ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and nine months ended September 30, 2009
Business Overview: A self-administered REIT focused on owning, developing, and managing retail properties net-leased to national tenants. As of September 30, 2009, the portfolio consisted of 72 properties (60 freestanding, 12 community shopping centers) totaling approximately 3.5 million square feet, with a 98.1% occupancy rate. Approximately 70% of annualized base rent is derived from three major tenants: Walgreen Co. (30%), Borders Group, Inc. (29%), and Kmart Corporation (11%).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 3.7% to $27.6 million for the nine months ended September 30, 2009, compared to $26.6 million in 2008. Minimum rents increased 4.4% driven by the completion of several Walgreens developments.
• Profitability: Net income attributable to the Company increased 13.2% to $12.7 million from $11.2 million in the prior year period. This was primarily due to increased rental income and a significant reduction in interest expense.
• Interest Expense: Interest expense decreased 11.5% to $3.4 million (from $3.9 million) due to substantial reductions in market interest rates.
• Operating Expenses: Property operating expenses decreased 11% to $1.2 million, largely due to lower snow removal and maintenance costs. However, General and Administrative expenses increased 2% to $3.3 million due to dead deal costs.
• Debt Structure: The company entered into an interest rate swap in January 2009 to fix the rate on $24.5 million of variable-rate borrowings at 3.744%.

Outlook, Risks, and Management Commentary

Liquidity and Capital Resources: Management believes cash flow from operations and existing credit facilities ($55 million Credit Facility and $5 million Line of Credit) are sufficient to fund operations and dividends for the next 12 months. The ratio of indebtedness to market capitalization was approximately 54% as of September 30, 2009, down from 65.4% at year-end 2008.

Forward-Looking Risks:

• Economic Conditions: The global financial crisis and recession pose risks to tenant solvency and the availability of capital for development.
• Tenant Concentration: Heavy reliance on three major tenants (Walgreens, Borders, Kmart) creates significant risk if any default. Borders Group and Kmart are noted as having faced financial difficulties during this period.
• Financing Constraints: Market dislocation may limit the ability to obtain construction financing for new projects or refinance existing debt on favorable terms.
• Internal Controls: The company previously reported a material weakness regarding segregation of duties in financial reporting. Changes were implemented on July 1, 2009, to address this, including the addition of a Director of Finance.

Unusual Items: The company recognized $158,430 in development fee income related to a project in Oakland, California, which was not present in the prior year.

Investor Verification Checklist

• Tenant Solvency: Verify the current financial status of Borders Group, Inc. and Kmart Corporation, which collectively represent 40% of annualized base rent.
• Development Pipeline: Assess the status of pre-leased development projects and the availability of permanent financing given current credit market conditions.
• Debt Maturities: Review the schedule of debt maturities, specifically the $39.95 million in notes payable maturing in 2011 and the variable-rate mortgage maturing in 2013.
• Internal Controls: Confirm the effectiveness of the new internal controls implemented in July 2009 regarding financial reporting segregation of duties.
• Lease Expirations: Evaluate the impact of 45 leases expiring between October 2009 and December 2011, representing $3.2 million in annualized base rent.