UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2012
For the transition period from to
Commission File Number: 001-13545 (Prologis, Inc.) 001-14245 (Prologis, L.P.)
Prologis, Inc.
Prologis, L.P.
(Exact name of registrant as specified in its charter)
Maryland (Prologis, Inc.)
Delaware (Prologis, L.P.)
94-3281941 (Prologis, Inc.)
94-3285362 (Prologis, L.P.)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
(415) 394-9000
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
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 for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website; if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter periods that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Prologis, Inc.:
Prologis, L.P.:
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
The number of shares of Prologis, Inc.’s common stock outstanding as of May 1, 2012 was approximately 460,398,400.
EXPLANATORY NOTE
This report combines the quarterly reports on Form 10-Q for the period ended March 31, 2012 of Prologis, Inc. and Prologis, L.P. Unless stated otherwise or the context otherwise requires, references to “Prologis, Inc.” or the “REIT”, mean Prologis, Inc., and its consolidated subsidiaries; and references to “Prologis, L.P.” or the “Operating Partnership” mean Prologis, L.P., and its consolidated subsidiaries. The terms “the Company”, “Prologis”, “we”, “our” or “us” means the REIT and the Operating Partnership collectively.
Prologis, Inc. is a real estate investment trust and the general partner of the Operating Partnership. As of March 31, 2012, the REIT owned an approximate 99.56% common general partnership interest in the Operating Partnership and 100% of the preferred units in the Operating Partnership. The remaining approximate 0.44% common limited partnership interest is owned by non-affiliated investors and certain current and former directors and officers of the REIT. As the sole general partner of the Operating Partnership, the REIT has full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Operating Partnership.
We operate the REIT and the Operating Partnership as one enterprise. The management of the REIT consists of the same members as the management of the Operating Partnership. These members are officers of the REIT and employees of the Operating Partnership or one of its direct or indirect subsidiaries. As general partner with control of the Operating Partnership, the REIT consolidates the Operating Partnership for financial reporting purposes, and the REIT does not have significant assets other than its investment in the Operating Partnership. Therefore, the assets and liabilities of the REIT and the Operating Partnership are the same on their respective financial statements.
We believe combining the quarterly reports on Form 10-Q of the REIT and the Operating Partnership into this single report results in the following benefits:
enhances investors’ understanding of the REIT and the Operating Partnership by enabling investors to view the business as a whole in the same manner as management views and operates the business;
eliminates duplicative disclosure and provides a more streamlined and readable presentation since a substantial portion of the Company’s disclosure applies to both the REIT and the Operating Partnership; and
creates time and cost efficiencies through the preparation of one combined report instead of two separate reports.
We believe it is important to understand the few differences between the REIT and the Operating Partnership in the context of how we operate as an interrelated consolidated company. The REIT’s only material asset is its ownership of partnership interests in the Operating Partnership. As a result, the REIT does not conduct business itself, other than acting as the sole general partner of the Operating Partnership and issuing public equity from time to time. The REIT itself does not issue any indebtedness, but guarantees the unsecured debt of the Operating Partnership. The Operating Partnership holds substantially all the assets of the business, directly or indirectly, and holds the ownership interests in the Company’s investment in certain investees. The Operating Partnership conducts the operations of the business and is structured as a partnership with no publicly traded equity. Except for net proceeds from equity issuances by the REIT, which are contributed to the Operating Partnership in exchange for partnership units, the Operating Partnership generates the capital required by the business through the Operating Partnership’s operations, its incurrence of indebtedness and the issuance of partnership units to third parties.
Noncontrolling interests, stockholders’ equity and partners’ capital are the main areas of difference between the consolidated financial statements of the REIT and those of the Operating Partnership. The noncontrolling interests in the Operating Partnership’s financial statements include the interests in consolidated investees not owned by the Operating Partnership. The noncontrolling interests in the REIT’s financial statements include the same noncontrolling interests at the Operating Partnership level, as well as the common limited partnership interests in the Operating Partnership, which are accounted for as partners’ capital by the Operating Partnership.
In order to highlight the differences between the REIT and the Operating Partnership, there are separate sections in this report, as applicable, that separately discuss the REIT and the Operating Partnership including separate financial statements, controls and procedures sections, and separate Exhibit 31 and 32 certifications. In the sections that combine disclosure of the REIT and the Operating Partnership, this report refers to actions or holdings as being actions or holdings of Prologis.
PROLOGIS
INDEX
PART I.
Item 1.
Financial Statements
Consolidated Balance Sheets - March 31, 2012 and December 31, 2011
Consolidated Statements of Operations - Three Months Ended March 31, 2012 and 2011
Consolidated Statements of Comprehensive Income - Three Months Ended March 31, 2012 and 2011
Consolidated Statement of Equity - Three Months Ended March 31, 2012
Consolidated Statements of Cash Flows - Three Months Ended March 31, 2012 and 2011
Consolidated Statement of Capital - Three Months Ended March 31, 2012
Prologis, Inc. and Prologis, L.P.:
Notes to Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Controls and Procedures
PART II.
Legal Proceedings
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Other Information
Exhibits
PART 1.
Item 1. Financial Statements
PROLOGIS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
ASSETS
Investments in real estate properties
Less accumulated depreciation
Net investments in real estate properties
Investments in and advances to unconsolidated investees
Notes receivable backed by real estate
Assets held for sale
Net investments in real estate
Cash and cash equivalents
Restricted cash
Accounts receivable
Other assets
Total assets
LIABILITIES AND EQUITY
Liabilities:
Debt
Accounts payable and accrued expenses
Other liabilities
Liabilities related to assets held for sale
Total liabilities
Equity:
Prologis, Inc. stockholders’ equity:
Preferred stock
Common stock; $0.01 par value; 460,359 shares issued and 459,555 shares outstanding at March 31, 2012 and 459,401 shares issued and 458,597 shares outstanding at December 31, 2011
Additional paid-in capital
Accumulated other comprehensive loss
Distributions in excess of net earnings
Total Prologis stockholders’ equity
Noncontrolling interests
Total equity
Total liabilities and equity
The accompanying notes are an integral part of these Consolidated Financial Statements.
