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ADC > SEC Filings for ADC > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for AGREE REALTY CORP

Form 10-Q for AGREE REALTY CORP


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and described our future plans, strategies and expectations, are generally identifiable by use of the words "anticipate," "estimate," "should," "expect," "believe," "intend," "may," "will," "seek," "could," "project," or similar expressions. Forward-looking statements in this report include information about possible or assumed future events, including, among other things, discussion and analysis of our future financial condition, results of operations, our strategic plans and objectives, occupancy and leasing rates and trends, liquidity and ability to refinance our indebtedness as it matures, anticipated expenditures of capital, and other matters. You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors, which are, in some cases, beyond our control and which could materially affect actual results, performances or achievements. Factors which may cause actual results to differ materially from current expectations, include but are not limited to: the global and national economic conditions and changes in general economic, financial and real estate market conditions; changes in our business strategy; risks that our acquisition and development projects will fail to perform as expected; the potential need to fund improvements or other capital expenditures out of operating cash flow; financing risks, such as the inability to obtain debt or equity financing on favorable terms or at all; the level and volatility of interest rates; our ability to re-lease space as leases expire; loss or bankruptcy of one or more of our major retail tenants; a failure of our properties to generate additional income to offset increases in operating expenses; our ability to maintain our qualification as a real estate investment trust ("REIT") for federal income tax purposes and the limitations imposed on our business by our status as a REIT; and other factors discussed in Item 1A. "Risk Factors" and elsewhere in this report and in subsequent filings with the Securities and Exchange Commission ("SEC") including our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. We caution you that any such statements are based on currently available operational, financial and competitive information, and that you should not place undue reliance on these forward-looking statements, which reflect our management's opinion only as of the date on which they were made. Except as required by law, we disclaim any obligation to review or update these forward-looking statements to reflect events or circumstances as they occur.

Overview

Agree Realty Corporation is a fully-integrated, self-administered and self-managed REIT. In this report, the terms "Company," "we," "our" and "us" and similar terms refer to Agree Realty Corporation and/or its majority owned operating partnership, Agree Limited Partnership ("Operating Partnership") and/or its majority owned and controlled subsidiaries, including its qualified taxable REIT subsidiaries ("TRS"), as the context may require. Our assets are held by and all of our operations are conducted through, directly or indirectly, the Operating Partnership, of which we are the sole general partner and in which we held a 97.05% and 96.59% interest as of September 30, 2012 and December 31, 2011, respectively. Under the partnership agreement of the Operating Partnership, we, as the sole general partner, have exclusive responsibility and discretion in the management and control of the Operating Partnership. We are operating so as to qualify as a REIT for federal income tax purposes.

We are primarily engaged in the acquisition and development of single tenant properties net leased to industry leading retail tenants. We were incorporated in December 1993 to continue and expand the business founded in 1971 by our current Chief Executive Officer and Chairman, Richard Agree. We specialize in acquiring and developing single tenant net leased retail properties for industry leading retail tenants. As of September 30, 2012, approximately 96% of our annualized base rent was derived from national and regional tenants and approximately 47% of our annualized base rent was derived from our top three tenants: Walgreens Co. ("Walgreens") - 32%; Kmart Corporation ("Kmart") - 8% and CVS Caremark Corporation ("CVS") - 7%.

As of September 30, 2012, our portfolio consisted of 96 properties, located in 25 states containing an aggregate of approximately 3.1 million square feet of gross leasable area ("GLA"). As of September 30, 2012, our portfolio included 87 freestanding single tenant net leased properties and nine community shopping centers that were 98% leased in aggregate with a weighted average lease term of approximately 12 years remaining. All of our freestanding property tenants and the majority of our community shopping center tenants have triple-net leases, which require the tenant to be responsible for property operating expenses, including property taxes, insurance and maintenance. We believe this strategy provides a generally consistent source of income and cash for distributions.

During the period from October 1, 2012 to December 31, 2012, we have one lease that is scheduled to expire assuming that the tenant does not exercise its renewal option or terminate its lease prior to the contractual expiration date. This lease represents 1,836 square feet of GLA and $15,147 of annualized base rent. During the first quarter of 2012, Kmart exercised options to extend the lease expiration date from September 2012 to September 2014 for two leases amounting to 142,700 square feet. In addition, during the second quarter of 2012, Best Buy extended their lease from January 2013 to January 2016 in 52,000 square feet.

