10-Q 1 k80567e10vq.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Mark One [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2003 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from __________ to __________ Commission File Number 1-12928 AGREE REALTY CORPORATION -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) MARYLAND 38-3148187 -------------------------------------------------------------------------------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 31850 NORTHWESTERN HIGHWAY, FARMINGTON HILLS, MICHIGAN 48334 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, included area code: (248) 737-4190 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No [X] [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No [X] [ ] 6,434,345 Shares of Common Stock, $.0001 par value, were outstanding as of November 13, 2003 AGREE REALTY CORPORATION FORM 10-Q INDEX
PAGE PART I: FINANCIAL INFORMATION Item 1. Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002 3-4 Consolidated Statements of Income for the six months ended September 30, 2003 and 2002 5 Consolidated Statements of Income for the three months ended September 30, 2003 and 2002 6 Consolidated Statement of Stockholders' Equity for the six months ended September 30, 2003 7 Consolidated Statements of Cash Flows for the six months ended September 30, 2003 and 2002 8-9 Notes to Consolidated Financial Statements 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-19 Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 Item 4. Controls and Procedures 20 PART II: OTHER INFORMATION Item 1. Legal Proceedings 21 Item 2. Changes in Securities and Use of Proceeds 21 Item 3. Defaults Upon Senior Securities 21 Item 4. Submission of Matters to a Vote of Security Holders 21 Item 5 Other Information 21 Item 6. Exhibits and Reports on Form 8-K 22 SIGNATURES 23
2 AGREE REALTY CORPORATION CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30, December 31, 2003 2002 ----------------------------- ASSETS REAL ESTATE INVESTMENTS Land $ 55,298,606 $ 51,546,016 Buildings 159,275,073 146,934,887 ----------------------------- 214,573,679 198,480,903 Less accumulated depreciation (37,666,649) (34,705,790) ----------------------------- 176,907,030 163,775,113 Operating property held for sale 7,321,554 7,482,839 Property under development 1,473,487 2,271,413 ----------------------------- NET REAL ESTATE INVESTMENTS 185,702,071 173,529,365 CASH AND CASH EQUIVALENTS 234,099 1,095,610 ACCOUNTS RECEIVABLE - TENANTS, net of allowance of $200,000 and $200,000 for possible losses 155,694 784,637 INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED ENTITIES 333,127 315,496 UNAMORTIZED DEFERRED EXPENSES Financing 764,207 1,117,253 Leasing costs 278,530 307,746 OTHER ASSETS 678,052 1,012,065 ----------------------------- $ 188,145,780 $ 178,162,172 =============================
See accompanying notes to consolidated financial statements. 3 AGREE REALTY CORPORATION CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30, December 31, 2003 2002 ---------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY MORTGAGE PAYABLE $ 41,434,760 $ 71,588,863 CONSTRUCTION LOANS 1,569,000 5,612,313 NOTES PAYABLE 39,500,000 38,083,232 DIVIDENDS AND DISTRIBUTIONS PAYABLE 3,447,328 2,356,156 ACCRUED INTEREST PAYABLE 168,251 249,706 ACCOUNTS PAYABLE Operating 557,317 1,179,273 Capital expenditures 432,471 589,760 TENANT DEPOSITS 97,339 93,138 ---------------------------- TOTAL LIABILITIES 87,206,466 119,752,441 ---------------------------- MINORITY INTEREST 5,704,168 5,787,007 ---------------------------- STOCKHOLDERS' EQUITY Common stock, $.0001 par value; 20,000,000 shares authorized, 6,434,345 and 4,479,345 shares issued and outstanding 643 445 Additional paid-in capital 108,267,762 64,506,772 Deficit (12,103,965) (11,135,499) ---------------------------- 96,164,440 53,371,718 Less: unearned compensation - restricted stock (929,294) (748,994) ---------------------------- TOTAL STOCKHOLDERS' EQUITY 95,235,146 52,622,724 $ 188,145,780 $178,162,172 ============================
See accompanying notes to consolidated financial statements. 4 AGREE REALTY CORPORATION CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
NINE MONTHS ENDED Nine Months Ended SEPTEMBER 30, 2003 September 30, 2002 --------------------------------------- REVENUES Minimum rents $ 18,072,243 $ 15,883,900 Percentage rents 98,708 77,996 Operating cost reimbursements 2,037,014 1,723,741 Other income 1,878 4,897 ----------------------------------- TOTAL REVENUES 20,209,843 17,690,534 ----------------------------------- OPERATING EXPENSES Real estate taxes 1,370,264 1,258,721 Property operating expenses 1,500,088 1,097,178 Land lease payments 554,220 554,175 General and administrative 1,676,007 1,465,993 Depreciation and amortization 3,040,640 2,778,118 ----------------------------------- TOTAL OPERATING EXPENSES 8,141,219 7,154,185 ----------------------------------- INCOME FROM CONTINUING OPERATIONS 12,068,624 10,536,349 ----------------------------------- OTHER INCOME (EXPENSE) Interest expense, net (4,561,282) (4,580,025) Early extinguishment of debt (961,334) - Equity in net income of unconsolidated entities 341,537 520,738 ----------------------------------- TOTAL