`

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

----

 

**FORM 10-Q**

 

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

 

**For the quarter ended March 31, 2003**

 

**Commission File Number 0-20449**

 

**PRICE LEGACY CORPORATION**

(Exact name of registrantas specified in its charter)

 

| **Maryland**                                                                   |   | **33-0628740**                        |
|--------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)               |   | (I.R.S. Employer  Identification No.) |
|                                                                           |   |                                  |
| **17140 Bernardo Center Drive, Suite  300, San Diego, California  92128** |
| (Address of principal  executive offices) (Zip Code)                           |
|                                                                           |
| **(858) 675-9400**                                                             |
| (Registrant’s telephone  number, including area code)                     |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 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 36,999,082 shares of common stock, par value $.0001per share, outstanding at May 13, 2003.

 

 

----

 

**PRICE LEGACY CORPORATION**

 

**INDEX TO FORM 10-Q**

 

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

 

2

----

 

#### **PART I - FINANCIAL INFORMATION**

 

# **ITEM 1 - FINANCIALSTATEMENTS**

 

**PRICE LEGACY CORPORATIONCONSOLIDATED BALANCE SHEETS(in thousands, except share data)**

 
|                                                                                                                                                   |   | **March 31  2003** |          | **December  31  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------------|------------------------|--------|
|                                                                                                                                                   |   | **(unaudited)**    |          |                   |   |
| **ASSETS**                                                                                                                                             |   |               | ** **    |                   |   |
| Real estate assets                                                                                                                                     |   |               | ** **    |                   |   |
| Land and land improvements                                                                                                                             |   | **$**              | **444,291**   | ** **             | $      | 446,331 |   |
| Building and improvements                                                                                                                              |   | **669,566**        | ** **    | 668,671                |   |
| Construction in progress                                                                                                                               |   | **40,967**         | ** **    | 35,235                 |   |
|                                                                                                                                                   |   | **1,154,824**      |          | 1,150,237              |   |
| Less accumulated depreciation                                                                                                                          |   | **(38,785**        | **)**         | (34,617                | )      |
|                                                                                                                                                   |   | **1,116,039**      |          | 1,115,620              |   |
|                                                                                                                                                   |   |               | ** **    |                   |   |
| Investment in real estate joint ventures                                                                                                               |   | **26,081**         | ** **    | 26,019                 |   |
| Cash and cash equivalents                                                                                                                              |   | **22,771**         | ** **    | 20,258                 |   |
| Accounts receivable, net of allowance of $1,993 and $1,669                                                                                             |   | **6,362**          | ** **    | 6,036                  |   |
| Notes receivable                                                                                                                                       |   | **63,622**         | ** **    | 62,788                 |   |
| Interest receivable                                                                                                                                    |   | **15,063**         | ** **    | 16,032                 |   |
| Deferred rents                                                                                                                                         |   | **10,369**         | ** **    | 9,460                  |   |
| Other assets                                                                                                                                           |   | **16,156**         | ** **    | 16,805                 |   |
| Total assets                                                                                                                                           |   | **$**              | **1,276,463** | ** **             | $      | 1,273,018 |   |
|                                                                                                                                                   |   |               | ** **    |                   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                          |   |               | ** **    |                   |   |
|                                                                                                                                                   |   |               | ** **    |                   |   |
| Liabilities                                                                                                                                            |   |               | ** **    |                   |   |
| Mortgages and notes payable                                                                                                                            |   | **$**              | **487,548**   | ** **             | $      | 487,811 |   |
| Revolving line of credit                                                                                                                               |   | **65,900**         | ** **    | 60,300                 |   |
| Accounts payable and other liabilities                                                                                                                 |   | **30,169**         | ** **    | 31,341                 |   |
| Total liabilities                                                                                                                                      |   | **583,617**        | ** **    | 579,452                |   |
|                                                                                                                                                   |   |               | ** **    |                   |   |
| Commitments                                                                                                                                            |   |               | ** **    |                   |   |
|                                                                                                                                                   |   |               | ** **    |                   |   |
| Minority interests                                                                                                                                     |   | **595**            | ** **    | 595                    |   |
|                                                                                                                                                   |   |               | ** **    |                   |   |
| Stockholders’ equity                                                                                                                              |   |               | ** **    |                   |   |
| Series A preferred stock, cumulative, redeemable, $0.0001 par value,  27,849,771 shares authorized, 27,434,166 shares issued and outstanding           |   | **399,615**        | ** **    | 399,615                |   |
| Series B preferred stock, junior, convertible, redeemable, $0.0001  par value, 27,458,855 shares authorized, 19,666,754 shares issued and  outstanding |   | **106,234**        | ** **    | 106,234                |   |
| Common stock, $0.0001 par value, 94,691,374 shares authorized,  36,999,082 and 37,255,748 issued and outstanding                                       |   | **4**              | ** **    | 4                      |   |
| Additional paid-in capital                                                                                                                             |   | **196,019**        | ** **    | 196,019                |   |
| Treasury stock at cost, 3,727,593 and 3,470,927 shares                                                                                                 |   | **(12,078**        | **)**         | (11,299                | )      |
| Accumulated other comprehensive loss                                                                                                                   |   | **(1,649**         | **)**         | (921                   | )      |
| Retained earnings                                                                                                                                      |   | **4,106**          | ** **    | 3,319                  |   |
| Total stockholders’ equity                                                                                                                        |   | **692,251**        | ** **    | 692,971                |   |
| Total liabilities and stockholders’ equity                                                                                                        |   | **$**              | **1,276,463** | ** **             | $      | 1,273,018 |   |

 

*Seeaccompanying notes.*

 

3

----

 

**PRICE LEGACY CORPORATIONCONSOLIDATED STATEMENTS OFOPERATIONS(unaudited - amounts in thousands, except per share data)**

 
|                                                                  |   | **First  Quarter  Three Months Ended  March 31** |       |
|-----------------------------------------------------------------------|--------|--------------------------------------------------|------------|
|                                                                  |   | **2003**                                         |       | **2002** |   |
|                                                                  |   |                                             |       |   |   |
| Rental revenues                                                       |   | **$**                                            | **31,957** | ** ** | $ | 27,581 |   |
|                                                                  |   |                                             | ** ** |   |   |
| Expenses                                                              |   |                                             | ** ** |   |   |
| Operating and  maintenance                                            |   | **6,213**                                        | ** ** | 4,990 |   |
| Property taxes                                                        |   | **3,813**                                        | ** ** | 3,158 |   |
| Depreciation and  amortization                                        |   | **4,396**                                        | ** ** | 4,103 |   |
| General and  administrative                                           |   | **1,984**                                        | ** ** | 2,804 |   |
| Total expenses                                                        |   | **16,406**                                       | ** ** | 15,055 |   |
|                                                                  |   |                                             | ** ** |   |   |
| Operating income                                                      |   | **15,551**                                       | ** ** | 12,526 |   |
|                                                                  |   |                                             | ** ** |   |   |
| Interest and  other                                                   |   |                                             | ** ** |   |   |
| Interest expense                                                      |   | **(6,610**                                       | **)**      | (6,242 | ) |
| Interest income                                                       |   | **812**                                          | ** ** | 1,269 |   |
| Equity in  earnings of joint ventures                                 |   | **149**                                          | ** ** | 178 |   |
| Total interest  and other                                             |   | **(5,649**                                       | **)**      | (4,795 | ) |
|                                                                  |   |                                             | ** ** |   |   |
| Income from  continuing operations before gain on sale of real estate |   | **9,902**                                        | ** ** | 7,731 |   |
|                                                                  |   |                                             | ** ** |   |   |
| Net gain on sale  of real estate                                      |   | **691**                                          | ** ** | 287 |   |
|                                                                  |   |                                             | ** ** |   |   |
| Income from  continuing operations                                    |   | **10,593**                                       | ** ** | 8,018 |   |
|                                                                  |   |                                             | ** ** |   |   |
| Discontinued  operations:                                             |   |                                             | ** ** |   |   |
| Income from  operations                                               |   | **7**                                            | ** ** | 1,144 |   |
| Net loss on sale  of real estate                                      |   | **(211**                                         | **)**      | — |   |
|                                                                  |   | **(204**                                         | **)**      | 1,144 |   |
|                                                                  |   |                                             | ** ** |   |   |
| Net income                                                            |   | **10,389**                                       | ** ** | 9,162 |   |
|                                                                  |   |                                             | ** ** |   |   |
| Dividends to  preferred stockholders                                  |   | **(12,360**                                      | **)**      | (12,126 | ) |
|                                                                  |   |                                             | ** ** |   |   |
| Net loss  applicable to common stockholders                           |   | **$**                                            | **(1,971** | **)** | $ | (2,964 | ) |
|                                                                  |   |                                             | ** ** |   |   |
| Basic and  diluted net loss per common share                          |   | **$**                                            | **(.05**   | **)** | $ | (.07 | ) |
|                                                                  |   |                                             | ** ** |   |   |
| Weighted average  common shares outstanding Basic and diluted         |   | **37,029**                                       | ** ** | 40,727 |   |
|                                                                  |   |                                             | ** ** |   |   |
| Dividends per  preferred share                                        |   | **$**                                            | **.35**    | ** ** | $ | .35 |   |

