Saul Centers Inc.
Annual Report 2012

Plain-text annual report

2012 ANNUAL REPO RT to shareholders SAUL CENTERS, INC. is a self-managed, self-administered equity real estate investment trust headquartered in Bethesda, Ma ryland. Saul Centers operates and manages a real estate portfolio of 59 community and neighborhood shopping centers, 7 mixed-use properties and 2 land parcels totaling approximately 9.5 million square feet of leasable area. Over 85% of the property operating income is generated from properties in the metropolitan Washington, DC/ Baltimore area. Saul Centers’ primary operating strategy is to focus on continuing its program of internal growth, renovations, and expansions of community and neighborhood shop- ping centers that primarily serve the day-to-day necessities and services sub-sector of the overall retail market. The Company plans to supplement its growth through effec- tive development of new retail and mixed-use properties, and acquisitions of operating properties as appropriate opportunities arise. PORTFOLIO COMPOSITION Based on 2012 Property Operating Income 75.4% Shopping Centers 24.6% Mixed-Use 85.2% Metropolitan Washington, DC/ Baltimore area 14.8% Rest of U.S. TOTAL REVENUE (In millions) NET INCOME Available to Common Stockholders (In millions) FUNDS FROM OPERATIONS* Available to Common Shareholders (In millions) $200 $160 $120 $80 $40 $30 $190.1 $30 $173.9 $26.2 $159.8 $160.5 $163.1 $21.6 $21.6 $18.2 $11.6 $25 $20 $15 $10 $5 $62.7 $56.0 $60.1 $50.6 $50.3 $70 $60 $50 $40 $30 $20 $10 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 * Funds From Operations (FFO) is a non-GAAP financial measure. See page 24 for a definition of FFO and reconciliation from Net Income. Year ended December 31, 2012 2011 2010 2009 2008 Summary Financial Data Total Revenue $190,092,000 $ 173,878,000 $163,108,000 $160,539,000 $ 159,775, 000 Net Income Available to Common Stockholders $ 18,234,000 $ 11,593,000 $ 21,623,000 $ 21,573,000 $ 26,241,000 FFO Available to Common Shareholders $ 60,100,000 $ 50,309,000 $ 50,556,000 $ 56,025,000 $ 62,695,000 Weighted Average Common Stock Outstanding 19,700,000 18,949,000 18,377,000 17,943,000 17,961,000 Weighted Average Shares and Units Outstanding 26,614,000 24,740,000 23,793,000 23,359,000 23,377,000 Net Income Available to Common Stockholders Per Share (Diluted) $ 0.93 $ 0.61 $ 1.18 $ 1.20 $ 1.46 FFO Available to Common Shareholders Per Share (Diluted) $ 2.26 $ 2.03 $ 2.12 $ 2.40 $ 2.68 Common Dividend as a Percentage of FFO (Per Share) 64% 71% 68% 64% 70% Interest Expense Coveragea 2.68 2.61 3.20 3.27 3.33 Property Data Number of Operating Propertiesb 57 58 55 52 50 Total Portfolio Square Feet 9,489,000 9,543,000 8,901,000 8,424,000 8,194,000 Shopping Center Square Feet 7,877,000 7,933,000 7,293,000 7,218,000 6,988,000 Mixed-Use Square Feet 1,612,000 1,610,000 1,608,000 1,206,000 1,206,000 Average Percentage Leased 91%c 90%c 91% 92% 95% (a) Interest expense coverage is defined as operating income before the sum of interest expense and amortization of deferred debt, predevelopment expenses and depreciation and amortization of deferred leasing costs, divided by interest expense. (b) Excludes development parcels (Ashland Square Phase II and New Market). (c) Average percentage leased excludes Clarendon Center residential which averaged 98% and 97% leased during 2012 and 2011, respectively. SAUL CENTERS, INC. 2012 ANNUAL REPORT 1 As a result of good tenant retention and successful leasing to new tenants, retail space was 93.4% leased at year-end 2012, the highest level during the past three years. MESSAGE TO SHAREHOLDERS Improving economic factors began to have a positive impact on our retail and mixed-use property operating performance during 2012, following the downturn of the last 5 years. The national unemployment rate has improved from 9.3% in December 2010 to 7.7% in February 2013. Un- employment in the Washington, D.C. metropolitan area, as reported by the Department of Labor, also improved from 5.7% to 5.2% during these past two years. The area’s housing recovery appears to have gained momentum with home sales volume and median prices both up from 2011 levels. These positive economic trends have improved con- sumer confidence and helped fuel increased retail sales volume. Within our shopping center portfolio, sales volumes of tenants reporting sales increased 4.8% in 2012 to $339 per square foot. Stronger retail demand is a primary driver of our overall property earnings, as 75% of our overall property operating income is generated from our 50 shop- ping centers. Over 80% of this shopping center operating income is generated from properties in the Washington, D.C./Baltimore metropolitan area. Our shopping center tenants renewed their leases at a 70% rate in 2012, a healthy increase from the 60% renewal rate in 2011. As a result of good tenant retention and successful leasing to new tenants, retail space was 93.4% leased at year-end 2012, the highest level during the past three years. Tenant delinquent rent payments have dropped to their lowest levels since 2009. In summary, we are cautiously optimistic for contin- ued improvement in our core portfolio operating performance because of better economic indicators, improved tenant sales volume, solid leasing results and reduced tenant delinquent rent payments. However, our retail and mixed-use property operat- ing fundamentals continue to be vulnerable to potential challenges in public and private sector job markets and the housing industry. BALANCE SHEET HIGHLIGHTS Throughout 2012, the favorable interest rate environ- ment allowed us to reduce our average cost of debt by closing $93 million of new long-term non-recourse property financings. At year-end 2012, fixed-rate debt comprised 94% of our $828 million total bor- rowings and has a weighted maturity of 10 years. Only $53 million of fixed-rate debt matures during the next 5 years. The fixed-rate debt weighted aver- age interest rate decreased from 6.0% at the end of 2011 to the current 5.8%. In May 2012, we also completed a new 4-year, $175 million line of credit, which replaced an expiring $150 million line. The current 2.1% interest rate payable under our new credit line is nearly 3.2% lower than the previous rate. Interest expense coverage improved to 2.7 times and leverage, as measured by debt to total capitalization, was 38% at December 31, 2012. Currently, 24 of our 59 properties are unencum- bered, and generated over 27% of our 2012 overall property operating income. Further improving our overall cost of capital, on Feb- ruary 12, 2013, we closed on $140 million of Series C perpetual preferred stock which has a coupon of 6.875%. The proceeds of this offering were used to redeem all $79.3 million of our 9% Series B pre- ferred shares and approximately $60 million of our 8% Series A preferred shares. As a result of this offering, our weighted average cost of preferred equity was reduced from 8.4% to 7.1%. Improved operating performance, a strengthened balance sheet and financing flexibility provide the capability to fund future development and redevel- opment activities. FINANCIAL RESULTS Total revenue increased to $190.1 million in 2012 from $173.9 million in 2011, and operating income increased to $36.2 million from $34.0 million. Net income available to common stockholders was $18.2 million in 2012 compared to $11.6 million in 2011. The primary sources of the revenue increase were $9.7 million of additional revenue from three subur- ban Maryland grocery anchored shopping centers acquired in 2011 and $4.9 million of additional rev- enue from Clarendon Center. Operating income 2 SAUL CENTERS, INC. 2012 ANNUAL REPORT 3 Improved operating performance, a strengthened balance sheet and financing flexibility provide the capability to fund future development and redevelopment activities. increased $2.2 million, of which the core portfolio generated $4.1 million and the three 2011 acquisitions produced $1.1 million, the combined impact of which was partially offset by $2.7 million of predevelopment expenses at Van Ness Square where we intend to develop a primarily res- idential apartment project with complementary street-level retail space. The 2012 results also included property sale gains totaling $4.5 million from the sale of two underperforming, unanchored shopping centers, partially offset by $1.1 million of costs incurred for the December 2012 acquisition of two operating shopping center properties. During 2012, overall same property revenue increased 1.0% and same property operating income increased 1.8%. Same property comparisons exclude the results of properties not in operation for the entirety of the comparable reporting periods. Shopping center same property operating income increased 2.0% and mixed-use portfolio same property operating income increased 0.6%. The same property results were adversely affected by Van Ness Square. If Van Ness Square was excluded, overall same prop- erty operating income would have increased 2.6% and mixed-use same property operating income would have increased 5.0%. FFO available to common stockholders (after deducting preferred stock dividends) increased 19.5% to $60.1 million ($2.26 per diluted share) from $50.3 million ($2.03 per diluted share) in 2011. FFO increased pri- marily as a result of (a) the three shopping centers acquired in 2011 ($4.7 million), the core portfolio ($3.9 million), and Clarendon Center ($1.0 million), (b) reduced acquisition costs ($1.4 million) and (c) a change in fair value of interest rate swaps ($1.4 million), the combined impact of which was partially offset by Van Ness Square predevelopment expenses ($2.7 million). ACQUISITION AND DEVELOPMENT ACTIVITY The three shopping centers we acquired in late 2011 were a significant source of the portfolio’s growth during 2012. Each of the three shopping centers is anchored by a Giant Food store. Two of the three grocery stores reported sales of over $600 per square foot and rank in the top 10 in sales volume of our 33 grocery stores. The three centers were 96.7% leased at year end, and exclusive of the one-time acquisition costs, added $4.7 million to 2012 FFO. During 2012, we substantially completed leasing Clarendon Center, a mixed-use development on two blocks adjacent to the Clarendon Metro Station in Arlington, VA. At year-end 2012, the 244 apartments and 42,000 square feet of retail space were 100% leased, and the 171,000 square feet of office space was 97% leased. Clarendon Center negatively impacted earnings during the lease-up phase, but added $1.0 million to FFO in 2012. This successful development is expected to provide further growth throughout 2013 as tenant build- out is completed and rent commences for the final office tenants. During 2012, we positioned our Van Ness Square office/retail property for redevelopment by not renewing expiring leases and entering into early lease termination agreements. As a result, the building’s leasing percentage decreased from 67% in January 2012 to 44% in December 2012. As of March 1, 2013, we successfully executed the final tenant lease termination agreement and we antici- pate that the building will be vacant in the spring of this year. We incurred $2.7 million of redevelop- ment expenses related to these lease terminations in 2012 and expect to incur approximately $3.3 mil- lion in 2013. In its place, we plan to construct a pri- marily apartment project with complementary street-level retail space. Construc- tion documents and governmental approvals are in process, with a final development time table yet to be determined. residential In December 2012, we purchased two operating shopping center properties in Montgomery County, MD for future redevelopment. The first property, 1500 Rockville Pike, which was acquired for $23.0 million, including acquisition costs, is a 6.7 acre property with 53,000 rentable square feet located near the Twinbrook Metro Station. The second property, 5541 Nicholson Lane, which was acquired for $12.2 million, including acquisition costs, is a 1.1 acre property with 20,000 rentable square feet lo- cated adjacent to our 11503 Rockville Pike property near the White Flint Metro Station. Although the current zoning permits us to develop 1.1 million square feet of new residential and commercial space on these two properties, we do not anticipate rede- veloping them in the foreseeable future. 4 SAUL CENTERS, INC. 2012 ANNUAL REPORT 5 We have entered our 20th year as a publicly-traded REIT. PROPERTY SALES We sold two unanchored shopping centers during 2012 and recognized a combined gain on sale of $4.5 million. In July, we sold the 77,000 square foot and 11.7% leased West Park in Oklahoma City, OK and in December, we sold the 55,000 square foot and 34.2% leased Belvedere Gardens in Baltimore, MD. SHOPPING CENTER OPERATIONS While the economic downturn and anchor tenant bankruptcies contributed to decreased same property operating results during 2010 and 2011, our shopping center results trended positive in 2012. Anchor tenant spaces vacated in 2011 by Borders, Superfresh, Syms and an independent grocer totaling 168,000 square feet were substantially re-tenanted during 2012. As of March 1, 2013, a total of 157,000 square feet of this space has been leased. This and other core property improved leasing activity were key drivers of the 2012 increase of 2.0% in same property operating income. Overall leasing volume continued to be strong, with 222 new and renewal retail leases executed, totaling 1.1 million square feet of space. The 2012 leasing volume compares similarly with the prior two annual averages of 223 leases signed for 1.1 million square feet of retail space. More significantly, same property rental rate growth turned positive in 2012 for the first time since 2008 for new and renewal leases. New and renewal cash rents increased 1.6% over expiring rents on a same space basis. The renewal percentage, as measured by expiring base rent, also trended positively to 70% of tenants renewing leases, up from 60% in 2011. Overall shopping center credit loss decreased from the historic high level of $1.86 million in 2011, to $840,000 in 2012. The improved leasing and rent collection trends were impacted by increasing retail tenant sales. On a same tenant basis, retail sales grew by 1.1% from 2011, after similarly modest 1.1% and 0.8% increases in 2011 and 2010, respectively. Same store grocery sales grew by 1.3% in 2012, after a 0.9% increase in 2011, which followed two years of declines. While these overall operating trends are encouraging, the recovery in the retail sector will continue to be impacted by conditions in the overall economy. MIXED-USE RESULTS Our 1.6 million square feet of mixed-use properties produced 24.6% of our property operating income in 2012. With the exclusion of our Van Ness Square building, which is being positioned for redevelop- ment, over 84% of our mixed-use property operat- ing income is generated by three projects – our newly developed Clarendon Center in Arlington, VA, 601 Pennsylvania Avenue in Washington, DC and Washington Square in Old Town Alexandria, VA. Entering 2013, all 244 apartments at Claren- don Center and 93.9% of the 676,000 square feet of office and retail space at the three properties are leased. Despite tepid office demand in the Wash- ington, DC metropolitan area due to the uncertainty surrounding federal government spending levels, these three properties are well positioned for the coming year with only 16,000 square feet of office leases expiring during 2013. We have entered our 20th year as a publicly-traded REIT. In September 1993, Saul Centers was a company with $500 million of total capitalization, operating 5.3 million square feet of rentable space in 26 properties and had a limited inventory of de- velopment opportunities. We have grown to $2.2 billion in total capitalization, operate 9.5 million rentable square feet in 57 properties, and have over 2.3 million square feet of zoned/master planned, mixed-use redevelopment potential focused around Washington, DC metropolitan area transit centers. While our larger property base provides operational efficiencies, we are small enough to generate mean- ingful growth with paced development activity throughout the coming years. We remain confident that our loyal team of dedicated professionals will meet the challenges and opportunities that lie ahead, and expect to continue to deliver attractive results for our loyal investors. For the Board B. Francis Saul II March 15, 2013 6 SAUL CENTERS, INC. 2012 ANNUAL REPORT 7 FINANCIAL SECTION TABLE OF CONTENTS Selected Financial Data Page 10 Management’s Discussion and Analysis of Financial Condition and Results of Operations Pages 11-27 Management’s Report on Internal Control Over Financial Reporting Page 27 Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Consolidated Balance Sheets Page 28 Page 29 Page 30 Consolidated Statements of Operations Page 31 Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders’ Equity Page 32 Page 33 Consolidated Statements of Cash Flows Page 34 Notes to Consolidated Financial Statements Pages 35-57 As of December 31, 2012, Saul Centers’ portfolio properties were located in Virginia, Maryland, Washington, DC, North Carolina, Delaware, Florida, Georgia, New Jersey and Oklahoma. Properties in the metropolitan Washington, DC/ Baltimore area represent 80% of the portfolio’s gross leasable area. PORTFO LIO PROPERTIES GROSS LEASABLE PROPERTY/LOCATION SQUARE FEET Shopping Centers ASHBURN VILLAGE, ASHBURN, VA 221,273 ASHLAND SQUARE PHASE I, DUMFRIES, VA 23,120 BEACON CENTER, ALEXANDRIA, VA 358,015 BJ’S WHOLESALE CLUB, ALEXANDRIA, VA 115,660 BOCA VALLEY PLAZA, BOCA RATON, FL 121,269 BOULEVARD, FAIRFAX, VA 49,140 BRIGGS CHANEY MARKETPLACE, SILVER SPRING, MD 194,347 BROADLANDS VILLAGE, ASHBURN, VA 159,734 COUNTRYSIDE MARKETPLACE, STERLING, VA 141,696 CRANBERRY SQUARE, WESTMINSTER, MD 141,569 CRUSE MARKETPLACE, CUMMING, GA 78,686 FLAGSHIP CENTER, ROCKVILLE, MD 21,500 FRENCH MARKET, OKLAHOMA CITY, OK 244,724 GERMANTOWN, GERMANTOWN, MD 27,241 GIANT, MILFORD MILL, MD 70,040 THE GLEN, WOODBRIDGE, VA 136,440 GREAT EASTERN, DISTRICT HEIGHTS, MD 255,398 GREAT FALLS CENTER, GREAT FALLS, VA 91,666 HAMPSHIRE LANGLEY, TAKOMA PARK, MD 131,700 HUNT CLUB CORNERS, APOPKA, FL 101,522 JAMESTOWN PLACE, ALTAMONTE SPRINGS, FL 96,372 KENTLANDS SQUARE I, GAITHERSBURG, MD 114,381 KENTLANDS SQUARE II, GAITHERSBURG, MD 240,683 KENTLANDS PLACE, GAITHERSBURG, MD 40,648 LANSDOWNE TOWN CENTER, LEESBURG, VA 189,352 LEESBURG PIKE PLAZA, BAILEYS CROSSROADS, VA 97,752 LUMBERTON PLAZA, LUMBERTON, NJ 193,044 METRO PIKE CENTER, ROCKVILLE, MD 67,488 SHOPS AT MONOCACY, FREDERICK, MD 109,144 NORTHROCK, WARRENTON, VA 99,789 OLDE FORTE VILLAGE, FT. WASHINGTON, MD 143,577 OLNEY, OLNEY, MD 53,765 GROSS LEASABLE PROPERTY/LOCATION SQUARE FEET ORCHARD PARK, DUNWOODY, GA 87,885 PALM SPRINGS CENTER, ALTAMONTE SPRINGS, FL 126,446 RAVENWOOD, BALTIMORE, MD 93,328 11503 ROCKVILLE PK / 5541 NICHOLSON LN, ROCKVILLE, MD 40,249 1500 ROCKVILLE PIKE, ROCKVILLE, MD 52,681 SEABREEZE PLAZA, PALM HARBOR, FL 146,673 MARKETPLACE AT SEA COLONY, BETHANY BEACH, DE 21,677 SEVEN CORNERS, FALLS CHURCH, VA 574,831 SEVERNA PARK MARKETPLACE, SEVERNA PARK, MD 254,174 SHOPS AT FAIRFAX, FAIRFAX, VA 68,762 SMALLWOOD VILLAGE CENTER, WALDORF, MD 173,281 SOUTHDALE, GLEN BURNIE, MD 484,115 SOUTHSIDE PLAZA, RICHMOND, VA 371,761 SOUTH DEKALB PLAZA, ATLANTA, GA 163,418 THRUWAY, WINSTON-SALEM, NC 362,547 VILLAGE CENTER, CENTREVILLE, VA 146,309 WESTVIEW VILLAGE, FREDERICK, MD 97,611 WHITE OAK, SILVER SPRING, MD 480,676 TOTAL SHOPPING CENTERS 7,877,159 Mixed-Use Properties AVENEL BUSINESS PARK, GAITHERSBURG, MD 390,683 CLARENDON CENTER – NORTH, ARLINGTON, VA 108,387 CLARENDON CENTER – SOUTH, ARLINGTON, VA 293,565 (INCLUDES 244 APARTMENTS AT 188,671 SQUARE FEET) CROSSTOWN BUSINESS CENTER, TULSA, OK 197,127 601 PENNSYLVANIA AVE., WASHINGTON, DC 226,604 VAN NESS SQUARE, WASHINGTON, DC 159,411 WASHINGTON SQUARE, ALEXANDRIA, VA 236,376 TOTAL MIXED-USE PROPERTIES 1,612,153 TOTAL PORTFOLIO 9,489,312 8 SAUL CENTERS, INC. 2012 ANNUAL REPORT 9 SELECTED FINANCIAL DATA MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In thousands, except per share data) Years Ended December 31, 2012 2011 2010 2009 2008 Operating Data: Total revenue $ 190,092 $ 173,878 $ 163,108 $ 160,539 $ 159,775 Total operating expenses 153,867 139,908 119,121 115,177 113,149 Operating income 36,225 33,970 43,987 45,362 46,626 Non-operating income: Acquisition related costs (1,129) (2,534) (1,179) – – Change in fair value of derivatives 36 (1,332) – – – Loss on early extinguishment of debt – – (5,405) (2,210) – Gain on casualty settlements 219 245 2,475 329 1,301 Discontinued operations 4,429 (55) 3,307 (251) (261) Net income 39,780 30,294 43,185 43,230 47,666 Income attibutable to the noncontrolling interest (6,406) (3,561) (6,422) (6,517) (7,972) Net income attributable to Saul Centers, Inc. 33,374 26,733 36,763 36,713 39,694 Preferred dividends (15,140) (15,140) (15,140) (15,140) (13,453) Net income available to common stockholders $ 18,234 $ 11,593 $ 21,623 $ 21,573 $ 26,241 Per Share Data (diluted): Net income available to common stockholders $ 0.93 $ 0.61 $ 1.18 $ 1.20 $ 1.46 Basic and diluted shares outstanding: Weighted average common shares - basic 19,649 18,888 18,267 17,904 17,816 Effect of dilutive options 51 61 110 39 145 Weighted average common shares - diluted 19,700 18,949 18,377 17,943 17,961 Weighted average convertible limited partnership units 6,914 5,791 5,416 5,416 5,416 Weighted average common shares and fully converted limited partnership units - diluted 26,614 24,740 23,793 23,359 23,377 Dividends Paid: Cash dividends to common stockholders (1) 28,134 $ 27,062 $ 26,186 $ 27,358 $ 33,450 Cash dividends per share $ 1.44 $ 1.44 $ 1.44 $ 1.50 $ 1.88 Balance Sheet Data: Real estate investments (net of accumulated depreciation) $ 1,112,763 $ 1,091,448 $ 927,250 $ 834,914 $ 774,718 Total assets 1,207,309 1,192,569 1,013,888 925,574 853,873 Total debt, including accrued interest 831,121 835,459 713,997 639,405 570,184 Preferred stock 179,328 179,328 179,328 179,328 179,328 Total stockholders’ equity 307,289 293,206 239,813 226,063 227,887 Other Data: Cash flow provided by (used in): Operating activities $ 78,423 $ 55,669 $ 62,887 $ 68,344 $ 73,101 Investing activities $ (46,873) $ (201,500) $ (98,239) $ (80,469) $ (115,070) Financing activities $ (31,740) $ 145,186 $ 27,713 $ 19,726 $ 49,210 Funds from operations (2): Net income $ 39,780 $ 30,294 $ 43,185 $ 43,230 $ 47,666 Real property depreciation and amortization 40,112 35,298 28,379 28,061 29,570 Real property depreciation - discontinued operations 77 102 198 203 213 Gain on property dispositions and casualty settlements (4,729) (245) (6,066) (329) (1,301) Funds from operations 75,240 65,449 65,696 71,165 76,148 Preferred dividends (15,140) (15,140) (15,140) (15,140) (13,453) Funds from operations available to common shareholders $ 60,100 $ 50,309 $ 50,556 $ 56,025 $ 62,695 (1) During 2012, 2011, 2010, 2009, and 2008, shareholders reinvested $23,124, $19,751, $16,696, $4,136, and $3,941, respectively, in newly issued common stock through the Company’s dividend reinvestment plan. (2) Funds From Operations (FFO) is a non-GAAP financial measure. See page 24 for a definition of FFO and reconciliation from Net Income. 10 SAUL CENTERS, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) begins with the Company’s primary business strategy to give the reader an overview of the goals of the Company’s business. This is followed by a discussion of the critical accounting policies that the Company believes are important to understanding the assumptions and judgments in- corporated in the Company’s reported financial results. The next section, beginning on page 14, discusses the Company’s results of operations for the past two years. Beginning on page 17, the Company provides an analysis of its liquidity and capital re- sources, including discussions of its cash flows, debt arrange- ments, sources of capital and financial commitments. Finally, on page 24, the Company discusses funds from operations, or FFO, which is a non-GAAP financial measure of performance of an equity REIT used by the REIT industry. The MD&A contained in this Annual Report should be read in conjunction with the Company’s Form 10-K, including the con- solidated financial statements and notes thereto appearing in this report. Historical results set forth in Selected Financial Informa- tion, the Consolidated Financial Statements and Supplemental Data should not be taken as indicative of the Company’s future operations. OVERVIEW The Company’s principal business activity is the ownership, man- agement and development of income-producing properties. The Company’s long-term objectives are to increase cash flow from operations and to maximize capital appreciation of its real estate investments. The Company’s primary operating strategy is to focus on its com- munity and neighborhood shopping center business and to op- erate its properties to achieve both cash flow growth and capital appreciation. Management believes there is potential for long term growth in cash flow as existing leases for space in the Shop- ping Centers and Mixed-Use properties expire and are renewed, or newly available or vacant space is leased. The Company in- tends to renegotiate leases where possible and seek new tenants for available space in order to optimize the mix of uses to improve foot traffic through the Shopping Centers. As leases expire, man- agement expects to revise rental rates, lease terms and condi- tions, relocate existing tenants, reconfigure tenant spaces and introduce new tenants with the goals of increasing occupancy, improving overall retail sales, and ultimately increasing cash flow as economic conditions improve. In those circumstances in which leases are not otherwise expiring, management selectively at- tempts to increase cash flow through a variety of means, or in connection with renovations or relocations, recapturing leases with below market rents and re-leasing at market rates, as well as replacing financially troubled tenants. When possible, man- agement also will seek to include scheduled increases in base rent, as well as percentage rental provisions, in its leases. The Company’s redevelopment and renovation objective is to se- lectively and opportunistically redevelop and renovate its prop- erties, by replacing leases that have below market rents with strong, traffic-generating anchor stores such as supermarkets and drug stores, as well as other desirable local, regional and national tenants. The Company’s strategy remains focused on continuing the operating performance and internal growth of its existing Shopping Centers, while enhancing this growth with selective retail redevelopments and renovations. During the fourth quarter of 2012, the Company acquired two properties along the Rockville Pike corridor of Rockville, Mary- land, one of which is adjacent to one of the Company’s existing properties. In December 2012, the Company purchased for $23.0 million, including acquisition costs, approximately 52,700 square feet of retail space located on the east side of Rockville Pike near the Twinbrook Metro Station. The property, which was 90.5% leased to multiple tenants at December 31, 2012, is zoned for up to 745,000 square feet of rentable mixed-use space. The Company intends to redevelop the site but has not committed to any redevelopment plan or time table. In December 2012, the Company purchased for $12.2 million, including acquisition costs, approximately 20,100 square feet of mixed-use space, which was 40.5% leased to multiple tenants, located on the east side of Rockville Pike and adjacent to 11503 Rockville Pike, which was purchased in 2010. The property, when combined with 11503 Rockville Pike, will provide zoning for up to 331,000 square feet of rentable mixed-use space for a total development potential of up to 622,000 square feet. The Company intends to redevelop the site but has not committed to any redevelopment plan or time table. In 2011, the Company acquired three Giant Food-anchored shopping centers located in the Maryland suburbs of the Wash- ington, D.C. and Baltimore metropolitan area. The three centers, Kentlands Square II, Severna Park MarketPlace and Cranberry Square, total 636,000 square feet of leasable area, of which 98% is leased. The $170.9 million purchase price, including acquisition costs, was financed with (1) $60.0 million from two bridge loans secured by Kentlands Square II and Cranberry Square, each with an initial term of six months and accruing interest, payable monthly, at a rate equal to LIBOR plus 175 basis points; (2) a $38.0 million non-recourse permanent loan secured by Severna Park MarketPlace; (3) approximately $17.1 million in cash and borrowings from the Company’s revolving credit facility; and (4) $55.8 million from the issuance of equity to a related party. In light of the limited amount of quality properties for sale and the escalated pricing of properties that the Company has been presented with or has inquired about over the past year, man- agement believes acquisition opportunities for investment in ex- isting and new Shopping Center and Mixed-Use Properties in the near future is uncertain. Because of its conservative capital structure, including its cash and capacity under its revolving