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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For The Quarterly Period Ended June 30, 2018
Commission File Number 1-12254
 
SAUL CENTERS, INC.
(Exact name of registrant as specified in its charter)
Maryland
52-1833074
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
7501 Wisconsin Avenue, Bethesda, Maryland 20814
(Address of principal executive office) (Zip Code)
Registrant’s telephone number, including area code (301) 986-6200
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days.    YES   x    NO  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES   x    NO   o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
x
Accelerated filer
 
o
 
 
 
 
Non-accelerated filer
 
o
(Do not check if a smaller reporting company)
 
 
 
 
 
 
 
 
 
 
 
Smaller reporting company
 
o
 
 
 
 
 
 
 
 
 
Emerging growth company
 
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     YES  o    NO  x
Number of shares of common stock, par value $0.01 per share outstanding as of July 31, 2018: 22.5 million.
 

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Table of Contents

SAUL CENTERS, INC.
Table of Contents
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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Table of Contents

PART I. FINANCIAL INFORMATION
Item 1.    Financial Statements


CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
(Dollars in thousands, except per share amounts)
June 30,
2018
 
December 31,
2017
Assets
 
 
 
Real estate investments
 
 
 
Land
$
450,256

 
$
450,256

Buildings and equipment
1,263,865

 
1,261,830

Construction in progress
139,285

 
91,114

 
1,853,406

 
1,803,200

Accumulated depreciation
(507,084
)
 
(488,166
)
 
1,346,322

 
1,315,034

Cash and cash equivalents
6,425

 
10,908

Accounts receivable and accrued income, net
50,634

 
54,057

Deferred leasing costs, net
27,139

 
27,255

Prepaid expenses, net
1,669

 
5,248

Other assets
14,293

 
9,950

Total assets
$
1,446,482

 
$
1,422,452

Liabilities
 
 
 
Notes payable
$
869,272

 
$
897,888

Revolving credit facility payable
23,065

 
60,734

Term loan facility payable
74,543

 

Dividends and distributions payable
18,599

 
18,520

Accounts payable, accrued expenses and other liabilities
29,078

 
23,123

Deferred income
25,594

 
29,084

Total liabilities
1,040,151

 
1,029,349

Equity
 
 
 
Preferred stock, 1,000,000 shares authorized:
 
 
 
Series C Cumulative Redeemable, 42,000 and 72,000 shares issued and outstanding, respectively
105,000

 
180,000

Series D Cumulative Redeemable, 30,000 and 0 shares issued and outstanding, respectively
75,000

 

Common stock, $0.01 par value, 40,000,000 shares authorized, 22,288,815 and 22,123,128 shares issued and outstanding, respectively
223

 
221

Additional paid-in capital
361,413

 
352,590

Distributions in excess of accumulated earnings
(204,404
)
 
(197,710
)
Accumulated other comprehensive loss
(285
)
 
(696
)
Total Saul Centers, Inc. equity
336,947

 
334,405

Noncontrolling interest
69,384

 
58,698

Total equity
406,331

 
393,103

Total liabilities and equity
$
1,446,482

 
$
1,422,452

The Notes to Financial Statements are an integral part of these statements.

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Table of Contents
Saul Centers, Inc.

CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
(Dollars in thousands, except per share amounts)
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Property revenue
 
 
 
 
 
 
 
Base rent
$
45,943

 
$
45,575

 
$
91,810

 
$
90,051

Expense recoveries
8,601

 
8,337

 
17,373

 
16,931

Percentage rent
249

 
519

 
667

 
901

Other
1,431

 
1,466

 
2,769

 
6,467

Total property revenue
56,224

 
55,897

 
112,619

 
114,350

Property expenses
 
 
 
 
 
 
 
Property operating expenses
6,732

 
6,473

 
13,856

 
13,125

Provision for credit losses
143

 
207

 
429

 
550

Real estate taxes
6,778

 
6,700

 
13,622

 
13,290

Total property expenses
13,653

 
13,380

 
27,907

 
26,965

Property operating income
42,571

 
42,517

 
84,712

 
87,385

 
 
 
 
 
 
 
 
Other revenue
69

 
10

 
170

 
23

Other expenses
 
 
 
 
 
 
 
Interest expense and amortization of deferred debt costs
11,237

 
11,900

 
22,764

 
23,764

Depreciation and amortization of deferred leasing costs
11,351

 
11,691

 
22,700

 
23,033

General and administrative
4,647

 
4,514

 
9,068

 
8,815

Total other expenses
27,235

 
28,105

 
54,532

 
55,612

Operating income
15,405

 
14,422

 
30,350

 
31,796

Change in fair value of derivatives
(12
)
 
(1
)
 
(12
)
 
(1
)
Gain on sale of property
509

 

 
509

 

Net Income
15,902

 
14,421

 
30,847

 
31,795

Noncontrolling interests
 
 
 
 
 
 
 
Income attributable to noncontrolling interests
(3,359
)
 
(2,911
)
 
(5,718
)
 
(6,581
)
Net income attributable to Saul Centers, Inc.
12,543

 
11,510

 
25,129

 
25,214

Extinguishment of issuance costs upon redemption of preferred shares

 

 
(2,328
)
 

Preferred stock dividends
(2,953
)
 
(3,094
)
 
(6,356
)
 
(6,188
)
Net income available to common stockholders
$
9,590

 
$
8,416

 
$
16,445

 
$
19,026

Per share net income available to common stockholders
 
 
 
 
 
 
 
Basic and diluted
$
0.43

 
$
0.38

 
$
0.74

 
$
0.87

Dividends declared per common share outstanding
$
0.52

 
$
0.51

 
$
1.04

 
$
1.02

The Notes to Financial Statements are an integral part of these statements.

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Table of Contents
Saul Centers, Inc.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(Dollars in thousands)
2018
 
2017
 
2018
 
2017
Net income
$
15,902

 
$
14,421

 
$
30,847

 
$
31,795

Other comprehensive income
 
 
 
 
 
 
 
Change in unrealized loss on cash flow hedge
165

 
55

 
554

 
332

Total comprehensive income
16,067

 
14,476

 
31,401

 
32,127

Comprehensive income attributable to noncontrolling interests
(3,402
)
 
(2,925
)
 
(5,861
)
 
(6,666
)
Total comprehensive income attributable to Saul Centers, Inc.
12,665

 
11,551

 
25,540

 
25,461

Extinguishment of issuance costs upon redemption of preferred shares


 

 
(2,328
)
 

Preferred stock dividends
(2,953
)
 
(3,094
)
 
(6,356
)
 
(6,188
)
Total comprehensive income available to common stockholders
$
9,712

 
$
8,457

 
$
16,856

 
$
19,273

The Notes to Financial Statements are an integral part of these statements.

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Table of Contents
Saul Centers, Inc.

CONSOLIDATED STATEMENT OF EQUITY
(Unaudited) 
(Dollars in thousands, except per share amounts)
Preferred
Stock
 
Common
Stock
 
Additional Paid-in
Capital
 
Distributions in Excess of Accumulated Earnings
 
Accumulated
Other Comprehensive
(Loss)
 
Total Saul
Centers, Inc.
 
