10-K 1 w53527e10-k.txt ANNUAL REPORT 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 ----------------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED COMMISSION FILE JUNE 30, 2001 NO. 0-24108 ------------------ SARNIA CORPORATION (Exact name of registrant as specified in its charter) VIRGINIA 54-1215366 (State or other jurisdiction of (I.R.S. employer identification no.) incorporation or organization) 6850 VERSAR CENTER, SPRINGFIELD, VIRGINIA 22151 (Address of principal executive offices) (Zip code)

(703) 642-6800 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO PAR VALUE (Title of Class) 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 X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. The aggregate market value of the voting stock held by non-affiliates of the registrant as of September 7, 2001 was approximately $2,722,277. The number of shares of Common Stock outstanding as of September 1, 2001 was 4,572,545. The Exhibit Index is located on Pages 14 through 15 hereof. ------------------ DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's Proxy Statement to be filed with the Securities and Exchange Commission with respect to the 2001 Annual Meeting of Stockholders are incorporated by reference into Part III hereof. 2 PART I ITEM 1. BUSINESS FORWARD-LOOKING STATEMENTS The statements in this report that are forward-looking are based on current expectations, and actual results may differ materially. The forward-looking statements include those regarding cost controls and reductions, the expected annual rent escalations, the possible impact of current and future claims against the Company based upon negligence and other theories of liability, the actions of the Virginia Department of Transportation, and the possibility of tenants continuing to or electing not to renew their leases or the Company's ability to attract new tenants. Forward-looking statements involve numerous risks and uncertainties that could cause actual results to differ materially, including, but not limited to, the possibilities that the demand for the Company's services may decline as a result of possible changes in general and regional specific economic conditions and the effects of competitive services and pricing; one or more current or future claims made against the Company may result in substantial liabilities; failure to obtain additional compensation in a condemnation proceeding, and such other risks and uncertainties as are described in reports and other documents filed by the Company from time to time with the Securities and Exchange Commission. Sarnia Corporation (Sarnia or the Company) is the owner and operator of commercial real estate. Its sole asset is an office park of approximately 15.76 acres located in Springfield, Virginia known as Versar Center. Sarnia was incorporated in Virginia on November 22, 1982 (under the name of Versar Virginia, Inc.) to acquire property for its then parent corporation, Versar, Inc. ("Versar"), in order to own, develop and manage the Versar Center complex. On June 30, 1994, Versar spun-off Sarnia to Versar's shareholders on the basis of one share of Sarnia common stock for every outstanding share of Versar common stock. Sarnia's common stock is now publicly traded on the over-the-counter market. Versar Center consists of two four-story office buildings: the 6850 Building (approximately 108,000 square feet) which was constructed in 1982, and the 6800 Building (approximately 110,000 square feet) which was constructed in 1986. Since 1996, the interior of the 6850 Building has been extensively reconditioned and upgraded. At the end of June 2001, the 6850 Building was 95% leased and the 6800 Building was 97% leased. Versar and National Capital Preferred Provider Organization, Inc. (NCPPO) are the major tenants leasing approximately 82% of the 6850 Building and have leases which terminate in May 2009 and July 2005, respectively. Five major tenants, Cornet, C-Cubed Corporation, Chenanga Technology Services Corporation, the General Services Administration (GSA) and Science Applications International Corporation (SAIC) lease approximately 80% of the 6800 Building and have leases which terminate between February 2004 and June 2006. In the third quarter of fiscal year 2000, the Company received an offer from the Virginia Department of Transportation (VDOT) of approximately $2,300,000 for approximately 2.54 acres of Sarnia's property and easements. After thorough review of the proposal and advice of retained experts, the Company rejected the VDOT offer. As a matter of law, VDOT took legal possession of the property under eminent domain. However, the Company has not agreed to the damage assessed by VDOT and the Company is seeking additional compensation through negotiation with VDOT. If unsuccessful, the Company will commence litigation to receive fair compensation. The Company recorded a gain on the condemnation of property of approximately $2,196,000 during fiscal year 2000. The use of the proceeds of $2,501,000 from the condemnation is restricted by the first mortgage with I.D.S. Life Insurance Company (IDS) for the purpose of correcting damage caused by the VDOT condemnation. The Company will be required to build a new parking garage and access road to the 6800 building. The Company