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AGREE REALTY CORP - Quarter Report: 2004 June (Form 10-Q)

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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 June 30, 2004

OR

     
o
  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
of incorporation or organization)
  (I.R.S. Employer
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
x
  No
o

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

     
Yes
x
  No
o

6,466,971 Shares of Common Stock, $.0001 par value, were outstanding as of August 6, 2004

 


Agree Realty Corporation

Form 10-Q

Index

             
        Page
Part I:
  Financial Information        
Item 1.
  Interim Consolidated Financial Statements        
 
  Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003     3-4  
 
  Consolidated Statements of Income for the six months ended June 30, 2004 and 2003     5  
 
  Consolidated Statements of Income for the three months ended June 30, 2004 and 2003     6  
 
  Consolidated Statement of Stockholders' Equity for the six months ended June 30, 2004     7  
 
  Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003     8-9  
 
  Notes to Consolidated Financial Statements     10  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     11-19  
  Quantitative and Qualitative Disclosures About Market Risk     19  
  Controls and Procedures     20  
  Other Information        
  Legal Proceedings     21  
  Changes in Securities     21  
  Defaults Upon Senior Securities     21  
  Submission of Matters to a Vote of Security Holders     21  
  Other Information     21  
  Exhibits and Reports on Form 8-K     22  
        23  
 Employment Agreement, dated July 1, 2004 between Richard Agree
 Employment Agreement dated July 1, 2004 between Kenneth R. Howe
 Certification of Chief Executive Officer, pursuant to Section 302
 Certification of Chief Financial Officer, pursuant to Section 302
 Certification of Chief Executive Officer pursuant to Section 906
 Certification of Chief Financial Officer pursuant to Section 906

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Agree Realty Corporation

Consolidated Balance Sheets (Unaudited)

                 
    June 30,   December 31,
    2004
  2003
Assets
               
Real Estate Investments
               
Land
  $ 62,912,606     $ 56,848,606  
Buildings
    166,049,502       161,265,188  
Property under development
    2,034,675       3,110,835  
 
   
 
     
 
 
 
    230,996,783       221,224,629  
Less accumulated depreciation
    (40,592,989 )     (38,475,767 )
 
   
 
     
 
 
Net Real Estate Investments
    190,403,794       182,748,862  
Cash and Cash Equivalents
    198,712       1,004,090  
Cash – Restricted
          4,309,914  
Accounts Receivable — Tenants, net of allowance of $70,000 and $120,000 for possible losses
    146,707       622,337  
Investments In and Advances to Unconsolidated Entities
    324,693       330,316  
Unamortized Deferred Expenses
               
Financing
    1,079,427       1,155,427  
Leasing costs
    223,544       231,344  
Other Assets
    1,593,857       1,283,424  
 
   
 
     
 
 
 
  $ 193,970,734     $ 191,685,714  
 
   
 
     
 
 

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Consolidated Balance Sheets (Unaudited)

                 
    June 30,   December 31,
    2004
  2003
Liabilities and Stockholders’ Equity
               
Mortgage Payable
  $ 54,905,800     $ 55,967,378  
Construction Loans
    1,569,000       1,569,000  
Notes Payable
    30,400,000       26,500,000  
Dividends and Distributions Payable
    3,463,151       3,447,328  
Accrued Interest Payable
    191,323       167,099  
Accounts Payable
               
Operating
    807,589       1,408,272  
Capital expenditures
    641,159       570,363  
Tenant Deposits
    58,863       47,099  
 
   
 
     
 
 
Total Liabilities
    92,036,885       89,676,539  
 
   
 
     
 
 
Minority Interest
    5,787,837       5,821,739  
 
   
 
     
 
 
Stockholders’ Equity
               
Common stock, $.0001 par value; 20,000,000 shares authorized, 6,466,971 and 6,434,345 shares issued and outstanding
    647       643  
Additional paid-in capital
    109,174,472       108,251,813  
Deficit
    (11,547,973 )     (11,227,636 )
 
   
 
     
 
 
 
    97,627,146       97,024,820  
Less: unearned compensation — restricted stock
    (1,481,134 )     (837,384 )
 
