SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR QUARTER ENDED March 31, 1999 COMMISSION FILE NUMBER 1-12254 SAUL CENTERS, INC. ------------------ (Exact name of registrant as specified in its charter) Maryland 52-1833074 --------------------------------- -------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification Number incorporation or organization) 8401 Connecticut Avenue, Chevy Chase, Maryland 20815 - -------------------------------------------------------------------------------- (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code (301) 986-6200 -------------- Number of shares outstanding of each of the registrant's classes of common stock, as of May 7, 1999: Common Stock par value $0.01 per share: 13,074,000 - -------------------------------------------------------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. YES |X| NO |_|
SAUL CENTERS, INC. PART I. FINANCIAL INFORMATION Page ---- Item 1. Financial Statements (Unaudited) (a) Consolidated Balance Sheets as of March 31, 1999 and December 31, 1998........................................... 4 (b) Consolidated Statements of Operations for the three months ended March 31, 1999 and 1998............................... 5 (c) Consolidated Statements of Stockholders' Equity as of March 31, 1999 and December 31, 1998........................ 6 (d) Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998............................... 7 (e) Notes to Consolidated Financial Statements................. 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (a) Liquidity and Capital Resources............................ 16 (b) Results of Operations Three months ended March 31, 1999 compared to three months ended March 31, 1998........................................ 21 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders........... 24 Item 6. Exhibits and Reports on Form 8-K.............................. 24 2
PART I. FINANCIAL INFORMATION Item 1. Financial Statements Basis of Presentation In the opinion of management, the accompanying consolidated financial statements reflect all adjustments necessary for fair presentation of the financial position and results of operations of Saul Centers, Inc. All such adjustments are of a normal recurring nature. These consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements of Saul Centers, Inc. for the year ended December 31, 1998, which are included in its Annual Report on Form 10-K. The results of operations for interim periods are not necessarily indicative of results to be expected for the year. 3
Saul Centers, Inc. CONSOLIDATED BALANCE SHEETS (Unaudited) <TABLE> <CAPTION> March 31, December 31, (Dollars in thousands) 1999 1998 - ------------------------------------------------------------------------------------- <S> <C> <C> Assets Real estate investments Land $ 63,795 $ 64,339 Buildings and equipment 286,654 283,722 --------- --------- 350,449 348,061 Accumulated depreciation (104,472) (101,910) --------- --------- 245,977 246,151 Construction in progress 8,941 4,506 Cash and cash equivalents 2,061 2,395 Accounts receivable and accrued income, net 5,661 6,347 Prepaid expenses 6,600 6,873 Deferred debt costs, net 3,510 3,604 Other assets 2,494 1,158 --------- --------- Total assets $ 275,244 $ 271,034 ========= ========= Liabilities Notes payable $ 291,781 $ 290,623 Accounts payable, accrued expenses and other liabilities 16,423 14,856 Deferred income 2,794 2,839 --------- --------- Total liabilities 310,998 308,318 --------- --------- Minority interests -- -- --------- --------- Stockholders' equity (deficit) Common stock, $0.01 par value, 30,000,000 shares authorized, 12,957,468 and 12,836,378 shares issued and outstanding, respectively 130 129 Additional paid-in capital 35,451 31,967 Accumulated deficit (71,335) (69,380) --------- --------- Total stockholders' equity (deficit) (35,754) (37,284) --------- --------- Total liabilities and stockholders' equity $ 275,244 $ 271,034 ========= ========= </TABLE> The accompanying notes are an integral part of these statements 4
Saul Centers, Inc. CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited) <TABLE> <CAPTION> For the Three Months Ended March 31, (Dollars in thousands, except per share amounts) 1999 1998 - ------------------------------------------------------------------------------------- <S> <C> <C> Revenue Base rent $ 14,333 $ 13,471 Expense recoveries 2,448 2,320 Percentage rent 780 799 Other 403 553 --------- --------- Total revenue 17,964 17,143 --------- --------- Operating expenses Property operating expenses 1,936 1,971 Provision for credit losses 61 40 Real estate taxes 1,534 1,422 Interest expense 5,530 5,604 Amortization of deferred debt expense 103 101 Depreciation and amortization 2,897 2,725 General and administrative 862 802 --------- --------- Total operating expenses 12,923 12,665 --------- --------- Net income before minority interests 5,041 4,478 --------- --------- Minority interests Minority share of income (1,381) (1,012) Distributions in excess of earnings (540) (701) --------- --------- Total minority interests (1,921) (1,713) --------- --------- Net income $ 3,120 $ 2,765 ========= ========= Net income per share (basic and dilutive) Net income before minority interests $ 0.28 $ 0.27 ========= ========= Net income $ 0.24 $ 0.22 ========= ========= </TABLE> The accompanying notes are an integral part of these statements 5
Saul Centers, Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited) <TABLE> <CAPTION> Additional Common Paid-in Accumulated (Dollars in thousands, except per share amounts) Stocks Capital Deficit Total - ------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Stockholders' equity (deficit): Balance, December 31, 1997 $ 124 $ 20,447 $ (58,625) $ (38,054) Issuance of 408,233 shares of common stock 5 6,629 -- 6,634 Issuance of 405,532 convertible limited partnership units in the Operating Partnership -- 4,891 -- 4,891 Net income -- -- 9,129 9,129 Distributions ($1.17 per share) -- -- (14,899) (14,899) Distributions payable ($.39 per share) -- -- (4,985) (4,985) --------- --------- --------- --------- Balance, December 31, 1998 129 31,967 (69,380) (37,284) Issuance of 121,090 shares of common stock 1 1,702 -- 1,703 Issuance of 126,702 convertible limited partnership units in the Operating Partnership -- 1,782 -- 1,782 Net income -- -- 3,120 3,120 Distributions payable ($.39 per share) -- -- (5,075) (5,075) --------- --------- --------- --------- Balance, March 31, 1999 $ 130 $ 35,451 $ (71,335) $ (35,754) ========= ========= ========= ========= </TABLE> The accompanying notes are an integral part of these statements 6
