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                                                                                  UNITED STATES

                                            SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

OR

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From .......... to ..........

Commission file number 0-19989

Stratus Properties Inc.

(Exact name of Registrant as specified in Charter)

 Delaware

  72-1211572

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)

            98 San Jacinto Blvd., Suite 220

            Austin, Texas

       78701

        (Address of principal executive offices)

                (Zip Code)

Registrant’s telephone number, including area code:  (512) 478-5788

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock Par Value $0.01 per Share

Preferred Stock Purchase Rights

(Title of Each Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes X   No   

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   X 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes__  No  X  

The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $54,353,636 on March 18, 2004 and was approximately $42,148,379 on June 30, 2003.

On March 18, 2004, 7,152,140 shares of Common Stock, par value $0.01 per share, of the registrant were outstanding, and on June 30, 2003, 7,123,278 shares of Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our Proxy Statement for our 2004 Annual Meeting to be held on May 13, 2004, are incorporated by reference into Part III (Items 10, 11, 12, 13 and 14) of this report.

                                                        TABLE OF CONTENTS

Page

Part I

1

Item 1.  Business

1

Overview

1

Company Strategies

1

Credit Facility and Other Financing Arrangements

3

Transactions with Olympus Real Estate Corporation

4

Regulation and Environmental Matters

4

Employees

5

Risk Factors

5

Item 2.

Properties

7

Item 3.

Legal Proceedings

8

Item 4.

Submission of Matters to a Vote of Security Holders

10

Executive Officers of the Registrant

10

Part II

10

Item 5.

Market for Registrant’s Common Equity and Related

Stockholder Matters

10

Item 6.

Selected Financial Data

11

Items 7. and 7A. Management’s Discussion and Analysis of Financial Condition and

Results of Operations and Quantitative and Qualitative Disclosures

About Market Risks

12

Item 8.

Financial Statements and Supplementary Data

24

Item 9.

Changes in and Disagreements with Accountants on Accounting and

Financial Disclosure

41

Item 9A. Controls and Procedures

41

Part III

42

Item 10.

Directors and Executive Officers of the Registrant

42

Item 11.

Executive Compensation

42

Item 12.

Security Ownership of Certain Beneficial Owners and Management and

Related Stockholder Matters

42

Item 13.

Certain Relationships and Related Transactions

43

Item 14. Principal Accountant Fees and Services

43

Part IV

43

Item 15.

Exhibits, Financial Statement Schedules and Reports on Form 8-K

43

Signatures

S-1

Index to Financial Statements

F-1

Exhibit Index

E-1

PART I

Item 1.  Business

All of our periodic report filings with the Securities and Exchange Commission (SEC) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available, free of charge, through our web site, www.stratusproperties.com, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports.  These reports and amendments are available through our web site as soon as reasonably practicable after we electronically file or furnish such material to the SEC.  All subsequent references to “Notes” refer to the Notes to Consolidated Financial Statements located in Item 8. elsewhere in this Form 10-K.

Overview

We are engaged in the acquisition, development, management and sale of commercial, multi-family and residential real estate properties located primarily in the Austin, Texas area.  We conduct real estate operations on properties we own and, until February 27, 2002, through unconsolidated affiliates we jointly owned with Olympus Real Estate Corporation (Olympus) (see “Transactions with Olympus Real Estate Corporation” below), pursuant to a strategic alliance formed in May 1998.  

Our principal real estate holdings are currently in southwest Austin, Texas.  Our most significant holding is the 2,034 acres of undeveloped residential, multi-family and commercial property and 43 developed residential estate lots located within the Barton Creek community.  Our remaining Austin holdings include 282 acres of undeveloped commercial property within the Lantana project and 1,000 acres of undeveloped residential, commercial and multi-family property within the Circle C Ranch (Circle C) community.

We also own three office buildings within the Lantana project.  In February 2002, we acquired the 140,000-square-foot Lantana Corporate Center office complex, which includes two fully leased 70,000-square-foot office buildings, at 7000 West William Cannon Drive (7000 West) in connection with the transactions that ended our business relationship with Olympus (see “Transactions with Olympus Real Estate Corporation” below).  During the third quarter of 2002, we completed construction of a 75,000-square-foot office building at 7500 Rialto Drive and initiated certain tenant improvements that allowed the first tenants to occupy their lease space during the first quarter of 2003.  

In January 2004, we acquired approximately 68 acres of land in Plano, Texas, subject to a preliminary subdivision plan for 234 residential lots (see “Development and Other Activities” within Items 7. and 7A.).  We also own two acres of undeveloped commercial property in both Houston, Texas, and San Antonio, Texas.   

