**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

----

 

**FORM10-Q**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the quarter ended September30, 2004**

 

**Commission File Number 0-20449**

 

**PRICELEGACY CORPORATION**

(Exact name of registrantas specified in its charter)

 

| **Maryland**                     | **33-0628740**      |
|----------------------------------|---------------------|
| (State or other  jurisdiction of | (I.R.S. Employer    |
| incorporation or  organization)  | 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 36,921,206 shares of common stock, par value $.0004per share, outstanding at November 5, 2004.

 

 

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**PRICE LEGACY CORPORATION**

 

**INDEX TO FORM 10-Q**

 

 
| **PART I - FINANCIAL INFORMATION** | **3**                                                                                                    |
|------------------------------------|----------------------------------------------------------------------------------------------------------|
| ** **                         | **ITEM 1 - FINANCIAL STATEMENTS**                                                                        | **3** |
|                               |                                                                                                     | CONSOLIDATED BALANCE SHEETS | 3 |
|                               |                                                                                                     | CONSOLIDATED STATEMENTS OF OPERATIONS | 5 |
|                               |                                                                                                     | CONSOLIDATED STATEMENTS OF STOCKHOLDERS’  EQUITY | 6 |
|                               |                                                                                                     | CONSOLIDATED STATEMENTS OF CASH FLOWS | 7 |
|                               |                                                                                                     | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS | 8 |
| ** **                         | **ITEM 2 - MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | **29** |
| ** **                         | **ITEM 3 - QUANTITATIVE AND QUALITATIVE  DISCLOSURES ABOUT MARKET RISK**                                 | **43** |
| ** **                         | **ITEM 4 – CONTROLS AND PROCEDURES**                                                                | **44** |
| **PART II - OTHER INFORMATION**    | **45**                                                                                                   |
| ** **                         | **ITEM 1 – LEGAL PROCEEDINGS**                                                                      | **45** |
| ** **                         | **ITEM 6 - EXHIBITS**                                                                                    | **46** |

 

2

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

 

# **ITEM 1 - FINANCIAL STATEMENTS**

 

**PRICELEGACY CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(unaudited– amounts in thousands, except share data)**

 

**ASSETS**

 
| ** **                                                  | ** ** | **September 30** | ** **    | **December 31** | ** ** |
|-------------------------------------------------------------|------------|------------------|---------------|-----------------|------------|
| ** **                                                  | ** ** | **2004**         | ** **    | **2003**        | ** ** |
|                                                        |       |             |          |            |       |
| Real estate  assets                                         |       |             |          |            |       |
| Land and land  improvements                                 | ** ** | **$**            | **366,305**   |            | $          | 410,207 |   |
| Building and  improvements                                  | ** ** | **663,557**      |          | 670,050         |       |
| Construction in  progress                                   | ** ** | **655**          |          | 582             |       |
| ** **                                                  |       | **1,030,517**    |          | 1,080,839       |       |
| Property held  for sale                                     | ** ** | **45,191**       |          | 70,988          |       |
| Less accumulated  depreciation                              | ** ** | **(67,352**      | )             | (54,836         | )          |
| ** **                                                  |       | **1,008,356**    |          | 1,096,991       |       |
|                                                        |       |             |          |            |       |
| Investment in  unconsolidated real estate joint ventures    | ** ** | **—**       |          | 4,113           |       |
| Cash and cash  equivalents                                  | ** ** | **54,760**       |          | 7,631           |       |
| Restricted cash                                             | ** ** | **11,410**       |          | 11,288          |       |
| Accounts  receivable, net of allowance of $1,219 and $1,415 | ** ** | **5,352**        |          | 7,440           |       |
| Notes receivable                                            | ** ** | **811**          |          | 10,311          |       |
| Deferred rents                                              | ** ** | **12,039**       |          | 11,161          |       |
| Other assets                                                | ** ** | **41,107**       |          | 21,953          |       |
| Total assets                                                | ** ** | **$**            | **1,133,835** |            | $          | 1,170,888 |   |

** **

*See accompanying notes.*

 

3

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**LIABILITIES ANDSTOCKHOLDERS’ EQUITY**

 
| ** **                                                                                                                                                                                                                         | ** ** | **September 30** | ** **    | **December 31** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|---------------|-----------------|------------|
| ** **                                                                                                                                                                                                                         | ** ** | **2004**         | ** **    | **2003**        | ** ** |
|                                                                                                                                                                                                                               |       |             |          |            |       |
| Liabilities                                                                                                                                                                                                                        |       |             |          |            |       |
| Mortgages and  notes payable                                                                                                                                                                                                       | ** ** | **$**            | **540,714**   |            | $          | 483,675 |   |
| Capital lease  payable on property held for sale                                                                                                                                                                                   | ** ** | **—**       |          | 11,706          |       |
| Revolving line  of credit                                                                                                                                                                                                          | ** ** | **—**       |          | 69,100          |       |
| ** **                                                                                                                                                                                                                         |       | **540,714**      |          | 564,481         |       |
| Accounts payable  and other liabilities                                                                                                                                                                                            | ** ** | **51,489**       |          | 29,945          |       |
| Total  liabilities                                                                                                                                                                                                                 | ** ** | **592,203**      |          | 594,426         |       |
|                                                                                                                                                                                                                               |       |             |          |            |       |
| Commitments and  contingencies                                                                                                                                                                                                     |       |             |          |            |       |
|                                                                                                                                                                                                                               |       |             |          |            |       |
| Minority  interests                                                                                                                                                                                                                | ** ** | **595**          |          | 1,608           |       |
|                                                                                                                                                                                                                               |       |             |          |            |       |
| Stockholders’  equity                                                                                                                                                                                                         |       |             |          |            |       |
| Series A  Preferred Stock, cumulative, redeemable, $0.0001 par value, 27,849,771 shares  authorized, 3,986,994 and 27,434,166 shares issued and outstanding                                                                        | ** ** | **58,116**       |          | 399,615         |       |
| Series 1  Preferred Stock, cumulative, redeemable, $0.0001 par value, 15,218,506 shares  authorized, 2,942,463 shares issued and outstanding at September 30, 2004                                                                 | ** ** | **47,227**       |          | —          |       |
| Series B  Preferred Stock, junior, convertible, redeemable, $0.0001 par value,  27,458,855 shares authorized, 24,125,208 shares issued and outstanding at December  31, 2003                                                       | ** ** | **—**       |          | 131,023         |       |
|                                                                                                                                                                                                                               |       |             |          |            |       |
| Common stock,  $0.0004 par value, 106,931,723 shares authorized, 36,921,206 issued and  outstanding at September 30, 2004; $0.0001 par value, 94,691,374 shares  authorized, 8,690,414 issued and outstanding at December 31, 2003 | ** ** | **15**           |          | 3               |       |
| Additional  paid-in capital                                                                                                                                                                                                        | ** ** | **649,032**      |          | 176,431         |       |
| Accumulated  comprehensive loss                                                                                                                                                                                                    | ** ** | **(2,776**       | **)**         | (1,479          | )          |
| Retained deficit                                                                                                                                                                                                                   | ** ** | **(210,577**     | **)**         | (130,739        | )          |
| Total  stockholders’ equity                                                                                                                                                                                                   | ** ** | **541,037**      |          | 574,854         |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                   | ** ** | **$**            | **1,133,835** |            | $          | 1,170,888 |   |

 

*See accompanying notes.*

 

4

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**PRICE LEGACY CORPORATION**

## ***CONSOLIDATED STATEMENTS OF OPERATIONS***

**(unaudited - amounts inthousands, except per share data)**

 
| ** **                                                     | ** ** | **Third Quarter  Three Months Ended  September 30** | ** ** | **Year-to-Date  Nine Months Ended  September 30** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                     | ** ** | **2004**                                            | ** ** | **2003**                                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Rental revenues                                                | ** ** | **$**                                               | **32,149** |                                              | $          | 29,286 | ** ** | **$** | **94,483** |   | $ | 89,174 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Expenses                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Operating and  maintenance                                     | ** ** | **3,994**                                           |       | 4,744                                             | ** ** | **13,279** |   | 15,381 |   |
| Property taxes                                                 | ** ** | **4,193**                                           |       | 3,786                                             | ** ** | **12,315** |   | 11,280 |   |
| Depreciation and  amortization                                 | ** ** | **5,525**                                           |       | 5,051                                             | ** ** | **16,436** |   | 14,379 |   |
| General and  administrative                                    | ** ** | **1,470**                                           |       | 5,706                                             | ** ** | **4,332** |   | 9,515 |   |
| Provision for  asset impairment                                | ** ** | **—**                                          |       | —                                            | ** ** | **1,225** |   | — |   |
| Total expenses                                                 | ** ** | **15,182**                                          |       | 19,287                                            | ** ** | **47,587** |   | 50,555 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Operating income                                               | ** ** | **16,967**                                          |       | 9,999                                             | ** ** | **46,896** |   | 38,619 |   |
|                                                           |       |                                                |       |                                              |       |   |   |   |   |
| Interest and  other                                            |       |                                                |       |                                              |       |   | ** ** |   |   |
| Interest expense                                               | ** ** | **(6,849**                                          | **)**      | (6,432                                            | )          | **(20,815** | **)** | (19,412 | ) |
| Interest and  other income                                     | ** ** | **3,055**                                           | ** ** | 81                                                |       | **3,163** | ** ** | 1,006 |   |
| Equity in (loss)  earnings of joint ventures                   | ** ** | **(45**                                             | **)**      | 4                                                 |       | **17** | ** ** | 1,168 |   |
| Total interest  and other                                      | ** ** | **(3,839**                                          | **)**      | (6,347                                            | )          | **(17,635** | **)** | (17,238 | ) |
|                                                           |       |                                                |       |                                              |       |   | ** ** |   |   |
| Income from  continuing operations                             | ** ** | **13,128**                                          |       | 3,652                                             | ** ** | **29,261** | ** ** | 21,381 |   |
|                                                           |       |                                                |       |                                              |       |   | ** ** |   |   |
| Discontinued  operations:                                      |       |                                                |       |                                              |       |   | ** ** |   |   |
| Income from  operations                                        | ** ** | **268**                                             |       | 647                                               | ** ** | **850** | ** ** | 1,285 |   |
| Provision for  asset impairment                                | ** ** | **(10,270**                                         | **)**      | —                                            | ** ** | **(10,270** | **)** | — |   |
| Net gain (loss)  on sale of real estate                        | ** ** | **80**                                              | ** ** | 153                                               | ** ** | **2,274** | ** ** | (2,368 | ) |
| (Loss) gain on  discontinued operations                        | ** ** | **(9,922**                                          | **)**      | 800                                               | ** ** | **(7,146** | **)** | (1,083 | ) |
|                                                           |       |                                                |       |                                              |       |   | ** ** |   |   |
| Net income  before gain on sale of real estate and investments | ** ** | **3,206**                                           |       | 4,452                                             | ** ** | **22,115** | ** ** | 20,298 |   |
|                                                           |       |                                                |       |                                              |       |   | ** ** |   |   |
| Net gain (loss)  on sale of real estate and investments        | ** ** | **123**                                             |       | (824                                              | )          | **12,744** | ** ** | (137 | ) |
|                                                           |       |                                                |       |                                              |       |   | ** ** |   |   |
| Net income                                                     | ** ** | **3,329**                                           |       | 3,628                                             |       | **34,859** | ** ** | 20,161 |   |
|                                                           |       |                                                |       |                                              |       |   | ** ** |   |   |
| Dividends to  preferred stockholders                           | ** ** | **(3,036**                                          | **)**      | (12,486                                           | )          | **(17,736** | **)** | (37,270 | ) |
| Preferred stock  conversion and redemption                     | ** ** | **(2,136**                                          | **)**      | —                                            |       | **(76,370** | **)** | — |   |
|                                                           |       |                                                | ** ** |                                              |       |   |   |   |   |
| Net loss  applicable to common stockholders                    | ** ** | **$**                                               | **(1,843** | **)**                                             | $          | (8,858 | ) | **$** | **(59,247** | **)** | $ | (17,109 | ) |
|                                                           |       |                                                | ** ** |                                              |       |   | ** ** |   |   |
| Net loss per  common share                                     |       |                                                | ** ** |                                              |       |   | ** ** |   |   |
| Basic and  diluted                                             | ** ** | **$**                                               | **(0.05**  | **)**                                             | $          | (0.96 | ) | **$** | **(1.77** | **)** | $ | (1.85 | ) |
|                                                           |       |                                                |       |                                              |       |   | ** ** |   |   |
| Weighted average  common shares outstanding                    |       |                                                |       |                                              |       |   | ** ** |   |   |
| Basic and  diluted                                             | ** ** | **36,920**                                          |       | 9,250                                             | ** ** | **33,457** | ** ** | 9,252 |   |
|                                                           |       |                                                |       |                                              |       |   | ** ** |   |   |
| Cash dividends  paid per Series A preferred share              | ** ** | **$**                                               | **0.35**   |                                              | $          | 0.35 | ** ** | **$** | **1.05** | ** ** | $ | 1.05 |   |
| Cash dividends  paid per Series 1 preferred share              | ** ** | **0.29**                                            |       | —                                            | ** ** | **0.45** | ** ** | — |   |
| Cash dividends  paid per common share                          | ** ** | **0.28**                                            |       | —                                            |       | **0.56** | ** ** | **—** |   |

 

*See accompanying notes.*

 

5

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**PRICE LEGACY CORPORATION**