 

*Seeaccompanying notes.*

 

4

----

 

**PRICE LEGACY CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited - amounts in thousands)**

 
|                                                                               |   | **First  Quarter  Three Months Ended  March 31** |       |
|------------------------------------------------------------------------------------|--------|--------------------------------------------------|------------|
|                                                                               |   | **2003**                                         |       | **2002** |   |
| Operating  activities                                                              |   |                                             |       |   |   |
| Net income                                                                         |   | **$**                                            | **10,389** | ** ** | **$** | **9,162** | ** ** |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |                                             | ** ** |   | ** ** |
| Depreciation and  amortization                                                     |   | **4,403**                                        | ** ** | **4,426** | ** ** |
| Deferred rents                                                                     |   | **(909**                                         | **)**      | **(1,512** | **)** |
| Equity in  earnings of joint venture                                               |   | **(149**                                         | **)**      | **(178** | **)** |
| Net gain on sale  of real estate                                                   |   | **(480**                                         | **)**      | **(287** | **)** |
| Changes in  operating assets and liabilities:                                      |   |                                             | ** ** |   | ** ** |
| Accounts  receivable and other assets                                              |   | **2,505**                                        | ** ** | **(469** | **)** |
| Accounts payable  and other liabilities                                            |   | **(1,099**                                       | **)**      | **(1,343** | **)** |
| Net cash  provided by operating activities                                         |   | **14,660**                                       | ** ** | **9,799** | ** ** |
|                                                                               |   |                                             | ** ** |   | ** ** |
| Investing  activities                                                              |   |                                             | ** ** |   | ** ** |
| Additions to  real estate assets                                                   |   | **(9,217**                                       | **)**      | **(15,311** | **)** |
| Proceeds from  the sale of real estate assets                                      |   | **2,902**                                        | ** ** | **1,892** | ** ** |
| Distributions  from real estate joint ventures                                     |   | **87**                                           | ** ** | **192** | ** ** |
| Advances on  notes receivable                                                      |   | **(14,207**                                      | **)**      | **(797** | **)** |
| Repayments on  notes receivable                                                    |   | **12,553**                                       | ** ** | **10** | ** ** |
| Net cash used in  investing activities                                             |   | **(7,882**                                       | **)**      | **(14,014** | **)** |
|                                                                               |   |                                             | ** ** |   | ** ** |
| Financing activities                                                               |   |                                             | ** ** |   | ** ** |
| Advances from  revolving line of credit and notes payable                          |   | **28,282**                                       | ** ** | **23,155** | ** ** |
| Repayments of  revolving line of credit and notes payable                          |   | **(22,945**                                      | **)**      | **(7,137** | **)** |
| Dividends paid  to preferred stockholders                                          |   | **(9,602**                                       | **)**      | **(9,602** | **)** |
| Proceeds from  exercise of stock options                                           |   | **—**                                       | ** ** | **303** | ** ** |
| Net cash(used  in) provided by financing activities                                |   | **(4,265**                                       | **)**      | **6,719** | ** ** |
|                                                                               |   |                                             | ** ** |   | ** ** |
| Net increase in  cash and cash equivalents                                         |   | **2,513**                                        | ** ** | **2,504** | ** ** |
|                                                                               |   |                                             | ** ** |   | ** ** |
| Cash and cash  equivalents at beginning of period                                  |   | **20,258**                                       | ** ** | **28,042** | ** ** |
|                                                                               |   |                                             | ** ** |   | ** ** |
| Cash and cash  equivalents at end of period                                        |   | **$**                                            | **22,771** | ** ** | **$** | **30,546** | ** ** |
|                                                                               |   |                                             | ** ** |   | ** ** |
| Supplemental  cash flow information:                                               |   |                                             |       |   |   |
| Cash paid for  interest                                                            |   | **$**                                            | **7,007**  | ** ** | **$** | **6,427** | ** ** |
|                                                                               |   |                                             | ** ** |   | ** ** |
| Supplemental  schedule of noncash investing activities:                            |   |                                             | ** ** |   | ** ** |
| Increase to  treasury stock for reduction in notes receivable                      |   | **779**                                          | ** ** | **—** | ** ** |
| Reduction of  notes receivable to acquire real estate assets                       |   | **—**                                       | ** ** | **2,362** | ** ** |
| Net adjustment  related to disposed real estate asset                              |   | **—**                                       | ** ** | **733** | ** ** |

 

*Seeaccompanying notes.*

 

5

----

 

**PRICE LEGACY CORPORATION**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENT****S(UNAUDITED)**

 

**March31, 2003**

 

### **Note 1 –Organization and Significant Accounting Policies**

 

***Organization***

Price Legacy Corporation (Price Legacy) operates as a real estateinvestment trust (REIT) incorporated in the state of Maryland.  Our principal business is to acquire,operate, and develop real property, primarily open-air shopping centers.  On September 18, 2001, Price Legacycompleted a merger between Price Enterprises, Inc. (PEI) and Excel LegacyCorporation (Excel Legacy) resulting in Excel Legacy becoming a wholly ownedsubsidiary of PEI (the Merger).  Thecombined company operates as a REIT under the name Price Legacy Corporation.

 

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

 

***AccountingPrinciples***

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

 

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

 

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

 

***Real Estate Assets and Depreciation***

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

 

6

----

 

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

 

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

 

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

 

We review long-lived assets for impairment when events or changes inbusiness conditions indicate that their full carrying value may not berecovered.  We consider assets to beimpaired and write them down to fair value if their expected associated futureundiscounted cash flows are less than their carrying amounts.  Generally, we estimate fair value usingdiscounted cash flow, direct capitalization or market comparison analyses.  The process of evaluating for impairmentrequires estimates as to future events and conditions, which are subject tovarying market and economic factors.

 

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

 

|                  |   | **Three Months Ended  March 31** |   |
|-----------------------|--------|----------------------------------|--------|
|                  |   | **2003**                         |   | **2002** |   |
| Interest  incurred    |   | $                                | 7,321  |   | $ | 7,009 |   |
| Interest  capitalized |   | 525                              |   | 572 |   |
|                       |        |                                  |        |  |  |  |  |

 

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

 

***Cash and Cash Equivalents***

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

 

7

----

 

We are required to maintain reserves with certain lenders for propertytaxes, insurance and capital expenditures. The aggregate amounts of these reserves held by lenders wereapproximately $10.5 million at March 31, 2003 and $8.8 million at December 31,2002.  These amounts are reflected ascash on the consolidated balance sheets.

 

Our cash balance at March 31, 2003 and December 31, 2002 includes $2.4million of restricted funds which represent the proceeds from the sale ofvacant land at our property in Hollywood/Oakwood Plaza, FL.  The funds will be held by the lender untilthe debt is repaid in 2009.

 

***Investment in Securities***

Included in other assets on the consolidated balance sheets areinvestments in securities.  We reviewour investments in securities for possible impairment whenever the market valueof the securities falls below cost and, in our opinion, such decline representsan other than temporary impairment. Factors considered in this review include:

 

•                  duration andextent, as well as reasons for which the market value has been less than cost

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

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

 

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

 

***Comprehensive Income***

Statement of Financial Accounting Standard (SFAS) No. 130 “ReportingComprehensive Income” requires that all components of comprehensive income bereported in the financial statements in the period in which they arerecognized.  The components ofcomprehensive income at March 31, 2003 and 2002 are as follows:

 
|                                                 |   | **Three Months Ended  March 31** |   |
|------------------------------------------------------|--------|----------------------------------|--------|
|                                                 |   | **2003**                         |   | **2002** |   |
| Net income                                           |   | $                                | 10,389 |   | $ | 9,162 |   |
| Unrealized gain  (loss) on marketable securities     |   | (3                               | )      | 15 |   |
| Unrealized loss  on derivative financial instruments |   | (725                             | )      | — |   |
| Total  comprehensive income                          |   | $                                | 9,661  |   | $ | 9,177 |   |

 

8

----

 

***Use of Estimates***

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

 

***Derivative Financial Instruments***

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

 

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

*** ***

***Asset Disposal***

In August 2001, the Financial Accounting Standards Board (FASB) issuedSFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets.”  SFAS No. 144 addressesfinancial accounting for the impairment or disposal of long-lived assets and iseffective in fiscal years beginning after December 15, 2001.   We have adopted this standard and reportoperations from properties sold in 2003 and 2002 as discontinued operations forthe three months ended March 31, 2003 and 2002.