Company Strategies

From our formation in 1992 through 2000, our primary objectives were to reduce our indebtedness and increase our financial flexibility.  In pursuing these objectives, we had reduced our debt to $8.4 million at December 31, 2000 from $493.3 million in March 1992.  As a result of the settlement of certain development-related lawsuits and an increasing level of cooperation between the City of Austin (the City) and us regarding the development of our properties, we substantially increased our development activities and expenditures during the last three years (see below), which has resulted in our debt increasing to $47.5 million at December 31, 2003.  This increase also includes the debt we assumed ($12.9 million) following our transactions with Olympus in February 2002, which totaled 11.9 million at December 31, 2003.  We have funded our development activities and our transactions with Olympus primarily through our expanded credit f acility (see “Credit Facility and Other Financing Arrangements” below and Note 5), which was established as a result of the positive financing relationship we have built with Comerica Bank (Comerica) over the past several years.  In August 2002, the City granted final approval of a development agreement (Circle C Settlement) and permanent zoning for our real estate located within the Circle C community thereby firmly establishing all essential municipal development regulations applicable to our Circle C properties for thirty years (see “Development and Other Activities” within Items 7. and 7A. and Note 8).  The credit facility and other sources of financing have increased our financial flexibility and, together with the Circle C Settlement, have allowed us to fully concentrate our efforts on developing our properties and increasing shareholder value.  

Our overall strategy is to enhance the value of our Austin properties by securing and maintaining development entitlements and developing and building real estate projects on these properties for sale or investment, thereby increasing the potential return from our core assets.  We also continue to investigate and pursue opportunities for new projects that would require minimal capital from us yet offer the possibility of acceptable returns and limited risk.  However, until the Austin real estate market improves, our available cash flow and cash flow requirements may preclude any near-term expansion.  Key factors in our progress towards accomplishing these goals include:

*

Over the past several years we have successfully permitted and developed significant projects in our Barton Creek and Lantana project areas.

During 1999, we completed the development of the 75 residential lots at the Wimberly Lane subdivision at Barton Creek all of which were sold by the end of 2003.  We completed and leased the two 70,000-square-foot office buildings at the 140,000-square-foot Lantana Corporate Center by the third quarter of 2000.  We are continuing to develop several new subdivisions around the new Tom Fazio designed “Fazio Canyons” golf course at Barton Creek.  Through the end of 2003, we had sold 38 of the 54 lots at Escala Drive.  

*

We have made significant progress in obtaining the permitting necessary to develop additional Austin-area property.

In August 2002, the City granted final approval of the Circle C Settlement and permanent zoning for our real estate located within the Circle C community.  These approvals permit development of approximately one million square feet of commercial space and 1,730 residential units, including 900 multi-family units and 830 single family residential lots.  The Circle C Settlement, effective August 15, 2002, firmly establishes all essential municipal development regulations applicable to our Circle C properties for 30 years.  The City also provided us $15 million of cash incentives, which are in the form of Credit Bank capacity, in connection with our future development of our Circle C and other Austin-area properties, which can be used for City fees and reimbursement for certain infrastructure costs.  Annually, we may elect to sell up to $1.5 million of the incentives to other developers for their use in paying City fees related to their projects.  As of December 31, 2003, we have permanently used approximately $1.1 million of our City-based incentives including the sale of $0.9 million to other developers, and we also have $2.0 million in Credit Bank capacity in use as temporary fiscal deposits.  At December 31, 2003, unencumbered Credit Bank capacity was $11.9 million.   

We commenced development activities at Circle C based on the entitlements set forth in our Circle C Settlement with the City.  The preliminary plan has been filed and approved for Meridian, an 800-lot residential development at Circle C.  We are processing a final plat and construction permit approvals for the first phase of Meridian.  In addition, several retail sites at Circle C have received final City approvals and are under development.  Other retail sites, including a proposed 160,000-square-foot grocery-store-anchored project are proceeding through the City approval process.  

Since January 2002, we have secured subdivision plat approval for three new residential subdivisions within the Barton Creek Community, including:  Versant Place – 54 lots; Wimberly Lane II – 47 lots; and Calera Drive – 155 lots.  We have commenced development of the initial phase of Calera Drive, which includes 17 courtyard homes located within a 19 acre site.  We began construction of four condominium units at Calera Court, the initial phase of the Calera Drive subdivision, in the third quarter of 2003, and they are nearing completion.  The second phase of Calera Drive, which will include 53 single-family lots, many of which adjoin the Fazio Canyons golf course, has received final plat and construction permit approval and is currently expected to begin construction after 2004.  Development of the third and last phase, which will include approximately 70 single-family lots, is not expected t o commence until after 2005.

