** **

###### **UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-Q**

 

**(Mark One)**

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

 

**For the quarterly period endedSeptember 30, 2003**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE 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)                         |
|                                                                               |
|                                                                               |
| (Former name, former address and former  fiscal year, if changed since last report |

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ýNo o

 

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).  Yes o No ý

 

As of November 1, 2003,6,118,935 shares of Common Stock ($.01 par value) were outstanding.

 

 

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**TABLE OF CONTENTS**

 
| PART I  | FINANCIAL INFORMATION                                                                                                                                                          |
|---------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |                                                                                                                                                                           |
| Item 1  | Financial Statements                                                                                                                                                           |
|    | Consolidated Balance Sheets at September 30, 2003 (unaudited)  and December 31, 2002                                                                                 |
|    | Consolidated Statements of Operations for  the three months ended September 30, 2003 and 2002 and for the nine  months ended September 30, 2003 and 2002 (unaudited) |
|    | Consolidated Statement of Stockholders’  Equity for the nine months ended September 30, 2003 (unaudited)                                                             |
|    | Consolidated Statements of Cash Flows for  the nine months ended September 30, 2003 and 2002 (unaudited)                                                                  |
|    | Notes to Consolidated Financial Statements                                                                                                                                     |
| Item 2  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                                                    |
| Item 3  | Quantitative and Qualitative Disclosures  about Market Risk                                                                                                                    |
| Item 4  | Controls and Procedures                                                                                                                                                        |
|    |                                                                                                                                                                           |
| PART II | OTHER INFORMATION                                                                                                                                                              |
|    |                                                                                                                                                                           |
| Item 1  | Legal Proceedings                                                                                                                                                              |
| Item 6  | Exhibits and Reports on Form 8-K                                                                                                                                               |

 

2

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**PARTI.  FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIALSTATEMENTS**

 

**AMERICANSPECTRUM REALTY, INC.CONSOLIDATED BALANCE SHEETS**(Dollars inthousands, except per share amounts) 

 
|                                                                                                                                                                 |   | **September 30, 2003** |    | **December 31, 2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|----------------------------|--------|
|                                                                                                                                                                 |   | **(Unaudited)**             |    |                       |   |
| **ASSETS**                                                                                                                                                           |   |                        |    |                       |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| Real estate held for investment                                                                                                                                      |   | $                           | 200,102 |                       | $      | 194,257 |   |
| Accumulated depreciation                                                                                                                                             |   | 17,904                      |    | 10,684                     |   |
| Real estate held for investment, net                                                                                                                                 |   | 182,198                     |    | 183,573                    |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| Real estate held for sale                                                                                                                                            |   | —                      |    | 56,256                     |   |
| Cash and cash equivalents                                                                                                                                            |   | 3,464                       |    | 788                        |   |
| Tenant and other receivables (including  $271 from related party at September 30, 2003), net of allowance for  doubtful accounts of $194 and $201, respectively |   | 557                         |    | 401                        |   |
| Deferred rents receivable                                                                                                                                            |   | 743                         |    | 431                        |   |
| Deposits held in escrow                                                                                                                                              |   | 560                         |    | 279                        |   |
| Investment in management company                                                                                                                                     |   | 4,000                       |    | 4,000                      |   |
| Prepaid and other assets, net                                                                                                                                        |   | 10,442                      |    | 7,829                      |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| Total Assets                                                                                                                                                         |   | $                           | 201,964 |                       | $      | 253,557 |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                       |   |                        |    |                       |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| Liabilities:                                                                                                                                                         |   |                        |    |                       |   |
| Notes payable, net of premiums of $3,229  and $3,655, respectively (including $1,799 to related parties at  December 31, 2002)                                  |   | $                           | 147,184 |                       | $      | 145,367 |   |
| Notes payable, litigation settlement                                                                                                                                 |   | 9,750                       |    | 10,000                     |   |
| Liabilities related to real estate held for  sale (including $800 to related party at December 31, 2002)                                                        |   | —                      |    | 41,163                     |   |
| Accrued and other liabilities (including  $1,078 and $1,594, respectively, to related parties                                                                        |   | 7,400                       |    | 7,608                      |   |
| Deferred tax liability                                                                                                                                               |   | 6,082                       |    | 6,082                      |   |
| Accounts payable                                                                                                                                                     |   | 2,408                       |    | 2,624                      |   |
| Notes payable, former limited partners                                                                                                                               |   | 237                         |    | 237                        |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| Total Liabilities                                                                                                                                                    |   | 173,061                     |    | 213,081                    |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| Minority Interest                                                                                                                                                    |   | 8,176                       |    | 9,319                      |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| Commitments and Contingencies:                                                                                                                                       |   |                        |    |                       |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| Redeemable Common Stock                                                                                                                                              |   | —                      |    | 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, 6,136,617 and 5,536,990 shares, respectively                                                  |   | 61                          |    | 55                         |   |
| Additional paid-in capital                                                                                                                                           |   | 44,269                      |    | 41,809                     |   |
| Accumulated deficit                                                                                                                                                  |   | (21,925                     | )       | (9,168                     | )      |
| Receivable from principal stockholders                                                                                                                               |   | (1,191                      | )       | (1,188                     | )      |
| Deferred compensation                                                                                                                                                |   | (418                        | )       | (651                       | )      |
| Treasury stock, at cost, 17,682 shares at  September 30, 2003                                                                                                   |   | (69                         | )       | —                     |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| Total Stockholders’ Equity                                                                                                                                      |   | 20,727                      |    | 30,857                     |   |
|                                                                                                                                                                 |   |                        |    |                       |   |
| Total Liabilities and Stockholders’ Equity                                                                                                                      |   | $                           | 201,964 |                       | $      | 253,557 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

3

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**AMERICANSPECTRUM REALTY, INC.CONSOLIDATED STATEMENTS OF OPERATIONS**(Dollarsin thousands, except per share amounts)(Unaudited)

 
|                                                           |   | **Three Months Ended  September 30,** |   | **Nine Months Ended****September 30,** |   |
|----------------------------------------------------------------|--------|--------------------------------------------|--------|---------------------------------------------|--------|
|                                                           |   | **2003**                                   |   | **2002**                                    |   | **2003** |   | **2002** |   |
| **REVENUES:**                                                  |   |                                       |   |                                        |   |   |   |   |   |
| Rental revenue                                                 |   | $                                          | 6,631  |                                        | $      | 7,368 |   | $ | 20,200 |   | $ | 21,667 |   |
| Interest and other income                                      |   | 34                                         |   | 46                                          |   | 77 |   | 197 |   |
| Total revenues                                                 |   | 6,665                                      |   | 7,414                                       |   | 20,277 |   | 21,864 |   |
|                                                           |   |                                       |   |                                        |   |   |   |   |   |
| **EXPENSES:**                                                  |   |                                       |   |                                        |   |   |   |   |   |
| Property operating expense                                     |   | 3,153                                      |   | 3,081                                       |   | 8,647 |   | 8,168 |   |
| General and administrative                                     |   | 1,650                                      |   | 2,117                                       |   | 4,952 |   | 6,346 |   |
| Depreciation and amortization                                  |   | 2,523                                      |   | 2,367                                       |   | 7,360 |   | 6,708 |   |
| Interest expense                                               |   | 2,753                                      |   | 2,774                                       |   | 8,398 |   | 8,215 |   |
| Impairment of real estate asset                                |   | 3,500                                      |   | —                                      |   | 3,500 |   | — |   |
| Total expenses                                                 |   | 13,579                                     |   | 10,339                                      |   | 32,857 |   | 29,437 |   |
|                                                           |   |                                       |   |                                        |   |   |   |   |   |
| **OTHER INCOME:**                                              |   |                                       |   |                                        |   |   |   |   |   |
| Net gain on sales of real estate assets                        |   | —                                     |   | 69                                          |   | — |   | 153 |   |
| Net gain on extinguishment of debt                             |   | —                                     |   | —                                      |   | — |   | 38 |   |
| Total other income                                             |   | —                                     |   | 69                                          |   | — |   | 191 |   |
|                                                           |   |                                       |   |                                        |   |   |   |   |   |
| Net loss before minority interest and  discontinued operations |   | (6,914                                     | )      | (2,856                                      | )      | (12,580 | ) | (7,382 | ) |
|                                                           |   |                                       |   |                                        |   |   |   |   |   |
| Minority interest                                              |   | 930                                        |   | 336                                         |   | 1,845 |   | 806 |   |
|                                                           |   |                                       |   |                                        |   |   |   |   |   |
| Net loss before discontinued operations                        |   | (5,984                                     | )      | (2,520                                      | )      | (10,735 | ) | (6,576 | ) |
|                                                           |   |                                       |   |                                        |   |   |   |   |   |
| Discontinued operations:                                       |   |                                       |   |                                        |   |   |   |   |   |
| (Loss) income from discontinued operations                     |   | (153                                       | )      | (37                                         | )      | (301 | ) | 436 |   |
| Gain on sale of discontinued operations                        |   | 51                                         |   | —                                      |   | 2,279 |   | — |   |
| Impairment of real estate assets                               |   | —                                     |   | —                                      |   | (4,000 | ) | — |   |
| (Loss) income from discontinued operations:                    |   | (102                                       | )      | (37                                         | )      | (2,022 | ) | 436 |   |
|                                                           |   |                                       |   |                                        |   |   |   |   |   |
| Net loss                                                       |   | $                                          | (6,086 | )                                           | $      | (2,557 | ) | $ | (12,757 | ) | $ | (6,140 | ) |
|                                                           |   |                                       |   |                                        |   |   |   |   |   |
| Basic and diluted per share data:                              |   |                                       |   |                                        |   |   |   |   |   |
| Net loss before discontinued operations                        |   | $                                          | (0.97  | )                                           | $      | (0.45 | ) | $ | (1.83 | ) | $ | (1.19 | ) |
| (Loss) income from discontinued operations                     |   | (0.02                                      | )      | (0.01                                       | )      | (0.34 | ) | 0.08 |   |
| Net loss                                                       |   | $                                          | (0.99  | )                                           | $      | (0.46 | ) | $ | (2.17 | ) | $ | (1.11 | ) |
|                                                           |   |                                       |   |                                        |   |   |   |   |   |
| Basic weighted average shares used                             |   | 6,125,717                                  |   | 5,536,990                                   |   | 5,870,303 |   | 5,533,467 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

4

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**AMERICAN SPECTRUMREALTY INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY** (Dollars inthousands)(Unaudited)

 
|                                                           |   | **Common****Stock** |   | **Additional****Paid-In  Capital** |   | **Accumulated  Deficit** |   | **Deferred  Compensation** |    | **Treasury  Stock** |   | **Receivable****from  Principal  Stockholders** |   | **Total  Equity** |   |
|----------------------------------------------------------------|--------|---------------------|--------|------------------------------------|--------|--------------------------|--------|----------------------------|---------|---------------------|--------|-------------------------------------------------|--------|-------------------|--------|
|                                                           |   |                |   |                               |   |                     |   |                       |    |                |   |                                            |   |              |   |
| Balance, December 31, 2002                                |   | $                   | 55     |                               | $      | 41,809                   |   | $                          | (9,168  | )                   | $      | (651                                            | )      | $                 | — |   | $ | (1,188 | ) | $ | 30,857 |   |
| Issuance of common stock                                       |   | 1                   |   | 249                                |   | —                   |   | —                     |    | —              |   | —                                          |   | 250               |   |
| Conversion of debt into common stock                           |   | 5                   |   | 2,126                              |   | —                   |   | —                     |    | —              |   | —                                          |   | 2,131             |   |
| Conversion of operating partnership units  into common stock   |   | —              |   | 232                                |   | —                   |   | —                     |    | —              |   | —                                          |   | 232               |   |
| Acquisition of minority interest in the  operating partnership |   | —              |   | (147                               | )      | —                   |   | —                     |    | —              |   | —                                          |   | (147              | )      |
| Amortization of deferred compensation                          |   | —              |   | —                             |   | —                   |   | 233                        |    | —              |   | —                                          |   | 233               |   |
| Repurchase of common stock                                     |   |                |   |                               |   |                     |   |                       |    | (69                 | )      | —                                          |   | (69               | )      |
| Accrued interest on receivable from  principal stockholders    |   | —              |   | —                             |   | —                   |   | —                     |    | —              |   | (3                                              | )      | (3                | )      |
| Net loss                                                       |   | —              |   | —                             |   | (12,757                  | )      | —                     |    | —              |   | —                                          |   | (12,757           | )      |
| Balance, September 30, 2003                               |   | $                   | 61     |                               | $      | 44,269                   |   | $                          | (21,925 | )                   | $      | (418                                            | )      | $                 | (69    | ) | $ | (1,191 | ) | $ | 20,727 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

5

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**AMERICAN SPECTRUM REALTY, INCCONSOLIDATED STATEMENTS OF CASH FLOWS**(Dollars in thousands)(Unaudited)

** **
|                                                                         |   | **Nine Months Ended  September 30,** |    |
|------------------------------------------------------------------------------|--------|-------------------------------------------|---------|
|                                                                         |   | **2003**                                  |    | **2002** |   |
| **CASH FLOWS FROM  OPERATING ACTIVITIES:**                                   |   |                                      |    |   |   |
| Net loss                                                                     |   | $                                         | (12,757 | ) | $ | (6,140 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                                      |    |   |   |
| Loss (income) from discontinued operations                                   |   | 2,022                                     |    | (436 | ) |
| Depreciation and amortization                                                |   | 7,360                                     |    | 6,708 |   |
| Impairment of real estate asset                                              |   | 3,500                                     |    | — |   |
| Deferred rental income                                                       |   | (312                                      | )       | (256 | ) |
| Minority interest                                                            |   | (1,845                                    | )       | (806 | ) |
| Deferred compensation expense                                                |   | 233                                       |    | 730 |   |
| Amortization of loan premiums, included in  interest expense                 |   | (425                                      | )       | (441 | ) |
| Mark to market adjustment on interest rate  protection agreements            |   | 202                                       |    | 57 |   |
| Interest income on receivable from  principal stockholders                   |   | (39                                       | )       | — |   |
| Net gain on sales of real estate assets                                      |   | —                                    |    | (153 | ) |
| Net gain on extinguishment of debt                                           |   | —                                    |    | (38 | ) |
| Changes in operating assets and  liabilities:                                |   |                                      |    |   |   |
| Decrease in tenant and other receivables                                     |   | 96                                        |    | 961 |   |
| Increase in accounts payable                                                 |   | (58                                       | )       | (647 | ) |
| Increase in prepaid and other assets                                         |   | (2,051                                    | )       | (3,268 | ) |
| (Decrease) increase in accrued and other  liabilities                        |   | (100                                      | )       | 586 |   |
| Net cash used in operating activities:                                       |   | (4,174                                    | )       | (3,143 | ) |
|                                                                         |   |                                      |    |   |   |
| **CASH FLOWS FROM  INVESTING ACTIVITIES:**                                   |   |                                      |    |   |   |
| Proceeds received from sales of real estate  assets                          |   | 11,336                                    |    | 209 |   |
| Capital improvements to real estate assets                                   |   | (2,824                                    | )       | (3,336 | ) |
| Real estate acquisitions                                                     |   | (281                                      | )       | (268 | ) |
| Net cash provided by (used in) investing  activities:                        |   | 8,231                                     |    | (3,395 | ) |
|                                                                         |   |                                      |    |   |   |
| **CASH FLOWS FROM  FINANCING ACTIVITIES:**                                   |   |                                      |    |   |   |
| Proceeds from borrowings                                                     |   | 2,098                                     |    | 21,931 |   |
| Repayment of borrowings                                                      |   | (4,498                                    | )       | (16,366 | ) |
| Note payments to former limited partners                                     |   | —                                    |    | (2,055 | ) |
| Note payments on litigation settlement                                       |   | (250                                      | )       | — |   |
| Issuance of common stock to principal  stockholder                           |   | 250                                       |    | — |   |
| Repurchase of common stock                                                   |   | (69                                       | )       | (14 | ) |
| Acquisition of minority interest in the  operating partnership               |   | (223                                      | )       | — |   |
| Distributions to common stockholders                                         |   | —                                    |    | (1,110 | ) |
| Distributions to unitholders in the  operating partnership                   |   | —                                    |    | (145 | ) |
| Collection of advance to affiliate                                           |   | —                                    |    | 8 |   |
| Net cash (used in) provided by financing  activities:                        |   | (2,692                                    | )       | 2,249 |   |
|                                                                         |   |                                      |    |   |   |
| Cash from discontinued operations                                            |   | 1,311                                     |    | 2,831 |   |
|                                                                         |   |                                      |    |   |   |
| Increase (decrease) in cash                                                  |   | 2,676                                     |    | (1,458 | ) |
|                                                                         |   |                                      |    |   |   |
| Cash, beginning of period                                                    |   | 788                                       |    | 2,284 |   |
|                                                                         |   |                                      |    |   |   |
| Cash, end of period                                                          |   | $                                         | 3,464   |   | $ | 826 |   |
|                                                                         |   |                                      |    |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:**                      |   |                                      |    |   |   |
| Cash paid for interest                                                       |   | $                                         | 10,114  |   | $ | 10,119 |   |
| Cash paid for income taxes                                                   |   | —                                    |    | — |   |