currently estimates that it will cost approximately $4,000,000 to complete the project. The Company has entered into a design/build contract with Versar Global Solutions, Inc. to design and construct the parking garage. The Company is seeking additional compensation from VDOT for the shortfall, as discussed above, and is also seeking 2 3 alternate financing sources in the event the Company is not successful with VDOT or if the timing of the construction is prior to settlement with VDOT. Sarnia believes that the relatively stable employment base provided by the federal government, supplemented by robust technical business growth in the region, makes Versar Center an attractive real estate investment. Because of the presence of the Federal government and the growth of technical business, the area has attracted a high percentage of professional workers which provide the region with a private sector labor force base particularly suited to an increasingly service-oriented national economy. The Washington, D.C. metropolitan area has had the sixth highest employment base in the nation. Population and employment growth in this metropolitan area have historically moved outward from the District of Columbia, first to the immediate suburbs, and then to the adjacent counties, with Montgomery County in Maryland and Fairfax County in Virginia absorbing most of the growth. Fairfax County, in which Versar Center is located, has experienced growth in terms of residential, commercial and industrial development. In the past four years, the regional economy, especially in Northern Virginia and Fairfax County has become robust. That growth, combined with the past lack of new buildings under construction, had led to an increase in occupancy and generally higher rentals for vacant or renewed office space. Recently, new construction has increased in the area. This construction coupled with the slow down in growth of technology companies has resulted in considerately softening of the local real estate rental market. Versar Center competes for tenants with other properties throughout Springfield and central Fairfax County. Competition for tenants is based on location and rent charged. The success of Sarnia depends on, among other factors, the trends of the economy in the Washington, D.C. metropolitan area, government spending and the ability of Sarnia to keep Versar Center leased at profitable levels while controlling operating costs. Sarnia's staff perform the actual day-to-day management functions of Versar Center, including maintenance of the property and equipment, tenant build-outs and other facilities management functions. OPERATING DATA The occupancy rate for the 6850 Building for fiscal years 2001 through 1997 was 95%, 98%, 98%, 98% and 98%, respectively. The occupancy rate for the 6800 Building for fiscal years 2001 through 1997 was 97%, 88%, 89%, 100% and 97%, respectively. The principal tenants in the 6850 Building and the 6800 Building are as follows: environmental consultants, government agencies, government contractors, computer software assembly firm, health care provider organization and various other service businesses. Versar and NCPPO are the only tenants which occupy more than 10% of the total rentable space in the 6850 Building. Versar's principal business is environmental engineering and consulting, and NCPPO is a national health care services provider. Cornet, C-Cubed Corporation, Chenanga Technology Services Corporation and GSA each occupy more than 10% of the rentable space in the 6800 Building. The loss of any of these tenants, if not replaced on substantially similar terms, would have an adverse effect on Sarnia's results of operations and financial condition. Versar has lease agreements with Sarnia for 68,414 square feet of office space in the 6850 Building, and 520 square feet of storage space in the 6800 Building, at an aggregate annual rent of approximately $1,124,000. Both leases expire on May 31, 2009. The lease on the 6850 Building has an annual 2% escalation in rent costs. The lease on the 6800 Building is subject to 2% annual rent escalation. There are no renewal options in the leases. With respect to the 6850 Building, the average effective annual rental per square foot was $15.18, $15.36, $15.18, $14.60 and $14.02 for fiscal years 2001, 2000, 1999, 1998 and 1997, respectively. With respect to the 6800 3 4 Building, the average effective annual rental per square foot was $14.68, $13.35, $13.04, $13.13 and $12.60 for fiscal years 2001, 2000, 1999, 1998 and 1997, respectively. In addition, the average net rental rates per square foot for both buildings were $8.90, $8.49, $7.98, $7.40 and $7.01 for fiscal years 2001, 2000, 1999, 1998 and 1997, respectively. The net rental rates per square foot for Versar alone, as a significant tenant, were $8.81, $8.00, $8.43, $7.85 and $7.83 for fiscal years 2001, 2000, 1999, 1998 and 1997, respectively. The average effective annual rental per square foot is derived using annual rental income divided by occupied square feet. The net rental rate represents the difference between income per square foot and operating expense per square foot. The following table sets forth the schedule of the lease expirations for each of the eight years commencing with calendar year 2002:

