###### **UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**(MarkOne)**

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

**THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended March 31, 2005**

**OR**

** **

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

**THE SECURITIES EXCHANGE ACT OF 1934**

 

**COMMISSION FILE NUMBER 001-16785**

 

**American Spectrum 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.) |
|                                                            |       |                                  |
| **5850 San Felipe, Suite 450  Houston, Texas 77057**            | ** ** | **77057**                             |
| (Address of principal executive offices)                        |       | (Zip Code)                            |

 

**(713) 706-6200**

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed sincelast report

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during 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 April 29, 20051,507,686 shares of Common Stock ($.01 par value) were outstanding.

 

 

----

 

**TABLE OF CONTENTS**

 
| PART I  | FINANCIAL INFORMATION                                                                                       |   |
|---------|-------------------------------------------------------------------------------------------------------------|--------|
|    |                                                                                                        |   |
| Item 1  | Financial Statements                                                                                        |   |
|    | Consolidated Balance Sheets  at March 31, 2005 (unaudited) and December 31, 2004                            |   |
|    | Consolidated  Statements of Operations for the three months ended March 31, 2005 and 2004  (unaudited)      |   |
|    | Consolidated  Statement of Stockholders’ Equity for the three months ended March 31, 2005  (unaudited) |   |
|    | Consolidated  Statements of Cash Flows for the three months ended March 31, 2005 and 2004  (unaudited)      |   |
|    | Notes to  Consolidated Financial Statements                                                                 |   |
| Item  2 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                 |   |
| Item 3  | Quantitative and  Qualitative Disclosures about Market Risk                                                 |   |
| Item 4  | Controls and  Procedures                                                                                    |   |
|    |                                                                                                        |   |
| PART II | OTHER INFORMATION                                                                                           |   |
|    |                                                                                                        |   |
| Item 1  | Legal Proceedings                                                                                           |   |
| Item 6  | Exhibits and  Reports on Form 8-K                                                                           |   |

 

2

----

 

**PARTI.  FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**AMERICAN SPECTRUM REALTY, INC.**

**CONSOLIDATEDBALANCE SHEETS**

(Dollarsin thousands, except per share amounts) 

 
| ** **                                                                                                                                                                      | ** ** | **March 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                      | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                      |       |               |       |                  |       |
|                                                                                                                                                                            |       |               |       |                  |       |   |   |
| Real estate held for investment                                                                                                                                                 |       | $                  | 197,009    |                  | $          | 195,834 |   |
| Accumulated depreciation                                                                                                                                                        |       | 29,953             |       | 27,303                |       |
| Real estate held for investment, net                                                                                                                                            |       | 167,056            |       | 168,531               |       |
|                                                                                                                                                                            |       |               |       |                  |       |
| Real estate held for sale                                                                                                                                                       |       | —             |       | 2,595                 |       |
| Cash and cash equivalents                                                                                                                                                       |       | 1,727              |       | 589                   |       |
| Tenant and other receivables, net of  allowance for doubtful accounts of $147 and $223, respectively (including  $244 from related party)                                       |       | 699                |       | 721                   |       |
| Deferred rents receivable                                                                                                                                                       |       | 1,616              |       | 1,566                 |       |
| Investment in management company                                                                                                                                                |       | 4,000              |       | 4,000                 |       |
| Prepaid and other assets, net                                                                                                                                                   |       | 9,196              |       | 9,543                 |       |
|                                                                                                                                                                            |       |               |       |                  |       |
| Total Assets                                                                                                                                                                    |       | $                  | 184,294    |                  | $          | 187,545 |   |
|                                                                                                                                                                            |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                   |       |               |       |                  |       |
|                                                                                                                                                                            |       |               |       |                  |       |
| Liabilities:                                                                                                                                                                    |       |               |       |                  |       |
| Notes payable, net of premiums of $2,240  and $2,355, respectively                                                                                                              |       | $                  | 148,747    |                  | $          | 149,589 |   |
| Notes payable, litigation settlement                                                                                                                                            |       | 9,512              |       | 9,512                 |       |
| Liabilities related to real estate held for  sale                                                                                                                               |       | —             |       | 1,712                 |       |
| Accounts payable                                                                                                                                                                |       | 2,280              |       | 2,330                 |       |
| Deferred tax liability                                                                                                                                                          |       | 1,109              |       | 1,109                 |       |
| Accrued and other liabilities (including  $233 and $185, respectively, to related parties)                                                                                      |       | 5,958              |       | 6,374                 |       |
|                                                                                                                                                                            |       |               |       |                  |       |
| Total Liabilities                                                                                                                                                               |       | 167,606            |       | 170,626               |       |
|                                                                                                                                                                            |       |               |       |                  |       |
| Minority Interest                                                                                                                                                               |       | 5,451              |       | 5,492                 |       |
|                                                                                                                                                                            |       |               |       |                  |       |
| Commitments and Contingencies:                                                                                                                                                  |       |               |       |                  |       |
|                                                                                                                                                                            |       |               |       |                  |       |
| 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, 1,597,645 and 1,597,160 shares, respectively;  outstanding, 1,507,686 and 1,509,801 shares, respectively |       | 16                 |       | 16                    |       |
| Additional paid-in capital                                                                                                                                                      |       | 46,043             |       | 46,031                |       |
| Accumulated deficit                                                                                                                                                             |       | (32,822            | )          | (32,623               | )          |
| Receivable from principal stockholders                                                                                                                                          |       | (950               | )          | (950                  | )          |
| Deferred compensation                                                                                                                                                           |       | (36                | )          | (55                   | )          |
| Treasury stock, at cost, 89,959 and 87,359  shares, respectively                                                                                                                |       | (1,014             | )          | (992                  | )          |
|                                                                                                                                                                            |       |               |       |                  |       |
| Total Stockholders’ Equity                                                                                                                                                 |       | 11,237             |       | 11,427                |       |
|                                                                                                                                                                            |       |               |       |                  |       |
| Total Liabilities and Stockholders’ Equity                                                                                                                                 |       | $                  | 184,294    |                  | $          | 187,545 |   |
|                                                                                                                                                                                 |            |                    |            |                       |            |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

3

----

 

**AMERICAN SPECTRUM REALTY, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(Dollarsin thousands, except per share amounts)

(Unaudited)

 
| ** **                                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                     | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| **REVENUES:**                                                  |       |                             |       |   |   |
| Rental revenue                                                 |       | $                                | 6,858      |   | $ | 6,856 |   |
| Interest and other income                                      |       | 49                               |       | 80 |   |
| Total revenues                                                 |       | 6,907                            |       | 6,936 |   |
|                                                           |       |                             |       |   |   |
| **EXPENSES:**                                                  |       |                             |       |   |   |
| Property operating expense                                     |       | 2,873                            |       | 2,494 |   |
| General and administrative                                     |       | 920                              |       | 1,127 |   |
| Depreciation and amortization                                  |       | 2,792                            |       | 2,487 |   |
| Interest expense                                               |       | 2,981                            |       | 2,809 |   |
| Total expenses                                                 |       | 9,566                            |       | 8,917 |   |
|                                                           |       |                             |       |   |   |
| Net loss before minority interest and  discontinued operations |       | (2,659                           | )          | (1,981 | ) |
|                                                           |       |                             |       |   |   |
| Minority interest                                              |       | 29                               |       | 263 |   |
|                                                           |       |                             |       |   |   |
| Net loss before discontinued operations                        |       | (2,630                           | )          | (1,718 | ) |
|                                                           |       |                             |       |   |   |
| Discontinued operations:                                       |       |                             |       |   |   |
| Loss from discontinued operations                              |       | (29                              | )          | (107 | ) |
| Gain on sale of discontinued operations                        |       | 2,460                            |       | — |   |
| Income (loss) from discontinued operations                     |       | 2,431                            |       | (107 | ) |
|                                                           |       |                             |       |   |   |
| Net loss                                                       |       | $                                | (199       | ) | $ | (1,825 | ) |
|                                                           |       |                             |       |   |   |
| Basic and diluted per share data:                              |       |                             |       |   |   |
| Net loss before discontinued operations                        |       | $                                | (1.75      | ) | $ | (1.10 | ) |
| Income (loss) from discontinued operations                     |       | 1.62                             |       | (0.07 | ) |
| Net loss                                                       |       | $                                | (0.13      | ) | $ | (1.17 | ) |
|                                                           |       |                             |       |   |   |
| Basic weighted average shares used                             |       | 1,499,419                        |       | 1,555,442 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

4

----

 

**AMERICANSPECTRUM REALTY INC.**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

(Dollarsin thousands)

