Agree Realty - 10-Q quarterly report FY

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.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

As of November 4, 2005 the Registrant had 7,671,846 shares of common stock, $.0001 par value outstanding.

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 future results to differ from the statements include, but are not limited to, the effect of economic and market conditions; risks that our 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 our major retail tenants; and failure of our properties to generate additional income to offset increases in operating expenses. For a description of the specific risks associated with the operation of our business, please see our Form 10-K for the fiscal year ended December 31, 2004.

We were established to continue to operate and expand the retail property business of our predecessor. We commenced operations in April 1994. Our assets are held by, and all operations are conducted through, Agree Limited Partnership (the “Operating Partnership”), of which Agree Realty Corporation is the sole general partner and held a 91.93% interest as of September 30, 2005. We are operating so as to qualify as a real estate investment trust (REIT) for federal income tax purposes.

On January 25, 2005, we completed an offering of 1,000,000 shares of common stock at $28.28 per share. On February 7, 2005, the underwriter exercised its over allotment option for an additional 150,000 shares at the same per share price (collectively, the 2005 Offering). The net proceeds from the 2005 Offering of approximately $31.5 million were used to repay amounts outstanding our credit facility.

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.

In December 2004, the FASB issued Statement of Financial Accounting Standard (SFAS) No. 123 (R), to expand and clarify SFAS No. 123 in several areas. The Statement requires companies to measure the cost of employee services received in exchange for an award of an equity instrument based on the grant-date fair value of the award. The cost is recognized over the requisite service period (usually the vesting period) for the estimated number of instruments where service is expected to be rendered. This statement is effective for the interim reporting periods beginning after December 15, 2005. We do not expect that our financial statements will be materially impacted by SFAS No. 123 (R).

In the course of developing and evaluating accounting policies and procedures, we use estimates, assumptions and judgments to determine the most appropriate methods to be applied. Such processes are used in determining 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 when due from tenants. Certain leases provide for additional percentage rents based on tenants’ sales volumes. These percentage rents are recognized when determinable by us. In addition, leases for certain tenants contain rent escalations and/or free rent during the first several months of the lease term; however such amounts are not material.

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 our 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, insurance, etc. The related revenue from tenant billings is recognized in the same period the expense is recorded.

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the Code), commencing with our 1994 tax year. As a result, we are not subject to federal income taxes to the extent that we distribute annually at least 90% of our REIT taxable income to our stockholders and satisfy certain other requirements defined in the Code. Accordingly, no provision was made for federal income taxes in the accompanying consolidated financial statements.

Minimum rental income increased $1,944,000, or 10%, to $21,097,000 in 2005, compared to $19,153,000 in 2004. The increase was the result of an increase of $931,000 due to additional rent resulting from the acquisition of our joint venture partner’s interest in two joint venture properties in 2004, an increase of $853,000 from the development and acquisition of five properties in 2004 and 2 properties in 2005, an increase of $64,000 from the settlement of our rent dispute with Borders and rental increases of $96,000 from new and existing tenants.

Percentage rental income increased $17,000, or 81%, to $39,000 in 2005, compared to $22,000 in 2004. The increase was the result of increased tenant sales.

Operating Cost Reimbursements increased $50,000, or 2%, to $2,097,000 in 2005, compared to $2,047,000 in 2004. Operating cost reimbursements increased due to the increase in real estate taxes and property operating expenses as explained below.

Other income decreased $14,000, to $18,000 in 2005, compared to $32,000 in 2004. The decrease was the result of signage sold at one of our properties in 2004. No signage was sold in 2005.

Real estate taxes increased $21,000, or 2%, to $1,316,000 in 2005, compared to $1,295,000 in 2004. The increase is the result of general assessment adjustments.

Property operating expenses (shopping center maintenance, insurance and utilities) increased $82,000, or 6%, to $1,434,000 in 2005 compared to $1,352,000 in 2004. The increase was the result of decreased snow removal costs of ($5,000); an increase in shopping center maintenance costs of $65,000; an increase in utility costs of $15,000; and an increase in insurance costs of $7,000 in 2005 versus 2004.

