SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB _______________________________________________________ [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended March 31, 1997 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period from ------------to------------ ________________________________________________________ Commission File Number 0-20047 I.R.S. Employer Identification Number 41-1691930 Royale Investments, Inc. 3430 List Place Minneapolis, MN 55416 Telephone: (612) 920-4078 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days. Yes X No --- --- The number of shares outstanding of the Registrant's stock as of May 1, 1997 was: 1,420,000 Shares of Common Stock ROYALE INVESTMENTS, INC. INDEX Page No. ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Balance Sheets March 31, 1997 and March 31, 1996............... 2 Statements of Income Three Months Ended March 31, 1997 and 1996...... 3 Statements of Cash Flows Three Months Ended March 31, 1997 and 1996...... 4 Notes to Financial Statements................... 5-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............. 11 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K................ 12 Signatures...................................... 12 Royale Investments, Inc. BALANCE SHEETS (Unaudited) March 31, 1997 1996 ---- ---- ASSETS REAL ESTATE INVESTMENTS SUBJECT TO OPERATING LEASES: Land $ 5,428,130 $ 5,428,130 Land improvements 2,577,901 2,577,901 Buildings 17,021,327 17,021,327 ----------- ----------- 25,027,358 25,027,358 Less: accumulated depreciation 2,096,055 1,541,626 ----------- ----------- 22,931,303 23,485,732 CASH AND CASH EQUIVALENTS 224,631 283,812 MARKETABLE SECURITIES 485,539 587,600 OTHER ASSETS 402,266 337,136 ----------- ----------- $24,043,739 $24,694,280 ----------- ----------- ----------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Mortgage notes payable $14,579,429 $14,855,756 Dividends payable 177,500 177,500 Accounts payable and other liabilities 202,282 189,164 ----------- ----------- 14,959,211 15,222,420 ----------- ----------- STOCKHOLDERS' EQUITY: Common stock - $.01 par value per share Authorized - 50,000,000 shares Issued - 1,420,000 shares 14,200 14,200 Additional paid-in capital 12,353,398 12,353,398 Distributions in excess of accumulated earnings (3,283,070) (2,895,738) ----------- ----------- 9,084,528 9,471,860 ----------- ----------- $24,043,739 $24,694,280 ----------- ----------- ----------- ----------- The accompanying notes are an integral part of these financial statements 2 Royale Investments, Inc. STATEMENTS OF OPERATIONS AND DISTRIBUTIONS IN EXCESS OF ACCUMULATED EARNINGS (Unaudited) Three Months Ended March 31, 1997 1996 ---- ---- INCOME: Rental income $ 625,429 $ 611,045 Interest earned 7,167 9,351 ----------- ----------- 632,596 620,396 ----------- ----------- EXPENSES: Operations and management 79,391 85,607 Mortgage and other interest 308,179 313,591 Depreciation and amortization 141,771 141,771 Administrative and general 12,581 18,375 ----------- ----------- 541,922 559,344 ----------- ----------- NET INCOME 90,674 61,052 DISTRIBUTIONS IN EXCESS OF ACCUMULATED EARNINGS: Balance - beginning (3,196,244) (2,779,290) Dividends paid and declared (177,500) (177,500) ----------- ----------- Balance - ending $(3,283,070) $(2,895,738) ----------- ----------- ----------- ----------- PER COMMON SHARE: Net income $.06 $.04 Dividends declared $.12 $.12 WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 1,420,000 1,420,000 The accompanying notes are an integral part of these financial statements 3 Royale Investments, Inc. STATEMENTS OF CASH FLOWS (Unaudited) Three Months Ended March 31, 1997 1996 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 90,674 $ 61,052 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 141,771 141,771 Amortization of marketable securities (6,160) (7,479) Changes in operating assets and liabilities: (Increase) in rent receivables (16,639) (18,638) (Increase) decrease in other assets 726 (4,719) Increase in accounts payable and other liabilities 12,305 91,242 ----------- ----------- Net cash provided by operating activities 222,677 263,229 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on mortgage loans (78,821) (59,887) Dividends paid to shareholders (177,500) (177,500) ----------- ----------- Net cash (used) by financing activities (256,321) (237,387) ----------- ----------- NET INCREASE (DECREASE) IN CASH (33,644) 25,842 CASH AND CASH EQUIVALENTS: Beginning of period 258,275 257,970 ----------- ----------- End of period $ 224,631 $ 283,812 ----------- ----------- ----------- ----------- Supplementary data: Income taxes paid $ - $25 Interest paid $ 342,961 $276,403 The accompanying notes are an integral part of these financial statements 4 Royale Investments, Inc. NOTES TO FINANCIAL STATEMENTS Three Months Ended