**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-Q**

 

**(Mark One)**

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

 

**For the quarterly period ended March 31, 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)      |
|                                                            |   |                                  |
| Securities registered under Section 12(b) of the Act:           |

 

 

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

 

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

 

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

 

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

 

As of May 2, 2003, 5,552,947shares 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 March 31, 2003 and December 31, 2002                           |
|    | Consolidated Statements of Operations for  the three months ended March 31, 2003 and 2002      |
|    | Consolidated Statement of Stockholders’  Equity for the three months ended March 31, 2003 |
|    | Consolidated Statements of Cash Flows for  the three months ended March 31, 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 Disclosure about Market Risk                                     |
| Item 4  | Controls  and Procedures                                                                       |
|    |                                                                                           |
| PART II | OTHER  INFORMATION                                                                             |
|    |                                                                                           |
| Item 1  | Legal Proceedings                                                                              |
| Item 6  | Exhibits and Reports on Form 8-K                                                               |

 

2

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**PART I****.  FINANCIAL INFORMATION**

 

**ITEM 1****.  FINANCIAL STATEMENTS**

 

**AMERICAN SPECTRUM REALTY, INC.**

**CONSOLIDATED BALANCE SHEETS**

(Dollarsin thousands, except per share amounts)

 
|                                                                                                                                                        |   | **March 31, 2003** |       | **December 31, 2002** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-----------------------|------------|
|                                                                                                                                                        |   |               |       |                  |       |
| **ASSETS**                                                                                                                                                  |   |               | ** ** |                  | ** ** |
| Real estate held for investment                                                                                                                             |   | $                  | 237,740    |                  | $          | 237,111 |   |
| Accumulated depreciation                                                                                                                                    |   | 16,191             |       | 13,242                |       |
| Real estate held for investment, net                                                                                                                        |   | 221,549            |       | 223,869               |       |
|                                                                                                                                                        |   |               |       |                  |       |
| Real estate held for sale                                                                                                                                   |   | 13,926             |       | 14,466                |       |
| Cash and cash equivalents                                                                                                                                   |   | 755                |       | 788                   |       |
| Tenant and other receivables (including  $270 from related party at March 31, 2003), net of allowance for doubtful  accounts of $330 and $285, respectively |   | 806                |       | 503                   |       |
| Deferred rents receivable                                                                                                                                   |   | 643                |       | 505                   |       |
| Deposits held in escrow                                                                                                                                     |   | 279                |       | 279                   |       |
| Investment in management company                                                                                                                            |   | 4,000              |       | 4,000                 |       |
| Prepaid and other assets, net                                                                                                                               |   | 9,621              |       | 9,147                 |       |
|                                                                                                                                                        |   |               |       |                  |       |
| Total Assets                                                                                                                                                |   | $                  | 251,579    |                  | $          | 253,557 |   |
|                                                                                                                                                        |   |               |       |                  |       |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                              |   |               |       |                  |       |
|                                                                                                                                                        |   |               |       |                  |       |
| Liabilities:                                                                                                                                                |   |               |       |                  |       |
| Notes payable, net of premiums of $3,515  and $3,655, respectively (including $1,799 to related parties at March 31,  2003 and December 31, 2002)           |   | $                  | 172,327    |                  | $          | 173,238 |   |
| Liabilities related to real estate held for  sale (including $851 and $800, respectively, to related parties)                                               |   | 11,543             |       | 11,472                |       |
| Notes payable to former limited partners                                                                                                                    |   | 237                |       | 237                   |       |
| Accounts payable                                                                                                                                            |   | 4,801              |       | 3,097                 |       |
| Deferred tax liability                                                                                                                                      |   | 6,082              |       | 6,082                 |       |
| Accrued and other liabilities (including $1,604  and $1,594, respectively, to related parties)                                                              |   | 18,604             |       | 18,955                |       |
|                                                                                                                                                        |   |               |       |                  |       |
| Total Liabilities                                                                                                                                           |   | 213,594            |       | 213,081               |       |
|                                                                                                                                                        |   |               |       |                  |       |
| Minority Interest                                                                                                                                           |   | 8,895              |       | 9,319                 |       |
|                                                                                                                                                        |   |               |       |                  |       |
| Commitments and Contingencies:                                                                                                                              |   |               |       |                  |       |
|                                                                                                                                                        |   |               |       |                  |       |
| Redeemable Common Stock                                                                                                                                     |   | 300                |       | 300                   |       |
|                                                                                                                                                        |   |               |       |                  |       |
| Stockholders’ Equity:                                                                                                                                  |   |               |       |                  |       |
|                                                                                                                                                        |   |               |       |                  |       |
| Preferred stock, $.01 par value;  authorized, 25,000,000 shares, none issued and outstanding                                                                |   | —             |       | —                |       |
| Common stock, $.01 par value; authorized,  100,000,000 shares; issued and outstanding, 5,547,121 and 5,536,990 shares,  respectively                        |   | 55                 |       | 55                    |       |
| Additional paid-in capital                                                                                                                                  |   | 41,939             |       | 41,809                |       |
| Accumulated deficit                                                                                                                                         |   | (11,444            | )          | (9,168                | )          |
| Receivable from principal stockholders                                                                                                                      |   | (1,188             | )          | (1,188                | )          |
| Deferred compensation                                                                                                                                       |   | (572               | )          | (651                  | )          |
|                                                                                                                                                        |   |               |       |                  |       |
| Total Stockholders’ Equity                                                                                                                             |   | 28,790             |       | 30,857                |       |
|                                                                                                                                                        |   |               |       |                  |       |
| Total Liabilities and Stockholders’ Equity                                                                                                             |   | $                  | 251,579    |                  | $          | 253,557 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

3

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**AMERICAN SPECTRUMREALTY, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(Dollars in thousands, except per share amounts)

 
|                                                           |   | **Quarter Ended March 31,** |   |
|----------------------------------------------------------------|--------|-----------------------------|--------|
|                                                           |   | **2003**                    |   | **2002** |   |
| **REVENUES:**                                                  |   |                        |   |   |   |
| Rental revenue                                                 |   | $                           | 8,848  |   | $ | 8,807 |   |
| Interest and other income                                      |   | 10                          |   | 79 |   |
| Total revenues                                                 |   | 8,858                       |   | 8,886 |   |
|                                                           |   |                        |   |   |   |
| **EXPENSES:**                                                  |   |                        |   |   |   |
| Property operating expense                                     |   | 3,639                       |   | 3,168 |   |
| General and administrative                                     |   | 1,593                       |   | 2,417 |   |
| Depreciation and amortization                                  |   | 3,003                       |   | 2,751 |   |
| Interest expense                                               |   | 3,297                       |   | 3,017 |   |
| Total expenses                                                 |   | 11,532                      |   | 11,353 |   |
|                                                           |   |                        |   |   |   |
| Net loss before minority interest and  discontinued operations |   | (2,674                      | )      | (2,467 | ) |
|                                                           |   |                        |   |   |   |
| Minority interest                                              |   | 294                         |   | 276 |   |
|                                                           |   |                        |   |   |   |
| Net loss before discontinued operations                        |   | (2,380                      | )      | (2,191 | ) |
|                                                           |   |                        |   |   |   |
| Discontinued operations:                                       |   |                        |   |   |   |
| Income from discontinued operations                            |   | 104                         |   | 90 |   |
|                                                           |   |                        |   |   |   |
| Net loss                                                       |   | $                           | (2,276 | ) | $ | (2,101 | ) |
|                                                           |   |                        |   |   |   |
| Basic and diluted per share data:                              |   |                        |   |   |   |
| Net loss before discontinued operations                        |   | $                           | (0.43  | ) | $ | (0.40 | ) |
| Income from discontinued operations                            |   | 0.02                        |   | 0.02 |   |
| Net loss                                                       |   | $                           | (0.41  | ) | $ | (0.38 | ) |
|                                                           |   |                        |   |   |   |
| Basic weighted average shares used                             |   | 5,545,075                   |   | 5,529,058 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