Land lease payments increased $45,000, or 8%, to $586,000 in 2005 compared to $541,000 for 2004. The increase is the result of the scheduled lease increase at our Aventura, Florida property.

General and administrative expenses increased by $682,000, or 34%, to $2,665,000 in 2005, compared to $1,983,000 in 2004. The increase was the result of increased compensation related expenses as a result of salary increases and the addition of three employees of $325,000, increased contracted services to investigate development opportunities of $278,000 and increased property related expenses of $79,000. General and administrative expenses as a percentage of total rental income increased from 10.3% for 2004 to 12.3% for 2005.

Depreciation and amortization increased $354,000, or 11%, to $3,461,000 in 2005, compared to $3,107,000 in 2004. The increase was the result of the development and acquisition of five properties in 2004, two properties in 2005 and the acquisition of the joint venture partner’s interest in two joint venture properties in 2004.

Interest expense decreased $282,000, or 8%, to $3,057,000 in 2005, from $3,339,000 in 2004. The decrease in interest expense resulted from decreased borrowings as a result of the reduction in outstanding indebtedness from the application of the net proceeds of the 2005 Offering.

We sold a parcel of land and recognized a gain on the sale of $6,000 in 2005. There were no sale of assets in 2004

Equity in net income of unconsolidated entities totaled $217,000 in 2004. There was no income from unconsolidated entities in 2005 since we acquired the interest of our joint venture partner in our final two joint ventures in 2004.

Our income before minority interest and discontinued operations increased $883,000, or 9%, to $10,737,000 in 2005 from $9,854,000 in 2004 as a result of the foregoing factors.

Minimum rental income increased $322,000, or 5%, to $7,062,000 in 2005, compared to $6,740,000 in 2004. The increase was the result of an increase of $190,000 due to additional rent resulting from the acquisition of our joint venture partner’s interest in two joint venture properties in 2004, an increase of $305,000 from the development and acquisition of three properties in 2004 and two properties in 2005 and rental decreases of ($173,000) from new and existing tenants.

Percentage rental income increased $26,000, to $14,000 in 2005 compared to ($12,000) in 2004. The increase was the result of increased tenant sales.

Operating Cost Reimbursements increased $13,000, or 2%, to $613,000 in 2005, compared to $600,000 in 2004. Operating cost reimbursements increased due to the increase in property operating expenses as explained below.

Other income decreased $29,000, to $1,000 in 2005, compared to $30,000 in 2004. The decrease was primarily the result of the sale of signage in 2004 with no such income in 2005.

Real estate taxes increased $19,000, or 5%, to $444,000 in 2005, compared to $425,000 in 2004. The increase is the result of general assessment adjustments.

Property operating expenses (shopping center maintenance, insurance and utilities) decreased ($7,000), or 2%, to $342,000 in 2005 compared to $349,000 in 2004. The decrease was the result of decreased shopping center maintenance costs of ($16,000); an increase in utility costs of $6,000; and an increase in insurance costs of $3,000 in 2005 versus 2004.

Land lease payments increased $15,000, or 8%, to $195,000 in 2005 compared to $180,000 for 2004. The increase is the result of the scheduled lease increase at our Aventura, Florida property.

General and administrative expenses increased by $225,000, or 33%, to $912,000 in 2005, compared to $687,000 in 2004. The increase was the result of increased compensation related expenses as a result of salary increases and the addition of three employees of $184,000, increased contracted services to investigate Florida development opportunities of $4,000 and increased property related expenses of $37,000. General and administrative expenses as a percentage of total rental income increased from 10.2% for 2004 to 12.0% for 2005.

Depreciation and amortization increased $108,000, or 10%, to $1,168,000 in 2005, compared to $1,060,000 in 2004. The increase was the result of the development and acquisition of three properties in 2004 and two properties in 2005 and the acquisition of the joint venture partner’s interest in two joint venture properties in 2004.

Interest expense decreased $47,000, or 4%, to $1,029,000 in 2005, from $1,076,000 in 2004. The decrease in interest expense resulted from decreased borrowings as a result of the reduction in outstanding indebtedness from the application of the net proceeds of the 2005 Offering.

We sold a parcel of land and recognized a gain on the sale of $6,000 in 2005. There were no sales of assets in 2004.

