Saul Centers Inc.
Annual Report 2016

Plain-text annual report

2016 ANNUAL REPORT to Shareholders Saul Centers, Inc. is a self-managed, self- administered equity Real Estate Investment Trust (REIT) headquartered in Bethesda, Maryland. Saul Centers operates and manages a real estate portfolio comprised of 59 properties including (a) 56 community and neighborhood shopping centers and mixed-use properties with approximately 9.5 million square feet of leasable area and (b) three land and development properties. Approximately 85% of the Company’s property operating income is generated by properties in the metropolitan Washington, DC/Baltimore area. TOTAL REVENUE (In millions) NET INCOME Available to Common Stockholders (In millions) FUNDS FROM OPERATIONS Available to Common Shareholders* (In millions) 1 . 7 1 2 $ 1 . 9 0 2 $ 1 . 7 0 2 $ 1 . 0 9 1 $ 9 . 7 9 1 $ 2 1 0 2 3 1 0 2 4 1 0 2 5 1 0 2 6 1 0 2 $35 $30 $25 $20 $15 $10 $5 $0 9 . 2 3 $ 1 . 2 3 $ 1 . 0 3 $ 2 . 8 1 $ 7 . 1 1 $ 2 1 0 2 3 1 0 2 4 1 0 2 5 1 0 2 6 1 0 2 $90 $80 $70 $60 $50 $40 $30 $20 $10 $0 7 . 7 8 8 $ . 3 8 3 $ . 8 7 $ 7 . 4 6 1 $ . 0 6 $ 2 1 0 2 3 1 0 2 4 1 0 2 5 1 0 2 6 1 0 2 $225 $200 $175 $150 $125 $100 $75 $50 $25 $0 * Funds From Operations (FFO) is a non-GAAP financial measure. The term Common Shareholders means common stockholders and holders of noncontrolling interests. See page 25 for a definition of FFO and reconciliation from Net Income. SAUL CENTERS, INC. 2016 ANNUAL REPORT Portfolio Composition BASED ON 2016 PROPERTY OPERATING INCOME 76.7% Shopping Centers 23.3% Mixed-Use 84.9% Metropolitan Washington, DC/ Baltimore area 15.1% Rest of U.S. Year ended December 31, 2016 2015 2014 2013 2012 Summary Financial Data Total Revenue $ 217,070,000 $209,077,000 $ 207,092,000 $ 197,897,000 $ 190,092,000 Net Income Available to Common Stockholders $ 32,904,000 $ 30,093,000 $ 32,102,000 $ 11,661,000 $ 18,234,000 FFO Available to Common Shareholders $ 87,749,000 $ 83,815,000 $ 78,281,000 $ 64,684,000 $ 60,100,000 Weighted Average Common Stock Outstanding (Diluted) 21,615,000 21,196,000 20,821,000 20,401,000 19,700,000 Weighted Average Common Stock and Units Outstanding 28,990,000 28,449,000 27,977,000 27,330,000 26,614,000 Net Income Per Share Available to Common Stockholders (Diluted) $ 1.52 $ 1.42 $ 1.54 $ 0.57 $ 0.93 FFO Per Share Available to Common Shareholders (Diluted) $ 3.03 $ 2.95 $ 2.80 $ 2.37 $ 2.26 Common Dividend as a Percentage of FFO 61% 57% 56% 61% 64% Interest Expense Coveragea 3.29 x 3.24x 3.15 x 2.98 x 2.68x Property Data Number of Operating Propertiesb 55 56 56 56 57 Total Portfolio Square Feet 9,362,000 9,350,000 9,339,000 9,333,000 9,489,000 Shopping Center Square Feet 7,882,000 7,897,000 7,886,000 7,880,000 7,877,000 Mixed-Use Square Feet 1,480,000 1,453,000 1,453,000 1,453,000 1,612,000 Average Percentage Leasedc 95% 95% 94% 93% 91% (a) Interest expense coverage equals (i) operating income before the sum of interest expense and amortization of deferred debt costs, predevelopment expenses, acquisition related costs, and depreciation and amortization of deferred leasing costs divided by (ii) interest expense. (b) Excludes development parcels (Ashland Square Phase II and New Market in 2012, Ashland Square Phase II, New Market and Park Van Ness in 2013, 2014, and 2015, and Ashland Square Phase II, New Market and N. Glebe Road in 2016) and does not include Burtonsville Town Square which was acquired in January 2017. Crosstown Business Center was sold in December 2016. (c) Average percentage leased includes commercial space only. SAUL CENTERS, INC. 2016 ANNUAL REPORT 1 Message to Shareholders The leased percentage of our core neighborhood shopping center portfolio has increased to pre-recession levels, ending 2016 at 96%. PARK VAN NESS, WASHINGTON, DC Steadily improving economic factors continued to have a positive impact on our retail and mixed-use property operating performance during the past year. 2016 marked the fifth consecutive year of growth in Funds From Operations (FFO) and property operating income for our Company. Our core neighborhood shopping center portfolio of approximately 7.9 million square feet averaged over 95% leased, ending 2016 at 96%. The overall leased percentage of our mixed-use portfolio (excluding residential space) was 91% as of year-end 2016. In May 2016, the Company delivered Park Van Ness, the second major project within our urban Metro oriented, mixed-use development platform. As of March 2017, the street-level retail is 100% occupied and the 271 apartments are over 81% leased. With a low level of debt on our balance sheet, we have sufficient capital available to fuel the continued expansion of this mixed-use portfolio. The Company’s next large-scale mixed-use project to be developed is 750 N. Glebe Road, located in the Ballston neighborhood of Arlington, Virginia, near the Ballston Metro Station. Development & Acquisition Park Van Ness is located one block north of the Van Ness Metro Station on Connecticut Avenue in Northwest Washington, DC, with the entire length of the site bordering the picturesque Rock Creek Park. Previously encumbered by an office building which the Company had owned since the mid-1970s, the site commenced redevelopment in 2013 as the next addition to our mixed-use portfolio, and as a follow-up to our successful 2 SAUL CENTERS, INC. 2016 ANNUAL REPORT delivery of Clarendon Center in late 2010. Our Van Ness property was redeveloped into 271 luxury apartments and 9,000 square feet of complimentary street-level retail space. Construction of Park Van Ness was completed in April 2016, with the initial residents taking occupancy in May 2016. As of March 2017, 10 months later, the residential units are over 81% leased to tenants ranging from young professionals to retirees seeking to downsize. The street-level retail space is 100% leased. The 6,000 square foot Soapstone Market offers eat-in casual dining and bar space combined with selections of prepared foods, among many other gourmet grocery offerings. The highly acclaimed Sfoglina pasta house restaurant occupies 3,000 square feet. Sfo glina, the fourth Washington, DC area restaurant by world renowned chef and restaurateur, Fabio Trabocci, offers an indoor and outdoor fine dining experience centered around a homemade pasta menu. We expect Park Van Ness to be accretive to FFO during 2017 as lease-up of this $93 million development is completed over the coming months. In June 2016, our 750 N. Glebe Road site in Ballston was granted rezoning and final site plan approval by Arlington County. Ballston is a very dynamic and walkable office, retail and residential neighborhood in Northern Virginia. As one of the last, large tracts of developable land within the Rosslyn- Ballston Corridor, this 2.8 acre site was granted approval for 490 residential units and 62,000 square feet of street-level retail space, marking a major milestone in the expansion of our mixed-use portfolio. Construction plans and specifications are currently being finalized, and we expect ground breaking to occur during the second quarter of 2017. While we view development/redevelopment to be our organic growth engine into the future, maintaining our core shopping center operation is vital to the Company’s success. We remain active in identifying and pursuing viable opportunities that are complementary to our existing shopping center operations. As such, in January 2017, we acquired Burtonsville Town Square, a well located grocery anchored neighborhood shopping center in Burtonsville, Maryland. The 121,000 square foot center, constructed in 2011, is located just outside of the Washington, DC Beltway along Route 29 in Montgomery County, Maryland, proximate to our White Oak PARK VAN NESS, WASHINGTON, DC GLEBE ROAD, ARLINGTON, VA (Artist Rendering) BURTONSVILLE TOWN SQUARE, BURTONSVILLE, MD SAUL CENTERS, INC. 2016 ANNUAL REPORT 3 Message to Shareholders and Briggs Chaney Plaza shopping centers. In addition to the purchase of Burtonsville Town Burtonsville Town Square is fully occupied and has a Square, we were able to enhance the value of our value-add component in its by-right expansion existing portfolio by purchasing the fee interest in two potential of up to 18,000 square feet of additional retail of our three properties that were subject to underlying space. Burtonsville Town Square was purchased for ground leases. The two shopping centers, Beacon $75 million with a very attractive $40 million, 15-year Center and Southdale, are two of our top five centers mortgage at a 3.39% fixed interest rate. With the (by property operating income). In addition, both addition of this Giant anchored center, this strategic centers have significant master planned future acquisition nicely complements our existing 31 grocery development potential. In total, for $37.5 million, anchored core shopping center portfolio. we secured the fee interest in 73 acres of land ASHBURN VILLAGE, ASHBURN, VA underlying these two centers, allowing us to maintain full control over these two assets with a combined market value of approximately $180 million. While these two transactions are not FFO accretive in the short term, they are integral to our long term vision for efficient capital allocation and maximization of future value enhancement. 2016 FINANCIAL RESULTS Total revenue increased to $217.1 million in 2016 from $209.1 million in 2015, and operating income increased to $55.7 million from $52.9 million. Net income available to common stockholders was $32.9 million in 2016 compared to $30.1 million in 2015. During 2016, overall same property revenue increased by 3.0% and same property operating income increased by 3.3%. Same property results exclude the results of properties not in operation for the entirety of the comparable reporting periods. 4 SAUL CENTERS, INC. 2016 ANNUAL REPORT SOUTHDALE, GLEN BURNIE, MD LANSDOWNE TOWN CENTER, LEESBURG, VA The same property operating income increase of $5.2 million was positively impacted by • higher base rent of $3.4 million (exclusive of the effect of the lease termination mentioned below), and • increased other revenue of $1.6 million, primarily due to the net impact of a lease termination at 11503 Rockville Pike. FFO available to common shareholders (after deducting preferred stock dividends) increased by 4.7% to $87.7 million ($3.03 per diluted share) in 2016 from $83.8 million ($2.95 per diluted share) in 2015. This increase is primarily attributable to • higher overall property operating income ($4.8 million), exclusive of the impact of Park Van Ness, and • lower interest and amortization of debt expense ($1.3 million), exclusive of the impact of Park Van Ness, partially offset by • the adverse impact of the initial operations of Park Van Ness ($1.1 million), and • higher general and administrative expenses ($1.1 million). Concurrent with the opening of Park Van Ness in May, interest, real estate taxes and all other costs associated with the property began to be charged to expense while revenue continues to grow in accordance with occupancy. As a result, FFO for 2016 was adversely impacted by $1.1 million, while the three month period ended December 31, 2016 was adversely impacted by only $0.2 million. Our 2016 same shopping center property operating income grew by 3.0% and same store rental rate increases over expiring rents on 1.1 million square feet of space were 3.0%. SHOPPING CENTER HIGHLIGHTS In spite of continuing challenges within the retail industry, the overall shopping center leasing percentage was 96% at December 31, 2016, and the Company’s core shopping center business enjoyed another year of positive operating results. While internet retail continues to experience rapid market share increases in the soft goods and electronics segments, our focus on in-fill grocery anchored, service-oriented neighborhood shopping centers has continued to be generally resilient against these market forces. Our 2016 same shopping center property operating income grew by 3.0% and same store rental rate increases over expiring rents on 1.1 million square feet of space were 3.0%, down slightly from the 4.5% increases in 2015. We renewed 76% of our shopping center tenants in 2016, as measured by annualized expiring base rents, representing an increase over our average of 74% over the past three years. Small shops are in-line tenants of less than 10,000 square feet. SAUL CENTERS, INC. 2016 ANNUAL REPORT 5 5 Message to Shareholders Although these small shops comprise only 31% of the During 2016, two of our seven Safeway anchors, Briggs total shopping center square footage, they generate Chaney and Broadlands Village, ceased operations. approximately 50% of our shopping center annualized With Safeway responsible for the remaining lease base rent. At December 31, 2016, our small shop liability, the financial impact on these two centers has leasing percentage was 90.4%. been minimal, as both leases have remained current WESTVIEW VILLAGE, FREDERICK, MD THRUWAY, WINSTON-SALEM, NC 6 SAUL CENTERS, INC. 2016 ANNUAL REPORT with rent payments. Since Safeway vacated, the Briggs Chaney Plaza center has continued to operate at over 98% leased. Nine months after Safeway’s closing, we are pleased to have Global Foods, a regional grocer with six locations in the Washington, DC metropolitan area, opening later this month. While Safeway ceased operations at Broadlands Village in Loudoun County, Virginia in April 2016, the center remains 100% leased. We have recently terminated the Safeway lease and executed a lease with Aldi Food Market to replace a portion of the former store, in accordance with Aldi’s prototypical 20,000 square foot store size. Aldi is expected to open in late 2017. We continue to actively market the balance of the former Safeway space. MIXED-USE HIGHLIGHTS As of December 31, 2016, our mixed-use portfolio consisted of 515 apartments and 1.1 million square feet of commercial space. Our core office leasing percentage was 91%, with only 32,000 square feet of space expiring in 2017. Clarendon Center and 601 Pennsylvania Avenue, our two largest income generating office properties, represented 64% of our total mix-use property operating income during 2016. These two assets were 99% leased as of December 31, 2016. The 244 apartments at Clarendon Center averaged 97.1% leased through 2016, with newly executed leases averaging 3.4% higher rents than the expiring rents. BALANCE SHEET HIGHLIGHTS As we enter 2017 with no maturing debt in the current year, we are well positioned for the future. Our fixed- rate debt maturities are staggered from 2018 through 2034, with no more than $60 million maturing during any one of those years. Our $275 million revolving credit line has $84 million drawn as of February 28, 2017, leaving over $190 million of capital available to fund our development pipeline. With a prudent CRANBERRY SQUARE, WESTMINSTER, MD leverage ratio of 30% (debt to total capitalization), Utilizing predominantly fixed-rate debt with 25-year adequate borrowing capacity remains to fund our amortization periods and staggering our debt near-term development activity and fund other maturities, we have minimized the effects of potentially strategic growth opportunities that may arise. volatile market conditions and risks. We feel that real Over the past 5 years, we have increased our dividend from $1.44 in 2011, to the current annualized rate of $2.04, representing a 7.2% compounded annual growth rate. Our dividend payout ratio (dividends divided by FFO) during 2016 remained at a conservative level of approximately 61%. The Company’s stock closed at $66.61 per share on December 31, 2016, resulting in total capitalization of $3.0 billion. When combining our dividend growth with our stock price appreciation, we are pleased that, since inception, the performance of our common stock has yielded our investors a 12% compounded annual return. While we anticipate future interest rate increases by the Federal Reserve, as well as challenging local and global political conditions, we have adequately positioned our balance sheet to minimize exposure to negative pressures and unknown market risks. estate fundamentals within our core operating markets remain solid, as demand continues to outpace supply, across our well-positioned properties. U.S. consumer outlook remains high, which should continue to drive demand for retail, residential and office space. The conservative nature of our current portfolio and our inherent development pipeline should allow for continued positive operating results and organic growth that will continue to provide attractive returns to our shareholders. We extend our thanks and appreciation to our committed and conscientious team of leasing, development and management professionals and to the shareholders who have invested with us over the past years. For the Board, B. Francis Saul II March 8, 2017 SAUL CENTERS, INC. 2016 ANNUAL REPORT 7 Portfo lio Properties As of December 31, 2016, Saul Centers’ portfolio properties were located in Virginia, Maryland, Washington, DC, North Carolina, Delaware, Florida, Georgia, New Jersey and Oklahoma. Properties in the metropolitan Washington, DC/ Baltimore area represent over 75% of the portfolio’s gross leasable area. GROSS LEASABLE PROPERTY/LOCATION SQUARE FEET GROSS LEASABLE PROPERTY/LOCATION SQUARE FEET Shopping Centers Ashburn Village, Ashburn, VA 221,585 Ashland Square Phase I, Dumfries, VA 23,120 Beacon Center, Alexandria, VA 358,071 BJ’s Wholesale Club, Alexandria, VA 115,660 Boca Valley Plaza, Boca Raton, FL 121,269 Boulevard, Fairfax, VA 49,140 Briggs Chaney MarketPlace, Silver Spring, MD 194,258 Broadlands Village, Ashburn, VA 174,734 Countryside Marketplace, Sterling, VA 138,229 Cranberry Square, Westminster, MD 141,450 Cruse MarketPlace, Cumming, GA 78,686 Flagship Center, Rockville, MD 21,500 French Market, Oklahoma City, OK 246,148 Germantown, Germantown, MD 18,982 The Glen, Woodbridge, VA 136,440 Great Eastern, District Heights, MD 255,398 Great Falls Center, Great Falls, VA 91,666 Hampshire Langley, Takoma Park, MD 131,700 Hunt Club Corners, Apopka, FL 105,882 Jamestown Place, Altamonte Springs, FL 96,341 Kentlands Square I, Gaithersburg, MD 114,381 Kentlands Square II, Gaithersburg, MD 246,965 Kentlands Place, Gaithersburg, MD 40,697 Lansdowne Town Center, Leesburg, VA 189,422 Leesburg Pike Plaza, Baileys Crossroads, VA 97,752 Lumberton Plaza, Lumberton, NJ 192,718 Metro Pike Center, Rockville, MD 67,488 Shops at Monocacy, Frederick, MD 109,144 Northrock, Warrenton, VA 99,789 Olde Forte Village, Ft. Washington, MD 143,577 8 SAUL CENTERS, INC. 2016 ANNUAL REPORT Olney, Olney, MD 53,765 Orchard Park, Dunwoody, GA 87,365 Palm Springs Center, Altamonte Springs, FL 126,446 Ravenwood, Baltimore, MD 93,328 11503 Rockville Pk / 5541 Nicholson Ln, Rockville, MD 40,249 1500/1580/1582/1584 Rockville Pike, Rockville, MD 110,128 Seabreeze Plaza, Palm Harbor, FL 146,673 Marketplace at Sea Colony, Bethany Beach, DE 21,677 Seven Corners, Falls Church, VA 573,481 Severna Park Marketplace, Severna Park, MD 254,174 Shops at Fairfax, Fairfax, VA 68,762 Smallwood Village Center, Waldorf, MD 173,341 Southdale, Glen Burnie, MD 484,035 Southside Plaza, Richmond, VA 371,761 South Dekalb Plaza, Atlanta, GA 163,418 Thruway, Winston-Salem, NC 366,693 Village Center, Centreville, VA 146,032 Westview Village, Frederick, MD 97,858 White Oak, Silver Spring, MD 480,676 TOTAL SHOPPING CENTERS 7,882,054 Mixed-Use Properties Avenel Business Park, Gaithersburg, MD 390,683 Clarendon Center – North, Arlington, VA 108,387 Clarendon Center – South, Arlington, VA 293,565 (includes 244 apartments comprising 188,671 square feet) Park Van Ness, Washington, DC 223,447 (includes 271 apartments comprising 214,600 square feet) 601 Pennsylvania Ave., Washington, DC 227,021 Washington Square, Alexandria, VA 236,376 TOTAL MIXED-USE PROPERTIES 1,479,479 TOTAL PORTFOLIO 9,361,533 Financial Section TABLE OF CONTENTS Selected Financial Data......................................... Page 10 Management’s Discussion and Analysis of Financial Condition and Results of Operations...................................... Pages 11-29 Quantitative and Qualitative Disclosures About Market Risk................................................Page 29 Management’s Report on Internal Control Over Financial Reporting...............................................Page 29 Report of Independent Registered Public Accounting Firm......................................... Page 30 Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting............................................... Page 31 Consolidated Balance Sheets................................ Page 32 Consolidated Statements of Operations..................Page 33 Consolidated Statements of Comprehensive Income........................................Page 34 Consolidated Statements of Stockholders’ Equity............................................ Page 35 Consolidated Statements of Cash Flows..................Page 36 Notes to Consolidated Financial Statements......Pages 37-59 SAUL CENTERS, INC. 2016 ANNUAL REPORT 9 Selected Financial Data (In thousands, except per share data) Years Ended December 31, 2016 2015 2014 2013 2012 Operating Data: Total revenue $ 217,070 $ 209,077 $ 207,092 $ 197,897 $ 190,092 Total operating expenses 161,357 156,147 155,163 162,628 154,996 Operating income 55,713 52,930 51,929 35,269 35,096 Non-operating income: Change in fair value of derivatives (6) (10) (10) (7) 36 Loss on early extinguishment of debt — — — (497) — Gain on sales of properties 1,013 11 6,069 — — Gain on casualty settlements — — — 77 219 Income from continuing operations 56,720 52,931 57,988 34,842 35,351 Discontinued operations — — — — 4,429 Net income 56,720 52,931 57,988 34,842 39,780 Income attibutable to the noncontrolling interests (11,441) (10,463) (11,045) (3,970) (6,406) Net income attributable to Saul Centers, Inc. 45,279 42,468 46,943 30,872 33,374 Preferred stock redemption — — (1,480) (5,228) — Preferred dividends (12,375) (12,375) (13,361) (13,983) (15,140) Net income available to common stockholders $ 32,904 $ 30,093 $ 32,102 $ 11,661 $ 18,234 Per Share Data (diluted): Net income available to common stockholders: Continuing operations $ 1.52 $ 1.42 $ 1.54 $ 0.57 $ 0.70 Discontinued operations — — — — 0.23 Total $ 1.52 $ 1.42 $ 1.54 $ 0.57 $ 0.93 Basic and diluted shares outstanding: Weighted average common shares - basic 21,505 21,127 20,772 20,364 19,649 Effect of dilutive options 110 69 49 37 51 Weighted average common shares - diluted 21,615 21,196 20,821 20,401 19,700 Weighted average convertible limited partnership units 7,375 7,253 7,156 6,929 6,914 Weighted average common shares and fully converted limited partnership units - diluted 28,990 28,449 27,977 27,330 26,614 Dividends Paid: Cash dividends to common stockholders (1) $ 39,472 $ 35,645 $ 32,346 $ 29,205 28,135 Cash dividends per share $ 1.84 $ 1.69 $ 1.56 $ 1.44 $ 1.44 Balance Sheet Data: Real estate investments (net of accumulated depreciation) $ 1,242,534 $ 1,197,340 $ 1,163,542 $ 1,094,776 $ 1,112,763 Total assets 1,343,025 1,295,408 1,257,113 1,189,000 1,199,596 Total debt, including accrued interest 903,709 869,652 850,727 813,653 823,408 Preferred stock 180,000 180,000 180,000 180,000 179,328 Total stockholders’ equity 373,249 353,727 339,257 315,126 307,289 Other Data: Cash flow provided by (used in): Operating activities $ 89,090 $ 88,896 $ 86,568 $ 73,527 $ 78,423 Investing activities (86,274) (69,587) (83,589) (26,034) (46,873) Financing activities (4,497) (21,434) (8,148) (42,329) (31,740) Funds from operations (2): Net income 56,720 52,931 57,988 34,842 39,780 Real property depreciation and amortization 44,417 43,270 41,203 49,130 40,112 Real property depreciation - discontinued operations — — — — 77 Gain on property dispositions and casualty settlements (1,013) (11) (6,069) (77) (4,729) Funds from operations 100,124 96,190 93,122 83,895 75,240 Preferred stock redemption — — (1,480) (5,228) — Preferred dividends (12,375) (12,375) (13,361) (13,983) (15,140) Funds from operations available to common shareholders and noncontrolling interests $ 87,749 $ 83,815 $ 78,281 $ 64,684 $ 60,100 (1) During 2016, 2015, 2014, 2013, and 2012, shareholders reinvested $10.3 million, $10.6 million, $9.3 million, $20.7 million and $23.1 million, respectively, in newly issued common (2) stock through the Company’s dividend reinvestment plan. Funds from operations (FFO) is a non-GAAP financial measure and is defined in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Funds From Operations.” 