4

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**AMERICAN SPECTRUMREALTY INC.**

**CONSOLIDATEDSTATEMENTS 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 |   |
| Conversion of operating  partnership units into common  stock |   | —            |   | 130                              |   | —                   |   | —                     |    | —                                         |   | 130              |   |
| Amortization of deferred  compensation                             |   | —            |   | —                           |   | —                   |   | 79                         |    | —                                         |   | 79               |   |
| Net loss                                                                |   | —            |   | —                           |   | (2,276                   | )      | —                     |    | —                                         |   | (2,276           | )      |
| Balance, March 31, 2003                                                 |   | $                 | 55     |                             | $      | 41,939                   |   | $                          | (11,444 | )                                              | $      | (572             | )      | $ | (1,188 | ) | $ | 28,790 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

5

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**AMERICAN SPECTRUM REALTY, INC**

**CONSOLIDATED STATEMENTSOF CASH FLOWS**

(Dollarsin thousands)

 
|                                                                                       |   | **Quarter Ended March 31** |   |
|--------------------------------------------------------------------------------------------|--------|----------------------------|--------|
|                                                                                       |   | **2003**                   |   | **2002** |   |
| **CASH FLOWS FROM  OPERATING ACTIVITIES:**                                                 |   |                       |   |   |   |
| Net loss                                                                                   |   | $                          | (2,276 | ) | $ | (2,101 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |   |                       |   |   |   |
| Income from discontinued operations                                                        |   | (104                       | )      | (90 | ) |
| Depreciation and amortization                                                              |   | 3,003                      |   | 2,751 |   |
| Deferred rental income                                                                     |   | (138                       | )      | (130 | ) |
| Minority interest                                                                          |   | (294                       | )      | (276 | ) |
| Deferred compensation expense                                                              |   | 79                         |   | 273 |   |
| Amortization of loan premiums, included in  interest expense                               |   | (140                       | )      | (134 | ) |
| Mark to market adjustments on interest rate  swap agreements                               |   | 222                        |   | — |   |
| Changes in operating assets and  liabilities:                                              |   |                       |   |   |   |
| Increase (decrease) in tenant and other  receivables                                       |   | (33                        | )      | 330 |   |
| Increase (decrease) in accounts payable                                                    |   | 1,943                      |   | (660 | ) |
| Increase in prepaid and other assets                                                       |   | (531                       | )      | (233 | ) |
| Decrease in accrued and other liabilities                                                  |   | (561                       | )      | (1,087 | ) |
| Net cash provided by (used in) operating  activities:                                      |   | 1,170                      |   | (1,357 | ) |
|                                                                                       |   |                       |   |   |   |
| **CASH FLOWS FROM  INVESTING ACTIVITIES:**                                                 |   |                       |   |   |   |
| Capital improvements to real estate assets                                                 |   | (652                       | )      | (1,002 | ) |
| Contributions to minority owner of  partially owned property                               |   | —                     |   | (30 | ) |
| Net cash used in investing activities:                                                     |   | (652                       | )      | (1,032 | ) |
|                                                                                       |   |                       |   |   |   |
| **CASH FLOWS FROM  FINANCING ACTIVITIES:**                                                 |   |                       |   |   |   |
| Proceeds from borrowings                                                                   |   | 30                         |   | 10,650 |   |
| Repayment of borrowings                                                                    |   | (810                       | )      | (8,102 | ) |
| Note payments to former limited partners                                                   |   | —                     |   | (1,154 | ) |
| Repurchase of common stock                                                                 |   | —                     |   | (2 | ) |
| Collection of advance to affiliate                                                         |   | —                     |   | 8 |   |
| Net cash (used in) provided by financing  activities:                                      |   | (780                       | )      | 1,400 |   |
|                                                                                       |   |                       |   |   |   |
| Cash from discontinued operations                                                          |   | 229                        |   | 422 |   |
|                                                                                       |   |                       |   |   |   |
| Decrease in cash                                                                           |   | (33                        | )      | (567 | ) |
|                                                                                       |   |                       |   |   |   |
| Cash, beginning of period                                                                  |   | 788                        |   | 2,284 |   |
|                                                                                       |   |                       |   |   |   |
| Cash, end of period                                                                        |   | $                          | 755    |   | $ | 1,717 |   |
|                                                                                       |   |                       |   |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:**                                    |   |                       |   |   |   |
| Cash paid for interest                                                                     |   | $                          | 3,207  |   | $ | 3,314 |   |
| Cash paid for income taxes                                                                 |   | —                     |   | — |   |
|                                                                                       |   |                       |   |   |   |
| **SUPPLEMENTAL DISCLOSURE OF NON-CASH  INVESTING AND FINANCING ACTIVITIES:**               |   |                       |   |   |   |
|                                                                                       |   |                       |   |   |   |
| Conversion of operating partnership units  into common stock                               |   | $                          | 130    |   | $ | — |   |
| Receivable from related party regarding  certain issues asserted by principal shareholder  |   | $                          | 270    |   | $ | — |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

6

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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 March 31, 2003, held a 1% generalpartner interest and an 87.58% limited partnership interest. As of March 31,2003, through its majority-owned subsidiary, the Operating Partnership, theCompany owned and operated 33 properties, which consisted of 15 office, 11industrial, three shopping center, and three apartment properties, and onedevelopmental land property. The properties are located in four geographicregions in nine states.  The Companyplans to sell certain of its properties and to acquire additional properties inits core property types and core geographic markets.  The Company will focus primarily on office and industrialproperties located in Texas, California and Arizona.

 

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

 

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

 

Management isreconsidering whether it is in the best interest of the Company to elect to betreated as a real estate investment trust or REIT, as defined under theInternal Revenue Code of 1986, as amended. In the event such election is made, the election could be effective asearly as January 1, 2003 upon the filing of the appropriate forms for 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 was taxedas a C corporation.

## ** **

## **CONSOLIDATIONTRANSACTION**

 

In October 2001, the Company acquired various properties in aconsolidation transaction (the “Consolidation”).  Pursuant to the Consolidation, subsidiaries of the Company mergedwith eight public limited partnerships, acquired the assets and liabilities oftwo private entities managed by CGS Real Estate Company, Inc. (“CGS”) and itsaffiliates and acquired certain assets and liabilities of CGS and its majority-ownedaffiliates.  Sierra Pacific PensionInvestors ‘84 (“SPPI84”), one of the eight public limited partnerships, wastreated, for accounting purposes, as the acquirer of the properties in theConsolidation.  Prior to theConsolidation, SPPI84’s activities involved the ownership and operation of tworeal estate properties in Arizona: Sierra Spectrum in Phoenix, Arizona and Sierra Valencia in Tucson,Arizona. Pursuant to the Consolidation, partners of the public partnershipsreceived shares in the Company or promissory notes in exchange for theirpartnership units and owners of existing related entities exchanged ownershipinterests in real estate for ASR shares or units in the Operating Partnership,an entity formed for this purpose and initially wholly owned by the Company.

 

7

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**NOTE2.  SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

**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, “Accountingfor 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 andthe results of operations during the reporting period. Actual results couldmaterially differ from those estimates.

 

**NEWACCOUNTING PRONOUNCEMENTS**

In April 2002, theFinancial Accounting Standards Board issued SFAS No. 145, “Rescission of FASBNo. 4, 44, and 62, Amendment of FASB No. 13, and Technical Corrections” (“FAS145”).  In most instances, FAS 145 willrequire gains and losses on extinguishments of debt to be classified as incomeor 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.

