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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarter ended June 30, 2002

Commission File Number 0-20449

PRICE LEGACY CORPORATION
(Exact name of registrant as specified in its charter)

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 reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ý    NO o

        The registrant had 40,726,675 shares of common stock, par value $.0001 per share, outstanding at August 9, 2002.

PRICE LEGACY CORPORATION

INDEX TO FORM 10-Q

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PART I—FINANCIAL INFORMATION

ITEM 1—FINANCIAL STATEMENTS

PRICE LEGACY CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

See accompanying notes.

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PRICE LEGACY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited—amounts in thousands, except per share data)

See accompanying notes.

4

PRICE LEGACY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited—amounts in thousands)

See accompanying notes.

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PRICE LEGACY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

June 30, 2002

Note 1—Organization and Significant Accounting Policies

Organization

        Price Legacy Corporation (Price Legacy) operates as a real estate investment trust (REIT) incorporated in the state of Maryland. Our principal business is to acquire, operate, and develop real property, primarily open-air shopping centers. On September 18, 2001, Price Legacy completed a merger between Price Enterprises, Inc. (PEI) and Excel Legacy Corporation (Excel Legacy) resulting in Excel Legacy becoming a wholly owned subsidiary of PEI. The combined company operates as a REIT under the name Price Legacy Corporation. The results of Excel Legacy are included in our operations beginning September 19, 2001.

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

Accounting Principles

        We prepared the financial statements following the requirements of the Securities and Exchange Commission (SEC) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America (GAAP) can be omitted. Certain prior year data have been reclassified to conform to the 2002 presentation.

        We are responsible for the financial statements included in this document. The financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. You should also read the financial statements and notes in our latest Annual Report on Form 10-K.

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

Real Estate Assets and Depreciation

        We record real estate assets at historical costs and adjust them for recognition of impairment losses. In following purchase accounting, we adjusted the historical costs of Excel Legacy's real estate assets to fair value at the time of the merger. Our consolidated balance sheets at June 30, 2002 and December 31, 2001 reflect the new basis of those real estate assets. See Note 2 for additional information on this transaction.

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

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

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

Cash and Cash Equivalents

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

        Our cash balances at June 30, 2002 and December 31, 2001 include $0.2 million and $1.5 million of restricted funds, respectively, which represent proceeds from the financing of a construction project. The funds are held in trust and released as work is completed.

        We are required to maintain reserves with certain lenders for capital expenditures, insurance, real estate taxes and debt service. As of June 30, 2002 and December 31, 2001, the aggregate amount of these reserves held by lenders is $10.3 million and $5.2 million, respectively, and is included with cash on the Consolidated Balance Sheets.

Investment in Securities

        We review our investments in securities for possible impairment whenever the market value of the securities falls below cost and, in our opinion, such decline represents an other than temporary impairment. Factors considered in this review include:

•

duration and extent, as well as reasons for which the market value has been less than cost



•

financial condition and near-term prospects of the investee, which includes consideration of proposed transactions known through Board of Directors participation



•

our ability and intent to retain the investment for a period of time to allow for a recovery in market value.

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

        Included in other assets on our consolidated balance sheets is an investment in Millennia Car Wash, LLC (Millennia) which owns approximately 3.8 million shares of common stock, and 62,500 common stock purchase warrants of Mace Security International (MACE) and 250,000 common shares of US Plastic Lumber Corporation (USPL). Our common shares in MACE are subject to certain sale restrictions and one of our senior officers is a member of the MACE board of directors. In following GAAP, we account for Millennia's investment in MACE under the equity method of accounting and owned approximately 15% of MACE at June 30, 2002. We classify our investment in USPL as available-for-sale and recognize changes in the fair value of this investment in other comprehensive income.