1
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
Revenues:
Rental income
Private capital revenue
Development management and other income
Total revenues
Expenses:
Rental expenses
Private capital expenses
General and administrative expenses
Merger, acquisition and other integration expenses
Impairment of real estate properties
Depreciation and amortization
Other expenses
Total expenses
Operating income
Other income (expense):
Earnings from unconsolidated investees, net
Interest expense
Impairment of other assets
Interest and other income (expense), net
Gains on acquisitions and dispositions of investments in real estate, net
Foreign currency exchange and derivative gains (losses), net
Gain on early extinguishment of debt, net
Total other income (expense)
Earnings (loss) before income taxes
Current income tax expense
Deferred income tax expense
Total income tax expense
Earnings (loss) from continuing operations
Discontinued operations:
Income attributable to disposed properties and assets held for sale
Net gains on dispositions, net of taxes
Total discontinued operations
Consolidated net earnings (loss)
Net earnings attributable to noncontrolling interests
Net earnings (loss) attributable to controlling interests
Less preferred share dividends
Net earnings (loss) available for common stockholders
Weighted average common shares outstanding - Basic
Weighted average common shares outstanding - Diluted
Net earnings (loss) per share available for common stockholders - Basic:
Continuing operations
Discontinued operations
Net earnings (loss) per share available for common stockholders - Basic
Net earnings (loss) per share available for common stockholders - Diluted:
Net earnings (loss) per share available for common stockholders - Diluted
Dividends per common share
2
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Other comprehensive income (loss):
Foreign currency translation gains (losses), net
Unrealized gains and amortization on derivative contracts, net
Comprehensive income
Comprehensive (income) loss attributable to noncontrolling interests
Comprehensive income available for common stockholders
CONSOLIDATED STATEMENT OF EQUITY
Three Months Ended March 31, 2012
Balance as of January 1, 2012
Consolidated net earnings
Adjustment to the Merger purchase price allocation
Effect of common stock plans
Capital contributions, net of acquisitions
Distributions and allocations
Balance as of March 31, 2012
3
CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating activities:
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:
Straight-lined rents
Cost (settlement) of stock-based compensation awards, net
Changes in operating receivables and distributions from unconsolidated investees
Amortization of debt and lease intangibles
Non-cash merger expenses
Impairment of real estate properties and other assets
Net gains on dispositions, net of taxes, included in discontinued operations
Gains recognized on property acquisitions and dispositions, net
Unrealized foreign currency and derivative losses (gains), net
Increase in restricted cash, accounts receivable and other assets
Increase (decrease) in accounts payable and accrued expenses and other liabilities
Net cash provided by operating activities
Investing activities:
Real estate investments
Tenant improvements and lease commissions on previously leased space
Non-development capital expenditures
Net advances from (investments in and net advances to) unconsolidated investees
Return of investment from unconsolidated investees
Proceeds from dispositions of real estate properties
Proceeds from repayment of notes receivable
Investments in notes receivable backed by real estate and advances on other notes receivable
Acquisition of NAIF II, net of cash received
Net cash provided by investing activities
Financing activities:
Issuance of common stock, net
Dividends paid on common stock
Dividends paid on preferred stock
Noncontrolling interest contributions
Noncontrolling interest distributions
Debt and equity issuance costs paid
Payments on credit facilities, net
Proceeds from issuance of debt
Payments on debt
Net cash used in financing activities
Effect of foreign currency exchange rate changes on cash
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
See Note 16 for information on non-cash investing and financing activities and other information.
4
PROLOGIS, L.P.
LIABILITIES AND CAPITAL
Capital:
Partners’ capital:
General partner - preferred
General partner - common
Limited partners
Total partners’ capital
Total capital
Total liabilities and capital
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(In thousands, except per unit amounts)
Net (earnings) loss attributable to noncontrolling interests
Less preferred unit dividends
Net earnings (loss) available for common unitholders
Weighted average common units outstanding - Basic
Weighted average common units outstanding - Diluted
Net earnings (loss) per unit available for common unitholders - Basic:
Net earnings (loss) per unit available for common unitholders - Basic
Net earnings (loss) per unit available for common unitholders - Diluted:
Net earnings (loss) per unit available for common unitholders - Diluted
Distributions per common unit
6
Comprehensive income available for common unitholders
CONSOLIDATED STATEMENT OF CAPITAL
Effect of REIT’s common stock plans
Unrealized gain and amortization on derivative contracts, net
7
Cost (settlement) of REIT stock-based compensation awards, net
Net advances from (investments in and advances to) unconsolidated investees
Proceeds from issuance of common partnership units in exchange for contributions from the REIT, net
Distributions paid on common partnership units
Distributions paid on preferred units
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PROLOGIS, INC. AND PROLOGIS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Business. On June 3, 2011, AMB Property Corporation (“AMB”) and AMB Property, LP completed the merger contemplated by the Agreement and Plan of Merger with ProLogis, a Maryland real estate investment trust (“ProLogis”) and its subsidiaries (the “Merger”). Following the Merger, AMB changed its name to Prologis, Inc. (the “REIT”). As a result of the Merger, each outstanding common share of beneficial interest of ProLogis was converted into 0.4464 of a newly issued share of common stock of the REIT. As further discussed in Note 2, AMB was the legal acquirer and ProLogis was the accounting acquirer. As such, the period ended March 31, 2011 includes the historical results of ProLogis only. See Note 2 for further discussion on the Merger.
Prologis, Inc. commenced operations as a fully integrated real estate company in 1997, elected to be taxed as a real estate investment trust under the Internal Revenue Code of 1986, as amended, and believes the current organization and method of operation will enable the REIT to maintain its status as a real estate investment trust. The REIT is the general partner of Prologis, L.P. (the “Operating Partnership”). Through our controlling interest in the Operating Partnership, we are engaged in the ownership, acquisition, development and operation of industrial properties in global, regional and other distribution markets throughout the Americas, Europe and Asia. Our current business strategy includes two reportable business segments: Real Estate Operations and Private Capital. Our Real Estate Operations segment represents the long-term ownership of industrial properties. Our Private Capital segment represents the long-term management of co-investment ventures and other unconsolidated investees. See Note 15 for further discussion of our business segments. Unless otherwise indicated, the notes to the Consolidated Financial Statements apply to both the REIT and the Operating Partnership. The terms “the Company”, “Prologis”, “we”, “our” or “us” means the REIT and Operating Partnership collectively.
As of March 31, 2012, the REIT owned an approximate 99.56% common general partnership interest in the Operating Partnership, and 100% of the preferred units. The remaining approximate 0.44% common limited partnership interest is owned by non-affiliated investors and certain current and former directors and officers of the REIT. As the sole general partner of the Operating Partnership, the REIT has full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Operating Partnership. We operate the REIT and the Operating Partnership as one enterprise. The management of the REIT consists of the same members as the management of the Operating Partnership. These members are officers of the REIT and employees of the Operating Partnership or one of its direct or indirect subsidiaries. As general partner with control of the Operating Partnership, the REIT consolidates the Operating Partnership for financial reporting purposes, and the REIT does not have significant assets other than its investment in the Operating Partnership. Therefore, the assets and liabilities of the REIT and the Operating Partnership are the same on their respective financial statements.
Basis of Presentation. The accompanying consolidated financial statements, presented in the U.S. dollar, are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the date of the financial statements and revenue and expenses during the reporting period. Our actual results could differ from those estimates and assumptions. All material intercompany transactions with consolidated entities have been eliminated.
The accompanying unaudited interim financial information has been prepared according to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with such rules and regulations. Our management believes that the disclosures presented in these financial statements are adequate to make the information presented not misleading. In our opinion, all adjustments and eliminations, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for both the REIT and the Operating Partnership for the reported periods have been included. The results of operations for such interim periods are not necessarily indicative of the results for the full year. The accompanying unaudited interim financial information should be read in conjunction with the December 31, 2011 Consolidated Financial Statements of Prologis, as previously filed with the SEC on Form 10-K and other public information.
Certain amounts included in the accompanying Consolidated Financial Statements for 2011 have been reclassified to conform to the 2012 financial statement presentation.
Recent Accounting Pronouncements. In December 2011, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update that requires disclosures about offsetting and related arrangements to enable financial statements users to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including rights of setoff associated with certain financial instruments and derivative instruments. The disclosure requirements are effective for us on January 1, 2013, and we do not expect the guidance to have a material impact on our Consolidated Financial Statements.
In December 2011, the FASB issued an accounting standard update to clarify the scope of current U.S. GAAP. The update clarifies that the real estate sales guidance applies to the derecognition of a subsidiary that is in-substance real estate as a result of default on the subsidiary’s nonrecourse debt. That is, even if the reporting entity ceases to have a controlling financial interest under the consolidation guidance, the reporting entity would continue to include the real estate, debt, and the results of the subsidiary’s operations in its consolidated financial statements until legal title to the real estate is transferred to legally satisfy the debt. This accounting standard update is effective for fiscal years and interim periods within those years beginning after June 15, 2012. We do not expect the guidance to impact our Consolidated Financial Statements.
