** **

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-Q**

 

**(Mark One)**

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2002**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

 

**COMMISSION FILE NUMBER 001-16785**

 

**AmericanSpectrum Realty, Inc.**

(Exactname of Registrant as specified in its charter)

 

| **State of Maryland**                                           |   | **52-2258674**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **7700 Irvine Center Drive, Suite 555  Irvine, California**     |   | **92618**                             |
| (Address of principal executive offices)                        |   | (Zip Code)                            |
|                                                            |   |                                  |
| **(949) 753-7111**                                              |
| (Registrant’s telephone number, including area code)       |

 

Securities registered underSection 12(b) of the Act:

 
| **Title of  each class**     |   | **Name of  exchange on  which registered** |
|------------------------------|--------|--------------------------------------------|
| Common Stock, $.01 par value |   | American Stock Exchange                    |

 

**Securitiesregistered pursuant to Section 12(g) of the Act: None**

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes ý No o

 

As of October 31, 2002, 5,536,990 shares of Common Stock ($.01 parvalue) were outstanding.

 

 

----

 

**TABLE OFCONTENTS**

 
| PART I  | FINANCIAL INFORMATION                                                                                                                                    |
|---------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |                                                                                                                                                     |
| Item 1  | Financial Statements                                                                                                                                     |
|    | Consolidated  Balance Sheets at September 30, 2002 and December 31, 2001                                                                                 |
|    | Consolidated Statements of Operations for  the nine months ended September 30, 2002 and 2001 and for the three months  ended September 30, 2002 and 2001 |
|    | Consolidated Statement of Stockholders’  Equity for the nine months ended September 30, 2002                                                        |
|    | Consolidated Statements of Cash Flows for  the nine months ended September 30, 2002 and 2001                                                             |
|    | Notes to Consolidated Financial Statements                                                                                                               |
| Item 2  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                              |
| Item 3  | Quantitative and Qualitative Disclosure  about Market Risk                                                                                               |
| Item 4  | Controls and Procedures                                                                                                                                  |
|    |                                                                                                                                                     |
| PART II | OTHER INFORMATION                                                                                                                                        |
|    |                                                                                                                                                     |
| Item 1  | Legal Proceedings                                                                                                                                        |
| Item 5  | Other Information                                                                                                                                        |
| Item 6  | Exhibits and Reports on Form 8-K                                                                                                                         |

 

2

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**PARTI.  FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIALSTATEMENTS**

 

**AMERICANSPECTRUM REALTY, INC.**

**CONSOLIDATED BALANCE SHEETS**

(Dollars in thousands,except share and per share amounts)

 
|                                                                                                                                 |   | **September  30, 2002** |    | **December  31, 2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                                                                                                 |   | **(Unaudited)**         |    |                   |   |
|                                                                                                                                 |   |                    |    |                   |   |
| **ASSETS**                                                                                                                           |   |                    |    |                   |   |
|                                                                                                                                 |   |                    |    |                   |   |
| Real estate held for investment                                                                                                      |   | $                       | 258,048 |                   | $      | 243,497 |   |
| Accumulated depreciation and valuation  allowance                                                                                    |   | 13,345                  |    | 5,094                  |   |
| Real estate held for investment, net                                                                                                 |   | 244,703                 |    | 238,403                |   |
|                                                                                                                                 |   |                    |    |                   |   |
| Real estate assets held for sale                                                                                                     |   | 11,141                  |    | 11,353                 |   |
| Cash and cash equivalents                                                                                                            |   | 826                     |    | 2,284                  |   |
| Tenant and other receivables, net of  allowance for doubtful accounts of $698 and $225, respectively                                 |   | 581                     |    | 1,303                  |   |
| Deferred rents receivable                                                                                                            |   | 452                     |    | 149                    |   |
| Mortgage loan receivable                                                                                                             |   | 1,100                   |    | —                 |   |
| Deposits held in escrow                                                                                                              |   | —                  |    | 1,956                  |   |
| Investment in management company                                                                                                     |   | 4,000                   |    | 4,000                  |   |
| Prepaid and other assets, net                                                                                                        |   | 9,778                   |    | 6,757                  |   |
| Total Assets                                                                                                                         |   | $                       | 272,581 |                   | $      | 266,205 |   |
|                                                                                                                                 |   |                    |    |                   |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                       |   |                    |    |                   |   |
|                                                                                                                                 |   |                    |    |                   |   |
| Liabilities:                                                                                                                         |   |                    |    |                   |   |
| Notes payable, net of premiums of $3,834  and $4,407, respectively (including $1,799 and $1,802, respectively, to  related parties)  |   | $                       | 184,850 |                   | $      | 168,969 |   |
| Liabilities related to real estate held for  sale (including $2,323 and $2,207, respectively, to related parties)                    |   | 10,412                  |    | 10,318                 |   |
| Notes payable to former limited partners                                                                                             |   | 237                     |    | 2,292                  |   |
| Accounts payable                                                                                                                     |   | 2,306                   |    | 3,180                  |   |
| Dividends and distributions payable                                                                                                  |   | 1,253                   |    | —                 |   |
| Deferred gain on disposition of property                                                                                             |   | —                  |    | 232                    |   |
| Accrued and other liabilities (including  $1,558 and $2,187, respectively, to related parties)                                       |   | 18,240                  |    | 17,194                 |   |
| Total Liabilities                                                                                                                    |   | 217,298                 |    | 202,185                |   |
|                                                                                                                                 |   |                    |    |                   |   |
| Minority interest                                                                                                                    |   | 9,521                   |    | 10,616                 |   |
|                                                                                                                                 |   |                    |    |                   |   |
| Commitments and contingencies:                                                                                                       |   |                    |    |                   |   |
|                                                                                                                                 |   |                    |    |                   |   |
| Redeemable common stock                                                                                                              |   | 300                     |    | 300                    |   |
|                                                                                                                                 |   |                    |    |                   |   |
| Stockholders’ equity:                                                                                                           |   |                    |    |                   |   |
|                                                                                                                                 |   |                    |    |                   |   |
| Preferred stock, $.01 par value;  authorized, 25,000,000 shares, none issued and outstanding                                         |   | —                  |    | —                 |   |
| Common stock, $.01 par value; authorized,  100,000,000 shares;  issued and outstanding, 5,536,990 and 5,529,190 shares, respectively |   | 55                      |    | 55                     |   |
| Additional paid-in capital                                                                                                           |   | 54,340                  |    | 56,502                 |   |
| Accumulated deficit                                                                                                                  |   | (8,178                  | )       | (2,038                 | )      |
| Deferred compensation                                                                                                                |   | (755                    | )       | (1,415                 | )      |
| Total stockholders’ equity                                                                                                      |   | 45,462                  |    | 53,104                 |   |
| Total Liabilities and Stockholders’ Equity                                                                                      |   | $                       | 272,581 |                   | $      | 266,205 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

3

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**AMERICAN SPECTRUMREALTY, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(Dollars inthousands, except share and per share amounts)

(Unaudited)

** **
|                                                                    |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|-------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                    |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
| **REVENUES:**                                                           |   |                                  |   |                                 |   |   |   |   |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Rental  revenue                                                         |   | $                                     | 9,813  |                                 | $      | 169 |   | $ | 29,055 |   | $ | 500 |   |
| Interest and other income                                               |   | 46                                    |   | 44                                   |   | 197 |   | 131 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Total revenues                                                          |   | 9,859                                 |   | 213                                  |   | 29,252 |   | 631 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| **EXPENSES:**                                                           |   |                                  |   |                                 |   |   |   |   |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Property operating expense                                              |   | 4,108                                 |   | 68                                   |   | 10,976 |   | 185 |   |
| General and administrative                                              |   | 2,117                                 |   | 63                                   |   | 6,346 |   | 214 |   |
| Depreciation and amortization                                           |   | 3,047                                 |   | 41                                   |   | 8,700 |   | 142 |   |
| Interest expense                                                        |   | 3,591                                 |   | 33                                   |   | 10,387 |   | 95 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Total expenses                                                          |   | 12,863                                |   | 205                                  |   | 36,409 |   | 636 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| **OTHER INCOME:**                                                       |   |                                  |   |                                 |   |   |   |   |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Net gain on sales of real estate assets                                 |   | 69                                    |   | —                               |   | 153 |   | — |   |
| Net loss on extinguishment of debt                                      |   | —                                |   | —                               |   | (53 | ) | — |   |
| Income from investment in unconsolidated  joint venture                 |   | —                                |   | 156                                  |   | — |   | 365 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Total other income                                                      |   | 69                                    |   | 156                                  |   | 100 |   | 365 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Net (loss) income before minority interest  and discontinued operations |   | (2,935                                | )      | 164                                  |   | (7,057 | ) | 360 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Minority interest                                                       |   | 336                                   |   | —                               |   | 806 |   | — |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Net (loss) income before discontinued  operations                       |   | (2,599                                | )      | 164                                  |   | (6,251 | ) | 360 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Net income from discontinued operations                                 |   | 42                                    |   | —                               |   | 111 |   | — |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Net (loss) income                                                       |   | $                                     | (2,557 | )                                    | $      | 164 |   | $ | (6,140 | ) | $ | 360 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Basic and diluted per share data:                                       |   |                                  |   |                                 |   |   |   |   |   |
| Net loss before discontinued operations                                 |   | $                                     | (.47   | )                                    | $      | — |   | $ | (1.13 | ) | $ | — |   |
| Net income from discontinued operations                                 |   | .01                                   |   | —                               |   | .02 |   | — |   |
| Net loss                                                                |   | $                                     | (.46   | )                                    | $      | — |   | $ | (1.11 | ) | $ | — |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Per unit data:                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Limited partner income per unit                                         |   | $                                     | — |                                 | $      | 2.11 |   | $ | — |   | $ | 4.63 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Basic weighted average shares used                                      |   | 5,536,990                             |   | —                               |   | 5,533,467 |   | — |   |
| Limited partnership units outstanding                                   |   | —                                |   | 77,000                               |   | — |   | 77,000 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

4

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**AMERICAN SPECTRUM REALTY, INC.**

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

(Dollars inthousands)

(Unaudited)

 
|                                  |   | **Common  Stock** |   | **Additional  Paid-In  Capital** |   | **Accumulated  Deficit** |   | **Deferred  Compensation** |   | **Treasury  Stock** |   | **Total  Equity** |   |
|---------------------------------------|--------|-------------------|--------|----------------------------------|--------|--------------------------|--------|----------------------------|--------|---------------------|--------|-------------------|--------|
|                                  |   |              |   |                             |   |                     |   |                       |   |                |   |              |   |
| Balance, December 31, 2001 (audited)  |   | $                 | 55     |                             | $      | 56,502                   |   | $                          | (2,038 | )                   | $      | (1,415            | )      | — |   | $ | 53,104 |   |
| Issuance of common stock to officer   |   | —            |   | 70                               |   | —                   |   | (70                        | )      | —              |   | —            |   |
| Retirement of common stock            |   | —            |   | —                           |   | —                   |   | —                     |   | $                   | (14    | )                 | (14    | ) |
| Common stock repurchases              |   | —            |   | (14                              | )      | —                   |   | —                     |   | 14                  |   | —            |   |
| Amortization of deferred compensation |   | —            |   | —                           |   | —                   |   | 730                        |   | —              |   | 730               |   |
| Dividends to common stockholders      |   | —            |   | (2,218                           | )      | —                   |   | —                     |   | —              |   | (2,218            | )      |
| Net loss                              |   | —            |   | —                           |   | (6,140                   | )      | —                     |   | —              |   | (6,140            | )      |
|                                  |   |              |   |                             |   |                     |   |                       |   |                |   |              |   |
| Balance, September 30, 2002           |   | $                 | 55     |                             | $      | 54,340                   |   | $                          | (8,178 | )                   | $      | (755              | )      | $ | — |   | $ | 45,462 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