Noncontrolling
Interest
 
Total
Balance, December 31, 2017
$
180,000

 
$
221

 
$
352,590

 
$
(197,710
)
 
$
(696
)
 
$
334,405

 
$
58,698

 
$
393,103

Issuance of 30,000 shares of Series D Cumulative preferred stock
75,000

 

 
(2,631
)
 

 

 
72,369

 

 
72,369

Redemption of 30,000 shares of Series C Cumulative preferred stock
(75,000
)
 

 
2,311

 
(2,328
)
 

 
(75,017
)
 

 
(75,017
)
Issuance of common stock:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
154,952 shares pursuant to dividend reinvestment plan

 
2

 
7,726

 

 

 
7,728

 

 
7,728

10,735 shares due to exercise of employee stock options, director share grant and issuance of directors’ deferred shares

 

 
1,417

 

 

 
1,417

 

 
1,417

Issuance of 257,139 partnership units

 

 

 

 

 

 
12,822

 
12,822

Net income

 

 

 
25,129

 

 
25,129

 
5,718

 
30,847

Change in unrealized loss on cash flow hedge

 

 

 

 
411

 
411

 
143

 
554

Preferred stock distributions:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Series C

 

 

 
(2,535
)
 

 
(2,535
)
 

 
(2,535
)
Series D

 

 

 
(868
)
 

 
(868
)
 

 
(868
)
Common stock distributions

 

 

 
(11,545
)
 

 
(11,545
)
 
(3,942
)
 
(15,487
)
Distributions payable on Series C preferred stock ($42.97/share)

 

 

 
(1,805
)
 

 
(1,805
)
 

 
(1,805
)
Distributions payable on Series D preferred stock ($38.28/share)

 

 

 
(1,148
)
 

 
(1,148
)
 

 
(1,148
)
Distributions payable common stock ($0.52/share) and distributions payable partnership units ($0.52/unit)

 

 

 
(11,594
)
 

 
(11,594
)
 
(4,055
)
 
(15,649
)
Balance, June 30, 2018
$
180,000

 
$
223

 
$
361,413

 
$
(204,404
)
 
$
(285
)
 
$
336,947

 
$
69,384

 
$
406,331

The Notes to Financial Statements are an integral part of these statements.

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Table of Contents
Saul Centers, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Six months ended June 30,
(Dollars in thousands)
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
30,847

 
$
31,795

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Change in fair value of derivatives
12

 
1

Gain on sale of property
(509
)
 

Depreciation and amortization of deferred leasing costs
22,700

 
23,033

Amortization of deferred debt costs
847

 
692

Compensation costs of stock grants and options
1,097

 
1,013

Provision for credit losses
429

 
550

Decrease in accounts receivable and accrued income
2,994

 
1,889

Additions to deferred leasing costs
(2,790
)
 
(2,821
)
Decrease in prepaid expenses
3,579

 
3,333

Increase in other assets
(4,536
)
 
(3,662
)
Increase in accounts payable, accrued expenses and other liabilities
2,511

 
3,570

Decrease in deferred income
(3,490
)
 
(1,693
)
Net cash provided by operating activities
53,691

 
57,700

Cash flows from investing activities:
 
 
 
Acquisitions of real estate investments (1)
(162
)
 
(79,499
)
Additions to real estate investments
(2,911
)
 
(7,280
)
Additions to development and redevelopment projects
(35,246
)
 
(7,731
)
Repayment of note receivable
1,326

 

Net cash used in investing activities
(36,993
)
 
(94,510
)
Cash flows from financing activities:
 
 
 
Proceeds from notes payable

 
40,000

Repayments on notes payable
(29,001
)
 
(13,391
)
Proceeds from term loan facility
75,000

 

Proceeds from revolving credit facility
50,000

 
47,000

Repayments on revolving credit facility
(86,000
)
 
(12,000
)
Proceeds from construction loan

 
1,358

Additions to deferred debt costs
(3,212
)
 
(285
)
Proceeds from the issuance of:
 
 
 
Common stock
8,048

 
9,313

Partnership units (1)
4,046

 
4,866

Series D preferred stock
72,369

 

Series C preferred stock redemption payment
(75,000
)
 

Preferred stock redemption costs
(13
)
 

Distributions to:
 
 
 
Series C preferred stockholders
(5,628
)
 
(6,188
)
Series D preferred stockholders
(868
)
 

Common stockholders
(23,058
)
 
(22,191
)
Noncontrolling interests
(7,864
)
 
(7,599
)
Net cash provided by (used in) financing activities
(21,181
)
 
40,883

Net increase (decrease) in cash and cash equivalents
(4,483
)
 
4,073

Cash and cash equivalents, beginning of period
10,908

 
8,322

Cash and cash equivalents, end of period
$
6,425

 
$
12,395

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
22,145

 
$
22,917

Increase in accrued real estate investments and development costs
$
3,987

 
$
975


(1) The 2018 acquisition of real estate and proceeds from the issuance of partnership units each excludes $8,776 in connection with the acquisition of Ashbrook Marketplace in exchange for limited partnership units.

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


 
1.
Organization, Formation and Structure
Saul Centers, Inc. (“Saul Centers”) was incorporated under the Maryland General Corporation Law on June 10, 1993, and 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 requirements. 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 limited 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.
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 “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 partnerships (the “Subsidiary Partnerships,” and, collectively with the Operating Partnership, the “Partnerships”), shopping center and mixed-use properties and the management functions related to the transferred properties. Since its formation, the Company has developed and purchased additional properties.
The following table lists the significant properties acquired, in development and disposed since December 31, 2016.
Name of Property
Location
 
Type
 
Year of Acquisition/ Development/Disposition
Acquisitions
 
 
 
 
 
Burtonsville Town Square
Burtonsville, MD
 
Shopping Center
 
2017
Developments
 
 
 
 
 
750 N. Glebe Road
Arlington, VA
 
Mixed-Use
 
2017 - 2018
Ashbrook Marketplace
Loudoun County, VA
 
Shopping Center
 
2018
Dispositions
 
 
 
 
 
Great Eastern
District Heights, MD
 
Shopping Center
 
2017
As of June 30, 2018, the Company’s properties (the “Current Portfolio Properties”) consisted of 49 shopping center properties (the “Shopping Centers”), six mixed-use properties, which are comprised of office, retail and multi-family residential uses (the “Mixed-Use Properties”) and four (non-operating) development properties.
 
2.
Summary of Significant Accounting Policies
Nature of Operations
The Company, which conducts all of its activities through its subsidiaries, the Operating Partnership and Subsidiary Partnerships, engages in the ownership, operation, management, leasing, acquisition, renovation, expansion, development and financing of community and neighborhood shopping centers and mixed-use properties, primarily in the Washington, DC/Baltimore metropolitan area.
Because the properties are located primarily in the Washington, DC/Baltimore metropolitan area, the Company is subject to a concentration of credit risk related to these properties. A majority of the Shopping Centers are anchored by one or more major tenants. As of June 30, 2018, 32 of the Shopping Centers were anchored by a grocery store and offer primarily day-to-day necessities and services. Two tenants individually accounted for 2.5% or more of the Company’s total revenue for the six months ended June 30, 2018. Giant Food, a tenant at ten Shopping Centers, and Capital One, a tenant at 18 properties, individually accounted for 4.8% and 2.7%, respectively, of the Company's total revenue for the six months ended June 30, 2018.

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


Principles of Consolidation
The accompanying consolidated financial statements of the Company include the accounts of Saul Centers and its subsidiaries, including the Operating Partnership and Subsidiary Partnerships, which are majority owned by Saul Centers. Substantially all assets and liabilities of the Company as of June 30, 2018 and December 31, 2017, are comprised of the assets and liabilities of the Operating Partnership. The debt arrangements which are subject to recourse are described in Note 5. All significant intercompany balances and transactions have been eliminated in consolidation.
The Operating Partnership is a variable interest entity ("VIE") because the limited partners do not have substantive kick-out or participating rights. The Company is the primary beneficiary of the Operating Partnership because it has the power to direct its activities and the rights to absorb 73.9% of its net income. Because the Operating Partnership was previously consolidated into the financial statements of the Company, classification of it as a VIE had no impact on the consolidated financial statements of the Company.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments necessary for the fair presentation of the financial position and results of operations of Saul Centers, Inc. for the interim periods have been included. All such adjustments are of a normal recurring nature. These consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements of Saul Centers, Inc. for the year ended December 31, 2017, which are included in its Annual Report on Form 10-K. The results of operations for interim periods are not necessarily indicative of results to be expected for the year.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions 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.
Accounts Receivable, Accrued Income and Allowance for Doubtful Accounts
Accounts receivable primarily represent amounts currently due from tenants in accordance with the terms of their respective leases. 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. Accounts receivable in the accompanying financial statements are shown net of an allowance for doubtful accounts of approximately $0.5 million and $0.4 million at June 30, 2018 and December 31, 2017, respectively.
In addition to rents due currently, accounts receivable includes approximately $43.8 million and $44.1 million, at June 30, 2018 and December 31, 2017, respectively, net of allowance for doubtful accounts totaling $0.2 million and $0.2 million, respectively, representing minimum rental income accrued on a straight-line basis to be paid by tenants over the remaining term of their respective leases.
Assets Held for Sale
The Company considers properties to be assets held for sale when all of the following criteria are met:
management commits to a plan to sell a property;
it is unlikely that the disposal plan will be significantly modified or discontinued;
the property is available for immediate sale in its present condition;
actions required to complete the sale of the property have been initiated;
sale of the property is probable and the Company expects the completed sale will occur within one year; and
the property is actively being marketed for sale at a price that is reasonable given its current market value.
The Company must make a determination as to the point in time that it is probable that a sale will be consummated, which generally occurs when an executed sales contract has no contingencies and the prospective buyer has significant funds at risk to ensure performance. Upon designation as an asset held for sale, the Company records the carrying value of each property at the lower of its carrying value or its estimated fair value, less estimated costs to sell, and ceases depreciation. As of June 30, 2018, the Company had no assets designated as held-for-sale.