During 2001, we reached agreement with the City concerning development of a 417-acre portion of the Lantana project.  This agreement reflected a cooperative effort between the City and us to allow development based on grandfathered entitlements, while adhering to stringent water quality standards and other enhancements to protect the environment.  With this agreement, we completed the core entitlement process for the entire Lantana project allowing for approximately 2.9 million square feet of office and retail development, approximately 400 multi-family units (previously sold to an unrelated third party, see below) and approximately 330 residential lots to which we sold the development rights in 2003.  As of December 31, 2003, the Lantana project inventory totaled approximately 2.7 million square feet of office and retail development.

In 2000, we received final subdivision plat approval from the City to develop approximately 170 acres of commercial and multi-family real estate within our Lantana project.  The required infrastructure development at the site, known as “Rialto Drive,” was completed during 2001.  We completed construction of the first of two 75,000-square-foot office buildings at 7500 Rialto Drive in 2002 and initiated certain tenant improvements that allowed the first tenants to occupy their lease space during the first quarter of 2003.  We are delaying development of the second office building until market conditions improve.  Full development of the 170 acres is expected to consist of over 800,000 square feet of office and retail space and 400 multi-family units, which were constructed by an apartment developer that purchased our 36.4-acre multi-family tract in 2000.

We completed construction of the Mirador subdivision within the Barton Creek community during 2001 and marketing efforts are ongoing.  Mirador adjoins the Escala Drive subdivision, which was previously owned by the Barton Creek Joint Venture (see “Transactions with Olympus Real Estate Corporation” below).  We currently own 27 estate lots, each averaging approximately 3.5 acres in size, in the Mirador subdivision.

*

We believe that we have the right to receive over $25 million of future reimbursements associated with previously incurred Barton Creek utility infrastructure development costs.  

At December 31, 2003, we had approximately $13 million of these expected future reimbursements of previously incurred costs recorded as a component of “Real estate and facilities” on our balance sheet.  The remaining reimbursements are not recorded on our balance sheet because they relate to properties previously sold or represent a component of the $115 million impairment charge we recorded in 1994.  Additionally, substantial additional costs eligible for reimbursement will be incurred in the future as our development activities at Barton Creek continue.  We received total infrastructure reimbursements of $5.3 million during 2003 and $7.2 million during 2002, including Barton Creek Municipal Utility District (MUD) reimbursements of $4.6 million and $6.5 million, respectively.  Our Barton Creek MUD reimbursements during 2002 included a $1.1 million payment that was previously associated with the uncons olidated Barton Creek Joint Venture, which we previously jointly-owned with Olympus.

*

In recent years we have expanded our real estate management activities and have been retained by third parties to provide management and development assistance on selective real estate projects near Austin, as further discussed below.

    In January 2001, we entered into an expanded development management agreement with Commercial Lakeway Limited Partnership covering a 552-acre portion of the Lakeway development known as Schramm Ranch, and we contributed $2.0 million as an investment in this project.  Under the agreement, we received enhanced management and development fees and sales commissions, as well as a net profits interest in the project.  Lakeway project distributions were made to us as sales installments closed.  During 2003, we sold the last 5-acre Schramm Ranch tract.  We received a total of $2.9 million of distributions associated with our involvement in this project (see Note 4).

Credit Facility and Other Financing Arrangements

We have established a banking relationship with Comerica that has substantially enhanced our financial flexibility.  Since December 1999, we have had a minimum of $30 million of borrowing availability under a credit facility agreement with Comerica, subject to certain conditions.  The terms of the credit facility provide for a $25 million revolving credit facility and a $5 million term loan designed to provide funding for certain development costs. These development costs already have been incurred and the related development loan proceeds are available for borrowing at our discretion. The credit facility has subsequently been amended three times, with each amendment reducing borrowing restrictions under the facility. The most recent Comerica credit facility amendment was finalized on June 30, 2003, extending the maturities of the revolver to May 2005 and the term loan to November 2005.  At December 31, 2003, we had net borrowings out standing of $18.5 million under the revolving credit facility and $2.4 million under the term loan portion of the facility.  In September 2003, we finalized with Comerica a $3.0 million project loan to fund the construction of condominium units at Calera Court.  We have not made any borrowings under the Calera Court project loan.  In February 2004, we entered into a $9.8 million three-year loan agreement with Comerica to finance the acquisition and development of approximately 68 acres of land in Plano, Texas, which we purchased in January 2004 (see “Development and Other Activities” in Items 7.and 7A.).

