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ADC > SEC Filings for ADC > Form 10-Q on 2-May-2014All Recent SEC Filings

Show all filings for AGREE REALTY CORP

Form 10-Q for AGREE REALTY CORP


2-May-2014

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, 2013. 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 97.73% and 97.72% interest as of March 31, 2014 and December 31, 2013, 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 net leased properties leased to industry leading retail tenants. We were incorporated in December 1993 to continue and expand the business founded in 1971 by our current Executive Chairman of the Board of Directors, Richard Agree.

As of March 31, 2014, our portfolio consisted of 139 properties, located in 34 states containing an aggregate of approximately 3.8 million square feet of gross leasable area ("GLA"). As of March 31, 2014, our portfolio included 131 freestanding net leased properties and eight community shopping centers that were 97% leased in aggregate with a weighted average lease term of approximately 11 years remaining. Substantially all of our net lease property tenants and the majority of our community shopping center tenants have 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.

As of March 31, 2014, approximately 88% of our annualized base rent was derived from national tenants. The following table sets forth annualized base rent as of March 31, 2014 for our top ten tenants:

   Tenant                   Annualized Base Rent       Percent of Total Base Rent
   Walgreens               $           12,362,304                             26.4 %
   CVS                                  2,463,490                              5.3 %
   Kmart                                2,386,344                              5.1 %
   Wawa                                 2,250,182                              4.8 %
   Wal-Mart                             2,093,931                              4.5 %
   Rite Aid                             1,962,135                              4.2 %
   Lowe's                               1,846,476                              3.9 %
   LA Fitness                           1,692,841                              3.6 %
   Kohl's                               1,179,650                              2.5 %
   Dick's Sporting Goods                1,087,982                              2.3 %
   Total                   $           29,325,335                             62.6 %

We expect to continue to grow our asset base through the development and acquisition of net leased retail properties that are leased on a long-term basis to industry leading retail tenants. Since our initial public offering in 1994, we have developed 60 of our 139 properties, including 52 of our 131 freestanding net leased properties and all eight of our community shopping centers. We expect to continue to expand our existing tenant relationships and diversify our tenant base through the development and acquisition of net leased properties.

We acquired nine net leased properties for approximately $22,000,000 during the quarter ended March 31, 2014. These assets are located in eight states and are leased to twelve different tenants across eight retail sectors.

In March 2014, we closed on the acquisition of a parcel of land in East Palatka, Florida for the development of a McDonald's restaurant. The project is pre-leased under a long-term ground lease and is expected to be completed during the third quarter of 2014. We have delivered a Wawa development in St. Petersburg, Florida with rent commencement in the second quarter of 2014. In addition, our second Joint Venture Capital Solutions project in New Lenox, Illinois is under construction on a 4.5 acre parcel of land for the development of a 62,450 square foot project in New Lenox, Illinois. TJ Maxx, Ross Dress for Less and Petco have executed 10 year net leases. The total project cost is estimated at approximately $8 million. The project is expected to be completed in late 2014. At March 31, 2014, our construction in progress balance totaled approximately $9,200,000.

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

In April 2014, the Financial Accounting Standards Board ("FASB") issued ASU 2014-08 "Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity" which updates ASC 205 "Presentation of Financial Statements" and ASC 360 "Property, Plant and Equipment". The amendments in this update change the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. For public entities, ASU 2014-08 is effective prospectively for fiscal years beginning after December 15, 2015; however, early adoption is permitted, but only for disposals or classifications as held for sale that have not been reported in financial statements previously issued or available for issuance. We have elected to early adopt this updated standard effective in the first quarter of 2014 and have applied the provisions prospectively.

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 will be 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 "Internal Revenue Code") since our 1994 tax year. As a result, we are not subject to federal income taxes to the extent that we distribute annually 100% of our REIT taxable income to our stockholders and satisfy certain other requirements for qualifying as a REIT.

We have established TRS entities pursuant to the provisions of the Internal Revenue Code. Our TRS entities are able to engage in activities resulting in income that would be nonqualifying income for a REIT. As a result, certain activities of our Company which occur within our TRS entities are subject to federal and state income taxes. As of March 31, 2014 and December 31, 2013, we had accrued a deferred income tax amount of $705,000. In addition, we have recognized income tax expense of $5,130 and $-0- for the three months ended March 31, 2014 and 2013, respectively.

Results of Operations

Comparison of Three Months Ended March 31, 2014 to Three Months Ended March 31, 2013

Minimum rental revenue increased $2,204,000, or 24%, to $11,577,000 in 2014, compared to $9,373,000 in 2013. Rental revenue increased $1,554,000 due to the acquisition of net leased properties and increased $695,000 due to the completed development of properties, offset by other of $45,000.