The following table sets forth information with respect to the 6850 Building and the 6800 Building regarding tax depreciation:

The real property tax rate is $1.23 per $100 of assessed value. Annual real property taxes for 2001 were approximately $104,000 and $120,000 for the 6850 Building and the 6800 Building, respectively. 4 5 EMPLOYEES At June 30, 2001, Sarnia employed four (4) full time and two (2) part time employees. Sarnia considers relations with its employees to be good. No employees are represented by labor unions. EXECUTIVE OFFICERS AND DIRECTORS The current executive officers and directors of Sarnia, their ages as of September 1, 2001, their current offices or positions and their business experience for at least the past five years are set forth below.

5 6

6 7 ITEM 2. PROPERTIES Versar Center is located at the east end of the 6900 block of Hechinger Drive in Springfield, Virginia, one-half mile northwest of the intersection of the Capital Beltway (I-495) and Shirley Highway (I-395). The 6800 Building and the 6850 Building, the two four-story office buildings in Versar Center, are located on a property encompassing 15.76 acres. The 6850 Building has approximately 108,000 rentable square feet, and the 6800 Building has approximately 110,000 rentable square feet. The property site is just inside the Capital Beltway, approximately 14.5 miles southwest of downtown Washington, D.C. Springfield is a major retail center with the Springfield Regional Mall, Springfield Plaza Shopping Center and other retail properties located within its boundaries. Major industrial parks are found on both sides of Shirley Highway inside the Capital Beltway. Springfield is generally considered a Class B office location. Versar Center is located in an I-5 zoning district, which is defined as a general industrial district; its permitted uses include the existing office use. Under existing zoning regulations, Sarnia could construct approximately 111,000 square feet of additional office space by right and up to an additional 258,000 square feet of office space by special exception. The 6800 Building and the 6850 Building are secured by a first deed of trust in favor of I.D.S. Life Insurance Company (IDS). Refer to Footnote D on Page F-8 for details. In connection with the improvements and expansion of the Springfield interchange highway system, the VDOT took approximately 2.54 acres of Sarnia's property. Also taken were additional easements for fire protection and water mains. The Company retained counsel and other professional assistance in determining the effect of such change on the property, its value to Sarnia and any actions which are required to maintain Versar Center as an attractive property to existing and prospective tenants. By law, VDOT is required to fairly compensate Sarnia for the property that it acquires, including any residual damages to the remaining property, either by negotiation or by exercise of its powers of eminent domain. Sarnia has employed the services of an expert real estate appraiser as well as a professional engineer to aid in the determination of the appropriate value of the acquisition and any adverse impact on the remainder of the property. In the third quarter of fiscal year 2000, the Company received an offer from VDOT for approximately $2,300,000 for approximately 2.54 acres of Sarnia's property and easements. After thorough review of the proposal and advice of retained experts, the Company rejected the VDOT offer. As a matter of law, VDOT took legal possession of the property under eminent domain, yet because the Company has not agreed to the damage assessed by VDOT, the Company is seeking additional compensation. The Company is seeking to increase the amount of the VDOT offer by negotiation. If unsuccessful, the Company will commence litigation to receive fair compensation. ITEM 3. LEGAL PROCEEDINGS Sarnia is not a party to any pending litigation or administrative proceedings, other than the VDOT condemnation described elsewhere in this report. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's security holders during the last quarter of fiscal year 2001. 7 8 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS COMMON STOCK At June 30, 2001, the Company had 699 stockholders of record, excluding stockholders whose shares were held in nominee name. The Company's common stock is traded on the over-the-counter market. There is no established public trading market for the Company's common stock and trades in the stock are sporadic. The quarterly high and low actual trade prices quoted by the NASDAQ Stock Market reflecting inter-dealer prices without adjustments for mark-ups, mark-downs, or commissions during fiscal years 2001 and 2000 are presented below.

