Business Context and Reporting Period
Agree Realty Corporation filed this Form 10-K for the fiscal year ended December 31, 2011. The company is a self-managed REIT focused on developing, acquiring, owning and managing single-tenant retail properties and community shopping centers, primarily under long-term net leases.
- Portfolio: 87 properties in 21 states, comprising approximately 3.6 million square feet.
- Occupancy: 92.7% leased; weighted-average remaining lease term of approximately 11.7 years.
- Annualized base rent: $34.0 million, of which 87% came from national tenants and 96% from national and regional tenants.
- Tenant concentration: Walgreens represented 34% of annualized base rent, Kmart 11%, and CVS 7%, or 52% combined.
- Michigan concentration: 42 of the 87 properties were located in Michigan.
Financial Performance and Key Metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Total revenue | $36.3 million | $33.7 million | Up 7.8% |
| Minimum rents | $32.7 million | $30.4 million | Up 8.0% |
| Income from operations | $15.6 million | $11.9 million | Up 31.6% |
| Income before discontinued operations | $13.2 million | $7.7 million | Up 70.8% |
| Net income | $9.9 million | $15.6 million | Down 36.7% |
| Net income attributable to Agree Realty | $9.6 million | $15.1 million | Down 36.6% |
| Diluted earnings per share | $0.99 | $1.64 | Down $0.65 |
| Funds from operations | $30.1 million | $24.9 million | Up 20.6% |
| Cash flow from operations | $25.5 million | $26.1 million | Down 2.4% |
- Operating margin was approximately 43.0% in 2011, compared with 35.2% in 2010. Net margin was approximately 27.2%, compared with 46.4%, reflecting the adverse effect of discontinued operations and impairment-related items.
- 2011 operating expenses were $20.7 million, including $6.5 million of depreciation and amortization and a $3.65 million continuing-operations impairment charge.
- Total real estate impairments were $13.5 million, including $9.85 million recorded in discontinued operations for former Borders properties.
- Cash and cash equivalents increased to $2.0 million from $0.6 million at year-end 2010.
- 2011 dividends were $1.60 per share, compared with $2.04 per share in 2010. Approximately 98% of the 2011 dividend was treated as ordinary income and 2% as return of capital for tax purposes.
Debt, Liquidity and Capital Resources
- Mortgage debt was $62.9 million at December 31, 2011, including $39.7 million of fixed-rate debt at a weighted-average rate of 7.64% and $23.2 million of variable-rate mortgage debt.
- Borrowings under the new unsecured revolving credit facility were $56.4 million at a weighted-average rate of 2.18%. The facility had total commitments of $85 million, expandable to $135 million subject to conditions, and matured in October 2014 with extension options.
- Total debt, including accrued interest, was approximately $120.0 million under the selected financial data presentation. Debt to total market capitalization was approximately 32.4% using OP-unit conversion assumptions; management also reported approximately 34.2% under another calculation.
- Cash flow from operations was $25.5 million, while investing activities used $29.3 million, primarily for real estate acquisitions and lease intangibles. Financing activities provided $5.2 million.
- Contractual obligations totaled approximately $151.0 million, including mortgage principal, credit-facility borrowings, land-lease obligations and estimated interest.
- Management stated that available operating cash flow and the credit facility were expected to fund operations, dividends and near-term capital needs for at least the following 12 months.
- In January and February 2012, the company completed a 1.495 million-share secondary offering that generated approximately $35.1 million of net proceeds, primarily used to repay credit-facility borrowings and for general corporate purposes.
Material Changes Versus the Prior Comparable Period
- Revenue increased primarily from ten 2011 acquisitions, the full-year contribution of nine 2010 acquisitions, and four developments completed in 2010. These gains were partly offset by $2.5 million of lost rental revenue from Borders store closures.
- The company acquired ten retail properties for approximately $38.8 million at a weighted-average capitalization rate of 8.6%, compared with nine properties acquired for approximately $37 million at an 8.0% rate in 2010.
- Income from continuing operations improved substantially, but net income declined because of Borders-related impairment charges and a $3.45 million loss from discontinued operations.
- Interest expense rose 15% to $4.7 million because of higher borrowings, the new credit facility and default interest on certain mortgage loans.
- General and administrative expense increased 13% to $5.7 million, while depreciation and amortization increased 23% to $6.5 million.
- Funds from operations increased to $30.1 million from $24.9 million, benefiting from add-on property income and the exclusion of real estate depreciation and impairment charges.
- Portfolio occupancy declined to 92.7% from approximately 99% in 2010, primarily because of the Borders liquidation.
Guidance, Outlook, Risks and Unusual Items
- Management expected continued growth through development and acquisition of pre-leased, single-tenant retail properties, but did not provide quantitative earnings or revenue guidance.
- The Borders bankruptcy and liquidation materially affected 2011 results. All Borders leases at the company’s properties were rejected, leaving five vacant former Borders locations at the filing date and requiring the company to fund operating expenses and pursue sales or re-leasing.
- During 2011, the company completed sales of former Borders properties and entered into deed-in-lieu-of-foreclosure transactions. In December 2011, it conveyed the former Borders corporate headquarters in Ann Arbor to the lender, satisfying approximately $5.5 million of debt.
- Four additional former Borders properties securing approximately $9.2 million of cross-defaulted and cross-collateralized mortgage debt were conveyed to the lender on March 6, 2012, satisfying those loans.
- The company recognized a $2.36 million gain on extinguishment of debt related to the release of a former Borders mortgage loan.
- Key risks include tenant concentration, potential financial deterioration or store closures involving Kmart/Sears, lease expirations and re-leasing risk, geographic concentration, property impairment, interest-rate and refinancing risk, credit-facility covenants, environmental liabilities and the ability to maintain REIT qualification.
- A 100-basis-point increase in variable interest rates was estimated to increase annual interest expense by approximately $564,000. An interest-rate swap effectively fixed $24.5 million of variable-rate borrowings at 3.744% through July 2013.
- The company reported no material litigation, no unresolved SEC staff comments, effective disclosure controls and effective internal control over financial reporting.
Most Important Facts for Investors to Verify
- Reconcile the reported debt-to-market-capitalization ratios of 32.4% and 34.2%, which use different calculation conventions.
- Assess the pace and cost of re-leasing or selling the remaining vacant former Borders properties and the effect on recurring rental income.
- Monitor Walgreens, Kmart/Sears and CVS credit quality because they generated 52% of annualized base rent.
- Review the March 2012 deed-in-lieu-of-foreclosure transaction and its effect on debt, assets, occupancy and future cash flow.
- Evaluate near-term refinancing exposure, particularly the $22.3 million balloon payment associated with variable-rate mortgage debt due in July 2013, subject to extension.
- Compare recurring FFO and operating cash flow with the $1.60-per-share dividend and required capital expenditures.
- Confirm the effect of the 2012 equity offering on leverage, share count, dilution and credit-facility utilization.