent  Change** |   |
|--------------------|--------|------------|--------|------------|--------|---------------------|--------|
| 2nd Quarter 2003   |   | $          | 13,872 |       | $      | (186                | )      | -1 | % |
| 2nd Quarter 2002   |   | 14,058     |   | —     |   | —              |   |
|               |   |       |   |       |   |                |   |
| Year-to-Date  2003 |   | $          | 29,382 |       | 3,287  |                | 13     | % |
| Year-to-Date  2002 |   | 26,095     |   | —     |   | —              |   |
|                    |        |            |        |            |        |                     |        |  |  |

 

Operating income decreased for the second quarter and increased for theyear-to-date periods of 2003 compared to the same periods in the prior yearprimarily because of the changes in Rental Revenues and Expenses discussedabove.

 

***Interest Expense***

 
|               |   | **Amount** |   | **Change** |   | **Percent  Change** |   |
|--------------------|--------|------------|--------|------------|--------|---------------------|--------|
| 2nd Quarter 2003   |   | $          | 6,659  |       | 1,013  |                | 18     | % |
| 2nd Quarter 2002   |   | 5,646      |   | —     |   | —              |   |
|               |   |       |   |       |   |                |   |
| Year-to-Date  2003 |   | 13,269     |   | 1,381      |   | 12                  | %      |
| Year-to-Date  2002 |   | 11,888     |   | —     |   | —              |   |
|                    |        |            |        |            |        |                     |        |  |

 

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Interest expense increased $1.0 million in the second quarter of 2003compared to 2002 because during the second quarter of 2003 we had an average of$558.2 million debt outstanding compared to $494.4 million in the secondquarter of 2002.  Interest expenseincreased $1.4 million for the six month year-to-date period compared to 2002because we had an average of $552.9 million debt outstanding compared to $492.7million during the same period of 2002. The increase in interest expense due to the amount of debt outstandingwas partially offset by a decrease in interest rates on our variable rate debt.

 

The weighted average interest rate on our variable rate debt decreasedto 2.8% on June 30, 2003 from 3.5% on June 30, 2002.  We discuss our outstanding debt further in “Liquidity and CapitalResources” located elsewhere in this Form 10-Q.

 

***Interest Income***

 
|               |   | **Amount** |   | **Change** |   | **Percent  Change** |   |
|--------------------|--------|------------|--------|------------|--------|---------------------|--------|
| 2nd Quarter 2003   |   | $          | 113    |       | $      | (1,006              | )      | -90 | % |
| 2nd Quarter 2002   |   | 1,119      |   | —     |   | —              |   |
|               |   |       |   |       |   |                |   |
| Year-to-Date  2003 |   | 925        |   | (1,463     | )      | -61                 | %      |
| Year-to-Date 2002  |   | 2,388      |   | —     |   | —              |   |
|                    |        |            |        |            |        |                     |        |  |  |

 

Interest income decreased $1.0 million in the second quarter of 2003compared to 2002 primarily because:

 

•                  westopped accruing interest on certain notes receivable when development projectswere added as collateral in 2002 to repay the notes, which decreased interestincome by $0.9 million

•                  inthe third quarter of 2002, we retired the notes receivable from certain of ourofficers which were collateralized by our common shares.  Emerging Issues Task Force 00-23 required usto account for these loans as being retired and the shares as beingrepurchased.  This decreased interestincome by $0.2 million

 

Interest income decreased $1.5 million in the six month year-to-dateperiod ended June 30, 2003 compared to the same period in 2002 primarilybecause:

•                  westopped accruing interest on certain notes receivable when development projectswere added as collateral in 2002 to repay the notes, which decreased interestincome by $1.0 million

•                  officers’notes receivable, which we retired in 2002, decreased interest income $0.4million

•                  interestincome on our outstanding cash balances decreased $0.1 million

 

***Gain/Loss on Sale of Real Estate***

During the first six months of 2003, we sold the following propertiesfor a net loss of $2.5 million.  Thisloss is recorded as discontinued operations in the Consolidated Statements ofOperations in accordance with SFAS No.144:

 

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| **Location**    |   | **Description**    |   | **Date  Sold** |   | **Sales  Price  (000’s)** |   |
|-----------------|--------|--------------------|--------|----------------|--------|--------------------------------|--------|
| Scottsdale, AZ  |   | Land, Restaurant   |   | 3/31/03        |   | $                              | 3,000  |   |
| Inglewood, CA   |   | Warehouse Building |   | 4/29/03        |   | 4,000                          |   |
| New Britain, CT |   | Warehouse Building |   | 5/15/03        |   | 3,529                          |   |
| Northridge, CA  |   | Shopping Center    |   | 6/27/03        |   | 5,850                          |   |
|                 |        |                    |        |                |        |                                |        |  |

 

Also during 2003, we received payment on three notes receivable relatedto the sale of our self storage development properties in 2002.  We recognized a gain of $0.7 million on thesales.