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


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 convertible to cash.
Construction In Progress
Construction in progress includes land, preconstruction and development costs of active projects. Preconstruction costs include legal, zoning and permitting costs and other project carrying costs incurred prior to the commencement of construction. Development costs include direct construction costs and indirect costs incurred subsequent to the start of construction such as architectural, engineering, construction management and carrying costs consisting of interest, real estate taxes and insurance. Construction in progress as of June 30, 2018 and December 31, 2017, is composed of the following:
(in thousands)
 
June 30, 2018
 
December 31, 2017
Glebe Road
 
$
117,156

 
$
83,462

Ashbrook Marketplace
 
9,519

 

Other
 
12,610

 
7,652

Total
 
$
139,285

 
$
91,114

Deferred Debt Costs
Deferred debt costs consist of fees and costs incurred to obtain long-term financing, construction financing and the credit facility. These fees and costs are being amortized on a straight-line basis over the terms of the respective loans or agreements, which approximates the effective interest method. Deferred debt costs totaled $8.6 million and $6.9 million, net of accumulated amortization of $7.1 million and $8.2 million, at June 30, 2018 and December 31, 2017, respectively, and are reflected as a reduction of the related debt in the Consolidated Balance Sheets. At June 30, 2018, deferred debt costs totaling $1.7 million, related to the Glebe Road construction loan, which has no outstanding balance, are included in Other Assets in the Consolidated Balance Sheet.
Deferred Income
Deferred income consists of payments received from tenants prior to the time they are earned and recognized by the Company 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 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.
Deferred Leasing Costs
Deferred leasing costs consist of commissions paid to third-party leasing agents, internal costs such as employee compensation and payroll-related fringe benefits directly related to time spent performing leasing-related activities for successful commercial leases, amounts attributed to in-place leases associated with acquired properties and lease inducement costs. Leasing related activities include evaluating the prospective tenant’s financial condition, evaluating and recording guarantees, collateral and other security arrangements, negotiating lease terms, preparing lease documents and closing the transaction. Unamortized deferred leasing 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 acquired leases. Collectively, deferred leasing costs totaled $27.1 million and $27.3 million, net of accumulated amortization of $35.0 million and $35.3 million, as of June 30, 2018 and December 31, 2017, respectively. Amortization expense, included in depreciation and amortization of deferred leasing costs in the consolidated statements of operations, totaled $2.9 million and $2.8 million for the six months ended June 30, 2018 and 2017, respectively.
Derivative Financial Instruments
The Company may, when appropriate, employ derivative instruments, 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 purposes. Derivative financial instruments are carried at fair value as either assets or liabilities in the Consolidated Balance Sheets. For those derivative instruments that qualify and are designated as hedging instruments, the Company designates the hedging instrument, based upon the exposure being hedged, as a fair value hedge or a cash flow hedge. For those derivative instruments that qualify and are designated as hedging instruments, the effective portion of the gain or loss on the hedge

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


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 period 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 qualify, or that qualify and are not designated, as hedging instruments, changes in fair value are immediately recognized in earnings.
Derivative financial instruments expose us to credit risk in the event of non-performance by the counterparties under the terms of the derivative instrument. The Company minimizes its credit risk on these transactions by dealing with major, creditworthy financial institutions as determined by management, and therefore, it believes that the likelihood of realizing losses from counterparty non-performance is remote.
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, provided that distributions to its stockholders equal or exceed its REIT taxable income and it complies with certain other requirements. Therefore, no provision has been made for federal income taxes in the accompanying consolidated financial statements.
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 cannot be predicted with certainty, the Company believes the final outcome of such matters will not have a material adverse effect on its financial position or results of operations. Upon determination that a loss is probable to occur and can be reasonably estimated, the estimated amount of the loss is recorded in the financial statements. Both the amount of the loss and the point at which its occurrence is considered probable can be difficult to determine.

Postemployment Benefits
From time to time, the Company may enter into an arrangement with an employee at the time of the employee’s separation from service whereby the employee will receive certain payments in exchange for certain releases, covenants not to compete, or other promises. If no future services are required in order for the employee to receive the payments, the Company estimates the amount of payments to be made over the life of the arrangement and records that amount as an expense as of the date of the arrangement with a corresponding liability representing the amount to be paid in the future.
Predevelopment Expenses
Predevelopment expenses represent certain costs incurred by the Company in connection with active development and redevelopment projects and include, for example, costs related to the early termination of tenant leases and demolition of existing structures.
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 relative 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 expected to be generated by the property including an initial lease up period. From time to time the Company may purchase a property for future development purposes. 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, renewal periods, and the likelihood of the tenant exercising its renewal options. The fair value of below market lease intangibles is recorded as deferred income and accreted as additional 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 amortized as a reduction of 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 associated with the lease-up period. Intangible assets associated with at-market in-place leases are amortized as additional expense over the remaining contractual lease term. To the extent customer relationship intangibles are present in an acquisition, the fair values of the

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


intangibles are amortized over the lives of the customer relationships. The Company has never recorded a customer relationship intangible asset. Effective with the adoption of ASU 2017-01 in January 2017, acquisition-related transaction costs are generally capitalized to the basis of the acquired asset.
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 indicators are present, the Company compares 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 equivalent to an amount required to adjust the carrying amount to its then estimated fair value. The 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 recognize an impairment loss on any of its real estate during the six months ended June 30, 2018 and 2017.
Interest, real estate taxes, development-related salary costs and other carrying costs are capitalized on projects under development and construction. Upon substantial completion of construction and the placement of the assets into service, 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 current operations and capitalization of interest ceases. Property operating expenses are charged to operations as incurred. Interest capitalized totaled $2.6 million and $1.6 million for the six months ended June 30, 2018 and 2017, respectively. Commercial development projects are considered substantially complete and available for occupancy upon completion of tenant improvements, but no later than one year from the cessation of major construction activity. Multi-family 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 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. Leasehold improvement expenditures are capitalized when certain criteria are met, including when the Company supervises construction 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 improvements, using the straight-line method. Depreciation expense in the Consolidated Statements of Operations totaled $19.8 million and $20.2 million for the six months ended June 30, 2018 and 2017, respectively. Repairs and maintenance expense totaled $5.9 million and $5.3 million for the six months ended June 30, 2018 and 2017, respectively, and is included in property operating expenses in the Consolidated Statements of Operations.
Revenue Recognition
Rental and interest income are accrued as earned. Recognition of rental income commences when control of the space has been given to the tenant. When rental payments due under leases vary from a straight-line basis because of free rent periods or scheduled rent increases, income is recognized on a straight-line basis. Expense recoveries represent a portion of property operating expenses billed to tenants, including common area maintenance, real estate taxes and other recoverable costs, and are recognized in the period 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 breakpoint specified in the lease agreement.
Stock-based Employee Compensation, Stock Plan and Deferred Compensation 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) corresponding 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 Company’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 expense in general and administrative expenses.