10 SAUL CENTERS, INC. 2016 ANNUAL REPORT Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) begins with the Company’s primary business strategy to give the reader an overview of the goals of the Company’s business. This is followed by a discussion of the critical accounting policies that the Company believes are important to understanding the assumptions and judgments in- corporated in the Company’s reported financial results. The next section, beginning on page 15, discusses the Company’s results of operations for the past two years. Beginning on page 18, the Company provides an analysis of its liquidity and capital resources, including discussions of its cash flows, debt arrangements, sources of capital and financial commitments. Finally, on page 25, the Company discusses funds from operations, or FFO, which is a non-GAAP financial measure of performance of an equity REIT used by the REIT industry. The MD&A should be read in conjunction with the other sections of this Annual Report, including the consolidated financial state- ments and notes thereto beginning on page 32. Historical results set forth in Selected Financial Information and the Consolidated Financial Statements should not be taken as indicative of the Company’s future operations. OVERVIEW The Company’s principal business activity is the ownership, man- agement and development of income-producing properties. The Company’s long-term objectives are to increase cash flow from operations and to maximize capital appreciation of its real estate investments. The Company’s primary operating strategy is to focus on its com- munity and neighborhood shopping center business and to operate its properties to achieve both cash flow growth and cap- ital appreciation. Management believes there is potential for long term growth in cash flow as existing leases for space in the Shop- ping Center and Mixed-Use Properties expire and are renewed, or newly available or vacant space is leased. The Company in- tends to renegotiate leases where possible and seek new tenants for available space in order to optimize the mix of uses to improve foot traffic through the Shopping Centers. As leases expire, man- agement expects to revise rental rates, lease terms and 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 which leases are not otherwise expiring, management selectively attempts to in- crease cash flow through a variety of means, or in connection with renovations or relocations, recapturing leases with below market rents and re-leasing at market rates, as well as replacing financially troubled tenants. When possible, management also will seek to include scheduled increases in base rent, as well as percentage rental provisions, in its leases. The Company’s redevelopment and renovation objective is to selectively and opportunistically redevelop and renovate its prop- erties, by replacing below-market-rent leases with strong, traffic-generating anchor stores such as supermarkets and drug stores, as well as other desirable local, regional and national ten- ants. The Company’s strategy remains focused on continuing the operating performance and internal growth of its existing Shop- ping Centers, while enhancing this growth with selective acquisitions, redevelopments and renovations. In 2016, the Company completed development of Park Van Ness, a 271-unit residential project with approximately 9,000 square feet of street-level retail, below street-level structured parking, and amenities including a community room, landscaped courtyards, a fitness room, a wi-fi lounge/business center, and a rooftop pool and deck. The structure comprises 11 levels, five of which on the east side are below street level. Because of the change in grade from the street eastward to Rock Creek Park, apartments on all 11 levels have park or city views. The street level retail space is 100% leased to a grocery/gourmet food market and an upscale Italian restaurant. As of March 1, 2017, leases have been executed for 217 apartments (80.1%) and 205 apartments were occupied. The total cost of the project, excluding predevelopment expense and land, which the Company has owned, was approximately $93.0 million, a portion of which was financed with a $71.6 million con- struction-to-permanent loan. Costs incurred through December 31, 2016, total approximately $92.9 million, of which $70.1 million has been financed by the loan. In 2014, in separate transactions, the Company purchased three properties, with approximately 57,400 square feet of retail space, for an aggregate $25.2 million. The three properties are adjacent to an existing property on the east side of Rockville Pike near the Twinbrook Metro station. Combined, the four properties total 10.3 acres and are zoned for up to 1.2 million square feet of rentable mixed-use space. The Company is actively engaged in a plan for redevelopment but has not committed to any timetable for com- mencement of construction. The Company owns properties on the east and west sides of Rockville Pike near the White Flint Metro station which combined total 7.6 acres which are zoned for a development potential of up to 1.6 million square feet of mixed-use space. The Company is ac- tively engaged in a plan for redevelopment but has not committed to any timetable for commencement of construction. In January 2016, the Company terminated a 16,500 square foot lease at 11503 Rockville Pike and received a $3.0 million lease ter- mination fee which was recognized as revenue in the first quarter. SAUL CENTERS, INC. 2016 ANNUAL REPORT 11 Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The space was previously occupied by an office supply store that had vacated in mid 2014 and the lease was scheduled to expire in 2019. The termination fee revenue was partially offset by the loss of approximately $1.1 million in rental revenue over the remain- der of 2016. The Company has executed a lease with a replacement tenant, with occupancy and rent commencement projected to be Spring 2017. While the Company continues to plan for a mixed-use development at this site and its neighboring Metro Pike Center, the initial phases of this development are ex- pected to be on the west side of Rockville Pike at Metro Pike Center. The Company has not committed to any timetable for commencement of construction. From 2014 through 2016, in separate transactions, the Company purchased four adjacent properties, with approximately 23,700 square feet of retail space, on North Glebe Road in Arlington, Vir- ginia, for an aggregate $54.0 million. Combined, the properties total 2.8 acres. Effective August 1, 2016, the Company's proper- ties at Glebe Road were vacant and removed from service. The Company previously received zoning and site plan approval from Arlington County, Virginia for the development of approximately 490 residential units and 62,000 square feet of retail space. Util- ities have been disconnected, plans and specifications are in process, interest, real estate taxes and other costs related to de- velopment are being capitalized and the assets were reclassified to construction in progress in the Consolidated Balance Sheets. The demolition of the existing structures is expected to commence in the Spring of 2017, pending the issuance of the demolition per- mit. Commencement of construction remains uncertain and dependent on completion of plans and specifications and award of a general contractor. Albertson's/Safeway, a tenant at nine 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 the space and Global Foods is expected to commence operations in the second quarter of 2017. The Company terminated the lease with Albertson's/Safeway at Broadlands and has executed a lease with Aldi Food Market for 20,000 square feet of this space which is expected to open in late 2017. We continue to actively market the balance of the former Safeway space. In January 2017, the Company purchased for $76.3 million, includ- ing acquisition costs, Burtonsville Town Square, a 121,000 square foot shopping center located in Burtonsville, Maryland. Bur- tonsville Town Square is 100% leased and anchored by Giant Food and CVS Pharmacy. It has expansion development potential of up to 18,000 square feet of additional retail space. The pur- chase was funded with a new $40.0 million mortgage loan and through the Company's credit line facility. In light of the limited amount of quality properties for sale and the escalated pricing of properties that the Company has been pre- sented with or has inquired about over the past year, management believes acquisition opportunities for investment in existing and new Shopping Center and Mixed-Use Properties in the near future is uncertain. Because of its conservative capital structure, including its cash and capacity under its revolving credit facility, manage- ment believes that the Company is positioned to take advantage of additional investment opportunities as attractive properties are identified and market conditions improve. (See “Item 1. Business - Capital Policies”). It is management’s view that several of the sub- markets in which the Company operates have, or are expected to have in the future, attractive supply/demand characteristics. The Company will continue to evaluate acquisition, development and redevelopment as integral parts of its overall business plan. The recent period of economic expansion has now run in excess of five years. While economic conditions within the local Wash- ington, DC metropolitan area have remained relatively stable, issues facing the Federal government relating to taxation, spend- ing and interest rate policy will likely 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 de- mand 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 mer- chandising strategies in a way to maximize our future performance. The Company’s strong underlying fundamentals have resulted in a commercial leasing percentage, on a comparable property basis, which excludes the impact of properties not in operation for the entirety of the comparable periods, which continues to im- prove and increased to 95.4% at December 31, 2016, from 95.0% at December 31, 2015. 12 SAUL CENTERS, INC. 2016 ANNUAL REPORT Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Because of the Company’s conservative capital structure, its liq- uidity has not been significantly affected by the recent turmoil in the credit markets. The Company maintains a ratio of total debt to total asset value of under 50%, which allows the Company to obtain additional secured borrowings if necessary. As of Decem- ber 31, 2016, amortizing fixed-rate mortgage debt with staggered maturities from 2018 to 2034 represented approxi- mately 93.0% of the Company’s notes payable, thus minimizing refinancing risk. The Company’s variable-rate debt consists of a $14.5 million bank term loan secured by the Metro Pike Center and $49.0 million outstanding under the unsecured revolving line of credit. As of December 31, 2016, the Company has loan availability of approximately $225.6 million under its $275.0 mil- lion unsecured revolving line of credit. Although it is management’s present intention to concentrate fu- ture acquisition and development activities on community and neighborhood shopping centers and office properties in the Washington, DC metropolitan area, the Company may, in the fu- ture, also acquire other types of real estate in other areas of the country as opportunities present themselves. While the Com- pany may diversify in terms of property locations, size and market, the Company does not set any limit on the amount or percentage of Company assets that may be invested in any one property or any one geographic area. CRITICAL ACCOUNTING POLICIES The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), which requires management to make certain estimates and assumptions that affect the reporting of financial position and results of operations. See Note 2 to the Consolidated Financial Statements in this report. The Company has identified the following policies that, due to estimates and assumptions inherent in those policies, involve a relatively high degree of judgment and complexity. REAL ESTATE INVESTMENTS Real estate investment properties are stated at historic cost less depreciation. Although the Company intends to own its real es- tate investment properties over a long term, from time to time it will evaluate its market position, market conditions, and other fac- tors 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 ag- gregate 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 pre- pared in conformity with GAAP, they do not report the current value of the Company’s real estate investment properties. The Company purchases real estate investment properties from time to time and records assets acquired and liabilities assumed, including land, buildings, and intangibles related to in-place leases and customer relationships based on their fair values. The fair value of buildings generally is determined as if the buildings were vacant upon acquisition and subsequently leased at market rental rates and considers the present value of all cash flows ex- pected to be generated by the property including an initial lease up period. The Company determines the fair value of above and below market intangibles associated with in-place leases by as- sessing the net effective rent and remaining term of the in-place lease relative to market terms for similar leases at acquisition tak- ing into consideration the remaining contractual lease period, renewal periods, and the likelihood of the tenant exercising its renewal options. The fair value of a below market lease compo- nent is recorded as deferred income and accreted as additional lease revenue over the remaining contractual lease period. If the fair value of the below market lease intangible includes fair value associated with a renewal option, such amounts are not accreted until the renewal option is exercised. If the renewal option is not exercised the value is recognized at that time. The fair value of above market lease intangibles is recorded as a deferred asset and is amortized as a reduction of lease revenue over the remain- ing contractual lease term. The Company determines the fair value of at-market in-place leases considering the cost of acquir- ing 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 value of the intangibles are amortized over the life of the customer relationship. From time to time the Company may purchase a property for future devel- opment purposes. The property may be improved with an existing structure that would be demolished as part of the devel- opment. In such cases, the fair value of the building may be determined based only on existing leases and not include esti- mated cash flows related to future leases. If there is an event or change in circumstance that indicates a po- tential impairment in the value of a real estate investment 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 in identifying impairment in- losses, significant dicators 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 undis- flows based upon estimated counted projected cash including recurring operating SAUL CENTERS, INC. 2016 ANNUAL REPORT 13 REVENUE RECOGNITION Rental and interest income are accrued as earned except when doubt exists as to collectability, in which case the accrual is dis- continued. Recognition of rental income commences when 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 recog- nized on a straight-line basis throughout the term of the lease. Expense recoveries represent a portion of property operating ex- penses billed to tenants, including common area maintenance, real estate taxes and other recoverable costs. Expense recoveries are recognized in the period when the expenses are incurred. Rental income based on a tenant’s revenue, known as percentage rent, is accrued when a tenant reports sales that exceed a specified breakpoint specified in the lease agreement. ALLOWANCE FOR DOUBTFUL ACCOUNTS -– CURRENT AND DEFERRED RECEIVABLES Accounts receivable primarily represent amounts accrued and un- paid from tenants in accordance with the terms of the respective leases, subject to the Company’s revenue recognition policy. Re- ceivables are reviewed monthly and reserves are established with a charge to current period operations when, in the opinion of man- agement, collection of the receivable is doubtful. In addition to rents due currently, accounts receivable include amounts represent- ing 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 ten- ant’s ability to perform under its lease obligations. LEGAL CONTINGENCIES The Company is subject to various legal proceedings and claims that arise in the ordinary course of business, which are generally covered by insurance. While the resolution of these matters can- not be predicted with certainty, the Company believes the final outcome of current matters will not have a material adverse effect on its financial position or the results of operations. Upon deter- mination 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. Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS capitalization rates, historic operating results and market condi- tions 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 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 pro- jections, the valuation could be negatively or positively affected. When incurred, the Company capitalizes the cost of improve- ments that extend the useful life of property and equipment. All repair and maintenance expenditures are expensed when in- curred. Leasehold improvements expenditures are capitalized when certain criteria are met, including when we supervise con- struction and will own the improvement. Tenant improvements 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, the assets are placed in service, rental income, direct operating expenses, and depreci- ation associated with such properties are included in current operations. Commercial development projects are substantially complete and available for occupancy upon completion of tenant improvements, but no later than one year from the cessation of major construction activity. Residential development projects are considered substantially complete and available for occupancy upon receipt of the certificate of occupancy from the appropriate licensing authority. Substantially completed portions of a project are accounted for as separate projects. Depreciation is calculated using the straight-line method and estimated useful lives of gener- ally 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 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 evalu- ating 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 acquisition properties. 14 SAUL CENTERS, INC. 2016 ANNUAL REPORT RESULTS OF OPERATIONS Same property revenue and same property operating income are non-GAAP financial measures of performance and improve the comparability of these measures by excluding the results of prop- erties which were not in operation for the entirety of the comparable reporting periods. We define same property revenue as total revenue minus the sum of interest income and revenue of properties not in operation for the entirety of the comparable reporting periods, and we define same property operating income as net income plus the sum of interest expense and amortization of deferred debt costs, depre- ciation and amortization, general and administrative expense, loss on the early extinguishment of debt (if any), predevelopment ex- pense and acquisition related costs, minus the sum of interest income, the change in the fair value of derivatives, gains on prop- erty dispositions (if any) and the results of properties which were not in operation for the entirety of the comparable periods. Other REITs may use different methodologies for calculating same property revenue and same property operating income. Accord- ingly, our same property revenue and same property operating income may not be comparable to those of other REITs. Same property revenue and same property operating income are used by management to evaluate and compare the operating per- formance of our properties, and to determine trends in earnings, because these measures are not affected by the cost of our funding, the impact of depreciation and amortization expenses, gains or losses from the acquisition and sale of operating real estate assets, general and administrative expenses or other gains and losses that relate to ownership of our properties. We believe the exclusion of these items from revenue and operating income is useful because the resulting measures capture the actual revenue generated and actual expenses incurred by operating our properties. Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Same property revenue and same property operating income are measures of the operating performance of our properties but do not measure our performance as a whole. Such measures are therefore not substitutes for total revenue, net income or operating income as computed in accordance with GAAP. The following tables provide reconciliations of total revenue and operating income under GAAP to same property revenue and operating income for the indicated periods. The same property results include 49 Shopping Centers and five Mixed-Use properties for each period. SAME PROPERTY REVENUE Year ended December 31, (In thousands) 2016 2015 Total revenue $ 217,070 $ 209,077 Less: Interest income (51) (51) Less: Acquisitions, dispositions and development properties (3,664) (1,835) Total same property revenue $ 213,355 $ 207,191 Shopping centers $ 159,744 $ 155,081 Mixed-Use properties 53,611 52,110 Total same property revenue $ 213,355 $ 207,191 The $6.2 million increase in same property revenue for 2016 compared to 2015 was primarily due to (a) a $0.30 per square foot increase in base rent ($2.6 million), exclusive of the impact of a lease termination at 11503 Rockville Pike, (b) the impact of a lease termination at 11503 Rockville Pike ($1.9 million), (c) increased expense recovery income ($1.4 million), and (d) a 32,855 square foot increase in leased space ($0.6 million), exclusive of the impact of a lease termination at 11503 Rockville Pike. SAUL CENTERS, INC. 2016 ANNUAL REPORT 15 Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SAME PROPERTY OPERATING INCOME Year Ended December 31, (In thousands) 2016 2015 Net income $ 56,720 $ 52,931 Add: Interest expense and amortization of deferred debt costs 45,683 45,165 Add: General and administrative 17,496 16,353 Add: Depreciation and amortization of deferred leasing costs 44,417 43,270 Add: Predevelopment expenses — 132 Add: Acquisition related costs 60 84 Add: Change in fair value of derivatives 6 10 Less: Gains on property dispositions (1,013) (1 1) Less: Interest income (51) (51) Property operating income 163,318 157,883 Less: Acquisitions, dispositions & development property (1,314) (1,115) Total same property operating income $ 162,004 $ 156,768 Shopping centers $ 124,917 $ 121,321 Mixed-Use properties 37,087 35,447 Total same property operating income $ 162,004 $ 156,768 Same property operating income increased $5.2 million for 2016 compared to 2015 due primarily to (a) a $0.30 per square foot in- crease in base rent ($2.6 million), exclusive of the impact of a lease termination at 11503 Rockville Pike, (b) the impact of a lease termi- nation at 11503 Rockville Pike ($1.9 million), (c) increased expense recovery income ($1.4 million), and (d) a 32,855 square foot increase in leased space ($0.6 million) partially offset by (e) higher real estate taxes ($0.7 million) and (f) higher provision for credit losses ($0.6 million), exclusive of the impact of a lease termination at 11503 Rockville Pike. The following is a discussion of the components of revenue and expense for the entire Company. REVENUE Year ended December 31, Percentage Change (Dollars in thousands) 2016 2015 2014 2016 from 2015 2015 from 2014 Base rent $ 172,381 $ 168,303 $ 164,599 2.4 % 2.3 % Expense recoveries 34,269 32,911 32,132 4.1 % 2.4 % Percentage rent 1,379 1,608 1,492 (14.2) % 7.8 % Other 9,041 6,255 8,869 44.5 % (29.5)% Total revenue $ 217,070 $ 209,077 $ 207,092 3.8 % 1.0 % 16 SAUL CENTERS, INC. 2016 ANNUAL REPORT Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Base rent includes $1.8 million, $2.4 million and $2.0 million, for the years 2016, 2015, and 2014, respectively, to recognize base rent on a straight-line basis. In addition, base rent includes $1.8 million, $1.8 million and $1.9 million, for the years 2016, 2015, and 2014, respectively, to recognize income from the amortization of in-place leases. Total revenue increased 3.8% in 2016 compared to 2015 primarily due to (a) a $0.34 per square foot increase in base rent ($3.0 mil- lion), exclusive of the impact of a lease termination at 11503 Rockville Pike, (b) higher residential base rent ($2.3 million), (c) the impact of a lease termination at 11503 Rockville Pike ($1.9 million), and (d) higher expense recoveries ($1.4 million) partially offset by (e) a 5,550 square foot decrease in leased space ($0.1 million), ex- clusive of the impact of a lease termination at 11503 Rockville Pike. Total revenue increased 1.0% in 2015 compared to 2014 primarily due to (a) a $0.45 per square foot increase in base rent ($3.9 mil- lion) and (b) higher expense recoveries ($0.8 million) partially offset by (c) a 2014 bankruptcy settlement and collection related to a former tenant at Seven Corners ($1.6 million), (d) the impact of a 2014 lease termination at Seven Corners ($1.9 million), and (e) a 6,586 square foot decrease in leased space ($0.1 million). A discussion of the components of revenue follows. BASE RENT The $4.1 million increase in base rent in 2016 compared to 2015 was attributable to (a) a $0.21 per square foot increase in base rent ($1.8 million) and (b) higher residential base rent ($2.3 million) par- tially offset by (c) a 5,550 square foot decrease in leased space ($0.1 million). The $3.7 million increase in base rent in 2015 com- pared to 2014 was attributable to (a) a $0.45 per square foot increase in base rent ($3.9 million) partially offset by (b) a 6,586 square foot decrease in leased space ($0.1 million). EXPENSE RECOVERIES Expense recovery income increased $1.4 million in 2016 com- pared to 2015 primarily due to higher property operating expenses and real estate tax expense. Expense recovery income increased $0.8 million in 2015 compared to 2014 primarily due to higher real estate tax expense. OTHER REVENUE Other revenue increased $2.8 million in 2016 compared to 2015 due to a $3.0 million lease termination fee at 11503 Rockville Pike. Other revenue decreased $2.6 million in 2015 compared to 2014 due primarily to (a) the 2014 bankruptcy settlement and collection related to a former tenant at Seven Corners ($1.6 million) and (b) a 2014 lease termination fee at Seven Corners ($1.9 million). Year ended December 31, Percentage Change (Dollars in thousands) 2016 2015 2014 2016 from 2015 2015 from 2014 OPERATING EXPENSES Property operating expenses $ 27,527 $ 26,565 $ 26,479 3.6% 0.3% Provision for credit losses 1,494 915 680 63.3% 34.6% Real estate taxes 24,680 23,663 22,354 4.3% 5.9% Interest expense and amortization of deferred debt costs 45,683 45,165 46,034 1.1% (1.9)% Depreciation and amortization of deferred leasing costs 44,417 43,270 41,203 2.7% 5.0% General and administrative 17,496 16,353 16,961 7.0% (3.6)% Acquisition related costs 60 84 949 (28.6)% (91.1)% Predevelopment expenses — 132 503 (100.0)% (73.8)% Total operating expenses $ 161,357 $ 156,147 $ 155,163 3.3% 0.6% Total operating expenses increased 3.3% in 2016 compared to 2015. Total operating expenses increased 0.6% in 2015 compared to 2014. SAUL CENTERS, INC. 2016 ANNUAL REPORT 17 Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PROPERTY OPERATING EXPENSES Property operating expenses increased $1.0 million in 2016 com- pared to 2015. Property operating expenses increased $0.1 million in 2015 compared to 2014. GAIN ON SALES OF PROPERTIES Gain on sale of property in 2016 resulted from the December 2016 sale of Crosstown Business Center. Gain on sale of property in 2014 resulted from the April 2014 sale of Giant Center shopping center. IMPACT OF INFLATION Inflation has remained relatively low during 2016 and 2015. The impact of rising operating expenses due to inflation on the oper- ating performance of the Company’s portfolio would have been mitigated by terms in substantially all of the Company’s leases which contain provisions designed to increase revenues to offset the adverse impact of inflation on the Company’s results of oper- ations. These provisions include upward periodic adjustments in base rent due from tenants, usually based on a stipulated increase and to a lesser extent on a factor of the change in the consumer price index, commonly referred to as the CPI. In addition, substantially all of the Company’s properties are leased to tenants under long-term leases, which provide for reim- bursement of operating expenses by tenants. These leases tend to reduce the Company’s exposure to rising property expenses due to inflation. Inflation and increased costs may have an adverse impact on the Company’s tenants if increases in their operating ex- penses exceed increases in their revenue. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents were $8.3 million and $10.0 million at December 31, 2016 and 2015, respectively. The changes in cash and cash equivalents during the years ended December 31, 2016 and 2015 were attributable to operating, investing and financing activities, as described below. Year Ended December 31, (In thousands) 2016 2015 Net cash provided by operating activities $ 89,090 $ 88,896 Net cash used in investing activities (86,274) (69,587) Net cash used in financing activities (4,497) (21,434) Decrease in cash and cash equivalents $ (1,681) $ (2,125) PROVISION FOR CREDIT LOSSES The provision for credit losses represents the Company’s estimate of amounts owed by tenants that may not be collectible and was 0.69%, 0.44%, and 0.33% for 2016, 2015, and 2014, respectively. The increases in 2016 and 2015 relate primarily to a single shop- ping center tenant. REAL ESTATE TAXES Real estate taxes increased $1.0 million in 2016 compared to 2015 primarily due to (a) Park Van Ness ($0.3 million) and (b) small in- creases at various properties throughout the portfolio. Real estate taxes increased $1.3 million in 2015 compared to 2014 primarily due to a $0.5 million increase at 601 Pennsylvania Avenue, a $0.3 million increase at Clarendon Center and small increases through- out the remainder of the portfolio. DEPRECIATION AND AMORTIZATION Depreciation and amortization of deferred leasing costs increased by $1.1 million in 2016 compared to 2015 primarily due to (a) Park Van Ness ($1.8 million) partially offset by (b) lower expense at Ger- mantown ($0.7 million). Depreciation and amortization of deferred leasing costs increased $2.1 million in 2015 compared to 2014 primarily due to (a) additional depreciation expense on a portion of the buildings at Germantown as a result of the reduction of their useful lives to six months effective May 2015 ($0.7 million) and (b) incremental depreciation expense on buildings purchased in 2014 and 2015 ($0.6 million). GENERAL AND ADMINISTRATIVE General and administrative costs increased $1.1 million in 2016 compared to 2015 primarily due to (a) increased salary and benefit expense ($1.0 million) and (b) increased stock option expense ($0.2 million). General and administrative costs decreased $0.6 million in 2015 compared to 2014 primarily due to the accrual in 2014 of $1.1 million of severance costs. ACQUISITION RELATED COSTS Acquisition related costs in 2016 totaling approximately $0.1 mil- lion relate to the purchase of a retail pad site adjacent to the Company's existing Thruway Shopping Center. Acquisition re- lated costs in 2015 totaling approximately $0.1 million relate to the purchase of 726 N. Glebe Road. Acquisition related costs in 2014 totaling approximately $0.9 million relate to the purchase of 1580, 1582 and 1584 Rockville Pike and 730 and 750 N. Glebe Road. PREDEVELOPMENT EXPENSES Predevelopment expenses include lease termination costs and demolition costs which are related to development projects and do not meet the criteria to be capitalized. 18 SAUL CENTERS, INC. 2016 ANNUAL REPORT OPERATING ACTIVITIES Net cash provided by operating activities increased $0.2 million to $89.1 million for the year ended December 31, 2016 compared to $88.9 million for the year ended December 31, 2015. Net cash provided by operating activities represents, in each year, cash re- ceived primarily from rental income, plus other income, less property operating expenses, normal recurring general and ad- ministrative expenses and interest payments on debt outstanding. INVESTING ACTIVITIES Net cash used in investing activities increased $16.7 million to $86.3 million for the year ended December 31, 2016 from $69.6 million for the year ended December 31, 2015. Investing activities in 2016 primarily reflect tenant improvements and capital expen- ditures ($15.6 million), the Company's development activities ($27.2 million) and the acquisition of various retail real estate assets ($48.3 million). Net cash used in investing activities decreased $14.0 million to $69.6 million for the year ended December 31, 2015 from $83.6 million for the year ended December 31, 2014. Investing activities in 2015 primarily reflect (a) tenant improve- ments and capital expenditures ($18.9 million), (b) the Company's development activities ($45.9 million) and (c) the acquisition of various retail real estate assets ($4.9 million). FINANCING ACTIVITIES Net cash used in financing activities was $4.5 million and $21.4 million for the years ended December 31, 2016 and 2015, respectively. Net cash used in financing activities in 2016 primarily reflects: • the repayment of mortgage notes payable totaling $24.7 mil- lion; • the repayment of amounts borrowed under the revolving credit facility totaling $57.5 million; • distributions to common stockholders totaling $39.5 million; • distributions to holders of convertible limited partnership units in the Operating Partnership totaling $13.5 million; • distributions made to preferred stockholders totaling $12.4 mil- lion; and • payments of $0.1 million for financing costs of mortgage notes payable; which was partially offset by: • proceeds of $78.5 million received from revolving credit facility draws; • proceeds of $6.9 million from the issuance of limited partner- ship units in the Operating Partnership under the dividend reinvestment program; • proceeds of $21.6 million from the issuance of common stock under the dividend reinvestment program, directors deferred plan and from the exercise of stock options; and • proceeds of $24.9 million received from construction loan draws. Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net cash used in financing activities for the year ended December 31, 2015 primarily reflects: • repayments of $35.0 million on the revolving credit facility; • the repayment of mortgage notes payable totaling $53.0 million; • distributions to common stockholders totaling $35.6 million; • distributions to holders of convertible limited partnership units in the Operating Partnership totaling $12.2 million; • distributions made to preferred stockholders totaling $12.4 mil- lion; and • payments of $0.3 million for financing costs of new mortgage loans; which was partially offset by: • proceeds of $20.0 million received from revolving credit facility; • proceeds of $5.7 million from the issuance of limited partner- ship units in the Operating Partnership under the dividend reinvestment program; • proceeds of $15.6 million received from the issuance of com- mon stock under the dividend reinvestment program and from the exercise of stock options; and • proceeds of $39.8 million from construction loan draws. LIQUIDITY REQUIREMENTS Short-term liquidity requirements consist primarily of normal recur- ring operating expenses and capital expenditures, debt service requirements (including debt service relating to additional and re- placement debt), distributions to common and preferred stockholders, distributions to unit holders and amounts required for expansion and renovation of the Current Portfolio Properties and selective acquisition and development of additional proper- ties. In order to qualify as a REIT for federal income tax purposes, the Company must distribute to its stockholders at least 90% of its “real estate investment trust taxable income,” as defined in the Code. The Company expects to meet these short-term liquidity requirements (other than amounts required for additional property acquisitions and developments) through cash provided from op- erations, available cash and its existing line of credit. SAUL CENTERS, INC. 2016 ANNUAL REPORT 19 Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Long-term liquidity requirements consist primarily of obligations under our long-term debt and dividends paid to our preferred shareholders. We anticipate that long-term liquidity requirements will also include amounts required for property acquisitions and developments. The Company is in the early stages of the devel- opment of a primarily residential project with street-level retail at 750 N. Glebe Road in Arlington, Virginia. The cost of this project, which has not been determined, is expected to be funded through debt financing and working capital, including the Com- pany's existing line of credit. The Company may also redevelop certain of the Current Portfolio Properties and may develop addi- tional freestanding outparcels or expansions within certain of the Shopping Centers. Acquisition and development of properties are undertaken only after careful analysis and review, and management’s determination that such properties are expected to provide long-term earnings and cash flow growth. During the coming year, developments, ex- pansions or acquisitions are expected to be funded with available cash, bank borrowings from the Company’s credit line, construc- tion and permanent financing, proceeds from the operation of the Company’s dividend reinvestment plan or other external debt or equity capital resources available to the Company. Any future bor- rowings may be at the Saul Centers, Operating Partnership or Subsidiary Partnership level, and securities offerings may include (subject to certain limitations) the issuance of additional limited partnership interests in the Operating Partnership which can be converted into shares of Saul Centers common stock. The avail- ability and terms of any such financing will depend upon market and other conditions. CONTRACTUAL PAYMENT OBLIGATIONS As of December 31, 2016, the Company had unfunded contrac- tual payment obligations of approximately $37.9 million, excluding operating obligations, due within the next 12 months. The table below shows the total contractual payment obligations as of December 31, 2016. Payments Due By Period (Dollars in thousands) One Year or Less 2 - 3 Years 4 - 5 Years After 5 Years Total CONTRACTUAL PAYMENT OBLIGATIONS Notes Payable: Interest $ 3,835 $ 6,657 $ 5,235 $ 11,027 $ 26,754 Scheduled Principal 26,418 51,431 44,190 109,761 231,800 Balloon Payments — 151,658 72,175 452,142 675,975 Subtotal 30,253 209,746 121,600 572,930 934,529 Ground Leases (1) 56 113 124 3,636 3,929 Corporate Headquarters Lease (1) 136 — — — 136 Development Obligations 1,528 1,964 — — 3,492 Tenant Improvements 5,878 1,797 — — 7,675 Total Contractual Obligations $ 37,851 $ 213,620 $ 121,724 $ 576,566 $ 949,761 (1) See Note 7 to Consolidated Financial Statements. Corporate Headquarters Lease amounts represent an allocation to the Company based upon em- ployees’ time dedicated to the Company’s business as specified in the Shared Services Agreement. Future amounts are subject to change as the number of employees employed by each of the parties to the lease fluctuates. Management believes that the Company’s cash flow from operations and its capital resources, which at December 31, 2016, included cash balances of $8.3 million and borrowing availability of approxi- mately $225.6 million on its revolving line of credit, will be sufficient to meet its contractual obligations for the foreseeable future. 20 SAUL CENTERS, INC. 2016 ANNUAL REPORT Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PREFERRED STOCK ISSUES In December 2014, the Company redeemed the remaining out- standing shares of its 8% Series A Cumulative Redeemable Preferred Stock. In February 2013, the Company sold, in an underwritten public of- fering, 5.6 million depositary shares, each representing 1/100th of a share of 6.875% Series C Cumulative Redeemable Preferred Stock (the “Series C Stock”), providing net cash proceeds of ap- proximately $135.2 million. The depositary shares may be redeemed at the Company’s option, in whole or in part, at the $25.00 liquidation preference plus accrued but unpaid dividends on or after February 12, 2018. The depositary shares pay an annual dividend of $1.71875 per share, equivalent to 6.875% of the $25.00 liquidation preference. The first dividend was paid on April 15, 2013 and covered the period from February 12, 2013 through March 31, 2013. The Series C Stock has no stated matu- rity, is not subject to any sinking fund or mandatory redemption and is not convertible into any other securities of the Company ex- cept 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. In November 2014, the Company sold, in an underwritten public offering, 1.6 million depositary shares of the Series C Stock (the “Additional Series C Stock”). The Company received proceeds of approximately $39.3 million from the offering and used the pro- ceeds to redeem its outstanding Series A Stock. The Additional Series C Stock represents a new issuance of additional depositary shares representing shares of Series C Stock. DIVIDEND REINVESTMENTS In December 1995, the Company established a Dividend Rein- vestment Plan (the “Plan”) to allow its common stockholders and holders of limited partnership interests an opportunity to buy ad- ditional shares of common stock by reinvesting all or a portion of their dividends or distributions. The Plan provides for investing in newly issued shares of common stock at a 3% discount from mar- ket price without payment of any brokerage commissions, service charges or other expenses. All expenses of the Plan are paid by the Company. The Company issued 178,787 and 193,678 shares under the Plan at a weighted average discounted price of $55.19 and $52.93 per share during the years ended December 31, 2016 and 2015, respectively. The Company issued 124,758 and 107,037 limited partnership units under the Plan at a weighted av- erage price of $55.39 and $53.00 per unit during the years ended December 31, 2016 and 2015, respectively. The Company also credited 8,010 and 7,534 shares to directors pursuant to the rein- vestment of dividends specified by the Directors’ Deferred Compensation Plan at a weighted average discounted price of $55.42 and $53.01 per share, during the years ended December 31, 2016 and 2015, respectively. CAPITAL STRATEGY AND FINANCING ACTIVITY As a general policy, the Company intends to maintain a ratio of its total debt to total asset value of 50% or less and to actively manage the Company’s leverage and debt expense on an ongoing basis in order to maintain prudent coverage of fixed charges. Asset value is the aggregate fair market value of the Current Portfolio Properties and any subsequently acquired properties as reason- ably determined by management by reference to the properties’ aggregate cash flow. Given the Company’s current debt level, it is management’s belief that the ratio of the Company’s debt to total asset value was below 50% as of December 31, 2016. The organizational documents of the Company do not limit the absolute amount or percentage of indebtedness that it may incur. The Board of Directors may, from time to time, reevaluate the Com- pany’s debt capitalization policy in light of current economic conditions, relative costs of capital, market values of the Company property portfolio, opportunities for acquisition, development or expansion, and such other factors as the Board of Directors then deems relevant. The Board of Directors may modify the Com- pany’s debt capitalization policy based on such a reevaluation without shareholder approval and consequently, may increase or decrease the Company’s debt to total asset ratio above or below 50% or may waive the policy for certain periods of time. The Com- pany selectively continues to refinance or renegotiate the terms of its outstanding debt in order to achieve longer maturities, and ob- tain generally more favorable loan terms, whenever management determines the financing environment is favorable. SAUL CENTERS, INC. 2016 ANNUAL REPORT 21 Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a summary of notes payable as of December 31, 2016 and 2015. NOTES PAYABLE Year Ended December 31, Interest Scheduled (Dollars in thousands) 2016 2015 Rate* Maturity* Fixed rate mortgages: $ 29,428 (a) $ 30,778 6.01% Feb-2018 32,036 (b) 33,766 5.88% Jan-2019 10,372 (c) 10,928 5.76% May-2019 14,335 (d) 15,098 5.62% Jul-2019 14,325 (e) 15,064 5.79% Sep-2019 12,725 (f) 13,387 5.22% Jan-2020 10,277 (g) 10,587 5.60% May-2020 8,697 (h) 9,127 5.30% Jun-2020 39,213 (i) 40,360 5.83% Jul-2020 7,685 (j) 8,025 5.81% Feb-2021 5,808 (k) 5,959 6.01% Aug-2021 33,571 (l) 34,420 5.62% Jun-2022 10,253 (m) 10,492 6.08% Sep-2022 11,129 (n) 11,365 6.43% Apr-2023 13,401 (o) 14,177 6.28% Feb-2024 15,917 (p) 16,348 7.35% Jun-2024 13,832 (q) 14,197 7.60% Jun-2024 24,504 (r) 25,088 7.02% Jul-2024 28,945 (s) 29,714 7.45% Jul-2024 28,822 (t) 29,564 7.30% Jan-2025 14,961 (u) 15,360 6.18% Jan-2026 109,144 (v) 112,299 5.31% Apr-2026 33,097 (w) 34,133 4.30% Oct-2026 37,701 (x) 38,842 4.53% Nov-2026 17,630 (y) 18,150 4.70% Dec-2026 66,210 (z) 67,850 5.84% May-2027 16,352 (aa) 16,826 4.04% Apr-2028 41,753 (bb) 31,844 3.51% Jun-2028 16,543 (cc) 17,011 3.99% Sep-2028 28,679 (dd) 29,444 3.69% Mar-2030 15,357 (ee) 15,748 3.99% Apr-2030 70,144 (ff) 45,208 4.88% Sep-2032 11,446 (gg) 11,282 8.00% Apr-2034 Total fixed rate 844,292 832,441 5.48% 8.5 Years Variable rate loans: 49,000 (hh) 28,000 LIBOR + 1.45% Jun-2018 14,482 (ii) 14,801 LIBOR + 1.65% Feb-2018 Total variable rate 63,482 42,801 2.22% 1.3 Years Total notes payable $ 907,774 $ 875,242 5.25% 8.0 Years * Interest rate and scheduled maturity data presented as of December 31, 2016. Totals computed using weighted averages. Amounts shown are principal amounts and have not been reduced by any deferred debt issuance costs. 22 SAUL CENTERS, INC. 2016 ANNUAL REPORT (a) The loan is collateralized by Washington Square and requires equal monthly principal and interest payments of $264,000 based upon a 27.5-year amorti- zation schedule and a final payment of $28.0 million at loan maturity. Principal of $1.4 million was amortized during 2016. (b) The loan is collateralized by three shopping centers, Broadlands Village, The Glen and Kentlands Square I, and requires equal monthly principal and interest payments of $306,000 based upon a 25-year amortization schedule and a final payment of $28.4 million at loan maturity. Principal of $1.7 million was amortized during 2016. (c) The loan is collateralized by Olde Forte Village and requires equal monthly principal and interest payments of $98,000 based upon a 25-year amortiza- tion schedule and a final payment of $9.0 million at loan maturity. Principal of $556,000 was amortized during 2016. (d) The loan is collateralized by Countryside and requires equal monthly principal and interest payments of $133,000 based upon a 25-year amortization sched- ule and a final payment of $12.3 million at loan maturity. Principal of $763,000 was amortized during 2016. (e) The loan is collateralized by Briggs Chaney MarketPlace and requires equal monthly principal and interest payments of $133,000 based upon a 25-year amortization schedule and a final payment of $12.2 million at loan maturity. Principal of $739,000 was amortized during 2016. (f) The loan is collateralized by Shops at Monocacy and requires equal monthly principal and interest payments of $112,000 based upon a 25-year amortiza- tion schedule and a final payment of $10.6 million at loan maturity. Principal of $662,000 was amortized during 2016. (g) The loan is collateralized by Boca Valley Plaza and requires equal monthly prin- cipal and interest payments of $75,000 based upon a 30-year amortization schedule and a final payment of $9.1 million at loan maturity. Principal of $310,000 was amortized during 2016. (h) The loan is collateralized by Palm Springs Center and requires equal monthly principal and interest payments of $75,000 based upon a 25-year amortiza- tion schedule and a final payment of $7.1 million at loan maturity. Principal of $430,000 was amortized during 2016. (i) The loan and a corresponding interest-rate swap closed on June 29, 2010 and are collateralized by Thruway. On a combined basis, the loan and the interest- rate swap require equal monthly principal and interest payments of $289,000 based upon a 25-year amortization schedule and a final payment of $34.8 mil- lion at loan maturity. Principal of $1,147,000 was amortized during 2016. (j) The loan is collateralized by Jamestown Place and requires equal monthly prin- cipal and interest payments of $66,000 based upon a 25-year amortization schedule and a final payment of $6.1 million at loan maturity. Principal of $340,000 was amortized during 2016. (k) The loan is collateralized by Hunt Club Corners and requires equal monthly principal and interest payments of $42,000 based upon a 30-year amortiza- tion schedule and a final payment of $5.0 million, at loan maturity. Principal of $151,000 was amortized during 2016. (l) The loan is collateralized by Lansdowne Town Center and requires monthly principal and interest payments of $230,000 based on a 30-year amortization schedule and a final payment of $28.2 million at loan maturity. Principal of $849,000 was amortized during 2016. (m) The loan is collateralized by Orchard Park and requires equal monthly principal and interest payments of $73,000 based upon a 30-year amortization sched- ule and a final payment of $8.6 million at loan maturity. Principal of $239,000 was amortized during 2016. (n) The loan is collateralized by BJ’s Wholesale and requires equal monthly prin- cipal and interest payments of $80,000 based upon a 30-year amortization schedule and a final payment of $9.3 million at loan maturity. Principal of $236,000 was amortized during 2016. (o) The loan is collateralized by Great Falls shopping center. The loan consists of three notes which require equal monthly principal and interest payments of $138,000 based upon a weighted average 26-year amortization schedule and a final payment of $6.3 million at maturity. Principal of $776,000 was amortized during 2016. (p) The loan is collateralized by Leesburg Pike and requires equal monthly princi- pal and interest payments of $135,000 based upon a 25-year amortization Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS schedule and a final payment of $11.5 million at loan maturity. Principal of $431,000 was amortized during 2016. (q) The loan is collateralized by Village Center and requires equal monthly princi- pal and interest payments of $119,000 based upon a 25-year amortization schedule and a final payment of $10.1 million at loan maturity. Principal of $365,000 was amortized during 2016. (r) The loan is collateralized by White Oak and requires equal monthly principal and interest payments of $193,000 based upon a 24.4 year weighted amor- tization schedule and a final payment of $18.5 million at loan maturity. The loan was previously collateralized by Van Ness Square. During 2012, the Com- pany substituted White Oak as the collateral and borrowed an additional $10.5 million. Principal of $584,000 was amortized during 2016. (s) The loan is collateralized by Avenel Business Park and requires equal monthly principal and interest payments of $246,000 based upon a 25-year amorti- zation schedule and a final payment of $20.9 million at loan maturity. Principal of $769,000 was amortized during 2016. (t) The loan is collateralized by Ashburn Village and requires equal monthly prin- cipal and interest payments of $240,000 based upon a 25-year amortization schedule and a final payment of $20.5 million at loan maturity. Principal of $742,000 was amortized during 2016. (u) The loan is collateralized by Ravenwood and requires equal monthly principal and interest payments of $111,000 based upon a 25-year amortization sched- ule and a final payment of $10.1 million at loan maturity. Principal of $399,000 was amortized during 2016. (v) The loan is collateralized by Clarendon Center and requires equal monthly principal and interest payments of $753,000 based upon a 25-year amortiza- tion schedule and a final payment of $70.5 million at loan maturity. Principal of $3.2 million was amortized during 2016. (w) The loan is collateralized by Severna Park MarketPlace and requires equal monthly principal and interest payments of $207,000 based upon a 25-year amortization schedule and a final payment of $20.3 million at loan maturity. Principal of $1,036,000 was amortized during 2016. (x) The loan is collateralized by Kentlands Square II and requires equal monthly principal and interest payments of $240,000 based upon a 25-year amorti- zation schedule and a final payment of $23.1 million at loan maturity. Principal of $1,141,000 was amortized during 2016. (y) The loan is collateralized by Cranberry Square and requires equal monthly principal and interest payments of $113,000 based upon a 25-year amortiza- tion schedule and a final payment of $10.9 million at loan maturity. Principal of $520,000 was amortized during 2016. (z) The loan in the original amount of $73.0 million closed in May 2012, is collat- eralized by Seven Corners and requires equal monthly principal and interest payments of $463,200 based upon a 25-year amortization schedule and a final payment of $42.3 million at loan maturity. Principal of $1.6 million was amortized during 2016. (aa) The loan is collateralized by Hampshire Langley and requires equal monthly principal and interest payments of $95,400 based upon a 25-year amortiza- tion schedule and a final payment of $9.5 million at loan maturity. Principal of $474,000 was amortized in 2016. (bb) The loan is collateralized by Beacon Center and requires equal monthly prin- cipal and interest payments of $268,500 based upon a 20-year amortization schedule and a final payment of $17.1 million at loan maturity. Principal of $1.3 million was amortized in 2016. (cc) The loan is collateralized by Seabreeze Plaza and requires equal monthly prin- cipal and interest payments of $94,900 based upon a 25-year amortization schedule and a final payment of $9.5 million at loan maturity. Principal of $468,000 was amortized in 2016. (dd) The loan is collateralized by Shops at Fairfax and Boulevard shopping centers and requires equal monthly principal and interest payments totaling $153,300 based upon a 25-year amortization schedule and a final payment of $15.5 mil- lion at maturity. Principal of $765,000 was amortized in 2016. (ee) The loan is collateralized by Northrock and requires equal monthly principal and interest payments totaling $84,400 based upon a 25-year amortization schedule and a final payment of $8.4 million at maturity. Principal of $391,000 was amortized in 2016. SAUL CENTERS, INC. 2016 ANNUAL REPORT 23 (hh) The loan is a $275.0 million unsecured revolving credit facility. Interest accrues at a rate equal to the sum of one-month LIBOR plus a spread of 145 basis points. The line may be extended at the Company’s option for one year with payment of a fee of 0.15%. Monthly payments, if required, are interest only and vary depending upon the amount outstanding and the applicable interest rate for any given month. (ii) The loan is collateralized by Metro Pike Center and requires monthly principal and interest payments of approximately $48,000 and a final payment of $14.2 million at loan maturity. Principal of $319,000 was amortized during 2016. On April 1, 2015, the Company closed on a 15-year, non-recourse $16.0 million mortgage loan secured by Northrock. The loan ma- tures in 2030, bears interest at a fixed rate of 3.99%, requires monthly principal and interest payments totaling $84,400 based on a 25-year amortization schedule and requires a final payment of $8.4 million at maturity. Proceeds of the loan were used to repay in full the $14.5 million remaining balance of existing debt secured by Northrock. 2014 FINANCING ACTIVITY On June 24, 2014, the Company amended and restated its revolv- ing credit facility. The unsecured revolving credit facility, which can be used for working capital, property acquisitions, develop- ment projects or letters of credit was increased to $275.0 million. The revolving credit facility matures on June 23, 2018, and may be extended by the Company for one additional year subject to the Company’s satisfaction of certain conditions. Saul Centers and cer- tain consolidated subsidiaries of the Operating Partnership have guaranteed the payment obligations of the Operating Partnership under the revolving credit facility. Letters of credit may be issued under the revolving credit facility. The interest rate under the facility is variable and equals the sum of one-month LIBOR and a margin that is based on the Company’s leverage ratio, and which can range from 145 basis points to 200 basis points. OFF-BALANCE SHEET ARRANGEMENTS The Company has no off-balance sheet arrangements that are rea- sonably likely to have a current or future material effect on the Company’s financial condition, revenue or expenses, results of op- erations, liquidity, capital expenditures or capital resources. Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (ff) The loan is a $71.6 million construction-to-permanent facility that is collateral- ized by and will finance a portion of the construction costs of Park Van Ness. During the construction period, interest will be funded by the loan. After con- version to a permanent loan, monthly principal and interest payments totaling $413,500 will be required based upon a 25-year amortization schedule. A final payment of $39.6 million will be due at maturity. (gg) The Company entered into a sale-leaseback transaction with its Olney prop- erty and is accounting for that transaction as a secured financing. The arrangement requires monthly payments of $60,400 which increase by 1.5% on May 1, 2015, and every May 1 thereafter. The arrangement provides for a final payment of $14.7 million and has an implicit interest rate of 8.0%. Neg- ative amortization in 2016 totaled $164,000. The carrying value of properties collateralizing the mortgage notes payable totaled $957.2 million and $856.8 million as of December 31, 2016 and 2015, respectively. The Company’s credit facility re- quires the Company and its subsidiaries to maintain certain financial covenants, which are summarized below. As of December 31, 2016, the Company was in compliance with all such covenants: • maintain tangible net worth, as defined in the loan agree- ment, of at least $542.1 million plus 80% of the Company’s net equity proceeds received after March 2014; • • • limit the amount of debt as a percentage of gross asset value, as defined in the loan agreement, to less than 60% (leverage ratio); limit the amount of debt so that interest coverage will exceed 2.0x on a trailing four-quarter basis (interest expense cover- age); and limit the amount of debt so that interest, scheduled principal amortization and preferred dividend coverage exceeds 1.3x on a trailing four-quarter basis (fixed charge coverage). 2016 FINANCING ACTIVITY In November 2016, the existing loan secured by Beacon Center was increased by $11.25 million. The interest rate, amortization period and maturity date did not change; the required monthly payment was increased to $268,500. Proceeds were used to partially fund the purchase of the ground which underlies Beacon Center. 2015 FINANCING ACTIVITY On March 3, 2015, the Company closed on a 15-year, $30.0 mil- lion non-recourse mortgage loan secured by Boulevard and Shops at Fairfax shopping centers in Fairfax, Virginia. The loan matures in 2030, bears interest at a fixed rate of 3.69%, requires monthly principal and interest payments totaling $153,300 based on a 25 - year amortization schedule and a final payment of $15.5 million at maturity. Proceeds of the loan were used to repay in full the exist- ing 7.45% mortgage in the amount of $15.2 million, which was scheduled to mature in June 2015 and to pay down outstanding balances under the revolving credit facility. 24 SAUL CENTERS, INC. 2016 ANNUAL REPORT Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FUNDS FROM OPERATIONS In 2016, the Company reported Funds From Operations (“FFO”)1 available to common stockholders and noncontrolling interests of $87.7 million, a 4.7% increase from 2015 FFO available to common stockholders and noncontrolling interests of $83.8 million. Initial operations of Park Van Ness adversely impacted 2016 FFO by approximately $1.1 million. The following table presents a reconciliation from net income to FFO available to common stockholders and noncontrolling interests for the periods indicated: Year ended December 31, (Dollars in thousands except per share amounts) 2016 2015 2014 2013 2012 Net income $ 56,720 $ 52,931 $ 57,988 $ 34,842 $ 39,780 Subtract: Gains on sales of properties (1,013) (11) (6,069) — (4,510) Gain on casualty settlement — — — (77) (219) Add: Real estate depreciation – discontinued operations — — — — 77 Real estate depreciation and amortization 44,417 43,270 41,203 49,130 40,112 FFO 100,124 96,190 93,122 83,895 75,240 Subtract: Preferred dividends (12,375) (12,375) (13,361) (13,983) (15,140) Preferred stock redemption — — (1,480) (5,228) — FFO available to common stockholders and noncontrolling interests $ 87,749 $ 83,815 $ 78,281 $ 64,684 $ 60,100 Average shares and units used to compute FFO per share 28,990 28,449 27,977 27,330 26,614 FFO per share $ 3.03 $ 2.95 $ 2.80 $ 2.37 $ 2.26 1 The National Association of Real Estate Investment Trusts (NAREIT) developed FFO as a relative non-GAAP financial measure of performance of an equity REIT in order to recognize that income-producing real estate historically has not depreciated on the basis determined under GAAP. FFO is defined by NAREIT as net income, computed in accordance with GAAP, plus real estate depreciation and amortization, and excluding extraordinary items, im- pairment charges on depreciable real estate assets and gains or losses from property dispositions. FFO does not represent cash generated from operating activities in accordance with GAAP and is not necessarily indicative of cash available to fund cash needs, which is disclosed in the Company’s Consolidated Statements of Cash Flows for the applicable periods. There are no material legal or functional restrictions on the use of FFO. FFO should not be considered as an alternative to net income, its most directly comparable GAAP measure, as an indicator of the Company’s operating perform- ance, or as an alternative to cash flows as a measure of liquidity. Management considers FFO a meaningful supplemental measure of operating performance because it primarily excludes the assumption that the value of the real estate assets diminishes predictably over time (i.e. depreciation), which is contrary to what we believe occurs with our assets, and because industry analysts have accepted it as a performance measure. FFO may not be comparable to similarly titled measures employed by other REITs. SAUL CENTERS, INC. 2016 ANNUAL REPORT 25 Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ACQUISITIONS, REDEVELOPMENTS AND RENOVATIONS Management anticipates that during the coming year the Com- pany will continue activities related to the redevelopment of 750 N. Glebe Road and complete activities related to Park Van Ness and may develop additional freestanding outparcels or expan- sions within certain of the Shopping Centers. Although not currently planned, it is possible that the Company may redevelop additional Current Portfolio Properties and may develop expan- sions within certain of the Shopping Centers. Acquisition and development of properties are undertaken only after careful analy- sis and review, and management’s determination that such properties are expected to provide long-term earnings and cash flow growth. During the coming year, any developments, expan- sions or acquisitions are expected to be funded with borrowings from the Company’s credit line, construction financing, proceeds from the operation of the Company’s dividend reinvestment plan or other external capital resources available to the Company. The Company has been selectively involved in acquisition, devel- opment, redevelopment and renovation activities. It continues to evaluate the acquisition of land parcels for retail and office devel- opment and acquisitions of operating properties for opportunities to enhance operating income and cash flow growth. The following describes significant acquisitions, developments, redevelopments and renovations which affected the Company’s financial position and results of operations in 2016, 2015, and 2014. 1500, 1580, 1582 AND 1584 ROCKVILLE PIKE In January 2014, the Company purchased for $8.0 million a single-tenant retail property with a 12,100 square foot CVS Pharmacy located at 1580 Rockville Pike in Rockville, Maryland, and incurred acquisition costs of $0.2 million. In April 2014, the Company purchased for $11.0 million a single-tenant retail property with a 40,700 square foot furniture store located at 1582 Rockville Pike in Rockville, Maryland, and incurred acquisition costs totaling approximately $0.2 million. Concurrently with the purchase, the Company sold to the same party, for $11.0 million, the 53,765 square foot Olney Center located in Olney, Maryland. In December 2014, the Company purchased for $6.2 million a single-tenant retail property with a 4,600 square foot restaurant located at 1584 Rockville Pike in Rockville, Maryland, and incurred acquisition costs totaling approximately $0.2 million. The properties at 1580, 1582 and 1584 Rockville Pike are contiguous with and an expansion of the Company’s assets at 1500 Rockville Pike. When combined with 1500 Rockville Pike, the four properties comprise 10.3 acres which are zoned for development potential of up to 1.2 million square feet of mixed-use space. The Company is actively engaged in a plan for redevelopment but has not committed to any timetable for commencement of construction. 26 SAUL CENTERS, INC. 2016 ANNUAL REPORT OLNEY Simultaneously with the sale of Olney Center in April 2014, the Company entered into a lease of the property with the buyer and the Company continues to operate and manage the property. The lease term is 20 years and the Company has the option to pur- chase the property for $14.6 million at the end of the lease term. The purchaser has the right to sell the property to the Company at any time from and after April 2016 at a price equal to $11.0 mil- lion increased by 1.5% annually beginning January 1, 2015 and continuing each January thereafter. The Company has accounted for this transaction as a secured financing. WESTVIEW PAD In February 2015, the Company purchased for $0.9 million, in- cluding acquisition costs, a 1.1 acre retail pad site in Frederick, Maryland, which is contiguous with and an expansion of the Com- pany's other Westview asset. 700, 726, 730, 750 N. GLEBE ROAD From 2014 through 2016, the Company purchased four adjacent properties for an aggregate $54.0 million located on N. Glebe Road in Arlington, Virginia. The properties comprise 2.8 acres of land. Effective August 1, 2016, the Company's properties at Glebe Road were vacant and removed from service. The Com- pany previously received zoning and site plan approval from Arlington County, Virginia for the development of approximately 490 residential units and 62,000 square feet of retail space. Util- ities have been disconnected, plans and specifications are in process, interest, real estate taxes and other costs related to de- velopment are being capitalized and the assets were reclassified to construction in progress in the Consolidated Balance Sheets. The demolition of the existing structures is expected to commence in the Spring of 2017, pending the issuance of the demolition per- mit. Commencement of construction remains uncertain and dependent on completion of plans and specifications and award of a general contract. PARK VAN NESS In 2016, the Company completed development of Park Van Ness, a 271-unit residential project with approximately 9,000 square feet of street-level retail, below street-level structured parking, and amenities including a community room, landscaped courtyards, a fitness room, a wi-fi lounge/business center, and a rooftop pool and deck. The structure comprises 11 levels, five of which on the east side are below street level. Because of the change in grade from the street eastward to Rock Creek Park, apartments on all 11 levels have park or city views. The street level retail space is 100% leased to a grocery/gourmet food market and an upscale Italian restaurant. As of March 1, 2017, leases have been executed for 217 apartments (80.1%) and 205 apartments were occupied. The total cost of the project, excluding predevelopment expense and land, which the Company has owned, was approximately $93.0 million, a portion of which was financed with a $71.6 million Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SOUTHDALE In the fourth quarter of 2016, the Company purchased for $15.0 million the land underlying Southdale. The land was previously leased by the Company with an annual rent of approximately $60,000. The purchase price was funded by the Company’s re- volving credit facility. BURTONSVILLE TOWN SQUARE In January 2017, the Company purchased for $76.3 million, includ- ing acquisition costs, Burtonsville Town Square, a 121,000 square foot shopping center located in Burtonsville, Maryland. Bur- tonsville Town Square is 100% leased and anchored by Giant Food and CVS Pharmacy. It has expansion development potential of up to 18,000 square feet of additional retail space. The pur- chase was funded with a new $40.0 million mortgage loan and through the Company's credit line facility. The mortgage bears in- terest at 3.39%, requires monthly principal and interest payments of $197,900 based upon a 25-year amortization schedule, and has a 15-year maturity. PROPERTY SALES GIANT CENTER In April 2014, the Company sold for $7.5 million the 70,040 square foot Giant Center located in Milford Mill, Maryland and rec- ognized a $6.1 million gain. As of March 31, 2014, the carrying amounts of the associated assets and liabilities were $0.5 million and $0.1 million, respectively. There was no debt on the property. CROSSTOWN BUSINESS CENTER In December 2016, the Company sold for $5.4 million the 197,100 square foot Crosstown Business Center located in Tulsa, Okla- homa and recognized a $1.0 million gain. construction-to-permanent loan. Costs incurred through Decem- ber 31, 2016, total approximately $92.9 million, of which $70.1 million has been financed by the loan. THRUWAY PAD In August 2016, the Company purchased for $3.1 million, a retail pad site with an occupied 4,200 square foot bank building in Win- ston Salem, North Carolina, and incurred acquisition costs of $60,000. The property is contiguous with and an expansion of the Company's Thruway Shopping Center. ASHBROOK MARKETPLACE In August 2016, the Company entered into an agreement to ac- quire from B. F. Saul Real Estate Investment Trust (the “Trust”), for an initial purchase price of $8.8 million, approximately 14.3 acres of land located at the intersection of Ashburn Village Boulevard and Russell Branch Parkway in Loudoun County, Virginia. The land is zoned for up to 115,000 square feet of retail development. In order to allow the Company time to pre-lease and complete proj- ect plans and specifications, the parties have agreed to a closing date in early 2018, at which time the Company will exchange lim- ited partnership units for the land. The number of limited partnership units to be exchanged will be based on the initial pur- chase price and the average share value (as defined in the agreement) of the Company’s common stock at the time of the ex- change. The Company intends to construct a shopping center and, upon stabilization, may be obligated to issue additional lim- ited partnership units to the Trust. BEACON CENTER In the fourth quarter of 2016, the Company purchased for $22.5 million the land underlying Beacon Center. The land was previ- ously leased by the Company with an annual rent of approximately $60,000. The purchase price was funded in part by an $11.25 mil- lion increase to the existing mortgage collateralized by Beacon Center and in part by the Company’s revolving credit facility. PORTFOLIO LEASING STATUS The following chart sets forth certain information regarding commercial leases at our properties for the periods indicated. Total Properties Total Square Footage Percentage Leased As of December 31, Shopping Centers Mixed-Use Shopping Centers Mixed-Use Shopping Centers Mixed-Use 2016 49 6 7,882,054 1,076,208 96.0% 91.0% 2015 50 6 7,896,499 1,264,488 95.4% 91.0% 2014 50 6 7,886,304 1,264,488 95.0% 90.8% SAUL CENTERS, INC. 2016 ANNUAL REPORT 27 Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The 2016 Mixed-Use leasing percentage includes the recently-de- veloped Park Van Ness commercial space and excludes Crosstown Business Center. The residential components of Clarendon Center and Park Van Ness were 97.1% and 72.7% leased at December 31, 2016. On a same property basis, which excludes the impact of properties not in operation for the entirety of the comparable peri- ods, the Shopping Center leasing percentage increased to 96.0% from 95.4% and the Mixed-Use leasing percentage decreased to 90.9% from 92.2%. The overall portfolio leasing percentage, on a comparative same property basis, increased to 95.4% at December 31, 2016 from 95.0% at December 31, 2015. The Clarendon Center residential component was 99.2% leased at December 31, 2015. On a same property basis, which excludes the impact of properties not in operation for the entirety of the comparable periods, the Shopping Center leasing percentage in- creased to 95.3% from 95.0%. and the Mixed-Use leasing percentage increased to 91.0% from 90.8%. The overall portfolio leasing percentage, on a comparative same property basis, in- creased to 94.7% at December 31, 2015 from 94.4% at December 31, 2014. The 2014 Shopping Center leasing percentage excludes the Giant Center, which was sold in 2014. The Clarendon Center residential component was 95.9% leased at December 31, 2014. On a same property basis, which excludes the impact of properties not in op- eration for the entirety of the comparable periods, the Shopping Center leasing percentage increased to 95.0% from 94.5% and the Mixed-Use leasing percentage increased to 90.8% from 90.5%. The overall portfolio leasing percentage, on a comparative same property basis, increased to 94.4% at December 31, 2014 from 93.9% at December 31, 2013. The following table shows selected data for leases executed in the indicated periods. The information is based on executed leases without adjustment for the timing of occupancy, tenant defaults, or landlord concessions. The base rent for an expiring lease is the an- nualized contractual base rent, on a cash basis, as of the expiration date of the lease. The base rent for a new or renewed lease is the annualized contractual base rent, on a cash basis, as of the expected rent commencement date. Because tenants that execute leases may not ultimately take possession of their space or pay all of their con- tractual rent, the changes presented in the table provide information only about trends in market rental rates. The actual changes in rental income received by the Company may be different. SELECTED LEASING DATA Base Rent per Square Foot Number New/Renewed Expiring Year ended December 31, Square Feet of Leases Leases Leases 2016 1,292,483 244 $ 17.24 $ 17.05 2015 1,583,310 259 15.15 14.82 2014 1,224,700 276 18.60 18.26 Additional information about commercial leasing activity during the three months ended December 31, 2016, is set forth below. The below information includes leases for space which had not been previously leased during the period of the Company's own- ership, either a result of acquisition or development. COMMERCIAL LEASING ACTIVITY New Leases Renewed Leases Number of leases 16 41 Square feet 65,221 214,737 Per square foot average annualized: Base rent $ 20.87 $ 20.34 Tenant improvements (0.62) (0.01) Leasing costs (0.08) –– Rent concessions (0.06) –– Effective rents $ 20.11 $ 20.33 During 2016, the Company entered into 216 new or renewed apart- ment leases, excluding new leases at Park Van Ness. The monthly rent per square foot for these leases was increased to $3.57 from $3.45. During 2015, the Company entered into 222 new or re- newed apartment leases. The monthly rent per square foot for these leases was unchanged at $3.45. During 2014, the Company en- tered into 234 new or renewed apartment leases. The monthly rent per square foot for these leases increased to $3.46 from $3.37. As of December 31, 2016, 952,517 square feet of Commercial space was subject to leases scheduled to expire in 2017. Below is information about existing and estimated market base rents per square foot for that space. EXPIRING LEASES Total Square feet 952,517 Average base rent per square foot $ 17.50 Estimated market base rent per square foot $ 17.83 28 SAUL CENTERS, INC. 2016 ANNUAL REPORT Management’s Discussion and Analysis OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company is exposed to interest rate fluctuations which will af- fect the amount of interest expense of its variable rate debt and the fair value of its fixed rate debt. As of December 31, 2016, the Company had variable rate indebtedness totaling $63.5 million. If the interest rates on the Company’s variable rate debt instru- ments outstanding at December 31, 2016 had been one percent higher, our annual interest expense relating to these debt instru- ments would have increased by $634,820, based on those balances. As of December 31, 2016, the Company had fixed-rate indebtedness totaling $844.3 million with a weighted average in- terest rate of 5.48%. If interest rates on the Company’s fixed-rate debt instruments at December 31, 2016 had been one percent higher, the fair value of those debt instruments on that date would have decreased by approximately $38.6 million. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to certain financial market risks, the most predominant being fluctuations in interest rates. Interest rate fluc- tuations are monitored by management as an integral part of the Company’s overall risk management program, which recognizes the unpredictability of financial markets and seeks to reduce the potentially adverse effect on the Company’s results of operations. The Company may, where appropriate, employ derivative instru- ments, such as interest rate swaps, to mitigate the risk of interest rate fluctuations. The Company does not enter into derivatives or other financial instruments for trading or speculative purposes. On June 29, 2010, the Company entered into an interest rate swap agreement with a $45.6 million notional amount to manage the interest rate risk associated with $45.6 million of variable-rate mort- gage debt. The swap agreement was effective July 1, 2010, terminates on July 1, 2020 and effectively fixes the interest rate on the mortgage debt at 5.83%. The aggregate fair value of the swap at December 31, 2016 was approximately $2.1 million and is re- flected in accounts payable, accrued expenses and other liabilities in the consolidated balance sheet. MANAGEMENT’S REPORT on Internal Control Over Financial Reporting ASSESSMENT OF EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING Management is responsible for establishing and maintaining adequate internal control over financial reporting. Manage- ment used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013 Framework) to assess the effec- tiveness of the Company’s internal control over financial reporting. Based upon the assessments, the Company’s management has concluded that, as of December 31, 2016, the Company’s internal control over financial reporting was effective. The Company’s independent registered public ac- counting firm has issued a report on the effectiveness of the Company’s internal control over financial reporting, which appears on page 31 in this Annual Report. SAUL CENTERS, INC. 2016 ANNUAL REPORT 29 Report OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders of Saul Centers, Inc. We have audited the accompanying consolidated balance sheets of Saul Centers, Inc. as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive in- come, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15(a)2(b). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and sched- ule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to ob- tain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Saul Centers, Inc. at December 31, 2016 and 2015, and the consol- idated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in rela- tion to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Saul Centers, Inc.’s internal control over financial reporting as of De- cember 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Spon- soring Organizations of the Treadway Commission (2013 framework) and our report dated March 7, 2017 expressed an un- qualified opinion thereon. Ernst & Young LLP McLean, Virginia March 7, 2017 30 SAUL CENTERS, INC. 2016 ANNUAL REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM on Internal Control Over Financial Reporting Report The Board of Directors and Stockholders of Saul Centers, Inc. We have audited Saul Centers, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Saul Centers, Inc.’s management is responsible for maintaining effective internal control over finan- cial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying As- sessment of Effectiveness of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Com- pany’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to ob- tain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effective- ness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circum- stances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted ac- counting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial state- ments in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of manage- ment and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unautho- rized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projec- tions of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Saul Centers, Inc. maintained, in all material re- spects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Saul Centers, Inc. as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended Decem- ber 31, 2016 of Saul Centers, Inc. and our report dated March 7, 2017 expressed an unqualified opinion thereon. Ernst & Young LLP McLean, Virginia March 7, 2017 SAUL CENTERS, INC. 2016 ANNUAL REPORT 31 Consolidated Balance Sheets December 31, December 31, (Dollars in thousands, except per share amounts) 2016 2015 Assets Real estate investments Land $ 422,546 $ 424,837 Buildings and equipment 1,214,697 1,114,357 Construction in progress 63,570 83,516 1,700,813 1,622,710 Accumulated depreciation (458,279) (425,370) 1,242,534 1,197,340 Cash and cash equivalents 8,322 10,003 Accounts receivable and accrued income, net 53,033 51,076 Deferred leasing costs, net 25,983 26,919 Prepaid expenses, net 5,057 4,663 Other assets 8,096 5,407 Total assets $ 1,343,025 $ 1,295,408 Liabilities Mortgage notes payable $ 783,400 $ 796,169 Revolving credit facility payable 48,217 26,695 Construction loan payable 68,672 43,641 Dividends and distributions payable 17,953 15,380 Accounts payable, accrued expenses and other liabilities 20,838 27,687 Deferred income 30,696 32,109 Total liabilities 969,776 941,681 Stockholders' equity Preferred stock, 1,000,000 shares authorized: Series C Cumulative Redeemable, 72,000 shares issued and outstanding 180,000 180,000 Common stock, $0.01 par value, 40,000,000 shares authorized, 21,704,359 and 21,266,239 shares issued and outstanding, respectively 217 213 Additional paid-in capital 328,171 305,008 Accumulated deficit (188,584) (180,091) Accumulated other comprehensive loss (1,299) (1,802) Total Saul Centers, Inc. stockholders' equity 318,505 303,328 Noncontrolling interests 54,744 50,399 Total stockholders' equity 373,249 353,727 Total liabilities and stockholders' equity $ 1,343,025 $ 1,295,408 The Notes to Financial Statements are an integral part of these statements. 