No dividends were paid on the Company's common stock since the Company became public. The Board of Directors intends to retain any future earnings for use in the Company's business and does not anticipate paying cash dividends in the foreseeable future. 8 9 ITEM 6. SELECTED FINANCIAL DATA The selected financial data set forth below should be read in conjunction with Sarnia's Financial Statements and notes thereto beginning on page F-1 of this report.

9 10 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS The statements in this report that are forward-looking are based on current expectations, and actual results may differ materially. The forward-looking statements include those regarding cost controls and reductions, the expected annual rent escalations, the possible impact of current and future claims against the Company based upon negligence and other theories of liability, the actions of the Virginia Department of Transportation, and the possibility of tenants continuing to or electing not to renew their leases or the Company's ability to attract new tenants. Forward-looking statements involve numerous risks and uncertainties that could cause actual results to differ materially, including, but not limited to, the possibilities that the demand for the Company's services may decline as a result of possible changes in general and regional specific economic conditions and the effects of competitive services and pricing; one or more current or future claims made against the Company may result in substantial liabilities; failure to obtain additional compensation in a condemnation proceeding, and such other risks and uncertainties as are described in reports and other documents filed by the Company from time to time with the Securities and Exchange Commission. Real estate revenue in fiscal year 2001 of $3,626,000 was $139,000 (4%) higher than the $3,487,000 of real estate revenue reported in fiscal year 2000. The increase in fiscal year 2001 was attributable to higher occupancy rate and rent escalations offset, in part, by a decrease in tenant requested services. Real estate revenue in fiscal year 2000 of $3,487,000 was $231,000 (7%) higher than the $3,256,000 of real estate revenue reported in 1999. The increase in fiscal year 2000 was due to rent escalations. The average occupancy rate for the two buildings in fiscal year 2001 and 2000 was 96% and 93%, respectively. Real estate expenses in fiscal year 2001 of $1,580,000 were $34,000 (2%) higher than the $1,546,000 of expense reported in fiscal year 2000. This increase was due to higher utility costs, legal expenses and real estate taxes offset, in part, by lower labor costs. Real estate expense in fiscal year 2000 of $1,546,000 was $124,000 (9%) higher than the $1,422,000 reported in fiscal year 1999. The increase was due to higher real estate taxes and legal expenses associated with the VDOT eminent domain taking in fiscal year 2000. Depreciation/amortization expenses in fiscal year 2001 were $561,000, a decrease of $15,000 (3%) when compared to fiscal year 2000. Depreciation/amortization expenses in fiscal year 2000 of $576,000 were $4,000 (1%) lower than depreciation/amortization expenses of $580,000 in fiscal year 1999. The decrease in fiscal year 2001 and 2000 was due to fully depreciated assets during the year that outpaced capital expenditures. General and administrative expenses were $93,000, $90,000 and $94,000 for fiscal years 2001, 2000 and 1999, respectively. General and administrative expenses consist of administrative services provided by Versar at a fixed annual fee of $36,000 (refer to Note B on page F-6) and property and general liability insurance. Fluctuations in insurance rates in the ordinary course caused the increase in fiscal year 2001 and the decrease in fiscal year 2000. In fiscal year 2000, the Company recorded a gain from the condemnation of property by VDOT in the amount of $2,196,000. (Refer to Note H on page F-10). Interest expense of $663,000 in fiscal year 2001 decreased by $47,000 (7%) when compared to fiscal year 2000. Interest expense of $710,000 in fiscal year 2000 was $32,000 (4%) lower compared to interest expense of $742,000 in fiscal year 1999. These decreases were due to the principal payments made in fiscal years 2001 and 2000. 10 11 In fiscal year 2001, the Company recorded $214,000 interest income from the VDOT eminent domain compensation. Income tax expenses were $358,000, $555,000, and $159,000 for fiscal years 2001, 2000 and 1999, respectively. The increase in income tax expense in fiscal year 2000 was due to taxes recorded on the gain from the VDOT condemnation of a portion of the Company's property offset by the reversal of the $514,000 valuation allowance maintained in fiscal year 1999. Sarnia recorded $79,000 of preferred stock dividends in each of the fiscal years 2001, 2000 and 1999. Preferred stock dividends are paid quarterly, on the first day of March, June, September and December of each year. The net income applicable to common stock was $506,000 in fiscal year 2001 compared to net income applicable to common stock of $2,127,000 in fiscal year 2000. Net income in fiscal year 2000 would have been $350,000 not giving effect to the gain from the condemnation of property. The improvements in net income without consideration of the gain from condemnation of property, were attributable to the combination of higher rental revenue, controlled operating expenses, and lower interest expense in fiscal year 2001. The net income applicable to common