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


The Company has a stock plan, which was originally approved in 2004, amended in 2008 and 2013 and which expires in 2023, for the purpose of attracting and retaining executive officers, directors and other key personnel (the “Stock Plan”). Pursuant to the Stock Plan, the Compensation 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 separation 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 closing market price of the Company’s common stock on the first trading day of the following quarter to determine the number of shares to be credited to the director. During the six months ended June 30, 2018, 4,619 shares were credited to director's deferred fee accounts and 33,149 shares were issued. As of June 30, 2018, the director's deferred fee accounts comprise 155,288 shares.
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 Stockholders, and their issuance may not be deferred.
Noncontrolling Interests
Saul Centers is the sole general partner of the Operating Partnership, owning a 73.9% common interest as of June 30, 2018. Noncontrolling interests in the Operating Partnership is comprised of limited partnership units owned by the Saul Organization. Noncontrolling interests reflected on the accompanying consolidated balance sheets is increased for earnings attributable to limited partnership interests and distributions reinvested in additional units, and is decreased for limited partner distributions. Noncontrolling interests reflected on the consolidated statements of operations represents earnings attributable to limited partnership interests.
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 presented, the convertible limited partnership units are non-dilutive. The following table sets forth, for the indicated periods, weighted averages of the number of common shares outstanding, basic and dilutive, the effect of dilutive options and the number of options which are not dilutive because the average price of the Company's common stock was less than the exercise prices. The treasury stock method was used to measure the effect of the dilution.
 
Three months ended June 30,
 
Six months ended June 30,
(In thousands)
2018
 
2017
 
2018
 
2017
Weighted average common stock outstanding-Basic
22,260

 
21,846

 
22,219

 
21,796

Effect of dilutive options
28

 
81

 
34

 
114

Weighted average common stock outstanding-Diluted
22,288

 
21,927

 
22,253

 
21,910

Non-dilutive options
635

 

 
541

 

Years non-dilutive options were issued
2015, 2016 and 2017
 
 
 
2015, 2016 and 2017
 
 


Recently Issued Accounting Standards
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09 titled “Revenue from Contracts with Customers” and subsequently issued several related ASUs (collectively “ASU 2014-09”). ASU 2014-09 replaces most existing revenue recognition guidance and requires an entity to recognize the amount of revenue which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 is effective for annual periods beginning after December 15, 2017, and interim periods within those years and must be applied retrospectively by either restating prior periods or by recognizing the cumulative effect as of the date of first application. The Company adopted ASU 2014-09 effective January 1, 2018, using the modified retrospective approach. The adoption of ASU 2014-09 did not have an impact on the consolidated financial statements because the majority of the Company’s revenue consists of lease-related income from leasing arrangements, which is specifically excluded from ASU 2014-09. Other revenues, as a whole, are immaterial to total revenues. There was no change to previously reported amounts as a result of the adoption of ASU 2014-09.

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


In February 2016, the FASB issued ASU 2016-02, ‘‘Leases’’ (“ASU 2016-02”). ASU 2016-02 amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, interim periods within those years, and requires a modified retrospective transition approach for all leases existing at the date of initial application, with an option to use certain practical expedients for those existing leases. We are evaluating the impact that ASU 2016-02 will have on our consolidated financial statements and related disclosures.
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses" ("ASU 2016-13"). ASU 2016-13 replaces the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of information to support credit loss estimates. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those years. We are evaluating the impact that ASU 2016-13 will have on our consolidated financial statements and related disclosures. 
Reclassifications
Certain reclassifications have been made to the prior year financial statements to conform to the presentation used for the six months ended June 30, 2018.


3.
Real Estate Transactions

Acquisitions
Burtonsville Town Square
In January 2017, the Company purchased for $76.4 million, including acquisition costs, Burtonsville Town Square located in Burtonsville, Maryland. The purchase was funded by a new $40.0 million mortgage loan and the revolving credit facility.
Olney Shopping Center
In March 2017, the Company purchased for $3.1 million, including acquisition costs, the land underlying Olney Shopping Center. The land was previously leased by the Company with an annual rent of approximately $56,000. The purchase was funded by the revolving credit facility.
Ashbrook Marketplace
In May 2018, the Company acquired from the Trust, in exchange for 176,680 limited partnership units, approximately 13.7 acres of land located at the intersection of Ashburn Village Boulevard and Russell Branch Parkway in Loudoun County, Virginia. Based on the closing price of the Company's common stock, the land and the limited partnership units were recorded at a value of $8.8 million. Acquisition costs related to the transaction totaled approximately $0.2 million.
Allocation of Purchase Price of Real Estate Acquired
The Company allocates the purchase price of real estate investment properties to various components, such as land, buildings and intangibles related to in-place leases and customer relationships, based on their relative fair values or fair values. See Note 2. Summary of Significant Accounting Policies-Real Estate Investment Properties.
During 2017, the Company purchased one property, Burtonsville Town Square, at a cost of $76.4 million, including acquisition costs. Of the total acquisition cost, $28.4 million was allocated to land, $45.8 million was allocated to buildings, $2.2 million was allocated to in-place leases, $0.6 million was allocated to above-market leases, and $(0.6) million was allocated to below market rent, based on their relative fair values.
Dispositions
Great Eastern Shopping Center
In September 2017, the Company sold for $8.5 million Great Eastern Shopping Center located in District Heights, Maryland. The Company provided $1.28 million second trust financing to the buyer, which bore interest at a fixed rate of 6%. In May 2018, the buyer repaid the loan in full and the Company recognized a $0.5 million gain that was previously deferred.

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


Commitments
7316 Wisconsin Avenue
On January 12, 2018, the Company entered into an agreement to purchase for $35.5 million, plus approximately $0.7 million of acquisition costs, an office building and the underlying ground located at 7316 Wisconsin Avenue in Bethesda, Maryland and has an earnest money deposit of $3.5 million at risk. The property has mixed-use development potential of up to 325 apartment units and approximately 10,000 square feet of street level retail pursuant to the recently approved Bethesda Downtown Plan. The purchase price will be funded through the Company's revolving credit facility. The Company anticipates closing the acquisition on or before January 12, 2019.

4.
Noncontrolling Interests - Holders of Convertible Limited Partnership Units in the Operating Partnership
As of June 30, 2018, the Saul Organization holds a 26.1% limited partnership interest in the Operating Partnership represented by approximately 7.8 million convertible limited partnership units. These units are convertible into shares of Saul Centers’ common stock, at the option of the unit holder, on a one-for-one basis provided that, in accordance with the Company's Articles of Incorporation, the rights may not be exercised at any time that the Saul Organization beneficially owns, directly or indirectly, in the aggregate more than 39.9% of the value of the outstanding common stock and preferred stock of Saul Centers (the “Equity Securities”). As of June 30, 2018, approximately 922,000 units were convertible into shares of Saul Centers common stock.
The impact of the Saul Organization’s approximately 26.1% limited partnership interest in the Operating Partnership is reflected as Noncontrolling Interests in the accompanying consolidated financial statements. Fully converted partnership units and diluted weighted average common stock outstanding for the three months ended June 30, 2018 and 2017, were approximately 30.0 million and 29.4 million, respectively, and for the six months ended June 30, 2018 and 2017, were approximately 29.9 million and 29.4 million, respectively.

5.
Notes Payable, Revolving Credit Facility, Interest and Amortization of Deferred Debt Costs
The principal amount of the Company’s outstanding debt totaled approximately $975.5 million at June 30, 2018, of which approximately $875.5 million was fixed-rate debt and approximately $100.0 million was variable rate debt, including
$25.0 million outstanding under an unsecured revolving credit facility and $75.0 million outstanding under a term loan credit facility. The carrying value of the properties collateralizing the notes payable totaled approximately $969.0 million as of June 30, 2018.
On January 26, 2018, the Company replaced its credit facility. The new credit facility, which can be used for working capital, property acquisitions, development projects or letters of credit, totals $400.0 million, of which $325.0 million is a revolving credit facility and $75.0 million is a term loan. The revolving credit facility matures on January 26, 2022, which term may be extended by the Company for one additional year, subject to satisfaction of certain conditions. The term loan matures on January 26, 2023, and may not be extended. In general, loan availability under the new credit facility is primarily determined by operating income from the Company’s existing unencumbered properties. Interest accrues at a rate of LIBOR plus a spread of 135 basis points to 195 basis points under the revolving credit facility, and 130 basis points to 190 basis points under the term loan, each as determined by certain leverage tests. As of June 30, 2018, the applicable spread for borrowings is 135 basis points under the revolving credit facility and 130 basis points under the term loan. Saul Centers and certain consolidated subsidiaries of the Operating Partnership have guaranteed the payment obligations of the Operating Partnership under the new credit facility. Letters of credit may be issued under the revolving credit facility. On June 30, 2018, based on the value of the Company’s unencumbered properties, approximately $208.9 million was available under the revolving credit facility, $25.0 million was outstanding and approximately $185,000 was committed for letters of credit.
On January 18, 2017, the Company closed on a 15-year, non-recourse $40.0 million mortgage loan secured by Burtonsville Town Square. The loan matures in 2032, bears interest at a fixed rate of 3.39%, requires monthly principal and interest payments of $197,900 based on a 25-year amortization schedule and requires a final payment of $20.3 million at maturity.
On August 14, 2017, the Company closed on a $157.0 million construction-to-permanent loan, the proceeds of which will be used to partially fund the Glebe Road development project. The loan matures in 2035, bears interest at a fixed rate of 4.67%, requires interest only payments, which will be funded by the loan, until conversion to permanent. The conversion is expected in the fourth quarter of 2021, and thereafter, monthly principal and interest payments of $887,900 based on a 25-year amortization schedule will be required.

