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AGREE REALTY CORP - Quarter Report: 2018 September (Form 10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

Mark One

 

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended September 30, 2018, or

 

¨Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

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   (I.R.S. Employer Identification No.)
Organization    

 

70 E. Long Lake Road, Bloomfield Hills, Michigan 48304

(Address of Principal Executive Offices)

 

Registrant’s telephone number, including 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            ¨

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

  

Yes            x No            ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated
Filer       x
Accelerated Filer        ¨ Non-accelerated Filer     ¨ Smaller reporting company       ¨ Emerging growth company       ¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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).

 

Yes            ¨ No            x

 

As of October 19, 2018, the Registrant had 34,481,545 shares of common stock, $0.0001 par value, issued and outstanding.

 

 

 

 

 

 

AGREE REALTY CORPORATION

Index to Form 10-Q

 

    Page
     
PART I Financial Information  
     
Item 1: Interim Consolidated Financial Statements  
     
  Consolidated Balance Sheets as of September 30, 2018 (Unaudited) and December 31, 2017 1
     
  Consolidated Statements of Income and Comprehensive Income (Unaudited) for the three and nine months ended September 30, 2018 and 2017 3
     
  Consolidated Statement of Equity (Unaudited) for the nine months ended September 30, 2018 4
     
  Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2018 and 2017 5
     
  Notes to Consolidated Financial Statements (Unaudited) 6
     
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations 25
     
Item 3: Quantitative and Qualitative Disclosures about Market Risk 34
     
Item 4: Controls and Procedures 35
     
PART II    
     
Item 1: Legal Proceedings 35
     
Item 1A: Risk Factors 35
     
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds 35
     
Item 3: Defaults Upon Senior Securities 35
     
Item 4: Mine Safety Disclosures 35
     
Item 5: Other Information 35
     
Item 6: Exhibits 36
     
SIGNATURES   36

 

 

 

 

AGREE REALTY CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per-share data)

 

PART I.FINANCIAL INFORMATION

 

Item 1.Financial Statements

 

   September 30,   December 31, 
   2018   2017 
   (Unaudited)     
         
ASSETS          
Real Estate Investments          
Land  $473,446   $405,457 
Buildings   1,041,666    868,396 
Less accumulated depreciation   (98,051)   (85,239)
    1,417,061    1,188,614 
Property under development   7,767    25,402 
Net Real Estate Investments   1,424,828    1,214,016 
           
Real Estate Held For Sale, net   1,367    2,420 
           
Cash and Cash Equivalents   16,811    50,807 
           
Cash Held in Escrows   1,436    7,975 
           
Accounts Receivable - Tenants, net of allowance of $465 and $296 for possible losses at September 30, 2018 and December 31, 2017, respectively   19,882    15,477 
           
Unamortized Deferred Expenses          
Credit facility finance costs, net of accumulated amortization of $744 and $433 at September 30, 2018 and December 31, 2017, respectively   1,267    1,174 
           
Leasing costs, net of accumulated amortization of $823 and $814 at September 30, 2018 and December 31, 2017, respectively   2,582    1,583 
           
Lease intangibles, net of accumulated amortization of $57,121 and $41,390 at September 30, 2018 and December 31, 2017, respectively   270,606    195,158 
           
Interest Rate Swaps   4,516    1,592 
           
Other Assets, net   5,339    4,432 
           
Total Assets  $1,748,634   $1,494,634 

 

See accompanying notes to consolidated financial statements.

 

 1 

 

 

AGREE REALTY CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per-share data)

 

   September 30,   December 31, 
   2018   2017 
   (Unaudited)     
         
LIABILITIES          
Mortgage Notes Payable, net  $61,537   $88,270 
           
Unsecured Term Loans, net   157,760    158,171 
           
Senior Unsecured Notes, net   384,073    259,122 
           
Unsecured Revolving Credit Facility   14,000    14,000 
           
Dividends and Distributions Payable   18,808    16,303 
           
Deferred Revenue   1,079    1,837 
           
Accrued Interest Payable   2,706    3,412 
           
Accounts Payable and Accrued Expenses   12,088    11,165 
           
Lease intangibles, net of accumulated amortization of $14,116 and $11,357 at September 30, 2018 and December 31, 2017, respectively   27,628    30,350 
           
Interest Rate Swaps   -    242 
           
Deferred Income Taxes   475    475 
           
Tenant Deposits   102    97 
           
Total Liabilities   680,256    583,444 
           
EQUITY          
Common stock, $.0001 par value, 45,000,000 shares authorized, 34,481,545 and 31,004,900 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively   3    3 
Preferred Stock, $.0001 par value per share, 4,000,000 shares authorized          
Series A junior participating preferred stock, $.0001 par value, 200,000 authorized, no shares issued and outstanding   -    - 
Additional paid-in-capital   1,096,679    936,046 
Dividends in excess of net income   (35,317)   (28,763)
Accumulated other comprehensive income (loss)   4,506    1,375 
           
Total Equity - Agree Realty Corporation   1,065,871    908,661 
Non-controlling interest   2,507    2,529 
Total Equity   1,068,378    911,190 
           
Total Liabilities and Equity  $1,748,634   $1,494,634 

 

See accompanying notes to consolidated financial statements.

 

 2 

 

 

AGREE REALTY CORPORATION

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(In thousands, except share and per-share data)

(Unaudited)

 

   Three Months Ended   Nine Months Ended 
   September 30, 2018   September 30, 2017   September 30, 2018   September 30, 2017 
Revenues                    
Minimum rents  $33,622   $27,325   $96,494   $76,500 
Percentage rents   -    -    216    212 
Operating cost reimbursement   3,654    2,791    10,615    8,016 
Other   30    271    168    299 
Total Revenues   37,306    30,387    107,493    85,027 
                     
Operating Expenses                    
Real estate taxes   2,824    2,149    7,825    5,988 
Property operating expenses   1,246    931    3,906    2,641 
Land lease expense   172    163    511    490 
General and administrative   2,947    2,454    8,994    7,299 
Depreciation and amortization   11,180    8,228    31,743    22,956 
Total Operating Expenses   18,369    13,925    52,979    39,374 
                     
Income from Operations   18,937    16,462    54,514    45,653 
                     
Other (Expense) Income                    
Interest expense, net   (6,538)   (4,666)   (17,965)   (13,213)
Gain (loss) on sale of assets, net   3,917    524    10,949    10,045 
Income tax expense   (125)   (37)   (391)   (366)
Other (expense) income   53    -    4    - 
Provision for impairment   (488)   -    (1,651)   - 
                     
Net Income   15,756    12,283    45,460    42,119 
                     
Less Net Income Attributable to Non-Controlling Interest   170    118    499    501 
              .    . 
Net Income Attributable to Agree Realty Corporation  $15,586   $12,165   $44,961   $41,618 
                     
Net Income Per Share Attributable to Agree Realty Corporation                    
Basic  $0.49   $0.42   $1.43   $1.53 
Diluted  $0.48   $0.42   $1.42   $1.52 
                     
Other Comprehensive Income                    
Net income  $15,756   $12,283   $45,460   $42,119 
Other Comprehensive Income (Loss) - Change in Fair Value of Interest Rate Swaps   454    203    3,166    533 
Total Comprehensive Income   16,210    12,486    48,626    42,652 
                     
Less Comprehensive Income Attributable to Non-Controlling Interest   174    149    534    509 
                     
Comprehensive Income Attributable to Agree Realty Corporation  $16,036   $12,337   $48,092   $42,143 
                     
Weighted Average Number of Common Shares Outstanding - Basic:   31,758,925    28,573,022    31,131,530    26,988,589 
                     
Weighted Average Number of Common Shares Outstanding - Diluted:   32,287,352    28,656,684    31,471,251    27,069,352 

 

See accompanying notes to consolidated financial statements.

 

 3 

 

 

AGREE REALTY CORPORATION

CONSOLIDATED STATEMENT OF EQUITY

(In thousands, except share and per-share data)

(Unaudited)

 

                   Accumulated         
               Dividends in   Other         
   Common Stock   Additional   excess of net   Comprehensive   Non-Controlling   Total 
   Shares   Amount   Paid-In Capital   income   Income (Loss)   Interest   Equity 
Balance, December 31, 2017   31,004,900   $3   $936,046   $(28,763)  $1,375   $2,529   $911,190 
Issuance of common stock, net of issuance costs   3,450,000    -    159,604    -    -    -    159,604 
Repurchase of common shares   (22,348)   -    (1,142)   -    -    -    (1,142)
Issuance of restricted stock under the Omnibus Incentive Plan   50,841    -    -    -    -    -    - 
Forfeiture of restricted stock   (1,848)   -    -    -    -    -    - 
Stock-based compensation   -    -    2,171    -    -    -    2,171 
Dividends and distributions declared for the period   -    -    -    (51,515)   -    (556)   (52,071)
Other comprehensive income (loss) - change in fair value of interest rate swaps   -    -    -    -    3,131    35    3,166 
Net income   -    -    -    44,961    -    499    45,460 
Balance, September 30, 2018   34,481,545   $3   $1,096,679   $(35,317)  $4,506   $2,507   $1,068,378 

 

See accompanying notes to consolidated financial statements.

 

 4 

 

 

AGREE REALTY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

   Nine Months Ended 
   September 30, 2018   September 30, 2017 
Cash Flows from Operating Activities          
Net income  $45,460   $42,119 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation   17,808    14,366 
Amortization   13,935    8,590 
Amortization from financing and credit facility costs   768    730 
Stock-based compensation   2,171    1,748 
Provision for impairment   1,651    - 
(Gain) loss on sale of assets   (10,949)   (10,045)
(Increase) decrease in accounts receivable   (5,122)   (4,192)
(Increase) decrease in other assets   (934)   (148)
Increase (decrease) in accounts payable and accrued expenses   923    1,837 
Increase (decrease) in deferred revenue   (758)   (371)
Increase (decrease) in accrued interest   (706)   549 
Increase (decrease) in tenant deposits   5    2 
Net Cash Provided by Operating Activities   64,252    55,185 
           
Cash Flows from Investing Activities          
Acquisition of real estate investments and other assets   (352,085)   (241,132)
Development of real estate investments and other assets (including capitalized interest of $381 in 2018 and $297 in 2017)   (17,390)   (27,240)
Payment of leasing costs   (1,191)   (544)
Net proceeds from sale of assets   60,038    29,414 
Net Cash Used In Investing Activities   (310,628)   (239,502)
           
Cash Flows from Financing Activities          
Proceeds from common stock offerings, net   159,604    136,733 
Repurchase of common shares   (1,142)   (1,108)
Unsecured revolving credit facility borrowings   260,000    184,000 
Unsecured revolving credit facility repayments   (260,000)   (198,000)
Payments of mortgage notes payable   (26,915)   (1,794)
Payments of unsecured term loans   (571)   (549)
Senior unsecured notes proceeds   125,000    100,000 
Dividends paid   (49,018)   (40,392)
Distributions to Non-Controlling Interest   (549)   (520)
Payments for financing costs   (568)   (159)
Net Cash Provided by Financing Activities   205,841    178,211 
           
Net Increase (Decrease) in Cash and Cash Equivalents   (40,535)   (6,106)
Cash and cash equivalents and restricted deposits, beginning of period   58,782    33,395 
Cash and cash equivalents and restricted deposits, end of period  $18,247   $27,289 
           
Supplemental Disclosure of Cash Flow Information          
Cash paid for interest (net of amounts capitalized)  $18,944   $12,658 
Cash paid (refunded) for income tax  $387   $- 
           
Supplemental Disclosure of Non-Cash Investing and Financing Activities          
Shares issued under equity incentive plans (in dollars)  $2,381   $3,022 
Dividends and limited partners' distributions declared and unpaid  $18,808   $14,930 

 

See accompanying notes to consolidated financial statements.