Operating cost reimbursements increased $487,000, or 91%, to $1,023,000 in 2014, compared to $536,000 in 2013. Operating cost reimbursements increased due to the change in real estate taxes and property operating expenses explained below.

Other income was $29,000 in 2014 due to non-recurring fee income.

Real estate taxes increased $274,000, or 65%, to $697,000 in 2014, compared to $423,000 in 2013. Real estate taxes increased $233,000 due to the acquisition of net leased properties for which expenses we will pay and will be reimbursed and increased $41,000 due to other adjustments.

Property operating expenses increased $173,000, or 53%, to $499,000 in 2014, compared to $326,000 in 2013. The increase was the result of an increase in snow removal costs of $102,000, shopping center maintenance costs of $30,000, an increase in utilities of $11,000, and an increase in insurance of $30,000.

Land lease payments were $107,000 in 2014 and 2013.

General and administrative expenses increased by $106,000, or 7%, to $1,592,000 in 2014, compared to $1,486,000 in 2013. The increase in general and administrative expenses was the result of increased employee costs of $135,000, a decrease in professional expenses of $43,000, and an increase in other expenses of $14,000. General and administrative expenses as a percentage of total rental income (minimum and percentage rents) decreased from 15.4% for 2013 to 13.8% for 2014.

Depreciation and amortization increased $626,000, or 33%, to $2,514,000 in 2014, compared to $1,888,000 in 2013. The increase was the result of the acquisition of properties in 2014 and 2013 and the completion of development projects in 2013.

We recognized a gain of $123,000 on the sale of the Ironwood Commons shopping center located in Ironwood, Michigan in 2014. We recognized a gain of $946,000 on the sale of a Walgreens in Ypsilanti, Michigan in 2013.

Interest expense increased $354,000, or 25%, to $1,794,000 in 2014, compared to $1,440,000, in 2013. The increase in interest expense was a result of the higher level of borrowings due to the acquisition of properties.

Income from discontinued operations was $15,000 in 2014 compared to $188,000 in 2013, as a result of the sale of one property during 2014 and one property in 2013.

Our net income increased $118,000, or 2%, to $5,510,000 in 2014 from $5,392,000 in 2013 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.

We sold one non-core shopping center property during 2014 for net proceeds of approximately $4,974,000. 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 increased $1,303,000 to $8,170,000 for the three months ended March 31, 2014, compared to $6,867,000 for the three months ended March 31, 2013. Cash used in investing activities increased by $9,553,000 to ($21,059,000) in 2014, compared to ($11,506,000) in 2013 due to the acquisition of additional net leased assets. Cash used by financing activities increased ($5,389,000) to ($821,000) in 2014, compared to a source of $4,568,000 in 2013.

We intend to maintain a ratio of total indebtedness (including construction or acquisition financing) to total market capitalization (common equity, on a fully diluted basis, plus total indebtedness) of 65% or less. Nevertheless, we may operate with debt levels which are in excess of 65% of total market capitalization for extended periods of time. At March 31, 2014, our ratio of indebtedness to total market capitalization was approximately 26%.

Dividends

During the quarter ended March 31, 2014, we declared a quarterly dividend of $0.43 per share. We paid the dividend on April 8, 2014 to holders of record on March 31, 2014.

Debt

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, 2015, and may be extended, at our election, for two one-year terms to October 2017, subject to certain conditions. Borrowings under the Credit Facility bear interest at LIBOR plus a spread of 150 to 215 basis points, or the base rate, depending on our leverage ratio. As of March 31, 2014, we had $15,988,273 in principal amount outstanding under the Credit Facility bearing a weighted average interest rate of 1.94%, and $69,011,727 was available for borrowing (subject to customary conditions to borrowing).

The Operating Partnership has in place a $35,000,000 seven year unsecured term loan ("Unsecured Term Loan"), which is guaranteed by our Company. The Unsecured Term Loan includes an accordion feature providing the opportunity to borrow up to an additional $35,000,000 under the same loan agreement, subject to customary conditions. The Unsecured Term Loan matures on September 29, 2020. Borrowings under the Unsecured Term Loan bear interest at LIBOR plus a spread of 165 to 225 basis points depending on our leverage ratio. In conjunction with the closing of the loan, we entered into a seven year interest rate swap agreement resulting in a fixed interest rate of 3.85%, based on the current spread. We used the proceeds from the Unsecured Term Loan to pay down amounts outstanding under the Credit Facility.

The Credit Facility and Unsecured Term Loan contain 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 March 31, 2014.

As of March 31, 2014, we had total mortgage indebtedness of $112,991,525. Including our mortgages that have been swapped to a fixed interest rate, the weighted average interest rate on our mortgage debt is 4.35%.

