** **

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

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-Q**

 

**(Mark One)**
| **ý********QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|------------------------------------------------------------------------------------------------------------|

 

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

** **

**OR**

 
| **o********TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|--------------------------------------------------------------------------------------------------------|

*** ***

**COMMISSION FILE NUMBER 001-16785**

 

**AmericanSpectrum Realty, Inc.**

(Exactname of Registrant as specified in its charter)

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

 

Securitiesregistered under Section 12(b) of the Act:

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

 

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

 

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

 

As of August 9, 2002,5,536,990 shares of Common Stock ($.01 par value) were outstanding.

 

 

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**TABLE OF CONTENTS**

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

 

2

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**PARTI.  FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIALSTATEMENTS**

 

**AMERICAN SPECTRUM REALTY, INC.**

**CONSOLIDATEDBALANCE SHEETS**

(Dollarsin thousands, except share and per share amounts) 

 
|                                                                                                                                 |   | **June 30, 2002** |    | **December 31, 2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|-----------------------|--------|
|                                                                                                                                 |   | **(Unaudited)**   |    |                  |   |
|                                                                                                                                 |   |              |    |                  |   |
| **ASSETS**                                                                                                                           |   |              |    |                  |   |
|                                                                                                                                 |   |              |    |                  |   |
| Real estate held for investment                                                                                                      |   | $                 | 266,830 |                  | $      | 254,679 |   |
| Accumulated depreciation and valuation  allowance                                                                                    |   | 10,666            |    | 5,172                 |   |
| Real estate held for investment, net                                                                                                 |   | 256,164           |    | 249,507               |   |
|                                                                                                                                 |   |              |    |                  |   |
| Cash and cash equivalents                                                                                                            |   | 1,908             |    | 2,284                 |   |
| Tenant and other receivables, net of  allowance for doubtful accounts of $519 and $234, respectively                                 |   | 934               |    | 1,378                 |   |
| Deferred rents receivable                                                                                                            |   | 420               |    | 149                   |   |
| Mortgage loan receivable                                                                                                             |   | 1,100             |    | —                |   |
| Deposits held in escrow                                                                                                              |   | —            |    | 1,956                 |   |
| Investment in management company                                                                                                     |   | 4,000             |    | 4,000                 |   |
| Prepaid and other assets, net                                                                                                        |   | 8,668             |    | 6,931                 |   |
|                                                                                                                                 |   |              |    |                  |   |
| Total Assets                                                                                                                         |   | $                 | 273,194 |                  | $      | 266,205 |   |
|                                                                                                                                 |   |              |    |                  |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                        |   |              |    |                  |   |
|                                                                                                                                 |   |              |    |                  |   |
| Liabilities:                                                                                                                         |   |              |    |                  |   |
| Notes payable, net of premiums of $4,361  and $4,829, respectively (including $2,799 and $2,802, respectively, to  related parties)  |   | $                 | 192,416 |                  | $      | 176,915 |   |
| Notes payable to former limited partners                                                                                             |   | 428               |    | 2,292                 |   |
| Accounts payable                                                                                                                     |   | 1,769             |    | 3,203                 |   |
| Deferred gain on disposition of property                                                                                             |   | —            |    | 232                   |   |
| Accrued and other liabilities (including  $2,803 and $3,394, respectively, to related parties)                                       |   | 18,337            |    | 18,510                |   |
|                                                                                                                                 |   |              |    |                  |   |
| Total Liabilities                                                                                                                    |   | 212,950           |    | 201,152               |   |
|                                                                                                                                 |   |              |    |                  |   |
| Minority Interests:                                                                                                                  |   |              |    |                  |   |
| Unit holders in the operating partnership                                                                                            |   | 10,001            |    | 10,616                |   |
| Partially owned property                                                                                                             |   | 1,031             |    | 1,033                 |   |
| Total minority interests                                                                                                             |   | 11,032            |    | 11,649                |   |
|                                                                                                                                 |   |              |    |                  |   |
| Commitments and Contingencies:                                                                                                       |   |              |    |                  |   |
|                                                                                                                                 |   |              |    |                  |   |
| Redeemable Common Stock                                                                                                              |   | 300               |    | 300                   |   |
|                                                                                                                                 |   |              |    |                  |   |
| Stockholders’ equity:                                                                                                           |   |              |    |                  |   |
|                                                                                                                                 |   |              |    |                  |   |
| Preferred stock, $.01 par value;  authorized, 25,000,000 shares, none issued and outstanding                                         |   | —            |    | —                |   |
| Common stock, $.01 par value; authorized,  100,000,000 shares; issued and outstanding, 5,536,990 and 5,529,190 shares,  respectively |   | 55                |    | 55                    |   |
| Additional paid-in capital                                                                                                           |   | 55,448            |    | 56,502                |   |
| Accumulated deficit                                                                                                                  |   | (5,621            | )       | (2,038                | )      |
| Deferred compensation                                                                                                                |   | (970              | )       | (1,415                | )      |
|                                                                                                                                 |   |              |    |                  |   |
| Total stockholders’ equity                                                                                                      |   | 48,912            |    | 53,104                |   |
|                                                                                                                                 |   |              |    |                  |   |
| Total Liabilities and Stockholders’ equity                                                                                      |   | $                 | 273,194 |                  | $      | 266,205 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

3

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**AMERICAN SPECTRUMREALTY, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

(Unaudited)

** **
|                                                          |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|---------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                          |   | **2002**                        |   | **2001**                      |   | **2002** |   | **2001** |   |
| **REVENUES:**                                                 |   |                            |   |                          |   |   |   |   |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Rental revenue                                                |   | $                               | 10,283 |                          | $      | 165 |   | $ | 20,159 |   | $ | 331 |   |
| Interest and other income                                     |   | 72                              |   | 44                            |   | 151 |   | 87 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Total revenues                                                |   | 10,355                          |   | 209                           |   | 20,310 |   | 418 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| **EXPENSES:**                                                 |   |                            |   |                          |   |   |   |   |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Property operating expense                                    |   | 3,607                           |   | 58                            |   | 7,167 |   | 117 |   |
| General and administrative                                    |   | 1,812                           |   | 57                            |   | 4,229 |   | 151 |   |
| Depreciation and amortization                                 |   | 2,872                           |   | 54                            |   | 5,854 |   | 101 |   |
| Interest expense                                              |   | 3,740                           |   | 31                            |   | 7,077 |   | 63 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Total expenses                                                |   | 12,031                          |   | 200                           |   | 24,327 |   | 432 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| **OTHER INCOME:**                                             |   |                            |   |                          |   |   |   |   |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Net gain on sales of real estate assets                       |   | 84                              |   | —                        |   | 84 |   | — |   |
| Income from investment in unconsolidated  joint venture       |   | —                          |   | 230                           |   | — |   | 210 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Total other income                                            |   | 84                              |   | 230                           |   | 84 |   | 210 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Minority Interests:                                           |   |                            |   |                          |   |   |   |   |   |
| Unit holders in the operating partnership                     |   | 194                             |   | —                        |   | 470 |   | — |   |
| Partially owned property                                      |   | (31                             | )      | —                        |   | (67 | ) | — |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Total minority interests                                      |   | 163                             |   | —                        |   | 403 |   | — |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Net (loss) income before extraordinary item                   |   | (1,429                          | )      | 239                           |   | (3,530 | ) | 196 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Extraordinary item – net loss on extinguishment  of debt |   | (53                             | )      | —                        |   | (53 | ) | — |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Net (loss) income                                             |   | $                               | (1,482 | )                             | $      | 239 |   | $ | (3,583 | ) | $ | 196 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Basic per share data:                                         |   |                            |   |                          |   |   |   |   |   |
| Net loss before extraordinary item                            |   | $                               | (.26   | )                             | $      | — |   | $ | (.64 | ) | $ | — |   |
| Extraordinary item – net loss on  extinguishment of debt |   | (.01                            | )      | —                        |   | (.01 | ) | — |   |
| Net loss                                                      |   | $                               | (.27   | )                             | $      | — |   | $ | (.65 | ) | $ | — |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Per unit data:                                                |   |                            |   |                          |   |   |   |   |   |
| Limited partner income per unit                               |   | $                               | N/A    |                          | $      | 3.07 |   | $ | N/A |   | $ | 2.52 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Basic weighted average shares used                            |   | 5,535,591                       |   | —                        |   | 5,531,705 |   | — |   |
| Limited partnership units outstanding                         |   | N/A                             |   | 77,000                        |   | N/A |   | 77,000 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

4

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**AMERICAN SPECTRUMREALTY, INC.**

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’EQUITY**

(Dollars in thousands)