 

 5 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

Note 1 – Organization

Agree Realty Corporation (the “Company”), a Maryland corporation, is a fully integrated real estate investment trust (“REIT”) primarily focused on the ownership, acquisition, development and management of retail properties net leased to industry leading tenants. The Company was founded in 1971 by its current Executive Chairman, Richard Agree, and our common stock was listed on the New York Stock Exchange (“NYSE”) in 1994.

 

Our assets are held by, and all of our operations are conducted through, directly or indirectly, Agree Limited Partnership (the “Operating Partnership”), of which Agree Realty Corporation is the sole general partner and in which it held a 99.0% interest as of September 30, 2018. Under the partnership agreement of the Operating Partnership, the Company, as the sole general partner, has exclusive responsibility and discretion in the management and control of the Operating Partnership.

 

The terms “Agree Realty,” the "Company," “Management,” "we,” “our” or "us" refer to Agree Realty Corporation and all of its consolidated subsidiaries, including the Operating Partnership.

 

Note 2 – Summary of Significant Accounting Policies

Basis of Accounting and Principles of Consolidation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) 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 GAAP for audited financial statements. The unaudited consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim period presented. Operating results for the nine months ended September 30, 2018 may not be indicative of the results that may be expected for the year ending December 31, 2018. Amounts as of December 31, 2017 included in the consolidated financial statements have been derived from the audited consolidated financial statements as of that date. The unaudited consolidated financial statements, included herein, should be read in conjunction with the audited consolidated financial statements and notes thereto, as well as Management's Discussion and Analysis of Financial Condition and Results of Operations, in our Form 10-K for the year ended December 31, 2017.

 

The unaudited consolidated financial statements include the accounts of the Company, the Operating Partnership and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated.

 

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of (1) assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and (2) revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Reclassification

Certain reclassifications of prior period amounts have been made in the consolidated financial statements and footnotes in order to conform to the current presentation. Income tax expense is presented in Other (Expense) Income of the Consolidated Statement of Operations and Comprehensive Income. In reports filed prior to March 2018, income tax expense was included in general and administrative expenses of the Consolidated Statement of Operations and Comprehensive Income.

 

Segment Reporting

The Company is primarily in the business of acquiring, developing and managing retail real estate which is considered to be one reporting segment. The Company has no other reporting segments.

 

 6 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

Real Estate Investments

The Company records the acquisition of real estate at cost, including acquisition and closing costs. For properties developed by the Company, all direct and indirect costs related to planning, development and construction, including interest, real estate taxes and other miscellaneous costs incurred during the construction period, are capitalized for financial reporting purposes and recorded as property under development until construction has been completed. Assets are classified as held for sale based on specific criteria as outlined in ASC 360, Property, Plant & Equipment. Properties classified as “held for sale” are recorded at the lower of their carrying value or their fair value, less anticipated selling costs. Assets are generally classified as held for sale once management has actively engaged in marketing the asset and has received a firm purchase commitment that is expected to close within one year. Real estate held for sale consisted of the following as of September 30, 2018 and December 31, 2017 (in thousands):

 

   September 30, 2018   December 31, 2017 
         
Land  $271   $393 
Buildings   1,087    1,857 
Lease Intangibles (Asset)   290    557 
    1,648    2,807 
Accumulated depreciation and amortization   (281)   (387)
Total Real Estate Held for Sale  $1,367   $2,420 

 

Accounting for Acquisitions of Real Estate

The acquisition of property for investment purposes is typically accounted for as an asset acquisition. The Company allocates the purchase price to land, buildings and identified intangible assets and liabilities, based in each case on their relative estimated fair values and without giving rise to goodwill. Intangible assets and liabilities represent the value of in-place leases and above- or below-market leases. In making estimates of fair values, the Company may use a number of sources, including data provided by independent third parties, as well as information obtained by the Company as a result of its due diligence, including expected future cash flows of the property and various characteristics of the markets where the property is located.

 

In allocating the fair value of the identified intangible assets and liabilities of an acquired property, in-place lease intangibles are valued based on the Company’s estimates of costs related to tenant acquisition and the carrying costs that would be incurred during the time it would take to locate a tenant if the property were vacant, considering current market conditions and costs to execute similar leases at the time of the acquisition. Above- and below-market lease intangibles are recorded based on the present value of the difference between the contractual amounts to be paid pursuant to the leases at the time of acquisition and the Company’s estimate of current market lease rates for the property. The capitalized above- and below-market lease intangibles are amortized over the non-cancelable term of the lease unless the Company believes it is reasonably certain that the tenant will renew the lease for an option term in which case the Company amortizes the value attributable to the renewal over the renewal period.

 

The fair value of identified intangible assets and liabilities acquired is amortized to amortization over the remaining term of the related leases.

 

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents consist of cash and money market accounts. The account balances periodically exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance coverage, and as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. We had $17.3 million and $57.5 million in cash and cash held in escrow as of September 30, 2018 and December 31, 2017, respectively, in excess of the FDIC insured limit.

 

 7 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

Accounts Receivable – Tenants

The Company reviews its rent receivables for collectability on a regular basis, taking into consideration changes in factors such as the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area where the property is located. In the event that the collectability of a receivable with respect to any tenant is in doubt, a provision for uncollectible amounts will be established or a direct write-off of the specific rent receivable will be made. For accrued rental revenues related to the straight-line method of reporting rental revenue, the Company performs a periodic review of receivable balances to assess the risk of uncollectible amounts and establish appropriate provisions.

 

The Company’s leases provide for reimbursement from tenants for common area maintenance (“CAM”), insurance, real estate taxes and other operating expenses ("Operating Cost Reimbursement Revenue"). A portion of our Operating Cost Reimbursement Revenue is estimated each period and is recognized as revenue in the period the recoverable costs are incurred and accrued. Receivables from Operating Cost Reimbursement Revenue are included in our Accounts Receivable - Tenants line item in our consolidated balance sheets. The balance of unbilled Operating Cost Reimbursement Receivable at September 30, 2018 and December 31, 2017 was $2.5 million and $1.4 million, respectively.

 

In addition, many of the Company’s leases contain rent escalations for which we recognize revenue on a straight-line basis over the non-cancelable lease term.  This method results in rental revenue in the early years of a lease being higher than actual cash received, creating a straight-line rent receivable asset which is included in the Accounts Receivable - Tenants line item in our consolidated balance sheet. The balance of straight-line rent receivables at September 30, 2018 and December 31, 2017 was $15.5 million and $12.9 million, respectively.  To the extent any of the tenants under these leases becomes unable to pay its contractual cash rents, the Company may be required to write down the straight-line rent receivable from the tenants, which would reduce operating income.

 

Sales Tax

The Company collects various taxes from tenants and remits these amounts, on a net basis, to the applicable taxing authorities.

 

Unamortized Deferred Expenses

Deferred expenses include debt financing costs related to the Company’s revolving credit facility, leasing costs and lease intangibles, and are amortized as follows: (i) debt financing costs related to the line of credit on a straight-line basis to interest expense over the term of the related loan, which approximates the effective interest method; (ii) leasing costs on a straight-line basis to amortization over the term of the related lease entered into; and (iii) lease intangibles on a straight-line basis to amortization over the remaining term of the related lease acquired.

 

The following schedule summarizes the Company’s amortization of deferred expenses for the three and nine months ended September 30, 2018 and 2017 (in thousands):

 

   Three Months Ended   Nine Months Ended 
   September 30, 2018   September 30, 2017   September 30, 2018   September 30, 2017 
                 
Credit Facility Financing Costs  $133   $102   $335   $304 
Leasing Costs   82    40    166    120 
Lease Intangibles (Asset)   5,998    3,802    16,781    11,209 
Lease Intangibles (Liability)   (1,083)   (1,037)   (3,168)   (3,167)
Total  $5,130   $2,907   $14,114   $8,466 

 

 8 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

The following schedule represents estimated future amortization of deferred expenses as of September 30, 2018 (in thousands):

 

Year Ending December 31,  2018                         
   (remaining)   2019   2020   2021   2022   Thereafter   Total 
                             
Credit Facility Financing Costs  $142   $556   $541   $28   $-   $-   $1,267 
Leasing Costs   76    276    302    293    285    1,350    2,582 
Lease Intangibles (Asset)   6,822    25,643    25,493    24,815    23,737    164,096    270,606 
Lease Intangibles (Liability)   (1,143)   (4,291)   (4,279)   (3,993)   (3,094)   (10,828)   (27,628)
Total  $5,897   $22,184   $22,057   $21,143   $20,928   $154,618   $246,827 

 

Earnings per Share

Earnings per share has been computed by dividing net income less net income attributable to unvested restricted shares by the weighted average number of common shares outstanding less unvested restricted shares. Diluted earnings per share is computed by dividing net income by the weighted average common shares and potentially dilutive common shares outstanding in accordance with the treasury stock method.

 

The following is a reconciliation of the denominator of the basic net earnings per common share computation to the denominator of the diluted net earnings per common share computation for each of the periods presented:

 

   Three Months Ended   Nine Months Ended 
   September 30, 2018   September 30, 2017   September 30, 2018   September 30, 2017 
Weighted average number of common shares outstanding   31,969,749    28,792,158    31,342,354    27,207,725 
Less: Unvested restricted stock   (210,824)   (219,136)   (210,824)   (219,136)
Weighted average number of common shares outstanding used in basic earnings per share   31,758,925    28,573,022    31,131,530    26,988,589 
                     
Weighted average number of common shares outstanding used in basic earnings per share   31,758,925    28,573,022    31,131,530    26,988,589 
Effect of dilutive securities: restricted stock   80,211    83,662    71,855    80,763 
Effect of dilutive securities: March 2018 forward equity offering   439,761    -    265,048    - 
Effect of dilutive securities: September 2018 forward equity offering   8,455    -    2,818    - 
Weighted average number of common shares outstanding used in diluted earnings per share   32,287,352    28,656,684    31,471,251    27,069,352 
                     
Operating Partnership Units ("OP Units")   347,619    347,619    347,619    347,619 
Weighted average number of common shares and OP Units outstanding used in diluted earnings per share   32,634,971    29,004,303    31,818,870    27,416,971 

 

Forward Equity Sales

In March 2018, the Company entered into a forward sale agreement to sell an aggregate of 3,450,000 shares of our common stock, which includes the underwriters’ option to purchase an additional 450,000 shares, at a public offering price of $48.00 per share, before underwriting discounts. In September 2018, the Company settled 3,450,000 shares from our forward sale agreement and received proceeds of $160.2 million, net of underwriting discounts, fees and expenses.

 

In September 2018, the Company entered into a forward sale agreement to sell an aggregate of 3,500,000 shares of our common stock at a public offering price of $55.20 per share, less issuance costs, underwriters’ discount, and further adjustments as provided for in the forward sale agreement. We are obligated to settle the forward sale agreement no later than September 3, 2019.

 

To account for the forward sale agreements, we considered the accounting guidance governing financial instruments and derivatives and concluded that our forward sale agreement was not a liability as it did not embody obligations to repurchase our shares nor did it embody obligations to issue a variable number of shares for which the monetary value was predominantly fixed, varying with something other than the fair value of the shares, or varying inversely in relation to our shares. We then evaluated whether the agreement met the derivatives and hedging guidance scope exception to be accounted for as an equity instrument, and concluded that the agreement can be classified as an equity contract based on the following assessment: (i) none of the agreement’s exercise contingencies was based on observable markets or indices besides those related to the market for our own stock price and operations; and (ii) none of the settlement provisions precluded the agreement from being indexed to our own stock.

 

 9 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

We also considered the potential dilution resulting from the forward sale agreement on the earnings per share calculations. We use the treasury stock method to determine the dilution resulting from the forward sale agreement during the period of time prior to settlement. The impact to our weighted-average number of common shares – diluted for the three and nine months ended September 30, 2018, was 448,217 and 267,867 weighted-average incremental shares, respectively.