Comprehensive Income

        In 1999, we adopted Statement of Financial Accounting Standard (SFAS) No. 130 "Reporting Comprehensive Income." This statement requires that all components of comprehensive income be reported in the financial statements in the period in which they are recognized. The components of comprehensive income at June 30, 2002 are as follows:

Use of Estimates

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

Derivative Financial Instruments

        In January 2001, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." In the normal course of business, we may use derivative financial instruments to manage or hedge interest rate risk. When entered into, we formally designate and document the financial instrument as a hedge of a specific underlying exposure, as well as the risk management objectives and strategies for undertaking the hedge transactions. We assess, both at the inception and at least quarterly thereafter, whether the financial instruments that are used in hedging transactions are effective at offsetting changes in either the fair value or cash flows of the related underlying exposure.

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Because of the high degree of effectiveness between the hedging instrument and the underlying exposure being hedged, fluctuations in the value of the derivative instruments are generally offset by changes in the fair value or cash flows of the underlying exposures being hedged. Any ineffective portion of a financial instrument's change in fair value is immediately recognized in earnings. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets.

        To determine the fair values of derivative instrument, we use a variety of methods and assumptions that are based on market conditions and risks 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 and techniques 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 result in a general approximation of value, and such value may never actually be realized.

Asset Disposal

        In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting for the impairment or disposal of long-lived assets and is effective in fiscal years beginning after December 15, 2001. We have adopted this standard and report operations from properties sold in 2002 as discontinued operations for the quarter and year-to-date periods ended June 30, 2002 and 2001.

New Accounting Standards

        In April 2002, the FASB issued SFAS No. 145, "Rescission of SFAS No. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections." SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains and Losses From Extinguishment of Debt", SFAS No. 44, Accounting for Intangible Assets of Motor Carriers", and SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS No. 145 requires, among other things, (i) that the modification of a lease that results in a change of the classification of the lease from capital to operating under the provisions of SFAS No. 13 be accounted for as a sale-leaseback transaction and (ii) the reporting of gains or losses from the early extinguishment of debt as extraordinary items only if they met the criteria of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations." The rescission of SFAS No. 4 is effective January 1, 2003. The amendment of SFAS No. 13 is effective for transactions occurring on or after May 15, 2002. The adoption of this statement did not have a material effect on our financial statements.

        In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 replaces current accounting literature and requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 is effective January 1, 2003 and we do not anticipate the adoption of this statement will have a material effect on our financial statements.

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Note 2—Merger and Significant Event

        On March 21, 2001, PEI, PEI Merger Sub, Inc., a Maryland corporation (Merger Sub), and Excel Legacy entered into an Agreement and Plan of Merger (the Merger Agreement). On September 18, 2001, Merger Sub was merged with and into Excel Legacy (the Merger), with Excel Legacy continuing as a wholly-owned subsidiary of PEI. On the effective date of the Merger, each outstanding share of Excel Legacy common stock was exchanged for 0.6667 of a share of PEI common stock, and each option to purchase shares of Excel Legacy common stock was exchanged for an option to purchase 0.6667 shares of PEI common stock. Following the Merger, PEI continues to operate as a REIT under the name Price Legacy Corporation. The Merger was structured to qualify as a tax-free reorganization and was approved by the stockholders of both PEI and Excel Legacy. The results of Excel Legacy are included in operations beginning September 19, 2001.

        The purchase price was calculated based on $4.89 per share for the PEI common stock, which is equal to the closing price of $5.75 per share on March 21, 2001 (the day immediately prior to the public announcement of the Merger), less a 15% discount to reflect the low trading volume of the PEI stock (amounts in thousands, except per share data):

        The purchase price resulted in an increase in the book value of the Excel Legacy assets acquired of approximately $26.0 million, which was allocated to real estate and other assets.

        Also on March 21, 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 aggregate purchase price of $100,000,000

•

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



•

a warrant to purchase an aggregate of 2.5 million shares of Price Legacy common stock at an exercise price of $8.25 per share (the Warburg Investment)

        On April 12, 2001, PEI and Sol Price, a significant stockholder of PEI and Excel Legacy through various trusts, agreed to convert an existing Excel Legacy loan payable to a trust controlled by Sol Price of approximately $9.3 million into 1,681,142 shares of the Series B Preferred Stock and a warrant to purchase 233,679 shares of our common stock at an exercise price of $8.25 per share.