stock in 2000 was $2,127,000, an increase of $1,947,000 over that reported in fiscal year 1999. The increase was attributable to the condemnation proceeds for a portion of the property. LIQUIDITY AND CAPITAL RESOURCES Cash flow provided by operating activities was $1,252,000, $737,000 and $900,000 for fiscal years 2001, 2000 and 1999, respectively. The increase in cash flow in fiscal year 2001 was due to improved net income and increase in other liabilities offset by the increase in other assets. The decrease in fiscal year 2000 is due to an increase in brokerage commissions, which are amortized over the life of the lease and reduced rental deposits. Principal payments on the mortgages for fiscal years 2001, 2000 and 1999 were $528,000, $510,000 and $495,000, respectively. Sarnia has a first mortgage of $9 million with I.D.S. Life Insurance Company at the fixed rate of 7.75% that is being amortized over twenty-two years with a balloon payment due in February 2003. As of June 30, 2001, the outstanding balance on the loan was $7,954,000. Sarnia has a $1.5 million five year term loan with Bank of America. The loan is guaranteed by Versar, Inc. and bears interest at the five-year Treasury Rate plus three hundred (300) basis points per annum (currently 7.7%), but not to exceed 9% per annum. The note matures on June 30, 2002 with $300,000 principal payment per year starting July 1, 1997. As of June 30, 2001, the outstanding balance on the loan was $300,000. Management believes that funds generated from rents should be sufficient to meet Sarnia's operating needs. Sarnia expects that it will require approximately $4,000,000 for capital expenditures to be made during fiscal year 2002. It is anticipated that a majority of the expenditures will be used to construct a parking garage and access road due to the VDOT condemnation of a portion of the property. The use of the proceeds of $2,501,000 from the condemnation is restricted for the purpose of correcting damage caused by the condemnation by VDOT. The Company will be required to build a new parking garage and access road to the 6800 building. The Company estimates that it will cost approximately $4,000,000 to complete the project. The Company is seeking additional compensation from VDOT for the shortfall and is also seeking alternate financing sources in the event the Company is not successful with VDOT or if the timing of the construction is prior to settlement with VDOT. No assurance can be given that the Company will be successful with VDOT or that alternative sources of funding will be available on terms acceptable to the Company or at all. 11 12 IMPACT OF INFLATION Sarnia continually seeks to protect itself from the effects of inflation. The majority of its leases provide for annual increases based on fixed percentages or increases in the Consumer Price Index. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has not entered into any transactions using derivative financial instruments or derivative commodity instruments and believes that its exposure to interest rate risk and other relevant market risk is not material. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements and supplementary data begin on page F-1 of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information required by this item with respect to directors of the Company will be contained in the Company's Proxy Statement for its 2001 Annual Meeting of Stockholders which is expected to be filed with the Commission not later than 120 days after the Company's 2001 fiscal year and is incorporated herein by reference. Information required by this item with respect to executive officers of the Company is included in Part I of this report and is incorporated herein by reference. For the purpose of calculating the aggregate market value of the voting stock of Sarnia held by non-affiliates as shown on the cover page of this report, it has been assumed that the directors and executive officers of the Company and the Versar Employee Savings and Stock Ownership Plan are the only affiliates of the Company. However, this is not an admission that all such persons are, in fact, affiliates of the Company. The information called for in Part III by: ITEM 11. EXECUTIVE COMPENSATION ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required by these items is incorporated herein by reference to the Company's Proxy Statement for its 2001 Annual Meeting of Stockholders which is expected to be filed with the Commission not later than 120 days after the end of the Company's 2001 fiscal year. 12 13 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (A)(1) Financial Statements: The financial statements and financial statement schedules of Sarnia Corporation are filed as part of this report and begin on page F-1. a) Report of Independent Public Accountants b) Balance Sheets as of June 30, 2001 and 2000 c) Statements of Operations for the Years Ended June 30, 2001, 2000 and 1999 d) Statements of Changes in Stockholders' Equity (Deficit) for the Years Ended June 30, 2001, 2000 and 1999 e) Statements of Cash Flows for the Years Ended June 30, 2001, 2000 and 1999 f) Notes to Financial Statements (2) Financial Statement Schedules: There are no financial statement schedules applicable to the Company. (3) Exhibits: The exhibits to this Form 10-K are set forth in a separate Exhibit Index which is included on page 14 of this report. (B) Reports on Form 8-K No reports were filed on Form 8-K during the Company's last quarter of fiscal year 2001. 13 14 EXHIBIT INDEX