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


Effective September 1, 2017, the Company's construction-to-permanent loan secured by and used to partially finance the construction of Park Van Ness, converted to permanent financing. The loan matures in 2032, bears interest at a fixed rate of 4.88%, requires monthly principal and interest payments of $413,460 based on a 25-year amortization schedule and requires a final payment of $39.6 million at maturity.
On November 20, 2017, the Company closed on a 15-year, non-recourse $60.0 million mortgage loan secured by Washington Square. The loan matures in 2032, bears interest at a fixed rate of 3.75%, requires monthly principal and interest payments of $308,500 based on a 25-year amortization schedule and requires a final payment of $31.1 million. Proceeds were used to repay the remaining balance of $28.1 million on the existing mortgage and reduce the outstanding balance of the revolving credit facility.
Saul Centers is a guarantor of the new credit facility, of which the Operating Partnership is the borrower. The Operating Partnership is the guarantor of (a) a portion of the Park Van Ness loan (approximately $53.7 million of the $70.5 million outstanding balance at June 30, 2018), which guarantee, subject to the achievement of certain leasing and cash flow levels, may be reduced and eventually eliminated, and (b) a portion of the Kentlands Square II mortgage loan (approximately $9.2 million of the $35.9 million outstanding at June 30, 2018). All other notes payable are non-recourse.
At December 31, 2017, the principal amount of the Company’s outstanding debt totaled approximately $965.5 million, of which $890.4 million was fixed rate debt and $75.1 million was variable rate debt, including $61.0 million outstanding under an unsecured revolving credit facility. The carrying value of the properties collateralizing the notes payable totaled approximately $1.0 billion as of December 31, 2017.
At June 30, 2018, the scheduled maturities of debt, including scheduled principal amortization, for years ending December 31, were as follows:
(In thousands)
Balloon
Payments
 
Scheduled
Principal
Amortization
 
Total
July 1 through December 31, 2018
$

 
$
15,277

 
$
15,277

2019
60,793

 
29,298

 
90,091

2020
61,163

 
26,771

 
87,934

2021
11,011

 
26,486

 
37,497

2022
61,503

(a)
26,990

 
88,493

2023
84,225

 
27,290

 
111,515

Thereafter
427,308

 
117,413

 
544,721

Principal amount
$
706,003

 
$
269,525

 
975,528

Unamortized deferred debt costs
 
 
 
 
8,648

Net
 
 
 
 
$
966,880

(a) Includes $25.0 million outstanding under the revolving credit facility.
Interest expense and amortization of deferred debt costs for the three and six months ended June 30, 2018 and 2017, were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
2018
 
2017
 
2018
 
2017
Interest incurred
$
12,302

 
$
12,378

 
$
24,503

 
$
24,667

Amortization of deferred debt costs
377

 
347

 
847

 
692

Capitalized interest
(1,442
)
 
(825
)
 
(2,586
)
 
(1,595
)
 
$
11,237

 
$
11,900

 
$
22,764

 
$
23,764

 

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


6.
Equity
The consolidated statements of operations for the six months ended June 30, 2018 and 2017, reflect noncontrolling interests of $5.7 million and $6.6 million, respectively, representing income attributable to the Saul Organization for each period.
On January 23, 2018, Saul Centers sold, in an underwritten public offering, 3.0 million depositary shares, each representing 1/100th of a share of 6.125% Series D Cumulative Redeemable Preferred Stock (the "Series D Stock"), providing net cash proceeds of approximately $72.6 million. The depositary shares may be redeemed at the Company’s option, in whole or in part, on or after January 23, 2023, at the $25.00 liquidation preference, plus accrued but unpaid dividends to but not including the redemption date. The depositary shares pay an annual dividend of $1.53125 per share, equivalent to 6.125% of the $25.00 liquidation preference. The Series D 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 in 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 22, 2018, the proceeds from the offering, together with cash on hand, were used to redeem 3.0 million depositary shares, each representing 1/100th of a share of the Company’s 6.875% Series C Cumulative Redeemable Preferred Stock (the “Series C Stock”). Costs associated with the redemption were charged against Net income available to common stockholders.
At June 30, 2018, the Company had outstanding 4.2 million depositary shares, each representing 1/100th of a share of 6.875% Series C Stock. The depositary shares are redeemable at the Company’s option, in whole or in part, at the $25.00 liquidation preference plus accrued but unpaid dividends. The depositary shares pay an annual dividend of $1.71875 per share, equivalent to 6.875% of the $25.00 liquidation preference. The Series C 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.

7.
Related Party Transactions
The Chairman and Chief Executive Officer, the President, the Executive Vice President-Chief Legal and Administrative Officer and the Senior Vice President-Chief Accounting Officer of the Company are also officers of various members of the Saul Organization and their management 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 President-Chief Accounting Officer whose share of annual compensation 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 administrative expense or property operating expenses in the Consolidated Statements of Operations, at the discretionary amount of up to six percent of the employee’s cash compensation, subject to certain limits, were $176,100 and $185,500 for the six months ended June 30, 2018 and 2017, respectively. All amounts contributed by employees and the Company are fully vested.
The Company also participates in a multiemployer nonqualified deferred compensation plan with entities in the Saul Organization which covers those full-time employees who meet the requirements 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 specified amount. For the six months ended June 30, 2018 and 2017, the Company credited to employee accounts $98,600 and $94,400, respectively, which is the sum of accrued earnings and three times the amount deferred by employees and is included in general and administrative expense. All amounts contributed by employees and credited by the Company are fully vested. The cumulative unfunded liability under this plan was $2.5 million and $2.4 million, at June 30, 2018 and December 31, 2017, respectively, and is included 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 determining 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. The terms of the Agreement and the payments made thereunder are deemed reasonable by management and are reviewed annually by the Audit Committee of the Board of Directors, which consists entirely of independent directors. Billings by the Saul Organization for

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


the Company’s share of these ancillary costs and expenses for the six months ended June 30, 2018 and 2017, which included rental expense for the Company’s headquarters lease, totaled approximately $4.1 million and $3.7 million, net, respectively. The amounts are generally expensed as incurred and are primarily reported as general and administrative expenses in the Consolidated Statements of Operations. As of June 30, 2018 and December 31, 2017, accounts payable, accrued expenses and other liabilities included approximately $788,200 and $993,200, respectively, representing amounts due to the Saul Organization for the Company’s share of these ancillary costs and expenses.
The Company has entered into a shared third-party predevelopment cost agreement (the “Predevelopment Agreement”) with the Trust. The Predevelopment Agreement relates to the sharing of third-party predevelopment costs incurred in connection with the planning of the future redevelopment of certain adjacent real estate assets in the Twinbrook area of Rockville, Maryland. The costs will be shared on a pro rata basis based on the acreage owned by each entity and neither party is obligated to advance funds to the other.
In August 2016, the Company entered into an agreement to acquire from the Trust approximately 13.7 acres of land located at the intersection of Ashburn Village Boulevard and Russell Branch Parkway in Loudoun County, Virginia. The transaction closed on May 9, 2018, and the Company issued 176,680 limited partnership units to the Trust. The Company intends to construct a shopping center and, upon stabilization, may be obligated to issue additional limited partnership units to the Trust.
The Company subleases its corporate headquarters space from a member of the Saul Organization. The lease commenced in March 2002, expires in 2022, 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 Agreement requires each party to pay 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 its headquarters location was $395,400 and $379,300 for the six months ended June 30, 2018 and 2017, respectively, and is included in general and administrative expense.
The B. F. Saul Insurance Agency of Maryland, Inc., a subsidiary of the B. F. Saul Company and a member of the Saul Organization, is a general insurance agency that receives commissions and fees in connection with the Company’s insurance program. Such commissions and fees amounted to $150,500 and $85,700 for the six months ended June 30, 2018 and 2017, respectively.

