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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 March 31, 2004 and December 31, 2003, and the results of operations and cash flows for the three-month periods ended March 31, 2004 and 2003. Operating results for the three months ended March 31, 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 309,000 shares in the first quarter of 2004 and 162,000 shares in the first quarter of 2003 that otherwise would have been included in the first-quarter 2004 and 2003 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 March 31, 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 first quarters of 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’ March 31, 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.  The Construction Agreement requires the homebuilder to complete development of the entire project by March 15, 2007. &n bsp;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 March 31, 2004, borrowings outstanding under the Deerfield loan totaled $4.1 million, which proceeds financed the acquisition of the Deerfield property.  

4. DEBT OUTSTANDING

At March 31, 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 February 27, 2004, Stratus entered into a $9.8 million loan agreement with Comerica to finance the acquisition and future development of the 68-acre Deerfield property in Plano, Texas, which Stratus acquired in January 2004 (see Note 3).  Stratus’ debt outstanding at March 31, 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.

*

$20.9 million of net borrowings under the $25.0 million revolver component of the Comerica credit facility, which will mature in May 2005.

*

$2.4 million of net borrowings under the $5.0 million term loan component of the Comerica facility, for which certain of the Mirador subdivision lots and the Calera Court condominium units within the Barton Creek community are currently serving as collateral.  The term loan will mature in November 2005.

*

$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.

*

$5.3 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.

*

$11.9 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.

*

$4.1 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 facilities see Note 5 of the Stratus 2003 Form 10-K.

5. 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.  During the first quarter of 2003, Stratus outsourced its property management functions to a property management firm.  Effective June 1, 2004, Stratus will terminate its agreement with this firm and Southwest Property Services L.L.C. will perform all property management responsibilities.  During the first quarter of 2004, Stratus executed leases that will bring the occupancy rate at the 7500 Rialto Drive office building to 94 percent in July 2004 when tenant improvements are completed.  The occupancy rates at the 7500 Rialto Drive office building were approximately 50 percent at March 31, 2004, compared with approximately 37 percent at December 31, 2003 and approximately 33 percent at March 31, 2003.  

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

a.

Includes sales commissions, management fees and other revenues together with related expenses.

b.

Represents all Stratus’ assets except for the plant, property and equipment assets comprising the Real Estate Operations and Commercial Leasing segments.

6. RESTRICTED CASH AND INTEREST COST

Restricted Cash.  At March 31, 2004 and December 31, 2003, Stratus had restricted cash deposits totaling $0.2 million, which reflect funds held to purchase the fractional shares of Stratus’ common stock resulting from its stock split transactions (see Note 7 of the Stratus 2003 Form 10-K).  

Interest Cost.  Interest expense excludes capitalized interest of $0.6 million in the first quarter of 2004 and $0.5 million in the first quarter of 2003.

REVIEW BY INDEPENDENT ACCOUNTANTS

The financial information as of March 31, 2004, and for the three-month periods ended March 31, 2004 and 2003, included in Part I of this Form 10-Q pursuant to Rule 10-01 of Regulation S-X has been reviewed by PricewaterhouseCoopers LLP (PricewaterhouseCoopers), Stratus’ independent accountants, in accordance with standards established by the American Institute of Certified Public Accountants. PricewaterhouseCoopers’ report is included in this quarterly report.

PricewaterhouseCoopers does not carry out significant or additional procedures beyond those that would have been necessary if its report had not been included in this quarterly report.  Accordingly, such report is not a “report” or “part of a registration statement” within the meaning of Sections 7 and 11 of the Securities Act of 1933 and the liability provisions of Section 11 of such Act do not apply.

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders

   of Stratus Properties Inc.:

We have reviewed the accompanying condensed consolidated balance sheet of Stratus Properties Inc. (a Delaware Corporation) as of March 31, 2004, and the related consolidated statements of operations and of cash flows for the three-month periods ended March 31, 2004 and 2003.  These interim financial statements are the responsibility of management.  

We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants.  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.  

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of Stratus Properties Inc. as of December 31, 2003, and the related consolidated statements of income, of changes in stockholders’ equity and of cash flows for the year then ended (not presented herein), and in our report dated March 23, 2004, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003, is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP

Austin, Texas

May 14, 2004  

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

Management’s discussion and analysis presented below should be read in conjunction with our discussion and analysis of financial results contained in our 2003 Annual Report on Form 10-K.  The operating results summarized in this report are not necessarily indicative of our future operating results.