## ** **

In July 2002, FASB issued SFAS No. 146, “Accounting for Costs Associatedwith Exit or Disposal Activities” (“FAS 146”). FAS 146 requires companies to recognize costs associated with exit ordisposal activities when they are incurred rather than at the date of acommitment to an exit or disposal plan. FAS 146 is to be applied prospectively to exit or disposal activitiesinitiated after December 31, 2002.  TheCompany does not expect the adoption of FAS 146 to have a material impact onits consolidated financial position or results of operations.

 

In November 2002, FASBissued Interpretation No. 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers” (“FIN 45”). FIN 45 requires a company, at the time it issues aguarantee, to recognize an initial liability for the fair value of obligationsassumed under the guarantee and elaborates on existing disclosure requirementsrelated to guarantees and warranties. The initial recognition requirements of FIN 45 are effective forguarantees issued or modified after December 31, 2002 and adoption of thedisclosure requirements are effective for financial statements ending afterDecember 15, 2002.  The adoption of FIN45 is not expected to have a significant impact on the Company’s consolidatedfinancial position or results of operations.

 

8

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In December 2002, FASBissued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition andDisclosure” (“FAS 148”), which amended SFAS Statement No. 123, “Accounting forStock-Based Compensation” (“FAS 123”). FAS 148 provides alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation.  Additionally, FAS 148amends the disclosure requirements of FAS 123 to require prominent disclosuresin the annual and interim financial statements about the method of accountingfor stock-based employee compensation and the effect of the method used onreported results.  FAS 148 is effectivefor financial statements for fiscal years ending after December 15, 2002.  In compliance with FAS 148, 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 “Accountingfor Stock Issued to Employees”.

 

**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 fromcurrent expectations.

 

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 carrying valueof the Company’s financial instruments approximate their respective fair marketvalues at March 31, 2003 and December 31, 2002.

 

**DERIVATIVEFINANCIAL INSTRUMENTS**

The Company followsStatement of Financial Accounting Standard No. 133, as amended, which establishesaccounting and reporting standards for derivative financial instruments,including certain derivative instruments embedded in other contracts andhedging activities.  All derivatives,whether designed in hedging relationships or not, are required to be recordedon the balance sheet at fair value.  Ifthe derivative is designated as a fair value hedge, the changes in the fairvalue of the derivative and of the hedged item attributable to the hedged riskare recognized in earnings.  If thederivative is designated as a cash flow hedge, the effective portions ofchanges in the fair value of the derivative are recorded in other comprehensiveincome and ineffective portions of changes in the fair value of cash flowhedges are recognized in earnings.

 

The Company uses interestrate swaps to hedge against fluctuations in interest rates on specificborrowings.  Interest rate swapcontracts in notional amounts of approximately $22,000,000, which expiredDecember 15, 2002, were renewed on January 7, 2003.  The interest rate swap contracts are reflected at fair value onthe Company’s balance sheet in accrued and other liabilities and the changes inthe fair value of the hedge

 

9

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are recognized asadjustments to interest expense.  Duringthe three months ended March 31, 2003, the Company recorded a charge of$222,000 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-BASED COMPENSATION**

The FinancialAccounting Standards Board issued SFAS No. 123, “Accounting for Stock-BasedCompensation” (“FAS 123”) in October 1995. This standard establishes a fair value approach to valuing stock optionsawarded to employees as compensation. In December 2002, FASB issued SFAS No.148, “Accounting for Stock-Based Compensation - Transition and Disclosure”(“FAS 148”), which amended FAS 123.  FAS148 provides alternative methods of transition for a voluntary change to thefair value based method of accounting for stock-based employeecompensation.  Additionally, FAS 148amends the disclosure requirements of FAS 123 to require prominent disclosuresin the annual and interim financial statements about the method of accountingfor stock-based employee compensation and the effect of the method used onreported results.  FAS 148 is effectivefor financial statements for fiscal years ending after December 15, 2002.  In compliance with FAS 148, 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 10K filed with the Securities and ExchangeCommission.  The Company haselected, as permitted by SFAS No. 123, to use the intrinsic value based methodof accounting for stock options consistent with Accounting Principles BoardOpinions No. 25, “Accounting for Stock Issued to Employees”.  The intrinsic value method measurescompensation cost for stock options as the excess, if any, of the quoted marketprice of the Company’s stock at the measurement date over the exerciseprice.  No stock-based employeecompensation cost is reflected in net income related to stock options, as alloptions granted under the Plan had an exercise price equal to the fair marketvalue of the underlying common stock on the date of grant.

 

The following tableillustrates the effect on net income and earnings per share if the Company hadapplied the fair value recognition of the provisions of FAS 123 to stock-basedemployee compensation (thousands of dollars):

 
|                                                                                                                     |   | **Three Months Ended March 31,** |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                                                                     |   | **2003**                         |   | **2002** |   |
| Net  (loss) income, as reported                                                                                          |   | $                                | (2,276 | ) | $ | (2,101 | ) |
| Deduct:  Employee compensation expense for stock  option grants under fair value method, net of related tax effects |   | (62                              | )      | (250 | ) |
| Pro  forma net (loss) income                                                                                             |   | $                                | (2,338 | ) | $ | (2,351 | ) |
|                                                                                                                     |   |                             |   |   |   |
| Per  share data:                                                                                                         |   |                             |   |   |   |
| Basic  and diluted, as reported                                                                                          |   | $                                | (0.41  | ) | $ | (0.38 | ) |
| Basic  and diluted, proforma                                                                                             |   | $                                | (0.42  | ) | $ | (0.43 | ) |

 

# **MINORITY INTEREST**

Unit holders in the Operating Partnership (other thanthe Company) held and 11.42% and 11.60% limited partnership interest in theOperating Partnership at March 31, 2003 and December 31, 2002,respectively.  Each of the holders ofthe interests in the Operating Partnership (other than the Company) has theoption 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.

 

10

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**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 isconsidered to commence as of the acquisition date for purposes of thiscalculation.

 

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 is located,the availability of competing space, and the level of improvements which may berequired at the property. No assurance can be given that the rental rates thatthe Company will obtain in the future will be equal to or greater than thoseobtained under existing contractual commitments.

 

# **NET LOSS PER SHARE**

Netloss per share is calculated based on the weighted average number of commonshares outstanding.  Stock optionsoutstanding of 189,500 at March 31, 2003 and OP Units (other than those held bythe Company) outstanding of 715,474 at March 31, 2003 have not been included inthe net loss per 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 jurisdictions in which the Companyoperates.  Should the actual resultsdiffer from the Company’s estimates, the Company would have to adjust theincome tax provision in the period in which the facts and circumstances thatgive rise to the revision become known. Tax law and rate changes are reflected in the income tax provision inthe period in which such changes are enacted.

 

## **NOTE 3.  REALESTATE**

## ** **

# **ACQUISITIONS**

No real estate acquisitionswere made during the first quarter of 2003.

 

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**

No real estatedispositions were made during the first quarter of 2003.  The Company sold oneproperty during thesecond quarter of 2003.  See Notes 4 and8.

 

On October 15, 2002, theCompany sold Maple Tree, a 72,149 square foot shopping center in Missouri, for$3,800,000.  On October 11, 2002, theCompany sold Creekside Apartments, a 152-unit apartment property in California,for $8,300,000.  Total net salesproceeds of $279,000, which were held in escrow at March 31, 2003 and December31, 2002, were received in April 2003.

 

11

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In July 2002, the Companyreceived compensation of $150,000 for a strip of land condemned for highwaypurposes on an office property in Illinois.

 

On April 30, 2002, theCompany sold Beach & Lampson, a 13,017 square foot shopping center inCalifornia, for $1,200,000.  The Companyreceived net cash proceeds of approximately $59,000 on the sale date and a$1,100,000 trust deed note from the buyer. The note, which contained a $200,000 early pay-off discount, was paid inOctober 2002 with the receipt of $900,000 from the buyer.