(Unaudited)

 
| ** **                                                 | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Deferred  Compensation** | ** ** | **Treasury  Stock** | ** ** | **Receivable  from  Principal  Stockholders** | ** ** | **Total  Equity** | ** ** |
|------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|----------------------------|------------|---------------------|------------|-----------------------------------------------|------------|-------------------|------------|
|                                                       |       |              |       |                             |       |                     |       |                       |       |                |       |                                          |       |              |       |   |   |   |   |   |   |   |
| Balance, December 31, 2004                                 |       | $                 | 16         |                             | $          | 46,031                   |       | $                          | (32,623    | )                   | $          | (55                                           | )          | $                 | (992       | ) | $ | (950 | ) | $ | 11,427 |   |
| Conversion of operating partnership units  to common stock |       | —            |       | 12                               |       | —                   |       | —                     |       | —              |       | —                                        |       | 12                |       |
| Repurchase of common stock                                 |       | —            |       | —                           |       | —                   |       | —                     |       | (22                 | )          | —                                        |       | (22               | )          |
| Amortization of deferred compensation                      |       | —            |       | —                           |       | —                   |       | 19                         |       | —              |       | —                                        |       | 19                |       |
| Net loss                                                   |       | —            |       | —                           |       | (199                     | )          | —                     |       | —              |       | —                                        |       | (199              | )          |
| Balance, March 31, 2005                                    |       | $                 | 16         |                             | $          | 46,043                   |       | $                          | (32,822    | )                   | $          | (36                                           | )          | $                 | (1,014     | ) | $ | (950 | ) | $ | 11,237 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

5

----

 

**AMERICAN SPECTRUM REALTY, INC**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(Dollarsin thousands)

(Unaudited)

** **
| ** **                                                                                 | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                 | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                  |       |                             |       |   |   |
| Net loss                                                                                   |       | $                                | (199       | ) | $ | (1,825 | ) |
| Adjustments to reconcile net loss to net  cash (used in) provided by operating activities: |       |                             |       |   |   |
| (Income) loss from discontinued operations                                                 |       | (2,431                           | )          | 107 |   |
| Depreciation and amortization                                                              |       | 2,792                            |       | 2,487 |   |
| Deferred rental income                                                                     |       | (50                              | )          | (250 | ) |
| Minority interest                                                                          |       | (29                              | )          | (263 | ) |
| Deferred compensation expense                                                              |       | 19                               |       | 28 |   |
| Mark to market adjustments on interest rate  protection agreements                         |       | —                           |       | (10 | ) |
| Interest on receivable from principal  stockholders                                        |       | (13                              | )          | (18 | ) |
| Amortization of note payable premiums,  included in interest expense                       |       | (114                             | )          | (133 | ) |
| Amortization of note receivable discount,  included in interest income                     |       | —                           |       | (25 | ) |
| Changes in operating assets and  liabilities:                                              |       |                             |       |   |   |
| Decrease (increase) in tenant and other  receivables                                       |       | 18                               |       | (50 | ) |
| (Decrease) increase in accounts payable                                                    |       | (50                              | )          | 1,410 |   |
| Decrease (increase) in prepaid and other  assets                                           |       | 35                               |       | (395 | ) |
| Decrease in accrued and other liabilities                                                  |       | (384                             | )          | (130 | ) |
| Net cash (used in) provided by operating  activities - continuing operations:              |       | (406                             | )          | 933 |   |
|                                                                                       |       |                             |       |   |   |
| Net cash provided by (used in) operating  activities – discontinued operations:       |       | 122                              |       | (171 | ) |
|                                                                                       |       |                             |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                  |       |                             |       |   |   |
| Proceeds received from sales of real estate  asset                                         |       | 4,921                            |       | — |   |
| Capital improvements to real estate assets                                                 |       | (1,175                           | )          | (2,390 | ) |
| Collections on mortgage loan receivable                                                    |       | —                           |       | 14 |   |
| Net cash provided by (used in) investing  activities:                                      |       | 3,746                            |       | (2,376 | ) |
|                                                                                       |       |                             |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                  |       |                             |       |   |   |
| Proceeds from borrowings                                                                   |       | 2,350                            |       | — |   |
| Repayment of borrowings – property sales                                              |       | (1,574                           | )          | — |   |
| Repayment of borrowings – refinances                                                  |       | (2,385                           | )          | — |   |
| Repayment of borrowings – scheduled  payments                                         |       | (693                             | )          | (757 | ) |
| Repurchase of common stock                                                                 |       | (22                              | )          | — |   |
| Net cash used in financing activities:                                                     |       | (2,324                           | )          | (757 | ) |
|                                                                                       |       |                             |       | — |   |
| Increase (decrease) in cash                                                                |       | 1,138                            |       | (2,371 | ) |
|                                                                                       |       |                             |       | — |   |
| Cash, beginning of period                                                                  |       | 589                              |       | 2,937 |   |
|                                                                                       |       |                             |       |   |   |
| Cash, end of period                                                                        |       | $                                | 1,727      |   | $ | 566 |   |
|                                                                                       |       |                             |       |   |   |
| **SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:**                                     |       |                             |       |   |   |
| Cash paid for interest                                                                     |       | $                                | 2,850      |   | $ | 2,876 |   |
| Cash paid for income taxes                                                                 |       | 24                               |       | 21 |   |
|                                                                                       |       |                             |       |   |   |
| **SUPPLEMENTAL DISCLOSURE OF NON-CASH  INVESTING AND FINANCING ACTIVITIES:**               |       |                             |       |   |   |
| Conversion of operating partnership units  into common stock                               |       | $                                | 12         |   | $ | — |   |
| Payable to principal shareholders offset  against receivable from principal shareholders   |       | —                           |       | 120 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

6

----

 

**AMERICAN SPECTRUM REALTY, INC.**

### **Notesto Consolidated Financial Statements**

 

**NOTE1.  DESCRIPTION OF BUSINESS**

 

American Spectrum Realty,Inc. (“ASR” or, collectively, as a consolidated entity with its subsidiaries, the“Company”) is a Maryland corporation established on August 8, 2000.  The Company is a full-service real estatecorporation, which owns, manages and operates income-producing properties.  Substantially all of the Company’s assets areheld through an operating partnership (the “Operating Partnership”) in whichthe Company, as of March 31, 2005, held the sole general partner interest of..91% and a limited partnership interest totaling 86.60%.  As of March 31, 2005, through itsmajority-owned subsidiary, the Operating Partnership, the Company owned andoperated 24 properties, which consisted of 18 office buildings, threeindustrial properties, two shopping centers and one apartment complex.  The 24 properties are located in sevenstates.

 

During the three monthsended March 31, 2005, the Company sold an industrial property located in SanDiego, California.  During 2004, theCompany sold three properties, which consisted of an office building, anindustrial property and a parcel of undeveloped land, and acquired two officebuildings in Houston, Texas.  Most of theproperty sales are part of the Company’s strategy to sell its non-core propertytypes – apartment and shopping center properties – and to sell its propertieslocated in the Midwest and Carolina’s, its non-core markets.  The Company intends to focus primarily onoffice and industrial properties located in Texas, California and Arizona.

 

The Company is the solegeneral partner of the Operating Partnership. As the sole general partner of the Operating Partnership, the Companygenerally has the exclusive power to manage and conduct the business of theOperating Partnership under its partnership agreement.  The Company’s interest as a limited partnerin the Operating Partnership entitles it to share in any cash distributionsfrom, and in profits and losses of, the Operating Partnership.  If the Company receives any distributionsfrom the Operating Partnership, it intends, in turn, to pay dividends to itscommon stockholders so that the amount of dividends paid on each share ofcommon stock equals four times the amount of distributions paid on each limitedpartnership unit in the Operating Partnership (“OP Unit”).  The intended dividend of four times thedistribution from each limited partnership unit is a result of the Company’sone-for-four reverse stock split in March 2004. Most of the properties are owned by the Operating Partnership throughsubsidiary limited partnerships or limited liability companies.

 

Holders of the OP Unitshave the option to redeem their units and to receive, at the option of theCompany, in exchange for each four OP Units (i) one share of Common Stock ofthe Company, or (ii) cash equal to the market value of one share of CommonStock of the Company at the date of conversion, but no fractional shares willbe issued.

 

Management continues toconsider 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. The Company currently operates in a manner that will permit it to electREIT status; however, the Company may enter into transactions which couldpreclude it from electing REIT status in the future.  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.  AREIT typically is not subject to federal income taxation on its net income,provided applicable income tax requirements are satisfied.   For the tax year 2004, the Company was taxedas a C corporation.  It is anticipatedthat the Company will be taxed as a C corporation for the 2005 tax year.

 

The Company expects tomeet its short-term liquidity requirements for normal property operatingexpenses and general and administrative payroll expenses from cash generated byoperations and cash currently held.  Inaddition, the Company anticipates capital costs to be incurred related toleasing space and improvements to properties provided the estimated leasing ofspace is complete, litigation settlement costs and other fees from professionalservices.  The funds to meet theseobligations will be obtained from proceeds of the sale of assets, lender heldfunds and refinancing of properties. 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 be generated.

 

7

----

 

If these sales orrefinancings do not occur, the Company will not have sufficient cash to meetits obligations.

 

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

 

**BASIS OFPRESENTATION**

 

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

 

The results for such 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, 2004 and the related notes theretoincluded in the Company’s 2004 Annual Report on Form 10-K filed with the SEC.

 

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

 

**RECLASSIFICATIONS**

## ** **

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”, real estate designated asheld for sale are accounted for in accordance with the provisions of SFAS No.144 and the results of operations of these properties are included in incomefrom discontinued operations.  Priorperiods have been reclassified for comparability, as required.

 

Pursuant to a one-for-four reverse stock split of theCompany’s Common Stock, every four shares of Common Stock outstanding as of theclose of business on March 1, 2004 became one share of new post-split CommonStock.  Share and per share data (exceptpar value) in the consolidated financial statements and notes for all periodspresented have been adjusted to reflect the reverse stock split.

