ITEM 3. LEGAL PROCEEDINGS
We are not presently involved in any litigation nor, to our knowledge, is any other 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 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth quarter of 2005.
Part II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the New York Stock Exchange under the symbol “ADC”. The following table sets forth the high and low sales prices of our common stock, as reported on the New York Stock Exchange Composite Tape, and the dividends declared per share of Common Stock by us for each calendar quarter in the last two fiscal years. Dividends were paid in the periods immediately subsequent to the periods in which such dividends were declared.
Market Information
At December 31, 2005, there were 7,706,846 shares of our common stock issued and outstanding which were held by approximately 210 stockholders of record. The stockholders of record do not reflect persons or entities who held their shares in nominee or “street” name.
We intend to continue to declare quarterly dividends to our stockholders. However, our distributions are determined by our board of directors and will depend on a number of factors, including the amount of our funds from operations, the financial and other condition of our properties, our capital requirements, our annual distribution requirements under the provisions of the Internal Revenue Code applicable to REITs and such other factors as our board of directors deems relevant.
During the year ended December 31, 2005, we did not sell any unregistered securities, except the grant, under our 2005 Equity Incentive Plan (the Plan), of 73,000 shares of restricted stock to certain of our employees. The transfer restrictions on such shares lapse in equal annual installments over a five-year period from the date of the grant, but the holder thereof is entitled to receive dividends on all such shares from the date of the grant. On January 1, 2005 the Company redeemed 4,000 shares of restricted stock previously issued under the Plan.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth our selected financial information on a historical basis and should be read in conjunction with “Management Discussion and Analysis of Financial Condition and Results of Operations” and all of the financial statements and notes thereto included elsewhere in this Form 10-K. Certain amounts have been reclassified to conform to the current presentation of discontinued operations. The balance sheet for the periods ending December 31, 2001 through 2005 and operating data for each of the periods presented were derived from our audited financial statements.
Selected Financial Data
(1)
Property expense includes real estate taxes, property maintenance, insurance, utilities and land lease expense.
(2)
Other income is composed of development fee income, gain on land sales, and equity in net income of unconsolidated entities.
(3)
Net income per share has been computed by dividing the net income by the weighted average number of shares of Common Stock outstanding. The per share amounts are presented in accordance with SFAS No. 128 “Earnings per share.”
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We were established to continue to operate and expand the retail property business of our predecessor. We commenced our operations in April 1994. Our assets are held by, and all operations are conducted through, Agree Limited Partnership (the Operating Partnership), of which Agree Realty Corporation is the sole general partner and held a 91.93% interest as of December 31, 2005. We are operating so as to qualify as a real estate investment trust (REIT) for federal income tax purposes.
On January 25, 2005, we completed an offering of 1,000,000 shares of common stock at $28.28 per share. On February 5, 2005, the underwriter exercised its over allotment option for an additional 150,000 shares at the same per share price (collectively, the 2005 Offering). The net proceeds from the 2005 Offering of approximately $31.5 million were used to repay amounts outstanding under our credit facility.
The following should be read in conjunction with the Consolidated Financial Statements of Agree Realty Corporation, including the respective notes thereto, which are included elsewhere in this Form 10-K.
Recent Accounting Pronouncements
In December 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 123 (R), to expand and clarify SFAS No. 123 in several areas. The Statement requires companies to measure the cost of employee services received in exchange for an award of an equity instrument based on the grant-date fair value of the award. The cost is recognized over the requisite service period (usually the vesting period) for the estimated number of instruments where service is expected to be rendered. This statement is effective for the interim reporting periods beginning after December 15, 2005. We do not expect that our financial statements will be materially impacted by SFAS No. 123 (R).
In December 2004, the FASB issued Statement No. 153, Exchange of Non-monetary Assets - an amendment of APB Opinion No. 29 (“SFAS No. 153”). The guidance in APB Opinion No. 29, Accounting for Non-monetary Transactions, is based on the principle that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion No. 29 to eliminate the exception for non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The impact of adopting this statement did not have a material impact on the Company’s financial position or results of operations.
In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 also requires that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, but does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of SFAS No. 154. The adoption of SFAS No. 154 will not have a material effect on our results of operations or our financial position.
In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (“FIN 47”). FIN 47 requires an entity to recognize a liability for a conditional asset retirement obligation when incurred if the liability can be reasonably estimated. FIN 47 clarifies that the term “Conditional Asset Retirement Obligation” refers to a legal obligation (pursuant to existing laws or by contract) to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN 47 also clarifies when an entity would have sufficient information
to reasonably estimate the fair value of an asset retirement obligation. FIN 47 was effective no later than fiscal years ended after December 15, 2005. The Company adopted FIN 47 as required effective December 31, 2005 and the initial application of FIN 47 did not have a material impact on the Company’s financial position or results of operations.
Critical Accounting Policies
In the course of developing and evaluating accounting policies and procedures, we use estimates, assumptions and judgments to determine the most appropriate methods to be applied. Such processes are used in determining capitalization of costs related to real estate investments, potential impairment of real estate investments, operating cost reimbursements, and taxable income.
Minimum rental income attributable to leases is recorded when due from tenants. Certain leases provide for additional percentage rents based on tenants’ sales volumes. These percentage rents are recognized when determinable by us. In addition, leases for certain tenants contain rent escalations and/or free rent during the first several months of the lease term; however such amounts are not material.
Real estate assets are stated at cost less accumulated depreciation. All costs related to planning, development and construction of buildings prior to the date they become operational, including interest and real estate taxes during the construction period, are capitalized for financial reporting purposes and recorded as property under development until construction has been completed. Subsequent to completion of construction, expenditures for property maintenance are charged to operations as incurred, while significant renovations are capitalized. Depreciation of the buildings is recorded on the straight-line method using an estimated useful life of forty years.
In determining the fair value of real estate investments, we consider future cash flow projections on a property by property basis, current interest rates and current market conditions of the geographical location of each property.
Substantially all of our leases contain provisions requiring tenants to pay as additional rent a proportionate share of operating expenses (Operating Cost Reimbursements) such as real estate taxes, repairs and maintenance, insurance, etc. The related revenue from tenant billings is recognized in the same period the expense is recorded.