## ** **

## **NOTE 4. DISCONTINUED OPERATIONS**

 

As of March 31, 2003 and December 31, 2002, two properties, wereclassified as “Real estate held for sale”. Valencia, an 82,560 square foot industrial property in Arizona, was soldon April 10, 2003 for $4,100,000.  VillaRedondo, a 125-unit apartment property in California, is expected to sellduring the second quarter of 2003.  Thesale of Valencia generated net proceeds of $1,179,000.  The Company anticipates a gain will berecognized in the second quarter of 2003 on the transactions.

 

During the fourth quarterof 2002, the Company sold two properties, Maple Tree and Creekside Apartments       (See Note 3).

 

In accordance with FAS 144, the net income related to these fourproperties for the three months ended March 31, 2003 and 2002 are reflected inthe consolidated statements of operations as “Discontinued operations”.

 

The carrying amounts of “Real estate held for sale” at March 31, 2003and December 31, 2002 and net income from discontinued operations for the threemonths ended March 31, 2003 and 2002 are summarized below (dollars inthousands):

 
| **Condensed Consolidated Balance Sheets**                                         |   | **March 31, 2003** |   | **December 31, 2002** |   |
|-----------------------------------------------------------------------------------|--------|--------------------|--------|-----------------------|--------|
|                                                                              |   |               |   |                  |   |
| Real estate                                                                       |   | $                  | 13,495 |                  | $      | 14,115 |   |
| Other                                                                             |   | 431                |   | 351                   |   |
| Real estate assets held for sale                                                  |   | $                  | 13,926 |                  | $      | 14,466 |   |
|                                                                              |   |               |   |                  |   |
| Notes payable, net (including $830 and  $800, respectively, to related party)     |   | $                  | 11,144 |                  | $      | 11,154 |   |
| Accounts payable                                                                  |   | 88                 |   | 52                    |   |
| Accrued and other liabilities (including  $21 at March 31, 2003 to related party) |   | 311                |   | 266                   |   |
| Liabilities related to real estate held for  sale                                 |   | $                  | 11,543 |                  | $      | 11,472 |   |

 
| **Condensed Consolidated Statements of Operations**    |   | **Three Months Ended  March 31, 2003** |   | **Three months Ended  March 31, 2002** |   |
|--------------------------------------------------------|--------|----------------------------------------|--------|----------------------------------------|--------|
| Rental revenue                                         |   | $                                      | 627    |                                   | $      | 1,069 |   |
| Total expenses                                         |   | 523                                    |   | 943                                    |   |
| Minority interest related to partially  owned property |   | —                                 |   | (36                                    | )      |
| Net income from discontinued operations                |   | $                                      | 104    |                                   | $      | 90 |   |

 

12

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

 

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

 
|                                                                                                                                                                                                                                                                                                                                                                  |   | **2003** |    | **2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Secured loans with various lenders, net of unamortized premiums of  $3,515 at March 31, 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 March 31, 2003 and December 31, 2002,  and maturing at various dates through September 1, 2012. |   | $        | 124,188 |     | $      | 124,606 |   |
|                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Secured  loans with various banks bearing interest at variable rates ranging between  5.31% and 9.00% at March 31, 2003 and 5.38% and 9.00% at December 31, 2002,  and maturing at various dates through May 1, 2008.                                                                                                                                                 |   | 33,135   |    | 33,368   |   |
|                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Secured Series A & B Bonds with a fixed interest rate of 6.39%,  monthly principal and interest payments of $74, and a maturity date of March  31, 2031.                                                                                                                                                                                                          |   | 11,643   |    | 11,679   |   |
|                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Secured Series C Bonds with a fixed interest rate of 9.50%,  semi-annual principal and interest payments ($102 at March 31, 2003 and  December 31, 2002), and a maturity date of November 1, 2006.                                                                                                                                                                    |   | 645      |    | 645      |   |
| Unsecured  loans with various lenders, bearing interest at fixed rates between 5.47% and  20.00% at March 31, 2003 and 8.00% and 20.00% at December 31, 2002, and  maturing at various dates through October 1, 2004.                                                                                                                                                 |   | 859      |    | 1,083    |   |
|                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Unsecured  loan, non-interest bearing, which matured January 1, 2003.  The loan was paid in April 2003.                                                                                                                                                                                                                                                          |   | 58       |    | 58       |   |
|                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Unsecured loan with Brown Parker and Leahy, LLP, a law firm in which  Timothy R. Brown, a director of the Company, is a partner.  The loan bears interest at prime (4.25% at  March 31, 2003 and December 31, 2002) and is payable on demand.                                                                                                                    |   | 199      |    | 199      |   |
|                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Unsecured loan with John N. Galardi, a principal stockholder, with a  fixed interest rate of 8.00%, payable on demand.                                                                                                                                                                                                                                                |   | 1,600    |    | 1,600    |   |
|                                                                                                                                                                                                                                                                                                                                                                  |   |     |    |     |   |
| Total                                                                                                                                                                                                                                                                                                                                                                 |   | $        | 172,327 |     | $      | 173,238 |   |

 

Debt premiums are amortized into interest expense over the terms of therelated mortgages using the effective interest method.  As of March 31, 2003 and December 31, 2002,the unamortized debt premiums included in the above schedule were $3,515,000and $3,655,000, respectively.

 

In January 2003, a note payable in the amount of $509,000 became dueand payable.  The Company continues topay the monthly interest due on this note and is discussing an extension withthe lender.

 

In December 2002, modification agreements were entered into with a bankto extend the maturity on five secured loans to December 31, 2004.  These loans, whose balances total$22,003,000, bear interest at Libor plus 4% through June 30, 2003 and, providedcertain lender conditions are satisfied, Libor plus 3% thereafter.

 

In December 2002, the Company entered into an $830,000 loan onValencia, an industrial property classified as “Real estate held for sale” inthe accompanying consolidated financial statements.      $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 Company received proceeds of $1,532,000 from twobridge loans on Maple Tree, one of its shopping center properties.  One of the loans, which totaled $700,000,was provided by an affiliate of a related party.  The mortgages were repaid upon the sale of the property inOctober 2002.

 

13

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

 

In July 2002, a lender notified the Company it was technically indefault under its loan agreement for non-compliance with certain covenants,including covenants requiring improvements to shopping center properties inSouth Carolina.  Thereafter, the lendernotified the Company it was in default for failure to pay a matured portion ofthe loan, which matured in November 2002. As of March 31, 2003, the amount due under the matured portion of the loanwas $2,790,000 and the aggregate principal balance of the loan agreement was$6,454,000.  In early 2003, the lendersold the loan to the major tenant in the shopping center.  The new lender has not accelerated the loanagreement.  The Company is consideringvarious alternatives, including selling the property or using proceeds from thesale of another property to provide capital to pay off the matured portion ofthe loan.  The Company continues todiscuss the 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 agreement whichprovided for seller financing of $955,000, bearing interest at a fixed rate of7.45% per annum and maturing in May 2004.

 

In May 2002, 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 interest at a fixed rateof 7.33% per annum and matures in June 2012. Net proceeds of $1,297,000 were received as a result of the refinancing.

 

In May 2002, the Companyrefinanced a $1,346,000 loan secured by Leawood Fountain Plaza, an officeproperty, and entered into a new 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 December 31,2002), and matures in June 2003.  Theloan contains a one-year extension option and an option to convert to apermanent loan provided certain lender conditions are satisfied.  Net proceeds of $1,026,000 were received asa result of the refinancing.

 

In May 2002, the Companyfinanced insurance premiums of $859,000 on its properties.  The loan bore interest at a fixed rate of5.47% per annum.  The loan was paid infull in February 2003.  Other insurancepremiums totaling $277,000 were financed during 2002.  These loans bear interest at fixed rates between 5.47% and 6.99%per annum and mature at various dates 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 North Creek Office Park and entered into a new loanagreement in the amount of $5,625,000. The new loan bears interest at a fixed rate of 7.58% per annum andmatures in February 2012.  Net proceedsof $639,000 were received as a result of the refinancing.