 

Income Taxes (not presented in thousands)

The Company has made an election to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”) and related regulations. The Company generally will not be subject to federal income taxes on amounts distributed to stockholders, providing it distributes 100% of its REIT taxable income and meets certain other requirements for qualifying as a REIT. For the periods ending September 30, 2018 and December 31, 2017, the Company believes it has qualified as a REIT. Notwithstanding the Company’s qualification for taxation as a REIT, the Company is subject to certain state taxes on its income and real estate.

 

The Company and its taxable REIT subsidiaries (“TRS”) have made a timely TRS election pursuant to the provisions of the REIT Modernization Act. A TRS is able to engage in activities resulting in income that previously would have been disqualified from being eligible REIT income under the federal income tax regulations. As a result, certain activities of the Company which occur within its TRS entity are subject to federal and state income taxes. All provisions for federal income taxes in the accompanying consolidated financial statements are attributable to the Company’s TRS.

 

As of September 30, 2018, and December 31, 2017, the Company had accrued a deferred income tax liability in the amount of $475,000. This deferred income tax balance represents the federal and state tax effect of deferring income tax in 2007 on the sale of an asset under section 1031 of the Internal Revenue Code. This transaction was accrued within the TRS entities described above. The Company recognized total federal and state tax expense of approximately $125,000 and $37,000 for the three months ended September 30, 2018 and 2017, respectively and approximately $391,000 and $366,000 for the nine months ended September 30, 2018 and 2017, respectively.

 

Fair Values of Financial Instruments

The Company’s estimates of fair value of financial and non-financial assets and liabilities are based on the framework established in the fair value accounting guidance. The framework specifies a hierarchy of valuation inputs which was established to increase consistency, clarity and comparability in fair value measurements and related disclosures. The guidance describes a fair value hierarchy based upon three levels of inputs that may be used to measure fair value, two of which are considered observable and one that is considered unobservable. The following describes the three levels:

 

Level 1 – Valuation is based upon quoted prices in active markets for identical assets or liabilities.
   
Level 2 – Valuation is based upon inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
   
Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include option pricing models, discounted cash flow models and similar techniques.

 

 10 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

Recent Accounting Pronouncements

In August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). These amendments modify the disclosure requirements in Topic 820 on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty. ASU 2018-13 will be effective for all entities for fiscal years beginning after December 15, 2019, including interim periods in the year of adoption. Early adoption is permitted for any interim or annual period. The Company is in the process of determining the impact that the implementation of ASU 2018-13 will have on the Company’s financial statements.

 

In June 2018, the FASB issued ASU No. 2018-07, “Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting” (“ASU 2018-07”). These amendments expand the scope of Topic 718, Compensation—Stock Compensation, which currently only includes share-based payments to employees, to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned, and the ASU supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees. ASU 2018-07 will be effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods in the year of adoption. Early adoption is permitted for any interim or annual period. The Company does not expect these amendments to have a material effect on its financial statements.

 

In August 2017, the FASB issued ASU No. 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities” (“ASU 2017-12”). The objective of ASU 2017-12 is to expand hedge accounting for both financial (interest rate) and commodity risks, and create more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes. ASU 2017-12 will be effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods in the year of adoption. Early adoption is permitted for any interim or annual period. The Company has evaluated the impact of the implementation of ASU 2017-12 and does not believe it will have a material effect on the financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02 “Leases” (“ASU 2016-02”). The new standard creates Topic 842, Leases, in FASB Accounting Standards Codification (“FASB ASC”) and supersedes FASB ASC 840, Leases. ASU 2016-02 requires a lessee to recognize the assets and liabilities that arise from leases (operating and finance). The main difference between the existing guidance on accounting for leases and the new standard is that operating leases for lessees will now be recorded in the statement of financial position as right of use assets and lease liabilities on the lessee’s balance sheet. The new standard requires lessors to account for leases for lessee’s using an approach that is substantially equivalent to existing guidance for sales-type leases and operating leases. In July 2018, the FASB issued ASU 2018-11, which provides a practical expedient for lessors by class of underlying assets to not separate non-lease components from the lease component. The Company intends to apply  the practical expedient to not separate lease and nonlease components in a contract if the timing and pattern of transfer for the lease components and nonlease components are the same and if the lease component is classified as an operating lease. ASU 2016-02 is effective for annual reporting periods (including interim periods within those periods) beginning after December 15, 2018. Early adoption is permitted. As part of ASU 2018-01, the FASB provided an optional transition method, allowing entities to not evaluate under ASC 842 land easements that existed or expired before the adoption of ASC 842 and that were not previously accounted for as leases under ASC 840. The Company intends to apply this practical expedient upon adoption of Topic 842. As part of ASU 2018-11, the FASB provided an additional (and optional) transition method that allows entities to initially apply Topic 842 at the adoption date (January 1, 2019) and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company intends to apply this practical expedient upon adoption of Topic 842.   The Company has engaged a professional services firm to assist in the implementation of ASU 2016-02. Based on its anticipated election of practical expedients, the Company anticipates that its retail leases, where it is the lessor, will continue to be accounted for as operating leases under the new standard. The Company is also the lessee under various land lease arrangements. The Company would not be required to reassess the classification of existing land leases where it is the lessee and therefore these leases would continue to be accounted for as operating leases. Therefore, as of January 1, 2019, the Company does not currently anticipate significant changes in the accounting for its lease revenues as lessor, but does anticipate the recognition of right of use assets and related lease liabilities on its consolidated balance sheets related to land leases as lessee. In the event the Company modifies existing land leases or enters into new land leases after adoption of the new standard, such leases may be classified as finance leases. The Company will continue to evaluate the impact of adopting the new leases standard on its consolidated statements of income and comprehensive income and consolidated balance sheets. 

 

 11 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

Note 3 – Real Estate Investments

Real Estate Portfolio

As of September 30, 2018, the Company owned 520 properties, with a total gross leasable area of approximately 10.0 million square feet. Net Real Estate Investments totaled $1.4 billion as of September 30, 2018. As of December 31, 2017, the Company owned 436 properties, with a total gross leasable area of approximately 8.7 million square feet. Net Real Estate Investments totaled $1.2 billion as of December 31, 2017.

 

Acquisitions

During the three months ended September 30, 2018, the Company purchased 43 retail net lease assets for approximately $150.0 million, which includes acquisition and closing costs. These properties are located in 20 states and are leased for a weighted average lease term of approximately 11.5 years.

 

During the nine months ended September 30, 2018, the Company purchased 96 retail net lease assets for approximately $349.9 million, which includes acquisition and closing costs. These properties are located in 29 states and are leased for a weighted average lease term of approximately 12.3 years.

 

The aggregate acquisitions for the nine months ended September 30, 2018 were allocated $81.6 million to land, $174.4 million to buildings and improvements, and $93.9 million to lease intangibles. The acquisitions were all cash purchases and there were no contingent considerations associated with these acquisitions.

 

None of the Company’s acquisitions during the first nine months of 2018 caused any new or existing tenant to comprise 10% or more of our total assets or generate 10% or more of our total annualized base rent at September 30, 2018.

 

Developments

During the third quarter of 2018, construction continued or commenced on five development and Partner Capital Solutions (“PCS”) projects with anticipated total project costs of approximately $14.0 million. The projects consist of the Company’s third and fourth development projects with Mister Car Wash; the Company’s first two development projects with Sunbelt Rentals; and the Company’s redevelopment with Hobby Lobby in Mount Pleasant, Michigan.

 

During the nine months ended September 30, 2018, the Company had 13 development or PCS projects completed or under construction.  Anticipated total costs for those projects are approximately $59.6 million and include the following completed or commenced projects:

 

 12 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

Tenant   Location   Lease Structure   Lease
Term
  Actual or
Anticipated Rent
Commencement
  Status
Mister Car Wash   Urbandale, IA   Build-to-Suit   20 years   Q1 2018   Completed
Mister Car Wash   Bernalillo, NM   Build-to-Suit   20 years   Q1 2018   Completed
Burger King(1)   North Ridgeville, OH   Build-to-Suit   20 years   Q1 2018   Completed
Art Van Furniture   Canton, MI   Build-to-Suit   20 years   Q1 2018   Completed
Camping World   Grand Rapids, MI   Build-to-Suit   20 years   Q2 2018   Completed
ALDI   Chickasha, OK   Build-to-Suit   10 years   Q3 2018   Completed
Burger King(1)   Aurora, IL   Build-to-Suit   20 years   Q3 2018   Completed
Burlington Coat Factory   Nampa, ID   Build-to-Suit   15 years   Q3 2018   Completed
Mister Car Wash   Orlando, FL   Build-to-Suit   20 years   Q4 2018   Under Construction
Mister Car Wash   Tavares, FL   Build-to-Suit   20 years   Q4 2018   Under Construction
Sunbelt Rentals   Batavia, OH   Build-to-Suit   10 years   Q1 2019   Under Construction
Sunbelt Rentals   Maumee, OH   Build-to-Suit   10 years   Q1 2019   Under Construction
Hobby Lobby   Mt. Pleasant, MI   Build-to-Suit   15 years   Q4 2019   Under Construction

 

Notes:

(1) Franchise restaurant operated by TOMS King, LLC.

 

Dispositions

During the three months ended September 30, 2018, the Company sold six properties for net proceeds of $29.6 million and the Company recorded a net gain of $3.9 million.

 

During the nine months ended September 30, 2018, the Company sold 16 properties for net proceeds of $56.4 million and the Company recorded a net gain of $9.9 million (net of any expected losses on real estate held for sale). In addition, a tenant exercised its option to purchase a store which had previously been ground leased from the Company. The option to purchase was exercised for net proceeds of $3.9 million and the Company recorded a net gain of $1.0 million.

 

Provision for Impairment

The Company reviews long-lived assets, including intangible assets, for possible impairment when certain events or changes in circumstances indicates that the carrying amount of the asset may not be recoverable through operations. Events or changes in circumstances may include significant changes in real estate market conditions and an expectation to sell assets before the end of the previously estimated life. Impairments are measured to the extent the current book value exceeds the estimated fair value of the asset less disposition costs for any assets classified as held for sale. During the three and nine months ended September 30, 2018, the Company recognized provisions for impairment of $0.5 million and $1.7 million, respectively. There were no provisions for impairment for the three and nine months ended September 30, 2017.

 

The valuation of impaired assets is determined using valuation techniques including discounted cash flow analysis, analysis of recent comparable sales transactions, and purchase offers received from third parties, which are Level 3 inputs. The Company may consider a single valuation technique or multiple valuation techniques, as appropriate, when estimating the fair value of its real estate.

 

Note 4 – Debt

As of September 30, 2018, the Company had total indebtedness of $619.9 million, including (i) $62.2 million of mortgage notes payable; (ii) $158.7 million of unsecured term loans; (iii) $385.0 million of senior unsecured notes; and (iv) $14.0 million of borrowings under our Credit Facility.

 

Mortgage Notes Payable

As of September 30, 2018, the Company had total gross mortgage indebtedness of $62.2 million which was collateralized by related real estate and tenants’ leases with an aggregate net book value of $107.9 million. Including mortgages that have been swapped to a fixed interest rate, the weighted average interest rate on the Company’s mortgage notes payable was 4.16% as of September 30, 2018 and 3.74% as of December 31, 2017.

 

 13 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

In December 2017, the Company assumed an interest-only mortgage note for $21.5 million with PNC Bank, National Association in connection with an acquisition. The mortgage note is due October 2019, secured by a multi-tenant property and has a fixed interest rate of 3.32%.