We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the Code), commencing with our 1994 tax year. As a result, we are not subject to federal income taxes to the extent that we distribute annually at lease 90% of our taxable income to our shareholders and satisfy certain other requirements defined in the Code. Accordingly, no provision was made for federal income taxes in the accompanying consolidated financial statements.
Comparison of Year Ended December 31, 2005 to Year Ended December 31, 2004
Minimum rental income increased $2,420,000, or 9%, to $28,386,000 in 2005, compared to $25,966,000 in 2004. The increase was the result of an increase of $989,000 due to additional rent resulting from the acquisition of our joint venture partner’s interest in two joint venture properties in 2004; an increase of $545,000 from the acquisition of three properties in 2004 and three properties in 2005; an increase of $707,000 from the development of two properties in 2004 and three properties in 2005; an increase of $64,000 from the settlement of our rent dispute with Borders; and rental increases of $116,000 from new and existing tenants.
Percentage rents increased $12,000, or 22%, to $68,000 in 2005, compared to $56,000 in 2004. The increase was primarily the result of increased tenant sales.
Operating cost reimbursements increased $198,000, or 7%, to $3,083,000 in 2005, compared to $2,885,000 in 2004. Operating cost reimbursements increased due to the increase in the reimbursable property operating expenses as explained below. Included in 2004 operating cost reimbursements are bad debt recoveries of $100,000 as a result of the decrease in the allowance for bad debts.
Other income increased $8,000 to $41,000 in 2005, compared to $33,000 in 2004. The increase was the result of a leasing commission being earned in 2005. No leasing commission was earned in 2004.
Real estate taxes increased $57,000, or 3%, to $1,749,000 in 2005 compared to $1,692,000 in 2004. The increase is the result of general assessment increases on the properties and additional real estate taxes related to the re-tenanting of a closed Kmart store.
Property operating expenses (shopping center maintenance, snow removal, insurance and utilities) increased $221,000, or 12%, to $2,012,000 in 2005 compared to $1,791,000 in 2004. The increase was the result of a increase in shopping center maintenance expenses of $122,000; increased snow removal costs of $75,000; an increase in utility costs of $18,000; and an increase in insurance costs of $6,000 in 2005 versus 2004.
Land lease payments increased $47,000, or 6%, to $784,000 in 2005 compared to $737,000 for 2004. The increase is the result of the scheduled lease increase at our Aventura, Florida property.
General and administrative expenses increased $1,343,000, or 47%, to $4,191,000 in 2005 compared to $2,848,000 in 2004. The increase was the result of an increase in compensation related expenses as a result of salary increases and the addition of four employees of $654,000; increased contracted services to investigate development opportunities of $570,000 and property management related expenses of $119,000. General and administrative expenses as a percentage of rental income increased from 11.0% for 2004 to 14.7% for 2005.
Depreciation and amortization increased $388,000, or 9%, to $4,637,000 in 2005 compared to $4,249,000 in 2004. The increase was the result the acquisition the development and acquisition of five properties in 2004, six properties in 2005 and the acquisition of the joint venture partner’s interest in two joint venture properties in 2004.
Interest expense decreased $348,000, or 8%, to $4,159,000 in 2005, from $4,507,000 in 2004. The decrease in interest expense was the result of decreased borrowings as a result of the reduction in outstanding indebtedness from the application of the net proceeds of the 2005 Offering.
We sold a parcel of land and recognized a gain on the sale of $6,000 in 2005. There were no sale of assets in 2004.
Equity in net income of unconsolidated entities totaled $217,000 in 2004. There was no income from unconsolidated entities in 2005 since we acquired the interest of our joint venture partner in our final two joint ventures in 2004.
The Company’s income before minority interest and discontinued operations increased $721,000, or 5%, to $14,053,000 in 2005, from $13,332,000 in 2004 as a result of the foregoing factors.
Comparison of Year Ended December 31, 2004 to Year Ended December 31, 2003
Minimum rental income increased $2,697,000, or 12%, to $25,966,000 in 2004, compared to $23,269,000 in 2003. The increase resulted from rental increases of $276,000 from existing properties; an increase of $909,000 due to additional rent resulting from the acquisition of our joint venture partner’s interest in two joint venture properties in 2003 and two joint venture properties in 2004; an increase of $640,000 from the acquisition of one property in 2003 and three properties in 2004; an increase of $533,000 from the development of one property in 2003 and two properties in 2004; and the receipt of a lease termination payment from Kmart with regard to their Lakeland, Florida store in the amount of $339,000.
Percentage rents decreased $120,000, or 68%, to $56,000 in 2004, compared to $176,000 in 2003. The decrease was primarily the result of decreased tenant sales ($86,000) and the refund of ($34,000) pertaining to percentage rent paid in error by a tenant in 2003.
Operating cost reimbursements increased $109,000, or 4%, to $2,885,000 in 2004, compared to $2,776,000 in 2003. Operating cost reimbursements increased due to the increase in the reimbursable property operating
expenses as explained below. Included in 2004 and 2003 operating cost reimbursements are bad debt recoveries of $100,000 and $65,000, respectively as a result of the decrease in the allowance for bad debts.
Other income increased $30,000 to $33,000 in 2004, compared to $3,000 in 2003. Other income increased due to the sale of signage at one of our properties.
Real estate taxes increased $30,000, or 2%, to $1,692,000 in 2004 compared to $1,662,000 in 2003. The increase is the result of general assessment increases on the properties and additional real estate taxes related to a closed Kmart store.
Property operating expenses (shopping center maintenance, snow removal, insurance and utilities) increased $30,000, or 2%, to $1,791,000 in 2004 compared to $1,761,000 in 2003. The increase was the result of a reduction in shopping center maintenance expenses of ($104,000); increased snow removal costs of $89,000; a decrease in utility costs of ($3,000); and an increase in insurance costs of $48,000 in 2004 versus 2003.
Land lease payments remained constant at $737,000 for 2004 and 2003.
General and administrative expenses increased $573,000, or 25%, to $2,848,000 in 2004 compared to $2,275,000 in 2003. The increase was primarily the result of an increase in compensation related expenses of $244,000; increased general state taxes of $80,000; increased contracted services to investigate development opportunities of $196,000; costs associated with Sarbanes-Oxley compliance of $24,000 and property management related expenses of $23,000. General and administrative expenses as a percentage of rental income increased from 9.7% for 2003 to 11.0% for 2004.