 

9

----

 

***New AccountingStandards***

 

In December 2002, the FASB issued SFAS No.148, “Accounting for Stock-Based Compensation – Transition and Disclosure – anamendment of SFAS No. 123.”  SFAS No.148 addresses transition provisions for a voluntary change to the fair valuemethod of accounting for stock-based employee compensation.  In addition, SFAS No. 148 amends thedisclosure requirements of SFAS No. 123. We have evaluated the effect of this statement and have determined itwill not have a significant impact on our consolidated financial statements.

 

We do not record compensation expense forstock option grants and we granted no options in the first quarter of2003.  The following table summarizesresults as if we had recorded compensation expense under the provisions of SFASNo. 123, as amended by SFAS No. 148, for the 2002 option grants.

 
|                                                                               |   | **Three  Months Ended March 31** |   |
|------------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                               |   | **2003**                         |   | **2002** |   |
| Net loss:                                                                          |   |                             |   |   |   |
| As reported                                                                        |   | $                                | (1,971 | ) | $ | (2,964 | ) |
| Deduct:  stock based  compensation expense determined under fair value method |   | (140                             | )      | (378 | ) |
| Pro forma                                                                          |   | $                                | (2,111 | ) | $ | (3,342 | ) |
| Net loss per share – basic and diluted:                                       |   |                             |   |   |   |
| As reported                                                                        |   | (.05                             | )      | (.07 | ) |
| Pro forma                                                                          |   | (.06                             | )      | (.08 | ) |

 

We discuss our stock option plan further in Note 9.

 

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

 

10

----

 

 

**Note 2 –Net Income Per Share**

 

SFAS No. 128, “Earnings per Share,” requires presentation of twocalculations of earnings per common share. Basic earnings per common share equals net income applicable to commonstockholders divided by weighted average common shares outstanding during theperiod.  Diluted earnings per commonshare equals net income applicable to common stockholders divided by the sum ofweighted average common shares outstanding during the period plus  dilutive potential shares.  Dilutive potential shares are shares assumedto be issued if outstanding stock options were exercised.  All earnings per share amounts have beenpresented, and where appropriate, restated to reflect these calculations.  We did not have any common stock equivalentsduring the periods presented.

 

There were 19,666,754 shares of Series B Preferred Stock outstanding atMarch 31, 2003 which may be exchanged on a one-to-one basis into common stock,subject to adjustment, after 24 months from issuance if certain events occur.  As of March 31, 2003, the Series B Preferredstockholders were entitled to approximately 2.9 million additional shares.

 

**Note 3 –Real Estate Assets**

 

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

 
|                                  |   | **Three  Months Ended March 31** |   |
|---------------------------------------|--------|----------------------------------|--------|
|                                  |   | **2003**                         |   | **2002** |   |
| Minimum rent                          |   | $                                | 23,304 |   | $ | 19,938 |   |
| Straight-line  accrual of future rent |   | 509                              |   | 1,302 |   |
| Expense  reimbursements               |   | 6,811                            |   | 5,022 |   |
| Percentage rent                       |   | 319                              |   | 117 |   |
| Other revenues                        |   | 1,014                            |   | 1,202 |   |
| Rental revenues                       |   | $                                | 31,957 |   | 27,581 |   |
|                                       |        |                                  |        |  |  |  |  |

 

***Acquisitions***

There were no acquisitions during the first three months of 2003 and2002.

*** ***

***Dispositions***

 

During the first three months of 2003, we sold a property inScottsdale, AZ for $3.0 million, recognizing a net loss of $0.2 million on thesale.  Also during the first threemonths in 2003, we received payment on three notes receivable related to thesale of our self storage development properties in 2002.  We recognized a gain of $0.7 million on thesales.

 

11

----

 

During the first three months of 2002, we sold the following propertiesfor a net gain of $0.3 million:

 
| **Location**       |   | **Description** |   | **Date  Sold** |   | **Sales  Price  (000’s)** |   |
|--------------------|--------|-----------------|--------|----------------|--------|--------------------------------|--------|
| Hollywood, FL      |   | Land            |   | 1/31/02        |   | $                              | 1,410  |   |
| Tucson/Marana,  AZ |   | Land            |   | 1/31/02        |   | 684                            |   |
|                    |        |                 |        |                |        |                                |        |  |

 

In April 2003, we sold our property in Inglewood, CA for $4.0million.  We recognized no gain or losson the sale. 

** **

**Note 4 –Discontinued Operations**

 

Included in the Consolidated Statements ofOperations are the discontinued operations of our property at Scottsdale, AZwhich was sold during 2003 and Glen Burnie, MD, our self storage properties inSan Diego/Murphy Canyon, CA, Solana Beach, CA and Azusa, CA which were soldduring 2002.  Discontinued operationsare summarized as follows (amounts in thousands):

 

|                                    |   | **First  Quarter  Three Months Ended  March 31** |   |
|-----------------------------------------|--------|--------------------------------------------------|--------|
|                                    |   | **2003**                                         |   | **2002** |   |
|                                    |   |                                             |   |   |   |
| Rental revenue                          |   | $                                                | 20     |   | $ | 1,793 |   |
| Expenses                                |   |                                             |   |   |   |
| Operating and  maintenance              |   | 1                                                |   | 76 |   |
| Property taxes                          |   | 6                                                |   | 56 |   |
| Depreciation and  amortization          |   | 6                                                |   | 322 |   |
| Interest expense                        |   | —                                           |   | 195 |   |
|                                    |   | 13                                               |   | 649 |   |
| Income from  operations                 |   | 7                                                |   | 1,144 |   |
| Net (loss) gain  on sale of real estate |   | (211                                             | )      | — |   |
|                                    |   |                                             |   |   |   |
| Net (loss)  income                      |   | $                                                | (204   | ) | $ | 1,144 |   |

 

**Note 5 –Investments in Unconsolidated Real Estate Joint Ventures**

 

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

 

12

----

 
| **Joint Venture**             |   | **Ownership %** |   | **March 31  2003** |   | **December 31  2002** |   |
|-------------------------------|--------|-----------------|--------|--------------------|--------|-----------------------|--------|
| Orlando Business  Park LLC    |   | 50              | %      | $                  | 16,020 |                  | $      | 16,020 |   |
| Old Mill  District Shops, LLC |   | 50              | %      | 3,990              |   | 3,999                 |   |
| 3017977 Nova  Scotia Company  |   | 55              | %      | 3,206              |   | 3,148                 |   |
| Blackstone  Ventures I        |   | 50              | %      | 2,559              |   | 2,546                 |   |
| Other                         |   | Various         |   | 306                |   | 306                   |   |
| Total                         |   |            |   | $                  | 26,081 |                  | $      | 26,019 |   |

 

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

 

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

 
| **As of**                     |               | **Total  Assets** |                   | **Debt** |               | **Total  Equity** |                   |
|-------------------------------|--------------------|-------------------|------------------------|----------|--------------------|-------------------|------------------------|
|                          | **March 31  2003** |              | **December  31  2002** |     | **March 31  2003** |              | **December  31  2002** |   | **March 31  2003** |   | **December  31  2002** |   |
| **(Unaudited)**               |               |              |                   |     |               |              |                   |   |   |   |   |   |   |
| Orlando Business  Park LLC    |               | $                 | 26,643                 |     | $                  | 26,492            |                   | $ | 11,342 |   | $ | 11,162 |   | $ | 15,131 |   | $ | 15,277 |   |
| Old Mill  District Shops, LLC |               | 23,932            |                   | 23,897   |               | 17,463            |                   | 17,356 |   | 6,295 |   | 6,314 |   |
| 3017977 Nova Scotia  Company  |               | 6,529             |                   | 6,529    |               | 5,131             |                   | 5,131 |   | 1,241 |   | 1,241 |   |
| Blackstone  Ventures I        |               | 12,534            |                   | 12,369   |               | 9,953             |                   | 9,982 |   | 2,147 |   | 2,071 |   |
| Other                         |               | 306               |                   | 306      |               | —            |                   | — |   | 306 |   | 306 |   |
|                          |               | $                 | 69,944                 |     | $                  | 69,593            |                   | $ | 43,889 |   | $ | 43,631 |   | $ | 25,120 |   | $ | 25,209 |   |

 
| **Quarter  ended March 31** |     | **Total Revenues** |     | **Net Income (Loss)** |     | **Company’s Share of Net  Income (Loss)** |     |
|----------------------------------|----------|--------------------|----------|-----------------------|----------|------------------------------------------------|----------|
|                             | **2003** |               | **2002** |                  | **2003** |                                           | **2002** |   | **2003** |   | **2002** |   |
| **(Unaudited)**                  |     |               |     |                  |     |                                           |     |   |   |   |   |   |   |
| Orlando Business  Park LLC       |     | $                  | —   |                  | $        | —                                         |     | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Old Mill  District Shops, LLC    |     | 658                |     | 680                   |     | (18                                            | )        | 97 |   | (9 | ) | 49 |   |
| 3017977 Nova  Scotia Company     |     | 517                |     | 446                   |     | 119                                            |     | 57 |   | 58 |   | 71 |   |
| Blackstone  Ventures I           |     | 523                |     | 354                   |     | 200                                            |     | 117 |   | 100 |   | 58 |   |
|                             |     | $                  | 1,698    |                  | $        | 1,480                                          |     | $ | 301 |   | $ | 271 |   | $ | 149 |   | $ | 178 |   |