5

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**AMERICANSPECTRUM REALTY, INC**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

(Dollars in thousands)

(Unaudited)

 
|                                                                                  |   | **For the Nine Months Ended  September 30,** |   |
|---------------------------------------------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                                  |   | **2002**                                     |   | **2001** |   |
| **CASH FLOWS FROM  OPERATING ACTIVITIES:**                                            |   |                                         |   |   |   |
| Net (loss) income                                                                     |   | $                                            | (6,140 | ) | $ | 360 |   |
| Adjustments to reconcile net (loss) income  to net cash used in operating activities: |   |                                         |   |   |   |
| Income from discontinued operations                                                   |   | (111                                         | )      | — |   |
| Depreciation and amortization                                                         |   | 8,700                                        |   | 142 |   |
| Net loss on extinguishments of debt                                                   |   | 53                                           |   | — |   |
| Net gain on sales of real estate assets                                               |   | (153                                         | )      | — |   |
| Income from investment in unconsolidated  joint venture                               |   | —                                       |   | (365 | ) |
| Minority interest                                                                     |   | (806                                         | )      | — |   |
| Deferred compensation expense                                                         |   | 730                                          |   | — |   |
| Deferred rental income                                                                |   | (303                                         | )      | (2 | ) |
| Amortization of loan premiums, included in  interest expense                          |   | (441                                         | )      | — |   |
| Changes in operating assets and  liabilities:                                         |   |                                         |   |   |   |
| Decrease (increase) in tenant and other  receivables                                  |   | 928                                          |   | (61 | ) |
| Increase in prepaid and other assets                                                  |   | (3,111                                       | )      | (96 | ) |
| Decrease in accounts payable                                                          |   | (874                                         | )      | (85 | ) |
| Increase in accrued and other liabilities                                             |   | 750                                          |   | 3 |   |
|                                                                                  |   |                                         |   |   |   |
| Net cash used in operating activities:                                                |   | (778                                         | )      | (104 | ) |
|                                                                                  |   |                                         |   |   |   |
| **CASH FLOWS FROM  INVESTING ACTIVITIES:**                                            |   |                                         |   |   |   |
| Capital improvements to real estate assets                                            |   | (3,336                                       | )      | (38 | ) |
| Proceeds received from sales of real estate  assets                                   |   | 209                                          |   | — |   |
| Real estate acquisition                                                               |   | (268                                         | )      | — |   |
| Distributions from unconsolidated joint venture                                       |   | —                                       |   | 542 |   |
|                                                                                  |   |                                         |   |   |   |
| Net cash (used in) provided by investing  activities:                                 |   | (3,395                                       | )      | 504 |   |
|                                                                                  |   |                                         |   |   |   |
| **CASH FLOWS FROM  FINANCING ACTIVITIES:**                                            |   |                                         |   |   |   |
| Proceeds from borrowings                                                              |   | 21,931                                       |   | — |   |
| Repayment of borrowings                                                               |   | (16,366                                      | )      | (14 | ) |
| Note payments to former limited partners                                              |   | (2,055                                       | )      | — |   |
| Collection of advances to affiliate                                                   |   | 8                                            |   | — |   |
| Advances to affiliate                                                                 |   | —                                       |   | (413 | ) |
| Dividends to common stockholders                                                      |   | (1,110                                       | )      | — |   |
| Distributions to unitholders in the  operating partnership                            |   | (145                                         | )      | — |   |
| Repurchase of common stock                                                            |   | (14                                          | )      | — |   |
|                                                                                  |   |                                         |   |   |   |
| Net cash provided by (used in) financing  activities:                                 |   | 2,249                                        |   | (427 | ) |
|                                                                                  |   |                                         |   |   |   |
| Cash provided by discontinued operations                                              |   | 466                                          |   | — |   |
|                                                                                  |   |                                         |   |   |   |
| Decrease in cash                                                                      |   | (1,458                                       | )      | (27 | ) |
|                                                                                  |   |                                         |   |   |   |
| Cash, beginning of period                                                             |   | 2,284                                        |   | 34 |   |
|                                                                                  |   |                                         |   |   |   |
| Cash, end of period                                                                   |   | $                                            | 826    |   | $ | 7 |   |
|                                                                                  |   |                                         |   |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:**                               |   |                                         |   |   |   |
| Cash paid for interest                                                                |   | $                                            | 10,119 |   | $ | 95 |   |
|                                                                                  |   |                                         |   |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:**         |   |                                         |   |   |   |
|                                                                                  |   |                                         |   |   |   |
| Assumption of mortgage loans in  acquisitions of real estate assets                   |   | $                                            | 9,863  |   | $ | — |   |
|                                                                                  |   |                                         |   |   |   |
| Seller financing of acquired real estate  assets                                      |   | $                                            | 955    |   | $ | — |   |
|                                                                                  |   |                                         |   |   |   |
| Trust deed note receivable from disposition  of real estate asset                     |   | $                                            | 1,100  |   | $ | — |   |

 

The accompanying notes arean integral part of these consolidated financial statements

 

6

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**AMERICANSPECTRUM REALTY, INC.**

### **Notes toConsolidated Financial Statements**

 

**NOTE 1. DESCRIPTION OF BUSINESS**

 

# **GENERAL**

American SpectrumRealty, Inc. (“ASR” or the “Company”) is a Maryland corporation established onAugust 8, 2000.  The Company is afull-service real estate corporation, which owns, manages and operatesincome-producing properties.  As ofSeptember 30, 2002, through its majority-owned subsidiary, American SpectrumRealty Operating Partnership, L.P. (the “Operating Partnership”), the Companyowned and operated 35 properties which consisted of 15 office, 11office/warehouse, four shopping center, and four apartment properties, and onedevelopmental land property.  In October2002, the Company sold one shopping center and one apartment property.  The properties are located in fourgeographic regions in nine states.  TheCompany plans to expand its business and net assets by acquiring additionalproperties.  The Company will focusprimarily on office and office/warehouse properties located in Texas,California, Arizona and the Midwest.

 

Although theCompany is not a REIT at this time, the structure of the Company is generallyreferred to as an “UPREIT” structure. Substantially all of the Company’s assets are held through the OperatingPartnership. The Company is the sole general partner of the OperatingPartnership.  As the sole generalpartner of the Operating Partnership, the Company generally has the exclusivepower under the Partnership Agreement to manage and conduct the business of theOperating Partnership. The Company’s interest in the Operating Partnershipentitles it to share in cash distributions from, and in profits and losses of,the Operating Partnership.  Holders oflimited partnership units in the Operating Partnership (“OP Units”) have thesame rights to distributions as holders of Common Stock in the Company.  Most of the properties are owned by theOperating Partnership through subsidiary limited partnerships or limitedliability companies.

 

At September 30, 2002, the Company held a 1% general partner interestand an 87.4% limited partner interest in the Operating Partnership.  Holders of the OP Units have the option toredeem their units and to receive, at the option of the Company, in exchangefor each OP Unit (i) one share of Common Stock of the Company, or (ii) cashequal to the fair market value of one share of Common Stock of the Company atthe date of conversion.

 

The Companyintends to qualify as a real estate investment trust, REIT, as defined underthe Internal Revenue Code of 1986, as amended, and to elect to be treated as aREIT beginning in 2003.  In general, aREIT is a company that owns or provides financing for real estate and paysannual distributions to investors of at least 90% of its taxable income.  A REIT typically is not subject to federalincome taxation on its net income, provided applicable income tax requirementsare satisfied.     Currently, the Companyis taxed as a C corporation.

 

## **CONSOLIDATION TRANSACTION**

In October 2001, the Companyacquired various properties in a consolidation transaction (the“Consolidation”).  Pursuant to theConsolidation, subsidiaries of the Company merged with eight public limitedpartnerships, acquired the assets and liabilities of two private entitiesmanaged by CGS Real Estate Company, Inc. (“CGS”) and its affiliates andacquired certain assets and liabilities of CGS and its majority-ownedaffiliates.  Sierra Pacific PensionInvestors `84 (“SPPI84”), one of the eight public limited partnerships, wastreated, for accounting purposes, as the acquirer of the properties in theConsolidation.  Prior to theConsolidation, SPPI84’s activities involved the ownership and operation of tworeal estate properties in Arizona: Sierra Spectrum in Phoenix, Arizona and Sierra Valencia in Tucson,Arizona.  Pursuant to the Consolidation,partners of the public partnerships received shares in the Company orpromissory notes in exchange for their partnership units and owners of existingrelated entities exchanged ownership interests in real estate for ASR shares orunits in the Operating Partnership, an entity formed for this purpose andinitially wholly owned by the Company.

 

The unaudited condensedcombined statement of operations and cash flows of CGS and its majority-ownedaffiliates for the three and nine months ended September 30, 2001 follows(dollars in thousands):

 

7

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**Condensed Combined Statementof Operations**

 
|                                        |   | **Three Months Ended  September 30, 2001** |   | **Nine Months Ended  September 30, 2001** |   |
|---------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                        |   | **(unaudited)**                            |   | **(unaudited)**                           |   |
|                                        |   |                                       |   |                                      |   |
| Total revenues                              |   | $                                          | 5,955  |                                      | $      | 18,638 |   |
| Operating expenses                          |   | 4,050                                      |   | 14,251                                    |   |
| Depreciation and amortization               |   | 522                                        |   | 2,999                                     |   |
| Interest expense                            |   | 3,200                                      |   | 9,300                                     |   |
| Equity in income of uncombined partnerships |   | —                                     |   | 53                                        |   |
| Loss on demolition of property              |   | 867                                        |   | 867                                       |   |
| Gain on sale of property                    |   | —                                     |   | 100                                       |   |
| Minority interest                           |   | 58                                         |   | 251                                       |   |
| Net loss                                    |   | $                                          | (2,742 | )                                         | $      | (8,877 | ) |

 

**Condensed Combined Statement of Cash Flows**

 
|                              |   | **Three Months Ended  September 30, 2001** |   | **Nine Months Ended  September 30, 2001** |   |
|-----------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                              |   | **(unaudited)**                            |   | **(unaudited**)                           |   |
| Cash flows provided by (used in): |   |                                       |   |                                      |   |
| Operating activities              |   | $                                          | (668   | )                                         | $      | (7,732 | ) |
| Investing activities              |   | 143                                        |   | (1,017                                    | )      |
| Financing activities              |   | 397                                        |   | 8,188                                     |   |
| Decrease in cash                  |   | (128                                       | )      | (561                                      | )      |
| Cash, beginning of period         |   | 1,354                                      |   | 1,787                                     |   |
| Cash, end of period               |   | $                                          | 1,226  |                                      | $      | 1,226 |   |

 

It is suggestedthat these condensed combined financial statements be read in conjunction withthe combined financial statements for the period January 1 to October 19, 2001and the related notes thereto included in the Company’s 2001 Annual Report onForm 10-K filed with the Securities and Exchange Commission (the “SEC”).

 

**NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**BASIS OF PRESENTATION**

The accompanying unaudited consolidated financial statements have beenprepared pursuant to the rules and regulations of the SEC.  In the opinion of the Company, theaccompanying interim unaudited consolidated financial statements contain allmaterial adjustments, consisting only of normal recurring adjustments necessaryto present fairly the financial condition, the results of operations andchanges in cash flows of the Company and its subsidiaries for interim periods.

 

The results for such interim periods are not necessarily indicative ofresults for a full year.  It issuggested that these consolidated financial statements be read in conjunctionwith the consolidated financial statements for the year ended December 31, 2001and the related notes thereto included in the Company’s 2001 Annual Report onForm 10-K filed with the SEC.

 

As discussed in Note 1, the accountingacquirer in the Consolidation was SPPI84. As such, the consolidated statement of operations and cash flows for thenine months and three months ended September 30, 2001 reflects the results ofoperations and cash flows of SPPI84.