Depreciation and amortization increased $413,000, or 11%, to $4,249,000 in 2004 compared to $3,836,000 in 2003. The increase was the result the acquisition of one property in 2003 and three properties in 2004; the acquisition of the joint venture partner’s interest in one joint venture property in 2003 and two Joint Venture Properties in 2004; and the development of two properties in 2003 and two properties in 2004.
Interest expense decreased $1,177,000, or 21%, to $4,507,000 in 2004, from $5,684,000 in 2003. The decrease in interest expense was the result of decreased borrowings as a result of the reduction in outstanding indebtedness from the net proceeds from the issuance of additional common stock.
Early extinguishment of debt totaled $961,000 in 2003, as a result of our repaying in 2003 three mortgages totaling approximately $37,000,000 prior to their scheduled maturity. In connection with these repayments we incurred pre-payment penalties of $555,000 and wrote-off unamortized mortgage costs in the amount of $406,000. There was no early extinguishment of debt in 2004.
Equity in net income of unconsolidated entities decreased $221,000 to $217,000 in 2004 compared to $438,000 in 2003 as a result of the acquisition of the joint venture partner’s interest in one joint venture property in 2003 and two joint venture properties in 2004.
The Company’s income before minority interest and discontinued interest increased $3,587,000, or 37%, to $13,332,000 in 2004, from $9,745,000 in 2003 as a result of the foregoing factors.
Discontinued Operations
In October 2003 we completed the sale of a shopping center for approximately $8.5 million. The shopping center was anchored by Kmart Corporation and Kash N Karry and was located in Winter Garden, Florida. In August 2004, we completed the sale of a single tenant property for approximately $2.2 million. The property was leased to Kmart Corporation and was located in Perrysburg, Ohio. In October 2005, we completed the sale of a shopping center for approximately $8.8 million. The shopping center was anchored by Kmart Corporation and Roundy’s Foods and was located in Iron Mountain, Michigan.
The aggregate revenues from these properties were $864,113, $1,125,842 and $2,127,070 for the years ending December 31, 2005, 2004 and 2003. The aggregate expenses for these properties were $377,960, $600,391 and $1,037,858, including minority interest of $43,137, $54,708 and $140,656 for the years ending December 31, 2005, 2004 and 2003.
Liquidity and Capital Resources
Our principal demands for liquidity are distributions to our stockholders, debt service, development of new properties and future property acquisitions.
During the quarter ended December 31, 2005, we declared a quarterly dividend of $.49 per share. The dividend was paid on January 5, 2006 to holders of record on December 23, 2005.
As of December 31, 2005, we had total mortgage indebtedness of $50,721,920 with a weighted average interest rate of 6.64%. Future scheduled annual maturities of mortgages payable for the years ending December 31 are as follows: 2006 - $2,369,315; 2007 - $2,592,435; 2008 - $2,749,772; 2009 - $2,937,232; 2010 - $3,137,505. The mortgage debt is all fixed rate, self-amortizing debt.
In addition, the Operating Partnership has in place a $50 million credit facility with LaSalle Bank, as the agent (Credit Facility), which is guaranteed by the Company. The Credit Facility matures in November 2006 and can be extended at our option, for an additional three years. During the three year extension period, we will have no further ability to borrow under the Credit Facility and will be required to repay a portion of the unpaid principal on a quarterly basis. Advances under the Credit Facility bear interest within a range of one-month to six-month LIBOR plus 150 basis points to 213 basis points or the lender’s prime rate, at our option, based on certain factors such as debt to property value and debt service coverage. The Credit Facility is used to fund property acquisitions and development activities and is secured by most of the properties which are not otherwise encumbered and properties to be acquired or developed. As of February 15, 2006, $12,000,000 was outstanding under the Credit Facility bearing a weighted average interest rate of 5.97%.
We also have in place a $5 million line of credit (Line of Credit), which matures on June 30, 2006, and which we expect to renew for an additional 12-month period. The Line of Credit bears interest at the lender’s prime rate less 50 basis points or 175 basis points in excess of the one-month LIBOR rate, at our option. The purpose of the Line of Credit is to provide working capital and fund land options and start-up costs associated with new projects. As of February 15, 2006, $1,200,000 was outstanding under the Line of Credit bearing a weighted average interest rate of 7.50%.
The following table outlines our contractual obligations (in thousands) as of December 31, 2005.
We intend to meet our short-term liquidity requirements, including capital expenditures related to the leasing and improvement of the properties, through cash flow provided by operations and the Line of Credit. We believe that adequate cash flow will be available to fund our operations and pay dividends in accordance with REIT requirements. We may obtain additional funds for future development or acquisitions through other borrowings or the issuance of additional shares of common stock. We intend to incur additional debt in a manner consistent with
our policy of maintaining a ratio of total debt (including construction and acquisition financing) to total market capitalization of 65% or less. We believe that these financing sources will enable us to generate funds sufficient to meet both our short-term and long-term capital needs.
We plan to begin construction of additional pre-leased developments and may acquire additional properties, which will initially be financed by the Credit Facility and Line of Credit. We will periodically refinance short-term construction and acquisition financing with long-term debt and/or equity. Upon completion of refinancing, we intend to lower the ratio of total debt to market capitalization to 50% or less. Nevertheless, we may operate with debt levels or ratios, which are in excess of 50% for extended periods of time prior to such refinancing.
Inflation
Our leases generally contain provisions designed to mitigate the adverse impact of inflation on net income. These provisions include clauses enabling us to pass through to our tenants certain operating costs, including real estate taxes, common area maintenance, utilities and insurance, thereby reducing our exposure to cost increases and operating expenses resulting from inflation. Certain of our leases contain clauses enabling us to receive percentage rents based on tenants’ gross sales, which generally increase as prices rise, and, in certain cases, escalation clauses, which generally increase rental rates during the term of the leases. In addition, expiring tenant leases permit us to seek increased rents upon re-lease at market rates if rents are below the then existing market rates.
Funds from Operations
We consider Funds from Operations (FFO) to be a useful supplemental measure to evaluate our operating performance because, by excluding gains or losses on dispositions and excluding depreciation, FFO can help an investor compare the operating performance of our real estate between periods or compare such performance to that of different companies. Management uses FFO as a supplemental measure to conduct and evaluate our business because there are certain limitations associated with using GAAP net income by itself as the primary measure of our 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 uses historical cost accounting is insufficient by itself.