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

        The Series B Preferred Stock is junior to the Series A Preferred Stock with respect to dividend, liquidation and other rights, and is convertible under certain conditions into Price Legacy common

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stock at a one-to-one ratio, which may be adjusted under certain circumstances, after 24 months from the date of issuance. The 9% coupon will be paid with additional shares of Series B Preferred Stock at $5.56 per share for the first 45 months from issuance.

        In addition, under the terms of the Merger Agreement, PEI commenced a tender offer for all outstanding shares of our common stock (other than those shares held by Excel Legacy and those shares issued in the Merger) at a cash price of $7.00 per share. In connection with the tender offer, 807,583 shares were purchased at a total cost of $5.7 million. Under terms of the Merger Agreement, we also commenced an exchange offer in which holders of Excel Legacy's outstanding debentures and notes were offered shares of our Series A Preferred Stock in exchange for their debt securities. In connection with the exchange offer, we exchanged approximately $30.4 million in Excel Legacy debentures and $15.8 million in Excel Legacy notes. The tender offer and exchange offer closed concurrently with the Merger.

        The exchange of Excel Legacy common stock for Price Legacy common stock in connection with the Merger was accounted for as a purchase of Excel Legacy by Price Legacy. Under purchase accounting, the assets and liabilities of Excel Legacy have been adjusted to fair value.

        The following unaudited pro forma information for the three months and year-to-date period ended June 30, 2001 and unaudited actual results for the three months and year-to-date period ended June 30, 2002, have been presented as if the Merger had been completed on January 1, 2001. It also reflects the Series B Preferred Stock dividends and exchange of Excel Legacy senior notes and convertible debentures into Series A Preferred Stock. It does not reflect any application of proceeds from the sale of Series B Preferred Stock. We present pro forma information for comparative purposes only and the pro forma information may not be indicative of our actual results of operations had the Merger been completed on January 1, 2001 (amounts in thousands, except per share data):

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Note 3—Net Income Per Share

        SFAS No. 128, "Earnings Per Share," requires presentation of two calculations of earnings per common share. Basic earnings per common share equals net income applicable to common stockholders divided by weighted average common shares outstanding during the period. Diluted earnings per common share equals net income applicable to common stockholders divided by the sum of weighted average common shares outstanding during the period plus common stock equivalents. Common stock equivalents are shares assumed to be issued if outstanding stock options and warrants that are dilutive were exercised. All earnings per share amounts have been presented, and where appropriate, restated to reflect these calculations. We did not have any common stock equivalents during the periods presented. There are 19,666,754 shares of Series B Preferred Stock outstanding and 1,424,422 shares payable as a dividend at June 30, 2002, which may be exchanged on a one-to-one basis into common stock, subject to adjustment, after September 18, 2003 if certain events occur.

Note 4—Real Estate Assets

Acquisitions

        During the first six months of 2002, we acquired the following properties:

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

        During the first six months of 2001, we acquired the following properties:

(1)

Capital Lease

        We funded these acquisitions using the proceeds from tax-deferred exchange transactions on properties we sold in 2000 and by assuming mortgages.

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Dispositions

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

(1)

Our equity in the development was exchanged for notes receivable with a participating interest

        During the first six months of 2001, we sold the following properties for a net gain of $1.2 million:

        We used the proceeds from the sale of properties to purchase additional properties in tax-deferred exchange transactions.

Destination Villages LLC

        We own a 55% interest in Destination Villages LLC. Destination Villages, LLC owns a Bermuda limited liability company that owns a hospitality project located in Bermuda, Daniel's Head Village Resort (Daniel's Head). Daniel's Head was closed in the fourth quarter of 2001, primarily due to low occupancy rates as a result of the terrorist events in the United States that occurred on September 11, 2001. The project was encumbered by a $6.0 million loan with a Bermuda bank. In March 2002, we informed the Bermuda bank that we did not intend to reopen this project due to large projected operating losses and instead intended to sell the project to an identified buyer. This resulted in a default of the loan. On March 27, 2002, the Bermuda bank exercised its rights under Bermuda law and put the project in "receivership", which gives the bank the right to negotiate directly with this buyer as well as other potential buyers. There was no impact on operating results for the quarter ended June 30, 2002 from this event. We no longer have involvement in the operations of Daniel's Head.

