**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-Q**

 

**(Mark One)**

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

**THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended June 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 mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the Registrant was required to file such reports), and (2) has beensubject to such filing requirements 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

 

Indicate by check markwhether the Registrant has filed all documents and reports required to be filedby Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequentto the distribution of securities under a plan confirmed by a court.  Yes ý No o

 

As of August 1, 2003,6,135,646 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 June 30, 2003 and December 31, 2002                                                                            |
|    | Consolidated Statements of Operations for  the three months ended June 30, 2003 and 2002 and for the six months ended  June 30, 2003 and 2002 |
|    | Consolidated Statement of Stockholders’  Equity for the six months ended June 30, 2003                                                   |
|    | Consolidated Statements of Cash Flows for  the six months ended June 30, 2003 and 2002                                                        |
|    | 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 4  | Submission of Matters to a Vote of Security  Holders                                                                                          |
| Item 6  | Exhibits and Reports on Form 8-K                                                                                                              |

 

2

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**PARTI.  FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIALSTATEMENTS**

 

**AMERICAN SPECTRUM REALTY, INC.**

**CONSOLIDATEDBALANCE SHEETS**

(Dollarsin thousands, except per share amounts)

 
|                                                                                                                                                       |   | **June 30, 2003** |    | **December 31, 2002** |    |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|-----------------------|---------|
| **ASSETS**                                                                                                                                                 |   |              |    |                  |    |
|                                                                                                                                                       |   |              |    |                  |    |
| Real estate held for investment                                                                                                                            |   | $                 | 211,147 |                  | $       | 205,799 |   |
| Accumulated depreciation                                                                                                                                   |   | 16,432            |    | 11,362                |    |
| Real estate held for investment, net                                                                                                                       |   | 194,715           |    | 194,437               |    |
|                                                                                                                                                       |   |              |    |                  |    |
| Real estate held for sale                                                                                                                                  |   | 26,560            |    | 45,251                |    |
| Cash and cash equivalents                                                                                                                                  |   | 1,839             |    | 788                   |    |
| Tenant and other receivables (including  $275 from related party at June 30, 2003), net of allowance for doubtful  accounts of $292 and $224, respectively |   | 589               |    | 462                   |    |
| Deferred rents receivable                                                                                                                                  |   | 660               |    | 431                   |    |
| Deposits held in escrow                                                                                                                                    |   | —            |    | 279                   |    |
| Investment in management company                                                                                                                           |   | 4,000             |    | 4,000                 |    |
| Prepaid and other assets, net                                                                                                                              |   | 9,696             |    | 7,909                 |    |
|                                                                                                                                                       |   |              |    |                  |    |
| Total Assets                                                                                                                                               |   | $                 | 238,059 |                  | $       | 253,557 |   |
|                                                                                                                                                       |   |              |    |                  |    |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                              |   |              |    |                  |    |
|                                                                                                                                                       |   |              |    |                  |    |
| Liabilities:                                                                                                                                               |   |              |    |                  |    |
| Notes payable, net of premiums of $3,372  and $3,655, respectively (including $1,799 to related parties at December 31,  2002)                             |   | $                 | 153,369 |                  | $       | 152,694 |   |
| Liabilities related to real estate held for  sale (including $800 to related party at December 31, 2002)                                                   |   | 21,719            |    | 33,449                |    |
| Obligations due on litigation settlement                                                                                                                   |   | 10,000            |    | 10,000                |    |
| Accrued and other liabilities (including  $1,619 and $1,594, respectively, to related parties                                                              |   | 7,694             |    | 7,924                 |    |
| Deferred tax liability                                                                                                                                     |   | 6,082             |    | 6,082                 |    |
| Accounts payable                                                                                                                                           |   | 3,270             |    | 2,695                 |    |
| Notes payable to former limited partners                                                                                                                   |   | 237               |    | 237                   |    |
|                                                                                                                                                       |   |              |    |                  |    |
| Total Liabilities                                                                                                                                          |   | 202,371           |    | 213,081               |    |
|                                                                                                                                                       |   |              |    |                  |    |
| Minority Interest                                                                                                                                          |   | 8,782             |    | 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 and outstanding, 6,133,704 and 5,536,990 shares,  respectively                       |   | 61                |    | 55                    |    |
| Additional paid-in capital                                                                                                                                 |   | 44,387            |    | 41,809                |    |
| Accumulated deficit                                                                                                                                        |   | (15,839           | )       | (9,168                | )       |
| Receivable from principal stockholders                                                                                                                     |   | (1,209            | )       | (1,188                | )       |
| Deferred compensation                                                                                                                                      |   | (494              | )  | (651                  | )  |
|                                                                                                                                                       |   |              |    |                  |    |
| Total Stockholders’ Equity                                                                                                                            |   | 26,906            |    | 30,857                |    |
|                                                                                                                                                       |   |              |    |                  |    |
| Total Liabilities and Stockholders’ Equity                                                                                                            |   | $                 | 238,059 |                  | $       | 253,557 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

3

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**AMERICAN SPECTRUMREALTY, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(Dollars in thousands, except per share amounts)

 
|                                                           |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|----------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                           |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
| **REVENUES:**                                                  |   |                            |   |                          |   |   |   |   |   |
| Rental revenue                                                 |   | $                               | 7,015  |                          | $      | 7,849 |   | $ | 14,550 |   | $ | 15,435 |   |
| Interest and other income                                      |   | 33                              |   | 72                            |   | 43 |   | 151 |   |
| Total revenues                                                 |   | 7,048                           |   | 7,921                         |   | 14,593 |   | 15,586 |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| **EXPENSES:**                                                  |   |                            |   |                          |   |   |   |   |   |
| Property operating expense                                     |   | 3,100                           |   | 2,974                         |   | 6,213 |   | 5,761 |   |
| General and administrative                                     |   | 1,709                           |   | 1,812                         |   | 3,302 |   | 4,229 |   |
| Depreciation and amortization                                  |   | 2,582                           |   | 2,221                         |   | 5,156 |   | 4,559 |   |
| Interest expense                                               |   | 2,948                           |   | 3,031                         |   | 5,851 |   | 5,653 |   |
| Total expenses                                                 |   | 10,339                          |   | 10,038                        |   | 20,522 |   | 20,202 |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| **OTHER INCOME:**                                              |   |                            |   |                          |   |   |   |   |   |
| Net gain on sale of real estate assets                         |   | —                          |   | 84                            |   | — |   | 84 |   |
| Net gain on extinguishment of debt                             |   | —                          |   | 38                            |   | — |   | 38 |   |
| Total other income                                             |   | —                          |   | 122                           |   | — |   | 122 |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Net loss before minority interest and  discontinued operations |   | (3,291                          | )      | (1,995                        | )      | (5,929 | ) | (4,494 | ) |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Minority interest                                              |   | 621                             |   | 194                           |   | 915 |   | 470 |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Net loss before discontinued operations                        |   | (2,670                          | )      | (1,801                        | )      | (5,014 | ) | (4,024 | ) |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Discontinued operations:                                       |   |                            |   |                          |   |   |   |   |   |
| Income from discontinued operations                            |   | 47                              |   | 319                           |   | 115 |   | 441 |   |
| Gain on sale of discontinued operations                        |   | 2,228                           |   |                          |   | 2,228 |   |   |   |
| Impairment of real estate assets held for  sale                |   | (4,000                          | )      | —                        |   | (4,000 | ) | — |   |
| (Loss) income from discontinued operations                     |   | (1,725                          | )      | 319                           |   | (1,657 | ) | 441 |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Net loss                                                       |   | $                               | (4,395 | )                             | $      | (1,482 | ) | $ | (6,671 | ) | $ | (3,583 | ) |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Basic and diluted per share data:                              |   |                            |   |                          |   |   |   |   |   |
| Net loss before discontinued operations                        |   | $                               | (0.45  | )                             | $      | (0.33 | ) | $ | (.87 | ) | $ | (0.73 | ) |
| (Loss) income from discontinued operations                     |   | (0.29                           | )      | 0.06                          |   | (.28 | ) | 0.08 |   |
| Net loss                                                       |   | $                               | (0.74  | )                             | $      | (0.27 | ) | $ | (1.15 | ) | $ | (0.65 | ) |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| Basic weighted average shares used                             |   | 5,940,118                       |   | 5,535,591                     |   | 5,742,597 |   | 5,531,705 |   |

 

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 in thousands)

 
|                                                         |   | **Common  Stock** |   | **Additional  Paid-In  Capital** |   | **Accumulated  Deficit** |   | **Deferred  Compensation** |    | **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 |   | —            |   | 203                              |   | —                   |   | —                     |    | —                                         |   | 203              |   |
| Amortization of deferred compensation                        |   | —            |   | —                           |   | —                   |   | 157                        |    | —                                         |   | 157              |   |
| Receivable from principal stockholders                       |   | —            |   | —                           |   | —                   |   | —                     |    | (21                                            | )      | (21              | )      |
| Net loss                                                     |   | —            |   | —                           |   | (6,671                   | )      | —                     |    | —                                         |   | (6,671           | )      |
| Balance, June 30, 2003                                       |   | $                 | 61     |                             | $      | 44,387                   |   | $                          | (15,839 | )                                              | $      | (494             | )      | $ | (1,209 | ) | $ | 26,906 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

5

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**AMERICAN SPECTRUM REALTY, INC**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(Dollarsin thousands)