(Unaudited)

 
|                                  |   | **Common  Stock** |   | **Additional  Paid-In  Capital** |   | **Accumulated  Deficit** |   | **Deferred  Compensation** |   | **Treasury  Stock** |   | **Total  Equity** |   |
|---------------------------------------|--------|-------------------|--------|----------------------------------|--------|--------------------------|--------|----------------------------|--------|---------------------|--------|-------------------|--------|
|                                  |   |              |   |                             |   |                     |   |                       |   |                |   |              |   |
| Balance, December 31, 2001 (audited)  |   | $                 | 55     |                             | $      | 56,502                   |   | $                          | (2,038 | )                   | $      | (1,415            | )      | — |   | $ | 53,104 |   |
| Issuance of common stock to officer   |   | —            |   | 70                               |   | —                   |   | (70                        | )      | —              |   | —            |   |
| Common stock repurchases              |   | —            |   | (14                              | )      | —                   |   | —                     |   | $                   | 14     |              | — |   |
| Retirement of common stock            |   | —            |   | —                           |   | —                   |   | —                     |   | (14                 | )      | (14               | )      |
| Amortization of deferred compensation |   | —            |   | —                           |   | —                   |   | 515                        |   | —              |   | 515               |   |
| Dividends paid to common stockholders |   | —            |   | (1,110                           | )      | —                   |   | —                     |   | —              |   | (1,110            | )      |
| Net loss                              |   | —            |   | —                           |   | (3,583                   | )      | —                     |   | —              |   | (3,583            | )      |
|                                  |   |              |   |                             |   |                     |   |                       |   |                |   |              |   |
| Balance, June 30, 2002                |   | $                 | 55     |                             | $      | 55,448                   |   | $                          | (5,621 | )                   | $      | (970              | )      | $ | — |   | $ | 48,912 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

5

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**AMERICAN SPECTRUM REALTY, INC**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(Dollarsin thousands)

(Unaudited)

 
|                                                                                  |   | **For the Six Months Ended June 30,** |   |
|---------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                  |   | **2002**                              |   | **2001** |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                             |   |                                  |   |   |   |
| Net (loss) income                                                                     |   | $                                     | (3,583 | ) | $ | 196 |   |
| Adjustments to reconcile net (loss) income  to net cash used in operating activities: |   |                                  |   |   |   |
| Depreciation and amortization                                                         |   | 5,854                                 |   | 102 |   |
| Extraordinary net loss on extinguishments  of debt                                    |   | 53                                    |   | — |   |
| Net gain on sales of real estate assets                                               |   | (84                                   | )      | — |   |
| Income from investment in unconsolidated  joint venture                               |   | —                                |   | (210 | ) |
| Minority interest                                                                     |   | (403                                  | )      | — |   |
| Deferred compensation expense                                                         |   | 515                                   |   | — |   |
| Deferred rental income                                                                |   | (271                                  | )      | (2 | ) |
| Amortization of loan premiums, included in  interest expense                          |   | (337                                  | )      | — |   |
| Changes in operating assets and  liabilities:                                         |   |                                  |   |   |   |
| Decrease (increase) in tenant and other  receivables                                  |   | 652                                   |   | (22 | ) |
| Increase in prepaid and other assets                                                  |   | (1,937                                | )      | (41 | ) |
| Decrease in accounts payable                                                          |   | (1,434                                | )      | (5 | ) |
| Decrease in accrued and other liabilities                                             |   | (413                                  | )      | (114 | ) |
|                                                                                  |   |                                  |   |   |   |
| Net cash used in operating activities:                                                |   | (1,388                                | )      | (96 | ) |
|                                                                                  |   |                                  |   |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                             |   |                                  |   |   |   |
| Capital  improvements to real estate assets                                           |   | (2,217                                | )      | (38 | ) |
| Proceeds received from sale of real estate  asset                                     |   | 59                                    |   | — |   |
| Contributions to minority owner of  partially owned property                          |   | (69                                   | )      | — |   |
| Distributions  from unconsolidated joint venture                                      |   | —                                |   | 334 |   |
|                                                                                  |   |                                  |   |   |   |
| Net cash (used in) provided by investing  activities:                                 |   | (2,227                                | )      | 296 |   |
|                                                                                  |   |                                  |   |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                             |   |                                  |   |   |   |
| Proceeds from borrowings                                                              |   | 21,773                                |   | — |   |
| Repayment of borrowings                                                               |   | (15,409                               | )      | (9 | ) |
| Note payments to former limited partners                                              |   | (1,864                                | )      | — |   |
| Collection of advances to affiliate                                                   |   | 8                                     |   | — |   |
| Advances to affiliate                                                                 |   | —                                |   | (191 | ) |
| Dividends to common stockholders                                                      |   | (1,110                                | )      | — |   |
| Distributions to unitholders in the  operating partnership                            |   | (145                                  | )      | — |   |
| Repurchase of common stock                                                            |   | (14                                   | )      | — |   |
|                                                                                  |   |                                  |   |   |   |
| Net cash provided by (used in) financing  activities:                                 |   | 3,239                                 |   | (200 | ) |
|                                                                                  |   |                                  |   |   |   |
| Decrease in cash                                                                      |   | (376                                  | )      | — |   |
|                                                                                  |   |                                  |   |   |   |
| Cash, beginning of period                                                             |   | 2,284                                 |   | 34 |   |
|                                                                                  |   |                                  |   |   |   |
| Cash, end of period                                                                   |   | $                                     | 1,908  |   | $ | 34 |   |
|                                                                                  |   |                                  |   |   |   |
| **SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:**                               |   |                                  |   |   |   |
| Cash paid for interest                                                                |   | $                                     | 6,435  |   | $ | 63 |   |
|                                                                                  |   |                                  |   |   |   |
| **SUPPLEMENTAL DISCLOSURES OF NON-CASH  INVESTING AND FINANCING ACTIVITIES:**         |   |                                  |   |   |   |
|                                                                                  |   |                                  |   |   |   |
| Assumption of mortgage loans in  acquisitions of real estate assets                   |   | $                                     | 8,650  |   | $ | — |   |
|                                                                                  |   |                                  |   |   |   |
| Seller financing of acquired real estate  assets                                      |   | $                                     | 955    |   | $ | — |   |
|                                                                                  |   |                                  |   |   |   |
| Trust deed note receivable from disposition  of real estate asset                     |   | $                                     | 1,100  |   | $ | — |   |
|                                                                                       |        |                                       |        |  |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

6

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**AMERICAN SPECTRUM REALTY, INC.**

### **Notesto Consolidated Financial Statements**

 

**NOTE1.  DESCRIPTION OF BUSINESS**

 

# **GENERAL**

American SpectrumRealty, Inc. (“ASR” or the “Company”) is a Maryland corporation established onAugust 8, 2000.  The Company is afull-service real estate corporation, which owns, manages and operatesincome-producing properties.  As of June30, 2002, through its majority-owned subsidiary, American Spectrum RealtyOperating Partnership, L.P. (the “Operating Partnership”), the Company ownedand operated 34 properties which consisted of 14 office, 11 office/warehouse,four shopping center, and four apartment properties, and one developmental landproperty. The properties are located in four geographic regions in ninestates.  The Company plans to expand itsbusiness and net assets by acquiring additional properties.  The Company will focus primarily on officeand office/warehouse properties located in Texas, California, Arizona and theMidwest.

 

The structure ofthe Company is generally referred to as an “UPREIT” structure.  Substantially all of the Company’s assetsare held through the Operating Partnership. The Company is the sole generalpartner of the Operating Partnership. As the sole general partner of the Operating Partnership, the Companygenerally has the exclusive power under the Partnership Agreement to manage andconduct the business of the Operating Partnership. The Company’s interest inthe Operating Partnership entitles it to share in cash distributions from, andin profits and losses of, the Operating Partnership.  Holders of limited partnership units in the Operating Partnership(“OP Units”) have the same rights to distributions as holders of Common Stockin the Company.  Most of the propertieswill be owned by the Operating Partnership through subsidiary limitedpartnerships or limited liability companies.

 

At June 30, 2002, the Company held a 1% general partner interest and an87.4% limited partner interest in the Operating Partnership.  Holders of the OP Units have the option toredeem their units and to receive, at the option of the Company, in exchangefor each OP Unit (i) one share of Common Stock of the Company, or (ii) cashequal to the fair market value of one share of Common Stock of the Company atthe date of conversion.  As of June 30,2002, the Operating Partnership, directly and through the subsidiaries in whichit and the Company own 100% of the ownership interests, owns a portfolio of 34real estate properties.

 

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

 

**CONSOLIDATIONTRANSACTION**

On October 19, 2001, theCompany was the legal acquirer and registrant in a consolidation transaction(the “Consolidation”).  Pursuant to theConsolidation, subsidiaries of the Company merged with eight public limitedpartnerships, acquired the assets and liabilities of two private entitiesmanaged by CGS Real Estate Company, Inc. (“CGS”) and its affiliates andacquired certain assets and liabilities of CGS and its majority-ownedaffiliates.  The accounting acquirer inthe Consolidation was Sierra Pacific Pension Investors `84 (“SPPI84”), one ofthe eight public limited partnerships. SPPI84’s activities have involved the ownership and operation of tworeal estate properties in Arizona: Sierra Spectrum in Phoenix, Arizona and Sierra Valencia in Tucson,Arizona.  Pursuant to the Consolidation,partners of the public partnerships received shares in the Company orpromissory notes in exchange for their partnership units and owners of existingrelated entities exchanged ownership interests in real estate for ASR shares orunits in the Operating Partnership, an entity formed for this purpose andinitially wholly owned by the Company.  Prior to October 19, 2001, the Company was a wholly owned subsidiary ofCGS.