 

   September 30, 2018   December 31, 2017 
(not presented in thousands)  (in thousands) 
Note payable in monthly installments of interest only at LIBOR plus 160 basis points, swapped to a fixed rate of 2.49%. A balloon payment in the amount of $25,000,000 was repaid on March 29, 2018  $-   $25,000 
           
Note payable in monthly installments of interest only at 3.32% per annum, with a balloon payment due October 2019   21,500    21,500 
           
Note payable in monthly installments of $153,838, including interest at 6.90% per annum, with the final monthly payment due January 2020   2,345    3,573 
           
Note payable in monthly installments of $23,004, including interest at 6.24% per annum, with a balloon payment of $2,781,819 due February 2020   2,896    2,963 
           
Note payable in monthly installments of interest only at 3.60% per annum, with a balloon payment due January 1, 2023   23,640    23,640 
           
Note payable in monthly installments of $35,673, including interest at 5.01% per annum, with a balloon payment of $4,034,627 due September 2023   5,003    5,131 
           
Note payable in monthly installments of $91,675 including interest at 6.27% per annum, with a final monthly payment due July 2026   6,795    7,288 
           
Total principal   62,179    89,095 
Unamortized debt issuance costs   (642)   (825)
Total  $61,537   $88,270 

 

The mortgage loans encumbering our properties are generally non-recourse, subject to certain exceptions for which we would be liable for any resulting losses incurred by the lender. These exceptions vary from loan to loan, but generally include fraud or material misrepresentations, misstatements or omissions by the borrower, intentional or grossly negligent conduct by the borrower that harms the property or results in a loss to the lender, filing of a bankruptcy petition by the borrower, either directly or indirectly, and certain environmental liabilities. At September 30, 2018, there were no mortgage loans with partial recourse to us.

 

 14 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

We have entered into mortgage loans which are secured by multiple properties and contain cross-default and cross-collateralization provisions. Cross-collateralization provisions allow a lender to foreclose on multiple properties in the event that we default under the loan. Cross-default provisions allow a lender to foreclose on the related property in the event a default is declared under another loan.

 

The Company was in compliance with covenant terms for all mortgages payable at September 30, 2018.

 

Senior Unsecured Notes

The following table presents the Senior Unsecured Notes balance net of unamortized debt issuance costs as of September 30, 2018, and December 31, 2017 (in thousands):

 

   September 30, 2018   December 31, 2017 
         
2025 Senior Unsecured Notes  $50,000   $50,000 
2027 Senior Unsecured Notes   50,000    50,000 
2028 Senior Unsecured Notes   60,000    60,000 
2029 Senior Unsecured Notes   100,000    100,000 
2030 Senior Unsecured Notes   125,000    - 
Total Principal   385,000    260,000 
           
Unamortized debt issuance costs   (927)   (878)
Total  $384,073   $259,122 

 

In May 2015, the Company and the Operating Partnership completed a private placement of $100.0 million principal amount of senior unsecured notes. The senior unsecured notes were sold in two series; $50.0 million of 4.16% notes due May 2025 (the “2025 Senior Unsecured Notes”) and $50.0 million of 4.26% notes due May 2027(the “2027 Senior Unsecured Notes”). The weighted average term of the senior unsecured notes is 11 years and the weighted average interest rate is 4.21%. The senior unsecured notes were sold only to institutional investors and did not involve a public offering in reliance on the exemption from registration in Section 4(a)(2) of the Securities Act.

 

In July 2016, the Company entered into a note purchase agreement with institutional purchasers. Pursuant to the note purchase agreement, the Operating Partnership completed a private placement of $60.0 million aggregate principal amount of our 4.42% senior unsecured notes due July 2028 (the “2028 Senior Unsecured Notes”). The senior unsecured notes were sold only to institutional investors and did not involve a public offering in reliance on the exemption from registration in Section 4(a)(2) of the Securities Act.

 

In August 2017, the Company entered into a note purchase agreement with institutional purchasers. Pursuant to the note purchase agreement, the Operating Partnership completed a private placement of $100.0 million aggregate principal amount of our 4.19% senior unsecured notes due September 2029 (the “2029 Senior Unsecured Notes”). The closing of the private placement was consummated in September 2017; and, on that date, the Operating Partnership issued the senior unsecured notes. The senior unsecured notes were sold only to institutional investors and did not involve a public offering in reliance on the exemption from registration in Section 4(a)(2) of the Securities Act.

 

In September 2018, the Company entered into two supplements to uncommitted master note facilities previously entered into with institutional purchasers in August 2017. Pursuant to the supplements, the Operating Partnership completed a private placement of $125.0 million aggregate principal amount of our 4.32% senior unsecured notes due September 2030 (the “2030 Senior Unsecured Notes”). The senior unsecured notes were sold only to institutional investors and did not involve a public offering in reliance on the exemption from registration in Section 4(a)(2) of the Securities Act.

 

 15 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

Unsecured Term Loan Facilities

The following table presents the Unsecured Term Loans balance net of unamortized debt issuance costs as of September 30, 2018 and December 31, 2017 (in thousands):

 

   September 30, 2018   December 31, 2017 
         
2019 Term Loan  $18,734   $19,304 
2023 Term Loan   40,000    40,000 
2024 Term Loans   100,000    100,000 
Total Principal   158,734    159,304 
           
Unamortized debt issuance costs   (974)   (1,133)
Total  $157,760   $158,171 

 

The amended and restated credit agreement, described below, extended the maturity dates of the $65.0 million unsecured term loan facility and $35.0 million unsecured term loan facility (together, the “2024 Term Loan Facilities”) to January 2024. In connection with entering into the amended and restated credit agreement, the prior notes evidencing the existing $65.0 million unsecured term loan facility and $35.0 million unsecured term loan facility were canceled and new notes evidencing the 2024 Term Loan Facilities were executed. Borrowings under the unsecured 2024 Term Loan Facilities bear interest at a variable LIBOR plus 150 to 245 basis points, depending on the Company's credit rating. The Company utilized existing interest rate swaps to effectively fix the LIBOR at 213 basis points until maturity. As of September 30, 2018, $100.0 million was outstanding under the 2024 Term Loan Facilities bearing an all-in interest rate of 3.78%.

 

In July 2016, the Company completed a $40.0 million unsecured term loan facility that matures July 2023 (the “2023 Term Loan”).  Borrowings under the 2023 Term Loan are priced at LIBOR plus 150 to 245 basis points, depending on the Company’s credit rating. The Company entered into an interest rate swap to fix LIBOR at 140 basis points until maturity.  As of September 30, 2018, $40.0 million was outstanding under the 2023 Term Loan, which was subject to an all-in interest rate of 3.05%.

 

In August 2016, the Company entered into a $20.3 million unsecured amortizing term loan that matures May 2019 (the “2019 Term Loan”).  Borrowings under the 2019 Term Loan are priced at LIBOR plus 170 basis points. In order to fix LIBOR on the 2019 Term Loan at 1.92% until maturity, the Company had an interest rate swap agreement in place, which was assigned by the lender under the Mortgage Note to the 2019 Term Loan lender.  As of September 30, 2018, $18.7 million was outstanding under the 2019 Term Loan bearing an all-in interest rate of 3.62%.

 

Senior Unsecured Revolving Credit Facility

In December 2016, the Company amended and restated the credit agreement (the “Credit Agreement”) that governs the Company's senior unsecured revolving credit facility and the Company's unsecured term loan facility to increase the aggregate borrowing capacity to $350.0 million. In July 2018, the Company elected to pursue commitments under the accordion option outlined in its senior unsecured revolving credit facility to increase the revolving commitments by $75.0 million, raising the total revolving commitments under the amended and restated credit agreement from $250.0 million to $325.0 million. Including the increased commitments, the amended and restated credit agreement provides for a $325.0 million unsecured revolving credit facility, a $65.0 million unsecured term loan facility and a $35.0 million unsecured term loan facility (referenced above as 2024 Term Loan Facilities). The unsecured revolving credit facility matures January 2021 with options to extend the maturity date to January 2022. The 2024 Term Loan Facilities mature January 2024. The Company has the ability to increase the aggregate borrowing capacity under the credit agreement to a maximum amount of $500.0 million, subject to lender approval.

 

 16 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

Borrowings under the revolving credit facility bear interest at LIBOR plus 85 to 155 basis points, depending on the Company’s credit rating. Additionally, the Company is required to pay a facility fee at an annual rate of 0 to 55 basis points of the total amount of the revolving credit facility, depending on the Company’s credit rating. The Credit Agreement contains certain financial covenants, including a maximum leverage ratio, a minimum fixed charge coverage ratio, and a maximum percentage of secured debt to total asset value. As of September 30, 2018, and December 31, 2017, the Company had $14.0 million, of outstanding borrowings under the revolving credit facility, respectively, bearing weighted average interest rates of approximately 3.2% and 2.6%, respectively. As of September 30, 2018, $311.0 million was available for borrowing under the revolving credit facility and the Company was in compliance with the credit agreement covenants.

 

Debt Maturities

The following table presents scheduled principal payments related to our debt as of September 30, 2018 (in thousands):

 

   Scheduled   Balloon     
   Principal   Payment   Total 
Remainder of 2018  $850   $-   $850 
2019   3,005    39,790    42,795 
2020   1,100    2,767    3,867 
2021 (1)   998    14,000    14,998 
2022   1,060    -    1,060 
Thereafter   3,687    552,656    556,343 
Total  $10,700   $609,213   $619,913 

 

(1)The balloon payment balance includes the balance outstanding under the Credit Facility as of September 30, 2018. The Credit Facility matures in January 2021, with options to extend the maturity for one year at the Company’s election, subject to certain conditions.

 

Note 5 – Common Stock

In June 2017, the Company filed an automatic shelf registration statement on Form S-3, registering an unspecified amount at an indeterminant aggregate initial offering price of common stock, preferred stock, depositary shares and warrants. The Company may periodically offer one or more of these securities in amounts, prices and on terms to be announced when and if these securities are offered. The specifics of any future offerings, along with the use of proceeds of any securities offered, will be described in detail in a prospectus supplement, or other offering materials, at the time of any offering.

 

In June 2017, the Company completed a follow-on underwritten offering of 2,415,000 shares of common stock. The offering, which included the full exercise of the overallotment option by the underwriters, raised net proceeds of approximately $108.0 million, after deducting the underwriting discount. The proceeds from the offering were used to repay borrowings under our revolving credit facility, to fund property acquisitions and for general corporate purposes.

 

In March 2018, the Company completed a follow-on public offering of 3,450,000 shares of common stock, which included the underwriters’ option to purchase an additional 450,000 shares of common stock in connection with a forward sale agreement.  The offering, which included the full exercise of the underwriters’ option to purchase additional shares, was settled in its entirety in September 2018. Upon settlement the Company issued 3,450,000 shares and received net proceeds of $160.2 million after deducting fees and expenses.

 

In September 2018, the Company completed a follow-on public offering of 3,500,000 shares of common stock in connection with a forward sale agreement. Upon settlement, the offering is anticipated to raise net proceeds of approximately $190.0 million net of underwriting discounts, fees and commissions and will be subject to certain adjustments as provided in the forward sale agreement. The Company has not received proceeds from the sale of shares of its common stock by the forward purchaser. Selling common stock through the forward sale agreement enabled the Company to set the price of such shares upon pricing the offering (subject to certain adjustments) while delaying the issuance of such shares and the receipt of the net proceeds by the Company.  The forward sale agreement is required to be settled no later than September 3, 2019.

 

 17 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

In May 2018, the Company entered into a $250.0 million at-the-market equity program (“ATM Program”) through which the Company may, from time to time, sell shares of common stock. In addition to selling shares of common stock, the Company may enter into forward sale agreements through its ATM Program. The Company intends to use the proceeds generated from its ATM Program for general corporate purposes, including funding our investment activity, the repayment or refinancing of outstanding indebtedness and working capital.