## ***CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY***

**(unaudited – amounts inthousands)**

 
| ** **                                                                                 | ** ** | **Preferred  Stock  Series A** | ** ** | **Preferred  Stock  Series 1** | ** ** | **Preferred  Stock  Series B** | ** ** | **Common  Stock** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|--------------------------------|------------|-------------------|------------|
| ** **                                                                                 | ** ** | **Shares**                     | ** ** | **Amount**                     | ** ** | **Shares**                     | ** ** | **Amount**        | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares*** | ** ** | **Amount** | ** ** |
|                                                                                       |       |                           |       |                           |       |                           |       |              |       |   |   |   |   |   |   |   |   |
| **Balance  at December 31, 2003**                                                          |       | 27,434                         |       | $                              | 399,615    |                           | —     |              | —     |   | 24,125 |   | $ | 131,023 |   | 8,690 |   | $ | 3 |   |
| Comprehensive  income:                                                                     |       |                           |       |                           |       |                           |       |              |       |   |   |   |   |   |   |   |   |
| Net income                                                                                 |       | —                         |       | —                         |       | —                         |       | —            |       | — |   | — |   | — |   | — |   |
| Unrealized loss  on marketable securities                                                  |       | —                         |       | —                         |       | —                         |       | —            |       | — |   | — |   | — |   | — |   |
| Unrealized loss  on interest rate caps                                                     |       | —                         |       | —                         |       | —                         |       | —            |       | — |   | — |   | — |   | — |   |
| Total  comprehensive income                                                                |       |                           |       |                           |       |                           |       |              |       |   |   |   |   |   |   |   |   |
| Dividends on  Series A Preferred Stock                                                     |       | —                         |       | —                         |       | —                         |       | —            |       | — |   | — |   | — |   | — |   |
| Dividends on  Series B Preferred Stock                                                     |       | —                         |       | —                         |       | —                         |       | —            |       | 398 |   | 2,212 |   | — |   | — |   |
| Dividends on  Series 1 Preferred Stock                                                     |       |                           |       |                           |       |                           |       |              |       |   |   |   |   |   |   |   |   |
| Dividends on common  stock                                                                 |       | —                         |       | —                         |       | —                         |       | —            |       | — |   | — |   | — |   | — |   |
| Common stock  issued in legal settlement                                                   |       | —                         |       | —                         |       | —                         |       | —            |       | — |   | — |   | 160 |   | — |   |
| Common stock and  Series 1 Preferred Stock issued in exchange for Series A Preferred Stock |       | (20,947                        | )          | (305,058                       | )          | 2,942                          |       | 47,227            |       | — |   | — |   | 18,900 |   | 8 |   |
| Common stock  issued in exchange for Series B Preferred Stock                              |       | —                         |       | —                         |       | —                         |       | —            |       | (24,523 | ) | (133,235 | ) | 8,522 |   | 4 |   |
| Issuance costs  associated with Recapitalization Transaction                               |       | —                         |       | —                         |       | —                         |       | —            |       | — |   | — |   | — |   | — |   |
| Common stock  options exercised                                                            |       | —                         |       | —                         |       | —                         |       | —            |       | — |   | — |   | 649 |   | — |   |
| Redemption of  Series A Preferred Stock                                                    |       | (2,500                         | )          | (36,441                        | )          | —                         |       | —            |       | — |   | — |   | — |   | — |   |
|                                                                                       |       |                           |       |                           |       |                           |       |              |       |   |   |   |   |   |   |   |   |
| **Balance  at September 30, 2004**                                                         | ** ** | **3,987**                      | ** ** | **$**                          | **58,116** | ** **                     | **2,942**  | ** **        | **$**      | **47,227** | ** ** | **—** | ** ** | **—** | ** ** | **36,921** |   | $ | 15 |   |
|                                                                                            |            |                                |            |                                |            |                                |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                                 | ** ** | **Additional  Paid-In  Capital** | ** **  | **Accumulated  Comprehensive  Loss** | ** ** | **Retained  Earnings  (Deficit)** | ** ** | **Total**  | ** **   |
|--------------------------------------------------------------------------------------------|------------|----------------------------------|-------------|--------------------------------------|------------|-----------------------------------|------------|------------|--------------|
|                                                                                       |       |                             |        |                                 |       |                              |       |       |         |
| **Balance  at December 31, 2003**                                                          |       | $                                | 176,431     |                                 | $          | (1,479                            | )          | $          | (130,739     | ) | $ | 574,854 |   |
| Comprehensive  income:                                                                     |       |                             |        |                                 |       |                              |       |       |         |
| Net income                                                                                 |       | —                           |        | —                               |       | 34,859                            |       | 34,859     |         |
| Unrealized loss  on marketable securities                                                  |       | —                           |        | (17                                  | )          | —                            |       | (17        | )            |
| Unrealized loss  on interest rate caps                                                     |       | —                           |        | (1,280                               | )          | —                            |       | (1,280     | )            |
| Total  comprehensive income                                                                |       |                             |        |                                 |       |                              |       | 33,562     |         |
| Dividends on  Series A Preferred Stock                                                     |       | —                           |        | —                               |       | (14,200                           | )          | (14,200    | )            |
| Dividends on  Series B Preferred Stock                                                     |       | —                           |        | —                               |       | (2,212                            | )          | —     |         |
| Dividends on  Series 1 Preferred Stock                                                     |       |                             |        |                                 |       | (1,324                            | )          | (1,324     | )            |
| Dividends on  common stock                                                                 |       | —                           |        | —                               |       | (20,590                           | )          | (20,590    | )            |
| Common stock  issued in legal settlement                                                   |       | 2,099                            |        | —                               |       | —                            |       | 2,099      |         |
| Common stock and  Series 1 Preferred Stock issued in exchange for Series A Preferred Stock |       | 293,337                          |        | —                               |       | (35,519                           | )          | (5         | )            |
| Common stock  issued in exchange for Series B Preferred Stock                              |       | 170,524                          |        | —                               |       | (37,293                           | )          | —     |         |
| Issuance costs  associated with Recapitalization Transaction                               |       | (1,500                           | )           | —                               |       | —                            |       | (1,500     | )            |
| Common stock  options exercised                                                            |       | 8,141                            |        | —                               |       | —                            |       | 8,141      |         |
| Redemption of  Series A Preferred Stock                                                    |       | —                           |        | —                               |       | (3,559                            | )          | (40,000    | )            |
| ** **                                                                                 | ** ** | ** **                       | ** **  | ** **                           | ** ** | ** **                        | ** ** | ** ** | ** **   |
| **Balance  at September 30, 2004**                                                         | ** ** | **$**                            | **649,032** | ** **                           | **$**      | **(2,776**                        | **)**      | **$**      | **(210,577** | **)** | **$** | **541,037** | ** ** |

 

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******Retroactively restated for1-for-4 reverse stock split*

 

*See accompanying notes.*

 

6

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**PRICE LEGACY CORPORATION**

## ***CONSOLIDATED STATEMENTS OF CASH FLOWS***

**(unaudited - amounts inthousands)**
| ** **                                                                         | ** ** | **Year to Date  Nine Months Ended  September 30** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                          | ** ** | **2003** | ** ** |
| Operating  activities                                                              |       |                                              |       |   |   |
| Net income                                                                         | ** ** | **$**                                             | **34,859** |   | $ | 20,161 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                              |       |   |   |
| Depreciation and  amortization                                                     | ** ** | **16,843**                                        |       | 15,684 |   |
| Deferred rents                                                                     | ** ** | **(1,140**                                        | **)**      | (1,135 | ) |
| Equity in  earnings of joint ventures                                              | ** ** | **(17**                                           | **)**      | (1,168 | ) |
| Net (gain) loss  on sale of real estate and investments                            | ** ** | **(15,018**                                       | **)**      | 2,505 |   |
| Provision for  asset impairments                                                   | ** ** | **11,495**                                        | ** ** | — |   |
| Changes in  operating assets and liabilities:                                      |       |                                              | ** ** |   |   |
| Accounts  receivable and other assets                                              | ** ** | **(22,334**                                       | **)**      | 2,155 |   |
| Accounts payable  and other liabilities                                            | ** ** | **24,518**                                        | ** ** | 1,651 |   |
| Net cash  provided by operating activities                                         | ** ** | **49,206**                                        |       | 39,853 |   |
|                                                                               |       |                                              |       |   |   |
| Investing  activities                                                              |       |                                              |       |   |   |
| Deposits to  restricted cash                                                       | ** ** | **(122**                                          | **)**      | (4,249 | ) |
| Additions to  real estate assets                                                   | ** ** | **(6,165**                                        | **)**      | (23,749 | ) |
| Proceeds from  the sale of real estate assets and investments                      | ** ** | **85,595**                                        |       | 16,608 |   |
| Contributions to  real estate joint ventures                                       | ** ** | **—**                                        |       | (6 | ) |
| Distributions  from real estate joint ventures                                     | ** ** | **119**                                           |       | 326 |   |
| Advances on  notes receivable                                                      | ** ** | **—**                                        |       | (14,677 | ) |
| Repayments on  notes receivable                                                    | ** ** | **8,275**                                         |       | 18,265 |   |
| Net cash  provided by (used in) investing activities                               | ** ** | **87,702**                                        |       | (7,482 | ) |
|                                                                               |       |                                              |       |   |   |
| Financing  activities                                                              |       |                                              |       |   |   |
| Advances from  revolving line of credit and notes payable                          | ** ** | **269,755**                                       |       | 72,872 |   |
| Repayments of  revolving line of credit and notes payable                          | ** ** | **(291,561**                                      | **)**      | (76,097 | ) |
| Dividends paid  to stockholders                                                    | ** ** | **(36,114**                                       | **)**      | (28,806 | ) |
| Redemption of  Series A Preferred Stock                                            | ** ** | **(40,000**                                       | **)**      | — |   |
| Proceeds from  exercise of stock options                                           | ** ** | **8,141**                                         | ** ** | — |   |
| Net cash used in  financing activities                                             | ** ** | **(89,779**                                       | **)**      | (32,031 | ) |
| Net increase in  cash and cash equivalents                                         | ** ** | **47,129**                                        |       | 340 |   |
| Cash and cash  equivalents at beginning of period                                  | ** ** | **7,631**                                         |       | 11,471 |   |
| Cash and cash  equivalents at end of period                                        | ** ** | **$**                                             | **54,760** |   | $ | 11,811 |   |
| Supplemental cash  flow information:                                               |       |                                              |       |   |   |
| Cash paid for  interest                                                            | ** ** | **$**                                             | **20,257** |   | $ | 22,328 |   |
|                                                                               |       |                                              |       |   |   |
| Supplemental  schedule of noncash investing and financing activities:              |       |                                              |       |   |   |
| Elimination of  capital lease obligation in exchange for property                  | ** ** | **11,706**                                        |       | — |   |
| Reduction in joint  ventures in connection with purchase of real estate            | ** ** | **4,012**                                         |       | — |   |
| Assumption of  mortgage in connection with purchase of real estate                 | ** ** | **9,745**                                         |       | — |   |
| Preferred stock  conversion                                                        | ** ** | **72,812**                                        |       | — |   |
| Increase to  treasury stock for reduction in notes receivable                      | ** ** | **—**                                        |       | 779 |   |
|                                                                                    |            |                                                   |            |  |  |  |  |  |

 

*See accompanying notes.*

 

7

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**PRICELEGACY CORPORATION**

 

## ***NOTES TO CONSOLIDATED FINANCIAL STATEMENTS***

**(UNAUDITED)**

 

**September30, 2004**

 

### **Note 1 – Organization and Significant AccountingPolicies**

 

***Organization***

PriceLegacy Corporation (Price Legacy) operates as a real estate investment trust(REIT) incorporated in the state of Maryland. Our principal business is to acquire, operate, and develop realproperty, primarily open-air shopping centers.

 

Oursubsidiaries include Excel Legacy Holdings, Inc., which has elected to betreated 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.

 

***Accounting Principles***

Weprepared the financial statements following the requirements of the Securitiesand 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)have been omitted.  However, except asdisclosed below, there have been no material changes to the informationdisclosed in the consolidated financial statements included in the AnnualReport on Form 10-K for the year ended December 31, 2003.  Certain prior year data have been reclassifiedto conform to the 2004 presentation.

 

Weare responsible for the financial statements included in this document.  The financial statements include all normaland recurring adjustments that are considered necessary for the fairpresentation of our financial position and operating results.  The information in this Quarterly Report onForm 10-Q should be read in conjunction with the consolidated financialstatements and accompanying notes included in our latest Annual Report on Form10-K.

 

Revenues,expenses, assets and liabilities can vary during each quarter of the year.  Therefore, the results and trends in theseinterim financial statements may not be the same as those for the full year.

 

***Real Estate Assets and Depreciation***

Wecapitalize interest incurred during the construction period of certain assetsand this interest is depreciated over the lives of those assets.  The following table shows interest expenseand the amount capitalized (amounts in thousands):

 

8

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| ** **            | ** ** | **Three Months Ended  September 30** | ** ** | **Nine Months Ended  September 30** | ** ** |
|-----------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **            | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest  incurred    |       | $                                    | 6,849      |                                | $          | 7,018 |   | $ | 20,833 |   | $ | 21,290 |   |
| Interest  capitalized |       | —                               |       | (381                                | )          | (18 | ) | (1,384 | ) |
|                       |            |                                      |            |                                     |            |  |  |  |  |  |  |  |  |

 

***Cash and Cash Equivalents***

Weare required to maintain reserves with certain lenders for property taxes,insurance and capital expenditures.  Theaggregate amounts of these reserves held by lenders were approximately $11.4million at September 30, 2004 and $11.3 million at December 31, 2003.  These amounts are reflected as restrictedcash on the Consolidated Balance Sheets.

 

Our restricted cash balances at September 30, 2004 and December 31,2003 include $2.4 million of restricted funds which represent the proceeds fromthe sale of vacant land at our property in Hollywood/Oakwood Plaza, FL.  The funds will be held by the lender untilthe debt is repaid in 2009.

 

***Stock-Based Compensation***

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

 

We do not record compensation expense for stock options.  The following table summarizes results as ifwe had recorded compensation expense under the provisions of SFAS 123, asamended by SFAS 148, for our option grants (amounts in thousands, except pershare data).

 

9

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| ** **                                                                   | ** ** | **Three Months Ended  September 30** | ** ** | **Nine Months Ended  September 30** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                   | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income  (loss) applicable to common stockholders:                        |       |                                 |       |                                |       |   |   |   |   |
| As reported                                                                  |       | $                                    | (1,843     | )                                   | $          | (8,858 | ) | $ | (59,247 | ) | $ | (17,109 | ) |
| Deduct: stock  based compensation expense determined under fair value method |       | (58                                  | )          | (154                                | )          | (174 | ) | (462 | ) |
| Pro forma                                                                    |       | $                                    | (1,901     | )                                   | $          | (9,012 | ) | $ | (59,421 | ) | $ | (17,571 | ) |
| Net income  (loss) per share – basic:                                   |       |                                 |       |                                |       |   |   |   |   |
| As reported                                                                  |       | $                                    | (0.05      | )                                   | $          | (0.96 | ) | $ | (1.77 | ) | $ | (1.85 | ) |
| Pro forma                                                                    |       | $                                    | (0.05      | )                                   | $          | (0.96 | ) | $ | (1.78 | ) | $ | (1.90 | ) |
| Net income  (loss) per share – diluted:                                 |       |                                 |       |                                |       |   |   |   |   |
| As reported                                                                  |       | $                                    | (0.05      | )                                   | $          | (0.96 | ) | $ | (1.77 | ) | $ | (1.85 | ) |
| Pro forma                                                                    |       | $                                    | (0.05      | )                                   | $          | (0.96 | ) | $ | (1.78 | ) | $ | (1.90 | ) |
| Weighted average  fair value of options granted during the period            |       | —                               |       | —                              |       | $ | 3.20 |   | — |   |

 

The FASB is currently considering amendingSFAS 123 and APB Opinion No. 25, “Accounting for Stock Issued toEmployees.”  The proposed standard willrequire us to record compensation expense for all share based compensationplans.  If adopted, this proposedstandard would have a negative impact on our earnings in future periods.  We discuss our stock option plan further inNote 13.