Saul Centers, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <TABLE> <CAPTION> For the Three Months Ended March 31, (Dollars in thousands) 1999 1998 - ------------------------------------------------------------------------------------- <S> <C> <C> Cash flows from operating activities: Net income $ 3,120 $ 2,765 Adjustments to reconcile net income to net cash provided by operating activities: Minority interests 1,921 1,713 Depreciation and amortization 3,000 2,826 Provision for credit losses 61 40 Decrease (increase) in accounts receivable 625 (334) Decrease (increase) in prepaid expenses (62) 122 Increase in other assets (1,336) (1,508) Increase in accounts payable and other liabilities 1,567 1,146 Increase (decrease) in deferred income (45) 592 --------- --------- Net cash provided by operating activities 8,851 7,362 --------- --------- Cash flows from investing activities: Additions to real estate investments (2,932) (1,412) Additions to construction in progress (3,891) (794) --------- --------- Net cash used in investing activities (6,823) (2,206) --------- --------- Cash flows from financing activities: Proceeds from notes payable 5,808 4,500 Repayments on notes payable (4,650) (3,280) Additions to deferred debt expense (9) (13) Proceeds from the issuance of common stock and convertible limited partnership units in the Operating Partnership 3,485 1,591 Distributions to common stockholders and holders of convertible limited partnership units in the Operating Partnership (6,996) (6,582) --------- --------- Net cash used in financing activities (2,362) (3,784) --------- --------- Net increase (decrease) in cash (334) 1,372 Cash, beginning of period 2,395 688 --------- --------- Cash, end of period $ 2,061 $ 2,060 ========= ========= </TABLE> The accompanying notes are an integral part of these statements 7
Saul Centers, Inc. Notes to Consolidated Financial Statements (Unaudited) 1. Organization, Formation and Structure Organization Saul Centers, Inc. ("Saul Centers") was incorporated under the Maryland General Corporation Law on September 10, 1993. The authorized capital stock of Saul Centers consists of 30,000,000 shares of common stock, having a par value of $0.01 per share and 1,000,000 shares of preferred stock. Each holder of common stock is entitled to one vote for each share held. Saul Centers, together with its wholly owned subsidiaries and the limited partnerships of which Saul Centers or one of its subsidiaries is the sole general partner, are referred to collectively as the "Company". Saul Centers operates as a real estate investment trust under the Internal Revenue Code of 1986, as amended (a "REIT"). Formation and Structure of Company Saul Centers was formed to continue and expand the shopping center business previously owned and conducted by the B.F. Saul Real Estate Investment Trust, the B.F. Saul Company, Chevy Chase Bank, F.S.B. and certain other affiliated entities (collectively, "The Saul Organization"). On August 26, 1993, The Saul Organization transferred to Saul Holdings Limited Partnership, a newly formed Maryland limited partnership (the "Operating Partnership"), and two newly formed subsidiary limited partnerships (the "Subsidiary Partnerships") 26 shopping center properties, one office property, one research park and one office/retail property and the management functions related to the transferred properties. Since its formation, the Company has purchased three additional community and neighborhood shopping center properties, an office property and purchased a land parcel which it developed into a community shopping center. The Company is currently in the predevelopment and approval process of converting an under-performing shopping center to an industrial / warehouse use. Therefore, as of March 31, 1999, the Company's properties (the "Current Portfolio Properties") consisted of 29 operating shopping center properties (the "Shopping Centers"), a property planned to be converted to an industrial / warehouse facility (the "Industrial Property") and four predominantly office properties (the "Office Properties"). To facilitate the placement of collateralized mortgage debt, the Company established Saul QRS, Inc. and SC Finance Corporation, each of which is a wholly owned subsidiary of Saul Centers. Saul QRS, Inc. was established to succeed to the interest of Saul Centers as the sole general partner of Saul Subsidiary I Limited Partnership. As a consequence of the transactions constituting the formation of the Company, Saul Centers serves as the sole general partner of the Operating Partnership and of Saul Subsidiary II Limited Partnership, while Saul QRS, Inc., Saul Centers' wholly owned subsidiary, serves as the sole general partner of Saul Subsidiary I Limited Partnership. The remaining limited partnership interests in Saul Subsidiary I Limited Partnership and Saul Subsidiary II Limited Partnership are held by the Operating Partnership as the sole limited partner. Through this structure, the Company owns 100% of the Current Portfolio Properties. 8
Saul Centers, Inc. Notes to Consolidated Financial Statements (Unaudited) 2. Summary of Significant Accounting Policies Nature of Operations The Company, which conducts all of its activities through its subsidiaries, the Operating Partnership and Subsidiary Partnerships, engages in the ownership, operation, management, leasing, acquisition, renovation, expansion, development and financing of community and neighborhood shopping centers and office properties, primarily in the Mid-Atlantic region. A majority of the Shopping Centers are anchored by several major tenants. Eighteen of the 29 Shopping Centers are anchored by a grocery store and offer primarily day-to-day necessities and services. As of December 1998, no single shopping center accounted for more than 11.4% of the total shopping center gross leasable area. Only one retail tenant, Giant Food at 7.1%, accounted for more than 1.7% of the Company's 1998 total revenues. No office tenant other than the United States General Service Administration, at 10.4%, accounted for more than 1.8% of 1998 total revenues. Principles of Consolidation The accompanying consolidated financial statements of the Company include the accounts of Saul Centers, its subsidiaries, and the Operating Partnership and Subsidiary Partnerships which are majority owned by Saul Centers. All significant intercompany balances and transactions have been eliminated in consolidation. Real Estate Investment Properties Real estate investment properties are stated at the lower of depreciated cost or fair value less cost to sell. Management believes that these assets have generally appreciated in value and, accordingly, the aggregate current value exceeds their aggregate net book value and also exceeds the value of the Company's liabilities as reported in these financial statements. These financial statements are prepared in conformity with generally accepted accounting principles, and accordingly, do not report the current value of the Company's real estate assets. Real estate investment properties are reviewed for potential impairment losses whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of an individual property's undiscounted expected future cash flows is less than its carrying amount, the Company's policy is to recognize an impairment loss measured by the amount the depreciated cost of the property exceeds its fair value. Fair value is calculated as the present value of expected future cash flows. Interest, real estate taxes and other carrying costs are capitalized on projects under development and construction. Once construction is substantially completed and the assets are placed in service, their rental income, direct operating expenses and depreciation are included in 9