 

6

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|                                                                                      |   | **Nine Months Ended  September 30,** |   |
|-------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                      |   | **2003**                                  |   | **2002** |   |
| **SUPPLEMENTAL  DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:**              |   |                                      |   |   |   |
| Assumptions of mortgage loans in  acquisition of real estate assets                       |   | $                                         | 6,077  |   | $ | 9,863 |   |
| Seller financing of acquired real estate  assets                                          |   | —                                    |   | 955 |   |
| Trust deed note receivable from disposition  of real estate asset                         |   | —                                    |   | 1,100 |   |
| Conversion of debt to related parties into  common stock                                  |   | 2,131                                     |   | — |   |
| Conversion of operating partnership units  into common stock                              |   | 232                                       |   | — |   |
| Issuance of operating partnership units in  acquisition of real estate asset              |   | 1,010                                     |   | — |   |
| Receivable from related party regarding  certain issues asserted by principal shareholder |   | 270                                       |   | — |   |
|                                                                                           |        |                                           |        |  |  |  |  |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

7

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**AMERICAN SPECTRUM REALTY, INC.Notes to Consolidated FinancialStatements**

### ** **

**NOTE1.  DESCRIPTION OF BUSINESS**

 

# **GENERAL**

# ** **

American Spectrum Realty,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. Substantially all of the Company’s assets are held through an operatingpartnership (the “Operating Partnership”) in which the Company, as ofSeptember 30, 2003, held a .89% general partner interest and an 85.74%limited partnership interest.  As ofSeptember 30, 2003, through its majority-owned subsidiary, the OperatingPartnership, the Company owned and operated 26 properties, which consisted of16 office, five industrial, three shopping center, and one apartment property,and one parcel of undeveloped land.  The26 properties are located in eight states.

 

During the first ninemonths of 2003, the Company sold nine properties, which consisted of twoapartment properties, one office property and six industrial properties, andacquired two office properties in Houston, Texas.  During 2002, the Company sold two shopping center properties andone apartment property, and purchased three office properties in the Houstonarea.  The property sales andacquisitions were part of the Company’s strategy to sell certain of itsproperties in its non-core markets and acquire additional properties in itscore property types and core geographic markets.  The Company will focus primarily on office and industrialproperties located in Texas, California and Arizona.

 

The Company is the solegeneral partner of the Operating Partnership. As the sole general partner of the Operating Partnership, the Companygenerally has the exclusive power to manage and conduct the business of theOperating Partnership under its partnership agreement.  The Company’s interest as a limited partnerin the Operating Partnership entitles it to share in any cash distributionsfrom, and in profits and losses of, the Operating Partnership.  If the Company receives any distributionsfrom the Operating Partnership, it will, in turn, pay dividends to its commonstockholders so that the amount of dividends paid on each share of common stockequals the amount of distributions paid on each limited partnership unit in theOperating Partnership (“OP Unit”).  Mostof the properties will be owned by the Operating Partnership through subsidiarylimited partnerships or limited liability companies.

 

Holdersof the OP Units have the option to redeem their units and to receive, at theoption of the Company, in exchange for each OP Unit (i) one share of CommonStock of the Company, or (ii) cash equal to the market value of one share ofCommon Stock of the Company at the date of conversion.

 

Management isreconsidering whether it is in the best interest of the Company to elect to betreated as a real estate investment trust (or REIT), as defined under theInternal Revenue Code of 1986, as amended. In the event such election is made, the election could be effective asearly as January 1, 2003 upon the filing of the appropriate forms for the2003 tax year.  In this regard, theCompany plans to operate in a manner that will permit it to elect REIT statusfor 2003.  In general, a REIT is acompany that owns or provides financing for real estate and pays annualdistributions 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.              Forthe tax year 2002, the Company was taxed as a C corporation.

 

## **CONSOLIDATIONTRANSACTION**

## ** **

In October 2001, the Company acquired various properties in aconsolidation transaction (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 Real Estate Company, Inc. (“CGS”) and itsaffiliates and acquired certain assets and liabilities of CGS and itsmajority-owned affiliates.  SierraPacific Pension Investors ‘84 (“SPPI84”), one of the eight public limitedpartnerships, was treated, for accounting purposes, as the acquirer of theproperties in the Consolidation.  Priorto the Consolidation, SPPI84’s activities involved the ownership and operationof two real estate properties in Arizona: Sierra Spectrum in Phoenix, Arizona and Sierra Valencia in Tucson,Arizona. Pursuant to the Consolidation, partners of the public partnershipsreceived shares in the Company or

 

8

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promissory notes in exchange for their partnership units, and owners ofexisting related entities exchanged ownership interests in real estate for ASRshares or units in the Operating Partnership, an entity formed for this purposeand initially wholly owned by the Company.

 

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

 

**BASIS OFPRESENTATION**

The accompanying unauditedconsolidated financial statements have been prepared pursuant to the rules andregulations of the SEC.  In the opinionof the Company, the accompanying interim unaudited consolidated financial statementscontain all material adjustments, consisting only of normal recurringadjustments necessary to present fairly the financial condition, the results ofoperations and changes in cash flows of the Company and its subsidiaries forinterim periods.

 

The results for such interimperiods are not necessarily indicative of results for a full year.  It is suggested that these consolidatedfinancial statements be read in conjunction with the consolidated financialstatements for the year ended December 31, 2002 and the related notesthereto included in the Company’s 2002 Annual Report on Form 10-K filed withthe SEC.

 

All significant intercompanytransactions, receivables and payables have been eliminated in consolidation.

 

**RECLASSIFICATION**

Certain prior year balanceshave been reclassified to conform with the current year presentation.                  In accordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”, which waseffective for the Company beginning January 1, 2002, real estatedesignated as held for sale subsequent to January 1, 2002 will beaccounted for in accordance with the provisions of SFAS No. 144 and the resultsof operations of these properties are included in income from discontinuedoperations.  Prior periods have beenreclassified for comparability, as required.

 

**USE OFESTIMATES**

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe results of operations during the reporting period. Actual results couldmaterially differ from those estimates.

 

**NEWACCOUNTING PRONOUNCEMENTS**

In May 2003, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 150*,*“Accounting for Certain FinancialInstruments with Characteristics of Both Liabilities and Equity” (“FAS 150”). * *FAS150 specifies that certain financial instruments within its scope constituteobligations of the issuer and that, therefore, the issuer must classify them asliabilities.  Such financial instrumentsinclude mandatorily redeemable financial instruments, obligations to repurchasethe issuer’s equity shares by transferring assets, and certain obligations toissue a variable number of shares.  SFASNo. 150 is effective immediately for all financial instruments enteredinto or modified after May 31, 2003. For all other instruments, FAS 150 is effective at the beginning ofthe third quarter of 2003.  The adoptionof FAS 150 did not have a material impact on the Company’s consolidatedfinancial position or results of operations.

 

In April 2003, theFASB issued SFAS No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities” (“FAS 149”).  FAS 149 amends and clarifies certain derivative instrumentsembedded in other contracts, and for hedging activities under SFASNo. 133.  FAS 149 is effectivefor certain contracts entered into or modified by the Company afterJune 30, 2003.  The adoption of FAS149 did not have a material impact on the Company’s consolidated financialposition or results of operations.

 

In December 2002,FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transitionand Disclosure” (“FAS 148”), which amended SFAS Statement No. 123, “Accountingfor Stock-Based Compensation” (“FAS 123”). FAS 148 provides alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation.  Additionally, FAS 148amends the disclosure requirements of FAS 123 to require prominent disclosuresin the annual and interim financial statements about the method of accountingfor stock-based employee compensation and the effect

 

9

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of the method used onreported results.  FAS 148 is effectivefor financial statements for fiscal years ending after December 15,2002.  In compliance with FAS 148, theCompany has elected to continue to follow the intrinsic value method inaccounting for its stock-based employee compensation arrangement as defined byAPB No. 25 “Accounting for Stock Issued to Employees”.

 

In November 2002, FASBissued Interpretation No. 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers” (“FIN 45”). FIN 45 requires a company, at the time it issues aguarantee, to recognize an initial liability for the fair value of obligationsassumed under the guarantee and elaborates on existing disclosure requirementsrelated to guarantees and warranties. The initial recognition requirements of FIN 45 are effective forguarantees issued or modified after December 31, 2002 and adoption of thedisclosure requirements are effective for financial statements ending afterDecember 15, 2002.  The adoption ofFIN 45 is not expected to have a significant impact on the Company’sconsolidated financial position or results of operations.

 

In July 2002, FASB issued SFAS No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities” (“FAS 146”).  FAS 146 requires companies to recognizecosts associated with exit or disposal activities when they are incurred ratherthan at the date of a commitment to an exit or disposal plan.  FAS 146 is to be applied prospectively toexit or disposal activities initiated after December 31, 2002.  The adoption of FAS 146 did not have amaterial impact on the Company’s consolidated financial position or results ofoperations.

 

**REAL ESTATE**

Rental properties are statedat cost, net of accumulated depreciation, unless circumstances indicate thatcost, net of accumulated depreciation, cannot be recovered, in which case thecarrying value of the property is reduced to estimated fair value.  Estimated fair value (i) is based upon theCompany’s plans for the continued operation of each property and (ii) iscomputed using estimated sales price, as determined by prevailing market valuesfor comparable properties and/or the use of capitalization rates multiplied byannualized net operating income based upon the age, construction and use of thebuilding.  The fulfillment of theCompany’s plans related to each of its properties is dependent upon, among otherthings, the presence of economic conditions which will enable the Company tocontinue to hold 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 from currentexpectations.

 

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

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

 

**CASHEQUIVALENTS**

Cash equivalents include allhighly liquid investments with a maturity of three months or less at the dateof purchase.

 

**FAIR VALUEOF FINANCIAL INSTRUMENTS**

The Company’s financialinstruments consist of cash and cash equivalents, escrow deposits, tenant andother receivables, notes payable, accounts payable and accrued expenses.  Management believes that the carrying valueof the Company’s financial instruments approximate their respective fair marketvalues at September 30, 2003 and December 31, 2002.

 

**DERIVATIVEFINANCIAL 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

 

10

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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 uses interestrate swaps to hedge against fluctuations in interest rates on specificborrowings.  As of September 30,2003, the Company had interest rate swap contracts in notional amounts ofapproximately $9,600,000, which expire in December 2004.  The interest rate swap contracts arereflected at fair value on the Company’s balance sheet in accrued and otherliabilities and the changes in the fair value of the hedge are recognized as adjustmentsto interest expense.  During the ninemonths ended September 30, 2003 and 2002, the Company recorded charges of$202,000 and $57,000, respectively, attributable to changes in the fair valueof its 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.

 

**DEFERREDFINANCING AND OTHER FEES**

Fees paid in connection withthe financing and leasing of the Company’s properties are amortized over theterm of the related note payable or lease and are included in other assets.

 

## **STOCK-BASED COMPENSATION**

The Financial AccountingStandards Board issued SFAS No. 123, “Accounting for Stock-Based Compensation”(“FAS 123”) in October 1995.  Thisstandard establishes a fair value approach to valuing stock options awarded toemployees as compensation. In December 2002, FASB issued SFAS No.148, “Accounting for Stock-Based Compensation - Transition and Disclosure”(“FAS 148”), which amended FAS 123.  FAS148 provides alternative methods of transition for a voluntary change to thefair value based method of accounting for stock-based employeecompensation.  Additionally, FAS 148amends the disclosure requirements of FAS 123 to require prominent disclosuresin the annual and interim financial statements about the method of accountingfor stock-based employee compensation and the effect of the method used onreported results.  FAS 148 is effectivefor financial statements for fiscal years ending after December 15,2002.  In compliance with FAS 148, theCompany has elected to continue to follow the intrinsic value method inaccounting for its stock-based employee compensation arrangement as defined byAPB No. 25 “Accounting for Stock Issued to Employees”.

 

The Companyhas in effect its Omnibus Stock Incentive Plan (the “Plan”), which is describedmore fully in its Form 10-K filed with the Securities and ExchangeCommission.  The Company haselected, as permitted by SFAS No. 123, to use the intrinsic value based methodof accounting for stock options consistent with Accounting Principles BoardOpinions No. 25, “Accounting for Stock Issued to Employees”.  The intrinsic value method measurescompensation cost for stock options as the excess, if any, of the quoted marketprice of the Company’s stock at the measurement date over the exerciseprice.  No stock-based employeecompensation cost is reflected in net income related to stock options, as alloptions granted under the Plan had an exercise price equal to the fair marketvalue of the underlying common stock on the date of grant.