   
 
     
 
 
Total Stockholders’ Equity
    96,146,012       96,187,436  
 
   
 
     
 
 
 
  $ 193,970,734     $ 191,685,714  
 
   
 
     
 
 

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Consolidated Statements of Income (Unaudited)

                 
    Six Months Ended   Six Months Ended
    June 30, 2004
  June 30, 2003
Revenues
               
Minimum rents
  $ 12,921,273     $ 11,983,813  
Percentage rents
    40,872       51,060  
Operating cost reimbursements
    1,539,667       1,440,385  
Other income
    1,842       1,777  
 
   
 
     
 
 
Total Revenues
    14,503,654       13,477,035  
 
   
 
     
 
 
Operating Expenses
               
Real estate taxes
    927,659       912,896  
Property operating expenses
    1,099,085       1,033,027  
Land lease payments
    369,480       369,480  
General and administrative
    1,296,420       1,123,000  
Depreciation and amortization
    2,169,995       2,009,438  
 
   
 
     
 
 
Total Operating Expenses
    5,862,639       5,447,841  
 
   
 
     
 
 
Income From Continuing Operations
    8,641,015       8,029,194  
 
   
 
     
 
 
Other Income (Expense)
               
Interest expense, net
    (2,262,515 )     (3,259,020 )
Equity in net income of unconsolidated entities
    193,903       231,399  
 
   
 
     
 
 
Total Other Expense
    (2,068,612 )     (3,027,621 )
 
   
 
     
 
 
Income Before Minority Interest and Discontinued Operations
    6,572,403       5,001,573  
Minority Interest
    619,778       653,702  
 
   
 
     
 
 
Income Before Discontinued Operations
    5,952,625       4,347,871  
Income From Discontinued Operations, net of minority interest of $40,609
          270,090  
 
   
 
     
 
 
Net Income
  $ 5,952,625     $ 4,617,961  
 
   
 
     
 
 
Earnings Per Share – Basic and Dilutive
  $ .92     $ 1.03  
 
   
 
     
 
 
Weighted Average Number of Common Shares Outstanding – Basic
    6,466,971       4,479,345  
 
   
 
     
 
 
Weighted Average Number of Common Shares Outstanding — Dilutive
    6,473,740       4,480,654  
 
   
 
     
 
 

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Consolidated Statements of Income (Unaudited)

                 
    Three Months Ended   Three Months Ended
    June 30, 2004
  June 30, 2003
Revenues
               
Minimum rents
  $ 6,551,445     $ 6,052,633  
Percentage rents
    16,111       9,651  
Operating cost reimbursements
    689,142       721,250  
Other income
    263       51  
 
   
 
     
 
 
Total Revenues
    7,256,961       6,783,585  
 
   
 
     
 
 
Operating Expenses
               
Real estate taxes
    475,348       445,311  
Property operating expenses
    409,835       428,195  
Land lease payments
    184,740       184,740  
General and administrative
    663,473       566,403  
Depreciation and amortization
    1,086,535       1,003,219  
 
   
 
     
 
 
Total Operating Expenses
    2,819,931       2,627,868  
 
   
 
     
 
 
Income From Continuing Operations
    4,437,030       4,155,717  
 
   
 
     
 
 
Other Income (Expense)
               
Interest expense, net
    (1,158,792 )     (1,674,915 )
Equity in net income of unconsolidated entities
    96,952       112,568  
 
   
 
     
 
 
Total Other Expense
    (1,061,840 )     (1,562,347 )
 
   
 
     
 
 
Income Before Minority Interest and Discontinued Operations
    3,375,190       2,593,370  
Minority Interest
    318,281       338,951  
 
   
 
     
 
 
Income Before Discontinued Operations
    3,056,909       2,254,419  
Income From Discontinued Operations, net of minority interest of $17,975
          119,552  
 
   
 
     
 
 
Net Income
  $ 3,056,909     $ 2,373,971  
 
   
 
     
 
 
Earnings Per Share – Basic and Dilutive
  $ .47     $ .53  
 
   
 
     
 