 

During the first six months of 2002, we sold the followingnon-depreciable properties for a net gain of $0.3 million:

 
| **Location**                 |   | **Description**          |   | **Date  Sold** |   | **Sales  Price  (000’s)** |   |
|------------------------------|--------|--------------------------|--------|----------------|--------|--------------------------------|--------|
| Hollywood, FL                |   | Land                     |   | 1/31/02        |   | $                              | 1,410  |   |
| Tucson/Marana,  AZ           |   | Land                     |   | 1/31/02        |   | 684                            |   |
| Hollywood, FL                |   | Land                     |   | 4/19/02        |   | 1,028                          |   |
| San  Diego/Pacific Beach, CA |   | Self Storage Development |   | 6/1/02         |   | 11,632                         |   |
| Walnut Creek, CA             |   | Self Storage Development |   | 6/1/02         |   | 7,708                          |   |
| San Juan  Capistrano, CA     |   | Self Storage Development |   | 6/1/02         |   | 6,918                          |   |
|                              |        |                          |        |                |        |                                |        |  |

 

Also during the first six months of 2002, we sold the followingoperating property and recorded a net loss of $0.8 million.  This loss is recorded as discontinuedoperations in the Consolidated Statements of Operations in accordance with SFASNo.144.

 
| **Location**    |   | **Description** |   | **Date  Sold** |   | **Sales  Price  (000’s)** |   |
|-----------------|--------|-----------------|--------|----------------|--------|--------------------------------|--------|
| Glen Burnie, MD |   | Shopping Center |   | 6/21/02        |   | $                              | 15,200 |   |
|                 |        |                 |        |                |        |                                |        |  |

 

***Funds From Operations***

 
|                                                      |   | **Three  Months  Ended June 30** |   | **Six Months  Ended June 30** |   |
|-----------------------------------------------------------|--------|----------------------------------|--------|-------------------------------|--------|
|                                                      |   | **2003**                         |   | **2002**                      |   | **2003** |   | **2002** |   |
| Net income                                                |   | $                                | 6,144  |                          | $      | 10,144 |   | $ | 16,533 |   | $ | 19,306 |   |
| Depreciation and  amortization                            |   | 5,828                            |   | 3,945                         |   | 10,181 |   | 7,987 |   |
| Depreciation and  amortization of discontinued operations |   | 28                               |   | 378                           |   | 78 |   | 761 |   |
| Price Legacy’s  share of joint venture depreciation  |   | 338                              |   | 152                           |   | 517 |   | 306 |   |
| Depreciation of  non-real estate assets                   |   | (31                              | )      | (35                           | )      | (62 | ) | (68 | ) |
| Provision for  asset impairment                           |   | —                           |   | 2,528                         |   | — |   | 2,528 |   |
| Net loss on sale  of depreciable real estate              |   | 2,314                            |   | 843                           |   | 1,834 |   | 843 |   |
| FFO before  preferred dividends                           |   | 14,621                           |   | 17,955                        |   | 29,081 |   | 31,663 |   |
| Preferred  dividends                                      |   | (12,423                          | )      | (12,183                       | )      | (24,783 | ) | (24,308 | ) |
| FFO                                                       |   | $                                | 2,198  |                          | $      | 5,772 |   | $ | 4,298 |   | $ | 7,355 |   |
|                                                      |   |                             |   |                          |   |   |   |   |   |
| Net cash provided  by (used in):                          |   |                             |   |                          |   |   |   |   |   |
| Operating  activities                                     |   | $                                | 7,449  |                          | $      | 13,989 |   | $ | 22,109 |   | $ | 23,788 |   |
| Investing  activities                                     |   | 10,036                           |   | (41,372                       | )      | 488 |   | (58,639 | ) |
| Financing  activities                                     |   | (12,094                          | )      | 11,703                        |   | (16,359 | ) | 18,422 |   |

 