Note 5—Provision for Asset Impairment

        We record real estate assets at historical costs and adjust them for recognition of impairment losses. During the second quarter ended June 30, 2002, we recognized an impairment loss of $2.5 million on our Inglewood, CA property. The tenant, House 2 Home, filed for bankruptcy and vacated, and the property is no longer generating income. The loss was determined based on the estimated fair value of the property.

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Note 6—Discontinued Operations

        Included in the Consolidated Statements of Operations are the discontinued operations of our property at Glen Burnie, MD, which was sold on June 21, 2002 and is summarized as follows (amounts in thousands):

Note 7—Investments in Unconsolidated Real Estate Joint Ventures

        As of June 30, 2002 and December 31, 2001, we had the following investments in unconsolidated joint ventures, which we account for under the equity method of accounting (amounts in thousands):

        Cash distributions and profits are typically allocated based on the above ownership percentages, adjusted for certain preferred returns for capital contributions which are made in excess of each partners' ownership percentages. The Orlando Business Park LLC assets consist primarily of land held for sale. The other joint ventures are primarily in the business of operating real estate. Their accounting principles are consistent with ours.

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

1)

Joint ventures acquired from Excel Legacy in the Merger.

2)

We sold our 50% share of this joint venture in December 2001 for $13.5 million and recognized no gain or loss on the sale.

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Note 8—Notes Receivable

        We have $50.7 million in notes receivable outstanding at June 30, 2002 related to various projects. The notes bear interest ranging from 10% to 15% per year and are collateralized by the related projects or other real estate. Of these notes, $47.1 million involve entities controlled by one individual. Repayment of the notes is anticipated to occur from the completion of various development projects or other events. The largest note is for approximately $22.8 million related to a development project in Scottsdale, AZ. The remaining notes are each less than $10.0 million. The notes do not require cash payments on the interest until specified future dates, typically when the projects are completed or sold. The notes mature on various dates between 2002 and the earlier of the sale of the related projects, or 2003 to 2004.

        We also have $12.3 million in notes receivable related to the sale of our self storage development properties. These notes bear interest at 12% per year and are due May 31, 2003 or earlier, depending on stabilization of the properties.

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Note 9—Debt

Mortgages and Notes Payable

        We had the following mortgages and notes payable outstanding at June 30, 2002 and December 31, 2001 (amounts in thousands):

        We have a 69% interest in Newport on the Levee, LLC (Newport) that is developing a retail project in Newport, KY. In addition to the $37.0 million, $4.7 million and $5.5 million notes in the above table, the City of Newport has issued two series of public improvement bonds. The Series 2000a tax exempt bonds total $44.2 million and are broken down as follows: (a) $18.7 million maturing 2018

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with interest 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 have a 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 $43.1 million of the bonds at June 30, 2002.

        Summarized debt information for our unconsolidated joint ventures and the amount guaranteed by us at June 30, 2002 is as follows:

        We also have guaranteed an $12.5 million note payable related to a development project in Scottsdale, AZ in which we have a $22.8 million note receivable with a participating interest.

        In connection with the sale of three self storage development properties in June 2002, we agreed to guarantee $14.2 million of debt the buyer assumed associated with the properties until April 2003, when the debt matures.

Convertible Debentures

        Prior to the Merger, Excel Legacy had $33.2 million in convertible debentures outstanding. As part of the Merger, $30.4 million of the debentures were exchanged for Series A Preferred Stock, with $2.8 million of debentures remaining. The debentures bear an interest rate of 9% per year and mature in November 2004. The holders of the debentures are entitled at any time before the day prior to the final maturity date, subject to prior redemption, to convert any debentures into common stock at an $8.25 per share conversion price.

Senior Notes

        Prior to the Merger, Excel Legacy had $18.1 million in senior notes outstanding. As part of the Merger, $15.8 million of the notes were exchanged for Series A Preferred Stock, with $2.3 million of notes remaining. The notes bear an interest rate of 10% per year and mature in November 2004. The notes are senior to the debentures.