 

**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**

 

InDecember 2004, the FASB issued SFAS No. 153, *Exchanges of Nonmonetary Assets – an amendment of APBOpinion No. 29,* to address the measurement of exchanges ofnonmonetary assets.  SFAS No. 153eliminates the exception from fair value measurement for nonmonetary exchangesof similar productive assets and replaces it with a general exception forexchanges of nonmonetary assets that do not have commercial substance.  A nonmonetary exchange has commercial substanceif the future cash flows of the entity are expected to change significantly asa result of the exchange.  SFASNo. 153 is effective for nonmonetary exchanges occurring afterJune 30, 2005.  The adoption of SFASNo. 153 is not expected to have a material impact on the Company’s consolidatedfinancial statements.

 

In December 2004,the FASB revised SFAS No. 123, *Share–BasedPayment*(“SFAS No. 123R”). SFAS No. 123R is a revision of SFAS No. 123 and supersedes APBNo. 25.  SFAS No. 123R requiresa public entity to measure the cost of employee services received in exchangefor an award of equity instruments based on the grant–date fair value of theaward.  That cost will be recognized overthe period in which an employee is required to provide service in exchange forthe award.  SFAS No. 123R also requires apublic entity to initially measure the cost of employee services rendered inexchange for an award of liability

 

8

----

 

instruments at itscurrent fair value.  The fair value ofthat award is to be remeasured subsequently at each reporting date through thesettlement date.  Changes in the fairvalue during the required service period are to be recognized as compensationcost over that period.  The Company willadopt SFAS No. 123R January 1, 2006.  Theadoption of SFAS No. 123R is not expected to have a material impact on theCompany’s consolidated financial statements.

 

**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) is computedusing estimated sales price, as determined by prevailing market values forcomparable 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 eventual sale.  Due to uncertainties inherent in thevaluation process and in the economy, actual results of operating and disposingof the Company’s properties could be materially different from currentexpectations.

 

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

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

 

**CASHEQUIVALENTS**

 

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

 

**FAIR VALUEOF FINANCIAL INSTRUMENTS**

 

The Company’s financialinstruments consist of cash and cash equivalents, tenant and other 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, 2005 and December 31, 2004.

 

**DERIVATIVEFINANCIAL INSTRUMENTS**

 

The Company follows Statementof 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 as 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 had nointerest rate swaps to hedge against fluctuations in interest rates on specificborrowings during the three months ended March 31, 2005.  At March 31, 2004, the Company had interestrate swap contracts in notional amounts of approximately $9,600,000.  During the three months ended March 31, 2004the Company recorded a benefit of $10,000 attributable to changes in the fairvalue of its derivative financial instruments.

 

9

----

 

**DEFERREDFINANCING AND OTHER FEES**

 

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

 

## **STOCK-BASED COMPENSATION**

 

The Financial AccountingStandards Board issued SFAS No. 123, “Accounting for Stock-Based Compensation”(“FAS 123”) in October 1995.  Thisstandard establishes a fair value approach to valuing stock options awarded toemployees as compensation. In December 2002, FASB issued SFAS No. 148,“Accounting for Stock-Based Compensation - Transition and Disclosure” (“FAS148”), which amended FAS 123.  FAS 148provides alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  Additionally, FAS 148 amends the disclosurerequirements of FAS 123 to require prominent disclosures in the annual andinterim financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on reportedresults.  FAS 148 is effective forfinancial statements for fiscal years ending after December 15, 2002.  In compliance with FAS 148, the Company haselected to continue to follow the intrinsic value method in accounting for itsstock-based employee compensation arrangement as defined by APB No. 25“Accounting for Stock Issued to Employees”.

 

The Company has in effectits Omnibus Stock Incentive Plan (the “Plan”), which is described more fully inits Form 10-K filed with the Securities and Exchange Commission.  The Company has elected, as permitted by FAS123, to use the intrinsic value based method of accounting for stock optionsconsistent with Accounting Principles Board Opinions No. 25, “Accounting forStock Issued to Employees”.  Theintrinsic value method measures compensation cost for stock options as theexcess, if any, of the quoted market price of the Company’s stock at the measurementdate over the exercise price.  Nostock-based employee compensation cost is reflected in net income related tostock options, as all options granted under the Plan had an exercise priceequal to the average of the high and low sales prices of the underlying commonstock on the date of grant.

 

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

 
| ** **                                                                                                         | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                         | ** ** | **March 31,**          | ** ** |
| ** **                                                                                                         | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Net loss, as reported                                                                                              |       | $                      | (199       | ) | $ | (1,825 | ) |
| Deduct: Employee compensation expense for  stock option grants under fair value method, net of related tax effects |       | (19                    | )          | (68 | ) |
| Pro forma net loss                                                                                                 |       | $                      | (218       | ) | $ | (1,893 | ) |
|                                                                                                               |       |                   |       |   |   |
| Per share data:                                                                                                    |       |                   |       |   |   |
| Basic and diluted, as reported                                                                                     |       | $                      | (0.13      | ) | $ | (1.17 | ) |
| Basic and diluted, proforma                                                                                        |       | $                      | (0.14      | ) | $ | (1.22 | ) |

# ** **

# **MINORITY INTEREST**

 

Unit holders in theOperating Partnership (other than the Company) held a 12.49% and 12.50% limitedpartnership interest in the Operating Partnership at March 31, 2005 andDecember 31, 2004, respectively.  Each ofthe holders of the interests in the Operating Partnership (other than theCompany) has the option (exercisable after the first anniversary of the issuanceof the OP Units) to redeem its OP Units and to receive, at the option of theCompany, in exchange for each four OP Units, either (i) one share of CommonStock of the Company, or (ii) cash equal to the value of one share of CommonStock of the Company at the date of conversion, but no fractional shares willbe issued.

 

10

----

 

**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 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.

 

Many of the Company’s leases provide for Common Area Maintenance (“CAM”)/Escalations(“ESC”) as the additional tenant revenue amounts due to the Company in additionto base rent.  CAM/ESC representsincreases in certain property operating expenses (as defined in each respectivelease agreement) over the actual operating expense of the property in the baseyear.  The base year is stated in thelease agreement; typically, the year in which the lease commenced.  Generally, each tenant is responsible for hisprorated share of increases in operating expenses. Tenants are billed anestimated CAM/ESC charge based on the budgeted operating expenses for theyear.  Within 90 days after the end ofeach fiscal year, a reconciliation and true up billing of CAM/ESC charges isperformed based on actual operating expenses.

 

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

 

# **NET LOSS PER SHARE**

 

Net loss per share iscalculated based on the weighted average number of common sharesoutstanding.  Stock options outstandingof 33,625 at March 31, 2005 and OP Units (other than those held by the Company)outstanding of 861,043 (convertible into approximately 215,260 shares of commonstock) at March 31, 2005 have not been included in the net loss per sharecalculation since their effect would be antidilutive.  See “Minority Interests” paragraph above.

 

**INCOMETAXES**

 

Management is unable toaccurately estimate the Company’s income taxes in interim periods due to theuncertainty of the gains or losses that would be recognized on propertysales.  Factors contributing to thisuncertainly include the number of properties the Company will eventually saleduring the year, the sales price to be obtained on each sale, the timing ofwhen the sale will occur, and whether such sale will be part of a tax-deferredexchange or an outright sale with full gain or loss recognition.

 

Annually, in preparing theCompany’s consolidated financial statements, management estimates the incometax in each of the jurisdictions in which the Company operates.  This process includes an assessment ofcurrent tax expense, the results of tax examinations, and the effects oftemporary differences resulting from the different treatment of transactions fortax and financial accounting purposes. These differences may result in deferred tax assets or liabilities whichare included in the consolidated balance sheet. The realization of deferred tax assets as a result of future taxableincome must be assessed and to the extent that the realization is doubtful, avaluation allowance is established.  TheCompany’s annual income tax provision is based on calculations and assumptionsthat will be subject to examination by the taxing authorities in the jurisdictionsin which the Company operates.  Shouldthe actual results differ from the Company’s estimates, the Company would haveto adjust the income tax provision in the period in which the facts andcircumstances that give rise to the revision become known.  Tax law and rate changes are reflected in theannual income tax provision in the period in which such changes are enacted.

 

11

----

 

## **SEGMENTS**

 

The Company owns a diverseportfolio of properties comprising office, industrial, shopping centerproperties, and an apartment property. Each of these property types represents a reportable segment withdistinct uses and tenant types and requires the Company to employ differentmanagement strategies.  The propertiescontained in the segments are located in various regions and markets within theUnited States.  The office portfolioconsists primarily of suburban office buildings.  The industrial portfolio consists ofproperties designed for warehouse, distribution and light manufacturing forsingle-tenant or multi-tenant use.  Theshopping center portfolio consists of community shopping centers located inSouth Carolina.  The Company’s soleremaining apartment property is located in Missouri and is rented toresidential tenants on either a month-by-month basis or for terms generally ofone year or less.

 

## **ALLOWANCE FOR DOUBTFUL ACCOUNTS**

 

The Companymaintains an allowance reserve for accounts receivable which may not beultimately collected.  The allowancebalance maintained is based upon historical collection experience, currentaging of amounts due and specific evaluations of the collectibility ofindividual balances.  All tenant accountbalances over 90 days past due are fully reserved.   Accounts are written off against the reservewhen they are deemed to be uncollectible.