 

The following tableillustrates the effect on net income (loss) and earnings per share if theCompany had applied the fair value recognition of the provisions of FAS 123 tostock-based employee compensation (thousands of dollars):

 
|                                                                                                                     |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                                     |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
| Net  loss, as reported                                                                                                   |   | $                                          | (6,086 | )                                         | $      | (2,557 | ) | $ | (12,757 | ) | $ | (6,140 | ) |
| Deduct:  Employee compensation expense for stock  option grants under fair value method, net of related tax effects |   | (68                                        | )      | (35                                       | )      | (212 | ) | (427 | ) |
| Pro  forma net loss                                                                                                      |   | $                                          | (6,154 | )                                         | $      | (2,592 | ) | $ | (12,969 | ) | $ | (6,567 | ) |
|                                                                                                                     |   |                                       |   |                                      |   |   |   |   |   |
| Per  share data:                                                                                                         |   |                                       |   |                                      |   |   |   |   |   |
| Basic  and diluted, as reported                                                                                          |   | $                                          | (.99   | )                                         | $      | (0.46 | ) | $ | (2.17 | ) | $ | (1.11 | ) |
| Basic  and diluted, proforma                                                                                             |   | $                                          | (1.00  | )                                         | $      | (.47 | ) | $ | (2.21 | ) | $ | (1.19 | ) |

# ** **

11

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# **MINORITY INTEREST**

Unit holders in the Operating Partnership (other thanthe Company) held a 13.37% and 11.60% limited partnership interest in theOperating Partnership at September 30, 2003 and December 31, 2002,respectively.  Each of the holders ofthe interests in the Operating Partnership (other than the Company) has theoption (exercisable after the first anniversary of the issuance of the OP Units)to redeem its OP Units and to receive, at the option of the Company, inexchange for each OP Unit, either (i) one share of Common Stock of the Company,or (ii) cash equal to the value of one share of Common Stock of the Company atthe date of conversion.

 

**RENTALREVENUE**

Certain leases provide fortenant occupancy during periods for which no rent is due or where minimum rentpayments increase during the term of the lease.  The Company records rental income for the full term of each leaseon a straight-line basis.  Accordingly,a receivable is recorded from tenants equal to the excess of the amount thatwould have been collected on a straight-line basis over the amount collectedand currently due (Deferred Rent Receivable). When a property is acquired, the term of existing leases is consideredto commence as of the acquisition date for purposes of this calculation.

 

The Company’s portfolio ofleases turns over continuously, with the number and value of expiring leasesvarying from year to year.  The Company’sability to re-lease the space to existing or new tenants at rates equal to orgreater than those realized historically is impacted by, among other things,the economic conditions of the market in which a property is located, theavailability of competing space, and the level of improvements which may berequired at the property. No assurance can be given that the rental rates thatthe Company will obtain in the future will be equal to or greater than thoseobtained under existing contractual commitments.

 

# **NET LOSS PER SHARE**

Netloss per share is calculated based on the weighted average number of commonshares outstanding.  Stock optionsoutstanding of 224,500 at September 30, 2003 and OP Units (other thanthose held by the Company) outstanding of 945,139 at September 30, 2003have not been included in the net loss per share calculation since their effectwould be antidilutive.

 

**INCOMETAXES**

In preparing the Company’sconsolidated financial statements, management estimates the income tax in eachof the jurisdictions in which the Company operates.  This process includes an assessment of current tax expense, theresults of tax examinations, and the effects of temporary differences resultingfrom the different treatment of transactions for tax and financial accountingpurposes.  These differences may resultin deferred tax assets or liabilities which are included in the consolidatedbalance sheet.  The realization ofdeferred tax assets as a result of future taxable income must be assessed andto the extent that the realization is doubtful, a valuation allowance isestablished.  The Company’s income taxprovision is based on calculations and assumptions that will be subject toexamination by the taxing authorities in the jurisdictions in which the Companyoperates.  Should the actual resultsdiffer from the Company’s estimates, the Company would have to adjust theincome tax provision in the period in which the facts and circumstances thatgive rise to the revision become known. Tax law and rate changes are reflected in the income tax provision inthe period in which such changes are enacted.

 

## **NOTE 3.  REALESTATE**

## ** **

# **ACQUISITIONS**

On July 30, 2003, theCompany acquired an office property from an affiliated entity.  The property is located in Houston, Texasand consists of approximately 44,036 rentable square feet.  Acquisition costs of approximately$2,900,000 included the assumption of existing debt, a deferred payment of$183,734 and the issuance of 104,465 OP Units.

 

On May 7, 2003, theCompany acquired an office property from an affiliated entity.  The property is located in Houston, Texasand consists of approximately 59,550 rentable square feet.  Acquisition costs of approximately$4,310,000 included the assumption of existing debt, a deferred payment of $343,228,of which $280,700 was paid in July 2003, and the issuance of 141,268 OPUnits.

 

12

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On August 28, 2002, theCompany acquired an office property in Houston, Texas consisting ofapproximately 46,821 rentable square feet. Acquisition costs of approximately $1,387,000 primarily included theassumption of existing debt with the remainder in cash.

 

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

 

## **DISPOSITIONS**

On September 30,2003, the Company sold Emerald Pointe, a 366-unit apartment property located inTexas for $10,100,000.

 

On September 12,2003, the Company sold two properties: Park Plaza, a 95,080 square foot industrial property located in Indiana,was sold for $3,225,000; and Oak Grove Commons, a 137,678 square footindustrial property located in Illinois, was sold for $5,921,000.

 

On July 18, 2003,the Company sold Northeast Commerce Center, a 100,000 square foot industrialproperty located in Ohio, for $4,771,000.

 

On July 9, 2003, theCompany sold three properties: Northcreek, a 92,282 square foot office propertylocated in Ohio, was sold for $5,620,000; Business Center, a 64,387 square footindustrial property located in Missouri, was sold for $3,655,000; and Jackson,a 320,000 square foot industrial property in Indiana, was sold for $4,000,000.

 

These seven propertiessold during the third quarter of 2003 produced net proceeds of approximately$7,211,000, of which $560,000 is being held in escrow as a source to facilitatethe funding of a future acquisition in a tax-deferred exchange.  The sales generated a third quarter net gainof approximately $51,000, which is reflected as discontinued operations in theconsolidated statements of operations. The net gain was after taking into consideration an impairment chargetotaling $4,000,000 recorded in the second quarter of 2003 related to three ofthe seven properties.

 

On April 10, 2003,the Company sold an 82,560 square foot industrial property in Arizona for$4,100,000.  On May 15, 2003, theCompany sold a 125-unit apartment property in California, for $12,500,000.  These two transactions produced net proceedsof $4,685,000 and generated a second quarter gain of $2,228,000.  The gain is reflected as discontinuedoperations in the consolidated statements of operations.

 

On October 15, 2002,the Company sold a 72,149 square foot shopping center in Missouri for$3,800,000 (“Maple Tree”).  OnOctober 11, 2002, the Company sold a 152-unit apartment property inCalifornia, for $8,300,000 (“Creekside Apartments”).  Total net sales proceeds of $279,000, which were held in escrowat June 30, 2003 and December 31, 2002, were received inApril 2003.

 

In July 2002, theCompany received compensation of $150,000 for a strip of land condemned forhighway purposes on an office property in Illinois.

 

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 on the sale date and a$1,100,000 trust deed note from the buyer. The note, which contained a $200,000 early pay-off discount, was paid inOctober 2002 with the receipt of $900,000 from the buyer.

 

# **IMPAIRMENT OF REAL ESTATEHELD FOR INVESTMENT**

Duringthe third quarter of 2003, the Company recorded an impairment charge of$3,500,000 on an office property in Leawood, Kansas.  The impairment was based on an estimated decrease in the fairmarket value of the property.  On October 31,2003, the property sold for $3,020,000. The sale generated net proceeds of approximately $184,000.

 

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## **NOTE 4. DISCONTINUED OPERATIONS**

## ** **

*Real estate assets held for sale*.

 

As of December 31, 2002, nine properties were classified as “Realestate held for sale”. These nine properties were sold during the second andthird quarters of 2003.  The properties,located in seven states, consisted of six industrial properties, two apartmentproperties and one office property.  Theindustrial and office properties had an aggregate rentable square footage ofapproximately 892,000 and the apartment properties consisted of 491 totalunits.  The transactions generated netproceeds of approximately $11,896,000, of which $560,000 is being held in escrowas a source to facilitate the funding of a future acquisition in a tax-deferredexchange.

 

The carrying amounts of the nine properties classified as “Real estateheld for sale” at December 31, 2002 are summarized below (dollars inthousands).

 
| **Condensed  Consolidated Balance Sheet**             |   | **December 31, 2002** |   |
|-------------------------------------------------------|--------|----------------------------|--------|
|                                                  |   |                       |   |
| Real estate                                           |   | $                          | 54,411 |   |
| Other                                                 |   | 1,845                      |   |
| Real estate assets held for sale                      |   | $                          | 56,256 |   |
|                                                  |   |                       |   |
| Notes payable, net (including $800 to  related party) |   | $                          | 39,025 |   |
| Accounts payable                                      |   | 525                        |   |
| Accrued and other liabilities                         |   | 1,613                      |   |
| Liabilities related to real estate held for  sale     |   | $                          | 41,163 |   |

 

All real estate assets held by the Company on September 30, 2003are considered assets held for investment. No real estate was classified as held for sale by the Company atSeptember 30, 2003.

 

*Net income (loss) from discontinuedoperations.*

 

Net loss from discontinued operations for the three and nine monthsended September 30, 2003 includes the operations of the nine propertiessold during the second and third quarters of 2003.  The seven properties sold during the third quarter of 2003generated a net gain on sale of discontinued operations of $51,000.  The nine properties sold during the ninemonths ended September 30, 2003 generated a net gain on sale of discontinuedoperations of $2,279,000.  Thenet gain recognized for the third quarter and nine months was after taking intoconsideration an impairment charge totaling $4,000,000 recorded in the secondquarter of 2003 related to three of the seven properties.  The impairment was based on the anticipatedsales price less cost to sell as compared to the carrying value of the assets.

 

The condensed consolidated statements of operations of discontinuedoperations are summarized below (dollars in thousands):

 
| **Condensed  Consolidated Statements of Operations**                          |   | **Three Months Ended  September 30, 2003** |   | **Nine Months Ended  September 30, 2003** |   |
|-------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|------------------------------------------------|--------|
| Rental revenue                                                                |   | $                                               | 893    |                                           | $      | 5,239 |   |
| Total expenses                                                                |   | 1,046                                           |   | 5,540                                          |   |
| Net loss from discontinued operations  before net gain on sale and impairment |   | (153                                            | )      | (301                                           | )      |
| Net gain on sale of discontinued operations                                   |   | 51                                              |   | 2,279                                          |   |
| Impairment of real estate assets held for  sale                               |   | —                                          |   | (4,000                                         | )      |
| Net loss from discontinued operations                                         |   | $                                               | (102   | )                                              | $      | (2,022 | ) |

 

Net income (loss) from discontinued operations for the three and ninemonths ended September 30, 2002 includes the operations of the nineproperties sold during the nine months ended September 30, 2003 and theoperations of Maple Tree and Creekside Apartments, which were sold in thefourth quarter of 2002.

 

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**Condensed Consolidated Statements ofOperations**

 
|                                                   |   | **Three Months Ended  September 30, 2002** |   | **Nine Months Ended  September 30, 2002** |   |
|--------------------------------------------------------|--------|-------------------------------------------------|--------|------------------------------------------------|--------|
| Rental revenue                                         |   | $                                               | 2,938  |                                           | $      | 8,798 |   |
| Total expenses                                         |   | 2,944                                           |   | 8,173                                          |   |
| Loss on early extinguishment of debt                   |   | —                                          |   | (91                                            | )      |
| Minority interest related to partially  owned property |   | (31                                             | )      | (98                                            | )      |
| Net (loss) income from discontinued  operations        |   | $                                               | (37    | )                                              | $      | 436 |   |

 

**NOTE5.  NOTES PAYABLE, NET OF PREMIUMS**

 

The Company had the following mortgage loans, banklines, and notes payable outstanding related to continuing operations as ofSeptember 30, 2003 and December 31, 2002 (dollars in thousands):

 
|                                                                                                                                                                                                                                                                                                                                                                                                  |   | **2003** |    | **2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Secured loans with various lenders, net of unamortized premiums of  $3,229 at September 30, 2003 and $3,655 at December 31, 2002, bearing  interest at fixed rates between 5.00% and 12.00%, with monthly principal and  interest payments ranging between $3 and $269 at September 30, 2003 and  December 31, 2002, and maturing at various dates through August 11,  2012. |   | $        | 117,356 |     | $      | 112,385 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Secured  loans with various banks bearing interest at variable rates ranging between  5.12% and 9.00% at September 30, 2003 and 5.38% and 9.00% at  December 31, 2002, and maturing at various dates through May 1,  2008.                                                                                                                                                             |   | 16,799   |    | 17,718   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Secured Series A & B Bonds with a fixed interest rate of 6.39%,  monthly principal and interest payments of $74, maturing June 30, 2031.                                                                                                                                                                                                                                                     |   | 11,570   |    | 11,679   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Secured  Series C Bonds with a fixed interest rate of 9.50%, semi-annual principal and  interest payments of $101, maturing November 1, 2006.                                                                                                                                                                                                                                                    |   | 475      |    | 645      |   |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Unsecured  loans with various lenders, bearing interest at fixed rates between 5.65% and  20.00% at September 30, 2003 and 8.00% and 20.00% at December 31,  2002, and maturing at various dates through October 1, 2004.                                                                                                                                                              |   | 984      |    | 1,083    |   |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Unsecured  loan, non-interest bearing, which matured January 1, 2003.  The loan was paid in April 2003.                                                                                                                                                                                                                                                                                |   | —   |    | 58       |   |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Unsecured loan with Brown Parker and Leahy, LLP, a law firm in which  Timothy R. Brown, a director of the Company, was a partner.  The loan, which bore interest at prime,  was exchanged for stock in May 2003.                                                                                                                                                                            |   | —   |    | 199      |   |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Unsecured loan with John N. Galardi, a director and principal  stockholder, with a fixed interest rate of 8.00%, payable on demand.  The loan was exchanged for stock in  May 2003.                                                                                                                                                                                                         |   | —   |    | 1,600    |   |
|                                                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Total                                                                                                                                                                                                                                                                                                                                                                                                 |   | $        | 147,184 |     | $      | 145,367 |   |

 

Debt premiums are amortized into interest expense over the terms of therelated mortgages using the effective interest method.  As of September 30, 2003 andDecember 31, 2002, the unamortized debt premiums included in the aboveschedule were $3,229,000 and $3,655,000, respectively.

 

InSeptember 2003, a note payable in the amount of $510,000 was repaid withthe proceeds from the sale of Emerald Pointe. The note bore interest at prime plus 1%.

 

InAugust 2003, the Company refinanced a $1,300,000 loan secured by VanBuren, a parcel of undeveloped land, and entered into a new two-year loanagreement in the amount of $1,340,000. The new loan bears interest at a fixed rate of 12% per annum and maturesAugust 1, 2005.

 

InJuly 2003, through the acquisition of an office property in Houston,Texas, the Company assumed a loan in the amount of $1,723,000.  The loan bears interest at a fixed rate of7.41% per annum and matures in May 2012. The Company also entered into an agreement that provided for sellerfinancing of $710,000, bearing interest at a fixed rate of 7.41% per annum andmaturing in July 2005.