We expect to continue to grow our asset base through the development and acquisition of single tenant net leased retail properties that are leased on a long-term basis to industry leading retail tenants. Historically we have focused on development because we believed, based on the historical returns we have been able to achieve, it generally has provided us a higher return on investment than the acquisition of similarly located properties. However, beginning in 2010, we commenced a strategic acquisition program to acquire retail properties net leased to industry leading retail tenants. Since our initial public offering in 1994, we have developed 55 of our 96 properties, including 46 of our 87 freestanding single tenant properties and all nine of our community shopping centers. As of September 30, 2012, the properties that we developed accounted for 65% of our annualized base rent. We expect to continue to expand our existing tenant relationships and diversify our tenant base to include other quality industry leading retail tenants through the development and acquisition of net leased properties.

In 2012, we announced a development project in Rancho Cordova, California for Walgreens, and three development projects for Wawa, one in Osceola County, Florida, one in Pinellas County, Florida, and another in Casselberry, Florida. Additionally, we have entered into a development project in Venice, Florida for JPMorgan Chase. We completed the development project for McDonald's in Southfield, Michigan during the second quarter of 2012 and the expansion of Miner's Super One Foods at our Ironwood Commons Center was completed during the third quarter of 2012. Miner's expects to open in the fourth quarter of 2012.

The following should be read in conjunction with the Interim Consolidated Financial Statements of Agree Realty Corporation, including the respective notes thereto, which are included in this Quarterly Report on Form 10-Q.

Recent Accounting Pronouncements

As of September 30, 2012, the impact of recent accounting pronouncements on our business is not considered to be material.

Critical Accounting Policies

Critical accounting policies are those that are both significant to the overall presentation of our financial condition and results of operations and require management to make difficult, complex or subjective judgments. For example, significant estimates and assumptions have been made with respect to revenue recognition, capitalization of costs related to real estate investments, potential impairment of real estate investments, operating cost reimbursements, and taxable income.

Minimum rental income attributable to leases is recorded on a straight-line basis over the lease term. Certain leases provide for additional percentage rents based on tenants' sales volumes. These percentage rents are recognized when determinable by us.

Real estate assets are stated at cost less accumulated depreciation. All costs related to planning, development and construction of buildings prior to the date they become operational, including interest and real estate taxes during the construction period, are capitalized for financial reporting purposes and recorded as property under development until construction has been completed. The viability of all projects under construction or development is regularly evaluated under applicable accounting requirements, including requirements relating to abandonment of assets or changes in use. To the extent a project, or individual components of the project, are no longer considered to have value, the related capitalized costs are charged against operations. Subsequent to the completion of construction, expenditures for property maintenance are charged to operations as incurred, while significant renovations are capitalized. Depreciation of the buildings is recorded in accordance with the straight-line method using an estimated useful life of 40 years.

We evaluate real estate for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through estimated undiscounted future cash flows from the use of these assets. When any such impairment exists, the related assets will be written down to fair value and such excess carrying value is charged to income. The expected cash flows of a project are dependent on estimates and other factors subject to change, including (1) changes in the national, regional, and/or local economic climates,
(2) competition from other shopping centers, stores, clubs, mailings, and the internet, (3) increases in operating costs, (4) bankruptcy and/or other changes in the condition of third parties, including tenants, (5) expected holding period, and (6) availability of credit. These factors could cause our expected future cash flows from a project to change, and, as a result, an impairment could be considered to have occurred.

Substantially all of our leases contain provisions requiring tenants to pay as additional rent a proportionate share of operating expenses ("operating cost reimbursements") including real estate taxes, repairs and maintenance and insurance. The related revenue from tenant billings is recognized in the same period the expense is recorded.

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code") since our 1994 tax year. As a result, we are not subject to federal income taxes to the extent that we distribute annually at least 90% of our REIT taxable income to our stockholders and satisfy certain other requirements defined in the Code.

We have established TRS entities pursuant to the provisions of the REIT Modernization Act. Our TRS entities are able to engage in activities resulting in income that previously would have been disqualified from being eligible REIT income under the federal income tax regulations. As a result, certain of our activities which occur within our TRS entities are subject to federal and state income taxes. As of September 30, 2012 and December 31, 2011, we had accrued a deferred income tax amount of $705,000. In addition, we have recognized income tax expense (benefit) of $0 and ($24,000) for the three months ended September 30, 2012 and 2011, respectively, and $8,000 and $252,000 for the nine months ended September 30, 2012 and 2011, respectively, and $236,000 for the year ended December 31, 2011.