In September 2011, the FASB issued an accounting standard update to amend and simplify the rules related to testing goodwill for impairment. The update allows an entity to make an initial qualitative evaluation, based on the entity’s events and circumstances, to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The results of this qualitative assessment determine whether it is necessary to perform the currently required two-step impairment test. The new guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We adopted this standard as of January 1, 2012 and it has not had a material impact on our Consolidated Financial Statements.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In June 2011, the FASB issued an accounting standard update that eliminates the option to present components of other comprehensive income as part of the changes in stockholders’ equity, and requires the presentation of components of net income and other comprehensive income either in a single continuous statement or in two separate but consecutive statements. This accounting standard update is effective, on a retrospective basis, for interim and annual periods beginning after December 15, 2011. We adopted this standard as of January 1, 2012. As this standard is for presentation purposes only, it had no impact on our Consolidated Financial Statements.
In May 2011, the FASB issued an accounting standard update to amend the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements in order to achieve further convergence with International Financial Reporting Standards. We adopted the standard as of January 1, 2012, and the adoption of this standard was not considered material.
Merger of AMB and ProLogis
As discussed in Note 1, we completed the Merger on June 3, 2011. After consideration of all applicable factors pursuant to the business combination accounting rules, the Merger resulted in a reverse acquisition in which AMB was the “legal acquirer” because AMB issued its common stock to ProLogis shareholders and ProLogis was the “accounting acquirer” due to various factors, including the fact that ProLogis shareholders held the largest portion of the voting rights in the merged entity and ProLogis appointees represented the majority of the Board of Directors. In our Consolidated Financial Statements, the period ended March 31, 2011 includes the historical results of ProLogis only.
The purchase price allocation reflects aggregate consideration of approximately $5.9 billion. The allocation of the purchase price requires a significant amount of judgment. The allocation was based on our valuation, estimates and assumptions of the acquisition date fair value of the tangible and intangible assets and liabilities acquired. While the current allocation of the purchase price is substantially complete, the valuation of the real estate properties is in process of being finalized. We do not expect future revisions, if any, to have a significant impact on our financial position or results of operations.
Acquisition of ProLogis European Properties
During the second quarter of 2011, we increased our ownership of ProLogis European Properties (“PEPR”) through open market purchases and a mandatory tender offer. In May 2011, we settled our mandatory tender offer that resulted in the acquisition of an additional 96.5 million ordinary units and 2.7 million convertible preferred units of PEPR. During all of the second quarter of 2011, we made aggregate cash purchases totaling €715.8 million ($1.0 billion). We funded the purchases through borrowings under our global line of credit and a new €500 million bridge facility, which was subsequently repaid with proceeds from an equity offering in June 2011.
Upon completion of the tender offer, we met the requirements to consolidate PEPR. In accordance with the accounting rules for business combinations, we marked our equity investment in PEPR from carrying value to fair value of approximately €486 million, which resulted in the recognition of a gain of €59.6 million ($85.9 million). We refer to this transaction as the “PEPR Acquisition”. The fair value was based on the trading price for our previously owned units and our acquisition price for the PEPR units purchased during the tender offer period.
We have allocated the aggregate purchase price, representing the share of PEPR we owned at the time of consolidation of €1.1 billion ($1.6 billion). The allocation was based on our valuation, estimates and assumptions of the acquisition date fair value of the tangible and intangible assets and liabilities acquired. While the current allocation of the purchase price is substantially complete, the valuation of the real estate properties is being finalized. We do not expect future revisions, if any, to have a significant impact on our financial position or results of operations.
Pro forma Information (unaudited)
The following unaudited pro forma financial information presents our results as though the Merger and the PEPR Acquisition, as well as the equity offering in June 2011 that was used, in part, to repay the loans used to fund the PEPR Acquisition, had been consummated as of January 1, 2010. The pro forma information does not necessarily reflect the actual results of operations had the transactions been consummated at the beginning of the period indicated nor is it necessarily indicative of future operating results. The pro forma information does not give effect to any cost synergies or other operating efficiencies that could result from the Merger and also does not include any merger and integration expenses. The results for the three months ended March 31, 2011 included three months of pro forma adjustments for both the Merger and PEPR Acquisition.
(amounts in thousands, except per share amounts)
Net earnings (loss) available for stockholders
Net earnings (loss) per share available for common stockholders - basic
Net earnings (loss) per share available for common stockholders - diluted
10
These results include certain adjustments, primarily decreased revenues resulting from the amortization of the net asset from the acquired leases with favorable or unfavorable rents relative to estimated market rents, increased depreciation and amortization expense resulting from the adjustment of real estate assets to estimated fair value and recognition of intangible assets related to in-place leases and acquired management contracts and lower interest expense due to the accretion of the fair value adjustment of debt.
Acquisitions of Unconsolidated Co-Investment Ventures
On February 3, 2012, we acquired our partner’s 63% interest in and now own 100% of our previously unconsolidated co-investment venture Prologis North American Industrial Fund II (“NAIF II”) and we repaid the loan from NAIF II to our partner for a total of $336.1 million. The assets and liabilities of this venture, as well as the activity since the acquisition date, have been included in our Consolidated Financial Statements. In accordance with the accounting rules for business combinations, we marked our equity investment in NAIF II from its carrying value to the estimated fair value. The fair value was determined and allocated based on our valuation, estimates, and assumptions of the acquisition date fair value of the tangible and intangible assets and liabilities. The preliminary allocation of net assets acquired is approximately $1.6 billion in real estate assets, $36.6 million of net other assets, and $880.9 million in debt. We have not recorded a gain or loss with this transaction, as the carrying value of our investment was equal to the estimated fair value. We have substantially completed the purchase price allocation, and we do not expect future revisions, if any, to have a significant impact on our financial position or results of operations.
On February 22, 2012, we dissolved the unconsolidated co-investment venture Prologis California (“Prologis California”) and divided the portfolio equally with our partner. The net value of the assets and liabilities distributed represents the fair value of our ownership interest in the co-investment venture on that date. In accordance with the accounting rules for business combinations, we marked our equity investment in Prologis California from its carrying value to the estimated fair value which resulted in a gain of $273.0 million. The gain is recorded in Gains on Acquisitions and Dispositions of Investments in Real Estate, Net in the Consolidated Statements of Operations. The fair value was determined and allocated based on our valuation, estimates, and assumptions of the acquisition date fair value of the tangible and intangible assets and liabilities. The preliminary allocation of net assets acquired is approximately $496.3 million in real estate assets, $17.7 million of net other assets, and $150.0 million in debt. We have substantially completed the purchase price allocation, and we do not expect future revisions, if any, to have a significant impact on our financial position or results of operations.
We refer to these two transactions collectively as “Q1 Venture Acquisitions”.
Investments in real estate properties are presented at cost, and consist of the following (in thousands):
Industrial operating properties (1):
Improved land
Buildings and improvements
Development portfolio, including cost of land (2)
Land (3)
Other real estate investments (4)
Total investments in real estate properties
Net investments in properties
At March 31, 2012, excluding our assets held for sale, we owned real estate assets in the Americas (Canada, Mexico and the United States), Europe (Austria, Belgium, the Czech Republic, France, Germany, Hungary, Italy, the Netherlands, Poland, Romania, Slovakia, Spain, Sweden and the United Kingdom) and Asia (China, Japan and Singapore).
During the three months ended March 31, 2012, we recognized Gains on Acquisitions and Dispositions of Investments in Real Estate, Net in continuing operations of $267.8 million. This included a gain of $273.0 million related to the acquisition of our share of Prologis California (see Note 2 for further discussion of the Prologis California transaction).
11
See Note 6 for further discussion of properties we sold to third parties that are reported in discontinued operations.