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. FFO should not be considered as an alternative to net income as the primary indicator of our operating performance or as an alternative to cash flow as a measure of liquidity. While we adhere to the NAREIT definition of FFO in making our calculation, our method of calculating FFO may not be comparable to the methods used by other REITs and accordingly may be different from similarly titled measures reported by other companies.
The following table illustrates the calculation of FFO for the years ended December 31, 2005, 2004 and 2003:
ITEM 7A
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate risk primarily through our borrowing activities. There is inherent roll over risk for borrowings as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and our future financing requirements.
Our interest rate risk is monitored using a variety of techniques. The table below presents the principal payments (in thousands) and the weighted average interest rates on remaining debt, by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes.
The fair value (in thousands) is estimated at $50,700 and $17,500 for fixed rate debt and variable rate debt, respectively.
The table above incorporates those exposures that exist as of December 31, 2005; it does not consider those exposures or position, which could arise after that date. As a result, our ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period and interest rates.
The Company does not enter into financial instrument transactions for trading or other speculative purposes or to manage interest rate exposure.
A 10% adverse change in interest rates on the portion of the Company’s debt bearing interest at variable rates would result in an increase in interest expense of approximately $112,000.
ITEM 8
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data are listed in the Index to Financial Statements and Financial Statement Schedules appearing on Page of this Form 10-K and are included in this Form 10-K following page.
ITEM 9
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
During our last two fiscal years, there have been no changes in the independent accountants or disagreements with such accountants as to accounting and financial disclosures of the type required to be disclosed in this Item 9.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report (the “Evaluation Date”).
Based on this evaluation, and due to the material weaknesses in our internal control over financial reporting (as described below in Report of Management on Agree Realty Corporation’s Internal Control over Financial Reporting), our chief executive officer and chief financial officer concluded that as of December 31, 2005, our disclosure controls and procedures were not effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. There was no change in our internal control over financial reporting during its most recently completed fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
Our audit committee has engaged an independent third party consultant to perform periodic reviews of our financial reporting process to help mitigate the material weakness in our internal controls described in Report of Management on Agree Realty Corporation’s Internal Control over Financial Reporting.
Because of its inherent limitations, our disclosure controls and procedures may not prevent or detect misstatements. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issued and instances of fraud, if any, have been detected.
Report of Management on Agree Realty Corporation’s Internal Control Over Financial Reporting
We, as members of management of Agree Realty Corporation, are responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, our internal controls and procedures may not prevent or detect misstatements. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
The following material weaknesses have been identified and reported to the audit committee:
•
We lack segregation of duties in the period-end financial reporting process. Our Chief Financial Officer (CFO) is the only employee with any significant knowledge of generally accepted accounting principles. The CFO is also the sole employee in charge of the general ledger (including the preparation of routine and non-routine journal entries and journal entries involving accounting estimates), the preparation of accounting reconciliations, the selection of accounting principles, and the preparation of interim and annual financial statements (including report combinations, consolidation entries and footnote disclosures) in accordance with generally accepted accounting principles.
•
We lack the expertise and resources to ensure complete application of generally accepted accounting principles to non-routine transactions. As a result of this material weakness, we recorded adjustments prior to the issuance of our consolidated financial statements. These adjustments affected other assets, unearned compensation, equity and general and administrative expenses.
We, under the supervision of and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, assessed the our internal control over financial reporting as of December 31, 2005, based on criteria for effective internal control over financial reporting described in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. As a result of the material weaknesses described above, management has concluded that our internal control was not effective as of December 31, 2005.
Management’s assessment of the effectiveness of our internal control over financial reporting has been audited by BDO Seidman, LLP, an independent registered public accounting firm, as stated in their report that is included herein.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Owners of Agree Realty Corporation
We have audited management’s assessment, included in the accompanying “Report of Management on Agree Realty Corporation’s Internal Control Over Financial Reporting”, that Agree Realty Corporation (the “Company”) did not maintain effective internal control over financial reporting as of December 31, 2005, because of the effect of the two material weaknesses noted below, based on criteria established in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Agree Realty Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as
we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessment:
•
The Company lacks segregation of duties in the period-end financial reporting process. The Chief Financial Officer (“CFO”) is the only employee with any significant knowledge of generally accepted accounting principles. The CFO is also the sole employee in charge of the general ledger (including the preparation of routine and non-routine journal entries and journal entries involving accounting estimates), the preparation of accounting reconciliations, the selection of accounting principles, and the preparation of interim and annual financial statements (including report combinations, consolidation entries and footnote disclosures) in accordance with generally accepted accounting principles.
•
The Company lacks the expertise and resources to ensure complete application of generally accepted accounting principles to non-routine transactions. As a result of this material weakness, the Company recorded adjustments prior to the issuance of its consolidated financial statements. These adjustments affected other assets, unearned compensation, equity and general and administrative expenses.
The material weaknesses related to the period-end financial reporting process and the application of generally accepted accounting principles to non-routine transactions affect all of the Company’s significant accounts and could result in a material misstatement to the Company’s annual or interim consolidated financial statements that would not be prevented or detected.
The material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2005 financial statements, and this report does not affect our report dated March 15, 2006 on those financial statements.
In our opinion, management’s assessment that Agree Realty Corporation did not maintain effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, Agree Realty Corporation has not maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)
BDO Seidman, LLP
Troy, Michigan
March 15, 2006
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting identified in connection with the above-referenced evaluation by management of the effectiveness of our internal control over financial reporting that occurred during our fourth quarter ended December 31, 2005.
None
PART III
ITEM 10.
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to its Annual Meeting of Stockholders to be held on May 8, 2006.
Incorporated herein by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to its Annual Meeting of Stockholders to be held on May 8, 2006.
The following table summarizes the equity compensation plans under which the Company’s common stock may be issued as of December 31, 2005.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference from our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its Annual Meeting of Stockholders to be held on May 8, 2006.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference from our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its Annual Meeting of Stockholders to be held on May 8, 2006.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Incorporated herein by reference from our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K with respect to its Annual Meeting of Stockholders to be held on May 8, 2006.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES
(a)
The following documents are filed as part of this Report
(1)(2) The financial statements indicated by Part II, Item 8, Financial Statements and Supplementary Data.