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Our Company, as well as real estate industry analysts, generallyconsiders FFO as another measurement of economic profitability for realestate-oriented companies.  The Board ofGovernors of the National Association for Real Estate Investment Trusts(NAREIT) defines FFO as net income in accordance with GAAP, excludingdepreciation and amortization expense and gains (losses) from depreciableoperating real estate.  We calculate FFOin accordance with the NAREIT definition which also excludes provisions forasset impairments and gains (losses) from the sale of investments, and adjustfor preferred dividends.  We believethat FFO is helpful to investors as a measure of our financial performancebecause, along with cash flow from operating activities, financing activitiesand investing activities, FFO provides investors with an indication of theability of a REIT to incur and service debt, to make capital expenditures andto fund other cash needs.  In addition,we believe that FFO provides useful information about our performance whencompared to other REITs since FFO is generally recognized as the industrystandard for reporting the operations of REITs.  FFO does not represent the cash flows from operations defined byGAAP, may not be comparable to similarly titled measures of other companies andshould not be considered as an alternative to net income as an indicator of ouroperating performance or to cash flows as a measure of liquidity.  Excluded from FFO are significant componentsin understanding our financial performance.

 

FFO before preferred dividends during the second quarter of 2003decreased $3.3 million or 18.6% to $14.6 million compared to the second quarterof 2002 primarily because:

 

•                  propertiessold contributed an additional $4.3 million to FFO in the prior year, primarilydue to a lease termination fee of $2.3 million received in 2002 for a propertywe sold in 2003

•                  additionalinterest expense reduced FFO by $1.0 million

•                  decreasedinterest income reduced FFO by $1.0 million

•                  propertieswe owned in both years decreased FFO by $1.0 million, primarily due toadditional operating expenses

•                  additionalgeneral and administrative expenses which decreased FFO by $0.2 million

•                  partiallyoffsetting these decreases are increases to FFO for the following:

•                  propertieswe acquired in 2002 increased FFO $2.9 million

•      joint ventureincome contributed an additional $1.1 million to FFO in the current quarter

 

FFO before preferred dividends during the six month year-to-date periodof 2003 decreased $2.6 million or 8.2% to $29.1 million compared to the secondquarter of 2002 primarily because:

 

•                  propertiessold contributed an additional $6.4 million to FFO in the prior year

•                  decreasedinterest income, which reduced FFO by $1.5 million

•                  increasedinterest expense, which reduced FFO by $1.4 million

•                  propertieswe owned in both years decreased FFO by $1.3 million, primarily due toadditional operating expenses

•                  partiallyoffsetting these decreases are increases to FFO for the following:

•                  propertieswe acquired in 2002, which increased FFO $6.1 million

 

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•                  jointventure income, which contributed an additional $1.1 million to FFO

•                  lowergeneral and administrative expenses, which increased FFO $0.6 million

 

**Liquidityand Capital Resources**

 

Liquidity refers to our ability to generate sufficient cash flows tomeet the short and long-term cash requirements of our business operations.  Capital resources represent those funds usedor available to be used to support our business operations and consist ofstockholders’ equity and debt.

 

Cash flow from operations has been the principal source of capital tofund our ongoing operations and dividend payments, while asset sales and use ofour credit facilities and mortgage financing have been the principal sources ofcapital required to fund our growth. While we are positioned to finance our business activities through avariety of sources, we expect to satisfy short-term liquidity requirementsthrough net cash provided by operations and through borrowings.

 

***Dividends***

As a REIT, we are required to distribute 90% of our taxable income,excluding capital gains, in dividends. Our Series A Preferred Stock requires a quarterly dividend payment of$9.6 million, an annual total of $38.4 million.  In connection with the Merger, we assumed a net operating loss(NOL) of approximately $18.7 million, which could be used to offset federaltaxable income.  In the future, if ourSeries A Preferred dividend is less than 90% of our taxable income (afterapplying any applicable NOLs), we have two options to meet the distributionrequirement:

1)              We can declare a Series B Preferred Stockdividend by issuing additional Series B Preferred shares.  The Series B Preferred Stock dividendsaccumulate at a rate of 9%, compounded quarterly, payable in additional sharesof Series B Preferred Stock until June 2005, and 10%, compounded quarterly,payable in cash thereafter.  As of June30, 2003, the Series B Preferred stockholders were entitled to approximately3.4 million additional shares.

2)              We can declare adividend to our common stockholders.