 
Weighted Average Number of Common Shares Outstanding — Basic
    6,466,971       4,479,345  
 
   
 
     
 
 
Weighted Average Number of Common Shares Outstanding – Dilutive
    6,472,257       4,481,962  
 
   
 
     
 
 

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Consolidated Statement of Stockholders’ Equity (Unaudited)

                                         
                                     
                                 
    Common Stock
  Additional
Paid-In
          Unearned
Compensation -
Restricted
    Shares
  Amount
  Capital
  Deficit
  Stock
Balance, January 1, 2004
    6,434,345     $ 643     $ 108,251,813     $ (11,227,636 )   $ (837,384 )
Issuance of shares under Stock Incentive Plan
    38,626       4       1,092,339             (883,750 )
Shares redeemed under the Stock Incentive Plan
    (6,000 )           (169,680 )            
Vesting of restricted stock
                            240,000  
Dividends declared for the period January 1, 2004 to June 30, 2004
                      (6,272,962 )      
Net income for the period January 1, 2004 to June 30, 2004
                      5,952,625        
 
   
 
     
 
     
 
     
 
     
 
 
Balance, June 30, 2004
    6,466,971     $ 647     $ 109,174,472     $ (11,547,973 )   $ (1,481,134 )
 
   
 
     
 
     
 
     
 
     
 
 

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Consolidated Statement of Cash Flows (Unaudited)

                 
    Six Months Ended   Six Months Ended
    June 30, 2004
  June 30, 2003
Cash Flows From Operating Activities
               
Net income
  $ 5,952,625     $ 4,617,961  
Adjustments to reconcile net income to net cash provided by operating activities
               
Depreciation
    2,144,235       2,090,134  
Amortization
    101,760       125,890  
Stock-based compensation
    240,000       184,000  
Equity in net income of unconsolidated entities
    (193,903 )     (231,399 )
Minority interests
    619,778       694,311  
Decrease in accounts receivable
    475,630       368,731  
Decrease (Increase) in other assets
    (335,599 )     82,098  
Decrease in accounts payable
    (600,683 )     (342,840 )
Increase (decrease) in accrued interest
    24,224       (8,407 )
Increase (decrease) in tenant deposits
    11,764       (10,622 )
 
   
 
     
 
 
Net Cash Provided By Operating Activities
    8,439,831       7,569,857  
 
   
 
     
 
 
Cash Flows From Investing Activities
               
Acquisition of real estate investments (including capitalized interest of $83,000 in 2004 and $91,000 in 2003)
    (9,130,995 )     (9,152,653 )
Distributions from unconsolidated entities
    193,903       231,399  
Decrease in restricted cash
    4,309,914        
 
   
 
     
 
 
Net Cash Used In Investing Activities
    (4,627,178 )     (8,921,254 )
 
   
 
     
 
 
Cash Flows From Financing Activities
               
Payments of mortgages payable
    (1,061,578 )     (1,216,365 )
Mortgage proceeds
          7,699,151  
Dividends and limited partners’ distributions paid
    (6,910,820 )     (4,829,544 )
Payment on construction loan
          (26,900 )
Line-of-credit net borrowings (payments)
    3,900,000       (625,000 )
Repayments of capital expenditure payables
    (361,769 )     (423,910 )
Payments for financing costs
          (6,954 )
Redemption of restricted stock
    (169,680 )     (101,400 )
Payment of leasing costs
    (14,184 )     (12,089 )
 
   
 
     
 
 
Net Cash Provided By (Used In) Financing Activities
    (4,618,031 )     456,989  
 
   
 
     
 
 
Net Decrease In Cash and Cash Equivalents
    (805,378 )     (894,408 )
Cash and Cash Equivalents, beginning of period
    1,004,090       1,095,610  
 
   
 
     
 
 
Cash and Cash Equivalents, end of period
  $ 198,712     $ 201,202  
 
   
 
     
 
 

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Agree Realty Corporation

Consolidated Statement of Cash Flows (Unaudited)

                 
    Six Months Ended   Six Months Ended
    June 30, 2004
  June 30, 2003
Supplemental Disclosure of Cash flow Information
               