 

**Note 6 –Notes Receivable**

 

We had $63.6million in principal amount of third party notes receivableoutstanding as of March 31, 2003 related to various real estate developmentsand related businesses.  Of this amount,$52.5 million relates to notes we assumed from the Merger with ExcelLegacy.  The

 

13

----

 

notes bear interest ranging from 2.0% to 15%per annum.  The notes generally do notrequire cash payments of interest until specified future dates, typically whendevelopments are completed or sold.  Asof March 31, 2003, we had $15.1 million of accrued but unpaid interest onthese notes.  Of this amount, we assumed$11.5 million from the Merger with Excel Legacy.  We typically do not recognize interest income on non-recoursenotes receivable related to development projects until the projects beginoperations or the notes are repaid.

 

Of the $63.6million in notes receivable, as of March 31, 2003, the notesreceivable from companies owned by or affiliated with Steven Ellman (the EllmanCompanies) had an aggregate outstanding principal balance of approximately$57.3 million and the aggregate outstanding accrued interest on such notesreceivable was approximately $14.9 million. Notes receivable of $12.2 million (principal amount and accruedinterest) matured in 2002 and on-going negotiations with the Ellman Companiescontemplate an extension of the maturity dates of these notes receivable to upto December 31, 2004.  The remainder ofthe notes receivable mature at various dates in 2003 or 2004 or earlier if therelated development is sold.  Repaymentof the notes depends upon the completion of the various development projects orother events.  The notes receivable aregenerally non-recourse obligations, but are typically collateralized by eitherreal estate liens or pledges of ownership interests in the borrower oraffiliated entities.

 

The largest note receivable was made in 1996to enable the Ellman Companies to purchase real estate located in Scottsdale,Arizona.  The Ellman Companies currentlyplan to develop a shopping center on the Scottsdale property but have yet toreceive, among other things, the necessary government entitlements to commenceconstruction of such shopping center. On February 18, 2003, the Scottsdale City Council voted to direct thestaff to negotiate a development agreement with the Ellman Companies on thisproperty.  We understand that thedevelopment agreement likely will come back to the City Council forconsideration during the summer of 2003. As of March 31, 2003, the outstanding principal balance on the notereceivable relating to the Scottsdale property was approximately $36.2 millionand the outstanding accrued interest on the note receivable was approximately$11.5****million.  We did not accrue interest on this note in2002 or 2003.  The note receivablecurrently matures on the earlier of the sale of the Scottsdale property orDecember 20, 2003.  The notecurrently is collateralized by a pledge of the owners’ ownership interests inthe borrower.  In order, among otherthings, to facilitate the development of the Scottsdale property, we haveengaged in negotiations with the Ellman Companies  to extend the maturity date of this note receivable to up toDecember 31, 2004, and in connection therewith to secure such note receivablewith a second priority deed of trust on the Scottsdale property.

 

14

----

 

In connection with prior development effortswith respect to the Scottsdale property, the Ellman Companies entity that ownsthe Scottsdale property obtained an additional loan from a third partylender.  The loan is collateralized by afirst priority deed of trust on the Scottsdale property and was guaranteed byus.  On February 27, 2003, one of ourwholly owned subsidiaries purchased the loan from the lender for an aggregatepurchase price of $13.0 million.  Theloan matures on July 10, 2003.

 

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

 

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

 

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

 

15

----

 

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

 

We also have a note receivable from Zonapar,LLC (Zonapar).  The note bears interestat 11% and is due June 30, 2003.  Theoutstanding amount at March 31, 2003 was $4.4 million.  The note is guaranteed by Yaromir Steiner,an individual, and Zonapar.  Zonaparowns development and land option rights related to a development in KansasCity, MO.  This note was paid in full onMay 9, 2003.

 

**Note 7 –Debt**

*** ***

***Mortgages and Notes Payable***

We had the following mortgages and notes payable outstanding at March31, 2003 and December 31, 2002 (amounts in thousands):

 

16

----

 
|                                                                                                                                                                                                                                                                                                      |   | **March 31  2003** |    | **December  31  2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------|------------------------|--------|
| Mortgages on five properties in Florida bearing  interest ranging from 8.18% to 9.00%.   The loans are collateralized by the properties and mature February  2009 and January 2010                                                                                                                   |   | $                  | 159,747 |                   | $      | 160,152 |   |
|                                                                                                                                                                                                                                                                                                      |   |               |    |                   |   |
| Mortgage payable with GMAC Commercial Mortgage  Corporation, bearing interest at LIBOR plus 98 basis points (2.28% at March  31, 2003).  The mortgage is  collateralized by five of our properties and matures June 2004                                                                             |   | 121,375            |    | 121,375                |   |
|                                                                                                                                                                                                                                                                                                      |   |               |    |                   |   |
| Mortgages and notes payable on nine properties  bearing interest ranging from 3.35% to 8.75%.  The loans are collateralized by the properties and mature on  various dates between May 2003 and February 2017                                                                                        |   | 99,894             |    | 101,948                |   |
|                                                                                                                                                                                                                                                                                                      |   |               |    |                   |   |
| Revolving $100.0 million credit facility bearing  interest at LIBOR plus 150 to 200 basis points (3.18% at March 31, 2003),  maturing September 2004                                                                                                                                                      |   | 65,900             |    | 60,300                 |   |
|                                                                                                                                                                                                                                                                                                      |   |               |    |                   |   |
| Construction loan outstanding on a $46.0 million  facility bearing interest at LIBOR plus 310 basis points (4.40% at March 31,  2003).  The loan is due March 2004 and  is collateralized by a retail center in Newport, KY (see below).  In April 2003, $10.0 million was repaid on  this loan |   | 38,500             |    | 38,500                 |   |
|                                                                                                                                                                                                                                                                                                      |   |               |    |                   |   |
| Capital lease arrangements with an individual on  three properties.  The capital leases  have effective interest rates ranging from 4.02% to 7.36% and mature on  various dates between June 2004 and June 2005                                                                                      |   | 34,067             |    | 34,052                 |   |
|                                                                                                                                                                                                                                                                                                      |   |               |    |                   |   |
| Mortgage on a property in Orlando, FL bearing  interest at LIBOR plus 225 basis points (3.55% at March 31, 2003).  The loan is collateralized by the property  and matures April 2003                                                                                                                |   | 21,801             |    | 21,888                 |   |
|                                                                                                                                                                                                                                                                                                      |   |               |    |                   |   |
| Construction loan payable to a bank bearing interest  at LIBOR plus 150 basis points (2.80% at March 31, 2003).  The loan matures November 2004 and is  collateralized by the project                                                                                                                |   | 6,267              |    | 5,159                  |   |
|                                                                                                                                                                                                                                                                                                      |   |               |    |                   |   |
| Note payable outstanding on a $4.7 million facility  related to Newport, KY (see below), bearing interest at Prime plus 50 basis  points (4.75% at March 31, 2003), matures May 2003                                                                                                                      |   | 4,737              |    | 4,737                  |   |
|                                                                                                                                                                                                                                                                                                      |   |               |    |                   |   |
| Construction loan payable to a bank bearing interest  at LIBOR plus 185 basis points (3.15% at March 31, 2003).  The loan matures March 2005 and is  collateralized by the project                                                                                                                   |   | 1,160              |    | —                 |   |
|                                                                                                                                                                                                                                                                                                      |   |               |    |                   |   |
| Total                                                                                                                                                                                                                                                                                                     |   | $                  | 553,448 |                   | $      | 548,111 |   |

 

17

----

 

We were in compliance with all convenants onour credit facility at March 31, 2003. In 2003 we plan to use cash flow from operations to fund our recurringdebt service obligations.

 

We have a 65% interest in Newport on the Levee, LLC (Newport) that isdeveloping a retail project in Newport, KY. In addition to the $38.5 million and $4.7 million notes in the abovetable, the City of Newport has issued two series of public improvementbonds.  The Series 2000a tax exemptbonds total $44.2 million and are broken down as follows:  (a) $18.7 million maturing 2018 withinterest at 8.375%; (b) $20.5 million maturing 2027 with interest at 8.5%; and(c) $5.0 million maturing 2027 with interest at 8.375%.  The Series 2000b bonds are taxable and havea par amount of $11.6 million with interest at 11% due 2009.  The bonds are guaranteed by us, by Newport,and the third party co-developers of the project.  Newport has drawn on $43.7 million of the bonds at March 31,2003.