Saul Centers, Inc. Notes to Consolidated Financial Statements (Unaudited) current operations. Expenditures for repairs and maintenance are charged to operations as incurred. Interest expense capitalized during the three month periods ended March 31, 1999 and 1998, was $133,000 and $34,000, respectively. A project is considered substantially complete and available for occupancy upon completion of tenant improvements, but no later than one year from the cessation of major construction activity. Substantially completed portions of a project are accounted for as separate projects. Depreciation is calculated using the straight-line method and estimated useful lives of 33 to 50 years for buildings and up to 20 years for certain other improvements. Leasehold improvements are amortized over the lives of the related leases using the straight-line method. Accounts Receivable and Accrued Income Accounts receivable primarily represent amounts currently due from tenants in accordance with the terms of the respective leases. In addition, at March 31, 1999 accounts receivable included $1,472,000, representing minimum rental income accrued on a straight-line basis to be paid by tenants over the terms of the respective leases. Receivables are reviewed monthly and reserves are established when, in the opinion of management, collection of the receivable is doubtful. Accounts receivable in the accompanying financial statements are shown net of an allowance for doubtful accounts of $718,000 at March 31, 1999. Deferred Debt Costs Deferred debt costs consist of financing fees and costs incurred to obtain long-term financing. These fees and costs are being amortized over the terms of the respective loans or agreements. Deferred debt costs in the accompanying financial statements are shown net of accumulated amortization of $693,000 at March 31, 1999. Revenue Recognition Rental and interest income is accrued as earned except when doubt exists as to collectibility, in which case the accrual is discontinued. When rental payments due under leases vary from a straight-line basis because of free rent periods or stepped increases, income is recognized on a straight-line basis in accordance with generally accepted accounting principles. Expense recoveries represent property operating expenses billed to the tenants, including common area maintenance, real estate taxes and other recoverable costs. Expense recoveries are recognized in the period the expenses are incurred. Additional rental income based on tenant's revenues ("percentage rent") is accrued at the time a tenant reports sales exceeding a specified breakpoint. 10
Saul Centers, Inc. Notes to Consolidated Financial Statements (Unaudited) Income Taxes The Company made an election to be treated, and intends to continue operating so as to qualify as a REIT under sections 856 through 860 of the Internal Revenue Code of 1986, as amended, commencing with its taxable year ending December 31, 1993. A REIT generally will not be subject to federal income taxation on that portion of its income that qualifies as REIT taxable income to the extent that it distributes at least 95% of its REIT taxable income to stockholders and complies with certain other requirements. Therefore, no provision has been made for federal income taxes in the accompanying financial statements. Per Share Data Per share data is calculated in accordance with SFAS No. 128, "Earnings Per Share." The Company has no dilutive securities; therefore, basic and diluted earnings per share are identical. Net income before minority interests is presented on a fully converted basis, that is, assuming the limited partners exercise their right to convert their partnership ownership into shares of Saul Centers, and is computed using weighted average shares of 17,800,000 and 16,887,000, for the quarters ended March 31, 1999 and 1998, respectively. Per share data relating to net income after minority interests is computed using weighted average shares of 12,917,000 and 12,494,000, for the quarters ended March 31, 1999 and 1998, respectively. Reclassifications Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. The reclassifications have no impact on operating results previously reported. Minority Interests - Holders of Convertible Limited Partner Units in the Operating Partnership The Saul Organization has a 27.5% limited partnership interest, represented by 4,925,000 convertible limited partnership units in the Operating Partnership, as of March 31, 1999. These Convertible Limited Partnership Units are convertible into shares of Saul Centers' common stock on a one-for-one basis, provided the rights may not be exercised at any time that The Saul Organization owns, directly or indirectly, in the aggregate more than 24.9% of the outstanding equity securities of Saul Centers. The impact of The Saul Organization's 27.5% limited partnership interest in the Operating Partnership is reflected as minority interests in the accompanying financial statements. 11
Saul Centers, Inc. Notes to Consolidated Financial Statements (Unaudited) Deferred Compensation and Stock Plan for Directors Saul Centers has established a Deferred Compensation and Stock Plan for Directors (the "Plan"), for the benefit of its directors and their beneficiaries. A director may elect to defer all or part of his or her director's fees to be earned subsequent to the election. A director has the option to have deferred director's fees paid in cash, in shares of common stock or in a combination of cash and shares of common stock. If the director elects to have the deferred fees paid in stock, the number of shares allocated to the director is determined based on the market value of the common stock on the day the deferred director's fee was earned. The Company has registered 70,000 shares for use under the Plan, all of which were authorized at March 31, 1999. As of March 31, 1999, 59,000 shares had been credited to the directors' deferred fee accounts. Each director that served on the Board of Directors of the Company as of February 22, 1999, the record date for the Company's Annual Meeting of Stockholders, received as additional compensation, an award of 100 shares of the Company's common stock on April 23, 1999. These shares may not be deferred and are restricted from transfer by the directors for a period of twelve months following the award date. New Accounting Pronouncements In September 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 130 "Reporting Comprehensive Income" which establishes standards for the reporting and display of comprehensive income in the Company's financial statements. The Company adopted this standard in the first quarter of 1998. The Company had no comprehensive income during the three month period ended March 31, 1999. In September 1997, the FASB issued SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" which establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also established standards for related disclosures about products and services, geographic areas, and major customers. Disclosures required by this new standard are presented in Note 6. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" which establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. SFAS 133 is effective for fiscal years beginning after June 15, 1999. The Company doesn't own derivative instruments nor does it engage in hedging activities, and therefore expects that SFAS 133 will not have an impact on the Company's financial condition or its results of operations. 12