credit facility, management believes that the Company is posi- 2012 ANNUAL REPORT 11 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS tioned to take advantage of additional investment opportunities as attractive properties are located and market conditions im- prove. (See “Item 1. Business - Capital Policies”). It is manage- ment’s view that several of the sub-markets in which the Company operates have, or are expected to have in the future, attractive supply/demand characteristics. The Company will con- tinue to evaluate acquisition, development and redevelopment as integral parts of its overall business plan. Although there has been a downturn in the national real estate market, to date, the effects on the office and retail markets in the metropolitan Washington, D.C. area, where the majority of the Company’s properties are located, have generally been less severe. However, continued economic stress in the local economies where the Company’s properties are located may lead to increased tenant bankruptcies, increased vacancies and decreased rental rates. While overall consumer confidence appears to have improved, retailers continue to be cautious about capital allocation when implementing store expansion. Vacancies continue to remain elevated compared to pre-recession levels; however, the Com- pany’s overall leasing percentage on a comparative same prop- erty basis, which excludes the impact of properties not in operation for the entirety of the comparable periods, at Decem- ber 31, 2012 increased to 91.9% from 90.7% at December 31, 2011, an increase in leased space of approximately 107,000 square feet, primarily caused by the leasing of a portion of the space vacated by major shopping center tenants in 2011. Because of the Company’s conservative capital structure, its liq- uidity has not been significantly affected by the recent turmoil in the credit markets. The Company maintains a ratio of total debt to total asset value of under 50%, which allows the Com- pany to obtain additional secured borrowings if necessary. As of December 31, 2012, amortizing fixed-rate mortgage debt with staggered maturities from 2013 to 2027 represented ap- proximately 93.6% of the Company’s notes payable, thus mini- mizing refinancing risk. The Company has two fixed-rate debt maturities scheduled for 2013, one of which was refinanced on February 27, 2013. Management currently expects to repay in full the $6.8 million remaining balance on the second loan when it matures in July 2013. The Company’s variable-rate debt con- sists of a $14.9 million bank term loan for the Northrock shop- ping center, which was refinanced on February 27, 2013, and $38.0 million outstanding under its line of credit. As of Decem- ber 31, 2012, the Company has loan availability of approxi- mately $136.8 million under its $175.0 million unsecured revolving line of credit. Although it is management’s present intention to concentrate future acquisition and development activities on community and neighborhood shopping centers and office properties in the Washington, D.C./Baltimore metropolitan area and the south- eastern region of the United States, the Company may, in the future, also acquire other types of real estate in other areas of 12 SAUL CENTERS, INC. the country as opportunities present themselves. While the Company may diversify in terms of property locations, size and market, the Company does not set any limit on the amount or percentage of Company assets that may be invested in any one property or any one geographic area. CRITICAL ACCOUNTING POLICIES The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), which requires management to make certain estimates and assumptions that affect the report- ing of financial position and results of operations. See Note 2 to the Consolidated Financial Statements in this report. The Com- pany has identified the following policies that, due to estimates and assumptions inherent in those policies, involve a relatively high degree of judgment and complexity. REAL ESTATE INVESTMENTS Real estate investment properties are stated at historic cost less depreciation. Although the Company intends to own its real es- tate investment properties over a long term, from time to time it will evaluate its market position, market conditions, and other factors and may elect to sell properties that do not conform to the Company’s investment profile. Management believes that the Company’s real estate assets have generally appreciated in value since their acquisition or development 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 the financial statements. Because the financial statements are prepared in conformity with GAAP, they do not report the current value of the Company’s real estate investment properties. The Company purchases real estate investment properties from time to time and records assets acquired and liabilities assumed, including land, buildings, and intangibles related to in-place leases and customer relationships based on their fair values. The fair value of buildings generally is determined as if the buildings were vacant upon acquisition and subsequently leased at market rental rates and considers the present value of all cash flows ex- pected to be generated by the property including an initial lease up period. The Company determines the fair value of above and below market intangibles associated with in-place leases by as- sessing the net effective rent and remaining term of the in-place lease relative to market terms for similar leases at acquisition tak- ing into consideration the remaining contractual lease period, re- newal periods, and the likelihood of the tenant exercising its renewal options. The fair value of a below market lease compo- nent is recorded as deferred income and accrued as additional lease revenue over the remaining contractual lease period and any renewal option periods included in the valuation analysis. The fair value of above market lease intangibles is recorded as a deferred asset and is amortized as a reduction of lease revenue over the remaining contractual lease term. The Company deter- mines the fair value of at-market in-place leases considering the cost of acquiring similar leases, the foregone rents associated with the lease-up period and carrying costs associated with the lease-up period. Intangible assets associated with at-market in- place leases are amortized as additional expense over the remain- ing contractual lease term. To the extent customer relationship intangibles are present in an acquisition, the fair value of the in- tangibles are amortized over the life of the customer relationship. From time to time the Company may purchase a property for fu- ture development purposes. The property may be improved with an existing structure that would be demolished as part of the de- velopment. In such cases, the fair value of the building may be determined based only on existing leases and not include esti- mated cash flows related to future leases. If there is an event or change in circumstance that indicates a po- tential impairment in the value of a real estate investment prop- erty, the Company prepares an analysis to determine whether the carrying value of the real estate investment property exceeds its estimated fair value. The Company considers both quantitative and qualitative factors in identifying impairment indicators includ- ing recurring operating losses, significant decreases in occupancy, and significant adverse changes in legal factors and business cli- mate. If impairment indicators are present, the Company com- pares the projected cash flows of the property over its remaining useful life, on an undiscounted basis, to the carrying value of that property. The Company assesses its undiscounted projected cash flows based upon estimated capitalization rates, historic operating results and market conditions that may affect the property. If the carrying value is greater than the undiscounted projected cash flows, the Company would recognize an impairment loss equiva- lent to an amount required to adjust the carrying amount to its then estimated fair value. The fair value of any property is sensitive to the actual results of any of the aforementioned estimated fac- tors, either individually or taken as a whole. Should the actual re- sults differ from management’s projections, the valuation could be negatively or positively affected. When incurred, the Company capitalizes the cost of improvements that extend the useful life of property and equipment. All repair and maintenance expenditures are expensed when incurred. Leasehold improvements expenditures are capitalized when certain criteria are met, including when we supervise construction and will own the improvement. Tenant improvements we own are depre- ciated over the life of the respective lease or the estimated useful life of the improvements, whichever is shorter. Interest, real estate taxes, development-related salary costs and other carrying costs are capitalized on projects under construction. Once construction is substantially complete and the assets are placed in service, rental income, direct operating expenses, and depreciation associated with such properties are included in current operations. Commercial development projects are substantially complete and available for occupancy upon completion of tenant improvements, but no later than one year from the cessation of major construction activity. Residential development projects are considered substantially complete and available for occupancy upon receipt of the certificate of occupancy from the appropriate licensing authority. 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 gen- erally between 35 and 50 years for base buildings, or a shorter pe- riod if management determines that the building has a shorter useful life, and up to 20 years for certain other improvements. DEFERRED LEASING COSTS Certain initial direct costs incurred by the Company in negotiat- ing and consummating successful commercial leases are capital- ized and amortized over the term of the leases. Deferred leasing costs consist of commissions paid to third-party leasing agents as well as internal direct costs such as employee compensation and payroll-related fringe benefits directly related to time spent performing successful leasing-related activities. Such activities include evaluating prospective tenants’ financial condition, eval- uating and recording guarantees, collateral and other security arrangements, negotiating lease terms, preparing lease docu- ments and closing transactions. In addition, deferred leasing costs include amounts attributed to in-place leases associated with acquisition properties. REVENUE RECOGNITION Rental and interest income are accrued as earned except when doubt exists as to collectability, in which case the accrual is dis- continued. Recognition of rental income commences when con- trol of the space has been given to the tenant. When rental payments due under leases vary from a straight-line basis be- cause of free rent periods or scheduled rent increases, income is recognized on a straight-line basis throughout the term of the lease. Expense recoveries represent a portion of property oper- ating expenses billed to tenants, including common area main- tenance, real estate taxes and other recoverable costs. Expense recoveries are recognized in the period when the expenses are incurred. Rental income based on a tenant’s revenue, known as percentage rent, is accrued when a tenant reports sales that ex- ceed a specified breakpoint specified in the lease agreement. ALLOWANCE FOR DOUBTFUL ACCOUNTS - CURRENT AND DEFERRED RECEIVABLES Accounts receivable primarily represent amounts accrued and unpaid from tenants in accordance with the terms of the respec- tive leases, subject to the Company’s revenue recognition policy. Receivables are reviewed monthly and reserves are established with a charge to current period operations when, in the opinion of management, collection of the receivable is doubtful. In ad- dition to rents due currently, accounts receivable include amounts representing minimum rental income accrued on a straight-line basis to be paid by tenants over the remaining term of their respective leases. Reserves are established with a charge to income for tenants whose rent payment history or financial condition casts doubt upon the tenant’s ability to perform under its lease obligations. 2012 ANNUAL REPORT 13 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LEGAL CONTINGENCIES The Company is subject to various legal proceedings and claims that arise in the ordinary course of business, which are generally covered by insurance. While the resolution of these matters can- not be predicted with certainty, the Company believes the final outcome of current matters will not have a material adverse ef- fect on its financial position or the results of operations. Once it has been determined that a loss is probable to occur, the esti- mated amount of the loss is recorded in the financial statements. Both the amount of the loss and the point at which its occur- rence is considered probable can be difficult to determine. RESULTS OF OPERATIONS Same property revenue and operating income were $160.1 million and $119.7 million, respectively, in 2012 representing increases of $1.5 million (1.0%) and $2.1 million (1.8%) over 2011. Same property comparisons for 2012 and 2011 include 46 Shopping Centers and 5 Mixed-Use Properties which were in operation for the entirety of 2012 and 2011. Same property revenue and operating income were $151.8 million and $112.6 million, respectively, in 2011 representing decreases of $8.9 million (5.6%) and $6.7 million (5.6%) compared to 2010. Same property comparisons for 2011 and 2010 include 44 Shopping Centers and 5 Mixed-Use Properties which were in operation for the entirety of 2011 and 2010. The following is a discussion of the components of revenue and expense for the entire Company. For the year ended December 31, Percentage Change (Dollars in thousands) 2012 2011 2010 2012 to 2011 2011 to 2010 REVENUE Expense recovery income decreased $1.1 million in 2011 com- pared to 2010 due primarily to recovery in 2010 of snow removal expenses incurred as a result of severe winter weather impacting the Mid-Atlantic states during January and February 2010. OTHER REVENUE The decline in operating income in 2012 compared to 2011 is primarily due to the collection in 2011 of $325,000 of past due rents from a former tenant, partially offset by increased parking income at the Mixed-Use Properties. Other revenue decreased in 2011 primarily due to the collection during 2010 of past due rents and other damages arising from a long-standing dispute with a tenant over the non-payment of rent over a period of time (approximately $1.9 million) partially offset by increased residential tenant fees and parking income (combined $755,000) at Clarendon Center. OPERATING EXPENSES For the year ended December 31, Percentage Change (Dollars in thousands) 2012 2011 2010 2012 to 2011 2011 to 2010 Property operating expenses $ 23,794 $ 24,715 $ 22,897 (3.7)% 7.9% Provision for credit losses 1,151 1,880 1,334 (38.8)% 40.9% Real estate taxes 22,325 18,435 17,744 21.1% 3.9% Interest expense and amortization of deferred debt 49,544 45,324 34,799 9.3% 30.2% Base rent $ 152,777 $ 138,486 $ 126,163 10.3% 9.8% Depreciation and amortization 40,112 35,298 28,379 13.6% 24.4% Expense recoveries 30,391 28,368 29,488 7.1% (3.8)% General and administrative 14,274 14,256 13,968 0.1% 2.1% Percentage rent 1,545 1,503 1,447 2.8% 3.9% Predevelopment Expenses 2,667 – – N/A N/A Other 5,379 5,521 6,010 (2.6)% (8.1)% Total revenue $ 190,092 $ 173,878 $ 163,108 9.3% 6.6% Note: Base rent includes $3,796, $3,694, and $227, for the years 2012, 2011, and 2010, respectively, to recognize base rent on a straight-line basis. In addition, base rent includes $1,495, $1,119, and $1,024, for the years 2012, 2011, and 2010, respectively, to recognize income from the amortization of in-place leases. Total revenue increased 9.3% in 2012 compared to 2011 prima- rily due to $14.5 million of aggregate revenue generated by Clarendon Center and the three Shopping Center Properties ac- quired in 2011 (collectively, the “New 2012 Properties”). Total revenue increased 6.6% in 2011 compared to 2010. The increased revenue resulted primarily from (a) rental income gen- erated by a development property (Clarendon Center) and five acquisition properties (11503 Rockville Pike, Metro Pike Center, Kentlands Square II, Severna Park MarketPlace and Cranberry Square), defined as the “2011 Acquisition Properties” and to- gether with Clarendon Center, the “2011 Development and Ac- quisition Properties” (approximately $19.1 million), offset in part by (b) (x) decreased revenue from rental properties fully in oper- ation during both 2011 and 2010 (approximately $8.9 million), comprised primarily of a decline in revenue generated by the Mixed-Use Properties (approximately $4.1 million) due to a de- crease in occupancy that occurred in the latter part of 2010 and the first quarter of 2011, (y) a decrease in other income com- pared to 2010, when the collection of rent and other damages arising from a long-standing dispute with a tenant over the non-payment of rent over a period of time was recorded ($1.9 14 SAUL CENTERS, INC. million), and (z) reduced expense recovery income resulting from substantial snow removal expenses incurred in 2010. A discussion of the components of revenue follows. BASE RENT The $14.3 million increase in base rent in 2012 compared to 2011 was attributable to $12.4 million of increased base rent generated by the New 2012 Properties and $2.3 million of in- creased base rent in the remainder of the portfolio. The $12.3 million increase in base rent in 2011 compared to 2010 was primarily attributable to the 2011 Development and Acquisition Properties (approximately $16.8 million) which was offset in part by decreases at same center Mixed-Use Properties (approximately $3.0 million) and the Shopping Centers (approx- imately $1.9 million). EXPENSE RECOVERIES Expense recovery income increased $2.0 million in 2012 com- pared to 2011 primarily due to $1.7 million of increased expense recovery income generated by the New 2012 Properties. Total operating expenses $ 153,867 $139,908 $119,121 10.0% 17.5% Total operating expenses increased 10.0% in 2012 compared to 2011 primarily due to increased real estate taxes, interest ex- pense, depreciation expense and predevelopment expense. Total operating expenses increased 17.5% in 2011 compared to 2010 primarily due to increased interest and depreciation ex- pense arising from the operation of the 2011 Development and Acquisition Properties. PROPERTY OPERATING EXPENSES Property operating expenses decreased $900,000 in 2012 com- pared to 2011 primarily due to lower snow removal costs. Property operating expenses increased $1.8 million in 2011 pri- marily due to operating expenses arising from the operation of the 2011 Development and Acquisition Properties ($3.3 million) and modest increases in non-snow removal same property op- erating expenses offset in part by a $2.3 million decrease in snow removal expense. PROVISION FOR CREDIT LOSSES The provision for credit losses represents the Company’s estimate of amounts owed by tenants that may not be collectible. The $729,000 decrease in 2012 compared to 2011 reflects a general improvement in the retail economy and lack of significant bank- ruptcy losses among the Company’s various tenants. The $546,000 increase in 2011 compared to 2010 reflects the con- tinued stress of a stagnant housing market and slowly recovering jobs market in the local economies where the Current Portfolio Properties are located. Approximately $505,000 of the increase was caused by the SuperFresh and Borders Bookstore bankrupt- cies and a local grocery store vacancy. REAL ESTATE TAXES The $3.9 million increase in real estate taxes in 2012 compared to 2011 is comprised of increased property taxes charged by the District of Columbia and taxes related to the New 2012 Proper- ties. The $691,000 increase in real estate taxes in 2011 over 2010 resulted primarily from the operation of the 2011 Devel- opment and Acquisition Properties. INTEREST AND AMORTIZATION OF DEFERRED DEBT Interest expense increased $4.2 million in 2012 compared to 2011 primarily due to approximately $4.1 million of interest re- lated to $67.2 million of higher average debt balances and $1.9 million of reduced capitalized interest, partially offset by $2.1 mil- lion of lower interest resulting from lower average cost of debt. Interest expense increased $10.5 million in 2011 compared to 2010 primarily due to Clarendon Center, because more than 85% of the project was placed in service during 2011, which caused an $8.9 million increase in interest expense, net of amounts capitalized, as well as increased interest expense arising from the refinancing in March 2011 of the project’s construction 2012 ANNUAL REPORT 15 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS loan with a higher fixed-rate, 15 year mortgage. Interest ex- pense also increased in 2011 by $1.3 million from debt incurred to finance the 2011 Acquisition Properties. DEPRECIATION AND AMORTIZATION Depreciation and amortization of deferred leasing costs in- creased $4.8 million in 2012 compared to 2011 primarily due to the New 2012 Properties. Depreciation and amortization of deferred leasing costs in- creased $6.9 million in 2011 compared to 2010 primarily as a result of depreciation commencement for the 2011 Develop- ment and Acquisition Properties placed in service during 2011. GENERAL AND ADMINISTRATIVE General and administrative expenses increased $288,000 in 2011 compared to 2010 primarily due to increased local taxes. PREDEVELOPMENT EXPENSES Predevelopment expenses represent costs incurred, primarily lease termination costs, in preparation of the potential reposi- tioning of Van Ness Square. ACQUISITION RELATED COSTS Acquisition related costs in 2012 totaling approximately $1.1 million arose from the December 2012 purchases of 1500 Rockville Pike and 5541 Nicholson Lane. Acquisition related costs in 2011 totaling approximately $2.5 million arose from the Company’s September 23, 2011, pur- chase of Kentlands Square II, Severna Park MarketPlace and Cranberry Square and the February 17, 2011 purchase of a 3,000 square foot retail property located adjacent to the Com- pany’s Van Ness Square in Washington, D.C. Acquisition related costs totaling approximately $1.2 million in 2010 relate to the Company’s October 1, 2010 purchase of a 20,000 square foot property and December 17, 2010 purchase of a 67,500 square foot property, both located near the White Flint Metro Station in Montgomery County, Maryland. GAIN ON CASUALTY SETTLEMENT Gain on casualty settlement in 2012 reflects insurance proceeds received in excess of the carrying value of assets damaged during a hail storm at French Market in 2012. Gain on casualty settle- ment in 2011 and 2010 reflects insurance proceeds received in excess of the carrying value of assets damaged during a severe hail storm at French Market in May 2010. In each instance, the insurance proceeds funded substantially all of the restoration of the damaged property. LOSS ON EARLY EXTINGUISHMENT OF DEBT In June 2010, the Company refinanced its Thruway shopping center, located in Winston-Salem, North Carolina. The $45.6 million loan requires principal and interest payments calculated using a 5.83% interest rate and a 25-year amortization schedule, and matures in ten years. In December 2010, the Company re- financed its Ravenwood shopping center, located in Baltimore, Maryland. The $17.0 million loan requires principal and interest payments calculated using a 6.18% interest rate and a 25-year amortization schedule, and matures in 15 years. These loans re- financed a portion of a 7.67%, multi-property loan that was scheduled to mature in October 2012. In conjunction with the refinancings, the Company incurred costs to retire the previous Thruway debt totaling $4.5 million (approximately $4.4 million to defease the original loan and write-offs of unamortized de- ferred debt costs of approximately $54,000) and to retire the previous Ravenwood debt totaling $926,000 (approximately $912,000 to defease the original loan and write-offs of unamor- tized deferred debt costs of approximately $14,000). The trans- actions reduced the Company’s future refinancing risk by decreasing the amount of debt maturing in 2012 from $95.7 million to $62.0 million, and provided net cash proceeds of ap- proximately $17.4 million. GAIN ON SALE OF PROPERTY Gain on sales of properties in 2012 resulted from the July 2012 sale of West Park shopping center and the December 2012 sale of the Belvedere shopping center. Gain on sale of property in 2010 resulted from the sale of the Lexington Center land parcel and Lexington pads. IMPACT OF INFLATION Inflation has remained relatively low during 2012 and 2011. The impact of rising operating expenses due to inflation on the op- erating performance of the Company’s portfolio would have been mitigated by terms in substantially all of the Company’s leases which contain provisions designed to increase revenues to offset the adverse impact of inflation on the Company’s re- sults of operations. These provisions include upward periodic adjustments in base rent due from tenants, usually based on a stipulated increase and to a lesser extent on a factor of the change in the consumer price index, commonly referred to as the CPI. In addition, substantially all of the Company’s properties are leased to tenants under long-term leases, which provide for re- imbursement of operating expenses by tenants. These leases tend to reduce the Company’s exposure to rising property ex- penses due to inflation. Inflation and increased costs may have an adverse impact on the Company’s tenants if increases in their operating expenses exceed increases in their revenue. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents were $12.1 million and $12.3 million at December 31, 2012 and 2011, respectively. The changes in cash and cash equivalents during the years ended December 31, 2012 and 2011 were attributable to operating, investing and fi- nancing activities, as described below. • the repayment of mortgage notes payable totaling $117.6 million; • distributions made to common stockholders and holders of convertible limited partnership units in the Operating Partner- ship during the year totaling $38.1 million; • distributions made to preferred stockholders during the year totaling $15.1 million; Year Ended December 31, (Dollars in thousands) 2012 2011 • repayments of $8.0 million on the revolving credit facility; and • payments of $2.2 million for financing costs of new mortgage Net cash provided by operating activities $ 78,423 $ 55,669 Net cash used in investing activities (46,873) (201,500) Net cash provided by/used in financing activities (31,740) 145,186 Decrease in cash and cash equivalents $ (190 ) $ (645) OPERATING ACTIVITIES Net cash provided by operating activities increased $22.7 million to $78.4 million for the year ended December 31, 2012 com- pared to $55.7 million for the year ended December 31, 2011, primarily reflecting the full year operating effect of properties acquired in September 2011. Net cash provided by operating activities represents, in each year, cash received primarily from rental income, plus other income, less property operating ex- penses, normal recurring general and administrative expenses and interest payments on debt outstanding. INVESTING ACTIVITIES Net cash used in investing activities decreased $154.6 million to $46.9 million for the year ended December 31, 2012 compared to $201.5 million for the year ended December 31, 2011. In- vesting activities in 2012 primarily reflect (a) the purchases of 1500 Rockville Pike and 5541 Nicholson Lane (b) tenant im- provements and capital expenditures and (c) Clarendon Center and Ashland Square Phase I development costs partially offset by (d) proceeds from the sales of West Park and Belvedere and (e) proceeds from casualty settlement. Investing activities for 2011 primarily reflect the purchase of Cranberry Square, Kent- lands Square II and Severna Park MarketPlace and Clarendon Center construction costs. Tenant improvement and property capital expenditures totaled $12.7 million and $11.6 million for 2012 and 2011, respectively. FINANCING ACTIVITIES Net cash used in financing activities was $31.7 million for the year ended December 31, 2012. Net cash provided by financing activities for the year ended December 31, 2011, was $145.2 million. Net cash used in financing activities for the year ended December 31, 2012 primarily reflects: loans; which was partially offset by: • proceeds received from one new and one modified mortgage notes payable totaling $83.5 million; • proceeds of $38.0 million from the revolving credit facility; and • $27.8 million of proceeds received from the issuance of com- mon stock under the dividend reinvestment program and from the exercise of stock options. Cash provided by financing activities for the year ended December 31, 2011 primarily reflects: • proceeds of $226.0 million received from mortgage notes payable; • proceeds of $60.0 million received from secured bridge financ- ing loans; • proceeds of $13.4 million received from construction loan draws; • proceeds of $16.0 million received from revolving credit facility draws; • proceeds of $55.8 million from an equity offering of common stock and limited partnership units in the Operating Partner- ship; and • proceeds of $20.9 million from the issuance of common stock under the dividend reinvestment program, directors deferred plan and the exercise of stock options; which was partially offset by: • the repayment of mortgage notes payable totaling $22.7 million; • the repayment of secured bridge financing loans totaling $60.0 million; • the repayment of construction loans payable totaling $104.2 million; • the repayment of amounts borrowed under the revolving credit facility of $8.0 million; • distributions to common stockholders totaling $27.1 million; • distributions to holders of convertible limited partnership units in the Operating Partnership totaling $8.3 million; • distributions made to preferred stockholders totaling $15.1 million; and • payments of $1.4 million for financing costs of mortgage notes payable. 