 

During the three and nine months ended September 30, 2018, the Company did not issue any shares of common stock under its ATM program. The Company had $250.0 million remaining under the ATM program as of September 30, 2018

 

Note 6 – Dividends and Distribution Payable

On September 4, 2018, the Company declared a dividend of $0.540 per share for the quarter ended September 30, 2018. The holders of limited partnership interests in the Operating Partnership (“OP Units”) were entitled to an equal distribution per OP Unit held as of September 28, 2018. The dividends and distributions payable were recorded as liabilities on the Company's consolidated balance sheet at September 30, 2018. The dividend has been reflected as a reduction of stockholders' equity and the distribution has been reflected as a reduction of the limited partners' non-controlling interest. These amounts were paid on October 12, 2018.

 

Note 7 – Derivative Instruments and Hedging Activity

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risk, including interest rate, liquidity and credit risk primarily by managing the amount, sources and duration of its debt funding and, to a limited extent, the use of derivative instruments. For additional information regarding the leveling of our derivatives (refer to Note 9 – Fair Value Measurements).

 

The Company’s objective in using interest rate derivatives is to manage its exposure to interest rate movements and add stability to interest expense. To accomplish this objective, the Company uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed rate payments over the life of the agreement without exchange of the underlying notional amount.

 

In April 2012, the Company entered into an amortizing forward-starting interest rate swap agreement to hedge against changes in future cash flows resulting from changes in interest rates on $22.3 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 1.92%. The notional amount as of September 30, 2018 is $18.7 million. This swap effectively converted $22.3 million of variable-rate borrowings to fixed-rate borrowings from July 1, 2013 to May 1, 2019. As of September 30, 2018, this interest rate swap was valued as an asset of approximately $0.1 million.

 

In September 2013, the Company entered into an interest rate swap agreement to hedge against changes in future cash flows resulting from changes in interest rates on $35.0 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 2.20%. This swap effectively converted $35.0 million of variable-rate borrowings to fixed-rate borrowings from October 3, 2013 to September 29, 2020. As of September 30, 2018, this interest rate swap was valued as an asset of approximately $0.4 million.

 

 18 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

In July 2014, the Company entered into interest rate swap agreements to hedge against changes in future cash flows resulting from changes in interest rates on $65.0 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 2.09%. This swap effectively converted $65.0 million of variable-rate borrowings to fixed-rate borrowings from July 21, 2014 to July 21, 2021. As of September 30, 2018, this interest rate swap was valued as an asset of approximately $1.3 million.

 

In September 2017, the Company entered into an interest rate swap agreement to hedge against changes in future cash flows resulting from changes in interest rates on $40.0 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 1.40%. This swap effectively converted $40.0 million of variable-rate borrowings to fixed-rate borrowings from August 1, 2016 to July 1, 2023. As of September 30, 2018, this interest rate swap was valued as an asset of approximately $2.7 million.

 

Companies are required to recognize all derivative instruments as either assets or liabilities at fair value on the balance sheet. The Company has designated these derivative instruments as cash flow hedges. As such, the effective portion of changes in the fair value of the derivatives designated, and that qualify as cash flow hedges, is recorded as a component of other comprehensive income (loss). The ineffective portion of the change in fair value of the derivative instrument is recognized directly in interest expense. For the three and nine months ended September 30, 2018, the Company has not recorded any hedge ineffectiveness in earnings. Amounts in Accumulated Other Comprehensive Income (Loss) related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the next twelve months, the Company estimates that an additional $1.0 million will be reclassified as a reduction to interest expense.

 

The Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk (in thousands, except number of instruments):

 

   Number of Instruments  Notional 
   September 30,  December 31,  September 30,   December 31, 
Interest Rate Derivatives  2018  2017  2018   2017 
                 
Interest Rate Swap  4  5  $158,734   $184,304 

 

The table below presents the estimated fair value of the Company’s derivative financial instruments, as well as their classification in the consolidated balance sheets (in thousands).

 

   Asset Derivatives 
   September 30, 2018   December 31, 2017 
   Fair Value   Fair Value 
Derivatives designated as cash flow hedges:          
Interest Rate Swaps  $4,516   $1,592 

 

   Liability Derivatives 
   September 30, 2018   December 31, 2017 
   Fair Value   Fair Value 
Derivatives designated as cash flow hedges:          
Interest Rate Swaps  $-   $242 

 

 19 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

The table below displays the effect of the Company’s derivative financial instruments in the consolidated statements of operations and other comprehensive loss for the three and nine months ended September 30, 2018 and 2017 (in thousands).

 

   Derivatives in
Cash Flow
Hedging
Relationships
  Amount of Income/(Loss) Recognized
in OCI on Derivative (Effective Portion)
   Location of
Income/(Loss)
Reclassifed from
Accumulated OCI
into Income
(Effective Portion)
  Amount of Income/(Loss) Reclassified
from Accumulated OCI into Expense
(Effective Portion)
 
               
Three months ended September 30     2018   2017      2018   2017 
                           
   Interest rate swaps  $454   $203   Interest Expense  $67   $(258)
                           
Nine months ended September 30     2018   2017      2018   2017 
                           
   Interest rate swaps  $3,166   $330   Interest Expense  $(24)  $(1,085)

 

Credit-risk-related Contingent Features

 

The Company has agreements with two of its derivative counterparties that contain a provision where the Company could be declared in default on its derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to the Company's default on the indebtedness.

 

As of September 30, 2018, the fair value of derivatives in a net liability position related to these agreements, which includes accrued interest but excludes any adjustment for nonperformance risk, was $0.0 million.

 

Although the derivative contracts are subject to master netting arrangements, which serve as credit mitigants to both us and our counterparties under certain situations, we do not net our derivative fair values or any existing rights or obligations to cash collateral on the consolidated balance sheets.

 

The table below presents a gross presentation of the effects of offsetting and a net presentation of the Company’s derivatives as of September 30, 2018 and December 31, 2017. The gross amounts of derivative assets or liabilities can be reconciled to the Tabular Disclosure of Fair Values of Derivative Instruments above, which also provides the location that derivative assets and liabilities are presented on the consolidated balance sheets (in thousands):

 

Offsetting of Derivative Assets
                         
As of September 30, 2018                    
               Gross Amounts Not Offset in the
Statement of Financial Position
     
   Gross Amounts
of Recognized
Assets
  

Gross Amounts
Offset in the
Statement of
Financial

Position

  

Net Amounts of
Assets presented
in the statement
of Financial

Position

   Financial
Instruments
   Cash Collateral
Received
   Net Amount 
Derivatives  $4,516   $       -   $4,516   $    -   $      -   $4,516 

 

 20 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

Offsetting of Derivative Liabilities
                         
As of September 30, 2018                    
               Gross Amounts Not Offset in the
 Statement of Financial Position
     
   Gross Amounts
of Recognized
Liabilities
  

Gross Amounts
Offset in the

Statement of
Financial

Position

  

Net Amounts of
Liabilities

presented in the

statement of

Financial

Position

   Financial
Instruments
   Cash Collateral
Received
   Net Amount 
Derivatives  $     -   $     -   $     -   $     -   $     -   $      - 

 

Offsetting of Derivative Assets
                         
As of December 31, 2017                    
               Gross Amounts Not Offset in the
Statement of Financial Position
     
   Gross Amounts
of Recognized
Assets
  

Gross Amounts
Offset in the
Statement of
Financial

Position

  

Net Amounts of

Assets presented

in the statement

of Financial

Position

   Financial
Instruments
   Cash Collateral
Received
   Net Amount 
Derivatives  $1,592   $     -   $1,592   $(42)  $      -   $1,550 

 

Offsetting of Derivative Liabilities
                         
As of December 31, 2017                    
               Gross Amounts Not Offset in the
Statement of Financial Position
     
   Gross Amounts
of Recognized
Liabilities
  

Gross Amounts
Offset in the
Statement of
Financial

Position

  

Net Amounts of
Liabilities
presented in the
statement of
Financial

Position

   Financial
Instruments
   Cash Collateral
Received
   Net Amount 
Derivatives  $242   $    -   $242   $(42)  $      -   $200 

 

Note 8 – Discontinued Operations

There were no properties classified as discontinued operations for the three and nine months ended September 30, 2018.

 

Note 9 – Fair Value Measurements

Assets and Liabilities Measured at Fair Value

The Company accounts for fair values in accordance with FASB Accounting Standards Codification Topic 820 Fair Value Measurements and Disclosure (ASC 820). ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  ASC 820 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances. 

 

ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement.  Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.  As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

 

 21 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls, is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

 

Derivative Financial Instruments

Currently, the Company uses interest rate swap agreements to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. 

 

To comply with the provisions of ASC 820, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.  In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

 

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties.  However, as of September 30, 2018, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives.  As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

 

The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2018 and December 31, 2017 (in thousands):

 

   Total Fair Value   Level 2 
September 30, 2018          
Derivative assets - interest rate swaps  $4,516   $4,516 
Derivative liabilities - interest rate swaps  $-   $- 
           
December 31, 2017          
Derivative assets - interest rate swaps  $1,592   $1,592 
Derivative liabilities - interest rate swaps  $242   $242 

 

The carrying values of cash and cash equivalents, receivables and accounts payable and accrued liabilities are reasonable estimates of their fair values because of the short maturity of these financial instruments.

 

 22 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

The Company estimated the fair value of our debt based on our incremental borrowing rates for similar types of borrowing arrangements with the same remaining maturity and on the discounted estimated future cash payments to be made for other debt.  The discount rate used to calculate the fair value of debt approximates current lending rates for loans and assumes the debt is outstanding through maturity.  Since such amounts are estimates that are based on limited available market information for similar transactions, which is a Level 2 non-recurring measurement, there can be no assurance that the disclosed value of any financial instrument could be realized by immediate settlement of the instrument.

 

Fixed rate debt (including variable rate debt swapped to fixed, excluding the value of the derivatives) with carrying values of $603.4 million and $505.6 million as of September 30, 2018 and December 31, 2017, respectively, had fair values of approximately $594.8 million and $516.5 million, respectively.  Variable rate debt’s fair value is estimated to be equal to the carrying values of $14.0 million as of September 30, 2018 and December 31, 2017.

 

Note 10 – Equity Incentive Plan

The Company estimates the fair value of restricted stock grants at the date of grant and amortizes those amounts into expense on a straight line basis or amount vested, if greater, over the appropriate vesting period.

 

As of September 30, 2018, there was $7.1 million of total unrecognized compensation costs related to the outstanding restricted stock, which is expected to be recognized over a weighted average period of 3.3 years. The Company used 0% for the forfeiture rate for determining the fair value of restricted stock.

 

The holder of a restricted stock award is generally entitled at all times on and after the date of issuance of the restricted shares to exercise the rights of a stockholder of the Company, including the right to vote the shares and the right to receive dividends on the shares.

 

Restricted stock activity is summarized as follows:

 

   Shares
Outstanding
(in thousands)
   Weighted Average
Grant Date
Fair Value
 
         
Unvested restricted stock at December 31, 2017   227   $39.47 
           
Restricted stock granted   50   $47.73 
Restricted stock vested   (65)  $35.40 
Restricted stock forfeited   (1)  $48.28 
           
Unvested restricted stock at September 30, 2018   211   $42.66 

 

Performance Shares

 

Equity compensation awarded February 23, 2018 for certain executive officers consisted of both performance shares and restricted stock. Performance shares are subject to a three-year performance period, at the conclusion of which, shares awarded are to be determined by the Company’s total shareholder return compared to the MSCI US REIT Index and a defined peer group. Vesting of the performance shares following their issuance will occur ratably over a three-year period, with the initial vesting occurring immediately following the conclusion of the performance period such that all shares vest within five years of the original award date of February 23, 2018. The grant date fair value of these awards is determined using a Monte Carlo simulation pricing model and compensation expense is amortized on a straight-line basis over a five-year period. Compensation expense related to performance shares is determined at the grant date and is not adjusted throughout the measurement or vesting periods. The Monte Carlo simulation pricing model utilizes assumptions including grant date, performance period, risk-free rate, grant date share price, dividend yield and annualized volatility.