 

***Other***

In April 2004, our TRS sold approximately 1.9 million shares of commonstock of Mace Security International for $10.7 million.  We recognized a gain on the sale ofapproximately $9.2 million.

 

In September 2004, we sold Kmart stock received as part of thesettlement of bankruptcy.  We recognizedother income of approximately $2.6 million related to the Kmart settlement.

 

**Note 2 – Proposed Merger Transaction with PLRetail LLC**

 

OnAugust 24, 2004, we entered into a definitive merger agreement with PLRetail LLC (PL Retail) pursuant to which a wholly-owned subsidiary of PL Retailwill merge with and into Price Legacy with Price Legacy continuing as thesurviving corporation with all of its common stock

 

10

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owned by PLRetail.  Under the terms of the mergeragreement, our common stockholders will be entitled to receive cashconsideration for each outstanding share of our common stock of

 

•                  $18.85 per share

•                  plus an amountequal to a quarterly common dividend of $0.28 per share prorated from October1, 2004 through the closing of the merger, which we currently expect to totalapproximately $9.2 million based upon an estimated closing date of December 21,2004, less any required withholding for taxes

 

Our existingSeries A and Series 1 Preferred Stock will remain issued and outstanding aspreferred stock of the surviving corporation. PL Retail has indicated that it may continue to redeem the Series A andSeries 1 Preferred Stock, subject to the availability of financing.

 

The merger issubject to the approval of our stockholders holding at least a majority of thecombined voting power of our outstanding common stock and Series A PreferredStock, voting together as a single class, and the satisfaction or waiver ofother closing conditions described in the merger agreement.  In addition, the completion of the merger isconditioned upon The Price Group, LLC (The Price Group), an entity affiliatedwith Sol Price, a founder and major stockholder of Price Legacy, entering intoa put agreement with PL Retail under which PL Retail has the right in itsdiscretion to require The Price Group to purchase certain non-core properties andother Price Legacy assets for approximately $147.7 million concurrently withthe closing of the merger.  In the eventthat any of these properties or other assets are sold prior to the closing ofthe merger, The Price Group will be entitled to receive the net proceeds fromany such sale.  On September 28, 2004,The Price Group entered into the put agreement, satisfying this condition, andPL Retail exercised its right under the put agreement to cause The Price Groupto purchase all right, title, and interest in and to two newly formed PriceLegacy subsidiaries that will own these non-core properties and other assets asof the closing of the merger.  There canbe no assurance that the merger will be consummated.  We have agreed to pay a termination fee of upto $20.0 million if the merger agreement is terminated under certaincircumstances.

 

**Note 3 – Recapitalization Transaction**

 

On September 22, 2003, we issued a pressrelease announcing that we were pursuing a series of transactions intended toresult in a significant simplification of our capital structure.  On or about February 11, 2004, we mailed toour stockholders definitive proxy materials and to our Series A

 

11

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Preferred stockholders exchange offer materialsrelated to our previously announced recapitalization transaction (theRecapitalization Transaction).

 

The Recapitalization Transaction consistedof:

 

•                  an exchangeoffer in which we offered to exchange, at the option of the holder, eithershares of our common stock or shares of our newly designated Series 1 PreferredStock for all outstanding shares of  ourSeries A Preferred Stock

•                  exchangetransactions with the holders of all of our outstanding Series B PreferredStock in which we exchanged 8,521,746 shares of our common stock (after givingeffect to the reverse stock split described below) for all of our outstandingshares of Series B Preferred Stock

•                  an amendment andrestatement of our charter to, among other things,

•                  effect a 1-for-4reverse stock split of our common stock

•                  designate andestablish the terms of our Series 1 Preferred Stock

•                  eliminate theSeries B Preferred Stock following its exchange for common stock

•                  change themanner in which our directors are elected so that the holders of common stockand Series A Preferred Stock, but not the holders of Series 1 Preferred Stock,voting together as a single class, are entitled to elect all of our directors

•                  change ourauthorized capital stock to provide sufficient shares to complete theRecapitalization Transaction

 

Our stockholders approved theRecapitalization Transaction at a special meeting of stockholders held on March11, 2004, and the Recapitalization Transaction was completed on March 12,2004.  As a result of the RecapitalizationTransaction, we issued a total of 27,421,965 shares of common stock (on a post1-for-4 reverse stock split basis) and 2,942,463 shares of Series 1 PreferredStock and we retired 20,947,172 shares of Series A Preferred Stock and24,523,015 shares of Series B Preferred Stock. After giving effect to the Recapitalization Transaction, we hadoutstanding 36,283,973 shares of common stock, 6,486,994 shares of Series APreferred Stock, and 2,942,463 shares of Series 1 Preferred Stock.

 

On March 12, 2004, we filed Articles ofAmendment and Restatement in the State Department of Assessments and Taxationof Maryland effecting the 1-for-4 reverse stock split of our common stock andthe other amendments to our charter contemplated by the RecapitalizationTransaction.

 

12

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For accounting purposes, Emerging Issue TaskForce (EITF) topic D-42 governs the effect on the calculation of earnings pershare for the redemption or induced conversion of preferred stock. The exchangeof the Series A Preferred Stock for either common stock or Series 1Preferred Stock is being treated as a redemption and, accordingly, the excessof the fair value of the consideration transferred to the holders of thepreferred stock over the carrying amount of the preferred stock on the balancesheet was subtracted from net income to arrive at net loss applicable to commonstockholders in the calculation of earnings per share.  Approximately 10.7% of the Series APreferred Stock was exchanged for Series 1 Preferred Stock and 65.6% ofthe Series A Preferred Stock was exchanged for common stock, requiring adeduction of approximately $35.5 million from net income to arrive at netloss applicable to common stockholders with the Series 1 Preferred Stockvalued at $16.05 per share.

 

The exchange of the Series B Preferred Stock forcommon stock is being treated as an induced conversion in accordance with EITFD-42.  The exchange of the Series BPreferred Stock for common stock at a ratio of 1.39 shares of common stock foreach share of Series B Preferred Stock resulted in a deduction of approximately$37.3 million from net income to arrive at net loss applicable to commonstockholders.

 

On June 7, 2004, we redeemed 1.0 million shares of our Series APreferred Stock at the redemption price of $16.00 per share, along with adividend of $0.145 per share which represented a quarterly dividend of $0.35per share pro-rated for the period of May 1, 2004 to June 7, 2004.  The redemption price of $16.00 per share wasin excess of the carrying value of the stock which resulted in a reduction of$1.4 million from net income to arrive at net income applicable to commonstockholders in accordance with EITF D-42.

 

On September 15, 2004, we redeemed 1.5 million shares of our Series APreferred Stock at the redemption price of $16.00 per share, along with adividend of $0.175 per share which represented a quarterly dividend of $0.35per share pro-rated for the period of August 1, 2004 to September 15, 2004.  The redemption price of $16.00 per share wasin excess of the carrying value of the stock which resulted in a reduction of$2.1 million from net income to arrive at net income applicable to commonstockholders in accordance with EITF D-42 (see Note 14).

 

**Note 4 – 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 common

 

13

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stockholders divided by weighted average common shares outstandingduring the period.  Diluted earnings percommon share equals net income applicable to common stockholders divided by thesum of weighted average common shares outstanding during the period plus dilutivepotential shares.  Dilutive potentialshares are shares assumed to be issued if outstanding stock options wereexercised using the treasury stock method. The effect of common stock equivalents for all periods presented wereantidilutive and, therefore, not included in the earnings per sharecalculations.

 
| ** **                                                    | ** ** | **Three Months Ended September** | ** ** | **Nine Months Ended September** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | **2004**                         | ** ** | **2003**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                          |       |                             |       |                            |       |   |   |   |   |
| Weighted average  shares outstanding                          |       | 36,920,047                       |       | 9,249,789                       |       | 33,457,491 |   | 9,252,235 |   |
| Effect of dilutive  securities:                               |       |                             |       |                            |       |   |   |   |   |
| Employee stock  options                                       |       | 37,715                           |       | 115,357                         |       | 424,398 |   | 9,322 |   |
| Weighted average  shares outstanding – assuming dilution |       | 36,957,762                       |       | 9,365,146                       |       | 33,881,889 |   | 9,261,557 |   |

 

In following the provisions of SFAS 128, we adjusted the computationsof basic and diluted earnings per share and the number of common sharesoutstanding retroactively for all periods presented to reflect our change incapital structure.  The earnings pershare for the three months and nine months ended September 30, 2004 and 2003have been restated to reflect the 1-for-4 reverse stock split of our commonstock in the first quarter of 2004 as if it occurred at the beginning of theperiod.

 

**Note 5 – Real Estate Assets**

 

Ourreal estate properties are generally leased under noncancelable leases withremaining terms ranging from 1 to 26 years. Rental revenues include the following (amounts in thousands):

 
| ** **                            | ** ** | **Three Months Ended  September 30** | ** ** | **Nine Months Ended  September 30** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                            | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Minimum rent                          |       | $                                    | 24,665     |                                | $          | 22,314 |   | $ | 71,754 |   | $ | 67,068 |   |
| Straight-line  accrual of future rent |       | 439                                  |       | 678                                 |       | 1,354 |   | 1,855 |   |
| Expense  reimbursements               |       | 6,597                                |       | 5,766                               |       | 19,652 |   | 18,486 |   |
| Percentage rent                       |       | 102                                  |       | 181                                 |       | 776 |   | 755 |   |
| Other revenues                        |       | 346                                  |       | 347                                 |       | 947 |   | 1,010 |   |
| Rental revenues                       |       | $                                    | 32,149     |                                | $          | 29,286 |   | $ | 94,483 |   | $ | 89,174 |   |

 

14

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***Acquisitions***

During the first nine months of 2004, we acquired our joint venturepartners’ 50% interest in a property in Fresno, CA for $2.8 million.  We assumed the outstanding mortgage of $9.7million.

 

During the first nine months of 2003, we acquired a parcel ofundeveloped land at our Anaheim, CA development property for $2.7 million.

*** ***

***Dispositions***

During the first nine months of 2004, we sold the following properties:

 
| **Location**                        | ** ** | **Description**      | ** ** | **Date  Sold** | ** ** | **Sales Price  (000’s)** | ** ** |
|-------------------------------------|------------|----------------------|------------|----------------|------------|-------------------------------|------------|
| Hampton, VA                         |       | Retail Building/Bank |       | 4/1/04         |       | $                             | 4,850      |   |
| San Diego/Rancho  Bernardo, CA (1)  |       | Office Building      |       | 5/12/04        |       | 14,655                        |       |
| Tempe, AZ (2)                       |       | Land, Building       |       | 5/13/04        |       | 1,724                         |       |
| Tucson/Marana,  AZ (2)              |       | Land                 |       | 6/16/04        |       | 408                           |       |
| Orlando, FL (3)                     |       | Land                 |       | 6/23/04        |       | 41,500                        |       |
| San  Diego/Morena, CA (2)           |       | Office Building      |       | 6/28/04        |       | 4,125                         |       |
| Scottsdale, AZ  (4)                 |       | Land                 |       | 8/9/04         |       | 22,000                        |       |
| Farmington, UT  (2)                 |       | Land                 |       | 8/11/04        |       | 3,078                         |       |
| Phoenix/One  North First Street, AZ |       | Office Building      |       | 9/30/04        |       | 5,900                         |       |
|                                     |            |                      |            |                |            |                               |            |  |

 

----

*(1)**       We subleased our interestin this property to former members of our senior management in October2003.  During the second quarter of 2004,they exercised their right to purchase all of our rights and interest in thebuilding*

*(2)**       Partial sale*

*(3)**       This was a consolidatedjoint venture investment classified as land on our Consolidated Balance Sheetin accordance with FIN 46R*

*(4)**       This was a consolidatednote receivable classified as land on our Consolidated Balance Sheet inaccordance with FIN 46R*

 

During the first nine months of 2003, we sold the following properties:

 
| **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                         |       |
| Tucson/Marana,  AZ |       | Land               |       | 8/22/03        |       | 416                           |       |
|                    |            |                    |            |                |            |                               |            |  |

 

15

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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.

*** ***

***Variable Interest Entities***

On July 1, 2003, we adopted FASB Interpretation No. 46R, “Consolidationof Variable Interest Entities—an interpretation of ARB No. 51” (FIN 46R).  This interpretation addresses theconsolidation of business enterprises (variable interest entities) to which theusual condition (ownership of a majority voting interest) of consolidation doesnot apply.  This interpretation

focuses on financial interests that indicate control.  It concludes that in the absence of clearcontrol through voting interests, a company’s exposure (variable interest) tothe economic risks and potential reward from the variable interest entity’sassets and activities are the best evidence of control.  Variable interests are rights and obligationsthat convey economic gains or losses from changes in the values of the variableinterest entity’s assets and liabilities. Variable interests may arise from financial instruments, servicecontracts, nonvoting ownership interests and other arrangements.

 

If an enterprise holds a majority of the variable interests of anentity, it would be considered the primary beneficiary.  The primary beneficiary is required toinclude assets, liabilities and the results of operations of the variableinterest entity in its financial statements. As of September 30, 2004, our analysis related to FIN 46R indicates weare not the primary beneficiary of any variable interest entities which requireconsolidation in our financial statements. Prior to September 2004, we had the following variable interest entities:

 
| ** **                  | ** ** | **Assets** | ** ** | **Liabilities** | ** ** | **Minority Interest** | ** ** | **Date Sold** | ** ** |
|-----------------------------|------------|------------|------------|-----------------|------------|-----------------------|------------|---------------|------------|
| Los Arcos  Development, LLC |       | $          | 22,000     |            | $          | —                |       | $             | —     |   | 8/9/04 |   |
| Orlando Business  Park LLC  |       | 28,900     |       | 4,645           |       | 1,013                 |       | 6/23/04       |       |
|                             |            |            |            |                 |            |                       |            |               |            |  |  |  |

 

Los Arcos Development, LLC (an Ellman Affiliate as defined in Note 9)owned 42 acres of land in Scottsdale, AZ. Commencing in 1996, non-recourse loans were made by one of ouraffiliates to Los Arcos Development, LLC to acquire the Scottsdaleproperty.  These loans were previouslyclassified as notes receivable on our balance sheet.  As of January 13, 2004, we entered into loanamendments with Los Arcos Development, LLC to confirm a second priority lien onthe Scottsdale property to collateralize the loans and to establish a new maturitydate of December 31, 2004.