 

## **NOTE 3.  REALESTATE**

## ** **

# **ACQUISITIONS**

 

*2005.*

 

No properties wereacquired during the first quarter of 2005.

 

*2004.*

 

On October 21, 2004, theCompany acquired an office property in Houston, Texas, consisting of approximately81,538 rentable square feet.  Theaggregate acquisition costs of approximately $5,900,000 included proceeds froma previously sold property, the assumption of existing debt and sellerfinancing.

 

On August 2, 2004,the Company acquired a 42,860 square foot office property in Houston, Texas,which is adjacent to an office property owned by the Company.  The Company previously held the note on theproperty.  Acquisition costs ofapproximately $2,084,000 included the settlement of the note, the issuance of10,000 shares of restricted Common Stock and cash.   The shares, which are currently held inescrow, will be released in August 2005 so long as the property’s largesttenant does not default on its lease agreement. The Company also entered into an agreement with the seller in which theseller will participate in any profits generated from the future sale of theproperty or, if demanded by the Company or seller after the third anniversarydate of the agreement, a sum determined by the property’s fair market value atthat time.

 

## **DISPOSITIONS**

 

*2005.*

 

On March 1, 2005, theCompany sold Sorrento I, a 43,036 square foot industrial property located inSan Diego, California for a sales price of $4,918,000.  Proceeds of $3,169,000 (net of debtrepayments and sales costs) were received as a result of the transaction.  A gain of $2,460,000 was generated inconnection with the sale, which is reflected as discontinued operations in theconsolidated statements of operations.

 

*2004.*

 

During 2004, the Companysold three properties for an aggregate sales price of $12,213,000.  The properties, which totaled 316,054 squarefeet, consisted of one office property, one industrial property and a 16.65acre parcel of undeveloped land.  Thesethree sales produced proceeds of approximately $4,316,000

 

12

----

 

(net of debt repaymentsand sales costs) of which $1,191,000 was used to assist the funding of anoffice property acquisition in a tax-deferred exchange.  Reference is made to the Company’s AnnualReport on Form 10-K for 2004 for more information with respect to the 2004property dispositions.

 

In the accompanyingconsolidated statements of operations for the three months ended March 31, 2005and 2004, the results of operations for the properties mentioned above areshown in the section “Discontinued operations” through their respective saledate.

 

**INTANGIBLEASSETS PURCHASED**

 

Upon acquisitions of realestate, the Company assesses the fair value of acquired tangible and intangibleassets (including land, buildings, tenant improvements, above and below marketleases, origination costs, acquired in-place leases, other identifiedintangible assets and assumed liabilities in accordance with Statement ofFinancial Accounting Standards No. 141), and allocates the purchase price tothe acquired assets and assumed liabilities. The Company also considers an allocation of purchase price of otheracquired intangibles, including acquired in-place leases.

 

## **TheCompany evaluates acquired “above and below” market leases at their fair value(using a discount rate which reflects the risks associated with the leasesacquired) equal to the difference between (i) the contractual amounts to bepaid pursuant to each in-place lease and (ii) management’s estimate of fairmarket lease rates for each corresponding in-place lease, measured over aperiod equal to the remaining term of the lease for above-market leases and theinitial term plus the term of any below-market fixed rate renewal options forbelow-market leases.  Based on itsacquisitions to date, the Company’s allocation to intangible assets for assetspurchased has been immaterial.**

 

## **NOTE 4. DISCONTINUED OPERATIONS**

 

Asof December 31, 2004, Sorrento I, a 43,100 square foot industrial propertylocated in San Diego, California was classified as “Real estate held forsale”.  Sorrento I, which had beenunoccupied since December 2002, was sold March 1, 2005.

 

Thecarrying amount of Sorrento I at December 31, 2004 is summarized below (dollarsin thousands).  All real estate assetsheld by the Company on March 31, 2005 are considered held for investment.  No real estate was classified as held forsale by the Company at March 31, 2005.

 

**Condensed Consolidated Balance Sheet**

 
| ** **                                        | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | ** **            | ** ** |
| Real estate                                       |       | $                     | 2,421      |   |
| Other                                             |       | 174                   |       |
| Real estate assets held for sale                  |       | $                     | 2,595      |   |
|                                              |       |                  |       |
| Note payable, net                                 |       | $                     | 1,694      |   |
| Accounts payable                                  |       | 5                     |       |
| Accrued and other liabilities                     |       | 13                    |       |
| Liabilities related to real estate held for  sale |       | $                     | 1,712      |   |

 

*Net income (loss) from discontinued operations.*

 

Netincome from discontinued operations of $2,431,000 for the three months endedMarch 31, 2005 includes a gain generated on the sale of Sorrento I and theproperty’s operating results through the March disposition date.

 

Netloss from discontinued operations of $107,000 for the three months ended March31, 2004 includes the results of operations of Sorrento I and three propertiessold during the third quarter of 2004.

 

Thecondensed consolidated statements of operations of discontinued operations forthe three months ended March 31, 2005 and 2004 are summarized below (dollars inthousands):

 

13

----

 

**Condensed Consolidated Statements of Operations**

 
| ** **                                                 | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                 | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Rental revenue                                             |       | —                           |       | $ | 517 |   |
| Total expenses                                             |       | $                                | 29         |   | 624 |   |
| Net loss from discontinued operations  before gain on sale |       | (29                              | )          | (107 | ) |
| Gain on sale of discontinued operations                    |       | 2,460                            |       | — |   |
| Net gain (loss) from discontinued  operations              |       | $                                | 2,431      |   | $ | (107 | ) |

 

**NOTE 5.MORTGAGE LOAN RECEIVABLE**

 

OnOctober 27, 2003, the Company acquired a note secured by a property adjacent toan office property owned by the Company. The property consists of 42,860 square feet and is located in Houston,Texas.  The purchase of this note wasfunded with a new loan to the Company from the lender that owned the note.  Loan costs of approximately $41,000 wereincurred in connection with the transaction. The note bore interest at 7.5% per annum.  The receivable balance of the note atDecember 31, 2003 was $1,666,504, net of discount of $83,253.

 

On August 2, 2004the Company acquired the property. Acquisition costs of approximately $2,084,000 included the settlement ofthe note, the issuance of 10,000 shares of restricted Common Stock and cash.

 

**NOTE6.  NOTES PAYABLE, NET OF PREMIUMS**

 

The Company had the following notes payableoutstanding as of March 31, 2005 and December 31, 2004 (dollars in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Secured loans with various lenders, net of  unamortized premiums of $2,240 at March 31, 2005 and $2,355 at December 31,  2004, bearing interest at fixed rates between 5.59% and 10.50% at March 31,  2005 and between 5.65% and 10.50% at December 31, 2004, with monthly  principal and interest payments ranging between $2 and $269 at March 31, 2005  and December 31, 2004, and maturing at various dates through February 22,  2015. |       | $        | 131,152    |     | $          | 131,653 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| Secured loans with various banks bearing  interest at variable rates ranging between 6.50% and 7.50% at March 31, 2005,  and 5.14% and at 6.50% December 31, 2004, and maturing at various dates  through May 1, 2008.                                                                                                                                                                                                                      |       | 5,119    |       | 5,165    |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| Secured Series A & B Bonds with a fixed  interest rate of 6.39%, monthly principal and interest payments of $74,  maturing September 30, 2031.                                                                                                                                                                                                                                                                                          |       | 11,336   |       | 11,377   |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| Secured Series C Bonds with a fixed  interest rate of 9.50%, semi-annual principal and interest payments ($75 at  March 31, 2005 and December 31, 2004), maturing November 1, 2006.                                                                                                                                                                                                                                                         |       | 325      |       | 325      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| Unsecured loans with various lenders,  bearing interest at fixed rates between 7.27% and 20.00% at March 31, 2005  and between 5.45% and 20.00% at December 31, 2004, and maturing at various  dates through December 15, 2005.                                                                                                                                                                                                             |       | 283      |       | 537      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| Unsecured loan from John N. Galardi, a  director and principal stockholder, with a fixed interest rate of 12.00%, due  December 14, 2005. The loan was paid in April 2005.                                                                                                                                                                                                                                                                  |       | 532      |       | 532      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                        |       |     |       |     |       |
| Total                                                                                                                                                                                                                                                                                                                                                                                                                                       |       | $        | 148,747    |     | $          | 149,589 |   |

 

Debtpremiums are amortized into interest expense over the terms of the relatedmortgages using the effective interest method. As of March 31, 2005 and December 31, 2004, the unamortized debtpremiums included in the above schedule were $2,240,000 and $2,355,000respectively.

 

In February 2005, theCompany refinanced debt of $2,385,000 on one of its office properties with anew loan in the amount of $2,350,000 and cash. The new loan bears interest at a fixed rate of 5.59% per annum andmatures in February 2015.  No proceedswere received as a result of the refinancing.

 

14

----

 

In December 2004, theCompany received a $532,000 loan from John N. Galardi.  The note, which bore interest at a fixedinterest rate of 12% per annum, was paid in April 2005.