 

All significant intercompany transactions, receivables and payableshave been eliminated in consolidation.

 

**RECLASSIFICATIONS**

Certain prior year balances have been reclassified to conform with thecurrent year presentation.      Inaccordance with SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets”, which was effective for the Company beginningJanuary 1, 2002, real estate designated as held for sale subsequent to January1, 2002 will be accounted for in accordance with the provisions of SFAS No. 144and the results of operations of these properties are included in income fromdiscontinued operations.  Prior periodshave been reclassified for comparability, as required.

 

8

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**USE OF ESTIMATES**

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the results of operations duringthe reporting period.  Actual resultscould materially differ from those estimates.

 

**NEW ACCOUNTING PRONOUNCEMENTS**

In June 2001, FASB issuedSFAS No. 141, which supercedes APB 16, “Business Combinations”, which iseffective for business combinations initiated after September 30, 2001.  SFAS No. 141 requires that all businesscombinations be accounted for under the purchase method and provides that thepooling-of-interest method is no longer allowed.  The Company accounted for the Consolidation under the purchasemethod.

 

In June 2001, FASB issuedSFAS No. 142, “Goodwill and Other Intangible Assets” (FAS 142), which iseffective for fiscal years beginning after December 15, 2001.  FAS 142 requires, among other things, thatgoodwill no longer be amortized to earnings, but instead be reviewed forimpairment.  The adoption of FAS 142 didnot have a material impact on the Company’s consolidated financial position orresults of operations.

 

In June 2001, FASB issuedSFAS No. 143, “Accounting for Asset Retirement Obligations” (FAS 143).  FAS 143 addresses financial accounting andreporting obligations associated with the retirement of tangible long-livedassets and the associated asset retirement costs.  The provisions of FAS 143 are required to be applied startingwith fiscal years beginning after September 15, 2002.  The Company believes the adoption of the provisions of FAS 143will not have a significant effect on its consolidated financial position orresults of operations.

 

In August 2001,FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets” (FAS 144), which addresses financial accounting andreporting for the impairment or disposal of long-lived assets.  FAS 144 supersedes SFAS No. 121, “Accountingfor the Impairment of Long-Lived Assets and for Long-Lived Assets to BeDisposed Of”.  However, FAS 144 retainsthe fundamental provisions of SFAS No. 121 for (a) recognition and measurementof the impairment of long-lived assets to be held for sale and used and (b) measurementof long-lived assets to be disposed of by sale.  FAS 144 was effective for the Company beginning January 1, 2002,the first day of the Company’s 2002 fiscal year.  Real estate designated as held for sale subsequent to January 1,2002 will be accounted for in accordance with the provisions of FAS 144 and theresults of operations of these properties are included in income fromdiscontinued operations.  Prior periodshave been reclassified for comparability, as required.  The adoption of FAS 144 did not have amaterial impact on the Company’s consolidated financial position or results ofoperations.

 

In April 2002,FASB issued SFAS No. 145, “Rescission of FASB No. 4, 44, and 62, Amendment ofFASB No. 13, and Technical Corrections” (“FAS 145”).  In most instances, FAS 145 will require gains and losses onextinguishments of debt to be classified as income or loss from continuingoperations rather than as extraordinary items as previously required under FASBStatement No. 4, Reporting Gains and Losses from Extinguishment of Debt (“FAS4”).  This provision of FAS 145 iseffective for fiscal years beginning after May 15, 2002, with early applicationencouraged.  Upon application, any gainor loss on extinguishments of debt previously classified as an extraordinaryitem in prior periods presented that does not meet the criteria of Opinion 30for such classifications should be reclassified to conform to the provisions ofFAS 145.  Earlier application of theprovisions of FAS 145 related to the rescission of FAS 4 is encouraged.  The Company adopted FAS 145 in the thirdquarter of 2002.  The adoption of FAS145 did not have a material impact on the Company’s consolidated financial positionor results of operations.

## ** **

In July 2002, FASB issued SFASNo. 146, “Accounting for Costs Associated with Exit or Disposal Activities”(FAS 146).  FAS 146 requires companiesto recognize costs associated with exit or disposal activities when they areincurred rather than at the date of a commitment to an exit or disposal plan.  FAS

 

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146 is to be appliedprospectively to exit or disposal activities initiated after December 31,2002.  The Company does not expect theadoption of FAS 146 to have a material impact on its consolidated financialposition or results of operations.

 

## **REAL ESTATE**

Rental properties are stated at cost, net of accumulated depreciation,unless circumstances indicate that cost, net of accumulated depreciation,cannot be recovered, in which case the carrying value of the property isreduced to estimated fair value. Estimated fair value (i) is based upon the Company’s plans for thecontinued operation of each property and (ii) is computed using estimated salesprice, as determined by prevailing market values for comparable propertiesand/or the use of capitalization rates multiplied by annualized net operatingincome based upon the age, construction and use of the building.  The fulfillment of the Company’s plansrelated to each of its properties is dependent upon, among other things, thepresence of economic conditions which will enable the Company to continue tohold and operate the properties prior to their eventual sale.  Due to uncertainties inherent in thevaluation process and in the economy, actual results of operating and disposingof the Company’s properties could be materially different than currentexpectations.

 

Depreciation is provided using the straight-line method over the usefullives of the respective assets. The useful lives are as follows:

 

| Building and Improvements |   | 10 to 40 years            |
|---------------------------|--------|---------------------------|
| Tenant Improvements       |   | Term of the related lease |
| Furniture and Equipment   |   | 3 to 5 years              |

 

**CASH EQUIVALENTS**

Cash equivalents are considered to be all highly liquid investmentswith a maturity of three months or less at the date of purchase.

 

**FAIR VALUE OF FINANCIAL INSTRUMENTS**

The Company’s financial instruments consist of cash and cashequivalents, escrow deposits, tenant and other receivables, mortgage loanreceivable, notes payable, accounts payable and accrued expenses.  The Company has entered into interest rateswap agreements in notional amounts totaling $21,800,000 to manage its interestrate risk.  The agreements effectivelyfix the interest rate at 2.68% plus the applicable variable rate margin(effective rate of 5.68% at September 30, 2002).  Management believes that the carrying value of the Company’sfinancial instruments approximate their respective fair market values atSeptember 30, 2002 and December 31, 2001.

 

**DERIVATIVE FINANCIAL INSTRUMENTS**

The Company followsStatement of Financial Accounting Standard No. 133, as amended, whichestablishes accounting and reporting standards for derivative financialinstruments, including certain derivative instruments embedded in othercontracts and hedging activities.  Allderivatives, whether designed in hedging relationships or not, are required tobe recorded on the balance sheet at fair value.  If the derivative is designated as a fair value hedge, thechanges in the fair value of the derivative and of the hedged item attributableto the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effectiveportions of changes in the fair value of the derivative are recorded in othercomprehensive income and ineffective portions of changes in the fair value ofcash flow hedges are recognized in earnings.

 

The Company usesinterest rate swaps to hedge against fluctuations in interest rates on specificborrowings.  The interest rate swapcontracts are reflected at fair value on the Company’s balance sheet in accruedand other liabilities and the changes in the fair value of the hedge arerecognized as adjustments to interest expense. During the nine months ended September 30, 2002, the Company recorded acharge of approximately $57,000 attributable to changes in the fair value ofits derivatives financial instruments. The Company’s objective is to minimize the risk of fluctuations usingthe most effective methods to eliminate or reduce the impact of this exposure.

 

10

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**DEFERRED FINANCING AND OTHER FEES**

Fees paid in connection with the financing and leasing of the Company’sproperties are amortized over the term of the related notes payable or leaseand are included in other assets.

 

## **STOCK-BASED COMPENSATION**

The Financial Accounting Standards Board issued SFAS No. 123,“Accounting for Stock-Based Compensation” in October 1995.  This standard establishes a fair valueapproach to valuing stock options awarded to employees as compensation.  The Company has elected, as permitted by thestandard, to use the intrinsic value based method of accounting for stockoptions consistent with Accounting Principles Board Opinions No. 25,“Accounting for Stock Issued to Employees”. The intrinsic value method measures compensation cost for stock optionsas the excess, if any, of the quoted market price of the Company’s stock at themeasurement date over the exercise price.

 

# **MINORITY INTEREST**

*Unitholders in the Operating Partnership.*  At September 30, 2002 and December 31, 2001,unit holders in the Operating Partnership held an 11.6% limited partnershipinterest in the Operating Partnership. Each of the holders of the interests in the Operating Partnership hasthe option to redeem its OP Units and to receive, at the option of the Company,in exchange for each OP Unit, either (i) one share of Common Stock of theCompany, or (ii) cash equal to the fair value of one share of Common Stock ofthe Company at the date of conversion.

 

*Partially owned property included in discontinued operations.*  On February 28, 2001, a third party buyer(the “Buyer”) purchased a 49% undivided tenancy-in-common interest in theCompany’s Creekside Apartments property for $1,000,000.  In addition, the sale agreement providesthat income and expenses shall be allocated to the Company and the Buyer basedupon the respective ownership interests.

 

The Company has accounted forthis transaction as a sale of a partial interest in real property and as such,the purchase price is accounted for as minority interest on the accompanyingbalance sheet.  Income and distributionsallocable to the buyer are accounted for as an offset to the minority interestaccount.  In addition, to the extentthat the accumulation of net income less distributions made to the Buyer doesnot cover the Buyer’s investment and simple interest of 12% per annum, theCompany records an accrual for any such difference in each fiscal period untilsuch obligation is paid in full.

 

As discussed in Note 4,Creekside Apartments was subsequently sold in October 2002.

 

**RENTAL REVENUE**

Certain leases provide for tenant occupancy during periods for which norent is due or where minimum rent payments increase during the term of thelease.  The Company records rentalincome for the full term of each lease on a straight-line basis.  Accordingly, a receivable is recorded fromtenants  equal to the excess of theamount that would have been collected on a straight-line basis over the amountcollected and currently due (Deferred Rent Receivable).  When a property is acquired, the term ofexisting leases is considered to commence as of the acquisition date forpurposes of this calculation.

 

The Company’s portfolio of leases turns over continuously, with thenumber and value of expiring leases varying from year to year.  The Company’s ability to re-lease the spaceto existing or new tenants at rates equal to or greater than those realizedhistorically is impacted by, among other things, the economic conditions of themarket in which a property is located, the availability of competing space, andthe level of improvements which may be required at the property.  No assurance can be given that the rentalrates that the Company will obtain in the future will be equal to or greaterthan those obtained under existing contractual commitments.

 

# **NETLOSS PER SHARE**

Net loss per share is calculated based on the weighted average numberof common shares outstanding.  Stockoptions outstanding and OP Units have not been included in the net loss pershare calculation since their effect would be antidilutive.

 

11

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**INCOME TAXES**

The Company is currently taxed as a C corporation.  Until the Company elects to be taxed as aREIT, it will be subject to federal income tax on its taxable income at regularcorporate rates.  Any distribution bythe Company to its stockholders will be subject to tax as a dividend at thestockholder’s respective federal income tax rates.  Beginning in 2003, the Company intends to elect to be taxed as aREIT for federal income tax purposes. The Company believes that it is organized and will operate so as toqualify as a REIT.  The qualificationand taxation of the Company as a REIT depends upon its ability to meet annuallydistribution levels, share ownership requirements and various qualificationsimposed under the Internal Revenue Code of 1986, as amended.  Accordingly, while the Company intends toqualify as a REIT and believes that it will be able to do so, the Companycannot predict that the actual results of its operations for any particularyear will satisfy the requirements.