 

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InMay 2003, through the acquisition of an office property in Houston, Texas,the Company assumed a loan in the amount of $3,180,000.  The loan bears interest at a fixed rate of6.80% per annum and matures in August 2012.  The Company also entered into an agreement that provided forseller financing of $464,000, bearing interest at a fixed rate of 6.80% perannum and maturing in May 2005.

 

InMay 2003, the successor of Brown Parker and Leahy, LLP cancelled its$199,180 note, plus $45,891 of accrued interest thereon, in exchange for aprivate placement of 59,773 shares of the Company’s common stock.

 

In May 2003, John N. Galardi cancelled his $1,600,000 note, plus$286,036 of accrued interest thereon, in exchange for a private placement of460,009 shares of the Company’s common stock.

 

In May 2003, theCompany financed insurance premiums of $643,000 on its properties and agreed topay a service fee of $85,000 over one year. The insurance premium note matures in February 2004.

 

In December 2002, modification agreements were entered into with abank to extend the maturity on five secured loans to December 31,2004.  Three of these loans were repaidin the third quarter of 2003 in connection with property sales.  The balance of the two remaining loanstotaled $9,615,000 as of September 30, 2003.

 

In December 2002, the Company entered into an $830,000 loan onValencia, one of its industrial properties.              $800,000 was funded in December 2002and $30,000 in March 2003.  Theloan was provided by an affiliate of a related party.  The mortgage was repaid in April 2003 upon the sale of theproperty.

 

In October 2002, the Company received proceeds of $1,532,000 fromtwo bridge loans on Maple Tree, one of its shopping center properties.  One of the loans, which totaled $700,000,was provided by an affiliate of a related party.  The mortgages were repaid upon the sale of the property inOctober 2002.

 

In August 2002, through the acquisition of an office property inHouston, Texas, the Company assumed a loan in the amount of $1,213,000.  The loan bears interest at a fixed rate of7.29% and matures in April 2005.

 

In July 2002, the lender for the loan agreement related to theSouth Carolina shopping center properties notified the Company it wastechnically in default under its loan agreement for non-compliance with certaincovenants, including covenants requiring improvements to shopping centerproperties.  Thereafter, the lendernotified the Company it was in default for failure to pay a matured portion ofthe loan, which matured in November 2002. As of September 30, 2003, the amount due under the matured portionof the loan was $2,929,000 and the aggregate principal balance of the loanagreement was $6,591,000.  In early2003, the lender sold the loan to the major tenant in two of the shoppingcenters.  The Company is working withthe new lender and a potential purchaser of one of the properties.  The lender has orally agreed to use theproceeds from the proposed sale of the property to pay off the maturedloan.  The Company and the lender arenegotiating how the remainder of the proceeds will be applied.  The Company continues to discuss thenon-compliance matter with the new lender. The new lender has not acceleratedthe loan.

 

# **In May 2002, through theacquisition of two office properties in Houston, Texas, the Company assumed twoloans totaling $8,650,000.  The loansbear interest at a fixed rate of 7.45% per annum and mature in May 2012.**                    The Company also entered into an agreement whichprovided for seller financing of $955,000, bearing interest at a fixed rate of7.45% per annum and maturing in May 2004.

# ** **

In May 2002, theCompany refinanced a $1,452,000 loan secured by Southwest Pointe, an industrialproperty, and entered into a new loan agreement in the amount of$2,950,000.  The new loan bears interestat a fixed rate of 7.33% per annum and matures in June 2012.  Net proceeds of $1,297,000 were received asa result of the refinancing.

 

In May 2002, theCompany refinanced a $1,346,000 loan secured by Leawood Fountain Plaza, anoffice property, and entered into a new one-year loan agreement in the amountof $3,000,000.  The new loan bearsinterest at Libor plus 2.85% with a minimum of 5.75% per annum (5.75% atSeptember 30, 2003).

 

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Net proceeds of $1,026,000were received as a result of the refinancing. The loan, which matured in June 2003, was extended toDecember 1, 2003 during the third quarter of 2003.

 

In May 2002, theCompany financed insurance premiums of $859,000 on its properties.  Other insurance premiums totaling $277,000were financed during 2002.  The debt waspaid in full in 2003.

 

In April 2002, theCompany refinanced a $3,650,000 loan secured by Oak Grove Commons, anindustrial property, and entered into a new loan agreement in the amount of$4,314,000.  Net proceeds of $383,000were received as a result of the refinancing.  The new loan, which bore interest at a fixed rate of 7.61% perannum, was repaid in September 2003 upon the sale of the property.

 

In March 2002, theCompany refinanced a $2,750,000 loan partially secured by Countryside OfficePark and entered into a new loan agreement in the amount of $5,025,000.  The new loan bears interest at a fixed rateof 7.38% per annum and matures in March 2012.  Net proceeds of $1,887,000 were received as a result of therefinancing.

 

In January 2002, the Company refinanced a$4,500,000 loan partially secured by Northcreek and entered into a new loanagreement in the amount of $5,625,000. Net proceeds of $639,000 were received as a result of therefinancing.  The new loan, which boreinterest at a fixed rate of 7.58% per annum, was repaid in July 2003 uponthe sale of the property.

 

# **NOTES PAYABLE,LITIGATION SETTLEMENT**

As the result of thesettlement of the Teachout matter, which was documented in the third quarter of2003, the Company reaffirmed its previously announced obligation to pay theformer limited partners of Sierra Pacific Development Fund II as of the date ofthe Consolidation, or their assignees or transferees, the loans which were madeand called by the former general partner of Sierra Pacific Development Fund IIas part of the Consolidation.  Pursuantto the settlement, the Company established a repayment plan and secured thedebt with a second deed of trust on an office property owned by theCompany.  This repayment plan consistsof a promissory note in the amount of $8,800,000, which bears interest at 6%per annum and matures in March 2006. Interest-only payments, which are payable quarterly, commencedJune 2, 2003.  The note may beprepaid in whole or in part at any time without penalty.

 

As part of the settlement,the Company agreed to pay legal fees totaling $1,200,000 to the plaintiff’scounsel.  The Company made a scheduledpayment of $250,000 in the third quarter of 2003 with the remaining $950,000consisting of two promissory notes.  Thefirst note, in the amount of $700,000, bears interest at 6% per annum andmatures in March 2006. Interest-only payments, which are payable quarterly, commencedJune 2, 2003.           The second promissory note, in the amount of$250,000, bears no interest and matures in March 2006.  The notes, which are secured by a seconddeed of trust on an office property owned by the Company, may be prepaid inwhole or in part at any time without penalty.

 

In connection with the agreement, John N. Galardi, a director andprincipal stockholder of the Company, and William J. Carden, a director and theChairman, President and Chief Executive Officer of the Company, acknowledged thatthey owe the Company the sum of $1,187,695 as indemnification against a portionof the Company’s settlement obligation. Mr. Galardi and certain affiliates of Mr. Carden and/or Mr. Galardi arebeneficiaries, in part, of the settlement of the Teachout matter and are owedan amount in excess of this obligation pursuant to that settlement.  Mr. Galardi and Mr. Carden have agreed topay the Company the principal sum of this obligation, plus interest thereon atthe annual rate of 6% from March 15, 2003, in the form of an assignment tothe Company of their right to receive $1,187,695 of principal payments on thenotes payable to them and their affiliates by reason of the settlement of theTeachout matter, plus all interest payable on such principal amount of notes.  The receivable of $1,187,695 and accruedinterest are reflected as a component of equity in the Company’s consolidatedfinancial statements.  The interest dueon the receivable was offset against a payable to an affiliated entity.

 

# **NOTES PAYABLE, FORMERLIMITED PARTNERS**

Limited partners of theeight public limited partnerships who voted against the Consolidation had theoption of electing to receive notes instead of ASR shares.  The notes, which totaled $2,291,671, boreinterest at 5.92% per annum and matured 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 the

 

17

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option of the Company, inwhole or from time to time in part, at a redemption price equal to the sum ofthe principal amount of the notes being redeemed plus accrued interest thereonto the redemption date.  During 2002,$2,055,049 of the notes, plus accrued interest, was paid.  The principal balance of the notes as ofSeptember 30, 2003 was $236,622. In October 2003, the balance of the notes, plus accrued interest,was paid.

 

## **NOTE 6. MINORITY INTEREST**

## ** **

Unit holders in the Operating Partnership (other thanthe Company) held a 13.37% and 11.60% limited partnership interest in theOperating Partnership at September 30, 2003 and December 31, 2002,respectively.  Each of the holders ofthe interests in the Operating Partnership (other than the Company) has theoption (exercisable after the first anniversary of the issuance of the OPUnits) to redeem its OP Units and to receive, at the option of the Company, inexchange for each OP Unit, either (i) one share of Common Stock of the Company,or (ii) cash equal to the value of one share of Common Stock of the Company atthe date of conversion.

 

In July 2003, the Company purchased 7,329 OPUnits from Nooney Development Partners, L.P. for $223,000 pursuant to anagreement entered into at the time of the Consolidation.

 

During the nine months ended September 30, 2003,the Company issued a total of 245,733 OP Units to an affiliated entity inconnection with the acquisition of two office properties in Houston, Texas.

 

During the nine months ended September 30, 2003, a total of 18,870OP Units were exchanged for an equivalent number of shares of Common Stock.

 

# **NOTE 7.  REDEEMABLE COMMON STOCK**

# ** **

On October 23, 2001,the Company issued 20,000 shares of its Common Stock, $.01 par value per share,with the holder’s right to compel the sale of (the “Put”) the stock back to theCompany at a fixed price of $15.00 per share during the period fromOctober 31, 2002 to November 30, 2002.  On November 26, 2002, the Company and holder agreed toextend the put exercise period to May 30, 2003 through June 30, 2003.  In May 2003, the Company receivednotice that the holder exercised its right to sell the Common Stock back to theCompany for $15.00 per share or a total of $300,000.  The Company and holder have agreed to the following paymentschedule:  $100,000 on November 29,2003; and $200,000 on February 28, 2004.

 

**NOTE 8.  REPURCHASE OFCOMMON STOCK**

 

InMay 2003, the Company’s Board of Directors authorized the repurchase of upto 300,000 shares of its common stock from the proceeds of property sales.  Such purchases would be made from time totime in open market transactions.

 

Duringthe third quarter of 2003, the Company repurchased a total of 17,500 shares atan average price of $3.69 per share in open market transactions.  The total cost of the stock repurchasesamounted to $66,310.

 

Pursuant to the settlement of the Teachout litigation (see Note 11),the Company repurchased 182 shares from a former limited partner of SierraPacific Development Fund II for $2,457, or $13.50 per share, during the thirdquarter of 2003.

 

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

## ** **

In October 2003 and July 2003, the Company made payments of$600,000 and $400,000, respectively, on its indebtedness to an affiliatedentity, reducing the balance due to $313,854, inclusive of the balance remainingon the deferred payments mentioned below.

 

In October 2003, the Company acquired an office property from anaffiliated entity.  The property islocated in Houston, Texas and consists of approximately 57,156 rentable squarefeet.  Acquisition costs of approximately$3,500,000 were funded with a new mortgage loan, the assumption of existingdebt, the issuance of 121,591 OP Units, a deferred payment of $6,740 and cash.

 

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In July 2003, theCompany acquired an office property from an affiliated entity.  The property is located in Houston, Texasand consists of 44,036 rentable square feet. Acquisition costs of approximately $2,900,000 included the assumption ofexisting debt, a deferred payment of $183,734 and the issuance of 104,465 OPUnits.

 

In May 2003, theCompany acquired an office property from an affiliated entity.  The property is located in Houston, Texasand consists of 59,550 rentable square feet. Acquisition costs of approximately $4,310,000 included the assumption ofexisting debt, a deferred payment of $343,228, of which $280,700 was paid inJuly 2003, and the issuance of 141,268 OP Units.

 

InMay 2003, the successor of Brown Parker and Leahy, LLP cancelled its$199,180 note, plus $45,891 of accrued interest thereon, in exchange for aprivate placement of 59,773 shares of the Company’s common stock.  Timothy Brown, a director of the Company,was a partner of Brown Parker Leahy, LLP.

 

In May 2003, John N. Galardi, a director and principal stockholderof the Company, cancelled his $1,600,000 note, plus $286,036 of accruedinterest thereon, in exchange for a private placement of 460,009 shares of theCompany’s common stock.

 

In May 2003, Mr. Galardi purchased a total of 60,975 shares of theCompany’s common stock for $4.10 per share.

 

In February 2003, the Company reached an agreement with CGS RealEstate Company, Inc. whereby CGS acknowledged that it owed the Company a netamount of $270,375 which related to several issues asserted by Mr. Carden thatwere owed by CGS to the Company and by the Company to CGS.  This amount is payable on March 15,2006 with interest accruing from March 15, 2003 at an annual rate of 6%and payable quarterly commencing on June 15, 2003.  Mr. Carden is a principal stockholder, anofficer and a director of CGS.  Mr.Carden and Mr. Galardi have agreed to guarantee this obligation of CGS, andthey have secured this guarantee with an assignment to the Company of theirright to receive $270,375 of principal payments on the notes payable to themand their affiliates by reason of the settlement of the Teachout litigation,plus all interest payable on such principal amount of notes.

 

In connection with the settlement of the Teachout litigation, Mr.Galardi and Mr. Carden acknowledged that they owe the Company the sum of$1,187,695 as indemnification against a portion of the Company’s settlementobligation.  Mr. Galardi and certainaffiliates of Mr. Carden and/or Mr. Galardi are beneficiaries, in part, of thesettlement of the Teachout matter and are owed an amount in excess of thisobligation pursuant to that settlement. Mr. Galardi and Mr. Carden have agreed to pay the Company the principalsum of this obligation, plus interest thereon at the annual rate of 6% fromMarch 15, 2003, in the form of an assignment to the Company of their rightto receive $1,187,695 of principal payments on the notes payable to them andtheir affiliates by reason of the settlement of the Teachout matter, plus allinterest payable on such principal amount of notes.  The receivable of $1,187,695 and accrued interest are reflectedas a component of equity in the Company’s consolidated financialstatements.  The interest due on the receivablewas offset against a payable to an affiliate.

 

Effective January 1, 2002, the Company acquired a receivable inthe amount of $177,000 from a related party in connection with the Company’sassumption of an executive suite in an office building owned by theCompany.  The Company cancelled thisreceivable by offsetting the amount of the receivable against the amountpayable by the Company to an entity owned by the related party.

 

Duringthe first quarter of 2002, the Company made payments totaling $521,808 on itsobligation to ASJ, Ltd., which is owned by Mr. Carden, his wife and a trust forhis children.  These payments reducedthe balance due to ASJ, Ltd. to $200,000 as of September 30, 2003.

 

**NOTE 10.  SEGMENTINFORMATION**

 

As of September 30,2003, the Company owned a diverse portfolio of properties comprising office,industrial, shopping center properties, an apartment property, and a parcel ofundeveloped land.  Each of theseproperty types represents a reportable segment with distinct uses and tenanttypes and requires the

 

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Company to employ differentmanagement strategies.  The propertiescontained in the segments are located in various regions and markets within theUnited States.  The office portfolioconsists primarily of suburban office buildings.  The industrial portfolio consists of properties designed forwarehouse, distribution and light manufacturing for single-tenant ormulti-tenant use.  The shopping centerportfolio consists of community shopping centers located in SouthCarolina.  The Company’s sole remaining apartmentproperty is located in Missouri and is rented to residential tenants on eithera month-by-month basis or for terms generally of one year or less.