16 SAUL CENTERS, INC. 2012 ANNUAL REPORT 17 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIQUIDITY REQUIREMENTS Short-term liquidity requirements consist primarily of normal re- curring operating expenses and capital expenditures, debt serv- ice requirements (including debt service relating to additional and replacement debt), distributions to common and preferred stockholders, distributions to unit holders and amounts required for expansion and renovation of the Current Portfolio Properties and selective acquisition and development of additional proper- ties. In order to qualify as a REIT for federal income tax purposes, the Company must distribute to its stockholders at least 90% of its “real estate investment trust taxable income,” as defined in the Code. The Company expects to meet these short-term liq- uidity requirements (other than amounts required for additional property acquisitions and developments) through cash provided from operations, available cash and its existing line of credit. Long-term liquidity requirements consist primarily of obligations under our long-term debt and dividends paid to our preferred shareholders. We anticipate that long-term liquidity require- ments will also include amounts required for property acquisi- tions and developments. Management anticipates that during the coming years the Company will commence activities related to the redevelopment of Van Ness Square and the adjacent 4469 Connecticut Avenue and may redevelop certain of the Current Portfolio Properties and may develop additional freestanding outparcels or expansions within certain of the Shopping Centers. Although not currently planned, it is possible that the Company may redevelop additional Current Portfolio Properties and may develop expansions within certain of the Shopping Centers. Acquisition and development of properties are undertaken only after careful analysis and review, and management’s determina- tion that such properties are expected to provide long-term earnings and cash flow growth. During the coming year, developments, expansions or acquisi- tions are expected to be funded with available cash, bank borrowings from the Company’s credit line, construction and permanent financing, proceeds from the operation of the Company’s dividend reinvestment plan or other external debt or equity capital resources available to the Company. Any future borrowings may be at the Saul Centers, Operating Partnership or Subsidiary Partnership level, and securities offer- ings may include (subject to certain limitations) the issuance of additional limited partnership interests in the Operating Partner- ship which can be converted into shares of Saul Centers common stock. The availability and terms of any such financing will depend upon market and other conditions. CONTRACTUAL PAYMENT OBLIGATIONS As of December 31, 2012, the Company had unfunded contrac- tual payment obligations of approximately $110.6 million, excluding operating obligations, due within the next 12 months. The table below shows the total contractual payment obligations as of December 31, 2012. Payments Due By Period (Dollars in thousands) One Year or Less 2-3 Years 4-5 Years After 5 Years Total CONTRACTUAL PAYMENT OBLIGATIONS Notes Payable: Interest $ 44,095 $ 81,751 $ 75,052 $ 185,757 $ 386,655 Scheduled Principal 19,212 39,886 43,369 148,817 251,284 Balloon Payments 37,305 28,295 38,000 472,892 576,492 Subtotal 100,612 149,932 156,421 807,466 1,214,431 Ground Leases (1) 176 352 352 9,538 10,418 Corporate Headquarters Lease (1) 818 1,711 1,045 – 3,574 Development Obligations 8,953 – – – 8,953 Total Contractual Obligations $ 110,559 $ 151,995 $ 157,818 $ 817,004 $1,237,376 (1) See Note 7 to Consolidated Financial Statements. Corporate Headquarters Lease amounts represent an allocation to the Company based upon employees’ time dedicated to the Company’s business as specified in the Shared Services Agreement. Future amounts are subject to change as the number of employees employed by each of the parties to the lease fluctuates. Management believes that the Company’s cash flow from oper- ations and its capital resources, which at December 31, 2012 in- cluded cash balances of $12.1 million and borrowing availability of approximately $136.8 million on its revolving line of credit, will be sufficient to meet its contractual obligations for the foreseeable future. 18 SAUL CENTERS, INC. PREFERRED STOCK ISSUES In November 2003, the Company sold 4,000,000 depositary shares, each representing 1/100th of a share of 8% Series A Cu- mulative Redeemable Preferred Stock. The depositary shares may be redeemed at the Company’s option, in whole or in part from time to time, at the $25.00 liquidation preference plus ac- crued but unpaid dividends. The depositary shares pay an an- nual dividend of $2.00 per share, equivalent to 8% of the $25.00 liquidation preference. The Series A preferred stock has no stated maturity, is not subject to any sinking fund or manda- tory redemption and is not convertible into any other securities of the Company. Investors in the depositary shares generally have no voting rights, but will have limited voting rights if the Company fails to pay dividends for six or more quarters (whether or not declared or consecutive) and in certain other events. On January 31, 2013, the Company issued a notice to redeem 60% of the outstanding depositary shares at a price of $25.00 per depositary share, plus accrued dividends. The redemption was completed on March 2, 2013. In March 2008, the Company sold, in an underwritten public of- fering, 3,173,115 depositary shares, each representing 1/100th of a share of 9% Series B Cumulative Redeemable Preferred Stock, providing net cash proceeds of $76.3 million. The de- positary shares may be redeemed at the Company’s option, in whole or in part, at the $25.00 liquidation preference plus ac- crued but unpaid dividends on or after March 15, 2013. The depositary shares pay an annual dividend of $2.25 per share, equivalent to 9% of the $25.00 liquidation preference. The first dividend was paid on July 15, 2008 and covered the period from March 27, 2008 through June 30, 2008. The Series B preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not convertible into any other securities of the Company. Investors in the depositary shares generally have no voting rights, but will have limited voting rights if the Company fails to pay dividends for six or more quar- ters (whether or not declared or consecutive) and in certain other events. On February 12, 2013, the Company issued a notice to redeem all of the outstanding depositary shares at a price of $25.00 per depositary share, plus accrued dividends. The re- demption date is March 15, 2013. In February 2013, the Company sold, in an underwritten public offering, 5.6 million depositary shares, each representing 1/100th of a share of 6.875% Series C Cumulative Redeemable Preferred Stock, providing net cash proceeds of approximately $135.0 mil- lion. The depositary shares may be redeemed at the Company’s option, in whole or in part, at the $25.00 liquidation preference plus accrued but unpaid dividends on or after February 12, 2018. The depositary shares pay an annual dividend of $1.71875 per share, equivalent to 6.875% of the $25.00 liquidation prefer- ence. The first dividend is scheduled to be paid on April 15, 2013 and covers the period from February 12, 2013 through March 31, 2013. The Series C preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not convertible into any other securities of the Company except in connection with certain changes of control or delisting events. Investors in the depositary shares generally have no voting rights, but will have limited voting rights if the Company fails to pay div- idends for six or more quarters (whether or not declared or con- secutive) and in certain other events. DIVIDEND REINVESTMENTS In December 1995, the Company established a Dividend Rein- vestment Plan (the “Plan”) to allow its common stockholders and holders of limited partnership interests an opportunity to buy additional shares of common stock by reinvesting all or a portion of their dividends or distributions. The Plan provides for investing in newly issued shares of common stock at a 3% dis- count from market price without payment of any brokerage commissions, service charges or other expenses. All expenses of the Plan are paid by the Company. The Company issued 586,838 and 489,890 shares under the Plan at a weighted av- erage discounted price of $38.85 and $39.64 per share during the years ended December 31, 2012 and 2011, respectively. The Company also credited 8,551 and 8,358 shares to directors pur- suant to the reinvestment of dividends specified by the Directors’ Deferred Compensation Plan at a weighted average discounted price of $38.76 and $39.94 per share, during the years ended December 31, 2012 and 2011, respectively. CAPITAL STRATEGY AND FINANCING ACTIVITY As a general policy, the Company intends to maintain a ratio of its total debt to total asset value of 50% or less and to actively man- age the Company’s leverage and debt expense on an ongoing basis in order to maintain prudent coverage of fixed charges. Asset value is the aggregate fair market value of the Current Portfolio Properties and any subsequently acquired properties as reasonably determined by management by reference to the properties’ aggre- gate cash flow. Given the Company’s current debt level, it is man- agement’s belief that the ratio of the Company’s debt to total asset value was below 50% as of December 31, 2012. The organizational documents of the Company do not limit the absolute amount or percentage of indebtedness that it may incur. The Board of Directors may, from time to time, reevaluate the Company’s debt capitalization policy in light of current eco- nomic conditions, relative costs of capital, market values of the Company property portfolio, opportunities for acquisition, de- velopment or expansion, and such other factors as the Board of Directors then deems relevant. The Board of Directors may mod- ify the Company’s debt capitalization policy based on such a reevaluation without shareholder approval and consequently, may increase or decrease the Company’s debt to total asset ratio above or below 50% or may waive the policy for certain periods of time. The Company selectively continues to refinance or rene- gotiate the terms of its outstanding debt in order to achieve longer maturities, and obtain generally more favorable loan terms, whenever management determines the financing envi- ronment is favorable. 2012 ANNUAL REPORT 19 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a summary of notes payable as of December 31, 2012 and 2011: NOTES PAYABLE December 31, Interest Scheduled (Dollars in thousands) 2012 2011 Rate * Maturity * Fixed rate mortgages: $ – (a) 64,844 7.67% Oct-2012 – (b) 10,244 6.12% Jan-2013 – (c) 24,598 7.88% Jan-2013 15,750 (d) 16,032 4.67% Jun-2013 6,936 (e) 7,203 5.77% Jul-2013 13,875 (f) 14,335 5.40% May-2014 16,798 (g) 17,415 7.45% Jun-2015 34,373 (h) 35,435 6.01% Feb-2018 38,388 (i) 39,757 5.88% Jan-2019 12,418 (j) 12,860 5.76% May-2019 17,145 (k) 17,755 5.62% Jul-2019 17,040 (l) 17,627 5.79% Sep-2019 15,176 (m) 15,713 5.22% Jan-2020 11,421 (n) 11,670 5.60% May-2020 10,288 (o) 10,636 5.30% Jun-2020 43,424 (p) 44,333 5.83% Jul-2020 8,934 (q) 9,204 5.81% Feb-2021 6,359 (r) 6,477 6.01% Aug-2021 36,699 (s) 37,377 5.62% Jun-2022 11,129 (t) 11,317 6.08% Sep-2022 11,989 (u) 12,172 6.43% Apr-2023 16,247 (v) 16,858 6.28% Feb-2024 17,469 (w) 17,791 7.35% Jun-2024 15,140 (x) 15,409 7.60% Jun-2024 26,635 (y) 16,494 7.02% Jul-2024 31,709 (z) 32,281 7.45% Jul-2024 31,490 (aa) 32,044 7.30% Jan-2025 16,419 (bb) 16,731 6.18% Jan-2026 120,822 (cc) 123,372 5.31% Apr-2026 36,986 (dd) 37,858 4.30% Oct-2026 41,970 (ee) 42,923 4.53% Nov-2026 19,569 (ff) 20,000 4.70% Dec-2026 72,233 (gg) – 5.84% May-2027 Total fixed rate 774,831 808,765 5.82% 10.0 Years Variable rate loans: Revolving credit facility 38,000 (hh) 8,000 LIBOR + 1.90% May-2016 Northrock bank term loan 14,945 (ii) 15,106 LIBOR + 3.00% May-2013 Total variable rate 52,945 23,106 2.80% 3.4 Years Total notes payable $ 827,776 $ 831,871 5.77% 9.7 Years * Interest rate and scheduled maturity data presented as of December 31, 2012. Totals computed using weighted averages. (a) The loan was collateralized by seven shopping centers (Seven Cor- ners, White Oak, Hampshire Langley, Great Eastern, Southside Plaza, Belvedere and Giant) and required equal monthly principal and in- terest payments of $734,000 based upon a 25-year amortization schedule and a final payment of $62.0 million at loan maturity. The loan was repaid in full in 2012. (c) (b) The loan was collateralized by Smallwood Village Center and re- quired equal monthly principal and interest payments of $71,000 based upon a 30-year amortization schedule and a final payment of $10.1 million at loan maturity. The loan was repaid in full in 2012. The loan was collateralized by 601 Pennsylvania Avenue and re- quired equal monthly principal and interest payments of $294,000 based upon a 25-year amortization schedule and a final payment of $23.0 million at loan maturity. The loan was repaid in full in 2012. (d) The loan, together with a corresponding interest-rate swap, was as- sumed with the December 17, 2010 acquisition of, and is collater- alized by, Metro Pike Center. On a combined basis, the loan and the swap required interest only payments of $63,000 until August 1, 2011, then equal monthly payments of $86,000 based upon a 25- year amortization schedule and a final payment of $15.6 million at loan maturity. Principal of $282,000 was amortized during 2012. (e) The loan is collateralized by Cruse MarketPlace and requires equal monthly principal and interest payments of $56,000 based upon an amortization schedule of approximately 24 years and a final pay- ment of $6.8 million at loan maturity. Principal of $267,000 was amortized during 2012. The loan is collateralized by Seabreeze Plaza and requires equal monthly principal and interest payments totaling $102,000 based upon a weighted average 26-year amortization schedule and a final payment of $13.3 million is due at loan maturity. Principal of $460,000 was amortized during 2012. (f) (g) The loan is collateralized by Shops at Fairfax and Boulevard shopping centers and requires equal monthly principal and interest payments totaling $156,000 based upon a weighted average 23-year amorti- zation schedule and a final payment of $15.2 million is due at loan maturity. Principal of $617,000 was amortized during 2012. (h) The loan is collateralized by Washington Square and requires equal monthly principal and interest payments of $264,000 based upon a 27.5-year amortization schedule and a final payment of $28.0 million at loan maturity. Principal of $1.1 million was amortized during 2012. The loan is collateralized by three shopping centers, Broadlands Vil- lage, The Glen and Kentlands Square I, and requires equal monthly principal and interest payments of $306,000 based upon a 25-year amortization schedule and a final payment of $28.4 million at loan maturity. Principal of $1.4 million was amortized during 2012. The loan is collateralized by Olde Forte Village and requires equal monthly principal and interest payments of $98,000 based upon a 25-year amortization schedule and a final payment of $9.0 million at loan maturity. Principal of $442,000 was amortized during 2012. (j) (i) (l) (k) The loan is collateralized by Countryside and requires equal monthly principal and interest payments of $133,000 based upon a 25-year amortization schedule and a final payment of $12.3 million at loan maturity. Principal of $610,000 was amortized during 2012. The loan is collateralized by Briggs Chaney MarketPlace and requires equal monthly principal and interest payments of $133,000 based upon a 25-year amortization schedule and a final payment of $12.2 million at loan maturity. Principal of $587,000 was amortized during 2012. (m) The loan is collateralized by Shops at Monocacy and requires equal monthly principal and interest payments of $112,000 based upon a 25-year amortization schedule and a final payment of $10.6 million at loan maturity. Principal of $537,000 was amortized during 2012. (n) The loan is collateralized by Boca Valley Plaza and requires equal monthly principal and interest payments of $75,000 based upon a 30-year amortization schedule and a final payment of $9.1 million at loan maturity. Principal of $249,000 was amortized during 2012. (o) The loan is collateralized by Palm Springs Center and requires equal monthly principal and interest payments of $75,000 based upon a 25-year amortization schedule and a final payment of $7.1 million at loan maturity. Principal of $348,000 was amortized during 2012. (p) The loan and a corresponding interest-rate swap closed on June 29, 2010 and are collateralized by Thruway. On a combined basis, the loan and the interest-rate swap require equal monthly principal and interest payments of $289,000 based upon a 25-year amortization schedule and a final payment of $34.8 million at loan maturity. Prin- cipal of $909,000 was amortized during 2012. (t) (r) (s) (q) The loan is collateralized by Jamestown Place and requires equal monthly principal and interest payments of $66,000 based upon a 25-year amortization schedule and a final payment of $6.1 million at loan maturity. Principal of $270,000 was amortized during 2012. The loan is collateralized by Hunt Club Corners and requires equal monthly principal and interest payments of $42,000 based upon a 30-year amortization schedule and a final payment of $5.0 million, at loan maturity. Principal of $118,000 was amortized during 2012. The loan is collateralized by Lansdowne Town Center and requires monthly principal and interest payments of $230,000 based on a 30-year amortization schedule and a final payment of $28.2 million at loan maturity. Principal of $678,000 was amortized during 2012. The loan is collateralized by Orchard Park and requires equal monthly principal and interest payments of $73,000 based upon a 30-year amortization schedule and a final payment of $8.6 million at loan maturity. Principal of $188,000 was amortized during 2012. (u) The loan is collateralized by BJ’s Wholesale and requires equal monthly principal and interest payments of $80,000 based upon a 30-year amortization schedule and a final payment of $9.3 million at loan maturity. Principal of $183,000 was amortized during 2012. (v) The loan is collateralized by Great Falls shopping center. The loan consists of three notes which require equal monthly principal and interest payments of $138,000 based upon a weighted average 26- year amortization schedule and a final payment of $6.3 million at maturity. Principal of $611,000 was amortized during 2012. (w) The loan is collateralized by Leesburg Pike and requires equal monthly principal and interest payments of $135,000 based upon a 25-year amortization schedule and a final payment of $11.5 million at loan maturity. Principal of $322,000 was amortized during 2012. The loan is collateralized by Village Center and requires equal monthly principal and interest payments of $119,000 based upon a 25-year amortization schedule and a final payment of $10.1 million at loan maturity. Principal of $269,000 was amortized during 2012. The loan is collateralized by White Oak and requires equal monthly principal and interest payments of $193,000 based upon a 24.4 year weighted amortization schedule and a final payment of $18.5 mil- lion at loan maturity. The loan was previously collateralized by Van Ness Square. During 2012, the Company substituted White Oak as the collateral and borrowed an additional $10.5 million. Principal of $359,000 was amortized during 2012. The loan is collateralized by Avenel Business Park and requires equal monthly principal and interest payments of $246,000 based upon a 25-year amortization schedule and a final payment of $20.9 million at loan maturity. Principal of $572,000 was amortized during 2012. (aa) The loan is collateralized by Ashburn Village and requires equal monthly principal and interest payments of $240,000 based upon a 25-year amortization schedule and a final payment of $20.5 million at loan maturity. Principal of $554,000 was amortized during 2012. (y) (z) (x) 20 SAUL CENTERS, INC. 2012 ANNUAL REPORT 21 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (bb) The loan is collateralized by Ravenwood and requires equal monthly principal and interest payments of $111,000 based upon a 25-year amortization schedule and a final payment of $10.1 million at loan maturity. Principal of $312,000 was amortized during 2012. (cc) The loan is collateralized by Clarendon Center and requires equal monthly principal and interest payments of $753,000 based upon a 25-year amortization schedule and a final payment of $70.5 million at loan maturity. Principal of $2.6 million was amortized during 2012. (dd) The loan is collateralized by Severna Park MarketPlace and requires equal monthly principal and interest payments of $207,000 based upon a 25-year amortization schedule and a final payment of $20.3 million at loan maturity. Principal of $872,000 was amortized during 2012. (ee) The loan is collateralized by Kentlands Square II and requires equal monthly principal and interest payments of $240,000 based upon a 25-year amortization schedule and a final payment of $23.1 million at loan maturity. Principal of $953,000 was amortized during 2012. (ff) The loan is collateralized by Cranberry Square and requires equal monthly principal and interest payments of $113,000 based upon a 25-year amortization schedule and a final payment of $10.9 million at loan maturity. Principal of $431,000 was amortized during 2012. (gg) The loan in the original amount of $73.0 million closed in May 2012, is collateralized by Seven Corners and requires equal monthly prin- cipal and interest payments of $463,200 based upon a 25-year amortization schedule and a final payment of $42.3 million at loan maturity. Principal of $767,000 was amortized during 2012. (hh)The loan is a $175.0 million unsecured revolving credit facility. In- terest accrues at a rate equal to the sum of one-month LIBOR plus a spread of 1.90 %. The line may be extended at the Company’s option for one year with payment of a fee of 0.20%. Monthly pay- ments, if required, are interest only and vary depending upon the amount outstanding and the applicable interest rate for any given month. The loan is collateralized by Northrock and requires monthly principal and interest payments of $13,409 and a final payment of $14.9 mil- lion at maturity. Principal of $161,000 was amortized during 2012. (ii) The carrying value of properties collateralizing the mortgage notes payable totaled $916.1 million and $997.5 million as of December 31, 2012 and 2011, respectively. The Company’s credit facility requires the Company and its subsidiaries to main- tain certain financial covenants, which are summarized below. As of December 31, 2012, the Company was in compliance with all such covenants: • maintain tangible net worth, as defined in the loan agree- ment, of at least $503.3 million plus 80% of the Company’s net equity proceeds received after May 2012; • limit the amount of debt as a percentage of gross asset value, as defined in the loan agreement, to less than 60% (leverage ratio); • limit the amount of debt so that interest coverage will exceed 2.0x on a trailing four-quarter basis (interest expense coverage); • limit the amount of debt so that interest, scheduled principal amortization and preferred dividend coverage exceeds 1.3x on a trailing four-quarter basis (fixed charge coverage); and • limit the amount of variable rate debt and debt with initial loan terms of less than five years to no more than 40% of total debt. 2013 FINANCING ACTIVITY On February 27, 2013, the Company closed on a three-year $15.6 million mortgage loan secured by Metro Pike Center. The loan matures in 2016, bears interest at a variable rate equal to the sum of one-month LIBOR and 165 basis points, requires monthly principal and interest payments based on a 25-year amortization schedule and requires a final payment of $14.7 million at maturity. The loan may be extended for up to two- years. Proceeds were used to pay-off the $15.9 million remain- ing balance of existing debt secured by Metro Pike Center, and to extinguish the related swap agreement, which were sched- uled to mature in June 2013. 22 SAUL CENTERS, INC. On February 27, 2013, the Company closed on a three-year $15.0 million mortgage loan secured by Northrock. The loan matures in 2016, bears interest at a variable rate equal to the sum of one- month LIBOR and 165 basis points, requires monthly principal and interest payments based on a 25-year amortization schedule and requires a final payment of $14.2 million at maturity. The loan may be extended for up to two years. Proceeds were used to pay- off the $15.0 million remaining balance of existing debt secured by Northrock, which was scheduled to mature in May 2013. 2012 FINANCING ACTIVITY On April 11, 2012, the Company closed on a 15-year non-re- course mortgage loan in the amount of $73.0 million secured by Seven Corners shopping center. The loan matures in May 2027, bears interest at a fixed rate of 5.84%, requires equal monthly principal and interest payments totaling $463,226 based upon a 25-year amortization schedule and a final payment of $42.5 million at maturity. Proceeds from the loan were used to pay-off the $63 million remaining balance of existing debt se- cured by Seven Corners and six other Shopping Center proper- ties, which was scheduled to mature in October 2012, and to provide cash of approximately $10 million. On April 26, 2012, the Company substituted the White Oak shopping center for Van Ness Square as collateral for one of its existing mortgage loans which will allow the Company to ana- lyze the feasibility of repositioning Van Ness Square. The terms of the original loan, including its 8.11% interest rate, are un- changed and, in conjunction with the collateral substitution, the Company borrowed an additional $10.5 million, also secured by White Oak. The new borrowing requires equal monthly pay- ments based upon a fixed 4.90% interest rate and 25-year amortization schedule, and will mature in July 2024, contermi- nously with the original loan. The consolidated loan requires equal monthly payments based upon a blended fixed interest rate of 7.0% and will require a final payment of $18.5 million at maturity. On May 21, 2012, the Company replaced its existing unsecured revolving credit facility with a new $175.0 million facility that ex- pires on May 20, 2016. The facility, which provides working cap- ital and funds for acquisitions, certain developments, redevelopments and letters of credit, may be extended for one year, at the Company’s option, subject to the satisfaction of cer- tain conditions. Loans under the facility bear interest at a rate equal to the sum of LIBOR and a margin, based on the Com- pany’s leverage ratio, ranging from 160 basis points to 250 basis points. Based on the leverage ratio of December 31, 2012, the margin was 190 basis points. 