We had $26.6 million of additional debt at December 31, 2003, representing borrowings associated with two $5 million unsecured term loans, $4.7 million of net borrowings on a project loan facility for the 7500 Rialto Drive office building project (see “Company Strategies” above) and $11.9 million of net borrowings on a project loan facility for the 7000 West office buildings.  We assumed the debt associated with the 7000 West office buildings after acquiring the two office buildings in February 2002 that we previously owned jointly with Olympus.  In January 2003, we amended the 7500 Rialto Drive and the 7000 West project loans to extend the loans’ maturities to January 31, 2004, with options to extend the maturities for two additional one-year periods, under certain circumstances.  Effective January 2004, we extended both project loans for an additional one-year period to January 31, 2005.  For a further discussion of the credit facility and our other long-term financing arrangements, see “Capital Resources and Liquidity – Credit Facility and Other Financing Arrangements” within Items 7. and 7A. and Note 5.   

Transactions with Olympus Real Estate Corporation

In 1998, we formed a strategic alliance with Olympus to develop certain of our existing properties and to pursue new real estate acquisition and development opportunities.  Under the terms of the agreement, Olympus purchased $10 million of our mandatorily redeemable preferred stock, provided us a $10 million convertible debt facility and agreed to make available up to $50 million of additional capital representing its share of direct investments in joint Stratus/Olympus projects.  

We subsequently entered into three joint ventures with Olympus, in which we generally owned approximately 49.9 percent of each joint venture and Olympus owned the remaining 50.1 percent.  We also served as the developer and manager for each of the joint venture projects.  Accordingly, in addition to partnership distributions, we received various development fees, sales commissions and other management fees for our services.

The initial two joint ventures were formed in 1998.  The first provided for the development of a 75 residential lot project at the Barton Creek Wimberly Lane subdivision.  We sold the land to the joint venture for approximately $3.2 million and paid approximately $0.5 million for our equity interest.  The other transaction involved approximately 700 developed lots and 80 acres of platted but undeveloped real estate at the Walden on Lake Houston project, which Olympus purchased in April 1998 and we managed from Olympus’ acquisition through February 2002.  We acquired our interest in the related partnership utilizing $2.0 million of funds available under the Olympus convertible debt facility.  During 1999, we formed a third joint venture associated with the construction of the first 70,000-square-foot-office building at the Lantana Corporate Center (7000 West).  In this transaction, we sold 5.5 acres of commercial rea l estate to the joint venture for $1.0 million.  In December 1999, we sold 174 acres of our Barton Creek residential property to the joint venture initially formed to develop the lots at the Wimberly Lane subdivision for $11.0 million.  The land was developed into 54 multi-acre single-family residential estate lots, which are the largest lots developed to date within the Barton Creek community.  In 2000, we sold an additional 5.5 acres of commercial real estate to 7000 West for $1.1 million.  Construction of the second 70,000-square-foot office building was completed in 2000.  For a detailed discussion of these transactions see “Joint Ventures with Olympus Real Estate Corporation” within Items 7. and 7A.

We repaid all our borrowings on the Olympus convertible debt facility during 2001, and terminated the facility in August 2001.  In February 2002, we concluded our business relationship with Olympus by completing the following transactions:

*

We purchased our $10.0 million of mandatorily redeemable preferred stock held by Olympus for $7.6 million.

*

We acquired Olympus’ ownership interest in the Barton Creek Joint Venture for $2.4 million.

*

We acquired Olympus’ ownership interest in the 7000 West Joint Venture for $1.5 million.  In connection with this acquisition, we assumed the debt outstanding for 7000 West, which at February 27, 2002 totaled $12.9 million.  Related amounts outstanding were included in our consolidated balance sheet commencing in 2002.

*

We sold our ownership interest in the Walden Partnership to Olympus for $3.1 million.  

We funded the $7.3 million net cash cost for these transactions, which is net of the approximate $1.1 million of cash we received by acquiring the Barton Creek and 7000 West Joint Ventures, through borrowings available to us under our $25 million revolving credit facility agreement (see above, and “Capital Resources and Liquidity – Credit Facility and Other Financing Arrangements” within Items 7. and 7A.).  

For a detailed discussion of our Olympus transactions see “Joint Ventures with Olympus Real Estate Corporation” within Items 7. and 7A. and Notes 3 and 4.

Regulation and Environmental Matters

Our real estate investments are subject to extensive local, city, county and state rules and regulations regarding permitting, zoning, subdivision, utilities and water quality as well as federal rules and regulations regarding air and water quality and protection of endangered species and their habitats.  Such regulation has delayed and may continue to delay development of our properties and result in higher developmental and administrative costs.  See “Risk Factors.”  

We have made, and will continue to make, expenditures for the protection of the environment with respect to our real estate development activities.  Emphasis on environmental matters will result in additional costs in the future. Based on an analysis of our operations in relation to current and presently anticipated environmental requirements, we currently do not anticipate that these costs will have a material adverse effect on our future operations or financial condition.