 

As of this date, theCompany has not paid the 2002 property taxes due on several properties.  This non-payment could be considered atechnical default on the loans for these properties.  The Company plans to pay these taxes with the proceeds from thesale of an apartment property expected to occur in the second quarter of2003.  There can be no assurance,however, that the sale of the property will occur.

 

14

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

 

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

 

# **NOTES PAYABLE TOFORMER 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.  On March 18, 2002, $1,153,862 of the notes, plus accruedinterest, was paid.  Additional paymentsof $4,971, $705,161 and $191,055, plus accrued interest, were paid on April 1,2002, April 25, 2002, and July 2, 2002, respectively.  The principal balance of the notes as of March 31, 2003 was$236,622.

 

## **NOTE 6. RELATED PARTY TRANSACTIONS**

 

In February 2003, the Company reached an agreement with CGS Real EstateCompany, Inc. whereby CGS acknowledged that it owed the Company a net amount of$270,375 which related to several issues asserted by Mr. Carden that were owedby CGS to the Company and by the Company to CGS.  This amount is payable on March 15, 2006 with interest accruingfrom March 15, 2003 at an annual rate of 6% and payable quarterly commencing onJune 15, 2003.  Mr. Carden is aprincipal stockholder, an officer and a director of CGS.  Mr. Carden and Mr. Galardi have agreed toguarantee this obligation of CGS, and they have secured this guarantee with anassignment to the Company of their right to receive $270,375 of principalpayments on the notes payable to them and their affiliates by reason of thesettlement of the Teachout matter, plus all interest payable on such principalamount of notes.

 

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

 

Duringthe first quarter of 2002, the Company made payments totaling $521,808 on itsobligation to ASJ, Ltd., which is owned by Mr. Carden, an executive officer andprincipal shareholder, his wife and a trust for his children.  These payments reduced the balance due toASJ, Ltd. to $200,000 as of March 31, 2003.

 

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

 

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

 

Mr. Galardi has agreed to purchase a total of 60,975 shares of commonstock for $250,000.  This purchase isexpected to close in May 2003.

 

**NOTE 7.  SEGMENTINFORMATION**

 

As of March 31, 2003, theCompany owned a diverse portfolio of properties comprising office, industrial,shopping center and apartment properties, and developmental land. Each of theseproperty types represents a reportable segment with distinct uses and tenant typesand requires the Company to employ different management strategies. Eachsegment contains properties located in various regions and markets within theUnited States. The office portfolio consists primarily of suburban officebuildings. The industrial portfolio consists of properties designed forwarehouse, distribution and light manufacturing for single-tenant ormulti-tenant use. The shopping center portfolio consists primarily of communityshopping centers. The properties in the apartment portfolio are apartmentbuildings with units rented to residential tenants on either a month-by-monthbasis or for terms generally of one year or less.

 

15

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The accounting policies ofthe segments are the same as those described in the summary of significantaccounting policies. The Company evaluates performance of its property typesbased on net operating income derived by subtracting property operatingexpenses from rental revenue. Significant information used by the Company forits reportable segments as of and for the three months ended March 31, 2003 and2002 is as follows (dollars in thousands):

 
| **Three  Months Ended March 31,**    |   | **Office** |    | **Industrial** |   | **Shopping  Center** |   | **Apartment** |   | **Land Held  for  Development  and Other** |   | **Property  Total** |   |
|--------------------------------------|--------|------------|---------|----------------|--------|----------------------|--------|---------------|--------|--------------------------------------------|--------|---------------------|--------|
| **2003**                             |   |       |    |           |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                       |   | $          | 5,705   |           | $      | 1,617                |   | $             | 348    |                                       | $      | 1,136               |   | $ | 42 |   | $ | 8,848 |   |
| Property operating expenses          |   | 2,077      |    | 743            |   | 134                  |   | 638           |   | 47                                         |   | 3,639               |   |
| Net operating income (NOI)           |   | $          | 3,628   |           | $      | 874                  |   | $             | 214    |                                       | $      | 498                 |   | $ | (5 | ) | $ | 5,209 |   |
| Real estate held for investment, net |   | $          | 138,076 |           | $      | 44,557               |   | $             | 9,832  |                                       | $      | 25,056              |   | $ | 4,028 |   | $ | 221,549 |   |
|                                 |   |       |    |           |   |                 |   |          |   |                                       |   |                |   |
| **2002**                             |   |       |    |           |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                       |   | $          | 5,489   |           | $      | 1,697                |   | $             | 402    |                                       | $      | 1,219               |   | — |   | $ | 8,807 |   |
| Property operating expenses          |   | 1,855      |    | 516            |   | 140                  |   | 643           |   | $                                          | 14     |                | 3,168  |   |
| Net operating income (NOI)           |   | $          | 3,634   |           | $      | 1,181                |   | $             | 262    |                                       | $      | 576                 |   | $ | (14 | ) | $ | 5,639 |   |
| Real estate held for investment, net |   | $          | 131,719 |           | $      | 45,972               |   | $             | 14,066 |                                       | $      | 25,263              |   | $ | 4,043 |   | $ | 221,063 |   |

 

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 March 31,** |   |
|----------------------------------------------------------------|--------|----------------------------------|--------|
|                                                           |   | **2003**                         |   | **2002** |   |
| **REVENUES**                                                   |   |                             |   |   |   |
| Total revenues for reportable segments                         |   | $                                | 8,848  |   | $ | 8,807 |   |
| Other revenues                                                 |   | 10                               |   | 79 |   |
| Total consolidated revenues                                    |   | $                                | 8,858  |   | $ | 8,886 |   |
|                                                           |   |                             |   |   |   |
| **NET (LOSS) INCOME**                                          |   |                             |   |   |   |
| NOI for reportable segments                                    |   | $                                | 5,209  |   | $ | 5,639 |   |
| Unallocated amounts:                                           |   |                             |   |   |   |
| Interest and other income                                      |   | 10                               |   | 79 |   |
| General and administrative expenses                            |   | (1,593                           | )      | (2,417 | ) |
| Depreciation and amortization                                  |   | (3,003                           | )      | (2,751 | ) |
| Interest expense                                               |   | (3,297                           | )      | (3,017 | ) |
| Net loss before minority interest and  discontinued operations |   | $                                | (2,674 | ) | $ | (2,467 | ) |

 
|                                 |   | **March 31,** |    |
|--------------------------------------|--------|---------------|---------|
|                                 |   | **2003**      |    | **2002** |   |
| **ASSETS**                           |   |          |    |   |   |
| Total assets for reportable segments |   | $             | 221,549 |   | $ | 221,063 |   |
| Real estate assets held for sale     |   | 13,926        |    | 27,279 |   |
| Cash and cash equivalents            |   | 755           |    | 1,717 |   |
| Tenant and other receivables, net    |   | 806           |    | 1,204 |   |
| Deferred rent receivable             |   | 643           |    | 228 |   |
| Deposits held in escrow              |   | 279           |    | 1,687 |   |
| Investment in management company     |   | 4,000         |    | 4,000 |   |
| Prepaid and other assets, net        |   | 9,621         |    | 6,530 |   |
| Total consolidated assets            |   | $             | 251,579 |   | $ | 263,708 |   |

 

16

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**NOTE 8.  SUBSEQUENTEVENTS**

 

On April 10, 2003 the Company sold Valencia, an 82,560 square footindustrial property in Arizona, for $4,100,000.  The property was classified as “Real estate held for sale” as ofMarch 31, 2003 and December 31, 2002. The sale generated net proceeds of $1,179,000.  The Company anticipates a gain will be recognized in the secondquarter of 2003 on the transaction.