32 SAUL CENTERS, INC. 2016 ANNUAL REPORT Consolidated Statements OF OPERATIONS For The Year Ended December 31, (Dollars in thousands, except per share amounts) 2016 2015 2014 Revenue Base rent $ 172,381 $ 168,303 $ 164,599 Expense recoveries 34,269 32,911 32,132 Percentage rent 1,379 1,608 1,492 Other 9,041 6,255 8,869 Total revenue 217,070 209,077 207,092 Operating expenses Property operating expenses 27,527 26,565 26,479 Provision for credit losses 1,494 915 680 Real estate taxes 24,680 23,663 22,354 Interest expense and amortization of deferred debt costs 45,683 45,165 46,034 Depreciation and amortization of deferred leasing costs 44,417 43,270 41,203 General and administrative 17,496 16,353 16,961 Acquisition related costs 60 84 949 Predevelopment expenses — 132 503 Total operating expenses 161,357 156,147 155,163 Operating income 55,713 52,930 51,929 Change in fair value of derivatives (6) (10) (10) Gains on sales of properties 1,013 11 6,069 Net Income 56,720 52,931 57,988 Income attributable to noncontrolling interests (11,441) (10,463) (11,045) Net income attributable to Saul Centers, Inc. 45,279 42,468 46,943 Preferred stock redemption — — (1,480) Preferred dividends (12,375) (12,375) (13,361) Net income available to common stockholders $ 32,904 $ 30,093 $ 32,102 Per share net income available to common stockholders Basic $ 1.53 $ 1.42 $ 1.55 Diluted $ 1.52 $ 1.42 $ 1.54 The Notes to Financial Statements are an integral part of these statements. SAUL CENTERS, INC. 2016 ANNUAL REPORT 33 Consolidated Statements OF COMPREHENSIVE INCOME For The Year Ended December 31, (Dollars in thousands) 2016 2015 2014 Net income $ 56,720 $ 52,931 $ 57,988 Other comprehensive income Unrealized gain (loss) on cash flow hedge 678 124 (675) Total comprehensive income 57,398 53,055 57,313 Comprehensive income attributable to noncontrolling interests (11,616) (10,495) (10,874) Total comprehensive income attributable to Saul Centers, Inc. 45,782 42,560 46,439 Preferred stock redemption — — (1,480) Preferred dividends (12,375) (12,375) (13,361) Total comprehensive income available to common stockholders $ 33,407 $ 30,185 $ 31,598 The Notes to Financial Statements are an integral part of these statements. 34 SAUL CENTERS, INC. 2016 ANNUAL REPORT Consolidated Statements OF STOCKHOLDERS’ EQUITY Accumulated Additional Other Preferred Common Paid-in Accumulated Comprehensive Total Saul Noncontrolling (Dollars in thousands, except per share amounts) Stock Stock Capital Deficit (Loss) Centers, Inc. Interests Total Balance, December 31, 2013 $ 180,000 $ 206 $ 270,428 $ (172,564) $ (1,392) $ 276,678 $ 38,448 $ 315,126 Issuance of 16,000 shares of Series C preferred stock 40,000 — (740) — — 39,260 — 39,260 Redemption of 16,000 shares of Series A preferred stock (40,000) — 1,475 (1,475) — (40,000) — (40,000) Issuance of common stock: 197,638 shares pursuant to dividend reinvestment plan — 2 9,262 — — 9,264 — 9,264 172,887 shares due to exercise of employee stock options and issuance of directors' deferred stock — 1 7,570 — — 7,571 — 7,571 Issuance of 196,183 partnership units pursuant to dividend reinvestment plan — — — — — — 8,877 8,877 Net income — — — 46,943 — 46,943 11,045 57,988 Change in unrealized loss on cash flow hedge — — — — (502) (502) (173) (675) Preferred stock distributions: Series A — — — (3,049) — (3,049) — (3,049) Series C — — — (7,219) — (7,219) — (7,219) Common stock distributions — — — (24,937) — (24,937) (8,597) (33,534) Distributions payable preferred stock: Series C, $42.97 per share — — — (3,094) — (3,094) — (3,094) Distributions payable common stock ($0.40/share) and distributions payable partnership units ($0.40/unit) — — — (8,379) — (8,379) (2,879) (11,258) Balance, December 31, 2014 $ 180,000 $ 209 $ 287,995 $ (173,774) $ (1,894) $ 292,536 $ 46,721 $ 339,257 Issuance of common stock: 201,212 shares pursuant to dividend reinvestment plan — 3 10,647 — — 10,650 — 10,650 117,886 shares due to exercise of employee stock options and issuance of directors' deferred stock — 1 6,366 — — 6,367 — 6,367 Issuance of 107,037 partnership units pursuant to dividend reinvestment plan — — — — — — 5,673 5,673 Net income — — — 42,468 — 42,468 10,463 52,931 Change in unrealized loss on cash flow hedge — — — — 92 92 32 124 Series C preferred stock distributions — — — (9,282) — (9,282) — (9,282) Common stock distributions — — — (27,265) — (27,265) (9,349) (36,614) Distributions payable on Series C preferred stock, $42.97 per share — — — (3,093) — (3,093) — (3,093) Distributions payable common stock ($0.43/share) and partnership units ($0.43/unit) — — — (9,145) — (9,145) (3,141) (12,286) Balance, December 31, 2015 $ 180,000 $ 213 $ 305,008 $ (180,091) $ (1,802) $ 303,328 $ 50,399 $ 353,727 Issuance of common stock: 186,797 shares pursuant to dividend reinvestment plan — 2 10,309 — — 10,311 — 10,311 251,323 shares due to exercise of employee stock options and issuance of directors' deferred stock — 2 12,854 — — 12,856 — 12,856 Issuance of 124,758 partnership units pursuant to dividend reinvestment plan — — — — — — 6,910 6,910 Net income — — — 45,279 — 45,279 11,441 56,720 Change in unrealized loss on cash flow hedge — — — — 503 503 175 678 Series C preferred stock distributions — — — (9,282) — (9,282) — (9,282) Common stock dis tributions — — — (30,328) — (30,328) (10,392) (40,720) Distributions payable on Series C preferred stock, $42.97 per share — — — (3,093) — (3,093) — (3,093) Distributions payable common stock ($0.51/share) and distributions payable partnership units ($0.51/unit) — — — (11,069) — (11,069) (3,789) (14,858) Balance, December 31, 2016 $ 180,000 $ 217 $ 328,171 $ (188,584) $ (1,299) $ 318,505 $ 54,744 $ 373,249 The Notes to Financial Statements are an integral part of these statements. SAUL CENTERS, INC. 2016 ANNUAL REPORT 35 Consolidated Statements OF CASH FLOWS For the Year Ended December 31, (Dollars in thousands) 2016 2015 2014 Cash flows from operating activities: Net income $ 56,720 $ 52,931 $ 57,988 Adjustments to reconcile net income to net cash provided by operating activities: Change in fair value of derivatives 6 10 10 Gains on sales of properties (1,013) (11) (6,069) Depreciation and amortization of deferred leasing costs 44,417 43,270 41,203 Amortization of deferred debt costs 1,343 1,433 1,327 Non cash compensation costs of stock grants and options 1,603 1,434 1,240 Provision for credit losses 1,494 915 680 Increase in accounts receivable and accrued income (3,516) (5,207) (3,320) Additions to deferred leasing costs (4,633) (5,563) (4,048) Increase in prepaid expenses (399) (570) (60) (Increase) decrease in other assets (6,377) 1,535 (694) Increase (decrease) in accounts payable, accrued expenses and other liabilities 921 (937) 1,149 Decrease in deferred income (1,476) (344) (2,838) Net cash provided by operating activities 89,090 88,896 86,568 Cash flows from investing activities: Acquisitions of real estate investments (1) (48,250) (4,894) (57,494) Additions to real estate investments (15,564) (18,855) (14,986) Additions to development and redevelopment projects (27,231) (45,870) (17,788) Proceeds from sale of properties 4,771 32 6,679 Net cash used in investing activities (86,274) (69,587) (83,589) Cash flows from financing activities: Proceeds from mortgage notes payable (1) 11,250 46,000 — Repayments on mortgage notes payable (24,653) (52,963) (22,071) Proceeds from construction loans payable 24,937 39,817 5,391 Proceeds from revolving credit facility 78,500 20,000 90,000 Repayments on revolving credit facility (57,500) (35,000) (47,000) Additions to deferred debt costs (125) (296) (1,264) Proceeds from the issuance of: Common stock 21,564 15,583 15,596 Partnership units 6,910 5,673 8,877 Series C preferred stock — — 39,260 Series A preferred stock redemption payment — — (40,000) Distributions to: Series A preferred stockholders — — (3,849) Series C preferred stockholders (12,375) (12,375) (9,625) Common stockholders (39,472) (35,645) (32,346) Noncontrolling interests (13,533) (12,228) (11,117) Net cash used in financing activities (4,497) (21,434) (8,148) Net increase (decrease) in cash and cash equivalents (1,681) (2,125) (5,169) Cash and cash equivalents, beginning of year 10,003 12,128 17,297 Cash and cash equivalents, end of year $ 8,322 $ 10,003 $ 12,128 Supplemental disclosure of cash flow information: Cash paid for interest $ 44,066 $ 45,965 $ 45,443 Increase (decrease) in accrued real estate investments and development costs $ (7,098) $ 5,201 $ 1,548 (1) The 2014 acquisition of real estate and proceeds from notes payable each exclude $11,000 in connection with the sale and leaseback of the Company's Olney property. The Notes to Financial Statements are an integral part of these statements. 36 SAUL CENTERS, INC. 2016 ANNUAL REPORT Notes TO CONSOLIDATED FINANCIAL STATEMENTS FORMATION AND STRUCTURE OF COMPANY Saul Centers was formed to continue and expand the shopping center business previously owned and conducted by the B. F. Saul Real Estate Investment Trust (the “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 Or- ganization”). On August 26, 1993, members of the Saul Organization transferred to Saul Holdings Limited Partnership, a newly formed Maryland limited partnership (the “Operating Part- nership”), and two newly formed subsidiary limited partnerships (the “Subsidiary Partnerships,” and collectively with the Operating Partnership, the “Partnerships”), shopping center and mixed-used properties, and the management functions related to the trans- ferred properties. Since its formation, the Company has developed and purchased additional properties. 1. ORGANIZATION, FORMATION, AND BASIS OF PRESENTATION ORGANIZATION Saul Centers, Inc. (“Saul Centers”) was incorporated under the Maryland General Corporation Law on June 10, 1993. Saul Centers operates as a real estate investment trust (a “REIT”) under the In- ternal 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 Cen- ters 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. The following table lists the significant properties acquired, developed and/or disposed of by the Company since January 1, 2014. Year of Acquisition/ Name of Property Location Type Development/ Disposal ACQUISITIONS 1580 Rockville Pike Rockville, Maryland Shopping Center January 2014 1582 Rockville Pike Rockville, Maryland Shopping Center April 2014 750 N. Glebe Road* Arlington, Virginia Shopping Center August 2014 730 N. Glebe Road* Arlington, Virginia Shopping Center December 2014 1584 Rockville Pike Rockville, Maryland Shopping Center December 2014 726 N. Glebe Road* Arlington, Virginia Shopping Center September 2015 700 N. Glebe Road Arlington, Virginia Development August 2016 DEVELOPMENTS Park Van Ness Washington, DC Mixed-Use 2013-2016 DISPOSITIONS Giant Center Milford Mill, Maryland Shopping Center April 2014 Crosstown Business Center Tulsa, Oklahoma Mixed-Use December 2016 * As of August 2016, these properties were removed from operations and reclassified to development. As of December 31, 2016, 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 three (non-operating) development properties. SAUL CENTERS, INC. 2016 ANNUAL REPORT 37 Notes TO CONSOLIDATED FINANCIAL STATEMENTS BASIS OF PRESENTATION The accompanying financial statements are presented on the his- torical cost basis of the Saul Organization because of affiliated ownership and common management and because the assets and liabilities were the subject of a business combination with the Operating Partnership, the Subsidiary Partnerships and Saul Cen- ters, all newly formed entities with no prior operations. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS The Company, which conducts all of its activities through its sub- sidiaries, the Operating Partnership and Subsidiary Partnerships, engages in the ownership, operation, management, leasing, ac- quisition, renovation, expansion, development and financing of community and neighborhood shopping centers and mixed-used properties, primarily in the Washington, DC/Baltimore metropol- itan area. Because the properties are located primarily in the Washington, DC/Baltimore metropolitan area, a disproportionate economic downturn in the local economy would have a greater negative impact on our overall financial performance than on the overall financial performance of a company with a portfolio that is more geographically diverse. A majority of the Shopping Centers are anchored by several major tenants. As of December 31, 2016, 29 of the Shopping Centers were anchored by a grocery store and offer primarily day-to-day necessities and services. The number of grocery-anchored centers excludes the Briggs Chaney Plaza and Broadlands Village shopping centers, where Safeway ceased op- erations during the quarter ended June 30, 2016, but whose leases remain in full force and effect. Three retail tenants, Giant Food (4.3%), a tenant at nine Shopping Centers, Capital One Bank (2.8%), a tenant at 20 properties, and Albertson's/Safeway (2.6%), a tenant at nine Shopping Centers, individually accounted for 2.5% or more of the Company’s total revenue for the year ended December 31, 2016. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of Saul Centers, its subsidiaries, and the Operating Part- nership and Subsidiary Partnerships which are majority owned by Saul Centers. All significant intercompany balances and transac- tions have been eliminated in consolidation. The Operating Partnership is a variable interest entity (“VIE”) of the Company 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 the activities of the Operating Partnership and the rights to absorb 74.3% of the net income of the Operating Partnership. Because the Operating Partnership was already consolidated into the financial statements of the Company, the identification of it as a VIE has no impact on the consolidated financial statements of the Company. 38 SAUL CENTERS, INC. 2016 ANNUAL REPORT USE OF ESTIMATES The preparation of financial statements in conformity with account- ing principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of con- tingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. REAL ESTATE INVESTMENT PROPERTIES The Company purchases real estate investment properties from time to time and records assets acquired and liabilities assumed, including land, buildings, and intangibles related to in-place leases and customer relationships, based on their fair values. The fair value of buildings generally is determined as if the buildings were vacant upon acquisition and then subsequently leased at market rental rates and considers the present value of all cash flows expected to be generated by the property including an initial lease up period. From time to time the Company may purchase a prop- erty for future development purposes. The property may be improved with an existing structure that would be demolished as part of the development. In such cases, the fair value of the build- ing may be determined based only on existing leases and not include estimated cash flows related to future leases. In certain cir- cumstances, such as if the building is vacant and the Company intends to demolish the building in the near term, the entire pur- chase price will be allocated to land. The Company determines the fair value of above and below market intangibles associated with in-place leases by assessing the net ef- fective rent and remaining term of the lease relative to market terms for similar leases at acquisition taking into consideration the remain- ing contractual lease period, renewal periods, and the likelihood of the tenant exercising its renewal options. The fair value of a below market lease component is recorded as deferred income and accreted as additional lease revenue over the remaining con- tractual lease period. If the fair value of the below market lease intangible includes fair value associated with a renewal option, such amounts are not accreted until the renewal option is exercised. If the renewal option is not exercised the value is recognized at that time. The fair value of above market lease intangibles is recorded as a deferred asset and is amortized as a reduction of lease revenue over the remaining contractual lease term. The Company deter- mines the fair value of at-market in-place leases considering the cost of acquiring similar leases, the foregone rents associated with the lease-up period and carrying costs associated with the lease-up pe- riod. 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 intangibles are amor- tized over the lives of the customer relationships. The Company has never recorded a customer relationship intangible asset. Ac- quisition-related transaction costs are either (a) expensed as incurred when related to business combinations or (b) capitalized to land and/or building when related to asset acquisitions. If there is an event or change in circumstance that indicates a po- tential impairment in the value of a real estate investment property, the Company prepares an analysis to determine whether the car- rying value of the real estate investment property exceeds its estimated fair value. The Company considers both quantitative and qualitative factors including recurring operating losses, signif- icant 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 capi- talization 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 rec- ognize an impairment loss 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 pro- jections, the valuation could be negatively or positively affected. The Company did not recognize an impairment loss on any of its real estate in 2016, 2015, or 2014. Interest, real estate taxes, development related salary costs and other carrying costs are capitalized on projects under develop- ment and construction. Once construction is substantially completed and the assets are placed in service, their rental in- come, real estate tax expense, property operating expenses (consisting of payroll, repairs and maintenance, utilities, insurance and other property related expenses) and depreciation are in- cluded in current operations. Property operating expenses are charged to operations as incurred. Interest expense capitalized totaled $2.5 million, $2.2 million, and $0.7 million during 2016, 2015, and 2014, 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 certifi- cate of occupancy from the appropriate licensing authority. Substantially completed portions of a project are accounted for as separate projects. Depreciation is calculated using the straight-line method and es- timated useful lives of generally between 35 and 50 years for base buildings, or a shorter period if management determines that the building has a shorter useful life, and up to 20 years for certain other improvements that extend the useful lives. Leasehold im- provements 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 improvement, using the straight-line method. Depreciation expense, which is included in Depreciation and amortization of Notes TO CONSOLIDATED FINANCIAL STATEMENTS deferred leasing costs in the Consolidated Statements of Opera- tions, for the years ended December 31, 2016, 2015, and 2014, was $38.7 million, $37.7 million, and $35.9 million, respectively. Repairs and maintenance expense totaled $11.8 million, $11.6 mil- lion, and $11.9 million for 2016, 2015, and 2014, respectively, and is included in property operating expenses in the accompanying consolidated financial statements. DEFERRED LEASING COSTS Deferred leasing costs consist of commissions paid to third-party leasing agents, internal direct costs such as employee compensa- tion and payroll-related fringe benefits directly related to time spent performing leasing-related activities for successful commer- cial leases and amounts attributed to in place leases associated with acquired properties and are amortized, using the straight-line method, over the term of the lease or the remaining term of an ac- quired lease. Leasing related activities include evaluating the prospective tenant’s financial condition, evaluating and recording guarantees, collateral and other security arrangements, negotiat- ing lease terms, preparing lease documents and closing the transaction. Unamortized deferred costs are charged to expense if the applicable lease is terminated prior to expiration of the initial lease term. Collectively, deferred leasing costs totaled $26.0 mil- lion and $26.9 million, net of accumulated amortization of approximately $30.4 million and $26.6 million, as of December 31, 2016 and 2015, respectively. Amortization expense, which is included in Depreciation and amortization of deferred leasing costs in the Consolidated Statements of Operations, totaled ap- proximately $5.7 million, $5.6 million, and $5.3 million, for the years ended December 31, 2016, 2015, and 2014, respectively. CONSTRUCTION IN PROGRESS Construction in progress includes preconstruction and develop- ment costs of active projects. Preconstruction costs include legal, zoning and permitting costs and other project carrying costs in- curred 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, en- gineering, construction management and carrying costs consisting of interest, real estate taxes and insurance. The follow- ing table shows the components of construction in progress. December 31, (In thousands) 2016 2015 Park Van Ness $ — $ 77,245 N. Glebe Road 58,147 — Other 5,423 6,271 Total $ 63,570 $ 83,516 SAUL CENTERS, INC. 2016 ANNUAL REPORT 39 Notes TO CONSOLIDATED FINANCIAL STATEMENTS ACCOUNTS RECEIVABLE AND ACCRUED INCOME Accounts receivable primarily represent amounts currently due from tenants in accordance with the terms of the respective leases. Receivables are reviewed monthly and reserves are established with a charge to current period operations when, in the opinion of management, collection of the receivable is doubtful. Accounts re- ceivable in the accompanying consolidated financial statements are shown net of an allowance for doubtful accounts of $2.0 million and $1.3 million, at December 31, 2016 and 2015, respectively. Year ended December 31, (In thousands) 2016 2015 2014 Beginning Balance $1,263 $ 677 $ 572 Provision for Credit Losses 1,494 915 680 Charge-offs (799) (329) (575) Ending Balance $1,958 $ 1,263 $ 677 In addition to rents due currently, accounts receivable also includes $43.1 million and $41.4 million, at December 31, 2016 and 2015, respectively, net of allowance for doubtful accounts totaling $0.5 million and $0.5 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 gener- ally 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 December 31, 2015, the Company has classified as held-for-sale one operating property, comprising 197,100 square feet of gross leasable area. The book 40 SAUL CENTERS, INC. 2016 ANNUAL REPORT value of this property, which is included in Other Assets, was $3.4 million, net of accumulated depreciation of $7.0 million, which does not exceed its estimated fair value, less costs to sell, and lia- bilities were $0.2 million. The asset was sold in 2016. 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, meas- ured from the acquisition date, and/or are readily convertible to cash. Substantially all of the Company’s cash balances at Decem- ber 31, 2016 are held in non-interest bearing accounts at various banks. From time to time the Company may maintain deposits with financial institutions in amounts in excess of federally insured limits. The Company has not experienced any losses on such de- posits and believes it is not exposed to any significant credit risk on those deposits. DEFERRED DEBT COSTS Deferred debt costs consist of fees and costs incurred to obtain long-term financing, construction financing and the revolving line of credit. These fees and costs are being amortized on a straight- line basis over the terms of the respective loans or agreements, which approximates the effective interest method. Deferred debt costs totaled $7.5 million and $8.7 million, net of accumulated amortization of $7.3 million and $6.2 million at December 31, 2016 and 2015, respectively. 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 dif- fering 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. DERIVATIVE FINANCIAL INSTRUMENTS The Company may, when appropriate, employ derivative instru- ments, such as interest-rate swaps, to mitigate the risk of interest rate fluctuations. The Company does not enter into derivative or other financial instruments for trading or speculative purposes. De- rivative financial instruments are carried at fair value as either assets or liabilities on the consolidated balance sheets. For those deriva- tive instruments that qualify, the Company may designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge or a cash flow hedge. Derivative instruments that are designated as a hedge are evaluated to ensure they continue to qualify for hedge accounting. The effective portion of any gain or loss on the hedge instruments is reported as a component of ac- cumulated 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 meet the criteria for hedge accounting, or that qualify and are not designated, changes in fair value are immediately recognized in earnings. 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 stepped increases, income is recognized on a straight-line basis. Expense recoveries represent a portion of property operating expenses billed to the tenants, including common area maintenance, real estate taxes and other recoverable costs. Expense recoveries are recognized in the period in which the expenses are incurred. Rental income based on a tenant’s revenue (“percentage rent”) is accrued when a tenant reports sales that exceed a specified break- point, pursuant to the terms of their respective leases. INCOME TAXES The Company made an election to be treated, and intends to con- tinue operating so as to qualify, as a REIT under the Code, commencing with its taxable year ended December 31, 1993. A REIT generally will not be subject to federal income taxation, pro- vided that distributions to its stockholders equal or exceed its REIT taxable income and complies with certain other requirements. Therefore, no provision has been made for federal income taxes in the accompanying consolidated financial statements. As of December 31, 2016, the Company had no material unrec- ognized tax benefits and there exist no potentially significant unrecognized tax benefits which are reasonably expected to occur within the next twelve months. The Company recognizes penalties and interest accrued related to unrecognized tax bene- fits, if any, as general and administrative expense. No penalties and interest have been accrued in years 2016, 2015, and 2014. The tax basis of the Company’s real estate investments was ap- proximately $1.3 billion and $1.1 billion as of December 31, 2016 and 2015, respectively. With few exceptions, the Company is no longer subject to U.S. federal, state, and local tax examinations by tax authorities for years before 2013. STOCK BASED EMPLOYEE COMPENSATION, DEFERRED COMPENSATION AND STOCK PLAN FOR DIRECTORS The Company uses the fair value method to value and account for employee stock options. The fair value of options granted is de- termined at the time of each award using the Black-Scholes model, a widely used method for valuing stock based employee compen- sation, and the following assumptions: (1) Expected Volatility determined using the most recent trading history of the Com- pany’s common stock (month-end closing prices) corresponding to the average expected term of the options; (2) Average Ex- pected Term of the options is based on prior exercise history, scheduled vesting and the expiration date; (3) Expected Dividend Notes TO CONSOLIDATED FINANCIAL STATEMENTS Yield determined by management after considering the Com- pany’s current and historic dividend yield rates, the Company’s yield in relation to other retail REITs and the Company’s market yield at the grant date; and (4) a Risk-free Interest Rate based upon the market yields of US Treasury obligations with maturities corre- sponding 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 compensa- tion in general and administrative expenses. 