8.
Stock Option Plans
In 2004, the Company has established a stock incentive plan (the "Plan"), as amended. Under the Plan, options were granted at an exercise price not less than the market value of the common stock on the date of grant and expire ten years from the date of grant. Officer options vest ratably over four years following the grant and are charged to expense using the straight-line method over the vesting period. Director options vest immediately and are charged to expense as of the date of grant. 
The following table summarizes the amount and activity of each grant with outstanding unexercised options, 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 six months ended June 30, 2018.

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


 
  
Directors
 
 
Grant date
4/24/2009
5/7/2010
5/13/2011
5/4/2012
5/10/2013
5/9/2014
5/8/2015
5/6/2016
5/5/2017
5/11/2018
Subtotals
Total grant
32,500

32,500

32,500

35,000

35,000

30,000

35,000

32,500

27,500

27,500

320,000

Vested
32,500

32,500

32,500

35,000

35,000

30,000

35,000

32,500

27,500

27,500

320,000

Exercised
27,500

25,000

22,500

22,500

22,500

17,500

12,500

7,500



157,500

Forfeited

2,500

2,500








5,000

Exercisable at June 30, 2018
5,000

5,000

7,500

12,500

12,500

12,500

22,500

25,000

27,500

27,500

157,500

Remaining unexercised
5,000

5,000

7,500

12,500

12,500

12,500

22,500

25,000

27,500

27,500

157,500

Exercise price
$
32.68

$
38.76

$
41.82

$
39.29

$
44.42

$
47.03

$
51.07

$
57.74

$
59.41

$
49.46


Volatility
0.344

0.369

0.358

0.348

0.333

0.173

0.166

0.166

0.173

0.192


Expected life (years)
6.0

5.0

5.0

5.0

5.0

5.0

5.0

5.0

5.0

5.0


Assumed yield
4.54
%
4.23
%
4.16
%
4.61
%
4.53
%
4.48
%
4.54
%
3.75
%
3.45
%
3.70
%

Risk-free rate
2.19
%
2.17
%
1.86
%
0.78
%
0.82
%
1.63
%
1.50
%
1.23
%
1.89
%
2.84
%

Total value at grant date
$
222,950

$
287,950

$
297,375

$
257,250

$
278,250

$
109,500

$
125,300

$
151,125

$
165,550

$
169,400

$
2,064,650

Expensed in previous years
222,950

287,950

297,375

257,250

278,250

109,500

125,300

151,125

165,550


1,895,250

Expensed in 2018









169,400

169,400

Future expense











 
Officers
 
 
 
 
Grant date
5/13/2011
5/4/2012
5/10/2013
5/9/2014
5/8/2015
5/6/2016
5/5/2017
5/11/2018
Subtotal
 
Grand 
Totals
Total grant
162,500

242,500

202,500

170,000

190,000

194,000

205,000

217,500

1,584,000

 
1,904,000

Vested
118,750

107,500

171,875

168,125

140,625

96,375

51,250


854,500

 
1,174,500

Exercised
103,750

91,830

116,500

41,250

20,000

3,750



377,080

 
534,580

Forfeited
43,750

135,000

30,625

1,875

3,125

1,875



216,250

 
221,250

Exercisable at June 30, 2018
15,000

15,670

55,375

126,875

120,625

92,625

51,250


477,420

 
634,920

Remaining unexercised
15,000

15,670

55,375

126,875

166,875

188,375

205,000

217,500

990,670

 
1,148,170

Exercise price
$
41.82

$
39.29

$
44.42

$
47.03

$
51.07

$
57.74

$
59.41

$
49.46

 
 
 
Volatility
0.330

0.315

0.304

0.306

0.298

0.185

0.170

0.177

 
 
 
Expected life (years)
8.0

8.0

8.0

7.0

7.0

7.0

7.0

7.0

 
 
 
Assumed yield
4.81
%
5.28
%
5.12
%
4.89
%
4.94
%
3.80
%
3.50
%
3.75
%
 
 
 
Risk-free rate
2.75
%
1.49
%
1.49
%
2.17
%
1.89
%
1.55
%
2.17
%
2.94
%
 
 
 
Gross value at grant date
$
1,366,625

$
1,518,050

$
1,401,300

$
1,349,800

$
1,584,600

$
1,136,840

$
1,324,300

$
1,313,700

$
10,995,215

 
$
13,059,865

Estimated forfeitures
367,937

845,100

211,925

14,887

141,780

86,628

91,642

83,157

1,843,056

 
1,843,056

Expensed in previous years
998,688

672,950

1,189,375

1,082,664

961,888

437,580

205,440


5,548,585

 
7,443,835

Expensed in 2018



252,249

180,354

131,274

154,080

51,272

769,229

 
938,629

Future expense




300,578

481,358

873,138

1,179,271

2,834,345

 
2,834,345

Weighted average term of remaining future expense (in years)
2.9

 
 
 
 
 
 
 
 
 
 
 

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


The table below summarizes the option activity for the six months ended June 30, 2018:
 
 
Number of
Shares
 
Weighted
Average
Exercise Price
per share
 
Aggregate
Intrinsic Value
Outstanding at January 1
 
913,320

 
$
52.80

 
$
8,172,970

Granted
 
245,000

 
49.46

 
1,009,400

Exercised
 
(7,650
)
 
41.82

 
153,306

Expired/Forfeited
 
(2,500
)
 
50.15

 

Outstanding at June 30
 
1,148,170

 
52.17

 
3,865,121

Exercisable at June 30
 
634,920

 
50.58

 
2,852,934

The intrinsic value measures the price 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 intrinsic value for shares exercised during the period was calculated by using the closing share price on the date of exercise. At June 29, 2018, the final trading day of the second quarter, the closing share price of $53.58 was lower than the exercise price of the 213,375 and 232,500 outstanding options granted in 2016 and 2017, respectively. The weighted average remaining contractual life of the Company’s outstanding and exercisable options is 7.7 years and 6.6 years, respectively.
 
9.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, accounts receivable, 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 4.40% and 3.90%, would be approximately $906.5 million and $951.7 million, respectively, compared to the principal balance of $875.5 million and $890.4 million at June 30, 2018 and December 31, 2017, respectively. A change in any of the significant inputs may lead to a change in the Company’s fair value measurement of its debt.
The Company carries its interest rate swap at fair value. The Company has determined the majority of the inputs used to value its derivatives 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 is not significant. Derivative 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 observable market data. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit spreads, measure of volatility, and correlations of such inputs. The swap agreement terminates on July 1, 2020. As of June 30, 2018, the fair value of the interest-rate swap was approximately $0.5 million and is included in Accounts payable, accrued expenses and other liabilities in the Consolidated Balance Sheets. The decrease in value from inception of the swap is reflected in Other Comprehensive Income in the Consolidated Statements of Comprehensive Income. Amounts recognized in earnings are included in Changes in Fair Value of Derivatives in the Consolidated Statements of Operations.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
 
2018
 
2017
 
2018
 
2017
Change in fair value:
 
 
 
 
 
 
 
 
Recognized in earnings
 
$
(12
)
 
$
(1
)
 
$
(12
)
 
$
(1
)
Recognized in other comprehensive income
 
165

 
55

 
554

 
332

 
 
$
153

 
$
54

 
$
542

 
$
331

 
10.
Commitments and Contingencies
Neither the Company nor the current portfolio properties are subject to any material litigation, nor, to management’s knowledge, is any material litigation currently threatened against the Company, other than routine litigation and administrative proceedings 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 current portfolio properties.
 