Employees

We currently have 20 employees, who manage our operations.  We also use contract personnel to perform certain management and administrative services, including administrative, accounting, financial and other services, under a management services agreement.  We may terminate this contract on an annual basis.  The cost of these services totaled $0.3 million in 2003 and 2002 and $0.4 million in 2001.  

Risk Factors

This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements are all statements other than statements of historical fact included in this report, including, without limitation, the statements under the headings “Business,” “Properties,” “Market for Registrant’s Common Equity and Related Stockholder Matters,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations and Disclosures About Market Risks” regarding our financial position and liquidity, payment of dividends, strategic plans, future financing plans, development and capital expenditures, business strategies, and our other plans and objectives for future operations and activities.  

Forward-looking statements are based on our assumptions and analysis made in light of our experience and perception of historical trends, current conditions, expected future developments and other factors that we believe are appropriate under the circumstances.  These statements are subject to a number of assumptions, risks and uncertainties, including the risk factors discussed below and in our other filings with the SEC, general economic and business conditions, the business opportunities that may be presented to and pursued by us, changes in laws or regulations and other factors, many of which are beyond our control.  Readers are cautioned that forward-looking statements are not guarantees of future performance, and the actual results or developments may differ materially from those projected, predicted or assumed in the forward-looking statements.  Important factors that could cause actual results to differ materially from our expe ctations include, among others, the following:

We are vulnerable to concentration risks because our operations are currently exclusive to the Austin, Texas, market.  Our real estate activities are almost entirely located in Austin, Texas.  Because of our geographic concentration and limited number of projects, our operations are more vulnerable to local economic downturns and adverse project-specific risks than those of larger, more diversified companies.

The performance of the Austin economy greatly affects our sales and consequently the underlying values of our properties.  The Austin economy is heavily influenced by conditions in the technology industry.  In a weak technology market, as is the current condition, we experience reduced sales, primarily affecting our “high-end” properties, which can significantly affect our financial condition and results of operations.

Two of our three office buildings are primarily leased by a single tenant.  Our two office buildings at 7000 West are primarily leased to a single tenant.  Should this tenant default on its obligations, we may not be able to find another tenant to occupy the space under similar terms or at all.  Failure to maintain high occupancy rates for these buildings could hinder our ability to repay project loans secured by these buildings or limit our ability to refinance or extend the maturity of these loans.

We will continue to preserve and vigorously defend our rights to the development entitlements of all our properties, but aggressive attempts by certain parties to restrict growth in the area of our holdings have in the past had and may in the future have a negative effect on our development and sales activities. Although the efforts of certain special interest groups have affected and may again negatively impact our development and sales activities, we will protect and defend our rights to the development entitlements of our properties.

If we are unable to generate sufficient cash from operations, we may find it necessary to curtail our development operations.  Significant capital resources will be required to fund our development expenditures.  Our performance continues to be dependent on future cash flows from real estate sales and rental income from our office buildings, and there can be no assurance that we will generate sufficient cash flow or otherwise obtain sufficient funds to meet the expected development plans for our properties.

Our results of operations and financial condition are greatly affected by the performance of the real estate industry.  Our real estate activities are subject to numerous factors beyond our control, including local real estate market conditions (both where our properties are located and in areas where our potential customers reside), substantial existing and potential competition, general national, regional and local economic conditions, fluctuations in interest rates and mortgage availability and changes in demographic conditions.  Real estate markets have historically been subject to strong periodic cycles driven by numerous factors beyond the control of market participants.

Real estate investments often cannot easily be converted into cash and market values may be adversely affected by these economic circumstances, market fundamentals, competition and demographic conditions. Because of the effect these factors have on real estate values, it is difficult to predict with certainty the level of future sales or sales prices that will be realized for individual assets.

Our real estate operations are also dependent upon the availability and cost of mortgage financing for potential customers, to the extent they finance their purchases, and for buyers of the potential customers’ existing residences.

Unfavorable changes in market and economic conditions could hurt occupancy or rental rates.  The market and economic conditions may significantly affect rental rates.  Occupancy and rental rates in our market, in turn, may significantly affect our profitability and our ability to satisfy our financial obligations.  The risks that may affect conditions in our market include the following:

*

the economic climate, which may be adversely impacted by industry slowdowns and other factors;

*

local conditions, such as oversupply of office space and the demand for office space;

*

the inability or unwillingness of tenants to pay their current rent or rent increases; and

*

competition from other available office buildings and changes in market rental rates.

Our operations are subject to an intensive regulatory approval process.  Before we can develop a property, we must obtain a variety of approvals from local and state governments with respect to such matters as zoning, density, parking, subdivision, site planning and environmental issues.  Certain of these approvals are discretionary by nature. Because certain government agencies and special interest groups have in the past expressed concerns about our development plans in or near Austin, our ability to develop these properties and realize future income from our properties could be delayed, reduced, prevented or made more expensive.