 

Summarized debt information for ourunconsolidated joint ventures and the amount guaranteed by us at March 31, 2003is as follows:

 
| **Joint Venture**                 |   | **March 31  2003** |   | **Debt  Guaranteed** |   | **Maturity  Date** |   |
|-----------------------------------|--------|--------------------|--------|----------------------|--------|--------------------|--------|
|                              |   |               |   |                 |   |               |   |
| Orlando Business  Park, LLC       |   | $                  | 11,342 |                 | $      | 11,342             |   | 6/1/04 |   |
| Old Mill  District Shops, LLC (1) |   | 17,463             |   | 13,952               |   | 7/22/03            |   |
| Blackstone  Ventures I (2)        |   | 9,953              |   | 9,953                |   | 10/1/04            |   |
| 3017977 Nova  Scotia Company (1)  |   | 5,131              |   | —               |   | 6/15/03            |   |
|                              |   | $                  | 43,889 |                 | $      | 35,247             |   |   |   |

 

----

*(1)**       Theseloans have one year extension options*

*(2)**       OnApril 1, 2003, our guarantee was reduced to $3.1 million*

 

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

 

In connection with the sale of three self storage developmentproperties in 2002, we agreed to guarantee $19.3 million of debt associatedwith the properties that was assumed by the buyer in the transaction. These notes were repaid in full in January 2003, and our guaranteed$19.3 million in debt was reduced to $4.6million.  We guaranteed this debtuntil it matured in May 2003.

 

18

----

 

**Note 8 – Financial Instruments: Derivatives and Hedging**

 

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

 

We have a policy of only entering intoderivative contracts with major financial institutions based upon their creditratings and other factors.  When viewedin conjunction with the underlying and offsetting exposure that the derivativesare designed to hedge, we have not sustained a material loss from thoseinstruments nor do we anticipate any material adverse effect on our netincome,  financial position, or cashflows in the future from the use of derivatives.

 

To manage interest rate risk, we may employoptions, forwards, swaps, caps and floors, or a combination thereof, dependingon the underlying exposure.  Weundertake a variety of borrowings from lines of credit to medium and long-termfinancings.  To manage overall costs, wecurrently use derivative instruments to cap our exposure to variability ininterest rates or to convert a portion of our variable-rate debt to fixed-ratedebt.  In July 2002, we paid $3.4million for forward-starting, LIBOR-based interest rate caps with a combinednotional value of $152 million and a strike of 7.0% to cap our exposure tointerest rate variability on anticipated floating-rate debt.  The interest rate caps are effective July 1,2004, and continue through 2009 to 2010.

 

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

 

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

 

19

----

 

Cash flow hedges hedge the future cashoutflows of current or forecasted debt. The interest rate caps described above protect against variability ininterest cash outflows above the cap strike rate.  The changes in the fair value of these hedges are reported on thebalance sheet with a corresponding adjustment to either Accumulated OtherComprehensive Income or in earnings, depending on the hedgingrelationship.  Unrealized gains andlosses held in Accumulated Other Comprehensive Income will be reclassified toearnings in the same period or periods that the hedged cash flows affectearnings.  As of March 31, 2003, thebalance in Accumulated Other Comprehensive Loss relating to derivatives was$1.5 million.  Within the next twelvemonths, we do not expect to reclassify any of this balance to earnings as thecaps are forward starting and take effect July 1, 2004.

 

We hedge our exposure to the variability infuture cash flows for forecasted transactions other than interest-related cashflows over a maximum period of 12 months. During the forecasted period, unrealized gains and losses in the hedginginstrument will be reported in Accumulated Other Comprehensive Income.  Once the hedged transaction takes place, thehedge gains and losses will be reported in earnings during the same period inwhich the hedged item is recognized in earnings.  We are not currently hedging exposure to variability in futurecash flows for forecasted transactions other than interest-related cash flowson future anticipated debt.

 

**Note 9 –Stock Option Plan**

 

In 2001, we established a Stock Option andIncentive Plan (the Plan) and we may grant stock options to any employee ordirector under this plan.  As of March31, 2003, we reserved 3,630,000 shares for issuance under the Plan.  Options generally vest over three years andexpire ten years after the grant date. Once exercisable, the employee or director can purchase shares of ourstock at the market price on the date we granted the option.

 

In connection with the Merger, eachoutstanding option to purchase Excel Legacy common stock automatically becamean option to purchase our common stock. The number of shares of our common stock which may be purchased withthese options, and the exercise price was adjusted to reflect the exchangeratio.

 

As we stated in Note 1, we follow theprovisions for APB No. 25, “Accounting for Stock Issued to Employees.”  In 1997 and 2002, we implemented thedisclosure provisions required by SFAS No. 123, “Accounting for Stock-BasedCompensation” and SFAS No. 148, “Accounting for

 

20

----

 

Stock-Based Compensation – Transition andDisclosure – an amendment of SFAS No.123,” respectively, for our stock optionplans.  SFAS No. 123 requires pro formanet income and earnings per share information, which is calculated assuming wehad accounted for our stock option plans under the “fair value” methoddescribed in that statement.  Weestimated the fair value using the Black-Scholes option pricing model, modifiedfor dividends and using the following assumptions:

 
|                                   |   | **Three  Months Ended March 31** |   |
|----------------------------------------|--------|----------------------------------|--------|
|                                   |   | **2003**                         |   | **2002** |   |
| Risk free interest rate                |   | 3.94                             | %      | 3.98 | % |
| Annual dividend rate                   |   | 0                                | %      | 0 | % |
| Volatility factor of the stock price   |   | 45.53                            | %      | 40.15 | % |
| Weighted average expected life (years) |   | 10                               |   | 10 |   |

 

We do not record compensation expense forstock option grants, and no options were granted in the first quarter of2003.  The table in Note 1 summarizesresults as if we had recorded compensation expense for the 2002 option grants.

 

**Note 10– Series B Preferred Stock**

 

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

 

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

•                  a warrant topurchase an aggregate of 2.5 million shares of Price Legacy common stock at anexercise price of $8.25 per share (the Warburg Investment)

 

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

 

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

 

21

----

 

The Series B Preferred Stock is junior to the Series A Preferred Stockwith respect to dividend, liquidation and other rights, and is convertibleunder certain conditions into Price Legacy common stock at a one-to-one ratio,which may be adjusted under certain circumstances, after 24 months from thedate of issuance.  The 9% coupon will bepaid with additional shares of Series B Preferred Stock at $5.56 per share forthe first 45 months from issuance. While no additional shares of Series B Preferred Stock have been issued,2,881,954 shares have accumulated through March 31, 2003.  These shares will be issued in the future.

** **

 

22

----

 

# **ITEM 2 -MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

***Introduction***

 

This report onForm 10-Q contains certain “forward-looking” statements within the meaning ofthe Private Securities Litigation Reform Act of 1995 which provides a “safeharbor” for these types of statements. You can identify these forward-looking statements by forward-lookingwords such as “believe,” “may,” “could,” “will,” “estimate,” “continue,”“anticipate,” “intend,” “seek,” “plan,” “expect,” “should,” “would” and similarexpressions in this report on Form 10-Q. These forward-looking statements are subject to a number of risks,uncertainties and assumptions about Price Legacy, including, among otherthings:

 

•                  the effect of economic, credit andcapital market conditions in general and on real estate companies inparticular, including changes in interest rates

•                  our ability to compete effectively

•                  developments in the retail industry

•                  the financial stability of PriceLegacy’s tenants, including our reliance on major tenants

•                  our ability to successfully completereal estate acquisitions, developments and dispositions

•                  the financial performance of ourproperties, joint ventures and investments

•                  government approvals, actions andinitiatives, including the need for compliance with environmental requirements

•                  our ability to continue to qualify asa real estate investment trust, or REIT

 

The factors identified above are believed to be some, but not all, ofthe important factors that could cause actual events and results to besignificantly different from those that may be expressed or implied in anyforward-looking statements.  Anyforward-looking statements should also be considered in light of theinformation provided in “Factors That May Affect Future Performance” located inour Form 10-K filing, as amended, for the 2002 fiscal year.  We assume no obligation to publicly updateor revise any forward-looking statements, whether as a result of newinformation, 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

•                  funds fromoperations (FFO)

•                  how we used cashfor capital projects and dividends and how we expect to use cash in 2003

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

 

23

----

 

**Critical Accounting Policies andEstimates**

 

***General***

Our discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States of America(GAAP).  Preparation of our financialstatements in accordance with GAAP requires management to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses and the related notes.  Webelieve that the following accounting policies are critical because they affectthe more significant judgments and estimates used in the preparation of ourconsolidated financial statements. Actual results may differ from these estimates under differentassumptions or conditions.  For adetailed discussion on the application of these and other accounting policies,see Note 1 in the Notes to the Consolidated Financial Statements in Item 8 ofour Annual Report on Form 10-K, as amended, for the 2002 fiscal year.