Results of Operations

Comparison of Three Months Ended September 30, 2012 to Three Months Ended September 30, 2011

Minimum rental revenue increased $1,593,000, or 22%, to $8,722,000 in 2012, compared to $7,129,000 in 2011. Rental revenue increased $1,483,000 due to the acquisition of 22 single tenant net leased properties subsequent to June 30, 2011. In addition, rental income increased $110,000 as a result of other rent adjustments.

Operating cost reimbursements decreased $27,000, or 5%, to $542,000 in 2012, compared to $569,000 in 2011.

Other income was $15,000 in 2012, compared to $28,000 in 2011.

Real estate taxes decreased $83,000, or 17%, to $395,000 in 2012, compared to $478,000 in 2011. The change was related to single tenant properties.

Property operating expenses (shopping center maintenance, snow removal, insurance and utilities) decreased $51,000, or 17%, to $254,000 in 2012, compared to $305,000 in 2011. The change was the result of a decrease in shopping center maintenance costs of $67,000, offset by an increase in insurance costs of $12,000, and other costs of $4,000 in 2012.

Land lease payments decreased $75,000, or 41%, to $106,000 in 2012, compared to $181,000 in 2011 due to acquisition of property previously leased.

General and administrative expenses increased by $227,000, or 21%, to $1,317,000 in 2012, compared to $1,090,000 in 2011. The increase in general and administrative expenses was the result of increased employee costs of $87,000, increased professional fees of $64,000, increased travel and convention costs of $14,000, increased insurance of $13,000, and other increased costs of $73,000 offset by decreased income tax expense in our TRS entities of $24,000. General and administrative expenses as a percentage of total rental income (minimum and percentage rents) increased from 12.73% for 2011 to 14.78% for 2012.

Depreciation and amortization increased $107,000, or 7%, to $1,659,000 in 2012, compared to $1,552,000 in 2011. The increase was the result of the acquisition of 22 properties in 2011 and 2012.

In 2011, we incurred an impairment charge $600,000 as a result of writing down the carrying value of our real estate assets for properties formerly leased to Borders

In 2011, we recognized a gain on extinguishment of debt in the amount of $2,360,000.

We recognized a loss of ($321,000) on the sale of assets in 2012. There was no gain or loss on sales in 2011.

Interest expense increased $374,000, or 39%, to $1,344,000 in 2012, compared to $970,000, in 2011. The increase in interest expense was a result of the higher level of borrowings due to the acquisition of properties.

We recognized a loss of $321,000 on the disposition of properties in 2012. We sold three properties, two in August and another one in September of 2012.

Income (loss) from discontinued operations was $142,000 in 2012 compared to ($6,766,000) in 2011, as a result of the sale of six properties, one in May, one in June, two in August, and another in September of 2012, the conveyance of four former Borders properties to the lender in March 2012, one of which was occupied, and the sale of the Ann Arbor office space which was not occupied. In addition, in December 2011, we sold one property, conveyed the former Borders corporate headquarters to the lender, and terminated the ground lease on a property and conveyed a portion of the property to the ground lessor.

Our net income increased $5,880,000 or 317%, to $4,025,000 in 2012 from ($1,855,000) in 2011 as a result of the foregoing factors.

Comparison of Nine Months Ended September 30, 2012 to Nine Months Ended September 30, 2011

Minimum rental income increased $3,493,000, or 16%, to $24,698,000 in 2012, compared to $21,205,000 in 2011. Rental income increased $3,405,000 due to the acquisition of 24 single tenant net leased properties subsequent to January 1, 2011. In addition, rental income increased $88,000 as a result of other rent adjustments.

Percentage rents were $23,000 in 2012 compared to $22,000 in 2011.

Operating cost reimbursements were $1,691,000 in 2012 and 2011.

We earned development fee income of $895,000 in 2011 related to a project in California. There were no development fee projects in the first nine months of 2012 and no additional development fee projects are currently anticipated.

Other income was $60,000 in 2012, compared to $112,000 in 2011.

Real estate taxes decreased $66,000, or 5%, to $1,364,000 in 2012, compared to $1,430,000 in 2011. The change was related to single tenant properties.

Property operating expenses (shopping center maintenance, snow removal, insurance and utilities) decreased $99,000, or 11%, to $811,000 in 2012, compared to $910,000 in 2011. The change was the result of a decrease in shopping center maintenance costs of $92,000, and a decrease in snow removal costs of $65,000, offset by an increase in utility costs of $22,000, including utilities for vacant spaces, and an increase in insurance costs of $36,000 in 2012.

