ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Three months ended March 31, 2008
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, 2008, the portfolio consisted of 65 properties (53 freestanding, 12 community shopping centers) totaling approximately 3.4 million square feet, with a 99.6% occupancy rate. Approximately 88% of annualized base rent is derived from national tenants, with the top three tenants (Borders, Walgreens, Kmart) accounting for 66% of rent.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 3.6% to $8.77 million, driven primarily by a $292,000 (4%) increase in minimum rents due to the completion of new developments (Walgreens locations and land parcels) in late 2007 and early 2008. This was partially offset by a decrease in rental income from redevelopment activities at the Big Rapids, Michigan shopping center.
• Expense Increases:
  • Property Operating Expenses: Increased 16% to $594,378, primarily due to higher snow removal costs ($68,000 increase) and maintenance costs.
  • General & Administrative: Increased 10% to $1.10 million, driven by higher compensation and stock award values ($71,000) and increased legal/auditing costs.
  • Interest Expense: Increased 7% to $1.26 million due to increased borrowings to fund property development.
• Net Income: Decreased slightly by 0.7% ($26,107) to $3.58 million, as increased operating and interest expenses offset revenue growth.
• Debt Levels: Total debt increased by approximately $3.28 million. Notes payable increased by $3.95 million (utilization of credit facility), while mortgages payable decreased by $670,537.

Guidance, Outlook, and Risks

• Outlook: Management expects to continue growing the asset base through the development of pre-leased retail properties. Three development projects under construction (adding 43,290 sq. ft.) and a redevelopment project in Big Rapids are expected to be completed in Q2 2008, requiring an estimated $4.86 million in additional funding.
• Liquidity: The company maintains a $50 million Credit Facility (matures Nov 2009) with $40 million outstanding and a $5 million Line of Credit with $750,000 outstanding. Management believes cash flow from operations and these facilities are sufficient to meet obligations for the next 12 months.
• Dividends: A quarterly dividend of $0.50 per share was declared for the period, payable April 15, 2008.
• Material Weakness in Internal Controls: Management identified a material weakness in internal controls over financial reporting due to a lack of segregation of duties. The Chief Financial Officer is the sole employee with significant GAAP knowledge and controls the general ledger, reconciliations, and financial statement preparation. Independent consultants have been engaged to mitigate this risk.
• Market Risk: The company is exposed to interest rate risk. A 1% adverse change in interest rates on variable-rate debt would increase annual interest expense by approximately $407,000.

Investor Verification Checklist

• Tenant Concentration: Verify the financial health of the top three tenants (Borders, Walgreens, Kmart), which collectively represent 66% of annualized base rent.
• Internal Controls: Monitor progress on remediation of the material weakness regarding segregation of duties in financial reporting.
• Development Funding: Confirm the availability of capital to fund the estimated $4.86 million required to complete ongoing development projects in Q2 2008.
• Debt Maturity: Review the maturity schedule of the $40.75 million variable-rate notes payable, which mature in 2011, and assess refinancing risks.
• Lease Expirations: Review the 46 leases scheduled to expire between April 2008 and December 2010, representing $2.92 million in annualized base rent.