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, di- rectors and other key personnel (the “Stock Plan”). Pursuant to the Stock Plan, the Compensation Committee established a De- ferred Compensation Plan for Directors for the benefit of its directors and their beneficiaries, which replaced a previous De- ferred 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 ag- gregated and divided by the common stock’s closing market price on the first trading day of the following quarter to determine the number of shares to be allocated to the director. As of December 31, 2016, the directors’ deferred fee accounts comprise 246,800 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 Shareholders, and their issuance may not be deferred. Each director was issued 200 shares for each of the years ended December 31, 2016, 2015, and 2014. The shares were valued at the closing stock price on the dates the shares were awarded and included in general and administrative expenses in the total amounts of $150,100, $143,000, and $112,900, for the years ended December 31, 2016, 2015, and 2014, respectively. NONCONTROLLING INTEREST Saul Centers is the sole general partner of the Operating Partner- ship, owning a 74.3% common interest as of December 31, 2016. Noncontrolling interest in the Operating Partnership is comprised of limited partnership units owned by the Saul Organization. Non- controlling interest reflected on the accompanying consolidated balance sheets is increased for earnings allocated to limited part- nership interests and distributions reinvested in additional units, and is decreased for limited partner distributions. Noncontrolling interest reflected on the consolidated statements of operations represents earnings allocated to limited partnership interests held by the Saul Organization. SAUL CENTERS, INC. 2016 ANNUAL REPORT 41 Notes TO CONSOLIDATED FINANCIAL STATEMENTS PER SHARE DATA Per share data for net income (basic and diluted) is computed using weighted average shares of common stock. Convertible lim- ited partnership units and employee stock options are the Company’s potentially dilutive securities. For all periods pre- sented, the convertible limited partnership units are anti-dilutive. The treasury stock method was used to measure the effect of the dilution. BASIC AND DILUTED SHARES OUTSTANDING December 31, (Shares in thousands) 2016 2015 2014 Weighted average common shares outstanding - Basic 21,505 21,127 20,772 Effect of dilutive options 110 69 49 Weighted average common shares outstanding - Diluted 21,615 21,196 20,821 Average share price $ 58.96 $ 53.38 $ 49.09 Non-dilutive options 129 111 107 Years non-dilutive options were issued 2007 , 2015 2007 2007 and 2016 and 2015 and 2008 LEGAL CONTINGENCIES The Company is subject to various legal proceedings and claims that arise in the ordinary course of business, which are generally covered by insurance. Upon determination that a loss is probable to occur and can be reasonably estimated, the estimated amount of the loss is recorded in the financial statements. RECENTLY ISSUED ACCOUNTING STANDARDS In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-08, “Pre- sentation of Financial Statements (Topic 205) and Property Plant and Equipment (Topic 360)” (“ASU 2014-08”). ASU 2014-08 changes the requirements for reporting discontinued operations such that disposals of components of an entity will be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations. ASU 2014-08 also requires additional disclosures about discontinued operations. ASU 2014-08 is effective for annual periods beginning after December 15, 2014, and interim periods within those years and early adoption is permitted. The Company retrospectively adopted ASU 2014-08 on April 15, 2014. The adoption of ASU 2014-08 did not have a material impact on the Company’s financial condition or results of operations. an entity to recognize the amount of revenue which it expects to be entitled for the transfer of promised goods or services to cus- tomers. ASU 2014-09 is effective for annual periods beginning after December 15, 2017, and interim periods within those years and early adoption is not permitted. ASU 2014-09 must be ap- plied retrospectively by either restating prior periods or by recognizing the cumulative effect as of the first date of application. We have not yet selected a transition method and are evaluating the impact that ASU 2014-09 will have on our consolidated finan- cial statements and related disclosures. (“ASU 2015-02”). In February 2015, the FASB issued ASU No. 2015-02, “Consolida- tion” ASU 2015-02 modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. All legal entities are subject to reevaluation under the revised con- solidation model. ASU 2015-02 is effective for annual periods beginning after December 15, 2015, and interim periods within those years. The adoption of ASU 2015-02 effective January 1, 2016, resulted in the Operating Partnership being classified as a variable interest entity. Because the Operating Partnership was already con- solidated into the financial statements, adoption had no impact on the Company’s consolidated financial statements or disclosures. In April 2015, the FASB issued ASU No. 2015-03, “Interest - Im- putation of Interest” (“ASU 2015-03”). ASU 2015-03 simplifies the presentation of debt issuance costs and will require an entity to deduct transaction costs from the carrying value of the related fi- nancial liability and not record those transaction costs as a separate asset. Recognition and measurement guidance for debt issuance costs are not affected by ASU 2015-03. ASU 2015-03 is effective for annual periods beginning after December 15, 2015, and in- terim periods within those years, and must be applied retrospectively by adjusting the balance sheet of each individual period presented. The Company retrospectively adopted ASU 2015-03 effective January 1, 2016. As a result of the adoption of ASU 2015-03, the Company no longer reports its net deferred debt costs as an asset and instead reports those amounts as re- duction of the carrying value of the associated debt. In February 2016, the FASB issued ASU 2016-02, ‘‘Leases’’ (“ASU 2016-02”). ASU 2016-02 amends the existing accounting stan- dards 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 consoli- dated financial statements and related disclosures. In May 2014, the FASB issued ASU No. 2014-09 titled “Revenue from Contracts with Customers” and subsequently issued several related ASUs (collectively “ASU 2014-09”). ASU 2014-09 will re- place most existing revenue recognition guidance and will require In March 2016, the FASB issued ASU 2016-09, “Compensation- Stock Compensation” (“ASU 2016-09”). ASU 2016-09 simplifies the accounting for several aspects of share-based payments in- cluding the income tax consequences, classification of awards as 42 SAUL CENTERS, INC. 2016 ANNUAL REPORT either equity or liabilities and classification on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016 and interim periods within those years. The transition method varies based on the specific amendment. The Company does not believe that the adoption of ASU 2016-09 will have a material impact on our consolidated financial statements or related disclosures. In June 2016, the FASB issued ASU 2016-13, “Financial Instru- ments-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 consoli- dated financial statements and related disclosures. In January 2017, the FASB issued ASU 2017-01, “Clarifying the Def- inition of a Business” (“ASU 2017-01”). ASU 2017-01 provides that when substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identi- fiable assets, the set is not a business. ASU 2017-01 is effective prospectively for annual periods beginning after December 15, 2017, and interim periods within those years. Early application is permitted for transactions for which the acquisition date occurs be- fore the effective date provided the transaction has not been reported in the financial statements. The Company expects to adopt ASU 2017-01 during the first quarter of 2017, the effect of which, for asset acquisitions, will be (a) the capitalization of acquisi- tion costs, instead of expense, and (b) recordation of acquired assets and assessment liabilities at relative fair value, instead of fair value. RECLASSIFICATIONS Certain reclassifications have been made to prior years to conform to the presentation used for year ended December 31, 2016. 3. REAL ESTATE ACQUIRED 1580, 1582 AND 1584 ROCKVILLE PIKE In January 2014, the Company purchased for $8.0 million 1580 Rockville Pike and incurred acquisition costs of $0.2 million. In April 2014, the Company purchased for $11.0 million 1582 Rockville Pike and incurred acquisition costs of $0.2 million. In December 2014, the company purchased for $6.2 million 1584 Rockville Pike and in- curred acquisition costs of $0.2 million. These retail properties are contiguous with each other and the Company's property at 1500 Rockville Pike and are located in Rockville, Maryland. Notes TO CONSOLIDATED FINANCIAL STATEMENTS 700, 726, 730 AND 750 N. GLEBE ROAD In August 2014, the Company purchased for $40.0 million, 750 N. Glebe Road and incurred acquisition costs of $0.4 million. In December 2014, the Company purchased for $2.8 million, 730 N. Glebe Road and incurred acquisition costs of $40,400. In September 2015, the Company purchased for $4.0 million, 726 N. Glebe Road and incurred acquisition costs of $0.1 million. In August 2016, the Company purchased for $7.2 million, including acquisition costs, 700 N. Glebe Road. These properties are contiguous and are located in Arlington, Virginia. WESTVIEW PAD In February 2015, the Company purchased for $0.9 million includ- ing acquisition costs, a 1.1 acre retail pad site in Frederick, Maryland, which is contiguous with and an expansion of the Com- pany's other Westview asset. THRUWAY PAD In August 2016, the Company purchased for $3.1 million, a retail pad site with an occupied bank building in Winston Salem, North Car- olina, and incurred acquisition costs of $60,000. The property is contiguous with and an expansion of the Company's Thruway asset. BEACON CENTER In the fourth quarter of 2016, the Company purchased for $22.5 million the land underlying Beacon Center. The land was previ- ously leased by the Company with an annual rent of approximately $60,000. The purchase price was funded in part by an $11.25 mil- lion increase to the existing mortgage collateralized by Beacon Center and in part by the Company’s revolving credit facility. SOUTHDALE In the fourth quarter of 2016, the Company purchased for $15.0 million the land underlying Southdale. The land was previously leased by the Company with an annual rent of approximately $60,000. The purchase price was funded by the Company’s re- volving credit facility. ALLOCATION OF PURCHASE PRICE OF REAL ESTATE ACQUIRED The Company allocates the purchase price of real estate invest- ment properties to various components, such as land, buildings and intangibles related to in-place leases and customer relation- ships, based on their fair values. See Note 2. Summary of Significant Accounting Policies-Real Estate Investment Properties. SAUL CENTERS, INC. 2016 ANNUAL REPORT 43 Notes TO CONSOLIDATED FINANCIAL STATEMENTS During 2016, the Company purchased two properties at an ag- gregate cost of $10.3 million, and incurred acquisition costs totaling $60,400. The purchase price was allocated to the assets acquired and liabilities assumed based on their fair value as shown in the following table. PURCHASE PRICE ALLOCATION OF ACQUISITIONS 700 N. Glebe Thruway Road Pad Total Land $ 7,236 $ 2,196 $ 9,432 Buildings — 874 874 In-place Leases — 93 93 Above Market Rent — — — Below Market Rent — (63) (63) Total Purchase Price $ 7,236 $ 3,100 $ 10,336 During 2015, the Company purchased one property, 726 N. Glebe Road, at a cost of $4.0 million and incurred acquisition costs of $0.1 million. Of the total purchase price, $3.9 million was allocated to land and $0.1 million was allocated to building. No amounts were allocated to in-place, above-market or below- market leases. During 2014, the Company purchased five properties at an aggre- gate cost of $68.0 million, and incurred acquisition costs of $0.9 million. The purchase prices were allocated to the assets acquired and liabilities assumed based on their fair value as shown in the following table. PURCHASE PRICE ALLOCATION OF ACQUISITIONS (In thousands) Land Buildings In-place Leases Above-Market Rent Below-Market Rent 1580 Rockville Pike 1582 Rockville Pike 750 N. Glebe Road 730 N. Glebe Road 1584 Rockville Pike Total $ 9,600 $ 9,742 $ 38,224 $ 2,683 $ 5,798 $ 66,047 2,200 828 1,327 78 440 4,873 513 849 449 39 249 2,099 — — — — — — (4,313) (419) — — (337) (5,069) Total Purchase Price $ 8,000 $ 11,000 $ 40,000 $ 2,800 $ 6,150 $ 67,950 44 SAUL CENTERS, INC. 2016 ANNUAL REPORT The gross carrying amount of lease intangible assets included in deferred leasing costs as of December 31, 2016 and 2015 was $24.1 million and $24.0 million, respectively, and accumulated amortization was $20.5 million and $19.2 million, respectively. Amortization expense totaled $1.2 million, $1.3 million and $1.3 million, for the years ended December 31, 2016, 2015, and 2014, respectively. The gross carrying amount of below market lease in- tangible liabilities included in deferred income as of December 31, 2016 and 2015 was $29.9 million and $29.9 million, respec- tively, and accumulated amortization was $15.5 million and $13.7 million, respectively. Accretion income totaled $1.8 million, $1.8 million, and $1.9 million, for the years ended December 31, 2016, 2015, and 2014, respectively. The gross carrying amount of above market lease intangible assets included in accounts receivable as of December 31, 2016 and 2015 was $1.0 million and $1.0 million, respectively, and accumulated amortization was $999,700 and $998,200, respectively. Amortization expense totaled $1,500, $1,500 and $22,500, for the years ended December 31, 2016, 2015 and 2014, respectively. The remaining weighted-average amortization period as of December 31, 2016 is 3.5 years, 1.0 year, and 5.9 years for lease acquisition costs, above market leases and below market leases, respectively. As of December 31, 2016, scheduled amortization of intangible assets and deferred income related to in place leases is as follows: AMORTIZATION OF INTANGIBLE ASSETS AND DEFERRED INCOME RELATED TO IN-PLACE LEASES Lease Above- Below- acquisition market market (In thousands) costs leases leases 2017 $ 762 $ 1 $ 1,677 2018 708 1 1,618 2019 537 — 1,481 2020 419 — 1,399 2021 384 — 1,375 Thereafter 840 — 6,887 Total $ 3,650 $ 2 $ 14,437 Notes TO CONSOLIDATED FINANCIAL STATEMENTS 4. NONCONTROLLING INTEREST - HOLDERS OF CONVERTIBLE LIMITED PARTNERSHIP UNITS IN THE OPERATING PARTNERSHIP The Saul Organization holds a 25.7% limited partnership interest in the Operating Partnership represented by 7,430,516 limited partnership units, as of December 31, 2016. The units are convert- ible into shares of Saul Centers’ common stock, at the option of the unit holder, on a one-for-one basis provided that, in accor- dance with the Saul Centers, Inc. 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 pre- ferred stock of Saul Centers (the “Equity Securities”). As of December 31, 2016, approximately 530,000 units were eligible for conversion. The impact of the Saul Organization’s 25.7% 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 shares outstanding for the years ended December 31, 2016, 2015, and 2014, were 28,989,900, 28,449,400, and 27,977,500, respectively. 5. MORTGAGE NOTES PAYABLE, REVOLVING CREDIT FACILITY, INTEREST EXPENSE AND AMORTIZATION OF DEFERRED DEBT COSTS At December 31, 2016, the principal amount of outstanding debt totaled $907.8 million, of which $844.3 million was fixed rate debt and $63.5 million was variable rate debt. The principal amount of the Company’s outstanding debt totaled $875.2 mil- lion at December 31, 2015, of which $832.4 million was fixed rate debt and $42.8 million was variable rate debt. At December 31, 2016, the Company had a $275.0 million unsecured revolving credit facility, which can be used for working capital, property ac- quisitions or development projects. The revolving credit facility matures on June 23, 2018, and may be extended by the Company SAUL CENTERS, INC. 2016 ANNUAL REPORT 45 Notes TO CONSOLIDATED FINANCIAL STATEMENTS for one additional year subject to the Company’s satisfaction of certain conditions. Saul Centers and certain consolidated sub- sidiaries of the Operating Partnership have guaranteed the payment obligations of the Operating Partnership under the re- volving credit facility. Letters of credit may be issued under the revolving credit facility. On December 31, 2016, based on the value of the Company's unencumbered properties, approximately $225.6 million was available under the line, $49.0 million was out- standing and approximately $448,000 was committed for letters of credit. The interest rate under the facility is variable and equals the sum of one-month LIBOR and a margin that is based on the Company’s leverage ratio and which can range from 145 basis points to 200 basis points. As of December 31, 2016, the margin was 145 basis points. Saul Centers is a guarantor of the revolving credit facility, of which the Operating Partnership is the borrower, the Metro Pike Center bank loan (approximately $7.8 million of the $14.5 million outstanding at December 31, 2016) and all of the Park Van Ness construction-to- permanent loan. All other notes payable are non-recourse. On June 24, 2014, the Company amended and restated its revolv- ing credit facility. The unsecured revolving credit facility, which can be used for working capital, property acquisitions, develop- ment projects or letters of credit was increased to $275.0 million. The revolving credit facility matures on June 23, 2018, and may be extended by the Company for one additional year subject to the Company’s satisfaction of certain conditions. Saul Centers and cer- tain consolidated subsidiaries of the Operating Partnership have guaranteed the payment obligations of the Operating Partnership under the revolving credit facility. Letters of credit may be issued under the revolving credit facility. The interest rate under the facility is variable and equals the sum of one-month LIBOR and a margin that is based on the Company’s leverage ratio, and which can range from 145 basis points to 200 basis points. On March 3, 2015, the Company closed on a 15-year, non-re- course $30.0 million mortgage loan secured by Shops at Fairfax and Boulevard. The loan matures in 2030, bears interest at a fixed rate of 3.69%, requires monthly principal and interest payments totaling $153,300 based on a 25-year amortization schedule and requires a final payment of $15.5 million at maturity. Proceeds were used to repay in full the $15.2 million remaining balance of existing debt secured by Shops at Fairfax and Boulevard and to reduce outstanding borrowings under the revolving credit facility. On April 1, 2015, the Company closed on a 15-year, non-recourse $16.0 million mortgage loan secured by Northrock. The loan ma- tures in 2030, bears interest at a fixed rate of 3.99%, requires monthly principal and interest payments totaling $84,400 based on a 25-year amortization schedule and requires a final payment of $8.4 million at maturity. Proceeds were used to repay in full the $14.5 million remaining balance of existing debt secured by Northrock. In November 2016, the existing loan secured by Beacon Center was increased by $11.25 million. The interest rate, amortization period and maturity date did not change; the required monthly payment was increased to $268,500. Proceeds were used to partially fund the purchase of the ground which underlies Beacon Center. 46 SAUL CENTERS, INC. 2016 ANNUAL REPORT Notes TO CONSOLIDATED FINANCIAL STATEMENTS The following is a summary of notes payable as of December 31, 2016 and 2015. NOTES PAYABLE Year Ended December 31, Interest Scheduled (Dollars in thousands) 2016 2015 Rate* Maturity* Fixed rate mortgages: $ 29,428 (a) $ 30,778 6.01% Feb-2018 32,036 (b) 33,766 5.88% Jan-2019 10,372 (c) 10,928 5.76% May-2019 14,335 (d) 15,098 5.62% Jul-2019 14,325 (e) 15,064 5.79% Sep-2019 12,725 (f) 13,387 5.22% Jan-2020 10,277 (g) 10,587 5.60% May-2020 8,697 (h) 9,127 5.30% Jun-2020 39,213 (i) 40,360 5.83% Jul-2020 7,685 (j) 8,025 5.81% Feb-2021 5,808 (k) 5,959 6.01% Aug-2021 33,571 (l) 34,420 5.62% Jun-2022 10,253 (m) 10,492 6.08% Sep-2022 11,129 (n) 11,365 6.43% Apr-2023 13,401 (o) 14,177 6.28% Feb-2024 15,917 (p) 16,348 7.35% Jun-2024 13,832 (q) 14,197 7.60% Jun-2024 24,504 (r) 25,088 7.02% Jul-2024 28,945 (s) 29,714 7.45% Jul-2024 28,822 (t) 29,564 7.30% Jan-2025 14,961 (u) 15,360 6.18% Jan-2026 109,144 (v) 112,299 5.31% Apr-2026 33,097 (w) 34,133 4.30% Oct-2026 37,701 (x) 38,842 4.53% Nov-2026 17,630 (y) 18,150 4.70% Dec-2026 66,210 (z) 67,850 5.84% May-2027 16,352 (aa) 16,826 4.04% Apr-2028 41,753 (bb) 31,844 3.51% Jun-2028 16,543 (cc) 17,011 3.99% Sep-2028 28,679 (dd) 29,444 3.69% Mar-2030 15,357 (ee) 15,748 3.99% Apr-2030 70,144 (ff) 45,208 4.88% Sep-2032 11,446 (gg) 11,282 8.00% Apr-2034 Total fixed rate 844,292 832,441 5.48% 8.5 Years Variable rate loans: 49,000 (hh) 28,000 LIBOR + 1.45% Jun-2018 14,482 (ii) 14,801 LIBOR + 1.65% Feb-2018 Total variable rate 63,482 42,801 2.22% 1.3 Years Total notes payable $ 907,774 $ 875,242 5.25% 8.0 Years * Interest rate and scheduled maturity data presented as of December 31, 2016. Totals computed using weighted averages. Amounts shown are principal amounts and have not been reduced by any deferred debt issuance costs. SAUL CENTERS, INC. 2016 ANNUAL REPORT 47 Notes TO CONSOLIDATED FINANCIAL STATEMENTS (a) The loan is collateralized by Washington Square and requires equal monthly principal and interest payments of $264,000 based upon a 27.5-year amorti- zation schedule and a final payment of $28.0 million at loan maturity. Principal of $1.4 million was amortized during 2016. (b) The loan is collateralized by three shopping centers, Broadlands Village, The Glen and Kentlands Square I, and requires equal monthly principal and interest payments of $306,000 based upon a 25-year amortization schedule and a final payment of $28.4 million at loan maturity. Principal of $1.7 million was amortized during 2016. (c) The loan is collateralized by Olde Forte Village and requires equal monthly principal and interest payments of $98,000 based upon a 25-year amortiza- tion schedule and a final payment of $9.0 million at loan maturity. Principal of $556,000 was amortized during 2016. (d) The loan is collateralized by Countryside and requires equal monthly principal and interest payments of $133,000 based upon a 25-year amortization sched- ule and a final payment of $12.3 million at loan maturity. Principal of $763,000 was amortized during 2016. (e) The loan is collateralized by Briggs Chaney MarketPlace and requires equal monthly principal and interest payments of $133,000 based upon a 25-year amortization schedule and a final payment of $12.2 million at loan maturity. Principal of $739,000 was amortized during 2016. (f) The loan is collateralized by Shops at Monocacy and requires equal monthly principal and interest payments of $112,000 based upon a 25-year amortiza- tion schedule and a final payment of $10.6 million at loan maturity. Principal of $662,000 was amortized during 2016. (g) The loan is collateralized by Boca Valley Plaza and requires equal monthly prin- cipal and interest payments of $75,000 based upon a 30-year amortization schedule and a final payment of $9.1 million at loan maturity. Principal of $310,000 was amortized during 2016. (h) The loan is collateralized by Palm Springs Center and requires equal monthly principal and interest payments of $75,000 based upon a 25-year amortiza- tion schedule and a final payment of $7.1 million at loan maturity. Principal of $430,000 was amortized during 2016. (i) The loan and a corresponding interest-rate swap closed on June 29, 2010 and are collateralized by Thruway. On a combined basis, the loan and the interest- rate swap require equal monthly principal and interest payments of $289,000 based upon a 25-year amortization schedule and a final payment of $34.8 mil- lion at loan maturity. Principal of $1,147,000 was amortized during 2016. (j) The loan is collateralized by Jamestown Place and requires equal monthly prin- cipal and interest payments of $66,000 based upon a 25-year amortization schedule and a final payment of $6.1 million at loan maturity. Principal of $340,000 was amortized during 2016. (k) The loan is collateralized by Hunt Club Corners and requires equal monthly principal and interest payments of $42,000 based upon a 30-year amortiza- tion schedule and a final payment of $5.0 million, at loan maturity. Principal of $151,000 was amortized during 2016. (l) The loan is collateralized by Lansdowne Town Center and requires monthly principal and interest payments of $230,000 based on a 30-year amortization schedule and a final payment of $28.2 million at loan maturity. Principal of $849,000 was amortized during 2016. (m) The loan is collateralized by Orchard Park and requires equal monthly principal and interest payments of $73,000 based upon a 30-year amortization sched- ule and a final payment of $8.6 million at loan maturity. Principal of $239,000 was amortized during 2016. (n) The loan is collateralized by BJ’s Wholesale and requires equal monthly prin- cipal and interest payments of $80,000 based upon a 30-year amortization schedule and a final payment of $9.3 million at loan maturity. Principal of $236,000 was amortized during 2016. (o) The loan is collateralized by Great Falls shopping center. The loan consists of three notes which require equal monthly principal and interest payments of $138,000 based upon a weighted average 26-year amortization schedule and a final payment of $6.3 million at maturity. Principal of $776,000 was amortized during 2016. (p) The loan is collateralized by Leesburg Pike and requires equal monthly princi- pal and interest payments of $135,000 based upon a 25-year amortization 48 SAUL CENTERS, INC. 2016 ANNUAL REPORT schedule and a final payment of $11.5 million at loan maturity. Principal of $431,000 was amortized during 2016. (q) The loan is collateralized by Village Center and requires equal monthly princi- pal and interest payments of $119,000 based upon a 25-year amortization schedule and a final payment of $10.1 million at loan maturity. Principal of $365,000 was amortized during 2016. (r) The loan is collateralized by White Oak and requires equal monthly principal and interest payments of $193,000 based upon a 24.4 year weighted amor- tization schedule and a final payment of $18.5 million at loan maturity. The loan was previously collateralized by Van Ness Square. During 2012, the Com- pany substituted White Oak as the collateral and borrowed an additional $10.5 million. Principal of $584,000 was amortized during 2016. (s) The loan is collateralized by Avenel Business Park and requires equal monthly principal and interest payments of $246,000 based upon a 25-year amorti- zation schedule and a final payment of $20.9 million at loan maturity. Principal of $769,000 was amortized during 2016. (t) The loan is collateralized by Ashburn Village and requires equal monthly prin- cipal and interest payments of $240,000 based upon a 25-year amortization schedule and a final payment of $20.5 million at loan maturity. Principal of $742,000 was amortized during 2016. (u) The loan is collateralized by Ravenwood and requires equal monthly principal and interest payments of $111,000 based upon a 25-year amortization sched- ule and a