 

***Consolidation***

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

 

***Revenue Recognition***

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

 

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

 

***Real Estate Assets and Depreciation***

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

 

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

 

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

 

24

----

 

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

 

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

 

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

 

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

 

***Derivative Instruments and Hedging Activities***

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

 

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

*** ***

***Asset Disposal***

In August 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses financial accounting for the impairment or 

 

25

----

 

disposal of long-lived assets and is effective in fiscal yearsbeginning after December 15, 2001.  Wehave adopted this statement and report discontinued operations for the threemonth period ended March 31, 2003 and March 31, 2002.

 

###### ***Rental Revenues***

 
|              |   | **Amount** |   | **Change** |   | **Percent  Change** |   |
|-------------------|--------|------------|--------|------------|--------|---------------------|--------|
| 1st  Quarter 2003 |   | $          | 31,957 |       | $      | 4,376               |   | 16 | % |
| 1st  Quarter 2002 |   | 27,581     |   | —     |   | —              |   |
|                   |        |            |        |            |        |                     |        |  |  |

 

Revenues increased $4.4 million to $32.0 million in the first quarterof 2003 compared to the same period in 2002 primarily because:

 

•                  properties weacquired during 2002 generated $4.0 million of additional revenues

•                  properties weowned both years generated $0.4 million of additional revenues, primarily dueto additional leasing activity at our Newport, KY and Moorestown, NJproperties, partially offset by vacancies at our Inglewood, CA and Miami, FLproperties

###### *** ***

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

 
|              |   | **Amount** |   | **Change** |   | **Percent  Change** |   |
|-------------------|--------|------------|--------|------------|--------|---------------------|--------|
| 1st  Quarter 2003 |   | $          | 16,406 |       | $      | 1,351               |   | 9 | % |
| 1st  Quarter 2002 |   | 15,055     |   | —     |   | —              |   |
|                   |        |            |        |            |        |                     |        |  |  |

 

Expenses increased $1.4 million to $16.4 million in the first quarterof 2003 compared to 2002 primarily because:

 

•                  expenses onproperties we acquired in 2002 generated $1.4 million of additional expenses

•                  expenses fromproperties we owned in both years increased by $0.8 million, primarily due toadditional operating expenses incurred at our Philadelphia, PA, Wayne, NJ, andWestbury, NY properties 

•                  these increasesto expenses were partially offset by a decrease in general and administrativeexpenses of $0.8 million primarily due to legal costs incurred in 2002 relatedto our investment in Destination Villages, LLC

 

***Operating Income***

 
|              |   | **Amount** |   | **Change** |   | **Percent  Change** |   |
|-------------------|--------|------------|--------|------------|--------|---------------------|--------|
| 1st  Quarter 2003 |   | $          | 15,551 |       | $      | 3,025               |   | 24 | % |
| 1st  Quarter 2002 |   | 12,526     |   | —     |   | —              |   |
|                   |        |            |        |            |        |                     |        |  |  |

 

Operating income increased for the first quarter of 2003 compared tothe same period in the prior year primarily because of the changes in RentalRevenues and Expenses discussed above.

 

26

----

 

***Interest Expense***

*** ***
|              |   | **Amount** |   | **Change** |   | **Percent  Change** |   |
|-------------------|--------|------------|--------|------------|--------|---------------------|--------|
| 1st  Quarter 2003 |   | $          | 6,610  |       | $      | 368                 |   | 6 | % |
| 1st  Quarter 2002 |   | 6,242      |   | —     |   | —              |   |
|                   |        |            |        |            |        |                     |        |  |  |

 

Interest expense increased $0.4 million in the first quarter of 2003compared to 2002 because during the first quarter of 2003 we had an average of$547.6 million of debt outstanding compared to $491.0 million in the firstquarter of 2002.  The increase ininterest expense due to the amount of debt outstanding was partially offset bya decrease in interest rates on our variable rate debt.

 

The weighted average interest rate on our variable rate debt decreasedto 3.1% on March 31, 2003 from 3.6% on March 31, 2002.  We discuss our outstanding debt further in“Liquidity and Capital Resources” located elsewhere in this Form 10-Q.

 

***Interest Income***

*** ***
|              |   | **Amount** |   | **Change** |   | **Percent  Change** |   |
|-------------------|--------|------------|--------|------------|--------|---------------------|--------|
| 1st  Quarter 2003 |   | $          | 812    |       | $      | (457                | )      | -36 | % |
| 1st  Quarter 2002 |   | 1,269      |   | —     |   | —              |   |
|                   |        |            |        |            |        |                     |        |  |  |

 

Interest income decreased $0.5 million in the first quarter of 2003compared to 2002 primarily because:

 

•                  we did notaccrue interest on several developers’ notes receivable when developmentprojects were consolidated into the assets expected to repay the notes, whichdecreased interest income by $0.2 million

•                  we retired thenotes receivable from certain of our officers which were collateralized by ourcommon shares.  Emerging Issues TaskForce 00-23 required us to account for these loans as being retired and theshares as being repurchased.  Thisdecreased interest income by $0.2 million

•                  interest income onour outstanding cash balances decreased by $0.1 million

 

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

 

During the first quarter of 2003 we sold a property in Scottsdale, AZfor $3.0 million and recognized a net loss of $0.2 million.  Also during the first quarter of 2003, wereceived payment on the notes receivable related to the sale of our developmentself storage properties and recognized additional gains on the sales of $0.7million.  During the first quarter of2002, we sold two parcels of land for $2.1 million and recognized a net gain of$0.3 million.

 

27

----

 

***Funds From Operations***

*** ***
|                                                         |   | **Three Months   Ended March 31** |   |
|--------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                         |   | **2003**                          |   | **2002** |   |
| Net income                                                   |   | $                                 | 10,389 |   | $ | 9,162 |   |
| Depreciation and  amortization                               |   | 4,396                             |   | 4,103 |   |
| Depreciation and  amortization of discontinued operations    |   | 7                                 |   | 323 |   |
| Price Legacy’s  share of depreciation of joint ventures |   | 179                               |   | 154 |   |
| Depreciation of  non-real estate assets                      |   | (31                               | )      | (33 | ) |
| Net gain on sale  of real estate                             |   | (480                              | )      | — |   |
| FFO before  preferred dividends                              |   | 14,460                            |   | 13,709 |   |
| Preferred  dividends                                         |   | (12,360                           | )      | (12,126 | ) |
| FFO                                                          |   | $                                 | 2,100  |   | $ | 1,583 |   |
|                                                         |   |                              |   |   |   |
| Net cash  provided by (used in):                             |   |                              |   |   |   |
| Operating  activities                                        |   | $                                 | 14,660 |   | $ | 9,799 |   |
| Investing  activities                                        |   | (7,882                            | )      | (14,014 | ) |
| Financing  activities                                        |   | (4,265                            | )      | 6,719 |   |

 

Our Company, aswell as real estate industry analysts, generally considers FFO as anothermeasurement of economic profitability for real estate-oriented companies.  The Board of Governors of the NationalAssociation for Real Estate Investment Trusts (NAREIT), defines FFO as netincome in accordance with GAAP, excluding depreciation and amortization expenseand gains (losses) from depreciable operating real estate.  We calculate FFO in accordance with theNAREIT definition which also excludes provisions for asset impairments andgains (losses) from the sale of investments, and adjust for preferreddividends.  During the periods presentedthere were no provisions for asset impairments.  We believe that FFO is helpful to investors as a measure of ourfinancial performance because, along with cash flow from operating activities,financing activities and investing activities, FFO provides investors with anindication of the ability of a REIT to incur and service debt, to make capitalexpenditures and to fund other cash needs. In addition, we believe that FFO provides useful information about ourperformance when compared to other REITs since FFO is generally recognized asthe industry standard for reporting the operations of REITs.  FFO does not represent the cash flows fromoperations defined by GAAP, may not be comparable to similarly titled measuresof other companies and should not be considered as an alternative to net incomeas an indicator of our operating performance or to cash flows as a measure ofliquidity.  Excluded from FFO aresignificant components in understanding our financial performance.