March 31, 1997 and 1996 (Unaudited) 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Royale Investments, Inc. (the company), a Minnesota corporation, was formed in 1988, to acquire a portfolio of income-producing commercial real estate properties. The company has qualified as a real estate investment trust (REIT) under provisions of the Internal Revenue Code. USE OF ESTIMATES The preparation of these financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that may affect certain reported amounts and disclosures in the financial statements and accompanying notes. Actual results could differ from these estimates. REAL ESTATE INVESTMENTS Real estate investments, consisting entirely of properties leased to operators of retail food stores, are recorded at cost and include land, land improvements, and buildings. For financial reporting purposes, depreciation is computed by the straight-line method using a 40-year life for buildings and a 20-year life for land improvements. For income tax purposes, depreciation is computed by the straight-line method using lives of 31.5-40 years for buildings and 15-20 years for land improvements. CASH AND CASH EQUIVALENTS The company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. The company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash. INCOME TAXES The company has qualified, and intends to continue to qualify, as a real estate investment trust under Sections 856 through 860 of the Internal Revenue Code and, to the extent available, the applicable state statutes. Under such provisions, the company is not subject to federal income tax on amounts distributed to stockholders, provided at least 95% of its real estate investment trust taxable income is distributed. As the company intends to distribute all of its income currently, no federal income tax provision was made. State income taxes are incurred in some of the states in which the company owns property. This expense is included with administrative and general expense. 5 Royale Investments, Inc. NOTES TO FINANCIAL STATEMENTS Three Months Ended March 31, 1997 and 1996 (Unaudited) 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NET INCOME PER COMMON SHARE Net income per common share is based upon the weighted average number of common and common equivalent shares outstanding during each year. Common stock equivalents represent stock options assumed to be exercised. Common stock equivalents were not considered if they had an anti-dilutive effect on net income per common share. DIRECTORS' STOCK OPTION PLAN In April 1993, the company adopted a stock option plan for directors which provides for the grant of an option to purchase 2,500 shares of common stock to a director upon appointment or election, and upon each re-election. The purchase price of the stock will be the fair market value at the time the option is granted. The options cannot be exercised for the first year after the option is granted and expires ten years from the date of the grant. The company reserved 75,000 shares of common stock for issuance pursuant to the plan. The company accounts for stock options issued to directors in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate fair value of each class of financial instruments: Cash and cash equivalents - The carrying amount approximates fair value because of their liquidity. Marketable securities - The fair value is based on quoted market prices. Mortgage notes payable - The carrying value approximates fair value. 2. MARKETABLE SECURITIES The company owns U.S. Treasury Bills which are accounted for as held-to-maturity securities. The held-to-maturity securities are due in one year or less and amortized cost approximates market value. 6 Royale Investments, Inc. NOTES TO FINANCIAL STATEMENTS Three Months Ended March 31, 1997 and 1996 (Unaudited) 3. OTHER ASSETS Other assets consists of the following as of March 31: 1997 1996 ---- ---- Accrued rental income $200,453 $133,898 Loan costs (net of accumulated amortization: 1997 - $37,206, and 1996 - $24,551) 182,262 194,917 Other 19,551 8,321 -------- -------- $402,266 $337,136 -------- -------- -------- -------- Loan costs include application fees, lender fees, and legal costs paid to acquire mortgage loans and are amortized over the terms of the loans. 