ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2004
Business Overview: Agree Realty operates and expands a portfolio of retail properties, primarily community shopping centers and net-leased properties. As of September 30, 2004, the company held a 90.57% interest in its Operating Partnership. The portfolio includes 13 leases with Kmart Corporation, which accounted for 15.3% of Annual Base Rent. All Kmart stores in the portfolio were open and operating as of the reporting date.

Key Financial Metrics

Debt Structure: Total mortgage indebtedness was $54.4 million (fixed rate, weighted average 6.63%). Notes payable totaled $33.9 million, consisting of a $31.0 million credit facility (variable rate, 2.93%) and a $2.9 million line of credit (variable rate, 4.25%).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 9.8% year-over-year. Minimum rents rose 10% to $19.75 million, driven by the acquisition of joint venture partner interests, new property acquisitions, and a $339,000 rent termination payment from Kmart regarding a closed Lakeland, FL store.
• Expense Management: Interest expense decreased 27% to $3.34 million due to reduced borrowings following a 2003 equity offering. General and administrative expenses increased 18% primarily due to higher compensation costs.
• Profitability: Net income increased 52% to $9.85 million. This was aided by the absence of a $961,000 early extinguishment of debt charge recorded in 2003 and gains from discontinued operations ($522,741).
• Portfolio Changes: The company sold two properties (Winter Garden, FL and Perrysburg, OH) previously reported as discontinued operations. In July 2004, the company acquired 100% ownership of two joint venture properties after the partner repaid $13.8 million in capital contributions, recorded as deferred revenue.

Outlook, Risks, and Management Commentary

• Liquidity and Capital Resources: The company declared a quarterly dividend of $0.49 per share. Management intends to maintain a debt-to-market capitalization ratio of 65% or less (currently approx. 31%). Future funding for development ($4.1 million required) and acquisitions will be sourced from the Credit Facility and Line of Credit.
• Development Pipeline: Three development projects are under construction, adding 43,290 square feet of Gross Leasable Area (GLA). One is expected to complete in Q4 2004, with two others in Q1 2005.
• Tenant Risk (Kmart): While all Kmart stores are currently operating, the company notes risks associated with tenant bankruptcy and lease rejections. The company successfully re-leased the vacant Kmart space in Lakeland, FL, to a department store in October 2004, though $600,000 in capital improvements were required.
• Market Risk: The company is exposed to interest rate risk on variable-rate debt. A 10% adverse change in interest rates would increase interest expense by approximately $96,000. The company does not use financial instruments for speculative purposes.

Investor Verification Checklist

• Kmart Exposure: Verify the stability of the 13 Kmart leases (15.3% of base rent) and the performance of the newly leased department store in Lakeland, FL.
• Deferred Revenue Recognition: Monitor the amortization schedule of the $13.8 million deferred revenue resulting from the buyout of joint venture partners.
• Debt Maturities: Review the scheduled mortgage maturities, with $2.15 million due in 2005 and significant portions maturing between 2006 and 2009.
• Development Costs: Track the $4.1 million in required funding for ongoing development projects and ensure they are completed on schedule to generate expected cash flows.
• Dividend Sustainability: Confirm that Funds from Operations (FFO) continue to support the quarterly dividend policy required for REIT status.