 

 23 

 

 

AGREE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018

(Unaudited)

 

As of September 30, 2018, there was $1.5 million of total unrecognized compensation costs related to the outstanding performance shares, which is expected to be recognized over a weighted average period of 4.4 years. The Company used 0% for the forfeiture rate for determining the fair value of performance shares.

 

Note 11 – Subsequent Events

In connection with the preparation of its financial statements, the Company has evaluated events that occurred subsequent to September 30, 2018 through the date on which these financial statements were available to be issued to determine whether any of these events required disclosure in the financial statements.

 

There were no reportable subsequent events or transactions.

 

 24 

 

 

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following should be read in conjunction with the Interim Consolidated Financial Statements of Agree Realty Corporation (the “Company”), including the respective notes thereto, which are included in this Quarterly Report on Form 10-Q.

 

Cautionary Note Regarding Forward-Looking Statements

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and includes this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend,” “may,” “will,” “seek,” “could,” “project,” or similar expressions. Forward-looking statements in this report include information about possible or assumed future events, including, among other things, discussion and analysis of our future financial condition, results of operations, our strategic plans and objectives, occupancy and leasing rates and trends, liquidity and ability to refinance our indebtedness as it matures, anticipated expenditures of capital, and other matters. You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors, which are, in some cases, beyond our control and which could materially affect actual results, performances or achievements. Factors which may cause actual results to differ materially from current expectations, include, but are not limited to: the global and national economic conditions and changes in general economic, financial and real estate market conditions; changes in our business strategy; the potential need to fund improvements or other capital expenditures out of operating cash flow; financing risks, such as the inability to obtain debt or equity financing on favorable terms or at all; the level and volatility of interest rates; our ability to re-lease space as leases expire; loss or bankruptcy of one or more of our major tenants; our ability to maintain our qualification as a real estate investment trust (“REIT”) for federal income tax purposes and the limitations imposed on our business by our status as a REIT; and legislative or regulatory changes, including changes to laws governing REITs. The factors included in this report, including the documents incorporated by reference, and documents the Company subsequently files or furnishes with the SEC are not exhaustive and additional factors could cause actual results to differ materially from that described in the forward-looking statements. For a discussion of additional risk factors, see the factors included under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017. All forward-looking statements are based on information that was available, and speak only, as of the date on which they were made. Except as required by law, the Company disclaims any obligation to review or update these forward–looking statements to reflect events or circumstances as they occur.

 

Overview

We are a fully integrated REIT primarily focused on the ownership, acquisition, development and management of retail properties net leased to industry leading tenants. We were founded in 1971 by our current Executive Chairman, Richard Agree, and our common stock was listed on the New York Stock Exchange (“NYSE”) in 1994. Our assets are held by, and all of our operations are conducted through, directly or indirectly, the Operating Partnership, of which we are the sole general partner and in which we held a 99.0% interest as of September 30, 2018.

 

As of September 30, 2018, our portfolio consisted of 520 properties located in 45 states and totaling approximately 10.0 million square feet of gross leasable area (“GLA”). As of September 30, 2018, our portfolio was approximately 99.7% leased and had a weighted average remaining lease term of approximately 10.1 years. Substantially all of our tenants are subject to net lease agreements. A net lease typically requires the tenant to be responsible for minimum monthly rent and property operating expenses including property taxes, insurance and maintenance.

 

Third Quarter 2018 Highlights

During the three months ended September 30, 2018, the Company acquired 43 retail net lease assets for approximately $150.0 million, which includes acquisition and closing costs. These properties are located in 20 states and are leased to 19 different tenants operating in 14 diverse retail sectors for a weighted average lease term of approximately 11.5 years. The underwritten weighted average capitalization rate on the Company’s third quarter 2018 acquisitions was approximately 7.2%.

 

 25 

 

 

During the three months ended September 30, 2018, the Company sold six properties for net proceeds of $29.6 million and recorded a net gain of $3.9 million.

 

In July 2018, the Company elected to pursue commitments under the accordion option outlined in its senior unsecured revolving credit facility to increase the borrowing available under its line of credit from $250.0 million to $325.0 million.

 

In March 2018, the Company completed a follow-on public offering of 3,450,000 shares of common stock, which included the underwriters’ option to purchase an additional 450,000 shares of common stock, in connection with a forward sale agreement.  The offering, which included the full exercise of the underwriters’ option to purchase additional shares, was settled in its entirety in September 2018. Upon settlement the Company issued 3,450,000 shares and received net proceeds of $160.2 million after deducting fees and expenses. The proceeds from the offering were used to repay borrowings under the Company’s revolving credit facility, to fund property acquisitions, and for general corporate purposes.

 

In September 2018, the Company completed a follow-on public offering of 3,500,000 shares of common stock in connection with a forward sale agreement. Upon settlement, the offering is anticipated to raise net proceeds of approximately $190.0 million net of underwriting discounts, fees and commissions and will be subject to certain adjustments as provided in the forward sale agreement. The Company has not received proceeds from the sale of shares of its common stock by the forward purchaser. Selling common stock through the forward sale agreement enabled the Company to set the price of such shares upon pricing the offering (subject to certain adjustments) while delaying the issuance of such shares and the receipt of the net proceeds by the Company.  The forward sale agreement is required to be settled no later than September 3, 2019.

 

In September 2018, the Company completed a private placement of $125.0 million of senior unsecured notes (the “Senior Notes”) to a group of institutional investors. The Senior Notes have a 12-year term, maturing on September 26, 2030, priced at a fixed interest rate of 4.32%.

 

Recent Accounting Pronouncements

Refer to Note 2 to the September 30, 2018 Interim Consolidated Financial Statements.

 

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires the Company’s management to use judgment in the application of accounting policies, including making estimates and assumptions. Management bases estimates on the best information available at the time, its experience, and on various other assumptions believed to be reasonable under the circumstances. These estimates affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. If management’s judgment or interpretation of the facts and circumstances relating to various transactions or other matters had been different, it is possible that different accounting principles would have been applied, resulting in a different presentation of the interim consolidated financial statements. From time to time, the Company may re-evaluate its estimates and assumptions. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current estimates and assumptions about matters that are inherently uncertain. A summary of the Company’s critical accounting policies is included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. The Company has not made any material changes to these policies during the periods covered by this quarterly report.

 

Results of Operations

 

Comparison of Three Months Ended September 30, 2018 to Three Months Ended September 30, 2017

Minimum rental income increased $6.3 million, or 23%, to $33.6 million for the three months ended September 30, 2018, compared to $27.3 million for the three months ended September 30, 2017. Minimum rental income increased approximately $6.7 million due to increased property count from acquisitions activity, $0.7 million due to increased property count from development activity, and was partially offset by a $1.1 million reduction due to disposition activity.

 

 26 

 

 

Operating cost reimbursements increased $0.9 million, or 31%, to $3.7 million for the three months ended September 30, 2018, compared to $2.8 million for the three months ended September 30, 2017. Operating cost reimbursements increased primarily due to increased property count. The portfolio recovery rate decreased to 90% for the three months ended September 30, 2018 compared to 91% for the three months September 30, 2017.

 

Real estate taxes increased $0.7 million, or 31%, to $2.8 million for the three months ended September 30, 2018, compared to $2.1 million for the three months ended September 30, 2017. The increase was due to the ownership of additional properties in the third quarter of 2018 compared to the third quarter of 2017 for which we remit real estate taxes and are reimbursed by tenants.

 

Property operating expenses increased $0.3 million, or 34%, to $1.2 million for the three months ended September 30, 2018, compared to $0.9 million for the three months ended September 30, 2017. The increase was due to the ownership of additional properties in the third quarter of 2018 compared to the third quarter of 2017.

 

General and administrative expenses increased $0.4 million, or 20%, to $2.9 million for the three months ended September 30, 2018, compared to $2.5 million for the three months ended September 30, 2017. The increase was primarily the result of increased employee headcount and professional costs. General and administrative expenses as a percentage of total revenue decreased to 7.9% in the third quarter of 2018 from 8.1% in the third quarter of 2017.

 

Depreciation and amortization increased $3.0 million, or 36%, to $11.2 million for the three months ended September 30, 2018, compared to $8.2 million for the three months ended September 30, 2017. The increase was primarily due to the ownership of additional properties in the third quarter of 2018 compared to the third quarter of 2017.

 

Interest expense increased $1.8 million, or 40%, to $6.5 million for the three months ended September 30, 2018, compared to $4.7 million for the three months ended September 30, 2017. The increase in interest expense was primarily a result of higher levels of borrowings to finance the acquisition and development of additional properties.

 

Income tax expense increased to $0.1 million for the three months ended September 30, 2018, compared to $0.0 million for the three months ended September 30, 2017. The change is due to ownership of an increased number of properties in the third quarter of 2018 compared to the third quarter of 2017 which are located in states that assess state and local income tax.

 

Provision for impairment increased $0.5 million for the three months ended September 30, 2018, compared to $0.0 million for the three months ended September 30, 2017. Provisions for impairment reflect the amount by which current book value exceeds estimated fair value. 

 

Gain on sale of assets increased $3.4 million to $3.9 million for the three months ended September 30, 2018, compared to $0.5 million for the three months ended September 30, 2017. The increase in gain on sale of assets was primarily a result of increased disposition activity during the third quarter of 2018 compared to the third quarter of 2017.

 

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Net Income increased $3.5 million, or 28%, to $15.8 million for the three months ended September 30, 2018, compared to $12.3 million for the three months ended September 30, 2017. The change was the result of items discussed above, including changes in non-cash amounts such as gain on the sale of assets, provision for impairments and depreciation and amortization expense.

 

Comparison of Nine Months Ended September 30, 2018 to Nine Months Ended September 30, 2017

Minimum rental income increased $20.0 million, or 26%, to $96.5 million for the nine months ended September 30, 2018, compared to $76.5 million for the nine months ended September 30, 2017. Minimum rental income increased approximately $20.8 million due to increased property count from acquisitions activity, $2.1 million due to increased property count from development activity, and was partially offset by a $3.3 million reduction due to disposition activity.

 

Operating cost reimbursements increased $2.6 million, or 32%, to $10.6 million for the nine months ended September 30, 2018, compared to $8.0 million for the nine months ended September 30, 2017. Operating cost reimbursements increased primarily due to increased property count. The portfolio recovery rate decreased to 90% for the nine months ended September 30, 2018 compared to 93% for the nine months ended September 30, 2017.

 

Real estate taxes increased $1.8 million, or 31%, to $7.8 million for the nine months ended September 30, 2018, compared to $6.0 million for the nine months ended September 30, 2017. The increase was due to the ownership of additional properties in the first nine months of 2018 compared to the first nine months of 2017 for which we remit real estate taxes and are reimbursed by tenants.

 

Property operating expenses increased $1.3 million, or 48%, to $3.9 million for the nine months ended September 30, 2018, compared to $2.6 million for the nine months ended September 30, 2017. The increase was due to the ownership of additional properties in the first nine months of 2018 compared to the first nine months of 2017.

 

General and administrative expenses increased $1.7 million, or 23%, to $9.0 million for the nine months ended September 30, 2018, compared to $7.3 million for the nine months ended September 30, 2017. The increase was primarily the result of increased employee headcount and professional costs. General and administrative expenses as a percentage of total revenue decreased to 8.4% in the first nine months of 2018 from 8.6% in the first nine months of 2017.

 

Depreciation and amortization increased $8.7 million, or 38%, to $31.7 for the nine months ended September 30, 2018, compared to $23.0 million for the nine months ended September 30, 2017. The increase was primarily due to the ownership of additional properties in the first nine months of 2018 compared to the first nine months of 2017.