Certain special interest groups have long opposed our plans in the Austin area and have taken various actions to partially or completely restrict development in some areas, including areas where some of our most valuable properties are located.  We have actively opposed these actions.  We currently do not believe unfavorable rulings would have a significant long-term adverse effect on the overall value of our property holdings. However, because of the regulatory environment that has existed in the Austin area and the intensive opposition of certain interest groups, there can be no assurance that such expectations will prove correct.  

Our operations are subject to governmental environmental regulation, which can change at any time and generally would result in an increase to our costs.  Real estate development is subject to state and federal regulations and to possible interruption or termination because of environmental considerations, including, without limitation, air and water quality and protection of endangered species and their habitats.  Certain of the Barton Creek properties include nesting territories for the Golden Cheek Warbler, a federally listed endangered species.  In 1995, we received a permit from the U.S. Wildlife Service pursuant to the Endangered Species Act, which to date has allowed the development of the Barton Creek and Lantana properties free of restrictions under the Endangered Species Act related to the maintenance of habitat for the Golden Cheek Warbler.  

Additionally, in April 1997, the U.S. Department of Interior listed the Barton Springs Salamander as an endangered species after a federal court overturned a March 1997 decision by the Department of Interior not to list the Barton Springs Salamander based on a conservation agreement between the State of Texas and federal agencies.  The listing of the Barton Springs Salamander has not affected, nor do we anticipate it will affect, our Barton Creek and Lantana properties for several reasons, including the results of technical studies and our U.S. Fish and Wildlife Service 10(a) permit obtained in 1995.  Our Circle C properties may, however, be affected, although the extent of any impact cannot be determined at this time.  Special interest groups provided written notice of their intention to challenge our 10(a) permit and compliance with water quality regulations, but no challenge has yet occurred.

We are making, and will continue to make, expenditures with respect to our real estate development for the protection of the environment.  Emphasis on environmental matters will result in additional costs in the future.   

The real estate business is very competitive and many of our competitors are larger and financially stronger than we are.  The real estate business is highly competitive.  We compete with a large number of companies and individuals, and many of them have significantly greater financial and other resources than we have. Our competitors include local developers who are committed primarily to particular markets and also national developers who acquire properties throughout the United States.

Our operations are subject to natural risks.  Our performance may be adversely affected by weather conditions that delay development or damage property.

The U.S military intervention in Iraq, the terrorist attacks in the United States on September 11, 2001 and the potential for additional future terrorist acts have created economic, political and social uncertainties that could materially and adversely affect our business.  It is possible that further acts of terrorism may be directed against the United States domestically or abroad, and such acts of terrorism could be directed against properties and personnel of companies such as ours. The attacks and the resulting economic, political and social uncertainties, including the potential for further terrorist acts, have caused the premiums charged for our insurance coverages to increase significantly.  Moreover, this insurance does not cover damages and losses caused by war. Terrorism and war developments may materially and adversely affect our business and profitability and the prices of our common stock in ways that we cannot predict at this time.

Arthur Andersen LLP, our former auditors, audited certain financial information included in this Form 10-K. In the event such financial information is later determined to contain false or misleading statements, you may be unable to recover damages from Arthur Andersen LLP.  Arthur Andersen LLP completed its audit of our financial statements for the year ended December 31, 2001, and issued its report with respect to such financial statements on February 4, 2002.  In August 2002, our board of directors, at the recommendation of our audit committee, approved the appointment of PricewaterhouseCoopers LLP as our independent accountants to audit our financial statements for fiscal year 2002.  PricewaterhouseCoopers LLP replaced Arthur Andersen, which had served as our independent auditors since 1992.  Arthur Andersen audited the financial statements that we include in this Form 10-K for the year ended December 31, 2001, as set forth in their repo rts herein.  

In June 2002, Arthur Andersen was convicted of obstructing justice, which is a felony offense.  The SEC prohibits firms convicted of a felony from auditing public companies.  Arthur Andersen is thus unable to consent to the incorporation of its opinion with respect to this Form 10-K.  Under these circumstances, Rule 437a under the Securities Act of 1933 (the “Securities Act”) permits us to file this Form 10-K, which is incorporated by reference into registration statements we have on file with the SEC, without a written consent from Arthur Andersen.  The Securities Act provides that if part of a registration statement at the time it becomes effective contains an untrue statement of a material fact, or omits a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring a security pursuant to such registration statement (unless it is proved that at the time o f such acquisition such person knew of such untruth or omission) may assert a claim against, among others, an accountant who has consented to be named as having certified any part of the registration statement or as having prepared any report for use in connection with the registration statement.  As a result, with respect to transactions in our common stock pursuant to our registration statements that occur after this Form 10-K is filed with the SEC, Arthur Andersen will not have any liability under the Securities Act for any untrue statements of a material fact contained in the financial statements audited by Arthur Andersen or any omissions of a material fact required to be stated therein.  Accordingly, you would be unable to assert a claim against Arthur Andersen under the Securities Act.