 

The accounting policies ofthe segments are the same as those described in the summary of significantaccounting policies.  The Companyevaluates performance of its property types based on net operating incomederived by subtracting property operating expenses from rental revenue.  Significant information used by the Companyfor its reportable segments as of and for the three months and nine monthsended September 30, 2003 and 2002 is as follows (dollars in thousands):

 

 
| **Three  Months Ended September 30,** |   | **Office** |    | **Industrial** |   | **Shopping  Center** |   | **Apartment** |   | **Undeveloped  Land and  Other** |   | **Property  Total** |   |
|--------------------------------------------|--------|------------|---------|----------------|--------|----------------------|--------|---------------|--------|----------------------------------|--------|---------------------|--------|
| **2003**                                   |   |       |    |           |   |                 |   |          |   |                             |   |                |   |
| Rental revenue                             |   | $          | 4,775   |           | $      | 840                  |   | $             | 338    |                             | $      | 671                 |   | $ | 7 |   | $ | 6,631 |   |
| Property operating expenses                |   | 2,285      |    | 264            |   | 188                  |   | 403           |   | 13                               |   | 3,153               |   |
| Net operating income (NOI)                 |   | $          | 2,490   |           | $      | 576                  |   | $             | 150    |                             | $      | 268                 |   | $ | (6 | ) | $ | 3,478 |   |
| Real estate held for investment, net       |   | $          | 133,658 |           | $      | 22,623               |   | $             | 9,496  |                             | $      | 14,050              |   | $ | 2,371 |   | $ | 182,198 |   |
|                                       |   |       |    |           |   |                 |   |          |   |                             |   |                |   |
| **2002**                                   |   |       |    |           |   |                 |   |          |   |                             |   |                |   |
| Rental revenue                             |   | $          | 5,614   |           | $      | 757                  |   | $             | 323    |                             | $      | 674                 |   | — |   | $ | 7,368 |   |
| Property operating expenses                |   | 2,249      |    | 247            |   | 126                  |   | 371           |   | $                                | 88     |                | 3,081  |   |
| Net operating income (NOI)                 |   | $          | 3,365   |           | $      | 510                  |   | $             | 197    |                             | $      | 303                 |   | $ | (88 | ) | $ | 4,287 |   |
| Real estate held for investment, net       |   | $          | 133,733 |           | $      | 23,665               |   | $             | 12,593 |                             | $      | 14,635              |   | $ | 4,044 |   | $ | 188,670 |   |

 
| **Nine  Months Ended September 30,** |   | **Office** | ** ** | **Industrial** | ** ** | **Shopping  Center** | ** ** | **Apartment** | ** ** | **Undeveloped  Land and  Other** | ** ** | **Property  Total** | ** ** |
|-------------------------------------------|--------|------------|------------|----------------|------------|----------------------|------------|---------------|------------|----------------------------------|------------|---------------------|------------|
| **2003**                                  |   |       |       |           |       |                 |       |          |       |                             |       |                |       |
| Rental revenue                            |   | $          | 14,765     |           | $          | 2,262                |       | $             | 1,054      |                             | $          | 2,062               |       | $ | 57 |   | $ | 20,200 |   |
| Property operating expenses               |   | 6,279      |       | 797            |       | 421                  |       | 1,055         |       | 95                               |       | 8,647               |       |
| Net operating income (NOI)                |   | $          | 8,486      |           | $          | 1,465                |       | $             | 633        |                             | $          | 1,007               |       | $ | (38 | ) | $ | 11,553 |   |
| Real estate held for investment, net      |   | $          | 133,658    |           | $          | 22,623               |       | $             | 9,496      |                             | $          | 14,050              |       | $ | 2,371 |   | $ | 182,198 |   |
|                                      |   |       |       |           |       |                 |       |          |       |                             |       |                |       |
| **2002**                                  |   |       |       |           |       |                 |       |          |       |                             |       |                |       |
| Rental revenue                            |   | $          | 16,016     |           | $          | 2,499                |       | $             | 1,124      |                             | $          | 2,028               |       | — |   | $ | 21,667 |   |
| Property operating expenses               |   | 5,864      |       | 655            |       | 400                  |       | 1,034         |       | $                                | 215        |                | 8,168      |   |
| Net operating income (NOI)                |   | $          | 10,152     |           | $          | 1,844                |       | $             | 724        |                             | $          | 994                 |       | $ | (215 | ) | $ | 13,499 |   |
| Real estate held for investment, net      |   | $          | 133,733    |           | $          | 23,665               |       | $             | 12,593     |                             | $          | 14,635              |       | $ | 4,044 |   | $ | 188,670 |   |

 

The followingis a reconciliation of segment revenues, income and assets to consolidatedrevenues, income and assets for the periods presented above (dollars inthousands):

 
|                                                           |   | **Three Months Ended September 30,** |   | **Nine Months Ended September 30,** |   |
|----------------------------------------------------------------|--------|-------------------------------------------|--------|------------------------------------------|--------|
|                                                           |   | **2003**                                  |   | **2002**                                 |   | **2003** |   | **2002** |   |
| **REVENUES**                                                   |   |                                      |   |                                     |   |   |   |   |   |
| Total revenues for reportable segments                         |   | $                                         | 6,631  |                                     | $      | 7,368 |   | $ | 20,200 |   | $ | 21,667 |   |
| Other revenues                                                 |   | 34                                        |   | 46                                       |   | 77 |   | 197 |   |
| Total consolidated revenues                                    |   | $                                         | 6,665  |                                     | $      | 7,414 |   | $ | 20,277 |   | $ | 21,864 |   |
|                                                           |   |                                      |   |                                     |   |   |   |   |   |
| **NET LOSS**                                                   |   |                                      |   |                                     |   |   |   |   |   |
| NOI for reportable segments                                    |   | $                                         | 3,478  |                                     | $      | 4,287 |   | $ | 11,553 |   | $ | 13,499 |   |
| Unallocated amounts:                                           |   |                                      |   |                                     |   |   |   |   |   |
| Interest and other income                                      |   | 34                                        |   | 46                                       |   | 77 |   | 197 |   |
| General and administrative expenses                            |   | (1,650                                    | )      | (2,117                                   | )      | (4,952 | ) | (6,346 | ) |
| Depreciation and amortization                                  |   | (2,523                                    | )      | (2,367                                   | )      | (7,360 | ) | (6,708 | ) |
| Impairment of real estate asset                                |   | (3,500                                    | )      | —                                   |   | (3,500 | ) | — |   |
| Interest expense                                               |   | (2,753                                    | )      | (2,774                                   | )      | (8,398 | ) | (8,215 | ) |
| Net gain on sales of real estate assets                        |   | —                                    |   | 69                                       |   | — |   | 153 |   |
| Net gain on extinguishment of debt                             |   | —                                    |   | —                                   |   | — |   | 38 |   |
| Net loss before minority interest and  discontinued operations |   | $                                         | (6,914 | )                                        | $      | (2,856 | ) | $ | (12,580 | ) | $ | (7,382 | ) |

 

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|                                 |   | **September 30,** |    |
|--------------------------------------|--------|------------------------|---------|
|                                 |   | **2003**               |    | **2002** |   |
| **ASSETS**                           |   |                   |    |   |   |
| Total assets for reportable segments |   | $                      | 182,198 |   | $ | 188,670 |   |
| Real estate assets held for sale     |   | —                 |    | 69,460 |   |
| Cash and cash equivalents            |   | 3,464                  |    | 826 |   |
| Tenant and other receivables, net    |   | 557                    |    | 330 |   |
| Deferred rent receivable             |   | 743                    |    | 342 |   |
| Deposits held in escrow              |   | 560                    |    | 1,100 |   |
| Investment in management company     |   | 4,000                  |    | 4,000 |   |
| Prepaid and other assets, net        |   | 10,442                 |    | 7,853 |   |
| Total consolidated assets            |   | $                      | 201,964 |   | $ | 272,581 |   |

 

# **NOTE 11.  COMMITMENTS AND CONTINGENCIES**

# ** **

The following is information concerning material, pending legalproceedings to which the Company or its subsidiaries is a party or of which anyof their property is subject:

 

Lewis-Madison Matter

On or about September 27, 2001, Robert L. Lewis, Madison LiquidityInvestors 103 LLC and Madison Liquidity Investors 112 LLC, purporting torepresent themselves and all others similarly situated, initiated an actionagainst the Company, CGS, William J. Carden, John N. Galardi and S-PProperties, Inc. in the Orange County Superior Court, Case No. 01 CC 000394.

 

Plaintiffs’ complaint in this action alleged claims against the Companyand others for breach of fiduciary duty and breach of contract.  Plaintiffs’ complaint challenged theConsolidation, although the Consolidation was disclosed in a Prospectus/ConsentSolicitation filed with the Securities and Exchange Commission and was approvedby a majority vote of the limited partners of the partnerships. Plaintiffsalleged that the approval was invalid and that the Consolidation constituted abreach of fiduciary duty by each of the defendants.  Plaintiffs further alleged that the Consolidation constitutedbreach of the partnership agreements governing the partnerships.

 

Plaintiffs’ prayer for relief sought the following: 1)an injunction prohibiting the defendants from commingling; 2) imposition of aconstructive trust providing for liquidation of the assets of the partnershipsand a distribution of the assets to the former limited partners therein; 3) ajudicial declaration that the action may be maintained as a class action; 4)monetary/compensatory damages; 5) plaintiffs’ costs of suit, includingattorneys’, accountants’ and expert fees; and 6) a judicial order ofdissolution of the partnerships and appointment of a liquidating trustee.  On March 15, 2002, the Court sustainedthe Company’s demurrer to plaintiffs’ complaint and held that the complaintfailed to state a cause of action for either breach of fiduciary duty or breachof contract against the Company.  TheCourt gave the plaintiffs twenty days leave to amend.

 

Subsequently, plaintiffs filed and served a Second Amended Complaintalleging claims against the Company for breach of fiduciary duty, breach ofcontract, intentional interference with prospective economic advantage, andintentional interference with contractual relations.  On June 14, 2002, the Court sustained the Company’s demurreron the grounds that Plaintiffs’ Second Amended Complaint failed to state acause of action against the Company for interference with contract orinterference with prospective economic advantage.  The Court gave Plaintiffs twenty days leave to amend.

 

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Subsequently,the plaintiffs filed and served a Third Amended Complaint on the Companyalleging claims against the Company for breach of fiduciary duty, breach ofcontract, intentional interference with prospective economic advantage, andintentional interference with contractual relations.  On September 6, 2002, the 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.

 

OnSeptember 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 contractualrelations.  The plaintiffs’ prayer forrelief on its Fourth Amended Compliant seeks the following:  1) an injunction prohibiting the defendantsfrom commingling; 2) imposition of a constructive trust providing forliquidation of the assets of the partnerships and a distribution of the assetsto the former limited partners therein; 3) a judicial declaration that theaction may be maintained as a class action; 4) monetary/compensatory damages;5) plaintiffs’ costs of suit, including attorneys’, accountants’ and expertfees; and 6) a judicial order of dissolution of the partnerships andappointment of a liquidating trustee. On October 29, 2002, the Company responded by answer and assertedgeneral and specific affirmative defenses to the allegations in the FourthAmended Complaint.

 

On January 10, 2003,plaintiffs filed and served a Notice of Motion and Motion for ClassCertification.  On January 31,2003, the Company filed an Opposition to Plaintiffs’ Motion for ClassCertification.  On March 7, 2003,the Court granted plaintiffs’ Motion for Class Certification but expresslyreserved the right  to visit the issueof certification should rescission be chosen as a remedy to determine whetherit is still a viable procedure in the class setting.

 

On October 16, 2003,counsel for the plaintiffs and counsel for the defendants executed a Memorandumof Understanding regarding the settlement in this matter.              By the terms of thatMemorandum, the defendants agreed to pay a total of $6,500,000 to settle thisaction and all other claims known and unknown relating to the facts set forthin the Fourth Amended Complaint. Plaintiffs have agreed to release such claims, pursuant to theMemorandum.  As this matter is a classaction, the parties need to obtain court approval to complete the settlementand to administer the payment of the settlement amounts to the classmembers.  The settlement is funded, inits entirety, by insurance coverage.

 

Teachout Matter

A subsidiary of CGS, S-P Properties, Inc., was a defendant in a lawsuitcommenced in Superior Court, County of Los Angles in November 1995,entitled Teachout et al. v. S.P. Properties, Inc. and Sierra PacificDevelopment Fund II (“Fund II”).  Thesuit was a derivative action brought by a limited partner on behalf of Fund II,which alleged that the general partner breached its fiduciary duty and breachedthe partnership agreement in connection with loans to an affiliate of thegeneral partner and the issuance of notes to an affiliate of CGS in connectionwith the purchase of a property from Fund II, among other things.  Fund II was merged into a subsidiary of theCompany pursuant to the Consolidation.

 

As part of the Consolidation, the Company assumed the repaymentobligation to the former Fund II investors and has carried these loans withaccrued interest on its books and records. The obligation totaled approximately $8,800,000 at December 31,2002.

 

In January 2003, the parties reached a settlement regarding thismatter.  Under the settlement, which wasdocumented in the third quarter of 2003, the Company reaffirmed its previouslyannounced obligation to pay the former limited partners of Fund II, or theirassignees or transferees, the loans which were made and called by the formergeneral partner of Fund II as part of the Consolidation.  Pursuant to the settlement, the Companyestablished a definitive repayment plan and secured the repayment obligationwith a second deed of trust on an office building owned by the Company.  The repayment plan consists of a promissorynote in the amount of $8,800,000 (the amount of such loans, plus interest as ofDecember 31, 2002), which shall accrue interest at 6% per annum.  Interest only payments will be madequarterly until the note is paid.  Thenote may be prepaid in whole or in part at any time without penalty.  Pursuant to the settlement agreement, theCompany made its first two interest payments on June 2, 2003 andSeptember 2, 2003, respectively.

 

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As part of the settlement, the plaintiffs dismissed the lawsuit and allclaims therein with prejudice, and the Company has no obligation to pay anyfurther amounts, except for legal fees of $1,200,000 to plaintiff’s counsel.  Pursuant to the settlement, the Company madea scheduled payment of $250,000 to plaintiff’s counsel in the third quarter of2003.  The remaining balance due toplaintiff’s counsel of $950,000 is due in March 2006.  The total obligation due under thesettlement as of September 30, 2003 and December 31, 2002 of$9,750,000 and $10,000,000, respectively, is reflected as a separate line itemin the accompanying consolidated financial statements.