 

If the Company fails toqualify as a REIT in any taxable year, it will be subject to federal incometaxes on its taxable income at regular corporate tax rates.  In addition, a REIT is subject to an entitylevel tax on the sale of property it held before electing REIT status.  During the 10-year period following itsqualification as a REIT, the Company will be subject to an entity level tax onthe income it recognizes upon the sale of assets (including all the assetstransferred to it as part of the Consolidation) it held before electing REITstatus in an amount up to the amount of the built-in gains at the time theCompany becomes a REIT.

 

The potential taxrelated to this built-in gain is approximately $12,943,000.  A deferred tax liability has not beenrecorded for this potential tax because the tax law provides a means by whichthe assets can be recovered tax-free. The Company expects that it willultimately hold the properties subject to the built-in gains tax throughout the10-year holding period after the Company’s qualification for REIT status orwill dispose of properties utilizing only tax-deferred exchanges.  If the Company’s expectation changes and itdisposes of property that is subject to the built-in gains tax without a taxdeferred exchange, the entire $12,943,000 deferred tax liability will berecorded immediately on the books of the Company.

 

## **NOTE 3.  REALESTATE**

 

**ACQUISITIONS**

On August 28, 2002, the Company acquired an office property in Houston,Texas consisting of approximately 46,821 rentable square feet.  Acquisition costs of approximately$1,387,000 consisted primarily of the assumption of existing debt with theremainder in cash.

 

On May 28, 2002, the Company acquired two office properties in Houston,Texas consisting of approximately 142,792 rentable square feet.  The aggregate acquisition costs ofapproximately $11,567,000 consisted of proceeds from a tax-deferred exchange,the assumption of existing debt and seller financing.

 

## **DISPOSITIONS**

In July 2002, theCompany received compensation of $150,000 for a strip of land condemned forhighway purposes on an office property in Illinois.  The Company recorded a $69,000 gain on sale of real estaterelated to the transaction.

 

On April 30, 2002,the Company sold Beach & Lampson, a 13,017 square foot shopping center inCalifornia for $1,200,000.  The Companyreceived net cash proceeds of approximately $59,000 and a $1,100,000 trust deednote from the buyer.  The note bearsinterest at 9.5% per annum and matures September 15, 2003.  The transaction resulted in a $148,000 losson sale of real estate.

 

In the secondquarter, the Company recognized a $232,000 deferred gain associated with thesale of Tower Industrial in 2001.

 

## **NOTE 4.  REALESTATE HELD FOR SALE**

 

As of September 30, 2002, twoproperties, which were subsequently sold in October 2002, were classified as“Real estate held for sale”.  CreeksideApartments, a 152-unit apartment property in California, was sold October 11,2002 for $8,600,000.  Maple Tree, a72,149 square foot shopping center in Missouri, was sold

 

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October 15, 2002 for$3,800,000.  The Company anticipates again will be recognized in the fourth quarter on the transactions.

 

In accordance with FAS 144, thenet income related to these properties for the three and nine months endedSeptember 30, 2002 are reflected in the consolidated statements of operationsas “Discontinued operations”.  The carryingamounts of these properties at September 30, 2002 and December 31, 2001 andtheir results of operations for the three and nine months ended September 30,2002 are summarized below (dollars in thousands):

 

**Condensed Consolidated Balance Sheets**

 
|                                                                                           |   | **September 30, 2002** |   | **December 31, 2001** |   |
|------------------------------------------------------------------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                                                                           |   |                   |   |                  |   |
| Real estate                                                                                    |   | $                      | 10,781 |                  | $      | 11,104 |   |
| Other                                                                                          |   | 360                    |   | 249                   |   |
| Real estate assets held for sale                                                               |   | $                      | 11,141 |                  | $      | 11,353 |   |
|                                                                                           |   |                   |   |                  |   |
| Notes payable, net (including $1,000 to  related parties)                                      |   | $                      | 7,810  |                  | $      | 7,946 |   |
| Accounts payable                                                                               |   | 54                     |   | 23                    |   |
| Accrued and other liabilities (including  $1,323 and $1,207, respectively, to related parties) |   | 1,523                  |   | 1,316                 |   |
| Minority interest related to partially  owned property                                         |   | 1,025                  |   | 1,033                 |   |
| Liabilities related to real estate held for  sale                                              |   | $                      | 10,412 |                  | $      | 10,318 |   |

 

**CondensedConsolidated Statements of Operations**

 
|                                                   |   | **Three Months Ended  September 30, 2002** |   | **Nine Months Ended  September 30, 2002** |   |
|--------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
| Rental revenue                                         |   | $                                          | 493    |                                      | $      | 1,410 |   |
| Total expenses                                         |   | 420                                        |   | 1,201                                     |   |
| Minority interest related to partially owned  property |   | (31                                        | )      | (98                                       | )      |
| Net income from discontinued operations                |   | $                                          | 42     |                                      | $      | 111 |   |

 

**NOTE 5. INVESTMENT IN UNCONSOLIDATED JOINT VENTURE**

 

The Company currently has no investments in operating jointventures.  Prior to the Consolidation,SPPI84 held an investment in Sierra Mira Mesa Partners (“SMMP”), which itaccounted for using the equity method.

 

SMMP is a California generalpartnership formed in 1985 between SPPI84 and Sierra-Pacific Development FundII (“SPDFII”), an affiliate of SPPI84, to develop and operate the real propertyknown as Mira Mesa, a 89,560 square foot office building located in San Diego,California.  At September 30, 2001,SPPI84’s interest in SMMP was 80.32%; the remaining 19.68% interest was ownedby SPDFII.  During the nine months andthree months ended September 30, 2001, SPPI84 recorded income from investmentin SMMP of $365,395 and $155,923, respectively.

 

On October 19, 2001, SPPI84 and SPDFII merged into a subsidiary of theCompany pursuant to the Consolidation. As a result, the assets and liabilities of Mira Mesa are included in theconsolidated balance sheets of the Company at September 30, 2002 and December31, 2001.

 

**NOTE 6.  NOTESPAYABLE, NET OF PREMIUMS**

 

The Company had thefollowing mortgage loans, bank lines, and notes payable outstanding related tocontinuing operations as of September 30, 2002 and December 31, 2001 (dollarsin thousands):

 

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|                                                                                                                                                                                                                                                                                                                                                                                          |   | **2002** |    | **2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Secured  loans with various lenders, net of unamortized premiums of $3,834 at  September 30, 2002 and $4,407 at December 31, 2001, bearing interest at fixed  rates between 5.00% and 13.00%, with monthly principal and interest payments  ranging between $3 and $269 at September 30, 2002 and $8 and $269 at December  31, 2001, and maturing at various dates through September 1, 2012. |   | $        | 135,436 |     | $      | 109,499 |   |
|                                                                                                                                                                                                                                                                                                                                                                                          |   |     |    |     |   |
| Secured loans with various  banks bearing interest at variable rates ranging between 4.84% and 9.00% at  September 30, 2002 and 4.93% and 9.00% at December 31, 2001, and maturing at  various dates through May 1, 2008.                                                                                                                                                                     |   | 33,625   |    | 43,337   |   |
|                                                                                                                                                                                                                                                                                                                                                                                          |   |     |    |     |   |
| Secured  Series A & B Bonds with a fixed interest rate of 6.39%, monthly principal  and interest payments of $74, and a maturity date of September 30, 2031.                                                                                                                                                                                                                              |   | 11,714   |    | 11,816   |   |
|                                                                                                                                                                                                                                                                                                                                                                                          |   |     |    |     |   |
| Secured  Series C Bonds with a fixed interest rate of 9.50%, semi-annual principal and  interest payments ($102 at September 30, 2002 and $106 at December 31, 2001),  and a maturity date of November 1, 2006.                                                                                                                                                                               |   | 700      |    | 765      |   |
|                                                                                                                                                                                                                                                                                                                                                                                          |   |     |    |     |   |
| Unsecured loans with  various lenders, bearing interest at fixed rates between 5.47% and 20.00% at  September 30, 2002 and 8.00% and 20.00% at December 31, 2001, and maturing at  various dates through October 1, 2004.                                                                                                                                                                     |   | 1,457    |    | 1,279    |   |
|                                                                                                                                                                                                                                                                                                                                                                                          |   |     |    |     |   |
| Unsecured loan with  various lenders, bearing interest at variable rates and maturing at various  dates through November 5, 2002.                                                                                                                                                                                                                                                             |   | 11       |    | 72       |   |
|                                                                                                                                                                                                                                                                                                                                                                                          |   |     |    |     |   |
| Unsecured loans with  various parties, non-interest bearing, and maturing at various dates through  January 1, 2003.                                                                                                                                                                                                                                                                          |   | 108      |    | 399      |   |
|                                                                                                                                                                                                                                                                                                                                                                                          |   |     |    |     |   |
| Unsecured  loan with Brown Parker and Leahy, LLP, a law firm in which Timothy R. Brown,  a director of the Company, is a partner.   The loan bears interest at prime (4.75% at September 30, 2002 and  5.00% at December 31, 2001) and is payable on demand.                                                                                                                             |   | 199      |    | 202      |   |
|                                                                                                                                                                                                                                                                                                                                                                                          |   |     |    |     |   |
| Unsecured  loan with John N. Galardi, a principal stockholder, with a fixed interest  rate of 8.00%, payable on demand.                                                                                                                                                                                                                                                                       |   | 1,600    |    | 1,600    |   |
|                                                                                                                                                                                                                                                                                                                                                                                          |   |     |    |     |   |
| Total                                                                                                                                                                                                                                                                                                                                                                                         |   | $        | 184,850 |     | $      | 168,969 |   |

 

Debt premiums are amortizedinto interest expense over the terms of the related mortgages using theeffective interest method.  As ofSeptember 30, 2002 and December 31, 2001, the unamortized debt premiumsincluded in the above schedule were $3,834,000 and $4,407,000, respectively.

 

In August 2002, through theacquisition of an office property in Houston, Texas, the Company assumed a loanin the amount of $1,213,000.  The loanbears interest at a fixed rate of 7.29% and matures in April 2005.

 

In July 2002, a lender notifiedthe Company it was technically in default under its loan agreement fornon-compliance with certain covenants, including covenants requiringimprovements to shopping center properties in South Carolina.  The aggregate principal balance of the loanagreement as of September 30, 2002 was approximately $6,325,000.  The lender has not accelerated the loanagreement.  The Company continues todiscuss the non-compliance matter with the lender.  Approximately $2,650,0000 of this loan matures in the fourthquarter of 2002.  The Company isconsidering various alternatives, including selling the property or usingproceeds from the sale of another property to provide capital to pay off thematuring portion of the loan.

 

The Company has other loanstotaling approximately $22,200,000 maturing in the fourth quarter of 2002.  The Company is analyzing an offer from thelender to extend the maturity to December 31, 2004.  There can be no assurance that this extension will be achieved.

 

# **In May2002, through the acquisition of two office properties in Houston, Texas, theCompany assumed two loans totaling $8,650,000. The loans bear interest at a fixed rate of 7.45% per annum and mature inMay 2012.  The Company also entered intoan agreement which provides for seller financing of $955,000, bearing interestat a fixed rate of 7.45% per annum and maturing in May 2004.**

 

During the third quarter of 2002, the Company financed insurancepremiums totaling $158,000.  The loansbear interest at 5.47% per annum and mature in May and June 2003.

 

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In May 2002, an $859,000unsecured loan was obtained to finance insurance premiums on the Company’sproperties.  The loan bears interest at5.47% per annum and matures in February 2003.

 

## **REFINANCINGS**

In October 2002, the Company received proceedsof $1,532,000 from two bridge loans on one of its shopping centerproperties.  The two mortgages wererepaid in conjunction with the sale of the shopping center property in October2002.  The additional proceeds from thesale of the property are being held by an escrow agent in order to meet therequirements of a tax-deferred exchange. One of these mortgages was provided by an affiliate of a related party.