 

16

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A separate note receivable from Los Arcos Development, LLC in theaggregate principal amount of $13.0 million was acquired by another affiliatein February 2003.  This note receivablewas non-recourse and collateralized by a first priority lien on the Scottsdaleproperty.  This loan was amended as ofJanuary 13, 2004 to establish a new maturity date of December 31, 2004.

 

The first and second lien loans were further amended in July 2004 toaccelerate the outside maturity date to August 31, 2004 and require certainpayments on the notes in the total amount of $30.3 million by July 15, August2, August 10, and August 16, 2004.  Ifsuch payments were timely made, the borrower and its affiliates would havereceived releases from further liability

under these loans and the related loans described in Note 9, and theliens would have been released.  Therequired July 15 and August 2 payments were received.  In addition, we granted Ellman Investments,Inc. certain rights to purchase the loans in lieu of making the requiredpayments (with the purchase price in such event approximately equal to theamount of the required payments).  Inreturn, Los Arcos Development, LLC agreed to certain restrictions with respectto the development of the Scottsdale property and also agreed to deliverdocuments satisfactory to us relasing and indemnifying us from liabilities withrespect to our various transactions with the Ellman Affiliates.  Futhermore, the amendment provided usprotection against claims from Los Arcos Development, LLC.

 

For accounting purposes, the cumulative balance of the notes receivablethru August 9, 2004 was $22.0 million, which was net of a $29.5 millionimpairment recorded in the fourth quarter of 2003.  This balance was classified as land on ourConsolidated Balance Sheets.  Althoughinterest had continued to accrue per the terms of the loan documents, we didnot accrue interest on the notes for accounting purposes in 2004 and 2003.  On August 9, 2004, the loans to Los ArcosDevelopment, LLC, and the related loans described in Note 9 were paid offpursuant to the July 2004 amendment described above for $30.3 million whichconcluded our existing business association with the Ellman Affiliates, theirholdings, the Scottsdale property, and the Phoenix Coyotes (see Note 9).

 

Orlando Business Park, LLC, previously classified as a consolidatedjoint venture on our balance sheet, owned land in Orlando, FL.  This land was sold in the second quarter of2004 and we recognized a gain of $2.6 million on the sale.

*** ***

***Property Held for Sale***

Included in the Consolidated Balance Sheets at September 30, 2004 andDecember 31, 2003 are the following properties held for sale, which are carriedat fair value less costs to sell (amounts in thousands):

 

17

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| **Location**                        | ** ** | **Description** | ** ** | **September 30  2004** | ** ** | **December 31  2003** | ** ** |
|-------------------------------------|------------|-----------------|------------|------------------------|------------|-----------------------|------------|
| Anaheim, CA                         |       | Land            |       | $                      | 29,997     |                  | $          | 37,000 |   |
| Tusayan, AZ                         |       | Hotel           |       | 9,723                  |       | —                |       |
| Farmington, UT                      |       | Land            |       | 3,014                  |       | 5,880                 |       |
| Tucson/Marana, AZ                   |       | Land            |       | 2,457                  |       | 2,787                 |       |
| San Diego/Rancho  Bernardo, CA      |       | Office Building |       | —                 |       | 15,141                |       |
| Phoenix/One  North First Street, AZ |       | Office Building |       | —                 |       | 5,551                 |       |
| Hampton, VA                         |       | Retail Building |       | —                 |       | 4,629                 |       |
| Total                               |       |            |       | $                      | 45,191     |                  | $          | 70,988 |   |

 

**Note 6 – Provision for Asset Impairments**

 

We record real estate assets at historical costs andadjust them for the recognition of impairment losses.  Duringthe third quarter of 2004, we recognized an impairment loss of $3.7 million onour hospitality property at Tusayan, AZ.  The loss was determined based on a contractprice to sell the property entered into during the third quarter of 2004.  The property was sold on October 22, 2004 forthe contract price of $9.5 million.  Alsoduring the third quarter of 2004, we recognized an impairment loss of $6.6million on our Anaheim, CA property.  Theloss was determined based on revised information as we continue to market theproperty for sale.  As both propertiesare classified as held for sale, these losses are recorded as discontinuedoperations in the Consolidated Statement of Operations in accordance with SFASNo. 144.

 

In the second quarter of 2004, we recorded animpairment of $1.2 million on a note receivable, which we discuss further inNote 9.

 

**Note 7 – Discontinued Operations**

 

We report discontinued operations for ourproperties in Anaheim, CA, Tusayan, AZ, Farmington, UT, and Tucson/Marana, AZwhich are classified as held for sale.

 

We also report discontinued operations forour properties in San Diego/Rancho Bernardo, CA, Hampton, VA, San Diego, CA,and Phoenix/One North First Street, AZ which were sold during the nine monthsended September 30, 2004.  Also includedin the Consolidated Statements of Operations for the three and nine monthsended September 30, 2003 are the discontinued operations of our properties atScottsdale, AZ, Inglewood, CA, New Britain, CT, and Northridge, CA which weresold in 2003.  Discontinued operationsare summarized as follows (amounts in thousands, except per share data):

 

18

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| ** **                              | ** ** | **Three Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
|-----------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                              | ** ** | **2004**                            | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                    |       | $                                   | 2,260      |                               | $          | 2,902 |   | $ | 6,068 |   | $ | 7,428 |   |
| Rental revenue                          |       |                                |       |                               |       |   |   |   |   |
| Expenses                                |       |                                |       |                               |       |   |   |   |   |
| Operating and  maintenance              |       | 1,654                               |       | 1,610                              |       | 4,287 |   | 4,015 |   |
| Property taxes                          |       | 211                                 |       | 65                                 |       | 524 |   | 330 |   |
| Depreciation and  amortization          |       | 127                                 |       | 375                                |       | 407 |   | 1,305 |   |
| Interest expense                        |       | —                              |       | 205                                |       | — |   | 493 |   |
|                                    |       | 1,992                               |       | 2,255                              |       | 5,218 |   | 6,143 |   |
| Income from  operations                 |       | 268                                 |       | 647                                |       | 850 |   | 1,285 |   |
| Provision for  asset impairment         |       | (10,270                             | )          | —                             |       | (10,270 | ) | — |   |
| Net gain (loss)  on sale of real estate |       | 80                                  |       | 153                                |       | 2,274 |   | (2,368 | ) |
| Net income  (loss)                      |       | $                                   | (9,922     | )                                  | $          | 800 |   | $ | (7,146 | ) | $ | (1,083 | ) |
|                                    |       |                                |       |                               |       |   |   |   |   |
| Earnings (loss)  per common share       |       |                                |       |                               |       |   |   |   |   |
| Basic and diluted                       |       | $                                   | (0.27      | )                                  | $          | 0.09 |   | $ | (0.21 | ) | $ | (0.12 | ) |

 

**Note 8 – Investments in Unconsolidated Real EstateJoint Ventures**

 

Asof September 30, 2004 and December 31, 2003, we had the following investmentsin unconsolidated joint ventures which we accounted for under the equity methodof accounting (amounts in thousands):

 
| ** **                   | ** ** | ** **      | ** ** | **September 30**

**2004** | ** ** | **December 31**

**2003** | ** ** |
|------------------------------|------------|-----------------|------------|----------------------------|------------|---------------------------|------------|
| **Joint Venture**            | ** ** | **Ownership %** | ** ** | ** **                 | ** ** |
| Blackstone  Ventures I       |       | 50              | %          | —                     |       | $                         | 2,469      |   |
| 3017977 Nova  Scotia Company |       | 55              | %          | —                     |       | 1,600                     |       |
| Other                        |       | Various         |       | —                     |       | 44                        |       |
| Total                        |       |            |       | —                     |       | $                         | 4,113      |   |

 

In March 2004, we paid$2.8 million to purchase our partners’ 50% share of Blackstone

Ventures I and we assumedthe outstanding mortgage of $9.7 million.

 

During the first quarterof 2004, we sold our investment in 3017977 Nova Scotia Company to an EllmanAffiliate.  In consideration, we added$1.6 million to an existing note receivable due from Los Arcos Development,LLC.  This note receivable wasconsolidated and recorded as land on our Consolidated Balance Sheets inaccordance with FIN 46R.  The note waspaid in August 2004.  See Note 5 forfurther discussion.

 

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Also in the first quarterof 2004, we disposed of a joint venture investment in an apartment complex andrecognized a loss on the disposal of $44,100.

 

**Note 9 – Notes Receivable**

 

As of September 30, 2004 and December 31, 2003, we had the followingnotes receivable outstanding related to various real estate developments andrelated businesses (amounts in thousands):

** **
| ** **                                 | ** ** | **September 30**

**2004** | ** ** | **December 31**

**2003** | ** ** |
|--------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **Note Receivable**                        | ** ** | ** **                 | ** ** |
| Arizona Hockey  Management/Ellman Holdings |       | $                          | —     |                      | $          | 9,500 |   |
| Other                                      |       | 811                        |       | 811                       |       |
| Total                                      |       | $                          | 811        |                      | $          | 10,311 |   |

 

The notes generally do not require cash payments of interest untilspecified future dates, typically when developments are completed or sold.

 

Prior to August 9, 2004, the notes receivable from companies owned byor affiliated with Steven Ellman (the Ellman Affiliates) represented anaggregate outstanding principal balance, for accounting purposes, of approximately$8.3 million.  The outstanding balancewas net of a $12.9 million impairment recorded in the fourth quarter of 2003 toreflect the fair value of the notes in connection with management’s plan tosell our non-core assets and an additional $1.2 million impairment recorded inthe second quarter of 2004 to reflect Ellman Affiliates’ exercise of its optionto purchase the loans pursuant to the terms specified below.  These notes receivable from the EllmanAffiliates were collateralized by a pledge of certain Ellman Affiliates’distributions from a holding company that owns the Phoenix Coyotes hockey teamand other related assets.  These loanswere made at a time when the Ellman Affiliates intended to relocate the hockeyteam to an arena that was to be constructed on the Scottsdale property owned byLos Arcos Development, LLC.

 

As a result of delays at the Scottsdale property, the Ellman Affiliateselected to pursue an alternative site for the hockey arena in Glendale,AZ.  In December 2002, the Ellman Affiliatesand the other investors involved in the ownership of the Phoenix Coyotesentered into a series of transactions in which the Phoenix Coyotes hockey teamand related real estate development

assets were consolidated for the purpose of assisting in obtainingadditional financing.    Althoughinterest continued to accrue per the terms of the notes, we stopped accruinginterest on

 

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the loans for accounting purposes when the development projects wereconsolidated into the holding company.

 

As of January 13, 2004, we entered into loan amendments with the EllmanAffiliates to, among other things, incorporate the pledge of certain EllmanAffiliates’ distributions from the holding company collateralizing the loansand set forth the new maturity date of the loans as December 31, 2004.

 

In August 2004, Ellman Investments, Inc. exercised its right topurchase the loans, provided that certain other obligations of the EllmanAffiliates owed to us, including the obligations to make the payments arisingwith respect to the notes receivable described in Note 5 have been satisfied,and provided further that the Ellman Affiliates deliver documents satisfactoryto us releasing and indemnifying us from liabilities with respect to ourvarious transactions with the Ellman Affiliates.  On August 9, 2004, Ellman Investments, Inc.purchased the loans and other notes receivable described in Note 5 whichconcluded our existing business association with the Ellman Affiliates, their holdings,the Scottsdale property, and the Phoenix Coyotes.

 

**Note 10 – Debt**

*** ***

We had the following debt outstanding at September 30, 2004 andDecember 31, 2003 (amounts in thousands):

 
| ** **                                                                                                                                                                                       | ** ** | **September 30**

**2004** | ** ** | **December 31**

**2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                                       | ** ** | ** **                 | ** ** |
| Mortgages on five properties in Florida bearing  interest at fixed rates ranging from 8.18% to 9.00%. The loans are  collateralized by the properties and mature February 2009 and January 2010  |       | $                          | 157,517    |                      | $          | 158,668 |   |
|                                                                                                                                                                                             |       |                       |       |                      |       |
| Mortgage payable with a bank, bearing interest at  LIBOR plus 90 basis points (2.74% at September 30, 2004). The mortgage is  collateralized by four of our properties and matures July 2005     |       | 121,375                    |       | —                    |       |
|                                                                                                                                                                                             |       |                       |       |                      |       |
| Mortgage on a property in Pentagon City, VA bearing  interest at LIBOR plus 145 basis points (3.29% at September 30, 2004). The  loan is collateralized by the property and matures January 2009 |       | 60,000                     |       | —                    |       |
|                                                                                                                                                                                                  |            |                            |            |                           |            |  |  |

 

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| ** **                                                                                                                                                                                                                                                                                 | ** ** | **September 30**

**2004** | ** ** | **December 31**

**2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                 | ** ** | ** **                 | ** ** |
| Mortgages and notes payable on four properties bearing  interest at fixed rates ranging from 5.88% to 8.45%. The loans are  collateralized by the properties and mature on various dates between October  2011 and February 2017                                                           |       | 56,503                     |       | 57,271                    |       |
|                                                                                                                                                                                                                                                                                       |       |                       |       |                      |       |
| Mortgages on two properties bearing interest at  LIBOR plus 205 basis points (3.89% at September 30, 2004). The loans are  collateralized by the properties and mature December 2006                                                                                                       |       | 29,289                     |       | 31,508                    |       |
|                                                                                                                                                                                                                                                                                       |       |                       |       |                      |       |
| Mortgage on a property in Temecula, CA bearing  interest at 5.20%. The loan is collateralized by the property and matures May  2014                                                                                                                                                        |       | 28,843                     |       | —                    |       |
|                                                                                                                                                                                                                                                                                       |       |                       |       |                      |       |
| Construction loan outstanding bearing interest at  LIBOR plus 310 basis points (4.94% at September 30, 2004). The loan is due  March 2005 and is collateralized by a retail center in Newport, KY (see  below)                                                                             |       | 28,500                     |       | 28,500                    |       |
|                                                                                                                                                                                                                                                                                       |       |                       |       |                      |       |
| Mortgage on a property in Orlando, FL bearing  interest at LIBOR plus 130 basis points (3.14% at September 30, 2004). The  loan is collateralized by the property and matures June 2008                                                                                                    |       | 22,099                     |       | 22,100                    |       |
|                                                                                                                                                                                                                                                                                       |       |                       |       |                      |       |
| Mortgage on a property in Greensburg, IN bearing  interest at LIBOR plus 155 basis points (3.39% at September 30, 2004). The  loan is collateralized by the property and matures May 2009                                                                                                  |       | 14,200                     |       | —                    |       |
|                                                                                                                                                                                                                                                                                       |       |                       |       |                      |       |
| Construction loan payable to a bank bearing interest  at LIBOR plus 185 basis points (3.69% at September 30, 2004). The loan  matures in March 2005 and is collateralized by the project in Orlando, FL                                                                                    |       | 12,746                     |       | 10,466                    |       |
|                                                                                                                                                                                                                                                                                       |       |                       |       |                      |       |
| Mortgage on a property in Fresno, CA bearing  interest at LIBOR plus 175 basis points (3.59% at September 30, 2004). The  loan is collateralized by the property and matures October 2004. This loan  has been extended for six months at an interest rate of LIBOR plus 150 basis  points |       | 9,642                      |       | —                    |       |
|                                                                                                                                                                                                                                                                                       |       |                       |       |                      |       |
| Revolving $50.0 million credit facility bearing interest  at LIBOR plus 118 to 170 basis points (3.39% at September 30, 2004), maturing  March 2007 (see below)                                                                                                                            |       | —                     |       | —                    |       |