** **
|                                                                         |   | **Six Months Ended June 30,** |   |
|------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                         |   | **2003**                      |   | **2002** |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                    |   |                          |   |   |   |
| Net loss                                                                     |   | $                             | (6,671 | ) | $ | (3,583 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                          |   |   |   |
| Loss (income) from discontinued operations                                   |   | 1,657                         |   | (441 | ) |
| Depreciation and amortization                                                |   | 5,156                         |   | 4,559 |   |
| Deferred rental income                                                       |   | (229                          | )      | (208 | ) |
| Minority interest                                                            |   | (915                          | )      | (470 | ) |
| Deferred compensation expense                                                |   | 157                           |   | 515 |   |
| Amortization of loan premiums, included in  interest expense                 |   | (283                          | )      | (294 | ) |
| Mark to market adjustment on interest rate  protection agreements            |   | 244                           |   | 89 |   |
| Interest income on receivable from  principal stockholders                   |   | (21                           | )      | — |   |
| Net gain on sales of real estate assets                                      |   | —                        |   | (84 | ) |
| Net gain on extinguishment of debt                                           |   | —                        |   | (38 | ) |
| Changes in operating assets and  liabilities:                                |   |                          |   |   |   |
| Decrease in tenant and other receivables                                     |   | 136                           |   | 546 |   |
| Decrease (increase) in accounts payable                                      |   | 514                           |   | (1,408 | ) |
| Increase in prepaid and other assets                                         |   | (1,352                        | )      | (1,259 | ) |
| Decrease in accrued and other liabilities                                    |   | (453                          | )      | (646 | ) |
| Net cash used in operating activities:                                       |   | (2,060                        | )      | (2,722 | ) |
|                                                                         |   |                          |   |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                    |   |                          |   |   |   |
| Proceeds received from sales of real estate  assets                          |   | 4,685                         |   | 59 |   |
| Capital improvements to real estate assets                                   |   | (1,417                        | )      | (2,217 | ) |
| Net cash provided by (used in) investing  activities:                        |   | 3,268                         |   | (2,158 | ) |
|                                                                         |   |                          |   |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                    |   |                          |   |   |   |
| Proceeds from borrowings                                                     |   | 758                           |   | 21,773 |   |
| Repayment of borrowings                                                      |   | (1,875                        | )      | (15,409 | ) |
| Note payments to former limited partners                                     |   | —                        |   | (1,864 | ) |
| Issuance of common stock to principal  stockholder                           |   | 250                           |   | — |   |
| Repurchase of common stock                                                   |   | —                        |   | (14 | ) |
| 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:                        |   | (867                          | )      | 3,239 |   |
|                                                                         |   |                          |   |   |   |
| Cash from discontinued operations                                            |   | 710                           |   | 1,265 |   |
|                                                                         |   |                          |   |   |   |
| Increase (decrease) in cash                                                  |   | 1,051                         |   | (376 | ) |
|                                                                         |   |                          |   |   |   |
| Cash, beginning of period                                                    |   | 788                           |   | 2,284 |   |
|                                                                         |   |                          |   |   |   |
| Cash, end of period                                                          |   | $                             | 1,839  |   | $ | 1,908 |   |
|                                                                         |   |                          |   |   |   |
| **SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:**                      |   |                          |   |   |   |
| Cash paid for interest                                                       |   | $                             | 6,781  |   | $ | 6,435 |   |
| Cash paid for income taxes                                                   |   | —                        |   | — |   |

 

6

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|                                                                                      |   | **Six Months Ended June 30,** |   |
|-------------------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                                      |   | **2003**                      |   | **2002** |   |
| **SUPPLEMENTAL DISCLOSURE OF NON-CASH  INVESTING AND FINANCING ACTIVITIES:**              |   |                          |   |   |   |
| Assumptions of mortgage loans in  acquisition of real estate assets                       |   | $                             | 3,644  |   | $ | 8,650 |   |
| 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                              |   | 203                           |   | — |   |
| Issuance of operating partnership units in  acquisition of real estate asset              |   | 581                           |   | — |   |
| 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 Financial Statements**

 

**NOTE1.  DESCRIPTION OF BUSINESS**

 

# **GENERAL**

 

American Spectrum Realty,Inc. (“ASR” or the “Company”) is a Maryland corporation established on August8, 2000.  The Company is a full-servicereal estate corporation, which owns, manages and operates income-producingproperties.  Substantially all of theCompany’s assets are held through an operating partnership (the “OperatingPartnership”) in which the Company, as of June 30, 2003, held a .90% generalpartner interest and an 86.92% limited partnership interest. As of June 30,2003, through its majority-owned subsidiary, the Operating Partnership, theCompany owned and operated 32 properties, which consisted of 16 office, 10industrial, three shopping center, and two apartment properties, and oneundeveloped land property.  In July2003, the Company sold four properties located in the Mid West: one officeproperty and three industrial properties. The remaining properties are located in eight states.  The Company plans to sell certain of itsproperties and to acquire additional properties in its core property types andcore geographic markets.  The Companywill focus primarily on office and industrial properties located in Texas,California and Arizona.

 

Substantially all of the Company’sassets are held through the Operating Partnership. 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 under the Partnership Agreement to manage andconduct the business of the Operating Partnership.  The Company’s interest as a limited partner in the OperatingPartnership entitles it to share in any cash distributions from, and in profitsand losses of, the Operating Partnership. If the Company receives any distributions from the OperatingPartnership, it will, in turn, pay dividends to its common stockholders so thatthe amount of dividends paid on each share of common stock equals the amount ofdistributions paid on each limited partnership unit in the OperatingPartnership (“OP Unit”).  Most of theproperties 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 the 2003tax year.  In this regard, the Companyplans to operate in a manner that will permit it to elect REIT status in 2003.  In general, a REIT is a company that owns orprovides financing for real estate and pays annual distributions to investorsof at least 90% of its taxable income. A REIT typically is not subject to federal income taxation on its netincome, provided applicable income tax requirements are satisfied.   For the tax year 2002, the Company wastaxed as a C corporation.

## ** **

## **CONSOLIDATIONTRANSACTION**

 

In October 2001, the Companyacquired various properties in a consolidation transaction (the“Consolidation”).  Pursuant to theConsolidation, subsidiaries of the Company merged with eight public limitedpartnerships, acquired the assets and liabilities of two private entitiesmanaged by CGS Real Estate Company, Inc. (“CGS”) and its affiliates andacquired certain assets and liabilities of CGS and its majority-owned affiliates.  Sierra Pacific Pension Investors ‘84(“SPPI84”), one of the eight public limited partnerships, was treated, foraccounting purposes, as the acquirer of the properties in the Consolidation.  Prior to the Consolidation, SPPI84’sactivities involved the ownership and operation of two real estate propertiesin Arizona:  Sierra Spectrum in Phoenix,Arizona and Sierra Valencia in Tucson, Arizona. Pursuant to the Consolidation,partners of the public partnerships received shares in the Company or promissorynotes in exchange for their partnership units, and owners of existing relatedentities exchanged ownership interests in real estate for ASR shares or unitsin the Operating Partnership, an entity formed for this purpose and initiallywholly owned by the Company.

 

8

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**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 financialstatements contain all material adjustments, consisting only of normalrecurring adjustments necessary to present fairly the financial condition, theresults of operations and changes in cash flows of the Company and itssubsidiaries for interim 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 notes theretoincluded in the Company’s 2002 Annual Report on Form 10-K filed with the 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,“Accounting for the Impairment or Disposal of Long-Lived Assets”, which waseffective for the Company beginning January 1, 2002, real estate designated asheld for sale subsequent to January 1, 2002 will be accounted for in accordancewith the provisions of SFAS No. 144 and the results of operations of theseproperties are included in income from discontinued operations.  Prior periods have been reclassified forcomparability, 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 and theresults of operations during the reporting period. Actual results couldmaterially differ from those estimates.

 

**NEWACCOUNTING PRONOUNCEMENTS**

In May 2003, the FinancialAccounting 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 Companyis currently evaluating FAS 150 to determine its impact on the financialcondition and results of operations of the Company.

 

In April 2003, the FASBissued SFAS No. 149, “Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities” (“FAS 149”). FAS 149 amends and clarifies certain derivative instruments embedded inother contracts, and for hedging activities under SFAS No. 133.  FAS 149 is effective for certaincontracts entered into or modified by the Company after June 30, 2003. TheCompany is currently evaluating FAS 149 to determine its impact on thefinancial condition and results of operations of the Company.

 

In December 2002, FASB issued SFAS No. 148,“Accounting for Stock-Based Compensation - Transition and Disclosure” (“FAS148”), which amended SFAS Statement No. 123, “Accounting for Stock-BasedCompensation” (“FAS 123”).  FAS 148provides alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  Additionally, FAS 148 amends the disclosurerequirements of FAS 123 to require prominent disclosures in the annual andinterim financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on reportedresults.  FAS 148 is effective forfinancial statements for fiscal years ending after December 15, 2002.  In compliance with FAS 148, the Company haselected to continue to follow the

 

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intrinsic value method in accounting for itsstock-based employee compensation arrangement as defined by APB 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 of Others”(“FIN 45”). FIN 45 requires a company, at the time it issues a guarantee, torecognize an initial liability for the fair value of obligations assumed underthe guarantee and elaborates on existing disclosure requirements related toguarantees and warranties.  The initialrecognition requirements of FIN 45 are effective for guarantees issued ormodified after December 31, 2002 and adoption of the disclosure requirementsare effective for financial statements ending after December 15, 2002.  The adoption of FIN 45 is not expected tohave a significant impact on the Company’s consolidated financial position orresults of operations.

 

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

 

In April 2002, FASB issued SFAS No. 145, “Rescissionof FASB No. 4, 44, and 62, Amendment of FASB No. 13, and Technical Corrections”(“FAS 145”).  In most instances, FAS 145will require gains and losses on extinguishments of debt to be classified asincome or loss from continuing operations rather than as extraordinary items aspreviously required under FASB Statement No. 4, “Reporting Gains and Lossesfrom Extinguishment of Debt” (“FAS 4”). This provision of FAS 145 is effective for fiscal years beginning afterMay 15, 2002, with early application encouraged.  Upon application, any gain or loss on extinguishments of debtpreviously classified as an extraordinary item in prior periods presented thatdoes not meet the criteria of Opinion 30 for such classifications should bereclassified to conform to the provisions of FAS 145.  The Company adopted FAS 145 in the third quarter of 2002.  The adoption of FAS 145 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, amongother things, the presence of economic conditions which will enable the Companyto continue to hold and operate the properties prior to their eventualsale.  Due to uncertainties inherent inthe valuation process and in the economy, actual results of operating anddisposing of 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 |   | 10 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

 

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carrying value of theCompany’s financial instruments approximate their respective fair market valuesat June 30, 2003 and December 31, 2002.