3.1
Articles of Incorporation and Articles of Amendment of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-11 (Registration Statement No. 33-73858, as amended (“Agree S-11”))
3.2
Bylaws of the Company (incorporated by reference to Exhibit 3.3 to Agree S-11)
4.1
Rights Agreement by and between Agree Realty Corporation and BankBoston, N.A. as Rights Agent dated as of December 7, 1998 (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed on December 7, 1998)
10.1
First Amended and Restated Agreement of Limited Partnership of Agree Limited Partnership, dated as of April 22, 1994, by and among the Company, Richard Agree, Edward Rosenberg and Joel Weiner (incorporated by reference to Exhibit 10.6 to the 1996 Form 10-K)
10.2
Amended and Restated Registration Rights Agreement, dated July 8, 1994 by and among the Company, Richard Agree, Edward Rosenberg and Joel Weiner (incorporated by reference to Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1994)
10.3
Contribution Agreement, dated as of April 21, 1994, by and among the Company, Richard Agree, Edward Rosenberg and the co-partnerships named therein (incorporated by reference to Exhibit 10.10 to the 1996 Form 10-K)
10.4
+
Agree Realty Corporation Profit Sharing Plan (incorporated by reference to Exhibit 10.13 to the 1996 Form 10-K)
10.5
Line of Credit Agreement by and among Agree Limited Partnership, the Company, the lenders parties thereto, and Michigan National Bank as Agent (incorporated by reference to Exhibit 10.10 to the 1995 Form 10-K)
10.6
First amendment to $5 million business loan agreement dated September 21, 1997 between Agree Limited Partnership and Michigan National Bank (incorporated by reference to Exhibit 10.2 to the September 1997 Form 10-Q)
10.7
Second amendment to amended and restated $5 million business Loan agreement dated October 19, 1998 between Agree Limited Partnership and Michigan National Bank (incorporated by reference to Exhibit 10.17 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998)
10.8
+
Employment Agreement, dated July 1, 2004, by and between the Company and Richard Agree (incorporated by reference to exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ending June 30, 2004 (June 2004 Form 10-Q))
10.9
+
Employment Agreement, dated July 1, 2004, by and between the Company, and Kenneth R. Howe (incorporated by reference to exhibit 10.2 to the June 2004 Form 10-Q)
10.10
Third amendment to amended and restated $5 million business Loan agreement dated December 19, 1999 between Agree Limited Partnership and Michigan National Bank (incorporated by reference to exhibit 10.17 to the 1999 Form 10-K)
10.11
Trust Mortgage dated as of June 27, 1999 from Agree Facility No. 1, L.L.C. as Grantor to Manufacturers and Traders Trust Company (incorporated by reference to exhibit 10.4 to the June 1999 Form 10-Q)
10.12
+
Employment Agreement, dated January 10, 2000, by and between the Company, and David J. Prueter (incorporated by reference to exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2000
10.13
Fourth amendment to amended and restated $5 million business Loan agreement dated February 19, 2001 between Agree Limited Partnership and Michigan National Bank (incorporated by reference to exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000 (the “2000 Form 10-K”))
10.14
Mortgage dated as of December 20, 2001, by Agree Limited Partnership to and in favor of Nationwide Life Insurance Company (incorporated by reference to exhibit 10.25 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001 (the “2001 from 10-K))
10.15
Fifth amendment to amended and restated $5 million business Loan agreement dated April 30, 2002 between Agree Limited Partnership and Standard Federal Bank (incorporated by reference to exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2002 (the “June 2002 Form 10-Q”))
10.16
Project Loan Agreement dated as of April 30, 2002 between Royal Identify Company (together with its successors and assigns) and Lawrence Store No. 203 L.L.C. (together with its permitted successors and assigns) (incorporated by reference to exhibit 10.2 to the June 2002 Form 10-Q)
10.17
Project Loan Agreement dated as of November 25, 2002 between Wilmington Trust Company, not in its individual capacity, but solely as Owner Trustee, and Indianapolis Store No. 16 L.L.C. (incorporated by reference to exhibit 10.28 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 (the “2002 Form 10-K”))
10.18
Project Loan Agreement dated as of January 30, 2003 between Modern Woodman of America and Phoenix Drive L.L.C. (incorporated by reference to exhibit 10.1 to the March 31, 2003 Form 10-Q)
10.19
Sixth amendment to amended and restated $5 million business loan agreement dated April 30, 2003, between Agree Limited Partnership and Standard Federal Bank (incorporated by reference to exhibit 10.1 to the June 30, 2003 Form 10-Q)
10.20
Amended and Restated $50 million Line of Credit agreement dated November 5, 2003, among Agree Realty Corporation, Standard Federal Bank and Bank One. (incorporated by reference to exhibit 10.1 to the Sep 30, 2003 Form 10-Q)
10.21
Indemnity Deed of Trust and Security Agreement dated October 31, 2003, by Agree - Columbia Crossing Project, L.L.C., and Nationwide Life Insurance Company (incorporated by reference to exhibit 10.33 to the December 31, 2003 Form 10-K)
10.22
Indemnity Deed of Trust and Security Agreement dated October 31, 2003, by Agree-Milestone Center Project, L.L.C., and Nationwide Life Insurance Company (incorporated by reference to exhibit 10.34 to the December 31, 2003 Form 10-K)
10.23
Mortgage and Security Agreement dated October 31, 2003, by Oklahoma Store No. 151, L.L.C. and Nationwide Life Insurance Company (incorporated by reference to exhibit 10.35 to the December 31, 2003 From 10-K)
10.24
Deed of Trust and Security Agreement dated October 31, 2003, by Omaha Store No. 166, L.L.C. and Nationwide Life Insurance Company (incorporated by reference to exhibit 10.36 to the December 31, 2003 Form 10-K)
10.25
+
The Company’s 2005 Equity Incentive Plan
10.26
+
Employment Agreement, dated August 1, 2005, by and between the Company, and Charles Carter (incorporated by reference to exhibit 10.1 to the September 2005 Form 10-Q)
10.27
+
Employment Agreement, dated September 1, 2005, by and between the Company, and Vicky Umphryes (incorporated by reference to exhibit 10.2 to the September 2005 Form 10-Q)
21.1
*
Subsidiaries of Agree Realty Corporation
*
Consent of BDO Seidman, LLP
31.1
*
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Richard Agree, Chief Executive Officer
SIGNATURES
PURSUANT to the requirements of Section 13 or 15 (d) 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.