4. LEASES The company leases its properties to operators of seven major retail food stores under long-term operating lease agreements. The leases are accounted for under the provisions of Statement of Financial Accounting Standards No. 13, "Accounting for Leases." The leases have initial terms of 17 to 20 years (expiring between 2006 and 2014) and provide for minimum and contingent rentals. In addition, the tenant is generally required to pay all property taxes, insurance, and maintenance costs. The leases have renewal options for 4 to 8 successive five-year periods, subject to substantially the same terms and conditions as the initial lease. Five of the leases are guaranteed by the lessee's parent company or franchisor. The guaranteed leases provide for escalating minimum rent to begin in subsequent years. Income from these scheduled rent increases is recognized on a straight-line basis over the term of each lease. The amount earned in excess of the amount received is included in accrued rental income. Approximate future minimum rentals on these leases are as follows: For the Years Ending December 31: Amount --------------------------------- ------ 1997 $ 2,441,000 1998 2,441,000 1999 2,462,000 2000 2,480,000 2001 2,488,000 thereafter 25,127,000 ---------- $37,439,000 ----------- ----------- 7 Royale Investments, Inc. NOTES TO FINANCIAL STATEMENTS Three Months Ended March 31, 1997 and 1996 (Unaudited) 5. MORTGAGE NOTES PAYABLE Mortgage notes payable as of March 31, are as follows: March 31, 1997 1996 ---- ---- Mortgage note collateralized by land, buildings, and assignments of rents in Indianapolis, Indiana and Plymouth, Minnesota, interest rate of 9.5%, monthly payments of principal and interest of $40,890 through May 2002, and final payment of $4,433,758 due June 2002. $ 4,695,208 $ 4,737,632 Mortgage note collateralized by land, a building, and an assignment of rents in Peru, Illinois, interest rate at 8%, monthly payments of principal and interest of $21,489 through December 1998, $22,212 from January 1999 through December 2003, $22,886 from January 2004 through December 2008, $23,537 from January 2009 through October 2013, and a final payment of $5,585 due November 2013. 2,470,453 2,532,759 Mortgage note collateralized by land, a building, and an assignment of rents in Minot, North Dakota, interest rate of 8%, monthly payments of principal and interest of $23,111 through February 1999, $23,888 from March 1999 through February 2004, $24,614 from March 2004 through February 2009, $25,313 from March 2009 through December 2013, and a final payment of $26,126 due January 2014. 2,671,752 2,737,531 Mortgage note collateralized by land, a building, and an assignment of rents in Glendale, Wisconsin, interest rate of 7.75%, monthly payments of principal and interest of $10,602 through April 2011, and a final pay- ment of approximately $11,125 due April 2011. 1,088,710 1,129,814 Mortgage note collateralized by land, a building, and an assignment of rents in Oconomowoc, Wisconsin, interest rate of 7.625%, monthly payments of principal and interest of $12,750 through June 1999, $13,500 from July 1999 through June 2004, $17,700 from July 2004 through June 2009, and $18,750 from July 2009 through June 2014. 1,751,981 1,770,614 ---------- ---------- Subtotal 12,678,104 12,908,350 ---------- ---------- ---------- ---------- 8 Royale Investments, Inc. NOTES TO FINANCIAL STATEMENTS Three Months Ended March 31, 1997 and 1996 (Unaudited) 5. MORTGAGE NOTES PAYABLE (CONTINUED) 1997 1996 ---- ---- Balance forward 12,678,104 12,908,350 Mortgage note collateralized by land, a building, and an assignment of rents in Delafield, Wisconsin, interest rate of 8.125%, monthly payments of principal and interest of $16,885 through November 2004, and a final payment of $1,401,001 due December 2004. In December 1999, the holder has the option to adjust the interest rate to 1.80% over the then current five-year U.S. Treasury yield. Monthly payments will be adjusted accordingly. 1,901,325 1,947,406 ----------- ----------- $14,579,429 $14,855,756 ----------- ----------- ----------- ----------- Approximate future maturities of mortgage notes are as follows: For the Years Ending December 31: Amount --------------------------------- ------ 1997 $ 283,000 1998 307,000 1999 355,000 2000 391,000 2001 425,000 thereafter 12,897,250 ----------- $14,658,250 ----------- ----------- 6. MAJOR TENANTS All of the company's rental revenue is derived from four major tenants, each of which contributed at least 20% of the total revenues for each of the periods presented in the statements of income. 7. DIVIDENDS On March 31, 1997, the board of directors declared a cash dividend of $.125 per common share payable on April 14, 1997, to stockholders of record on March 31, 1997. 