2011 FINANCING ACTIVITY On March 23, 2011, the Company closed on a 15-year non-re- course mortgage loan in the amount of $125.0 million, secured by Clarendon Center. The loan matures April 5, 2026, bears in- terest at a fixed rate of 5.31%, requires equal monthly principal and interest payments of $753,000, based upon a 25-year amor- tization schedule, and requires a final principal payment of ap- proximately $70.5 million at maturity. Proceeds from the loan were used to repay $104.2 million outstanding on the Clarendon Center construction loan. On September 23, 2011, the Company closed on a 15-year non- recourse mortgage loan in the amount of $38.0 million, secured by Severna Park MarketPlace. The loan matures October 1, 2026, bears interest at a fixed rate of 4.30%, requires equal monthly principal and interest payments of $207,000, based upon a 25-year amortization schedule, and requires a final prin- cipal payment of approximately $20.3 million at maturity. Pro- ceeds from the loan were used to purchase Severna Park MarketPlace. Also on September 23, 2011, the Company closed on two six- month bridge financing loans in the total amount of $60.0 mil- lion, secured by Kentlands Square II and Cranberry Square. Proceeds from the loans were used to purchase Kentlands Square II and Cranberry Square. On October 5, 2011, the Company closed on a new 15-year non-recourse mortgage loan in the amount of $43.0 million, se- cured by Kentlands Square II. The loan matures November 5, 2026, bears interest at a fixed rate of 4.53%, requires equal monthly principal and interest payments of $240,000, based upon a 25-year principal amortization, and requires a final principal payment of approximately $23.1 million at maturity. Proceeds from the loan were used to repay the $40.0 million bridge financing used to acquire Kentlands Square II. On November 6, 2011, the Company closed on a new 15-year non-recourse mortgage loan in the amount of $20.0 million, se- cured by Cranberry Square. The loan matures December 1, 2026, bears interest at a fixed rate of 4.70%, requires equal monthly principal and interest payments of $113,000, based upon a 25-year principal amortization, and requires a final prin- cipal payment of approximately $10.9 million at maturity. Proceeds from the loan were used to repay the $20.0 million bridge financing used to acquire Cranberry Square. 2010 FINANCING ACTIVITY On June 29, 2010, the Company closed on a new 10-year mort- gage loan in the amount of $45.6 million, secured by Thruway. The loan matures July 1, 2020, and bears interest at a variable rate equal to the sum of one-month LIBOR and 260 basis points. In conjunction with the financing, the Company entered into an interest rate swap agreement with a $45.6 million notional amount to manage the interest rate risk associated with the above $45.6 million of variable-rate mortgage debt. The swap agreement was effective June 29, 2010, terminates on July 1, 2020 and effectively fixes the interest rate on the mortgage debt at 5.83%. The Company has designated this agreement as a cash flow hedge for accounting purposes. The Company rec- ognizes interest expense on the combined variable-rate debt and the interest-rate swap at the effective fixed rate of 5.83%. On a combined basis, the loan and the interest-rate swap require equal monthly principal and interest payments of approximately $289,000, based upon an assumed interest rate of 5.83% and a 25-year principal amortization, and requires a final principal payment of approximately $34.8 million at maturity. Prior to the refinancing, Thruway was one of nine properties se- curing debt included in a collateralized mortgage-backed secu- rity (CMBS) with an outstanding balance of $108.3 million, an interest rate of 7.67% and due to mature October 2012. In order to release Thruway, the Company defeased $30.2 million of the outstanding balance at a cost of approximately $4.4 mil- lion, using proceeds from the new mortgage financing. On August 24, 2010, the Company entered into an amendment to its Northrock construction loan to provide an option to extend the loan for two years. The extension is available at the Com- pany’s option subject to notice to the bank, and to a principal repayment in an amount required to cause property operating income to meet certain debt service coverage levels. On December 9, 2010, the Company closed on a new 15-year, fixed-rate mortgage loan in the amount of $17.0 million secured by Ravenwood. The loan matures January 2026, requires monthly interest and principal payments of approximately $111,000 based upon a fixed interest rate of 6.18% and a 25- year principal amortization and requires a final principal payment of approximately $10.1 million at maturity. Prior to the refinancing, Ravenwood was one of eight remaining properties securing debt included in a CMBS with an outstand- ing balance of $76.3 million, an interest rate of 7.67% and due to mature October 2012. In order to release Ravenwood, the Company defeased $7.8 million of the outstanding balance at a cost of approximately $900,000, using proceeds from the new mortgage financing. On December 17, 2010, the Company purchased Metro Pike Center, a 67,000 square foot retail property located in Rockville, Maryland. In conjunction with the acquisition, the Company 2012 ANNUAL REPORT 23 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS assumed a mortgage loan with a principal balance of $16.2 mil- lion. The loan matures June 30, 2013, bears interest at a variable rate equal to the sum of one-month LIBOR and 245 basis points. In conjunction with the loan assumption, the Company assumed a corresponding interest rate swap agreement with a $16.2 mil- lion notional amount to manage the interest rate risk associated with the variable-rate mortgage debt. The swap agreement was effective at closing, terminates on June 30, 2013 and effectively fixes the interest rate on the mortgage debt at 4.67%. On a com- bined basis, the loan and the interest-rate swap require interest- only payments of approximately $63,000 until August 1, 2011, followed by equal monthly principal and interest payments of ap- proximately $86,000 based upon a 25-year amortization sched- ule and a final payment of $15.6 million at loan maturity. OFF-BALANCE SHEET ARRANGEMENTS The Company has no off-balance sheet arrangements that are reasonably likely to have a current or future material effect on the Company's financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources. FUNDS FROM OPERATIONS In 2012, the Company reported Funds From Operations (FFO) available to common shareholders (common stockholders and lim- ited partner unitholders) of $60.1 million, a 19.5% increase from 2011 FFO available to common shareholders of $50.3 million. The following table presents a reconciliation from net income to FFO available to common shareholders for the periods indicated: FUNDS FROM OPERATIONS The following table presents a reconciliation from net income to FFO available to common shareholders for the periods indicated: For the Year Ended December 31, (Dollars in thousands) 2012 2011 2010 2009 2008 Net income $ 39,780 $ 30,294 $ 43,185 $ 43,230 $ 47,666 Subtract: Gain on property sales (4,510) – (3,591) – – Gain on casualty settlement (219) (245) (2,475) (329) (1,301) Add: Real estate depreciation – discontinued operations 77 102 198 203 213 Real estate depreciation and amortization 40,112 35,298 28,379 28,061 29,570 FFO 75,240 65,449 65,696 71,165 76,148 Subtract: Preferred dividends (15,140) (15,140) (15,140) (15,140) (13,453) FFO available to common shareholders $ 60,100 $ 50,309 $ 50,556 $ 56,025 $ 62,695 Average shares and units used to compute FFO per share 26,614 24,740 23,793 23,359 23,377 FFP per share $ 2.26 $ 2.03 $ 2.12 $ 2.40 $ 2.68 1 The National Association of Real Estate Investment Trusts (NAREIT) developed FFO as a relative non-GAAP financial measure of performance of an equity REIT in order to recognize that income-producing real estate historically has not depreciated on the basis determined under GAAP. FFO is defined by NAREIT as net income, computed in accordance with GAAP, plus real estate depreciation and amortization, and excluding ex- traordinary items, impairment charges on depreciable real estate assets and gains or losses from property dispositions. FFO does not represent cash generated from operating activities in accordance with GAAP and is not necessarily indicative of cash available to fund cash needs, which is disclosed in the Company’s Consolidated Statements of Cash Flows for the applicable periods. There are no material legal or functional re- strictions on the use of FFO. FFO should not be considered as an alternative to net income, its most directly comparable GAAP measure, as a indicator of the Company’s operating performance, or as an alternative to cash flows as a measure of liquidity. Management considers FFO a meaningful supplemental measure of operating performance because it primarily excludes the assumption that the value of the real estate assets diminishes predictably over time (i.e. depreciation), which is contrary to what we believe occurs with our assets, and because industry an- alysts have accepted it as a performance measure. FFO may not be comparable to similarly titled measures employed by other REITs. ACQUISITIONS, REDEVELOPMENTS AND RENOVATIONS Management anticipates that during the coming year the Com- pany will commence activities related to the redevelopment of Van Ness Square and the adjacent 4469 Connecticut Avenue and may develop additional freestanding outparcels or expan- sions within certain of the Shopping Centers. Although not cur- rently planned, it is possible that the Company may redevelop additional Current Portfolio Properties and may develop expan- sions within certain of the Shopping Centers. Acquisition and development of properties are undertaken only after careful analysis and review, and management’s determination that such properties are expected to provide long-term earnings and cash flow growth. During the coming year, any developments, expan- sions or acquisitions are expected to be funded with 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 has been selectively involved in acquisition, de- velopment, redevelopment and renovation activities. It continues to evaluate the acquisition of land parcels for retail and office development and acquisitions of operating properties for oppor- tunities to enhance operating income and cash flow growth. The following describes the acquisitions, developments, redevelop- ments and renovations which affected the Company’s financial position and results of operations in 2012, 2011, and 2010. ASHLAND SQUARE PHASE I On December 15, 2004, the Company purchased for $6.3 mil- lion, a 19.3 acre parcel of land in Manassas, Prince William County, Virginia. The Company has an approved site plan to de- velop a grocery-anchored neighborhood shopping center total- ing approximately 160,000 square feet. Capital One Bank operates a branch on the site and the Company previously exe- cuted a lease with CVS. During 2012, the Company completed the site work for two pads, constructed a 6,500 square foot building that has been leased to a restaurant and CVS con- structed a 13,000 square foot pharmacy building. Both facilities have opened for business, and the cost to the Company was ap- proximately $3.0 million. The balance of the center is being mar- keted to grocers and other retail businesses, with a development timetable yet to be finalized. CLARENDON CENTER In late 2010, the Company substantially completed construction of a mixed-use project which includes approximately 42,000 square feet of retail space, 171,000 square feet of office space, 244 apartments and 600 underground parking spaces, on two city blocks, adjacent to the Clarendon Metro Station in Arlington County, Virginia. Development costs are expected to total ap- proximately $195.0 million upon the completion of final office tenant improvements which are expected to total approximately $2.9 million. As of December 31, 2012, 208,900 square feet (97.9%) of the commercial space (comprising of all of the retail space and 167,200 square feet (97.4%) of the office space) as well as 244 apartments (100.0%), were leased. SEVEN CORNERS During 2010, the Company expanded the Seven Corners shop- ping center by approximately 6,000 square feet. Red Robin Gourmet Burgers opened in November 2010 in a newly-con- structed, free-standing building. The Company also completed construction of parking lot, landscaping and site lighting im- provements to enhance the common areas. 11503 ROCKVILLE PIKE On October 1, 2010, the Company purchased for $15.6 million, including acquisition costs, approximately 20,000 square feet of retail space located on the east side of Rockville Pike (Route 355), near the White Flint Metro Station in Montgomery County, Mary- land. The property, which was fully leased to two tenants at De- cember 31, 2012, is zoned for up to 297,000 square feet of rentable mixed use space. The Company intends to redevelop the property but has not committed to any redevelopment plan or time table. METRO PIKE CENTER On December 17, 2010, the Company purchased for $34.3 mil- lion, including acquisition costs, approximately 67,000 square feet of retail space located on the west side of Rockville Pike (Route 355) near the White Flint Metro Station in Montgomery County, Maryland. The property was acquired subject to the as- sumption of a $16.2 million mortgage loan and a corresponding interest rate swap with a fair value of $0.5 million. The property, which was 83.6% leased to multiple tenants at December 31, 2012, is zoned for up to 807,000 square feet of rentable mixed use space. The Company does not anticipate redeveloping the property in the foreseeable future. 4469 CONNECTICUT AVENUE On February 17, 2011, the Company purchased for $1.7 million, including acquisition costs, approximately 3,000 square feet of retail space located adjacent to the Company’s Van Ness Square in Washington D.C. The property is unoccupied and will be in- cluded in the project to redevelop Van Ness Square. KENTLANDS SQUARE II On September 23, 2011, the Company purchased for $74.5 mil- lion Kentlands Square II, and incurred acquisition costs of $1.1 million. Kentlands Square II is a 241,000 square foot neighbor- hood shopping center located in Gaithersburg, Maryland, in Montgomery County, the state’s most populous and affluent county. More than 38,000 households, with annual household incomes averaging over $114,000, are located within a three- mile radius of the center. As of December 31, 2012, the center was 95.8% leased and anchored by a 61,000 square foot Giant Food supermarket and a 104,000 square foot Kmart. The prop- erty is adjacent to the Company’s Kentlands Square I, which is anchored by Lowe’s Home Improvement and Kentlands Place. SEVERNA PARK MARKETPLACE On September 23, 2011, the Company purchased for $61.0 mil- lion Severna Park MarketPlace, and incurred acquisition costs of $0.8 million. Severna Park MarketPlace is a 254,000 square foot neighborhood shopping center located in Severna Park, Mary- land, in Anne Arundel County. More than 15,000 households, with annual household incomes averaging over $112,000, are located within a three-mile radius of the center. As of December 31, 2012, the center was 100% leased and anchored by a 63,000 square foot Giant Food supermarket and a 92,000 square foot Kohl’s. 24 SAUL CENTERS, INC. 2012 ANNUAL REPORT 25 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CRANBERRY SQUARE On September 23, 2011, the Company purchased for $33.0 mil- lion Cranberry Square, and incurred acquisition costs of $0.5 mil- lion. Cranberry Square is a 140,000 square foot neighborhood shopping center located in Westminster, Maryland, in Carroll County. More than 12,000 households, with annual household incomes averaging over $72,000, are located within a three-mile radius of the center. As of December 31, 2012, the center was 92.2% leased and anchored by a 56,000 square foot Giant Food supermarket and a 24,000 square foot Staples. 1500 ROCKVILLE PIKE In December 2012, the Company purchased for $23.0 million, including acquisition costs, approximately 52,700 square feet of retail space located on the east side of Rockville Pike near the Twinbrook Metro Station. The property, which was 90.5% leased to multiple tenants at December 31, 2012, is zoned for up to 745,000 square feet of rentable mixed-use space. The Company intends to redevelop the site but has not committed to any redevelopment plan or time table. 5541 NICHOLSON LANE In December 2012, the Company purchased for $12.2 million, including acquisition costs, approximately 20,100 square feet of mixed-use space, which was 40.5% leased to multiple tenants, located on the east side of Rockville Pike and adjacent to 11503 Rockville Pike, which was purchased in 2010. The property, when combined with 11503 Rockville Pike, will provide zoning for up to 331,000 square feet of rentable mixed-use space for a total development potential of up to 622,000 square feet. The Company intends to redevelop the site but has not committed to any redevelopment plan or time table. VAN NESS SQUARE The Company recently completed negotiation of lease termina- tion agreements with the tenants of Van Ness Square and ex- pects the building will be vacant on or about April 30, 2013. Costs incurred related to those termination arrangements are being amortized to expense using the straight-line method over the remaining terms of the leases, are included in “Predevelop- ment Expenses” in the Consolidated Statements of Operations, totaled $2.7 million in 2012 and are expected to total approxi- mately $3.3 million over the first two quarters of 2013. The Company intends to develop a primarily residential project with street-level retail and will recognize additional predevelopment expenses in future periods when the existing improvements of Van Ness Square and the adjacent 4469 Connecticut Avenue are demolished, the timing of which is uncertain and dependent on the issuance of various governmental approvals and permits. PROPERTY SALES WEST PARK On July 25, 2012, the Company sold for $2.0 million the 77,000 square foot West Park shopping center in Oklahoma City, Okla- homa and recorded a $1.1 million gain. As of June 30, 2012, West Park was 11.7% leased and the carrying amounts of the associated assets and liabilities were $1.0 million and $207,000, respectively. There was no debt associated with the property. BELVEDERE In December 2012, the Company sold for $4.0 million, the 54,900 square foot Belvedere shopping center in Baltimore, Maryland and recorded a $3.4 million gain. As of September 30, 2012, Belvedere was 34% leased and the carrying amounts of the associated assets and liabilities were $488,000 and $22,000, respectively. There was no debt associated with the property. PORTFOLIO LEASING STATUS The following chart sets forth certain information regarding commercial leases at our properties for the periods indicated. Total Properties Total Square Footage Percentage Leased As of December 31, Shopping Centers Mixed-Use Shopping Centers Mixed-Use Shopping Centers Mixed-Use 2012 50 7 7,877,200 1,612,200 93.4% 82.8% 2011 51 7 7,930,000 1,610,400 90.8% 85.8% 2010 48 6 7,293,000 1,608,000 92.0% 81.5% The 2012 shopping center leasing percentages include 1500 Rockville Pike and 5541 Nicholson Lane, which were acquired in December 2012, and exclude West Park and Belvedere, which were sold during 2012. The 2012 mixed-use leasing percent- ages include Clarendon Center commercial area, which was 97.9% leased at December 31, 2012. The Clarendon Center residential component was 100% leased at December 31, 2012. On a same property basis, which excludes the impact of proper- ties not in operation for the entirety of the comparable periods, Shopping Center leasing percentages increased to 93.5% from 91.6% and Mixed-Use leasing percentages decreased to 82.8% from 85.8%. The overall portfolio leasing percentage, on a com- parative same center basis, ended the year at 91.9%, an increase from 90.7% at yearend 2011. The 2012 shopping center leas- ing percentages were impacted by a net increase of approxi- mately 151,000 square feet of leased space, the majority of which resulted from the leasing of space vacated by major ten- ants during 2011. The 2012 mixed-use leasing percentages were adversely impacted by a net decrease of approximately 44,000 square feet of leased space, the majority of which resulted from the early termination of leases at Van Ness Square in preparation for redevelopment. The 2011 shopping center percentages leased included three centers acquired September 23, 2011, Kentlands Square II (100% leased), Severna Park MarketPlace (100% leased) and Cranberry Square (91% leased). The 2011 and 2010 mixed-use percentages include Clarendon Center commercial area, which was 92.4% and 58.6% leased at December 31, 2011 and 2010, respectively. The Clarendon Center residential component was 100% and 43.9% leased at December 31, 2011 and 2010, respectively. On a same property basis, shopping center leasing percentages de- creased to 90.2% from 92.0% and mixed-use leasing percent- ages decreased to 84.9% from 85.5%. Overall portfolio leasing percentage, on a comparative same center basis, ended the year at 89.4%, a decrease from 91.1% at year end 2010. The 2011 commercial leasing percentages were adversely impacted by a net decrease of approximately 140,000 square feet of leased space, of which approximately 98,000 square feet was caused by the Syms, SuperFresh and Borders Books bankruptcies and the balance resulting from the early lease termination of a local gro- cer. As of March 1, 2012, a total of 61,000 square feet of these four vacant spaces had been leased. The 2010 shopping center percentage leased included recently constructed but not yet fully leased Northrock and Westview Vil- lage, which were 72.3% and 36.1% leased as of December 31, 2010, respectively. On a same property basis, shopping center leasing percentages increased to 93.1% from 93.0%. The 2010 mixed-use percentage leased included Clarendon Center, whose construction was substantially completed at year end 2010 and whose residential component was 43.9% leased and office and retail component was 58.6% leased as of December 31, 2010. Including Clarendon Center, overall mixed-use property leasing percentages decreased to 81.5% from 90.6%. On a compara- tive same property basis, overall property leasing ended the year at 92.0%, a decrease from 92.7% at year end 2009, a space leased reduction of approximately 55,000 square feet. Shopping center same property leasing was 93.1% and 93.0%, and mixed-use same property leasing was 85.5% and 90.5%, as of December 31, 2010 and 2009, respectively. The following table shows selected dates for leases executed in the indicated periods. The information is based on executed leases without adjustment for the timing of occupancy, tenant defaults, or landlord concessions. The base rent for an expiring lease is the annualized contractual base rent, on a cash basis, as of the expiration date of the lease. The base rent for a new or renewed lease is the annualized contractual base rent, on a cash basis, as of the expected rent commencement date. Because tenants that execute leases may not ultimately take possession of their space or pay all of their contractual rent, the changes presented in the table provide information only about trends in market rental rates. The actual changes in rental income re- ceived by the Company may be different. Year Ended December 31, 2012 2011 2010 Square Feet 1,579,000 1,178,000 1,336,000 Number of Leases 256 245 253 Base Rent per Square Foot New/Renewed Leases $ 16.39 15.21 13.19 $ Expiring Leases 16.30 16.41 14.62 During 2012, the Company entered into 216 new or renewed apartment leases. The monthly rent per square foot for these leases increased to $3.31 from $3.11. MANAGEMENT’S REPORT on Internal Control Over Financial Reporting ASSESSMENT OF EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING Management is responsible for establishing and maintaining adequate internal control over financial reporting. Manage- ment used the criteria issued by the Committee of Sponsor- ing Organizations of the Treadway Commission in Internal Control - Integrated Framework to assess the effectiveness of the Company’s internal control over financial reporting. Based upon the assessments, the Company’s management has concluded that, as of December 31, 2012, the Company’s internal control over financial reporting was effective. The Company’s independent registered public accounting firm has issued a report on the effectiveness of the Company’s in- ternal control over financial reporting, which appears on page 28 in this Annual Report. 26 SAUL CENTERS, INC. 2012 ANNUAL REPORT 27 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM on Internal Control Over Financial Reporting Board of Directors and Stockholders Saul Centers, Inc. We have audited the accompanying consolidated balance sheets of Saul Centers, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehen- sive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15(a)2(b). These financial statements and schedule are the responsibility of the Company’s management. Our responsi- bility is to express an opinion on these financial statements and schedule based on our audits. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Saul Centers, Inc. at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial state- ments taken as a whole, presents fairly in all material respects the information set forth therein. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial state- ments are free of material misstatement. An audit includes ex- amining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes as- sessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a rea- sonable basis for our opinion. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Saul Centers, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Spon- soring Organizations of the Treadway Commission and our report dated March 13, 2013 expressed an unqualified opinion thereon. Ernst & Young LLP McLean, Virginia March 13, 2013 Board of Directors and Stockholders Saul Centers, Inc. We have audited Saul Centers, Inc.’s internal control over finan- cial reporting as of December 31, 2012, based on criteria es- tablished in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Saul Centers, Inc.’s manage- ment is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effective- ness of internal control over financial reporting included in the accompanying Assessment of Effectiveness of Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial re- porting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material re- spects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reason- able basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted ac- counting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accu- rately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted ac- counting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s as- sets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projec- tions of any evaluation of effectiveness to future periods are sub- ject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Saul Centers, Inc. maintained, in all material re- spects, effective internal control over financial reporting as of De- cember 31, 2012, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Saul Centers, Inc. as of December 31, 2012 and 2011 and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended De- cember 31, 2012 of Saul Centers, Inc. and our report dated March 13, 2013 expressed an unqualified opinion thereon. Ernst & Young LLP McLean, Virginia March 13, 2013 28 SAUL CENTERS, INC. 2012 ANNUAL REPORT 29 CONSOLIDATED BALANCE SHEETS CONSOLIDATED STATEMENTS OF OPERATIONS December 31, December 31, (Dollars in thousands, except per share amounts) 2012 2011 For The Year Ended December 31, (Dollars in thousands, except per share amounts) 2012 2011 2010 Assets Real estate investments Land $ 353,890 $ 324,183 Buildings and equipment 1,109,911 1,092,533 Construction in progress 2,267 1,129 1,466,068 1,417,845 Accumulated depreciation (353,305) (326,397) 1,112,763 1,091,448 Cash and cash equivalents 12,133 12,323 Revenue Base rent $ 152,777 $ 138,486 $ 126,163 Expense recoveries 30,391 23,368 29,488 Percentage rent 1,545 1,503 1,447 Other 5,379 5,521 6,010 Total revenue 190,092 173,878 163,108 Operating expenses Property operating expenses 23,794 24,715 22,897 Provision for credit losses 1,151 1,880 1,334 Real estate taxes 22,325 18,435 17,744 Accounts receivable and accrued income, net 41,406 39,094 Interest expense and amortization of deferred debt costs 49,544 45,324 34,799 Deferred leasing costs, net 26,102 25,876 Prepaid expenses, net 3,895 3,868 Deferred debt costs, net 7,713 7,090 Other assets 3,297 12,870 Total assets $ 1,207,309 $ 1,192,569 Liabilities Depreciation and amortization of deferred leasing costs 40,112 35,298 28,379 General and administrative 14,274 14,256 13,968 Predevelopment expenses 2,667 – – Total operating expenses 153,867 139,908 119,121 Operating income 36,225 33,970 43,987 Acquisition related costs (1,129) (2,534) (1,179) Change in fair value of derivatives 36 (1,332) – Mortgage notes payable $ 789,776 $ 823,871 Loss on early extinguishment of debt – – (5,405) Revolving credit facility payable 38,000 8,000 Gain on casualty settlement 219 245 2,475 Dividends and distributions payable 13,490 13,219 Income from continuing operations 35,351 30,349 39,878 Accounts payable, accrued expenses and other liabilities 27,434 22,992 Discontinued Operations Deferred income 31,320 31,281 Total liabilities 900,020 899,363 Stockholders’ equity Preferred stock, 1,000,000 shares authorized: Series A Cumulative Redeemable, 40,000 shares issued and outstanding 100,000 100,000 Series B Cumulative Redeemable, 31,731 shares issued and outstanding 79,328 79,328 Common stock, $0.01 par value, 30,000,000 shares authorized, 20,045,452 and 19,291,845 shares issued and outstanding, respectively 201 193 Additional paid-in capital 246,557 217,829 Accumulated deficit (154,830) (144,659) Accumulated other comprehensive loss (3,553) (2,863) Total Saul Centers, Inc. stockholders’ equity 267,703 249,828 Noncontrolling interest 39,586 43,378 Loss from operations of properties sold (81) (55) (284) Gain on sales of properties 4,510 – 3,591 Income (loss) from discontinued operations 4,429 (55) 3,307 Net income 39,780 30,294 43,185 Noncontrolling interest Income from continuing operations attributable to noncontrolling interests (5,693) – (5,930) Income from discontinued operations attributable to noncontrolling interests (713) (3,561) (492) Income attibutable to noncontrolling interests (6,406) (3,561) (6,422) Net income attributable to Saul Centers, Inc. 33,374 26,733 36,763 Preferred dividends (15,140) (15,140) (15,140) Net income available to common stockholders $ 18,234 $ 11,593 $ 21,623 Per share net income available to common stockholders Total stockholders’ equity 307,289 293,206 Basic and diluted: Total liabilities and stockholders’ equity $ 1,207,309 $ 1,192,569 Continuing operations $ 0.70 $ 0.61 $ 1.00 Discontinued operations 0.23 – 0.18 $ 0.93 $ 0.61 $ 1.18 The Notes to Financial Statements are an integral part of these statements. The Notes to Financial Statements are an integral part of these statements. 