OTHER EXPENSE (5,181,079) (4,059,287) ----------------------------------- INCOME BEFORE MINORITY INTEREST AND DISCONTINUED OPERATIONS 6,887,545 6,477,062 MINORITY INTEREST (835,457) (851,678) ----------------------------------- INCOME BEFORE DISCONTINUED OPERATIONS 6,052,088 5,625,384 INCOME FROM DISCONTINUED OPERATIONS, net of minority interest of $58,347 and $87,109 422,671 574,814 ----------------------------------- NET INCOME $ 6,474,759 $ 6,200,198 =================================== EARNINGS PER SHARE - BASIC AND DILUTIVE $ 1.33 $ 1.39 =================================== WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - BASIC 4,880,993 4,446,205 =================================== WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - DILUTIVE 4,883,401 4,446,205 ===================================
See accompanying notes to consolidated financial statements. 5 AGREE REALTY CORPORATION CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED Three Months Ended SEPTEMBER 30, 2003 September 30, 2002 --------------------------------------- REVENUES Minimum rents $ 6,088,431 $ 5,400,772 Percentage rents 47,648 34,399 Operating cost reimbursements 596,629 530,203 Other income 101 332 ----------------------------------- TOTAL REVENUES 6,732,809 5,965,706 ----------------------------------- OPERATING EXPENSES Real estate taxes 457,368 420,486 Property operating expenses 467,061 332,765 Land lease payments 184,740 184,695 General and administrative 553,007 502,552 Depreciation and amortization 1,025,763 925,980 ----------------------------------- TOTAL OPERATING EXPENSES 2,687,939 2,366,478 ----------------------------------- INCOME FROM CONTINUING OPERATIONS 4,044,870 3,599,228 ----------------------------------- OTHER INCOME (EXPENSE) Interest expense, net (1,302,262) (1,556,900) Early extinguishment of debt (961,334) - Equity in net income of unconsolidated entities 110,138 - ----------------------------------- TOTAL OTHER EXPENSE (2,153,458) (1,383,321) ----------------------------------- INCOME BEFORE MINORITY INTEREST AND DISCONTINUED OPERATIONS 1,891,412 2,215,907 MINORITY INTEREST (181,983) (290,923) ----------------------------------- INCOME BEFORE DISCONTINUED OPERATIONS 1,709,429 1,924,984 INCOME FROM DISCONTINUED OPERATIONS, net of minority interest of $17,510 and $32,121 147,369 212,148 ----------------------------------- NET INCOME $ 1,856,798 $ 2,137,132 =================================== EARNINGS PER SHARE - BASIC AND DILUTIVE $ .33 $ .48 =================================== WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - BASIC 5,671,193 4,446,547 =================================== WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - DILUTIVE 5,675,806 4,446,547 ===================================
See accompanying notes to consolidated financial statements. 6 AGREE REALTY CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
Unearned Common Stock Additional Compensation - -------------------- Paid-In Restricted Shares Amount Capital Deficit Stock ------------------------------------------------------------------------ BALANCE, January 1, 2003 4,448,531 $ 445 $ 64,506,772 $ (11,135,499) $ (748,994) Issuance of shares under Stock Incentive Plan 36,814 3 622,150 - (456,300) Shares redeemed under the Stock Incentive Plan (6,000) - (101,400) - - Issuance of common stock 1,955,000 195 43,240,240 - - Vesting of restricted stock - - - - 276,000 Dividends declared for the period January 1, 2003 to September 30, 2003 - - - (7,443,225) - Net income for the period January 1, 2003 to September 30, 2003 - - - 6,474,759 - ------------------------------------------------------------------------ BALANCE, September 30, 2003 6,434,345 $ 643 $108,267,762 $ (12,103,965) $ (929,294) ========================================================================
See accompanying notes to consolidated financial statements. 7 AGREE REALTY CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED Nine Months Ended SEPTEMBER 30, 2003 September 30, 2002 --------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 6,474,759 $ 6,200,198 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 3,152,834 2,881,888 Amortization 174,093 267,366 Stock-based compensation 276,000 236,000 Write-off of deferred finance costs 406,152 - Equity in net income of unconsolidated entities (341,537) (520,738) Minority interests 893,804 938,787 Decrease in accounts receivable 628,943 526,915 Decrease in other assets 280,032 185,840 Decrease in accounts payable (621,956) (594,737) Increase (decrease) in accrued interest (81,455) 31,116 Increase in tenant deposits 4,201 46,238 --------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 11,245,870 10,198,873 --------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Acquisition of real estate investments (including capitalized interest of $118,000 in 2003 and $76,000 in 2002) (14,862,379) (3,227,728) Distributions from unconsolidated entities 341,537 520,738 --------------------------------- NET CASH USED IN INVESTING ACTIVITIES (14,520,842) (2,706,990) --------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Net proceeds from the issuance of common stock 43,240,435 - Payments of mortgages payable (37,853,254) (1,557,103) Mortgage proceeds 7,699,151 - Dividends and limited partners' distributions paid (7,328,697) (7,051,603) Payment on construction loan (4,043,313) (40,350) Line-of-credit net borrowings 1,416,768 800,000 Repayments of capital expenditure payables (423,910) (401,229) Payments for financing costs (178,108) (16,353) Redemption of restricted stock (101,400) (110,940) Payment of leasing costs (14,211) (23,630) --------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,413,461 (8,401,208) --------------------------------- NET DECREASE IN CASH AND CASH EQUIVALENTS (861,511) (909,325) CASH AND CASH EQUIVALENTS, beginning of period 1,095,610 1,101,861 --------------------------------- CASH AND CASH EQUIVALENTS, end of period $ 234,099 $ 192,536 =================================