 

In October 2004, inconnection with the acquisition of an office property in Houston, Texas, theCompany assumed a loan in the amount of $4,384,000.  The loan bears interest at a fixed rate of5.93% per annum and matures in June 2014. The Company also entered into an agreement that provided for sellerfinancing of $316,000, bearing interest at a fixed rate of 5.93% per annum andmaturing in June 2014.

 

In October 2004, theCompany refinanced a $1,176,000 loan on 888 Sam Houston Parkway, one of itsoffice properties, and entered into a revolving credit promissory note in theamount of $2,250,000, of which $1,226,000 has been drawn to cover the repaymentof existing debt and financing costs. The availability on the note as of March 31, 2005 and December 31, 2004was $1,024,000.  The note bears interestat prime plus 1% per annum and matures in November 2006.

 

In August 2004, theCompany refinanced a $5,350,000 loan on San Felipe, one of its officeproperties, with a new loan agreement in the amount of $5,500,000.  The new loan bears interest at a fixed rateof 5.65% per annum and matures in August 2014.  The Company funded closing costs of approximately $178,000 and escrowed$327,000 for future capital expenditures, real estate taxes and insurancerelated to the August 2004 refinance. Net proceeds of $2,059,000 were received in December 2003 related to theDecember 2003 refinance of the original $3,000,000 loan on the property.

 

In July 2004, the Companyrefinanced a $5,330,000 loan on Northwest Corporate Center, one of its officeproperties, with a new loan agreement in the amount of $5,750,000.  The new loan bears interest at a fixed rateof 6.26% per annum and matures in August 2014. No proceeds were received directly as a result of the refinance, however$350,000 is being held in escrow by the lender to assist the funding of futurecapital expenditures at the property.

 

In May 2004, the Companyrefinanced a $3,132,000 loan on Mira Mesa, one of its office properties, with anew one-year loan agreement in the amount of $7,500,000.  The new loan, which contains two six-monthextension options, bears interest at a fixed rate of 7.95% per annum.  Net proceeds of $3,440,000 were received as aresult of the refinance.

 

In May 2004, the Companyfinanced insurance premiums of $373,000 on its properties and agreed to pay aservice fee of $85,000 over one year. The insurance premium note was paid in full in February 2005.  The Company financed an additional insurancepremium during 2004 of $133,000, with scheduled payments through June 2005.

 

In 2002, the lender undera loan agreement related to the South Carolina shopping center propertiesnotified the Company it was technically in default under its loan agreement fornon-compliance with certain covenants, including covenants requiring improvementsto shopping center properties. Thereafter, the lender notified the Company that it was in default forfailure to pay a matured portion of the loan, which matured in November 2002.  In early 2003, the lender sold the loan tothe major tenant in two of the shopping centers.  In December 2003, the Company sold one of theshopping center properties and repaid $3,935,000, which included the pay-off ofthe matured portion of the loan.  As ofMarch 31, 2005, the remaining balance of the loan was approximately$2,756,000.   The Company continues todiscuss the non-compliance matter with the new lender.  The new lender has not accelerated the loan.

# ** **

# **NOTE 7.  NOTES PAYABLE, LITIGATION SETTLEMENT**

 

As the result of thesettlement of the Teachout litigation, which was documented in the thirdquarter of 2003, the Company reaffirmed its previously announced obligation topay the former limited partners of Sierra Pacific Development Fund II (“FundII”) as of the date of the Consolidation, or their assignees or transferees,the loans which were made and called by the former general partner of Fund IIas part of the Consolidation.  Pursuantto the settlement, the Company established a repayment plan and secured thedebt with a second deed of trust on an office property owned by theCompany.  This repayment plan consists ofa promissory note in the amount of $8,800,000, which bears interest at 6% perannum and matures in March 2006.  The noteis payable to the former limited partners of Fund II, each of whom has a pro-rata

 

15

----

 

interest in the note.  Interest-only payments, which are payablequarterly, commenced June 2, 2003.  Thenote may be prepaid in whole or in part at any time without penalty.

 

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

 

During the fourth quarter of 2004, the Companypurchased 2,347 of the 86,653 interests outstanding in the $8,800,000promissory note.  The Company paid$140,820 (or $60 per unit), which reduced it debt obligation related to thesettlement by $238,338.

 

## **NOTE 8. MINORITY INTEREST**

 

Unit holders in theOperating Partnership (other than the Company) held a 12.49% and 12.50% limitedpartnership interest in the Operating Partnership at March 31, 2005 andDecember 31, 2004, respectively.  Each ofthe holders of the interests in the Operating Partnership (other than theCompany) has the option (exercisable after the first anniversary of theissuance of the OP Units) to redeem its OP Units and to receive, at the optionof the Company, in exchange for each four OP Units, either (i) one share ofCommon Stock of the Company, or (ii) cash equal to the value of one share ofCommon Stock of the Company at the date of conversion, but no fractional shareswill be issued.

 

Duringthe three months ended March 31, 2005, a total of 1,942 OP Units were exchangedfor 485 shares of Common Stock.

 

Duringthe year ended December 31, 2004, a total of 35,772 OP Units were exchanged for8,943 shares of Common Stock.

 

# **NOTE 9.  REDEEMABLE COMMON STOCK**

 

On October 23, 2001, theCompany issued 5,000 shares of its Common Stock, $.01 par value per share, withthe holder’s right to compel the sale of the stock back to the Company (the“Put”) at a fixed price of $60.00 per share during the period from October 31,2002 to November 30, 2002.  The Putexercise period was subsequently extended to November 30, 2004 through December31, 2004.  In December 2004, the Companyreceived notice that the holder exercised its right to sell the Common Stockback to the Company for $60.00 per share or a total of $300,000 andsubsequently agreed to pay the sum in twelve monthly installments of $25,000 in2005.

 

**NOTE10.  REPURCHASE OF COMMON STOCK**

 

OnApril 4, 2005 the Company offered to purchase up to 250,000 sharespursuant to an odd lot buy back program. Shareholders who participate in the program will receive theprice-per-share equal to the average of the daily closing prices of theCompany’s Common Stock during the week in which response cards are received andprocessed.  Shareholders with fewer than100 shares are eligible to participate. The offer expires July 1, 2005, unless extended by the Company.

 

In March 2005, the Company repurchased a total of2,600 shares at an average price of $8.27 per share in open markettransactions.  The total cost of thestock repurchased amounted to $22,110.

 

On October 11, 2004 the Company offered to purchase up to 250,000 shares at$8.25 per share to holders of fewer than 100 shares pursuant to an odd lot buyback program previously postponed.  Theoffer, which expired December 1, 2004, resulted in 63,327 odd lot sharesvalidly tendered.

 

In September 2004, inconjunction with a resignation agreement, an employee relinquished 1,250 sharesof restricted common stock.

 

16

----

 

## **NOTE 11. RELATED PARTY TRANSACTIONS**

 

In December 2004, theCompany received a $532,000 loan from John N. Galardi, a director and aprincipal stockholder of the Company. The note, which bore interest at a fixed interest rate of 12% per annum,was paid in April 2005.

 

In September 2004, theCompany began managing an apartment complex owned by an affiliated entity ofMr. Carden.  During the three monthsended March 31, 2005 and the year ended December 31, 2004, the Company receivedmanagement fees of $12,000 and $20,000, respectively, from this entity.

 

In March 2004, theCompany paid $224,520 (“Guarantee Fee”) to William J. Carden, John N. Galardiand CGS Real Estate Company, Inc. (“the Guarantors”) in consideration for theirguarantees of certain obligations of the Company as of December 31, 2003.  Mr. Carden is the Chief Executive Officer, adirector and a principal stockholder of the Company.  The Company has agreed to pay the Guarantorsan annual guarantee fee equal to between .25% and .75% (depending on the natureof the guarantee) of the outstanding balance as of December 31 of theguaranteed obligations.  The GuaranteeFee is to be paid for a maximum of three years on any particularobligation.  In December 2004, theCompany paid $187,944 related to the Guarantee Fee payable for the 2004year.  The payments were made in the formof an offset against certain sums owed to the Company by the Guarantors.  For the first three months ended March 31,2005, the Company has accrued $48,000 related to the guarantee fee payable forthe 2005 year.

 

InFebruary 2003, the Company reached an agreement with CGS Real Estate Company,Inc. whereby CGS acknowledged that it owed the Company a net amount of $270,375which related to several issues asserted by William J. Carden that were owed byCGS to the Company and by the Company to CGS.   This amount is payable on March 15, 2006 with interest accruing fromMarch 15, 2003 at an annual rate of 6% and payable quarterly commencing on June15, 2003.  An affiliate of Mr. Carden isa principal stockholder of CGS.  Mr.Carden is an officer and a director of CGS, and an affiliate of Mr. Galardi isa principal stockholder of CGS.  Mr.Carden and Mr. Galardi have agreed to guarantee this obligation of CGS, andthey have secured this guarantee with an assignment to the Company of their rightto receive $270,375 of principal payments on the notes payable to them andtheir affiliates by reason of the settlement of the Teachout litigation, plusall interest payable on such principal amount of notes.  In March 2004, as part of the payment of the2003 Guarantee Fee, interest due on this obligation for 2004 was paid inadvance and $26,606 was applied to the principal due on this obligation.  In December 2004, as part of the payment ofthe 2004 Guarantee Fee, interest due on this obligation for 2005 was paid inadvance.  The principal balance due as ofMarch 31, 2005 was $243,858.