Saul Centers, Inc. Notes to Consolidated Financial Statements (Unaudited) Change In Accounting Method On May 21, 1998, the EITF discussed Issue 98-9 "Accounting for Contingent Rent In Interim Financial Periods" and reached a consensus that lessors should defer the accounting recognition of contingent rent, such as percentage rent, until the specific tenant sales breakpoint is achieved. The Company's prior accounting method, which was permitted under generally accepted accounting principles, recognized percentage rent when a tenant's achievement of its sales breakpoint was considered probable. This EITF consensus was implemented retroactively to January 1, 1998, as a change in accounting method. The new accounting method is not expected to materially affect the amount of percentage rent income reported on an annual basis, but is expected to have an impact on the recognition of percentage rent income reported on a quarterly basis by increasing revenues the Company reports in the first and fourth quarters and decreasing revenues reported in the second and third quarters. The change in accounting method has no impact on the Company's cash flows. The comparative three month period financial statements ending March 31, 1998 have not been restated. Had the accounting method been retroactively applied, net income for the three month period ended March 31, 1998 would have been $2,179,000. 3. Construction In Progress Construction in progress includes the costs of active development projects and other predevelopment project costs. Development costs include direct construction costs and indirect costs such as architectural, engineering, construction management and carrying costs consisting of interest, real estate taxes and insurance. Construction in progress balances as of March 31, 1999 and December 31, 1998 are as follows: Construction in Progress ------------------------ (In thousands) March 31, 1999 December 31, 1998 -------------- ----------------- Avenel Business Park V ............... $3,371 $2,800 North WashingtonSt ................... 2,361 -- Shops At Fairfax ..................... 2,091 702 French Market ........................ 980 949 Other ................................ 138 55 ------ ------ Total ................................ $8,941 $4,506 ====== ====== 4. Notes Payable Notes payable totaled $291.8 million at March 31, 1999, of which $271.2 million (92.9%) was fixed rate debt and $20.8 million (7.1%) was floating rate debt. As of March 31, 1999, the Company had a $60 million unsecured revolving credit facility with outstanding borrowings of $19.5 million and additional borrowing availability of $40.5 million. The facility requires monthly interest payments at a rate of LIBOR plus 1.5%. 13
Saul Centers, Inc. Notes to Consolidated Financial Statements (Unaudited) As of March 31, 1999, the Company had a $38.0 million construction loan secured by the new North Washington Street development in Alexandria, Virginia, with outstanding borrowings of $1.3 million. The facility requires monthly interest payments at a rate of LIBOR plus 1.9%. As of March 31, 1999, the scheduled maturities of all debt for years ending December 31, were as follows: Debt Maturity Schedule ---------------------- (In thousands) April 1 through December 31, 1999................ $ 3,606 2000............................................. 25,148 2001............................................. 6,057 2002............................................. 7,043 2003............................................. 6,215 2004............................................. 16,078 Thereafter....................................... 227,634 -------- Total............................................. $291,781 ======== 5. Shareholders' Equity and Minority Interests These financial statements are prepared in conformity with generally accepted accounting principles and accordingly do not report the current value of the Company's real estate assets. The Shareholders' Equity reported on the Consolidated Balance Sheets does not reflect any increase in the value resulting from the difference between the current value and the net book value of the Company's assets. Therefore, Shareholders' Equity reported on the Consolidated Balance Sheets does not reflect the market value of stockholders' investment in the Company. The Consolidated Statement of Operations for the three months ended March 31, 1999 includes a charge for minority interests of $1,921,000 consisting of $1,381,000 related to The Saul Organization's share of the net income for the 1999 quarter and $540,000 related to distributions to minority interests in excess of allocated net income for the 1999 quarter. The charge for the three month period ended March 31, 1998 of $1,713,000 consists of $1,012,000 related to The Saul Organization's share of net income for the 1998 quarter, and $701,000 related to distributions to minority interests in excess of allocated net income for the 1998 quarter. 14
Saul Centers, Inc. Notes to Consolidated Financial Statements (Unaudited) 6. Business Segments The company has two reportable business segments: Shopping Centers and Office Properties. The accounting policies of the segments presented below are the same as those described in the summary of significant accounting policies (see Note 1). The Company evaluates performance based upon income train real estate for the combined properties in each segment. <TABLE> <CAPTION> (Dollars in thousands) Shopping Office Corporate Consolidated Centers Properties and Other(1) Totals ------- ---------- ------------ ------ <S> <C> <C> <C> <C> Quarter ended March 31, 1999 Real estate rental operations: Revenues .................................... $ 13,397 $ 4,566 $ 1 $ 17,964 Expenses .................................... (2,408) (1,121) (2) (3,531) --------- --------- --------- --------- Income from Real Estate ....................... 10,989 3,445 (1) 14,433 Interest expense & amortization of debt costs (5,633) (5,633) General and administrative .................. (862) (862) --------- --------- --------- --------- Subtotal ...................................... 10,989 3,445 (6,496) 7,938 Depreciation and amortization ............... (2,004) (871) (22) (2,897) Minority interests .......................... (1,921) (1,921) --------- --------- --------- --------- Net income .................................... $ 8,985 $ 2,574 (8,439) $ 3,120 ========= ========= ========= ========= Capital investment ............................ $ 5,420 $ 1,298 $ 105 $ 6,823 ========= ========= ========= ========= Total assets .................................. 