ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 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 March 31, 2009, the portfolio consisted of 70 properties (58 freestanding, 12 shopping centers) totaling approximately 3.5 million square feet across 16 states. The portfolio was 98.2% leased with a weighted average lease term of 10.6 years. Approximately 69% of annualized base rent was derived from three tenants: Borders Group (30%), Walgreen Co. (28%), and Kmart Corporation (11%).

Key Financial Metrics

Debt Structure: Total mortgage indebtedness was $66,795,430 ($42.3M fixed, $24.5M variable). Notes payable (Credit Facility) totaled $34,505,000. The ratio of indebtedness to market capitalization was approximately 75.7% as of March 31, 2009.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 5.4% year-over-year. Minimum rents rose 7% ($532,000) primarily due to the completion of six new Walgreens developments and a bank land lease.
• Expense Management: Property operating expenses decreased 23% ($135,000) due to lower snow removal and maintenance costs. However, General and Administrative (G&A) expenses increased 14% ($155,000) due to dead deal costs from property searches.
• Interest Expense: Interest expense decreased 11% ($134,000) to $1,125,624, driven by substantial reductions in market interest rates.
• Profitability: Net income attributable to Agree Realty increased 12% ($431,694) to $4,010,646.
• Cash Flow: Operating cash flow increased 15.6% to $5.46M. Investing cash outflows decreased significantly ($1.71M reduction) due to lower acquisition activity.

Outlook, Risks, and Contingencies

Management Commentary & Guidance: Management expects to continue growing the asset base through pre-leased development. They intend to maintain a debt-to-market capitalization ratio of 65% or less, though it currently stands at 75.7% due to stock price declines. Two development projects are under construction, expected to be completed in Q2 and Q3 2009, requiring an estimated $2.17M in additional funding.

Risks and Contingencies:

• 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. Consequently, disclosure controls and procedures were deemed ineffective.
• Market Conditions: The filing cites risks related to the ongoing U.S. recession, global credit crisis, and potential inability to obtain debt or equity financing on favorable terms.
• Tenant Concentration: High reliance on three major tenants (Borders, Walgreens, Kmart) for 69% of base rent creates concentration risk.
• Interest Rate Risk: A 100 basis point increase in rates on variable debt would increase annual interest expense by approximately $590,000. The company has hedged $24.5M of variable debt via an interest rate swap.

Investor Verification Checklist

• Internal Control Remediation: Verify the status of the remediation plan for the material weakness in financial reporting segregation of duties.
• Tenant Solvency: Assess the financial health of major tenants, specifically Borders Group and Kmart, given the high concentration of rent (69%) and the 2009 economic environment.
• Debt Refinancing: Monitor the ability to refinance the $34.5M Credit Facility (maturing Nov 2011) and the $24.5M variable mortgage (maturing July 2013) given tight credit markets.
• Development Funding: Confirm availability of capital to complete the two ongoing development projects requiring $2.17M.
• Stock Price Impact: Review the impact of the declining stock price on the debt-to-market capitalization ratio, which has exceeded the company's 65% target.