 

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| ** **                                                                                                                                                                               | ** ** | **September 30**

**2004** | ** ** | **December 31**

**2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                               | ** ** | ** **                 | ** ** |
| Mortgage payable with GMAC Commercial Mortgage  Corporation, bearing interest at LIBOR plus 98 basis points. The mortgage  matured in July 2004 and was refinanced                       |       | —                     |       | 121,375                   |       |
|                                                                                                                                                                                     |       |                       |       |                      |       |
| Revolving $100.0 million credit facility bearing  interest at LIBOR plus 150 to 200 basis points. In February 2004, we repaid  $60.0 million and amended our credit facility (see below) |       | —                     |       | 69,100                    |       |
|                                                                                                                                                                                     |       |                       |       |                      |       |
| Capital lease arrangements with an individual on two  properties. The capital leases had effective interest rates of 4.43% and  7.36%. Both leases were repaid in 2004                   |       | —                     |       | 31,006                    |       |
|                                                                                                                                                                                     |       |                       |       |                      |       |
| Construction loan payable to a bank bearing interest  at LIBOR plus 150 basis points. This loan was refinanced with a new lender in  April 2004                                          |       | —                     |       | 20,929                    |       |
|                                                                                                                                                                                     |       |                       |       |                      |       |
| Note payable to a bank bearing interest at LIBOR  plus 375 basis points. This loan was paid in full in June 2004                                                                         |       | —                     |       | 8,821                     |       |
|                                                                                                                                                                                     |       |                       |       |                      |       |
| Note payable outstanding on a $4.7 million facility  related to Newport, KY. This loan was paid in full in March 2004                                                                    |       | —                     |       | 4,737                     |       |
|                                                                                                                                                                                     |       |                       |       |                      |       |
| Total                                                                                                                                                                                    |       | $                          | 540,714    |                      | $          | 564,481 |   |
|                                                                                                                                                                                          |            |                            |            |                           |            |  |  |

 

We were in compliance with all covenants on our credit facility atSeptember 30, 2004.  In 2004, we plan touse cash flow from operations to fund our recurring debt service obligations.

 

In February 2004, we amended our credit facility, repaid $60.0 millionand Wells Fargo Bank assumed the amended facility.  The amended facility provided for a maximumborrowing of $25.0 million.  Thisamendment was intended to provide financing through the completion of theRecapitalization Transaction (see Note 3). In April 2004, we entered into a new $50.0 million credit facility withWells Fargo Bank.  The new facility has a3-year term and has a current interest rate of LIBOR plus 155 basispoints.  The LIBOR rate add-on may varybetween 118 and 170 basis points based on our leverage and other financialratios.  The new facility also can beincreased by $25.0 million to allow up to $75.0 million of borrowings.

 

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We have a 69% interest in Newport on the Levee, LLC (Newport) that ownsa retail project in Newport, KY.  Inaddition to the $28.5 million construction loan in the above table, the City of  Newport has issued two series of publicimprovement bonds.  The Series 2000a taxexempt bonds total $44.2 million and are broken down as follows:  (a) $18.7 million maturing 2018 with  interest at 8.375%; (b) $20.5 millionmaturing 2027 with interest at 8.5%; and (c) $5.0 million maturing 2027 withinterest at 8.375%.  The Series 2000bbonds are taxable and have a par amount of $11.6 million with interest at 11%due 2009.  The bonds issued andoutstanding, a total of $55.8 million, are guaranteed by us, by  Newport, and the third party co-developers ofthe project.  Newport has drawn on $46.8million of the bonds at September 30, 2004.

 

On August 2, 2004, we purchased all of the outstanding Newport, KYSeries 2000b taxable bonds for $10.2 million (including accrued interest).  Also, on August 18, 2004, we purchased $9.7 millionof the 8.5% Series 2000a tax exempt bonds for $10.1 million (including accruedinterest).  These bonds are recorded asother assets in the Consolidated Balance Sheet at September 30, 2004.

 

On October 14, 2004, we purchased $27.9 million of the Newport, KYSeries 2000a tax exempt bonds for $29.7 million (including accrued interest).

 

**Note 11 — Financial Instruments: Derivatives and Hedging**

 

In the normal course of business, we are exposed to the effect ofchanges in interest rates.  We limitthese risks by following established risk management policies and proceduresincluding the use of derivatives.  Forinterest rate exposures, derivatives are used primarily to manage the cost ofborrowing obligations.

 

We have a policy of only entering into derivative contracts with majorfinancial institutions based upon their credit ratings and other factors.  When viewed in conjunction with theunderlying and offsetting exposure that the derivatives are designed to hedge,we have not sustained a material loss from those instruments nor do weanticipate any material adverse effect on our net income,  financial position, or cash flows in thefuture from the use of derivatives.

 

To manage interest rate risk, we may employ options, forwards, swaps,caps and floors, or a combination thereof, depending on the underlyingexposure.  We undertake a variety ofborrowings from lines of credit to medium and long-term financings.  To manage overall costs, we currently usederivative instruments to cap our exposure to variability in interest rates orto

 

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convert a portion of our variable-rate debt to fixed-rate debt.  In July 2002, we paid $3.4 million forforward-starting, LIBOR-based interest rate caps with a combined notional valueof $152 million and a strike of 7.0% to cap our exposure to interest ratevariability on anticipated  floating-ratedebt.  The interest rate caps areeffective July 1, 2004, and continue through 2009 to 2010.  The interest rate caps had a fair value of $0.6 million atSeptember 30, 2004 and  $1.9 million atDecember 31, 2004, and are included with other assets on the ConsolidatedBalance Sheets. 

 

We also use derivatives to protect the fair value of existing oranticipated fixed-rate debt.  During2002, we had five amortizing swaps with approximately $161 million currentnotional value protecting the fair value of approximately $161 millionfixed-rate debt from changes in value attributable to interest rate movement.  In October 2002, we sold our five Interest Rate  Swap Agreements back to the counter party fora $13.8 million gain and will amortize the gain over the fixed-rate debt’sremaining life through 2009 to 2010.  Theremaining deferred gain of  $10.4 millionis included with accounts payable and other liabilities on the ConsolidatedBalance Sheets.

 

Hedges that are designated as fair value hedges mitigate risk onchanges in the fair value of fixed-rate debt. The unrealized gains/losses in the fair value of these hedges arereported in earnings with an offsetting adjustment through earnings to thecarrying value of the hedged debt. Adjustments to the carrying value of the hedged debt are amortized toearnings beginning no later than when the hedged debt ceases to be adjusted forchanges in its fair value attributable to the interest rate risk being hedged.

 

Cash flow hedges hedge the future cash outflows of current orforecasted debt.  The interest rate capsdescribed above protect against variability in interest cash outflows above thecap strike rate.  The changes in the fairvalue of these hedges are reported on the Consolidated Balance Sheets with acorresponding adjustment to either Accumulated Comprehensive Income or  in earnings, depending on the hedgingrelationship.  Unrealized gains andlosses held in Accumulated Comprehensive Income will be reclassified toearnings in the same period or periods that the hedged cash flows affectearnings.  As of September 30, 2004, thebalance in Accumulated Comprehensive Loss relating to derivatives was $2.7million.  During the third quarter of2004, we reclassified approximately $18,000 into earnings as additionalinterest expense.  Within the next twelvemonths, we estimate that approximately $0.3 million will be reclassified fromAccumulated Comprehensive Loss to earnings as additional interest expense.

 

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We hedge our exposure to the variability in future cash flows forforecasted transactions other than interest-related cash flows over a maximumperiod of 12 months.  During theforecasted period, unrealized gains and losses in the hedging instrument willbe reported in Accumulated  ComprehensiveIncome.  Once the hedged transactiontakes place, the hedge gains and losses will be reported in earnings during thesame period in which the hedged item is recognized  in earnings. We are not currently hedging exposure to variability in future cashflows for forecasted transactions other than interest-related cash flows onfuture anticipated debt.

 

**Note 12 — Related Party Transaction**

 

During the first quarter of 2004, Mr. Mark Burton, a former member ofour senior management, resigned his position with us effective February 1,2004.  In connection with hisresignation, we  entered into aconsulting and office services agreement whereby Mr. Burton and other employeesformerly with our company provide various acquisition and disposition servicesand related due diligence.  The term ofthe agreement is for one year ending January 31, 2005.  In connection with this agreement, we paidapproximately $50,000 in consulting services for the quarter ended September30, 2004 and $133,000 for the nine months ended September 30, 2004.

 

**Note 13 — Stock Option Plan**

 

During the first nine months of 2004, we granted 85,000 stock options(on a post 1-for-4 reverse stock split basis) under our 2001 Stock Option andIncentive Plan (the Plan).  As ofSeptember 30, 2004, we had reserved 998,250 shares for issuance under the Plan.  We issued no stock options during the firstnine months of 2003.

 

As we stated in Note 1, we follow the provisions of APB No. 25, “Accountingfor Stock Issued to Employees.”  In 1997and 2002, we implemented the disclosure provisions required by SFAS No. 123, “Accountingfor Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-BasedCompensation — Transition and Disclosure — an amendment of SFAS No.123,”  respectively, for our stock optionplans.  SFAS 123 requires pro forma netincome and earnings per share information, which is calculated assuming we hadaccounted for our stock option plans under the “fair value” method described inthat statement.  We estimated the fairvalue using the Black-Scholes option pricing model, modified for dividends andusing the following assumptions:

 

26

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| ** **                             | ** ** | **Nine Months Ended September 30** | ** ** |
|----------------------------------------|------------|-----------------------------------------|------------|
| ** **                             | ** ** | **2004**                                | ** ** | **2003** | ** ** |
| Risk free interest rate                |       | 4.21-4.49                               | %          | — |   |
| Annual dividend rate                   |       | 6.06-6.59                               | %          | — |   |
| Volatility factor of the stock price   |       | 38.67-40.98                             | %          | — |   |
| Weighted average expected life (years) |       | 10                                      |       | — |   |

 

We do not record compensation expense for stock option grants.  The table in Note 1 summarizes results as ifwe had recorded compensation expense for options granted in 2004.

 

**Note 14 — Commitments and Contingencies**

 

On August 25, 2004 and August 26, 2004, two purported class actioncomplaints were filed in the Superior Court of California, County of San Diego,against us and each current member and one past member of our Board ofDirectors.  The lawsuits, Jeanne M.Calamore v. Price Legacy Corporation, Jack McGrory, James F. Cahill, MurrayGalinson, Charles L. Goldberg, Robert N. Goodman, Keene Wolcott, JacklynHorton, and Giles H. Bateman (Case No. GIC834768) and Carl E. Atkinson, Jr. v.Price Legacy Corporation, Jack McGrory, James F. Cahill, Murray Galinson,Charles L. Goldberg, Robert N. Goodman, Keene Wolcott, Jacklyn Horton, andGiles H. Bateman (Case No. GIC834830) were consolidated by the court.  The operative complaint alleges the defendantsbreached their fiduciary duty to our stockholders in connection with theproposed merger pursuant to which we will be acquired by PL Retail LLC.  The complaint challenges the sufficiency ofthe merger consideration, the adequacy of disclosures and the independence ofthe directors, and seeks a preliminary and permanent injunction of the mergertransaction and unspecified damages from the defendants.  The discovery process has been ongoing.  On October 27, 2004, the defendants filed ademurrer to the plaintiff’s complaint contending that the complaint fails tostate a valid cause of action against any of the defendants and is fatallyuncertain.  The demurrer is set forhearing on January 14, 2005.  On October27, 2004, the defendants also filed a motion to stay the action.  The motion to stay is set for hearing onJanuary 21, 2005.

 

On September 23, 2004, a purported class action complaint was filed inthe Circuit Court for Baltimore City, Maryland, against us and members of ourBoard of Directors, as well as The Price Group. The lawsuit is captioned Robert Allen v. Price Legacy Corporation, JackMcGrory, Murray Galinson, Keene Wolcott, Charles Goldberg, Robert N. Goodman,Giles H. Bateman, Jacklyn Horton, and The Price Group LLC (Case No.24-C-04-007204 OT).  On

 

27

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October 21, 2004, an Amended Class Action Complaint was filed, whichalleges that the defendants breached their fiduciary duty to our stockholdersin connection with the proposed merger pursuant to which we will be acquired byPL Retail LLC.  The amended complaintchallenges the sufficiency of the merger consideration, the adequacy ofdisclosures and the independence of the directors, and seeks a preliminary andpermanent injunction of the merger transaction, the imposition of a constructivetrust, and unspecified damages from the defendants.The claims have notprogressed sufficiently for us to estimate a range of possible exposure, ifany.

 

**Note 15 — Subsequent Events**

 

On October 1, 2004, we redeemed 1.6 million shares of our Series APreferred Stock at the redemption price of $16.00 per share, along with adividend of $0.236 per share which represented a quarterly dividend of $0.35per share pro-rated for the period of August 1, 2004 to October 1, 2004.  The redemption price of $16.00 per share wasin excess of the carrying value of the stock will result in a reduction of $2.2million from net income to arrive at net income applicable to commonstockholders for the fourth quarter of 2004 in accordance with EITF topic D-42.

 

We discuss other subsequent events in Note 6 and Note 10.