 

7

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

 

| **Condensed  Combined Statements  of Operations** |   | **Six Months Ended  June 30, 2001** |   | **Three Months Ended  June 30, 2001** |   |
|--------------------------------------------------------|--------|-------------------------------------|--------|---------------------------------------|--------|
|                                                   |   |                                |   |                                  |   |
| Total revenues                                         |   | $                                   | 12,682 |                                  | $      | 6,541 |   |
| Operating expenses                                     |   | 10,201                              |   | 5,998                                 |   |
| Depreciation and amortization                          |   | 2,132                               |   | 966                                   |   |
| Interest expense                                       |   | 6,445                               |   | 3,474                                 |   |
| Equity in income of uncombined partnerships            |   | 54                                  |   | 61                                    |   |
| Gain on sale of property                               |   | 100                                 |   | —                                |   |
| Minority interest                                      |   | 193                                 |   | 207                                   |   |
| Net loss                                               |   | $                                   | (6,135 | )                                     | $      | (4,043 | ) |

 

 

| **Condensed  Combined Statements of Cash Flows** |   | **Six Months Ended  June 30, 2001** |   | **Three Months Ended  June 30, 2001** |   |
|--------------------------------------------------|--------|-------------------------------------|--------|---------------------------------------|--------|
|                                             |   |                                |   |                                  |   |
| Cash flows provided by (used in):                |   |                                |   |                                  |   |
| Operating activities                             |   | $                                   | (7,064 | )                                     | $      | (6,687 | ) |
| Investing activities                             |   | (1,160                              | )      | (924                                  | )      |
| Financing activities                             |   | 7,791                               |   | 7,614                                 |   |
| (Decrease) increase in cash                      |   | (433                                | )      | 3                                     |   |
| Cash, beginning of period                        |   | 1,787                               |   | 1,351                                 |   |
| Cash, end of period                              |   | $                                   | 1,354  |                                  | $      | 1,354 |   |

 

It is suggested thatthese condensed combined financial statements be read in conjunction with thecombined financial statements for the period January 1 to October 19, 2001 andthe related notes thereto included in the Company’s 2001 Annual Report on Form10-K filed with the Securities and Exchange Commission (the “SEC”).

 

**NOTE2.  SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

**BASIS OFPRESENTATION**

The accompanying unauditedconsolidated financial statements have been prepared pursuant to the rules andregulations of the SEC.  In the opinionof the Company, the accompanying interim unaudited consolidated financialstatements contain all material adjustments, consisting only of normalrecurring adjustments necessary to present fairly the financial condition, theresults of operations and changes in cash flows of the Company and itssubsidiaries for interim periods.

 

The results for such interimperiods are not necessarily indicative of results for a full year.  It is suggested that these consolidatedfinancial statements be read in conjunction with the consolidated financialstatements for the year ended December 31, 2001 and the related notes theretoincluded in the Company’s 2001 Annual Report on Form 10-K filed with the SEC.

 

As discussedin Note 1, the accounting acquirer in the Consolidation was SPPI84.  As such, the consolidated statement ofoperations and cash flows for the six months and three months ended June 30,2001 reflects the results of operations and cash flows of SPPI84.

 

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

 

**RECLASSIFICATION**

Certain prior year balanceshave been reclassified to conform with the current year presentation.

 

**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

 

8

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amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the results of operations during the reportingperiod.  Actual results could materiallydiffer from those estimates.

 

**NEWACCOUNTING PRONOUNCEMENTS**

In June 2001, FASB issued SFAS No. 141, whichsupercedes APB 16, “Business Combinations”, which is effective for businesscombinations initiated after June 30, 2001. SFAS 141 requires all business combinations to be accounted for underthe purchase method and that the pooling-of-interest method is no longerallowed.  The Company accounted for theConsolidation under the purchase method.

 

In June 2001, FASB issued SFAS No. 142, “Goodwill andOther Intangible Assets”, which is effective for fiscal years beginning afterDecember 15, 2001.  SFAS 142 requires,among other things, that goodwill no longer be amortized to earnings, butinstead be reviewed for impairment.  Theadoption of SFAS No. 142 did not have a material impact on the Company’sconsolidated financial position or results of operations.

 

In June 2001, FASB issued SFAS No. 143, “Accountingfor Asset Retirement Obligations”.  SFAS143 addresses financial accounting and reporting obligations associated withthe retirement of tangible long-lived assets and the associated assetretirement costs.  The provisions ofSFAS 143 are required to be applied starting with fiscal years beginning afterJune 15, 2002.  The Company believes theadoption of the provisions of SFAS 143 will not have a significant effect onits consolidated financial position or results of operations.

 

InAugust 2001, FASB issued SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets”, which addresses financial accounting andreporting for the impairment or disposal of long-lived assets.  SFAS 144 supersedes SFAS No. 121,“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto Be Disposed Of”.  SFAS 144 will beeffective for the Company beginning January 1, 2002, the first day of its 2002fiscal year.  The adoption of SFAS No.144 did not have a material impact on the Company’s consolidated financialposition or results of operations.

 

In April 2002, FASB issued SFASNo. 145, “Rescission of FASB No. 4, 44, and 62, Amendment of FASB No. 13, andTechnical Corrections” (“FAS 145”).  Inmost instances, FAS 145 will require gains and losses on extinguishments ofdebt to be classified as income or loss from continuing operations rather thanas extraordinary items as previously required under FASB Statement No. 4,Reporting Gains and Losses from Extinguishment of Debt (“FAS 4”).  This provision of FAS 145 is effective forfiscal years beginning after May 15, 2002, with early applicationencouraged.  Upon application, any gainor loss on extinguishments of debt previously classified as an extraordinaryitem in prior periods presented that does not meet the criteria of Opinion 30for such classifications should be reclassified to conform to the provisions ofFAS 145.  Earlier application of theprovisions of FAS 145 related to the rescission of FAS 4 is encouraged.  The Company will adopt FAS 145 in the thirdquarter of 2002.

 

**REALESTATE**

Rental properties are statedat cost, net of accumulated depreciation, unless circumstances indicate thatcost, net of accumulated depreciation, cannot be recovered, in which case, thecarrying value of the property is reduced to estimated fair value.  Estimated fair value: (i) is based upon theCompany’s plans for the continued operation of each property; and (ii) iscomputed using estimated sales price, as determined by prevailing market valuesfor comparable properties and/or the use of capitalization rates multiplied byannualized net operating income based upon the age, construction and use of thebuilding.  The fulfillment of theCompany’s plans related to each of its properties is dependent upon, amongother things, the presence of economic conditions which will enable the Companyto continue to hold and operate the properties prior to their eventualsale.  Due to uncertainties inherent inthe valuation process and in the economy, it is reasonably possible that theactual results of operating and disposing of the Company’s properties could bematerially different than current expectations.

 

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

 

9

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

 

**CASHEQUIVALENTS**

Cash equivalents areconsidered to be all highly liquid investments with a maturity of three monthsor less at the date of purchase.

 

**FAIR VALUEOF FINANCIAL INSTRUMENTS**

The Company’s financialinstruments consist of cash and cash equivalents, escrow deposits, tenant andother receivables, mortgage loan receivable, notes payable, accounts payableand accrued expenses.  The Company hasentered into interest rate swap agreements in notional amounts totaling$21,800,000 to manage its interest rate risk. The agreements effectively fix the interest rate at 2.68% plus theapplicable variable rate margin (5.68% at June 30, 2002).  Management believes that the carrying valueof the Company’s financial instruments approximate their respective fair marketvalues at June 30, 2002 and December 31, 2001.

 

**DERIVATIVEFINANCIAL INSTRUMENTS**

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

 

The Company uses interestrate swaps to hedge against fluctuations in interest rates on specificborrowings.  The interest rate swapcontracts are reflected at fair value in the Company’s balance sheet and thechanges in the fair value of the hedge are recognized as adjustments tointerest expense.  During the six monthsended June 30, 2002, the Company recorded a charge of approximately $89,000attributable to changes in the fair value of its derivatives financialinstruments.  The Company’s objective isto minimize the risk of fluctuations using the most effective methods toeliminate or reduce the impact of this exposure.

 

**DEFERREDFINANCING AND OTHER FEES**

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

 

**STOCK-BASEDCOMPENSATION**

The Financial AccountingStandards Board issued SFAS No. 123, “Accounting for Stock-Based Compensation”in October 1995.  This standardestablishes a fair value approach to valuing stock options awarded to employeesas compensation.  The Company haselected, as permitted by the standard to use the intrinsic value based methodof accounting for stock options consistent with Accounting Principles BoardOpinions No. 25, “Accounting for Stock Issued to Employees”.  The intrinsic value method measurescompensation cost for stock options as the excess, if any, of the quoted marketprice of the Company’s stock at the measurement date over the exercise price.

 

**MINORITYINTERESTS**

*Unit holders in the OperatingPartnership.*  At June30, 2002 and December 31, 2001, unit holders in the Operating Partnership heldan 11.6% limited partnership interest in the Operating Partnership.  Each of the holders of the interests in theOperating Partnership has the option to redeem its OP Units and to receive, atthe option of the Company, in exchange for each OP Unit, either (i) one shareof Common Stock of the Company, or (ii) cash equal to the fair value of oneshare of Common Stock of the Company at the date of conversion.