182,210 $ 70,609 $ 22,425 $ 275,244 ========= ========= ========= ========= Quarter ended March 31, 1998 Real estate rental operations: Revenues ................................... $ 12,668 $ 4,417 $ 58 $ 17,143 Expenses ................................... (2,374) (1,058) (1) (3,433) ========= ========= ========= ========= Income from Real Estate 10,294 3,359 57 13,710 Interest expense & amortization of debt costs ..................................... (5,705) (5,705) General and administrative ................. (802) (802) --------- --------- --------- --------- Subtotal ...................................... 10,294 3,359 (6,450) 7,203 Depreciation and amortization .............. (1,823) (869) (33) (2,725) Minority interests ......................... (1,713) (1,713) --------- --------- --------- --------- Net income .................................... $ 8,471 $ 2,490 $ (8,196) $ 2,765 ========= ========= ========= ========= Capital investment ............................ $ 1,241 $ 945 $ 20 $ 2,206 ========= ========= ========= ========= Total Assets .................................. $ 174,218 $ 67,092 $ 22,077 $ 263,387 ========= ========= ========= ========= </TABLE> (1) Includes the Industrial Property, Crosstown 15
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General The following discussion is based primarily on the consolidated financial statements of Saul Centers, Inc. ("Saul Centers") and, together with its wholly owned subsidiaries and the limited partnerships of which it or one of its wholly owned subsidiaries is the sole general partner (the "Company"), as of March 31, 1999 and for the three month period ended March 31, 1999. Liquidity and Capital Resources The Company's principal demands for liquidity are expected to be distributions to its stockholders, debt service and loan repayments, expansion, renovation, and redevelopment of the Current Portfolio Properties and selective acquisition and development of additional properties. In order to qualify as a REIT for federal income tax purposes, the Company must distribute to its stockholders at least 95% of its "real estate investment trust taxable income," as defined in the Internal Revenue Code of 1986, as amended. The Company anticipates that operating revenues will provide the funds necessary for operations, debt service, distributions, and required recurring capital expenditures. Balloon principal repayments are expected to be funded by refinancings. Management anticipates that during the current year the Company may: 1) redevelop certain of the Shopping Centers, 2) develop additional freestanding outparcels or expansions within certain of the Shopping Centers, 3) acquire existing neighborhood and community shopping centers and/or office properties and 4) develop new shopping center or office sites. Acquisition and development of properties are undertaken only after careful analysis and review, and management's determination that such property is expected to provide long-term earnings and cash flow growth. During the current year, any developments, redevelopments, expansions or acquisitions are expected to be funded with bank borrowings from the Company's credit line, construction financing, proceeds from the operation of the Company's dividend reinvestment plan or other external capital resources available to the Company. The Company expects to fulfill its long range requirements for capital resources in a variety of ways, including undistributed cash flow from operations, secured or unsecured bank and institutional borrowings, private or public offerings of debt or equity securities and proceeds from the sales of properties. Borrowings may be at the Saul Centers, Operating Partnership or Subsidiary Partnership level, and securities offerings may include (subject to certain limitations) the issuance of additional limited partnership interests in the Operating Partnership which can be converted into shares of Saul Centers common stock. Management believes that the Company's current capital resources, which includes the Company's credit line of which $40,500,000 was available for borrowing as of March 31, 1999, will be sufficient to meet its liquidity needs for the foreseeable future. 16
Financial Information For the first quarter of 1999, the Company reported Funds From Operations ("FFO") of $7,938,000. This represents an 7.4% increase over the comparable 1998 period's FFO of $7,388,000. FFO is presented on a fully converted basis and as the most widely accepted measure of operating performance for REITs is defined as net income before extraordinary and nonrecurring items and before real estate depreciation and amortization. The following table represents a reconciliation from net income before minority interests to FFO: <TABLE> <CAPTION> Funds From Operations Schedule - ------------------------------ (In thousands) For the Three Months Ended March 31, ------------------------------------ 1999 1998 ---- ---- <S> <C> <C> Net income before minority interests....................... $5,041 $4,478 Add: Depreciation and amortization of real property......... 2,897 2,725 ------ ------ 7,938 7,203 Retroactive impact of change in accounting method (1).. - 185 ------ ------ Funds From Operations...................................... $7,938 $7,388 ====== ====== </TABLE> (1) Retroactive to January 1, 1998, the Company began recognition of percentage rental income in accordance with a new accounting pronouncement. The 1998 first quarter FFO amounts previously reported have been increased $185,000 to provide comparability. FFO, as defined by the National Association of Real Estate Investment Trusts, is calculated as net income excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. FFO does not represent cash generated from operating activities in accordance with generally accepted accounting principles and is not necessarily indicative of cash available to fund cash needs, which is disclosed in the Consolidated Statements of Cash Flows for the applicable periods. There are no material legal or functional restrictions on the use of FFO. FFO should not be considered as an alternative to net income, as an indicator of the Company's operating performance, or as an alternative to cash flows as a measure of liquidity. Management considers FFO a supplemental measure of operating performance and along with cash flow from operating activities, financing activities and investing activities, it provides investors with an indication of the ability of the Company to incur and service debt, to make capital expenditures and to fund other cash needs. FFO may not be comparable to similarly titled measures employed by other REITs. 17