 

Interest expense increased $4.8 million, or 36%, to $18.0 million for the nine months ended September 30, 2018, compared to $13.2 million for the nine months ended September 30, 2017. The increase in interest expense was primarily a result of higher levels of borrowings to finance the acquisition and development of additional properties.

 

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Provision for impairment increased $1.7 million for the nine months ended September 30, 2018, compared to $0.0 million for the nine months ended September 30, 2017. Provisions for impairment reflect the amount by which current book value exceeds estimated fair value.

 

Gain on sale of assets increased $0.9 million, or 8.3%, to $10.9 million for the nine months ended September 30, 2018, compared to $10.0 million for the nine months ended September 30, 2017. The increase in gain on sale of assets was primarily a result of increased disposition activity during the first nine months of 2018, compared to the first nine months 2017.

 

Net Income increased $3.4 million, or 8.0%, to $45.5 million for the nine months ended September 30, 2018, compared to $42.1 million for the nine months ended September 30, 2017. The change was the result of items discussed above, including changes in non-cash amounts such as gain on the sale of assets, provision for impairments and depreciation and amortization expense.

 

Liquidity and Capital Resources

Our principal demands for funds include payment of operating expenses, payment of principal and interest on our outstanding indebtedness, distributions to our shareholders and future property acquisitions and development.

 

We expect to meet our short-term liquidity requirements through cash provided from operations and borrowings under our revolving credit facility. As of September 30, 2018, available cash and cash equivalents was $16.8 million. As of September 30, 2018, we had $14.0 million outstanding on our revolving credit facility and $311.0 million was available for future borrowings, subject to our compliance with covenants. In July 2018, the Company elected to pursue commitments under the accordion option outlined in its senior unsecured revolving credit facility to increase the borrowing available under its the line of credit from $250.0 million to $325.0 million. We anticipate funding our long-term capital needs through cash provided from operations, borrowings under our revolving credit facility, the issuance of debt and common or preferred equity or other instruments convertible into or exchangeable for common or preferred equity.

 

We continually evaluate alternative financing and believe that we can obtain financing on reasonable terms. However, there can be no assurance that additional financing or capital will be available, or that the terms will be acceptable or advantageous to us.

 

Equity

In March 2018, the Company completed a follow-on public offering of 3,450,000 shares of common stock, which includes the underwriters’ option to purchase an additional 450,000 shares of common stock in connection with a forward sale agreement.  The offering, which included the full exercise of the underwriters’ option to purchase additional shares, was settled in its entirety in September 2018. Upon settlement the Company issued 3,450,000 shares and received net proceeds of $160.2 million after deducting fees and expenses. The proceeds from the offering were used to repay borrowings under the Company’s revolving credit facility, to fund property acquisitions, and for general corporate purposes.

 

In September 2018, the Company completed a follow-on public offering of 3,500,000 shares of common stock in connection with a forward sale agreement. Upon settlement, the offering is anticipated to raise net proceeds of approximately $190.0 million net of underwriting discounts, fees and commissions and will be subject to certain adjustments as provided in the forward sale agreement. The Company has not received proceeds from the sale of shares of its common stock by the forward purchaser. Selling common stock through the forward sale agreement enabled the Company to set the price of such shares upon pricing the offering (subject to certain adjustments) while delaying the issuance of such shares and the receipt of the net proceeds by the Company.  The forward sale agreement is required to be settled no later than September 3, 2019.

 

In May 2018, the Company entered into a $250.0 million at-the-market equity program (“ATM Program”) through which the Company may, from time to time, sell shares of common stock. In addition to selling shares of common stock, the Company may enter into forward sale agreements through its ATM Program. The Company intends to use the proceeds generated from its ATM Program for general corporate purposes, including funding our investment activity, the repayment or refinancing of outstanding indebtedness, working capital and other general purposes. The Company has not issued any shares of common stock under its ATM Program.

 

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Capitalization

As of September 30, 2018, the Company’s total market capitalization was approximately $2.5 billion. Market capitalization consisted of $1.9 billion of common equity (based on the September 28, 2018 closing price on the NYSE of $53.12 per common share and assuming the conversion of operating partnership units in the Operating Partnership (“OP units”) and $619.9 million of total gross debt, including (i) $62.2 million of mortgage notes payable; (ii) $158.7 million of unsecured term loans; (iii) $385.0 million of senior unsecured notes; and (iv) $14.0 million of borrowings under our revolving credit facility. Our ratio of total debt to total market capitalization was 25.1% at September 30, 2018.

 

At September 30, 2018, the non-controlling interest in the Operating Partnership represented ownership of 1.1% of the Operating Partnership. The OP Units may, under certain circumstances, be exchanged for shares of common stock on a one-for-one basis. The Company, as sole general partner of the Operating Partnership, has the option to settle exchanged OP Units held by others for cash based on the current trading price of its shares. Assuming the exchange of all OP Units, there would have been 34,829,164 shares of common stock outstanding at September 30, 2018.

 

Debt

The below table summarizes the Company’s outstanding debt for the periods ended September 30, 2018 and December 31, 2017 (in thousands):

 

   Interest      Principal Amount Outstanding 
Senior Unsecured Revolving Credit Facility  Rate   Maturity  September 30, 2018   December 31, 2017 
Credit Facility (1)   3.26%  January 2021  $14,000   $14,000 
Total Credit Facility          $14,000   $14,000 
                   
Unsecured Term Loans (2)                  
2019 Term Loan   3.62%  May 2019  $18,734   $19,304 
2023 Term Loan   3.05%  July 2023   40,000    40,000 
2024 Term Loan Facility   3.74%  January 2024   65,000    65,000 
2024 Term Loan Facility   3.85%  January 2024   35,000    35,000 
Total Unsecured Term Loans          $158,734   $159,304 
                   
Senior Unsecured Notes (2)                  
2025 Senior Unsecured Notes   4.16%  May 2025  $50,000   $50,000 
2027 Senior Unsecured Notes   4.26%  May 2027   50,000    50,000 
2028 Senior Unsecured Notes   4.42%  July 2028   60,000    60,000 
2029 Senior Unsecured Notes   4.19%  September 2029   100,000    100,000 
2030 Senior Unsecured Notes   4.32%  September 2030   125,000    - 
Total Senior Unsecured Notes          $385,000   $260,000 
                   
Mortgage Notes Payable (2)                  
Secured Term Loan   2.49%  March 2018  $-   $25,000 
Single Asset Mortgage Loan   3.32%  October 2019   21,500    21,500 
Portfolio Mortgage Loan   6.90%  January 2020   2,345    3,573 
Single Asset Mortgage Loan   6.24%  February 2020   2,896    2,963 
CMBS Portfolio Loan   3.60%  January 2023   23,640    23,640 
Single Asset Mortgage Loan   5.01%  September 2023   5,003    5,131 
Portfolio Credit Tenant Lease   6.27%  July 2026   6,795    7,288 
Total Mortgage Notes Payable          $62,179   $89,095 
                   
Total Principal Amount Outstanding          $619,913   $522,399 

 

(1) The annual interest rate of the Credit Facility assumes one month LIBOR as of September 30, 2018 of 2.26%.

(2) Interest rate includes the effects of variable interest rates that have been swapped to fixed interest rates.

 

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Senior Unsecured Revolving Credit Facility

In December 2016, the Company amended and restated the credit agreement (the “Credit Agreement”) that governs the Company's senior unsecured revolving credit facility and the Company's unsecured term loan facility to increase the aggregate borrowing capacity to $350.0 million. In July 2018, the Company elected to pursue commitments under the accordion option outlined in its senior unsecured revolving credit facility to increase the revolving commitments by $75.0 million, raising total revolving commitments under the amended and restated credit agreement from $250.0 million to $325.0 million. Including the increased commitments, the amended and restated credit agreement provides for a $325.0 million unsecured revolving credit facility, a $65.0 million unsecured term loan facility and a $35.0 million unsecured term loan facility (Referenced above as 2024 Term Loan Facilities). The unsecured revolving credit facility matures January 2021 with options to extend the maturity date to January 2022. The 2024 Term Loan Facilities mature January 2024. The Company has the ability to increase the aggregate borrowing capacity under the credit agreement to a maximum amount of $500.0 million, subject to lender approval.

 

Borrowings under the revolving credit facility bear interest at LIBOR plus 85 to 155 basis points, depending on the Company’s credit rating. Additionally, the Company is required to pay a facility fee at an annual rate of 0 to 55 basis points of the total amount of the revolving credit facility, depending on the Company’s credit rating. The Credit Agreement contains certain financial covenants, including a maximum leverage ratio, a minimum fixed charge coverage ratio, and a maximum percentage of secured debt to total asset value. As of September 30, 2018, and December 31, 2017, the Company had $14.0 million, of outstanding borrowings under the revolving credit facility, respectively, bearing weighted average interest rates of approximately 3.2% and 2.6%, respectively. As of September 30, 2018, $311.0 million was available for borrowing under the revolving credit facility and the Company was in compliance with the credit agreement covenants.

 

Unsecured Term Loan Facilities

The amended and restated credit agreement (Referenced above in Senior Unsecured Revolving Credit Facility) extended the maturity dates of the $65.0 million unsecured term loan facility and $35.0 million unsecured term loan facility (together, the “2024 Term Loan Facilities”) to January 2024. In connection with entering into the amended and restated credit agreement, the prior notes evidencing the existing $65.0 million unsecured term loan facility and $35.0 million unsecured term loan facility were canceled and new notes evidencing the 2024 Term Loan Facilities were executed. Borrowings under the unsecured 2024 Term Loan Facilities bear interest at a variable LIBOR plus 150 to 245 basis points, depending on the Company's credit rating. The Company utilized existing interest rate swaps to effectively fix the LIBOR at 213 basis points until maturity. As of September 30, 2018, $100.0 million was outstanding under the 2024 Term Loan Facilities bearing an all-in interest rate of 3.78%.

 

In July 2016, the Company completed a $40.0 million unsecured term loan facility that matures July 2023 (the “2023 Term Loan”).  Borrowings under the 2023 Term Loan are priced at LIBOR plus 150 to 245 basis points, depending on the Company’s credit rating. The Company entered into an interest rate swap to fix LIBOR at 140 basis points until maturity.  As of September 30, 2018, $40.0 million was outstanding under the 2023 Term Loan, which was subject to an all-in interest rate of 3.05%.

 

In August 2016, the Company entered into a $20.3 million unsecured amortizing term loan that matures May 2019 (the “2019 Term Loan”).  Borrowings under the 2019 Term Loan are priced at LIBOR plus 170 basis points. In order to fix LIBOR on the 2019 Term Loan at 1.92% until maturity, the Company had an interest rate swap agreement in place, which was assigned by the lender under the Mortgage Note to the 2019 Term Loan lender.  As of September 30, 2018, $18.7 million was outstanding under the 2019 Term Loan bearing an all-in interest rate of 3.62%.

 

Senior Unsecured Notes

In May 2015, the Company and Operating Partnership completed a private placement of $100.0 million principal amount of senior unsecured notes. The senior unsecured notes were sold in two series; $50.0 million of 4.16% notes due May 2025 (the “2025 Senior Unsecured Notes”) and $50.0 million of 4.26% notes due May 2027(the “2027 Senior Unsecured Notes”). The weighted average term of the senior unsecured notes is 11 years and the weighted average interest rate is 4.21%. The senior unsecured notes were sold only to institutional investors and did not involve a public offering in reliance on the exemption from registration in Section 4(a)(2) of the Securities Act.

 

In July 2016, the Company entered into a note purchase agreement with institutional purchasers. Pursuant to the note purchase agreement, the Operating Partnership completed a private placement of $60.0 million aggregate principal amount of our 4.42% senior unsecured notes due July 2028 (the “2028 Senior Unsecured Notes”). The senior unsecured notes were sold only to institutional investors and did not involve a public offering in reliance on the exemption from registration in Section 4(a)(2) of the Securities Act.

