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STRATUS PROPERTIES INC.

Part I.  FINANCIAL INFORMATION

Item 1.

Financial Statements.

STRATUS PROPERTIES INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

The accompanying notes are an integral part of these financial statements.

STRATUS PROPERTIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

The accompanying notes are an integral part of these financial statements.

STRATUS PROPERTIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

The accompanying notes are an integral part of these financial statements.

STRATUS PROPERTIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.

BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2003, included in Stratus Properties Inc.’s (Stratus) Annual Report on Form 10-K (Stratus 2003 Form 10-K) filed with the Securities and Exchange Commission. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments (consisting only of normal recurring items) considered necessary to present fairly the financial position of Stratus at June 30, 2004 and December 31, 2003, and the results of operations for the three-month and six-month periods ended June 30, 2004 and 2003, and cash flows for the six-months ended June 30, 2004 and 2003.  Operating results for the three months and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

The consolidated financial statements include accounts of those subsidiaries where Stratus has more than 50 percent of the voting rights and for which the right to participate in significant management decisions is not shared with other shareholders.  Stratus consolidates its wholly owned subsidiaries, which include: Stratus Properties Operating Co., L.P.; Circle C Land, L.P.; Stratus 7000 West, Ltd.; 7500 Rialto Boulevard, L.P.; Austin 290 Properties, Inc.; Stratus Management L.L.C.; Stratus Realty Inc.; Longhorn Properties Inc.; Stratus Investments L.L.C., STRS Plano, L.P., Southwest Property Services L.L.C. and STRS L.L.C.  All significant intercompany transactions have been eliminated in consolidation.  

Certain prior year amounts have been reclassified to conform to the current year presentation.

2.

EARNINGS PER SHARE

Stratus’ basic and diluted net loss per share of common stock was calculated by dividing the net loss by the weighted-average number of common shares outstanding during the period.

Stock options representing 320,000 shares in the second quarter of 2004, 128,000 shares in the second quarter of 2003, 297,000 shares for the six months ended June 30, 2004 and 151,000 shares for the six months ended June 30, 2003 that otherwise would have been included in the diluted earnings per share calculations were excluded because of the net losses reported for the periods.  Outstanding stock options excluded from the computation of diluted net loss per share of common stock because their exercise prices were greater than the average market price of the common stock during the periods presented are as follows (in thousands, except exercise prices):

Stock-Based Compensation Plans

As of June 30, 2004, Stratus had four stock-based employee and director compensation plans, which are described in Note 7 of the Stratus 2003 Form 10-K.  Stratus accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations.  The following table illustrates the effect on net loss and earnings per share if Stratus had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” to all stock-based employee compensation (in thousands, except per share amounts).

For the pro forma computations, the values of option grants were calculated on the dates of grant using the Black-Scholes option-pricing model.  There were no stock option grants during the six months ended June 30, 2004 and 2003.  

3.

DEERFIELD PROJECT AND LOAN

In January 2004, Stratus, through its subsidiary, STRS Plano, L.P., acquired approximately 68 acres of land in Plano, Texas, for $7.0 million.  The property (Deerfield) is zoned and subject to a preliminary subdivision plan for 234 residential lots.  On February 27, 2004, Stratus executed an Option Agreement and a Construction Agreement with a national homebuilder.  Pursuant to the Option Agreement, Stratus received $1.4 million for an option to purchase all 234 lots over 36 monthly take-downs.  The $1.4 million is recorded in other liabilities in Stratus’ June 30, 2004 balance sheet.  The net purchase price for each of the 234 lots is $61,500.  The $1.4 million option payment is non-refundable, but would be applied against subsequent purchases of lots by the homebuilder after certain thresholds are achieved and will be recognized as income as lots are sold.  The Construction Agreement requires the homebuilder to complete develo pment of the entire project by March 15, 2007.  Stratus agreed to pay up to $5.2 million of the homebuilder’s development costs.  The homebuilder must pay all property taxes and maintenance costs.

On February 27, 2004, Stratus entered into a loan agreement (Deerfield loan) with Comerica Bank (Comerica) for $9.8 million with a maturity date of February 27, 2007, including an option to extend the maturity date by six months to August 27, 2007, subject to certain conditions.  The timing of advances from and payments on the loan coincides with the development and lot purchase schedules.  As of June 30, 2004, borrowings outstanding under the Deerfield loan totaled $4.4 million, which proceeds financed the acquisition and the initial development costs of the Deerfield property.  Stratus currently has $5.4 million in remaining availability under the loan.