final payment of $10.1 million at loan maturity. Principal of $399,000 was amortized during 2016. (v) The loan is collateralized by Clarendon Center and requires equal monthly principal and interest payments of $753,000 based upon a 25-year amortiza- tion schedule and a final payment of $70.5 million at loan maturity. Principal of $3.2 million was amortized during 2016. (w) The loan is collateralized by Severna Park MarketPlace and requires equal monthly principal and interest payments of $207,000 based upon a 25-year amortization schedule and a final payment of $20.3 million at loan maturity. Principal of $1,036,000 was amortized during 2016. (x) The loan is collateralized by Kentlands Square II and requires equal monthly principal and interest payments of $240,000 based upon a 25-year amorti- zation schedule and a final payment of $23.1 million at loan maturity. Principal of $1,141,000 was amortized during 2016. (y) The loan is collateralized by Cranberry Square and requires equal monthly principal and interest payments of $113,000 based upon a 25-year amortiza- tion schedule and a final payment of $10.9 million at loan maturity. Principal of $520,000 was amortized during 2016. (z) The loan in the original amount of $73.0 million closed in May 2012, is collat- eralized by Seven Corners and requires equal monthly principal and interest payments of $463,200 based upon a 25-year amortization schedule and a final payment of $42.3 million at loan maturity. Principal of $1.6 million was amortized during 2016. (aa) The loan is collateralized by Hampshire Langley and requires equal monthly principal and interest payments of $95,400 based upon a 25-year amortiza- tion schedule and a final payment of $9.5 million at loan maturity. Principal of $474,000 was amortized in 2016. (bb) The loan is collateralized by Beacon Center and requires equal monthly prin- cipal and interest payments of $268,500 based upon a 20-year amortization schedule and a final payment of $17.1 million at loan maturity. Principal of $1.3 million was amortized in 2016. (cc) The loan is collateralized by Seabreeze Plaza and requires equal monthly prin- cipal and interest payments of $94,900 based upon a 25-year amortization schedule and a final payment of $9.5 million at loan maturity. Principal of $468,000 was amortized in 2016. (dd) The loan is collateralized by Shops at Fairfax and Boulevard shopping centers and requires equal monthly principal and interest payments totaling $153,300 based upon a 25-year amortization schedule and a final payment of $15.5 mil- lion at maturity. Principal of $765,000 was amortized in 2016. (ee) The loan is collateralized by Northrock and requires equal monthly principal and interest payments totaling $84,400 based upon a 25-year amortization schedule and a final payment of $8.4 million at maturity. Principal of $391,000 was amortized in 2016. (ff) The loan is a $71.6 million construction-to-permanent facility that is collateral- ized by and will finance a portion of the construction costs of Park Van Ness. During the construction period, interest will be funded by the loan. After con- version to a permanent loan, monthly principal and interest payments totaling $413,500 will be required based upon a 25-year amortization schedule. A final payment of $39.6 million will be due at maturity. (gg) The Company entered into a sale-leaseback transaction with its Olney prop- erty and is accounting for that transaction as a secured financing. The arrangement requires monthly payments of $60,400 which increase by 1.5% on May 1, 2015, and every May 1 thereafter. The arrangement provides for a final payment of $14.7 million and has an implicit interest rate of 8.0%. Neg- ative amortization in 2016 totaled $164,000. The carrying value of properties collateralizing the mortgage notes payable totaled $957.2 million and $856.8 million as of December 31, 2016 and 2015, respectively. The Company’s credit facility re- quires the Company and its subsidiaries to maintain certain financial covenants, which are summarized below. As of December 31, 2016, the Company was in compliance with all such covenants: • • • maintain tangible net worth, as defined in the loan agree- ment, of at least $542.1 million plus 80% of the Company’s net equity proceeds received after March 2014; limit the amount of debt as a percentage of gross asset value, as defined in the loan agreement, to less than 60% (leverage ratio); limit the amount of debt so that interest coverage will exceed 2.0 x on a trailing four-quarter basis (interest expense cover- age); and limit the amount of debt so that interest, scheduled principal amortization and preferred dividend coverage exceeds 1.3x on a trailing four-quarter basis (fixed charge coverage). • Mortgage notes payable at each of December 31, 2016 and 2015, totaling $51.0 million, are guaranteed by members of the Saul Or- ganization. As of December 31, 2016, the scheduled maturities of all debt including scheduled principal amortization for years ended December 31 are as follows: DEBT MATURITY SCHEDULE Scheduled Balloon Principal (In thousands) Payments Amortization Total Notes TO CONSOLIDATED FINANCIAL STATEMENTS (hh) The loan is a $275.0 million unsecured revolving credit facility. Interest accrues at a rate equal to the sum of one-month LIBOR plus a spread of 145 basis points. The line may be extended at the Company’s option for one year with payment of a fee of 0.15%. Monthly payments, if required, are interest only and vary depending upon the amount outstanding and the applicable interest rate for any given month. (ii) The loan is collateralized by Metro Pike Center and requires monthly principal and interest payments of approximately $48,000 and a final payment of $14.2 million at loan maturity. Principal of $319,000 was amortized during 2016. The components of interest expense are set forth below. INTEREST EXPENSE Year ended December 31, (In thousands) 2016 2015 2014 Interest incurred $ 46,867 $ 45,898 $ 45,396 Amortization of deferred debt costs 1,343 1,433 1,327 Capitalized interest (2,527) (2,166) (689) Total $ 45,683 $ 45,165 $ 46,034 Deferred debt costs capitalized during the years ending Decem- ber 31, 2016, 2015 and 2014 totaled $0.1 million, $0.3 million and $1.3 million, respectively. 6. LEASE AGREEMENTS Lease income includes primarily base rent arising from noncance- lable leases. Base rent (including straight-line rent) for the years ended December 31, 2016, 2015, and 2014, amounted to $172.4 million, $168.3 million, and $164.6 million, respectively. Future contractual payments under noncancelable leases for years ended December 31 (which exclude the effect of straight-line rents), are as follows: FUTURE CONTRACTUAL RENT PAYMENTS 2017 $ — $ 26,418 $ 26,418 (In thousands) 2018 90,865 (a) 26,394 117,259 2019 60,793 25,037 85,830 2020 61,163 22,331 83,494 2021 11,011 21,859 32,870 Thereafter 452,142 109,761 561,903 $ 675,974 $ 231,800 907,774 Unamortized deferred debt costs 7,485 Net $ 900,289 (a) Includes $49.0 million outstanding under the line of credit. 2017 $ 154,489 2018 138,724 2019 117,135 2020 97,155 2021 78,248 Thereafter 245,218 Total $ 830,969 SAUL CENTERS, INC. 2016 ANNUAL REPORT 49 Notes TO CONSOLIDATED FINANCIAL STATEMENTS The majority of the leases provide for rental increases and expense recoveries based on fixed annual increases or increases in the Con- sumer Price Index and increases in operating expenses. The expense recoveries generally are payable in equal installments throughout the year based on estimates, with adjustments made in the succeeding year. Expense recoveries for the years ended December 31, 2016, 2015, and 2014, amounted to $34.3 million, $32.9 million, and $32.1 million, respectively. In addition, certain retail leases provide for percentage rent based on sales in excess of the minimum specified in the tenant’s lease. Percentage rent amounted to $1.4 million, $1.6 million, and $1.5 million, for the years ended December 31, 2016, 2015, and 2014, respectively. The Company’s corporate headquarters space is leased by a mem- ber of the Saul Organization. The lease commenced in March 2002, and was extended to March 2017. A lease extension is being finalized which will extend the term to March 2022. The Company and the Saul Organization entered into a Shared Serv- ices Agreement whereby each party pays an allocation of total rental payments based on a percentage proportionate to the num- ber of employees employed by each party. The Company’s rent expense for the years ended December 31, 2016, 2015, and 2014 was $843,300, $904,900, and $840,800, respectively. Ex- penses arising from the lease are included in general and administrative expense (see Note 9 – Related Party Transactions). 7. LONG-TERM LEASE OBLIGATIONS During 2016, the Company purchased the land underlying Beacon Center and Southdale - See Note 3. As a result, at December 31, 2016, one remaining property is subject to a noncancelable long- term lease which applies to land underlying the Shopping Center. The lease provides for periodic adjustments of the base annual rent and requires the payment of real estate taxes on the underlying land. The lease expires in 2068. Reflected in the accompanying consol- idated financial statements is minimum ground rent expense of $159,000, $176,000, and $176,000, for the years ended Decem- ber 31, 2016, 2015, and 2014, respectively. The future minimum rental commitments under this ground lease are as follows: LONG-TERM LEASE OBLIGATIONS (In thousands) 2017 $ 56 2018 56 2019 57 2020 62 2021 62 Therafter 3,636 $ 3,929 In addition to the above, Flagship Center consists of two devel- oped out parcels that are part of a larger adjacent community shopping center formerly owned by the Saul Organization and sold to an affiliate of a tenant in 1991. The Company has a 90-year ground leasehold interest which commenced in September 1991 with a minimum rent of one dollar per year. Countryside shopping center was acquired in February 2004. Because of certain land use considerations, approximately 3.4% of the underlying land is held under a 99-year ground lease. The lease requires the Company to pay minimum rent of one dollar per year as well as its pro-rata share of the real estate taxes. 8. STOCKHOLDERS’ EQUITY AND NONCONTROLLING INTEREST The Consolidated Statements of Operations for the years ended December 31, 2016, 2015, and 2014 reflect noncontrolling inter- est of $11.4 million, $10.5 million, and $11.0 million, respectively, representing the Saul Organization’s share of the net income for the year. In November 2003, the Company sold 4,000,000 depositary shares, each representing 1/100th of a share of 8% Series A Cumu- lative Redeemable Preferred Stock (the “Series A Stock”). The depositary shares were redeemable, in whole or in part at the Com- pany’s option, from time to time, at $25.00 per share. The depositary shares paid an annual dividend of $2.00 per share, equivalent to 8% of the $25.00 per share liquidation preference. The Series A preferred stock had no stated maturity, was not subject to any sinking fund or mandatory redemption and was not convert- ible into any other securities of the Company. Investors in the depositary shares generally had no voting rights, but would have had limited voting rights if the Company failed to pay dividends for six or more quarters (whether or not declared or consecutive) and in certain other events. In March 2013, the Company redeemed 60% of its then-outstanding Series A Stock. In December 2014, the Company redeemed the remaining outstanding Series A Stock. Costs associated with the redemptions were charged against accu- mulated deficit in the respective periods. On February 12, 2013, the Company sold, in an underwritten public offering, 5.6 million depositary shares, each representing 1/100th of a share of 6.875% Series C Cumulative Redeemable Preferred Stock (“Series C Stock” ), and received net cash pro- ceeds of approximately $135.2 million. The depositary shares may be redeemed on or after February 12, 2018 at the Company’s op- tion, in whole or in part, at the $25.00 liquidation preference plus accrued but unpaid dividends. The depositary shares pay an an- nual dividend of $1.71875 per share, equivalent to 6.875% of the $25.00 liquidation preference. The first dividend was paid on April 15, 2013 and covered the period from February 12, 2013 through March 31, 2013. The Series C Stock has no stated matu- rity, is not subject to any sinking fund or mandatory redemption 50 SAUL CENTERS, INC. 2016 ANNUAL REPORT and is not convertible into any other securities of the Company ex- cept in connection with certain changes of control or delisting events. Investors in the depositary shares generally have no voting rights, but will have limited voting rights if the Company fails to pay dividends for six or more quarters (whether or not declared or consecutive) and in certain other events. On November 12, 2014, the Company sold, in an underwritten public offering, 1.6 million depositary shares of Series C Stock and received net cash pro- ceeds of approximately $39.3 million (the “Additional Series C Stock”). The terms of Additional Series C Stock are identical to the Series C Stock. 9. RELATED PARTY TRANSACTIONS The Chairman and Chief Executive Officer, the President and Chief Operating Officer, the Executive Vice President-Chief Legal and Administrative Officer and the Senior Vice President-Chief Ac- counting 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 (de- scribed below). The Company participates in a multiemployer 401K plan with enti- ties in the Saul Organization which covers those full-time employees who meet the requirements as specified in the plan. Company con- tributions, 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 $329,000, $400,000, and $379,000, for 2016, 2015, and 2014, respectively. All amounts deferred by employees and contributed by the Company are fully vested. The Company also participates in a multiemployer nonqualified de- ferred 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 mod- ified or discontinued at any time, participating employees defer 2% of their compensation in excess of a specified amount. For the years ended December 31, 2016, 2015, and 2014, the Company con- tributed three times the amount deferred by employees. The Company’s expense, included in general and administrative ex- pense, totaled $250,800, $224,900, and $192,800, for the years ended December 31, 2016, 2015, and 2014, respectively. All amounts deferred by employees and the Company are fully vested. The cumulative unfunded liability under this plan was $2.1 million and $1.8 million, at December 31, 2016 and 2015, respectively, and is included in accounts payable, accrued expenses and other liabil- ities in the consolidated balance sheets. Notes TO CONSOLIDATED FINANCIAL STATEMENTS 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 com- puter hardware, software, and support services and certain direct and indirect administrative personnel. The method for determin- ing the cost of the shared services is provided for in the Agreement and is based upon head count, estimates of usage or estimates of time incurred, as applicable. Senior management has determined that the final allocations of shared costs are reasonable. The terms of the Agreement and the payments made thereunder are re- viewed annually by the Audit Committee of the Board of Directors, which consists entirely of independent directors. Billings by the Saul Organization for the Company’s share of these ancillary costs and expenses for the years ended December 31, 2016, 2015, and 2014, which included rental expense for the Company’s head- quarters lease (see Note 7. Long Term Lease Obligations), totaled $7.5 million, $8.2 million, and $7.4 million, respectively. The amounts are expensed when incurred and are primarily reported as general and administrative expenses or capitalized to specific development projects in these consolidated financial statements. As of December 31, 2016 and 2015, accounts payable, accrued expenses and other liabilities included $829,000 and $655,000, respectively, representing billings 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 predevelop- ment cost agreement with the Trust (the “Predevelopment Agreement”). The Predevelopment Agreement, which expired on December 31, 2015 and was extended to December 31, 2016, 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. On December 8, 2016, the Company en- tered into a replacement agreement with the Saul Trust which extended the expiration date to December 31, 2017 and provides for automatic twelve months renewals unless either party provides notice of termination. 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. 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 counter-signature fees in connection with the Company’s insur- ance program. Such commissions and fees amounted to approximately $360,500, $443,500, and $427,300, for the years ended December 31, 2016, 2015, and 2014, respectively. Effective as of September 4, 2012, the Company entered into a consulting agreement with B. F. Saul III, one of the Company’s for- mer presidents, whereby Mr. Saul III provided certain consulting services to the Company as an independent contractor and was paid at a rate of $60,000 per month. The consulting agreement included certain noncompete, nonsolicitation and nondisclosure covenants, and expired in September 2014. During 2014, such consulting fees totaled $495,000. SAUL CENTERS, INC. 2016 ANNUAL REPORT 51 Notes TO CONSOLIDATED FINANCIAL STATEMENTS In August 2016, the Company entered into an agreement to ac- quire from the Trust, for an initial purchase price of $8.8 million, approximately 14.3 acres of land located at the intersection of Ash- burn Village Boulevard and Russell Branch Parkway in Loudoun County, Virginia. In order to allow the Company time to pre-lease and complete project plans and specifications, the parties have agreed to a closing date in early 2018, at which time the Company will exchange limited partnership units for the land. The number of limited partnership units to be exchanged will be based on the initial purchase price and the average share value (as defined in the agreement) of the Company’s common stock at the time of the exchange. The Company intends to construct a shopping center and, upon stabilization, may be obligated to issue additional lim- ited partnership units to the Trust. 10. STOCK OPTION PLAN The Company established a stock option plan in 1993 (the “1993 Plan”) for the purpose of attracting and retaining executive officers and other key personnel. The 1993 Plan provides for grants of op- tions to purchase up to 400,000 shares of common stock. The 1993 Plan authorizes the Compensation Committee of the Board of Directors to grant options at an exercise price which may not be less than the market value of the common stock on the date the option is granted. At the annual meeting of the Company’s stockholders in 2004, the stockholders approved the adoption of the 2004 stock plan for the purpose of attracting and retaining executive officers, di- rectors and other key personnel. The 2004 stock plan was subsequently amended by the Company’s stockholders at the 2008 Annual Meeting and further amended at the 2013 Annual Meeting (the “Amended 2004 Plan”). The Amended 2004 Plan, which terminates in 2023, provides for grants of options to pur- chase up to 2,000,000 shares of common stock as well as grants of up to 200,000 shares of common stock to directors. The Amended 2004 Plan authorizes the Compensation Committee of the Board of Directors to grant options at an exercise price which may not be less than the market value of the common stock on the date the option is granted. Effective April 27, 2007, the Compensation Committee granted options to purchase 165,000 shares (27,560 incentive stock op- tions and 137,440 nonqualified stock options) to thirteen Company officers and twelve Company Directors (the “2007 op- tions”), which expire on April 26, 2017. The officers’ 2007 Options vest 25% per year over four years and are subject to early expira- tion upon termination of employment. The directors’ options were immediately exercisable. The exercise price of $54.17 per share was the closing market price of the Company’s common stock on the date of award. Using the Black-Scholes model, the Company determined the total fair value of the 2007 Options to be $1.5 mil- lion, of which $1.3 million and $285,300 were the values assigned to the officer options and director options, respectively. Because the directors’ options vested immediately, the entire $285,300 was expensed as of the date of grant. The expense for the officers’ options was recognized as compensation expense monthly dur- ing the four years the options vested. Effective April 25, 2008, the Compensation Committee granted options to purchase 30,000 shares (all nonqualified stock options) to twelve Company directors (the “2008 Options”), which were immediately exercisable and expire on April 24, 2018. The exer- cise price of $50.15 per share was the closing market price of the Company’s common stock on the date of the award. Using the Black-Scholes model, the Company determined the total fair value of the 2008 Options to be $254,700. Because the directors’ op- tions vested immediately, the entire $254,700 was expensed as of the date of grant. No options were granted to the Company’s officers in 2008. Effective April 24, 2009, the Compensation Committee granted options to purchase 32,500 shares (all nonqualified stock options) to thirteen Company directors (the “2009 Options”), which were immediately exercisable and expire on April 23, 2019. The exer- cise price of $32.68 per share was the closing market price of the Company’s common stock on the date of the award. Using the Black-Scholes model, the Company determined the total fair value of the 2009 Options to be $222,950. Because the directors’ op- tions vested immediately, the entire $222,950 was expensed as of the date of grant. No options were granted to the Company’s officers in 2009. Effective May 7, 2010, the Compensation Committee granted op- tions to purchase 32,500 shares (all nonqualified stock options) to thirteen Company directors (the “2010 Options”), which were immediately exercisable and expire on May 6, 2020. The exercise price of $38.76 per share was the closing market price of the Company’s common stock on the date of the award. Using the Black-Scholes model, the Company determined the total fair value of the 2010 Options to be $287,950. Because the directors’ op- tions vested immediately, the entire $287,950 was expensed as of the date of grant. No options were granted to the Company’s officers in 2010. Effective May 13, 2011, the Compensation Committee granted options to purchase 195,000 shares (65,300 incentive stock op- tions and 129,700 nonqualified stock options) to fifteen Company officers and thirteen Company Directors (the “2011 options”), which expire on May 12, 2021. The officers’ 2011 Options vest 25% per year over four years and are subject to early expiration 52 SAUL CENTERS, INC. 2016 ANNUAL REPORT upon termination of employment. The directors’ 2011 options were immediately exercisable. The exercise price of $41.82 per share was the closing market price of the Company’s common stock on the date of award. Using the Black-Scholes model, the Company determined the total fair value of the 2011 Options to be $1.6 million, of which $1.3 million and $297,375 were as- signed to the officer options and director options, respectively. Because the directors’ options vested immediately, the entire $297,375 was expensed as of the date of grant. The expense for the officers’ options is being recognized as compensation ex- pense monthly during the four years the options vest. Effective May 4, 2012, the Compensation Committee granted op- tions to purchase 277,500 shares (26,157 incentive stock options and 251,343 nonqualified stock options) to fifteen Company offi- cers and fourteen Company Directors (the “2012 options”), which expire on May 3, 2022. The officers’ 2012 Options vest 25% per year over four years and are subject to early expiration upon ter- mination of employment. The directors’ 2012 Options were immediately exercisable. The exercise price of $39.29 per share was the closing market price of the Company’s common stock on the date of award. Using the Black-Scholes model, the Company determined the total fair value of the 2012 Options to be $1.7 mil- lion, of which $1.4 million and $257,250 were assigned to the officer options and director options, respectively. Because the di- rectors’ options vested immediately, the entire $257,250 was expensed as of the date of grant. The expense for the officers’ op- tions is being recognized as compensation expense monthly during the four years the options vest. Effective May 10, 2013, the Compensation Committee granted options to purchase 237,500 shares (35,592 incentive stock op- tions and 201,908 nonqualified stock options) to fifteen Company officers and fourteen Company Directors (the “2013 options”), which expire on May 9, 2023. The officers' 2013 Options vest 25% per year over four years and are subject to early expiration upon termination of employment. The directors' 2013 options were immediately exercisable. The exercise price of $44.42 per share was the closing market price of the Company's common stock on the date of award. Using the Black-Scholes model, the Company determined the total fair value of the 2013 Options to be $1.5 million, of which $1.2 million and $278,250 were as- signed to the officer options and director options, respectively. Because the directors' options vested immediately, the entire $278,250 was expensed as of the date of grant. The expense for the officers' options is being recognized as compensation ex- pense monthly during the four years the option was vested. Effective May 9, 2014, the Compensation Committee granted op- tions to purchase 200,000 shares (29,300 incentive stock options and 170,700 nonqualified stock options) to eighteen Company Notes TO CONSOLIDATED FINANCIAL STATEMENTS officers and twelve Company Directors (the “2014 options”), which expire on May 8, 2024. The officers’ 2014 Options vest 25% per year over four years and are subject to early expiration upon termination of employment. The directors’ 2014 Options were immediately exercisable. The exercise price of $47.03 per share was the closing market price of the Company’s common stock on the date of award. Using the Black-Scholes model, the Company determined the total fair value of the 2014 Options to be $1.3 million, of which $1.2 million and $109,500 were as- signed to the officer options and director options, respectively. Because the directors’ options vested immediately, the entire $109,500 was expensed as of the date of grant. The expense for the officers’ options is being recognized as compensation ex- pense monthly during the four years the options vest. Effective May 8, 2015, the Compensation Committee granted op- tions to purchase 225,000 shares (33,690 incentive stock options and 191,310 nonqualified stock options) to 19 Company officers and 14 Company Directors (the “2015 options”), which expire on May 7, 2025. The officers’ 2015 Options vest 25% per year over four years and are subject to early expiration upon termination of employment. The directors’ 2015 Options were immediately ex- ercisable. The exercise price of $51.07 per share was the closing market price of the Company’s common stock on the date of award. Using the Black-Scholes model, the Company determined the total fair value of the 2015 Options to be $1.6 million, of which $1.4 million and $125,300 were assigned to the officer options and director options, respectively. Because the directors’ options vested immediately, the entire $125,300 was expensed as of the date of grant. The expense for the officers’ options is being rec- ognized as compensation expense monthly during the four years the options vest. Effective May 6, 2016, the Compensation Committee granted op- tions to purchase 226,500 shares (24,248 incentive stock options and 202,252 nonqualified stock options) to 19 Company officers and 13 Company Directors (the “2016 options”), which expire on May 5, 2026. The officers’ 2016 Options vest 25% per year over four years and are subject to early expiration upon termination of employment. The directors’ 2016 Options were immediately ex- ercisable. The exercise price of $57.74 per share was the closing market price of the Company’s common stock on the date of award. Using the Black-Scholes model, the Company determined the total fair value of the 2016 Options to be $1.2 million, of which $1.0 million and $151,125 were assigned to the officer options and director options, respectively. Because the directors’ options vested immediately, the entire $151,125 was expensed as of the date of grant. The expense for the officers’ options is being rec- ognized as compensation expense monthly during the four years the options vest. SAUL CENTERS, INC. 2016 ANNUAL REPORT 53 Notes TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the amount and activity of each grant, the total value and variables used in the computation and the amount expensed and included in general and administrative expense in the Consolidated Statements of Operations for the years ended December 31, 2016, 2015 and 2014. (Dollars in thousands, except per share data) STOCK OPTIONS ISSUED TO DIRECTORS Grant date Total grant Vested Exercised Forfeited Exercisable at December 31, 2016 4/27/2007 4/25/2008 4/24/2009 5/7/2010 5/13/2011 5/4/2012 5/10/2013 5/9/2014 5/8/2015 5/6/2016 Subtotals 30,000 30,000 32,500 32,500 32,500 35,000 35,000 30,000 35,000 32,500 325,000 30,000 30,000 32,500 32,500 32,500 35,000 35,000 30,000 35,000 32,500 325,000 10,000 12,500 25,000 17,500 17,500 17,500 15,000 10,000 5,000 — 130,000 7,500 7,500 — 2,500 2,500 — — — — — 20,000 12,500 10,000 7,500 12,500 12,500 17,500 20,000 20,000 30,000 32,500 175,000 Remaining unexercised 12,500 10,000 7,500 12,500 12,500 17,500 20,000 20,000 30,000 32,500 175,000 Exercise price $ 54.17 $ 50.15 $ 32.68 $ 38.76 $ 41.82 $ 39.29 $ 44.42 $ 47.03 $ 51.07 $ 57.74 Volatility 0.225 0.237 0.344 0.369 0.358 0.348 0.333 0.173 0.166 0.166 Expected life (years) 8.0 7.0 6.