Cash paid for interest (net of amounts capitalized)
  $ 2,225,178     $ 3,173,823  
 
   
 
     
 
 
Supplemental Disclosure of Non-Cash Transactions
               
Dividends and limited partners’ distributions declared and unpaid
  $ 3,463,151     $ 2,499,153  
Shares issued under Stock Incentive Plan
  $ 1,092,343     $ 622,153  
Real estate investments financed with accounts payable
  $ 641,159     $ 345,514  
 
   
 
     
 
 

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Notes to Consolidated Financial Statements

         
1.
  Basis of Presentation   The accompanying unaudited consolidated financial statements for the fiscal quarter ended June 30, 2004 have been prepared in accordance 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, 2003 has been derived from the audited consolidated financial statements at that date. Operating results for the six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004, 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, 2003.
 
       
2.
  Earnings Per
Share
  Earnings per share has been computed by dividing the 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.
  Discontinued
Operations
  In October 2003 the Company completed the sale of a shopping center for approximately $8.5 million. 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 $628,298 for the six months ended June 30, 2003. The expenses for this property were $358,208, including minority interest charges of $40,609, for the six months ending June 30, 2003.
 
       
      The revenues from this property were $302,493 for the three months ended June 30, 2003. The expenses for this property were $182,941, including minority interest charges of $17,975 for the three months ending June 30, 2003.

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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 future results to differ from the statements 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

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 an 90.57% interest as of June 30, 2004. We are operating so as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes.

On August 4, 2003, we 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.

We have fourteen (14) leases with Kmart Corporation. Eleven (11) of the Kmart stores are currently anchors in the Company’s Community Shopping Centers and three (3) Kmart stores are free-standing net leased properties. The Kmart stores in the Company’s Portfolio provided 16.7% of our Annual Base Rent as of June 30, 2004. Four of the Kmart stores paid percentage rent in addition to their minimum rent during 2003. As of June 30, 2004, all of our Kmart stores were open and operating as Kmart discount stores.

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Agree Realty Corporation

Part I

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 approximately 600 of its stores, including one located in our center in Lakeland, Florida. Kmart vacated the premises in Lakeland, Florida in April 2003 and we have actively marketed the space formerly occupied by Kmart. Kmart’s annual rent on this property was approximately $480,000 and their 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 closed, and we are unable to obtain a replacement anchor tenant. As of July 31, 2004, none of these tenants has indicated that they will exercise their option to terminate their leases with us. In addition, we have agreed to a rent reduction of $150,000 per year under a Kmart lease for a store in Perrysburg, Ohio. The rent reduction is for a 5-year period.

We have entered into a lease with a department store to lease the entire vacant Kmart space. The terms of the lease are similar to the terms under the previous Kmart lease. We expect the tenant to commence paying rent and other charges in October 2004. In connection with re-letting the Kmart location, we have agreed to make capital expenditures of approximately $600,000 with respect to the property.

During October 2003, we sold a community shopping center that was located in Winter Garden, Florida and was anchored by Kmart. We developed the 233,512 square foot shopping center in 1988. The property was sold to a private investor for approximately $8.5 million. We recognized a gain of approximately $835,000 on the sale.

The lost revenue and increased property expenses resulting from the rejection by any bankrupt tenant of any of their respective leases with the Company could have a material adverse effect on the liquidity and results of operations of the Company, if the Company is unable to re-lease the space at comparable rental rates and in a timely manner.

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.

Recent Accounting Pronouncements

In May 2003, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (“SFAS 150”). The objective of SFAS 150 is to establish standards for how an issuer classifies and measurers certain financial instruments with characteristics of both liabilities and equity. In November 2003 the FASB indefinitely delayed the effective date of SFAS 150 with respect to certain mandatory redeemable non-controlling interests in consolidated financial statements. Adoption of SFAS did no have an impact on the results of operations or financial position of the Company.

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Agree Realty Corporation

Part I

Critical Accounting Policies

In the course of developing and evaluating accounting policies and procedures, we use 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, 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 the Company’s 1994 tax year. As a result, the Company is not subject to federal income taxes to the extent that we distribute annually at least 90% of its 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.