 

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In August 2017, the Company entered into a note purchase agreement with institutional purchasers. Pursuant to the note purchase agreement, the Operating Partnership completed a private placement of $100.0 million aggregate principal amount of our 4.19% senior unsecured notes due September 2029 (the “2029 Senior Unsecured Notes”). The closing of the private placement was consummated in September 2017; and, on that date, the Operating Partnership issued the senior unsecured notes. The senior unsecured notes were sold only to institutional investors and did not involve a public offering in reliance on the exemption from registration in Section 4(a)(2) of the Securities Act.

 

In September 2018, the Company entered into two supplements to uncommitted master note facilities previously entered into with institutional purchasers in August 2017. Pursuant to the supplements, the Operating Partnership completed a private placement of $125.0 million aggregate principal amount of our 4.32% senior unsecured notes due September 2030 (the “2030 Senior Unsecured Notes”). The senior unsecured notes were sold only to institutional investors and did not involve a public offering in reliance on the exemption from registration in Section 4(a)(2) of the Securities Act.

 

Mortgage Notes Payable

As of September 30, 2018, the Company had total gross mortgage indebtedness of $62.2 million, with a weighted average term to maturity of 3.3 years. Including our mortgages that have been swapped to a fixed interest rate, our weighted average interest rate on mortgage debt was 4.16%.

 

We have entered into mortgage loans which are secured by multiple properties and contain cross-default and cross-collateralization provisions. Cross-collateralization provisions allow a lender to foreclose on multiple properties in the event that we default under the loan. Cross-default provisions allow a lender to foreclose on the related property in the event a default is declared under another loan.

 

Contractual Obligations

The following table summarizes our contractual obligations as of September 30, 2018 (in thousands):

 

   Remainder of                         
   2018   2019   2020   2021   2022   Thereafter   Total 
Mortgage Notes Payable  $660   $24,251   $3,867   $998   $1,060   $31,343   $62,179 
Revolving Credit Facility   -    -    -    14,000    -    -    14,000 
Unsecured Term Loans   190    18,544    -    -    -    140,000    158,734 
Senior Unsecured Notes   -    -    -    -    -    385,000    385,000 
Land Lease Obligations   142    566    564    521    437    6,908    9,138 
Estimated Interest Payments on Outstanding Debt   6,294    24,470    23,376    22,861    22,781    104,558    204,340 
Total  $7,286   $67,831   $27,807   $38,380   $24,278   $667,809   $833,391 

 

Includes estimated interest payments based on (i) the stated rates for mortgage notes payable, including the effect of interest rate swaps; (ii) the stated rates for unsecured term loans, including the effect of interest rate swaps and assuming the interest rate in effect for the most recent quarter remains in effect through the respective maturity dates; and (iii) the stated rates for senior unsecured notes.

 

Dividends

During the quarter ended September 30, 2018, the Company declared a quarterly dividend of $0.540 per share. The cash dividend was paid on October 12, 2018 to holders of record on September 28, 2018.

 

Non-GAAP Financial Measures

 

Funds from Operations

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

 

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FFO should not be considered 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. Further, while the Company adheres to the NAREIT definition of FFO, its presentation of FFO is not necessarily comparable to similarly titled measures of other REITs due to the fact that all REITs may not use the same definition.

 

Adjusted Funds from Operations

Adjusted Funds from Operations (“AFFO”) is a non-GAAP financial measure of operating performance used by many companies in the REIT industry. AFFO further adjusts FFO for certain non-cash items that reduce or increase net income in accordance with GAAP. Management considers AFFO a useful supplemental measure of the Company’s performance, however, AFFO should not be considered an alternative to net income as an indication of the Company’s performance, or to cash flow as a measure of liquidity or ability to make distributions. The Company’s computation of AFFO may differ from the methodology for calculating AFFO used by other equity REITs, and therefore may not be comparable to such other REITs.

 

The following table provides a reconciliation from net income to FFO for the three and nine months ended September 30, 2018 and 2017 (in thousands):

 

   Three Months Ended   Nine Months Ended 
Reconciliation from Net Income to Funds from Operations  September 30, 2018   September 30, 2017   September 30, 2018   September 30, 2017 
Net income  $15,756   $12,283   $45,460   $42,119 
Depreciation of real estate assets   6,156    5,101    17,745    14,286 
Amortization of leasing costs   90    40    174    120 
Amortization of lease intangibles   4,914    3,059    13,761    8,470 
Provision for impairment   488    -    1,651    - 
Gain on sale of assets   (3,917)   (524)   (10,949)   (10,045)
Funds from Operations  $23,487   $19,959   $67,842   $54,950 
                     
Funds from Operations Per Share - Diluted  $0.72   $0.69   $2.13   $2.00 
                     
Weighted average shares and OP units outstanding                    
Basic   32,106,544    28,920,641    31,479,149    27,336,208 
Diluted   32,634,971    29,004,303    31,818,870    27,416,971 

 

The following table provides a reconciliation from net income to AFFO for the three and nine months ended September 30, 2018 and 2017 (in thousands):

 

   Three Months Ended   Nine Months Ended 
Reconciliation from Net Income to Adjusted Funds from Operations  September 30, 2018   September 30, 2017   September 30, 2018   September 30, 2017 
Net income  $15,756   $12,283   $45,460   $42,119 
Cumulative adjustments to calculate FFO   7,731    7,676    22,382    12,831 
Funds from Operations  $23,487   $19,959   $67,842   $54,950 
Straight-line accrued rent   (1,138)   (860)   (3,344)   (2,545)
Stock based compensation expense   850    622    2,375    1,898 
Amortization of financing costs   135    142    433    426 
Non-real estate depreciation   20    28    63    80 
Adjusted Funds from Operations  $23,354   $19,891   $67,369   $54,809 
                     
Adjusted Funds from Operations Per Share - Diluted  $0.72   $0.69   $2.12   $2.00 
                     
Additional supplemental disclosure                    
Scheduled principal repayments  $838   $797   $2,486   $2,343 
Capitalized interest  $88   $143   $381   $297 
Capitalized building improvements  $966   $34   $1,042   $76 

 

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ITEM 3.Quantitative and Qualitative Disclosures about Market Risk

 

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 and the weighted average interest rates on outstanding debt, by year of expected maturity, to evaluate the expected cash flows and sensitivity to interest rate changes.

 

($ in thousands)                            
   2018   2019   2020   2021   2022   Thereafter   Total 
Mortgage Notes Payable  $660   $24,251   $3,867   $998   $1,060   $31,343   $62,179 
Average Interest Rate   6.59%   3.69%   6.21%   6.02%   6.02%   3.86%     
                                    
Unsecured Revolving Credit Facility  $-   $-   $-   $14,000   $-   $-   $14,000 
Average Interest Rate                  3.26%               
                                    
Unsecured Term Loans  $190   $18,544   $-   $-   $-   $140,000   $158,734 
Average Interest Rate   3.62%   3.62%                  3.57%     
                                    
Senior Unsecured Notes  $-   $-   $-   $-   $-   $385,000   $385,000 
Average Interest Rate                            4.27%     

 

The fair value is estimated to be $61.8 million, $153.2 million and $379.8 million for mortgage notes payable, unsecured term loans and senior unsecured notes, respectively, as of September 30, 2018.

 

The table above incorporates those exposures that exist as of September 30, 2018; it does not consider those exposures or positions 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 seek to limit the impact of interest rate changes on earnings and cash flows and to lower the overall borrowing costs by closely monitoring our variable rate debt and converting such debt to fixed rates when we deem such conversion advantageous. From time to time, we may enter into interest rate swap agreements or other interest rate hedging contracts. While these agreements are intended to lessen the impact of rising interest rates, they also expose us to the risks that the other parties to the agreements will not perform. We could incur significant costs associated with the settlement of the agreements, the agreements will be unenforceable and the underlying transactions will fail to qualify as highly-effective cash flow hedges under GAAP guidance.

 

In April 2012, the Company entered into an amortizing forward-starting interest rate swap agreement to hedge against changes in future cash flows resulting from changes in interest rates on $22.3 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 1.92%. The notional amount as of September 30, 2018 is $18.7 million. This swap effectively converted $22.3 million of variable-rate borrowings to fixed-rate borrowings from July 1, 2013 to May 1, 2019. As of September 30, 2018, this interest rate swap was valued as an asset of approximately $0.1 million.

 

In September 2013, the Company entered into an interest rate swap agreement to hedge against changes in future cash flows resulting from changes in interest rates on $35.0 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 2.20%. This swap effectively converted $35.0 million of variable-rate borrowings to fixed-rate borrowings from October 3, 2013 to September 29, 2020. As of September 30, 2018, this interest rate swap was valued as an asset of approximately $0.4 million.

 

In July 2014, the Company entered into interest rate swap agreements to hedge against changes in future cash flows resulting from changes in interest rates on $65.0 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 2.09%. This swap effectively converted $65.0 million of variable-rate borrowings to fixed-rate borrowings from July 21, 2014 to July 21, 2021. As of September 30, 2018, this interest rate swap was valued as an asset of approximately $1.3 million.

 

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In September 2017, the Company entered into an interest rate swap agreement to hedge against changes in future cash flows resulting from changes in interest rates on $40.0 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 1.40%. This swap effectively converted $40.0 million of variable-rate borrowings to fixed-rate borrowings from August 1, 2016 to July 1, 2023. As of September 30, 2018, this interest rate swap was valued as an asset of approximately $2.7 million.

 

We do not use derivative instruments for trading or other speculative purposes and we did not have any other derivative instruments or hedging activities as of September 30, 2018.

 

ITEM 4.Controls and Procedures

 

Disclosure Controls and Procedures

At the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

 

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II Other Information

 

Item 1.Legal Proceedings

 

We are not presently involved in any material litigation nor, to our knowledge, is any other material litigation threatened against us, except for routine litigation arising in the ordinary course of business which is expected to be covered by our liability insurance.

 

Item 1A.Risk Factors

 

There have been no material changes from our risk factors set forth under Item 1A of Part 1 of our most recently filed Form 10-K.

 

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3.Defaults upon Senior Securities

 

None.

 

Item 4.Mine Safety Disclosures

 

Not applicable.

 

Item 5.Other Information

 

None.

 

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Item 6.Exhibits

 

*4.1 Form of 4.32% Senior Guaranteed Note, Series 2018-A, due September 26, 2030
   
*4.2 Form of 4.32% Senior Guaranteed Note, Series 2018-B, due September 26, 2030
   
10.1 Increase Agreement, dated July 18, 2018 among Agree Limited Partnership, as the Borrower, the Company, as the parent, PNC Bank, National Association and the other lender parties thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 23, 2018)
   
10.2 Form of Revolving Note (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on July 23, 2018)
   
*10.3 First Supplement to Uncommitted Master Note Facility, dated as of September 26, 2018, among Agree Limited Partnership, Agree Realty Corporation and Teachers Insurance and Annuity Association of America (“TIAA”)
   
*10.4 First Supplement to Uncommitted Master Note Facility, dated as of September 26, 2018, among Agree Limited Partnership, Agree Realty Corporation, AIG Asset Management (U.S.), LLC and the institutional investors named therein
   
*31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Joel N. Agree, Chief Executive Officer
   
*31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Clayton R. Thelen, Chief Financial Officer
   
*32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Joel N. Agree, Chief Executive Officer
   
*32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Clayton R. Thelen, Chief Financial Officer
   
*101 The following materials from Agree Realty Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2018 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income and Comprehensive Income, (iii) the Consolidated Statement of Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) related notes to these consolidated financial statements.

 

 

*Filed herewith.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Agree Realty Corporation

 

/s/ JOEL N. AGREE  
Joel N. Agree
President and Chief Executive Officer

 

/s/ CLAYTON R. THELEN  
Clayton R. Thelen
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)

 

Date:      October 22, 2018  

 

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