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ADC > SEC Filings for ADC > Form 10-Q on 1-Aug-2014All Recent SEC Filings

Show all filings for AGREE REALTY CORP

Form 10-Q for AGREE REALTY CORP


1-Aug-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 June 30, 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 June 30, 2014, our portfolio consisted of 142 properties, located in 34 states containing an aggregate of approximately 3.9 million square feet of gross leasable area ("GLA"). As of June 30, 2014, our portfolio included 134 freestanding net leased properties and eight community shopping centers that were 99% 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 June 30, 2014, approximately 86% of our annualized base rent was derived from national tenants. The following table sets forth annualized base rent as of June 30, 2014 for our top ten tenants:

Tenant                   Annualized Base Rent       Percent of Total Base Rent
Walgreens               $           12,362,304                             25.6 %
Wawa                                 2,464,165                              5.1 %
CVS                                  2,463,490                              5.1 %
Kmart                                2,386,344                              4.9 %
Wal-Mart                             2,036,850                              4.2 %
Rite Aid                             1,962,135                              4.1 %
Lowe's                               1,846,476                              3.8 %
LA Fitness                           1,692,841                              3.5 %
Kohl's                               1,179,650                              2.4 %
Dick's Sporting Goods                1,087,982                              2.3 %
Total                   $           29,482,237                             61.1 %

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 61 of our 142 properties, including 53 of our 134 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.

During the six months ended June 30, 2014, we acquired 11 retail net lease properties for approximately $34,500,000. These assets are located in 10 states and leased to 13 different tenants across nine retail sectors which we believe are e-commerce and recession resistant. We also delivered a Wawa development in St. Petersburg, Florida for a total cost of approximately $2,200,000 and commenced a McDonald's development project in East Palatka, Florida for a total projected cost of approximately $1,300,000 and a redevelopment project for Buffalo Wild Wings in St. Augustine, Florida for a total projected cost of approximately $1,700,000. The McDonald's is expected to be delivered in the third quarter of 2014 and the Buffalo Wild Wings is expected to be delivered in the fourth quarter of 2014. Within our Joint Venture Capital Solutions program, in June 2014 we announced the commencement of a Cash & Carry development project in Burlington, Washington for a total cost of approximately $4,300,000, and continue work on our New Lenox, Illinois project which has a total cost of approximately $8,100,000 and is pre-leased to TJ Maxx, Ross Dress for Less and Petco. The Cash & Carry is expected to be delivered in the first quarter of 2015, while the New Lenox project is expected to be delivered in the fourth quarter of 2014.

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. The adoption of this guidance will have an effect on the presentation of our consolidated financial statements. Beginning in 2014, activities related to individual sales of properties are generally no longer classified as discontinued operations except for the property classified as held for sale as of December 31, 2013.

In May 2014, the Financial Accounting Standards Board issued ASU No. 2014-09 "Revenue from Contracts with Customers" as a new Topic, Accounting Standards Codification ("ASC") Topic 606. The objective of ASU 2014-19 is to establish a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most of the existing revenue recognition guidance, including industry-specific guidance. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the new standard, companies will perform a five-step analysis of transactions to determine when and how revenue is recognized. ASU 2014-09 applies to all contracts with customers except those that are within the scope of other topics in the FASB ASC. This ASU is effective for annual reporting periods (including interim periods within those periods) beginning after December 15, 2016 and shall be applied using either a full retrospective or modified retrospective approach. Early adoption is not permitted. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on the consolidated financial statements nor decided upon the method of adoption.

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 June 30, 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 $4,775 and $(20,204) for the six months ended June 30, 2014 and 2013, respectively.

Results of Operations

Comparison of Three Months Ended June 30, 2014 to Three Months Ended June 30, 2013

Minimum rental revenue increased $1,769,000, or 18%, to $11,791,000 in 2014, compared to $10,022,000 in 2013. Rental revenue increased $1,428,000 due to the acquisition of net leased properties and increased $559,000 due to the completed development of properties, offset by other minimum rental changes of $218,000.