 

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

 

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

 

Mr. Galardi has agreed to purchase a total of 60,975 shares of commonstock for $250,000.  This purchase isexpected to close in May 2003.

 

17

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**ITEM 2****.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**OVERVIEW**

 

ASR is a full-service real estate corporation which owns, manages andoperates various income-producing properties. Substantially all of the Company’s assets are held through the OperatingPartnership, in which the Company, as of March 31, 2003, held a 1% generalpartner interest and an 87.58% limited partnership interest.  As of March 31, 2003, through the OperatingPartnership, the Company owned and operated 33 properties which consisted of 15office, 11 industrial, three shopping center, and three apartment properties,and one developmental land property. The properties are located in four geographic regions in nine 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 Company acquired various properties in theConsolidation.  Pursuant to theConsolidation, subsidiaries of the Company merged with eight public limitedpartnerships, acquired the assets and liabilities of two private entitiesmanaged by CGS and acquired certain assets and liabilities of CGS and themajority owned affiliates of CGS. SPPI84, one of the eight public limited partnerships, was treated, foraccounting purposes, as the acquirer of the properties in the Consolidation.  Pursuant to the Consolidation, partners ofthe public partnerships received shares in the Company or promissory notes inexchange for their partnership units and owners of existing related entitiesexchanged ownership interests in real estate for ASR shares or units in theOperating Partnership, an entity formed for this purpose and initially whollyowned by the Company.

 

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

 

The major accountingpolicies followed by the Company are listed in Note 2 – Summary of SignificantAccounting Policies – in the Notes to the Consolidated FinancialStatements.  The consolidated financialstatements of the Company are prepared in accordance with accounting principlesgenerally accepted in the United States of America, which requires managementto make estimates and assumptions that affect the reported amounts of 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:

 

•                  Certain leases provide for tenantoccupancy during periods for which no rent is due or where minimum rent paymentsincrease during the term of the lease. The Company records rental income for the full term of each lease on astraight-line basis.  Accordingly, areceivable 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.

 

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

 

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•                  Gainson property sales are accounted for in accordance with the provisions of SFASNo. 66, “Accounting for Sales of Real Estate”. Gains are recognized in full when real estate is sold, provided (i) thegain is determinable, that is, the collectibility of the sales price isreasonably assured or the amount that will not be collectible can be estimated,and (ii) the earnings process is virtually complete, that is, the Company isnot obligated to perform significant activities after the sale to earn thegain.  Losses on property sales arerecognized immediately.

 

•                  Managementis reconsidering whether it is in the best interest of the Company to elect tobe treated 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 was taxedas a C corporation.

# ** **

# **RESULTS OFOPERATIONS**

 

In accordance with generallyaccepted accounting principles, the operating results of two properties arereported as discontinued operations in the first quarter of 2003, as are theoperating results of four properties in the first quarter of 2002.  For 2003, these consist of an industrialproperty and apartment property classified as “Real estate held for sale”.  For 2002, these consist of the propertiesmentioned and a shopping center and an apartment property sold in 2002.  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 March31, 2003 and March 31, 2002.***

 

*RentalRevenue*. For thethree months ended March 31, 2003, the Company recorded rental revenue of $8,848,000compared to $8,807,000 for the three months ended March 31, 2002.  Although the weighted occupancy ofproperties held from investment decreased from 86% at March 31, 2002 to 79% atMarch 31, 2003, rental revenue remained relatively constant due to the revenuerelated to the properties acquired in 2002. The Company acquired two properties in May 2002 and one property inAugust 2002.  Rental revenue from theacquired properties are included in the Company’s results since theirrespective dates of acquisition.

 

*PropertyOperating Expenses*.  For the three months ended March 31, 2003,the Company recorded property operating expenses of $3,639,000 compared to$3,168,000 for the three months ended March 31, 2002, a $471,000 increase or15%.  This increase is primarily due toproperty operating expenses related to the above mentioned propertyacquisitions of $308,000 and increased snow removal fees for the current yearquarter compared to the prior year quarter of approximately $96,000.

 

*Generaland administrative*.  General and administrative expensesdecreased by $824,000 or 34% for the first three months of 2003 compared to theprior year first quarter.  This decreaseis due (i) to a reduction of compensation expense in the 2003 quarter due todownsizing of staff and lower compensation expense related to common stockgrants, (ii) to the inclusion of non recurring expenses related to theconsolidation in the first quarter of 2002, and (iii) to expense controlmeasures put in place during the past year.

 

*Depreciationand amortization*.                    Depreciation and amortization expenseincreased $252,000 in the first quarter of 2003 compared to the first quarterof the prior year due to the acquisition of the three properties previouslymentioned and, to a lesser extent, depreciation of improvements and capitalizedlease costs incurred after the first quarter of 2002 for the existingproperties.

 

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*Interestexpense*.  Interest expense increased $280,000primarily due to interest costs related to the acquisition of the threeproperties previously mentioned and the effects of the mark-to-marketadjustment for the interest protection agreements in place.  The increase was also attributable torefinancings in the prior year.

 

*Discontinued operations*.  TheCompany recorded income from discontinued operations of $104,000 for the threemonths ended March 31, 2003 compared to $90,000 for the first three months ofthe prior year.  The discontinuedoperations represent net income from the properties held for sale.  For 2003, these properties consist of anindustrial property and apartment property. For 2002, these consist of the properties mentioned and a shoppingcenter and an apartment property sold in 2002. See Note 4 – Discontinued Operations – of the Notes to ConsolidatedFinancial Statements.

 

Theincome from discontinued operations is summarized below.

 
| **Condensed Consolidated Statements of Operations**    |   | **Three Months Ended  March 31, 2003** |   | **Three Months Ended  March 31, 2002** |   |
|--------------------------------------------------------|--------|----------------------------------------|--------|----------------------------------------|--------|
| Rental revenue                                         |   | $                                      | 627    |                                   | $      | 1,069 |   |
| Total expenses                                         |   | 523                                    |   | 943                                    |   |
| Minority interest related to partially  owned property |   | —                                 |   | (36                                    | )      |
| Net income from discontinued operations                |   | $                                      | 104    |                                   | $      | 90 |   |

 

# **LIQUIDITY ANDCAPITAL RESOURCES**

 

TheCompany reported a net loss of $2,276,000 for the three months ended March 31,2003, which included (i) the following non-cash charges: depreciation andamortization from real estate held for investment of $3,003,000, deferredcompensation expense of $79,000; and (ii) the following other non-cash items:deferred rental income of $138,000, minority interest of $294,000, andamortization of loan premiums of $140,000. Net cash provided by operating activities amounted to $1,170,000 for thethree months ended March 31, 2003. During the quarter ended March 31, 2003, accounts payable increased by$1,943,000 primarily due to the Company receiving invoices for amounts includedin accrued liabilities at year end and incurring costs related to capitalexpenditures.  The Company anticipatesreducing the accounts payable in the second quarter with proceeds of the saleof two properties, one of which sold in April 2003 and the other expected toclose in early May.

 

Net cash used in investing activities of $652,000 was due to capitalexpenditures incurred during the quarter ended March 31, 2003.  A new tenant build-out on an industrialproperty and a tenant expansion on an office property accounted for 44% ofthese capital expenditures.  Cash usedin investing activities of $1,032,000 for the three months ended March 31, 2002consisted of (i) $1,002,000 paid for capital expenditures, which in large partwere related to renovations on an apartment property, and (ii) $30,000 indistributions to the minority owner of Creekside Apartments.