Note 10—Financial Instruments: Derivatives and Hedging

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

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

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        To manage interest rate risk, we may employ options, forwards, swaps, caps and floors, or a combination thereof, depending on the underlying exposure. We undertake a variety of borrowings from lines of credit to medium and long-term financings. To manage overall costs, we currently use derivative instruments to convert a portion of our fixed-rate debt to variable-rate debt. Interest rate differentials that arise under the swap contracts are recognized in interest expense over the life of the contracts.

        We may also use derivative instruments to protect the fair value of existing or anticipated floating-rate debt. We may employ Treasury locks, forward-starting swaps, swaptions, and interest rate swaps to this end. Such derivatives, when entered into, must be expected to effectively hedge the risks they are intended to mitigate. As of June 30, 2002, we had five amortizing swaps with approximately $161 million current notional amount protecting the fair value of approximately $161 million fixed-rate debt from changes in value attributable to interest rate movement.

        The following table summarizes the notional values and fair values of our derivative financial instruments. The notional value at June 30, 2002 provides an indication of the extent of our involvement in these instruments at that time, but does not represent exposure to credit, interest rate, or market risk. The fixed rates shown below include spreads of 3.08% for the swaps maturing in 2009 and 3.77% for the swap maturing in 2010.

        On June 30, 2002, the derivative instruments were reported at their fair value as Other Assets of $3.5 million.

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

Note 11—Related Party Transactions

        Prior to the Merger, Excel Legacy was responsible for the daily management of PEI, including property management, finance and administration. We reimbursed Excel Legacy for these Services based on our historical costs for similar expenses. We expensed $0.8 million for these services during the second quarter of 2001 and $1.7 million for the six month year-to-date period of 2001.

        Prior to the Merger, we executed a note receivable with Excel Legacy allowing them to borrow up to $40.0 million. During the second quarter of 2001 we recorded $1.1 million in interest income on this note, and $2.0 million for the six month year-to-date period of 2001. As a result of the Merger, interest income is no longer recorded on this note.

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        In connection with the San Diego/Rancho Bernardo, CA office building purchased from Excel Legacy, we leased the building back to Excel Legacy under a 10-year lease agreement. We recorded $0.3 million of rental revenue from Excel Legacy in connection with this lease during the second quarter of 2001, and $0.5 million for the six months year-to-date period of 2001. Due to the Merger, rental revenue is no longer recorded on this lease.

        In connection with the purchase of the Anaheim land in the first quarter of 2001, we executed a ground lease agreement with Excel Legacy. The lease has a term of 50 years and requires payments of $2.8 million per year in rent. During the second quarter of 2001, we recorded $0.7 million in rental revenue from Excel Legacy related to this lease, and $1.2 million for the six month year-to-date period of 2001. Due to the Merger, rental revenue is no longer recorded on this lease.

        In connection with the Merger, we acquired notes receivable from certain officers and affiliates of Excel Legacy, of which $9.4 million was outstanding at June 30, 2002. The notes bear interest at a fixed rate of 7%, and are due in March 2003. The total interest receivable at June 30, 2002 from these notes was $2.9 million. The notes were for the purchase of Excel Legacy common stock and have been offset against stockholders' equity on our accompanying Consolidated Balance Sheets.

        We discuss other related party transactions in Note 2.

Note 12—Subsequent Events

        In July 2002, we acquired the following interest rate cap agreements that limit the one-month LIBOR index associated with certain of our outstanding debt at 7%:

        To the extent the one-month LIBOR index exceeds 7% the counter parties on the above instruments will pay us the difference between the actual index and 7%. These instruments are accounted for under SFAS 133. Both the instrument and hedged debts will be adjusted on the Consolidated Balance Sheets.