Land lease payments decreased $72,000, or 13%, to 468,000 in 2012, compared to $540,000 in 2011 due to acquisition of property previously leased.

General and administrative expenses increased by $100,000, or 2%, to $4,153,000 in 2012, compared to $4,053,000 in 2011. The increase in general and administrative expenses was the result of increased employee costs of $306,000, increased travel and convention costs of $61,000, and other increased costs of $31,000 offset by decreased income tax expense in our TRS entities of $244,000 and decreased professional fees of $54,000. General and administrative expenses as a percentage of total rental income (minimum and percentage rents) increased from 12.78% for 2011 to 15.88% for 2012.

Depreciation and amortization increased $746,000, or 18%, to $4,845,000 in 2012, compared to $4,099,000 in 2011. The increase was the result of the acquisition of 24 properties in 2011 and 2012.

In 2011, we incurred an impairment charge of $600,000 as a result of writing down the carrying value of our real estate assets for properties formerly leased to Borders

In 2011, we recognized a gain on extinguishment of debt in the amount of $2,360,000.

We recognized a gain of $1,747,000 on the sale of assets in 2012. There was no gain or loss on sales in 2011.

Interest expense increased $741,000, or 26%, to $3,626,000 in 2012, compared to $2,885,000 in 2011. The increase in interest expense was a result of the higher level of borrowings due to the acquisition of properties.

We recognized a gain of $1,747,000 on the disposition of properties in 2012. We sold six properties and conveyed four former Borders properties to the lender pursuant to a consensual deed-in-lieu-of-foreclosure process that satisfied the loans, which had an aggregate principal amount outstanding of approximately $9.2 million as of December 31, 2011.

Income (loss) from discontinued operations was $905,000 in 2012 compared to ($5,100,000) in 2011, as a result of the sale of six properties, one in May, one in June, two in August, and another in September of 2012, the conveyance of four former Borders properties to the lender in March 2012, one of which was occupied, and the sale of the Ann Arbor office space which was not occupied. In addition, in January 2011, we sold two properties and in December 2011 we sold one property, conveyed the former Borders corporate headquarters to the lender, and terminated the ground lease on a property and conveyed a portion of the property to the ground lessor.

Our net income increased $7,189,000, or 108%, to $13,857,000 in 2012 from $6,668,000 in 2011 as a result of the foregoing factors.

Liquidity and Capital Resources

Our principal demands for liquidity are operations, distributions to our stockholders, debt repayment, development of new properties, redevelopment of existing properties and future property acquisitions. We intend to meet our short-term liquidity requirements, including capital expenditures related to the leasing and improvement of our properties, through cash flow provided by operations, our $85 million credit facility (the "Credit Facility") and additional financings. We believe that adequate cash flow will be available to fund our operations and pay dividends in accordance with REIT requirements for at least the next 12 months. We may obtain additional funds for future developments or acquisitions through other borrowings or the issuance of additional shares of common stock. Although market conditions have limited the availability of new sources of financing and capital, which may have an impact on our ability to obtain financing, we believe that these financing sources will enable us to generate funds sufficient to meet both our short-term and long-term capital needs. The Company anticipates securing term loan or ten year financing during the fourth quarter 2012 in order to take advantage of the low interest rate environment and to increase its liquidity position.

We completed an underwritten public offering of 1,495,000 shares of common stock at a public offering price of $24.75 per share in January/February of 2012. The offering, which included the full exercise of the overallotment option by the underwriters, raised net proceeds of approximately $35 million after deducting the underwriting discount and other expenses. We used the net proceeds of the offering to pay down amounts outstanding under the Credit Facility and for general corporate purposes.

We sold six non-core properties during 2012 for net proceeds of approximately $15,330,000. The six properties included three former Borders locations located in Omaha, Nebraska; Ann Arbor, Michigan and Columbus, Ohio and three shopping centers located in Charlevoix, Michigan, Plymouth, Wisconsin, and Shawano, Wisconsin. We will continue to evaluate our portfolio to identify opportunities to further diversify our holdings and improve asset quality while executing on our operating strategy.

Our cash flows from operations decreased $2,237,000 to $14,340,000 for the nine months ended September 30, 2012, compared to $16,577,000 for the nine months ended September 30, 2011. Cash used in investing activities increased by $18,660,000 to ($32,813,000) in 2012, compared to ($14,153,000) in 2011. Cash provided by (used in) financing activities increased $19,144,000 to $17,014,000 in 2012, compared to ($2,130,000) in 2011.