 

**DERIVATIVEFINANCIAL INSTRUMENTS**

The Company follows Statement of Financial AccountingStandard No. 133, as amended, which establishes accounting and reportingstandards for derivative financial instruments, including certain derivativeinstruments embedded in other contracts and hedging activities.  All derivatives, whether designed in hedgingrelationships or not, are required to be recorded on the balance sheet at fairvalue.  If the derivative is designatedas a fair value hedge, the changes in the fair value of the derivative and ofthe hedged item attributable to the hedged risk are recognized inearnings.  If the derivative isdesignated as a cash flow hedge, the effective portions of changes in the fairvalue of the derivative are recorded in other comprehensive income andineffective portions of changes in the fair value of cash flow hedges arerecognized in earnings.

 

The Company uses interest rate swaps to hedge againstfluctuations in interest rates on specific borrowings.  Interest rate swap contracts in notionalamounts of approximately $22,000,000, which expired December 15, 2002, wererenewed on January 7, 2003.  Theinterest rate swap contracts are reflected at fair value on the Company’sbalance sheet in accrued and other liabilities and the changes in the fairvalue of the hedge are recognized as adjustments to interest expense.  During the six months ended June 30, 2003and 2002, the Company recorded charges of $244,000 and $89,000, respectively,attributable to changes in the fair value of its derivatives financialinstruments.  The Company’s objective isto minimize the risk of fluctuations using the most effective methods toeliminate 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-BASEDCOMPENSATION**

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” (“FAS148”), which amended FAS 123.  FAS 148provides alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  Additionally, FAS 148 amends the disclosurerequirements of FAS 123 to require prominent disclosures in the annual andinterim financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on reportedresults.  FAS 148 is effective forfinancial statements for fiscal years ending after December 15, 2002.  In compliance with FAS 148, the Company haselected to continue to follow the intrinsic value method in accounting for itsstock-based employee compensation arrangement as defined by APB 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 exercise price.  No stock-based employee compensation cost isreflected in net income related to stock options, as all options granted underthe Plan had an exercise price equal to the fair market value of the underlyingcommon stock on the date of grant.

 

The following table illustrates the effect on netincome and earnings per share if the Company had applied the fair valuerecognition of the provisions of FAS 123 to stock-based employee compensation(thousands of dollars):

 

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|                                                                                                                     |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                                                                                     |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
| Net  (loss) income, as reported                                                                                          |   | $                               | (4,395 | )                             | $      | (1,482 | ) | $ | (6,671 | ) | $ | (3,583 | ) |
| Deduct:  Employee compensation expense for stock  option grants under fair value method, net of related tax effects |   | (81                             | )      | (142                          | )      | (145 | ) | (392 | ) |
| Pro  forma net (loss) income                                                                                             |   | $                               | (4,476 | )                             | $      | (1,624 | ) | $ | (6,816 | ) | $ | (3,975 | ) |
|                                                                                                                     |   |                            |   |                          |   |   |   |   |   |
| Per  share data:                                                                                                         |   |                            |   |                          |   |   |   |   |   |
| Basic  and diluted, as reported                                                                                          |   | $                               | (0.74  | )                             | $      | (0.27 | ) | $ | (1.15 | ) | $ | (0.65 | ) |
| Basic  and diluted, proforma                                                                                             |   | $                               | (0.75  | )                             | $      | (0.29 | ) | $ | (1.19 | ) | $ | (0.72 | ) |

 

**MINORITYINTEREST**

Unit holders in the Operating Partnership (other thanthe Company) held a 12.18% and 11.60% limited partnership interest in theOperating Partnership at June 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 May 2003, the Company issued 141,268 OP Units inconnection with the acquisition of an office property in Houston, Texas from anaffiliated entity.  During the sixmonths ended June 30, 2003, a total of 15,957 OP Units were exchanged for anequivalent number of shares of Common Stock.

 

**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.  TheCompany’s ability to re-lease the space to existing or new tenants at ratesequal to or greater than those realized historically is impacted by, amongother things, the economic conditions of the market in which a property islocated, the availability of competing space, and the level of improvementswhich may be required at the property. No assurance can be given that therental rates that the Company will obtain in the future will be equal to orgreater than those obtained under existing contractual commitments.

 

**NETLOSS PER SHARE**

Net loss per share iscalculated based on the weighted average number of common sharesoutstanding.  Stock options outstandingof 189,500 at June 30, 2003 and OP Units (other than those held by the Company)outstanding of 850,916 at June 30, 2003 have not been included in the net lossper share calculation since their effect would 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

 

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jurisdictions in which theCompany operates.  Should the actualresults differ from the Company’s estimates, the Company would have to adjustthe income tax provision in the period in which the facts and circumstancesthat give 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.

 

**NOTE3.  REAL ESTATE**

 

**ACQUISITIONS**

On May 7, 2003, the Companyacquired 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 consisted of the assumption of existing debt, a deferred payment andthe issuance of 141,268 OP Units.

 

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 consisted primarily of theassumption of existing debt with the remainder in cash.

 

On May 28, 2002, the Companyacquired two office properties in Houston, Texas consisting of approximately142,792 rentable square feet.  Theaggregate acquisition costs of approximately $11,567,000 consisted of proceedsfrom a tax-deferred exchange, the assumption of existing debt and sellerfinancing.

 

**DISPOSITIONS**

On April 10, 2003, the Company sold an 82,560 squarefoot industrial property in Arizona for $4,100,000 (“Valencia”).  On May 15, 2003, the Company sold a 125-unitapartment property in California, for $12,500,000 (“Villa Redondo”).  The transactions produced net proceeds of$4,685,000 and generated a total gain of $2,228,000.  The gain is reflected as discontinued operations in theconsolidated statements of operations.

 

On October 15, 2002, the Company sold a 72,149 squarefoot shopping center in Missouri, for $3,800,000 (“Maple Tree”).  On October 11, 2002, the Company sold a152-unit apartment property in California, for $8,300,000 (“CreeksideApartments”).  Total net sales proceedsof $279,000, which were held in escrow at June 30, 2003 and December 31, 2002,were received in April 2003.

 

In July 2002, the Company received compensation of$150,000 for a strip of land condemned for highway purposes on an officeproperty in Illinois.

 

On April 30, 2002, the Company sold Beach &Lampson, a 13,017 square foot shopping center in California, for$1,200,000.  The Company received netcash proceeds of approximately $59,000 on the sale date and a $1,100,000 trustdeed note from the buyer.  The note,which contained a $200,000 early pay-off discount, was paid in October 2002with the receipt of $900,000 from the buyer.

 

**NOTE4.  DISCONTINUED OPERATIONS**

 

*Real estate assets held for sale*.

 

As of June 30, 2003 sixproperties were classified as “Real estate held for sale”.  These properties, located in four states,consisted of five industrial and one office property with an aggregate rentablesquare footage of approximately 809,000. Four of these properties were subsequently sold in July 2003 for anaggregate sales price of $18,046,000. The sales generated net proceeds of approximately $3,000,000, of which$560,000 is being held in escrow as a source to assist the funding of a futureacquisition in a tax-deferred exchange. An impairment charge of $4,000,000 was recorded in the second quarter of2003 relating to three of these properties.

 

As of December 31, 2002, eightproperties were classified as “Real estate held for sale”.  These properties, located in six states,consisted of the above six properties and Valencia and Villa Redondo.  Valencia and Villa Redondo were sold in thesecond quarter of 2003.

 

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The carrying amounts, net ofthe $4,000,000 impairment charge, of “Real estate held for sale” at June 30,2003 and December 31, 2002 are summarized below (dollars in thousands):

 
| **Condensed  Consolidated Balance Sheets**                                 |   | **June 30, 2003** |   | **December 31, 2002** |   |
|----------------------------------------------------------------------------|--------|-------------------|--------|-----------------------|--------|
|                                                                       |   |              |   |                  |   |
| Real estate                                                                |   | $                 | 24,931 |                  | $      | 43,547 |   |
| Other                                                                      |   | 1,629             |   | 1,704                 |   |
| Real estate assets held for sale                                           |   | $                 | 26,560 |                  | $      | 45,251 |   |
|                                                                       |   |              |   |                  |   |
| Notes payable, net (including $800 to  related party at December 31, 2002) |   | $                 | 20,348 |                  | $      | 31,698 |   |
| Accounts payable                                                           |   | 322               |   | 454                   |   |
| Accrued and other liabilities                                              |   | 1,049             |   | 1,297                 |   |
| Liabilities related to real estate held for  sale                          |   | $                 | 21,719 |                  | $      | 33,449 |   |

 

*Net income from discontinued operations.*

 

Net income from discontinuedoperations for the three and six months ended June 30, 2003 includes theoperations of the six properties classified as “Real estate held for sale” asof June 30, 2003 and the operations of Valencia and Villa Redondo, which weresold in the second quarter of 2003.  Again on sale of discontinued operations of $2,228,000 on the dispositionValencia and Villa Redondo was recognized in the second quarter.  An impairment totaling $4,000,000 wasrecognized on three properties classified as “Real estate held for sale” in thesecond quarter of 2003.  The impairmentwas based on the anticipated sales price less cost to sell as compared to thecarrying value of the assets.  The threeproperties, which were sold in the third quarter of 2003, consisted of oneoffice and two industrial properties.

 

The condensed consolidatedstatements of operations of discontinued operations are summarized below(dollars in thousands):

 
| **Condensed  Consolidated Statements of Operations**                        |   | **Three Months Ended  June 30, 2003** |   | **Six Months Ended  June 30, 2003** |   |
|-----------------------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
| Rental revenue                                                              |   | $                                     | 1,425  |                                | $      | 3,365 |   |
| Total expenses                                                              |   | 1,378                                 |   | 3,250                               |   |
| Net income from discontinued operations  before gain on sale and impairment |   | 47                                    |   | 115                                 |   |
| Gain on sale of discontinued operations                                     |   | 2,228                                 |   | 2,228                               |   |
| Impairment of real estate assets held for  sale                             |   | (4,000                                | )      | (4,000                              | )      |
| Net loss from discontinued operations                                       |   | $                                     | (1,725 | )                                   | $      | (1,657 | ) |

 

Net income from discontinuedoperations for the three and six months ended June 30, 2002 includes theoperations of the eight properties classified as “Real estate held for sale” asof December 31, 2002 and the operations of Maple Tree and Creekside Apartments,which were sold in the fourth quarter of 2002.