8 AGREE REALTY CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED Nine Months Ended SEPTEMBER 30, 2003 September 30, 2002 --------------------------------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid for interest (net of amounts capitalized) $ 4,535,514 $ 4,344,074 ================================= SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS Dividends and limited partners' distributions declared and unpaid $ 3,447,328 $ 2,356,156 Shares issued under Stock Incentive Plan $ 622,153 $ 680,033 Real estate investments financed with accounts payable $ 432,471 $ 301,820 Construction loan paid with mortgage $ - $ 3,181,670 =================================
See accompanying notes to consolidated financial statements. 9 AGREE REALTY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The accompanying unaudited 2003 consolidated 1. BASIS OF financial statements have been prepared in accordance PRESENTATION with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The consolidated balance sheet at December 31, 2002 has been derived from the audited consolidated financial statements at that date. Operating results for the three months ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003, or for any other interim period. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. 2. EARNINGS PER Earnings per share has been computed by dividing the SHARE net income by the weighted average number of common shares outstanding. The per share amounts reflected in the consolidated statements of income are presented in accordance with Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings per Share". 3. ISSUANCE OF During August 2003, the Company sold 1,955,000 shares COMMON STOCK of common stock. The cash proceeds (net of underwriting fees and related issuance costs) to the Company from the stock issuance were approximately $43.2 million, which was used to reduce outstanding indebtedness. 4. SUBSEQUENT EVENT During October 2003 the Company completed the sale of a shopping center for approximately $8.5. The shopping center was anchored by Kmart Corporation and Kash N Karry and was located in Winter Garden, Florida. The results of operations for this property are presented as discontinued operations in the Company's Consolidated Statements of Income. The revenues from this property were $930,272 and $1,005,332 for the nine months ended September 30, 2003 and 2002, respectively. The expenses for this property were $507,601 and $430,518, including minority interest charges of $58,347 and $87,109, for the nine months ending September 30, 2003 and 2002, respectively. The revenues from this property were $301,974 and $361,800 for the three months ended September 30, 2003 and 2002, respectively. The expenses for this property were $154,605 and $149,652, including minority interest charges of $17,510 and $32,121, for the three months ending September 30, 2003 and 2002, respectively. 10 AGREE REALTY CORPORATION PART I ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS Management has included herein certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. When used, statements which are not historical in nature including the words "anticipate," "estimate," "should," "expect," "believe," "intend" and similar expressions are intended to identify forward-looking statements. Such statements are, by their nature, subject to certain risks and uncertainties. Risks and other factors that might cause such a difference include, but are not limited to, the effect of economic and market conditions; risks that the Company's acquisition and development projects will fail to perform as expected; financing risks, such as the inability to obtain debt or equity financing on favorable terms; the level and volatility of interest rates; loss or bankruptcy of one or more of the Company's major retail tenants; and failure of the Company's properties to generate additional income to offset increases in operating expenses. OVERVIEW Agree Realty Corporation (the "Company") was established to continue to operate and expand the retail property business of its predecessors. The Company commenced its operations in April 1994. The assets of the Company are held by, and all operations are conducted through, Agree Limited Partnership (the "Operating Partnership"), of which the Company is the sole general partner and held an 90.52% interest as of September 30, 2003. The Company is operating so as to qualify as a real estate investment trust ("REIT") for federal income tax purposes. On August 4, 2003, the Company completed an offering of 1,700,000 shares of common stock at $23.50 per share; on August 12, 2003 the underwriters exercised their over allotment option for an additional 255,000 shares at the same per share price (collectively, the "2003 Offering"). The net proceeds from the 2003 Offering of approximately $43.2 million were used to repay amounts outstanding under the Company's credit facility. The Company has fifteen (15) leases with Kmart Corporation. Twelve (12) of the Kmart stores are currently anchors in the Company's Community Shopping Centers and three (3) Kmart stores are free-standing properties. The Kmart stores in the Company's Portfolio provided 19% of the Company's Annual Base Rent as of September 30, 2003. Nine of the Kmart stores paid percentage rent in addition to their minimum rent during 2002. As of September 30, 2003, all of the Kmart stores in the Company's Portfolio were open and operating as Kmart discount stores. In May 2003, Kmart Corporation emerged from the bankruptcy proceeding which it had initiated in January 2002. Pursuant to the confirmed plan of reorganization, Kmart closed a number of stores, including one that was located on our property in Lakeland, Florida. Kmart vacated the premises in Lakeland, Florida in April 2003 and we are actively marketing the space formerly occupied by Kmart. Kmart's annual rent on this property was approximately $480,000 11 AGREE REALTY CORPORATION PART I and Kmart's annual contribution under the lease for real estate taxes, insurance and common area maintenance was approximately $110,000. Certain tenants in the Lakeland, Florida community shopping center have co-tenancy clauses in their leases which provide either for modification of their rent to be based on gross sales or an option to terminate their lease when the Kmart store closes, if we are unable to obtain a replacement anchor tenant. As of September 30, 2003, none of these tenants has indicated that it will exercise its option to terminate its lease with us. We believe it will take between nine to 12 months to re-let the Kmart location. In connection with this re-letting of the Kmart location, we may have to agree to make capital expenditures with respect to the property. In addition, we have agreed to rent reductions aggregating $300,000 per year under two other Kmart leases, for the stores in Perrysburg, Ohio and Winter Garden, Florida. In both cases, the rent reductions are for a 5-year period. During October 2003, the Company completed the sale of the Winter Garden, Florida shopping center. The following should be read in conjunction with the Consolidated Financial Statements of Agree Realty Corporation, including the respective notes thereto, which are included in this Form 10-Q. CRITICAL ACCOUNTING POLICIES In the course of developing and evaluating accounting policies and procedures, the Company used estimates, assumptions and judgements to determine the most appropriate methods to be applied. Such processes are used in determining capitalization of costs related to real estate investments, potential impairment of real estate investments, operating cost reimbursements, and taxable income. 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. Subsequent to completion of construction, expenditures for property maintenance are charged to operations as incurred, while significant renovations are capitalized. Depreciation of the buildings is recorded on the straight-line method using an estimated useful life of forty years. In determining the fair value of real estate investments, we consider future cash flow projections on a property by property basis, current interest rates and current market conditions of the geographical location of each property. Substantially all of the Company's leases contain provisions requiring tenants to pay as additional rent a proportionate share of operating expenses (Operating Cost Reimbursements) such as real estate taxes, repairs and maintenance, and insurance. The related revenue from tenant billings is recognized in the same period the expense is recorded. 12 AGREE REALTY CORPORATION PART I The Company elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"), commencing with the Company's 1994 tax year. As a result, the Company is not subject to federal income taxes to the extent that it distributes annually at least 90% of its taxable income to its shareholders and satisfies certain other requirements defined in the Code. Accordingly, no provision was made for federal income taxes in the accompanying consolidated financial statements. COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2003 TO NINE MONTHS ENDED SEPTEMBER 30, 2002 Minimum rental income increased $2,188,000, or 14%, to $18,072,000 in 2003, compared to $15,884,000 in 2002. The increase was the result of rental increases of $459,000 from existing properties; an increase of $1,444,000 due to additional rent as a result of the acquisition of our joint venture partner's interest in three Joint Venture Properties in 2002 and two Joint Venture Properties in 2003; and an increase of $285,000 from the development of one property in 2002 and two properties in 2003. Percentage rental