 

10

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

 

The Company has accounted forthis transaction as a partial interest in real property and as such, thepurchase price is accounted for as minority interest on the accompanyingbalance sheet.  Further, income and distributionsallocable to the buyer are accounted for as an offset to the minority interestaccount.  In addition, to the extentthat the accumulation of net income less distributions made to the Buyer doesnot cover the guaranteed return of $30,000 and simple interest of 12% perannum, the Company records an accrual for any such difference in each fiscalperiod until such obligation is paid in full.

 

**RENTALREVENUE**

Certain leases provide fortenant occupancy during periods for which no rent is due or where minimum rentpayments increase during the term of the lease.  The Company records rental income for the full term of each leaseon a straight-line basis.  Accordingly,a receivable is recorded from tenants for the amount that is expected to becollected over the remaining lease term rather than currently (Deferred RentReceivable).  When a property isacquired, the term of existing leases is considered to commence as of theacquisition date for purposes of this calculation.

 

The Company’s portfolio ofleases turns over continuously, with the number and value of expiring leasesvarying from year to year. The Company’s ability to re-lease the space toexisting or new tenants at rates equal to or greater than those realizedhistorically is impacted by, among other things, the economic conditions of themarket in which a property is located, the availability of competing space, andthe level of improvements which may be required at the property. No 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.

 

**NETLOSS PER SHARE**

Netloss per share is calculated based on the weighted average number of commonshares outstanding.  Stock optionsoutstanding and OP Units have not been included in the net loss per sharecalculation since their effect would be antidilutive.

 

**INCOMETAXES**

The Company is currentlytaxed as a C corporation.  Until theCompany elects to be taxed as a REIT, it will be subject to federal income taxon its taxable income at regular corporate rates.  Any distribution by the Company to its stockholders will besubject to tax as a dividend at the stockholder’s respective federal income taxrates.  Beginning in 2003, the Companyintends to elect to be taxed as a REIT for federal income tax purposes.  The Company believes that it is organizedand will operate so as to qualify as a REIT. The qualification and taxation of the Company as a REIT depends upon itsability to meet, through actual annual operating results, distribution levels,share ownership requirements and various qualifications imposed under theInternal Revenue Code of 1986, as amended. Accordingly, while the Company intends to qualify as a REIT and believesthat it will be able to do so, the Company cannot predict that the actualresults of its operations for any particular year will satisfy therequirements.

 

If the Company fails to qualify as a REIT in anytaxable year, it will be subject to federal income taxes on its taxable incomeat regular corporate tax rates.  Inaddition, a REIT is subject to an entity level tax on the sale of property itheld before electing REIT status. During the 10-year period following its qualification as a REIT, theCompany will be subject to an entity level tax on the income it recognizes uponthe sale of assets, including all the assets transferred to it as part of theConsolidation it held before electing REIT status in an amount up to the amountof the built-in gains at the time the Company becomes a REIT.

 

The potential tax relatedto this built-in gain is approximately $12,943,000.  A deferred tax liability has not been recorded for this potentialtax because the tax law provides a means by which the assets can be recoveredtax-free. The Company expects that it will ultimately hold the propertiessubject to the built-in gains tax throughout the 10-year holding period or todispose of properties utilizing only tax-deferred

 

11

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exchanges.  If the Company’s expectation changes and itdisposes of property that is subject to the built-in gains tax without a taxdeferred exchange upon the Company’s qualification for REIT status, the entire$12,943,000 deferred tax liability will be recorded immediately on the books ofthe Company.

 

**NOTE3.  REAL ESTATE**

 

**ACQUISITIONS**

On May 28, 2002, the Companyacquired two office properties in Houston, Texas consisting of 142,792 totalsquare feet.  The aggregate acquisitioncosts of approximately $11,567,000 consisted of proceeds from a tax-deferredexchange, the assumption of debt and seller financing.  The Company is in the process of finalizingassumption of the existing debt.  If theexisting lender does not approve the Company’s assumption of the debt, theCompany can elect to waive the requirement for approval of debt assumption orcause the Seller to repurchase the properties. In the event the Company elects to have the Seller repurchase theproperties prior to electing to be treated as a Real Estate Investment Trustfor Federal income tax purposes, the Company would record a deferred taxliability of $12,943,000.  See Note 2. –Summary of Significant Accounting Policies – Income Taxes.

 

**DISPOSITIONS**

On April 30, 2002, theCompany sold Beach & Lampson, a 13,017 square foot shopping center inCalifornia for $1,200,000.  The Companyreceived net cash proceeds of approximately $59,000 and obtained a $1,100,000trust deed note from the buyer (See Note 4). The transaction resulted in a $148,000 loss on sale of real estate.  In the second quarter, the Companyrecognized a $232,000 deferred gain associated with the sale of TowerIndustrial in 2001.

 

**NOTE4.  MORTGAGE LOAN RECEIVABLE**

 

On April 30, 2002, theCompany obtained a $1,100,000 trust deed note receivable from the sale of Beach& Lampson.  The note bears interestat 9.5% per annum and matures September 15, 2003.  A discount in the amount of $200,000 will apply in the event thenote is paid in full by September 15, 2002.

 

**NOTE5.  INVESTMENT IN UNCONSOLIDATED JOINTVENTURE**

 

The Company currently has noinvestments in operating joint ventures. Prior to the Consolidation, SPPI84 held an investment in Sierra MiraMesa Partners (“SMMP”), which it accounted for using the equity method.

 

SMMP is a California generalpartnership formed in 1985 between SPPI84 and Sierra-Pacific Development FundII (“SPDFII”), an affiliate of SPPI84, to develop and operate the real propertyknown as Mira Mesa, a 89,560 square foot office building located in San Diego,California.   At June 30, 2001, SPPI84’sinterest in SMMP was 80.32%; the remaining 19.68% interest was owned bySPDFII.  During the six months and threemonths ended June 30, 2001, SPPI84 recorded income from investment in SMMP of$209,472 and $229,922, respectively.

 

On October 19, 2001, SPPI84 and SPDFII merged into a subsidiary of theCompany pursuant to the Consolidation. As a result, the assets and liabilities of Mira Mesa are included in theconsolidated balance sheets of the Company at June 30, 2002 and December 31,2001.

 

**NOTE6.  NOTES PAYABLE**

 

The Company had the following mortgage loans, banklines, and notes payable outstanding as of June 30, 2002 and December 31, 2001(dollars in thousands):

 

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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   | **2002** |    | **2001** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Unsecured loans with various lenders,  bearing interest at fixed rates between 5.47% and 20.00% at June 30, 2002 and  8.00% and 20.00% at December 31, 2001, and maturing at various dates through  October 1, 2004.                                                                                                                                                                                                                                                                                                                                                 |   | $        | 1,614   |     | $      | 1,279 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |     |    |     |   |
| Unsecured  loans with various lenders, bearing interest at variable rates between 4.75%  and 6.25% at June 30, 2002 and 5.17% and 6.25% at December 31, 2001, and  maturing at various dates through November 5, 2002.                                                                                                                                                                                                                                                                                                                                               |   | 31       |    | 72       |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |     |    |     |   |
| Unsecured  loans with various parties, non-interest bearing, and maturing at various  dates through January 1, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   | 158      |    | 399      |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |     |    |     |   |
| Secured loans with various lenders, net of unamortized premiums of  $4,361 at June 30, 2002 and $4,829 at December 31, 2001, bearing interest at  fixed rates between 5.00% and 12.00%, with monthly principal and interest  payments ranging between $8 and $269 at June 30, 2002 and December 31, 2001,  and maturing at various dates through June 1, 2012.                                                                                                                                                                                                       |   | 141,499  |    | 116,445  |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |     |    |     |   |
| Secured  loans with various banks bearing interest at variable rates ranging between  4.84% and 9.00% at June 30, 2002 and 4.93% and 9.00% at December 31, 2001,  and maturing at various dates through May 1, 2008.                                                                                                                                                                                                                                                                                                                                                 |   | 33,878   |    | 43,337   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |     |    |     |   |
| Secured Series A & B Bonds with a fixed interest rate of 6.39%,  monthly principal and interest payments of $74, and a maturity date of  September 30, 2031.                                                                                                                                                                                                                                                                                                                                                                                                     |   | 11,737   |    | 11,816   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |     |    |     |   |
| Secured Series C Bonds with a fixed interest rate of 9.50%,  semi-annual principal and interest payments that increase by $5 from the  previous semi-annual payment ($65 at June 30, 2002 and $70 at December 31,  2001), and a maturity date of November 1, 2006.                                                                                                                                                                                                                                                                                                   |   | 700      |    | 765      |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |     |    |     |   |
| Secured loan with IDM Participating Mortgage Income Fund (“IDM  PMIF”), a California limited partnership.   Entities owned by William J. Carden own a 5% limited partnership  interest and a 1% general partnership interest in IDM PMIF.  Mr. Carden is Chairman of the Board of the  Company and an over 5% stockholder of the Company.  The loan bears interest at the Federal Discount Rate plus 3%,  with a minimum of 12.12% and a maximum of 15.15% (12.12% at June 30, 2002 and  December 31, 2001), maturing on November 30, 2002. |   | 1,000    |    | 1,000    |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |     |    |     |   |
| Unsecured loan with Brown Parker and Leahy, LLP, a law firm in which  Timothy R. Brown, a director of the Company, is a partner.  The loan bears interest at prime (4.75% at  June 30, 2002 and 5.00% at December 31, 2001) and is payable on demand.                                                                                                                                                                                                                                                                                                           |   | 199      |    | 202      |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |     |    |     |   |
| Unsecured loan with John N. Galardi, a principal stockholder, with a  fixed interest rate of 8.00%, payable on demand.                                                                                                                                                                                                                                                                                                                                                                                                                                               |   | 1,600    |    | 1,600    |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |     |    |     |   |
| Total                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |   | $        | 192,416 |     | $      | 176,915 |   |

 

Debt premiums are amortizedinto interest expense over the terms of the related mortgages using theeffective interest method.  As of June30, 2002 and December 31, 2001, the unamortized debt premiums were $4,361,000and $4,829,000, respectively.