 

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# **ITEM2 - MANAGEMENT’S DISCUSSION AND ANALYSIS**OF FINANCIAL CONDITION 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:

 

•                  the effect ofeconomic, credit and capital market conditions in general and on real estatecompanies in particular, including changes in interest rates

•                  our ability tocompete effectively

•                  developments inthe retail industry

•                  the possibilitythat the proposed merger with PL Retail will not be consummated on the termsdescribed in this report, or at all

•                  the operatingconvenants in the merger agreement

•                  the diversion ofmanagements’ attention to effectuating the proposed merger

•                  costs related tothe proposed merger

•                  our ability toattract and retain key employees, particularly in light of the proposed merger

•                  the lawsuitsarising out of the proposed merger

•                  the financialstability of Price Legacy’s tenants, including our reliance on major tenants

•                  our ability tosuccessfully complete real estate acquisitions, developments and dispositions

•                  the financialperformance of our properties, joint ventures and investments

•                  government approvals,actions and initiatives, including the need for compliance with environmentalrequirements

•                  our ability tocontinue to qualify as a real estate investment trust, or REIT

•                  our ability torealize the value of various assets through negotiated transactions

 

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.  Any forward-lookingstatements should also be considered in light of the information provided in “FactorsThat May Affect Future Performance” located in our Form 10-K filing for the2003 fiscal year.  We assume noobligation to publicly update or revise any forward-looking statements, whetheras a result of new information, future events or otherwise.

 

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

 

•                  why revenues,costs and earnings changed from the prior period

 

29

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•                  funds fromoperations (FFO)

•                  how we used cashfor capital projects and dividends and how we expect to use cash for theremainder of 2004

•                  where we plan onobtaining cash for future dividend payments and future capital expenditures

 

**Critical Accounting Policies and Estimates**

 

Our discussionand analysis of our financial condition and results of operations are basedupon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (GAAP).  Preparation of ourfinancial statements in accordance with GAAP requires management to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses and the related notes.  Refer to our 2003 Annual Report on Form 10-Kfor a discussion of our critical accounting policies which include revenuerecognition, valuation of real estate assets and depreciation, and the disposalor impairment of long-lived assets. There have been no material changes to these policies in 2004.  We believe that our estimates and assumptionsare reasonable based upon historical experience, however, actual results maydiffer from 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-Kfor the 2003 fiscal year.

 

###### ***Overview***

 

We receive income primarily from rental revenue from open-air shoppingcenter properties, including recoveries from tenants, offset by operating andgeneral and administrative expenses. During the fourth quarter of 2003, we segregated a number of ournon-core assets for disposal.  During thefirst nine months of 2004, we have continued our efforts to sell our non-coreassets.  We sold our properties inHampton, VA, San Diego/Rancho Bernardo, CA, and Phoenix/One North First Street,AZ.  We also sold land in Tucson, AZ, landin Orlando, FL, and a partial sale of our land in Farmington, UT.  We completed partial sales of properties inSan Diego/Morena, CA and Tempe, AZ.  Wesold our investment in Mace Security International stock and recognized a gainof $9.2 million.  Finally, the loans toLos Arcos Development, LLC and the related loans to the Phoenix Coyotes hockeyteam were paid off for $30.3 million during the third quarter of 2004.  We redeployed the proceeds from the dispositionof these assets into the redemption of our Series A Preferred Stock and thereduction of debt.  During the first ninemonths of 2004, we redeemed 2.5 million shares of Series A Preferred Stock forthe redemption price of $16 per share. The redemption price was in excess of the carrying value of the stockwhich resulted in a reduction of $3.5 million from net income to arrive at netincome applicable to common stockholders in accordance with Emerging IssuesTask Force (EITF) topic D-42.  On October1, 2004, we redeemed an additional 1.6 million shares of Series A PreferredStock.  During the first nine months of2004, we acquired our joint venture partners’ 50% share of a property inFresno, CA.

 

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During the first nine months of 2004, we completed a RecapitalizationTransaction that resulted in a significant simplification of our capitalstructure.  In accordance with EITF D-42which governed this transaction, approximately $72.8 million was deducted fromnet income to arrive at net loss applicable to common stockholders in thecalculation of earnings per share.

 

On August 24, 2004, we entered into a definitive merger agreementwith PL Retail LLC (PL Retail) pursuant to which a wholly-owned subsidiary of PLRetail will merge with and into Price Legacy with Price Legacy continuing asthe surviving corporation with all of its common stock owned by PL Retail.  Under the terms of the merger agreement, ourcommon stockholders will be entitled to receive cash consideration for eachoutstanding share of our common stock of

 

•                  $18.85 per share

•                  plus an amountequal to a quarterly common dividend of $0.28 per share prorated from October1, 2004 through the closing of the merger, which we currently expect to totalapproximately $9.2 million based upon an estimated closing date of December 21,2004, less any required withholding for taxes

 

Our existing Series A and Series 1 Preferred Stock will remain issuedand outstanding as preferred stock of the surviving corporation.  PL Retail has indicated that it may continueto redeem the Series A and Series 1 Preferred Stock, subject to theavailability of financing.

 

The merger is subject to theapproval of our stockholders holding at least a majority of the combined votingpower of our outstanding common stock and Series A Preferred Stock, votingtogether as a single class, and the satisfaction or waiver of other closingconditions described in the merger agreement. In addition, the completion of the merger is conditioned upon The PriceGroup, LLC (The Price Group), an entity affiliated with Sol Price, a founderand major stockholder of Price Legacy, entering into a put agreement with PLRetail under which PL Retail has the right in its discretion to require ThePrice Group to purchase certain non-core properties and other Price Legacyassets for approximately $147.7 million concurrently with the closing of themerger.  In the event that any of theseproperties or other assets are sold prior to the closing of the merger, The PriceGroup will be entitled to receive the net proceeds from any such sale.  On September 28, 2004, The Price Groupentered into the put agreement, satisfying this condition, and PL Retailexercised its right under the put agreement to cause The Price Group topurchase all right, title, and interest in and to two newly formed Price Legacysubsidiaries that will own these non-core properties and other assets as of theclosing of the merger.  There can be noassurance that the merger will be consummated. We have agreed to pay a termination fee of up to $20.0 million if themerger agreement is terminated under certain circumstances.

 

###### ***RentalRevenues***

 
| ** **        | ** ** | **Amount  (000’s)** | ** ** | **Change  (000’s)** | ** ** | **Percent  Change** | ** ** |
|-------------------|------------|--------------------------|------------|--------------------------|------------|---------------------|------------|
| 3rd Quarter  2004 |       | $                        | 32,149     |                     | $          | 2,863               |       | 10% | ** ** |
| 3rd Quarter 2003  |       | 29,286                   |       |                     |       |                |       |
|              |       |                     |       |                     |       |                |       |
| Year-to-Date 2004 |       | 94,483                   |       | 5,309                    |       | 6                   | %          |
| Year-to-Date 2003 |       | 89,174                   |       |                     |       |                |       |
|                   |            |                          |            |                          |            |                     |            |  |  |

 

31

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Rental revenues increased $2.9 million to $32.1 million in the thirdquarter of 2004 compared to the same period in 2003 primarily because:

 

•                  properties weowned both years generated $2.4 million of additional revenues, primarily dueto additional leasing activity at our Westbury, NY, Mesa, AZ, and Miami, FLproperties and the opening of our Temecula, CA and Orlando/Millenia II, FLproperties

•                  we acquired ourjoint venture partners’ 50% share of a property in Fresno, CA in March 2004which generated $0.5 million of additional revenues

 

Rental revenues increased $5.3 million to $94.5 million in the ninemonth year-to-date period of 2004 compared to the same period in 2003 primarilybecause:

 

•                  properties weowned both years generated $4.4 million of additional revenues, primarily dueto additional leasing activity at our Miami, FL property, the opening of ourTemecula, CA and Orlando/Millenia II, FL properties, partially offset byvacancies at our Wayne, NJ property due to Today’s Man and The Wiz bankruptcies

•                  we acquired ourjoint venture partners’ 50% share of a property in Fresno, CA in March 2004 whichgenerated $1.0 million of additional revenues

 

###### ***Expenses***

 
| ** **              | ** ** | **Amount (000’s)** | ** ** | **Change  (000’s)** | ** ** | **Percent  Change** | ** ** |
|-------------------------|------------|-------------------------|------------|--------------------------|------------|---------------------|------------|
|  3rd  Quarter 2004 |       | $                       | 15,182     |                     | $          | (4,105              | )          | -21 | % |
|  3rd  Quarter 2003 |       | 19,287                  |       |                     |       |                |       |
|                    |       |                    |       |                     |       |                |       |
| Year-to-Date 2004       |       | 47,587                  |       | (2,968                   | )          | -6                  | %          |
| Year-to-Date 2003       |       | 50,555                  |       |                     |       |                |       |
|                         |            |                         |            |                          |            |                     |            |  |  |

 

Expenses decreased $4.1 million to $15.2 million in the third quarterof 2004 compared to 2003 primarily because:

 

•                  general andadministrative expenses decreased by $4.2 million primarily due to a $4.0million lawsuit settlement recorded in the prior year

•                  we recovered$0.6 million of amounts written off in the prior year related to finalsettlement of the Kmart bankruptcy

•                  these decreasesto expenses were partially offset by

•                  expenses fromproperties we owned in both years increased $0.5 million

•                  an increase inexpenses of $0.2 million due to the acquisition of our joint venture partners’50% share of a property in Fresno, CA

 

Expenses decreased $3.0 million to $47.6 million for the nine monthyear-to-date period of 2004 compared to 2003 primarily because:

 

•                  general andadministrative expenses decreased $5.2 million, primarily due to a $4.0 millionlawsuit settlement recorded in the prior year and also due to reduced salaryand legal expenses in the current year

 

32

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•                  bad debt expensedecreased by $0.8 million, primarily due to a recovery of $0.6 million ofamounts written off in the prior year due to final settlement of the Kmartbankruptcy

•                  these decreasesto expenses were partially offset by

•                  expenses fromproperties we owned in both years increased which $1.4 million, primarily dueto additional operating expenses due to the openings of our properties inTemecula, CA and Orlando/Millenia II, FL and increased depreciation expense atour Newport, KY property

•                  a provision forasset impairment of $1.2 million we recorded related to our notes receivablewith the Ellman Affiliates when they exercised their right to purchase thenotes

•                  an increase inexpenses of $0.4 million related to the acquisition of our joint venturepartners’ 50% share of a property in Fresno, CA

 

***Operating Income***

 
| ** **        | ** ** | **Amount  (000’s)** | ** ** | **Change  (000’s)** | ** ** | **Percent  Change** | ** ** |
|-------------------|------------|--------------------------|------------|--------------------------|------------|---------------------|------------|
| 3rd Quarter 2004  |       | $                        | 16,967     |                     | $          | 6,968               |       | 70 | % |
| 3rd Quarter 2003  |       | 9,999                    |       |                     |       |                |       |
|              |       |                     |       |                     |       |                |       |
| Year-to-Date 2004 |       | 46,896                   |       | 8,277                    |       | 21                  | %          |
| Year-to-Date 2003 |       | 38,619                   |       |                     |       |                |       |
|                   |            |                          |            |                          |            |                     |            |  |  |

 

Operating income increased for the third quarter and year-to-dateperiods of 2004 compared to the same periods in the prior year primarilybecause of the changes in Rental Revenues and Expenses discussed above.

 

***Interest Expense***

 
| ** **        | ** ** | **Amount  (000’s)** | ** ** | **Change  (000’s)** | ** ** | **Percent  Change** | ** ** |
|-------------------|------------|--------------------------|------------|--------------------------|------------|---------------------|------------|
| 3rd Quarter 2004  |       | $                        | 6,849      |                     | $          | 417                 |       | 6 | % |
| 3rd Quarter 2003  |       | 6,432                    |       |                     |       |                |       |
|              |       |                     |       |                     |       |                |       |
| Year-to-Date 2004 |       | 20,815                   |       | 1,403                    |       | 7                   | %          |
| Year-to-Date 2003 |       | 19,412                   |       |                     |       |                |       |
|                   |            |                          |            |                          |            |                     |            |  |  |

 

Interestexpense increased $0.4 million in the third quarter of 2004 compared to 2003primarily due to the increase in interest rates.  The weighted average interest rate on ourvariable rate debt increased to 3.3% on September 30, 2004 from 2.8% on September30, 2003.

 

Interestexpense increased $1.4 million for the nine month year-to-date period comparedto the prior year because our average debt outstanding for 2004 was $560.3million compared to $557.8 million for the same period of 2003.  Also, the increase in interest expense wasdue to the increase in variable interest rates as noted above.

 

Wediscuss our outstanding debt further in “Liquidity and Capital Resources”located elsewhere in this Form 10-Q.

 

33

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***Interest and Other Income***

 
| ** **        | ** ** | **Amount  (000’s)** | ** ** | **Change  (000’s)** | ** ** | **Percent  Change** | ** ** |
|-------------------|------------|--------------------------|------------|--------------------------|------------|---------------------|------------|
| 3rd Quarter 2004  |       | $                        | 3,055      |                     | $          | 2,974               |       | 3,672 | % |
| 3rd Quarter 2003  |       | 81                       |       |                     |       |                |       |
|              |       |                     |       |                     |       |                |       |
| Year-to-Date 2004 |       | 3,163                    |       | 2,157                    |       | 214                 | %          |
| Year-to-Date 2003 |       | 1,006                    |       |                     |       |                |       |
|                   |            |                          |            |                          |            |                     |            |  |  |

 

Interest and other income increased $3.0 million in the third quarterof 2004 compared to 2003 primarily because:

 

•                  we recognizedother income of $2.6 million related to the Kmart stock received as part of thebankruptcy settlement

•                  we earned $0.3million on our investment in Newport bonds

 

Interest and other incomeincreased $2.2 million in the nine month year-to-date period of 2004 comparedto 2003 primarily because:

 

•                  we recognizedother income of $2.6 million related to the Kmart stock received as part of thebankruptcy settlement

•                  we earned $0.3million on our investment in Newport bonds

•                  these increasesto interest and other income were partially offset by:

•                  interest earnedon notes receivable outstanding with other real estate developers decreased $0.8million.  These notes are no longeroutstanding

 

***Discontinued Operations***

 

We report discontinued operations for ourproperties in Anaheim, CA, Farmington, UT, Tucson/Marana, AZ, and Tusayan, AZwhich are classified as held for sale. We also report discontinued operations for our properties in SanDiego/Rancho Bernardo, CA, San Diego, CA, Hampton, VA, and Phoenix/One NorthFirst Street, AZ which were sold in 2004. Also included in the 2003 Consolidated Statements of Operations are thediscontinued operations of our properties at Scottsdale, AZ, Inglewood, CA, NewBritain, CT, and Northridge, CA which were sold in 2003.