 

If our taxable income is less than the Series A Preferred Stockdividends, we are still obligated to pay them. If we are unable to pay these dividends when due, they accumulate untilpaid.

 

***Debt***

In September 2001, we obtained a $100.0 million unsecured creditfacility with Fleet Bank as agent.  Thefacility has a three-year term and has a current interest rate of LIBOR plus187.5 basis points.  The rate may varybetween 150 and 200 basis points based on our leverage and other financialratios.  At June 30, 2003, we had $64.7million outstanding on the facility at a 3.1% weighted average interest rate.

 

Our credit facility requires us to comply with specified financialcovenants, the most restrictive of which relate to fixed charge coverage andleverage.  Covenants in some of ourconstruction

 

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loans are also tied to our credit facility.  We were in compliance with all covenants in our credit facilityat June 30, 2003.  To the extent that weviolate any of these covenants in the future, we would need to obtain waiversfrom our lenders to maintain compliance. We cannot assure that any such waivers would be forthcoming.

 

In 2003 we had or will have the following significant debt maturities:

•                  InApril 2003, a $38.5 million construction loan related to our project inNewport, KY matured.  We extended theloan for another year and paid-down $10.0 million on the outstandingamount.  The current loan balance is$28.5 million.

•                  InApril 2003, a $22 million loan related to our project in Orlando, FLmatured.  We refinanced this debt with anew loan which matures in June 2008.

•                  InMay 2003, a $4.7 million loan related to our property in Newport, KYmatured.  The lender extended this loanfor another year.

•                  InJune 2003, a $3.2 million loan related to our property in Terre Haute, INmatured.  We repaid this loan withavailable cash.

•                  OnAugust 31, 2003 we will repay a $3.1 million capital lease obligation relatedto our Scottsdale, AZ office building at the lessor’s request.  We plan to repay this obligation withavailable cash.

 

On September 28, 2003, a $6.3 million note related to our Anaheimproject matures.  We plan to repay thisnote with available cash or borrowing on our unsecured line of credit.

 

The following table summarizes all of our long-term contractualobligations, excluding interest, to pay third parties as of June 30, 2003:

 
|                        |   | **Contractual Cash Obligations** |   |
|-----------------------------|--------|----------------------------------|--------|
|                        |   | **2003**                         |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   |
| Mortgages and notes payable |   | $                                | 10,959 |   | $ | 250,809 |   | $ | 26,640 |   | $ | 33,011 |   | $ | 3,343 |   | $ | 226,194 |   | $ | 550,956 |   |
| Capital lease obligations   |   | 399                              |   | 796 |   | 796 |   | 796 |   | 796 |   | 15,455 |   | 19,038 |   |
| Total                       |   | $                                | 11,358 |   | $ | 251,605 |   | $ | 27,436 |   | $ | 33,807 |   | $ | 4,139 |   | $ | 241,649 |   | $ | 569,994 |   |

 

In 2003 we plan to use cash flow from operations to fund our recurringdebt service obligations.

 

***Off-Balance Sheet Financing Matters***

The City of Newport, KY in 1999 issued two series of public improvementbonds related to our project in Newport, KY. The Series 2000a tax exempt bonds total $44.2 million and are brokendown as follows: (a) $18.7** **million maturing 2018 with interestat 8.375%; (b) $20.5 million maturing 2027 with interest at 8.5%; and (c) $5.0million maturing 2027 with interest at 8.375%. The Series 2000b bonds are taxable and have a par amount of $11.6million with interest at 11% due 2009. The bonds are guaranteed by the Newport project, the Company, and theproject’s third party developers.  As ofJune 30, 2003, Newport had drawn on $48.6** **million of the bonds for constructionincurred prior to that date.

 

We also have guaranteed the following off-balance sheet debt withmaturities in 2003:

 

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•                  OnFebruary 28, 2003, a $12.9 million bank loan related to a development projectin Scottsdale, AZ matured.  We have anote receivable to a developer related to this project and guaranteed the bankloan.  On February 27, 2003, wepurchased the loan from the lender for an aggregate purchase price of $13.0million, which was funded through borrowing on our credit facility.

 

•                  Wehave a $10.3 million loan related to land we own in Orlando, FL through a jointventure.  This loan is guaranteed by usand by our partner.  Beginning November2003, the loan requires monthly principal repayments of $1.5 million.  If this land is not refinanced beforeNovember 2003, we anticipate funding these repayments on behalf of the partnership.  In April 2003, we repaid $1.0 million onthis loan with funds we received as a non-refundable deposit from a potentialbuyer.