14 15 -------------------------------------------------------------------------------- (A) Incorporated by reference to similarly numbered exhibit to the Registrant's Form 10 Information Statement (Information Statement), effective June 30, 1994 (File No. 0-24108). (B) Incorporated by reference to the similarly numbered exhibit to the Registrant's Form 10-K Annual Report for the fiscal year ended June 30, 1994 (FY 1994 Form 10-K) filed with the Commission on September 27, 1994. (C) Incorporated by reference to the similarly numbered exhibit to the Registrant's Form 10-K Annual Report for the fiscal year ended June 30, 1995 (FY 1995 Form 10K) filed with the Commission on September 29, 1995. (D) Incorporated by reference to the similarly numbered exhibit to the Registrant's Form 10-K Annual Report for the fiscal year ended June 30, 1996 (FY 1996 Form 10K) filed with the Commission on September 24, 1996. (E) Incorporated by reference to the similarly numbered exhibit to the Registrant's form 10-K Annual Report for the fiscal year ended June 30, 1997 (FY 1997 Form 10K) filed with the Commission on September 18, 1997. 15 16 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SARNIA CORPORATION --------------------------- (Registrant) Date: September 27, 2001 /s/ CHARLES I. JUDKINS, JR. --------------------------- Charles I. Judkins, Jr. President & CEO Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

16 17 Report of Independent Public Accountants To the Board of Directors and Stockholders of Sarnia Corporation: We have audited the accompanying balance sheets of Sarnia Corporation (a Virginia corporation) as of June 30, 2001 and 2000, and the related statements of operations, changes in stockholders' equity (deficit) and cash flows for the three years ended June 30, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Sarnia Corporation as of June 30, 2001 and 2000, and the results of its operations and its cash flows for the three years ended June 30, 2001 in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP ------------------------------------ Arthur Andersen LLP Vienna, Virginia August 16, 2001 F-1 18 SARNIA CORPORATION BALANCE SHEETS

The accompanying notes are an integral part of these financial statements. F-2 19 SARNIA CORPORATION STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these financial statements. F-3 20 SARNIA CORPORATION STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