income increased $21,000, or 27%, to $99,000 in 2003, compared to $78,000 in 2002. The increase was primarily the result of increased tenant sales. Operating Cost Reimbursements increased $313,000, or 18%, to $2,037,000 in 2003, compared to $1,724,000 in 2002. Operating cost reimbursements increased due to the increase in real estate taxes and property operating expenses as explained below. Other income remained relatively constant at $2,000 in 2003, compared to $5,000 in 2002. Real estate taxes increased $111,000, or 9%, to $1,370,000 in 2003, compared to $1,259,000 in 2002. The increase is the result of general assessment changes on the Company's properties and additional real estate taxes paid directly by the Company related to a closed Kmart store. Property operating expenses (shopping center maintenance, insurance and utilities), which are reimbursed by the tenants, increased $403,000, or 37%, to $1,500,000 in 2003 compared to $1,097,000 in 2002. The increase was the result of increased snow removal costs of $19,000; an increase in shopping center maintenance costs of $179,000; an increase in utility costs of $20,000; and an increase in insurance costs of $185,000 in 2003 versus 2002. Land lease payments remained constant at $554,000 for 2003 and 2002. General and administrative expenses increased by $210,000, or 14%, to $1,676,000 in 2003, compared to $1,466,000 in 2002. The increase was primarily the result of an increase in compensation-related expenses and property management related expenses. General and administrative expenses as a percentage of total rental income remained constant at 9.2% in 2003 and 2002. 13 AGREE REALTY CORPORATION PART I Depreciation and amortization increased $263,000, or 9%, to $3,041,000 in 2003, compared to $2,778,000 in 2002. The increase was the result of the development of one property in 2002 and two properties in 2003; and the acquisition of the joint venture partner's interest in three (3) Joint Venture Properties in 2002 and two (2) Joint Venture Properties in 2003. Interest expense decreased $19,000, or .4%, to $4,561,000 in 2003, from $4,580,000 in 2002. The decrease in interest expense was the result of decreased borrowings as a result of the Company reducing outstanding indebtedness with the net proceeds from the issuance of additional common stock. Equity in net income of unconsolidated entities decreased $179,000, or 34%, to $342,000 in 2003 compared to $521,000 in 2002 as a result of the acquisition of our joint venture partner's interest in three Joint Venture Properties in 2002 and two Joint Venture Properties in 2003. Early extinguishment of debt totaled $961,000 in 2003, as a result of the Company repaying in August 2003 three mortgages totaling approximately $37,000,000 prior to their scheduled maturity. In connection with this transaction the Company incurred a pre-payment penalty of $555,000 and wrote-off unamortized mortgage costs in the amount of $406,000. The Company's income before minority interest and discontinued operations increased $411,000, or 6%, to $6,888,000 in 2003 from $6,477,000 in 2002 as a result of the foregoing factors. COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2003 TO THREE MONTHS ENDED SEPTEMBER 30, 2002 Minimum rental income increased $687,000, or 13%, to $6,088,000 in 2003, compared to $5,401,000 in 2002. The increase was the result of rental increases of $56,000 from existing properties; an increase of $536,000 due to additional rent as a result of the acquisition of our joint venture partner's interest in three Joint Venture Properties in 2002 and two Joint Venture Properties in 2003; and an increase of $95,000 from the development of two properties in 2003. Percentage rental income increased $14,000, or 39%, to $48,000 in 2003, compared to $34,000 in 2002. The increase was primarily the result of increased tenant sales. Operating cost reimbursements increased $67,000, or 13%, to $597,000 in 2003, compared to $530,000 in 2002. Operating cost reimbursements increased due to the increase in real estate taxes and property operating expense as explained below. Real estate taxes increased $37,000, or 9%, to $457,000 in 2003, compared to $420,000 in 2002. The increase is the result of general assessment changes on the Company's properties and additional real estate taxes related to a closed Kmart store. 14 AGREE REALTY CORPORATION PART I Property operating expenses (shopping center maintenance, insurance and utilities), which are reimbursed by the tenants, increased $134,000, or 40%, to $467,000 in 2003 compared to $333,000 in 2002. The increase was the result of increased shopping center maintenance costs of $68,000; an increase in utility costs of $7,000; and an increase in insurance costs of $59,000 in 2003 versus 2002. Land lease payments remained constant at $185,000 for 2003 and 2002. General and administrative expenses increased by $50,000, or 10%, to $553,000 in 2003, compared to $503,000 in 2002. The increase was primarily the result of an increase in compensation-related expenses and property management related expenses. General and administrative expenses as a percentage of total rental income decreased from 9.2% in 2002 to 9.0% in 2003. Depreciation and amortization increased $100,000, or 11%, to $1,026,000 in 2003, compared to $926,000 in 2002. The increase was the result of the development of two properties in 2003; the acquisition of the joint venture partner's interest in three (3) Joint Venture Properties in 2002 and two (2) Joint Venture Properties in 2003. Interest expense decreased $255,000, or 16%, to $1,302,000 in 2003, from $1,557,000 in 2002. The decrease in interest expense was the result of decreased borrowings as a result of the Company reducing outstanding indebtedness with the net proceeds from the issuance of additional common stock. Equity in net income of unconsolidated entities decreased $64,000, or 37%, to $110,000 in 2003 compared to $174,000 in 2002 as a result of the acquisition of the joint venture partner's interest in three Joint Venture Properties in 2002 and two Joint Venture Properties in 2003. Early extinguishment of debt totaled $961,000 in 2003, as a result of the Company repaying in August 2003 three mortgages totaling $37,000,000 prior to their scheduled maturity. In connection with this transaction the Company incurred a pre-payment penalty of $555,000 and wrote-off unamortized mortgage costs in the amount of $406,000. The Company's income before minority interest and discontinued operations decreased $325,000, or 15%, to $1,891,000 in 2003 from $2,216,000 in 2002 as a result of the foregoing factors. FUNDS FROM OPERATIONS Management considers Funds from Operations ("FFO") to be a useful supplemental measure to evaluate operating performance. The Company considers FFO to be an appropriate supplemental measure of operating performance because, by excluding gains or losses on dispositions and excluding depreciation, FFO can help one compare the operating performance of a company's real estate between periods or as compared to different companies. FFO is defined by the National Association of Real Estate Investment Trusts, Inc. ("NAREIT") to mean net income computed in accordance with generally accepted accounting principles ("GAAP"), excluding gains (or losses) from sales of property, plus real estate related depreciation and amortization. FFO should not be considered as an alternative to net income as the primary 15 AGREE REALTY CORPORATION PART I indicator of the Company's operating performance or as an alternative to cash flow as a measure of liquidity. In addition, our method of calculating FFO may not be comparable to the methods used by other REITs and, accordingly, may be different from similarly titled measures reported by other companies. The following tables illustrate the calculation of FFO for the nine months and three months ended September 30, 2003 and 2002 and a reconciliation of net income to FFO:
Nine Months Ended September 30, 2003 2002 ----------------------------------------------------------------------------------------- Net income $ 6,474,759 $ 6,200,198 Depreciation of real estate assets 3,336,243 2,866,054 Amortization of leasing costs 43,427 51,252 Minority interest 893,804 938,787 --------------------------- FUNDS FROM OPERATIONS $ 10,748,233 $ 10,056,291 =========================== WEIGHTED AVERAGE SHARES AND OP UNITS OUTSTANDING - DILUTIVE 5,556,948 5,119,752 ===========================
Three Months Ended September 30, 2003 2002 ----------------------------------------------------------------------------------------- Net income $ 1,856,798 $ 2,137,132 Depreciation of real estate assets 1,055,896 955,009 Amortization of leasing costs 14,937 17,084 Minority interest 199,493 323,044 --------------------------- FUNDS FROM OPERATIONS $ 3,127,124 $ 3,432,269 =========================== WEIGHTED AVERAGE SHARES AND OP UNITS OUTSTANDING - DILUTIVE 6,349,353 5,120,094 ===========================
16 AGREE REALTY CORPORATION PART I LIQUIDITY AND CAPITAL RESOURCES The Company's principal demands for liquidity are distributions to its stockholders, debt repayment, development of new properties and future property acquisitions. During the quarter ended September 30, 2003, the Company declared a quarterly dividend of $.485 per share. The dividend was paid on October 16, 2003, to holders of record on September 30, 2003. As of September 30, 2003, the Company had total mortgage indebtedness of $41,434,760 with a weighted average interest rate of 6.78%. Future scheduled annual maturities of mortgages payable for the years ending September 30 are as follows: 2004 - $1,447,043; 2005 - $1,601,600; 2006 - $1,713,463; 2007 - $1,833,147; and 2008 - $1,946,772. This mortgage debt is all fixed rate debt. In addition, our operating partnership has in place a $50 million line of Credit Facility (the "Credit Facility") which is guaranteed by the Company. The credit facility has a draw termination date in November 2006 and matures in November 2009. During the period between termination and maturity, the Company will have no further ability to borrow under this facility and will be required to repay a portion of the unpaid principal on a quarterly basis. Advances under the Credit Facility bear interest within a range of one month to six month LIBOR plus 150 basis points to 213 basis points or the bank's prime rate, at the option of the Company, based on certain factors such as debt to property value and debt