 

Net cash used in financing activities amounted to $780,000 during thethree months ended March 31, 2003. Repayments of borrowings of $810,000 consisted of scheduled principal payments made during thequarter.  In addition, the Companyreceived proceeds of $30,000 from an affiliate of a related party whichcompleted the funding of an $830,000 loan on Valencia entered into in Decemberof 2002.  The mortgage was repaid inconjunction with the sale of the property in April 2003.  Net cash provided by financing activitiesamounted to $1,400,000 during the three months ended March 31, 2002.  Proceeds received from borrowings totaled$10,650,000.  Repayment of borrowings,which consisted of $7,250,000 from refinances and $852,000 in scheduledprincipal payments, totaled $8,102,000. Note payments to former limited partners totaling $1,154,000 were alsomade during the quarter ended March 31, 2002.

 

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

 

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

 

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Mr. Galardi has agreed to purchase a total of 60,975 shares of commonstock for $250,000.  This purchase isexpected to close in May 2003.

 

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 isdiscussing an extension with the lender.

 

In January 2002, the Company refinanced a $4,500,000loan partially secured by North Creek Office Park and entered into a new loanagreement in the amount of $5,625,000. The new loan bears interest at a fixed rate of 7.58% per annum andmatures in February 2012.  Net proceedsof $639,000 were received as a result 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 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 May 2002, the Companyrefinanced a $1,346,000 loan secured by Leawood Fountain Plaza, an officeproperty, and entered into a new 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 December 31,2002), and matures in June 2003.  Theloan contains a one-year extension option and an option to convert to apermanent loan provided certain lender conditions are satisfied.  Net proceeds of $1,026,000 were received asa result of the refinancing.

 

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.  The loan bore interest at a fixed rate of5.47% per annum.  The loan was paid infull in February 2003.  Other insurancepremiums totaling $277,000 were financed during 2002.  These loans bear interest at fixed rates between 5.47% and 6.99%per annum and mature at various dates in 2003.

 

In July 2002, a lender notified the Company it was technically indefault under its loan agreement for non-compliance with certain covenants,including covenants requiring improvements to shopping center properties inSouth Carolina.  Thereafter, the lendernotified the Company it was in default for failure to pay a matured portion ofthe loan, which matured in November 2002. As of March 31, 2003, the amount due under the matured portion of theloan was $2,790,000 and the aggregate principal balance of the loan agreementwas $6,454,000.  In early 2003, thelender sold the loan to the major tenant in the shopping center.  The new lender has not accelerated the loanagreement.  The Company is consideringvarious alternatives, including selling the property or using proceeds from thesale of another property to provide capital to pay off the matured portion ofthe loan.  The Company continues todiscuss the non-compliance matter with the new lender.

 

In October 2002, the Company received proceeds of $1,532,000 from twobridge loans on Maple Tree, one of its shopping center properties.  One of the loans, which totaled $700,000,was provided by an affiliate of a related party.  The mortgages were repaid in conjunction with the sale of theproperty in October 2002.

 

In December 2002, the Company entered into an $830,000 loan onValencia, an industrial property classified as “Real estate held for sale” inthe accompanying consolidated financial statements.      The loan was provided by anaffiliate of a related party.  $800,000was funded in December 2002 and $30,000 in March 2003.

 

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In December 2002, modification agreements were entered into with a bankto extend maturity on five secured loans to December 31, 2004.  These loans, whose balances total$22,003,000, bear interest at Libor plus 4% through June 30, 2003 and, providedcertain lender conditions are satisfied, Libor plus 3% thereafter.

 

During 2002, the Company received a $900,000 payoff on its $1,100,000mortgage loan receivable.  These fundswere used to meet obligations for capital costs relating to re-leasing andimprovements to properties.

 

The Operating Partnership has paid the following distributions on theOP Units, including OP Units held by the Company:  $1,255,000 on June 3, 2002; $1,253,000 on October 18, 2002; and$626,000 on December 30, 2002.  Thesedistributions correspond to dividends per share of Common Stock of $.20, $.20and $.10, respectively.

 

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 provide funds for paymentsof certain 2002 payables, consisting primarily of 2002 property taxes, tenantimprovements and capital improvements on properties and fees for professionalservices.  Also, the Company isprojecting the need for cash to fund obligations in 2003, including capitalcosts incurred and to be incurred related to re-leasing space and improvementsto properties and litigation settlement costs. The funds to meet these obligations will be obtained from proceeds ofthe sale of assets and lender held funds. Based on current analysis, the Company believes that the cash generatedby these anticipated sales will be adequate to meet these obligations.  There can be no assurance, however, that thesales of these assets will occur and that substantial cash will begenerated.  If these sales do not occur,the Company will not have sufficient cash to meet its obligations.

 

As of this date, the Company has not paid the 2002 property taxes dueon several properties.  This non-paymentcould be considered a technical default on the loans for these properties.  The Company plans to pay these taxes withthe proceeds from the sales of a property which is currently expected to occurin the second quarter of 2003.  Therecan be no assurance, however, the sale of a property will occur.

 

## **CONTRACTUALOBLIGATIONS AND COMMITMENTS**

 

TheCompany has contractual obligations with regards to future principal paymentsof debt, a litigation settlement, operating leases, employment agreements, andthe purchase of OP Units from Nooney Development Partners.  The following table aggregates the Company’sexpected contractual obligations and commitments subsequent to March 31, 2003(dollars in thousands):

 
|                                                               |   | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   |
|--------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|-----------|--------|
| Long-term debt                                                     |   | $        | 12,036 |     | $      | 32,947   |   | $        | 3,298  |     | $      | 7,413          |   | $         | 12,938 |   | $ | 100,180 |   | $ | 168,812 |   |
| Debt to former limited   partners                             |   | —   |   | —   |   | —   |   | —   |   | —   |   | 237            |   | 237       |   |
| Litigation settlement                                              |   | 250      |   | —   |   | —   |   | 9,750    |   | —   |   | —         |   | 10,000    |   |
| Employee obligations                                               |   | 879      |   | 283      |   | —   |   | —   |   | —   |   | —         |   | 1,162     |   |
| Operating lease commitments                                        |   | 117      |   | 37       |   | 12       |   | —   |   | —   |   | —         |   | 166       |   |
| Purchase of OP Units  from  Nooney  Development Partners |   | 223      |   | —   |   | —   |   | —   |   | —   |   | —         |   | 223       |   |
| Total                                                              |   | $        | 13,505 |     | $      | 33,267   |   | $        | 3,310  |     | $      | 17,163         |   | $         | 12,938 |   | $ | 100,417 |   | $ | 180,600 |   |

 

**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 for unconsolidatedpartnerships and joint ventures. Adjustments for 

 

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unconsolidated partnershipsand joint ventures will be calculated to reflect funds from operations on thesame basis.”  In 2002, NAREIT clarifiedthat FFO related to assets held for sale, sold or otherwise transferred andincluded in results of discontinued operations should continue to be includedin FFO.  This clarification waseffective January 1, 2002 and requires restatement for all periods presented infinancial statements or tables.  TheCompany believes that FFO is helpful to investors as a measure of performanceof an equity REIT 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 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.  FFOdoes not necessarily indicate that cash flows will be sufficient to fund all ofthe Company’s cash needs, including principal amortization, capitalimprovements and distributions to stockholders.  Further, FFO as disclosed by other companies may not becomparable to the Company’s calculation of FFO.

 

The following table setsforth the Company’s calculation of FFO for the three months ended March 31,2003 and 2003 (in thousands except weighted average shares and per shareamounts).