Comparison of Six Months Ended June 30, 2004 to Six Months Ended June 30, 2003

Minimum rental income increased $937,000, or 8%, to $12,921,000 in 2004, compared to $11,984,000 in 2003. The increase was the result of rental decreases of ($183,000) from existing properties; an increase of $591,000 due to additional rent as a result of the acquisition of our joint venture partner’s interest in three Joint Venture Properties in 2003; an increase of $258,000 from the acquisition of one property in 2003 and one property in 2004; and an increase of $271,000 from the development of two properties in 2003 and one property in 2004.

Percentage rental income decreased ($10,000), or 20%, to $41,000 in 2004, compared to $51,000 in 2003. The decrease was primarily the result of decreased tenant sales.

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Agree Realty Corporation

Part I

Operating Cost Reimbursements increased $100,000, or 7%, to $1,540,000 in 2004, compared to $1,440,000 in 2003. Operating cost reimbursements increased due to the increase in real estate taxes and property operating expenses as explained below.

Other income remained constant at $2,000 in 2004 and 2003.

Real estate taxes increased $15,000, or 2%, to $928,000 in 2004, compared to $913,000 in 2003. 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) increased $66,000, or 6%, to $1,099,000 in 2004 compared to $1,033,000 in 2003. The increase was the result of increased snow removal costs of $47,000; a decrease in shopping center maintenance costs of ($13,000); a decrease in utility costs of ($1,000); and an increase in insurance costs of $33,000 in 2004 versus 2003. Included in shopping center maintenance is approximately $85,000 to paint the exterior walls of two shopping centers in 2004. This cost, in accordance with our tenant’s leases was not a reimbursable expense.

Land lease payments remained constant at $369,000 for 2004 and 2003.

General and administrative expenses increased by $173,000, or 15%, to $1,296,000 in 2004, compared to $1,123,000 in 2003. The increase was primarily the result of increased compensation related expenses of $112,000; increased general state taxes of $40,000 and property management related expenses of $21,000. General and administrative expenses as a percentage of total rental income increased from 9.3% for 2003 to 10.0% for 2004.

Depreciation and amortization increased $161,000, or 8%, to $2,170,000 in 2004, compared to $2,009,000 in 2003. The increase was the result of the development of two properties in 2003 and one property in 2004; the acquisition of the joint venture partner’s interest in three (3) Joint Venture Properties in 2003; and the acquisition of one property in 2003 and one property in 2004.

Interest expense decreased $996,000, or 31%, to $2,263,000 in 2004, from $3,259,000 in 2003. The decrease in interest expense was the result of decreased borrowings as a result of the reduction in outstanding indebtedness with the net proceeds from the issuance of additional common stock.

Equity in net income of unconsolidated entities decreased $37,000, or 16%, to $194,000 in 2004 compared to $231,000 in 2003 as a result of the acquisition of our joint venture partner’s interest in three Joint Venture Properties in 2003.

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Part I

The Company’s income before minority interest and discontinued operations increased $1,570,000, or 31%, to $6,572,000 in 2004 from $5,002,000 in 2003 as a result of the foregoing factors.

Comparison of Three Months Ended June 30, 2004 to Three Months Ended June 30, 2003

Minimum rental income increased $498,000, or 8%, to $6,551,000 in 2004, compared to $6,053,000 in 2003. The increase was the result of rental decreases of ($53,000) from existing properties; an increase of $254,000 due to additional rent as a result of the acquisition of our joint venture partner’s interest in three Joint Venture Properties in 2003; an increase of $164,000 from the acquisition of one property in 2003 and one property in 2004; and an increase of $133,000 from the development of two properties in 2003 and one property in 2004.

Percentage rental income increased $6,000, or 67%, to $16,000 in 2004, compared to $10,000 in 2003. The increase was primarily the result of increased tenant sales.

Operating cost reimbursements decreased $32,000, or 4%, to $689,000 in 2004, compared to $721,000 in 2003. Operating cost reimbursements decreased due to the decrease in property operating expense as explained below.