 

Inconnection with the settlement of the Teachout litigation, Mr. Galardi and Mr.Carden acknowledged that they owe the Company the sum of $1,187,695 asindemnification against a portion of the Company’s settlement obligation.  Mr. Galardi and certain affiliates of Mr.Carden and/or Mr. Galardi are beneficiaries, in part, of the settlement of theTeachout litigation and are owed an amount in excess of this obligation pursuantto that settlement.  Mr. Galardi and Mr.Carden have agreed to pay the Company the principal sum of this obligation,plus interest thereon at the annual rate of 6% from March 15, 2003, in the formof an assignment to the Company of their right to receive $1,187,695 ofprincipal payments on the notes payable to them and their affiliates by reasonof the settlement of the Teachout litigation, plus all interest payable on suchprincipal amount of notes.  Thereceivable of $1,187,695 and accrued interest are reflected as a component ofequity in the Company’s consolidated financial statements.  In March 2004, as part of the payment of the2003 Guarantee Fee, interest due on this obligation for 2004 was paid inadvance and $116,875 was applied to the principal due on this obligation.  In December 2004, as part of the payment ofthe 2004 Guarantee Fee, interest due on this obligation for 2005 was paid inadvance and $120,340 was applied to the principal due on this obligation.  The balance due as of March 31, 2005 was$950,480.

 

For the three monthsended March 31, 2005, the Company paid $10,639 for real estate related servicesto a firm in which Patricia A. Nooney, an executive officer of the Company,holds an ownership interest.  For theyear ended December 31, 2004, the Company paid $134,890 to this firm.

 

17

----

 

Forthe year ended December 31, 2004, the Company incurred professional fees of$54,505 to a law firm in which Timothy R. Brown, a director of the Company, isa partner.  No professional fees wereincurred to this firm during the three months ended March 31, 2005.

 

**NOTE 12.  SEGMENTINFORMATION**

 

As of March 31, 2005, theCompany owned a portfolio of properties comprising office, industrial, shoppingcenter properties, and an apartment property. Each of these property types represents a reportable segment withdistinct uses and tenant types and requires the Company to employ differentmanagement strategies.  The propertiescontained in the segments are located in various regions and markets within theUnited States.  The office portfolioconsists primarily of suburban office buildings.  The industrial portfolio consists ofproperties designed for warehouse, distribution and light manufacturing forsingle-tenant or multi-tenant use.  Theshopping center portfolio consists of community shopping centers located inSouth Carolina.  The Company’s soleremaining apartment property is located in Missouri and is rented toresidential tenants on either a month-by-month basis or for terms generally ofone year or less.

 

The accounting policies ofthe segments are the same as those described in the summary of significantaccounting policies.  The Companyevaluates performance of its property types based on net operating incomederived by subtracting property operating expenses from rental revenue.  Significant information used by the Companyfor its reportable segments as of and for the three months and three monthsended March 31, 2005 and 2004 is as follows (dollars in thousands):

 
| **Three Months Ended March 31,**     | ** ** | **Office** | ** ** | **Industrial** | ** ** | **Shopping  Center** | ** ** | **Apartment** | ** ** | **Other** | ** ** | **Property  Total** | ** ** |
|--------------------------------------|------------|------------|------------|----------------|------------|----------------------|------------|---------------|------------|-----------|------------|---------------------|------------|
| **2005**                             |       |       |       |           |       |                 |       |          |       |      |       |                |       |
| Rental revenue                       |       | $          | 5,368      |           | $          | 577                  |       | $             | 242        |      | $          | 671                 |       | — |   | $ | 6,858 |   |
| Property operating expenses          |       | 2,252      |       | 183            |       | 49                   |       | 382           |       | 7         |       | 2,873               |       |
| Net operating income (NOI)           |       | $          | 3,116      |           | $          | 394                  |       | $             | 193        |      | $          | 289                 |       | $ | (7 | ) | $ | 3,985 |   |
| Real estate held for investment, net |       | $          | 134,639    |           | $          | 14,197               |       | $             | 4,987      |      | $          | 13,192              |       | $ | 41 |   | $ | 167,056 |   |
|                                 |       |       |       |           |       |                 |       |          |       |      |       |                |       |
| **2004**                             |       |       |       |           |       |                 |       |          |       |      |       |                |       |
| Rental revenue                       |       | $          | 5,327      |           | $          | 624                  |       | $             | 247        |      | $          | 658                 |       | $ | — |   | $ | 6,856 |   |
| Property operating expenses          |       | 1,900      |       | 155            |       | 52                   |       | 376           |       | 11        |       | 2,494               |       |
| Net operating income (NOI)           |       | $          | 3,427      |           | $          | 469                  |       | $             | 195        |      | $          | 282                 |       | $ | (11 | ) | $ | 4,362 |   |
| Real estate held for investment, net |       | $          | 131,629    |           | $          | 15,136               |       | $             | 5,352      |      | $          | 13,761              |       | $ | 87 |   | $ | 165,965 |   |

 

The following is areconciliation of segment revenues, income and assets to consolidated revenues,income

and assets for the periodspresented above (dollars in thousands):

 
| ** **                                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                     | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| **REVENUES**                                                   |       |                             |       |   |   |
| Total revenues for reportable segments                         |       | $                                | 6,858      |   | $ | 6,856 |   |
| Other revenues                                                 |       | 49                               |       | 80 |   |
| Total consolidated revenues                                    |       | $                                | 6,907      |   | $ | 6,936 |   |
|                                                           |       |                             |       |   |   |
| **NET LOSS**                                                   |       |                             |       |   |   |
| NOI for reportable segments                                    |       | $                                | 3,985      |   | $ | 4,362 |   |
| Unallocated amounts:                                           |       |                             |       |   |   |
| Interest and other income                                      |       | 49                               |       | 80 |   |
| General and administrative expenses                            |       | (920                             | )          | (1,127 | ) |
| Depreciation and amortization                                  |       | (2,792                           | )          | (2,487 | ) |
| Interest expense                                               |       | (2,981                           | )          | (2,809 | ) |
| Net loss before minority interest and  discontinued operations |       | $                                | (2,659     | ) | $ | (1,981 | ) |

 

18

----

 
| ** **                                | ** ** | **March 31,** | ** ** |
|-------------------------------------------|------------|---------------|------------|
| ** **                                | ** ** | **2005**      | ** ** | **2004** | ** ** |
| **ASSETS**                                |       |          |       |   |   |
| Total assets for reportable segments      |       | $             | 167,056    |   | $ | 165,965 |   |
| Real estate held for sale                 |       | —        |       | 16,986 |   |
| Cash and cash equivalents                 |       | 1,727         |       | 566 |   |
| Tenant and other receivables, net         |       | 699           |       | 353 |   |
| Deferred rent receivable                  |       | 1,616         |       | 1,289 |   |
| Mortgage loan receivable, net of discount |       | —        |       | 1,678 |   |
| Insurance proceeds receivable             |       | —        |       | 6,500 |   |
| Investment in management company          |       | 4,000         |       | 4,000 |   |
| Prepaid and other assets, net             |       | 9,196         |       | 8,192 |   |
| Total consolidated assets                 |       | $             | 184,294    |   | $ | 205,529 |   |

 

# **NOTE 13.  COMMITMENTS AND CONTINGENCIES**

 

In connection withthe acquisition of an office property in 2004, the Company entered into anagreement with the seller in which the seller will participate in any profitsgenerated from the future sale of the property or, if demanded by the Companyor seller after the third anniversary date of the agreement, a sum determinedby the property’s fair market value at that time.

 

The Company has becomeaware that three of its properties may contain hazardous substances abovereportable levels.  The Company iscurrently evaluating this situation to determine an appropriate course ofaction.

 

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.

 

**NOTE 14.  SUBSEQUENTEVENT**

 

On April 6, 2005, theCompany refinanced a $4,574,000 loan on one of its office properties due tomature in November 2005 and entered into a fixed rate promissory note in theamount of $4,758,000 which bears interest at 5.51% per annum and matures in May2015.  No proceeds were generated from thisrefinance.

 

19

----

 

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

 

**OVERVIEW**

****ASR is a full-service real estate corporation, which owns,manages and operates income-producing properties.  Substantially all of the Company’s assets areheld through its Operating Partnership in which the Company, as of March 31,2005, held the sole general partner interest of .91% and a limited partnershipinterest totaling 86.60%.  As of March31, 2005, through its majority-owned subsidiary, the Operating Partnership, theCompany owned and operated 24 properties, which consisted of 18 officebuildings, three industrial properties, two shopping centers and one apartmentcomplex.  The 24 properties are locatedin seven states.

 

During the first threemonths of 2005, the Company sold one industrial property (“Sorrento I”) locatedin San Diego, California.  During 2004,the Company sold three properties, which consisted of one office building, anindustrial property and a parcel of undeveloped land, and acquired two officebuildings in Houston, Texas.   Most ofthe property sales are part of the Company’s strategy to sell its non-coreproperty types – apartment and shopping center properties – and to sell itsproperties located in the Midwest and Carolina’s, its non-core markets.  The Company will focus primarily on officeand industrial properties located in Texas, California and Arizona.