** **
| **Condensed  Consolidated Statements of Operations**   |   | **Three Months Ended June 30, 2002** |   | **Six Months Ended June 30, 2002** |   |
|--------------------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
| Rental revenue                                         |   | $                                    | 2,434  |                               | $      | 4,724 |   |
| Total expenses                                         |   | 1,993                                |   | 4,125                              |   |
| Loss on early extinguishment of debt                   |   | (91                                  | )      | (91                                | )      |
| Minority interest related to partially  owned property |   | (31                                  | )      | (67                                | )      |
| Net income from discontinued operations                |   | $                                    | 319    |                               | $      | 441 |   |

 

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

 

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

 

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|                                                                                                                                                                                                                                                                                                                                                              |   | **2003** |    | **2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Secured loans with various lenders, net of unamortized premiums of  $3,372 at June 30, 2003 and $3,655 at December 31, 2002, bearing interest at  fixed rates between 5.00% and 13.00%, with monthly principal and interest  payments ranging between $3 and $269 at June 30, 2003 and December 31, 2002,  and maturing at various dates through August 11, 2012. |   | $        | 115,266 |     | $      | 112,385 |   |
|                                                                                                                                                                                                                                                                                                                                                              |   |     |    |     |   |
| Secured  loans with various banks bearing interest at variable rates ranging between  5.04% and 9.00% at June 30, 2003 and 5.38% and 9.00% at December 31, 2002,  and maturing at various dates through May 1, 2008.                                                                                                                                              |   | 24,699   |    | 25,045   |   |
|                                                                                                                                                                                                                                                                                                                                                              |   |     |    |     |   |
| Secured Series A & B Bonds with a fixed interest rate of 6.39%,  monthly principal and interest payments of $74, maturing June 30, 2031.                                                                                                                                                                                                                      |   | 11,607   |    | 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.                                                                                                                                                                                                                     |   | 575      |    | 645      |   |
|                                                                                                                                                                                                                                                                                                                                                              |   |     |    |     |   |
| Unsecured  loans with various lenders, bearing interest at fixed rates between 5.65% and  20.00% at June 30, 2003 and 8.00% and 20.00% at December 31, 2002, and  maturing at various dates through October 1, 2004.                                                                                                                                              |   | 1,222    |    | 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                                                                                                                                                                                                                                                                                                                                                             |   | $        | 153,369 |     | $      | 152,694 |   |

 

Debt premiums are amortizedinto interest expense over the terms of the related mortgages using theeffective interest method.  As of June30, 2003 and December 31, 2002, the unamortized debt premiums included in theabove schedule were $3,372,000 and $3,655,000, respectively.

 

InMay 2003, through the acquisition of an office property in Houston, Texas, theCompany assumed a loan in the amount of $3,180,000.  The loan bears interest at a fixed rate of 6.80% and matures inAugust 2012.  The Company also enteredinto an agreement that provided for seller debt of $464,000, bearing interestat a fixed rate of 6.80% per annum and maturing in May 2005.

 

In May 2003, the successor of Brown Parkerand Leahy, LLP cancelled its $199,180 note, plus $45,891 of accrued interestthereon, in exchange for a private placement of 59,773 shares of the Company’scommon stock.

 

In May 2003, John N. Galardicancelled his $1,600,000 note, plus $286,036 of accrued interest thereon, inexchange for a private placement of 460,009 shares of the Company’s commonstock.

 

In May 2003, the Companyfinanced insurance premiums of $643,000 on its properties and agreed to pay aservice fee of $85,000 over one year. The insurance premium note matures in February 2004.

 

In January 2003, a note payablein the amount of $509,000 became due and payable.  The Company continues to pay the monthly interest due on thisnote and is planning to pay this loan with proceeds from the sale of properties.

 

In December 2002, modificationagreements were entered into with a bank to extend the maturity on five securedloans to December 31, 2004.  Two ofthese loans, with balances of $4,682,000 at June 30, 2003, were paid in thethird quarter of 2003 in connection with property sales.

 

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In December 2002, the Companyentered into an $830,000 loan on Valencia, an industrial property classified as“Real estate held for sale” in the accompanying consolidated financialstatements.    $800,000 was funded inDecember 2002 and $30,000 in March 2003. The loan was provided by an affiliate of a related party.  The mortgage was repaid in April 2003 uponthe sale of the property.

 

In October 2002, the Companyreceived proceeds of $1,532,000 from two bridge loans on Maple Tree.  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 theacquisition of an office property in Houston, Texas, the Company assumed a loanin the amount of $1,213,000.  The loanbears interest at a fixed rate of 7.29% and matures in April 2005.

 

In July 2002, a lender notifiedthe Company it was technically in default under its loan agreement fornon-compliance with certain covenants, including covenants requiringimprovements to shopping center properties in South Carolina.  Thereafter, the lender notified the Companyit was in default for failure to pay a matured portion of the loan, whichmatured in November 2002.  As of June30, 2003, the amount due under the matured portion of the loan was $2,860,000and the aggregate principal balance of the loan agreement was $6,522,000.  In early 2003, the lender sold the loan tothe major tenant in the shopping center. The new lender has not accelerated the loan agreement.  The Company is considering variousalternatives, including selling the property or using proceeds from the sale ofanother property to provide capital to pay off the matured portion of theloan.  The Company continues to discussthe non-compliance matter with the new lender.

 

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, the Companyrefinanced 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, the Companyrefinanced a $1,346,000 loan secured by Leawood Fountain Plaza, an officeproperty, and entered into a new one-year loan agreement in the amount of$3,000,000.  The new loan bears interestat Libor plus 2.85% with a minimum of 5.75% per annum (5.75% at June 30,2003).  Net proceeds of $1,026,000 werereceived as a result of the refinancing. The loan matured in June 2003. The Company is negotiating with the lender to extend the maturity for anadditional two years.  There can be noassurance that an extension will be achieved.

 

In May 2002, the Companyfinanced 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, the Companyrefinanced a $3,650,000 loan secured by Oak Grove Commons, an industrialproperty, and entered into a new loan agreement in the amount of$4,314,000.  The new loan bears interestat a fixed rate of 7.61% per annum and matures in May 2012.  Net proceeds of $383,000 were received as aresult of the refinancing.

 

In March 2002, the Companyrefinanced a $2,750,000 loan partially secured by Countryside Office Park andentered 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 the refinancing.

 

In January 2002, the Company refinanced a $4,500,000loan partially secured by Northcreek and entered into a new loan agreement inthe amount of $5,625,000.  The new loanbears interest at a fixed rate of 7.58% per annum and matures in February2012.  Net proceeds of $639,000 werereceived as a result of the refinancing. The loan was repaid in the third quarter of 2003 upon the sale of theproperty.

 

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As of this date, the Company has not paid 2002property taxes of $151,000 due on one of its properties.  This non-payment could be considered atechnical default on the loan for this property.  The Company plans to pay these taxes with the proceeds from thesale of the property expected to occur in the third quarter of 2003.  There can be no assurance, however, that thesale of the property will occur.

 

**NOTESPAYABLE TO FORMER LIMITED 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 mature in October 2009.  Interest is payable semi-annually in arrearson each June 15 and December 15, commencing June 15, 2002.  The notes may be redeemed at any time at theoption of the Company, in whole or from time to time in part, at a redemptionprice equal to the sum of the principal amount of the notes being redeemed plusaccrued interest thereon to the redemption date.  During 2002, $2,055,049 of the notes, plus accrued interest, waspaid.  The principal balance of thenotes as of June 30, 2003 was $236,622.

 

**NOTE6.  RELATED PARTY TRANSACTIONS**

 

In July 2003, the Company madea $400,000 payment on its indebtedness to an affiliated entity, reducing the balancedue from $1,060,852 to $660,852.

 

In May 2003, the Company acquired an office propertyfrom an affiliated entity.  The propertyis located in Houston, Texas and consists of approximately 59,550 rentablesquare feet.  Acquisition costs ofapproximately $4,310,000 consisted of the assumption of existing debt, adeferred payment of $343,228, of which $280,700 was paid in July 2003, and theissuance of 141,268 OP Units.

 

In May 2003, the successor of Brown Parkerand Leahy, LLP cancelled its $199,180 note, plus $45,891 of accrued interestthereon, in exchange for a private placement of 59,773 shares of the Company’scommon stock.  Timothy Brown, a directorof the Company, was a partner of Brown Parker Leahy, LLP.

 

In May 2003, John N. Galardi, adirector and principal stockholder of the Company, cancelled his $1,600,000note, plus $286,036 of accrued interest thereon, in exchange for a privateplacement of 460,009 shares of the Company’s common stock.

 

In May 2003, Mr. Galardipurchased a total of 60,975 shares of the Company’s common stock for $4.10 pershare.

 

In February 2003, the Companyreached an agreement with CGS Real Estate Company, Inc. whereby CGSacknowledged that it owed the Company a net amount of $270,375 which related toseveral issues asserted by William J Carden that were owed by CGS to theCompany and by the Company to CGS.  Thisamount is payable on March 15, 2006 with interest accruing from March 15, 2003at an annual rate of 6% and payable quarterly commencing on June 15, 2003.  Mr. Carden, a director and the Chairman,President and Chief Executive Officer of the Company, is a principalstockholder, an officer and a director of CGS. Mr. Carden and Mr. Galardi have agreed to guarantee this obligation ofCGS, and they have secured this guarantee with an assignment to the Company oftheir right to receive $270,375 of principal payments on the notes payable tothem and their affiliates by reason of the settlement of the Teachoutlitigation, plus all interest payable on such principal amount of notes.

 

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

 

During the first quarter of2002, the Company made payments totaling $521,808 on its obligation to ASJ,Ltd., which is owned by Mr. Carden, his wife and a trust for his children.  These payments reduced the balance due toASJ, Ltd. to $200,000 as of June 30, 2003.