Real estate taxes increased $30,000, or 7%, to $475,000 in 2004, compared to $445,000 in 2003. 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.

Property operating expenses (shopping center maintenance, insurance and utilities) decreased $18,000, or 4%, to $410,000 in 2004 compared to $428,000 in 2003. The decrease was the result of increased shopping center maintenance costs of $14,000; a decrease in snow removal costs of ($46,000); a decrease in utility costs of ($2,000); and an increase in insurance costs of $16,000 in 2004 versus 2003. Included in shopping center maintenance is approximately $85,000 to paint the exterior walls of two shopping centers in 2004. This cost, in accordance with our tenant’s leases was not a reimbursable expense.

Land lease payments remained constant at $185,000 for 2004 and 2003.

General and administrative expenses increased by $97,000, or 17%, to $663,000 in 2004, compared to $566,000 in 2003. The increase was primarily the result of an increase in compensation-related expenses of $57,000; increased state taxes of $20,000; and property management related expenses of $20,000. General and administrative expenses as a percentage of total rental income increased from 9.3% in 2003 to 10.1% in 2004.

Depreciation and amortization increased $84,000, or 8%, to $1,087,000 in 2004, compared to $1,003,000 in 2003. The increase was the result of the development of two properties in 2003 and one property in 2004; the acquisition of the joint venture partner’s interest in three (3) Joint Venture Properties in 2003; and the acquisition of one property in 2003 and one property in 2004.

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Part I

Interest expense decreased $516,000, or 31%, to $1,159,000 in 2004, from $1,675,000 in 2003. The decrease in interest expense was the result of decreased borrowings as a result of the reduction in outstanding indebtedness with the net proceeds from the issuance of additional common stock.

Equity in net income of unconsolidated entities decreased $16,000, or 14%, to $97,000 in 2004 compared to $113,000 in 2003 as a result of the acquisition of the joint venture partner’s interest in three Joint Venture Properties in 2003.

The Company’s income before minority interest and discontinued operations increased $782,000, or 30%, to $3,375,000 in 2004 from $2,593,000 in 2003 as a result of the foregoing factors.

Liquidity and Capital Resources

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

During the quarter ended June 30, 2004, the Company declared a quarterly dividend of $.485 per share. The dividend was paid on July 13, 2004, to holders of record on June 30, 2004.

As of June 30, 2004, the Company had total mortgage indebtedness of $54,905,800 with a weighted average interest rate of 6.63%. Future scheduled annual maturities of mortgages payable for the years ending June 30 are as follows: 2005 — $2,118,624; 2006 — $2,375,235; 2007 — $2,536,963; 2008 — $2,700,189; and 2009 — $2,874,208. This mortgage debt is all fixed rate debt.

In addition, the operating partnership has in place a $50 million credit facility with Standard Federal Bank, as the agent (Credit Facility), which is guaranteed by the Company. 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 the Company’s properties which are not otherwise encumbered and properties to be acquired or developed. As of June 30, 2004 $27,500,000 was outstanding under the Credit Facility bearing a weighted average interest rate of 2.87%.

We also have in place a $5 million line of credit (Line of Credit), which matures on June 30, 2005. 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 June 30, 2004, $2,900,000 was outstanding under the Line of Credit bearing a weighted average interest rate of 3.75%.

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Part I

We have 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 June 30, 2004, $1,569,000 was outstanding under this arrangement.

The following table outlines our contractual obligations (in thousands) as of June 30, 2004.