Cash flow from operating activities, financing activities and investing activities for the three months ended March 31, 1999 and 1998 are as follows: Cash Flow provided by (used in): - -------------------------------- (In thousands) For the Three Months Ended March 31, ------------------------------------ 1999 1998 ---- ---- Operating activities................................... $8,851 $7,362 Investing activities................................... -6,823 -2,206 Financing activities................................... -2,362 -3,784 Capital Strategy and Financing Activity The Company's capital strategy is to maintain a ratio of total debt to total asset value of 50% or less, and to actively manage the Company's leverage and debt expense on an ongoing basis in order to maintain prudent coverage of fixed charges. Management believes that current total debt remains less than 50% of total asset value. In January 1999, the Company closed a $38 million construction loan, which is anticipated to fully fund the development costs associated with the 230,000 square foot North Wasington Street mixed-use office/retail complex, which the Company is constructing in Old Town Alexandria, Virginia. The loan has an initial three year term with an interest rate of LIBOR plus 1.90%, with the spread over LIBOR declining as leasing of the office and retail space proceeds. As of April 30, 1999, outstanding borrowings on this construction loan totaled $1.8 million. As of April 30, 1999, outstanding borrowings on the Company's $60 million unsecured credit line totaled $21.5 million, leaving $38.5 million of credit availability. The Company has fixed interest rates on approximately 92% of its total debt outstanding, which now has a weighted remaining term of approximately 12 years. 18
Redevelopment, Renovations and Acquisitions The Company has been selectively involved in redevelopment, renovation and acquisition activities. It continues to evaluate land parcels for retail and office development and potential acquisitions of operating properties for opportunities to enhance operating income and cash flow growth. The Company also continues to take advantage of redevelopment, renovation and expansion opportunities within the portfolio, as demonstrated by its activities at French Market, Beacon Center, Shops at Fairfax, Avenel, and North Washington Street. The Company has completed construction on a facade renovation and is retenanting a 103,000 square foot anchor space at the 213,000 square foot French Market center in Oklahoma City, Oklahoma. Leasing and occupancy of the first three new spaces, a 41,000 square foot Bed, Bath and Beyond, an 8,000 square foot Lakeshore Learning, a children's educational toy store and an 8,000 square foot BridesMart formal wear retailer were completed in 1998. During the first quarter of 1999, the Company signed a lease with a 25,000 square foot Staples office supply store, which leaves only 21,000 square feet remaining to lease. Staples is scheduled to open in late summer of 1999. The Company is redeveloping the Beacon Center, located along Route 1 in Alexandria, Virginia. Beacon Center's central enclosed mall area was demolished and construction has commenced on a 148,000 square foot Lowe's home improvement and garden center store, which is scheduled to open in the summer of 1999. The center's other tenants include anchors Giant Food, Marshalls and Office Depot, with a complement of small shop space and restaurants. The 356,000 square feet Beacon Center is now 100% leased. In addition to the new home improvement store, 8,000 square feet of new small shop space adjacent to Lowe's and Giant was constructed in late 1998 and is fully occupied. The Company commenced another significant redevelopment during 1998 when it signed a lease with SuperFresh for a new 53,000 square foot grocery store at the Shops at Fairfax, located in Fairfax, Virginia. A portion of the shopping center which includes a small enclosed mall was demolished to allow SuperFresh to occupy a new building, with construction projected to be completed in the fall of 1999. An additional 7,500 square feet of shop space is being constructed adjacent to the supermarket. The facade of the adjacent Boulevard shopping center, also owned by the Company, is being renovated and modernized. This renovation was driven by a new 12,000 square foot lease with Party City, scheduled to open during May 1999, which replaced a previous lease with below market rents. Redevelopment plans also include new landscaping and a more efficient parking scheme, which should enhance the property as a desirable neighborhood shopping center. Office development and acquisition activities will be an integral part of the Company's focus during 1999. In July 1998, the Company began development of approximately 27,000 square feet of additional office / flex space at Avenel Business Park on excess land that it owns. Construction of this new project (Avenel V) was substantially completed during January 1999. Approximately 46% of the space is leased, while leases are in negotiation for a portion of the remaining space. Including this new development, Avenel Business Park is currently over 95% leased. In February 1999, the Company announced the development of a new 230,000 square foot Class A mixed-use office / retail complex along North Washington Street in historic Old Town Alexandria in Northern Virginia. The project is well located on a two-acre site along Alexandria's main street. Demolition of the Company's existing 41,500 square foot building, formerly leased to Mastercraft furniture, was completed in March 1999. Site 19
excavation is currently in progress. Construction is scheduled to be completed by the summer of 2000. Two twin four-story buildings will feature a brick and cast stone exterior facade with a glass curtain wall overlooking a spacious courtyard. Amenities will include 3-story atrium lobbies, a fitness center, concierge service, a 600 space parking structure and the latest computerized energy management system. The street level will have 45,000 square feet of retail space. Office space totals approximately 185,000 square feet, with the top floor containing walkout terraces. Portfolio Leasing Status At March 31, 1999, the portfolio consisted of twenty-nine Shopping Centers, four Office Properties and one Industrial Property, all of which are located in seven states and the District of Columbia. The Office Properties consist of one office property and one office/retail property, both located in the District of Columbia, and one research park located in a Maryland suburb of Washington, D.C. At March 31, 1999, 91.5 % of the Company's 5.9 million square feet of leasable space was leased to tenants, as compared to 89.2 % at March 31, 1998. The shopping center portfolio was 94.5 % leased at March 31, 1999 versus 91.8 % as of March 31, 1998. The Office Properties were 95.6 % leased at March 31, 1999 compared to 94.0 % as of March 31, 1998. The overall improvement in the 1999 leasing was primarily caused by the Company's successful leasing at recently renovated shopping centers: Seven Corners, Great Eastern and Beacon Center as well as improved leasing at the Van Ness Square office property. 20