On September 21, 2012, we filed articles supplementary to our charter reclassifying and designating 2,500,000 authorized but unissued shares of excess stock, par value $0.0001 per share, of the Company ("Excess Stock"), as shares of common stock, par value $0.0001 per share, of the Company with the preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends and other distribution, qualifications and terms and conditions of redemption as set forth our charter.

We have the authority to issue 20,000,000 shares of capital stock, par value $0.0001 per share, of which 15,850,000 shares are classified as shares of common stock, 4,000,000 shares are classified as shares of Excess Stock and 150,000 shares are classified as shares of our Series A Junior Participating Preferred Stock.

In September 2012, we filed a new shelf registration statement on Form S-3 (No. 333-184095) with the SEC, which was declared effective on October 15, 2012. The new shelf registration statement may permit us, from time to time, to offer and sell up to $250 million of equity securities, including common stock, preferred stock, depositary shares and warrants, in one or more public offerings. However, there can be no assurance that we will be able to complete any such offerings of securities. Factors influencing the availability of additional financing include investor perception of our prospects and the general condition of the financial markets, among others.

We intend to maintain a ratio of total indebtedness (including construction or acquisition financing) to total enterprise value of 45% or less. Nevertheless, we may operate with debt levels which are in excess of 45% of total enterprise value for extended periods of time. At September 30, 2012, our ratio of indebtedness to total enterprise value was approximately 29%.

Dividends

During the quarter ended September 30, 2012, we declared a quarterly dividend of $0.40 per share. We paid the dividend on October 9, 2012 to holders of record on September 28, 2012.

Debt

As of September 30, 2012, we had total mortgage indebtedness of $69,572,236. Of this total mortgage indebtedness, $46,828,508 is fixed rate, with a weighted average interest rate of 6.21%. The remaining mortgage debt of $22,743,728 bears interest at 170 basis points over LIBOR or 1.91% as of September 30, 2012 and has a maturity date of May 14, 2017, which can be extended at our option for two additional years, subject to certain terms and conditions. In January 2009, we entered into an interest rate swap agreement that fixes the interest rate through June 30, 2013 for the variable-interest mortgage at 3.744%. In April 2012, we entered into an interest rate swap agreement that fixes the interest rate for the variable-interest mortgage at 3.62% from July 1, 2013 to May 1, 2019.

In March 2012, we conveyed four former Borders properties located in Columbia, Maryland, Germantown, Maryland, Oklahoma City, Oklahoma and Omaha, Nebraska, which were subject to non-recourse mortgage loans in default, to the lender pursuant to a consensual deed-in-lieu-of-foreclosure process that satisfied the loans with principal balances amounting to approximately $9.2 million.

In June 2012, we entered into an amendment and restatement of a mortgage loan in the amount of $22,882,778 to provide for an extension of the maturity date to May 14, 2017, with an option to extend for two years to May 14, 2019, subject to certain conditions. Borrowings under the loan bear interest at LIBOR plus a spread of 170 basis points.

In addition, the Operating Partnership has in place an $85 million unsecured revolving Credit Facility, which is guaranteed by our Company. Subject to customary conditions, at our option, total commitments under the Credit Facility may be increased up to an aggregate of $135 million. We intend to use borrowings under the Credit Facility for general corporate purposes, including working capital, development and acquisition activities, capital expenditures, repayment of indebtedness or other corporate activities. The Credit Facility matures on October 26, 2014, and may be extended, at our election, for two one-year terms to October 2016, subject to certain conditions. Borrowings under the Credit Facility bear interest at LIBOR plus a spread of 175 to 260 basis points depending on our leverage ratio. As of September 30, 2012, we had $54,840,000 in principal amount outstanding under the Credit Facility bearing a weighted average interest rate of 2.18%, and $30,160,000 was available for borrowing (subject to customary conditions to borrowing).

The Credit Facility contains customary covenants, including, among others, financial covenants regarding debt levels, total liabilities, tangible net worth, fixed charge coverage, unencumbered borrowing base properties and permitted investments. We were in compliance with the covenant terms at September 30, 2012.

Capitalization

As of September 30, 2012, our total enterprise value was approximately $425 million. Enterprise value consisted of $124 million of debt (including property related mortgages and the Credit Facility), and $300.3 million of shares of common stock and operating partnership units in the Operating Partnership ("OP . . .

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