 

In May 2002, the Company refinanced $1,452,000 on a loan secured bySouthwest Pointe, an office/warehouse property, and entered into a new loanagreement in the amount of $2,950,000. The new loan bears interest at a fixed rate of 7.33% per annum andmatures in June 2012.  Net proceeds of$1,297,000 were received as a result of the refinancing.

 

In May 2002, the Company refinanced $1,346,000 on a loan secured byLeawood Fountain Plaza, an office property, and entered into a new loanagreement in the amount of $3,000,000. The new loan bears interest at Libor plus 2.85% with a minimum of 5.75%per annum (5.75% at September 30, 2002), and matures in June 2003.  The loan contains a one-year extensionoption and an option to convert to a permanent loan provided certain lenderconditions are satisfied.  Net proceedsof $1,026,000 were received as a result of the refinancing.

 

In April 2002, the Company refinanced $3,650,000 on a loan secured byOak Grove Commons, an office/warehouse property, and entered into a new loanagreement in the amount of $4,313,700. The new loan bears interest at a fixed rate of 7.61% per annum andmatures in May 2012.  Net proceeds of$383,000 were received as a result of the refinancing.

 

In March 2002, the Company refinanced $2,750,000 on a loan partiallysecured by Countryside Office Park and entered into a new loan agreement in theamount of $5,025,000.  The new loanbears interest at a fixed rate of 7.38% per annum and matures in March2012.  Net proceeds of $1,887,000 werereceived as a result of the refinancing.

 

InJanuary 2002, the Company refinanced $4,500,000 on a loan partially secured byNorth Creek Office Park and entered into a new loan agreement in the amount of$5,625,000.  The new loan bears interestat a fixed rate of 7.58% per annum and matures in February 2012.  Net proceeds of $639,000 were received as aresult of the refinancing.

# ** **

# **NOTES PAYABLE TO FORMER LIMITED PARTNERS**

Limited partners of the eight public limited partnerships who votedagainst the Consolidation had the option of electing to receive notes insteadof ASR shares.  The notes, which totaled$2,291,671, bore interest at 5.92% per annum and mature in October 2009.  Interest is payable semi-annually in arrearson each June 15 and December 15, commencing June 15, 2002.  The notes may be redeemed at any time at theoption of the Company, in whole or from time to time in part, at a redemptionprice equal to the sum of the principal amount of the notes being redeemed plusaccrued interest thereon to the redemption date.  On March 18, 2002, $1,153,862 of the notes, plus accruedinterest, was paid.  Additional paymentsof $4,971, $705,161 and $191,055, plus accrued interest, were paid on April 1,2002, April 25, 2002, and July 2, 2002, respectively.  The principal balance of the notes as of September 30, 2002 was$236,622.

 

**NOTE 7.  STOCKOPTION AND RESTRICTED SHARE PLANS**

 

The Company has in effectits Omnibus Stock Incentive Plan (the “Plan”) which is administered by theBoard of Directors and provides for the granting of incentive and non qualifiedstock options, stock appreciation rights, restricted stock, performance unitsand performance shares.   The Boardreserved a total of 720,000 shares of Common Stock under the Plan.  As of September 30, 2002, 436,000 shares areavailable for issuance to executive officers, directors or other key employeesof the Company.  Of the 436,000 sharesavailable, the Company plans to grant options to purchase a total of 15,000shares to

 

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non-employee BoardMembers on November 15, 2002, the date of the 2002 Annual Meeting of Stockholders.

 

During fiscal 2001, options to purchase87,250 shares were granted at an exercise price of $15.00 per share, which wasthe amount at which shares of Common Stock were valued for purposes of theConsolidation.  Of the total of 87,250options, 62,250 of the stock options granted vest 25% annually, with theinitial 25% vesting on the date of grant. The remaining 25,000 stock options vested on the date of grant.  On April 15, 2002, options to purchase anadditional 87,250 were granted.  Of thetotal of 87,250 options, 62,250 of the stock options granted vest 25% annuallywith the initial 25% vesting on the date of grant.  The remaining 25,000 stock options vested on the date of grant.  On September 30, 2002, options to purchase81,124 shares were exercisable and options to purchase 174,500 shares wereoutstanding.  The options to purchasethese shares terminate on the tenth anniversary of the grant date.

 

The Company accounts for the Plan under APB Opinion 25.  Therefore, no compensation cost has beenrecognized for the granting of options. For pro forma disclosures, the estimated fair value of the options isamortized to expense over the options’ vesting period.  The estimated fair value of options grantedwas $10.29 and $11.97, respectively, for the period ended December 31, 2001 andSeptember 30, 2002.  Had compensationcost for the stock options granted been based on the estimated fair value atthe grant date, as prescribed by Statement of Financial Accounting StandardsNo. 123, the Company’s pro forma net loss and net loss per share would haveincreased by $86,605, or $.02 per basic and diluted share for the quarter endedSeptember 30, 2002 and $1,095,000, or $.20 per basic and diluted share for thenine month ended September 30, 2002.

 

The fair value of each option is estimated, as of the grant date, usingthe Black-Scholes option pricing model with the following assumptions used forthe grants:  dividends reinvested,expected volatility of 54%; risk-free interest rate of 3.99% and expected livesof 10 years.  The Black-Scholes optionvaluation model was developed for use in estimating the fair value of tradedoptions which have no vesting restrictions and are fully transferable.  In addition, option valuation models requirethe input of highly subjective assumptions including the expected stock pricevolatility.  Because the Company’s stockoptions have characteristics significantly different from those of tradedoptions and because changes in the subjective input assumptions can materiallyaffect the fair value estimate, in management’s opinion, the existing models donot necessarily provide a reliable single measure of the fair value of itsemployee stock options.

 

In addition, during fiscal2001, the Company granted 99,500 shares of restricted stock, and on April 16,2002, the Company granted an additional 10,000 shares of restricted stock.  The restricted stock is subject torepurchase by the Company on termination of the grantee’s employment for aprice of $.01 per share.  Compensationexpense is recognized on a straight-line basis over the vesting period, whichis determined based on the agreement and the period which the restrictionlapses.  For the quarter ended September30, 2002, $215,000 was recognized as expense for restricted shares issued.  For the nine months ended September 30,2002, $730,000 was recognized as expense for the restricted shares issued.

# ** **

# **NOTE8.  NET LOSS ON EARLY EXTINGUISHMENTS OFDEBT**

 

In connection with therefinancing of several loans, as discussed above, the Company recorded a netloss on early extinguishments of debt of $53,000 in the second quarter of2002.  Losses of $184,000 due to thewrite-off of unamortized deferred loan costs and prepayment penalties werepartially offset by a $131,000 gain on the write-off of an unamortized loanpremium.  The net loss is included inother income on the consolidated statements of operations.

 

## **NOTE 9. RELATED PARTY TRANSACTIONS**

 

Effective January 1, 2002, theCompany acquired a receivable in the amount of $177,000 from a related party inconnection with the Company’s assumption of an executive suite in an officebuilding owned by the Company.  TheCompany cancelled this receivable by offsetting the amount of the receivableagainst the amount payable by the Company to an entity owned by the relatedparty.

 

16

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During the first quarter of 2002, the Company made payments totaling$521,808 on its obligation to ASJ, Ltd., which is owned by Mr. Carden, anexecutive officer and principal shareholder, his wife and a trust for hischildren.  These payments reduced thebalance due to ASJ, Ltd. to $200,000 as of September 30, 2002.

 

During 2002, the Company paidprofessional fees of $112,887 to a law firm in which Timothy R. Brown, adirector of the Company, is a partner.

 

**NOTE10.  SEGMENT INFORMATION**

 

As of September 30, 2002, the Company owned a diverse portfolio ofproperties comprising office, office/warehouse, shopping center and apartmentproperties, and developmental land. Each of these property types represents areportable segment with distinct uses and tenant types and requires the Companyto employ different management strategies. Each segment contains propertieslocated in various regions and markets within the United States. The officeportfolio consists primarily of suburban office buildings. The office/warehouseportfolio consists of properties designed for warehouse, distribution and lightmanufacturing for single-tenant or multi-tenant use. The shopping centerportfolio consists primarily of community shopping centers. The properties inthe apartment portfolio are apartment buildings with units rented toresidential tenants on either a month-by-month basis or for terms generally ofone year or less.

 

The accounting policies of the segments are the same as those describedin the summary of significant accounting policies. The Company evaluatesperformance of its property types based on net operating income derived bysubtracting rental expenses and real estate taxes (operating expenses) fromrental revenue. Significant information used by the Company for its reportablesegments as of and for the three months and nine months ended September 30,2002 and 2001 is as follows (dollars in thousands):

 
| **Three Months Ended September 30,**                    |   | **Office** |    | **Office/  Warehouse** |   | **Shopping  Center** |   | **Apartment** |   | **Land Held  for  Development  and Other** |   | **Property  Total** |   |
|---------------------------------------------------------|--------|------------|---------|------------------------|--------|----------------------|--------|---------------|--------|--------------------------------------------|--------|---------------------|--------|
| **2002**                                                |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                                          |   | $          | 5,993   |                   | $      | 1,803                |   | $             | 323    |                                       | $      | 1,694               |   | — |   | $ | 9,813 |   |
| Property operating expenses                             |   | 2,378      |    | 579                    |   | 126                  |   | 937           |   | $                                          | 88     |                | 4,108  |   |
| Net operating income (NOI)                              |   | $          | 3,615   |                   | $      | 1,224                |   | $             | 197    |                                       | $      | 757                 |   | $ | (88 | ) | $ | 5,705 |   |
| Real estate held for investment, net, at  end of period |   | $          | 141,806 |                   | $      | 46,187               |   | $             | 12,593 |                                       | $      | 40,073              |   | $ | 4,044 |   | $ | 244,703 |   |
|                                                    |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| **2001**                                                |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                                          |   | —     |    | $                      | 169    |                 | — |          | — |                                       | — |                | $      | 169 |   |
| Property operating expenses                             |   | —     |    | 68                     |   | —               |   | —        |   | —                                     |   | 68                  |   |
| Net operating income (NOI)                              |   | —     |    | $                      | 101    |                 | — |          | — |                                       | — |                | $      | 101 |   |
| Real estate held for investment, net, at  end of period |   | —     |    | $                      | 1,152  |                 | — |          | — |                                       | — |                | $      | 1,152 |   |

 
| **Nine months Ended September 30,**                     |   | **Office** |    | **Office/  Warehouse** |   | **Shopping  Center** |   | **Apartment** |   | **Land Held  for  Development  and Other** |   | **Property  Total** |   |
|---------------------------------------------------------|--------|------------|---------|------------------------|--------|----------------------|--------|---------------|--------|--------------------------------------------|--------|---------------------|--------|
| **2002**                                                |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                                          |   | $          | 17,186  |                   | $      | 5,663                |   | $             | 1,124  |                                       | $      | 5,082               |   | — |   | $ | 29,055 |   |
| Property operating expenses                             |   | 6,238      |    | 1,569                  |   | 400                  |   | 2,554         |   | $                                          | 215    |                | 10,976 |   |
| Net operating income (NOI)                              |   | $          | 10,948  |                   | $      | 4,094                |   | $             | 724    |                                       | $      | 2,528               |   | $ | (215 | ) | $ | 18,079 |   |
| Real estate held for investment, net, at  end of period |   | $          | 141,806 |                   | $      | 46,187               |   | $             | 12,593 |                                       | $      | 40,073              |   | $ | 4,044 |   | $ | 244,703 |   |
|                                                    |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| **2001**                                                |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                                          |   | —     |    | $                      | 500    |                 | — |          | — |                                       | — |                | $      | 500 |   |
| Property operating expenses                             |   | —     |    | 185                    |   | —               |   | —        |   | —                                     |   | 185                 |   |
| Net operating income (NOI)                              |   | —     |    | $                      | 315    |                 | — |          | — |                                       | — |                | $      | 315 |   |
| Real estate held for investment, net, at  end of period |   | —     |    | $                      | 1,152  |                 | — |          | — |                                       | — |                | $      | 1,152 |   |

