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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.  

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.

7.

RESTRICTED CASH AND INTEREST COST

Restricted Cash.  Stratus had restricted cash deposits totaling $0.8 million at June 30, 2004 and $0.2 million at December 31, 2003, of which $0.2 million at both dates reflects 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).  The remaining restricted cash of $0.6 million at June 30, 2004 represents funds held for payment on the Comerica credit facility that were applied in July 2004.

Interest Cost.  Interest expense excludes capitalized interest of $0.8 million in the second quarter of 2004, $0.6 million in the second quarter of 2003, $1.4 million in the first six months of 2004 and $1.1 million in the first six months of 2003.

REVIEW BY INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The financial information as of June 30, 2004, and for the three-month and six-month periods ended June 30, 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 registered public accounting firm, in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

   of Stratus Properties Inc.:

We have reviewed the condensed consolidated balance sheet of Stratus Properties Inc. (a Delaware Corporation) as of June 30, 2004, the related consolidated statements of operations for the three-month and six-month periods ended June 30, 2004 and 2003, and the consolidated statements of cash flows for the six-months ended June 30, 2004 and 2003.  These interim financial statements are the responsibility of management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States).  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 the standards of the Public Company Accounting Oversight Board, 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 review, we are not aware of any material modifications that should be made to the condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), 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 consolidated balance sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP

Austin, Texas

August 12, 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 2,030 acres of undeveloped residential, multi-family and commercial property and 53 developed residential estate lots located within the Barton Creek community.  We also own approximately 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 (7000 Wes t), 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 ACTIVITIES

In May 2004, we entered into a contract with a national homebuilder to sell 41 lots within the Wimberly Lane Phase II subdivision.  We are retaining and marketing the six estate lots in the subdivision. In June 2004, the homebuilder paid us 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 deposit 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.

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 and will be recognized as income as lots are sold.  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 co sts.  The homebuilder must pay all property taxes 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.  Development is proceeding on schedule and we currently have $5.4 million in remaining availability under the loan.

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 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.  Zoning for the 160,000-square-foot project was approved during the second quarter of 2004.  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 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 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 first quarter of 2004, we borrowed $1.2 million under the project loan, which matures in No vember 2005 and is secured by the condominium units at Calera Court.

During the first quarter of 2004, we executed leases that brought our 7500 Rialto Drive office building to 90 percent occupancy in July 2004.  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 30, 2004, we terminated 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

Real Estate Operations

Summary real estate operating results follow:  

Developed Property Sales.  Developed property sales of $1.8 million for the second quarter of 2004 included sales of three residential estate lots at the Escala Drive subdivision for $1.0 million and two residential estate lots at the Mirador subdivision for $0.8 million.  Second-quarter 2003 developed property sales included the sale of a Wimberly Lane subdivision residential lot.  The first six months of 2004 also included the first-quarter 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 $0.7 million for the first six months of 2003 included sales of two residential estate lots, one at the Mirador subdivision and one at the Escala Drive subdivision, during the first quarter.

Undeveloped Property Sales.  During the second quarter of 2004, we sold two tracts totaling three acres within the Circle C community for $1.4 million.  We sold six acres of undeveloped property located in southwest Austin during the first quarter of 2003.

Commissions, Management Fees and Other.  Commissions, management fees and other revenues totaled $0.2 million during the first six months of 2004, compared to $1.0 million for the 2003 period.  The 2004 amount included sales of our development fee credits to third parties totaling $0.1 million, compared to $0.6 million for the 2003 period. We received these development fee credits as part of the Circle C Settlement.  During 2003, commissions and management fees also included fees paid to us associated with our involvement in the Lakeway Project, near Austin, Texas, totaling $0.1 million for the second quarter and $0.2 million for the six months ended June 30, 2003.  During the second quarter of 2003, we sold the last remaining 5-acre commercial tract at the Lakeway Project for $0.7 million and received $0.3 million representing our 40 percent share of the related net sales proceeds.  For more information regarding our involvement in th e Lakeway Project, see Note 4 of our 2003 Annual Report on Form 10-K.

Cost of Sales.  Cost of sales totaled $2.1 million during the second quarter of 2004 and $0.6 million for the second quarter of 2003.  Cost of sales totaled $3.3 million during the first six months of 2004 and $1.5 million for the 2003 period.  The increases reflect the larger number of lot and home sales during the 2004 periods compared to the 2003 periods.