 

17

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**NOTE7.  SEGMENT INFORMATION**

 

As of June 30, 2003, theCompany owned a diverse portfolio of properties comprising office, industrial,shopping center and apartment properties, and developmental land.  Each of these property types represents areportable segment with distinct uses and tenant types and requires the Companyto employ different management strategies. Each segment contains properties located in various regions and marketswithin the United States.  The officeportfolio consists primarily of suburban office buildings. The industrialportfolio consists of properties designed for warehouse, distribution and lightmanufacturing for single-tenant or multi-tenant use.  The shopping center portfolio consists primarily of communityshopping centers.  The properties in theapartment portfolio are apartment buildings with units rented to residentialtenants on either a month-by-month basis or for terms generally of one year orless.

 

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 six months endedJune 30, 2003 and 2002 is as follows (dollars in thousands):

 
| **Three  Months Ended June 30,**     |   | **Office** |    | **Industrial** |   | **Shopping  Center** |   | **Apartment** |   | **Land Held  for Development  and Other** |   | **Property  Total** |   |
|--------------------------------------|--------|------------|---------|----------------|--------|----------------------|--------|---------------|--------|-------------------------------------------|--------|---------------------|--------|
| **2003**                             |   |       |    |           |   |                 |   |          |   |                                      |   |                |   |
| Rental revenue                       |   | $          | 4,710   |           | $      | 693                  |   | $             | 368    |                                      | $      | 1,236               |   | $ | 8 |   | $ | 7,015 |   |
| Property operating expenses          |   | 2,044      |    | 189            |   | 99                   |   | 733           |   | 35                                        |   | 3,100               |   |
| Net operating income (NOI)           |   | $          | 2,666   |           | $      | 504                  |   | $             | 269    |                                      | $      | 503                 |   | $ | (27 | ) | $ | 3,915 |   |
| Real estate held for investment, net |   | $          | 135,301 |           | $      | 22,901               |   | $             | 9,664  |                                      | $      | 24,760              |   | $ | 2,089 |   | $ | 194,715 |   |
|                                 |   |       |    |           |   |                 |   |          |   |                                      |   |                |   |
| **2002**                             |   |       |    |           |   |                 |   |          |   |                                      |   |                |   |
| Rental revenue                       |   | $          | 5,283   |           | $      | 896                  |   | $             | 399    |                                      | $      | 1,271               |   | — |   | $ | 7,849 |   |
| Property operating expenses          |   | 1,874      |    | 160            |   | 134                  |   | 694           |   | $                                         | 112    |                | 2,974  |   |
| Net operating income (NOI)           |   | $          | 3,409   |           | $      | 736                  |   | $             | 265    |                                      | $      | 577                 |   | $ | (112 | ) | $ | 4,875 |   |
| Real estate held for investment, net |   | $          | 133,746 |           | $      | 23,852               |   | $             | 12,667 |                                      | $      | 25,565              |   | $ | 4,056 |   | $ | 199,886 |   |

 
| **Six Months Ended June 30,**        |   | **Office** |    | **Industrial** |   | **Shopping  Center** |   | **Apartment** |   | **Land Held  for  Development  and Other** |   | **Property  Total** |   |
|--------------------------------------|--------|------------|---------|----------------|--------|----------------------|--------|---------------|--------|--------------------------------------------|--------|---------------------|--------|
| **2003**                             |   |       |    |           |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                       |   | $          | 9,990   |           | $      | 1,422                |   | $             | 716    |                                       | $      | 2,372               |   | $ | 50 |   | $ | 14,550 |   |
| Property operating expenses          |   | 3,994      |    | 533            |   | 233                  |   | 1,371         |   | 82                                         |   | 6,213               |   |
| Net operating income (NOI)           |   | $          | 5,996   |           | $      | 889                  |   | $             | 483    |                                       | $      | 1,001               |   | $ | (32 | ) | $ | 8,337 |   |
| Real estate held for investment, net |   | $          | 135,301 |           | $      | 22,901               |   | $             | 9,664  |                                       | $      | 24,760              |   | $ | 2,089 |   | $ | 194,715 |   |
|                                 |   |       |    |           |   |                 |   |          |   |                                       |   |                |   |
| **2002**                             |   |       |    |           |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                       |   | $          | 10,402  |           | $      | 1,742                |   | $             | 801    |                                       | $      | 2,490               |   | — |   | $ | 15,435 |   |
| Property operating expenses          |   | 3,616      |    | 408            |   | 274                  |   | 1,337         |   | $                                          | 126    |                | 5,761  |   |
| Net operating income (NOI)           |   | $          | 6,786   |           | $      | 1,334                |   | $             | 527    |                                       | $      | 1,153               |   | $ | (126 | ) | $ | 9,674 |   |
| Real estate held for investment, net |   | $          | 133,746 |           | $      | 23,852               |   | $             | 12,667 |                                       | $      | 25,565              |   | $ | 4,056 |   | $ | 199,886 |   |

 

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 June 30,** |   | **Six Months Ended June 30,** |   |
|----------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                           |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
| **REVENUES**                                                   |   |                            |   |                          |   |   |   |   |   |
| Total revenues for reportable segments                         |   | $                               | 7,015  |                          | $      | 7,849 |   | $ | 14,550 |   | $ | 15,435 |   |
| Other revenues                                                 |   | 33                              |   | 72                            |   | 43 |   | 151 |   |
| Total consolidated revenues                                    |   | $                               | 7,048  |                          | $      | 7,921 |   | $ | 14,593 |   | $ | 15,586 |   |
|                                                           |   |                            |   |                          |   |   |   |   |   |
| **NET (LOSS) INCOME**                                          |   |                            |   |                          |   |   |   |   |   |
| NOI for reportable segments                                    |   | $                               | 3,915  |                          | $      | 4,875 |   | $ | 8,337 |   | $ | 9,674 |   |
| Unallocated amounts:                                           |   |                            |   |                          |   |   |   |   |   |
| Interest and other income                                      |   | 33                              |   | 194                           |   | 43 |   | 273 |   |
| General and administrative expenses                            |   | (1,709                          | )      | (1,812                        | )      | (3,302 | ) | (4,229 | ) |
| Depreciation and amortization                                  |   | (2,582                          | )      | (2,221                        | )      | (5,156 | ) | (4,559 | ) |
| Interest expense                                               |   | (2,948                          | )      | (3,031                        | )      | (5,851 | ) | (5,653 | ) |
| Net loss before minority interest and  discontinued operations |   | $                               | (3,291 | )                             | $      | (1,995 | ) | $ | (5,929 | ) | $ | (4,494 | ) |

 

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|                                 |   | **June 30,** |    |
|--------------------------------------|--------|--------------|---------|
|                                 |   | **2003**     |    | **2002** |   |
| **ASSETS**                           |   |         |    |   |   |
| Total assets for reportable segments |   | $            | 194,715 |   | $ | 199,886 |   |
| Real estate assets held for sale     |   | 26,560       |    | 58,477 |   |
| Cash and cash equivalents            |   | 1,839        |    | 1,908 |   |
| Tenant and other receivables, net    |   | 589          |    | 779 |   |
| Deferred rent receivable             |   | 660          |    | 294 |   |
| Mortgage loan receivable             |   | —       |    | 1,100 |   |
| Investment in management company     |   | 4,000        |    | 4,000 |   |
| Prepaid and other assets, net        |   | 9,696        |    | 6,750 |   |
| Total consolidated assets            |   | $            | 238,059 |   | $ | 273,194 |   |

 

**NOTE8.  COMMITMENTS AND CONTINGENCIES**

 

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

Reference is made to theCompany’s Annual Report on Form 10-K for 2002 for information with respect tothis matter.

 

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 inconnection with loans to an affiliate of the general partner and the issuanceof notes to an affiliate of CGS in connection with the purchase of a propertyfrom Fund II, among other things.  FundII was merged into 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, the partiesreached a settlement regarding this matter. Under the settlement, which is expected to be documented in the thirdquarter due to an unresolved dispute on one of the settlement terms, theCompany reaffirmed its previously announced obligation to pay the formerlimited partners of Fund II, or their assignees or transferees, the loans whichwere made and called by the former general partner of Fund II as part of theConsolidation.  Pursuant to thesettlement, the Company has established a definitive repayment plan and willsecure the repayment obligation with a second deed of trust on an officebuilding owned by the Company.  Therepayment plan consists of a promissory note in the amount of $8,800,000 (theamount of such loans, plus interest as of December 31, 2002), which shallaccrue interest at 6% per annum. Interest only payments will be made quarterly until the note is paid.  The note may be prepaid in whole or in partat any time without penalty.  Pursuantto the settlement agreement, the Company made the first interest payment onJune 2, 2003.

 

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.  Thetotal obligation under the settlement of $10,000,000 is reflected as a separateline item in the consolidated financial statements.

 

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In connection with theagreement, Mr. Galardi and Mr. Carden 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 right toreceive $1,187,695 of principal payments on the notes payable to them and theiraffiliates 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 financial statements.

 

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.

 

The Company has contractualobligations and commitments with regards to the litigation settlement,operating leases, employment agreements, and the purchase of OP Units fromNooney Development Partners.  Thefollowing table aggregates these contractual obligations and commitmentssubsequent to June 30, 2003 (dollars in thousands):

 
|                                                  |   | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   |
|-------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|-----------|--------|
| Litigation settlement                                 |   | $        | 250    |     | $      | —   |   | $        | — |     | $      | 9,750          |   | $         | — |   | $ | — |   | $ | 10,000 |   |
| Employee obligations                                  |   | 500      |   | 283      |   | —   |   | —   |   | —   |   | —         |   | 783       |   |
| Operating lease commitments                           |   | 63       |   | 37       |   | 12       |   | —   |   | —   |   | —         |   | 112       |   |
| Purchase of OP Units from Nooney Development Partners |   | 223      |   | —   |   | —   |   | —   |   | —   |   | —         |   | 223       |   |
| Total                                                 |   | $        | 1,036  |     | $      | 320      |   | $        | 12     |     | $      | 9,750          |   | $         | — |   | $ | — |   | $ | 11,118 |   |

 

In July 2003, the Companypurchased the OP Units from Nooney Development Partners.