Item 2. Properties

Our acreage to be developed as of December 31, 2003, is provided in the following table.  The potential development acreage is presented according to anticipated uses for single-family lots, multi-family units and commercial development based upon our understanding of the properties’ existing entitlements.  However, there is no assurance that the undeveloped acreage will be so developed because of the nature of the approval and development process and market demand for a particular use.

The following schedule summarizes the estimated development potential of our Austin-area acreage as of December 31, 2003:

Item 3.  Legal Proceedings

Various regulatory matters and litigation involving the development of our Austin properties are summarized below.

SOS Lawsuit 1:  The Save Our Springs Alliance and Circle C Neighborhood Association v. The City of Austin, Circle C Land Corp., and Stratus Properties Inc. Cause No. GN-202018 (261st Judicial District Court of Travis County, Texas, filed June 24, 2002).  The Save Our Springs Alliance, a non-profit public-interest corporation (“SOSA”), and the Circle C Neighborhood Association, an unincorporated association with a single member (“CCNA”) opposed any settlement between the City of Austin (the City) and Stratus concerning the development of Circle C. SOSA and CCNA worked diligently to oppose the proposed settlement in myriad ways, including public protests, mail and other media campaigns, lobbying efforts, and litigation.  On June 24, 2002, in advance of the City Council’s consideration of the settlement proposal, SOSA and CCNA filed a lawsuit against the City, Circle C Land Corp., and Stratus Properties Inc. i n the 261st Judicial District Court of Travis County.  In their petition, plaintiffs request the following judicial declarations:

1.

The City’s Save Our Springs (“SOS”) Ordinance (“SOS Ordinance”) is exempt from Chapter 245 of the Texas Local Government Code (the “Grandfathering Statute”).

2.

Chapter 245 is an unconstitutional intrusion on the municipal authority of Texas homerule cities, either on its face or as applied in the Barton Springs Edwards Aquifer Watershed.

3.

Under the Texas Constitution, the City has the authority and duty to apply the SOS Ordinance and its zoning authority to Stratus’ Circle C properties.

4.

Residents of the Circle C community, including Plaintiffs, are entitled to full application of the City’s current watershed protection ordinances, including the SOS Ordinance, and the City’s zoning powers.

Stratus’ Position.  As a result of the City’s approval of the settlement agreement, effective August 15, 2002, certain of Plaintiffs’ requests are moot.  The proposal was approved by six of seven Council members and, as such, constitutes a valid amendment to the SOS Ordinance.  In addition, in connection with the approval of the settlement agreement, the City exercised its zoning authority and granted zoning for each of Stratus’ seventeen Circle C parcels.  As such, each of plaintiffs’ requested judicial declarations concerning the applicability of current City watershed ordinances or City zoning authority to Circle C have been fully satisfied and are moot.  Stratus filed a motion for summary judgment, along with the City, to dismiss the claims as to the Circle C properties on the basis that they are moot as a result of the settlement.  Stratus’ and the City’s summary judgment was heard on January 22, 2003 and granted, dismissing the lawsuit as to the Circle C properties.

The lawsuit remained pending as to Stratus’ non-Circle C properties.  Stratus and the City asserted that there is no live controversy and, as a result, the court has no jurisdiction and must dismiss the suit.  A hearing was held on May 7, 2003, at which the court agreed with the City’s and Stratus’ position and dismissed the suit.  On May 27, 2003, SOSA filed a Notice of Appeal with the Texas Third Court of Appeals.  All parties submitted briefs and oral argument occurred on December 3, 2003.  The appellate court has not yet issued a ruling.

SR Ridge / Wal-Mart Litigation:  S.R. Ridge Limited Partnership vs. The City of Austin and Stratus Properties Inc. (Cause No. A03CA832 SS).  S.R. Ridge Limited Partnership, an Arizona partnership (“S.R. Ridge”), owns a 53 acre commercial tract close to Stratus’ Circle C property.  S.R. Ridge contracted to sell its 53 acre tract to Endeavor Real Estate Group, L.L.C., an Austin developer (“Endeavor”).  Endeavor, in turn, contracted to sell a substantial portion of that property to Wal-Mart for a “Supercenter.”  S.R. Ridge’s property is subject to a 1996 settlement agreement with the City permitting development under grandfathered watershed ordinances.  Numerous neighborhood groups and environmental groups, including those who had supported Stratus’ Circle C 2002 settlement with the City, opposed Wal-Mart’s plans.  Th ose groups requested Stratus’ support, including financial support, in organizing the opposition to the proposed Wal-Mart Supercenter.  Ultimately, Wal-Mart elected not to proceed with its project.  In turn, Endeavor elected to terminate its contract with S.R. Ridge.