Operating cost reimbursements increased $367,000, or 63%, to $947,000 in 2014, compared to $580,000 in 2013. Operating cost reimbursements increased due to the change in real estate taxes and property operating expenses explained below.

Other income was $24,000 in 2014 due to non-recurring income.

Real estate taxes increased $232,000, or 46%, to $740,000 in 2014, compared to $508,000 in 2013. Real estate taxes increased $263,000 due to the acquisition of net leased properties for which expenses we will pay and will be reimbursed and decreased $31,000 due to other adjustments.

Property operating expenses increased $193,000, or 73%, to $458,000 in 2014, compared to $265,000 in 2013. The increase was the result of an increase in shopping center maintenance costs of $167,000, insurance of $18,000 and snow removal costs of $8,000.

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

General and administrative expenses increased by $23,000, or 1%, to $1,617,000 in 2014, compared to $1,594,000 in 2013. The increase in general and administrative expenses was the result of increased employee costs of $74,000, a decrease in professional expenses of $40,000, and a decrease in other expenses of $11,000. General and administrative expenses as a percentage of total rental income (minimum and percentage rents) decreased from 15.9% for 2013 to 13.6% for 2014.

Depreciation and amortization increased $364,000, or 16%, to $2,591,000 in 2014, compared to $2,227,000 in 2013. The increase was the result of the acquisition of properties in 2014 and 2013 and the completion of development projects in 2014 and 2013.

We recognized an impairment charge of $2,800,000 in the second quarter of 2014 related to the Chippewa Commons shopping center due to an anchor tenant declining to exercise an extension option which will contribute to vacancy and diminished cash flows and resulted in fair value which was below the net book value of the asset. There was no impairment recognized in the second quarter of 2013.

Interest expense increased $350,000, or 23%, to $1,875,000 in 2014, compared to $1,525,000, 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 $0 in 2014 compared to $153,000 in 2013, as a result of the sale of one property during the first quarter of 2014 and one property in 2013.

Our net income decreased $1,813,000, or 40%, to $2,716,000 in 2014 from $4,529,000 in 2013 as a result of the foregoing factors.

Comparison of Six Months Ended June 30, 2014 to Six Months Ended June 30, 2013

Minimum rental revenue increased $3,920,000, or 20%, to $23,314,000 in 2014, compared to $19,394,000 in 2013. Rental revenue increased $2,916,000 due to the acquisition of net leased properties and increased $1,254,000 due to the completed development of properties, offset by other minimum rental charges of $250,000.

Operating cost reimbursements increased $854,000, or 77%, to $1,970,000 in 2014, compared to $1,116,000 in 2013. Operating cost reimbursements increased due to the change in real estate taxes and property operating expenses explained below.

Other income was $53,000 in 2014 due to non-recurring income.

Real estate taxes increased $506,000, or 54%, to $1,437,000 in 2014, compared to $931,000 in 2013. Real estate taxes increased $498,000 due to the acquisition of net leased properties for which expenses we will pay and will be reimbursed and increased $8,000 due to other adjustments.

Property operating expenses increased $366,000, or 62%, to $957,000 in 2014, compared to $591,000 in 2013. The increase was the result of an increase in snow removal costs of $110,000, shopping center maintenance costs of $199,000, utilities of $9,000, and insurance of $48,000.

Land lease payments were $214,000 in 2014 and 2013.

General and administrative expenses increased by $129,000, or 4%, to $3,209,000 in 2014, compared to $3,080,000 in 2013. The increase in general and administrative expenses was the result of increased employee costs of $204,000, a decrease in professional expenses of $100,000, and an increase in other expenses of $25,000. General and administrative expenses as a percentage of total rental income (minimum and percentage rents) decreased from 15.9% for 2013 to 13.7% for 2014.

Depreciation and amortization increased $990,000, or 24%, to $5,105,000 in 2014, compared to $4,115,000 in 2013. The increase was the result of the acquisition of properties in 2014 and 2013 and the completion of development projects in 2014 and 2013.