PURSUANT to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 16th day of March 2006.
By:
/s/ Richard Agree
By:
/s/ Farris G. Kalil
Richard Agree
Farris G. Kalil
President and Chairman of the
Director
Board of Directors
(Principal Executive Officer)
By:
/s/ Michael Rotchford
Michael Rotchford
Director
By:
/s/ Kenneth R. Howe
By:
/s/Ellis G. Wachs
Kenneth R. Howe
Ellis G. Wachs
Vice President, Finance and
Director
Secretary
(Principal Financial and
Accounting Officer)
By:
/s/ Gene Silverman
Gene Silverman
Director
By:
/s/ Leon M. Schurgin
Leon M. Schurgin
Director
Agree Realty Corporation
Financial Statements
Years Ended December 31, 2005, 2004 and 2003
Agree Realty Corporation
Index
F - 1
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Owners of
Agree Realty Corporation
Farmington Hills, Michigan
We have audited the accompanying consolidated balance sheets of Agree Realty Corporation (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. We have also audited the schedule listed in the accompanying index. These financial statements and the schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and the schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and the schedule, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and the schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Agree Realty Corporation at December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board, the effectiveness of Agree Realty Corporation’s internal control over financial reporting as of December 31, 2005, based on criteria established in “Internal Control - Integrated Framework”, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 15, 2006 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effectiveness of internal control over financial reporting.
BDO SEIDMAN, LLP
Troy, Michigan
March 15, 2006
F - 2
Agree Realty Corporation
Consolidated Balance Sheets
See accompanying notes to consolidated financial statements.
F - 3
Agree Realty Corporation
Consolidated Balance Sheets
See accompanying notes to consolidated financial statements.
F - 4
Agree Realty Corporation
Consolidated Statements of Income
See accompanying notes to consolidated financial statements.
F - 5
Agree Realty Corporation
Consolidated Statements of Stockholders’ Equity
See accompanying notes to consolidated financial statements.
F - 6
Agree Realty Corporation
Consolidated Statements of Cash Flows
See accompanying notes to consolidated financial statements.
F - 7
Agree Realty Corporation
Consolidated Statements of Cash Flows
See accompanying notes to consolidated financial statements.
F - 8
Agree Realty Corporation
Notes to Consolidated Financial Statements
1. The Company
Agree Realty Corporation (the Company) is a self-administered, self-managed real estate investment trust, which develops, acquires, owns and operates properties, which are primarily leased to national and regional retail companies under net leases. At December 31, 2005 the Company’s properties are comprised of forty-seven single tenant retail facilities and twelve shopping centers located in fifteen states. At December 31, 2005, approximately 96% of the Company’s annual base rental revenues will be received from national and regional tenants under long-term leases, including approximately 33% from Borders, Inc., 21% from Walgreen Co., and 13% from Kmart Corporation, a wholly owned subsidiary of Sears Holdings Corporation
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements of Agree Realty Corporation include the accounts of the Company, its majority-owned partnership, Agree Limited Partnership (the Operating Partnership), and its wholly-owned subsidiaries. The Company controlled, as the sole general partner, 91.96% and 90.59% of the Operating Partnership as of December 31, 2005 and 2004, respectively. All material intercompany accounts and transactions are eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles, 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.
Fair Values of Financial Instruments
The carrying amounts of the Company’s financial instruments, which consist of cash, cash equivalents, receivables, notes payable, accounts payable and long-term debt, approximate their fair values.
F - 9
Agree Realty Corporation
Notes to Consolidated Financial Statements
Valuation of Long-Lived Assets
Long-lived assets such as real estate investments are evaluated for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows from the use of these assets. When any such impairment exists, the related assets will be written down to fair value. No impairment loss recognition has been required through December 31, 2005.
Real Estate Investments
Real estate assets are stated at cost less accumulated depreciation. All costs related to planning, development and construction of buildings prior to the date they become operational, including interest and real estate taxes during the construction period, are capitalized for financial reporting purposes and recorded as “Property under development” until construction has been completed.
Subsequent to completion of construction, expenditures for property maintenance are charged to operations as incurred, while significant renovations are capitalized. Depreciation of the buildings is recorded on the straight-line method using an estimated useful life of forty years.
Cash and Cash Equivalents
Cash and cash equivalents include cash and money market accounts.
F - 10
Agree Realty Corporation
Notes to Consolidated Financial Statements
Accounts Receivable - Tenants
Accounts receivable from tenants reflect primarily reimbursement of specified common area expenses. The Company determines its allowance for uncollectible accounts based on historical trends, existing economic conditions, and known financial position of its tenants. Tenant accounts receivable are written-off by the Company only when receipt is remote.
Unamortized Deferred Expenses
Deferred expenses are stated net of total accumulated amortization. The nature and treatment of these capitalized costs are as follows: (1) financing costs, consisting of expenditures incurred to obtain long-term financing, are being amortized using the interest method over the term of the related loan, and (2) leasing costs, which are amortized on a straight-line basis over the term of the related lease.
Other Assets
The Company records prepaid expenses, deposits, vehicles, furniture and fixtures, leasehold improvements, acquisition advances and miscellaneous receivables as other assets in the accompanying balance sheets.
Accounts Payable - Capital Expenditures
Included in accounts payable are amounts related to the construction of buildings. Due to the nature of these expenditures, they are reflected in the statements of cash flows as a financing activity.
F - 11
Agree Realty Corporation
Notes to Consolidated Financial Statements
Minority Interest
This amount represents the limited partners’ interest (OP Units) of 8.04% and 9.41% (convertible into 637,547 shares) in the Operating Partnership as of December 31, 2005 and 2004, respectively.
Revenue Recognition
Minimum rental income attributable to leases is recorded when due from tenants. Certain leases provide for additional percentage rents based on tenants’ sales volume. These percentage rents are recognized when determinable by the Company. In addition, leases for certain tenants contain rent escalations and/or free rent during the first several months of the lease term; however, such amounts are not material.