 

In July 2002, a lender notifiedthe Company it was technically in default under its loan agreement.  The principal balance of the loan as of June30, 2002 was $6,262,000.  The Company isworking to resolve this matter as of the filing date of this Form 10-Q.

 

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

 

In May 2002, an $859,000unsecured loan was obtained to finance insurance premiums on the Company’sproperties.  The loan bears interest ata fixed rate of 5.47% per annum and matures in February 2003.

 

**REFINANCINGS**

In May 2002, the Companyrefinanced $1,452,000 on a loan secured by Southwest Pointe, anoffice/warehouse property, and entered into a new loan agreement in the amountof $2,950,000.  The new

 

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loan bears interest at afixed rate of 7.33% per annum and matures in June 2012.  Net proceeds of $1,297,000 were received asa result of the refinancing.

 

In May 2002, the Companyrefinanced $1,346,000 on a loan secured by Leawood Fountain Plaza, an officeproperty, and entered into a new loan agreement in the amount of$3,000,000.  The new loan bears interestat Libor plus 2.85% with a minimum of 5.75% per annum (5.75% at June 30, 2002),and matures in June 2003.  The loancontains a one-year extension option and an option to convert to a permanentloan provided certain lender conditions are satisfied.  Net proceeds of $1,026,000 were received asa result of the refinancing.

 

In April 2002, the Companyrefinanced $3,650,000 on a loan secured by Oak Grove Commons, anoffice/warehouse property, and entered into a new loan agreement in the amountof $4,313,700.  The new loan bearsinterest at a fixed rate of 7.61% per annum and matures in May 2012.  Net proceeds of $383,000 were received as aresult of the refinancing.

 

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

 

In January 2002, the Company refinanced $4,500,000 ona loan partially secured by North Creek Office Park and entered into a new loanagreement in the amount of $5,625,000. The new loan bears interest at a fixed rate of 7.58% per annum and maturesin February 2012.  Net proceeds of $639,000were received as a result of the refinancing.

 

**NOTESPAYABLE TO FORMER LIMITED PARTNERS**

Limited partners of theeight public limited partnerships who voted against the Consolidation had theoption of electing to receive notes instead of ASR shares.  The notes, which totaled $2,291,671, boreinterest at 5.92% per annum and mature in October 2009.  Interest is payable semi-annually in arrearson each June 15 and December 15, commencing June 15, 2002.  The notes may be redeemed at any time at theoption of the Company, in whole or from time to time in part, at a redemptionprice equal to the sum of the principal amount of the notes being redeemed plusaccrued interest thereon to the redemption date.  On March 18, 2002, $1,153,862 of the notes, plus accruedinterest, were paid.  Additionalpayments of $4,971 and $705,161, plus accrued interest, were paid on April 1,2002 and April 25, 2002, respectively. These payments reduced the principal balance of the notes to $427,677 asof June 30, 2002.  On July 2, 2002, apayment of $191,055, plus accrued interest, reduced the principal balance to$236,622.

 

**NOTE7.  NET LOSS ON EARLY EXTINGUISHMENTS OFDEBT**

 

Inconnection with the refinancing of several loans, as discussed above, theCompany recorded a net loss on early extinguishments of debt of $53,000 in thesecond quarter of 2002.  Losses of$184,000 due to the write-off of unamortized deferred loan costs and prepaymentpenalties were partially offset by a $131,000 gain on the write-off of anunamortized loan premium.

 

**NOTE8.  RELATED PARTY TRANSACTIONS**

 

Effective January 1, 2002, theCompany assumed, from a related party, operations of an executive suite in anoffice building owned by the Company. The note and receivables due the Company for rent from the executivesuite business through the date of acquisition of $177,000 has been offset byreducing a payable owed by the Company to an entity owned by the relatedparty.  No gain or loss was recorded asa result of the assumption.

 

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

 

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**NOTE9.  SEGMENT INFORMATION**

 

As of June 30, 2002, theCompany owned a diverse portfolio of properties comprising of office,office/warehouse, shopping center, apartment, and developmental land. Each ofthese property types represents a reportable segment with distinct uses andtenant types, which require the Company to employ different managementstrategies. Each segment contains properties located in various regions andmarkets within the United States. The office portfolio consists primarily ofsuburban office buildings. The office/warehouse portfolio consists ofproperties designed for warehouse, distribution and light manufacturing forsingle-tenant or multi-tenant use. The shopping center portfolio consists primarilyof community shopping centers. The properties in the apartment portfolio areapartment buildings with units rented to residential tenants on either amonth-by-month basis or for terms of one year or less.

 

The accounting policies ofthe segments are the same as those described in the summary of significantaccounting policies. The Company evaluates performance of its property typesbased on net operating income derived by subtracting rental expenses and realestate taxes (operating expenses) from rental revenue. Significant informationused by the Company for its reportable segments as of and for the three monthsand six months ended June 30, 2002 and 2001 is as follows (dollars inthousands):

 
|                                  |   | **Office** |    | **Office/  Warehouse** |   | **Shopping  Center** |   | **Apartment** |   | **Land Held  for  Development  and Other** |   | **Property  Total** |   |
|---------------------------------------|--------|------------|---------|------------------------|--------|----------------------|--------|---------------|--------|--------------------------------------------|--------|---------------------|--------|
| **Three Months Ended June 30,  2002** |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                        |   | $          | 5,704   |                   | $      | 1,999                |   | $             | 561    |                                       | $      | 2,019               |   | — |   | $ | 10,283 |   |
| Property operating expenses           |   | 2,005      |    | 422                    |   | 146                  |   | 922           |   | $                                          | 112    |                | 3,607  |   |
| Net operating income (NOI)            |   | $          | 3,699   |                   | $      | 1,577                |   | $             | 415    |                                       | $      | 1,097               |   | $ | (112 | ) | $ | 6,676 |   |
| Real estate assets, net               |   | $          | 141,891 |                   | $      | 46,599               |   | $             | 16,109 |                                       | $      | 47,511              |   | $ | 4,054 |   | $ | 256,164 |   |
|                                  |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| **2001**                              |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                        |   | —     |    | $                      | 165    |                 | — |          | — |                                       | — |                | $      | 165 |   |
| Property operating expenses           |   | —     |    | 58                     |   | —               |   | —        |   | —                                     |   | 58                  |   |
| Net operating income (NOI)            |   | —     |    | $                      | 107    |                 | — |          | — |                                       | — |                | $      | 107 |   |
| Real estate assets, net               |   | —     |    | $                      | 1,178  |                 | — |          | — |                                       | — |                | $      | 1,178 |   |

 
|                                |   | **Office** |    | **Office/  Warehouse** |   | **Shopping  Center** |   | **Apartment** |   | **Land Held  for  Development  and Other** |   | **Property  Total** |   |
|-------------------------------------|--------|------------|---------|------------------------|--------|----------------------|--------|---------------|--------|--------------------------------------------|--------|---------------------|--------|
| **Six Months Ended June 30,  2002** |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                      |   | $          | 11,193  |                   | $      | 3,860                |   | $             | 1,112  |                                       | $      | 3,994               |   | — |   | $ | 20,159 |   |
| Property operating expenses         |   | 3,861      |    | 990                    |   | 379                  |   | 1,811         |   | $                                          | 126    |                | 7,167  |   |
| Net operating income (NOI)          |   | $          | 7,332   |                   | $      | 2,870                |   | $             | 733    |                                       | $      | 2,183               |   | $ | (126 | ) | $ | 12,992 |   |
| Real estate assets, net             |   | $          | 141,891 |                   | $      | 46,599               |   | $             | 16,109 |                                       | $      | 47,511              |   | $ | 4,054 |   | $ | 256,164 |   |
|                                |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| **2001**                            |   |       |    |                   |   |                 |   |          |   |                                       |   |                |   |
| Rental revenue                      |   | —     |    | $                      | 331    |                 | — |          | — |                                       | — |                | $      | 331 |   |
| Property operating expenses         |   | —     |    | 117                    |   | —               |   | —        |   | —                                     |   | 117                 |   |
| Net operating income (NOI)          |   | —     |    | $                      | 214    |                 | — |          | — |                                       | — |                | $      | 214 |   |
| Real estate assets, net             |   | —     |    | $                      | 1,178  |                 | — |          | — |                                       | — |                | $      | 1,178 |   |