During the three months ended March 31, 2012, we recorded an impairment charge of $16.1 million related to the land received in 2011 in exchange for a note receivable. This impairment was recorded in Impairment of Other Assets in our consolidated Financial Statements.
Summary of Investments
We have investments in entities through a variety of ventures. We co-invest in entities that own multiple properties with private capital investors and provide asset and property management services to these entities. We refer to these entities as co-investment ventures. Our ownership interest in these entities generally ranges from 10-50%. These entities may be consolidated or unconsolidated, depending on the structure, our partner’s rights and participation and our level of control of the entity. This Note details our unconsolidated co-investment ventures. See Note 10 for more detail regarding our consolidated investments.
We also have investments in joint ventures, generally with one partner and that we do not manage. We refer to our investments in the entities accounted for on the equity method, both unconsolidated co-investment ventures and other joint ventures, as unconsolidated investees.
Our investments in and advances to our unconsolidated investees are summarized below (in thousands):
Unconsolidated co-investment ventures
Other joint ventures
Totals
Unconsolidated Co-Investment Ventures
As of March 31, 2012, we had investments in and managed 13 unconsolidated co-investment ventures that own portfolios of operating industrial properties and may also develop properties. Private capital revenue includes revenues we earn for the management services we provide to unconsolidated investees and certain third parties. These fees are recognized as earned and may include property and asset management fees or transactional fees for leasing, acquisition, construction, financing, legal and tax services. We may also earn promote payments based on the third party investor returns over time. In addition, we may earn fees for services provided to develop a building within the co-investment venture. These are reflected as Development Management and Other Income in the Consolidated Statements of Operations.
Summarized information regarding our investments in the co-investment ventures is as follows (in thousands):
Earnings (loss) from unconsolidated co-investment ventures:
Americas
Europe
Asia
Total earnings from unconsolidated co-investment ventures, net
Private capital revenue and other income:
Total private capital revenue
Total
We completed the Merger and PEPR Acquisition in the second quarter of 2011. During the first quarter of 2012, we also acquired one of our unconsolidated co-investment venture and dissolved another, both located in the Americas. Therefore 2011 may not be comparable to 2012. See Note 2 for more information on these transactions.
Private capital revenues include fees and incentives we earn for services provided to our unconsolidated co-investment ventures (shown above), as well as fees earned from other unconsolidated investees and third parties of $1.0 million and $3.1 million during the three months ended March 31, 2012 and 2011, respectively.
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Information about our investments in the co-investment ventures is as follows (dollars in thousands):
Unconsolidated co-investment ventures by region
Summarized financial information of the co-investment ventures (for the entire entity, not our proportionate share) and our investment in such ventures is presented below (dollars in millions):
2012
For the three months ended March 31, 2012: (1)
Revenues
Net earnings (loss)
As of March 31, 2012:
Amounts due to (from) us (2)
Third party debt (3)
Noncontrolling interest
Venture partners’ equity
Our weighted average ownership (4)
Our investment balance (5)
Deferred gains, net of amortization (6)
2011
For the three months ended March 31, 2011:
As of December 31, 2011:
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Equity Commitments Related to Certain Unconsolidated Co-Investment Ventures
Certain unconsolidated co-investment ventures have equity commitments from us and our venture partners. We may fulfill our equity commitment through contributions of properties or cash. Our venture partners fulfill their equity commitment with cash. We are committed to offer to contribute certain properties that we develop and stabilize in select markets in Europe and Mexico to certain ventures. These ventures are committed to acquire such properties, subject to certain exceptions, including that the properties meet certain specified leasing and other criteria, and that the ventures have available capital. We are not obligated to contribute properties at a loss. Depending on market conditions, the investment objectives of the ventures, our liquidity needs and other factors, we may make contributions of properties to these ventures through the remaining commitment period.
The following table is a summary of remaining equity commitments as of March 31, 2012 (in millions):
Prologis Targeted U.S. Logistics Fund (1)
Prologis
Venture Partners
Prologis SGP Mexico (2)
Venture Partner
Europe Logistics Venture 1 (3)
Prologis China Logistics Venture 1
Other Joint Ventures
Our investments in and advances to these entities are as follows (in thousands):
Total investments in and advances to other joint ventures
14
The activity on the notes receivable backed by real estate for the three months ended March 31, 2012 is as follows (in thousands):
Balance as of December 31, 2011
Elimination upon acquisition of NAIF II
Accrued interest/(interest payments received), net
Held for Sale
As of March 31, 2012, we had land and nine operating properties that met the criteria to be classified as held for sale. The amounts included in held for sale as of March 31, 2012 primarily include real estate investment balances and the related assets and liabilities for each property.
Discontinued Operations
During the three months ended March 31, 2012, we disposed of land subject to ground leases and 70 operating properties aggregating 7.9 million square feet to third parties, most of which was included in Assets Held for Sale at December 31, 2011. During all of 2011, we disposed of land subject to ground leases and 94 properties aggregating 10.7 million square feet to third parties.
The operations of the properties held for sale or disposed of to third parties and the aggregate net gains recognized upon their disposition are presented as Discontinued Operations in our Consolidated Statements of Operations for all periods presented. Interest expense is included in discontinued operations only if it is directly attributable to these properties.
Discontinued operations are summarized as follows (in thousands):
Depreciation and amortization expense
Net gains on dispositions
Income tax on dispositions
The following information relates to properties disposed of during the periods presented and recorded as discontinued operations, including adjustments to previous dispositions for actual versus estimated selling costs (dollars in thousands):
Number of properties
Net proceeds from dispositions
Net gains from dispositions, net of taxes
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All debt is held directly or indirectly by the Operating Partnership. The REIT itself does not have any indebtedness, but guarantees the unsecured debt of the Operating Partnership. We generally do not guarantee the debt issued by consolidated subsidiaries in which we own less than 100%.
Our debt consisted of the following (dollars in thousands):
Credit Facilities
Senior notes
Exchangeable senior notes (2)
Secured mortgage debt
Secured mortgage debt of consolidated investees
Other debt of consolidated investees
Other debt
We have a global senior credit facility (“Global Facility”), where funds may be drawn in U.S. dollar, euro, Japanese yen, British pound sterling and Canadian dollar on a revolving basis. The loans cannot exceed $1.71 billion (subject to currency fluctuations). We may increase the Global Facility to $2.75 billion, subject to currency fluctuations and obtaining additional lender commitments. The Global Facility is scheduled to mature on June 3, 2015, but the Operating Partnership may, at its option and subject to the satisfaction of certain conditions and payment of an extension fee, extend the maturity date to June 3, 2016. Pricing under the Global Facility, including the spread over LIBOR, facility fees and letter of credit fees, varies based upon the public debt ratings of the Operating Partnership. The Global Facility contains customary representations, covenants and defaults (including a cross-acceleration to other recourse indebtedness of more than $50 million).
We also have a ¥36.5 billion (approximately $445 million at March 31, 2012) yen revolver (the “Revolver”). The Revolver matures on March 1, 2014, but we may, at our option and subject to the satisfaction of customary conditions and payment of an extension fee, extend the maturity date to February 27, 2015. We may increase availability under the Revolver to an amount not exceeding ¥56.5 billion (approximately $688.8 million at March 31, 2012) subject to obtaining additional lender commitments. Pricing under the Revolver is consistent with the Global Facility pricing. The Revolver contains certain customary representations, covenants and defaults that are substantially the same as the corresponding provisions of the Global Facility.
We refer to the Global Facility and the Revolver, collectively, as our “Credit Facilities”.