We recognized an impairment charge of $2,800,000 in the six months ended June 30, 2014, related to the Chippewa Commons shopping center due to an anchor tenant declining to exercise an extension option which will contribute to vacancy and diminished cash flows and resulted in fair value which was below the net book value of the asset. There was no impairment recognized in the corresponding period of 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 $704,000, or 24%, to $3,669,000 in 2014, compared to $2,965,000, 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 $342,000 in 2013, as a result of the sale of one property during the first quarter of 2014 and one property in 2013.

Our net income decreased $1,697,000, or 17%, to $8,225,000 in 2014 from $9,922,000 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"), additional financings and new credit facilities. 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 $2,433,000 to $16,659,000 for the six months ended June 30, 2014, compared to $14,226,000 for the six months ended June 30, 2013. Cash used in investing activities decreased by $4,557,000 to $39,480,000 in 2014, compared to $44,037,000 in 2013 due to the development and acquisition of fewer net leased assets. Cash provided by financing activities decreased $19,858,000 to $9,908,000 in 2014, compared to a source of $29,766,000 in 2013 as proceeds from stock offering, net of note and mortgage activity, decreased approximately $17,324,000 and dividends and distributions increased $2,544,000.

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 June 30, 2014, our ratio of indebtedness to total market capitalization was approximately 28%.

Dividends

During the quarter ended June 30, 2014, we declared a quarterly dividend of $0.43 per share. We paid the dividend on July 8, 2014 to holders of record on June 30, 2014.

Debt

The Operating Partnership had in place an $85 million unsecured revolving Credit Facility at June 30, 2014, which is guaranteed by our Company. Subject to customary conditions, at our option, total commitments under the Credit Facility could have been increased up to an aggregate of $135 million. Borrowings under the Credit Facility were used for general corporate purposes, including working capital, development and acquisition activities, capital expenditures, repayment of indebtedness or other corporate activities. The Credit Facility was to mature on October 26, 2015, and could have been extended, at our election, for two one-year terms to October 2017, subject to certain conditions. Borrowings under the Credit Facility bore interest at LIBOR plus a spread of 150 to 215 basis points, or the base rate, depending on our leverage ratio. As of June 30, 2014, we had $43,364,000 in principal amount outstanding under the Credit Facility bearing a weighted average interest rate of 1.72%, and $41,636,000 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") at June 30, 2014, 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.

The Credit Facility and Unsecured Term Loan contained 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 June 30, 2014.

In July 2014, the Company entered into a $250 million senior unsecured revolving credit and term loan agreement consisting of a new $150 million revolving credit facility, a new $65 million seven-year unsecured term loan facility, and the existing $35 million Unsecured Term Loan.

The revolving credit facility is due July 21, 2018, with an additional one-year extension at the Company's option, subject to customary conditions. Borrowings under the revolving credit facility will be priced at LIBOR plus 135 to 200 basis points, depending on the Company's leverage, with an initial applicable margin of 135 basis points. The revolving credit facility replaces the Company's existing $85 million Credit Facility and may be increased to an aggregate of $250 million at the Company's election, subject to certain terms and conditions.

The new $65 million unsecured term loan facility is due July 21, 2021. Borrowings under the unsecured term loan facility will be priced at LIBOR plus 165 to 225 basis points, depending on the Company's leverage, with an initial applicable margin of 165 basis points. The Company has entered into interest rate swaps to fix LIBOR at 2.09% until maturity, implying an all-in interest rate of 3.74% at closing. Proceeds from the new term loan facility were used to repay borrowings under the Company's prior Credit Facility. The new term loan facility may be increased to an aggregate of $75 million at the Company's election, subject to certain terms and conditions.

Additionally, conforming changes were made to certain terms and conditions of the Company's existing Unsecured Term Loan as part of the agreement. The maturity date and pricing remains unchanged.

As of June 30, 2014, we had total mortgage indebtedness of $102,929,022. Including our mortgages that have been swapped to a fixed interest rate, the weighted average interest rate on our mortgage debt is 4.27%.

The mortgage loans encumbering our properties are generally non-recourse, subject to certain exceptions for which we would be liable for any resulting . . .

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