 

Summarized debt information for ourunconsolidated joint ventures and the amount guaranteed by us at June 30, 2003is as follows:

 
| **Joint  Venture**            |   | **June 30  2003** |   | **Debt  Guaranteed** |   | **Maturity  Date** |   |
|-------------------------------|--------|-------------------|--------|----------------------|--------|--------------------|--------|
|                          |   |              |   |                 |   |               |   |
| Orlando Business  Park, LLC   |   | $                 | 10,284 |                 | $      | 10,284             |   | 6/1/04 |   |
| Old Mill  District Shops, LLC |   | 17,470            |   | 13,973               |   | 9/22/03            |   |
| Blackstone  Ventures I        |   | 9,918             |   | 3,098                |   | 10/1/04            |   |
| 3017977 Nova  Scotia Company  |   | 5,982             |   | —               |   | 6/15/04            |   |
|                          |   | $                 | 43,654 |                 | $      | 27,355             |   |   |   |

 

In addition, we have guaranteed a $4.5 million note payable to a thirdparty lender which matures in April 2004 relating to an office building inPhoenix, AZ on which we have notes receivable of $1.0 million in principalamount.

 

In connection with the sale of three self storage developmentproperties in September 2002, we agreed to guarantee $19.3 million of debtassociated with the properties that was assumed by the buyer in the transaction.  In January 2003, the guarantee was reducedto $4.6 million and the remaining $4.6 million guarantee was eliminated in May2003.

 

***Development***

We have a significant retail project in Newport, KY.  The majority of the construction wascompleted in October 2001, with all of the primary buildings completed exceptfor one out parcel yet to be leased. The project opened in October 2001. At June 30, 2003, the project was approximately 78% occupied, excludingground leases.  As the project becomesfully leased, there may be capital required to fund the remaining tenantimprovements.

 

The Anaheim GardenWalk project in Anaheim, CA, located between Disney’stwo Theme Parks on Harbor Boulevard and Disney’s new proposed Theme Park onKatella Avenue is expected to consist of a 626,000 square foot open-air retailcenter and four hotels.  Total cost ofthe retail portion of this project will be approximately $250 million with anestimated cost of $200 million remaining to complete construction over the nexteight years for all phases.  Weanticipate that 

 

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the first phase of the project will cost approximately $125million.  We are currently evaluatingour options on this project.

 

We also have retail development projects in which construction willcontinue through 2004.  The Temecula, CAproject is an open-air retail shopping center with Wal-Mart, Kohl’s and othertenants.  We estimate $0.6 millionremaining to complete construction.  Weexpect to fund the remaining cost through a construction loan.  In December 2002, we purchased additionalland adjacent to this development project to develop an additional open-airretail center.  We estimate the totalcost of this development to be approximately $14.4 million with an estimated$9.8 million remaining to complete construction, which we plan to fund througha construction loan.

 

In November 2002, we purchased land adjacent to our property inOrlando, FL to develop an open-air retail center.  We estimate the total cost of this development to beapproximately $21 million with an estimated $9.3 million remaining to completeconstruction, which we will fund through a construction loan.

 

***Notes Receivable***

We had $59.0****million inprincipal amount of third party notes receivable outstanding as of June 30,2003 related to various real estate developments and related businesses.  The notes bear interest ranging from 2.0% to15% per annum.  The notes generally donot require cash payments of interest until specified future dates, typicallywhen developments are completed or sold. As of June 30, 2003, we had $14.9 million of accrued but unpaid intereston these notes.  Of this amount, weassumed $11.5 million from the Merger with Excel Legacy.  We typically do not recognize interestincome on these notes receivable until development projects beginoperations.  Of the $59.0****million in notes receivable, as of June30, 2003, the notes receivable from companies owned by or affiliated withSteven Ellman (the Ellman Companies) had an aggregate outstanding principalbalance of approximately $57.5 million and the aggregate outstanding accruedinterest on such notes receivable was approximately $14.9 million.  Notes receivable of $12.2 million (principalamount and accrued interest) matured in 2002 and on-going negotiations with theEllman Companies contemplate an extension of the maturity dates of these notesreceivable to up to December 31, 2004. The remainder of the notes receivable mature at various dates in 2003 or2004 or earlier if the related development is sold.  Repayment of the notes depends upon the completion of the variousdevelopment projects or other events. The notes receivable are generally non-recourse obligations, but aretypically collateralized by either real estate liens or pledges of ownershipinterests in the borrower or affiliated entities.