 

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

 

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|                                                          |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|---------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                          |   | **2002**                        |   | **2001**                      |   | **2002** |   | **2001** |   |
| **REVENUES**                                                  |   |                            |   |                          |   |   |   |   |   |
| Total revenues for reportable segments                        |   | $                               | 10,283 |                          | $      | 165 |   | $ | 20,159 |   | $ | 331 |   |
| Other revenues                                                |   | 72                              |   | 44                            |   | 151 |   | 87 |   |
| Total consolidated revenues                                   |   | $                               | 10,355 |                          | $      | 209 |   | $ | 20,310 |   | $ | 418 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| **NET (LOSS) INCOME**                                         |   |                            |   |                          |   |   |   |   |   |
| NOI for reportable segments                                   |   | $                               | 6,676  |                          | $      | 107 |   | $ | 12,992 |   | $ | 214 |   |
| Unallocated amounts:                                          |   |                            |   |                          |   |   |   |   |   |
| Interest and other income                                     |   | 72                              |   | 44                            |   | 151 |   | 87 |   |
| General and administrative expenses                           |   | (1,812                          | )      | (57                           | )      | (4,229 | ) | (151 | ) |
| Depreciation and amortization                                 |   | (2,872                          | )      | (54                           | )      | (5,854 | ) | (101 | ) |
| Interest expense                                              |   | (3,740                          | )      | (31                           | )      | (7,077 | ) | (63 | ) |
| Income from investment in unconsolidated  joint venture       |   | —                          |   | 230                           |   | — |   | 210 |   |
| Net gain on sales of real estate assets                       |   | 84                              |   | —                        |   | 84 |   | — |   |
| (Loss) income from operations before  minority interests      |   | (1,592                          | )      | 239                           |   | (3,933 | ) | 196 |   |
| Minority interests                                            |   | 163                             |   | —                        |   | 403 |   | — |   |
| Net (loss) income before extraordinary item                   |   | $                               | (1,429 | )                             | $      | 239 |   | $ | (3,530 | ) | $ | 196 |   |
| Extraordinary item – net loss on  extinguishment of debt |   | (53                             | )      | —                        |   | (53 | ) | — |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| Net (loss) income                                             |   | $                               | (1,482 | )                             | $      | 239 |   | $ | (3,583 | ) | $ | 196 |   |

 
|                                       |   | **June 30,** |    |
|--------------------------------------------|--------|--------------|---------|
|                                       |   | **2002**     |    | **2001** |   |
| **ASSETS**                                 |   |         |    |   |   |
| Total assets for reportable segments       |   | $            | 256,164 |   | $ | 1,178 |   |
| Cash and cash equivalents                  |   | 1,908        |    | 34 |   |
| Tenant and other receivables, net          |   | 934          |    | 4 |   |
| Deferred rent receivable                   |   | 420          |    | 51 |   |
| Note receivable from affiliate, net        |   | —       |    | 1,618 |   |
| Accounts receivable from affiliate         |   | —       |    | 1,128 |   |
| Interest receivable                        |   | —       |    | 87 |   |
| Mortgage loan receivable                   |   | 1,100        |    | — |   |
| Investment in management company           |   | 4,000        |    | — |   |
| Investment in unconsolidated joint venture |   | —       |    | 6,937 |   |
| Prepaid and other assets, net              |   | 8,668        |    | 241 |   |
| Total consolidated assets                  |   | $            | 273,194 |   | $ | 11,278 |   |

 

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

 

**OVERVIEW**

 

American SpectrumRealty, Inc. is a full-service real estate corporation which owns, manages andoperates various income-producing properties. As of June 30, 2002, through the Operating Partnership, the Companyowned and operated 34 properties which consisted of 14 office, 11 office/warehouse,four shopping center, four apartment properties, and one developmental landproperty.  The properties are located infour geographic regions in nine states. The Company plans to expand its business and net assets by acquiringadditional properties.  The Company willfocus primarily on office and office/warehouse properties located in Texas,California, Arizona and the Midwest. The Company intends to qualify as a real estate investment trust asdefined under the Internal Revenue Code of 1986, as amended, and to elect to betreated as a REIT beginning in 2003.

 

On October 19, 2001, theCompany was the legal acquirer and registrant in the Consolidation.  Pursuant to the Consolidation, subsidiariesof the Company merged with eight public limited partnerships, acquired theassets and liabilities of two private entities managed by CGS and acquiredcertain assets and liabilities of CGS and the majority owned affiliates ofCGS.  The accounting acquirer in theConsolidation was SPPI84,

 

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one of the eight public limitedpartnerships.  Pursuant to theConsolidation, partners of the public partnerships received shares in theCompany or promissory notes in exchange for their partnership units and ownersof existing related entities exchanged ownership interests in real estate forASR shares or units in the Operating Partnership, an entity formed for thispurpose and initially wholly owned by the Company.   Prior to October 19, 2001, the Company was a wholly ownedsubsidiary of CGS.

 

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

 

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

 

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

 

•                  Certain leasesprovide for tenant occupancy during periods for which no rent is due or whereminimum rent payments increase during the term of the lease.  The Company records rental income for thefull term of each lease on a straight-line basis.  Accordingly, a receivable is recorded from tenants for the amountthat is expected to be collected over the remaining lease term rather than currently(Deferred Rent Receivable).  When aproperty is acquired, the term of existing leases is considered to commence asof the acquisition date for purposes of this calculation.

 

•                  Rental properties are stated at cost, net ofaccumulated depreciation, unless circumstances indicate that cost, net ofaccumulated depreciation, cannot be recovered, in which case, the carryingvalue of the property is reduced to estimated fair value. Estimated fair value:(i) is based upon the Company’s plans for the continued operation of eachproperty; and (ii) is computed using estimated sales price, as determined byprevailing market values for comparable properties and/or the use ofcapitalization rates multiplied by annualized net operating income based uponthe age, construction and use of the building. The fulfillment of the Company’s plans related to each of its propertiesis dependent upon, among other things, the presence of economic conditionswhich will enable the Company to continue to hold and operate the propertiesprior to their eventual sale. Due to uncertainties inherent in the valuationprocess and in the economy, it is reasonably possible that the actual resultsof operating and disposing of the Company’s properties could be materiallydifferent than current expectations.

 

•                  The Company is currently taxed as a Ccorporation.  Until the Company electsto be taxed as a REIT, it will be subject to federal income tax on its taxableincome at regular corporate rates.  Anydistribution by the Company to its stockholders will be subject to tax as adividend at the stockholder’s respective federal income tax rates.  Beginning in 2003, the Company intends toelect to be taxed as a REIT for federal income tax purposes.  The Company believes that it is organizedand will operate so as to qualify as a REIT. The qualification and taxation of the Company as a REIT depends upon itsability to meet, through actual annual operating results, distribution levels,share ownership requirements and various qualifications imposed under theInternal Revenue Code of 1986, as amended. Accordingly, while the Company intends to qualify as a REIT and believesthat it will be able to do so, the Company cannot predict that the actualresults of its operations for any particular year will satisfy therequirements.

 

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**RESULTSOF OPERATIONS**

 

The statements of operationsfor the three and six months ended June 30, 2001 solely reflects the operatingresults of SPPI84, the accounting acquirer in the Consolidation.  Therefore, a discussion of operating resultsfor the three and six months ended June 30, 2002 and 2001 is not a truecomparison.

 

***Comparison of the three months ended June 30,2002 to the three months ended June 30, 2001.***

The Company recorded rentalrevenue of $10,283,000 and expenses of $12,031,000 for the three months endedJune 30, 2002.  The Company acquired twooffice properties during the quarter consisting of 142,792 rentable square feetwith an average occupancy of 93% at June 30, 2002.  One shopping center property, consisting of 13,017 square feetwas sold during the period.  Theweighted average occupancy of the Company’s properties increased from 87% atMarch 31, 2002 to 88% at June 30, 2002. Rental revenue increased $407,000 between the first and second quartersof 2002 primarily due the acquisition of the two office properties and a leasebuy-out.  The Company owned and operated34 properties at June 30, 2002.

 

Rental revenue of $165,000and operating expenses of $200,000 generated in the corresponding period in2001 reflected the operations SPPI84’s sole wholly owned property, SierraValencia.

 

The Company recorded an $84,000 net gain from sales of real estateassets during the three months ended June 30, 2002.  The Company recognized a $232,000 deferred gain associated withthe sale of the Tower Industrial in 2001. This gain was partially offset by a $148,000 loss on the sale of Beach& Lampson.

 

Holders of OPUnits share of the loss for the quarter ended June 30, 2002 was $194,000, whichrepresented the 11.6% limited partner interest in the Operating Partnership notheld by the Company at June 30, 2002. In addition, minority interest expense of $31,000 was recognized as aresult of income generated on a partially owned property.  SPPI84 had no minority interests in thecorresponding period of 2001.