Commitments and availability under our Credit Facilities as of March 31, 2012 were as follows (dollars in millions):
Aggregate lender - commitments
Less:
Borrowings outstanding
Outstanding letters of credit
Current availability
Exchangeable Senior Notes
In connection with the Merger and exchange offer, our convertible senior notes became exchangeable senior notes issued by the Operating Partnership that are exchangeable into common stock of the REIT. As a result, the accounting for the exchangeable senior notes now requires us to separate the fair value of the derivative instrument (exchange feature) from the debt instrument and account for it separately as a derivative. We have determined that the exchangeable notes issued in 2010 are the only exchangeable notes where the fair value of the derivative is not zero at March 31, 2012, therefore this modification in accounting for the exchangeable notes only affected these notes. At each reporting period, we adjust the derivative instrument to fair value with the resulting adjustment being recorded in earnings as Foreign Currency Exchange and Derivative Gains (Losses), Net. The fair value of the derivative associated with our exchangeable notes was a liability of $44.3 million and $17.5 million at March 31, 2012 and December 31, 2011, respectively, and therefore, we have recognized an unrealized loss of $26.8 million for the three months ended March 31, 2012.
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Secured Mortgage Debt
TMK bonds are a financing vehicle in Japan for special purpose companies known as TMKs. In the first quarter of 2012, we issued ¥30.5 billion ($372 million as of March 31, 2012) TMK bonds with maturity dates ranging from March 2017 to March 2019 with interest rates ranging from 1.0% to 1.2%, and secured by three properties and with an undepreciated cost at March 31, 2012 of $528.9 million.
In the first quarter of 2012 in connection with the acquisition of NAIF II (see Note 2 for more details), we have assumed additional mortgage debt of $880.9 million, with maturity dates ranging from September 2012 to December 2018. Subsequent to the acquisition, we have paid down a portion of outstanding debt and reduced the balance to $728.7 million, secured by 90 properties with an undepreciated cost of $1.4 billion at March 31, 2012.
In the first quarter of 2012 in connection with the acquisition of our share of Prologis California (See Note 2 for more details), we assumed additional mortgage debt of $150.0 million payable in 2014 and secured by 24 properties with an undepreciated cost of $236.2 million at March 31, 2012.
Other Debt
On February 2, 2012, we entered into a senior term loan agreement where we may obtain loans in an aggregate amount not to exceed €487.5 million ($641.9 million at March 31, 2012). The loans can be obtained in U.S. dollar, euro, Japanese yen, and British pound sterling. We may increase the borrowings to approximately €987.5 million ($1.3 billion at March, 2012), subject to obtaining additional lender commitments. The loan agreement is scheduled to mature on February 2, 2014, but we may extend the maturity date three times at our option, in each case up to one year, subject to satisfaction of certain conditions and payment of an extension fee. We used the proceeds of the entire senior term loan to pay off the existing two term loans assumed in connection with the Merger and the remainder to pay down credit facilities.
Long-Term Debt Maturities
Principal payments due on our debt, for the remainder of 2012 and for each of the years in the ten-year period ending December 31, 2021 and thereafter are as follows (in millions):
Maturity
2012 (1) (2)
2013 (2)
2014
2015
2016
2017
2018
2019
2020
2021
Thereafter
Subtotal
Unamortized (discounts) premiums, net
Debt Covenants
Our debt agreements contain various covenants, including maintenance of specified financial ratios. As of March 31, 2012 we were in compliance with all covenants.
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Other liabilities consisted of the following, net of amortization, if applicable, as of March 31, 2012 and December 31, 2011 (in thousands):
Income tax liabilities
Tenant security deposits
Unearned rents
Lease intangible assets
Deferred income
Environmental
Value added tax and other tax liabilities
Other
Operating Partnership
For each share of common stock or preferred stock the REIT issues, the Operating Partnership issues a corresponding common or preferred partnership unit, as applicable, to the REIT in exchange for the contribution of the proceeds from the stock issuance. In addition, other third parties and certain current and former directors and officers of the REIT own common limited partnership units that make up approximately 0.44% of the common partnership units.
Preferred Stock of the REIT
We had the following preferred stock issued and outstanding (in thousands, except per share and par value data):
Series L Preferred stock at stated liquidation preference of $25 per share;
$0.01 par value; 2,000 shares
Series M Preferred stock at stated liquidation preference of $25 per share;
$0.01 par value; 2,300 shares
Series O Preferred stock at stated liquidation preference of $25 per share;
$0.01 par value; 3,000 shares
Series P Preferred stock at stated liquidation preference of $25 per share;
Series Q Preferred stock at stated liquidation preference of $50 per share;
Series R Preferred stock at stated liquidation preference of $25 per share;
$0.01 par value; 5,000 shares
Series S Preferred stock at stated liquidation preference of $25 per share;
Total preferred stock
The holders of the preferred stock have preference rights with respect to distributions and liquidation over the common stock and certain rights in the case of arrearage. Holders of the preferred stock are not entitled to vote on any matters, except under certain limited circumstances. The series L, M, O, P, R and S preferred stock are redeemable solely at our option, in whole or in part. The series Q preferred stock will be redeemable at our option on and after November 13, 2026.
We report noncontrolling interest related to several entities we consolidate but do not own 100% of the common equity. These entities include four real estate partnerships that have issued limited partnership units to third parties. Depending on the specific partnership agreements, these limited partnership units are exchangeable into shares of our common stock (or cash), generally at a rate of one share of common stock to one unit. We evaluated the noncontrolling interests with redemption provisions that permit the issuer to settle in either cash or common stock at the option of the issuer to determine whether temporary or permanent equity classification on the balance sheet is appropriate, including the requirement to settle in unregistered shares, and determined that these units meet the requirements to qualify for presentation as permanent equity.
We also consolidate several entities in which we do not own 100% but the units are not exchangeable into our common stock. If we contribute a property to a consolidated co-investment venture, the property is still reflected in our Consolidated Financial Statements, but due to our ownership of less than 100%, there is an increase in noncontrolling interest related to the contributed properties, which represents the cash we receive from our partners.
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REIT
The noncontrolling interest of the REIT includes the noncontrolling interests presented in the Operating Partnership, as well as the common limited partnership units in the Operating Partnership that are not owned by the REIT. As of March 31, 2012, the REIT owned approximately 99.56% of the common partnership units of the Operating Partnership.
The following is a summary of the noncontrolling interest and the consolidated entity’s total investment in real estate and debt at March 31, 2012 and December 31, 2011 (dollars in thousands):
Partnerships with exchangeable units (1)
Prologis Institutional Alliance Fund II
PEPR (2)
Mexico Fondo Logistico (AFORES)
Prologis AMS
Other consolidated entities
Operating Partnership noncontrolling interests
Limited partners in the Operating Partnership (3)
REIT noncontrolling interests
Under its incentive plans, Prologis had stock options and full value awards (restricted stock, restricted share units (“RSUs”) and performance based shares (“PSAs”)).
Summary of Activity
The activity for the three months ended March 31, 2012, with respect to our stock options, was as follows:
Balance at December 31, 2011
Exercised
Forfeited
Balance at March 31, 2012
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The activity for the three months ended March 31, 2012, with respect to our unvested restricted stock, was as follows:
Granted
Vested
The activity for the three months ended March 31, 2012, with respect to our RSU and PSA awards, was as follows:
Distributed
Forfeited/Expired
In the first quarter of 2012, we granted 1,523,222 RSUs, which will vest over three years. In addition, 39,005 PSAs were earned based on 2011 performance.