Operating Cost Reimbursement
Substantially all of the Company’s leases contain provisions requiring tenants to pay as additional rent a proportionate share of operating expenses such as real estate taxes, repairs and maintenance, insurance, etc. The related revenue from tenant billings is recognized in the same period the expense is recorded.
Income Taxes
The Company elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the Code), and began operating as such on April 22, 1994. As a result, the Company is not subject to federal income taxes to the extent that it distributes annually at least 90% of its taxable income to its shareholders and satisfies certain other requirements defined in the Code. Accordingly, no provision was made for federal income taxes in the accompanying consolidated financial statements.
Stock Options
The Company has elected to adopt the recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation (SFAS 123) using the prospective method beginning January 1, 2003. SFAS 123 establishes a fair value based method of accounting for stock-based compensation plans under which employees receive shares of stock or other equity instruments of the Company or the Company incurs liabilities to employees in amounts based on the price of its stock. No stock options were granted during 2005, 2004 or 2003 and there was no expense for stock options that would be required.
F - 12
Agree Realty Corporation
Notes to Consolidated Financial Statements
Dividends
The Company declared dividends of $1.96, $1.95 and $1.94 per share during the years ended December 31, 2005, 2004, and 2003; the dividends have been reflected for federal income tax purposes as follows:
The aggregate federal income tax basis of Real Estate Investments is approximately $22.8 million less than the financial statement basis.
Discontinued Operations
In October 2003, the Company completed the sale of a shopping center for approximately $8.5 million and recognized a gain of approximately $740,000, net of minority interest. The shopping center was anchored by Kmart Corporation and Kash N Karry and was located in Winter Garden, Florida. In August 2004, the Company completed the sale of a single tenant property for approximately $2.2 million and recognized a gain of approximately $523,000, net of minority interest. The property was leased to Kmart Corporation and was located in Perrysburg, Ohio. In November 2005 the Company completed the sale of a shopping center for approximately $8.8 million and recognized a gain of approximately $2,654,000, net of minority interest. The shopping center was anchored by Kmart Corporation and Roundy’s Foods and was located in Iron Mountain, Michigan. The gain on sale and results of operations for these properties are presented as discontinued operations in the Company’s consolidated statements of income.
The revenues from the properties were $864,113, $1,125,842 and $2,127,069 for the years ended December 31, 2005, 2004 and 2003, respectively. The expenses for the properties were $377,960, $600,391 and $1,037,857, including minority interest charges of $43,137, $54,708 and $140,646, for the years ended December 31, 2005, 2004 and 2003, respectively.
F - 13
Agree Realty Corporation
Notes to Consolidated Financial Statements
Early Extinguishment of Debt
In August 2003, the Company repaid three mortgages totaling approximately $37,000,000 prior to their scheduled maturity. In connection with this transaction, the Company incurred a pre-payment penalty of $555,000 and wrote-off unamortized mortgage costs in the amount of $406,000.
Earnings Per Share
Earnings per share reflected in the consolidated statements of income are presented for all periods in accordance with SFAS No. 128, “Earnings per Share”. In connection therewith, any conversion of OP Units to common stock would have no effect on the earnings per share calculation since the allocation of earnings to an OP Unit is equivalent to earnings allocated to a share of common stock.
The following table sets forth the computation of basic and diluted earnings per share:
F - 14
Agree Realty Corporation
Notes to Consolidated Financial Statements
Recent Accounting Pronouncements
In December 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 123(R), to expand and clarify SFAS No. 123 in several areas. The Statement requires companies to measure the cost of employee services received in exchange for an award of an equity instrument based on the grant-date fair value of the award. The cost is recognized over the requisite service period (usually the vesting period) for the estimated number of instruments where service is expected to be rendered. This Statement is effective for the interim reporting periods beginning after December 15, 2005. We do not expect that our financial statements will be materially impacted by SFAS No. 123(R).
In December 2004, the FASB issued Statement No. 153, Exchanges of Non-monetary Assets - An amendment of APB Opinion No. 29 (“SFAS No. 153”). The guidance in APB Opinion No. 29, Accounting for Non-monetary Transactions is based on the principle that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion No. 29 to eliminate the exception for non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005.
F - 15
Agree Realty Corporation
Notes to Consolidated Financial Statements
The impact of adopting this statement did not have a material impact on the Company’s financial position or results of operations.
In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (“FIN 47”). FIN 47 requires an entity to recognize a liability for a conditional asset retirement obligation when incurred if the liability can be reasonably estimated. FIN 47 clarifies that the term “Conditional Asset Retirement Obligation” refers to a legal obligation (pursuant to existing laws or by contract) to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 was effective no later than fiscal years ended after December 15, 2005. The Company adopted FIN 47 as required effective December 31, 2005 and the initial application of FIN 47 did not have a material impact on the Company’s financial position or results of operations.
In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 also requires that a change in method of depreciation, amortization , or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, but does not change the transaction provisions of any existing accounting pronouncements, including those that are in a transaction phase as of the effective date of SFAS No. 154. The adoption of SFAS No. 154 will not have a material effect on our results of operations or our financial position.
F - 16
Agree Realty Corporation
Notes to Consolidated Financial Statements
F - 17
Agree Realty Corporation
Notes to Consolidated Financial Statements
Future scheduled annual maturities of mortgages payable for years ending December 31 are as follows: 2006 - $2,369,315; 2007 - $2,592,435; 2008 - $2,749,772; 2009 - $2,937,232; 2010 - $3,137,505 and $36,935,661 thereafter.
F - 18
Agree Realty Corporation
Notes to Consolidated Financial Statements
4. Notes Payable
The Operating Partnership has in place a $50 million line-of-credit agreement, which is guaranteed by the Company. The agreement expires in November 2006 and can be extended, solely at the option of the Operating Partnership, for an additional three years. Advances under the Credit Facility bear interest within a range of one-month to six-month LIBOR plus 150 basis points to 213 basis points or the bank’s prime rate, at the option of the Company, based on certain factors such as debt to property value and debt service coverage. Our borrowing under the agreement is limited to a percentage of our borrowing base value. In addition, we must maintain certain leverage and debt service coverage ratios, maintain our adjusted net worth at a minimum level, maintain our tax status as a REIT, and distribute no more than 95% of our adjusted funds from operations. The Credit Facility is used to fund property acquisitions and development activities and is secured by most of the Company’s Properties which are not otherwise encumbered and properties to be acquired or developed. At December 31, 2005 and 2004, $17,000,000 and $39,000,000, respectively, was outstanding under this facility with a weighted average interest rate of 6.35% and 3.77%, respectively.