 

**NOTE9.  REDEEMABLE COMMON STOCK**

 

On October 23, 2001, the Company issued 20,000 sharesof its Common Stock, $.01 par value per share, with the holder’s right tocompel the sale of (the “Put”) the stock back to the Company at a fixed priceof $15.00 per share during the period from October 31, 2002 to November 30,2002.  On November 26, 2002, the Companyand holder agreed to extend the put exercise period to May 30, 2003 throughJune 30, 2003.  The holder may exercisethe Put by giving written notice thereof to the Company, within three businessdays of the date of exercise in writing. Within three business days’ of receipt of the notice of exercise of thePut, the Company shall deliver to the holder in good funds the full exerciseprice for the shares exercised under the Put and within three days afterreceipt of such funds the holder will deliver to the Company the certificatesrepresenting the number of shares of Common Stock being sold pursuant to thePut.  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 agreed to pay such amount by August 29, 2003.

 

**NOTE10.  SUBSEQUENT EVENTS**

 

In July 2003, the Company sold fourproperties, which were classified as “Real estate held for sale” in theconsolidated financial statements as of June 30, 2003.

 

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

 

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On July 18, 2003, the Company sold Northeast CommerceCenter, a 100,000 square foot industrial property located in Ohio, for$4,771,000.

 

An impairment totaling$4,000,000 was recorded on three of these properties in the second quarter of2003.  The sales generated net proceedsof approximately $3,000,000, of which $560,000 is being held in escrow as asource to assist the funding of a future acquisition in a tax-deferredexchange.

 

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**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS 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 June 30, 2003, held a .90% generalpartner interest and an 86.92% limited partnership interest.   As of June 30, 2003, through the OperatingPartnership, the Company owned and operated 32 properties, which consisted of16 office, 10 industrial, three shopping center, and two apartment properties,and one undeveloped land property.  InJuly 2003, the Company sold four properties located in the Mid West: one officeproperty and three industrial properties. The remaining properties are located in eight states.  The Company plans to sell certain of itsproperties and to acquire additional properties in its core property types andcore geographic markets.  The Companywill focus primarily on office and industrial properties located in Texas,California and Arizona.

 

In October 2001, the Companyacquired various properties in the Consolidation.  Pursuant to the Consolidation, subsidiaries of the Company mergedwith eight public limited partnerships, acquired the assets and liabilities oftwo private entities managed by CGS and acquired certain assets and liabilitiesof CGS and the majority owned affiliates of CGS.  SPPI84, one of the eight public limited partnerships, wastreated, for accounting purposes, as the acquirer of the properties in theConsolidation.  Pursuant to theConsolidation, partners of the public partnerships received shares in the Companyor 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.

 

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

 

The 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 assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the results of operations during the reportingperiod. Actual results could differ materially from those estimates.

 

The 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 capitalization ratesmultiplied by annualized net operating income based upon the age, constructionand use of the building.  Thefulfillment of the Company’s plans related to each of its properties isdependent upon, among other things, the presence of economic conditions whichwill

 

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enablethe Company to continue to hold and operate the properties prior to theireventual sale.  When the Company hasdetermined a property should be considered held for sale, it estimates thevalue 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 the 2003tax year.  In this regard, the Companyplans to operate in a manner that will permit it to elect REIT status in2003.  In general, a REIT is a companythat owns or provides financing for real estate and pays annual distributionsto investors of at least 90% of its taxable income.  A REIT typically is not subject to federal income taxation on itsnet income, provided applicable income tax requirements are satisfied.   For the tax year 2002, the Company wastaxed as a C corporation.

# ** **

**RESULTSOF OPERATIONS**

 

In accordance with generallyaccepted accounting principles, the operating results of eight properties, sixof which were considered held for sale as of June 30, 2003 and two of whichwere sold in the second quarter, are reported as discontinued operations in thesecond quarter of 2003.  For the secondquarter of 2002, the results of ten properties (the above mentioned eight andtwo properties sold in 2002) are reported as discontinued operations.  See Note 4 – Discontinued Operations – ofthe Notes to Consolidated Financial Statements.  Unless otherwise indicated, the following discussion reflects theresults from continuing operations, which include the real estate assets heldfor investment.  The operating resultsof any properties acquired during the period include operations from the dateof acquisition.

 

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

 

*RentalRevenue*. For thethree months ended June 30, 2003, the Company recorded rental revenue of$7,015,000 compared to $7,849,000 for the three months ended June 30,2002.  This reduction was primarily theresult of a decrease in occupancy particularly in certain properties located inSan Diego, California due to the expiration of leases of three majortenants.  This reduction was offset byrevenue related to acquired properties. The Company acquired one property in May 2003, two properties in May2002 and one property in August 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 for investment was 86% at June 30, 2002 and 76% at June 30, 2003.

 

*PropertyOperating Expenses*.  For the three months ended June 30, 2003,the Company recorded property operating expenses of $3,100,000 compared to$2,974,000 for the three months ended June 30, 2002, a slight increase.  This increase was primarily due to propertyoperating expenses of $300,000 related to the above mentioned propertyacquisitions, partially offset by a decrease in expenses for existing propertiesdue to expense control measures put in place during the past year.

 

*General and administrative*.  General and administrative expensesdecreased by $103,000 for the second quarter of 2003 compared to the prior yearsecond quarter due to lower compensation expense related to common stock grants.  Duringthe second quarter of 2003, the Company recorded a $45,000 charge relating tothe closure of its administrative offices in St. Louis, Missouri and New York,New York.  The charge, which is relatedto severance payments to the administrative support staff, is included ingeneral and administrative expenses. Additional charges, primarily relating to severances and lease expense,will be

 

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incurred in the third andthe fourth quarters of 2003.  Closure ofthese offices will reduce expenses in the future.

 

*Depreciationand amortization*.    Depreciation and amortization expenseincreased $361,000 in the second quarter of 2003 compared to the second quarterof the prior year due to the acquisition of the four properties previouslymentioned and, to a lesser extent, depreciation of improvements and capitalizedlease costs incurred after the second quarter of 2002 for the existingproperties.

 

*InterestExpense*.  Interest expense decreased $83,000 for thesecond quarter of 2003 in comparison to the second quarter of the prioryear.  This decrease was in large partattributable to the conversion of debt to common stock and due to reducedinterest on an outstanding payable related to an expected settlement agreement.  This decrease was offset to an extent byinterest costs related to the acquisition of the four properties.

 

*Discontinued operations*.  TheCompany recorded income from discontinued operations of $47,000 for the threemonths ended June 30, 2003 compared to $319,000 for the second three months ofthe prior year.  The discontinuedoperations represent net income from the properties held for sale and thosesold.  For 2003, these propertiesconsist of eight properties versus ten properties for 2002.  See Note 4 – Discontinued Operations – ofthe Notes to Consolidated Financial Statements.

 

Theincome from discontinued operations is summarized below.

 
| **Condensed  Consolidated Statements of Operations**   |   | **Three Months Ended  June 30, 2003** |   | **Three Months Ended  June 30, 2002** |   |
|--------------------------------------------------------|--------|---------------------------------------|--------|---------------------------------------|--------|
|                                                   |   |                                  |   |                                  |   |
| Rental revenue                                         |   | $                                     | 1,425  |                                  | $      | 2,434 |   |
| Total expenses                                         |   | 1,378                                 |   | 1,993                                 |   |
| Loss on early extinguishment of debt                   |   | —                                |   | (91                                   | )      |
| Minority interest related to partially  owned property |   | —                                |   | (31                                   | )      |
| Net income from discontinued operations                |   | $                                     | 47     |                                  | $      | 319 |   |

 

*Gain onsale of discontinued operations*.  The Company sold one industrial property andone apartment property in the second quarter of 2003 for an aggregate of$16,600,000 and recognized a gain of $2,228,000.    The sales generated net proceeds of $4,685,000.

 

*Impairmentof real estate assets held for sale.*  TheCompany recorded an impairment of $4,000,000 on three properties held for salein the second quarter of 2003.  Theimpairment was based on the anticipated sales price less cost to sell as comparedto the carrying value of the assets. The three properties consist of one office and two industrialproperties.

 

***Discussion of the six months ended June 30,2003 and 2002.***

 

*RentalRevenue*. For the sixmonths ended June 30, 2003, the Company recorded rental revenue of $14,550,000compared to $15,435,000 for the six months ended June 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 by revenue relatedto acquired properties.  The Companyacquired one property in May 2003, two properties in May 2002 and one propertyin August 2002.  Rental revenue from theacquired properties was included in the Company’s results since theirrespective dates of acquisition.  Theweighted average occupancy of properties held from investment was 86% at June30, 2002 and 76% at June 30, 2003.

 

*PropertyOperating Expenses*.  For the six months ended June 30, 2003, theCompany recorded property operating expenses of $6,213,000 compared to$5,761,000 for the six months ended June 30, 2002, an increase of $452,000 or8%.  This increase is primarily due toproperty operating expenses of $608,000 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.

 

*General and administrative*.  General and administrative expensesdecreased by $927,000 for the first six months of 2003 compared to the prioryear first six months.  This decrease isdue (i) to a reduction of

 

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compensation expense in the 2003 due to downsizing ofstaff and lower compensation expense related to common stock grants, (ii) tothe inclusion of non recurring expenses related to the consolidation in thefirst quarter of 2002, and (iii) to expense control measures put in placeduring the past year.  During the second quarter of 2003, theCompany recorded a $45,000 charge relating to the closure of its administrativeoffices 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 third and the fourth quarters of 2003. Closure of these offices will reduce expenses in the future.

 

*Depreciationand amortization*.    Depreciation and amortization expenseincreased $597,000 in the first six months of 2003 compared to the first sixmonths of the prior year due to the acquisition of the four propertiespreviously mentioned and, to a lesser extent, depreciation of improvements andcapitalized lease costs incurred after the second quarter of 2002 for theexisting properties.

 

*InterestExpense*.  Interest expense increased $198,000 for thefirst six months of 2003 compared to the first six months of the prior yearprimarily due to interest associated with the four new properties acquiredoffset to an extent by reduced interest on an outstanding payable due to anexpected settlement agreement.