In connection with the Merger, we have incurred significant transaction, integration, and transitional costs. These costs include investment banker advisory fees; legal, tax, accounting and valuation fees; termination and severance costs (both cash and stock based compensation awards) for terminated and transitional employees; system conversion costs; and other integration costs. These costs are expensed as incurred, which in some cases will be through the end of 2012. Certain of these costs were obligations of AMB and expensed prior to the closing of the Merger by AMB. In addition, we have included costs associated with the acquisition of a controlling interest in PEPR and the reduction in workforce charges associated with dispositions made in 2011. The following is a breakdown of the costs incurred during the three months ended March 31:
Termination, severance and transitional employee costs
Professional fees
Office closure, travel and other costs
We determine basic earnings per share/unit based on the weighted average number of shares of common stock/units outstanding during the period. We compute diluted earnings per share/unit based on the weighted average number of shares outstanding combined with the incremental weighted average effect from all outstanding potentially dilutive instruments.
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The following table sets forth the computation of our basic and diluted earnings per share/unit (in thousands, except per share/unit amounts):
Noncontrolling interest attributable to exchangeable limited partnership units
Interest expense on exchangeable debt assumed exchanged
Adjusted net earnings (loss) available for common stockholders
Incremental weighted average effect on exchange of limited partnership units
Incremental weighted average effect of share awards
Incremental weighted average effect on exchange of certain exchangeable debt
Weighted average common shares outstanding - Diluted (3)
Net earnings (loss) per share available for common stockholders - Basic and Diluted
Adjusted net earnings (loss) available for common unitholders
Weighted average common partnership units outstanding - Basic
Weighted average common partnership units outstanding - Diluted (3)
Net earnings (loss) per unit available for common unitholders - Basic and Diluted
Derivative Financial Instruments
In the normal course of business, our operations are exposed to global market risks, including the effect of changes in foreign currency exchange rates and interest rates. To manage these risks, we may enter into various derivative contracts. We may use foreign currency contracts, including forwards and options, to manage foreign currency exposure. We may use interest rate swaps or caps to manage the effect of interest rate fluctuations. We do not use derivative financial instruments for trading purposes. The majority of our derivative financial instruments are customized derivative transactions and are not exchange-traded. Management reviews our hedging program, derivative positions, and overall risk management strategy on a regular basis. We only enter into transactions that we believe will be effective at offsetting the underlying risk.
Our use of derivatives does involve the risk that counterparties may default on a derivative contract. We establish exposure limits for each counterparty to minimize this risk and provide counterparty diversification. Substantially all of our derivative exposures are with counterparties that have long-term credit ratings of single-A or better. We enter into master agreements with counterparties that generally allow for netting of certain exposures; therefore, the actual loss we would recognize if all counterparties failed to perform as contracted would be significantly lower. To mitigate pre-settlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal.
All derivatives are recognized at fair value in our Consolidated Balance Sheets within the line items Other Assets or Accounts Payable and Accrued Expenses, as applicable. We do not net our derivative position by counterparty for purposes of balance sheet presentation and disclosure. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives are designated as, and qualify as, hedging instruments. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations.
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Changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recorded in Accumulated Other Comprehensive Loss in our Consolidated Balance Sheets. We reclassify changes in the fair value of derivatives into the applicable line item in our Consolidated Statements of Operations in which the hedged items are recorded in the same period that the underlying hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures hedged, fluctuations in the value of the derivative instruments will generally be offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized in earnings.
For derivatives that will be accounted for as hedging instruments in accordance with the accounting standards, we formally designate and document, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, we formally assess both at inception and at least quarterly thereafter, whether the derivatives used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. Any ineffective portion of a derivative financial instrument’s change in fair value is immediately recognized in earnings. Derivatives not designated as hedges are not speculative and are used to manage our exposure to foreign currency fluctuations but do not meet the strict hedge accounting requirements.
Our interest rate risk management strategy is to limit the impact of future interest rate changes on earnings and cash flows as well as to stabilize interest expense and manage our exposure to interest rate movements. To achieve this objective, we have entered into interest rate swap and cap agreements, which allow us to borrow on a fixed rate basis for longer-term debt issuances. The maximum length of time that we hedge our exposure to future cash flows is typically less than 10 years. We use cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in interest rates. We also have entered into interest rate swap agreements which allow us to receive variable-rate amounts from a counterparty in exchange for us making fixed-rate payments over the life of our agreements without the exchange of the underlying notional amount. We had 40 interest rate swap contracts, including 33 contracts denominated in euro, two contracts denominated in British pound sterling, four contracts denominated in Japanese yen and one contract denominated in U.S. dollar, outstanding at March 31, 2012. We also had one interest rate cap contract, denominated in Japanese yen, outstanding at March 31, 2012.
We had $32.5 million and $28.5 million accrued in Accounts Payable and Accrued Expenses in our Consolidated Balance Sheets relating to these unsettled derivative contracts at March 31, 2012 and December 31, 2011, respectively.
We recorded a loss of $0.9 million for ineffectiveness during the three months ended March 31, 2012. We did not have ineffectiveness during the three months ended March 31, 2011. The amount reclassified to interest expense for the three months ended March 31, 2012 was $2.6 million. The amount reclassified to interest expense for the three months ended March 31, 2011 is not considered material. Amounts included in Accumulated Other Comprehensive Loss in our Consolidated Balance Sheet at March 31, 2012 and December 31, 2011 were losses of $48.3 million and $51.7 million, respectively.
We typically designate our interest rate swap and interest rate cap agreements as cash flow hedges as these derivative instruments may be used to manage the interest rate risk on potential future debt issuances or to fix the interest rate on a variable rate debt issuance. The effective portion of the gain or loss on the derivative is reported as a component of Accumulated Other Comprehensive Loss (“AOCI”) in our Consolidated Balance Sheets, and reclassified to Interest Expense in the Consolidated Statements of Operations over the corresponding period of the hedged item. For the next twelve months from March 31, 2012, we estimate that an additional $14.2 million will be reclassified as interest expense. Losses on the derivative representing hedge ineffectiveness are recognized in Interest Expense at the time the ineffectiveness occurred.
The following table summarizes the activity in our derivative instruments (in millions) for the three months ended March 31:
Notional amounts at January 1
New contracts
Acquired contracts
Matured or expired contracts
Notional amounts at March 31
Fair Value Measurements
We have estimated the fair value of our financial instruments using available market information and valuation methodologies we believe to be appropriate for these purposes. Considerable judgment and a high degree of subjectivity are involved in developing these estimates and, accordingly, they are not necessarily indicative of amounts that we would realize upon disposition.
Fair Value Measurements on a Recurring and Non-recurring Basis
At March 31, 2012, other than the derivatives discussed above and in Note 7, we do not have any significant financial assets or financial liabilities that are measured at fair value on a recurring basis in our consolidated financial statements.
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Non-financial assets measured at fair value on a non-recurring basis in our consolidated financial statements consist of real estate assets and investments in and advances to unconsolidated investees that were subject to impairment charges. The fair value of these assets at March 31, 2012 was not considered material.
Fair Value of Financial Instruments
At March 31, 2012 and December 31, 2011, the carrying amounts of certain of our financial instruments, including cash and cash equivalents, accounts and notes receivable and accounts payable and accrued expenses were representative of their fair values due to the short-term nature of these instruments and the recent acquisition of these items.
