ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Reporting Period: Fiscal year ended December 31, 2003
Business Model: Self-administered REIT focused on developing, acquiring, and owning retail properties net-leased to national tenants. The portfolio consists of 50 properties (37 freestanding, 13 community shopping centers) totaling approximately 3.5 million square feet across 13 states.
Key Tenants: As of year-end, 67% of annualized lease revenue was derived from three tenants: Borders Group (33%), Walgreen Co. (17%), and Kmart Corporation (17%).

Key Financial Metrics

Note: Total Debt includes Mortgages Payable ($55.97M), Construction Loans ($1.57M), and Notes Payable ($26.5M).

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 12.6% to $27.5 million, driven by a 13% increase in minimum rental income due to new developments, acquisitions, and the acquisition of joint venture partner interests.
• Net Income Increase: Net income rose 19.4% to $10.5 million. This was supported by higher operating income and a $740,000 gain on the sale of a discontinued property (Winter Garden Plaza), partially offset by a $961,000 charge for early extinguishment of debt.
• Debt Reduction: Total debt decreased significantly from $115.3 million in 2002 to $84.0 million in 2003. The company repaid approximately $37 million in mortgages early and used proceeds from a $43.2 million common stock offering to reduce credit facility borrowings.
• Interest Expense: Interest expense decreased 8.3% to $5.68 million due to reduced outstanding indebtedness.
• Portfolio Activity: Completed development of two freestanding properties and acquired one freestanding property. Sold one community shopping center. Acquired 100% interest in two joint venture properties.

Guidance, Outlook, and Risks

Management Commentary & Outlook: The company intends to continue growing its asset base through the development of pre-leased retail properties. Management plans to maintain a ratio of total indebtedness to market capitalization of 65% or less, with a target to lower this to 50% or less upon refinancing short-term construction debt. The company expects to meet liquidity requirements through operating cash flow and existing credit facilities.

Key Risks & Contingencies:

• Tenant Concentration: Heavy reliance on Borders, Walgreen, and Kmart (67% of revenue). The bankruptcy of any major tenant could materially adversely affect operations.
• Kmart Specifics: Kmart emerged from bankruptcy in May 2003, closing one store in the company's portfolio (Lakeland, FL). The company is actively marketing the space, estimating a 9-15 month re-letting period. A rent reduction of $150,000/year was agreed upon for a Kmart store in Perrysburg, OH.
• REIT Status: Failure to qualify as a REIT would subject the company to corporate income taxes, substantially reducing funds available for dividends.
• Geographic Concentration: 26 of 50 properties are located in Michigan, creating exposure to regional economic downturns.

Investor Verification Checklist

• Kmart Re-leasing: Verify the status of the vacant Lakeland, FL property and the timeline for securing a replacement anchor tenant.
• Debt Maturities: Review the schedule of mortgage maturities, noting $2.05 million due in 2004 and $2.30 million in 2005, to assess refinancing needs.
• Joint Venture Refinancing: Monitor the refinancing of the two joint venture properties (Ann Arbor, MI and Tulsa, OK), which are currently under short-term leases expiring June 2004.
• Dividend Coverage: Confirm that Funds from Operations ($15.2M) continue to cover the required 90% taxable income distribution and declared dividends ($12.5M paid in 2003).
• Environmental Liabilities: Review Phase I and Phase II environmental study results for the 2003 acquisitions and developments to ensure no undisclosed contamination costs.