 

In connection with the agreement, Mr. Galardi and Mr. Cardenacknowledged that they owe the Company the sum of $1,187,695 as indemnificationagainst a portion of the Company’s settlement obligation.  Mr. Galardi and certain affiliates of Mr.Carden and/or Mr. Galardi are beneficiaries, in part, of the settlement of theTeachout matter and are owed an amount in excess of this obligation pursuant tothat settlement.  Mr. Galardi and Mr.Carden have agreed to pay the Company the principal sum of this obligation,plus interest thereon at the annual rate of 6% from March 15, 2003, in theform of an assignment to the Company of their right to receive $1,187,695 ofprincipal payments on the notes payable to them and their affiliates by reasonof the settlement of the Teachout matter, plus all interest payable on suchprincipal amount of notes.  Thereceivable of $1,187,695 and accrued interest are reflected as a component ofequity in the Company’s consolidated financial statements.  The interest due on the receivable wasoffset against a payable to an affiliated entity.

 

Other Matters

Certain claims and lawsuitshave arisen against the Company in its normal course of business. The Companybelieves that such claims and lawsuits will not have a material adverse effecton the Company’s financial position, cash flow or results of operations.

 

TheCompany has contractual obligations and commitments with regards to thelitigation settlement, employment agreements and an operating lease andconsulting commitment.  The followingtable aggregates these contractual obligations and commitments subsequent toSeptember 30, 2003 (dollars in thousands):

 
|                             |   | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   |
|----------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|-----------|--------|
| Litigation settlement            |   | $        | — |     | $      | —   |   | $        | — |     | $      | 9,750          |   | $         | — |   | $ | — |   | $ | 9,750 |   |
| Employee obligations             |   | 279      |   | 664      |   | —   |   | —   |   | —   |   | —         |   | 943       |   |
| Operating lease  commitment |   | 9        |   | 37       |   | 12       |   | —   |   | —   |   | —         |   | 58        |   |
| Consulting commitment            |   | 25       |   | 5        |   |     |   |     |   |     |   |           |   | 30        |   |
| Total                            |   | $        | 313    |     | $      | 706      |   | $        | 12     |     | $      | 9,750          |   | $         | — |   | $ | — |   | $ | 10,781 |   |
|                                  |        |          |        |          |        |          |        |          |        |          |        |                |        |           |        |  |  |  |  |  |  |  |  |

 

# **NOTE 12.  SUBSEQUENT EVENTS**

# ** **

On October 27, 2003, the Company acquired an office property froman affiliated entity.  The property islocated in Houston, Texas and consists of approximately 57,156 rentable squarefeet.  Acquisition costs ofapproximately $3,476,000 were funded with a new mortgage loan, the assumptionof existing debt, the issuance of 121,591 OP Units, a deferred payment and cash.

 

On October 27, 2003, the Company acquired a note secured by aproperty adjacent to an office property owned by the Company.  The purchase of this note was funded with anew loan to the Company from the lender that owned the note.  Loan costs of approximately $41,000 wereincurred in connection with the transaction.

 

On October 31, 2003, the Company sold Leawood, an 86,355 squarefoot office property located in Kansas, for $3,020,000.  An impairment charge of $3,500,000 wasrecorded on the property during the third quarter of 2003.

 

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**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**OVERVIEW**

 

ASRis a full-service real estate corporation, which owns, manages and operatesvarious income-producing properties. Substantially all of the Company’s assets are held through the OperatingPartnership, in which the Company, as of September 30, 2003, held a .89%general partner interest and an 85.74% limited partnership interest.  As of September 30, 2003, through theOperating Partnership, the Company owned and operated 26 properties, whichconsisted of 16 office, five industrial, three shopping center, and oneapartment property, and a parcel of undeveloped land.  The 26 properties are located in eight states.

 

During 2003, the Companysold nine properties, which consisted of two apartment properties, one officeproperty and six industrial properties, and acquired two office properties inHouston, Texas.  During 2002, theCompany sold two shopping center properties and one apartment property, andpurchased three office properties in the Houston area.  The property sales and acquisitions werepart of the Company’s strategy to sell certain of its properties in its non coremarkets and acquire additional properties in its core property types and coregeographic markets.  The Company willfocus primarily on office and industrial properties located in Texas,California and Arizona.

 

In October 2001, the Company acquired various properties in theConsolidation.  Pursuant to theConsolidation, subsidiaries of the Company merged with eight public limitedpartnerships, acquired the assets and liabilities of two private entitiesmanaged by CGS and acquired certain assets and liabilities of CGS and themajority owned affiliates of CGS. SPPI84, one of the eight public limited partnerships, was treated, foraccounting purposes, as the acquirer of the properties in the Consolidation.  Pursuant to the Consolidation, partners ofthe public partnerships received shares in the Company or promissory notes inexchange for their partnership units and owners of existing related entitiesexchanged ownership interests in real estate for ASR shares or units in theOperating Partnership, an entity formed for this purpose and initially whollyowned by the Company.

 

The following discussion and analysis of the financial condition andresults of operations of the Company should be read in conjunction with theaccompanying consolidated financial statements of the Company, including thenotes thereto, included in Item 1.

 

The major accountingpolicies followed by the Company are listed in Note 2 – Summary of SignificantAccounting 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 assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the results of operations during the reportingperiod. Actual results could differ materially from those estimates.

 

The Company believes thefollowing critical accounting policies affect its more significant judgmentsand estimates used in the preparation of its consolidated financial statements:

 

•                  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 theexcess of the amount that would have been collected on a straight-line basisover the amount 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.

 

•                  Rental properties are stated at cost, net ofaccumulated depreciation, unless circumstances indicate that cost, net ofaccumulated depreciation, cannot be recovered, in which case the carrying valueof the property is reduced to estimated fair value. Estimated fair value (i) isbased upon the Company’s plans for the continued operation of each property and(ii) is computed using estimated sales price, as determined by prevailingmarket values for comparable properties and/or the use of

 

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capitalizationrates multiplied by annualized net operating income based upon the age,construction and use of the building. The fulfillment of the Company’s plans related to each of its propertiesis dependent upon, among other things, the presence of economic conditionswhich will enable the Company to continue to hold and operate the propertiesprior to their eventual sale.  When theCompany has determined a property should be considered held for sale, itestimates the value of the property and costs to sell such property.  The Company records an impairment for anydecrease from its current carrying value at that time. Due to uncertaintiesinherent in the valuation process and in the economy, the actual results ofoperating and disposing of the Company’s properties could be materiallydifferent than current expectations

 

•                  Gains on property sales are accounted for inaccordance with the provisions of SFAS No. 66, “Accounting for Sales of RealEstate”.  Gains are recognized in fullwhen real estate is sold, provided (i) the gain is determinable, that is, thecollectibility of the sales price is reasonably assured or the amount that willnot be collectible can be estimated, and (ii) the earnings process is virtuallycomplete, that is, the Company is not obligated to perform significantactivities after the sale to earn the gain. Losses on property sales are recognized immediately.

 

•                  Management isreconsidering whether it is in the best interest of the Company to elect to betreated as a real estate investment trust (or REIT), as defined under theInternal Revenue Code of 1986, as amended. In the event such election is made, the election could be effective asearly as January 1, 2003 upon the filing of the appropriate forms for the2003 tax year.  In this regard, theCompany plans to operate in a manner that will permit it to elect REIT statusfor 2003.  In general, a REIT is acompany that owns or provides financing for real estate and pays annualdistributions 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.  For the tax year 2002,the Company was taxed as a C corporation.

 

# **RESULTS OF OPERATIONS**

# ** **

In accordance with generallyaccepted accounting principles, the operating results of the nine propertiessold in 2003 were reported as discontinued operations in the results ofoperations for the third quarter and nine months of 2003.  For the third quarter and nine months of2002, the results of the eleven properties sold are reported as discontinuedoperations.  See Note 4 – DiscontinuedOperations – of the Notes to Consolidated Financial Statements.  Unless otherwise indicated, the followingdiscussion reflects the results from continuing operations, which include thereal estate assets held for investment. The operating results of any properties acquired during the periodinclude operations from the date of acquisition.

 

***Discussion of the three months endedSeptember 30, 2003 and 2002.***

 

*Rentalrevenue*. For thethree months ended September 30, 2003, the Company recorded rental revenueof $6,631,000 compared to $7,368,000 for the three months endedSeptember 30, 2002.  This reductionwas primarily the result of a decrease in occupancy, particularly in certainproperties located in San Diego, California due to the expiration of leases ofthree major tenants.  This reduction wasoffset in part by revenue related to acquired properties.  The third quarter revenue includes resultsfrom two office properties acquired subsequent to the end of the third quarterof 2002 and one office property acquired during the third quarter of 2002.  These three office properties were acquiredin July 2003, May 2003 and August 2002.  Rental revenue from the acquired propertieswas included in the Company’s results since their respective dates ofacquisition.  The weighted averageoccupancy of properties held for investment was 83% at September 30, 2002and 75% at September 30, 2003.

 

*Propertyoperating expenses*.  For the three months endedSeptember 30, 2003, the Company recorded property operating expenses of$3,153,000 compared to $3,081,000 for the three months ended September 30,2002, a 2% increase.  This increase was primarilydue to property operating expenses of $200,000 related to the above mentionedproperty acquisitions, partially offset by a decrease in expenses for existingproperties due to expense control measures put in place during the past year.

 

*Generaland administrative*. General and administrative expenses decreased by $467,000 for the thirdquarter of 2003 compared to the prior year third quarter primarily due to lowerprofessional fees especially

 

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for legal services andalso due to a decrease in compensation expense related to common stockgrants.  During the third quarter of 2003, the Companyrecorded a $77,000 charge relating to the closure of its administrative officesin St. Louis, Missouri and New York, New York. The charge, which is related to severance payments to the administrativesupport staff, is included in general and administrative expenses.  Additional charges, primarily relating toseverances and lease expense, will be incurred in the fourth quarter of 2003and possibly early 2004.  Closure ofthese offices is expected to reduce expenses in the future.

 

*Depreciationand amortization*.  Depreciation and amortization expenseincreased by $156,000 in the third quarter of 2003 compared to the thirdquarter of the prior year due to the acquisition of the three propertiespreviously mentioned and depreciation of improvements and amortization ofcapitalized lease costs incurred after the thrid quarter of 2002 for theexisting properties.

 

*Interestexpense*.  Interest expense decreased by $21,000 forthe third quarter of 2003 in comparison to the third quarter of the prioryear.  This decrease was attributable tothe conversion of debt to common stock and due to reduced interest on anoutstanding payable related to a settlement agreement.  This decrease was offset to an extent byinterest costs related to the acquisition of three properties.

 

*Impairment of real estate asset held for investment.* During the third quarter of 2003, the Company recorded an impairmentcharge of $3,500,000 on an office property in Leawood, Kansas.  The impairment was based on an estimateddecrease in the fair market value of the property.  On October 31, 2003, the property sold for $3,020,000.  The sale generated net proceeds ofapproximately $184,000.

 

*Discontinued operations*.  TheCompany recorded a loss from discontinued operations of $153,000 for the threemonths ended September 30, 2003 compared to a loss of $37,000 for thethird quarter of the prior year.  Thediscontinued operations represent net loss from operations of the propertiessold.  For 2003, these propertiesconsist of nine properties versus eleven properties for 2002.  See Note 4 – Discontinued Operations – ofthe Notes to Consolidated Financial Statements.

 

Theloss from discontinued operations is summarized below.

 
| **Condensed  Consolidated Statements of Operations**   |   | **Three Months Ended  September 30, 2003** |   | **Three Months Ended  September 30, 2002** |   |
|--------------------------------------------------------|--------|-------------------------------------------------|--------|-------------------------------------------------|--------|
| Rental revenue                                         |   | $                                               | 893    |                                            | $      | 2,938 |   |
| Total expenses                                         |   | 1,046                                           |   | 2,944                                           |   |
| Minority interest related to partially  owned property |   | —                                          |   | (31                                             | )      |
| Net loss from discontinued operations                  |   | $                                               | (153   | )                                               | $      | (37 | ) |

 

*Gain on sale of discontinued operations*. The Company sold sevenproperties (five industrial properties, one office property and one apartmentproperty) in the third quarter of 2003 for an aggregate of $37,292,000 andrecognized a net gain of $51,000, after taking into consideration an impairmentcharge totaling $4,000,000 recorded in the second quarter of 2003 related tothree of the seven properties.  Thethree properties consisted of one office and two industrial properties.  The impairment was based on the anticipatedsales price less cost to sell as compared to the carrying value of the assets.The sales of the seven properties generated net proceeds of approximately$7,211,000 of which $560,000 is being held in escrow as a source to facilitatethe funding of a future acquisition in a tax deferred exchange.

 

***Discussion of the nine months endedSeptember 30, 2003 and 2002.***

 

*Rental revenue*. For the nine months endedSeptember 30, 2003, the Company recorded rental revenue of $20,200,000compared to $21,667,000 for the nine months ended September 30, 2002.  This reduction was primarily the result of adecrease in occupancy, particularly in certain properties located in San Diego,California due to the expiration of leases of three major tenants.  This reduction was offset in part by revenuerelated to acquired properties.  For thefirst nine months of 2003, revenue includes results from five office propertiesacquired during 2003.  The officeproperties were acquired in the following months:  one in each of July 2003, May 2003 andAugust 2002; and two in May 2002. Rental revenue from the acquired properties was included in theCompany’s results since their respective dates of acquisition.  The weighted average occupancy of propertiesheld from investment was 83% at September 30, 2002 and 75% at

 

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September 30, 2003.

 

*Propertyoperating expenses*.  For the nine months ended September 30,2003, the Company recorded property operating expenses of $8,647,000 comparedto $8,168,000 for the nine months ended September 30, 2002.  This increase is primarily due to propertyoperating expenses of $864,000 related to the above mentioned propertyacquisitions, partially offset by a decrease in expenses for existingproperties due to expense control measures put in place during the past year.

 

*Generaland administrative*. General and administrative expenses decreased by $1,394,000 for thefirst nine months of 2003 compared to the prior year first nine months.  This decrease is due (i) to a reduction ofcompensation expense in the 2003 due to downsizing of staff and lowercompensation expense related to common stock grants, (ii) to the inclusion ofnon recurring expenses related to the consolidation in the first quarter of2002, (iii) lower professional fees, especially for legal services, and (iv) toexpense control measures put in place during the past year.  Duringthe second and third quarter of 2003, the Company recorded an aggregate chargeof  $122,000 relating to the closure ofits administrative offices in St. Louis, Missouri and New York, New York.  The charge, which is related to severancepayments to the administrative support staff, is included in general andadministrative expenses.  Additionalcharges, primarily relating to severances and lease expense, will be incurredin the fourth quarter of 2003 and possibly early 2004.  Closure of these offices is expected toreduce expenses in the future.

 

*Depreciationand amortization*.  Depreciation and amortization expenseincreased by $652,000 in the first nine months of 2003 compared to the firstnine months of the prior year due to the acquisition of the five propertiespreviously mentioned and, to a lesser extent, depreciation of improvements andamortization of capitalized lease costs incurred after the third quarter of2002 for the existing properties.

 

*Interestexpense*.  Interest expense increased by $183,000 forthe first nine months of 2003 compared to the first nine months of the prioryear primarily due to interest associated with the five new propertiesacquired, offset in part by reduced interest on an outstanding payable due to asettlement agreement and the conversion of debt to common stock.