On November 20, 2003, S.R. Ridge sued the City and Stratus in the United States District Court for the Western District of Texas.  In its suit, S.R. Ridge claims that the City breached its 1996 settlement agreement with S.R. Ridge and is liable for damages resulting from the breach, including both actual and consequential damages. S.R. Ridge claims that Stratus, in an effort to protect the competitive value of its nearby land, conspired with the City to cause the City to breach the 1996 settlement agreement, thereby committing tortious interference with the City’s contractual obligations under the 1996 settlement agreement.  S.R. Ridge seeks actual and exemplary damages against Stratus.

Stratus’ Position.  Both the City and Stratus filed motions to dismiss the lawsuit on the basis that there has been no breach of the City’s 1996 settlement agreement with S.R. Ridge.  Stratus believes that since there is no breach, the plaintiff’s claim that Stratus conspired with the City to cause a breach is unfounded.  In addition, Stratus asserts that it has a constitutionally protected right to express its opinion as to proposed developments, including expressing those opinions to City Council members.  S.R. Ridge filed answers to the City’s and Stratus’ separate motions to dismiss the lawsuit and, in turn, Stratus and the City filed reply briefs.  The Court heard argument on the motions to dismiss on February 18, 2004 and (i) ordered plaintiff to replead its allegations on or before March 4, 2004 to cure legal deficiencies raised in both the City’s and Stratus’ motions to di smiss, and (ii) denied the City’s and Stratus’ motions to dismiss.  Plaintiff subsequently filed its amended pleading on March 4, 2004.  In response, the City filed a second motion to dismiss on March 15, 2004, arguing that the legal deficiencies in plaintiff’s initial petition had still not been cured.  Stratus anticipates that is will also file a second motion to dismiss.

In addition to the litigation described above, we may from time to time be involved in various legal proceedings of a character normally incident to the ordinary course of our business.  We believe that potential liability from any of these pending or threatened proceedings will not have a material adverse effect on our financial condition or results of operations.  We maintain liability insurance to cover some, but not all, potential liabilities normally incident to the ordinary course of our business as well as other insurance coverage customary in our business, with such coverage limits as management deems prudent.

Item 4.  Submission of Matters to a Vote of Security Holders

Not applicable.

Executive Officers of the Registrant

Certain information, as of March 29, 2004, regarding our executive officers is set forth in the following table and accompanying text.

Mr. Armstrong has been employed by us since our inception in 1992.  He has served us as Chairman of the Board since August 1998, Chief Executive Officer since May 1998 and President since August 1996. Previously Mr. Armstrong served as Chief Operating Officer from August 1996 to May 1998 and as Chief Financial Officer from May 1996 to August 1996.  He served as Executive Vice President from August 1995 to August 1996.

Mr. Baker has served as our Senior Vice President and Chief Financial Officer since August 2002.  He previously served as Senior Vice President – Accounting from May 2001 until August 2002 and as our Vice President – Accounting from August 1996 until May 2001.

Mr. Jones has served as our General Counsel since August 1998.  Mr. Jones is a partner with the law firm of Armbrust & Brown, L.L.P. and he provides legal and business advisory services under a consulting arrangement with his firm.

PART II

Item 5.  Market for Registrant’s Common Equity and Related Stockholder Matters

Our common stock trades on Nasdaq under the symbol STRS.  The following table sets forth, for the periods indicated, the range of high and low sales prices, as reported by Nasdaq.  

As of March 18, 2004, there were 928 holders of record of our common stock.  We have not in the past paid, and do not anticipate in the future paying, cash dividends on our common stock.  The decision whether or not to pay dividends and in what amounts is solely within the discretion of our Board of Directors.  However, our current ability to pay dividends is also restricted by terms of our credit agreement, as discussed in Note 5.  

Item 6.  Selected Financial Data

The following table sets forth our selected historical financial data for each of the five years in the period ended December 31, 2003.  The historical financial information is derived from our audited financial statements and is not necessarily indicative of our future results.  You should read the information in the table below together with Items 7. and 7A. “Management’s Discussion and Analysis of Financial Condition and Results of Operations and Quantitative and Qualitative Disclosures About Market Risks” and Item 8. “Financial Statements and Supplementary Data.”