 

***Growth***

We continue to evaluate various properties for acquisition ordevelopment and continue to evaluate other investment opportunities.  We anticipate borrowing available amounts onour credit facility or mortgages to fund these acquisition and developmentopportunities.  We also anticipateobtaining construction loans to fund our development activities.  We did not purchase any properties duringthe first six months of 2003.

 

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From time to time we will consider selling properties to better alignour portfolio with our geographic and tenant composition strategies.  We may also participate in additionaltax-deferred exchange transactions, which allow us to dispose of properties andreinvest the proceeds in a tax efficient manner.  During the six months ended June 30, 2003 we sold four propertiesand a land parcel for $16.4 million. When we sell an operating property, we anticipate a temporary reductionin operating income due to the time lag between selling a property andreinvesting the proceeds.

 

We are contemplating purchasing various properties and selling certainother properties.  As we sellproperties, our cash flows from operations may decrease until the proceeds arereinvested into new properties.

 

***Litigation***

We own a 55% interest in Destination Villages LLC, which indirectlyowns a hospitality project located in Bermuda, Daniel’s Head Village Resort(Daniel’s Head).  Daniel’s Head wasclosed in the fourth quarter of 2001, primarily due to low occupancy rates as aresult of the terrorist events in the United States that occurred on September11, 2001.  The project was encumbered bya $6 million loan with a Bermuda bank.  In March 2002, we informed the Bermuda bank that we did not intendto re-open this project due to large projected operating losses and insteadintended to sell the project to an identified buyer.  This resulted in a default of the loan.  On March 27, 2002, the Bermuda bank exercised its rights underBermuda law and put the project in “receivership,” which gives the bank theright to negotiate directly with this buyer as well as other potentialbuyers.  On June 13, 2002 the BermudaBank filed a lawsuit against us in Bermuda for $6.1 million plus other costsrelated to a guarantee agreement for a promissory note on the DestinationVillages Daniel’s Head project in Bermuda. We believe we were in full compliance with the guarantee and intend tovigorously defend the lawsuit.  On June3, 2003, trial of this matter commenced in Bermuda.  On June 6, 2003, the trial was temporarily suspended due toillness of counsel.  The matter iscurrently expected to be reset by the court for November 2003.

 

On or about February 13, 2001, Lewis P. Geyser filed a lawsuit againstExcel Legacy in Santa Barbara County Superior Court, Anacapa Division, Case No.01038577.  The suit arose out of anOperating Agreement for Destination Villages, LLC, an entity which is ownedjointly by Excel Legacy and Mr. Geyser, under which Destination Villages, LLCwould develop certain eco-tourism resorts. The complaint included causes of action for breach of contract, breachof fiduciary duty, fraud and negligent misrepresentation.  The lawsuit included a prayer forcompensatory and punitive damages. Excel Legacy had also filed a cross-complaint against Mr. Geyser forbreach of contract, fraud, breach of fiduciary duty and other related claims.

 

The trial of this matter began February 26, 2002 and concluded on March19, 2002.  The trial judge dismissedboth the complaint and cross-complaint, and granted nothing to Mr. Geyser underany of his allegations.  On June 5,2002, Mr. Geyser filed an appeal and Excel Legacy subsequently filed across-appeal against Mr. Geyser.  On May12, 2003, the appellate court reversed the judgment of dismissal on thecomplaint and cross-complaint and remanded the case for retrial.  The court has not yet set a date for theretrial of the matter.  We believe thatour 

 

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positions have merit and intend to vigorously defend against Mr.Geyser’s claims and pursue our counterclaims.

 

***Other***

In April 2002, we entered into five Interest Rate Swap Agreements withFleet Bank that are accounted for under SFAS No. 133 and sold them in October2002.  The combined notional amount wasapproximately $161 million and the maturities ranged from 2009 to 2010.  We paid monthly interest of LIBOR plus 3.08%to 3.77% and Fleet Bank assumed our fixed rates of 8.18% to 9.00%.  These swaps hedged the fair value offixed-rate debt.  In October 2002, wesold the five swaps back to the counter party for $13.8 million and willamortize the gain over the fixed-rate debt’s remaining life through 2009 to 2010.