30 SAUL CENTERS, INC. 2012 ANNUAL REPORT 31 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY For The Year Ended December 31, (Dollars in thousands) 2012 2011 2010 Net income $ 39,780 $ 30,294 $ 43,185 Other comprehensive income Change in unrealized loss on cash flow hedge (932) (3,195) (543) Total comprehensive income 38,848 27,099 42,642 Comprehensive income attributable to noncontrolling interests 6,164 2,811 6,298 Total comprehensive income attributable to Saul Centers, Inc. 32,684 24,288 36,344 Preferred dividends (15,140) (15,140) (15,140) Total comprehensive income available to common stockholders $ 17,544 $ 9,148 $ 21,204 Accumulated Additional Other Preferred Common Paid-in Accumulated Comprehensive Total Saul Noncontrolling (Dollars in thousands,except per share amounts) Stock Stock Capital Deficit (Loss) Centers, Inc. Interest Total Balance, December 31, 2009 $179,328 $ 180 $169,363 $(124,167) $ – $224,704 $ 1,359 $226,063 Issuance of 544,643 shares of common stock: 426,847 shares pursuant to dividend reinvestment plan – 4 16,696 – – 16,700 – 16,700 117,796 shares due to exercise of employee stock options and issuance of directors’ deferred stock – 2 3,728 – – 3,730 – 3,730 Net income – – – 36,763 – 36,763 6,422 43,185 Change in unrealized loss on cash flow hedge – – – – (419) (419) (124) (543) Preferred stock distributions: Series A – – – (6,000) – (6,000) – (6,000) Series B – – – (5,355) – (5,355) – (5,355) Common stock distributions – – – (19,701) – (19,701) (5,850) (25,551) Distributions payable preferred stock: Series A, $50.00 per share – – – (2,000 ) – (2,000) – (2,000) Series B, $56.25 per share – – – (1,785) – (1,785) – (1,785) Distributions payable common stock ($0.36/share) and distributions payable partnership units ($0.36/unit) – – – (6,681) – (6,681) (1,950) (8,631) Balance, December 31, 2010 179,328 186 189,787 (128,926) (419) 239,956 (143) 239,813 Issuance of 734,786 shares of common stock: 186,968 restricted shares – 2 6,159 – – 6,161 – 6,161 498,248 shares pursuant to dividend reinvestment plan – 3 19,751 – – 19,754 – 19,754 49,570 shares due to exercise of employee stock options and issuance of directors’ deferred stock – 2 2,132 – – 2,134 – 2,134 Issuance of 1,497,814 partnership units – – – – – – 49,589 49,589 Net income – – – 26,733 – 26,733 3,561 30,294 Change in unrealized loss on cash flow hedge – – – – (2,444) (2,444) (751) (3,195) Preferred stock distributions: Series A – – – (6,000) – (6,000) – (6,000) Series B – – – (5,355) – (5,355) – (5,355) Common stock distributions – – – (20,381) – (20,381) (6,389) (26,770) Distributions payable preferred stock: Series A, $50.00 per share – – – (2,000 ) – (2,000) – (2,000) Series B, $56.25 per share – – – (1,785) – (1,785) – (1,785) Distributions payable common stock ($0.36/share) and distributions payable partnership units ($0.36/unit) – – – (6,945) – (6,945) (2,489) (9,434) Balance, December 31, 2011 179,328 193 217,829 (144,659) (2,863) 249,828 43,378 293,206 Issuance of 753,607 shares of common stock: 595,388 shares pursuant to dividend reinvestment plan – 6 23,124 – – 23,130 – 23,130 158,219 shares due to exercise of employee stock options and issuance of directors’ deferred stock – 2 5,604 – – 5,606 – 5,606 Net income – – – 33,374 – 33,374 6,406 39,780 Change in unrealized loss on cash flow hedge – – – – (690) (690) (242) (932) Preferred stock distributions: Series A – – – (6,000) – (6,000) – (6,000) Series B – – – (5,355) – (5,355) – (5,355) Common stock distributions – – – (21,189) – (21,189) (7,467) (28,656) Distributions payable preferred stock: Series A, $50.00 per share – – – (2,000 ) – (2,000) – (2,000) Series B, $56.25 per share – – – (1,785) – (1,785) – (1,785) Distributions payable common stock ($0.36/share) and distributions payable partnership units ($0.36/unit) – – – (7,216) – (7,216) (2,489) (9,705) Balance, December 31, 2012 $179,328 $ 201 $246,557 $(154,830) $(3,553) $267,703 $39,586 $307,289 The Notes to Financial Statements are an integral part of these statements. The Notes to Financial Statements are an integral part of these statements. 32 SAUL CENTERS, INC. 2012 ANNUAL REPORT 33 CONSOLIDATED STATEMENTS OF CASH FLOWS For the Year Ended December 31, (Dollars in thousands) 2012 2011 2010 Cash flows from operating activities: Net income $ 39,780 $ 30,294 $ 43,185 Adjustments to reconcile net income to net cash provided by operating activities: Change in fair value of derivatives (36) 1,332 – Gain on sale of property, discontinued operations (4,510) – (3,591) Gain on casualty settlement, continuing operations (219) (245) (2,475) Depreciation and amortization of deferred leasing costs 40,189 35,400 28,576 Amortization of deferred debt costs 1,576 1,547 1,467 Non cash compensation costs of stock grants and options 952 948 951 Provision for credit losses 1,151 1,883 1,337 (Increase) decrease in accounts receivable and accrued income (3,240) (5,291) 703 Additions to deferred leasing costs (5,362) (6,257) (4,902) (Increase) decrease in prepaid expenses (54) (844) 72 (Increase) decrease in other assets 9,573 (3,668) (2,894) Increase (decrease) in accounts payable, accrued expenses and other liabilities (930) 1,478 1,069 Decrease in deferred income (447) (908) (611) Net cash provided by operating activities 78,423 55,669 62,887 Cash flows from investing activities: Acquisitions of real estate investments, net (1) (34,050) (170,100) (32,747) Additions to real estate investments (12,680) (11,624) (6,573) Additions to development and redevelopment projects (7,913) (20,780) (68,867) Proceeds from sale of properties 5,818 – 8,132 Proceeds from casualty settlement 1,952 1,004 1,816 Net cash used in investing activities (46,873) (201,500) (98,239) Cash flows from financing activities: Proceeds from mortgage notes payable 83,500 286,000 62,600 Repayments on mortgage notes payable (117,595) (82,685) (53,691) Proceeds from construction loans payable – 13,410 49,505 Repayments on construction loans payable – (104,243) – Proceeds from revolving credit facility 38,000 16,000 – Repayments on revolving credit facility (8,000) (8,000) – Additions to deferred debt costs (2,199) (1,445) (1,054) Proceeds from the issuance of: Common Stock 27,784 27,101 19,479 Partnership Units – 49,589 – Distributions to: Series A preferred stockholders (8,000) (8,000) (8,000) Series B preferred stockholders (7,140) (7,140) (7,140) Common stockholders (28,135) (27,062) (26,186) Noncontrolling interest (9,955) (8,339) (7,800) Net cash provided by (used in) financing activities (31,740) 145,186 27,713 Net decrease in cash and cash equivalents (190) (645) (7,639) Cash and cash equivalents, beginning of year 12,323 12,968 20,607 Cash and cash equivalents, end of year $ 12,133 $ 12,323 $ 12,968 Supplemental disclosure of cash flow information: Cash paid for interest $ 48,302 $ 42,948 $ 40,678 Supplemental discussion of non-cash investing and financing activities: (1) The 2010 real estate acquisition costs of $32,747 are presented exclusive of a mortgage loan assumed of $16,169 with a $546 swap fair value. The Notes to Financial Statements are an integral part of these statements. 34 SAUL CENTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 and certain other affiliated entities, each of which is controlled by B. Francis Saul II and his family members (collectively, “The Saul Organization”). On August 26, 1993, members of The Saul Organization transferred to Saul Holdings Limited Partnership, a newly formed Maryland limited partnership (the “Operating Partnership”), and two newly formed subsidiary limited partner- ships (the “Subsidiary Partnerships,” and collectively with the Operating Partnership, the “Partnerships”), shopping center and mixed-used properties, and the management functions related to the transferred properties. Since its formation, the Company has developed and purchased additional properties. 1. ORGANIZATION, FORMATION, AND BASIS OF PRESENTATION ORGANIZATION Saul Centers, Inc. (“Saul Centers”) was incorporated under the Maryland General Corporation Law on June 10, 1993. Saul Centers operates as a real estate investment trust (a “REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). The Company is required to annually distribute at least 90% of its REIT taxable income (excluding net capital gains) to its stockholders and meet certain organizational and other re- quirements. Saul Centers has made and intends to continue to make regular quarterly distributions to its stockholders. Saul Centers, together with its wholly owned subsidiaries and the lim- ited partnerships of which Saul Centers or one of its subsidiaries is the sole general partner, are referred to collectively as the “Company.” B. Francis Saul II serves as Chairman of the Board of Directors and Chief Executive Officer of Saul Centers. The following table lists the properties acquired, developed and/or disposed of by the Company since January 1, 2010. Name of Property Location Type Year of Acquisition/ Development/Disposal ACQUISITIONS 11503 Rockville Pike Metro Pike Center 4469 Connecticut Ave Kentlands Square II Severna Park MarketPlace Cranberry Square 1500 Rockville Pike 5541 Nicholson Lane DEVELOPMENTS Clarendon Center North Clarendon Center South DISPOSITIONS Lexington West Park Belvedere Rockville, MD Rockville, MD Washington, DC Gaithersburg, MD Severna Park, MD Westminster, MD Rockville, MD Rockville, MD Shopping Center Shopping Center Mixed-Use Shopping Center Shopping Center Shopping Center Shopping Center Shopping Center Arlington, VA Arlington, VA Mixed-Use Mixed-Use Lexington, KY Oklahoma City, OK Baltimore, MD Shopping Center Shopping Center Shopping Center 2010 2010 2011 2011 2011 2011 2012 2012 2010/2011 2010/2011 2010 2012 2012 2012 ANNUAL REPORT 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2012, the Company’s properties (the “Current Portfolio Properties”) consisted of 50 shopping center properties (the “Shopping Centers”), seven mixed-use properties which are comprised of office, retail and multi-family residential uses (the “Mixed-Use Properties”) and two (non-operating) de- velopment properties. BASIS OF PRESENTATION The accompanying financial statements are presented on the historical cost basis of The Saul Organization because of affili- ated ownership and common management and because the as- sets and liabilities were the subject of a business combination with the Operating Partnership, the Subsidiary Partnerships and Saul Centers, all newly formed entities with no prior operations. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS The Company, which conducts all of its activities through its sub- sidiaries, the Operating Partnership and Subsidiary Partnerships, engages in the ownership, operation, management, leasing, ac- quisition, renovation, expansion, development and financing of community and neighborhood shopping centers and mixed-use properties, primarily in the Washington, DC/Baltimore metropol- itan area. Because the properties are located primarily in the Washington, DC/Baltimore metropolitan area, a disproportionate economic downturn in the local economy would have a greater negative impact on our overall financial performance than on the overall financial performance of a company with a portfolio that is more geographically diverse. A majority of the Shopping Centers are anchored by several major tenants. As of December 31, 2012, 33 of the Shopping Centers were anchored by a gro- cery store and offer primarily day-to-day necessities and services. Two retail tenants, Giant Food (5.0%), a tenant at ten Shopping Centers, and Safeway (2.7%), a tenant at eight Shopping Cen- ters, individually accounted for more than 2.5% of the Com- pany’s total revenue for the year ended December 31, 2012. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements 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. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assump- tions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. REAL ESTATE INVESTMENT PROPERTIES The Company purchases real estate investment properties from time to time and records assets acquired and liabilities assumed, including land, buildings, and intangibles related to in-place leases and customer relationships, based on their fair values. The fair value of buildings generally is determined as if the buildings were vacant upon acquisition and then subsequently leased at market rental rates and considers the present value of all cash flows expected to be generated by the property including an ini- tial lease up period. From time to time the Company may pur- chase a property, for future development purposes. The property may be improved with an existing structure that would be demolished as part of the development. In such cases, the fair value of the building may be determined based only on ex- isting leases and not include estimated cash flows related to fu- ture leases. The Company determines the fair value of above and below market intangibles associated with in-place leases by assessing the net effective rent and remaining term of the lease relative to market terms for similar leases at acquisition taking into consideration the remaining contractual lease period, re- newal periods, and the likelihood of the tenant exercising its re- newal options. The fair value of a below market lease component is recorded as deferred income and accreted as ad- ditional lease revenue over the remaining contractual lease pe- riod and any renewal option periods included in the valuation analysis. The fair value of above market lease intangibles is recorded as a deferred asset and is amortized as a reduction of lease revenue over the remaining contractual lease term. The Company determines the fair value of at-market in-place leases considering the cost of acquiring similar leases, the foregone rents associated with the lease-up period and carrying costs as- sociated with the lease-up period. Intangible assets associated with at-market in-place leases are amortized as additional ex- pense over the remaining contractual lease term. To the extent customer relationship intangibles are present in an acquisition, the fair values of the intangibles are amortized over the lives of the customer relationships. The Company has never recorded a customer relationship intangible asset. Acquisition-related transaction costs are expensed as incurred. If there is an event or change in circumstance that indicates a potential impairment in the value of a real estate investment property, the Company prepares an analysis to determine whether the carrying value of the real estate investment property exceeds its estimated fair value. The Company considers both quantitative and qualitative factors including recurring operating losses, significant decreases in occupancy, and significant adverse changes in legal factors and business climate. If impairment in- dicators are present, the Company compares the projected cash flows of the property over its remaining useful life, on an undis- counted basis, to the carrying value of that property. The Com- pany assesses its undiscounted projected cash flows based upon estimated capitalization rates, historic operating results and mar- ket conditions that may affect the property. If the carrying value is greater than the undiscounted projected cash flows, the Com- pany would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to its then esti- mated fair value. The fair value of any property is sensitive to the actual results of any of the aforementioned estimated factors, either individually or taken as a whole. Should the actual results differ from management’s projections, the valuation could be negatively or positively affected. The Company did not recog- nize an impairment loss on any of its real estate in 2012, 2011, or 2010. Interest, real estate taxes, development related salary costs and other carrying costs are capitalized on projects under develop- ment and construction. Once construction is substantially com- pleted and the assets are placed in service, their rental income, real estate tax expense, property operating expenses (consisting of payroll, repairs and maintenance, utilities, insurance and other property related expenses) and depreciation are included in cur- rent operations. Property operating expenses are charged to op- erations as incurred. Interest expense capitalized totaled $42,000, $1.9 million, and $7.2 million during 2012, 2011, and 2010, respectively. Commercial development projects are con- sidered substantially complete and available for occupancy upon completion of tenant improvements, but no later than one year from the cessation of major construction activity. Multi-family residential development projects are considered substantially complete and available for occupancy upon receipt of the cer- tificate of occupancy from the appropriate licensing authority. Substantially completed portions of a project are accounted for as separate projects. Depreciation is calculated using the straight-line method and es- timated useful lives of generally between 35 and 50 years for base buildings, or a shorter period if management determines that the building has a shorter useful life, and up to 20 years for certain other improvements that extend the useful lives. Lease- hold improvements expenditures are capitalized when certain criteria are met, including when the Company supervises con- struction and will own the improvements. Tenant improvements are amortized, over the shorter of the lives of the related leases or the useful life of the improvement, using the straight-line method. Depreciation expense and amortization of leasehold improvements for the years ended December 31, 2012, 2011, and 2010, was $40.1 million, $35.3 million, and $28.4 million, respectively. Repairs and maintenance expense totaled $9.3 mil- lion, $10.9 million, and $12.0 million for 2012, 2011, and 2010, respectively, and is included in property operating expenses in the accompanying consolidated financial statements. DEFERRED LEASING COSTS Deferred leasing costs consist of commissions paid to third-party leasing agents, internal direct costs such as employee compen- sation and payroll-related fringe benefits directly related to time spent performing leasing-related activities for successful com- mercial leases and amounts attributed to in place leases associ- ated with acquired properties. Leasing related activities include evaluating the prospective tenant’s financial condition, evaluat- ing and recording guarantees, collateral and other security arrangements, negotiating lease terms, preparing lease docu- ments and closing the transaction. Unamortized deferred costs are charged to expense if the applicable lease is terminated prior to expiration of the initial lease term. Deferred leasing costs are amortized over the term of the lease or remaining term of ac- quired leases. Collectively, deferred leasing costs totaled $26.1 million and $25.9 million, net of accumulated amortization of approximately $16.2 million and $14.7 million, as of December 31, 2012 and 2011, respectively. Amortization expense, in- cluded in depreciation and amortization in the consolidated statements of operations, totaled approximately $5.6 million, $4.8 million, and $3.7 million, for the years ended December 31, 2012, 2011, and 2010, respectively. CONSTRUCTION IN PROGRESS Construction in progress includes preconstruction and develop- ment costs of active projects. Preconstruction costs include legal, zoning and permitting costs and other project carrying costs incurred prior to the commencement of construction. Develop- ment costs include direct construction costs and indirect costs incurred subsequent to the start of construction such as archi- tectural, engineering, construction management and carrying costs consisting of interest, real estate taxes and insurance. Con- struction in progress totaled $2.3 million and $1.1 million, respectively, as of December 31, 2012 and 2011. 36 SAUL CENTERS, INC. 2012 ANNUAL REPORT 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ACCOUNTS RECEIVABLE AND ACCRUED INCOME Accounts receivable primarily represent amounts currently due from tenants in accordance with the terms of the respective leases. Receivables are reviewed monthly and reserves are es- tablished with a charge to current period operations when, in the opinion of management, collection of the receivable is doubtful. Accounts receivable in the accompanying consoli- dated financial statements are shown net of an allowance for doubtful accounts of $1.2 million and $671,000, at December 31, 2012 and 2011, respectively. ALLOWANCE FOR DOUBTFUL ACCOUNTS For the Year Ended December 31, (In thousands) 2012 2011 2010 Beginning Balance $ 671 $ 898 $1,265 Provision for Credit Losses 1,160 1,883 1,337 Charge-offs (623) (2,110) (1,704) Ending Balance $ 1,208 $ 671 $ 898 In addition to rents due currently, accounts receivable also in- cludes $34.4 million and $31.0 million, at December 31, 2012 and 2011, respectively, net of allowance for doubtful accounts totaling $92,000 and $63,000, respectively, representing mini- mum rental income accrued on a straight-line basis to be paid by tenants over the remaining term of their respective leases. CASH AND CASH EQUIVALENTS Cash and cash equivalents include short-term investments. Short-term investments include money market accounts and other investments which generally mature within three months, measured from the acquisition date, and/or are readily convert- ible to cash. Substantially all of the Company’s cash balances at December 31, 2012 are held in non-interest bearing accounts at various banks. DEFERRED DEBT COSTS Deferred debt costs consist of fees and costs incurred to obtain long-term financing, construction financing and the revolving line of credit. These fees and costs are being amortized on a straight-line basis over the terms of the respective loans or agree- ments, which approximates the effective interest method. De- ferred debt costs totaled $7.7 million and $7.1 million, net of accumulated amortization of $3.8 million and $6.9 million at December 31, 2012 and 2011, respectively. DEFERRED INCOME Deferred income consists of payments received from tenants prior to the time they are earned and recognized by the Com- pany as revenue, including tenant prepayment of rent for future periods, real estate taxes when the taxing jurisdiction has a fiscal year differing from the calendar year reimbursements specified 38 SAUL CENTERS, INC. in the lease agreement and tenant construction work provided by the Company. In addition, deferred income includes the fair value of certain below market leases. DERIVATIVE FINANCIAL INSTRUMENTS The Company may, when appropriate, employ derivative instru- ments, such as interest-rate swaps, to mitigate the risk of interest rate fluctuations. The Company does not enter into derivative or other financial instruments for trading or speculative pur- poses. Derivative financial instruments are carried at fair value as either assets or liabilities on the consolidated balance sheets. For those derivative instruments that qualify, the Company may designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge or a cash flow hedge. De- rivative instruments that are designated as a hedge are evaluated to ensure they continue to qualify for hedge accounting. The ef- fective portion of any gain or loss on the hedge instruments is reported as a component of accumulated other comprehensive income (loss) and recognized in earnings within the same line item associated with the forecasted transaction in the same pe- riod or periods during which the hedged transaction affects earnings. Any ineffective portion of the change in fair value of a derivative instrument is immediately recognized in earnings. For derivative instruments that do not meet the criteria for hedge accounting, or that qualify and are not designated, changes in fair value are immediately recognized in earnings. DISCONTINUED OPERATIONS During 2012, the Company sold its West Park and Belvedere properties for $2.0 million and $4.0 million and recognized gains of $1.1 million and $3.4 million, respectively. During 2010, the Company sold its Lexington property for $8.1 million and rec- ognized a gain of $3.6 million. The results of operations of West Park and Belvedere for the years ended December 31, 2012, 2011 and 2010 and of the Lexington property for the year ended December 31, 2010 are included in the statements of operations as “Loss from operations of property sold.” The Company has no other discontinued operations. REVENUE RECOGNITION Rental and interest income are accrued as earned except when doubt exists as to collectability, in which case the accrual is dis- continued. Recognition of rental income commences when con- trol of the space has been given to the tenant. When rental payments due under leases vary from a straight-line basis be- cause of free rent periods or stepped increases, income is rec- ognized on a straight-line basis. Expense recoveries represent a portion of property operating expenses billed to the tenants, in- cluding common area maintenance, real estate taxes and other recoverable costs. Expense recoveries are recognized in the pe- riod in which the expenses are incurred. Rental income based on a tenant’s revenue (“percentage rent”) is accrued when a tenant reports sales that exceed a specified breakpoint, pursuant to the terms of their respective leases. INCOME TAXES The Company made an election to be treated, and intends to continue operating so as to qualify, as a REIT under the Code, commencing with its taxable year ended December 31, 1993. A REIT generally will not be subject to federal income taxation, pro- vided that distributions to its stockholders equal or exceed its REIT taxable income and complies with certain other requirements. Therefore, no provision has been made for federal income taxes in the accompanying consolidated financial statements. As of December 31, 2012, the Company had no material unrec- ognized tax benefits and there exist no potentially significant un- recognized tax benefits which are reasonably expected to occur within the next twelve months. The Company recognizes penal- ties and interest accrued related to unrecognized tax benefits, if any, as general and administrative expense. No penalties and interest have been accrued in years 2012, 2011, and 2010. The tax basis of the Company’s real estate investments was approx- imately $1.1 billion, as of December 31, 2012 and 2011. With few exceptions, the Company is no longer subject to U.S. fed- eral, state, and local tax examinations by tax authorities for years before 2007. STOCK BASED EMPLOYEE COMPENSATION, DEFERRED COMPENSATION AND STOCK PLAN FOR DIRECTORS The Company uses the fair value method to value and account for employee stock options. The fair value of options granted is determined at the time of each award using the Black-Scholes model, a widely used method for valuing stock based employee compensation, and the following assumptions: (1) Expected Volatility determined using the most recent trading history of the Company’s common stock (month-end closing prices) correspon- ding to the average expected term of the options; (2) Average Expected Term of the options is based on prior exercise history, scheduled vesting and the expiration date; (3) Expected Dividend Yield determined by management after considering the Com- pany’s current and historic dividend yield rates, the Company’s yield in relation to other retail REITs and the Company’s market yield at the grant date; and (4) a Risk-free Interest Rate based upon the market yields of US Treasury obligations with maturities corresponding to the average expected term of the options at the grant date. The Company amortizes the value of options granted ratably over the vesting period and includes the amounts as compensation in general and administrative expenses. At the annual meeting of the Company’s stockholders in 2004, the stockholders approved the adoption of the 2004 stock plan for the purpose of attracting and retaining executive officers, di- rectors and other key personnel. The 2004 stock plan was sub- sequently amended by the Company’s stockholders at the 2008 Annual Meeting (the “Amended 2004 Plan”) and terminates in April 2018. Pursuant to the Amended 2004 Plan, the Compen- sation Committee established a Deferred Compensation Plan for Directors for the benefit of its directors and their beneficiaries, which replaced a previous Deferred Compensation and Stock Plan for Directors. A director may make an annual election to defer all or part of his or her director’s fees and has the option to have the fees paid in cash, in shares of common stock or in a combination of cash and shares of common stock upon separa- tion from the Board. If the director elects to have fees paid in stock, fees earned during a calendar quarter are aggregated and divided by the common stock’s closing market price on the first trading day of the following quarter to determine the number of shares to be allocated to the director. As of December 31, 2012, 220,500 shares are in the directors’ deferred fee accounts. The Compensation Committee has also approved an annual award of shares of the Company’s common stock as additional compensation to each director serving on the Board of Directors as of the record date for the Annual Meeting of Stockholders. The shares are awarded as of each Annual Meeting of Share- holders, and their issuance may not be deferred. Each director was issued 200 shares for each of the years ended December 31, 2012, 2011, and 2010. The shares were valued at the clos- ing stock price on the dates the shares were awarded and included in general and administrative expenses in the total amounts of $110,000, $109,000, and $101,000, for the years ended December 31, 2012, 2011, and 2010, respectively. NONCONTROLLING INTEREST Saul Centers is the sole general partner of the Operating Part- nership, owning a 74.4% common interest as of December 31, 2012. Noncontrolling interest in the Operating Partnership is comprised of limited partnership units owned by The Saul Or- ganization. Noncontrolling interest reflected on the accompa- nying consolidated balance sheets is increased for earnings allocated to limited partnership interests and distributions rein- vested in additional units, and is decreased for limited partner distributions. Noncontrolling interest reflected on the consoli- dated statements of operations represents earnings allocated to limited partnership interests held by The Saul Organization. PER SHARE DATA Per share data for net income (basic and diluted) is computed using weighted average shares of common stock. Convertible limited partnership units and employee stock options are the Company’s potentially dilutive securities. For all periods pre- sented, the convertible limited partnership units are anti-dilutive. For the years ended December 31, 2012, 2011, and 2010, certain options are dilutive because the average share price of the Com- pany’s common stock exceeded the exercise prices. The treasury stock method was used to measure the effect of the dilution. 