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ITEM 2—MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

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

•

the effect of economic, credit and capital market conditions in general and on real estate companies in particular, including changes in interest rates

•

our ability to compete effectively

•

developments in the retail industry

•

the financial stability of our tenants, including our reliance on major tenants

•

our ability to successfully complete real estate acquisitions, developments and dispositions

•

our ability to achieve the expected benefits of our merger with Excel Legacy Corporation

•

government approvals, actions and initiatives, including the need for compliance with environmental requirements

•

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

        The factors identified above are believed to be some, but not all, of the important factors that could cause actual events and results to be significantly different from those that may be expressed or implied in any forward-looking statements. Any forward-looking statements should also be considered in light of the information provided in "Factors That May Affect Future Performance" located in our Form 10-K filing for the 2001 fiscal year. We assume no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our reports on Forms 10-K, 10-Q and 8-K filed with the SEC. Our Form 10-K filing for the 2001 fiscal year listed various important factors that could cause actual results to differ materially from expected and historic results.

        In Management's Discussion and Analysis we explain our general financial condition and results of operations including:

•

why revenues, costs and earnings changed from the prior period

•

funds from operations (FFO)

•

how we used cash for capital projects and dividends and how we expect to use cash in the remainder of 2002

•

where we plan on obtaining cash for future dividend payments and future capital expenditures

Critical Accounting Policies and Estimates

General

        Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). Preparation of our financial statements in accordance with GAAP requires management to make estimates and judgments that affect the reported

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amounts of assets, liabilities, revenues and expenses and the related notes. We believe that the following accounting policies are critical because they affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions. For a detailed discussion on the application of these and other accounting policies, see Note 1 in the Notes to the Consolidated Financial Statements in Item 8 of our Annual Report on Form 10-K for the 2001 fiscal year.

Consolidation

        We combine our financial statements with those of our wholly-owned subsidiaries as well as all affiliates in which we have control and present them on a consolidated basis. The consolidated financial statements do not include the results of transactions between us and our subsidiaries or among our subsidiaries.

Revenue Recognition

        Recognition of revenue is dependent upon the quality and ability of our tenants to pay their rent in a timely manner. Rental revenues include: (1) minimum annual rentals, adjusted for the straight-line method for recognition of fixed future increases; (2) additional rentals, including recovery of property operating expenses, and certain other expenses 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, which we recognize when earned.

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

Real Estate Assets and Depreciation

        We record real estate assets at historical costs and adjust them for recognition of impairment losses. In following purchase accounting, we adjusted the historical costs of Excel Legacy's real estate assets to fair value at the time of the Merger. Our consolidated balance sheets at June 30, 2002 and December 31, 2001 reflect the new basis of those real estate assets.

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

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

        We review long-lived assets for impairment when events or changes in business conditions indicate that their full carrying value may not be recovered. We consider assets to be impaired and write them down to fair value if their expected associated future undiscounted cash flows are less than their carrying amounts.

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

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

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Derivative Instruments and Hedging Activities

        As we stated in Note 1, we follow the provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." In the normal course of business, we may use derivative financial instruments to manage or hedge interest rate risk. When entered into, we formally designate and document the financial instrument as a hedge of a specific underlying exposure, as well as the risk management objectives and strategies for undertaking the hedge transactions. We assess, both at the inception and at least quarterly thereafter, whether the financial instruments that are used in hedging transactions are effective at offsetting changes in either the fair value or cash flows of the related underlying exposure. Because of the high degree of effectiveness between the hedging instrument and the underlying exposure being hedged, fluctuations in the value of the derivative instruments are generally offset by changes in the fair value or cash flows of the underlying exposures being hedged. Any ineffective portion of a financial instrument's change in fair value is immediately recognized in earnings. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets.

        To determine the fair values of derivative instruments, we use a variety of methods and assumptions that are based on market conditions and risks 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 and techniques 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 result in a general approximation of value, and such value may never actually be realized.

Asset Disposal

        In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting for the impairment or disposal of long-lived assets and is effective in fiscal years beginning after December 15, 2001. We have adopted this statement and report discontinued operations for the quarter and six month period ended June 30, 2002.