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.  Our principal real estate holdings are in southwest Austin, Texas.  Our most significant holding is the 2,034 acres of undeveloped residential, multi-family and commercial property and 42 developed residential estate lots located within the Barton Creek community.  We own an additional 1,000 acres of undeveloped residential, commercial and multi-family property within the Circle C Ranch (Circle C) community.  Our remaining Austin holdings consist of 282 acres of undeveloped commercial property located within the Lantana project, as well as three Lantana office buildings.  The office buildings include a 75,000-square-foot building at 7500 Rialto Drive, and two fully leased 70,000-square-foot buildings at 7000 West William Cannon Drive, known as the Lantana Corporate Center.  We also own approximately 68 acres of land in Plano, Texas, which we acquired in January 2004.

For a discussion of current real estate market conditions and our resultant business strategy to these conditions, see “Real Estate Market Conditions” and “Business Strategy” located in our 2003 Annual Report on Form 10-K.

DEVELOPMENT AND OTHER ACTIVITIES

In January 2004, we acquired approximately 68 acres of land in Plano, Texas, for $7.0 million.  The property, which we refer to as Deerfield, is zoned and subject to a preliminary subdivision plan for 234 residential lots.  In February 2004, we executed an Option Agreement and a Construction Agreement with a national homebuilder. Pursuant to the Option Agreement, we were paid $1.4 million for an option to purchase all 234 lots over 36 monthly take-downs.  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.  The Construction Agreement requires the homebuilder to complete development of the entire project by March 15, 2007.  We agreed to pay up to $5.2 million of the homebuilder’s development costs.  The homebuilder must pay all property t axes and maintenance costs.  In February 2004, we entered into a $9.8 million three-year loan agreement with Comerica Bank (Comerica) to finance the acquisition and development of Deerfield.  

We have commenced development activities at Circle C based on the entitlements set forth in our Circle C Settlement with the City of Austin (the City).  The preliminary plan has been 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 being developed.  Other retail sites, including a proposed 160,000-square-foot project anchored by a grocery store, are currently proceeding through the City approval process.  The Circle C Settlement permits development of one million square feet of commercial space, 900 multi-family units and 830 single-family residential lots.

Within the Barton Creek community during the first quarter of 2004, we commenced development of the 47-residential-lot Wimberly Lane II subdivision and completed construction of four condominium units at Calera Court, the initial phase of the “Calera Drive” subdivision.  Calera Court will include 17 courtyard homes on 19 acres.  The second phase of Calera Drive, consisting of 53 single-family lots, has received final plat and construction permit approval.  The development of these lots, many of which adjoin the Fazio Canyons Golf Course, is expected to begin construction after 2004.  Development of the third and last phase of Calera Drive, which will include approximately 70 single-family lots, is not expected to commence until after 2005.  Funding for the construction of condominium units at Calera Court is provided by a $3.0 million project loan, which we established with Comerica in September 2003. During the fi rst quarter of 2004, we borrowed $1.2 million under the project loan, which matures in November 2005 and is secured by the condominium units at Calera Court.

During the first quarter of 2004, we executed leases that will bring our 7500 Rialto Drive office building to 94 percent occupancy in July 2004 when tenant improvements are completed.  In March 2004, we brought our property management functions in-house and formed Southwest Property Services L.L.C. to manage our office buildings. Effective June 1, 2004, we will terminate our agreement with the external property management firm.  We anticipate that this change in management responsibility should provide future cost savings for our commercial leasing operations and better control of building operations.

RESULTS OF OPERATIONS

We are continually evaluating the development potential of our properties and will continue to consider opportunities to enter into significant transactions involving our properties.  As a result, and because of numerous other factors affecting our business activities as described herein, our past operating results are not necessarily indicative of our future results.

The following is a discussion of our operating results by segment.

Real Estate Operations

Summary real estate operating results follow:

Developed Property Sales.  Developed property sales of $1.0 million for the first quarter of 2004 included sales of a residential estate lot at the Mirador subdivision for $0.4 million and the first courtyard home at Calera Court for $0.6 million.  Developed property sales of $0.6 million for the 2003 period included sales of two residential estate lots, one at the Mirador subdivision and one at the Escala Drive subdivision.

Undeveloped Property Sales.  During the first quarter of 2003, we sold six acres of property located in southwest Austin for $0.7 million.  

Commissions, Management Fees and Other.  Commissions, management fees and other revenues totaled $0.1 million during the first quarter of 2004, compared to $0.5 million for the 2003 period.  The 2004 amount included sales of our development fee credits to third parties totaling $0.1 million, compared to $0.4 million for the 2003 period.  We received these development fee credits as part of the Circle C Settlement.  

Cost of Sales.  Cost of sales totaled $1.1 million during the first quarter of 2004 and $0.9 million for the first quarter of 2003.  The increase in the first quarter of 2004 primarily relates to costs associated with the sale of the first courtyard home at Calera Court.