 

*Discontinued operations*.  TheCompany recorded income from discontinued operations of $115,000 for the sixmonths ended June 30, 2003 compared to $441,000 for the six months ended June30, 2002.  The discontinued operationsrepresent net income from the properties held for sale and those sold.  For 2003, these properties consist of eightproperties versus ten properties for 2002. See Note 4 – Discontinued Operations – of the Notes to ConsolidatedFinancial Statements.

 

Theincome from discontinued operations is summarized below.

 
| **Condensed Consolidated Statements of Operations**    |   | **Six Months Ended  June 30, 2003** |       | **Six Months Ended  June 30, 2002** |       |
|--------------------------------------------------------|--------|-------------------------------------|------------|-------------------------------------|------------|
|                                                   |   |                                | ** ** |                                | ** ** |
| Rental revenue                                         |   | $                                   | 3,365      |                                | $          | 4,724 |   |
| Total expenses                                         |   | 3,250                               |       | 4,125                               |       |
| Loss on early extinguishment of debt                   |   | —                              |       | (91                                 | )          |
| Minority interest related to partially  owned property |   | —                              |       | (67                                 | )          |
| Net income from discontinued operations                |   | $                                   | 115        |                                | $          | 441 |   |

 

*Gain onsale of discontinued operations*.  The Company sold one industrial property andone apartment property in the second quarter of 2003 for an aggregate of$16,600,000 and recognized a gain of $2,228,000.    The sales generated net proceeds of $4,685,000.

 

*Impairmentof real estate assets held for sale.*  TheCompany recorded an impairment of $4,000,000 on three properties held for salein the first six months of 2003.  Theimpairment is based on the anticipated sales price less cost to sell ascompared to the carrying value of the assets. The three properties consist of one office and two industrialproperties.

 

# **LIQUIDITY AND CAPITAL RESOURCES**

 

TheCompany reported a net loss of $6,671,000 for the six months ended June 30,2003, which included (i) the following non-cash charges: depreciation andamortization from real estate held for investment of $5,156,000, deferredcompensation expense of $157,000, mark to market adjustments on interest rateprotection agreements of $244,000, $4,000,000 impairment of the value ofcertain properties classified as held for sale; and (ii) the following othernon-cash items: deferred rental income of $229,000, minority interest of$915,000, and amortization of loan premiums of $283,000.  Net cash used by operating activitiesamounted to $2,060,000 for the six months ended June 30, 2003 primarily to fundprepaid and other assets and fund operations.

 

Net cash provided by investingactivities of $3,268,000 was primarily due to the sale of two properties in thesecond quarter of 2003, partially offset by capital expenditures incurredduring the first six months of 2003. The capital expenditures of $1,417,000 were primarily due to tenantbuild-outs.   Net cash used in investingactivities of $2,158,000 for the six months ended June 30, 2002 consisted of(i) $2,217,000 paid

 

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for capital expenditures, whichin large part were related to major renovations on an apartment property, less(ii) $59,000 in proceeds received from the sale of the Beach & Lampsonproperty.

 

Net cash used in financingactivities amounted to $867,000 during the six months ended June 30, 2003.  Repayments of borrowings of  $1,875,000 consisted of scheduled principalpayments made during the quarter. Proceeds from borrowings, which totaled $758,000, consisted of (i)$728,000 to fund property insurance premiums and service fee and (ii) $30,000from an affiliate of a related party which completed the funding of an $830,000loan on Valencia entered into in December of 2002.  The mortgage was repaid in conjunction with the sale of theproperty in April 2003.  In addition,John N. Galardi purchased 60,975 shares of the Company’s common stock for $250,000in May 2003.  Net cash provided byfinancing activities amounted to $3,239,000 during the six months ended June30, 2002.  Proceeds received fromborrowings totaled $21,773,000. Repayment of borrowings, which consisted of $13,698,000 from refinancesand $1,711,000 in scheduled principal payments, totaled $15,409,000.  Note payments to former limited partnerstotaling $1,864,000 and distributions totaling $1,255,000 were also made duringthe six months ended June 30, 2002.

 

InMay 2003, through the acquisition of an office property in Houston, Texas, theCompany assumed a loan in the amount of $3,180,000.  The loan bears interest at a fixed rate of 6.80% and matures inAugust 2012.  The Company also enteredinto an agreement that provided for seller debt of $464,000, bearing interestat a fixed rate of 6.80% per annum and maturing in May 2005.

 

In May 2003, the successor of Brown Parkerand Leahy, LLP cancelled its $199,180 note, plus $45,891 of accrued interestthereon, in exchange for a private placement of 59,773 shares of the Company’scommon stock.

 

In May 2003, John N. Galardicancelled his $1,600,000 note, plus $286,036 of accrued interest thereon, inexchange for a private placement of 460,009 shares of the Company’s commonstock.

 

In May 2003, the Companyfinanced insurance premiums of $643,000 on its properties and agreed to pay aservice fee of $85,000 over one year. The insurance premium note matures in February 2004.

 

In January 2003, a note payable in the amount of$509,000 became due and payable.  TheCompany continues to pay the monthly interest due on this note and is planningto pay this loan with proceeds from the sale of properties.

 

In January 2002, the Company refinanced a $4,500,000loan partially secured by Northcreek and entered into a new loan agreement inthe amount of $5,625,000.  The new loanbears interest at a fixed rate of 7.58% per annum and matures in February2012.  Net proceeds of $639,000 werereceived as a result of the refinancing. The loan was repaid in the third quarter of 2003 upon the sale of theproperty.

 

In March 2002, the Companyrefinanced a $2,750,000 loan partially secured by Countryside Office Park andentered 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 the refinancing.

 

In April 2002, the Companyrefinanced a $3,650,000 loan secured by Oak Grove Commons, an industrialproperty, and entered into a new loan agreement in the amount of$4,314,000.  The new loan bears interestat a fixed rate of 7.61% per annum and matures in May 2012.  Net proceeds of $383,000 were received as aresult of the refinancing.

 

# **InMay 2002, through the acquisition of two office properties in Houston, Texas,the Company assumed two loans totaling $8,650,000.  The loans bear interest at a fixed rate of 7.45% per annum andmature in May 2012.    The Company alsoentered into an agreement which provided for seller financing of $955,000,bearing interest at a fixed rate of 7.45% per annum and maturing in May 2004.**

 

In May 2002, the Companyrefinanced a $1,346,000 loan secured by Leawood Fountain Plaza, an officeproperty, and entered into a new one-year loan agreement in the amount of $3,000,000.  The new loan bears interest at Libor plus2.85% with a minimum of 5.75% per annum (5.75% at June 30, 2003).  Net

 

26

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proceeds of $1,026,000 werereceived as a result of the refinancing. The loan matured in June 2003. The Company is negotiating with the lender to extend the maturity for anadditional two years.  There can be noassurance that an extension will be achieved.

 

In May 2002, the Companyrefinanced 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, the Companyfinanced 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, a lender notifiedthe Company it was technically in default under its loan agreement fornon-compliance with certain covenants, including covenants requiringimprovements to shopping center properties in South Carolina.  Thereafter, the lender notified the Companyit was in default for failure to pay a matured portion of the loan, whichmatured in November 2002.  As of June30, 2003, the amount due under the matured portion of the loan was $2,860,000and the aggregate principal balance of the loan agreement was $6,522,000.  In early 2003, the lender sold the loan tothe major tenant in the shopping center. The new lender has not accelerated the loan agreement.  The Company is considering variousalternatives, including selling the property or using proceeds from the sale ofanother property to provide capital to pay off the matured portion of theloan.  The Company continues to discussthe non-compliance matter with the new lender.

 

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

 

In October 2002, the Companyreceived proceeds of $1,532,000 from two bridge loans on Maple Tree, one of itsshopping center properties.  One of theloans, which totaled $700,000, was provided by an affiliate of a relatedparty.  The mortgages were repaid inconjunction with the sale of the property in October 2002.

 

In December 2002, the Companyentered 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 agreementswere entered into with a bank to extend the maturity on five secured loans toDecember 31, 2004.  Two of these loans,with balances of $4,682,000 at June 30, 2003, were paid in the third quarter of2003 in connection with property sales.

 

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 by theCompany funded the payment of dividends per share of Common Stock of $.20, $.20and $.10, respectively.

 

During the second quarter of2003, the Company recorded a $45,000 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.  Additionalcharges, primarily relating to severances and lease expense, will be incurredin the third and the fourth quarters of 2003. Closure of these offices will reduce expenses in the future.

 

TheCompany expects to meet its short-term liquidity requirements for normalproperty operating expenses and general and administrative payroll expensesfrom cash generated by operations.  Inaddition, the Company anticipates selling assets to fund obligations in 2003,including capital costs incurred and to be incurred related to re-leasing spaceand improvements to properties, litigation settlement costs and other

 

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feesfor professional services.  The funds tomeet these obligations will be obtained from proceeds of the sale of assets andlender held funds.  Based on currentanalysis, the Company believes that the cash generated by these anticipatedsales will be adequate to meet these obligations.  There can be no assurance, however, that the sales of theseassets will occur and that substantial cash will be generated.  If these sales do not occur, the Companywill not have sufficient cash to meet its obligations.

 

As of this date, the Company has not paid 2002property taxes of $151,000 due on one of its properties.  This non-payment could be considered atechnical default on the loan for this property.  The Company plans to pay these taxes with the proceeds from thesale of the property expected to occur in the third quarter of 2003.  There can be no assurance, however, that thesale of the property will occur.