** **
|                                                                        |   | **March 31, 2003** |   | **March 31, 2002** |   |
|-----------------------------------------------------------------------------|--------|--------------------|--------|--------------------|--------|
| Loss from operations before minority  interest and discontinued operations  |   | $                  | (2,674 | )                  | $      | (2,467 | ) |
| Depreciation and amortization                                               |   | 3,003              |   | 2,751              |   |
| Net income from discontinued operations                                     |   | 104                |   | 90                 |   |
| Depreciation and amortization from  discontinued operations                 |   | 134                |   | 231                |   |
| Minority interest on partially owned  Property from discontinued operations |   | —             |   | 36                 |   |
| FFO                                                                         |   | $                  | 567    |               | $      | 641 |   |
|                                                                        |   |               |   |               |   |
| Basic weighted average shares                                               |   | 5,545,075          |   | 5,529,058          |   |
| FFO per share                                                               |   | $                  | .10    |               | $      | .12 |   |

 

FFO decreased by $74,000for the three months ended March 31, 2003 as compared to the three months endedMarch 31, 2002 for the reasons discussed in the analysis of Results ofOperations.

 

**INFLATION**

 

Substantially all of theleases at the industrial and retail properties provide for pass-through to tenantsof 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 propertiestypically provide for rent adjustment and pass-through of increases inoperating expenses during the term of the lease. All of these provisions maypermit the Company to increase rental rates or other charges to tenants inresponse to rising prices and, therefore, serve to reduce the Company’sexposure to the adverse effects of inflation.

 

**FORWARD-LOOKINGSTATEMENTS**

 

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

 

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**RISKFACTORS**

 

Stockholders or potentialstockholders should read the “Risk Factors” section of the Company’s latestannual report on Form 10-K filed with the Securities and Exchange Commission inconjunction with this quarterly report on Form 10-Q to better understand thefactors affecting the Company’s financial condition and results of operations.

 

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

 

**INTERESTRATES**

The Company’s primary marketrisk exposure is to changes in interest rates on its secured and unsecuredborrowings.

 

It is the Company’spolicy to manage its exposure to fluctuations in market interest rates for itsborrowings through the use of fixed rate debt instruments to the extent thatreasonably favorable rates are obtainable with such arrangements. In order tomaximize financial flexibility when selling properties and minimize potentialprepayment penalties on fixed rate loans, the Company has also entered intovariable rate debt arrangements.

 

The Company has entered intointerest rate swap agreements to manage its interest rate risk.  The agreements, in nominal amounts totalingapproximately $22,000,000, effectively fix the interest rate at 2.42% plus theapplicable variable rate margin (effective rate of 6.42% at March 31, 2003).

 

At March 31, 2003, theCompany’s total indebtedness included fixed-rate debt of approximately$139,230,000 and floating-rate indebtedness of approximately $33,334,000. 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 $333,000, or $0.06 pershare, based upon the balances outstanding on variable rate instruments atMarch 31, 2003.

 

**ITEM 4****.  CONTROLS ANDPROCEDURES**

 

During the 90-day periodprior to the filing date of this report, management, including the Company’sChief Executive Officer and Acting Chief Financial Officer, evaluated theeffectiveness of the Company’s disclosure controls and procedures.  Based on, and as of the date of, thatevaluation, the Chief Executive Officer and Acting Chief Financial Officerconcluded that the disclosure controls and procedures were effective, in allmaterial respects, to ensure that information required to be disclosed in thereports the Company files and submits under the Exchange Act is recorded,processed, summarized and reported as and when required.

 

There have been no significantchanges in the Company’s internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of the evaluationreferred to above.

 

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**PART II****.  OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS**

 

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

 

Lewis-Madison Matter

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

 

Teachout Matter

A subsidiary of CGS, S-P Properties, Inc., was a defendant in a lawsuitcommenced in Superior Court, County of Los Angles in November 1995, entitledTeachout et al. v. S.P. Properties, Inc. and Sierra Pacific Development Fund II(“Fund II”).  The suit was a derivativeaction brought by a limited partner on behalf of Fund II, which alleged thatthe general partner breached its fiduciary duty and breached the partnershipagreement in connection with loans to an affiliate of the general partner andthe issuance of notes to an affiliate of CGS in connection with the purchase ofa property from Fund II, among other things. Fund II was merged into a subsidiary of the Company pursuant to theConsolidation.

 

As part of the Consolidation, the Company assumed the repaymentobligation to the former Fund II investors and has carried these loans withaccrued interest on its books and records. The obligation, totaling approximately $8,800,000 at December 31, 2002,is reflected in accrued and other liabilities in the accompanying consolidatedfinancial statements.

 

In January 2003, the parties reached a settlement regarding thismatter.  Under the settlement, which isexpected to be documented in the second quarter of 2003, the Company reaffirmedits previously announced obligation to pay the former limited partners of FundII, or their assignees or transferees, the loans which were made and called bythe former general partner of Fund II as part of the Consolidation.  Pursuant to the settlement, the Company hasestablished a definitive repayment plan and will secure the repaymentobligation with a second deed of trust on an office building owned by theCompany.  The repayment plan consists ofa promissory note in the amount of $8,800,000 (the amount of such loans, plusinterest as of December 31, 2002), which shall accrue interest at 6% perannum.  Interest only payments will bemade quarterly until the note is paid. The note may be prepaid in whole or in part at any time without penalty.

 

As part of the settlement, the plaintiffs dismissed the lawsuit and allclaims therein with prejudice, and the Company has no obligation to pay anyfurther amounts, except for legal fees of $1,200,000 to plaintiff’s counsel.

 

In connection with the agreement, Mr. John Galardi, a principalstockholder of the Company, and Mr. William J. Carden, the Chief ExecutiveOfficer, a director and a principal stockholder of the Company, acknowledgedthat they owe the Company the sum of $1,187,695 as indemnification against aportion of the Company’s settlement obligation.  Mr. Galardi and certain affiliates of Mr. Carden and/or Mr.Galardi are beneficiaries, in part, of the settlement of the Teachout matterand are owed an amount in excess of this obligation pursuant to thatsettlement.  Mr. Galardi and Mr. Cardenhave agreed to pay the Company the principal sum of this obligation, plusinterest thereon at the annual rate of 6% from March 15, 2003, in the form ofan assignment to the Company of their right to receive $1,187,695 of principalpayments on the notes payable to them and their affiliates by reason of thesettlement of the Teachout matter, plus all interest payable on such principal amountof notes.  The receivable of $1,187,695is reflected as a component of equity in the Company’s consolidated financialstatements as of March 31, 2003.

 

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

 

(a)  Exhibits:

 

The Exhibit Indexattached hereto is hereby incorporated by reference this item.

 

(b)  Reports on Form 8-K:

 

None.

 

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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: May 12, 2003* |   |                                                                                           |
|----------------------|--------|------------------------------------------------------------------------------------------------|
|                 | By:    | /s/ William J. Carden                                                                          |   |
|                 |   | William J. Carden                                                                              |
|                 |   | Chairman of the Board, President,  Chief Executive Officer and Acting  Chief Financial Officer |
|                 |   |                                                                                           |
| *Date: May 12, 2003* |   |                                                                                           |
|                 | By:    | /s/ Patricia A. Nooney                                                                         |   |
|                 |   | Patricia A. Nooney                                                                             |
|                 |   | Senior Vice President and Director of Accounting  (Principal Accounting Officer)               |

 

 

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CERTIFICATION

 

I, William J. Carden, certify that:

 

1.               I have reviewed this quarterly report onForm 10-Q of American Spectrum Realty, Inc.;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport,

 

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

 

4. The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

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

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

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

 

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

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

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

 

6. The registrant’s other certifying officers and I have indicated inthis quarterly report whether or not there were significant changes in internalcontrols or in other factors that could significantly affect internal controlssubsequent to the date of our most recent evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 

 
|   | Date: May 12, 2003                 |   |
|--------|------------------------------------|--------|
|   |                               |
|   |                               |
|   | */s/ William J.  Carden*           |   |   |
|   | William J. Carden                  |   |
|   | Chief Executive Officer and Acting |   |
|   | Chief Financial Officer            |   |
|        |                                    |        |  |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** |   | **Exhibit Title**                                                                                                       |
|-----------------|--------|-------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                    |
| 99              |   | 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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