 

During the first nine months of 2004, we soldthe following properties and recognized a net gain of $2.3 million.  This gain is recorded as discontinuedoperations in the Consolidated Statement of Operations in accordance with Statement of FinancialAccounting Standards No. 144.

 
| **Location**                       | ** ** | **Description**      | ** ** | **Date  Sold** | ** ** | **Sales Price  (000’s)** | ** ** |
|------------------------------------|------------|----------------------|------------|----------------|------------|-------------------------------|------------|
| Hampton, VA                        |       | Retail Building/Bank |       | 4/1/04         |       | $                             | 4,850      |   |
| San Diego/Rancho Bernardo, CA      |       | Office Building      |       | 5/12/04        |       | 14,655                        |       |
| Tucson/Marana, AZ                  |       | Land                 |       | 6/16/04        |       | 408                           |       |
| San Diego/Morena, CA               |       | Office Building      |       | 6/28/04        |       | 4,125                         |       |
| Farmington, UT                     |       | Land                 |       | 8/11/04        |       | 3,078                         |       |
| Phoenix/One North First Street, AZ |       | Office Building      |       | 9/30/04        |       | 5,900                         |       |
|                                    |            |                      |            |                |            |                               |            |  |

 

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During the first nine months of 2003, we sold the following propertiesand recognized a net loss of $2.4 million. This loss is recorded as discontinued operations in the ConsolidatedStatement of Operations in accordance with Statement of Financial AccountingStandards No. 144.

 
| **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                         |       |
| Tucson/Marana, AZ |       | Land               |       | 8/22/03        |       | 416                           |       |
|                   |            |                    |            |                |            |                               |            |  |

 

During the third quarter of 2004, we recognized animpairment loss of $3.7 million on our hospitality property at Tusayan,AZ.  The loss was determined based on acontract price to sell the property entered into during the third quarter of2004.  The property was sold on October22, 2004 for the contract price of $9.5 million.  Also during the third quarter of 2004, werecognized an impairment loss of $6.6 million on our Anaheim, CA property.  The loss was determined based on revisedinformation as we continue to market the property for sale.  As both properties are classified as held forsale, these losses are recorded as discontinued operations in theConsolidated Statement of Operations in accordance with Statement of FinancialAccounting Standards No. 144.

 

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

 

During the first nine months of 2004, we disposed of a joint ventureinvestment, sold our investment in Mace stock, sold a parcel of land at ourproperty in Tempe, AZ and sold our joint venture investment which owned land inOrlando, FL.   We recognized a net gainof $12.7 million on the sale of these investments.

 

During the first nine months of 2003, we received payment on the notesreceivable related to the sale of our development self storage properties andrecognized additional gains on the sales of $0.7 million.  We also disposed of a joint ventureinvestment and recognized a loss on the disposal of $0.8 million.

 

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***Funds From Operations (amounts in thousands)***

 
| ** **                                                | ** ** | **Three Months Ended  September 30** | ** ** | **Nine Months Ended  September 30** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                                                |       | $                                    | 3,329      |                                | $          | 3,628 |   | $ | 34,859 |   | $ | 20,161 |   |
| Depreciation and amortization                             |       | 5,525                                |       | 5,051                               |       | 16,436 |   | 14,379 |   |
| Depreciation and amortization of  discontinued operations |       | 127                                  |       | 375                                 |       | 407 |   | 1,305 |   |
| Price Legacy’s share of joint venture  depreciation  |       | 113                                  |       | 629                                 |       | 139 |   | 1,146 |   |
| Depreciation of non-real estate assets                    |       | (32                                  | )          | (16                                 | )          | (106 | ) | (78 | ) |
| Net (gain) loss on sale of discontinued  operations       |       | (80                                  | )          | (153                                | )          | (2,274 | ) | 2,368 |   |
| Net (gain) loss on sale of real estate and  investments   |       | (123                                 | )          | 824                                 |       | (12,744 | ) | 137 |   |
| FFO before preferred dividends                            |       | 8,859                                |       | 10,338                              |       | 36,717 |   | 39,418 |   |
| Preferred dividends                                       |       | (3,036                               | )          | (12,486                             | )          | (17,736 | ) | (37,270 | ) |
| Preferred stock conversion and redemption                 |       | (2,136                               | )          | —                              |       | (76,370 | ) | — |   |
| FFO                                                       |       | $                                    | 3,687      |                                | $          | (2,148 | ) | $ | (57,389 | ) | $ | 2,148 |   |
|                                                      |       |                                 |       |                                |       |   |   |   |   |
| Net cash provided by (used in):                           |       |                                 |       |                                |       |   |   |   |   |
| Operating activities                                      |       | $                                    | 24,669     |                                | $          | 17,744 |   | $ | 49,206 |   | $ | 39,853 |   |
| Investing activities                                      |       | 39,165                               |       | (7,970                              | )          | 87,702 |   | (7,482 | ) |
| Financing activities                                      |       | (38,300                              | )          | (15,672                             | )          | (89,779 | ) | (32,031 | ) |
| Significant non-cash items:                               |       |                                 |       |                                |       |   |   |   |   |
| Provision for asset impairment                            |       | 10,270                               |       | —                              |       | 11,495 |   |   |   |
| Preferred stock conversion                                |       | —                               |       |                                |       | 72,812 |   |   |   |
| Series B preferred dividends                              |       | —                               |       |                                |       | 2,212 |   |   |   |
| Deferred rents                                            |       | 442                                  |       | 698                                 |       | 1,364 |   | 1,896 |   |
|                                                           |            |                                      |            |                                     |            |  |  |  |  |  |  |  |  |  |

 

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, excluding gains (orlosses) from sales of property, plus depreciation and amortization.  We calculate FFO in accordance with theNAREIT definition which also excludes gains (losses) from the sale ofinvestments, and adjusts for preferred dividends.  We believe that FFO is helpful to investorsas a measure of our financial performance because, along with cash flow fromoperating activities, financing activities and investing activities, FFO providesinvestors with an indication of the ability of a REIT to incur and servicedebt, to make capital expenditures and to fund other cash needs.  In addition, we believe that FFO providesuseful information about our performance when compared to other REITs since FFOis generally recognized as the industry standard for reporting the operationsof REITs.  FFO does not represent thecash flows from operations defined by GAAP, may not be comparable to similarlytitled measures of other companies and should not be considered as analternative to net income as an indicator of our operating performance or tocash flows as a measure of liquidity. Excluded from FFO are significant components in understanding ourfinancial performance.

 

FFO before preferred dividends and preferred redemption during thethird quarter of 2004 decreased $1.5 million or 14.3% to $8.9 million comparedto the third quarter of 2003 primarily because:

 

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•                  we recognizedimpairment losses on two of our properties held for sale, which  reduced FFO by $10.3 million

•                  properties soldor held for sale contributed $0.6 million to FFO in the prior year

•                  joint ventureinvestments contributed $0.6 million to FFO in the prior year

•                  additionalinterest expense reduced FFO $0.4 million

•                  these decreasesto FFO were partially offset by:

•                  reduced generaland administrative expenses increased FFO $4.2 million

•                  we recognizedother income of $2.6 million in the current year on the sale of Kmart stockreceived as part of the bankruptcy settlement

•                  properties weowned in both years increased FFO $2.2 million

•                  we recoveredamounts written off in the prior year related to final settlement of the Kmartbankruptcy, which increased FFO $0.6 million

•                  we acquired ourjoint venture partners’ 50% share of a property in Fresno, CA which contributed$0.4 million to FFO

•                  additionalinterest income increased FFO $0.3 million

 

FFO before preferred dividends and preferred stock conversion andredemption during the nine month year-to-date period of 2004 decreased $2.7million or 6.9% to $36.7 million compared to the same period of 2003 primarilybecause:

 

•                  we recognizedimpairment losses on two of our properties held for sale and our notesreceivable, which reduced FFO by $11.5 million

•                  joint ventureinvestments contributed $2.2 million to FFO in the prior year

•                  properties soldor held for sale contributed $1.4 million to FFO in the prior year

•                  additionalinterest expense reduced FFO $1.4 million

•                  decreasedinterest income reduced FFO $0.5 million

•                  these decreasesto FFO were partially offset by:

•                  reduced generaland administrative expenses increased FFO $5.2 million

•                  properties weowned in both years, which increased FFO $4.8 million

•                  we recognizedother income of $2.6 million in the current year on the sale of Kmart stockreceived as part of the bankruptcy settlement

•                  we acquired ourjoint venture partners’ 50% share of a property in Fresno, CA which contributed$0.9 million to FFO

•                  reduced bad debtexpense increased FFO $0.8 million, primarily due to a $0.6 million recovery ofamounts written off in the prior year related to final settlement of the Kmartbankruptcy

 

**Liquidity and 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.

 

37

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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 required a quarterly dividend payment of$9.6 million during the first quarter of 2004, $2.4 million during the secondquarter of 2004, and $2.2 million during the third quarter of 2004.  Our Series 1 Preferred Stock required adividend of $0.5 million during the second quarter of 2004.  Also during 2004, we declared and issued adividend of 397,807 additional shares of Series B Preferred Stock.  As of September 30, 2004, we had a federalnet operating loss (NOL) carry-forward of approximately $17.1 million, whichcould be used to offset future taxable income.

 

As a result of our Recapitalization Transaction, our Series B PreferredStock was exchanged for shares of common stock. In addition, based on a final report from the exchange agent in theSeries A Exchange Offer, 20,942,672 shares of our Series A Preferred Stock weretendered for exchange in the Series A Exchange Offer for a total of 2,942,463shares of our Series 1 Preferred Stock and 18,900,219 shares of our commonstock (on a post 1-for-4 reverse stock split basis).  If the dividends we pay to holders of ourSeries A and Series 1 Preferred Stock are less than 90% of our taxable income(after applying any applicable NOLs), we can declare a dividend to our commonstockholders.  On May 14, 2004 and onAugust 16, 2004, we paid a dividend to our common stockholders of $0.28 per share.  .

 

If our taxable income is less than the dividends we pay to holders ofour Series A and Series 1 Preferred Stock, we are still obligated to paythem.  If we are unable to pay thesedividends when due, they accumulate until paid.

 

On June 7, 2004, we redeemed 1.0 million shares of our Series APreferred Stock.  On September 15, 2004,we redeemed 1.5 million shares of our Series A Preferred Stock.  Finally, on October 1, 2004, we redeemed 1.6million share of our Series A Preferred Stock. All of the shares were purchased for the redemption price of $16 pershare.

 

***Debt***

 

In April 2004, we entered into a new $50.0 million unsecured creditfacility with Wells Fargo Bank.  Prior tothis new facility we had a $100 million unsecured credit facility with FleetBank as agent, which was amended in February 2004 when we repaid $60.0 millionand Wells Fargo assumed the facility. The new facility has a 3-year term with a current interest rate as ofLIBOR plus 155 basis points.  The ratewill be variable, between 118 and 170 basis points based on our leverage andother financial ratios.  We will be ableto increase the new facility by $25.0 million

 

38

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to allow up to $75.0 million of borrowings.  As of September 30, 2004 we had no amountoutstanding on the new facility.

 

Our current credit facility requires us to comply with specifiedfinancial covenants, the most restrictive of which relate to fixed chargecoverage and leverage.  Covenants in someof our construction loans are also tied to our credit facility.  We were in compliance with all covenants inour credit facility at September 30, 2004. To the extent that we violate any of these covenants in the future, wewould need to obtain waivers from our lenders to maintain compliance.  We cannot assure that any such waivers wouldbe forthcoming.

 

In 2004 we had or will have the following significant debt financingand maturities:

 

•                  In January 2004,we obtained a $60.0 million loan secured by our property in Pentagon City,VA.  We used the proceeds to reduce theamount outstanding on our credit facility

•                  In February2004, we repaid a $4.7 million loan related to our property in Newport,KY.  We repaid the loan through borrowingon our credit facility

•                  In March 2004, a$28.5 million construction loan related to our property in Newport, KYmatured.  We extended this loan for oneyear at the same terms

•                  In April 2004,we refinanced a construction loan related to our property in Temecula, CA witha new lender for $29.0 million

•                  In April 2004,we repaid a $19.3 million capital lease obligation on our Greensburg, INproperty with proceeds from the sale of our property in Hampton, VA(approximately $4.6 million) with the balance through a borrowing on our creditfacility.

•                  In May 2004, weobtained a $14.2 million loan secured by our property in Greensburg, IN.  We used the proceeds to reduce the amountoutstanding on our credit facility

•                  In May 2004, an$11.7 million capital lease related to our office building in San Diego/RanchoBernardo, CA was repaid by former member of our senior management.  We subleased our interest and granted themthe right to purchase the property.  Thisright to purchase was exercised and closed in May 2004

•                  In June 2004, a$4.6 million loan related to land we owned in Orlando, FL matured.  This loan was guaranteed by us and by ourpartner.  We paid this loan in full andsubsequently sold the land

•                  In July 2004, a$121.4 million loan related to five properties matured.  We refinanced this loan with another lenderfor the same amount with four of the properties

•                  In October 2004,a $9.6 million loan related to our property in Fresno, CA matures.  We extended this loan for six months

 

The following table summarizes all of our long-term contractualobligations, excluding interest, to pay third parties as of September 30, 2004(amounts in thousands):

 
| ** **               | ** ** | **Contractual Cash Obligations** | ** ** |
|--------------------------|------------|----------------------------------|------------|
| ** **               | ** ** | **Total**                        | ** ** | **Less than   1 year** | ** ** | **1-3  years** | ** ** | **3-5  Years** | ** ** | **More  than 5  years** | ** ** |
| Debt                     |       | $                                | 540,714    |   | $ | 1,014 |   | $ | 208,025 |   | $ | 29,926 |   | $ | 301,749 |   |
| Ground lease obligations |       | 23,055                           |       | 249 |   | 1,993 |   | 1,994 |   | 18,820 |   |
| Total                    |       | $                                | 563,769    |   | $ | 1,263 |   | $ | 210,018 |   | $ | 31,920 |   | $ | 320,569 |   |
|                          |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

39

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For the remainder of 2004,we plan to use cash flow from operations to fund our recurring debt serviceobligations.

 

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

##### ** **

The City of Newport, KY in1999 issued two series of public improvement bonds related to our project inNewport, KY.  The Series 2000a tax exemptbonds total $44.2 million and are broken down as follows: (a)$18.7 million maturing 2018 with interest at 8.375%; (b) $20.5 millionmaturing 2027 with interest at 8.5%; and (c) $5.0 million maturing 2027 withinterest at 8.375%.  The Series 2000bbonds are taxable and have a par amount of $11.6 million with interest at 11%due 2009.  The bonds issued andoutstanding, a total of $55.8 million, are guaranteed by the Newport project,Excel Legacy, and the project’s third party developer.  As of September 30, 2004, Newport had drawnon $46.8 million of the bonds for construction incurred prior to thatdate.