 

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The following is a reconciliation of segmentrevenues, income and assets to consolidated revenues, income and assets for theperiods presented above (dollars in thousands):

 
|                                                                    |   | **Three Months Ended  September 30,** |   | **Nine months Ended  September 30,** |   |
|-------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                    |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
| **REVENUES**                                                            |   |                                  |   |                                 |   |   |   |   |   |
| Total revenues for reportable segments                                  |   | $                                     | 9,813  |                                 | $      | 169 |   | $ | 29,055 |   | $ | 500 |   |
| Other revenues                                                          |   | 46                                    |   | 44                                   |   | 197 |   | 131 |   |
| Total consolidated revenues                                             |   | $                                     | 9,859  |                                 | $      | 213 |   | $ | 29,252 |   | $ | 631 |   |
|                                                                    |   |                                  |   |                                 |   |   |   |   |   |
| **NET (LOSS) INCOME**                                                   |   |                                  |   |                                 |   |   |   |   |   |
| NOI for reportable segments                                             |   | $                                     | 5,705  |                                 | $      | 101 |   | $ | 18,079 |   | $ | 315 |   |
| Unallocated amounts:                                                    |   |                                  |   |                                 |   |   |   |   |   |
| Interest and other income                                               |   | 46                                    |   | 44                                   |   | 197 |   | 131 |   |
| General and administrative expenses                                     |   | (2,117                                | )      | (63                                  | )      | (6,346 | ) | (214 | ) |
| Depreciation and amortization                                           |   | (3,047                                | )      | (41                                  | )      | (8,700 | ) | (142 | ) |
| Interest expense                                                        |   | (3,591                                | )      | (33                                  | )      | (10,387 | ) | (95 | ) |
| Income from investment in unconsolidated  joint venture                 |   | —                                |   | 156                                  |   | — |   | 365 |   |
| Net gain on sales of real estate assets                                 |   | 69                                    |   | —                               |   | 153 |   | — |   |
| Net loss on extinguishment of debt                                      |   | —                                |   | —                               |   | (53 | ) | — |   |
| Net (loss) income before minority interest  and discontinued operations |   | $                                     | (2,935 | )                                    | $      | 164 |   | $ | (7,057 | ) | $ | 360 |   |

 

|                                       |   | **September 30,** |    |
|--------------------------------------------|--------|-------------------|---------|
|                                       |   | **2002**          |    | **2001** |   |
| **ASSETS**                                 |   |              |    |   |   |
| Total assets for reportable segments       |   | $                 | 244,703 |   | $ | 1,152 |   |
| Real estate assets held for sale           |   | 11,141            |    | — |   |
| Cash and cash equivalents                  |   | 826               |    | 7 |   |
| Tenant and other receivables, net          |   | 581               |    | — |   |
| Deferred rent receivable                   |   | 452               |    | 49 |   |
| Note receivable from affiliate, net        |   | —            |    | 1,618 |   |
| Accounts receivable from affiliate         |   | —            |    | 1,350 |   |
| Interest receivable from affiliate         |   | —            |    | 131 |   |
| Mortgage loan receivable                   |   | 1,100             |    | — |   |
| Investment in management company           |   | 4,000             |    | — |   |
| Investment in unconsolidated joint venture |   | —            |    | 6,884 |   |
| Prepaid and other assets, net              |   | 9,778             |    | 283 |   |
| Total consolidated assets                  |   | $                 | 272,581 |   | $ | 11,474 |   |

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

**OVERVIEW**

 

American Spectrum Realty, Inc.is a full-service real estate corporation which owns, manages and operatesvarious income-producing properties.  Asof September 30, 2002, through the Operating Partnership, the Company owned andoperated 35 properties that consisted of 15 office, 11 office/warehouse, fourshopping center, four apartment properties, and one developmental landproperty.  In October 2002, the Companysold one shopping center and one apartment property.  The properties are located in four geographic regions in ninestates.  The Company plans to expand itsbusiness and net assets by acquiring additional properties.  The Company will focus primarily on officeand office/warehouse properties located in Texas, California, Arizona and theMidwest.  The Company intends to qualifyas a real estate investment trust as

 

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defined under theInternal Revenue Code of 1986, as amended, and to elect to be treated as a REITbeginning in 2003.

 

In October 2001, the Companyacquired various properties in the Consolidation.  Pursuant to the Consolidation, subsidiaries of the Company mergedwith eight public limited partnerships, acquired the assets and liabilities oftwo private entities managed by CGS and acquired certain assets and liabilitiesof CGS and the majority owned affiliates of CGS.  SPPI84, one of the eight public limited partnerships, wastreated, for accounting purposes, as the acquirer of the properties in theConsolidation.  Pursuant to theConsolidation, partners of the public partnerships received shares in theCompany or promissory notes in exchange for their partnership units and ownersof existing related entities exchanged ownership interests in real estate forASR shares or units in the Operating Partnership, an entity formed for thispurpose and initially wholly owned by the Company.

 

The following discussion andanalysis of the financial condition and results of operations of the Companyshould be read in conjunction with the accompanying consolidated financialstatements of the Company, including the notes thereto, included in Item 1.

 

The majoraccounting policies followed by the Company are listed in Note 2 – Summary ofSignificant Accounting Policies. – in the Notes to the Consolidated FinancialStatements.  The consolidated financialstatements of the Company are prepared in accordance with accounting principlesgenerally accepted in the United States of America, which requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the results of operations during the reportingperiod. Actual results could differ materially from those estimates.

 

The Companybelieves the following critical accounting policies affect its more significantjudgments and estimates used in the preparation of its consolidated financialstatements:

 

•                       Certainleases provide for tenant occupancy during periods for which no rent is due orwhere minimum rent payments increase during the term of the lease.  The Company records rental income for thefull term of each lease on a straight-line basis.  Accordingly, a receivable is recorded from tenants equal to the excessof the amount that would have been collected on a straight-line basis over theamount collected and currently due (Deferred Rent Receivable).  When a property is acquired, the term ofexisting leases is considered to commence as of the acquisition date forpurposes of this calculation.

 

•                       Rentalproperties are stated at cost, net of accumulated depreciation, unlesscircumstances indicate that cost, net of accumulated depreciation, cannot berecovered, in which case the carrying value of the property is reduced toestimated fair value. Estimated fair value (i) is based upon the Company’splans for the continued operation of each property and (ii) is computed usingestimated sales price, as determined by prevailing market values for comparableproperties and/or the use of capitalization rates multiplied by annualized netoperating income based upon the age, construction and use of the building.  The fulfillment of the Company’s plansrelated to each of its properties is dependent upon, among other things, thepresence of economic conditions which will enable the Company to continue tohold and operate the properties prior to their eventual sale. Due touncertainties inherent in the valuation process and in the economy, the actualresults of operating and disposing of the Company’s properties could bematerially different than current expectations.

 

•                       TheCompany is currently taxed as a C corporation. Until the Company elects to be taxed as a REIT, it will be subject tofederal income tax on its taxable income at regular corporate rates.  Any distribution by the Company to itsstockholders will be subject to tax as a dividend at the stockholder’srespective federal income tax rates. Beginning in 2003, the Company intends to elect to be taxed as a REITfor federal income tax purposes.  TheCompany believes that it is organized and will operate so as to qualify as aREIT.  The qualification and taxation ofthe Company as a REIT depends upon its ability to meet annually distributionlevels, share ownership

 

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requirements andvarious qualifications imposed under the Internal Revenue Code of 1986, asamended.  Accordingly, while the Companyintends to qualify as a REIT and believes that it will be able to do so, theCompany cannot predict that the actual results of its operations for anyparticular year will satisfy the requirements.

# ** **

# **RESULTS OF OPERATIONS**

 

The statement of operations for the three and nine months endedSeptember 30, 2001 solely reflects the operating results of SPPI84, which foraccounting purposes, was treated as the acquirer of the properties in theConsolidation.  SPPI84 wholly owned oneproperty and held an equity interest in another entity prior to theConsolidation.  Therefore, a comparison ofoperating results for the three and nine months ended September 30, 2002 and2001 is not meaningful.

 

In accordance with generally accepted accounting principles, for thethree and nine months ended September 30, 2002, the operating results of ashopping center and an apartment property which were sold in October 2002 arereported as income from discontinued operations.  See Note 4 – Real Estate Held For Sale – of the Notes toConsolidated Financial Statements. Unless otherwise indicated, the following discussion reflects theresults from continuing operations, which include the real estate assets heldfor investment.  The operating resultsof any properties acquired during the period include operations from the dateof acquisition.

 

***Discussion of the three months endedSeptember 30, 2002 and the three months ended September 30, 2001.***

The Company recorded rental revenue of $9,813,000 and expenses of$12,863,000 for the three months ended September 30, 2002 (“SeptemberQuarter”).  On August 28, 2002, the Companyacquired a 46,821 square foot office building (“August Acquisition”).  In addition, on May 28, 2002, the Companyacquired two office buildings (“May Acquisitions”).  The rental revenues from these properties are included sincetheir respective dates of acquisition. Reported rental revenues for the three months ended September 30, 2002remained constant with the three months ended June 30, 2002 (“JuneQuarter”).  However, the May and Augustacquisitions provided an additional $400,000 in rental revenue in the SeptemberQuarter compared to the June Quarter. This additional rental revenue was offset by a decrease in deferredrental income recognized during the September Quarter compared to the JuneQuarter and the effects of rental revenue recognized on a lease buy-out in theJune quarter.  In addition, the weightedaverage occupancy of the Company’s properties held for investment decreasedfrom 88% at June 30, 2002 to 86% at September 30, 2002.

 

Property operating expenses for the September Quarter increasedapproximately $609,000 compared to the June Quarter due to the effects of theMay and August acquisitions, higher seasonal electrical costs, additionalreserves for bad debts recognized and professional fees incurred.

 

General and administrative expenses increased $305,000 in the SeptemberQuarter compared to the June Quarter due to increases in legal fees expensed.

 

Rental revenue of $169,000 and operating expenses of $205,000 reportedfor the three months ended September 30, 2001 reflected the operations SPPI84’ssole wholly owned property, Sierra Valencia.

 

The Company recorded a $69,000gain on sale of real estate during the three months ended September 30,2002.  This gain was the result ofcompensation for a strip of land condemned for highway purposes at one of itsoffice properties.

 

The share of loss for the threemonths ended September 30, 2002 for the holders of the OP Units was $336,000which represents the 11.6% limited partner interest in the OperatingPartnership not held by the Company at September 30, 2002.  SPPI84 had no minority interests in thecorresponding period of 2001.

 

SPPI84 recorded income of$156,000 from investment in its unconsolidated joint venture partner, SMMP,during the three months ended September 30, 2001.  This represents SPPI84’s share of income generated

 

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by SMMP and SMMP’s jointventure partners.  The Company had noinvestments in unconsolidated joint ventures during the quarter ended September30, 2002.

 

The Company recorded income from discontinued operations of $42,000 forthe three months ended September 30, 2002. The discontinued operations represent net income from two propertiesheld for sale, which were subsequently sold in October 2002.  Creekside Apartments, a 152-unit apartmentproperty in California, was sold October 11, 2002 and Maple Tree, a 72,149square foot shopping center in Missouri, was sold on October 15, 2002.  The aggregate sales price for the two propertieswas $12,400.000.  The Company anticipatesa gain will be recognized in the fourth quarter on the transactions.    SPPI84 had no income from discontinuedoperations in the corresponding period of 2001.