                                         
    Total
  Yr 1
  2-3 Yrs
  4-5 Yrs
  Over 5 Yrs
Mortgages Payable
  $ 54,906     $ 2,119     $ 4,912     $ 5,574     $ 42,301  
Construction Loan
    1,569                         1,569  
Notes Payable
    30,400       2,900       734       734       26,032  
Land Lease Obligation
    14,702       725       1,533       1,535       10,909  
Other Long-Term Liabilities
                             
 
   
 
     
 
     
 
     
 
     
 
 
Total
  $ 101,577     $ 5,744     $ 7,179     $ 7,843     $ 80,811  
 
   
 
     
 
     
 
     
 
     
 
 

We have one development project under construction that will add an additional 13,650 square feet of GLA to our portfolio. The project is expected to be completed during the fourth quarter of 2004. Additional Company funding required to complete this project is estimated to be $1,300,000 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 its 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 Line of Credit. We will periodically refinance short-term construction and acquisition financing with long-term debt and /or equity. Upon completion of refinancing, we intend to lower the ratio of total debt to market capitalization to 50% or less. Nevertheless, we may operate with debt levels or ratios, which are in excess of 50% for extended periods of time prior to such refinancing.

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Part I

Inflation

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

Funds from Operations

Management considers Funds from Operations (“FFO”) to be a useful supplemental measure to evaluate our operating performance because, by excluding gains or losses on dispositions and excluding depreciation FFO can help one compare the operating performance of our real estate between periods or compare such performance to that of 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 indicator of the Company’s operating performance or as an alternative to cash flow as a measure of liquidity. While we adhere to the NAREIT definition of FFO in making our calculation 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 six months and three months ended June 30, 2004 and 2003 and a reconciliation of net income to FFO:

                 
Six Months Ended June 30,
  2004
  2003
Net income
  $ 5,952,625     $ 4,617,961  
Depreciation of real estate assets
    2,126,621       2,080,347  
Amortization of leasing costs
    21,984       28,490  
Minority interest
    619,778       694,311  
 
   
 
     
 
 
Funds from Operations
  $ 8,721,008     $ 7,421,109  
 
   
 
     
 
 
Weighted Average Shares and OP Units Outstanding — Dilutive
    7,147,287       5,155,509  
 
   
 
     
 
 

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Part I

                 
Three Months Ended June 30,
  2004
  2003
Net income
  $ 3,056,909     $ 2,373,971  
Depreciation of real estate assets
    1,064,410       1,038,670  
Amortization of leasing costs
    11,214       14,245  
Minority interest
    318,281       356,926  
 
   
 
     
 
 
Funds from Operations
  $ 4,450,814     $ 3,783,812  
 
   
 
     
 
 
Weighted Average Shares and OP Units Outstanding — Dilutive
    7,145,804       5,155,509  
 
   
 
     
 
 

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 June 30,
       
    2005
  2006
  2007
  2008
  2009
  Thereafter
  Total
Fixed rate debt
    2,119       2,376       2,537       2,700       2,874       42,300       54,906  
Average interest rate 6.63
    6.63       6.63       6.63       6.63       6.63                  
Construction loans
                                  1,569       1,569  
Average interest rate
                                         
Variable rate debt
    2,900             734       734       26,032             30,400  
Average interest rate
    3.75       2.87       2.87       3.12       3.12              

The fair value (in thousands) is estimated at $55,500, $1,569 and $30,400 for fixed rate debt, construction loans and variable rate debt, respectively.

The table above incorporates those exposures that exist as of June 30, 2004; 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 $91,000.

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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.

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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

On May 10, 2004, the Company held its Annual Meeting of Stockholders. The following were the results of the meeting:

The stockholders elected Ellis Wachs and Leon M. Schurgin as Directors until the annual meeting of stockholders in 2007 or until a successor is elected and qualified.

The vote was as follows:

                 
    Ellis Wachs
  Leon M. Schurgin
Votes cast for
    5,974,080       6,015,719  
Votes withheld
    125,453       83,814  

Item 5. Other Information

None

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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   Employment Agreement, dated July 1, 2004, by and between the Company, and Richard Agree
 
10.2   Employment Agreement dated July 1, 2004, by and between the Company and Kenneth R. Howe
 
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 29, 2004, the Company furnished a Form 8-K disclosing its second quarter 2004 results of operations and financial condition.

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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: August 6, 2004

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Exhibit Index

     
Exhibit no.
  Description
10.1
  Employment Agreement, dated July 1, 2004, by and between the Company, and Richard Agree
 
   
10.2
  Employment Agreement dated July 1, 2004, by and between the Company and Kenneth R. Howe
 
   
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