2012 ANNUAL REPORT 39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS BASIC AND DILUTED SHARES OUTSTANDING December 31 (In thousands) 2012 2011 2010 Weighted average common shares outstanding – Basic 19,649 18,888 18,267 Effect of dilutive options 51 61 110 Weighted average common shares outstanding – Diluted 19,700 18,949 18,377 Average Share Price $40.94 $39.39 $40.87 LEGAL CONTINGENCIES The Company is subject to various legal proceedings and claims that arise in the ordinary course of business, which are generally covered by insurance. Upon determination that a loss is proba- ble to occur and can be reasonably estimated, the estimated amount of the loss is recorded in the financial statements. RECLASSIFICATIONS Certain reclassifications have been made to prior year and prior quarter information to conform to the presentation used for the three-months and year ended December 31, 2012. 3. REAL ESTATE ACQUIRED 11503 ROCKVILLE PIKE On October 1, 2010, the Company purchased for $15.1 million a retail property located in Rockville, Maryland, and incurred ac- quisition costs of $0.5 million. METRO PIKE CENTER On December 17, 2010, the Company purchased for $33.6 mil- lion (including the assumption of a $16.2 million mortgage loan and a related interest-rate swap with a value of $0.5 million) the Metro Pike Center located in Rockville, Maryland, and incurred acquisition costs of $0.7 million. As of the date of acquisition, management determined the fair value of the mortgage loan equaled its outstanding balance because the terms of the loan were market terms. 4469 CONNECTICUT AVENUE In February 2011, the Company purchased for $1.6 million 4469 Connecticut Avenue, a one retail space property, currently un- leased, located adjacent to Van Ness Square in northwest Wash- ington, DC and incurred acquisition costs of $74,000. KENTLANDS SQUARE II In September 2011, the Company purchased for $74.5 million Kentlands Square II, a retail property located adjacent to the Company’s Kentlands Square I and Kentlands Place shopping centers in Gaithersburg, Maryland, and incurred acquisition costs of $1.1 million. 40 SAUL CENTERS, INC. SEVERNA PARK MARKETPLACE In September 2011, the Company purchased for $61.0 million Severna Park MarketPlace, a retail property located in Severna Park, Maryland, and incurred acquisition costs of $0.8 million. CRANBERRY SQUARE In September 2011, the Company purchased for $33.0 million Cranberry Square, a retail property located in Westminster, Mary- land, and incurred acquisition costs of $0.5 million. 1500 ROCKVILLE PIKE In December 2012, the Company purchased for $22.4 million 1500 Rockville Pike, a retail property located in Rockville, Mary- land, and incurred acquisition costs of $0.6 million. 5541 NICHOLSON LANE In December 2012, the Company purchased for $11.7 million 5541 Nicholson Lane, a retail property located in Rockville, Mary- land, and incurred acquisition costs of $0.5 million. The revenue and expenses of 1500 Rockville Pike and 5541 Nicholson Lane have been included in the Consolidated State- ments of Operations for the period subsequent to acquisition. Revenue and earnings (defined as revenue less the sum of oper- ating expenses, provision for credit losses and real estate taxes, all arising from the operation of a property) totaled $101,000 and $14,000, respectively, from acquisition through December 31, 2012. The proforma results for the year ended December 31, 2012 and 2011 have been prepared for comparative pur- poses only and do not purport to be indicative of the results of operations that would have actually occurred had the transac- tion taken place on January 1, 2011, or of future results of op- erations. The following table shows proforma revenue and earnings of the Company assuming the acquisitions occurred as of January 1, 2011. Year ended December 31 (In thousands) 2012 2011 Revenue $ 191,866 $ 175,262 Earnings 144,320 129,981 ALLOCATION OF PURCHASE PRICE OF REAL ESTATE ACQUIRED The Company allocates the purchase price of real estate invest- ment properties to various components, such as land, buildings and intangibles related to in-place leases and customer relation- ships, based on their fair values. See Note 2. Summary of Sig- nificant Accounting Policies-Real Estate Investment Properties. During 2012, the Company purchased two properties at an ag- gregate cost of $34.1 million and incurred acquisition costs of $1.1 million. Of the total purchase price, $3.8 million was allo- cated to buildings, $30.4 million was allocated to land, and $0.5 million was allocated to in-place leases and $0.7 million was allocated to below market leases which is included in deferred income and is being accreted to income over the lives of the underlying leases, which is approximately 3.1 years. During 2011, the Company purchased four properties at an ag- gregate cost of $170.1 million, and incurred acquisition costs of $2.5 million. Of the total purchase price, $5.5 million was allo- cated to below market leases which is included in deferred income and is being accreted to income over the lives of the underlying leases, or approximately 10.9 years, and $28,000 was allocated to above market leases, which is included as a deferred asset in accounts receivable and is being amortized against income over the lives of the underlying leases, which is approximately 4.1 years. The allocation of the purchase prices for Severna Park Market- Place, Kentlands Square II, and Cranberry Square to the acquired assets and liabilities based on their fair values was as follows: Severna Three Kentlands Park Cranberry Property (In thousands) Square II MarketPlace Square Total Land $ 20,500 $ 12,700 $ 6,700 $ 39,900 Buildings 51,973 50,554 24,878 127,405 In-Place Leases 2,697 2,433 1,499 6,629 Above Market Rents 6 4 18 28 Below Market Rents (676) (4,691) (95) (5,462) Total Purchase Price $ 74,500 $ 61,000 $33,000 $168,500 The gross carrying amount of lease intangible assets included in deferred leasing costs as of December 31, 2012 and 2011 was $21.9 million and $21.4 million, respectively, and accumulated amortization was $14.7 million and $12.7 million, respectively. Amortization expense totaled $2.0 million, $1.3 million and $747,000, for the years ended December 31, 2012, 2011, and 2010, respectively. The gross carrying amount of below market lease intangible liabilities included in deferred income as of De- cember 31, 2012 and 2011 was $24.8 million and $24.1 million, respectively, and accumulated amortization was $8.3 million and $6.7 million, respectively. Accretion income totaled $1.6 million, $1.2 million, and $1.1 million, for the years ended December 31, 2012, 2011, and 2010, respectively. The gross carrying amount of above market lease intangible assets included in ac- counts receivable as of December 31, 2012 and 2011 was $1.0 million and $1.0 million, respectively, and accumulated amorti- zation was $930,000 and $870,000, respectively. Amortization expense totaled $60,000, $62,000, and $62,000, for the years ended December 31, 2012, 2011, and 2010, respectively. As of December 31, 2012, scheduled amortization of intangible assets and deferred income related to in place leases is as follows: AMORTIZATION OF INTANGIBLE ASSETS AND DEFERRED INCOME RELATED TO IN-PLACE LEASES Lease Above Below acquisition market market (In thousands) costs leases leases 2013 $ 1,957 $ 45 $ 1,694 2014 1,066 21 1,482 2015 721 3 1,182 2016 566 1 1,116 2017 517 – 1,095 Thereafter 2,403 – 9,933 Total $ 7,230 $ 70 $ 16,502 4. NONCONTROLLING INTEREST - HOLDERS OF CONVERTIBLE LIMITED PARTNERSHIP UNITS IN THE OPERATING PARTNERSHIP The Saul Organization holds a 25.6% limited partnership interest in the Operating Partnership represented by 6,914,000 limited partnership units, as of December 31, 2012. The units are con- vertible into shares of Saul Centers’ common stock, at the option of the unit holder, on a one-for-one basis provided that, in ac- cordance with the Saul Centers, Inc. Articles of Incorporation, the rights may not be exercised at any time that The Saul Or- ganization beneficially owns, directly or indirectly, in the aggre- gate more than 39.9% of the value of the outstanding common stock and preferred stock of Saul Centers (the “Equity Securi- ties”). As of December 31, 2012, 987,000 units were eligible for conversion. The impact of The Saul Organization’s 25.6% limited partnership interest in the Operating Partnership is reflected as Noncontrol- ling Interest in the accompanying consolidated financial state- ments. Fully converted partnership units and diluted weighted average shares outstanding for the years ended December 31, 2012, 2011, and 2010, were 26,613,900, 24,739,700, and 23,793,000, respectively. 2012 ANNUAL REPORT 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. MORTGAGE NOTES PAYABLE, REVOLVING CREDIT FACILITY, INTEREST EXPENSE AND AMORTIZATION OF DEFERRED DEBT COSTS At December 31, 2012, outstanding debt totaled $827.8 million, of which $774.9 million was fixed rate debt and $52.9 million was variable rate debt. The Company’s outstanding debt totaled $831.9 million at December 31, 2011, of which $808.8 million was fixed rate debt and $23.1 million was variable rate debt. At December 31, 2012, the Company had a $175.0 million unse- cured revolving credit facility, which can be used for working capital, property acquisitions or development projects, under which $38.0 million was outstanding. The revolving credit fa- cility matures on May 20, 2016, and may be extended by the Company for one additional year subject to the Company’s sat- isfaction of certain conditions. Saul Centers and certain consol- idated subsidiaries of the Operating Partnership have guaranteed the payment obligations of the Operating Partnership under the revolving credit facility. Letters of credit may be issued under the revolving credit facility. On December 31, 2012, approximately $136.8 million was available under the line and approximately $224,000 was committed for letters of credit. The interest rate under the facility is based on the Company’s leverage and is the sum of LIBOR and a margin ranging from 160 basis points to 250 basis points.. As of December 31, 2012, the margin was 1.90%. Saul Centers is a guarantor of the revolving credit facility, of which the Operating Partnership is the borrower. Saul Centers is also the guarantor of 50% of the Northrock bank term loan (approx- imately $7.5 million of the $14.9 million outstanding at Decem- ber 31, 2012). The fixed-rate notes payable are all non-recourse debt except for $3.9 million of the Great Falls Center mortgage, 25% of the Metro Pike Center loan (approximately $3.7 million of the $15.7 million outstanding at December 31, 2012), and $27.6 million of the Clarendon Center mortgage which will be eliminated upon the achievement of certain leasing and debt serv- ice covenants which are guaranteed by Saul Centers. On June 29, 2010, the Company closed on a new 10-year mort- gage loan in the amount of $45.6 million, secured by Thruway. The loan matures July 1, 2020, bears interest at a variable rate equal to the sum of one-month LIBOR and 260 basis points. In conjunction with the financing, the Company entered into an interest rate swap agreement with a $45.6 million notional amount to manage the interest rate risk associated with the above $45.6 million of variable-rate mortgage debt. The swap agreement was effective June 29, 2010, terminates on July 1, 2020 and effectively fixes the interest rate on the mortgage debt at 5.83%. The Company has designated this agreement as a cash flow hedge for accounting purposes. The Company, there- fore, will recognize interest expense on the variable-rate debt at the effective fixed rate of 5.83%. The Company tests the hedge for effectiveness on a quarterly basis. On a combined basis, the loan and the interest-rate swap require equal monthly principal and interest payments of $289,081, based upon an assumed in- terest rate of 5.83% and a 25-year principal amortization, and requires a final principal payment of approximately $34.8 million at maturity. Immediately prior to the refinancing, Thruway was one of nine properties securing debt included in a collateralized mortgage- backed security (CMBS) with an outstanding balance of $108.3 million, an interest rate of 7.67% and due to mature October 2012. In order to release Thruway, the Company defeased $30.2 million of the outstanding balance at a cost of approximately $4.4 million, using proceeds from the new mortgage financing. On August 24, 2010, the Company entered into an amendment to its Northrock construction loan to provide an option to extend the loan for two years. The extension is available at the Com- pany’s option subject to notice to the bank, and to a principal repayment in an amount required to cause property operating income to meet certain debt service coverage levels. On December 9, 2010, the Company closed on a new 15-year, fixed-rate mortgage loan in the amount of $17.0 million secured by Ravenwood. The loan matures January 2026, requires monthly interest and principal payments of $111,409 based upon a fixed interest rate of 6.18% and a 25-year principal amortization and requires a final principal payment of approxi- mately $10.1 million at maturity. Immediately prior to the refinancing, Ravenwood was one of eight remaining properties securing debt included in a CMBS with an outstanding balance of $76.3 million, an interest rate of 7.67% and due to mature October 2012. In order to release Ravenwood, the Company defeased $7.8 million of the out- standing balance at a cost of approximately $900,000, using proceeds from the new mortgage financing. On December 17, 2010, the Company purchased Metro Pike Center, a 62,000 square foot retail property located in Rockville, Maryland. In conjunction with the acquisition, the Company as- sumed a mortgage loan with a principal balance of $16.2 mil- lion. The loan matures June 30, 2013, bears interest at a variable rate equal to the sum of one-month LIBOR and 245 basis points. In conjunction with the loan assumption, the Company assumed a corresponding interest rate swap agreement with a $16.2 mil- lion notional amount to manage the interest rate risk associated with the variable-rate mortgage debt. The swap agreement was effective at closing, terminates on June 30, 2013 and effectively fixes the interest rate on the mortgage debt at 4.67%. Although the swap is an effective hedge of the loan, the Company elected not to designate this agreement as a hedge for accounting pur- poses. Interest expense on the loan is recognized at its variable interest rate. The swap agreement is carried at its fair value with changes in fair value recognized in change in fair value of derivatives in the Consolidated Statements of Operations as they occur. On a combined basis, the loan and the interest-rate swap require interest-only payments of $62,925, based upon an as- sumed interest rate of 4.67% until August 1, 2011, followed by equal monthly payments of $86,000 based upon a 25-year amortization schedule and a final payment of $15.6 million at loan maturity. On March 23, 2011, the Company closed on a 15-year non-re- course mortgage loan in the amount of $125.0 million, secured by Clarendon Center. The loan matures April 5, 2026, bears in- terest at a fixed rate of 5.31%, requires equal monthly principal and interest payments of $753,491, based upon a 25-year prin- cipal amortization, and requires a final principal payment of ap- proximately $70.5 million at maturity. Proceeds from the loan were used to repay $104.2 million outstanding on the Clarendon Center construction loan. On September 23, 2011, the Company closed on a 15-year non- recourse mortgage loan in the amount of $38.0 million, secured by Severna Park MarketPlace. The loan matures October 1, 2026, bears interest at a fixed rate of 4.30%, requires equal monthly principal and interest payments of $206,926, based upon a 25-year principal amortization, and requires a final prin- cipal payment of approximately $20.3 million at maturity. Pro- ceeds from the loan were used to purchase Severna Park MarketPlace. Also on September 23, 2011, the Company closed on two six- month bridge financing loans in the total amount of $60.0 mil- lion, secured by Kentlands Square II and Cranberry Square. Proceeds from the loans were used to purchase Kentlands Square II and Cranberry Square. On October 5, 2011, the Company closed on a new 15-year non-recourse mortgage loan in the amount of $43.0 million, se- cured by Kentlands Square II. The loan matures November 5, 2026, bears interest at a fixed rate of 4.53%, requires equal monthly principal and interest payments of $239,741, based upon a 25-year principal amortization, and requires a final prin- cipal payment of approximately $23.3 million at maturity. Pro- ceeds from the loan were used to repay the $40.0 million bridge financing used to acquire Kentlands Square II. On November 6, 2011, the Company closed on a new 15-year non-recourse mortgage loan in the amount of $20.0 million, se- cured by Cranberry Square. The loan matures December 1, 2026, bears interest at a fixed rate of 4.70%, requires equal monthly principal and interest payments of $113,449, based upon a 25-year principal amortization, and requires a final prin- cipal payment of approximately $10.9 million at maturity. Pro- ceeds from the loan were used to repay the $20.0 million bridge financing used to acquire Cranberry Square. On April 11, 2012, the Company closed on a 15-year non-re- course mortgage loan in the amount of $73.0 million secured by Seven Corners shopping center. The loan matures in May 2027, bears interest at a fixed rate of 5.84%, requires equal monthly principal and interest payments totaling $463,226 based upon a 25-year amortization schedule and a final payment of $42.5 million at maturity. Proceeds from the loan were used to pay-off the $63 million remaining balance of existing debt se- cured by Seven Corners and six other shopping center proper- ties, which was scheduled to mature in October 2012, and to provide cash of approximately $10 million. On April 26, 2012, the Company substituted the White Oak shopping center for Van Ness Square as collateral for one of its existing mortgage loans which allowed the Company to analyze the feasibility of repositioning Van Ness Square. The terms of the original loan, including its 8.11% interest rate, are un- changed and, in conjunction with the collateral substitution, the Company borrowed an additional $10.5 million, also secured by White Oak. The new borrowing requires equal monthly pay- ments based upon a fixed 4.90% interest rate and 25-year amortization schedule, and will mature in July 2024, cotermi- nously with the original loan. The consolidated loan requires equal monthly payments based upon a blended fixed interest rate of 7.0% and will require a final payment of $18.5 million at maturity. On May 21, 2012, the Company replaced its existing unsecured revolving credit facility with a new $175.0 million facility that ex- pires on May 20, 2016. The facility, which provides working cap- ital and funds for acquisitions, certain developments, redevelopments and letters of credit, may be extended for one year, at the Company’s option, subject to the satisfaction of cer- tain conditions. Loans under the facility bear interest at a rate equal to the sum of LIBOR and a margin, based on the Com- pany’s leverage ratio, ranging from 160 basis points to 250 basis points. Based on the leverage ratio of December 31, 2012, the margin was 190 basis points. 42 SAUL CENTERS, INC. 2012 ANNUAL REPORT 43 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following is a summary of notes payable as of December 31, 2012 and 2011: NOTES PAYABLE December 31, Interest Scheduled (Dollars in thousands) 2012 2011 Rate * Maturity * Fixed rate mortgages: $ – (a) 64,844 7.67% Oct-2012 – (b) 10,244 6.12% Jan-2013 – (c) 24,598 7.88% Jan-2013 15,750 (d) 16,032 4.67% Jun-2013 6,936 (e) 7,203 5.77% Jul-2013 13,875 (f) 14,335 5.40% May-2014 16,798 (g) 17,415 7.45% Jun-2015 34,373 (h) 35,435 6.01% Feb-2018 38,388 (i) 39,757 5.88% Jan-2019 12,418 (j) 12,860 5.76% May-2019 17,145 (k) 17,755 5.62% Jul-2019 17,040 (l) 17,627 5.79% Sep-2019 15,176 (m) 15,713 5.22% Jan-2020 11,421 (n) 11,670 5.60% May-2020 10,288 (o) 10,636 5.30% Jun-2020 43,424 (p) 44,333 5.83% Jul-2020 8,934 (q) 9,204 5.81% Feb-2021 6,359 (r) 6,477 6.01% Aug-2021 36,699 (s) 37,377 5.62% Jun-2022 11,129 (t) 11,317 6.08% Sep-2022 11,989 (u) 12,172 6.43% Apr-2023 16,247 (v) 16,858 6.28% Feb-2024 17,469 (w) 17,791 7.35% Jun-2024 15,140 (x) 15,409 7.60% Jun-2024 26,635 (y) 16,494 7.02% Jul-2024 31,709 (z) 32,281 7.45% Jul-2024 31,490 (aa) 32,044 7.30% Jan-2025 16,419 (bb) 16,731 6.18% Jan-2026 120,822 (cc) 123,372 5.31% Apr-2026 36,986 (dd) 37,858 4.30% Oct-2026 41,970 (ee) 42,923 4.53% Nov-2026 19,569 (ff) 20,000 4.70% Dec-2026 72,233 (gg) – 5.84% May-2027 Total fixed rate 774,831 808,765 5.82% 10.0 Years Variable rate loans: Revolving credit facility 38,000 (hh) 8,000 LIBOR + 1.90% May-2016 Northrock bank term loan 14,945 (ii) 15,106 LIBOR + 3.00% May-2013 Total variable rate 52,945 23,106 2.80% 3.4 Years Total notes payable $ 827,776 $ 831,871 5.77% 9.7 Years * Interest rate and scheduled maturity data presented as of December 31, 2012. Totals computed using weighted averages. (a) The loan was collateralized by seven shopping centers (Seven Cor- ners, White Oak, Hampshire Langley, Great Eastern, Southside Plaza, Belvedere and Giant) and required equal monthly principal and in- terest payments of $734,000 based upon a 25-year amortization schedule and a final payment of $62.0 million at loan maturity. The loan was repaid in full in 2012. (c) (b) The loan was collateralized by Smallwood Village Center and re- quired equal monthly principal and interest payments of $71,000 based upon a 30-year amortization schedule and a final payment of $10.1 million at loan maturity. The loan was repaid in full in 2012. The loan was collateralized by 601 Pennsylvania Avenue and re- quired equal monthly principal and interest payments of $294,000 based upon a 25-year amortization schedule and a final payment of $23.0 million at loan maturity. The loan was repaid in full in 2012. (d) The loan, together with a corresponding interest-rate swap, was as- sumed with the December 17, 2010 acquisition of, and is collater- alized by, Metro Pike Center. On a combined basis, the loan and the swap required interest only payments of $63,000 until August 1, 2011, then equal monthly payments of $86,000 based upon a 25- year amortization schedule and a final payment of $15.6 million at loan maturity. Principal of $282,000 was amortized during 2012. (e) The loan is collateralized by Cruse MarketPlace and requires equal monthly principal and interest payments of $56,000 based upon an amortization schedule of approximately 24 years and a final pay- ment of $6.8 million at loan maturity. Principal of $267,000 was amortized during 2012. The loan is collateralized by Seabreeze Plaza and requires equal monthly principal and interest payments totaling $102,000 based upon a weighted average 26-year amortization schedule and a final payment of $13.3 million is due at loan maturity. Principal of $460,000 was amortized during 2012. (f) (g) The loan is collateralized by Shops at Fairfax and Boulevard shopping centers and requires equal monthly principal and interest payments totaling $156,000 based upon a weighted average 23-year amorti- zation schedule and a final payment of $15.2 million is due at loan maturity. Principal of $617,000 was amortized during 2012. (h) The loan is collateralized by Washington Square and requires equal monthly principal and interest payments of $264,000 based upon a 27.5-year amortization schedule and a final payment of $28.0 million at loan maturity. Principal of $1.1 million was amortized during 2012. The loan is collateralized by three shopping centers, Broadlands Vil- lage, The Glen and Kentlands Square I, and requires equal monthly principal and interest payments of $306,000 based upon a 25-year amortization schedule and a final payment of $28.4 million at loan maturity. Principal of $1.4 million was amortized during 2012. The loan is collateralized by Olde Forte Village and requires equal monthly principal and interest payments of $98,000 based upon a 25-year amortization schedule and a final payment of $9.0 million at loan maturity. Principal of $442,000 was amortized during 2012. (j) (i) (l) (k) The loan is collateralized by Countryside and requires equal monthly principal and interest payments of $133,000 based upon a 25-year amortization schedule and a final payment of $12.3 million at loan maturity. Principal of $610,000 was amortized during 2012. The loan is collateralized by Briggs Chaney MarketPlace and requires equal monthly principal and interest payments of $133,000 based upon a 25-year amortization schedule and a final payment of $12.2 million at loan maturity. Principal of $587,000 was amortized during 2012. (m) The loan is collateralized by Shops at Monocacy and requires equal monthly principal and interest payments of $112,000 based upon a 25-year amortization schedule and a final payment of $10.6 million at loan maturity. Principal of $537,000 was amortized during 2012. (n) The loan is collateralized by Boca Valley Plaza and requires equal monthly principal and interest payments of $75,000 based upon a 30-year amortization schedule and a final payment of $9.1 million at loan maturity. Principal of $249,000 was amortized during 2012. (o) The loan is collateralized by Palm Springs Center and requires equal monthly principal and interest payments of $75,000 based upon a 25-year amortization schedule and a final payment of $7.1 million at loan maturity. Principal of $348,000 was amortized during 2012. (p) The loan and a corresponding interest-rate swap closed on June 29, 2010 and are collateralized by Thruway. On a combined basis, the loan and the interest-rate swap require equal monthly principal and interest payments of $289,000 based upon a 25-year amortization schedule and a final payment of $34.8 million at loan maturity. Prin- cipal of $909,000 was amortized during 2012. (t) (r) (s) (q) The loan is collateralized by Jamestown Place and requires equal monthly principal and interest payments of $66,000 based upon a 25-year amortization schedule and a final payment of $6.1 million at loan maturity. Principal of $270,000 was amortized during 2012. The loan is collateralized by Hunt Club Corners and requires equal monthly principal and interest payments of $42,000 based upon a 30-year amortization schedule and a final payment of $5.0 million, at loan maturity. Principal of $118,000 was amortized during 2012. The loan is collateralized by Lansdowne Town Center and requires monthly principal and interest payments of $230,000 based on a 30-year amortization schedule and a final payment of $28.2 million at loan maturity. Principal of $678,000 was amortized during 2012. The loan is collateralized by Orchard Park and requires equal monthly principal and interest payments of $73,000 based upon a 30-year amortization schedule and a final payment of $8.6 million at loan maturity. Principal of $188,000 was amortized during 2012. (u) The loan is collateralized by BJ’s Wholesale and requires equal monthly principal and interest payments of $80,000 based upon a 30-year amortization schedule and a final payment of $9.3 million at loan maturity. Principal of $183,000 was amortized during 2012. (v) The loan is collateralized by Great Falls shopping center. The loan consists of three notes which require equal monthly principal and interest payments of $138,000 based upon a weighted average 26- year amortization schedule and a final payment of $6.3 million at maturity. Principal of $611,000 was amortized during 2012. (w) The loan is collateralized by Leesburg Pike and requires equal monthly principal and interest payments of $135,000 based upon a 25-year amortization schedule and a final payment of $11.5 million at loan maturity. Principal of $322,000 was amortized during 2012. The loan is collateralized by Village Center and requires equal monthly principal and interest payments of $119,000 based upon a 25-year amortization schedule and a final payment of $10.1 million at loan maturity. Principal of $269,000 was amortized during 2012. The loan is collateralized by White Oak and requires equal monthly principal and interest payments of $193,000 based upon a 24.4 year weighted amortization schedule and a final payment of $18.5 mil- lion at loan maturity. The loan was previously collateralized by Van Ness Square. During 2012, the Company substituted White Oak as the collateral and borrowed an additional $10.5 million. Principal of $359,000 was amortized during 2012. The loan is collateralized by Avenel Business Park and requires equal monthly principal and interest payments of $246,000 based upon a 25-year amortization schedule and a final payment of $20.9 million at loan maturity. Principal of $572,000 was amortized during 2012. (aa) The loan is collateralized by Ashburn Village and requires equal monthly principal and interest payments of $240,000 based upon a 25-year amortization schedule and a final payment of $20.5 million at loan maturity. Principal of $554,000 was amortized during 2012. (y) (z) (x) 44 SAUL CENTERS, INC. 2012 ANNUAL REPORT 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (bb) The loan is collateralized by Ravenwood and requires equal monthly principal and interest payments of $111,000 based upon a 25-year amortization schedule and a final payment of $10.1 million at loan maturity. Principal of $312,000 was amortized during 2012. (cc) The loan is collateralized by Clarendon Center and requires equal monthly principal and interest payments of $753,000 based upon a 25-year amortization schedule and a final payment of $70.5 million at loan maturity. Principal of $2.6 million was amortized during 2012. (dd) The loan is collateralized by Severna Park MarketPlace and requires equal monthly principal and interest payments of $207,000 based upon a 25-year amortization schedule and a final payment of $20.3 million at loan maturity. Principal of $872,000 was amortized during 2012. (ee) The loan is collateralized by Kentlands Square II and requires equal monthly principal and interest payments of $240,000 based upon a 25-year amortization schedule and a final payment of $23.1 million at loan maturity. Principal of $953,000 was amortized during 2012. (ff) The loan is collateralized by Cranberry Square and requires equal monthly principal and interest payments of $113,000 based upon a 25-year amortization schedule and a final payment of $10.9 million at loan maturity. Principal of $431,000 was amortized during 2012. (gg) The loan in the original amount of $73.0 million closed in May 2012, is collateralized by Seven Corners and requires equal monthly prin- cipal and interest payments of $463,200 based upon a 25-year amortization schedule and a final payment of $42.3 million at loan maturity. Principal of $767,000 was amortized during 2012. (hh)The loan is a $175.0 million unsecured revolving credit facility. In- terest accrues at a rate equal to the sum of one-month LIBOR plus a spread of 1.90 %. The line may be extended at the Company’s option for one year with payment of a fee of 0.20%. Monthly pay- ments, if required, are interest only and vary depending upon the amount outstanding and the applicable interest rate for any given month. The loan is collateralized by Northrock and requires monthly principal and interest payments of $13,409 and a final payment of $14.9 mil- lion at maturity. Principal of $161,000 was amortized during 2012. (ii) The carrying value of the properties collateralizing the mortgage notes payable totaled $916.1 million and $997.5 million, as of December 31, 2012 and 2011, respectively. The Company’s credit facility requires the Company and its subsidiaries to main- tain certain financial covenants, which are summarized below. The Company was in compliance as of December 31, 2012. • maintain tangible net worth, as defined in the loan agreement, of at least $503.3 million plus 80% of the Company’s net equity proceeds received after May 2012; • limit the amount of debt as a percentage of gross asset value, as defined in the loan agreement, to less than 60% (leverage ratio); • limit the amount of debt so that interest coverage will exceed 2.0x on a trailing four-quarter basis (interest expense coverage); • limit the amount of debt so that interest, scheduled principal amortization and preferred dividend coverage exceeds 1.3x on a trailing four-quarter basis (fixed charge coverage); and • limit the amount of variable rate debt and debt with initial loan terms of less than five years to no more than 40% of total debt. Mortgage notes payable at December 31, 2012 and 2011, total- ing $51.0 million and $99.4 million, respectively, are guaranteed by members of The Saul Organization. As of December 31, 2012, the scheduled maturities of all debt including scheduled principal amortization for years ended December 31, are as follows: DEBT MATURITY SCHEDULE (In thousands) Scheduled Balloon Principal Payments Amortization Total 2013 $ 37,305 $ 19,212 $ 56,517 2014 13,218 19,677 32,895 2015 15,077 20,209 35,286 2016 38,000 (a) 21,058 59,058 2017 – 22,311 22,311 Thereafter 472,892 148,817 621,709 Total $ 576,492 $ 251,284 $ 827,776 (a) Includes $38 million outstanding under the line of credit. INTEREST EXPENSE AND AMORTIZATION OF DEFERRED DEBT COSTS Year ended December 31, (In thousands) 2012 2011 2010 The majority of the leases provide for rental increases and ex- pense recoveries based on fixed annual increases or increases in the Consumer Price Index and increases in operating expenses. The expense recoveries generally are payable in equal install- ments throughout the year based on estimates, with adjust- ments made in the succeeding year. Expense recoveries for the years ended December 31, 2012, 2011, and 2010, amounted to $30.4 million, $28.4 million, and $29.5 million, respectively. In addition, certain retail leases provide for percentage rent based on sales in excess of the minimum specified in the tenant’s lease. Percentage rent amounted to $1.5 million, $1.5 million, and $1.5 million, for the years ended December 31, 2012, 2011, and 2010, respectively. 6. LEASE AGREEMENTS Lease income includes primarily base rent arising from noncance- lable leases. Base rent (including straight-line rent) for the years ended December 31, 2012, 2011, and 2010, amounted to $152.8 million, $138.4 million, and $126.2 million, respectively. Future contractual payments under noncancelable leases for years ended December 31 (which exclude the effect of straight- line rents), are as follows: FUTURE CONTRACTUAL PAYMENTS (In thousands) 2013 $ 146,293 2014 123,137 2015 104,558 2016 87,335 2017 70,306 Thereafter 310,790 Total $ 842,419 7. LONG-TERM LEASE OBLIGATIONS Certain properties are subject to noncancelable long-term leases which apply to land underlying the Shopping Centers. Certain of the leases provide for periodic adjustments of the base annual rent and require the payment of real estate taxes on the under- lying land. The leases will expire between 2058 and 2068. Reflected in the accompanying consolidated financial statements is minimum ground rent expense of $176,000, $173,000, and $169,000, for the years ended December 31, 2012, 2011, and 2010, respectively. The future minimum rental commitments under these ground leases are as follows: GROUND LEASE RENTAL COMMITMENTS Year ending December 31, (In thousands) 2013 2014 2015 2016 2017 Thereafter Total Beacon Center $ 60 $ 60 $ 60 $ 60 $ 60 $ 2,660 $ 2,960 Olney 56 56 56 56 56 3,873 4,153 Southdale 60 60 60 60 60 3,005 3,305 Interest incurred $ 48,010 $ 45,673 $ 40,528 Total $ 176 $ 176 $ 176 $ 176 $ 176 $ 9,538 $10,418 Amortization of deferred debt costs 1,576 1,547 1,467 Capitalized interest (42) (1,896) (7,196) Total $ 49,544 $ 45,324 $ 34,799 Deferred debt costs capitalized in 2012 totaled $2.2 million. No deferred debt costs were capitalized during 2011 and 2010. In addition to the above, Flagship Center consists of two devel- oped out parcels that are part of a larger adjacent community shopping center formerly owned by The Saul Organization and sold to an affiliate of a tenant in 1991. The Company has a 90- year ground leasehold interest which commenced in September 1991 with a minimum rent of one dollar per year. Countryside shopping center was acquired in February, 2004. Because of certain land use considerations, approximately 3.4% of the un- derlying land is held under a 99-year ground lease. The lease requires the Company to pay minimum rent of one dollar per year as well as its pro-rata share of the real estate taxes. 46 SAUL CENTERS, INC. 2012 ANNUAL REPORT 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company’s corporate headquarters space is leased by a member of The Saul Organization. The lease commenced in March 2002 was extended in 2012 for five years, and provides for base rent increases of 3% per year, with payment of a pro- rata share of operating expenses over a base year amount. The Company and The Saul Organization entered into a Shared Serv- ices Agreement whereby each party pays an allocation of total rental payments based on a percentage proportionate to the number of employees employed by each party. The Company’s rent expense for the years ended December 31, 2012, 2011, and 2010 was $850,000, $945,000, and $893,000, respectively. Ex- penses arising from the lease are included in general and admin- istrative expense (see Note 9 – Related Party Transactions). 8. STOCKHOLDERS’ EQUITY AND NONCONTROLLING INTEREST The Consolidated Statements of Operations for the years ended December 31, 2012, 2011, and 2010 reflect noncontrolling in- terest of $6.4 million, $3.6 million, and $6.4 million, respectively, representing The Saul Organization’s share of the net income for the year. In November 2003, the Company sold 4,000,000 depositary shares, each representing 1/100th of a share of 8% Series A Cu- mulative Redeemable Preferred Stock. The depositary shares are redeemable, in whole or in part at the Company’s option, from time to time, at $25.00 per share. The depositary shares pay an annual dividend of $2.00 per share, equivalent to 8% of the $25.00 per share liquidation preference. The Series A preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not convertible into any other secu- rities of the Company. Investors in the depositary shares generally have no voting rights, but will have limited voting rights if the Com- pany fails to pay dividends for six or more quarters (whether or not declared or consecutive) and in certain other events. In March 2008, the Company sold 3,173,115 depositary shares, each representing 1/100th of a share of 9% Series B Cumulative Redeemable Preferred Stock. The depositary shares may be re- deemed at the Company’s option, on or after March 15, 2013, in whole or in part, at $25.00 per share. The depositary shares pay an annual dividend of $2.25 per share, equivalent to 9% of the $25.00 per share liquidation preference. The Series B pre- ferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not convertible into any other securities of the Company. Investors in the depositary shares generally have no voting rights, but will have limited vot- ing rights if the Company fails to pay dividends for six or more quarters (whether or not declared or consecutive) and in certain other events. In September 2011, in connection with the acquisition of three shopping centers, the Company and the Operating Partnership issued to members of The Saul Organization 186,968 shares of 48 SAUL CENTERS, INC. the Company’s common stock, par value $0.01 per share (“Shares”) and 1,497,814 units of limited partnership interests in the Operating Partnership (“Units”) with an aggregate value of $55.8 million. The price of the Shares and Units was equal to the average closing prices of the Company’s common stock listed on the New York Stock Exchange for the five trading days ending with the trading day immediately preceding the date of closing of the property acquisition. 9. RELATED PARTY TRANSACTIONS The Chairman and Chief Executive Officer, the President, the Ex- ecutive Vice President-Real Estate and the Senior Vice President- Chief Accounting Officer of the Company are also officers of various members of The Saul Organization and their manage- ment time is shared with The Saul Organization. Their annual compensation is fixed by the Compensation Committee of the Board of Directors, with the exception of the Senior Vice Presi- dent-Chief Accounting Officer whose share of annual compen- sation allocated to the Company is determined by the shared services agreement (described below). The Company participates in a multiemployer 401K plan with entities in The Saul Organization which covers those full-time employees who meet the requirements as specified in the plan. Company contributions, which are included in general and ad- ministrative expense or property operating expenses in the con- solidated statements of operations, at the discretionary amount of up to six percent of the employee’s cash compensation, sub- ject to certain limits, were $379,000, $378,000, and $358,000, for 2012, 2011, and 2010, respectively. All amounts deferred by employees and the Company are fully vested. The Company also participates in a multiemployer nonqualified deferred compensation plan with entities in The Saul Organiza- tion which covers those full-time employees who meet the re- quirements as specified in the plan. According to the plan, which can be modified or discontinued at any time, participating employees defer 2% of their compensation in excess of a spec- ified amount. For the years ended December 31, 2012, 2011, and 2010, the Company contributed three times the amount deferred by employees. The Company’s expense, included in general and administrative expense, totaled $238,000, $231,000, and $213,000, for the years ended December 31, 2012, 2011, and 2010, respectively. All amounts deferred by employees and the Company are fully vested. The cumulative unfunded liability under this plan was $2.2 million and $1.9 mil- lion, at December 31, 2012 and 2011, respectively, and is in- cluded in accounts payable, accrued expenses and other liabilities in the consolidated balance sheets. The Company has entered into a shared services agreement (the “Agreement”) with The Saul Organization that provides for the sharing of certain personnel and ancillary functions such as computer hardware, software, and support services and certain direct and indirect administrative personnel. The method for de- termining the cost of the shared services is provided for in the Agreement and is based upon head count, estimates of usage or estimates of time incurred, as applicable. Senior management has determined that the final allocations of shared costs are rea- sonable. The terms of the Agreement and the payments made thereunder are reviewed annually by the Audit Committee of the Board of Directors, which consists entirely of independent directors. Billings by The Saul Organization for the Company’s share of these ancillary costs and expenses for the years ended December 31, 2012, 2011, and 2010, which included rental ex- pense for the Company’s headquarters lease (see Note 7. Long Term Lease Obligations), totaled $6.0 million, $6.1 million, and $6.5 million, respectively. The amounts are expensed when in- curred and are primarily reported as general and administrative expenses or capitalized to specific development projects in these consolidated financial statements. As of December 31, 2012 and 2011, accounts payable, accrued expenses and other liabil- ities included $499,000 and $560,000, respectively, representing billings due to The Saul Organization for the Company’s share of these ancillary costs and expenses. The B. F. Saul Insurance Agency of Maryland, Inc., a subsidiary of the B. F. Saul Company and a member of the Saul Organiza- tion, is a general insurance agency that receives commissions and counter-signature fees in connection with the Company’s insurance program. Such commissions and fees amounted to approximately $372,000, $341,000, and $324,000, for the years ended December 31, 2012, 2011, and 2010, respectively. Effective as of September 4, 2012, the Company entered into a consulting agreement with B. F. Saul III, the Company’s former president, whereby Mr. Saul III will provide certain consulting services to the Company as an independent contractor. Under the consulting agreement, Mr. Saul III will be paid at a rate of $60,000 per month. The consulting agreement includes certain noncompete, nonsolicitation and nondisclosure covenants, and has a term of up to two years, although the consulting agree- ment is terminable by the Company at any time. During 2012, such consulting fees totaled $225,000. 10. STOCK OPTION PLAN The Company established a stock option plan in 1993 (the “1993 Plan”) for the purpose of attracting and retaining execu- tive officers and other key personnel. The 1993 Plan provides for grants of options to purchase up to 400,000 shares of com- mon stock. The 1993 Plan authorizes the Compensation Com- mittee of the Board of Directors to grant options at an exercise price which may not be less than the market value of the com- mon stock on the date the option is granted. On May 23, 2003, the Compensation Committee granted options to purchase a total of 220,000 shares (80,000 shares from incentive stock op- tions and 140,000 shares from nonqualified stock options) to six Company officers (the “2003 Options”). Following the grant of the 2003 Options, no additional shares remained for issuance under the 1993 Plan. The 2003 Options vested 25% per year over four years and have a term of ten years, subject to earlier expiration upon termination of employment. The exercise price of $24.91 per share was the closing market price of the Com- pany’s common stock on the date of the award. At the annual meeting of the Company’s stockholders in 2004, the stockholders approved the adoption of the 2004 stock plan for the purpose of attracting and retaining executive officers, di- rectors and other key personnel. The 2004 stock plan was sub- sequently amended by the Company’s stockholders at the 2008 Annual Meeting (the “Amended 2004 Plan”). The Amended 2004 Plan, which terminates in April 2018, provides for grants of options to purchase up to 1,000,000 shares of common stock as well as grants of up to 200,000 shares of common stock to directors. The Amended 2004 Plan authorizes the Compensa- tion Committee of the Board of Directors to grant options at an exercise price which may not be less than the market value of the common stock on the date the option is granted. Effective April 26, 2004, the Compensation Committee granted options to purchase a total of 152,500 shares (27,500 shares from incentive stock options and 125,000 shares from nonqual- ified stock options) to eleven Company officers and to the twelve Company directors (the “2004 Options”), which expire on April 25, 2014. The officers’ 2004 Options vested 25% per year over four years and are subject to early expiration upon termination of employment. The directors’ options were immediately exer- cisable. The exercise price of $25.78 per share was the closing market price of the Company’s common stock on the date of the award. Using the Black-Scholes model, the Company de- termined the total fair value of the 2004 Options to be $360,000, of which $293,000 and $67,000 were the values as- signed to the officer options and director options, respectively. Because the directors’ options vested immediately, the entire $67,000 was expensed as of the date of grant. The expense of the officers’ options was recognized as compensation expense monthly during the four years the options vested. Effective May 6, 2005, the Compensation Committee granted options to purchase a total of 162,500 shares (35,500 shares from incentive stock options and 127,000 shares from nonqual- ified stock options) to twelve Company officers and to twelve Company directors (the “2005 Options”), which expire on May 5, 2015. The officers’ 2005 Options vested 25% per year over four years and are subject to early expiration upon termination of employment. The directors’ options were immediately exer- cisable. The exercise price of $33.22 per share was the closing market price of the Company’s common stock on the date of the award. Using the Black-Scholes model, the Company de- termined the total fair value of the 2005 Options to be $484,500, of which $413,400 and $71,100 were the values as- signed to the officer options and director options, respectively. 2012 ANNUAL REPORT 49 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Because the directors’ options vested immediately, the entire $71,100 was expensed as of the date of grant. The expense of the officers’ options was recognized as compensation expense monthly during the four years the options vested. determined the total fair value of the 2009 Options to be $222,950. Because the directors’ options vested immediately, the entire $222,950 was expensed as of the date of grant. No options were granted to the Company’s officers in 2009. The following table summarizes the amount and activity of each grant, the total value and variables used in the computation and the amount expensed and included in general and administrative expense in the Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 2010: Effective May 1, 2006, the Compensation Committee granted options to purchase a total of 30,000 shares (all nonqualified stock options) to twelve Company directors (the “2006 Op- tions”), which were immediately exercisable and expire on April 30, 2016. The exercise price of $40.35 per share was the closing market price of the Company’s common stock on the date of the award. Using the Black-Scholes model, the Company de- termined the total fair value of the 2006 Options to be $143,400. Because the directors’ options vested immediately, the entire $143,400 was expensed as of the date of grant. No options were granted to the Company’s officers in 2006. Effective April 27, 2007, the Compensation Committee granted options to purchase a total of 165,000 shares (27,560 shares from incentive stock options and 137,440 shares from nonqual- ified stock options) to thirteen Company officers and twelve Company Directors (the “2007 options”), which expire on April 26, 2017. The officers’ 2007 Options vest 25% per year over four years and are subject to early expiration upon termination of employment. The directors’ options were immediately exer- cisable. The exercise price of $54.17 per share was the closing market price of the Company’s common stock on the date of award. Using the Black-Scholes model, the Company deter- mined the total fair value of the 2007 Options to be $1.5 million, of which $1.3 million and $285,300 were the values assigned to the officer options and director options, respectively. Because the directors’ options vested immediately, the entire $285,300 was expensed as of the date of grant. The expense for the offi- cers’ options was recognized as compensation expense monthly during the four years the options vested. Effective April 25, 2008, the Compensation Committee granted options to purchase a total of 30,000 shares (all nonqualified stock options) to twelve Company directors (the “2008 Op- tions”), which were immediately exercisable and expire on April 24, 2018. The exercise price of $50.15 per share was the closing market price of the Company’s common stock on the date of the award. Using the Black-Scholes model, the Company de- termined the total fair value of the 2008 Options to be $254,700. Because the directors’ options vest immediately, the entire $254,700 was expensed as of the date of grant. No op- tions were granted to the Company’s officers in 2008. Effective April 24, 2009, the Compensation Committee granted options to purchase a total of 32,500 shares (all nonqualified stock options) to thirteen Company directors (the “2009 Op- tions”), which were immediately exercisable and expire on April 23, 2019. The exercise price of $32.68 per share was the closing market price of the Company’s common stock on the date of the award. Using the Black-Scholes model, the Company Effective May 7, 2010, the Compensation Committee granted options to purchase a total of 32,500 shares (all nonqualified stock options) to thirteen Company directors (the “2010 Op- tions”), which were immediately exercisable and expire on May 6, 2020. The exercise price of $38.76 per share was the closing market price of the Company’s common stock on the date of the award. Using the Black-Scholes model, the Company de- termined the total fair value of the 2010 Options to be $287,950. Because the directors’ options vested immediately, the entire $287,950 was expensed as of the date of grant. No options were granted to the Company’s officers in 2010. Effective May 13, 2011, the Compensation Committee granted options to purchase a total of 195,000 shares (65,300 shares from incentive stock options and 129,700 shares from nonqual- ified stock options) to 15 Company officers and 13 Company Directors (the “2011 options”), which expire on May 12, 2021. The officers’ 2011 Options vest 25% per year over four years and are subject to early expiration upon termination of employ- ment. The directors’ 2011 options were immediately exercisable. The exercise price of $41.82 per share was the closing market price of the Company’s common stock on the date of award. Using the Black-Scholes model, the Company determined the total fair value of the 2011 Options to be $1.6 million, of which $1.3 million and $297,000 were assigned to the officer options and director options, respectively. Because the directors’ options vested immediately, the entire $297,000 was expensed as of the date of grant. The expense for the officers’ options is being rec- ognized as compensation expense monthly during the four years the options vest. Effective May 4, 2012, the Compensation Committee granted options to purchase a total of 277,500 shares (26,157 shares from incentive stock options and 251,343 shares from nonqual- ified stock options) to 15 Company officers and 14 Company Directors (the “2012 options”), which expire on May 3, 2022. The officers’ 2012 Options vest 25% per year over four years and are subject to early expiration upon termination of employ- ment. The directors’ 2012 options were immediately exercisable. The exercise price of $39.29 per share was the closing market price of the Company’s common stock on the date of award. Using the Black-Scholes model, the Company determined the total fair value of the 2012 Options to be $1.7 million, of which $1.44 million and $244,000 were assigned to the officer options and director options, respectively. Because the directors’ options vested immediately, the entire $244,000 was expensed as of the date of grant. The expense for the officers’ options is being rec- ognized as compensation expense monthly during the four years the options vest. Grant date Total grant Vested Exercised Forfeited Exercisable at December 31, 2012 Remaining unexercised Exercise price Volatility Expected life (years) Assumed yield Risk-free rate Total value at grant date Forfeited options Expensed in previous years Expensed in 2010 Expensed in 2011 Expensed in 2012 Future expense Grant date Total grant Vested Exercised Forfeited Exercisable at $ December 31, 2012 Remaining unexercised Exercise price Volatility Expected life (years) Assumed yield Risk-free rate Total value at grant date Forfeited options Expensed in previous years Expensed in 2010 Expensed in 2011 Expensed in 2012 Future expense Remaining weighted average term of future expense STOCK OPTIONS ISSUED TO DIRECTORS 04/26/2004 05/06/2005 05/01/2006 04/27/2007 04/25/2008 04/24/2009 05/07/2010 05/13/2011 5/4/2012 Subtotals 30,000 30,000 21,200 – 8,800 8,800 $ 25.78 0.183 5.0 30,000 30,000 17,500 – 30,000 30,000 2,500 2,500 12,500 12,500 $ 33.22 0.198 10.0 25,000 25,000 $ 40.35 0.206 9.0 30,000 30,000 – 5,000 25,000 25,000 $ 54.17 0.225 8.0 30,000 30,000 – 5,000 25,000 25,000 $ 50.15 0.237 7.0 32,500 32,500 10,000 – 22,500 22,500 $ 32.68 0.344 6.0 32,500 32,500 2,500 2,500 32,500 32,500 2,500 2,500 35,000 35,000 2,500 – 282,500 282,500 58,700 17,500 27,500 27,500 $ 38.76 0.369 5.0 27,500 27,500 $ 41.82 0.358 5.0 32,500 32,500 $ 39.29 0.348 5.0 206,300 206,300 5.75% 3.57% 6.91% 4.28% 5.93% 5.11% 4.39% 4.65% 4.09% 3.49% 4.54% 2.19% 4.23% 2.17% 4.16% 1.86% 4.61% 0.78% $66,600 – $71,100 – $143,400 – $285,300 – 66,600 – – – – 71,100 – – – – 143,400 – – – – 285,300 – – – – $254,700 – – 254,700 – – – – $222,950 – $287,950 – $ 297,375 – $ 244,388 – $1,873,763 – 222,950 – – – – – 287,950 – – – – – 297,375 – – – – – 244,388 – 1,044,050 287,950 297,375 244,388 – STOCK OPTIONS ISSUED TO OFFICERS AND GRAND TOTALS 05/23/2003 04/26/2004 05/06/2005 04/27/2007 05/13/2011 5/4/2012 Subtotals Grand Totals 220,000 212,500 211,585 7,500 122,500 115,000 91,250 7,500 132,500 118,750 66,375 13,750 135,000 67,500 – 67,500 162,500 40,625 13,750 41,250 242,500 – – 130,000 $ 915 915 24.91 0.175 7.0 7.00% 4.00% 23,750 23,750 25.78 0.183 7.0 5.75% 4.05% $ $ 52,375 52,375 33.22 0.207 8.0 6.37% 4.15% 67,500 67,500 54.17 0.233 6.5 4.13% 4.61% $ 26,875 107,500 41.82 0.330 8.0 4.81% 2.75% $ – 112,500 39.29 0.315 8.0 5.28% 1.49% 1,015,000 554,375 382,960 267,500 171,415 364,540 1,297,500 836,875 441,660 285,000 377,715 570,840 $ 332,200 11,325 $ 292,775 17,925 $ 413,400 35,100 $1,258,848 – $1,277,794 252,300 $1,442,148 813,800 $ 5,017,165 1,130,450 $ 6,890,928 1,130,450 320,875 – – – – 274,850 – – – – 378,300 – – – – 2.9 years 839,245 314,712 104,891 – – – – 186,347 270,391 568,756 – – – 104,724 523,624 1,813,270 314,712 291,238 375,115 1,092,380 2,857,320 602,662 588,613 619,503 1,092,380 50 SAUL CENTERS, INC. 2012 ANNUAL REPORT 51 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The table below summarizes the option activity for the years 2012, 2011, and 2010: 2012 2011 2010 Wtd Avg Wtd Avg Wtd Avg Shares Exercise Price Shares Exercise Price Shares Exercise Price Outstanding at January 1 674,585 $ 40.40 532,881 $ 39.12 609,253 $ 36.71 Granted 277,500 39.29 195,000 41.82 32,500 38.76 Exercised (149,995) 31.03 (40,796) 29.03 (108,872) 25.52 Expired/Forfeited (231,250) 43.56 (12,500) 45.05 – – Outstanding December 31 570,840 41.04 674,585 40.40 532,881 39.12 Exercisable at December 31 377,715 41.41 512,085 39.96 502,256 38.21 The intrinsic value of options exercised in 2012, 2011, and 2010, was $1.6 million, $688,000, and $2.0 million, respectively. The intrinsic value of options outstanding and exercisable at year end 2012 was $2.2 million and $1.7 million, respectively. The intrin- sic value measures the difference between the options’ exercise price and the closing share price quoted by the New York Stock Exchange as of the date of measurement. The date of exercise was the measurement date for shares exercised during the pe- riod. At December 31, 2012, the final trading day of calendar 2012, the closing price of $42.79 per share was used for the cal- culation of aggregate intrinsic value of options outstanding and exercisable at that date. Options having an exercise price in ex- cess of the December 31, 2012 closing price have no intrinsic value. The weighted average remaining contractual life of the Company’s exercisable and outstanding options at December 31, 2012 are 5.0 and 6.4 years, respectively. 