Commercial Leasing Operations

Summary commercial leasing operating results follow:  

Rental Income.  Commercial leasing rental income totaled $0.8 million for the first quarter of 2004, compared to $0.9 million for the 2003 period.  In the first quarter of 2004, rental income from the 7000 West office buildings totaled $0.7 million, compared to $0.9 million for the 2003 period.  The decrease in rental income at 7000 West primarily relates to adjustments for common area maintenance (CAM) revenues, which include the allocation of property taxes, utilities, insurance and general building maintenance costs to tenants based on estimates of these costs for the year.  In the first quarter, we reconcile the annual CAM revenues with the actual costs incurred for the prior year and either charge or credit the tenants for the difference.  In the first quarter of 2003, we charged our tenants an additional $25,000 due to the CAM-related costs being higher than estimated for the year ended December 31, 2002.  In the first quarte r of 2004, we credited our tenants for $67,000 due to the actual CAM-related costs for the year ended December 31, 2003 being less than estimated.  In addition, CAM-related costs billed during the first quarter of 2004 were $48,000 less than the 2003 period primarily due to a decrease in property taxes.  In the first quarter of 2004, we earned $0.1 million in rental income from the 7500 Rialto Drive office building, as the occupancy rate increased from 33 percent in the first quarter of 2003 to 50 percent in the first quarter of 2004.

Non-Operating Results

Interest expense, net of capitalized interest, totaled $0.2 million in the first quarter of 2004, compared with $0.3 million in the first quarter of 2003.  Capitalized interest totaled $0.6 million in the first quarter of 2004 and $0.5 million in the first quarter of 2003.  The increase in capitalized interest primarily reflects the higher average balance of our borrowings outstanding during 2004 compared with 2003.

Interest income totaled $12,000 in the first quarter of 2004 and $98,000 in the first quarter of 2003.  Interest income included interest on municipal utility district (MUD) reimbursements totaling approximately $51,000 in the 2003 period.    

CAPITAL RESOURCES AND LIQUIDITY

Comparison of First Quarter 2004 and 2003 Cash Flows

Net cash used in operating activities totaled $0.5 million during the first quarter of 2004 and $0.9 million during the first quarter of 2003.  The $0.4 million improvement in operating cash flows primarily reflects working capital changes related to accounts receivable and payable.

Cash used in investing activities totaled $9.8 million during the first quarter of 2004, compared to $3.1 million during the first quarter of 2003, reflecting $7.0 million in the first quarter of 2004 for the acquisition of the Deerfield property.  In the 2004 quarter, expenditures also included improvements to certain properties in the Barton Creek and Circle C communities.  For the first quarter of both 2004 and 2003, other expenditures included the completion of certain tenant improvements to our 7500 Rialto Drive office building.  The expenditures for the first quarter of 2003 were partly offset by MUD reimbursements of $0.2 million.

Financing activities provided cash of $8.4 million during the first quarter of 2004 compared to $4.2 million during the first quarter of 2003.  During the first quarter of 2004, our financing activities included $2.4 million of net borrowings from our revolving line of credit and $5.9 million of borrowings from our project construction loans, including borrowings of $4.1 million from the Deerfield loan (see below and Note 3) and $1.2 million from the Calera Court project loan.  During the first quarter of 2003, our financing activities reflected $6.1 million of net borrowings under our revolving line of credit partially offset by payments totaling $2.0 million under our project construction loans.

Credit Facility and Other Financing Arrangements

At March 31, 2004, our total debt was $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 February 27, 2004, we entered into a $9.8 million loan agreement with Comerica to finance the acquisition and future development of the 68-acre Deerfield property in Plano, Texas, which we acquired in January 2004 (see Note 3).  Our outstanding debt at March 31, 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.

*

$20.9 million of net borrowings under the $25.0 million revolver component of the Comerica credit facility, which will mature in May 2005.

*

$2.4 million of net borrowings under the $5.0 million term loan component of the Comerica facility, for which certain of the Mirador subdivision lots and the Calera Court condominium units within the Barton Creek community are currently serving as collateral.  The term loan will mature in November 2005.

*

$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.

*

$5.3 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, we have an option to extend the maturity for one additional year under certain conditions.

*

$11.9 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, we have an option to extend the maturity for one additional year under certain conditions.

*    $4.1 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 our bank credit facility and other borrowings, see Note 5 included in our 2003 Annual Report on Form 10-K.

Project Loan Amendments

In January 2004, we amended our project loans associated with the 75,000-square-foot office building at 7500 Rialto Drive and the 140,000-square-foot office complex at 7000 West William Cannon Drive.  Under the terms of the project loan amendments, each project loan’s maturity was extended from January 31, 2004 to January 31, 2005, with options to extend the maturities for additional one-year periods.  The amendment on the 7500 Rialto Drive project loan required us to repay $69,900 of borrowings and reduced the commitment under the facility by $0.2 million to $7.6 million.  We may make additional borrowings under this facility to fund certain tenant improvements upon leasing the remaining available office space.  During the first quarter of 2004, we executed leases that will bring our 7500 Rialto Drive building to 94 percent occupancy in July 2004 when tenant improvements are completed.  As of Mar ch 31, 2004, we had $1.7 million of remaining availability under the 7500 Rialto Drive project loan and had borrowed all amounts available under the 7000 West project loan.