Equity in net income of unconsolidated entities totaled $23,000 in 2004. There was no income from unconsolidated entities in 2005 since we acquired the interest of our joint venture partner in our final two joint ventures in 2004.

Our income before minority interest and discontinued operations increased $4,000, to $3,607,000 in 2005 from $3,603,000 in 2004 as a result of the foregoing factors.

Our principal demands for liquidity are distributions to our stockholders, debt repayment, development of new properties and future property acquisitions.

During the quarter ended September 30, 2005, we declared a quarterly dividend of $.49 per share. The dividend was paid on October 13, 2005, to holders of record on September 30, 2005.

As of September 30, 2005, we had total mortgage indebtedness of $52,151,161 with a weighted average interest rate of 6.63%. Future scheduled annual maturities of mortgages payable for the years ending September 30 are as follows: 2006 — $2,357,881; 2007 — $2,579,091; 2008 - $2,740,300; 2009 — $2,921,939; and 2010 — $3,120,947. This mortgage debt is all fixed rate debt.

In addition, the operating partnership has in place a $50 million credit facility with LaSalle Bank, as the agent (Credit Facility), which we guarantee. The credit facility matures in November 2006 and can be extended for an additional three years. During the three year extension period, we 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 our option, 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 our properties which are not otherwise encumbered and properties to be acquired or developed. As of September 30, 2005 $9,000,000 was outstanding under the credit facility bearing a weighted average interest rate of 4.95%.

We also have in place a $5 million line of credit, which matures on June 30, 2006. The line of credit bears interest at the lender’s prime rate less 50 basis points or 175 basis points in excess of the one-month LIBOR rate, at our option. 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, 2005, $2,200,000 was outstanding under the line of credit bearing a weighted average interest rate of 6.25%.

The following table outlines our contractual obligations (in thousands) as of September 30, 2005.

We have one development project under construction that will add an additional 14,559 square feet of GLA to our portfolio. The project is expected to be completed during the fourth quarter of 2005. Additional funding required to complete the project is estimated to be $313,000 and will come from the credit facility.

We intend to meet our short-term liquidity requirements, including capital expenditures related to the leasing and improvement of the properties, through cash flow provided by operations and the line of credit. We believe that adequate cash flow will be available to fund our operations and pay dividends in accordance with REIT requirements. We may obtain additional funds for future development or acquisitions through other borrowings or the issuance of additional shares of common stock. We intend to incur additional debt in a manner consistent with our policy of maintaining a ratio of total debt (including construction and acquisition financing) to total market capitalization of 65% or less. 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 plan to begin construction of additional pre-leased developments and may acquire additional properties, which will initially be financed by the credit facility and lien of credit. We will periodically refinance short-term construction and acquisition financing with long-term debt and / or equity.

The following tables illustrate the calculation of FFO for the nine months and three months ended September 30, 2005 and 2004:

We are exposed to interest rate risk primarily through 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 our future financing requirements.

Our 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.

The fair value (in thousands) is estimated at $52,200 and $11,200 for fixed rate debt and variable rate debt, respectively

The table above incorporates those exposures that exist as of September 30, 2005; it does not consider those exposures or position, which could arise after that date. As a result, our ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period and interest rates.

We do 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 our debt bearing interest at variable rates would result in an increase in interest expense of approximately $67,000.

At December 31, 2004 management identified a material weakness in our internal controls regarding the segregation of duties resulting from the fact that we do not have an accounting staff sufficient to enable us to comply with acceptable internal controls under Section 404 of the Sarbanes-Oxley Act of 2002. At September 30, 2005, we had ten employees, one of which (our Chief Financial Officer) was engaged full time in the period-end financial reporting process. Our audit committee has engaged an independent third party consultant to perform periodic reviews of our financial reporting process to help mitigate the material weakness in our internal controls.

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act), as of the end of the period covered by this report.

Based on this evaluation as of September 30, 2005, and due to the material weakness in our internal control over financial reporting as described above, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were not effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. There was no change in our internal control over financial reporting during the most recently completed fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

Our audit committee has engaged independent third party consultants to perform periodic reviews of our financial reporting process to help mitigate the material weakness in our internal controls.

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.