4.

WIMBERLY LANE PHASE II

In May 2004, Stratus entered into a contract with a national homebuilder to sell 41 lots within the Wimberly Lane Phase II subdivision.  Stratus is retaining and marketing the six estate lots in the subdivision.  In June 2004, the homebuilder paid Stratus a non-refundable $0.6 million deposit for the right to purchase the lots, which has been used to pay ongoing development costs of the lots.  The $0.6 million deposit is recorded in other liabilities in Stratus’ June 30, 2004 balance sheet and will be recognized as income as lots are sold.  The lots will be sold on an installment basis, with six lots to be sold upon substantial completion of subdivision utilities, and then three lots per quarter beginning 150 days after the sale of the initial lots.  The average purchase price for each of the 41 lots is $150,400, subject to a six percent annual escalator commencing upon substantial completion of development.

5.

DEBT OUTSTANDING

At June 30, 2004, Stratus had total debt of $55.8 million, including $0.4 million of current debt, compared to total debt of $47.5 million, including $0.4 million of current debt, at December 31, 2003.  On June 23, 2004, Stratus modified its $30.0 million credit facility agreement with Comerica to convert the $5.0 million term loan component to a revolver and to extend the maturity to May 2006.  The entire $30.0 million revolver facility is now available for corporate purposes. On February 27, 2004, Stratus entered into the $9.8 million Deerfield loan (see Note 3).  Stratus’ debt outstanding at June 30, 2004 consisted of the following:

*

$10.0 million of borrowings outstanding under the two unsecured $5.0 million term loans, one of which will mature in January 2006 and the other in July 2006.

*

$23.2 million of net borrowings under the $30.0 million Comerica credit facility, which was amended effective June 23, 2004 to convert the $5.0 million term loan component to a revolver and to extend the maturity to May 2006, as discussed above.  The Mirador and Escala subdivision lots and the Calera Court condominium lots within the Barton Creek community are currently serving as collateral for this credit facility.

*

$1.2 million of net borrowings under the Calera Court project loan, for which certain of the condominium units at Calera Court are serving as collateral.  The project loan will mature in November 2005.

*

$5.2 million of net borrowings under the 7500 Rialto Drive project loan, which was amended effective January 31, 2004 to extend the maturity from January 31, 2004 to January 31, 2005.  Based on the terms of a previous amendment, Stratus has an option to extend the maturity for one additional year under certain conditions.

*

$11.8 million of net borrowings under the 7000 West project loan, which was amended effective January 31, 2004 to extend the maturity from January 31, 2004 to January 31, 2005.  Based on the terms of a previous amendment, Stratus has an option to extend the maturity for one additional year under certain conditions.

*

$4.4 million of net borrowings under the Deerfield loan, for which the Deerfield property and any future improvements are serving as collateral.  The project loan will mature in February 2007.

For a discussion of Stratus’ bank credit facility and other borrowings, see Note 5 of the Stratus 2003 Form 10-K.

6.

BUSINESS SEGMENTS

Stratus has two operating segments, “Real Estate Operations” and “Commercial Leasing.”  The Real Estate Operations segment is comprised of all Stratus’ developed and undeveloped properties in Austin, Texas, which consist of its properties in the Barton Creek community; its Circle C community properties; and until their sale in August 2003, the properties in Lantana other than its office buildings.  In addition, the 68-acre Deerfield property in Plano, Texas, which Stratus acquired in January 2004, is included in the Real Estate Operations segment (see Note 3).  

The Commercial Leasing segment currently includes the 140,000-square-foot Lantana Corporate Center office complex at 7000 West, which consists of two fully leased 70,000-square-foot office buildings, as well as Stratus’ 75,000-square-foot office building at 7500 Rialto Drive.  In March 2004, Stratus formed Southwest Property Services L.L.C. to manage these office buildings.  Previously, Stratus had outsourced its property management functions to a property management firm.  Effective June 30, 2004, Stratus terminated its agreement with this firm and Southwest Property Services L.L.C. is performing all property management responsibilities.  During the first quarter of 2004, Stratus executed leases that brought the occupancy rate at the 7500 Rialto Drive office building to 90 percent in July 2004.  The occupancy rates at the 7500 Rialto Drive office building were approximately 57 percent at June 30, 2004, compared with app roximately 37 percent at December 31, 2003 and 32 percent at June 30, 2003.  

The segment data presented below (in thousands) was prepared on the same basis as the consolidated financial statements.