At March 31, 2012 and December 31, 2011, the fair value of our senior notes and exchangeable senior notes, has been estimated based upon quoted market prices for the same (Level 1) or similar (Level 2) issues when current quoted market prices are available, the fair value of our Credit Facilities has been estimated by discounting the future cash flows using rates and borrowing spreads currently available to us (Level 3), and the fair value of our secured mortgage debt and assessment bonds that do not have current quoted market prices available has been estimated by discounting the future cash flows using rates currently available to us for debt with similar terms and maturities (Level 3). The fair value of our derivative financial instruments is determined through widely accepted valuation techniques, such as a discounted cash flow analysis on the expected cash flows and a Black Sholes option pricing model (Level 2). The differences in the fair value of our debt from the carrying value in the table below are the result of differences in interest rates and/or borrowing spreads that were available to us at March 31, 2012 and December 31, 2011, as compared with those in effect when the debt was issued or acquired. The senior notes and many of the issues of secured mortgage debt contain pre-payment penalties or yield maintenance provisions that could make the cost of refinancing the debt at lower rates exceed the benefit that would be derived from doing so.
The following table reflects the carrying amounts and estimated fair values of our debt (in thousands):
Debt:
Exchangeable senior notes
Total debt
Our business strategy currently includes two operating segments, as follows:
Real Estate Operations — representing the direct long-term ownership of industrial operating properties. Each operating property is considered to be an individual operating segment having similar economic characteristics that are combined within the reportable segment based upon geographic location. Also included in this segment is the development and acquisition of properties for continued direct ownership, including land held for development and properties currently under development and land we own and lease to customers under ground leases. We own real estate in the Americas (Canada, Mexico and the United States), Europe (Austria, Belgium, the Czech Republic, France, Germany, Hungary, Italy, the Netherlands, Poland, Romania, Slovakia, Spain, Sweden and the United Kingdom) and Asia (China, Japan and Singapore)
Private Capital — representing the long-term management of unconsolidated co-investment ventures and other joint ventures. We recognize fees and incentives earned for services performed on behalf of the unconsolidated investees and certain third parties. In connection with the Merger, we have reevaluated this segment to exclude our investments and earnings of all of our unconsolidated co-investment ventures to better align the segment with the way management evaluates this line of business. We have reclassified prior periods to reflect this change.
We report the costs associated with our private capital segment for all periods presented in the line item Private Capital Expenses in our Consolidated Statements of Operations. These costs include the direct expenses associated with the asset management of the property funds provided by individuals who are assigned to our private capital segment. In addition, in order to achieve efficiencies and economies of scale, all of our property management functions are provided by a team of professionals who are assigned to our real estate operations segment. These individuals perform the property-level management of the properties we own and the properties we manage that are owned by the unconsolidated investees. We allocate the costs of our property management function to the properties we consolidate (reported in Rental Expenses) and the properties owned by the unconsolidated investees (included in Private Capital Expenses), by using the square feet owned by the respective portfolios. We are further reimbursed by the co-investments ventures for certain expenses associated with managing these property funds.
Each entity we manage is considered to be an individual operating segment having similar economic characteristics that are combined within the reportable segment based upon geographic location. Our operations in the private capital segment are in the Americas (Brazil, Canada, Mexico and the United States), Europe (Belgium, the Czech Republic, France, Germany, Hungary, Italy, the Netherlands, Poland, Slovakia, Spain, Sweden and the United Kingdom) and Asia (China and Japan).
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We present the operations and net gains associated with properties sold to third parties or classified as held for sale as discontinued operations, which results in the restatement of prior year operating results to exclude the items presented as discontinued operations.
Reconciliations are presented below for: (i) each reportable business segment’s revenue from external customers to our Total Revenues; (ii) each reportable business segment’s net operating income from external customers to our Earnings (Loss) before Income Taxes; and (iii) each reportable business segment’s assets to our Total Assets. Our chief operating decision makers rely primarily on net operating income and similar measures to make decisions about allocating resources and assessing segment performance. The applicable components of our Total Revenues, Earnings (Loss) before Income Taxes and Total Assets are allocated to each reportable business segment’s revenues, net operating income and assets. Items that are not directly assignable to a segment, such as certain corporate income and expenses, are reflected as reconciling items. The following reconciliations are presented in thousands:
Real estate operations (1):
Total Real Estate Operations segment
Private capital (2):
Total Private Capital segment
Net operating income:
Real estate operations (3):
Private capital (2)(4):
Total segment net operating income
Reconciling items:
Impairment of goodwill and other assets
Gains on acquisitions and dispositions of investments in real estate, net (5)
Total reconciling items
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Assets:
Real estate operations:
Private capital (6):
Total segment assets
Investments in and advances to other unconsolidated investees
Non-cash investing and financing activities for the three months ended March 31, 2012 and 2011 are as follows:
See Note 2 for discussion on Q1 Venture Acquisitions.
During the three months ended March 31, 2012 and 2011, we capitalized portions of the total cost of our stock-based compensation awards of $2.1 million and $1.4 million, respectively, to the investment basis of our real estate or other assets.
In the first quarter of 2012, we received $2.5 million of ownership interests in certain unconsolidated investees as a portion of our proceeds from the contribution of properties to these entities.
The amount of interest paid in cash, net of amounts capitalized, for the three months ended March 31, 2012 and 2011 was $127.6 million and $68.2 million, respectively.
During the three months ended March 31, 2012 and 2011, cash paid for income taxes, net of refunds, was $9.8 million and $5.9 million, respectively.
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Litigation
In the normal course of business, from time to time, we and our unconsolidated investees are parties to a variety of legal proceedings arising in the ordinary course of business. We believe that, with respect to any such matters that we are currently a party to, the ultimate disposition of any such matter will not result in a material adverse effect on our business, financial position or results of operations.
In December 2011, arbitration hearings began in connection with a dispute related to a real estate development project known as Pacific Commons. The plaintiff, Cisco Technology, Inc. (“Cisco”), is seeking rescission of a 2007 Restructuring and Settlement Agreement (the “Contract”) and other agreements, and declaratory relief, and damages for breach of the Contract. Specifically, Cisco seeks (1) declaratory relief that Prologis owes certain Community Facilities District taxes that have been assessed against its land, following Cisco’s purchase of the land from Prologis through the exercise of option agreements; (2) declaratory relief that Prologis’ partial transfers of rights and obligations under the Contract to third parties are void; and (3) damages for alleged breaches of the Contract relating to the plans to build a baseball stadium at Pacific Commons. Although the total damages alleged by Cisco are approximately $200 million, we believe these claims are without merit and are defending these matters vigorously. Based on the facts and circumstances surrounding this dispute, we believe the low end of our range of loss is zero and therefore, in accordance with GAAP, we have not recorded any liability with respect to this matter as of March 31, 2012
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
We have reviewed the accompanying consolidated balance sheet of Prologis, Inc. and subsidiaries (the “Company”) as of March 31, 2012, the related consolidated statements of operations, comprehensive income and cash flows for the three-month periods ended March 31, 2012 and 2011, and the related consolidated statement of equity for the three-month period ended March 31, 2012. These consolidated financial statements are the responsibility of the Company’s management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Prologis, Inc. and subsidiaries as of December 31, 2011, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows for the year then ended (not presented herein); and in our report dated February 28, 2012, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2011, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
Denver, Colorado
May 7, 2012
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The Partners
We have reviewed the accompanying consolidated balance sheet of Prologis, L.P. and subsidiaries (the “Operating Partnership”) as of March 31, 2012, the related consolidated statements of operations, comprehensive income and cash flows for the three-month periods ended March 31, 2012 and 2011, and the related consolidated statement of capital for the three-month period ended March 31, 2012. These consolidated financial statements are the responsibility of the Operating Partnership’s management.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Prologis, L.P. and subsidiaries as of December 31, 2011, and the related consolidated statements of operations, comprehensive income (loss), capital, and cash flows for the year then ended (not presented herein); and in our report dated February 28, 2012, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2011, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our Consolidated Financial Statements and the related notes included in Item 1 of this report and our 2011 Annual Report on Form 10-K.