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Assumed yield 4.39% 4.09% 4.54% 4.23% 4.16% 4.61% 4.53% 4.48% 4.54% 3.75% Risk-free rate Total value at grant date Expensed in previous years 4.65% 3.49% 2.19% 2.17% 1.86% 0.78% 0.82% 1.63% 1.50% 1.23% $ 285 $ 255 $ 223 $ 288 $ 298 $ 257 $ 278 $ 110 $125 $151 $ 2,270 285 255 223 288 298 257 278 — — — 1,884 Expensed in 2014 — — — — — — — 110 — — 110 Expensed in 2015 — — — — — — — — 125 — 125 Expensed in 2016 — — — — — — — — — 151 151 Future expense — — — — — — — — — — — Grant date Total grant Vested Exercised Forfeited Exercisable at December 31, 2016 STOCK OPTIONS ISSUED TO OFFICERS AND GRAND TOTALS 4/27/2007 5/13/2011 5/4/2012 5/10/2013 5/9/2014 5/8/2015 5/6/2016 Subtotals 135,000 162,500 242,500 202,500 170,000 190,000 194,000 1,296,500 67,500 118,750 107,500 131,875 85,000 47,500 — 558,125 67,500 92,915 91,205 68,750 31,250 6,250 — 357,870 67,500 43,750 135,000 30,625 1,250 1,875 — 280,000 — 25,835 16,295 63,125 53,750 41,250 — 200,255 Remaining unexercised — 25,835 16,295 103,125 137,500 181,875 194,000 658,630 Exercise price $ 54.17 $ 41.82 $ 39.29 $ 44.42 $ 47.03 $ 51.07 $ 57.74 Volatility 0.233 0.330 0.315 0.304 0.306 0.298 0.185 Expected life (years) 6.5 8.0 8.0 8.0 7.0 7.0 7.0 Assumed yield Risk-free rate Gross value at grant date 4.13% 4.61% 4.81% 2.75% 5.28% 1.49% 5.12% 1.49% 4.89% 2.17% 4.94% 1.89% 3.80% 1.55% $ 1,339 $ 1,366 $ 1,518 $ 1,401 $ 1,350 $ 1,585 $ 1,137 $ 9,696 Estimated forfeitures 62 368 845 280 169 142 87 1,953 Expensed in previous years 1,277 692 262 209 — — — 2,440 Expensed in 2014 — 217 157 284 197 — — 855 Expensed in 2015 — 89 157 269 295 241 — 1,051 Expensed in 2016 — — 97 269 295 361 175 1,197 Future expense — — — 90 394 841 875 2,200 Grand Totals 1,621,500 883,125 487,870 300,000 375,255 833,630 $ 11,966 1,953 4,324 965 1,176 1,348 2,200 Weighted average term of remaining future expense 2.5 years 54 SAUL CENTERS, INC. 2016 ANNUAL REPORT Notes TO CONSOLIDATED FINANCIAL STATEMENTS The table below summarizes the option activity for the years 2016, 2015, and 2014: OPTION ACTIVITY 2016 2015 2014 Weighted Average Weighted Average Weighted Average Shares Exercise Price Shares Exercise Price Shares Exercise Price Outstanding at January 1 860,274 $ 46.58 748,208 $ 44.79 753,625 $ 42.55 Granted 226,500 57.74 225,000 51.07 200,000 47.03 Exercised (246,894) 45.59 (112,934) 43.67 (167,917) 37.71 Expired/Forfeited (6,250) 45.31 –– –– (37,500) 43.56 Outstanding December 31 833,630 49.92 860,274 46.58 748,208 44.79 Exercisable at December 31 375,255 46.68 435,899 45.33 380,708 44.85 The intrinsic value of options exercised in 2016, 2015, and 2014, was $3.4 million, $1.5 million and $2.0 million, respectively. The intrinsic value of options outstanding and exercisable at year end 2016 was $13.9 million and $7.5 million, respectively. The intrinsic value measures the difference between the options’ exercise price and the closing share price quoted by the New York Stock Ex- change as of the date of measurement. The date of exercise was the measurement date for shares exercised during the period. At De- cember 30, 2016, the final trading day of calendar 2016, the closing price of $66.61 per share was used for the calculation of aggregate intrinsic value of options outstanding and exercisable at that date. The weighted average remaining contractual life of the Company’s exercisable and outstanding options at December 31, 2016 are 6.4 and 7.5 years, respectively. 11. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying values of cash and cash equivalents, accounts receiv- able, 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 cur- rently available to the Company for fixed rate financing, and assuming long term interest rates of approximately 4.25% and 3.75%, would be approximately $851.3 million and $892.9 mil- lion as of December 31, 2016 and 2015, respectively, compared to the principal balance of $844.3 million and $832.4 million at December 31, 2016 and 2015, respectively. A change in any of the significant inputs may lead to a change in the Company’s fair value measurement of its debt. Effective June 30, 2011, the Company determined that one of its in- terest-rate swap arrangements was a highly effective hedge of the cash flows under one of its variable-rate mortgage loans and desig- nated the swap as a cash flow hedge of that mortgage. The swap is carried at fair value with changes in fair value recognized either in income or comprehensive income depending on the effectiveness of the swap. The following chart summarizes the changes in fair value of the Company’s swap for the indicated periods. SWAPS FAIR VALUE Year ended December 31, (Dollars in thousands) 2016 2015 2014 Increase (decrease) in fair value: Recognized in earnings $ (6) $ (10) $ (10) Recognized in other comprehensive income 678 124 (675) Total $ 672 $ 114 $ (685) The Company carries its interest rate swaps at fair value. The Com- pany has determined the majority of the inputs used to value its derivative fall within Level 2 of the fair value hierarchy with the ex- ception of the impact of counter-party risk, which was determined using Level 3 inputs and are 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 con- tain inputs that are derived from observable market data. Where possible, the values produced by the pricing models are verified by the market prices. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit spreads, measure of volatility, and correlations of such inputs. The swap agreement terminates on July 1, 2020. As of December 31, 2016, the fair value of the interest-rate swap was approximately $2.1 million and is included in “Accounts payable, accrued ex- penses and other liabilities” in the consolidated balance sheets. The decrease in value from inception of the swap designated as a cash flow hedge is reflected in “Other Comprehensive Income” in the Consolidated Statements of Comprehensive Income. SAUL CENTERS, INC. 2016 ANNUAL REPORT 55 Notes TO CONSOLIDATED FINANCIAL STATEMENTS 12. COMMITMENTS AND CONTINGENCIES Neither the Company nor the Current Portfolio Properties are sub- ject 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 ad- verse impact on the Company or the Current Portfolio Properties. 13. DISTRIBUTIONS In December 1995, the Company established a Dividend Rein- vestment and Stock Purchase Plan (the “Plan”), to allow its stockholders and holders of limited partnership interests an op- portunity to buy additional shares of common stock by reinvesting all or a portion of their dividends or distributions. The Plan pro- vides for investing in newly issued shares of common stock at a 3% discount from market price without payment of any brokerage commissions, service charges or other expenses. All expenses of the Plan are paid by the Company. The Operating Partnership also maintains a similar dividend reinvestment plan that mirrors the Plan, which allows holders of limited partnership interests the op- portunity to buy either additional limited partnership units or common stock shares of the Company. The Company paid common stock distributions of $1.84 per share in 2016 and $1.69 per share during 2015 and $1.56 per share dur- ing 2014, Series A preferred stock dividends of $2.41 per depositary share in 2014 and Series C preferred stock dividends of $1.72 per depositary share during each of 2016, 2015, and 2014. Of the common stock dividends paid, $1.75 per share, $1.69 per share, and $1.56 per share, represented ordinary divi- dend income in 2016, 2015, and 2014, respectively, and $0.09 per share represented return of capital to the shareholders in 2016. All of the preferred stock dividends paid were considered ordinary dividend income. The following summarizes distributions paid during the years ended December 31, 2016, 2015, and 2014, and includes activity in the Plan as well as limited partnership units issued from the rein- vestment of unit distributions: Total Distributions to Dividend Reinvestments Limited Common Limiited Average (Dollars in thousands, Preferred Common Partnership Stock Shares Discounted Partnership Unit except per share amounts) Stockholders Stockholders Unitholders Issued Share Price Units Issued Price Distributions during 2016 October 31 $ 3,094 $ 10,168 $ 3,478 44,176 $ 57.18 30,891 $ 57.18 July 31 3,094 10,133 3,465 39,487 65.64 26,897 65.64 April 30 3,094 10,029 3,449 48,854 51.59 34,201 51.59 January 31 3,093 9,142 3,141 54,280 49.24 32,769 49.24 Total 2016 $ 12,375 $ 39,472 $ 13,533 186,797 124,758 Distributions during 2015 October 31 $ 3,094 $ 9,106 $ 3,129 47,313 $ 55.73 28,936 $ 55.73 July 31 3,094 9,081 3,115 56,003 50.30 32,041 50.30 April 30 3,094 9,055 3,104 54,921 50.21 25,264 50.21 January 31 3,093 8,403 2,880 42,975 56.74 20,796 56.74 Total 2015 $ 12,375 $ 35,645 $ 12,228 201,212 107,037 Distributions during 2014 October 31 $ 3,856 $ 8,348 $ 2,879 40,142 $ 52.71 July 31 3,206 8,314 2,879 57,696 46.79 April 30 3,206 8,269 2,838 60,212 44.14 104,831 $ 44.77 January 31 3,206 7,415 2,521 39,588 45.15 91,352 45.80 Total 2014 $ 13,474 $ 32,346 $ 11,117 197,638 196,183 56 SAUL CENTERS, INC. 2016 ANNUAL REPORT Notes TO CONSOLIDATED FINANCIAL STATEMENTS In December 2016, the Board of Directors of the Company author- ized a distribution of $0.51 per common share payable in January 2017, to holders of record on January 17, 2017. As a result, $11.0 million was paid to common shareholders on January 31, 2017. Also, $3.8 million was paid to limited partnership unitholders on January 31, 2017 ($0.51 per Operating Partnership unit). The Board of Directors authorized preferred stock dividends of $0.4297 per Series C depositary share to holders of record on Jan- uary 6, 2017. As a result, $3.1 million was paid to preferred share- holders on January 13, 2017. These amounts are reflected as a reduction of stockholders’ equity in the case of common stock and preferred stock dividends and noncontrolling interests deductions in the case of limited partner distributions and are included in div- idends and distributions payable the accompanying consolidated financial statements. in 14. INTERIM RESULTS (UNAUDITED) The following summary presents the results of operations of the Company for the quarterly periods of calendar years 2016 and 2015. (In thousands, except per share amounts) 2016 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Revenue $ 56,926 $ 52,710 $ 53,233 $ 54,201 Operating income before loss on early extinguishment of debt, gain on casualty settlement, and noncontrolling interests 16,381 13,250 12,722 13,360 Gain on sales of properties — — — 1,013 Net income attributable to Saul Centers, Inc. 12,948 10,627 10,239 11,465 Net income available to common stockholders 9,854 7,533 7,146 8,371 Net income available to common stockholders per diluted share 0.46 0.35 0.33 0.38 2015 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Revenue $ 52,088 $ 51,711 $ 52,376 $ 52,902 Operating income before loss on early extinguishment of debt, gain on casualty settlement, and noncontrolling interests 12,687 12,922 13,238 14,083 Gain on sales of properties — 11 — — Net income attributable to Saul Centers, Inc. 10,207 10,396 10,615 11,250 Net income available to common stockholders 7,113 7,302 7,522 8,156 Net income available to common stockholders per diluted share 0.33 0.35 0.36 0.38 SAUL CENTERS, INC. 2016 ANNUAL REPORT 57 Notes TO CONSOLIDATED FINANCIAL STATEMENTS 15. 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 sig- nificant accounting policies (see Note 2). The Company evaluates performance based upon income and cash flows from real estate for the combined properties in each segment. All of our properties within each segment generate similar types of revenues and expenses related to tenant rent, reimbursements and operating expenses. Although services are provided to a range of tenants, the types of services provided to them are similar within each seg- ment. The properties in each portfolio have similar economic characteristics and the nature of the products and services pro- vided 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 2016 presentation. Shopping Mixed-Use Corporate and Consolidated (In thousands) Centers Properties Other Totals As of or for the year ended December 31, 2016 Real estate rental operations: Revenue $ 160,179 $ 56,840 $ 51 $ 217,070 Expenses (34,931) (18,770) — (53,701) Income from real estate 125,248 38,070 51 163,369 Interest expense and amortization of deferred debt costs — — (45,683) (45,683) General and administrative — — (17,496) (17,496) Subtotal 125,248 38,070 (63,128) 100,190 Depreciation and amortization of deferred leasing costs (29,964) (14,453) — (44,417) Acquisition related costs (60) — — (60) Change in fair value of derivatives — — (6) (6) Gain on sale of property — 1,013 — 1,013 Net income (loss) $ 95,224 $ 24,630 $ (63,134) $ 56,720 Capital investment $ 64,044 $ 27,001 $ — $ 91,045 Total assets $ 976,545 $ 358,419 $ 8,061 $ 1,343,025 As of or for the year ended December 31, 2015 Real estate rental operations: Revenue $ 156,110 $ 52,916 $ 51 $ 209,077 Expenses (33,877) (17,266) — (51,143) Income from real estate 122,233 35,650 51 157,934 Interest expense and amortization of deferred debt costs — — (45,165) (45,165) General and administrative — — (16,353) (16,353) Subtotal 122,233 35,650 (61,467) 96,416 Depreciation and amortization of deferred leasing costs (30,171) (13,099) — (43,270) Acquisition related costs (84) — — (84) Predevelopment expenses (57) (75) — (132) Change in fair value of derivatives — — (10) (10) Gain on sale of property 11 — — 11 Net income (loss) $ 91,932 $ 22,476 $ (61,477) $ 52,931 Capital investment $ 17,159 $ 52,460 $ — $ 69,619 Total assets $ 931,256 $ 354,254 $ 9,898 $ 1,295,408 58 SAUL CENTERS, INC. 2016 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Shopping Mixed-Use Corporate and Consolidated (In thousands) Centers Properties Other Totals As of or for the year ended December 31, 2014 Real estate rental operations: Revenue $ 154,385 $ 52,632 $ 75 $ 207,092 Expenses (33,781) (15,732) — (49,513) Income from real estate 120,604 36,900 75 157,579 Interest expense and amortization of deferred debt costs — — (46,034) (46,034) General and administrative — — (16,961) (16,961) Subtotal 120,604 36,900 (62,920) 94,584 Depreciation and amortization of deferred leasing costs (28,082) (13,121) — (41,203) Acquisition related costs (949) — — (949) Predevelopment expenses — (503) — (503) Change in fair value of derivatives — — (10) (10) Gain on sale of property 6,069 — — 6,069 Net income (loss) $ 97,642 $ 23,276 $ (62,930) $ 57,988 Capital investment $ 66,508 $ 23,760 $ — $ 90,268 Total assets $ 939,267 $ 305,579 $ 12,267 $ 1,257,113 16. SUBSEQUENT EVENTS The Company has reviewed operating activities for the period sub- sequent to December 31, 2016 and prior to the date that financial settlements are issued, March 7, 2017, and determined the follow- ing subsequent event is required to be disclosed. In January 2017, the Company purchased for $76.3 million, includ- ing acquisition costs, Burtonsville Town Square located in Burtonsville, Montgomery County, Maryland. SAUL CENTERS, INC. 2016 ANNUAL REPORT 59 Dividend REINVESTMENT PLAN AND DISTRIBUTIONS Dividend Reinvestment Plan Saul Centers, Inc. offers a dividend reinvestment plan which enables its shareholders to automatically invest some of or all div- idends in additional shares. The plan provides shareholders with a convenient and cost-free way to increase their investment in Saul Centers. Shares purchased under the dividend reinvestment plan are issued at a 3% discount from the average price of the stock on the dividend payment date. The Plan’s prospectus is available for review in the Shareholders Information section of the Company’s web site. To receive more information please call the plan administrator at (800) 509-5586 and request to speak with a service represen- tative or write: Continental Stock Transfer and Trust Company Saul Centers, Inc. Attention: Dividend Reinvestment Plan 17 Battery Place New York, NY 10004 Dividends and Distributions Under the Code, REITs are subject to numerous organizational and operating requirements, including the requirement to dis- tribute at least 90% of REIT taxable income. The Company distributed more than the required amount in 2016 and 2015. Distributions by the Company to common stockholders and holders of limited partnership units in the Operating Partnership were $53.0 million and $47.9 million in 2016 and 2015, respec- tively. Distributions to preferred stockholders were $12.4 million in each of 2016 and 2015. See Notes to Consolidated Financial Statements, No. 13, “Distributions.” The Company may or may not elect to distribute in excess of 90% of REIT taxable income in future years. The Company’s estimate of cash flow available for distributions is believed to be based on reasonable assumptions and repre- sents a reasonable basis for setting distributions. However, the actual results of operations of the Company will be affected by a variety of factors, including but not limited to actual rental rev- enue, operating expenses of the Company, interest expense, general economic conditions, federal, state and local taxes (if any), unanticipated capital expenditures, the adequacy of re- serves and preferred dividends. While the Company intends to continue paying regular quarterly distributions, any future pay- ments will be determined solely by the Board of Directors and will depend on a number of factors, including cash flow of the Company, its financial condition and capital requirements, the annual distribution amounts required to maintain its status as a REIT under the Code, and such other factors as the Board of Di- rectors deems relevant. We are obligated to pay regular quarterly distributions to holders of depositary shares, prior to distributions on the common stock. The Company paid four quarterly distributions totaling $1.84, $1.69 and $1.56 per common share during 2016, 2015 and 2014, respectively. The annual distribution amounts paid by the Company exceeded the distribution amounts required for tax purposes. Distributions to the extent of our current and accumu- lated earnings and profits for federal income tax purposes generally will be taxable to a stockholder as ordinary dividend income. Distributions in excess of current and accumulated earn- ings and profits will be treated as a nontaxable reduction of the stockholder’s basis in such stockholder’s shares, to the extent thereof, and thereafter as taxable gain. Distributions that are treated as a reduction of the stockholder’s basis in its shares will have the effect of deferring taxation until the sale of the stock- holder’s shares. Of the $1.84 per common share dividend paid in 2016, 95% was treated as a taxable dividend and 5% repre- sented a return of capital. All of the 2015 and 2014 common dividends were treated as taxable dividends. No assurance can be given regarding what portion, if any, of distributions in 2017 or subsequent years will constitute a return of capital for federal income tax purposes. All of the preferred stock dividends paid are treated as ordinary dividend income. 60 SAUL CENTERS, INC. 2016 ANNUAL REPORT  Shares of Saul Centers common stock are listed on the New York Stock Exchange under the symbol “BFS”. The composite high and low closing sale prices for the Company’s shares of common stock were reported by the New York Stock Exchange for each quarter of 2016 and 2015 as follows: Market Infor mation COMMON STOCK PRICES Period Share Price High Low October 1, 2016 – December 31, 2016 $ 68.23 $ 58.79 July 1, 2016 – September 30, 2016 $ 68.58 $ 61.28 April 1, 2016 – June 30, 2016 $ 61.71 $ 51.59 January 1, 2016– March 31, 2016 $ 53.50 $ 47.77 October 1, 2015 – December 31, 2015 $ 58.87 $ 51.27 July 1, 2015 – September 30, 2015 $ 52.90 $ 47.65 April 1, 2015 – June 30, 2015 $ 56.93 $ 49.19 January 1, 2015– March 31, 2015 $ 60.30 $ 53.52 On March 1, 2017, the closing price was $64.62 per share. The approximate number of holders of record of the common stock was 190 as of March 1, 2017. SAUL CENTERS, INC. 2016 ANNUAL REPORT 61 Performance Graph Rules promulgated under the Exchange Act require the Company to present a graph comparing the cumulative total stockholder return on its Common Stock with the cumulative total stockholder return of (i) a broad equity market index, and (ii) a published industry index or peer group. The following graph compares the cumulative total stockholder return of the Company’s common stock, based on the market price of the common stock and assuming reinvestment of dividends, with the National Association of Real Estate Invest- ment Trust Equity Index (“NAREIT Equity”), the S&P 500 Index (“S&P 500”) and the Russell 2000 Index (“Russell 2000” ). The graph assumes the investment of $100 on December 31, 2011. Comparison of Cumulative Total Return d e t s e v n I 0 0 1 $ n r u t e R l a t o T $250 $225 $200 $175 $150 $125 $100 Dec. 31, 2011 Dec. 31, 2012 Dec. 31, 2013 Dec. 31, 2014 Dec. 31, 2015 Dec. 31, 2016 Dec. 31, 2011 Dec. 31, 2012 Dec. 31, 2013 Dec. 31, 2014 Dec. 31, 2015 Dec. 31, 2016 Saul Centers1 S&P 5002 Russell 20003 $100 $100 $100 $125.24 $144.16 $178.42 $165.06 $221.52 $116.00 $153.57 $174.60 $177.01 $198.18 $116.35 $161.52 $169.42 $161.95 $196.45 NAREIT Equity4 $100 $118.06 $120.97 $157.43 $162.46 $176.30 1 Source: S&P Capital I.Q. 2 Source: Bloomberg 3 Source: FTSE Russell 4 Source: National Association of Real Estate Investment Trusts 62 SAUL CENTERS, INC. 2016 ANNUAL REPORT Saul Centers CORPORATE INFORMATION DIRECTORS EXECUTIVE OFFICERS B. Francis Saul II Chairman and Chief Executive Officer J. Page Lansdale President and Chief Operating Officer Philip D. Caraci Vice Chairman The Honorable John E. Chapoton Partner, Brown Investment Advisory George P. Clancy, Jr. Executive Vice President, Emeritus Chevy Chase Bank Gilbert M. Grosvenor Chairman Emeritus of the Board of Trustees, National Geographic Society Philip C. Jackson, Jr. Adjunct Professor Emeritus, Birmingham-Southern College Patrick F. Noonan Founder/Chairman Emeritus, The Conservation Fund H. Gregory Platts Senior Vice President and Treasurer, Emeritus, National Geographic Society Andrew M. Saul II Chief Executive Officer Genovation Cars B. Francis Saul II Chairman and Chief Executive Officer J. Page Lansdale President and Chief Operating Officer Christine N. Kearns Executive Vice President – Chief Legal and Administrative Officer Scott V. Schneider Senior Vice President, Chief Financial Officer, Treasurer and Secretary Debra Stencel Senior Vice President and General Counsel Joel A. Friedman Senior Vice President, Chief Accounting Officer Christopher H. Netter Senior Vice President, Retail Leasing Steven N. Corey Senior Vice President, Office Leasing John F. Collich Senior Vice President, Acquisitions and Development Donald A. Hachey Senior Vice President, Construction Mark Sullivan III Financial and Legal Consultant Charles W. Sherren, Jr. Senior Vice President, Management The Honorable James W. Symington Of Counsel, O’Connor and Hannan, Attorneys at Law Benjamin Underwood Vice President, Residential John R. Whitmore Financial Consultant COUNSEL Pillsbury Winthrop Shaw Pittman LLP Washington, DC 20036 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Ernst and Young LLP McLean, Virginia 22102 WEB SITE www.saulcenters.com EXCHANGE LISTING New York Stock Exchange (NYSE) Symbol: Common Stock: BFS Preferred Stock: BFS.PrC TRANSFER AGENT Continental Stock Transfer and Trust Company 17 Battery Place New York, NY 10004 (800) 509-5586 INVESTOR RELATIONS A copy of the Saul Centers, Inc. annual report to the Securities and Exchange Commission on Form 10-K, which includes as exhibits the Chief Executive Officer and Chief Financial Officer Certifications required by Section 302 of the Sarbanes-Oxley Act, may be printed from the Company’s web site or obtained at no cost to stockholders by writing to the address below or calling (301) 986-6016. In 2016, the Company filed with the NYSE the Certification of its Chief Executive Officer confirming that he was not aware of any violation by the Company of the NYSE’s corporate governance listing standards. HEADQUARTERS 7501 Wisconsin Ave. Suite 1500E Bethesda, MD 20814-6522 Phone: (301) 986-6200 SAUL CENTERS, INC. 2016 ANNUAL REPORT 63 ANNUAL MEETING OF STOCKHOLDERS The Annual Meeting of Stockholders will be held at 11:00 a.m., local time, on May 5, 2017, at the Hyatt Regency Bethesda, One Bethesda Metro Center, Bethesda, MD (at the southwest corner of the Wisconsin Avenue and Old Georgetown Road intersection, adjacent to the Bethesda Metro Stop on the Metro Red Line.) 64 SAUL CENTERS, INC. 2016 ANNUAL REPORT 7501 Wisconsin Avenue, Suite 1500E Bethesda, MD 20814-6522 Phone: (301) 986-6200 Website: www.saulcenters.com 

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