ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Six months ended June 30, 2002
Business Overview: The Company operates and expands a retail property business through Agree Limited Partnership. As of June 30, 2002, the Company held an 86.84% interest in the Operating Partnership. The portfolio includes 16 leases with Kmart Corporation, representing 24% of annual base rent as of December 31, 2001.

Key Financial Metrics

Note: Total Debt calculated as Mortgage Payable ($71,371,468) + Notes Payable ($19,758,232) + Construction Loans ($13,351,632).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased slightly by 0.5% ($67,333) compared to the prior year. Minimum rents increased by 2% ($203,000) due to property development, while percentage rents dropped 67% ($87,000) following a tenant agreement to increase base rent in exchange for eliminating percentage rent provisions.
• Expense Increases: General and administrative expenses rose 12% ($104,000) primarily due to compensation costs. Property operating expenses increased 10% ($75,000) driven by higher snow removal costs ($117,000), partially offset by lower maintenance and utility costs.
• Interest Expense Reduction: Net interest expense decreased 16% ($574,000) to $3,023,125, attributed to lower interest rates on variable rate notes payable.
• Asset Sales: The Company recognized a $138,543 gain on the sale of assets in 2001; no such gain occurred in 2002.
• Liquidity: Cash and cash equivalents increased to $761,470 from $152,621 in the prior year, despite a net decrease in cash of $340,391 during the period.

Outlook, Risks, and Management Commentary

• Kmart Bankruptcy Risk: Kmart Corporation filed for Chapter 11 reorganization. While none of the Company's 16 Kmart stores were included in the initial list of 284 closures announced in March 2002, management notes there is no assurance that additional closures will not occur in the future. A $96,000 charge was recorded in 2002 for a possible collection loss related to Kmart.
• Lease Renewal: The lease with A&P on a free-standing property in Roseville, Michigan, expired and was not renewed. The land has been leased to Sam's Real Estate Business Trust (guaranteed by Wal-Mart Stores, Inc.) for the construction of a Sam's Club, expected to positively impact FFO.
• Capital Resources: The Company maintains a $50 million Credit Facility (matures August 2003) with $19.76 million outstanding and a $5 million Line of Credit (matures April 2003) with no outstanding balance. Management intends to maintain a debt-to-market capitalization ratio of 65% or less, targeting 50% or less upon refinancing.
• Dividends: A quarterly dividend of $0.46 per share was declared and paid on July 11, 2002.
• Market Risk: The Company is exposed to interest rate risk on variable rate debt. A 10% adverse change in interest rates would increase annual interest expense by approximately $75,000.

Investor Verification Checklist

• Kmart Exposure: Verify the current status of the 16 Kmart leases and any updates regarding store closures or rent concessions following the Chapter 11 filing.
• Debt Maturities: Review the scheduled maturities of the $71.4 million in mortgage debt, noting a significant maturity of $30.3 million in 2006.
• Construction Pipeline: Confirm the progress and financing status of the three retail properties under development funded by $13.4 million in construction loans.
• FFO vs. Net Income: Analyze the divergence between Net Income ($4.06M) and Funds From Operations ($6.78M) to understand the impact of depreciation and amortization on cash generation.
• Dividend Sustainability: Assess whether operating cash flow ($6.67M) sufficiently covers dividend obligations ($4.09M declared) and debt service requirements.