 

The income from discontinued operations is summarized below.

 

**CondensedConsolidated Statement of Operations**

 

|                                                   |   | **Three Months Ended  September 30, 2002** |   |
|--------------------------------------------------------|--------|--------------------------------------------|--------|
| Rental revenue                                         |   | $                                          | 493    |   |
| Total expenses                                         |   | 420                                        |   |
| Minority interest related to partially  owned property |   | (31                                        | )      |
| Net income from discontinued operations                |   | $                                          | 42     |   |

 

***Discussion of thenine months ended September 30, 2002 and the nine months ended September 30,2001.***

The Company recorded rental revenue of $29,055,000 and expenses of$36,409,000 for the nine months ended September 30, 2002.  On May 28, 2002, the Company acquired twooffice buildings consisting of 142,792 square feet.  On August 28, 2002, the Company acquired a 46,821 square footoffice building.  The rental revenuesfrom these properties are included since their respective dates ofacquisition.  Without the effects of theMay and August acquisitions, the weighted average occupancy of the Company’sproperties held for investment decreased from 88% at December 31, 2001 to 86%at September 30, 2002.  As of September30, 2002, the average occupancy of the acquired properties was 88%.  Expenses not anticipated to be recurringtotaled approximately $250,000 during the nine months ended September 30, 2002due to professional fees associated with the Consolidation.

# ** **

Rental revenue of $500,000 and operating expenses of $636,000 generatedduring the nine months ended September 30, 2001 reflect the operations SPPI84’ssole wholly owned property, Sierra Valencia.

 

The Company recorded a $153,000 net gain on sales of real estate assetsduring the nine months ended September 30, 2002.  The Company recognized a $232,000 deferred gain associated withthe sale of the Tower Industrial in 2001 and a $69,000 gain as a result ofcompensation for a strip of land condemned for highway purposes at one of itsoffice properties.  These gains werepartially offset by a $148,000 loss on the sale of Beach & Lampson, ashopping center property sold in April 2002.

 

The share of loss for the nine months endedSeptember 30, 2002 for the holders of OP Units was $806,000 which representsthe 11.6% limited partner interest in the Operating Partnership not held by theCompany at September 30, 2002.  SPPI84had no minority interests in the corresponding period of 2001.

 

SPPI84 recorded income of $365,000 from investment in itsunconsolidated joint venture partner, SMMP, during the nine months endedSeptember 30, 2001.  This representsSPPI84’s share of income generated by SMMP and SMMP’s joint venturepartners.  The Company had noinvestments in unconsolidated joint ventures during the nine months endedSeptember 30, 2002.

 

The Company recorded a $53,000 net loss on early extinguishments ofdebt in connection with the refinancing of several loans during the nine monthsended September 30, 2002.  Losses of$184,000 due to the write-off of deferred loan costs and prepayment penaltieswere partially offset by a $131,000 gain on the write-off of an unamortizedloan premiums.

 

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The Company recorded income from discontinued operations of $111,000for the nine months ended September 30, 2002. The discontinued operations represent net income from two propertiesheld for sale, which were subsequently sold in October 2002.  Creekside Apartments, a 152-unit apartmentproperty in California was sold October 11, 2002 and Maple Tree, a 72,149 squarefoot shopping center in Missouri was sold on October 15, 2002.  The aggregate sales price for the twoproperties was $12,400,000.  The Companyanticipates a gain will be recognized in the fourth quarter on thetransactions.  SPPI84 had no income fromdiscontinued operations in the corresponding period of 2001.

 

The net income from discontinued operations is summarized below.

 

**Condensed Consolidated Statement ofOperations**

 

|                                                   |   | **Nine Months Ended  September 30, 2002** |   |
|--------------------------------------------------------|--------|-------------------------------------------|--------|
| Rental revenue                                         |   | $                                         | 1,410  |   |
| Total expenses                                         |   | 1,201                                     |   |
| Minority interest related to partially  owned property |   | (98                                       | )      |
| Net income from discontinued operations                |   | $                                         | 111    |   |

 

# **LIQUIDITY AND CAPITAL RESOURCES**

 

The Company reported a net loss of $6,140,000 for the nine months endedSeptember 30, 2002, which included depreciation and amortization from realestate held for investment of $8,700,000. Excluding the Company’s pay-down of accounts payables, attributable tothe Consolidation, the Company would have had positive cash flow from itsoperating activities.  Nonetheless, theCompany used cash for operating activities, to fund improvements and to paydividends.  Cash was used in operatingactivities primarily for payment of prepaid and other assets, which primarilyconsists of required lender-held funds. Lender-held funds are amounts requiredto be deposited with a lender and drawn by the Company with lender approvalwhen certain conditions are met, for example, improvements on a property andpayments of taxes and insurance premiums.

 

Net cash used in investingactivities of $3,395,000 for the nine months ended September 30, 2002 comprised(i) $3,336,000 paid for capital expenditures, 42% related to major renovationson an apartment property and (ii) $268,000 paid for real estate acquisitions,offset by (iii) $209,000 in proceeds received from the sales of real estateassets.

 

Net cash provided by financingactivities amounted to $2,249,000 during the nine months ended September 30,2002.  Proceeds received from borrowingstotaled $21,931,000, as detailed below, of which $13,698,000 was used to repaydebt.  The Company paid $2,668,000 inscheduled principal payments during the nine months ended September 30,2002.  Note payments to former limitedpartners totaling $2,055,000 were also made during the period.  Dividends to common stockholders of$1,110,000 and distributions to unitholders in the operating partnership of$145,000 were also made during the period.

 

InJanuary 2002, the Company refinanced $4,500,000 on a loan partially secured byNorth Creek Office Park and entered into a new loan agreement in the amount of$5,625,000.  The new loan bears interestat a fixed rate of 7.58% per annum and matures in February 2012.  Net proceeds of $639,000 were received as aresult of the refinancing.

 

In March 2002, the Company refinanced $2,750,000 on a loan partiallysecured by Countryside Office Park and entered into a new loan agreement in theamount of $5,025,000.  The new loanbears interest at a fixed rate of 7.38% per annum and matures in March2012.  Net proceeds of $1,887,000 werereceived as a result of the refinancing.

 

In April 2002, the Company refinanced $3,650,000 on a loan secured byOak Grove Commons, an office/warehouse property, and entered into a new loanagreement in the amount of $4,313,700. The new loan bears interest at a fixed rate of 7.61% per annum andmatures in May 2012.  Net proceeds of$383,000 were received as a result of the refinancing.

 

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In May 2002, the Company refinanced $1,346,000 on a loan secured byLeawood Fountain Plaza, an office property, and entered into a new loanagreement in the amount of $3,000,000. The new loan bears interest at Libor plus 2.85% with a minimum of 5.75%per annum (5.75% at September 30, 2002), and matures in June 2003.  The loan contains a one-year extensionoption and an option to convert to a permanent loan provided certain lenderconditions are satisfied.  Net proceedsof $1,026,000 were received as a result of the refinancing.

 

In May 2002, the Company refinanced $1,452,000 on a loan secured bySouthwest Pointe, an office/warehouse property, and entered into a new loanagreement in the amount of $2,950,000. The new loan bears interest at a fixed rate of 7.33% per annum andmatures in June 2012.  Net proceeds of$1,297,000 were received as a result of the refinancing.

 

In May 2002, an $859,000 unsecured loan was obtained to financeinsurance premiums on the Company’s properties.  The loan bears interest at a fixed rate of 5.47% per annum andmatures in February 2003.

 

In July 2002, a lender notifiedthe Company it was technically in default under its loan agreement fornon-compliance with certain covenants, including covenants requiringimprovements to shopping center properties in South Carolina.  The aggregate principal balance under theloan agreement as of September 30, 2002 was $6,325,000. The lender has notaccelerated the loan agreement.  TheCompany continues to discuss the non-compliance matter with the lender.  Approximately $2,650,000 of the loan maturesin the fourth quarter of 2002.  TheCompany is considering various alternatives, including selling the propertiesor using proceeds from the sale of another property to provide capital to payoff the maturing portion of the loan.

 

During the third quarter of 2002, the Company financed insurancepremiums totaling $158,000.  The loansbear interest at 5.47% per annum and mature in May and June 2003.

 

In April 2002, the Board ofDirectors declared a dividend of 20 cents per share to each holder of commonstock and operating partnership unit as of April 30, 2002.  The dividend, which totaled approximately$1,255,000, was paid on June 3, 2002. In August 2002, the Board of Directors declared a dividend of 20 centsper share to each holder of common stock and operating partnership unit as ofSeptember 19, 2002.  The dividend, whichtotaled approximately $1,253,000, was paid on October 18, 2002.

 

In October 2002, the Companyreceived proceeds of $1,532,000 from two bridge loans on one of its shoppingcenter properties.  The two mortgageswere repaid in conjunction with the sale of the shopping center property inOctober 2002.  The additional proceedsfrom the sale of the property are being held by an escrow agent in order tomeet the requirements of a tax-deferred exchange.  One of these mortgages was provided by an affiliate of a relatedparty.  On October 31, 2002, the Companyreceived a $900,000 payoff on its $1,100,000 mortgage loan receivable.  These funds will be used to meet theCompany’s obligations for capital costs relating to re-leasing and improvementsto properties.  The Company will recorda $200,000 loss in the fourth quarter of 2002 related to the payoff.

 

The Company expects to meet itsshort-term liquidity requirements for normal operating expenses from cashgenerated by operations.  In addition,the Company anticipates selling one of its apartment properties, which has thepotential to generate substantial cash. The Company is projecting the need for cash to fund obligations otherthan normal operating expenses during the last quarter of 2002 and 2003.  These obligations include capital costsincurred and to be incurred related to re-leasing space and improvements toproperties.  The Company believes thatits cash generated by the anticipated sale of the apartment property will beadequate to meet capital costs in the short term.  There can be no assurance that the sale of the apartment propertywill occur and that substantial cash will be generated.

 

The Company has other loans totaling approximately$22,200,000 maturing in the fourth quarter of 2002.  The Company is analyzing an offer from the lender to extend thematurity to December 31, 2004.  Therecan be no assurance that this extension will be achieved.

 

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The Company intends to qualifyas a REIT beginning in 2003.  If theCompany becomes a REIT, it must pay distributions to investors of at least 90%of its taxable net income.  The Companyanticipates cash generated by operations will be sufficient to meetdistribution requirements.

 

**FUNDS FROM OPERATIONS**

In October 1999, the Board of Governors of NAREIT issued “White Paperon FFO-October 1999” to clarify its definition of Funds from Operations(“FFO”).  The clarification waseffective January 1, 2000 and requires restatement for all periods presented infinancial statements or tables. FFO, as clarified by NAREIT, represents “netincome excluding gains (or losses) from sales of property, plus depreciationand amortization, and after adjustments for unconsolidated partnerships andjoint ventures.  Adjustments forunconsolidated partnerships and joint ventures will be calculated to reflectfunds from operations on the same basis.” In 2002, NAREIT clarified that FFO related to assets held for sale, soldor otherwise transferred and included in results of discontinued operationsshould continue to be included in FFO. This clarification was effective January 1, 2002 and requiresrestatement for all periods presented financial statements or tables.  The Company computes FFO in accordance withthe clarified definition except that the Company eliminates straight-line rentfrom the calculation, which may not be comparable to FFO reported by REITs thatinterpret the clarified definition differently.  The Company believes that FFO is helpful to investors as ameasure of performance of an equity REIT because, along with cash flow fromoperating activities, FFO provides investors with an indication of our abilityto incur and service debt, to make capital expenditures and to fund other cashneeds.  FFO does not represent netincome or cash flows from operations, as defined by GAAP, and should not beconsidered as an alternative to net income (determined in accordance with GAAP)as an indicator of the Company’s operating performance or as an alternative tocash flows from operating, investing and financing activities (determined inaccordance with GAAP) as a measure of liquidity.  FFO does not necessarily indicate that cash flows will besufficient to fund all of the Company’s cash needs including principalamortization, capital improvements and distributions to stockholders.  Further, FFO as disclosed by other companiesmay not be comparable to the Company’s calculation of FFO.