Rental Revenues

        Revenues increased $13.5 million to $32.2 million in the second quarter of 2002 compared to the same period in 2001 primarily because:

•

properties we acquired during 2001 and 2002 generated $12.0 million of additional revenues

•

properties we owned both years generated $2.4 million of additional revenues, mainly due to a $2.3 million termination fee received in the second quarter of 2002

•

partially offsetting these increases were:

•

revenues from properties we sold, which contributed $0.8 million of revenues in 2001

•

revenues associated with the self storage facilities, which decreased $0.1 million due to the master lease of our self storage business. In May 2001, we began collecting rent net of expenses when we entered into a master lease arrangement on these properties

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        Revenues increased $25.1 million to $61.0 million in the six month year-to-date period of 2002 compared to the same period in 2001 primarily because:

•

properties we acquired during 2001 and 2002 generated $24.2 million of additional revenues

•

properties we owned both years generated $2.9 million of additional revenues, primarily due to a $2.3 million termination fee received in the second quarter of 2002

•

partially offsetting these increases were:

•

revenues from properties we sold, which contributed $1.8 million of revenues in 2001

•

revenues associated with the self storage facilities, which decreased $0.2 million due to the master lease agreement

Expenses

        Expenses increased $9.1 million to $16.9 million in the second quarter of 2002 compared to 2001 primarily because:

•

expenses on properties we acquired in 2001 and 2002 generated $6.5 million of additional expenses

•

we recognized an impairment loss of $2.5 million on one of our properties in the second quarter of 2002. The loss was based on the assessed fair value of the property

•

general and administrative expense increased $0.8 million, primarily due to additional salaries and benefits. Prior to the Merger, these expenses were paid by Excel Legacy and we reimbursed them for those services based on our historical costs for similar expenses

•

expenses from properties we owned in both years increased by $0.1 million

•

these increases to expenses were partially offset by:

•

a decrease in expenses of $0.5 million related to the master lease agreement for our self storage facilities as noted above

•

expenses from properties we sold, which contributed $0.3 million to expenses in the second quarter of 2001

        Expenses increased $17.1 million to $32.2 million for the year-to-date period ended June 2002 compared to 2001 primarily because:

•

expenses on properties we acquired in 2002 and 2001 generated $13.2 million of additional expenses

•

general and administrative expense increased $2.8 million, primarily due to legal fees and other costs of $1.5 million related to our investment in Destination Villages, LLC. General and administrative expenses also increased $1.1 million related to salaries and benefits

•

we recognized an impairment loss of $2.5 million on one of our properties in the second quarter of 2002, discussed above

•

expenses from properties we owned in both years increased by $0.2 million

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•

these increases to expenses were partially offset by:

•

a decrease in expenses of $1.0 million related to the master lease agreement for our self storage facilities as noted above

•

expenses from properties we sold, which contributed $0.6 million to expenses in the prior year

Operating Income

        Operating income increased for the second quarter and year-to-date periods of 2002 compared to the same periods in the prior year primarily because of the changes in Rental Revenues and Expenses discussed above.

Interest Expense

        Interest expense increased $2.3 million in the second quarter of 2002 and $5.3 million for the year-to-date period compared to 2001 because during the second quarter of 2002 we had an average of $494.4 million debt outstanding compared to $233.4 million in the second quarter of 2001. The increase in interest expense due to the amount of debt outstanding was partially offset by a decrease in interest rates on our variable rate debt and by the use of interest rate swap agreements which exchange rates on some of our fixed rate debt for lower variable rates.

        The weighted average interest rate on our variable rate debt decreased to 3.5% on June 30, 2002 from 5.5% on June 30, 2001. We discuss our outstanding debt further in "Liquidity and Capital Resources" located elsewhere in this Form 10-Q.

Interest Income

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        Interest income decreased $0.7 million in the second quarter of 2002 compared to 2001 primarily because:

•

during the second quarter of 2001 we recorded $1.1 million in interest income on our note with Excel Legacy. As a result of the Merger, interest income is no longer recorded on this note

•

partially offsetting this decrease was an increase in interest income of $0.4 million from other developers' notes receivable

        Interest income decreased $1.3 million in the six month year-to-date period ended June 2002 compared to the same period in 2001 primarily because:

•

during the six months ended June 2001 we recorded $2.0 million in interest income on our note with Excel Legacy. As a result of the Merger, interest income is no longer recorded on this note

•

partially offsetting this decrease was an increase in interest income of $0.7 million from other developers' notes receivable

Gain/Loss on Sale of Real Estate

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