 

FFO before preferred dividends during the first quarter of 2003increased $0.8 million or 5.5% to $14.5 million compared to the first quarterof 2002 primarily because

 

•                  properties weacquired during 2002 increased FFO $3.2 million

•                  decreasedgeneral and administrative expenses increased FFO by $0.8 million

•                  these increasesto FFO were partially offset by:

•                  properties soldwhich contributed $1.6 million to FFO in the previous year

•                  properties weowned in both years decreased FFO by $0.5 million

•                  decreasedinterest income, which reduced FFO by $0.5 million

 

28

----

 

•                  additionalinterest expense which reduced FFO by $0.4 million 

•                  gain onnon-depreciable land sold in 2002 contributed $0.3 million to FFO in the prioryear

 

**Liquidityand Capital Resources**

 

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

 

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

 

***Dividends***

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

1)              We can declare a Series B Preferred Stockdividend by issuing additional Series B Preferred shares.  The Series B Preferred Stock dividendsaccumulate at a rate of 9%, compounded quarterly.  As of March 31, 2003, the Series B Preferred stockholders wereentitled to approximately 2.9 million additional shares.

2)              We can declare adividend to our common stockholders.

 

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

 

***Debt***

In September 2001, we obtained a $100.0 million unsecured creditfacility with Fleet Bank as agent.  Thefacility has a three-year term and has a current interest rate of LIBOR plus187.5 basis points.  The rate may varybetween 150 and 200 basis points based on our leverage and other financialratios.  At March 31, 2003, we had $65.9million outstanding on the facility at a 3.2% weighted average interest rate.

 

Our credit facility requires us to comply with specified financial covenants,the most restrictive of which relate to fixed charge coverage andleverage.  Covenants in some of ourconstruction loans are also tied to our credit facility.  We were in compliance with all covenants inour credit 

 

29

----

 

facility at March 31, 2003.  Tothe extent that we violate any of these covenants in the future, we would needto obtain waivers from our lenders to maintain compliance.  We cannot assure that any such waivers wouldbe forthcoming.

 

In 2003 we have the following significant debt maturities:

 

•                  On December 31,2002, a $38.5 million construction loan related to our project in Newport, KYmatured.  The lender granted us a 90-dayextension and in April 2003 we extended the loan for another year and paid-down$10.0 million on the outstanding amount. The current loan balance is $28.5 million.

 

•                  On April 4,2003, a $22 million loan related to our project in Orlando, FL matured.  The lender extended this loan until May 16,2003 as we complete the refinancing of this debt with a new loan.

 

•                  On May 1, 2003,a $4.7 million loan related to our property in Newport, KY matured.  The lender agreed to extend this loan foranother year.

 

The following table summarizes all of our long-term contractualobligations, excluding interest, to pay third parties as of March 31, 2003:

 
|                        |   | **Contractual Cash Obligations** |   |
|-----------------------------|--------|----------------------------------|--------|
|                        |   | **2003**                         |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   |
| Mortgages and notes payable |   | $                                | 44,786 |   | $ | 245,160 |   | $ | 23,054 |   | $ | 33,011 |   | $ | 3,343 |   | $ | 204,094 |   | $ | 553,448 |   |
| Capital lease obligations   |   | 598                              |   | 796 |   | 796 |   | 796 |   | 796 |   | 15,455 |   | 20,033 |   |
| Total                       |   | $                                | 45,384 |   | $ | 245,956 |   | $ | 23,850 |   | $ | 33,807 |   | $ | 4,139 |   | $ | 219,549 |   | $ | 573,481 |   |

 

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

 

Included in the 2004 mortgage and notes payable obligations is a $3.1million capital lease obligation whereby the lessor can require us to repay thelease with a 30-day notice.  If thisoccurs, we would replace the obligation with other mortgage debt or borrowingon our credit facility.

 

##### ***Off-BalanceSheet Financing Matters***

Related to our Newport, KY project discussed previously, the City ofNewport, KY in 1999 issued two series of public improvement bonds related tothe Newport development project.  TheSeries 2000a tax exempt bonds total $44.2 million and are broken down asfollows: (a) $18.7** **million maturing 2018 with interestat 8.375%; (b) $20.5 million maturing 2027 with interest at 8.5%; and (c) $5.0million maturing 2027 with interest at 8.375%. The Series 2000b bonds are taxable and have a par amount of $11.6million with interest at 11% due 2009. The bonds are guaranteed by the Newport project, the Company, and theproject’s third party developers.  As ofMarch 31, 2003, Newport had drawn on $43.7** **million of the bonds for constructionincurred prior to that date.

 

30

----

 

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

 

•                  On February 28,2003, a $12.9 million bank loan related to a development project in Scottsdale,AZ matured.  We have a note receivableto a developer related to this project and have guaranteed this loan.  On February 27, 2003, we purchased the loanfrom the lender for an aggregate purchase price of $13.0 million, which wasfunded through borrowing on our credit facility.

 

•                  We have an $11.1million loan related to land we own in Orlando, FL through a jointventure.  This loan is guaranteed by usand by our partner.  Beginning August2003, the loan requires monthly principal repayments of $1.1 million.  If this land is not refinanced or soldbefore August 2003, we anticipate funding these repayments on behalf of thepartnership.  In April 2003, we repaid$1.0 million on this loan with funds we received as a non-refundable depositfrom a potential buyer.

 

Summarized debt information for ourunconsolidated joint ventures and the amount guaranteed by us at March 31, 2003is as follows:

 
| **Joint  Venture**                |   | **March 31  2003** |   | **Debt  Guaranteed** |   | **Maturity  Date** |   |
|-----------------------------------|--------|--------------------|--------|----------------------|--------|--------------------|--------|
|                              |   |               |   |                 |   |               |   |
| Orlando Business  Park, LLC       |   | $                  | 11,342 |                 | $      | 11,342             |   | 6/1/04 |   |
| Old Mill  District Shops, LLC (1) |   | 17,463             |   | 13,952               |   | 7/22/03            |   |
| Blackstone  Ventures I (2)        |   | 9,953              |   | 9,953                |   | 10/1/04            |   |
| 3017977 Nova  Scotia Company (1)  |   | 5,131              |   | —               |   | 6/15/03            |   |
|                              |   | $                  | 43,889 |                 | $      | 35,247             |   |   |   |

* *

----

*(1)**       Theseloans have one year extension options*

*(2)**       OnApril 1, 2003, our guarantee was reduced to $3.1 million*

 

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

 

In connection with the sale of three self storage developmentproperties in September 2002, we agreed to guarantee $19.3 million of debtassociated with the properties that was assumed by the buyer in thetransaction.  In January 2003, theguarantee was reduced to $4.6 million and we guaranteed this debt until May2003.

 

***Development***

We have a significant retail project in Newport, KY.  The majority of the construction wascompleted in October 2001, with all of the primary buildings completed exceptfor one out parcel yet to be leased. The project opened in October 2001. At March 31, 2003, the project was approximately 76% occupied, excludingground leases.  As the project becomesfully leased, there may be capital required to fund the remaining tenantimprovements.

 

The Anaheim GardenWalk project in Anaheim, CA, located between Disney’stwo Theme Parks on Harbor Boulevard and Disney’s new proposed Theme Park onKatella Avenue is expected to 

 

31

----

 

consist of a 626,000 square foot open-air retail center and fourhotels.  Total cost of the retailportion of this project will be approximately $250 million with an estimatedcost of $200 million remaining to complete construction over the next eightyears for all phases.  We anticipatethat the first phase of the project will cost approximately $125 million, ofwhich approximately $40 million may be spent in 2003.  We expect to fund construction costs through a construction loan,sales of hotel land parcels or potential joint venture investors and only afterwe meet certain lease thresholds.

 

We also have retail development projects in which construction willcontinue through 2004.  The Temecula, CAproject is an open-air retail shopping center with Wal-Mart, Kohl’s and othertenants.  We estimate $3.3 millionremaining to complete construction.  Weexpect to fund the remaining cost through a construction loan.  In December 2002, we purchased additionalland adjacent to this development project to develop an additional open-airretail center.  We estimate the totalcost of this development to be approximately $12.7 million with an estimated$8.3 million remaining to complete construction.

 

In November 2002, we purchased land adjacent to our property inOrlando, FL to develop an open-air retail center.  We estimate the total cost of this development to beapproximately $21 million with an estimated $12.5 million remaining to completeconstruction, which we will fund through a construction loan.