11. NON-OPERATING ITEMS Gain on casualty settlement in 2012 reflects insurance proceeds received in excess of the carrying value of assets damaged during a hail storm at French Market in 2012. Gain on casualty settle- ment in 2011 and 2010 reflects the excess of insurance proceeds over the carrying value of assets damaged during a severe hail storm at French Market. The insurance proceeds funded sub- stantially all of the restoration of the damaged property. to the carrying value of $774.8 million and $808.8 million at De- cember 31, 2012 and 2011, respectively. A change in any of the significant inputs may lead to a change in the Company’s fair value measurement of its debt. Effective June 30, 2011, the Company determined that one of its interest-rate swap arrangements was a highly effective hedge of the cash flows under one of its variable-rate mortgage loans and designated the swap as a cash flow hedge of that mort- gage. The swap is carried at fair value with changes in fair value recognized either in income or comprehensive income depend- ing on the effectiveness of the swap. The following chart sum- marizes the changes in fair value of the Company’s swaps for the indicated periods. Year Ended December 31, (In thousands) 2012 2011 2010 Increase (decrease) in fair value: Recognized in earnings $ 36 $ (1,332) $ – Recognized in other comprehensive income (932) (3,195) (543) and correlations of such inputs. The swap agreements terminate on June 30, 2013 and July 1, 2020. As of December 31, 2012, the fair value of the interest-rate swaps was approximately $5.9 million and is included in “Accounts payable, accrued expenses and other liabilities” in the consolidated balance sheets. The de- crease in value from inception of the swap designated as a cash flow hedge is reflected in “Other Comprehensive Income” in the Consolidated Statements of Comprehensive Income. 13. COMMITMENTS AND CONTINGENCIES Neither the Company nor the Current Portfolio Properties are subject to any material litigation, nor, to management’s knowl- edge, is any material litigation currently threatened against the Company, other than routine litigation and administrative pro- ceedings arising in the ordinary course of business. Management believes that these items, individually or in the aggregate, will not have a material adverse impact on the Company or the Cur- rent Portfolio Properties. 14. DISTRIBUTIONS In December 1995, the Company established a Dividend Rein- vestment and Stock Purchase Plan (the “Plan”), to allow its stockholders and holders of limited partnership interests an op- portunity to buy additional shares of common stock by reinvest- ing all or a portion of their dividends or distributions. The Plan provides for investing in newly issued shares of common stock at a 3% discount from market price without payment of any brokerage commissions, service charges or other expenses. All expenses of the Plan are paid by the Company. The Operating Partnership also maintains a similar dividend reinvestment plan that mirrors the Plan, which allows holders of limited partnership interests the opportunity to buy either additional limited part- nership units or common stock shares of the Company. The Company paid common stock distributions of $1.44 per share, $1.44 per share, and $1.44 per share, during 2012, 2011, and 2010, respectively, and Series A preferred stock dividends of $2.00 per depositary share and Series B preferred stock divi- dends of $2.25 per share during each of the years in the period ended December 31, 2012. Of the common stock dividends paid, $0.95 per share, $0.72 per share, and $1.008 per share, represented ordinary dividend income and $0.49 per share, $0.72 per share, and $0.432 per share represented return of capital to the shareholders. All of the preferred stock dividends paid were considered ordinary dividend income. The following summarizes distributions paid during the years ended December 31, 2012, 2011, and 2010, and includes activity in the Plan as well as limited partnership units issued from the reinvestment of unit distributions: Total Distributions to Dividend Reinvestments Limited Common Preferred Common Partnership Stock Shs Discounted (In thousands) Stockholders Stockholders Unitholders Issued Share Price Distributions during 2012 October 31 $ 3,785 $ 7,121 $ 2,489 141,960 $ 42.23 July 31 3,785 7,063 2,489 144,881 40.43 April 30 3,785 7,005 2,489 145,118 38.93 January 31 3,785 6,946 2,489 163,429 34.44 Total $ (896) $ (4,527) $ (543) Total 2012 $ 15,140 $ 28,135 $ 9,956 595,388 12. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying values of cash and cash equivalents, accounts re- ceivable, accounts payable and accrued expenses are reasonable estimates of their fair value. The aggregate fair value of the notes payable with fixed-rate payment terms was determined using Level 3 data in a discounted cash flow approach, which is based upon management’s estimate of borrowing rates and loan terms currently available to the Company for fixed rate financing, and assuming long term interest rates of approximately 4.0% and 4.30%, would be approximately $848.1 million and $889.2 mil- lion, as of December 31, 2012 and 2011, respectively, compared The Company carries its interest rate swaps at fair value. The Company has determined the majority of the inputs used to value its derivative fall within Level 2 of the fair value hierarchy with the exception of the impact of counter-party risk, which was determined using Level 3 inputs and are not significant. De- rivative instruments are classified within Level 2 of the fair value hierarchy because their values are determined using third-party pricing models which contain inputs that are derived from ob- servable market data. Where possible, the values produced by the pricing models are verified by the market prices. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit spreads, measure of volatility, Distributions during 2011 October 31 $ 3,785 $ 6,867 $ 2,489 160,589 $ 34.82 July 31 3,785 6,772 1,950 125,973 38.30 April 30 3,785 6,730 1,950 111,592 42.49 January 31 3,785 6,693 1,950 100,094 45.92 Total 2011 $ 15,140 $ 27,062 $ 8,339 498,248 Distributions during 2010 October 31 $ 3,785 $ 6,608 $ 1,950 114,854 $ 41.14 July 31 3,785 6,567 1,950 107,932 41.27 April 30 3,785 6,525 1,950 103,496 39.07 January 31 3,785 6,486 1,950 100,565 34.58 Total 2010 $ 15,140 $ 26,186 $ 7,800 426,847 52 SAUL CENTERS, INC. 2012 ANNUAL REPORT 53 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In December 2012, the Board of Directors of the Company au- thorized a distribution of $0.36 per common share payable in January 2013, to holders of record on January 17, 2013. As a result, $7.2 million was paid to common shareholders on January 31, 2013. Also, $2.5 million was paid to limited partnership unitholders on January 31, 2013 ($0.36 per Operating Partner- ship unit). The Board of Directors authorized preferred stock div- idends of $0.50 per Series A depositary share, to holders of record on January 7, 2013 and $0.5625 per Series B depositary share to holders of record on January 7, 2013. As a result, $3.8 million was paid to preferred shareholders on January 15, 2013. These amounts are reflected as a reduction of stockholders’ eq- uity in the case of common stock and preferred stock dividends and noncontrolling interest deductions in the case of limited part- ner distributions and are included in dividends and distributions payable in the accompanying consolidated financial statements. 15. INTERIM RESULTS (UNAUDITED) The following summary presents the results of operations of the Company for the quarterly periods of calendar years 2012 and 2011. (In thousands, except per share amounts) 2012 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Revenue $46,989 $47,373 $47,443 $48,287 Operating income before loss on early extinguishment of debt, gain on casualty settlement, acquisition costs, discontinued operations and noncontrolling interest 9,318 9,598 8,160 9,149 Gain on sales of properties – – – 4,510 Net income attributable to Saul Centers, Inc. 7,864 8,079 7,948 9,483 Net income available to common shareholders 4,079 4,294 4,163 5,698 Net income available to common shareholders per share (diluted) 0.21 0.22 0.21 0.29 2011 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Revenue $41,608 $42,666 $42,756 $46,848 Operating income before loss on early extinguishment of debt, gain on casualty settlement, acquisition costs, discontinued operations and noncontrolling interest 8,340 8,247 8,636 8,747 Net income attributable to Saul Centers, Inc. 7,309 6,398 5,504 7,522 Net income available to common shareholders 3,524 2,613 1,719 3,737 Net income available to common shareholders per share (diluted) 0.19 0.14 0.09 0.19 16. BUSINESS SEGMENTS The Company has two reportable business segments: Shopping Centers and Mixed-Use Properties. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note 2). The Company evaluates per- formance based upon income and cash flows from real estate for the combined properties in each segment. All of our properties within each segment generate similar types of revenues and expenses related to tenant rent, reimbursements and operating expenses. Although services are provided to a range of tenants, the types of services provided to them are similar within each segment. The properties in each portfolio have similar economic characteristics and the nature of the products and services provided to our tenants and the method to distribute such services are consistent throughout the portfolio. Certain reclassifications have been made to prior year information to conform to the 2012 presentation. Shopping Mixed-Use Corporate Consolidated (In thousands) Centers Properties and Other Totals As of or for the year ended December 31, 2012 Real estate rental operations: Revenue $ 137,647 $ 52,309 $ 136 $ 190,092 Expenses (30,139) (17,131) – (47,270) Income from real estate 107,508 35,178 136 142,822 Interest expense and amortization of deferred debt costs – – (49,544) (49,544) General and administrative – – (14,274) (14,274) Subtotal 107,508 35,178 (63,682) 79,004 Depreciation and amortization of deferred leasing costs (25,667) (14,445) – (40,112) Predevelopment expenses – (2,667) – (2,667) Acquisition related costs (1,129) – – (1,129) Change in fair value of derivatives – – 36 36 Gain on casualty settlement 219 – – 219 Loss from operations of property sold (81) – – (81) Gain on property dispositions 4,510 – – 4,510 Net income $ 85,360 $ 18,066 $ (63,646) $ 39,780 Capital investment $ 46,353 $ 8,290 $ – $ 54,643 Total assets $ 894,027 $ 301,355 $ 11,927 $ 1,207,309 As of or for the year ended December 31, 2011 Real estate rental operations: Revenue $ 127,767 $ 46,035 $ 76 $ 173,878 Expenses (30,372) (14,658) – (45,030) Income from real estate 97,395 31,377 76 128,848 Interest expense and amortization of deferred debt costs – – (45,324) (45,324) General and administrative – – (14,256) (14,256) Subtotal 97,395 31,377 (59,504) 69,268 Depreciation and amortization of deferred leasing costs (23,077) (12,221) – (35,298) Decrease in fair value of derivatives – – (1,332) (1,332) Acquisition related costs (2,534) – – (2,534) Loss from operations of property sold (55) – – (55) Gain on casualty settlement 245 – – 245 Net income $ 71,974 $ 19,156 $ (60,836) $ 30,294 Capital investment $ 177,958 $ 24,546 $ – $ 202,504 Total assets $ 871,409 $ 308,053 $ 13,107 $ 1,192,569 54 SAUL CENTERS, INC. 2012 ANNUAL REPORT 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. BUSINESS SEGMENTS (CONTINUED) Shopping Mixed-Use Corporate Consolidated (In thousands) Centers Properties and Other Totals As of or for the year ended December 31, 2010 Real estate rental operations: Revenue $ 125,015 $ 38,060 $ 33 $ 163,108 Expenses (29,923) (12,052) – (41,975) Income from real estate 95,092 26,008 33 121,133 Interest expense and amortization of deferred debt costs – – (34,799) (34,799) General and administrative – – (13,968) (13,968) Subtotal 95,092 26,008 (48,734) 72,366 Depreciation and amortization of deferred leasing costs (20,491) (7,888) – (28,379) Loss on early extinguishment of debt – – (5,405) (5,405) Acquisition related costs (1,179) – – (1,179) Gain on casualty settlement 2,475 – – 2,475 Loss from operations of property sold (284) – – (284) Gain on property sale 3,591 – – 3,591 Net income $ 79,204 $ 18,120 $ (54,139) $ 43,185 Capital investment $ 29,253 $ 68,986 $ – $ 98,239 Total assets $ 704,624 $ 294,791 $ 14,473 $1,013,888 17. SUBSEQUENT EVENTS On January 31, 2013, the Company issued a notice to redeem 60% of the depositary shares related to the 8% Series A Cumu- lative Redeemable Preferred Stock at a price of $25.00 per de- positary share, plus accrued dividends. The depositary shares were redeemed pro-rata on March 2, 2013. On February 12, 2013, the Company sold, in an underwritten public offering, 5.6 million depositary shares, each representing 1/100th of a share of 6.875% Series C Cumulative Redeemable Preferred Stock, providing net cash proceeds of approximately $134.8 million. The depositary shares may be redeemed at the Company’s option, in whole or in part, at the $25.00 liquidation preference plus accrued but unpaid dividends on or after Febru- ary 12, 2018. The depositary shares pay an annual dividend of $1.71875 per share, equivalent to 6.875% of the $25.00 liqui- dation preference. The first dividend is scheduled to be paid on April 15, 2013 and covers the period from February 12, 2013 through March 31, 2013. The Series C preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not convertible into any other securities of the Company except in connection with certain changes of control or delisting events. Investors in the depositary shares generally have no voting rights, but will have limited voting rights if the Company fails to pay dividends for six or more quarters (whether or not declared or consecutive) and in certain other events. On February 12, 2013, the Company issued a notice to redeem all of the outstanding depositary shares related to the 9% Series B Cumulative Redeemable Preferred Stock at a price of $25.00 per depositary share, plus accrued dividends. The redemption date is March 15, 2013. On February 27, 2013, the Company closed on a three-year $15.6 million mortgage loan secured by Metro Pike Center. The loan matures in 2016, bears interest at a variable rate equal to the sum of one-month LIBOR and 165 basis points, requires monthly principal and interest payments based on a 25-year amortization schedule and a final payment of $14.7 million at maturity. The loan may be extended for up to two-years. Pro- ceeds were used to pay-off the $15.9 million remaining balance of existing debt secured by Metro Pike Center, and to extinguish the related swap agreement, which were scheduled to mature in June 2013. On February 27, 2013, the Company closed on a three-year $15.0 million mortgage loan secured by Northrock. The loan matures in 2016, bears interest at a variable rate equal to the sum of one-month LIBOR and 165 basis points, requires monthly principal and interest payments based on a 25-year amortization schedule and a final payment of $14.2 million at maturity. The loan may be extended for up to two years. Proceeds were used to pay-off the $15.0 million remaining balance of existing debt secured by Northrock, which was scheduled to mature in May 2013. The Company recently completed negotiation of lease termina- tion agreements with the tenants of Van Ness Square and ex- pects the building will be vacant on or about April 30, 2013. Costs incurred related to those termination arrangements are being amortized to expense using the straight-line method over the remaining terms of the leases. In addition, the remaining lives of (a) straight line rent recognition and (b) the building, have been adjusted to end on April 30, 2013. 56 SAUL CENTERS, INC. 2012 ANNUAL REPORT 57 DIVIDEND REINVESTMENT PLAN AND DISTRIBUTIONS MARKET INFORMATION DIVIDEND REINVESTMENT PLAN Saul Centers, Inc. offers a dividend reinvestment plan which enables its shareholders to automatically invest some of or all div- idends in additional shares. The plan provides shareholders with a convenient and cost-free way to increase their investment in Saul Centers. Shares purchased under the dividend reinvestment plan are issued at a 3% discount from the average price of the stock on the dividend payment date. The Plan’s prospectus is available for review in the Shareholders Information section of the Company’s web site. To receive more information please call the plan administrator at (800) 509-5586 and request to speak with a service representa- tive or write: Continental Stock Transfer and Trust Company Attention: Saul Centers, Inc. Dividend Reinvestment Plan 17 Battery Place New York, NY 10004 DIVIDENDS AND DISTRIBUTIONS Under the Code, REITs are subject to numerous organizational and operating requirements, including the requirement to dis- tribute at least 90% of REIT taxable income. The Company dis- tributed amounts greater than the required amount in 2012 and 2011. Distributions by the Company to common stockholders and holders of limited partnership units in the Operating Part- nership were $38.1 million and $35.4 million in 2012 and 2011, respectively. Distributions to preferred stockholders were $15.1 million in both 2012 and 2011. See Notes to Consolidated Finan- cial Statements, No. 14, “Distributions.” The Company may or may not elect to distribute in excess of 90% of REIT taxable income in future years. The Company’s estimate of cash flow available for distributions is believed to be based on reasonable assumptions and represents a reasonable basis for setting distributions. However, the actual results of operations of the Company will be affected by a variety of factors, including but not limited to actual rental revenue, op- erating expenses of the Company, interest expense, general eco- nomic conditions, federal, state and local taxes (if any), unanticipated capital expenditures, the adequacy of reserves and preferred dividends. While the Company intends to continue pay- ing regular quarterly distributions, any future payments will be determined solely by the Board of Directors and will depend on a number of factors, including cash flow of the Company, its fi- nancial condition and capital requirements, the annual distribu- tion amounts required to maintain its status as a REIT under the Code, and such other factors as the Board of Directors deems relevant. We are obligated to pay regular quarterly distributions to holders of depositary shares of Series A preferred stock, 60% of which was redeemed on March 2, 2013, at the rate of $2.00 per annum per depositary share, to holders of depositary shares of Series B preferred stock at the rate of $2.25 per annum per depositary share through its March 15, 2013 redemption, and to holders of depositary shares of Series C preferred stock at the rate of $1.71875 per annum per depositary share beginning Feb- ruary 12, 2013, prior to distributions on the common stock. The Company paid four quarterly distributions totaling $1.44 per common share during each of the years in the three-year period ended December 31, 2012. The annual distribution amounts paid by the Company exceed the distribution amounts required for tax purposes. Distributions to the extent of our current and ac- cumulated earnings and profits for federal income tax purposes generally will be taxable to a stockholder as ordinary dividend in- come. Distributions in excess of current and accumulated earn- ings and profits will be treated as a nontaxable reduction of the stockholder’s basis in such stockholder’s shares, to the extent thereof, and thereafter as taxable gain. Distributions that are treated as a reduction of the stockholder’s basis in its shares will have the effect of deferring taxation until the sale of the stock- holder’s shares. Of the $1.44 per common share dividend paid in 2012, 66% was treated as a taxable dividend and 34% was treated as a return of capital. Of the $1.44 per common share dividend paid in 2011, 50% was treated as a taxable dividend income and 50% was treated as a return of capital. Of the $1.44 per common share dividend paid in 2010, 70.0% was taxable dividend income and 30.0% was considered return of capital. No assurance can be given regarding what portion, if any, of dis- tributions in 2013 or subsequent years will constitute a return of capital for federal income tax purposes. All of the preferred stock dividends paid are treated as ordinary dividend income. Shares of Saul Centers common stock are listed on the New York Stock Exchange under the symbol “BFS”. The composite high and low closing sale prices for the shares of common stock were reported by the New York Stock Exchange for each quarter of 2012 and 2011 as follows: COMMON STOCK PRICES Period Share Price High Low October 1, 2012 – December 31, 2012 $45.34 $40.81 July 1, 2012 – September 30, 2012 $45.83 $40.59 April 1, 2012 – June 30, 2012 $43.32 $39.01 January 1, 2012 – March 31, 2012 $40.62 $33.44 October 1, 2011 – December 31, 2011 $36.66 $32.26 July 1, 2011 – September 30, 2011 $41.72 $31.54 April 1, 2011 – June 30, 2011 $44.29 $37.16 January 1, 2011 – March 31, 2011 $48.40 $42.30 On March 1, 2013, the closing price was $44.34 per share. The approximate number of holders of record of the common stock was 220 as of March 1, 2013. PERFORMANCE GRAPH Rules promulgated under the Exchange Act require the Company to present a graph comparing the cumulative total stockholder return on its Common Stock with the cumulative total stockholder return of (i) a broad equity market index, and (ii) a published industry index or peer group. The following graph compares the cumulative total stockholder return of the Company’s common stock, based on the market price of the common stock and assuming reinvestment of dividends, with the National Association of Real Estate Investment Trust Equity Index (“NAREIT Equity”), the S&P 500 Index (“S&P 500”) and the Russell 2000 Index (“Russell 2000”). The graph assumes the investment of $100 on January 1, 2008. COMPARISON OF CUMULATIVE TOTAL RETURN $130 $120 $110 $100 $90 $80 $70 $60 58 SAUL CENTERS, INC. 2012 ANNUAL REPORT 59 Jan. 1, 2008 Dec. 31, 2008 Dec. 31, 2009 Dec. 31, 2010 Dec. 31, 2011 Dec. 31, 2012 Jan. 1, 2008 Dec. 31, 2008 Dec. 31, 2009 Dec. 31, 2010 Dec. 31, 2011 Dec. 31, 2012 Saul Centers S&P 500 Russell 2000 NAREIT Equity $100 $100 $100 $100 $77 $63 $66 $62 $67 $80 $84 $80 $101 $92 $107 $102 $78 $94 $102 $110 $98 $109 $119 $130 SAUL CENTERS CORPORATE INFORMATION DIRECTORS B. Francis Saul II Chairman and Chief Executive Officer EXECUTIVE OFFICERS B. Francis Saul II Chairman and Chief Executive Officer Thomas H. McCormick President and Chief Operating Officer Thomas H. McCormick President and Chief Operating Officer J. Page Lansdale Executive Vice President, Real Estate Scott V. Schneider Senior Vice President, Chief Financial Officer, Treasurer and Secretary Debra Stencel Senior Vice President and General Counsel Joel A. Friedman Senior Vice President, Chief Accounting Officer Christopher H. Netter Senior Vice President, Leasing John F. Collich Senior Vice President, Acquisitions and Development Charles W. Sherren, Jr. Senior Vice President, Management COUNSEL Pillsbury Winthrop Shaw Pittman LLP Washington, DC 20037 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Ernst and Young LLP McLean, Virginia 22102 Philip D. Caraci Vice Chairman The Honorable John E. Chapoton Partner, Brown Investment Advisory George P. Clancy, Jr. Executive Vice President, Emeritus Chevy Chase Bank Gilbert M. Grosvenor Chairman Emeritus of the Board of Trustees, National Geographic Society Philip C. Jackson, Jr. Adjunct Professor Emeritus, Birmingham-Southern College General Paul X. Kelley 28th Commandant of the Marine Corps Charles R. Longsworth Chairman Emeritus, Colonial Williamsburg Foundation Patrick F. Noonan Chairman Emeritus, The Conservation Fund H. Gregory Platts Senior Vice President and Treasurer, Emeritus, National Geographic Society Mark Sullivan III Financial and Legal Consultant The Honorable James W. Symington Of Counsel, O’Connor and Hannan, Attorneys at Law John R. Whitmore Financial Consultant 60 SAUL CENTERS, INC. WEB SITE www.saulcenters.com EXCHANGE LISTING New York Stock Exchange (NYSE) Symbol: Common Stock: BFS Preferred Stock: BFS.PrA BFS.PrC TRANSFER AGENT Continental Stock Transfer and Trust Company 17 Battery Place New York, NY 10004 (800) 509-5586 INVESTOR RELATIONS A copy of the Saul Centers, Inc. annual report to the Securities and Exchange Commission on Form 10-K, which includes as exhibits the Chief Executive Officer and Chief Financial Officer Certifications required by Section 302 of the Sarbanes-Oxley Act, may be printed from the Company’s web site or obtained at no cost to stockholders by writing to the address below or calling (301) 986-6016. In 2012, the Company filed with the NYSE the Certification of its Chief Executive Officer confirming that he was not aware of any violation by the Company of the NYSE’s corporate governance listing standards. HEADQUARTERS 7501 Wisconsin Ave. Suite 1500E Bethesda, MD 20814-6522 Phone: (301) 986-6200 Annual Meeting of Shareholders The Annual Meeting of Shareholders will be held at 11:00 a.m., local time, on May 10, 2013, at the Hyatt Regency Bethesda, One Bethesda Metro Center, Bethesda, MD (at the southwest corner of the Wisconsin Avenue and Old Georgetown Road intersection, adjacent to the Bethesda Metro Stop on the Metro Red Line.) 7501 Wisconsin Avenue, Suite 1500E Bethesda, MD 20814-6522 Phone: (301) 986-6200 Website: www.saulcenters.com 

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