 

On March 31, 2005, theproperties owned by the Company were 87% occupied compared to 85% occupied onMarch 31, 2004.  Properties held forinvestment considered stabilized, not undergoing major redevelopment, were 88%occupied at March 31, 2005 and 2004, and properties under redevelopment were79% occupied at March 31, 2005 compared to 72% at March 31, 2004.  The Company continues to aggressively pursueprospective tenants to increase its occupancy, which is expected to improveoperational results.

In the accompanying consolidated statement of operations, the results ofoperations for the properties sold in 2004 and 2005 are shown in the section“Discontinued operations”.  The propertysold in 2005 is classified as “Real estate held for sale” on the December 31,2004 balance sheet.  Therefore therevenues and expenses reported for the periods presented reflect results fromproperties currently owned.

 

**CRITICALACCOUNTING POLICIES**

 

The major accountingpolicies followed by the Company are listed in Note 2 – Summary of SignificantAccounting Policies – of 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 rentpayments increase during the term of the lease. The Company records rental income for the full term of each lease on astraight-line basis.  Accordingly, areceivable, if deemed collectible, is recorded from tenants equal to the excessof the amount that would have been collected on a straight-line basis over theamount collected and currently due (Deferred Rent Receivable).  When a property is acquired, the term ofexisting leases is considered to commence as of the acquisition date forpurposes of this calculation.

 

•                  Manyof the Company’s leases provide for CommonArea Maintenance (“CAM”)/Escalations (“ESC”) as the additional tenant revenueamounts due to the Company in addition to base rent.  CAM/ESC represents increases in certainproperty operating expenses (as defined in each respective lease agreement)over the actual operating expense of the property in the base year.

 

20

----

 

Thebase year is stated in the lease agreement; typically, the year in which thelease commenced.  Generally, each tenantis responsible for his prorated share of increases in operating expenses. Tenantsare billed an estimated CAM/ESC charge based on the budgeted operating expensesfor the year.  Within 90 days after theend of each fiscal year, a reconciliation and true up billing of CAM/ESCcharges is performed based on actual operating expenses.

 

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

 

•                  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.

 

•                  Managementcontinues to consider whether it is in the best interest of the Company toelect to be treated as a real estate investment trust (or REIT), as definedunder the Internal Revenue Code of 1986, as amended.  The Company currently operates in a mannerthat will permit it to elect REIT status; however, the Company may enter intotransactions which could preclude it from electing REIT status in the future.  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.  AREIT typically is not subject to federal income taxation on its net income,provided applicable income tax requirements are satisfied.   For the tax year 2004, the Company was taxedas a C corporation.  It is anticipatedthat the Company will be taxed as a C corporation for the 2005 tax year.

# ** **

# **RESULTS OFOPERATIONS**

 

In accordance with generallyaccepted accounting principles, the operating results of the three propertiessold in 2004 and the one property sold in 2005 are reported as discontinuedoperations in the results of operations. See Note 4 – Discontinued Operations – of the Notes to ConsolidatedFinancial Statements.  Unless otherwiseindicated, the following discussion reflects the results from continuingoperations, which include the real estate assets held for investment.

 

***Discussion of the three months ended March 31, 2005 and 2004.***

 

The following table shows acomparison of rental revenues and certain expenses for the quarter ended March31:

 
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|--------------|------------|
| ** **                    | ** ** | **2005**   | ** ** | **2004**   | ** ** | **$**        | ** ** | **%** | ** ** |
| Rental revenue                |       | $          | 6,858,000  |       | $          | 6,856,000    |       | 2,000 |   | 0.3 | % |
| Operating expenses:           |       |       |       |       |       |         |       |   |   |
| Property operating expenses   |       | 2,873,000  |       | 2,494,000  |       | 379,000      |       | 15.2 | % |
| General and administrative    |       | 920,000    |       | 1,127,000  |       | (207,000     | )          | (18.4 | )% |
| Depreciation and amortization |       | 2,792,000  |       | 2,487,000  |       | 305,000      |       | 12.3 | % |
| Interest expense              |       | 2,981,000  |       | 2,809,000  |       | 172,000      |       | 6.1 | % |
|                               |            |            |            |            |            |              |            |  |  |  |  |

 

21

----

 

*Rentalrevenue*. Rentalrevenue was relatively unchanged for the three months ended March 31, 2005 incomparison to the three months ended March 31, 2004, increasing $2,000, or0.3%. This increase was attributable to $329,000 in revenue generated from twooffice properties acquired subsequent to the first quarter of 2004 offset by$327,000 in fewer revenues from properties owned on March 31, 2005 and March31, 2004 (“Same Properties”). This decrease in Same Properties revenue isprimarily due to a $196,000 payment received from the owner of a neighboringproperty for past use of common parking areas and $159,000 in lease buyoutsincurred at an office property in California in the first quarter of 2004.  Rental revenue from the acquired propertieswas included in the Company’s results since their respective dates ofacquisition.

 

*Propertyoperating expenses*.  The increase of $379,000, or 15.2% was dueprimarily to $208,000 in expenses related to the two acquired propertiesmentioned above.  In addition, realestate taxes rose due to an increase in the assessed values of severalproperties.  Also attributing to thisincrease were higher utility costs associated with increased occupancy.

 

*Generaland administrative*. The decrease of $207,000 was in large part due to a decrease incompensation expense of $87,000, primarily due to an overall downsizing ofcorporate management.  Further,non-recurring costs of $105,000 associated with the Company’s March 2004reverse stock split were included in the first quarter of 2004.

 

*Depreciationand amortization*.  The increase of $305,000 was related todepreciation of capital improvements and amortization of capitalized leasecosts incurred in 2005 and 2004 and also the depreciation related to the twoabove mentioned acquired properties. During the last two years, 2003 and 2004, the Company spentapproximately $8,295,000 in capital improvements on its existing properties,primarily for renovations and tenant improvements.

 

*Interest expense*.  The increase of $172,000 was dueto (i) higher interest expense and fees on increased debt on two of itsproperties, (ii) the interest expense associated with the two acquiredproperties mentioned above, and (iii) the Company recording interest at thedefault rate on debt related to one of its shopping center properties.

 

InJuly 2002, the lender under a loan agreement related to the South Carolinashopping center properties notified the Company it was technically in defaultunder its loan agreement for non-compliance with certain covenants, includingcovenants requiring improvements to shopping center properties.  Thereafter, the lender notified the Companythat it was in default for failure to pay a matured portion of the loan, whichmatured in November 2002.  In early 2003,the lender sold the loan to the major tenant in two of the shoppingcenters.  In December 2003, the Companysold one of the shopping center properties and repaid $3,935,000, whichincluded the pay-off of the matured portion of the loan.  As of March 31, 2005, the remaining balanceof the loan was approximately $2,756,000.  The Company continues to discuss the non-compliance matter with the newlender.  The new lender has notaccelerated the loan.

 

*Discontinuedoperations*.  TheCompany recorded a loss from operations of discontinued operations of $29,000for the three months ended March 31, 2005 related to Sorrento I, a 43,036square foot industrial property located in San Diego, California that was soldin March 2005. The Company recorded a loss from operations of discontinuedoperations of $107,000 for the quarter ended March 31, 2004 related to SorrentoI and the three properties sold during 2004. No properties were classified as held for sale as of March 31, 2005.  See Note 4 – Discontinued Operations – of theNotes to Consolidated Financial Statements.

 

The loss fromdiscontinued operations is summarized below.

 

**CondensedConsolidated Statements of Operations**

 
| ** **                            | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                            | ** ** | **March 31, 2005**     | ** ** | **March 31, 2004**     | ** ** |
| Rental revenue                        |       | —                 |       | $                      | 517        |   |
| Total expenses                        |       | $                      | 29         |                   | 624        |   |
| Net loss from discontinued operations |       | $                      | (29        | )                      | $          | (107 | ) |

 

22

----

 

*Gain on sale of discontinued operations*.   TheMarch 1, 2005 sale of Sorrento I generated a gain of $2,460,000.  Proceeds of approximately $3,169,000 werereceived as a result of the transaction. No properties were sold during the first quarter of 2004.

 

# **LIQUIDITY ANDCAPITAL RESOURCES**

 

During first three monthsof 2005, the Company derived cash from collection of rents and the sale ofSorrento I.  Major uses of cash includedpayment for capital improvements to real estate assets, primarily for tenantimprovements, payment of operational expenses and repayment of borrowings.

 

The Company reported anet loss of $199,000 for the three months ended March 31, 2005 compared to anet loss of $1,825,000 for the three months ended March 31, 2004.  These results include the following non-cashitems:

 
| ** **                                                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                          | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| Non-Cash Charges:                                                   |       |                              |       |   |   |
| Depreciation and amortization from real  estate held for investment |       | $                                 | 2,792      |   | $ | 2,487 |   |
| Deferred compensation expense                                       |       | 19                                |       | 28 |   |
| Non-Cash Items:                                                     |       |                              |       |   |   |
| Deferred rental income                                              |       | (50                               | )          | (250 | ) |
| Minority interest                                                   |       | (29                               | )          | (263 | ) |
| Interest on receivable from principal  stockholders                 |       | (13                               | )          | (18 | ) |
| Amortization of loan premiums                                       |       | (114                              | )          | (133 | ) |
| Amortization of note receivable discount                            |       | —                            |       | (25 | ) |
| Mark-to-market adjustments on interest rate  protection agreements  |       | —                            |       | (10 | ) |
|                                                                     |            |                                   |            |  |  |  |  |

 

Netcash provided by investing activities for three months ended March 31, 2005amounted to $3,746,000.  This amount wasprimarily attributable proceeds received from the sale of Sorrento I during theperiod.    Funds were used for capitalexpenditures, primarily for tenant improvements.  Net cash used in investing activities for thethree months ended March 31, 2004 was $2,376,000 primarily attributable to thefunding of capital expenditures of $2,390,000.