The accompanying notes are an integral part of these financial statements. F-4 21 SARNIA CORPORATION STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these financial statements. F-5 22 SARNIA CORPORATION NOTES TO FINANCIAL STATEMENTS NOTE A GENERAL INFORMATION Sarnia Corporation (the Company), formerly Versar Virginia, Inc., was a wholly-owned real estate subsidiary of Versar, Inc. (Versar) until June 30, 1994. The Company owns and operates the 6850 Building and the 6800 Building in Versar Center, Springfield, Virginia. NOTE B SIGNIFICANT ACCOUNTING POLICIES Basis of presentation: These financial statements are presented using the accrual basis of accounting. Sarnia Corporation has a Master Corporate Services and Support Agreement with Versar. Certain general and administrative functions, including general management, treasury, financial service, legal, benefits and human resources administration, investor and public relations and information management are provided by Versar for a fixed fee of $36,000 per annum. Telephone expenses charged from Versar based on the number of extensions used by the Company and its tenants are included in real estate expenses. In March 2001, Sarnia obtained separate phone lines from the local carrier. Telephone expenses are recorded based on actual costs incurred. Cash and cash equivalents: For purposes of these statements, cash and cash equivalents consist of government treasury bills and time deposits with a maturity of ninety days or less. Rent and other receivables: It is the Company's policy to provide reserves for the collectibility of rents and other receivables when it is determined that it is probable that the Company will not collect all amounts due and the amount of reserve requirement can be reasonably estimated. Allowance for doubtful accounts were $7,076 and $7,447 for the fiscal years ended June 30, 2001 and 2000, respectively. Construction in progress: Construction in progress is stated at cost. Interest, property taxes, and insurance are capitalized as property costs during periods in which activities necessary to get the property ready for its intended use are in progress. Indirect project costs including administrative costs, legal fees, and various office costs that directly relate to development are also capitalized. No depreciation is recorded while construction is in process. Accounting estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue recognition: Rental revenue is recognized based upon tenant lease agreements in accordance with Statement of Financial Accounting Standards (SFAS) No. 13, "Accounting for Leases". Provisions for any anticipated lease losses are made in the period that the losses become evident. Property and equipment: Property and equipment are carried at historical cost until a decline in value which is other than temporary occurs. At such time, the property will be reduced by a direct write-down for any impairment in value if it is probable that the carrying amount of the property cannot be fully recovered. Depreciation and amortization: Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the assets. Maintenance and repair costs are expensed while improvements are capitalized. F-6 23 SARNIA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) Net income per share applicable to common stock: Basic income per share applicable to common stock is computed by dividing net income applicable to common stock by the weighted average number of shares outstanding during the applicable period being reported upon. Diluted net income per share is computed by dividing net income applicable to common stock by the weighted average number of shares outstanding plus the effect of assumed exercise of stock options using the Treasury Stock Method. The following is a reconciliation of weighted average shares outstanding for basic net income per share to diluted net income per share:

Income taxes: The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. Stock Options: The Company accounts for its stock option plan in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," the Company has made pro forma disclosures of net income and per share information as if the fair value based method had been applied. (See Note E) Classification: Certain prior year information has been reclassified to conform to current year presentation. NOTE C PROPERTY AND EQUIPMENT

F-7 24 SARNIA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) Depreciation and amortization of property and equipment included as expense in the accompanying Statements of Operations was $500,000, $530,000, and $525,000 for the fiscal years ended June 30, 2001, 2000 and 1999, respectively. Amortization of brokerage fees of $61,000, $46,000, and $55,000 were included in the Statements of Operations for the fiscal years ended June 30, 2001, 2000 and 1999, respectively. Refer to Note H regarding partial condemnation of property. Maintenance and repair expenses (included in real estate expenses) approximated $190,000, $192,000 and $200,000 for the fiscal years ended June 30, 2001, 2000 and 1999, respectively. NOTE D MORTGAGES On January 25, 1996, Sarnia obtained a first mortgage of $9 million with I.D.S. Life Insurance Company (IDS) at the fixed rate of 7.75% to be amortized over twenty-two years with a balloon payment due in February 2003. The I.D.S. mortgage is collateralized by the first deed of trust on the 6800 and 6850 buildings. Sarnia has a $1.5 million five-year term loan with Bank of America. The loan is guaranteed by Versar and bears interest at the five-year Treasury Rate plus three hundred (300) basis points per annum, but not to exceed 9% per annum. The note matures in five years with $300,000 principal payment per year starting July 1, 1997. The Company is in compliance with the financial covenants at June 30, 2001. Outstanding balances at June 30, are as follows:

Maturity of the loans is as follows:

NOTE E STOCK OPTIONS The Sarnia 1994 Stock Option Plan (the Plan) is compensatory in nature and provides employees of the Company and certain other persons an incentive to remain in the employment of the Company and encourages superior performance for the Company's benefit. The Company originally segregated 300,000 shares of stock for inclusion in the Plan, which was increased to 600,000 in 1998 after shareholder approval. Options to purchase an aggregate of 312,500 shares of common stock with exercise prices ranging from $0.1875 to $0.375 were granted.