 

*Impairment of real estate asset held for investment.*  During the third quarter of 2003, theCompany recorded an impairment charge of $3,500,000 on an office property inLeawood, Kansas.  The impairment wasbased on an estimated decrease in the fair market value of the property.  On October 31, 2003, the property soldfor $3,020,000.  The sale generated netproceeds of approximately $184,000.

 

*Discontinued operations*.  The Company recorded a loss from discontinuedoperations of $301,000 for the nine months ended September 30, 2003compared to net income of $436,000 for the nine months ended September 30,2002.  The discontinued operationsrepresent results from the properties sold. For 2003, these properties consist of nine properties versus elevenproperties for 2002.  See Note 4 –Discontinued Operations – of the Notes to Consolidated Financial Statements.

 

The (loss) income fromdiscontinued operations is summarized below.

 
| **Condensed Consolidated Statements of Operations**    |   | **Nine Months Ended  September 30, 2003** |   | **Nine Months Ended  September 30, 2002** |   |
|--------------------------------------------------------|--------|------------------------------------------------|--------|------------------------------------------------|--------|
| Rental revenue                                         |   | $                                              | 5,239  |                                           | $      | 8,798 |   |
| Total expenses                                         |   | 5,540                                          |   | 8,173                                          |   |
| Loss on early extinguishment of debt                   |   | —                                         |   | (91                                            | )      |
| Minority interest related to partially owned  property |   | —                                         |   | (98                                            | )      |
| Net (loss) income from discontinued  operations        |   | $                                              | (301   | )                                              | $      | 436 |   |

 

*Gain onsale of discontinued operations*.  The Company sold nine properties (sixindustrial properties, one office property and two apartment properties) in thefirst nine months of 2003 for an aggregate of $53,892,000 and recognized a gainof $2,279,000, after taking into consideration an impairment charge totaling$4,000,000 recorded in the second quarter of 2003 related to three of the nineproperties sold.  The three propertiesconsisted of one office and two industrial properties.  The impairment was based on the anticipatedsales price less cost to sell as compared to the carrying value of the assets.  The sales of the

 

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nine properties generated net proceeds ofapproximately $11,896,000 of which $560,000 is being held in escrow as a sourceto facilitate the funding of a future acquisition in a tax deferred exchange.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

The Company reported a net lossof $12,757,000 for the nine months ended September 30, 2003, whichincluded (i) the following non-cash charges: depreciation and amortization onreal estate held for investment of $7,360,000, impairment on real estate held investmentof $3,500,000, deferred compensation expense of $233,000, mark to marketadjustments on interest rate protection agreements of $202,000 and impairmenton the value of certain properties sold during the period of $4,000,000; and(ii) the following other non-cash items: deferred rental income of $312,000,minority interest of $1,845,000 and amortization of loan premiums of$425,000.  Net cash used by operatingactivities amounted to $4,174,000 for the nine months ended September 30,2003 primarily to (i) fund prepaid and other assets, which includescontributions to lenders for funds held in escrow, mainly for payment of taxes,insurance and capital improvements, (ii) fund operations, and (iii) pay$400,000 on an amount owed to a related party.

 

Net cash provided by investingactivities of $8,231,000 was primarily due to proceeds of $11,336,000 generatedfrom the sale of eight properties in the second and third quarters of 2003,partially offset by capital expenditures of $2,824,000 and a cash payment of $281,000related to an acquisition of a property in May 2003.  The proceeds from the sale of the one otherproperty are being held in escrow to facilitate the funding of a futureacquisition in a tax deferred exchange. The capital expenditures were primarily due to tenant build-outs.  Net cash used in investing activities of$3,395,000 for the nine months ended September 30, 2002 consisted of (i)$3,336,000 paid for capital expenditures, which in large part were related tomajor renovations on an apartment property (which was sold inSeptember 2003) and $268,000 paid as part of the consideration for aproperty acquisition, less (ii) $209,000 in proceeds received from the sales ofreal estate assets.

 

Net cash used in financingactivities amounted to $2,692,000 during the nine months endedSeptember 30, 2003.  Repayments ofborrowings of  $4,498,000 during thenine months ended September 30, 2003 consisted of scheduled principalpayments of $2,688,000, payment of a loan for $1,300,000, which was refinanced,and repayment of a loan with a balance of $510,000.  Proceeds from borrowings, which totaled $2,098,000, consisted of(i) $1,340,000 to refinance debt on a property, (ii) $728,000 to fund propertyinsurance premiums and service fees and (ii) $30,000 from an affiliate of arelated party which completed the funding of an $830,000 loan on Valenciaentered into in December of 2002. The mortgage of $830,000 was repaid in conjunction with the sale of theproperty in April 2003.  Inaddition, funds were used to pay amounts due related to the Teachoutsettlement, to acquire units in the Operating Partnership, and to purchase17,500 shares of common stock of the Company pursuant to a stock repurchaseplan previously disclosed (see Note 8). Also, John N. Galardi purchased 60,975 shares of the Company’s commonstock for $250,000 in May 2003. Net cash provided by financing activities amounted to $2,249,000 duringthe nine months ended September 30, 2002. Proceeds received from borrowings totaled $21,931,000, which was primarilyreceived from refinancing of existing debt. Repayment of borrowings, which amounted to $16,366,000, was primarilyfor repayment of the debt refinanced and $2,668,000 for scheduled principalpayments.  Note payments to formerlimited partners totaling $2,055,000 and distributions totaling $1,255,000 werealso made during the nine months ended September 30, 2002.

 

In September 2003, a note payable in the amount of $510,000 wasrepaid with the proceeds from the sale of Emerald Pointe.  The note bore interest at prime plus 1%.

 

In August 2003, the Company refinanced a $1,300,000 loan securedby Van Buren, a parcel of undeveloped land, and entered into a new two-yearloan agreement in the amount of $1,340,000. The new loan bears interest at a fixed rate of 12% per annum and maturesAugust 1, 2005.

 

In July 2003, in connection with the acquisition of an officeproperty in Houston, Texas, the Company assumed a loan in the amount of$1,723,000.  The loan bears interest ata fixed rate of 7.41% per annum and matures in May 2012.  The Company also entered into an agreementthat provided for seller financing of $710,000, bearing interest at a fixedrate of 7.41% per annum and maturing in July 2005.

 

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In May 2003, through the acquisition of an office property inHouston, Texas, the Company assumed a loan in the amount of $3,180,000.  The loan bears interest at a fixed rate of6.80% and matures in August 2012. The Company also entered into an agreement that provided for sellerfinancing of $464,000, bearing interest at a fixed rate of 6.80% per annum andmaturing in May 2005.

 

In May 2003, the successor of BrownParker and Leahy, LLP cancelled its $199,180 note, plus $45,891 of accruedinterest thereon, in exchange for a private placement of 59,773 shares of theCompany’s common stock.

 

In May 2003, John N.Galardi cancelled his $1,600,000 note, plus $286,036 of accrued interestthereon, in exchange for a private placement of 460,009 shares of the Company’scommon stock.

 

In May 2003, theCompany financed insurance premiums of $643,000 on its properties and agreed topay a service fee of $85,000 over one year. The insurance premium note matures in February 2004.

 

In January 2002, the Company refinanced a$4,500,000 loan partially secured by Northcreek and entered into a new loanagreement in the amount of $5,625,000. Net proceeds of $639,000 were received as a result of therefinancing.  The new loan, which boreinterest at a fixed rate of 7.58% per annum, was repaid in July 2003 uponthe sale of the property.

 

In March 2002, theCompany refinanced a $2,750,000 loan partially secured by Countryside OfficePark and entered into a new loan agreement in the amount of $5,025,000.  The new loan bears interest at a fixed rateof 7.38% per annum and matures in March 2012.  Net proceeds of $1,887,000 were received as a result of therefinancing.

 

In April 2002, theCompany refinanced a $3,650,000 loan secured by Oak Grove Commons, anindustrial property, and entered into a new loan agreement in the amount of$4,314,000.  Net proceeds of $383,000were received as a result of the refinancing.  The new loan, which bore interest at a fixed rate of 7.61% perannum, was repaid in September 2003 upon the sale of the property.

 

# **In May 2002, through theacquisition of two office properties in Houston, Texas, the Company assumed twoloans totaling $8,650,000.  The loansbear interest at a fixed rate of 7.45% per annum and mature in May 2012.  The Company also entered into an agreementwhich provided for seller financing of $955,000, bearing interest at a fixedrate of 7.45% per annum and maturing in May 2004.**

 

In May 2002, theCompany refinanced a $1,346,000 loan secured by Leawood Fountain Plaza, anoffice property, and entered into a new one-year loan agreement in the amountof $3,000,000.  The new loan bearsinterest at Libor plus 2.85% with a minimum of 5.75% per annum (5.75% atJune 30, 2003).  Net proceeds of$1,026,000 were received as a result of the refinancing.  The loan, which matured in June 2003,was extended to December 1, 2003 during the third quarter of 2003.

 

In May 2002, theCompany refinanced a $1,452,000 loan secured by Southwest Pointe, an industrialproperty, and entered into a new loan agreement in the amount of $2,950,000.  The new loan bears interest at a fixed rateof 7.33% per annum and matures in June 2012.  Net proceeds of $1,297,000 were received as a result of therefinancing.

 

In May 2002, theCompany financed insurance premiums of $859,000 on its properties.  Other insurance premiums totaling $277,000were financed during 2002.  The debt waspaid in full in 2003.

 

In July 2002, the lenderfor the loan agreement related to the South Carolina shopping center propertiesnotified the Company it was technically in default under its loan agreement fornon-compliance with certain covenants, including covenants requiringimprovements to shopping center properties. Thereafter, the lender notified the Company it was in default forfailure to pay a matured portion of the loan, which matured inNovember 2002.  As ofSeptember 30, 2003, the amount due under the matured portion of the loanwas $2,929,000 and the aggregate principal balance of the loan agreement was$6,591,000.  In early 2003, the lendersold the loan to the major tenant in two of the shopping centers.  The Company is working with the new lenderand a potential purchaser of one of the properties.  The lender has orally agreed to use the proceeds from theproposed sale of the property to pay off the matured loan.  The Company and the

 

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lender are negotiating how theremainder of the proceeds will be applied. The Company continues to discuss the non-compliance matter with the newlender. The new lender has not accelerated the loan.

 

In August 2002, throughthe acquisition of an office property in Houston, Texas, the Company assumed aloan in the amount of $1,213,000.  Theloan bears interest at a fixed rate of 7.29% and matures in April 2005.

 

In October 2002, theCompany received proceeds of $1,532,000 from two bridge loans on Maple Tree,one of its shopping center properties. One of the loans, which totaled $700,000, was provided by an affiliateof a related party.  The mortgages wererepaid in conjunction with the sale of the property in October 2002.

 

In December 2002, theCompany entered into an $830,000 loan on Valencia, one of its industrialproperties.  The loan was provided by anaffiliate of a related party.  $800,000was funded in December 2002 and $30,000 in March 2003.  The mortgage was repaid in conjunction withthe sale of the property in April 2003.

 

In December 2002,modification agreements were entered into with a bank to extend the maturity onfive secured loans to December 31, 2004. Three of these loans were repaid in the third quarter of 2003 inconnection with property sales.  Thebalance of the two remaining loans totaled $9,615,000 as of September 30,2003.

 

During 2002, the Companyreceived a $900,000 payoff on its $1,100,000 mortgage loan receivable.  These funds were used to meet obligationsfor capital costs relating to re-leasing and improvements to properties.

 

The Operating Partnership haspaid the following distributions on the OP Units, including OP Units held bythe Company:  $1,255,000 on June 3,2002; $1,253,000 on October 18, 2002; and $626,000 on December 30,2002.  Distributions on OP Units held bythe Company funded the payment of dividends per share of Common Stock of $.20,$.20 and $.10, respectively.

 

During the first nine months of2003, the Company recorded a $122,000 charge relating to the closure of itsadministrative offices in St. Louis, Missouri and New York, New York.  The charge, which is related to severancepayments to the administrative support staff, is included in general andadministrative expenses.  As ofSeptember 30, 2003, the Company has paid $21,450 of the $122,000charge.  Additional charges, primarilyrelating to severances and lease expense, will be incurred in the fourthquarter of 2003 and possibly early 2004. Closure of these offices is expected to reduce expenses in the future.

 

The Company expects to meet itsshort-term liquidity requirements for normal property operating expenses andgeneral and administrative expenses from cash generated by operations and cashcurrently held.  In addition, theCompany anticipates capital costs to be incurred related to re-leasing spaceand improvements to properties, litigation settlement costs and other fees forprofessional services.  The funds tomeet these obligations will be obtained from proceeds of the sale of assets,lender held funds and refinancings of properties.  Based on current analysis, the Company believes that the cashgenerated by these anticipated activities will be adequate to meet these obligations.  There can be no assurance, however, thatthese activities will occur and that substantial cash will be generated.  If these activities do not occur, theCompany will not have sufficient cash to meet its obligations.

 

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**CONTRACTUALOBLIGATIONS AND COMMITMENTS**

 

TheCompany has contractual obligations with regards to future principal paymentsof debt, a litigation settlement, employment agreements and an operating leaseand consulting commitment.  Thefollowing table aggregates the Company’s expected contractual obligations andcommitments subsequent to September 30, 2003 (dollars in thousands):

 
|                                   |   | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   |
|----------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|-----------|--------|
| Long-term debt                         |   | $        | 6,890  |     | $      | 17,800   |   | $        | 7,309  |     | $      | 7,227          |   | $         | 12,738 |   | $ | 91,991 |   | $ | 143,955 |   |
| Debt to former limited   partners |   | —   |   | —   |   | —   |   | —   |   | —   |   | 237            |   | 237       |   |
| Litigation settlement                  |   | —   |   | —   |   | —   |   | 9,750    |   | —   |   | —         |   | 9,750     |   |
| Employee obligations                   |   | 279      |   | 664      |   | —   |   | —   |   | —   |   | —         |   | 943       |   |
| Operating lease commitment             |   | 9        |   | 37       |   | 12       |   | —   |   | —   |   | —         |   | 58        |   |
| Consulting commitment                  |   | 25       |   | 5        |   |     |   |     |   |     |   |           |   | 30        |   |
| Total                                  |   | $        | 7,203  |     | $      | 18,506   |   | $        | 7,321  |     | $      | 16,977         |   | $         | 12,738 |   | $ | 92,228 |   | $ | 154,973 |   |

 

The Company plans on meetingdebt maturing over the next two years through properties sales andrefinancings.

 

**FUNDS FROMOPERATIONS**

 

In October 1999, theBoard of Governors of NAREIT issued “White Paper on FFO-October 1999” toclarify its definition of Funds from Operations (“FFO”).  The clarification was effectiveJanuary 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 in financial statements or tables.  The Company believes that FFO is helpful toinvestors as a measure of performance of the Company and equity REITs because,along with cash flow from operating activities, FFO provides investors with anindication of our ability to incur and service debt, to make capital expendituresand to fund other cash needs.  FFO is anon-GAAP financial measure.  FFO doesnot represent net income or cash flows from operations, as defined by GAAP, andshould not be considered as an alternative to net income (determined inaccordance with GAAP) as an indicator of the Company’s operating performance oras an alternative to cash flows from operating, investing and financingactivities (determined in accordance with GAAP) as a measure of liquidity.  FFO does not necessarily indicate that cashflows will be sufficient to fund all of the Company’s cash needs, includingprincipal amortization, capital improvements and distributions tostockholders.  Further, FFO as disclosedby other companies may not be comparable to the Company’s calculation of FFO.