The mortgage loans encumbering our properties are generally non-recourse, subject to certain exceptions for which we would be liable for any resulting losses incurred by the lender. These exceptions vary from loan to loan but generally include fraud or a material misrepresentation, misstatement or omission by the borrower, intentional or grossly negligent conduct by the borrower that harms the property or results in a loss to the lender, filing of a bankruptcy petition by the borrower, either directly or indirectly, and certain environmental liabilities. At March 31, 2014, the mortgage debt of $21,867,398 is recourse debt and is secured by a limited guaranty of payment and performance by us for approximately 50% of the loan amount. We have entered into mortgage loans which are secured by multiple properties and contain cross-default and cross-collateralization provisions. Cross-collateralization provisions allow a lender to foreclose on multiple properties in the event that we default under the loan. Cross-default provisions allow a lender to foreclose on the related property in the event a default is declared under another loan.

Capitalization

As of March 31, 2014, our total market capitalization was approximately $630 million. Market capitalization consisted of $164 million of total indebtedness (including construction or acquisition financing, property related mortgages, the Credit Facility, and the Unsecured Term Loan), and $466 million of shares of common equity, including common stock and operating partnership units in the Operating Partnership ("OP units") (based on the closing price on the New York Stock Exchange of $30.41 per share on March 31, 2014). Our ratio of indebtedness to total market capitalization was approximately 26% at March 31, 2014.

At March 31, 2014, the non-controlling interest in the Operating Partnership represented a 2.27% ownership in the Operating Partnership. The OP units may, under certain circumstances, be exchanged for our shares of common stock on a one-for-one basis. We, as sole general partner of the Operating Partnership, have the option to settle exchanged OP units held by others for cash based on the current trading price of our shares. Assuming the exchange of all OP units, there would have been 15,312,015 shares of common stock outstanding at March 31, 2014, with a market value of approximately $466 million.

Contractual Obligations

The following table outlines our contractual obligations, as of March 31, 2014,
for the periods presented below (in thousands).



                                                       April 1, 2014 - March      April 1, 2015 - March      April 1, 2017 - March
                                         Total                31, 2015                   31, 2017                   31, 2019             Thereafter
Mortgage notes payable                $    112,992     $               12,724     $               16,238     $               49,595     $      34,435
Unsecured revolving credit facility         15,988                          -                     15,988                          -                 -
Unsecured term loan                         35,000                                                                                             35,000
Land lease obligation                       10,247                        416                        832                        831             8,168
Estimated interest payments on
notes payable                               31,255                      6,152                     10,526                      7,096             7,481
Total                                 $    205,482     $               19,292     $               43,584     $               57,522     $      85,084

Estimated interest payments for mortgage notes payable are based on stated rates. Estimated interest payments for the notes payable are based on the interest rate in effect for the most recent quarter, which is assumed to be in effect through the respective maturity date.

We are constructing and plan to begin construction of additional pre-leased developments and may acquire additional properties, which will initially be financed by the Credit Facility. We will periodically refinance short-term construction and acquisition financing with long-term debt and/or equity to the extent available.

Off-Balance Sheet Arrangements

We do not engage in any off-balance sheet arrangements with unconsolidated entities or financial partnerships, such as structured finance or special purpose entities.

Inflation

Our leases generally contain provisions designed to mitigate the adverse impact of inflation on net income. These provisions include clauses enabling us to pass through to tenants certain operating costs, including real estate taxes, common area maintenance, utilities and insurance, thereby reducing our exposure to increases in costs and operating expenses resulting from inflation. Certain of our leases contain clauses enabling us to receive percentage rents based on tenants' gross sales, which generally increase as prices rise, and, in certain cases, escalation clauses, which generally increase rental rates during the terms of the leases. In addition, expiring tenant leases permit us to seek increased rents upon re-lease at market rates if rents are below the then existing market rates.

Funds from Operations

Funds from Operations ("FFO") is defined by the National Association of Real Estate Investment Trusts, Inc. ("NAREIT") to mean net income computed in accordance with U.S. generally accepted accounting principles ("GAAP"), excluding gains (or losses) from sales of property and impairment charges on depreciable property, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. Management uses FFO as a supplemental measure to conduct and evaluate our business because there are certain limitations associated with using GAAP net income by itself as the primary measure of our operating performance. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, management believes that the presentation of operating results for real estate companies that use historical cost accounting is insufficient by itself.

FFO should not be considered as an alternative to net income as the primary indicator of our operating performance or as an alternative to cash flow as a measure of liquidity. Further, while we adhere to the NAREIT definition of FFO, our presentation of FFO is not necessarily comparable to similarly titled measures of other REITs due to the fact that not all REITs use the same definition.

Adjusted Funds from Operations ("AFFO") is a non-GAAP financial measure of operating performance used by many companies in the REIT industry. AFFO further adjusts FFO for certain non-cash items that reduce or increase net income in . . .

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