 

Net cash used byfinancing activities amounted to $2,324,000 for the three months ended March 31,2005.  In March 2005, borrowings of$1,574,000 were paid in connection with the sale of Sorrento I.  Scheduled principal payments for the quarterMarch 31, 2005 amounted to $693,000.  InFebruary 2005, the Company refinanced two loans of $1,684,000 and $701,250 onone of its office properties due to mature in July 2005 and November 2006 andentered into a fixed rate note in the amount of $2,350,000 which bears interestat 5.59% per annum and matures in February 2015.  Net cash used in financing activities of$757,000 for the three months ended March 31, 2004 consisted of scheduledprincipal payments on debt.

 

In December 2004, theCompany received a $532,000 loan from John N. Galardi.  The note bore interest at a fixed interestrate of 12% per annum.  The loan was paidin April 2005.

 

In October 2004, inconnection with the acquisition of an office property in Houston, Texas, theCompany assumed a loan in the amount of $4,384,000.  The loan bears interest at a fixed rate of5.93% per annum and matures in June 2014. The Company also entered into an agreement that provided for sellerfinancing of $316,000, bearing interest at a fixed rate of 5.93% per annum andmaturing in June 2014.

 

In October 2004, theCompany refinanced a $1,176,000 loan on 888 Sam Houston Parkway, one of itsoffice properties, and entered into a revolving credit promissory note in theamount of $2,250,000, of which $1,226,000 has been drawn to cover the repaymentof existing debt and financing costs. The availability on the note as of March 31, 2005 and December 31, 2004was $1,024,000.  The note bears interestat prime plus 1% per annum and matures in November 2006.

 

In August 2004, theCompany refinanced a $5,350,000 loan on San Felipe, one of its officeproperties with a new loan agreement in the amount of $5,500,000.  The new loan bears interest at a fixed rateof 5.65%

 

23

----

 

per annum and matures inAugust 2014.  The Company funded closingcosts of approximately $178,000 and escrowed $327,000 for future capitalexpenditures, real estate taxes and insurance related to the August 2004refinance.  Net proceeds of $2,059,000were received in December 2003 related to the December 2003 refinance of theoriginal $3,000,000 loan on the property.

 

In July 2004, the Companyrefinanced a $5,330,000 loan on Northwest Corporate Center, one of its officeproperties, with a new loan agreement in the amount of $5,750,000.  The new loan bears interest at a fixed rate of6.26% per annum and matures in August 2014. No proceeds were received directly as a result of the refinance, however$350,000 is being held in escrow by the lender to assist the funding of futurecapital expenditures at the property.

 

In May 2004, the Companyrefinanced a $3,132,000 loan on Mira Mesa, one of its office properties, with anew one-year loan agreement in the amount of $7,500,000.  The new loan, which contains two six-monthextension options, bears interest at a fixed rate of 7.95% per annum.

 

In May 2004, the Companyfinanced insurance premiums of $373,000 on its properties and agreed to pay aservice fee of $85,000 over one year.

 

The Company expects tomeet its short-term liquidity requirements for normal property operatingexpenses and general and administrative expenses from cash generated byoperations and cash currently held.  Inaddition, the Company anticipates capital costs to be incurred related tore-leasing space and improvements to properties, state income taxes and otherfees for professional services.  Thefunds to meet these obligations will be obtained from proceeds of the sale ofassets, refinancing activity and the use of lender held funds.  Based on current analysis, the Companybelieves that the cash generated by these anticipated activities will beadequate to meet these obligations. There can be no assurance, however, that these activities will occur andthat substantial cash will be generated. If these activities do not occur, the Company will not have sufficientcash to meet its obligations if all leasing projections are met.

 

In addition, as of March31, 2005, the Company has substantial debt becoming due in 2005 and 2006.  Based on the Company’s historical losses andcurrent debt level, there can be no assurances as to the Company’s ability toobtain funds necessary for the refinancing of these maturing debts.  If refinancing transactions are notconsummated, the Company will seek extensions and/or modifications from theexisting lenders.  If these refinancingsdo not occur, the Company will not have sufficient cash to meet itsobligations.

 

**CONTRACTUALOBLIGATIONS AND COMMITMENTS**

 

The following tableaggregates the Company’s contractual obligations subsequent to March 31, 2005(dollars in thousands):

 
| ** **                     | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Long-term debt (1) (2)         |       | $        | 15,318     |     | $          | 9,673    |       | $        | 1,763      |     | $          | 5,099          |       | $         | 8,552      |   | $ | 106,102 |   | $ | 146,507 |   |
| Litigation settlement (3)      |       | —   |       | 9,512    |       | —   |       | —   |       | —   |       | —         |       | 9,512     |       |
| Capital lease expenditures (4) |       | 1,671    |       | —   |       | —   |       | —   |       | —   |       | —         |       | 1,671     |       |
| Employee obligations (5)       |       | 117      |       | —   |       | —   |       | —   |       | —   |       | —         |       | 117       |       |
| Total                          |       | $        | 17,106     |     | $          | 19,185   |       | $        | 1,763      |     | $          | 5,099          |       | $         | 8,552      |   | $ | 106,102 |   | $ | 157,807 |   |

 

----

(1)   See Note 6 – Notes Payable – in theaccompanying consolidated financial statements of the Company.  These amounts do not include interestassociated with the debt.

(2)   2005 includes debt of $7,500,000 with two6-month extension options to May 2006; debt of $532,000 paid in April 2005; anddebt of $4,574,000 refinanced in April 2005 with a new $4,758,000 loan maturingin May 2015.

(3)   Represents obligations related to thesettlement of the Teachout litigation. See Note 7 – Notes Payable, Litigation Settlement – in the accompanyingconsolidated financial statements of the Company.

(4)   Represents commitments for tenantimprovements and lease commissions related to the leasing of space to new orrenewing tenants.

(5)   Represents employment agreement commitmentsfor officers of the Company.

 

24

----

 

**INFLATION**

 

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

 

**FORWARD-LOOKINGSTATEMENTS**

 

This Report onForm 10-Q contains forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities and ExchangeAct of 1934.  These forward-lookingstatements are based on management’s beliefs and expectations, which may not becorrect.  Important factors that couldcause actual results to differ materially from the expectations reflected inthese forward-looking statements include the following: the Company’s level ofindebtedness and ability to refinance its debt; the fact that the Company’spredecessors have had a history of losses in the past; unforeseen liabilitieswhich could arise as a result of the prior operations of companies acquired inthe 2001 consolidation transaction; risks inherent in the Company’s acquisitionand development of properties in the future, including risks associated withthe Company’s strategy of investing in under-valued assets; general economic,business and market conditions, including the impact of the current economicdownturn; changes in federal and local laws, and regulations; increasedcompetitive pressures; and other factors, including the factors set forthbelow, as well as factors set forth elsewhere in this Report on Form 10-Q.

 

**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.

 

**ITEM3.  QUANTITATIVE AND QUALITATIVE****DISCLOSURE ABOUT MARKET RISK**

 

**INTERESTRATES**

 

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

 

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

 

At March 31, 2005, theCompany’s total indebtedness included fixed-rate debt of approximately$153,140,000 and floating-rate indebtedness of approximately $5,119,000. 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 materialmarket-sensitive financial 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 $51,190, or $0.03 pershare, based upon the balances outstanding on variable rate instruments atMarch 31, 2005.

 

25

----

 

**ITEM4.  CONTROLS AND PROCEDURES**

 

Management, including theCompany’s Chief Executive Officer and Acting Chief Financial Officer, haveevaluated the effectiveness of the Company’s disclosure controls and proceduresas of the end of the quarter covered by this report.  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 nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of theevaluation referred to above.

 

**PARTII.  OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS**

 

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

 

 

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

 

(a)  Exhibits:

 

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

 

(b)  Reports on Form 8-K:

 

On April 4, 2005, areport on Form 8-K was filed with respect to Item 8.01.

On March 21, 2005, areport on Form 8-K was filed with respect to Item 2.02

 

26

----

 

**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 9, 2005* | * * |
|---------------------|----------|
| * *            | By:      | */s/ William J. Carden* |   |
| * *            |     | William J. Carden |
|                |     | Chairman of the Board, President, |
|                |     | Chief Executive Officer and  Acting |
|                |     | Chief Financial Officer |
|                |     |
| *Date: May 9, 2005* | * * |
| * *            | By:      | */s/ Patricia A. Nooney* |   |
| * *            |     | Patricia A. Nooney |
|                |     | Senior Vice President and Director of Accounting |
|                |     | (Principal Accounting  Officer) |
|                     |          |  |  |  |

 

27

----

 

**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Exhibit Title**                                                                                                       |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                    |
| 31              |       | Certification pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                |
|            |       |                                                                                                                    |
| 32              |       | Certification pursuant to  18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|            |       |                                                                                                                    |

 

28

----