 

***Notes Receivable***

We had $63.6****million inprincipal amount of third party notes receivable outstanding as of March 31,2003 related to various real estate developments and related businesses.  The notes bear interest ranging from 2.0% to15% per annum.  The notes generally donot require cash payments of interest until specified future dates, typicallywhen developments are completed or sold. As of March 31, 2003, we had $15.1 million of accrued but unpaidinterest on these notes.  Of thisamount, we assumed $11.5 million from the Merger with Excel Legacy.  We typically do not recognize interestincome on these notes receivable until development projects begin operations.  Of the $63.6****million in notes receivable, as of March 31, 2003, the notesreceivable from companies owned by or affiliated with Steven Ellman (the EllmanCompanies) had an aggregate outstanding principal balance of approximately$57.3 million and the aggregate outstanding accrued interest on such notesreceivable was approximately $14.9 million. Notes receivable of $12.2 million (principal amount and accruedinterest) matured in 2002 and on-going negotiations with the Ellman Companiescontemplate an extension of the maturity dates of these notes receivable to upto December 31, 2004.  The remainder ofthe notes receivable mature at various dates in 2003 or 2004 or earlier if therelated development is sold.  Repaymentof the notes depends upon the completion of the various development projects orother events.  The notes receivable aregenerally non-recourse obligations, but are typically collateralized by eitherreal estate liens or pledges of ownership interests in the borrower oraffiliated entities.

 

***Growth***

We continue to evaluate various properties for acquisition ordevelopment and continue to evaluate other investment opportunities.  We anticipate borrowing available amounts onour 

 

32

----

 

credit facility or mortgages to fund these acquisition and developmentopportunities.  We also anticipateobtaining construction loans to fund our development activities.  We did not purchase any properties duringthe first quarter of 2003.

 

From time to time we will consider selling properties to better alignour portfolio with our geographic and tenant composition strategies.  We may also participate in additionaltax-deferred exchange transactions, which allow us to dispose of properties andreinvest the proceeds in a tax efficient manner.  During the quarter ended March 31, 2003 we sold one property anda land parcel in Scottsdale, AZ for $3.0 million.  When we sell an operating property, we anticipate a temporaryreduction in operating income due to the time lag between selling a propertyand reinvesting the proceeds.

 

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

 

***Litigation***

We own a 55% interest in Destination Villages LLC, which indirectlyowns a hospitality project located in Bermuda, Daniel’s Head Village Resort(Daniel’s Head).  Daniel’s Head wasclosed in the fourth quarter of 2001, primarily due to low occupancy rates as aresult of the terrorist events in the United States that occurred on September11, 2001.  The project was encumbered bya $6 million loan with a Bermuda bank. In March 2002, we informed the Bermuda bank that we did not intend tore-open this project due to large projected operating losses and insteadintended to sell the project to an identified buyer.   This resulted in a default of the loan.  On March 27, 2002, the Bermuda bankexercised its rights under Bermuda law and put the project in “receivership,”which gives the bank the right to negotiate directly with this buyer as well asother potential buyers.  On June 13,2002 the Bermuda Bank filed a lawsuit against us in Bermuda for $6.1 millionplus other costs related to a guarantee agreement for a promissory note on theDestination Villages Daniel’s Head project in Bermuda.  We believe we were in full compliance withthe guarantee and intend to vigorously defend the lawsuit.

 

***Other***

In April 2002, weentered into five Interest Rate Swap Agreements with Fleet Bank that areaccounted for under SFAS No. 133 and sold them in October 2002.  The combined notional amount wasapproximately $161 million and the maturities ranged from 2009 to 2010.  We paid monthly interest of LIBOR plus 3.08%to 3.77% and Fleet Bank assumed our fixed rates of 8.18% to 9.00%.  These swaps hedged the fair value offixed-rate debt.  In October 2002, wesold the five swaps back to the counter party for $13.8 million and willamortize the gain over the fixed-rate debt’s remaining life through 2009 to2010.

 

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

 

33

----

 

**Inflation**

 

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

 

# **ITEM 3 -QUANTITATIVE AND QUALITATIVE DISCLOSURES 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 $226.1 million in variable rate debt outstanding at March 31,2003.  Based upon these year-end debtlevels, a hypothetical increase in interest rates by 100 basis points wouldincrease interest expense by approximately $2.3 million on an annual basis, andlikewise decrease our earnings and cash flows. We cannot predict market fluctuations in interest rates and their impacton our variable rate debt, nor can there be any assurance that fixed ratelong-term debt will be available to us at favorable rates, if at all.  Consequently, future results may differmaterially from the estimated adverse changes discussed above.

 

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

 

The following table presents the scheduled principal payments on notesreceivable and the scheduled principal payments on mortgages payable over thenext five years and thereafter.  Thetable also includes the average interest rates of the financial instrumentsduring each respective year and the fair value of the notes receivable and mortgagespayable.  We determine the fair value offinancial instruments through the use of discounted cash flows analysis usingcurrent interest rates for notes receivable with terms and creditcharacteristics similar to our existing portfolio and borrowings under termssimilar to our existing mortgages payable.

 

34

----

 
|                                               |   | **Expected Maturity Date****(dollar amounts in thousands)** |   |
|----------------------------------------------------|--------|-------------------------------------------------------------|--------|
|                                               |   | **2003**                                                    |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   | **Fair****Value** |   |
| Notes receivable,  including notes from affiliates |   | $                                                           | 50,766 |   | $ | 12,856 |   | — |   | — |   | — |   | — |   | $ | 63,622 |   | $ | 63,622 |   |
| Average interest  rate                             |   | 12                                                          | %      | 14 | % | — |   | — |   | — |   | — |   | 12 | % |   |   |
| Mortgages and  notes payable                       |   | $                                                           | 44,786 |   | $ | 245,160 |   | $ | 23,054 |   | $ | 33,011 |   | $ | 3,343 |   | $ | 204,094 |   | $ | 553,448 |   | $ | 567,781 |   |
| Average interest  rate                             |   | 5                                                           | %      | 3 | % | 8 | % | 4 | % | 8 | % | 8 | % | 5 | % |   |   |
|                                                    |        |                                                             |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

# **ITEM 4** – CONTROLS AND PROCEDURES

 

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

 

Within 90 days prior to the date of this quarterly report, under thesupervision and with the participation of certain management, including ourChief Executive Officer and Chief Financial Officer, we evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures.  Based on the foregoing, ourChief Executive Officer and Chief Financial Officer concluded that theCompany’s disclosure controls and procedures were effective.

 

There have been no significant changes in our internal controls or in otherfactors that could significantly affect the internal controls subsequent to thedate we completed our evaluation.

 

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

 

# **ITEM 1 – LEGAL PROCEEDING**S

 

On or aboutFebruary 13, 2001, Lewis P. Geyser filed a lawsuit against Excel Legacy inSanta Barbara County Superior Court, Anacapa Division, Case No. 01038577.  The suit arose out of an Operating Agreementfor Destination Villages, LLC, an entity which is owned jointly by Excel Legacyand Mr. Geyser, under which Destination Villages, LLC would develop certaineco-tourism resorts.  The complaintincluded causes of action for breach of contract, breach of fiduciary duty,fraud and negligent misrepresentation. The lawsuit included a prayer for compensatory and punitivedamages.  Excel Legacy had also filed across-complaint against Mr. Geyser for breach of contract, fraud, breach offiduciary duty and other related claims.

 

The trial of thismatter concluded on March 19, 2002.  The trial judge dismissed both the complaint and cross-complaint, andgranted nothing to Mr. Geyser under any of his allegations.  

 

35

----

 

On June 5, 2002,Mr. Geyser filed an appeal and Excel Legacy subsequently filed a cross-appealagainst Mr. Geyser.  These appeals arestill pending.

 

On June 13, 2002the Bank of NT Butterfield & Sons Limited filed a lawsuit against PriceLegacy and Excel Legacy in Bermuda for $6.1 million plus other costs related toa guarantee agreement for a promissory note on the Destination VillagesDaniel’s Head project in Bermuda.  Thebank claims that Excel Legacy did not provide sufficient capital for theproject to be completed which was required in the guarantee agreement.  The bank has currently appointed a receiverwho is actively marketing the project for sale to third parties.  We believe we were in full compliance withthe guarantee and intend to vigorously defend the lawsuit.

 

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

 

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

(a)          The following exhibitsare included herein or incorporated by reference:

None

(b)         Reports on Form 8-K

None

 

36

----

 

**SIGNATURES**

 

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

 

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

 

37

----

 

**CERTIFICATIONS**

 

I, Gary B. Sabin, certify that:

 

1.               I have reviewedthis quarterly report on Form 10-Q of Price Legacy Corporation;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date:      May 13, 2003 |                    |
|-------------------------------------------------------|-------------------------|
|                                                  |                    |
|                                                  |                    |
|                                                  | /s/ Gary B. Sabin       |
|                                                  | Gary B. Sabin           |
|                                                  | Chief Executive Officer |

 

38

----

 

I, James Y. Nakagawa, certify that:

 

1.               I have reviewedthis quarterly report on Form 10-Q of Price Legacy Corporation;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date:      May 13,  2003 |                    |
|--------------------------------------------------------|-------------------------|
|                                                   |                    |
|                                                   |                    |
|                                                   | /s/ James Nakagawa      |
|                                                   | James Y. Nakagawa       |
|                                                   | Chief Financial Officer |

 

39

----