 

The followingtable sets forth the Company’s calculation of FFO for the three months endedMarch 31, June 30, and September 30, 2002, and for the nine months endedSeptember 30, 2002 (in thousands except weighted average shares and per shareamounts).  FFO for the three months endedMarch 31, June 30, and September 30, 2001 and the nine months ended September30, 2001 is not presented as it is not comparable or meaningful.

** **
|                                                                        |   | **March 31,  2002** |   | **June 30,  2002** |   | **September  30, 2002** |   | **Year to Date  2002** |   |
|-----------------------------------------------------------------------------|--------|---------------------|--------|--------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                        |   |                |   |               |   |                    |   |                   |   |
| Loss from operations before minority  interest                              |   | $                   | (2,357 | )                  | $      | (1,765                  | )      | $                      | (2,935 | ) | $ | (7,057 | ) |
| Depreciation and amortization                                               |   | 2,881               |   | 2,772              |   | 3,047                   |   | 8,700                  |   |
| Net gain on sales of real estate assets                                     |   | —              |   | (84                | )      | (69                     | )      | (153                   | )      |
| Adjustment for straight-line rents                                          |   | (137                | )      | (134               | )      | (32                     | )      | (303                   | )      |
| Net (loss) income from discontinued  operations                             |   | (20                 | )      | 89                 |   | 42                      |   | 111                    |   |
| Depreciation and amortization from  discontinued operations                 |   | 101                 |   | 100                |   | 101                     |   | 302                    |   |
| Minority interest on partially owned  property from discontinued operations |   | 36                  |   | 31                 |   | 31                      |   | 98                     |   |
| FFO                                                                         |   | $                   | 504    |               | $      | 1,009                   |   | $                      | 185    |   | $ | 1,698 |   |
|                                                                        |   |                |   |               |   |                    |   |                   |   |
| Basic weighted average shares                                               |   | 5,529,058           |   | 5,535,591          |   | 5,536,990               |   | 5,533,467              |   |
| FFO per share                                                               |   | $                   | .09    |               | $      | .18                     |   | $                      | .03    |   | $ | .31 |   |

 

FFO decreased by$824,000 for the three months ended September 30, 2002 as compared to the threemonths ended June 30, 2002 for the reasons discussed in the analysis of Resultsof Operations.

 

**INFLATION**

Substantially all of the leases at the industrial and retail propertiesprovide for pass-through to tenants of certain operating costs, including realestate taxes, common area maintenance expenses, and insurance.

 

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Leases at the multifamily properties generally provide for an initialterm of one month to one year and allow for rent adjustments at the time ofrenewal. Leases at the office properties typically provide for rent adjustmentand pass-through of increases in operating expenses during the term of thelease. All of these provisions may permit the Company to increase rental ratesor other charges to tenants in response to rising prices and, therefore, serveto reduce the Company’s exposure to the adverse effects of inflation.

 

**FORWARD-LOOKING STATEMENTS**

ThisReport on Form 10-Q contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of the Securities andExchange Act of 1934.  Theseforward-looking statements are based on management’s beliefs and expectations,which may not be correct.  Importantfactors that could cause actual results to differ materially from theexpectations reflected in these forward-looking statements include thefollowing: the Company’s level of indebtedness and ability to refinance itsdebt; the fact that the Company’s predecessors have had a history of losses inthe past; unforeseen liabilities which could arise as a result of the prioroperations of companies acquired in the Consolidation; risks inherent in theCompany’s acquisition and development of properties in the future, includingrisks associated with the Company’s strategy of investing in under-valuedassets; general economic, business and market conditions, including the impactof the current economic downturn; changes in federal and local laws, andregulations; increased competitive pressures; and other factors, including thefactors set forth below, as well as factors set forth elsewhere in this Reporton Form 10-Q.

 

**RISK FACTORS**

Stockholders or potential stockholders should read the“Risk Factors” section of the Company’s latest annual report on Form 10-K filedwith the Securities and Exchange Commission in conjunction with this quarterlyreport on Form 10-Q to better understand the factors affecting the Company’sfinancial condition and results of operations.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

 

**INTEREST RATES**

The Company’s primary market risk exposure is to changes in interestrates on its secured and unsecured borrowings.

 

It is theCompany’s policy to manage its exposure to fluctuations in market interestrates for its borrowings through the use of fixed rate debt instruments to theextent that reasonably favorable rates are obtainable with such arrangements.In order to maximize financial flexibility when selling properties and minimizepotential prepayment penalties on fixed rate loans, the Company has alsoentered into variable rate debt arrangements.

 

The Company has entered into interest rate swap agreements to manageits interest rate risk.  The agreements,in nominal amounts totaling $21,800,000, effectively fix the interest rate at2.68% plus the applicable variable rate margin (effective rate of 5.68% atSeptember 30, 2002).

 

At September 30, 2002, the Company’s total indebtedness includedfixed-rate debt of approximately $151,251,000 and floating-rate indebtedness ofapproximately $33,835,000. The Company continually reviews the portfolio’sinterest rate exposure in an effort to minimize the risk of interest ratefluctuations.  The Company does not haveany other material market-sensitive financial instruments.

 

A change of 1.00% in the index rate to which the Company’s variablerate debt is tied would change the annual interest incurred by the Company byapproximately $340,000 based upon the balances outstanding on variable rateinstruments at September 30, 2002.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

During the 90-day period prior to the filing date ofthis report, management, including the Company’s Chief Executive Officer andActing Chief Financial Officer, evaluated the effectiveness of the Company’sdisclosure controls and procedures. Based on, and as of the date of, that evaluation, the Chief Executive

 

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Officer and Acting Chief Financial Officer concludedthat the disclosure controls and procedures were effective, in all materialrespects, to ensure that information required to be disclosed in the reportsthe Company files and submits under the Exchange Act is recorded, processed,summarized and reported as and when required.

 

There have been no significant changes in theCompany’s internal controls or in other factors that could significantly affectinternal controls subsequent to the date of the evaluation referred to above.

 

**PARTII.  OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS**

 

The following is informationconcerning material, pending legal proceedings to which the Company or itssubsidiaries is a party or of which any of their property is subject in whichthere were material developments during the quarter:

 

Lewis-Madison Matter

 

Reference is made to theCompany’s Annual Report on Form 10-K for 2001 and its Quarterly Reports on Form10-Q for the quarters ended March 31 and June 30, 2002 for information withrespect to this matter.  Since the lastreport, the following developments have occurred:

 

On July 2, 2002, the plaintiffs filed and served a Third AmendedComplaint on the Company alleging claims against the Company for breach offiduciary duty, breach of contract, intentional interference with prospectiveeconomic advantage, and intentional interference with contractualrelations.  On August 6, 2002, theCompany filed a demurrer to plaintiffs’ Third Amended Complaint contending thatthe plaintiffs’ Third Amended Complaint still failed to state a cause of actionfor interference with contract or interference with prospective economicadvantage against the Company.  OnSeptember 6, 2002, the Orange County Superior Court sustained the Company’sdemurrer on the grounds that the plaintiffs’ Third Amended Compliant failed tostate a cause of action for either interference with contract or interferencewith prospective economic advantage against the Company.  The Court gave the plaintiffs twenty days toamend.

 

On September 25, 2002, the plaintiffs filed and served a Fourth AmendedComplaint on the Company alleging claims against the Company for breach offiduciary duty, breach of contract, intentional interference with prospectiveeconomic advantage, and intentional interference with contractual relations.  The plaintiffs’ prayer for relief on itsFourth Amended Compliant seeks the following: 1) an injunction prohibiting the defendants from commingling; 2)imposition of a constructive trust providing for liquidation of the assets ofthe partnerships and a distribution of the assets to the former limitedpartners therein; 3) a judicial declaration that the action may be maintainedas a class action; 4) monetary/compensatory damages; 5) plaintiffs’ costs ofsuit, including attorneys’, accountants’ and expert fees; and 6) a judicialorder of dissolution of the partnerships and appointment of a liquidatingtrustee.  The Company hasresponded by answer and asserted general and specific affirmative defenses tothe allegations in the Fourth Amended Complaint.

 

Teachout Matter

Reference is made to theCompany’s Annual Report on Form 10-K for 2001 for information with respect tothis matter.

 

Other Matters

Certain claims and lawsuits have arisen against the Company in itsnormal course of business. The Company believes that such claims and lawsuits willnot have a material adverse effect on the Company’s financial position, cashflow or results of operations.

 

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**ITEM 5.  OTHER INFORMATION**

 

Effective August 7, 2002, Thomas N. Thurber resignedas Chief Financial Officer and Secretary of the Company.  On August 9, 2002, the Company’s Board ofDirectors appointed William J. Carden, the Company’s Chairman, Chief ExecutiveOfficer and President, to serve as Acting Chief Financial Officer on an interimbasis.  Mr. Thurber has been appointedSenior Vice President Corporate Development of the Company.  Harry A. Mizrahi, Chief Operating Officer,was appointed Secretary.

 

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

 

(a)  Exhibits:

 

The Exhibit Index attached hereto is herebyincorporated by reference this item.

 

(b)  Reports on Form 8-K:

 

On August 12, 2002, a report on Form 8-K was filedwith respect to the Chief Executive Officer and Chief Financial OfficerCertification of the Company’s Form 10-Q for the quarterly period ended June30, 2002.

 

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**SIGNATURES**

 

Pursuant to the requirementsof Section l3 or l5(d) of the Securities Exchange Act of l934, the Registranthas duly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

**AMERICANSPECTRUM REALTY INC**

 

 
| *Date: November 11, 2002* | */s/ William J. Carden*  |                                             |
|---------------------------|--------------------------|--------------------------------------------------|
|                      | By:                      |                                             |   |   |
|                      |                     | William J. Carden                                |
|                      |                     | Chairman of the Board, President,                |
|                      |                     | Chief Executive Officer  and Acting              |
|                      |                     | Chief Financial Officer                          |
|                      |                     |                                             |
| *Date: November 11, 2002* | */s/ Patricia A. Nooney* |                                             |   |
|                      | By:                      |                                             |   |   |
|                      |                     | Patricia A. Nooney                               |
|                      |                     | Senior Vice President and Director of Accounting |
|                      |                     | (Principal Accounting  Officer)                  |

 

CERTIFICATION

 

I, William J.Carden, certify that

1. I havereviewed this quarterly report on Form 10-Q of American Spectrum Realty, Inc.;

2. Based on my knowledge, this quarterly report does not contain anyuntrue statement of a material fact or omit to state a material fact necessaryto make the statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the period covered by thisquarterly report,

3. Based on my knowledge, the financial statements, and other financialinformation included in this quarterly report, fairly present in all materialrespects the financial condition, results of operations and cash flows of theregistrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible forestablishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to filing date of thisquarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed,based on our most recent evaluation, to the registrant’s auditors and the auditcommittee of registrant’s board of directors (or persons performing theequivalent function):

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

 

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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: November 11, 2002 |
|-------------------------|
|                    |   |
|                    | */s/ William J. Carden* |   |   |
|                    |   |   |
|                    | William J. Carden |
|                    | Chief Executive Officer and Acting |
|                    | Chief Financial Officer |

 

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** |   | **Exhibit Title**                                                                                                       |
|-----------------|--------|-------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                    |
| 10.5            |   | Employment Agreement dated October 15, 2001  between the Company and William J. Carden                                  |
|            |   |                                                                                                                    |
| 99.1            |   | Certification  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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