ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2009
Business Overview: Agree Realty is a self-administered REIT focused on owning, developing, and managing retail properties net-leased to national tenants. As of June 30, 2009, the portfolio consisted of 71 properties (59 freestanding, 12 shopping centers) totaling approximately 3.5 million square feet, with a 98.2% occupancy rate. Approximately 70% of annualized base rent was derived from three tenants: Walgreen Co. (29%), Borders Group, Inc. (29%), and Kmart Corporation (11%).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 4.6% year-over-year for the six-month period. Minimum rents rose 5.1% ($830,000 increase), driven by the completion of several Walgreens developments and a bank land lease. This was partially offset by a $164,000 decrease in rental income due to the closure of a Circuit City store in Boynton Beach, Florida.
• Expense Management: Property operating expenses decreased 17% ($163,000) primarily due to lower snow removal and maintenance costs. General and administrative expenses increased slightly by 1% ($24,000) due to dead deal costs. Interest expense decreased 9% ($213,000) due to lower market interest rates.
• Profitability: Net income attributable to Agree Realty increased 12.3% ($904,813) compared to the prior year period.
• Capital Structure: Total indebtedness increased by approximately $3.7 million. The company utilized its Credit Facility and Line of Credit to fund operations and development. The debt-to-market capitalization ratio increased to 66.6% from 65.4% at year-end 2008, attributed to a decline in the market value of common stock.

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. However, current market conditions have limited the availability of new financing sources, which may impact construction financing for planned developments.
• Dividends: A quarterly dividend of $0.50 per share was declared for the quarter ended June 30, 2009, paid on July 14, 2009.
• Development Pipeline: One development project (13,650 sq. ft.) is under construction with an estimated completion in Q3 2009. Additional funding of $1.068 million is required to complete this project.
• Interest Rate Risk: 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%. A 100 basis point increase in rates on remaining variable debt would increase annual interest expense by approximately $383,000.
• Internal Controls: Management identified a material weakness in internal controls over financial reporting due to a lack of segregation of duties. The CFO and Director of Finance are the only employees with significant GAAP knowledge and control over the general ledger. Independent consultants have been engaged to mitigate this risk.
• Tenant Concentration Risk: The company faces significant concentration risk with its top three tenants (Walgreens, Borders, Kmart) comprising 70% of annualized base rent. The filing notes risks associated with the bankruptcy or failure of major tenants.

Investor Verification Checklist

• Tenant Solvency: Verify the financial health of Borders Group, Inc. and Kmart Corporation, which collectively represent 40% of annualized base rent.
• Internal Control Remediation: Monitor progress on remediation of the material weakness regarding segregation of duties in financial reporting.
• Financing Availability: Assess the company's ability to refinance short-term debt (Credit Facility matures Nov 2011; Line of Credit matures Nov 2009) given the tight credit market conditions noted in the filing.
• Development Costs: Confirm the $1.068 million funding requirement for the ongoing development project and its impact on cash flow.
• Lease Expirations: Review the schedule of 48 leases expiring between July 2009 and December 2011, representing $3.3 million in annualized base rent.