 

The following table setsforth the Company’s calculation of FFO and a reconciliation to a comparableGAAP disclosure for the nine months ended September 30, 2003 and 2002 (inthousands):

 
|                                                                        |   | **2003** |    | **2002** |   |
|-----------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Loss from operations before minority  interest and discontinued operations  |   | $        | (12,580 | )        | $      | (7,382 | ) |
| Depreciation and amortization                                               |   | 7,360    |    | 6,708    |   |
| Impairment of real estate asset                                             |   | 3,500    |    | —   |   |
| Net gain on sale of real estate assets                                      |   | —   |    | (153     | )      |
| (Loss) income from discontinued operations                                  |   | (301     | )       | 436      |   |
| Depreciation and amortization from  discontinued operations                 |   | 1,490    |    | 2,294    |   |
| Minority interest on partially owned  property from discontinued operations |   | —   |    | 98       |   |
| FFO                                                                         |   | $        | (531    | )        | $      | 2,001 |   |

 

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| Reconciliation to comparable GAAP  measurement:                       |   |   |   |   |   |
|-----------------------------------------------------------------------|--------|--------|--------|--------|--------|
|                                                                  |   |   |   |   |   |
| FFO                                                                   |   | $      | (531   | )      | $      | 2,001 |   |
| Deferred rental income                                                |   | (312   | )      | (256   | )      |
| Deferred compensation expense                                         |   | 233    |   | 730    |   |
| Amortization of loan premiums, included in  interest expense          |   | (425   | )      | (441   | )      |
| Mark to market adjustment on interest rate  protection agreements     |   | 202    |   | 57     |   |
| Interest income on receivable from  principal stockholders            |   | (39    | )      | — |   |
| Net gain on extinguishment of debt                                    |   | — |   | (38    | )      |
| Changes in operating assets and  liabilities, continuing operations   |   | (2,114 | )      | (2,368 | )      |
| Changes in operating assets and  liabilities, discontinued operations |   | 123    |   | 3      |   |
|                                                                  |   | $      | (2,863 | )      | $      | (312 | ) |
|                                                                  |   |   |   |   |   |
| Net cash used in operating activities                                 |   | $      | (4,174 | )      | $      | (3,143 | ) |
| Cash provided from discontinued operations                            |   | 1,311  |   | 2,831  |   |
|                                                                  |   | $      | (2,863 | )      | $      | (312 | ) |

 

FFO decreased by$2,532,000 for the nine months ended September 30, 2003 compared to sameperiod in 2002 for the reasons discussed in the analysis of Results ofOperations.

 

**INFLATION**

 

Substantially all of theleases at the industrial and retail properties provide for pass-through totenants of certain operating costs, including real estate taxes, common areamaintenance expenses, and insurance. Leases at the apartment property generallyprovide for an initial term of one month to one year and allow for rentadjustments at the time of renewal. Leases at the office properties typically provide for rent adjustmentsand pass-through of increases in operating expenses during the term of thelease.  All of these provisions maypermit the Company to increase rental rates or other charges to tenants inresponse to rising prices and, therefore, serve to reduce the Company’sexposure to the adverse effects of inflation.

 

**FORWARD-LOOKINGSTATEMENTS**

 

This Report on Form 10-Q contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities and Exchange Act of 1934. These forward-looking statements are based on management’s beliefs andexpectations, which may not be correct. Important factors that could cause actual results to differ materiallyfrom the expectations 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-Kfiled with the Securities and Exchange Commission in conjunction with thisquarterly report on Form 10-Q to better understand the factors affecting theCompany’s financial condition and results of operations.

 

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

 

**INTERESTRATES**

 

One of the Company’s primarymarket risk exposure is to changes in interest rates on its borrowings.

 

It is the Company’spolicy to manage its exposure to fluctuations in market interest rates for itsborrowings through the use of fixed rate debt instruments to the extent thatreasonably favorable rates are obtainable with such arrangements.  In order to maximize financial flexibilitywhen selling properties and minimize potential prepayment penalties on fixedrate loans, the Company has also entered into variable rate debt arrangements.

 

The Company has entered intointerest rate swap agreements to manage its interest rate risk.  The agreements, in notional amounts totalingapproximately $9,600,000 at September 30, 2003, effectively fix theinterest rate at 2.42% plus the applicable variable rate margin (effective rateof 6.42% at September 30, 2003).

 

At September 30, 2003,the Company’s total indebtedness included fixed-rate debt of approximately$140,371,000 and floating-rate indebtedness of approximately $16,800,000. TheCompany continually reviews the portfolio’s interest rate exposure in an effortto minimize the risk of interest rate fluctuations.  The Company does not have any other material market-sensitivefinancial instruments.

 

A change of 1.00% in theindex rate to which the Company’s variable rate debt is tied would change theannual interest incurred by the Company by approximately $168,000, or $0.03 pershare, based upon the balances outstanding on variable rate instruments atSeptember 30, 2003.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

Management, including the Company’s Chief ExecutiveOfficer and Acting Chief Financial Officer, have evaluated the effectiveness ofthe Company’s disclosure controls and procedures as of the end of the quartercovered by this report.  Based on, andas of the date of, that evaluation, the Chief Executive Officer and ActingChief Financial Officer concluded that the disclosure controls and procedureswere effective, in all material respects, to ensure that information requiredto be disclosed in the reports the Company files and submits under the ExchangeAct 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.

 

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**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:

 

Lewis-Madison Matter

On or about September 27,2001, Robert L. Lewis, Madison Liquidity Investors 103 LLC and MadisonLiquidity Investors 112 LLC, purporting to represent themselves and all otherssimilarly situated, initiated an action against the Company, CGS, William J.Carden, John N. Galardi and S-P Properties, Inc. in the Orange County SuperiorCourt, Case No. 01 CC 000394.

 

Plaintiffs’ complaint in thisaction alleged claims against the Company and others for breach of fiduciaryduty and breach of contract. Plaintiffs’ complaint challenged the Consolidation, although theConsolidation was disclosed in a Prospectus/Consent Solicitation filed with theSecurities and Exchange Commission and was approved by a majority vote of thelimited partners of the partnerships. Plaintiffs alleged that the approval wasinvalid and that the Consolidation constituted a breach of fiduciary duty byeach of the defendants.  Plaintiffsfurther alleged that the Consolidation constituted breach of the partnershipagreements governing the partnerships.

 

Plaintiffs’ prayer for relief sought the following: 1)an injunction prohibiting the defendants from commingling; 2) imposition of aconstructive trust providing for liquidation of the assets of the partnershipsand a distribution of the assets to the former limited partners therein; 3) ajudicial declaration that the action may be maintained as a class action; 4)monetary/compensatory damages; 5) plaintiffs’ costs of suit, includingattorneys’, accountants’ and expert fees; and 6) a judicial order ofdissolution of the partnerships and appointment of a liquidating trustee.  On March 15, 2002, the Court sustainedthe Company’s demurrer to plaintiffs’ complaint and held that the complaintfailed to state a cause of action for either breach of fiduciary duty or breachof contract against the Company.  TheCourt gave the plaintiffs twenty days leave to amend.

 

Subsequently, plaintiffs filedand served a Second Amended Complaint alleging claims against the Company forbreach of fiduciary duty, breach of contract, intentional interference withprospective economic advantage, and intentional interference with contractualrelations.  On June 14, 2002, theCourt sustained the Company’s demurrer on the grounds that Plaintiffs’ SecondAmended Complaint failed to state a cause of action against the Company forinterference with contract or interference with prospective economicadvantage.  The Court gave Plaintiffstwenty days leave to amend.

 

Subsequently, the plaintiffs filed and served a Third Amended Complainton the Company alleging claims against the Company for breach of fiduciaryduty, breach of contract, intentional interference with prospective economicadvantage, and intentional interference with contractual relations.  On September 6, 2002, the Courtsustained the Company’s demurrer on the grounds that the Plaintiffs’ ThirdAmended Compliant failed to state a cause of action for either interferencewith contract or interference with prospective economic advantage against the Company.  The Court gave the Plaintiffs twenty days toamend.

 

On September 25, 2002, the plaintiffs filed and served a FourthAmended Complaint on the Company alleging claims against the Company for breachof fiduciary duty, breach of contract, intentional interference withprospective economic advantage, and intentional interference with contractualrelations.  The plaintiffs’ prayer forrelief on its Fourth Amended Compliant seeks the following:  1) an injunction prohibiting the defendantsfrom commingling; 2) imposition of a constructive trust providing forliquidation of the assets of the partnerships and a distribution of the assetsto the former limited partners therein; 3) a judicial declaration that theaction may be maintained as a class action; 4) monetary/compensatory damages;5) plaintiffs’ costs of suit, including attorneys’, accountants’ and expertfees; and 6) a judicial order of dissolution of the partnerships andappointment of a liquidating trustee. On October 29, 2002, the Company responded by answer and assertedgeneral and specific affirmative defenses to the allegations in the FourthAmended Complaint.

 

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On January 10, 2003,plaintiffs filed and served a Notice of Motion and Motion for ClassCertification.  On January 31,2003, the Company filed an Opposition to Plaintiffs’ Motion for ClassCertification.  On March 7, 2003,the Court granted plaintiffs’ Motion for Class Certification but expresslyreserved the right  to visit the issue ofcertification should rescission be chosen as a remedy to determine whether itis still a viable procedure in the class setting.

 

On October 16, 2003,counsel for the plaintiffs and counsel for the defendants executed a Memorandumof Understanding regarding the settlement in this matter.  By the terms of that Memorandum, thedefendants agreed to pay a total of $6,500,000 to settle this action and allother claims known and unknown relating to the facts set forth in the FourthAmended Complaint.  Plaintiffs haveagreed to release such claims, pursuant to the Memorandum.  As this matter is a class action, theparties need to obtain court approval to complete the settlement and toadminister the payment of the settlement amounts to the class members.  The settlement is funded, in its entirety,by insurance coverage.

 

Teachout Matter

A subsidiary of CGS, S-PProperties, Inc., was a defendant in a lawsuit commenced in Superior Court,County of Los Angles in November 1995, entitled Teachout et al. v. S.P.Properties, Inc. and Sierra Pacific Development Fund II (“Fund II”).  The suit was a derivative action brought bya limited partner on behalf of Fund II, which alleged that the general partnerbreached its fiduciary duty and breached the partnership agreement in connectionwith loans to an affiliate of the general partner and the issuance of notes toan affiliate of CGS in connection with the purchase of a property from Fund II,among other things.  Fund II was mergedinto a subsidiary of the Company pursuant to the Consolidation.

 

As part of the Consolidation,the Company assumed the repayment obligation to the former Fund II investorsand has carried these loans with accrued interest on its books andrecords.  The obligation totaledapproximately $8,800,000 at December 31, 2002.

 

In January 2003, theparties reached a settlement regarding this matter.  Under the settlement, which was documented in the third quarterof 2003, the Company reaffirmed its previously announced obligation to pay theformer limited partners of Fund II, or their assignees or transferees, theloans which were made and called by the former general partner of Fund II aspart of the Consolidation.  Pursuant tothe settlement, the Company established a definitive repayment plan and securedthe repayment obligation with a second deed of trust on an office buildingowned by the Company.  The repaymentplan consists of a promissory note in the amount of $8,800,000 (the amount ofsuch loans, plus interest as of December 31, 2002), which shall accrue interestat 6% per annum.  Interest only paymentswill be made quarterly until the note is paid. The note may be prepaid in whole or in part at any time without penalty.  Pursuant to the settlement agreement, theCompany made its first two interest payments on June 2, 2003 andSeptember 2, 2003, respectively.

 

As part of the settlement, theplaintiffs dismissed the lawsuit and all claims therein with prejudice, and theCompany has no obligation to pay any further amounts, except for legal fees of$1,200,000 to plaintiff’s counsel. Pursuant to the settlement, the Company made a scheduled payment of$250,000 to plaintiff’s counsel in the third quarter of 2003.  The remaining balance due to plaintiff’scounsel of $950,000 is due in March 2006. The total obligation due under the settlement as of September 30,2003 and December 31, 2002 of $9,750,000 and $10,000,000, respectively, isreflected as a separate line item in the accompanying consolidated financialstatements.

 

In connection with theagreement, John N. Galardi, a director and principal stockholder of theCompany, and William J. Carden, the Chief Executive Officer, a director and aprincipal stockholder of the Company, acknowledged that they owe the Companythe sum of $1,187,695 as indemnification against a portion of the Company’ssettlement obligation.  Mr. Galardi andcertain affiliates of Mr. Carden and/or Mr. Galardi are beneficiaries, in part,of the settlement of the Teachout matter and are owed an amount in excess ofthis obligation pursuant to that settlement. Mr. Galardi and Mr. Carden have agreed to pay the Company the principalsum of this obligation, plus interest thereon at the annual rate of 6% fromMarch 15, 2003, in the form of an assignment to the Company of their rightto receive $1,187,695 of principal payments on the notes payable to them andtheir affiliates by reason of the settlement of the Teachout matter, plus allinterest payable on such principal amount of notes.  The receivable of $1,187,695 and accrued interest are reflectedas a component of equity in the Company’s consolidated financialstatements.  The interest due on thereceivable was offset against a payable to an affiliated entity.

 

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Other Matters

Certain claims and lawsuitshave arisen against the Company in its normal course of business. The Companybelieves that such claims and lawsuits will not have a material adverse effecton the Company’s financial position, cash flow or results of operations.

 

**ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)  Exhibits:

 

The Exhibit Index attachedhereto is hereby incorporated by reference this item.

 

(b)  Reports on Form 8-K:

 

On July 24, 2003, a reporton Form 8-K was filed with respect to Item 2.

 

On August 11, 2003, areport on Form 8-K was filed with respect to Item 12.

 

On September 26, 2003, areport on Form 8-K was filed with respect to Item 5.

 

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**SIGNATURES**

 

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

 

**AMERICAN SPECTRUM REALTY, INC.**

 
|                           |   |                                             |   |
|--------------------------------|--------|--------------------------------------------------|--------|
| *Date: November 10, 2003* |   |                                             |   |
|                           | By:    | */s/ William J. Carden*                          |   |   |
|                           |   | William J. Carden                                |   |
|                           |   | Chairman of the Board, President,                |   |
|                           |   | Chief Executive Officer  and Acting              |   |
|                           |   | Chief Financial Officer                          |   |
|                           |   |                                             |   |
| *Date: November 10, 2003* |   |                                             |   |
|                           | By:    | */s/ Patricia A. Nooney*                         |   |   |
|                           |   | Patricia A. Nooney                               |   |
|                           |   | Senior Vice President and Director of Accounting |   |
|                           |   | (Principal Accounting  Officer)                  |   |
|                                |        |                                                  |        |  |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** |   | **Exhibit  Title**                                                                                                                 |
|-----------------|--------|------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                               |
| 31              |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                      |
|            |   |                                                                                                                               |
| 32              |   | 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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