Results of Operations The following discussion compares the results of the Company for the three month periods ended March 31, 1999 and 1998, respectively. This information should be read in conjunction with the accompanying consolidated financial statements and the notes related thereto. These financial statements include all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the interim periods presented. Three Months Ended March 31, 1999 Compared to Three Months Ended March 31, 1998 Revenues for the three month period ended March 31, 1999 (the "1999 Quarter"), totaled $17,964,000 compared to $17,143,000 for the comparable quarter in 1998 (the "1998 Quarter"). Had the Company retroactively applied the change in accounting method required by EITF 98-9, total revenues for the 1998 Quarter would have been $17,328,000. The 1999 Quarter's increase on this comparable basis was $636,000 (3.7%). Base rent was $14,333,000 for the 1999 Quarter, compared to $13,471,000 for the 1998 Quarter, representing an increase of $862,000 (6.4%). The increase in base rent resulted primarily from new leases at Seven Corners, Ravenwood and Avenel IV (which was acquired in April 1998) for the 1999 Quarter that were not present during the 1998 Quarter. Expense recoveries were $2,448,000 for the 1999 Quarter compared to $2,320,000 for the comparable 1998 Quarter, representing an increase of $128,000 (5.5%). Recovery income increased primarily as a result of new leases in place during 1999 at Seven Corners, Beacon Center, Southside and Avenel IV. Percentage rent was $780,000 in the 1999 Quarter, compared to $799,000 in the 1998 Quarter. Had the Company retroactively applied the change in accounting method required by EITF 98-9, percentage rent for the 1998 Quarter would have been $984,000. The 1999 Quarter's decrease would have been $204,000 (20.7%). The decrease in percentage rent resulted primarily from the rollover of a Ravenwood anchor lease into higher paying base rent in lieu of percentage rent. Other income, which primarily consists of parking income, kiosk and temporary leasing, and fees associated with early termination of leases, was $403,000 in the 1999 Quarter, compared to $553,000 in the 1998 Quarter, representing a decrease of $150,000 (27.1%). The decrease in other income resulted primarily from a lease termination payment collected at Avenel Business Park during the 1998 Quarter. Operating expenses, consisting primarily of repairs and maintenance, utilities, payroll, insurance and other property related expenses, decreased $35,000 (1.8%) to $1,936,000 in the 1999 Quarter from $1,971,000 in the 1998 Quarter. The expense decrease resulted in part from reduced property payroll expense due to the elimination of maintenance positions associated with former shopping mall space converted into strip shopping area and reduced legal expenses connected with collections of tenant receivables. 21
The provision for credit losses increased $21,000 (52.5%) to $61,000 in the 1999 Quarter from $40,000 in the 1998 Quarter. Real estate taxes increased $112,000 (7.9%) to $1,534,000 in the 1999 Quarter from $1,422,000 in the 1998 Quarter. The increase resulted from higher taxes imposed primarily upon Seven Corners and to a lesser extent several of the Company's other Virginia properties. Interest expense of $5,530,000 for the 1999 Quarter represented a decrease of $74,000 (1.3 %) from $5,604,000 reported for the 1998 Quarter. Amortization of deferred debt expense increased $2,000 (2.0%) to $103,000 in the 1999 Quarter from $101,000 in the 1998 Quarter. Depreciation and amortization expense increased $172,000 (6.3%) from $2,725,000 in the 1998 Quarter to $2,897,000 in the 1999 Quarter, primarily as a result of depreciation attributable to recently completed redevelopments and renovations. General and administrative expense, which consists of payroll, administrative and other overhead expense, was $862,000 for the 1999 Quarter, an increase of $60,000 (7.5%) over the 1998 Quarter. The increase in 1999 expenses compared to 1998 resulted from increases in payroll and state income tax expenses. Year 2000 Issue The year 2000 issue relates to whether computer systems will properly recognize date sensitive information to allow accurate processing of transactions and data relating to the year 2000 and beyond. In addition, the year 2000 issue relates to whether non-Information Technology (IT) systems that depend upon embedded electronic technology will recognize the year 2000. Systems that do not properly recognize such information could generate erroneous information or fail. In 1995, the Company contracted to replace virtually all of its management information and accounting systems and install a local area network (LAN). One of the selection criteria of the new software and hardware was that they be fully year 2000 compliant. The new LAN and management and accounting information systems have been installed . Therefore, the Company's management information and accounting systems are fully year 2000 compliant. As a result of its efforts, the Company does not expect to incur any additional expense for its information systems related to the year 2000 issue. 22
The Company's property management staff has conducted a comprehensive review of its non-IT systems at its shopping centers and office buildings to determine whether any computer hardware and software in mechanical systems (i.e. escalators, elevators, security, heating, ventilating and air conditioning systems, etc.) are not year 2000 compliant. Work has commenced on repairs and replacements required to make the Company's non-IT systems year 2000 compliant. Management has determined that the costs will be less than $100,000 and will be completed prior to July 1999. The Company believes there is risk that its operations may be affected by vendors and tenants who are unable to perform as contracted due to their own year 2000 exposure. It is very difficult to identify "the most reasonably likely worst case scenario" at this time. The Company's potential exposure is wide spread; however there is no known or expected major direct exposure. The Company believes that the most likely worst case exposure is at this indirect level where vendors and tenants fail to perform their obligations to the Company. For example, the Company believes it is possible that certain tenants' information systems may fail, which may delay the payment of rents. To help minimize this risk, the Company sent a letter to each tenant prior to January 1, 1999 advising the tenant that rent payments due January 1, 2000 must be paid on-time. These reminders will be sent twice again later in 1999. The Company's leases contain provisions empowering it to take certain actions to enforce it's right to the timely payment of rent, regardless of the tenant's year 2000 exposure. While it is not possible at this time to determine the likely impact of these potential problems, the Company will continue to evaluate these areas and develop contingency plans, as appropriate. 23
PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders On April 23, 1999, the Company held its Annual Meeting of Stockholders, at which Messrs. B. Francis Saul II, Mark Sullivan III, James W. Symington and John R Whitmore were reelected to the Board of Directors, for three year terms expiring at the 2002 Annual Meeting, each receiving in excess of 90% of the votes of the approximately 12,957,000 shares outstanding and eligible to vote at the meeting. The terms of the remaining Board members did not expire as of the April 23, 1999 meeting and such individuals continue as directors of the Company. Item 6. Exhibits and Reports on Form 8-K Exhibits 3.(a) First Amended and Restated Articles of Incorporation of Saul Centers, Inc. filed with the Maryland Department of Assessments and Taxation on August 23, 1994 and filed as Exhibit 3.(a) of the 1993 Annual Report of the Company on Form 10-K is hereby incorporated by reference. (b) Amended and Restated Bylaws of Saul Centers, Inc. as in effect at and after August 24, 1993 and as of August 26, 1993 and filed as Exhibit 3 (b) of the 1993 Annual Report of the Company on Form 10-K is hereby incorporated by reference. The First Amendment to the First Amended and Restated Agreement of Limited Partnership of Saul Subsidiary I Limited Partnership, the Partnership of Saul Subsidiary I Limited Partnership, the Third Amendment to the First Amended and Restated Agreement of Limited Partnership of Saul Subsidiary I Limited Partnership and the Fourth Amendment to the First Amended and Restated Agreement of Limited Partnership of Saul Subsidiary I Limited Partnership as filed as Exhibit 3.(b) of the 1997 Annual Report of the Company on Form 10-K is hereby incorporated by reference. 10.(a) First Amended and Restated Agreement of Limited Partnership of Saul Holdings Limited Partnership filed as Exhibit No. 10.1 to Registration Statement No. 33-64562 is hereby incorporated by reference. The First Amendment to the First Amended and Restated Agreement of Limited Partnership of Saul Holdings Limited Partnership, the Second Amendment to the First Amended and Restated Agreement of Limited Partnership of Saul Holdings Limited Partnership, and the Third Amendment to the First Amended and Restated Agreement of Limited Partnership of Saul Holdings Limited Partnership filed as Exhibit 10.(a) of the 1995 Annual Report of the Company on Form 10-K is hereby incorporated by reference. The Fourth Amendment to the First Amended and Restated Agreement of Limited Partnership of Saul Holdings Limited Partnership 24
filed as Exhibit 10.(a) of the March 31, 1998 Quarterly Report of the Company is hereby incorporated by reference. (b) First Amended and Restated Agreement of Limited Partnership of Saul Subsidiary I Limited Partnership and Amendment No. 1 thereto filed as Exhibit 10.2 to Registration Statement No. 33-64562 are hereby incorporated by reference. The Second Amendment to the First Amended and Restated Agreement of Limited Partnership of Saul Subsidiary I Limited Partnership, the Third Amendment to the First Amended and Restated Agreement of Limited Partnership of Saul Subsidiary I Limited Partnership and the Fourth Amendment to the First Amended and Restated Agreement of Limited Partnership of Saul Subsidiary I Limited Partnership as filed as Exhibit 10.(b) of the 1997 Annual Report of the Company on Form 10-K is hereby incorporated by reference. (c) First Amended and Restated Agreement of Limited Partnership of Saul II Subsidiary Partnership and Amendment No. 1 thereto filed as Exhibit 10.3 to Registration Statement No. 33-64562 are hereby incorporated by reference. (d) Property Conveyance Agreement filed as Exhibit 10.4 to Registration Statement No. 33-64562 is hereby incorporated by reference. (e) Management Functions Conveyance Agreement filed as Exhibit 10.5 to Registration Statement No. 33-64562 is hereby incorporated by reference. (f) Registration Rights and Lock-Up Agreement filed as Exhibit 10.6 to Registration Statement No. 33-64562 is hereby incorporated by reference. (g) Exclusivity and Right of First Refusal Agreement filed as Exhibit 10.7 to Registration Statement No. 33-64562 is hereby incorporated by reference. (h) Saul Centers, Inc. 1993 Stock Option Plan filed as Exhibit 10.8 to Registration Statement No. 33-64562 is hereby incorporated by reference. (i) Agreement of Assumption dated as of August 26, 1993 executed by Saul Holdings Limited Partnership and filed as Exhibit 10. (I) of the 1993 Annual Report of the Company on Form 10-K is hereby incorporated by reference. (j) Saul Centers, Inc. 1995 Dividend Reinvestment and Stock Purchase Plan as filed with the Securities and Exchange Commission as File No. 33-80291 is hereby incorporated by reference. (k) Deferred Compensation Plan for Directors dated as of December 13, 1993 as filed as Exhibit 10.(r) of the 1995 Annual Report of the Company on Form 10-K, as amended and restated by the Deferred Compensation and Stock Plan for Directors, dated as of March 18, 1999, filed herewith. 25
(l) Deed of Trust, Assignment of Rents, and Security Agreement dated as of September 9, 1994 by and between Saul Holdings Limited Partnership and Ameribanc Savings Bank, FSB as filed as Exhibit 10.(t) of the 1995 Annual Report of the Company on Form 10-K is hereby incorporated by reference. (m) Deed of Trust Note dated as of January 22, 1996 by and between Saul Holdings Limited Partnership and Clarendon Station Limited Partnership, filed as Exhibit 10.(s) of the March 31, 1998 Quarterly Report of the Company, is hereby incorporated by reference. (n) Loan Agreement dated as of November 7, 1996 by and among Saul Holdings Limited Partnership, Saul Subsidiary II Limited Partnership and PFL Life Insurance Company, c/o AEGON USA Realty Advisors, Inc., filed as Exhibit 10.(t) of the March 31, 1998 Quarterly Report of the Company, is hereby incorporated by reference. (o) Promissory Note dated as of January 10, 1997 by and between Saul Subsidiary II Limited Partnership and The Northwestern Mutual Life Insurance Company, filed as Exhibit 10.(z) of the March 31, 1998 Quarterly Report of the Company, is hereby incorporated by reference. (p) Loan Agreement dated as of October 1, 1997 between Saul Subsidiary I Limited Partnership, as Borrower and Nomura Asset Capital Corporation, as Lender, is as filed as Exhibit 10.(p) of the 1997 Annual Report of the Company on Form 10-K is hereby incorporated by reference. (q) Revolving Credit Agreement dated as of October 1, 1997 by and between Saul Holdings Limited Partnership and Saul Subsidiary II Limited Partnership, as Borrower and U.S. Bank National Association, as agent, is as filed as Exhibit 10.(q) of the 1997 Annual Report of the Company on Form 10-K is hereby incorporated by reference. (r) Construction Loan Agreement dated as of January 11, 1999 by and between Saul Holdings Limited Partnership and Saul Centers, Inc. as Borrower and Wells Fargo Bank, National Association, as Lender, is filed herewith. (s) Promissory Note dated as of January 11, 1999 by and between Saul Holdings Limited Partnership and Saul Centers, Inc. as Borrower and Wells Fargo Bank, National Association, as Lender, is filed herewith. 27. Financial Data Schedule 99. Schedule of Portfolio Properties Reports on Form 8-K None. 26
SIGNATURES 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. SAUL CENTERS, INC. (Registrant) Date: May 11, 1999 /s/ Philip D. Caraci ---------------------- --------------------------------------- Philip D. Caraci, President Date: May 11, 1999 /s/ Scott V. Schneider ---------------------- --------------------------------------- Scott V. Schneider Senior Vice President, Chief Financial Officer