Deerfield Loan

On February 27, 2004, we entered into a loan agreement (Deerfield loan) with 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 received and payments made under the loan coincides with the development and lot purchase schedules.  As of March 31, 2004, borrowings outstanding under the loan totaled $4.1 million, which proceeds financed the acquisition of the Deerfield property.  

Outlook

As discussed in “Risk Factors” located in our 2003 Annual Report on Form 10-K, our financial condition and results of operations are highly dependent upon market conditions in Austin.  Our future operating cash flows and, ultimately, our ability to develop our properties and expand our business will be largely dependent on the level of our real estate sales.  In turn, these sales will be significantly affected by future real estate market conditions in Austin, Texas, development costs, interest rate levels and regulatory issues including our land use and development entitlements.  The Austin real estate market has experienced a slowdown during the past several years which has affected, and will likely in the near-term continue to affect, our operating results and liquidity.  We cannot at this time project how long or to what extent this current slowdown will persist.

We have made progress securing permitting for our Austin-area properties (see “Development and Other Activities” above).   Significant development expenditures must be incurred and additional permits secured prior to the sale of certain properties.  Certain of our properties benefit from grandfathered entitlements that are not subject to the development requirements currently in effect.  We continue to engage in positive and cooperative dialogue with the City concerning land use and development permit issues.

We are continuing to pursue additional development and management fee opportunities.  We also believe that we can obtain bank financing at a reasonable cost for developing our properties.  However, obtaining land acquisition financing is generally expensive and uncertain.

CAUTIONARY STATEMENT

Management’s discussion and analysis of financial condition and results of operations contains forward-looking statements regarding anticipated sales, debt repayments, future reimbursement for infrastructure costs, future events related to financing and regulatory matters, the expected results of our business strategy and other plans and objectives of management for future operations and activities.  Important factors that could cause actual results to differ materially from our expectations include economic and business conditions, 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, that are described in more detail under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2003.

Item 3.  Quantitative and Qualitative Disclosures about Market Risks.

There have been no significant changes in our market risks since the year ended December 31, 2003.  For more information, please read the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003.

Item 4.  Controls and Procedures.

Our chief executive officer and chief financial officer, with the participation of management, have evaluated the effectiveness of our disclosure controls and procedures as of a date within 90 days prior to the filing of this quarterly report on Form 10-Q.  Based on their evaluation, they have concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to Stratus (including our consolidated subsidiaries) required to be disclosed in our periodic Securities and Exchange Commission filings.   There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

PART II. – OTHER INFORMATION

Item 1.  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. in the 261st Judicial Distr ict 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.  On May 6, 2004, the Texas Third Court of Appeals issued a ruling in favor of Stratus and the City, denying SOSA’s appeal and affirming the District Court’s ruling dismissing the lawsuit.

S.R. 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.  Those 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 and Stratus each filed second motions to dismiss, arguing that the legal deficiencies in plaintiff’s initial petition had still not been cured.  On April 8, 2004, the Court denied both the City’s and Stratus’ second motions to dismiss, expressly stating, however, that the denials were without prejudice to either Stratus or the City filing a motion for summary judgment after the plaintiff has had an opportunity to conduct discovery.  Stratus anticipates filing a motion for summary judgment after S.R. Ridge has had an opportunity to conduct limited discovery.

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 6.  Exhibits and Reports on Form 8-K.

(a)

The exhibits to this report are listed in the Exhibit Index beginning on page E-1 hereof.  

Instruments with respect to other long-term debt of the Company and its consolidated subsidiaries are omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K since the total amount authorized under each such omitted instrument does not exceed 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis.  The Company hereby agrees to furnish a copy of any such instrument to the Securities and Exchange Commission upon request.

(a)

During the quarter for which this report is filed, the registrant filed one Current Report on Form 8-K furnishing information under Item 12 dated March 30, 2004.

Subsequent to the end of the quarter for which this report is filed and prior to the date of this filing, the registrant filed one Current Report on Form 8-K furnishing information under Item 12 dated May 13, 2004.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

STRATUS PROPERTIES INC.

By:  /s/ John E. Baker            

            John E. Baker

    Senior Vice President and

       Chief Financial Officer

       (authorized signatory and

        Principal Financial Officer)

Date:

May 17, 2004

STRATUS PROPERTIES INC.

EXHIBIT INDEX

  Exhibit

 Number