F-8 25 SARNIA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) There have been no stock options granted since fiscal year 1999. Under the Plan, options may be granted to key employees at the fair market value on the date of grant, and vesting varies depending on the discretion of the Compensation Committee. Unexercised options are cancelled on the tenth anniversary of the grant. The Company applies APB Opinion No. 25 and related interpretations in accounting for its Plan. Accordingly, no compensation cost has been recognized for stock options. Had compensation cost for stock options been determined based on the fair value at the grant dates for awards under this Plan consistent with the method of SFAS No. 123, the Company's net income and net income per share would have been reduced to the pro forma amounts indicated as follows:

As permitted by SFAS No. 123, the fair value approach to valuing stock options used for pro forma presentation has not been applied to stock options granted prior to July 1, 1995. The compensation cost calculated under the fair value approach is recognized over the vesting period of the stock options. NOTE F PREFERRED STOCK On January 25, 1996, 30,000 shares of Series A preferred stock were issued by the Company for an aggregate price of $750,000. The Series A preferred stock bears a $25 par value and is entitled to receive preferential cumulative dividends at the annual rate of $2.625 per share. Also, the Series A preferred stock is redeemable at the option of the Company and is convertible into common stock, at the option of the holders, at a conversion price of $0.40 per share. NOTE G INCOME TAXES The provision for income taxes consists of the following:

F-9 26 SARNIA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) At June 30, 2001, the Company had, for tax reporting purposes, approximately $302,000 of net operating loss carryforwards available to offset future taxable income through 2012. Deferred tax (liabilities) assets are comprised of the following:

The tax provision is composed of the following:

NOTE H COMMITMENTS AND CONTINGENCIES In connection with the improvement and expansion of the Springfield interchange highway system, the Virginia Department of Transportation (VDOT) has taken pursuant to eminent domain approximately 2.54 acres of Sarnia's property. In addition, VDOT took additional easements for fire protection and water mains. The Company retained counsel and other professional assistance in determining the effect of such change on the property, its value to Sarnia and any actions which are required to maintain Versar Center as an attractive property to existing and prospective tenants. By law, VDOT is required to pay fair market value for the property that it acquires and to pay for damages to the remaining property, either by negotiation or by exercise of its powers of eminent domain. Sarnia has F-10 27 SARNIA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) employed the services of an expert real estate appraiser as well as a professional engineer to aid in the determination of the appropriate value of the acquisition and any adverse impact on the remainder of the property. In the third quarter of fiscal year 2000, the Company received an offer from the VDOT for approximately $2,300,000 for approximately 2.54 acres of Sarnia's property and easements. After thorough review of the proposal and advice of retained experts, the Company rejected the VDOT offer. The Company is seeking to increase the amount of the VDOT offer by negotiation. If unsuccessful, the Company will commence litigation to receive fair compensation. In fiscal year 2000, the Company recorded a gain on the condemnation of property of approximately $2,196,000. The proceeds of $2,287,000 from the condemnation are restricted by IDS for the purpose of correcting damage caused by the VDOT condemnation. In fiscal year 2001, the Company recorded $214,000 of interest income on the restricted cash. Total restricted cash at June 30, 2001 was $2,501,000. The Company will build a new parking garage for the 6850 building and access road to the 6800 building. The Company estimates that it will cost approximately $4,000,000 to complete the project. The Company has entered into a design/build contract with Versar Global Solutions, Inc. to design and construct the parking garage. The Company is seeking additional compensation from VDOT for the shortfall and is also seeking alternate financing sources in the event the Company is not successful with VDOT or if the timing of the construction is prior to settlement with VDOT. NOTE I RENTAL UNDER OPERATING LEASES Leases between Sarnia and its tenants expire from 2001 to 2010. During the years ended June 30, 2001, 2000 and 1999, rentals to major tenants were as follows:

F-11 28 SARNIA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) Noncancellable leases provide for approximate minimum rental payments during each of the next five years as set forth below. Certain of the other rentals may increase in future years based on changes in the Consumer Price Index and other rental increase factors. At June 30, 2001, 96% of Sarnia's space was leased.

F-12 29 SARNIA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE J QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Quarterly financial information for fiscal years 2001 and 2000 is as follows (in thousands, except per share amounts):

Quarterly financial data may not equal annual totals due to rounding. Quarterly earnings per share data may not equal annual total due to fluctuations in common shares outstanding. F-13

SARNIA CORP 10-K