 

In July 2002, we entered into four Interest Rate Cap Agreements withWells Fargo Bank and Fleet Bank that are also accounted for under SFAS No.133.  The combined notional amount is$152.0 million and the maturities range from 2009 to 2010.  The agreements cap our variable rate risk onone month LIBOR interest at 7%.

 

**Inflation**

Because a substantial number of our leases contain provisions for rentincreases based on changes in various consumer price indices, based on fixedrate increases, or based on percentage rent if tenant sales exceed certain baseamounts, we do not expect inflation to have a material impact on future netincome or cash flow from developed and operating properties.  In addition, substantially all retail leasesare triple net, which means specific operating expenses and property taxes arepassed through to the tenant.

 

**ITEM 3****- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

Market risks relating to our operations result primarily from changesin short-term LIBOR interest rates.  Wedo not have any significant foreign exchange or other material market risk.

 

Our exposure to market risk for changes in interest rates relatesprimarily to our variable interest rate debt. We enter into variable rate debt obligations to support generalcorporate purposes, including acquisitions, capital expenditures and workingcapital needs.  We continuously evaluateour level of variable rate debt with respect to total debt and other factors,including our assessment of the current and future economic environment.

 

We had $228.7 million in variable rate debt outstanding at June 30,2003.  Based upon these year-end debtlevels, a hypothetical increase in interest rates by 100 basis points wouldincrease interest expense by approximately $2.3 million on an annual basis, andlikewise decrease our earnings and cash flows. We cannot predict market fluctuations in interest rates and their impacton our variable rate debt, nor can there be any assurance that fixed ratelong-term debt will be available to us at favorable rates, if at all.  Consequently, future results may differmaterially from the estimated adverse changes discussed above.

 

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In July 2002, in order to mitigate ourvariable interest rate exposure, we acquired four interest rate caps, whichhedge our exposure on $152 million of variable rate debt.  The hedges limit our exposure to theone-month LIBOR index associated with certain of our outstanding debt at7%.  To the extent the one-month LIBORindex exceeds 7%, the counter parties on the hedges will pay us the differencebetween the actual index and 7%.

 

The following table presents the scheduled principal payments on notesreceivable and the scheduled principal payments on mortgages payable over thenext five years and thereafter.  Thetable also includes the average interest rates of the financial instrumentsduring each respective year and the fair value of the notes receivable andmortgages payable.  We determine thefair value of financial instruments through the use of discounted cash flowsanalysis using current interest rates for notes receivable with terms andcredit characteristics similar to our existing portfolio and borrowings underterms similar to our existing mortgages payable.

 
|                                              |   | **Expected Maturity Date|  (dollar amounts in thousands)** |   |
|---------------------------------------------------|--------|------------------------------------------------------------|--------|
|                                              |   | **2003**                                                   |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   | **Fair  Value** |   |
| Notes receivable, including notes from affiliates |   | $                                                          | 45,992 |   | $ | 12,975 |   | — |   | — |   | — |   | — |   | $ | 58,967 |   | $ | 58,967 |   |
| Average interest rate                             |   | 12                                                         | %      | 14 | % | — |   | — |   | — |   | — |   | 12 | % |   |   |
| Mortgages and notes payable                       |   | $                                                          | 10,959 |   | $ | 250,809 |   | $ | 26,640 |   | $ | 33,011 |   | $ | 3,343 |   | $ | 226,194 |   | $ | 550,956 |   | $ | 565,569 |   |
| Average interest rate                             |   | 6                                                          | %      | 3 | % | 7 | % | 4 | % | 8 | % | 7 | % | 5 | % |   |   |
|                                                   |        |                                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

**ITEM 4****– CONTROLS AND PROCEDURES**

 

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the rules and forms of the Securities and Exchange Commission, and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure.  In designing and evaluating the disclosure controls andprocedures, management recognized that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationshipof possible controls and procedures.

 

As of June 30, 2003, the end of the quarter covered by this report,under the supervision and with the participation of certain management,including our Chief Executive Officer and Chief Financial Officer, we evaluatedthe effectiveness of the design and operation of our disclosure controls andprocedures.  Based on the foregoing, ourChief Executive Officer and Chief Financial Officer concluded that theCompany’s disclosure controls and procedures were effective at the reasonableassurance level.

 

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There have been no significant changes in our internal controls overfinancial reporting during the quarter covered by this report that havematerially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting.