service coverage. The Credit Facility is used to fund property acquisitions and development activities and is secured by most of the Company's properties which are not otherwise encumbered and properties to be acquired or developed. As of September 30, 2003, $39,000,000 was outstanding under the Credit Facility bearing a weighted average interest rate of 2.62%. The Company also has in place a $5 million line of credit (the "Line of Credit"), which matures on April 30, 2004, and which the Company expects to renew for an additional 12-month period. The Line of Credit bears interest at the bank's prime rate less 50 basis points or 175 basis points in excess of the one-month LIBOR rate, at the option of the Company. The purpose of the Line of Credit is to provide working capital to the Company and fund land options and start-up costs associated with new projects. As of September 30, 2003, $500,000 was outstanding under the Line of Credit with an annual interest rate of 3.50%. 17 AGREE REALTY CORPORATION PART I The Company has received funding from an unaffiliated third party for the construction of one of its properties. Advances under this agreement bear no interest and are secured by the specific land and buildings being developed. As of September 30, 2003, $1,569,000 was outstanding under this arrangement. During the third quarter 2003, the Company negotiated an early payment on three mortgage notes totaling approximately $37 million and bearing an interest rate of 7.00%. The mortgages were secured by eight (8) community shopping centers. Two of the mortgages totaling approximately $30.3 million were scheduled to mature in November, 2005 and required a final payment in the amount of approximately $28.2 million on the maturity date. The third mortgage in the amount of approximately $6.7 million had a scheduled maturity date of April 2013 and required a final payment in the amount of approximately $2.9 million on the maturity date. This mortgage contained a provision that would reset the interest rate to the then current rate in December 2005. The Company incurred a pre-payment penalty of 1.50% on the outstanding mortgage balance. The Company has one development project under construction that will add an additional 14,560 square feet of GLA to the Company's portfolio. The project is expected to be completed during the fourth quarter of 2003. Additional Company funding required to complete this project is estimated to be $2,500,000 and will come from the Credit Facility. The Company intends to meet its short-term liquidity requirements, including capital expenditures related to the leasing and improvement of the properties, through its cash flow provided by operations and the Credit Facility. Management believes that adequate cash flow will be available to fund the Company's operations and pay dividends in accordance with REIT requirements. The Company may obtain additional funds for future development or acquisitions through other borrowings or the issuance of additional shares of capital stock. The Company intends to incur additional debt in a manner consistent with its policy of maintaining a ratio of total debt (including construction and acquisition financing) to total market capitalization of 65% or less. The Company believes that these financing sources will enable the Company to generate funds sufficient to meet both its short-term and long-term capital needs. The Company plans to begin construction of additional pre-leased developments and may acquire additional properties, which will initially be financed by the Credit Facility. Management has refinanced in the past and intends to periodically refinance short-term construction and acquisition financing with long-term debt or equity. Upon completion of any refinancing, the Company intends to lower the ratio of total debt to market capitalization to 50% or less. Nevertheless, the Company may operate with debt levels or ratios which are in excess of 50% for extended periods of time prior to such refinancing. 18 AGREE REALTY CORPORATION PART I INFLATION The Company's leases generally contain provisions designed to mitigate the adverse impact of inflation on net income. These provisions include clauses enabling the Company to pass through to tenants certain operating costs, including real estate taxes, common area maintenance, utilities and insurance, thereby reducing the Company's exposure to increases in costs and operating expenses resulting from inflation. Certain of the Company's leases contain clauses enabling the Company 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 the Company to seek increased rents upon re-lease at market rates if rents are below the then existing market rates. ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to interest rate risk primarily through its borrowing activities. There is inherent roll over risk for borrowings as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and the Company's' future financing requirements. The Company's interest rate risk is monitored using a variety of techniques. The table below presents the principal payments (in thousands) and the weighted average interest rates on remaining debt, by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes.