 

SPPI84 recorded income of $230,000 from investment in itsunconsolidated joint venture partner, SMMP, during the three months ended June30, 2001.  This represents SPPI84’s shareof income generated by SMMP and SMMP’s joint venture partners.  The Company had no investments inunconsolidated joint ventures during the quarter.

 

The Company recorded a$53,000 net loss on early extinguishments of debt in connection with therefinancing of several loans during the quarter.  Losses of $184,000 due to the write-off of unamortized deferredloan costs and prepayment penalties were partially offset by a $131,000 gain onthe write-off of an unamortized loan premium.

 

***Comparison of the six months ended June 30,2002 to the six months ended June 30, 2001.***

The Company recorded rentalrevenue of $20,159,000 and expenses of $24,327,000 for the six months endedJune 30, 2002.  The Company acquired twooffice properties during the period consisting of 142,792 rentable square feetwith an average occupancy of 93% at June 30, 2002.    One shopping center property, consisting of 13,017 square feetwas sold during the period.  Theweighted average occupancy of the Company’s properties was 88% at December 31,2001 and June 30, 2002.  Expenses notanticipated to be recurring totaled approximately $250,000 during the sixmonths ended June 30, 2002 due to professional fees associated with theConsolidation.

 

Rental revenue of $331,000and operating expenses of $432,000 generated during the six months ended June30, 2001 reflect the operations SPPI84’s sole wholly owned property, SierraValencia.

 

The Company recorded an $84,000 net gain from sales of real estateassets during the six months ended June 30, 2002.  The Company recognized a $232,000 deferred gain associated withthe sale of the Tower Industrial in 2001. This gain was partially offset by a $148,000 loss on the sale of Beach& Lampson.

 

Holders of OPUnits share of the loss for six months ended June 30, 2002 was $470,000, whichrepresented the 11.6% limited partner interest in the Operating Partnership notheld by the Company at June 30, 2002.

 

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In addition,minority interest expense of $67,000 was recognized as a result of incomegenerated on a partially owned property. SPPI84 had no minority interests in the corresponding period of 2001.

 

SPPI84 recorded income of $210,000 from investment in itsunconsolidated joint venture partner, SMMP, during the six months ended June30, 2001.  This represents SPPI84’sshare of income generated by SMMP and SMMP’s joint venture partners.  The Company had no investments inunconsolidated joint ventures during the six months ended June 30, 2002.

 

The Company recorded a$53,000 net loss on early extinguishments of debt in connection with therefinancing of several loans during the six months ended June 30, 2002.  Losses of $184,000 due to the write-off ofunamortized deferred loan costs and prepayment penalties were partially offsetby a $131,000 gain on the write-off of an unamortized loan premium.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

While the Company had a netloss of $3,583,000 for the six months ended June 30, 2002, the Company’sexpenses included non-cash items of $5,327,000, net, which includeddepreciation and amortization of $5,854,000. Thus, excluding the Company’s pay-down of payables, the Company wouldhave had positive cash flow from its operating activities.  Nonetheless, the Company used net cash inoperating activities of $1,388,000, primarily as a result of the pay-down ofpayables resulting from the Consolidation.

 

Net cash used in investingactivities of $2,227,000 for the six months ended June 30, 2002 was comprisedof (i) $2,217,000 paid for capital expenditures, which in large part wererelated to major renovations on an apartment property, (ii) $69,000 indistributions to the minority owner of the Company’s Creekside/Riversideproperty, and (iii) $59,000 in proceeds received from the sale of the Beach& Lampson property.

 

Net cash provided by financingactivities amounted to $3,239,000 during the six months ended June 30,2002.  Proceeds received from borrowingstotaled $21,773,000 as detailed below, of which $13,698,000 was used to repaydebt.  The Company paid $1,711,000 inscheduled principal payments during the six months ended June 30, 2002.  Note payments to former limited partnerstotaling $1,864,000 were also made during the period.  Further, dividends to common stockholders of $1,110,000 and distributionsto unitholders in the operating partnership of $145,000 were made during theperiod.

 

In January 2002, the Company refinanced $4,500,000 ona loan partially secured by North Creek Office Park and entered into a new loanagreement in the amount of $5,625,000. The new loan bears interest at a fixed rate of 7.58% per annum andmatures in February 2012.  Net proceedsof $639,000 were received as a result of the refinancing.

 

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

 

In April 2002, the Companyrefinanced $3,650,000 on a loan secured by Oak Grove Commons, anoffice/warehouse property, and entered into a new loan agreement in the amountof $4,313,700.  The new loan bearsinterest at a fixed rate of 7.61% per annum and matures in May 2012.  Net proceeds of $383,000 were received as aresult of the refinancing.

 

In May 2002, the Companyrefinanced $1,346,000 on a loan secured by Leawood Fountain Plaza, an officeproperty, and entered into a new loan agreement in the amount of$3,000,000.  The new loan bears interestat Libor plus 2.85% with a minimum of 5.75% per annum (5.75% at June 30, 2002),and matures in June 2003.  The loancontains a one-year extension option and an option to convert to a permanentloan provided certain lender conditions are satisfied.  Net proceeds of $1,026,000 were received asa result of the refinancing.

 

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In May 2002, the Companyrefinanced $1,452,000 on a loan secured by Southwest Pointe, anoffice/warehouse property, and entered into a new loan agreement in the amountof $2,950,000.  The new loan bearsinterest at a fixed rate of 7.33% per annum and matures in June 2012.  Net proceeds of $1,297,000 were received asa result of the refinancing.

 

In May 2002, an $859,000unsecured loan was obtained to finance insurance premiums on the Company’sproperties.  The loan bears interest ata fixed rate of 5.47% per annum and matures in February 2003.

 

In July 2002, a lender notifiedthe Company it was technically in default under its loan agreement.  The principal balance of the loan as of June30, 2002 was $6,262,000.  The Company isworking to resolve this matter as of the filing date of this Form 10-Q.

 

The Company expects to meet itsshort-term liquidity requirements from cash generated by operations andrefinancings.  The Company believes thatits cash generated by operations and refinancings will be adequate to meetnormal operating expenses.

 

The Company is projecting theneed for substantial cash to fund obligations other than normal operatingexpenses in 2002.  These obligationsinclude capital costs related to re-leasing space, improvements to properties,repayment of notes issued in the Consolidation, and payment of otherliabilities arising from a litigation settlement agreement that wassubsequently declared void.  The Companyis in the process of refinancing several properties to generate the cashnecessary to fund the non-operating capital costs.

 

The Companywill consider issuance of stock or OP Units in order to acquire additionalproperties.  There can be no assurancethat the Company will be successful in doing so.

 

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

 

**FUNDS FROMOPERATIONS**

In October 1999, the Boardof Governors of NAREIT issued `White Paper on FFO-October 1999’ to clarify itsdefinition of Funds from Operations (FFO). The clarification was effective January 1, 2000 and requires restatementfor all periods presented in financial statements or tables. FFO, as clarifiedby NAREIT, represents “net income excluding gains (or losses) from sales ofproperty, plus depreciation and amortization, and after adjustments forunconsolidated partnerships and joint ventures.  Adjustments for unconsolidated partnerships and joint ventureswill be calculated to reflect funds from operations on the same basis.”  In 2002, NAREIT clarified that FFO relatedto assets held for sale, sold or otherwise transferred and included in resultsof discontinued operations should continue to be included in FFO.  This clarification was effective January 1,2002 and requires restatement for all periods presented financial statements ortables.   The Company computes FFO inaccordance with the clarified definition except that we eliminate straight-linerent from the calculation, which may not be comparable to FFO reported by REITsthat interpret the clarified definition differently than we do.  The Company believes that FFO is helpful toinvestors as a measure of performance of an equity REIT because, along withcash flow from operating activities, FFO provides investors with an indicationof our ability in incur and service debt, to make capital expenditures and tofund other cash needs.  FFO does notrepresent net income or cash flows from operations as defined by GAAP, and shouldnot be considered as an alternative to net income (determined in accordancewith GAAP) as an indicator of the Company’s operating performance or as analternative to cash flows from operating, investing and financing activities(determined in accordance with GAAP) as a measure of liquidity.  FFO does not necessarily indicate that cashflows will be sufficient to fund all of the Company’s cash needs includingprincipal amortization, capital improvements and distributions tostockholders.  Further, FFO as disclosedby other companies may not be comparable to the Company’s calculation of FFO.