 

On August 2, 2004, we purchased all of the outstanding Newport, KYSeries 2000b taxable bonds for $10.2 million (including accrued interest).  Also, on August 18, 2004, we purchased $9.7million of the 8.5 % Series 2000a tax exempt bonds for $10.1 million (includingaccrued interest).  On October 14, 2004,we purchased $27.9 million of the Newport, KY Series 2000a tax exempt bonds for$29.7 million (including accrued interest). As of October 15, 2004, we owned $47.0 million of the Newport bonds.

 

***Growth***

 

During the first quarterof 2004, we paid $2.8 million to purchase our joint venture partners’ 50%interest in a property in Fresno, CA and assumed a mortgage of $9.7 million.

 

***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.  Theproject opened in October 2001.  AtSeptember 30, 2004, the project was approximately 76% occupied, excludingground leases.  As the project becomesfully leased, there may be capital required to fund the remaining tenantimprovements.  We spent $1.0 million ontenant improvements during the first nine months of 2004 and estimate spendingan additional $0.3 million through the remainder of 2004.

 

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.  At September 30, 2004, theproject was 100% leased.  We plan todevelop an historical parcel within this project for approximately $5.0million.  We spent approximately $250,000on this development during the first nine months of 2004 and estimate spendingan additional $50,000 through the remainder of 2004.  We expect to fund these costs throughavailable cash.

 

In November 2002, we purchased land adjacent to our retail property inOrlando, FL to develop an open-air retail center.  At September 30, 2004, the project wasapproximately 71% occupied.  We estimatethe total cost of this development to be approximately $19.7 million with an

 

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estimated $0.6 million remaining to complete construction, which wewill fund through an existing construction loan.

 

Los Arcos Development, LLC (an affiliate of the Ellman Companies) ownedland in Scottsdale, AZ.  Commencing in1996 loans were made to Los Arcos Development, LLC to acquire this real estate,and we also acquired an additional senior loan secured by the Scottsdaleproperty in 2003 (see Note 5).  AtDecember 31, 2003, we wrote down the value of these notes receivable andrecognized an impairment of $29.5 million. We contributed $0.9 million in the first six months of 2004 forpre-development expenses related to this project, and this sum was includedwithin the indebtedness under the loans. On August 9, 2004, the loans were paid off as described inNote 5.

 

Orlando Business Park, LLC owned approximately 2,400 acres of land inOrlando, FL.  During the second quarterof 2004 we sold this land and recognized a gain of $2.6 million.

 

***Properties Held for Sale***

 

From time to time we will consider selling properties to better alignour portfolio with our geographic and tenant composition strategies.  During the first nine months of 2004, we solda property in Hampton, VA for $4.8 million. We also sold an office building at our property in San Diego/Morena, CAfor $4.1 million and a portion of our property in Tempe, AZ for $1.7million.  Finally, we sold an officebuilding in Phoenix, AZ for $5.9 million. When we sell an operating property, we anticipate a temporary reductionin operating income due to the time lag between selling a property and reinvestingthe proceeds.

 

The Anaheim GardenWalk project in Anaheim, CA, located adjacent toDisney’s two theme parks on Harbor Boulevard and Disney’s new proposed themepark on Katella Avenue, is expected to consist of a 626,000 square footopen-air retail center and four hotels. During the fourth quarter of 2003, we decided to sell the propertyrather than develop it and wrote down the value by $43.4 million to its thenestimated fair market value.  During thethird quarter of 2004 we wrote down the property by an additional $6.6 millionbased on a new fair market value analysis.

 

We owned approximately 40 acres of land in Farmington, UT.  During the fourth quarter of 2003, we decidedto sell the property rather than develop it and wrote down the value by $3.6million to its estimated fair market value. We sold a portion of this land in the third quarter of 2004 and continueour efforts to sell the remaining parcels. We also own some land in Tucson/Marana, AZ.  We sold portions of this land during the secondand third quarters of 2004 and continue our efforts to sell the remainingparcels.

 

As of September 30, 2004, we own a hospitality property in Tusayan,AZ.  During the third quarter of 2004, wedecided to sell the property and wrote down the value by $3.7 million based ona contract price.  The property was sold on October 22, 2004 forthe contract price of $9.5 million.

 

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***Notes Receivable***

 

We have $0.8 million in principal amount of third party notesreceivable outstanding as of September 30, 2004 related to various real estatedevelopments and related businesses.  Thenotes generally do not require cash payments of interest until specified futuredates, typically when developments are completed or sold.

 

Prior to August 9, 2004, we had notes receivable from companies ownedby or affiliated with Steven Ellman (the Ellman Affiliates) with an aggregateoutstanding principal balance, for accounting purposes, of approximately $8.3million.  The outstanding balance was netof a $12.9 million impairment recorded in the fourth quarter of 2003 to reflectthe fair value of the notes in connection with management’s plan to sell ournon-core assets and an additional $1.2 million impairment recorded in thesecond quarter of 2004 to reflect Ellman Affiliates’ exercise of its option topurchase the loans pursuant to the terms specified below.  These notes receivable from the EllmanAffiliates were collateralized by a pledge of certain Ellman Affiliates’distributions from a holding company that owns the Phoenix Coyotes hockey teamand other related assets.  These loanswere made at a time when the Ellman Affiliates intended to relocate the hockeyteam to an arena that was to be constructed on the Scottsdale property owned byLos Arcos Development, LLC.

 

As a result of delays at the Scottsdale property, the Ellman Affiliateselected to pursue an alternative site for the hockey arena in Glendale,AZ.  In December 2002, the EllmanAffiliates and the other investors involved in the ownership of the PhoenixCoyotes entered into a series of transactions in which the Phoenix Coyoteshockey team and related real estate development assets were consolidated for the purpose of assisting in obtainingadditional financing.    Althoughinterest continued to accrue per the terms of the notes, we stopped accruinginterest on  the loans for accountingpurposes when the development projects were consolidated into the holdingcompany.

 

As of January 13, 2004, we entered into loan amendments with the EllmanAffiliates to, among other things, incorporate the pledge of certain EllmanAffiliates’ distributions from the holding company collateralizing the loansand set forth the new maturity date of the loans as December 31, 2004.

 

InAugust 2004, Ellman Investments, Inc. exercised its right to purchase theloans, provided that certain other obligations of the Ellman Affiliates owed tous, including the obligations to make the payments arising with respect to thenotes receivable described in Note 5 have been satisfied, and provided furtherthat the Ellman Affiliates deliver documents satisfactory to us releasing andindemnifying us from liabilities with respect to our various transactions withthe Ellman Affiliates.  On August 9,2004, Ellman Investments, Inc. purchased the loans and other notes receivabledescribed in Note 5, which concluded our existing business association with theEllman Affiliates, their holdings, the Scottsdale property, and the PhoenixCoyotes.

 

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***Other***

 

In April 2004,we sold our investment in Mace Security International stock and recognized again on the sale of $9.2 million.

 

In April 2002,we entered into five Interest Rate Swap Agreements with Fleet Bank that areaccounted for under SFAS No. 133.  Thecombined notional amount was approximately $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 to2010.

 

In July 2002, we paid $3.4 million for four Interest Rate CapAgreements with Wells Fargo Bank and Fleet Bank that are also accounted forunder SFAS No. 133.  The combinednotional 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.

 

# **ITEM3 - QUANTITATIVE AND QUALITATIVE** DISCLOSURES ABOUT MARKET 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 $297.9 million in variable rate debt outstanding at September30, 2004.  Based upon these year-end debtlevels, a hypothetical increase in interest rates by 100 basis points wouldincrease interest expense by approximately $3.0 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

 

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debt will be available to us at favorable rates, if at all.  Consequently, future results may differmaterially from the estimated adverse changes discussed above.

 

In July 2002, in order to mitigate our variable interest rate exposure,we acquired four interest rate caps, which hedge our exposure on $152 millionof variable rate debt.  The hedges limitour exposure to the one-month LIBOR index associated with certain of ouroutstanding debt at 7%.  To the extentthe one-month LIBOR index exceeds 7%, the counter parties on the hedges willpay us the difference between 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 the fairvalue of financial instruments through the use of discounted cash flow analysisusing current interest rates for notes receivable with terms and creditcharacteristics similar to our existing portfolio and borrowings under termssimilar to our existing mortgages payable.

 
| ** **                                         | ** ** | **Expected Maturity Date as of September 30, 2004 (dollar amounts in  thousands)** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **2004**                                                                           | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **Fair  Value** | ** ** |
| Notes receivable, including notes from  affiliates |       | $                                                                                  | 811        |   | — |   | — |   | — |   | — |   | — |   | $ | 811 |   | $ | 811 |   |
| Average interest rate                              |       | —                                                                             |       | — |   | — |   | — |   | — |   | — |   | — |   |   |   |
| Debt                                               |       | $                                                                                  | 1,014      |   | $ | 176,443 |   | $ | 31,582 |   | $ | 3,791 |   | $ | 26,135 |   | $ | 301,749 |   | $ | 540,714 |   | $ | 547,740 |   |
| Average interest rate                              |       | 6                                                                                  | %          | 3 | % | 4 | % | 7 | % | 4 | % | 6 | % | 5 | % |   |   |
|                                                    |            |                                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

# **ITEM 4 — CONTROLSAND**PROCEDURES

# ** **

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in our reports filed under theSecurities Exchange Act of 1934, as amended, is recorded, processed, summarizedand reported within the time periods specified in the rules and forms of theSecurities and Exchange Commission, and that such information is accumulatedand communicated to our management, including our Chief Executive Officer andChief Financial Officer, as appropriate, to allow timely decisions regardingrequired disclosure.  Indesigning and evaluating the disclosure controls and procedures,management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and management necessarily was required to applyits judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures.

 

As required by Securities and Exchange Commission Rule 13a-15(b), underthe supervision and with the participation of management, including our ChiefExecutive Officer and Chief Financial Officer, we carried out an evaluation ofthe effectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this report.  Based on the foregoing, our Chief ExecutiveOfficer and Chief Financial Officer concluded that the Company’s disclosurecontrols and procedures were effective at the reasonable assurance level.

 

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In conjunction with our preparation toward compliance with Section 404of the Sarbanes-Oxley Act of 2002, we are formalizing and enhancing ourfinancial control processes and general computer controls.  These mattershave been discussed with our independent accountants, our audit committee andour Board of Directors.

 

There were no changes in our internal control over financial reportingthat occurred during the quarter ended September 30, 2004 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

A control system, no matter how well conceived and operated, canprovide only reasonable, not absolute, assurance that the objectives of thecontrol system are met.  Because ofinherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues, if any, within a companyhave been detected.  Accordingly, ourdisclosure controls and procedures are designed to provide reasonable, notabsolute, assurance that the objectives of our disclosure control system aremet and, as set forth above, our chief executive officer and chief financialofficer have concluded, based on their evaluation as of the end of the periodcovered by this report, that our disclosure controls and procedures weresufficiently effective to provide reasonable assurance that the objectives ofour disclosure control system were met.

 

#### **PART II - OTHERINFORMATION**

#### ** **

# **ITEM 1 — LEGALPROCEEDINGS**

# ** **

On August 25, 2004 and August 26, 2004, two purported class actioncomplaints were filed in the Superior Court of California, County of San Diego,against us and each current member and one past member of our Board ofDirectors.  The lawsuits, Jeanne M.Calamore v. Price Legacy Corporation, Jack McGrory, James F. Cahill, MurrayGalinson, Charles L. Goldberg, Robert N. Goodman, Keene Wolcott, JacklynHorton, and Giles H. Bateman (Case No. GIC834768) and Carl E. Atkinson, Jr. v.Price Legacy Corporation, Jack McGrory, James F. Cahill, Murray Galinson,Charles L. Goldberg, Robert N. Goodman, Keene Wolcott, Jacklyn Horton, andGiles H. Bateman (Case No. GIC834830) were consolidated by the court.  The operative complaint alleges thedefendants breached their fiduciary duty to our stockholders in connection withthe proposed merger pursuant to which we will be acquired by PL RetailLLC.  The complaint challenges thesufficiency of the merger consideration, the adequacy of disclosures and theindependence of the directors, and seeks a preliminary and permanent injunctionof the merger transaction and unspecified damages from the defendants.  The discovery process has been ongoing.  On October 27, 2004, the defendants filed ademurrer to the plaintiff’s complaint contending that the complaint fails tostate a valid cause of action against any of the defendants and is fatallyuncertain.  The demurrer is set forhearing on January 14, 2005.  On October27, 2004, the defendants also filed a motion to stay the action.  The motion to stay is set for hearing onJanuary 21, 2005.

 

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On September 23, 2004, a purported class action complaint was filed inthe Circuit Court for Baltimore City, Maryland, against us and members of ourBoard of Directors, as well as The Price Group. The lawsuit is captioned Robert Allen v. Price Legacy Corporation, JackMcGrory, Murray Galinson, Keene Wolcott, Charles Goldberg, Robert N. Goodman,Giles H. Bateman, Jacklyn Horton, and The Price Group LLC (Case No.24-C-04-007204 OT).  On October 21, 2004,an Amended Class Action Complaint was filed, which alleges that the defendantsbreached their fiduciary duty to our stockholders in connection with theproposed merger pursuant to which we will be acquired by PL Retail LLC.  The amended complaint challenges thesufficiency of the merger consideration, the adequacy of disclosures and theindependence of the directors, and seeks a preliminary and permanent injunctionof the merger transaction, the imposition of a constructive trust, andunspecified damages from the defendants. The claims have not progressed sufficiently for us to estimate a rangeof possible exposure, if any.

 

# **ITEM 6 - EXHIBITS**

# ** **

The following exhibits are included herein or incorporated byreference:

 
|   | 2.1  | Agreement and Plan of Merger, dated as of August 24, 2004, by and  among Price Legacy Corporation, PL Retail LLC and PL Acquisition Corp.  (Incorporated by reference to Exhibit 2.1 to the Company’s filing on Form 8-K  dated August 26, 2004).   |
|--------|------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 10.1 | Put Agreement, dated September 28, 2004, by and between PL Retail LLC  and The Price Group LLC and acknowledged by Price Legacy Corporation  (Incorporated by reference to Exhibit 2.1 to the Company’s filing of Form 8-K  dated October 4, 2004). |
|   | 31.1 | Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                                                                                                                |
|   | 32.1 | Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                 |

 

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**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: November 9, 2004 |                      |
|                   | /s/ Jack McGrory          |   |
|                   | Jack McGrory              |
|                   | *Chief Executive Officer* |
|                   |                      |
| Date: November 9, 2004 |                      |
|                   | /s/ Jeffrey R. Fisher     |   |
|                   | Jeffrey R. Fisher         |
|                   | *Chief Financial Officer* |

 

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