In addition, the Company maintains a $5,000,000 line-of-credit agreement with a bank. Monthly interest payments are required, either at the bank’s prime rate less 50 basis points, or 175 basis points in excess of the one-month LIBOR rate, at the option of the Company. The line-of-credit is secured by Second Leasehold Mortgages, Assignments of Leases and Rents, Security Agreements and Fixture Financing Statements of the properties securing the $50 million Credit Facility, At December 31, 2005 and 2004, $500,000 and $200,000, respectively, was outstanding under this agreement with a weighted average interest rate of 6.75% and 4.75%, respectively.
5. Dividends and Distributions Payable
On December 5, 2005 the Company declared a dividend of $.49 per share for the quarter ended December 31, 2005. The holders of OP Units were entitled to an equal distribution per OP Unit held as of December 31, 2005. The dividends and distributions payable are recorded as liabilities in the Company’s balance sheet at December 31, 2005. The dividend has been reflected as a reduction of stockholders’ equity and the distribution has been reflected as a reduction of the limited partners’ minority interest. These amounts were paid on January 5, 2006.
F - 19
Agree Realty Corporation
Notes to Consolidated Financial Statements
6. Minority Interest
The following summarizes the changes in minority interest since January 1, 2003:
7. Stock Incentive Plan
The Company established a stock incentive plan in 1994 (the 1994 Plan) under which options were granted. The options, which have an exercise price equal to the initial public offering price ($19.50/share), can be exercised in increments of 25% on each anniversary of the date of the grant, and expire upon employment termination. There were 4,900, 4,900 and 23,275 options outstanding and exercisable at December 31, 2005, 2004 and 2003, respectively. There were 18,375 options exercised in 2004. No options were granted during 2005, 2004 or 2003. In 2005, our stockholders approved the 2005 Equity Incentive Plan (the 2005 Plan) which replaced the 1994 Plan. The 2005 Plan authorizes the issuance of a maximum of one million shares of common stock.
F - 20
Agree Realty Corporation
Notes to Consolidated Financial Statements
8. Unearned Compensation -Restricted Stock
As part of the Company’s 2005 Equity Incentive Plan, restricted common shares are granted to certain employees. On the date of the award, the Company increases unearned compensation - restricted stock on the balance sheet by the stock price multiplied by the number of shares awarded. The Company issued 73,000, 41,126 and 36,814 shares of restricted stock and an average price of $30.26, $25.51 and $16.90 per share for the years ended December 31, 2005, 2004 and 2003 respectively. The Company redeemed 4,000, 6,000 and 6,000 shares of restricted stock during the years ended December 31, 2005, 2004 and 2003 respectively. No awards were forfeited during 2005, 2004 or 2003. The restricted shares vest and are charged to expense in increments of 20% per year for five years. The Company incurred compensation expense related to restricted shares of $656,112, $546,345 and $367,910 for the years ended December 31, 2005, 2004 and 2003 respectively. At December 31, 2005 there were 922,100 shares available to be issued under the 2005 Equity Incentive Plan. Plan participants are entitled to receive the quarterly dividends on their respective restricted shares.
9. Profit-Sharing Plan
The Company has a discretionary profit-sharing plan whereby it contributes to the plan such amounts as the Board of Directors of the Company determines. The participants in the plan cannot make any contributions to the plan. Contributions to the plan are allocated to the employees based on their percentage of compensation to the total compensation of all employees for the plan year. Participants in the plan become fully vested after six years of service. No contributions were made to the plan in 2005, 2004 or 2003.
10. Rental Income
The Company leases premises in its properties to tenants pursuant to lease agreements, which provide for terms ranging generally from 5 to 25 years. The majority of leases provide for additional rents based on tenants’ sales volume.
F - 21
Agree Realty Corporation
Notes to Consolidated Financial Statements
As of December 31, 2005, the future minimum rentals for the next five years from rental property under the terms of all noncancellable tenant leases, assuming no new or renegotiated leases are executed for such premises, are as follows (in thousands):
Of these future minimum rentals, approximately 37% of the total is attributable to Borders, Inc., approximately 32% of the total is attributable to Walgreen and approximately 10% is attributable to Kmart Corporation a wholly owned subsidiary of Sears Holdings Corporation. Borders is a major operator of book superstores in the United States, Walgreen operates in the national drugstore chain industry and Kmart’s principal business is general merchandise retailing through a chain of discount department stores. The loss of any of these anchor tenants or the inability of any of them to pay rent could have an adverse effect on the Company’s business.
11. Lease Commitments
The Company has entered into certain land lease agreements for four of its properties. As of December 31, 2005, future annual lease commitments under these agreements are as follows:
F - 22
Agree Realty Corporation
Notes to Consolidated Financial Statements
12. Interim Results (Unaudited)
The following summary represents the unaudited results of operations of the Company, expressed in thousands except per share amounts, for the periods from January 1, 2004 through December 31, 2005. Certain amounts have been reclassified to conform to the current presentation of discontinued operations:
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Agree Realty Corporation
Notes to Consolidated Financial Statements
13. Deferred Revenue
In July 2004, our tenant in two joint venture properties located in Ann Arbor, MI and Boynton Beach, FL repaid $13.8 million that had been contributed by our joint venture partner. As a result of this repayment the Company became the sole member of the limited liability companies holding the properties. Total assets of the two properties were approximately $13.8 million. We have treated the $13.8 million repayment of the capital contribution as deferred revenue and accordingly, will recognize rental income over the term of the related leases.
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Agree Realty Corporation
Schedule III - Real Estate and Accumulated Depreciation
December 31, 2004
Agree Realty Corporation
Schedule III - Real Estate and Accumulated Depreciation
December 31, 2004
3)
Tax Basis of Buildings and Improvements
The aggregate cost of Building and Improvements for federal income tax purposes is approximately $22,816,000 less than the cost basis used for financial statement purpose.
Exhibit Index
*
Filed herewith
+
Management contract or compensatory plan or arrangement