 

**PART II****- OTHER INFORMATION**

 

**ITEM 1 –LEGAL PROCEEDINGS**

 

In July 2003, a lawsuit was filed by four members of our Board ofDirectors elected by holders of the Series A Preferred Stock against a directorelected by Warburg, Pincus Equity Partners, L.P., a significant holder of theSeries B Preferred Stock.  The lawsuitseeks a declaration that the plaintiff directors are not required to vote withrespect to a proposed redemption of the Series A Preferred Stock in a mannerthat would be detrimental to the interests of holders of Series A PreferredStock and are entitled to vote in a manner that reflects and supports thoseinterests rather than prefer the interests of other classes of Price Legacy’sequity securities.  The plaintiffdirectors also seek a declaration that their ownership of shares of Series APreferred Stock does not disqualify them from considering, voting or otherwiseacting on matters affecting the holders of Series A Preferred Stock, includingthe redemption of that stock.  PriceLegacy is not a party to the lawsuit.

 

On or about February 13, 2001, Lewis P. Geyser filed a lawsuit againstExcel Legacy in Santa Barbara County Superior Court, Anacapa Division, Case No.01038577.  The suit arose out of anOperating Agreement for Destination Villages, LLC, an entity which is owned jointlyby Excel Legacy and Mr. Geyser, under which Destination Villages, LLC woulddevelop certain eco-tourism resorts. The complaint included causes of action for breach of contract, breachof fiduciary duty, fraud and negligent misrepresentation.  The lawsuit included a prayer forcompensatory and punitive damages. Excel Legacy had also filed a cross-complaint against Mr. Geyser forbreach of contract, fraud, breach of fiduciary duty and other related claims.

 

The trial of this matter began February 26, 2002 and concluded on March19, 2002.  The trial judge dismissedboth the complaint and cross-complaint, and granted nothing to Mr. Geyser underany of his allegations.  On June 5,2002, Mr. Geyser filed an appeal and Excel Legacy subsequently filed a cross-appealagainst Mr. Geyser.  On May 12, 2003,the appellate court reversed the judgment of dismissal on the complaint andcross-complaint and remanded the case for retrial.  The court has not yet set a date for the retrial of the matter.  We believe that our positions have merit and intend to vigorouslydefend against Mr. Geyser’s claims and pursue our counterclaims.

 

On June 13, 2002, the Bank of NT Butterfield & Sons Limited filed alawsuit against Price Legacy and Excel Legacy in Bermuda for $6.1 million plusother costs related to a guarantee agreement for a promissory note on theDestination Villages Daniel’s Head project in Bermuda.  The bank claims that Excel Legacy did notprovide sufficient capital for the project to be completed which was requiredin the guarantee agreement.  The bank hascurrently appointed a receiver who is actively marketing the project for saleto third parties.  We believe we were infull compliance with the guarantee and intend to vigorously defend the lawsuit.  On June 3, 2003,  

 

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trial of this matter commenced in Bermuda.  On June 6, 2003,the trial was temporarily suspended due toillness of counsel.  The matter iscurrently expected to be reset by the court for November 2003.

 

We are not party to any other legal proceedings other than variousclaims and lawsuits arising in the ordinary course of business that, in theopinion of our management, are not individually or in the aggregate material toour business.

 

**ITEM 6****- EXHIBITS AND REPORTS ON FORM 8-K**

(a)              The followingexhibits are included herein or incorporated by reference:

 

(31.1)                   Certifications Pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

(32.1)                   Certifications Pursuant to 18 U.S.C. Section1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)             Reports on Form 8-K

We filed a report on Form8-K on May 20, 2003 reporting under Item 5 certain developments in an ongoinglawsuit involving Price Legacy.

 

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|                         |   | PRICE LEGACY CORPORATION   |
|------------------------------|--------|----------------------------|
|                         |   | *Registrant*               |
|                         |   |                       |   |
|                         |   |                       |   |
| Date:  August  13, 2003 |   |                       |   |
|                         |   | /s/ Gary B. Sabin          |   |
|                         |   | Gary B. Sabin              |   |
|                         |   | *Chief  Executive Officer* |   |
|                         |   |                       |   |
|                         |   |                       |   |
| Date:  August  13, 2003 |   |                       |   |
|                         |   | /s/ James Nakagawa         |   |
|                         |   | James Y. Nakagawa          |   |
|                         |   | *Chief  Financial Officer* |   |

 

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