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


11.
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 performance based upon income and cash flows from real estate of 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 2018 presentation.
 
(In thousands)
 Shopping
Centers
 
Mixed-Use
Properties
 
Corporate
and Other
 
Consolidated
Totals
Three months ended June 30, 2018
 
 
 
 
 
 
 
Real estate rental operations:
 
 
 
 
 
 
 
Revenue
$
40,848

 
$
15,376

 
$

 
$
56,224

Expenses
(8,574
)
 
(5,079
)
 

 
(13,653
)
Income from real estate
32,274

 
10,297

 

 
42,571

Other revenue

 

 
69

 
69

Interest expense and amortization of deferred debt costs

 

 
(11,237
)
 
(11,237
)
General and administrative

 

 
(4,647
)
 
(4,647
)
Depreciation and amortization of deferred leasing costs
(7,333
)
 
(4,018
)
 

 
(11,351
)
Gain on sale of property
509

 

 

 
509

Change in fair value of derivatives

 

 
(12
)
 
(12
)
Net income (loss)
$
25,450

 
$
6,279

 
$
(15,827
)
 
$
15,902

Capital investment
$
3,883

 
$
16,387

 
$

 
$
20,270

Total assets
$
804,939

 
$
464,534

 
$
177,009

 
$
1,446,482

 
 
 
 
 
 
 
 
Three months ended June 30, 2017
 
 
 
 
 
 
 
Real estate rental operations:
 
 
 
 
 
 
 
Revenue
$
40,583

 
$
15,314

 
$

 
$
55,897

Expenses
(8,378
)
 
(5,002
)
 

 
(13,380
)
Income from real estate
32,205

 
10,312

 

 
42,517

Other revenue

 

 
10

 
10

Interest expense and amortization of deferred debt costs

 

 
(11,900
)
 
(11,900
)
General and administrative

 

 
(4,514
)
 
(4,514
)
Depreciation and amortization of deferred leasing costs
(7,798
)
 
(3,893
)
 

 
(11,691
)
Change in fair value of derivatives

 

 
(1
)
 
(1
)
Net income (loss)
$
24,407

 
$
6,419

 
$
(16,405
)
 
$
14,421

Capital investment
$
1,942

 
$
5,219

 
$

 
$
7,161

Total assets
$
983,476

 
$
425,298

 
$
12,104

 
$
1,420,878

 
 
 
 
 
 
 
 

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Table of Contents
Notes to Consolidated Financial Statements (Unaudited)


(Dollars in thousands)
 Shopping
Centers
 
Mixed-Use
Properties
 
Corporate
and Other
 
Consolidated
Totals
Six months ended June 30, 2018
 
 
 
 
 
 
 
Real estate rental operations:
 
 
 
 
 
 
 
Revenue
$
81,821

 
$
30,798

 
$

 
$
112,619

Expenses
(17,499
)
 
(10,408
)
 

 
(27,907
)
Income from real estate
64,322

 
20,390

 

 
84,712

Other revenue

 

 
170

 
170

Interest expense and amortization of deferred debt costs

 

 
(22,764
)
 
(22,764
)
General and administrative

 

 
(9,068
)
 
(9,068
)
Depreciation and amortization of deferred leasing costs
(14,631
)
 
(8,069
)
 

 
(22,700
)
Gain on sale of property
509

 

 

 
509

Change in fair value of derivatives

 

 
(12
)
 
(12
)
Net income (loss)
$
50,200

 
$
12,321

 
$
(31,674
)
 
$
30,847

Capital investment
$
7,143

 
$
29,850

 
$

 
$
36,993

Total assets
$
804,939

 
$
464,534

 
$
177,009

 
$
1,446,482

 
 
 
 
 
 
 
 
Six months ended June 30, 2017
 
 
 
 
 
 
 
Real estate rental operations:
 
 
 
 
 
 
 
Revenue
$
84,020

 
$
30,330

 
$

 
$
114,350

Expenses
(17,077
)
 
(9,888
)
 

 
(26,965
)
Income from real estate
66,943

 
20,442

 

 
87,385

Other revenue

 

 
23

 
23

Interest expense and amortization of deferred debt costs

 

 
(23,764
)
 
(23,764
)
General and administrative

 

 
(8,815
)
 
(8,815
)
Depreciation and amortization of deferred leasing costs
(15,192
)
 
(7,841
)
 

 
(23,033
)
Change in fair value of derivatives

 

 
(1
)
 
(1
)
Net income (loss)
$
51,751

 
$
12,601

 
$
(32,557
)
 
$
31,795

Capital investment
$
84,285

 
$
10,225

 
$

 
$
94,510

Total assets
$
983,476

 
$
425,298

 
$
12,104

 
$
1,420,878

 
 
 
 
 
 
 
 

12. Subsequent Events
The Company has reviewed operating activities for the period subsequent to June 30, 2018 and determined there are no subsequent events required to be disclosed.


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Table of Contents

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This section should be read in conjunction with the consolidated financial statements of the Company and the accompanying notes in “Item 1. Financial Statements” of this report and the more detailed information contained in the Company’s Form 10-K for the year ended December 31, 2017. Historical results and percentage relationships set forth in Item 1 and this section should not be taken as indicative of future operations of the Company. Capitalized terms used but not otherwise defined in this section have the meanings given to them in Item 1 of this Form 10-Q.
Forward-Looking Statements
This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are generally characterized by terms such as “believe,” “expect” and “may.”
Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the Company’s actual results could differ materially from those given in the forward-looking statements as a result of changes in factors which include, among others, the following:
continuing risks related to the challenging domestic and global credit markets and their effect on discretionary spending;
risks that the Company’s tenants will not pay rent;
risks related to the Company’s reliance on shopping center “anchor” tenants and other significant tenants;
risks related to the Company’s substantial relationships with members of the Saul Organization;
risks of financing, such as increases in interest rates, restrictions imposed by the Company’s debt, the Company’s ability to meet existing financial covenants and the Company’s ability to consummate planned and additional financings on acceptable terms;
risks related to the Company’s development activities;
risks that the Company’s growth will be limited if the Company cannot obtain additional capital;
risks that planned and additional acquisitions or redevelopments may not be consummated, or if they are consummated, that they will not perform as expected;
risks generally incident to the ownership of real property, including adverse changes in economic conditions, changes in the investment climate for real estate, changes in real estate taxes and other operating expenses, adverse changes in governmental rules and fiscal policies, the relative illiquidity of real estate and environmental risks;
risks related to the Company’s status as a REIT for federal income tax purposes, such as the existence of complex regulations relating to the Company’s status as a REIT, the effect of future changes in REIT requirements as a result of new legislation and the adverse consequences of the failure to qualify as a REIT; and
such other risks as described in Part I, Item 1A of the Company’s Form 10-K for the year ended December 31, 2017.
General
The following discussion is based primarily on the consolidated financial statements of the Company as of and for the three and six months ended June 30, 2018.
Overview
The Company’s principal business activity is the ownership, management 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 community and neighborhood shopping center business and its transit-centric, primarily residential mixed-use 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 Shopping Centers and Mixed-Use properties expire and are renewed, or newly-available or vacant space is leased. The Company intends 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, management expects to revise rental rates, lease terms and conditions, 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

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Table of Contents

which leases are not otherwise expiring, or in connection with renovations or relocations, management selectively attempts to increase cash flow through a variety of means, including recapturing leases with below market rents and re-leasing at market rates, as well as replacing financially troubled tenants. When possible, management also will seek to include scheduled increases in base rent, as well as percentage rental provisions, in its leases.
The following table sets forth average annualized base rent per square foot and average annualized effective rent per square foot for the Company's Commercial properties (all properties except for the Clarendon Center and Park Van Ness apartments). For purposes of this table, annualized effective rent is annualized base rent minus amortized tenant improvements and amortized leasing commissions.
 