 

The following table setsforth the Company’s calculation of FFO for the three months ended March 31 andJune 30, 2002, and for the six months ended June 30, 2002 (in thousands exceptweighted average shares and per share amounts):  FFO for the three months ended March 31 and June 30, 2001 and thesix months

 

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ended June 30, 2001 isnot presented as it is not comparable or meaningful.

 
|                                                                   |   | **March 31,  2002** |   | **June 30,  2002** |   | **Year to Date  2002** |   |
|------------------------------------------------------------------------|--------|---------------------|--------|--------------------|--------|------------------------|--------|
| Loss from operations before minority  interests and extraordinary item |   | $                   | (2,341 | )                  | $      | (1,592                 | )      | $ | (3,933 | ) |
| Depreciation and amortization                                          |   | 2,982               |   | 2,872              |   | 5,854                  |   |
| Net gain on sales of real estate assets                                |   | —              |   | (84                | )      | (84                    | )      |
| Adjustment for straight-line rents                                     |   | (137                | )      | (134               | )      | (271                   | )      |
| **FFO**                                                                |   | $                   | 504    |               | $      | 1,062                  |   | $ | 1,566 |   |
|                                                                   |   |                |   |               |   |                   |   |
| Basic weighted average shares                                          |   | 5,529,058           |   | 5,535,591          |   | 5,531,705              |   |
| FFO per share                                                          |   | $                   | .09    |               | $      | .19                    |   | $ | .28 |   |

 

FFO increased by $558,000for the three months ended June 30, 2002 as compared to the three months endedMarch 31, 2002 for the same reasons discussed in the analysis of Results ofOperations.

 

**INFLATION**

Substantially all of theleases at the industrial and retail properties provide for pass-through totenants of certain operating costs, including real estate taxes, common areamaintenance expenses, and insurance. Leases at the multifamily propertiesgenerally provide for an initial term of one month to one year and allow forrent adjustments at the time of renewal. Leases at the office propertiestypically provide for rent adjustment and pass-through of increases inoperating expenses during the term of the lease. All of these provisions maypermit the Company to increase rental rates or other charges to tenants inresponse to rising prices and therefore, serve to reduce the Company’s exposureto the adverse effects of inflation.

 

**FORWARD-LOOKINGSTATEMENTS**

ThisReport on Form 10-Q contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of the Securities andExchange Act of 1934.  Theseforward-looking statements are based on Management beliefs and expectations,which may not be correct.  Importantfactors that could cause actual results to differ materially from theexpectations reflected in these forward-looking statements include thefollowing: ASR’s level of indebtedness and ability to refinance its debt; thefact that ASR’s predecessors have had a history of losses in the past;unforeseen liabilities which could arise as a result of the prior operations ofcompanies acquired in the Consolidation; risks inherent in the Company’sacquisition and development of properties in the future, including risks associatedwith ASR’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.

 

**RISK FACTORS**

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

 

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

 

**INTERESTRATES**

The Company’s primary marketrisk exposure is to changes in interest rates obtainable on its secured andunsecured 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 tomaximize financial flexibility when selling properties and minimize potentialprepayment penalties on fixed rate loans, the Company has also entered intovariable rate debt arrangements.

 

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The Company has entered intointerest rate swap agreements to manage its interest rate risk.  The agreements, in nominal amounts totaling$21,800,000, effectively fix the interest rate at 2.68% plus the applicablevariable rate margin (5.68% at June 30, 2002).

 

At June 30, 2002, theCompany’s total indebtedness included fixed-rate debt of approximately$157,735,000 and floating-rate indebtedness of approximately $35,109,000.  The Company continually reviews theportfolio’s interest rate exposure in an effort to minimize the risk ofinterest rate fluctuations.  The Companydoes not have any other material market-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 $197,000 based uponthe balances outstanding on variable rate instruments at June 30, 2002.

 

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**PARTII.  OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS**

 

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

 

Lewis-Madison Matter

On or about September 27, 2001,Robert L. Lewis, Madison Liquidity Investors 103 LLC and Madison LiquidityInvestors 112 LLC (“Plaintiffs”), purporting to represent themselves and allothers similarly situated, initiated an action (the “Action”) against theCompany, CGS, William J. Carden, John N. Galardi and S-P Properties, Inc. inthe Orange County Superior Court, Case No. 01 CC 000394 (“Defendants”)(hereinafter refer to as “Plaintiffs’ Compliant”).

 

Plaintiffs’ Complaint in theAction alleges claims against the Company and others for breach of fiduciaryduty and breach of contract.  Plaintiffs’Complaint challenges the Consolidation, although the Consolidation wasdisclosed in a Prospectus/Consent Solicitation filed with the Securities andExchange Commission and was approved by a majority vote of the limited partnersof the partnerships. Plaintiffs allege that the approval was invalid and thatthe Consolidation constitutes a breach of fiduciary duty by each of theDefendants.  Plaintiffs further allegethat the Consolidation constitutes a breach of partnership agreements governingthe partnerships.

 

Plaintiffs’ prayer for reliefseeks the following: 1) an injunction prohibiting the Defendants fromcommingling; 2) imposition of a constructive trust providing for liquidation ofthe assets of the partnerships and a distribution of the assets to the formerlimited partners therein; 3) a judicial declaration that the Action may bemaintained as a class action; 4) monetary/compensatory damages; 5) Plaintiffs’costs of suit, including attorneys’, accountants’ and expert fees; and 6) ajudicial order of dissolution of the partnerships and appointment of aliquidating trustee.

 

The Company intends tovigorously defend against the claims asserted in the action.  On February 13, 2002, the Company filed aDemurrer to Plaintiff Complaint contending Plaintiffs lack standing to assertsome of the claims alleged, that Plaintiffs’ Complaint fails to state a causeof action for breach of fiduciary duty against the Company and that thePlaintiffs’ Complaint fails to state a cause of action for breach of contract againstthe Company.  On March 15, 2002, theOrange County Superior Court sustained the Company’s Demurrer on the groundthat Plaintiffs’ Complaint fails to state a cause of action for either breachof fiduciary duty or breach of contract against the Company, and overruled theCompany’s Demurrer on the ground of standing. The Court gave the Plaintiffs’ twenty days leave to amend.

 

On April 3, 2002, Plaintiffsfiled and served a Second Amended Complaint alleging claims against the Companyfor breach of fiduciary duty, breach of contract, intentional interference withprospective economic advantage, and intentional interference with contractualrelations.  On May 8, 2002, the Companyfiled a Demurrer to Plaintiffs’ Second Amended Complaint contending Plaintiffs’Second Amended Complaint failed to state a cause of action for interferencewith contract or interference with prospective economic advantage against theCompany.  On June 14, 2002, the OrangeCounty Superior Court sustained the Company’s Demurrer on the grounds thatPlantiffs’ Second Amended Complaint failed to state a cause of action againstthe Company.  The Court gave Plantiffs’twenty days leave to amend.

 

On July 2, 2002, Plaintiffs filed and served a Third Amended Complainton the Company alleging claims against the Company for breach of fiduciaryduty, breach of contract, intentional interference with prospective economicadvantage, and intentional interference with contractual relations.  Plaintiffs’ prayer for relief on its ThirdAmended Compliant seeks the following: 1) an injunction prohibiting the Defendants from commingling; 2)imposition of a constructive trust providing for liquidation of the assets ofthe partnerships and a distribution of the assets to the former limitedpartners therein; 3) a judicial declaration that the Action may be maintainedas a class action; 4) monetary/compensatory damages; 5) Plaintiffs’ costs ofsuit, including attorneys’, accountants’ and expert fees; and 6) a judicialorder of dissolution of the

 

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partnerships and appointment of a liquidating trustee.  On August 6, 2002, the Company responded toPlaintiffs’ Third Amended Compliant by Demurrer.  The Court set a hearing for September 6, 2002.

 

Other Matters

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

 

**ITEM 5.  OTHER INFORMATION**

 

Effective August 7, 2002, Thomas N. Thurber resignedas Chief Financial Officer and Secretary of the Company.  On August 9, 2002, the Company’s Board ofDirectors appointed William J. Carden, the Company's Chairman, Chief ExecutiveOfficer and President, to serve as Acting Chief Financial Officer on an interimbasis.  Mr. Thurber will remain with theCompany as Senior Vice President Corporate Development.

 

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

 

(a)  Exhibits:

 

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

 

(b)  Reports onForm 8-K:

 

On April 26, 2002, a report on Form 8-K was filed withrespect to a cover letter sent to stockholders of American Spectrum Realty,Inc., which accompanied the Company’s Annual Report on Form 10-K

 

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**SIGNATURES**

 

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

 
| **AMERICAN SPECTRUM REALTY INC** |
|----------------------------------|
|                             |   |
|                             |   | By: American Spectrum  Realty Inc., |
|                             |   |
| Date: August  12, 2002           |   | /s/ William J. Carden |   |
|                             |   | William J. Carden  Chairman of the Board, President, Chief Executive Officer and  Acting Chief Financial Officer |   |
|                             |   |   |   |
| Date: August  12, 2002           |   | /s/ Patricia A. Nooney |   |
|                             |   | Patricia A. Nooney |   |
|                             |   | Principal  Accounting Officer |   |
|                             |   | Senior Vice President |   |
|                                  |  |  |  |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit  No.** |   | **Exhibit Title**                                                                                                                                                                                                                                 |
|------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |   |                                                                                                                                                                                                                                              |
| 3.01             |   | Amended and  Restated Bylaws of the Company                                                                                                                                                                                                       |
|             |   |                                                                                                                                                                                                                                              |
| 10.04            |   | Employment Agreement dated September 1,  2002 between the Company and Thomas N.   Thurber (Exhibits pursuant to the Agreement have not been filed by the  Registrant, who hereby undertakes to file such exhibits upon request of the  SEC). |

 

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