Commercial Leasing Operations

Summary commercial leasing operating results follow:

Rental Income.   For the second quarters of both 2004 and 2003, we received rental income of $0.8 million from our two fully leased 7000 West office buildings in the Lantana project in southwest Austin.  In addition, we earned $0.2 million in rental income from our 75,000-square-foot office building at 7500 Rialto Drive for the second quarter of 2004, compared to $0.1 million for the second quarter of 2003, as the occupancy rate increased from 32 percent in the second quarter of 2003 to approximately 57 percent in the second quarter of 2004.  During the first quarter of 2004, we executed leases that brought our 7500 Rialto Drive office building to 90 percent occupancy in July 2004.  

Rental Property Costs.  Rental property costs increased in the 2004 periods compared to the 2003 periods, reflecting the services provided by Southwest Property Services L.L.C., which we formed in March 2004 to manage these office buildings.  Previously, we had outsourced our property management functions to a property management firm.  Effective June 30, 2004, we terminated our agreement with this firm and Southwest Property Services L.L.C. now performs all property management responsibilities.

CAPITAL RESOURCES AND LIQUIDITY

Comparison of Six Months 2004 and 2003 Cash Flows

Operating activities provided cash of $2.4 million during the first six months of 2004 compared to a use of $0.8 million during the first six months of 2003.  Compared to the 2003 period, operating cash flows improved primarily due to the increase in sales activities and working capital changes.

Cash used in investing activities totaled $13.5 million during the first six months of 2004, compared to $5.6 million during the 2003 period, reflecting $7.0 million for the acquisition of the Deerfield property in the first quarter of 2004.  In the first half of 2004, expenditures also included improvements to certain properties in the Barton Creek and Circle C communities.  For the first six months of both 2004 and 2003, other expenditures included the completion of certain tenant improvements to our 7500 Rialto Drive office building.  The expenditures for both the 2004 and 2003 periods were partly offset by municipal utility district (MUD) reimbursements of $0.1 million and $0.5 million, respectively.  Our investing proceeds during the first half of 2003 reflect proceeds from our involvement in the Lakeway Project.  During 2003, we received $0.3 million of proceeds from the Lakeway Project, including $0.2 million represent ing the final return of our investment in the project.

Financing activities provided cash of $9.0 million during the first six months of 2004 compared to $6.9 million during the first six months of 2003.  During 2004, our financing activities included $2.3 million of net borrowings from our revolving line of credit and $6.0 million of net borrowings from our project construction loans, including borrowings of $4.4 million from the Deerfield loan and $1.2 million from the Calera Court project loan.  During 2003, our financing activities reflected $9.0 million of net borrowings under our revolving line of credit partially offset by payments of $2.1 million under our project construction loans.

Credit Facility and Other Financing Arrangements

At June 30, 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 the $9.8 million Deerfield loan (see below and Note 3).  Our outstanding debt 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.  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, we have 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, we have 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 our bank credit facility and other borrowings, see Note 5 included in our 2003 Annual Report on Form 10-K.

Credit Facility Amendment

On June 23, 2004, we modified our $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.  

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.  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 brought our 7500 Rialto Drive building to 90 percent occupancy in July 2004.  As of June 30, 2004, we had $2.0 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 June 30, 2004, borrowings outstanding under the loan totaled $4.4 million, which proceeds financed the acquisition and the initial development costs of the Deerfield property.  Currently, we have $5.4 million in remaining availability under the loan.  

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 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.  On June 7, 2004, SOSA filed a motion requesting that the Texas Third Court of Appeals reconsider its ruling.

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.  On July 16, 2004, S.R. Ridge filed an Agreed Motion to Abate.  On July 20, 2004, the court granted the motion, abating the case for one month to permit S.R. Ridge to evaluate the sale of its property to a third party, which would lead to a resolution of the case.  If resolution is not reached as a result of a sale to a third party,  Stratus anticipates filing a mot ion 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 4.  Submission of Matters to a Vote of Security Holders

Our annual meeting of stockholders was held on May 13, 2004 (the “Annual Meeting”).  Proxies were solicited pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.  The following matters were submitted to a vote of security holders during our Annual Meeting:  

There were no abstentions with respect to the election of directors.  In addition to the director elected at the Annual Meeting, the terms of the following directors continued after the Annual Meeting: Bruce G. Garrison, James C. Leslie and Michael D. Madden.

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.

(b)

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 May 13, 2004.

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

August 13, 2004

STRATUS PROPERTIES INC.

EXHIBIT INDEX

  Exhibit

 Number