 
Six months ended June 30,
 
 
2018
 
2017
 
2016
 
2015
 
2014
Base rent
 
$
20.27

 
$
19.19

 
$
18.68

 
$
18.38

 
$
17.99

Effective rent
 
$
18.35

 
$
17.37

 
$
16.87

 
$
16.72

 
$
16.38

 
 
 
 
 
 
 
 
 
 
 
The Company’s redevelopment and renovation objective is to selectively and opportunistically redevelop and renovate its properties, 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.
From 2014 through 2016, in separate transactions, the Company purchased four adjacent properties on North Glebe Road in Arlington, Virginia, for an aggregate $54.0 million. The Company is developing approximately 490 residential units and 60,000 square feet of retail space on 2.8 acres of land. Construction is complete on the three level below grade parking structure. Pouring of the ground floor and second floor slabs is complete and concrete work is proceeding up to and including the fifth floor. The development is scheduled for substantial completion in early 2020. The total cost of the project, including acquisition of land, is expected to be approximately $275.0 million. In 2017, the Company closed on a $157.0 million construction-to-permanent loan, the proceeds of which will be used to partially finance the project. Leases have been executed for a 41,500 square foot Target and 9,000 square feet of retail shop space, resulting in approximately 84% of the planned retail space being leased.
Albertson's/Safeway, currently a tenant at eight of the Company's shopping centers, closed two Safeway stores located at the Company's properties during the June 2016 quarter. The stores that closed were located in Broadlands Village, Loudoun County, Virginia and Briggs Chaney Plaza, Montgomery County, Maryland. The lease at Briggs Chaney remains in full force and effect and Albertson’s/Safeway has executed a sublease with a replacement grocer, Global Foods, for that space and Global Foods commenced operations in March 2017. In February 2017, the Company terminated the lease with Albertson's/Safeway at Broadlands and received a $3.6 million termination fee which was recognized as revenue in the first quarter. The termination fee revenue was partially offset by the loss of approximately $1.6 million of rental revenue over the course of 2017. The Company has executed a lease with Aldi Food Market for 20,000 square feet of this space, which opened in November 2017, and lease negotiations are in progress for substantially all of the remaining space.
In January 2017, the Company purchased for $76.4 million, including acquisition costs, Burtonsville Town Square, a 121,000 square foot shopping center located in Burtonsville, Maryland. Burtonsville Town Square is 100% leased and anchored by Giant Food and CVS Pharmacy. The purchase was funded with a new $40.0 million mortgage loan and through the revolving credit facility. The Company has substantially completed construction of the shell of a 16,000 square foot small shop expansion and construction of interior improvements is underway. Delivery of tenant spaces is projected in late 2018, with tenant openings scheduled for the first quarter of 2019. The total development cost is expected to be approximately $5.7 million. Leases have been executed for approximately 55% of the space and negotiations are in progress for approximately 15% of the space. In addition, we are negotiating a lease with a tenant who will construct a free-standing building on a pad site within the property.
During the three months ended June 30, 2017, the Company executed a termination agreement with Kmart at Kentlands Square II. Kmart closed its 104,000 square foot store at Kentlands in September 2017, and the Company gained possession on October 31, 2017. Lease negotiations are in progress for the space. As a result of the termination, the mortgage loan agreement requires that Saul Centers guarantee approximately $9.2 million of that loan effective October 31, 2017 (the termination date), which will be reduced upon satisfaction of conditions stated in the loan documents. Annual revenue to the Company under the Kmart lease totaled approximately $1.3 million.

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Table of Contents

In September 2017, the Company sold for $8.5 million the 255,400 square foot Great Eastern Shopping Center located in District Heights, Maryland. The Company provided $1.28 million second trust financing to the buyer, which bore interest at a fixed rate of 6%. In May 2018, the buyer repaid the loan in full and the Company recognized a $0.5 million gain that was previously deferred.
The recent period of economic expansion has now run in excess of five years. While economic conditions within the local Washington, DC metropolitan area have remained relatively stable, issues facing the Federal government relating to taxation, spending and interest rate policy will likely continue to impact the office, retail and residential real estate markets over the coming years. Because the majority of the Company’s property operating income is produced by our shopping centers, we continually monitor the implications of government policy changes, as well as shifts in consumer demand between on-line and in-store shopping, on future shopping center construction and retailer store expansion plans. Based on our observations, we continue to adapt our marketing and merchandising strategies in a way to maximize our future performance.  The Company’s overall leasing percentage, on a comparative same property basis, which excludes the impact of properties not in operation for the entirety of the comparable periods, was 94.0% at June 30, 2018, compared to 95.6% at June 30, 2017.
The Company maintains a ratio of total debt to total asset value of under 50%, which allows the Company to obtain additional secured borrowings if necessary. As of June 30, 2018, amortizing fixed-rate debt with staggered maturities from 2019 to 2035 represented approximately 89.7% of the Company’s notes payable, thus minimizing refinancing risk in any given year. As of June 30, 2018, the Company’s variable-rate debt consisted of $100.0 million outstanding under the new credit facility. As of June 30, 2018, the Company has availability of approximately $208.9 million under its $325.0 million unsecured revolving credit facility.
Although it is management’s present intention to concentrate future acquisition and development activities on community and neighborhood shopping centers and transit-centric, primarily residential mixed-use properties in the Washington, DC/Baltimore metropolitan area and the southeastern region of the United States, the Company may, in the future, also acquire other types of real estate in other areas of 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 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 reporting of financial position and results of operations. If judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied resulting in a different presentation of the financial statements. The Company has identified the following policies that, due to estimates and assumptions inherent in these 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 estate 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 relative 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 expected to be generated by the property including an initial lease up period. The fair value of above and below market intangibles associated with in-place leases is determined by assessing the net effective rent and remaining term of the in-place lease relative to market terms for similar leases at acquisition taking into consideration the remaining contractual lease period, renewal periods, and the likelihood of the tenant exercising its renewal options. The fair value of below market lease intangibles is recorded as deferred income and accreted 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 amortized as a reduction of revenue over the remaining contractual lease term. The fair value of at-market in-place leases is determined 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

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expense over the remaining contractual lease term. To the extent customer relationship intangibles are present in an acquisition, the fair value of the intangibles are amortized over the life of the customer relationship.
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 indicators are present, the projected cash flows of the property over its remaining useful life, on an undiscounted basis, are compared 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, an impairment loss is recognized equivalent 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 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.
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 that we own are depreciated 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. Upon substantial completion of construction and the placement of assets into service, rental income, direct operating expenses, and depreciation associated with such properties are included in current operations and capitalization of interest ceases. 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 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.
Deferred Leasing Costs
Certain initial direct costs incurred by the Company in negotiating and consummating successful Commercial leases are capitalized and amortized over the initial base 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, evaluating and recording guarantees, collateral and other security arrangements, negotiating lease terms, preparing lease documents and closing transactions. In addition, deferred leasing costs include amounts attributed to in-place leases associated with acquired properties.
Revenue Recognition
Rental and interest income is accrued as earned. Recognition of rental income commences when control of the space has been given to the tenant. When rental payments due under leases vary from a straight-line basis because of free rent periods or scheduled rent increases, income is recognized on a straight-line basis. Expense recoveries represent a portion of property operating expenses billed to tenants, including common area maintenance, real estate taxes and other recoverable costs. Expense recoveries are recognized in the period in which the expenses are incurred. Rental income based on a tenant’s revenue, known as percentage rent, is recognized when a tenant reports sales that exceed a 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 respective 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 addition 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.

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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 cannot be predicted with certainty, the Company believes the final outcome of current matters will not have a material adverse effect on its financial position or the results of operations. Upon determination that a loss is probable to occur, the estimated amount of the loss is recorded in the financial statements. Both the amount of the loss and the point at which its occurrence is considered probable can be difficult to determine.

Results of Operations
Three months ended June 30, 2018 (the "2018 Quarter") compared to the three months ended June 30, 2017 (the "2017 Quarter")
Revenue
 
  
 
Three months ended June 30,
 
2017 to 2018 Change
(Dollars in thousands)
 
2018
 
2017
 
Amount
 
Percent
Base rent
 
$
45,943

 
$
45,575

 
$
368

 
0.8
 %
Expense recoveries
 
8,601

 
8,337

 
264

 
3.2
 %
Percentage rent
 
249

 
519

 
(270
)
 
(52.0
)%
Other property revenue
 
1,431

 
1,466

 
(35
)
 
(2.4
)%
Other revenue
 
69

 
10