 

## **CONTRACTUAL OBLIGATIONS ANDCOMMITMENTS**

 

The Company has contractualobligations with regards to future principal payments of debt, a litigationsettlement, operating leases, employment agreements, and the purchase of OPUnits from Nooney Development Partners. The following table aggregates the Company’s expected contractualobligations and commitments subsequent to June 30, 2003 (dollars in thousands):

 
|                                                  |   | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   |
|-------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|-----------|--------|
| Long-term debt                                        |   | $        | 9,252  |     | $      | 25,201   |   | $        | 3,580  |     | $      | 7,227          |   | $         | 12,738 |   | $ | 91,999 |   | $ | 149,997 |   |
| Debt to former limited partners                       |   | —   |   | —   |   | —   |   | —   |   | —   |   | 237            |   | 237       |   |
| Litigation settlement                                 |   | 250      |   | —   |   | —   |   | 9,750    |   | —   |   | —         |   | 10,000    |   |
| Employee obligations                                  |   | 500      |   | 283      |   | —   |   | —   |   | —   |   | —         |   | 783       |   |
| Operating lease commitments                           |   | 63       |   | 37       |   | 12       |   | —   |   | —   |   | —         |   | 112       |   |
| Purchase of OP Units from Nooney Development Partners |   | 223      |   | —   |   | —   |   | —   |   | —   |   | —         |   | 223       |   |
| Total                                                 |   | $        | 10,288 |     | $      | 25,521   |   | $        | 3,592  |     | $      | 16,977         |   | $         | 12,738 |   | $ | 92,236 |   | $ | 161,352 |   |

 

In July 2003,the Company purchased the OP Units from Nooney Development Partners.  The Company plans on meeting debtmaturing over the next two years through properties sales and refinancings.

 

**FUNDS FROMOPERATIONS**

 

In October 1999, the Boardof Governors of NAREIT issued “White Paper on FFO-October 1999” to clarify itsdefinition of Funds from Operations (“FFO”). The clarification was effective January 1, 2000 and requires restatementfor all periods presented in financial statements or tables. FFO, as clarifiedby NAREIT, represents “net income excluding gains (or losses) from sales ofproperty, plus depreciation and amortization, and after adjustments forunconsolidated partnerships and joint ventures.  Adjustments for unconsolidated partnerships and joint ventureswill be calculated to reflect funds from operations on the same basis.”  In 2002, NAREIT clarified that FFO relatedto assets held for sale, sold or otherwise transferred and included in resultsof discontinued operations should continue to be included in FFO.  This clarification was effective January 1,2002 and requires restatement for all periods presented in financial statementsor tables.  The Company believes thatFFO is helpful to investors as a measure of performance of the Company andequity REITs because, along with cash flow from operating activities, FFOprovides investors with an indication of our ability to incur and service debt,to make capital expenditures and to fund other cash needs.  FFO is a non-GAAP financial measure.  FFO does not represent net income or cashflows from operations, as defined by GAAP, and should not be considered as analternative to net income (determined in accordance with GAAP) as an indicatorof the Company’s operating performance or as an alternative to cash flows fromoperating, investing and financing activities (determined in accordance withGAAP) as a measure of liquidity.  FFO doesnot necessarily indicate that cash flows will be sufficient to fund all of theCompany’s cash needs, including principal amortization, capital improvementsand distributions to stockholders. Further, FFO as disclosed by other companies may not be comparable tothe Company’s calculation of FFO.

 

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The following table sets forth the Company’scalculation of FFO and a reconciliation to a comparable GAAP disclosure for thesix months ended June 30, 2003 and 2002 (in thousands):

 
|                                                                        |   | **2003** |   | **2002** |   |
|-----------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Loss from operations before minority  interest and discontinued operations  |   | $        | (5,929 | )        | $      | (4,494 | ) |
| Depreciation and amortization                                               |   | 5,156    |   | 4,559    |   |
| Net gain on sale of real estate assets                                      |   | —   |   | (84      | )      |
| Income from discontinued operations                                         |   | 115      |   | 441      |   |
| Depreciation and amortization from  discontinued operations                 |   | 1,006    |   | 1,295    |   |
| Minority interest on partially owned  property from discontinued operations |   | —   |   | 67       |   |
| FFO                                                                         |   | $        | 348    |     | $      | 1,784 |   |
|                                                                        |   |     |   |     |   |
| Reconciliation to comparable GAAP  measurement:                             |   |     |   |     |   |
|                                                                        |   |     |   |     |   |
| FFO                                                                         |   | $        | 348    |     | $      | 1,784 |   |
| Deferred rental income                                                      |   | (229     | )      | (208     | )      |
| Deferred compensation expense                                               |   | 157      |   | 515      |   |
| Amortization of loan premiums, included in  interest expense                |   | (283     | )      | (294     | )      |
| Mark to market adjustment on interest rate  protection agreements           |   | 244      |   | 89       |   |
| Interest income on receivable from  principal stockholders                  |   | (21      | )      | —   |   |
| Net gain on extinguishment of debt                                          |   | —   |   | (38      | )      |
| Changes in operating assets and  liabilities, continuing operations         |   | (1,155   | )      | (2,767   | )      |
| Changes in operating assets and  liabilities, discontinued operations       |   | (411     | )      | (538     | )      |
|                                                                        |   | (1,350   | )      | (1,457   | )      |
|                                                                        |   |     |   |     |   |
| Net cash used in operating activities                                       |   | (2,060   | )      | (2,722   | )      |
| Cash provided from discontinued operations                                  |   | 710      |   | 1,265    |   |
|                                                                        |   | (1,350   | )      | (1,457   | )      |

 

FFO decreased by $1,436,000 for the six months endedJune 30, 2003 compared to same period in 2002 for the reasons discussed in theanalysis of Results of Operations.

 

**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 multifamily propertiesgenerally provide for an initial term of one month to one year and allow forrent adjustments at the time of renewal. Leases at the office properties typically provide for rent adjustmentand pass-through of increases in operating expenses during the term of thelease.  All of these provisions 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**

 

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

 

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**RISK FACTORS**

 

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

 

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

 

**INTERESTRATES**

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

 

It is the Company’s policy to manage its exposure tofluctuations in market interest rates for its borrowings through the use offixed rate debt instruments to the extent that reasonably favorable rates areobtainable with such arrangements.  Inorder to maximize financial flexibility when selling properties and minimizepotential prepayment penalties on fixed rate loans, the Company has alsoentered into variable rate debt arrangements.

 

The Company has entered intointerest rate swap agreements to manage its interest rate risk.  The agreements, in notional amounts totalingapproximately $22,000,000, effectively fix the interest rate at 2.42% plus theapplicable variable rate margin (effective rate of 6.42% at June 30, 2003).

 

At June 30, 2003, theCompany’s total indebtedness included fixed-rate debt of approximately$128,907,000 and floating-rate indebtedness of approximately $24,699,000. 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 $247,000, or $0.04 pershare, based upon the balances outstanding on variable rate instruments at June30, 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

Reference is made to theCompany’s Annual Report on Form 10-K for 2002 for information with respect tothis matter.

 

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 inconnection with loans to an affiliate of the general partner and the issuanceof notes to an affiliate of CGS in connection with the purchase of a propertyfrom Fund II, among other things.  FundII was merged into 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 totaled approximately$8,800,000 at December 31, 2002.

 

In January 2003, the partiesreached a settlement regarding this matter. Under the settlement, which is expected to be documented in the thirdquarter due to an unresolved dispute on one of the settlement terms, theCompany reaffirmed its previously announced obligation to pay the formerlimited partners of Fund II, or their assignees or transferees, the loans whichwere made and called by the former general partner of Fund II as part of theConsolidation.  Pursuant to thesettlement, the Company has established a definitive repayment plan and willsecure the repayment obligation with a second deed of trust on an officebuilding owned by the Company.  Therepayment plan consists of a promissory note in the amount of $8,800,000 (theamount of such loans, plus interest as of December 31, 2002), which shallaccrue interest at 6% per annum. Interest only payments will be made quarterly until the note is paid.  The note may be prepaid in whole or in partat any time without penalty.  Pursuantto the settlement agreement, the Company made the first interest payment onJune 2, 2003.

 

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.  Thetotal obligation under the settlement of $10,000,000 is reflected as a separateline item in the accompanying consolidated financial statements.

 

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 right toreceive $1,187,695 of principal payments on the notes payable to them and theiraffiliates 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 financial statements.

 

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.

 

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**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

The 2003 annual meeting of stockholderswas held on May 7, 2003.  The matters onwhich the stockholders voted, in person or by proxy, were i) to elect sevendirectors to serve until the Company’s next annual meeting of stockholders anduntil their successors are duly elected and qualified, and ii) to ratify theselection of BDO Seidman, LLP, as the Company’s independent auditors for thefiscal year ended December 31, 2003.  The results of the voting are shown below:

 

Election of directors:

 
| **Name of  Nominee**   |   | **Number of  Votes For** |   | **Number of  Votes Withheld** |   |
|------------------------|--------|--------------------------|--------|-------------------------------|--------|
| Timothy  R. Brown      |   | 3,354,984                |   | 84,909                        |   |
| William  J. Carden     |   | 3,341,133                |   | 98,760                        |   |
| Lawrence  E. Fiedler   |   | 3,359,450                |   | 80,443                        |   |
| John  N. Galardi       |   | 3,355,643                |   | 84,250                        |   |
| William  W. Geary, Jr. |   | 3,358,601                |   | 81,292                        |   |
| John  F. Itzel         |   | 3,359,264                |   | 80,629                        |   |
| Harry  A. Mizrahi      |   | 3,360,779                |   | 79,114                        |   |

 

Ratify the selection of BDOSeidman, LLP as independent auditors:

 
| **Number of  Votes For** |   | **Number of  Votes Against** |   | **Number of  Votes Abstaining** |   |
|--------------------------|--------|------------------------------|--------|---------------------------------|--------|
| 3,367,640                |   | 20,532                       |   | 51,721                          |   |

 

 

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

 

(a)  Exhibits:

 

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

 

(b)  Reports onForm 8-K:

 

On April 8, 2003, a report on Form 8-K was filed withrespect to Item 5.

 

On May 14, 2003, a report on Form 8-K was filed withrespect to Item 12.

 

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**SIGNATURES**

 

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

 

**AMERICAN SPECTRUM REALTY, INC.**

 
|                    |   |
|-------------------------|--------|
| *Date:  August 7, 2003* | By:    | */s/ William J. Carden* |   |
|                    |   | William J. Carden |
|                    |   | Chairman of the Board, President, |
|                    |   | Chief Executive Officer  and Acting |
|                    |   | Chief Financial Officer |
|                    |   |   |
|                    |   |   |
| *Date:  August 7, 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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