Year ended September 30, ------------------------ 2004 2005 2006 2007 2008 THEREAFTER TOTAL ---- ---- ---- ---- ---- ---------- ----- FIXED RATE DEBT 1,447 1,602 1,713 1,833 1,947 32,893 41,435 AVERAGE INTEREST RATE 6.78 6.78 6.79 6.79 6.79 6.79 CONSTRUCTION LOANS - - - - - 1,569 1,569 AVERAGE INTEREST RATE - - - - - - - VARIABLE RATE DEBT 1,541 1,041 36,918 - - - 39,500 AVERAGE INTEREST RATE 4.00 4.00 4.00 - - - -
The fair value (in thousands) is estimated at $41,400, $1,569 and $39,500 for fixed rate debt, construction loans and variable rate debt, respectively. The table above incorporates those exposures that exist as of September 30, 2003; it does not consider those exposures or position, which could arise after that date. As a result, the Company's ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period and interest rates. The Company does not enter into financial instruments transactions for trading or other speculative purposes or to manage interest rate exposure. A 10% adverse change in interest rates on the portion of the Company's debt bearing interest at variable rates would result in an increase in interest expense of approximately $103,000. 19 AGREE REALTY CORPORATION PART I ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Our Chief Executive Officer and Vice-President-Finance have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) as of the end of the period covered by this quarterly report. Based on that evaluation, the Chief Executive Officer and Vice-President-Finance have concluded that our current disclosure controls and procedures are effective and timely, providing them with material information relating to us required to be disclosed in the reports we file or submit under the Exchange Act. CHANGES IN INTERNAL CONTROLS There have not been any significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. We are not aware of any significant deficiencies or material weaknesses; therefore, no corrective actions were taken. 20 AGREE REALTY CORPORATION PART II OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities and Use of Proceeds None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None 21 AGREE REALTY CORPORATION PART II Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 3.1 Articles of Incorporation and Articles of Amendment of the Company (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-11 (Registration Statement No. 33-73858, as amended ("Agree S-11")) 3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.3 to Agree S-11) 10.1 Amended and Restated $50 million Line of Credit agreement dated November 5, 2003 among Agree Realty Corporation and Standard Federal Bank, N.A. and Bank One. 31.1 Certification of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Richard Agree, Chief Executive Officer 32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Kenneth R. Howe, Chief Financial Officer (b) Reports on Form 8-K - On July 24, 2003, the Company filed a Form 8-K under Item 7 and Item 12 furnishing its second quarter 2003 results of operations and financial condition. 22 AGREE REALTY CORPORATION SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has fully caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AGREE REALTY CORPORATION /s/ RICHARD AGREE ---------------------------------------- Richard Agree President and Chief Executive Officer /s/ KENNETH R. HOWE ---------------------------------------- Kenneth R. Howe Vice-President - Finance and Secretary (Principal Financial Officer) Date: November 13, 2003 23 AGREE REALTY CORPORATION EXHIBIT INDEX
Exhibit No. DESCRIPTION ----------- ----------- 3.1 Articles of Incorporation and Articles of Amendment of the Company (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-11 (Registration Statement No. 33-73858, as amended ("Agree S-11")) 3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.3 to Agree S-11) 10.1 Amended and Restated $50 million Line of Credit agreement dated November 5, 2003 among Agree Realty Corporation and Standard Federal Bank, N.A. and Bank One. 31.1 Certification of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Richard Agree, Chief Executive Officer 32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Kenneth R. Howe, Chief Financial Officer
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