9 Royale Investments, Inc. NOTES TO FINANCIAL STATEMENTS Three Months Ended March 31, 1997 and 1996 (Unaudited) 8. RELATED-PARTY TRANSACTIONS Pursuant to an advisory agreement, Crown Advisors, Inc., an affiliate of the company, acts as investment advisor to the company and assists in the management of the day-to-day operations. Under this agreement, the company pays the advisor an annual fee of up to 1% of "invested real estate assets", as defined in the agreement. The advisor is also entitled to a performance fee, also as defined in the agreement. No performance fee has been incurred under this agreement. In addition, the company must pay a 3% commission for each real estate acquisition and disposition. Upon termination of the agreement, the company must pay a fee equal to 3% of the invested real estate assets plus 25% of the increase in the value of invested real estate assets from the date of acquisition to the date of termination. Fees and commissions incurred were as follows for the three months ended March 31: 1997 1996 ---- ---- Advisory fee $62,568 $62,568 Commissions - - ------- ------- $62,568 $62,568 ------- ------- ------- ------- An officer and director of the company is a partner in a law firm which received fees from the company relating to legal services totaling $1,315 for the three months ended March 31, 1997. 9. GUARANTY FEES The company obtained a lease guaranty from the seller of the Plymouth and Indianapolis properties, for up to the lesser of $3.5 million or the aggregate amount of the remaining lease obligations. The guaranty will expire in 2002. In consideration of the guaranty, the company agreed to pay to the seller an annual fee of 1% of the value of the guaranty. In 1996, the Indianapolis tenant sold their operation to a new tenant, with the approval of the company. As an inducement to allow this lease transfer, the new tenant agreed to reimburse the company one-half of this fee. The amount receivable is included in other assets. 10. FUNDS FROM OPERATIONS Funds from operations for the three months ended March 31, 1997, and 1996, were $232,445 ($.16 per share), and $202,823 ($.14 per share), respectively. 10 ROYALE INVESTMENTS, INC. ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION RESULTS OF OPERATIONS During the three month periods ended March 31, 1997 and 1996, the Company owned and leased seven properties in five states to operators of retail food stores. Revenues for the first quarter ended March 31, 1997, increased slightly over the comparable period of 1996 due to scheduled increases in rent income, which was partially offset by decreases in interest income. Expenses during the quarter were reduced 3.1% compared with the compable period of 1996. Mortgage interest, operations and management and administrative and general expenses decreased in 1997, and are the primary reasons for the increase in net income. Net income increased to $90,674 for the first quarter of 1997, versus $61,052 for the first quarter of 1996, a 49% increase and within management's expectations. The Company considers Funds from operations ("FFO") along with net income and cash flows as a measure of the Company's operating performance and liquidity. FFO is essentially net income computed in accordance with generally accepted accounting principles, but excluding depreciation expense and gains (or losses) from sales of property. For the first quarter of 1997, FFO increased 14.6% to $232,445 from $202,823 in first quarter of 1996. LIQUIDITY AND CAPITAL RESOURCES The Company's properties are all leased on a triple-net basis, which places the risk of rising property costs, such as maintenance, insurance and property taxes, on the tenant. The leases generally provide that the tenant is also responsible for roof and structural repairs. Hence, the Company's only demand for funds has been for the payment of management and administrative expenses, dividends and mortgage payments. Property acquisitions have been funded by equity offerings and mortgage borrowing's. Net cash provided by operating activities totaled $222,677 and $263,229 for the three months ended March 31, 1997 and 1996, respectively. The decrease was primarily the result of changes in operating assets and liabilities arising from timing differences in receipts and disbursements from year to year. The Company considers its liquidity to be sufficient to meet its operating and distribution requirements for the remainder of 1997. The Company invests in short-term treasury securities from time to time, and net cash provided by investing activities reflects those transactions. Net cash used in financing activities totaled $256,321 and $237,387 for the three months ended March 31, 1997 and 1996, respectively, including dividends paid to shareholders. This increase is due primarily to the increase in mortgage amortization. The Company declared a dividend of $177,500, or $.125 per share, on March 21, 1997, payable to shareholders of record on March 31, 1997. The dividend was paid on April 14, 1997. 11 PART II OTHER INFORMATION ITEM 1 - 5. NONE ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits filed with Form 10-QSB None b) No reports filed on Form 8-K for the quarter ended March 31, 1997. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused the report to be signed on it's behalf by the undersigned, thereunto duly authorized. Dated: May 7, 1997 ROYALE INVESTMENTS, INC. By: ____________________ Vernon R. Beck Chief Executive Officer 12