Certain statements contained in this discussion or elsewhere in this report may be deemed “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Words and phrases such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, “designed to achieve”, variations of such words and similar expressions are intended to identify such forward-looking statements, which generally are not historical in nature. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future—including statements relating to rent and occupancy growth, development activity and sales or contribution volume or profitability on such sales and contributions, economic and market conditions in the geographic areas where we operate and the availability of capital in existing or new co-investment ventures – are forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be attained and therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Many of the factors that may affect outcomes and results are beyond our ability to control. For further discussion of these factors see Part II, “Item 1A. Risk Factors” in our 2011 Annual Report on Form 10-K. References to “we”, “us” and “our” refer to ProLogis and its consolidated subsidiaries prior to the Merger (defined below) and to Prologis, Inc. and its consolidated subsidiaries following the Merger.
Management’s Overview
We are the leading global owner, operator and developer of industrial real estate, focused on global or regional markets across the Americas, Europe and Asia. As of March 31, 2012, we owned, or had investments in, on a consolidated basis or through unconsolidated ventures, properties and development projects totaling approximately 584 million square feet (54.3 million square meters) in 22 countries. These properties are leased to approximately 4,500 customers, including manufacturers, retailers, transportation companies, third-party logistics providers and other enterprises.
Of the approximately 584 million square feet of our owned and managed portfolio as of March 31, 2012:
approximately 537 million square feet were in our operating portfolio with a gross book value of $41.1 billion that were 92.3% occupied;
approximately 12 million square feet were in our development portfolio with a total expected investment of $1.4 billion and were 43.5% leased;
approximately 35 million square feet consisted of properties we manage on behalf of third parties, properties in which we have an ownership interest but do not manage and other properties we own; and
the largest customer and 25 largest customers accounted for 2.5% and 18.4%, respectively, of the annualized base rent of the combined portfolio.
Prologis, Inc. (the “REIT”) is a self-administered and self-managed real estate investment trust, and is the sole general partner of Prologis, L.P. (the “Operating Partnership”). We operate the REIT and the Operating Partnership as one enterprise, and, therefore, our discussion and analysis refers to the REIT and its consolidated subsidiaries, including the Operating Partnership, collectively.
Our current business strategy includes two operating segments: Real Estate Operations and Private Capital. We generate revenues, earnings, net operating income (calculated on rental income less rental expenses), and funds from operations (as defined below), and cash flows through our segments primarily through three lines of business, as follows:
Real Estate Operations Segment
Rental Operations—This represents the primary source of our core revenue, earnings and funds from operations (or FFO as defined below). We collect rent from our customers under operating leases, including reimbursements for the vast majority of our operating costs. We seek to generate long-term internal growth in rents by maintaining a high occupancy rate at our properties, by controlling expenses and through contractual rent increases on existing space and renewals on rollover space, thus capitalizing on the economies of scale inherent in owning, operating and growing a large global portfolio. Our rental income is diversified due to both our global presence and our broad customer base. We expect to increase overall rental income primarily through the leasing of space currently available in our properties. We believe that our regular maintenance programs, capital expenditure programs, energy management and sustainability programs create cost efficiencies that provide a benefit to our customers as well as the Company.
Capital Deployment Activities—Our development and re-development activities support our rental operations and are, therefore, included with that line of business for segment reporting. We develop and re-develop industrial properties primarily in global and regional markets to meet our customers’ needs. Within this line of business, we provide additional value creation by utilizing: (i) the land that we currently own in global and regional markets; (ii) the development expertise of our local personnel; (iii) our global customer relationships; and (iv) the demand for high quality distribution facilities in key markets. We seek to increase our rental income and the net asset value of the Company through the leasing of newly developed space, as well as through the acquisition of new properties. Depending on several factors, we may develop properties directly or in co-investment ventures for long-term hold, for contribution into one of our co-investment ventures, or for sale to third parties. Properties that we choose to contribute or sell may result in the recognition of gains or losses. Generally, in the U.S., Europe and Japan, we are developing directly while in emerging markets, such as Brazil, China and Mexico, we are developing with our private capital partners in a variety of co-investment ventures.
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Private Capital Segment -We co-invest in properties with private capital investors through a variety of co-investment ventures. We have a direct and long-standing relationship with a significant number of institutional investors. We tailor industrial portfolios to investors’ specific needs and deploy capital in both close-ended and open-ended fund structures and joint ventures, while providing complete portfolio management and financial reporting services. We generally own 10-50% in the ventures. We believe our co-investment in each of our ventures provides a strong alignment of interests with our co-investment partners’ interests. We generate revenues from our unconsolidated co-investment ventures by providing asset management and property management services. We may also earn revenues through additional services provided such as leasing, acquisition, construction, development, disposition, legal and tax services. Depending on the structure of the venture and the returns provided to our partners, we may also earn revenues through incentive returns or promotes. We believe our co-investment program with private capital investors will continue to serve as a source of capital for new investments and provide revenues for our stockholders, as well as mitigate risk associated with our foreign currency exposure. We expect to grow this business with the formation of new ventures and by raising additional third-party capital in our existing ventures.
On June 3, 2011, we completed a merger in which ProLogis shareholders received 0.4464 of a share of AMB Property Corporation (“AMB”) common stock for each outstanding common share of beneficial interest in ProLogis (the “Merger”). Following the Merger, AMB changed its name to Prologis, Inc. In the Merger, AMB was the legal acquirer and ProLogis was the accounting acquirer. In May 2011, we also acquired a controlling interest in and began consolidating ProLogis European Properties (“PEPR Acquisition”). Since the Merger and PEPR Acquisition did not occur until second quarter 2011, our results for the first quarter of 2011 do not reflect any impact from the Merger or the PEPR Acquisition. Therefore, period to period comparisons may not provide as meaningful information as if those transactions were reflected in both periods. See Note 2 to the Consolidated Financial Statements in Item 1 for more information relating to both the Merger and PEPR Acquisition.
At the time of the Merger, we established key strategic priorities to guide our path over the next two years. These priorities are:
to align our portfolio with our investment strategy while serving the needs of our customers;
to strengthen our financial position and build one of the top balance sheets in the real estate investment trust industry;
to streamline our private capital business and position it for substantial growth;
to improve the utilization of our low yielding assets; and
to build the most effective and efficient organization in the real estate investment trust industry and to become the employer of choice among top professionals interested in real estate as a career.
Align our Portfolio with our Investment Strategy
Subsequent to the Merger, we performed a comprehensive review of our owned and managed portfolio, and categorized the portfolio into three main segments—global, regional and other markets. As of March 31, 2012, global markets represented approximately 83% of our overall owned and managed platform (based on our share of net operating income of the properties) and regional markets represented 12% of our total owned and managed platform. We intend to hold only the highest quality class-A product in our regional markets. We also own a small number of assets in other markets, which account for 5% of our owned and managed platform and that we plan to exit from in an orderly fashion in the next few years. By segmenting our markets in this manner, we were able to construct a strategy that includes culling the portfolio for buildings and potentially submarkets that are no longer a strategic fit for the company. We expect to use the proceeds from dispositions to pay down debt and to recycle capital into new development projects or strategic acquisitions.
Strengthen our Financial Position
We intend to further strengthen our financial position by lowering our financial risk and currency exposure and building one of the strongest balance sheets in the real estate investment trust industry. We expect to lower our financial risk by reducing leverage and maintaining staggered debt maturities, which will provide us with more financial flexibility and allow continued access to debt capital markets. This financial flexibility will position us to capitalize on market opportunities across the entire business cycle as they become available. We will reduce our exposure to foreign currency exchange fluctuations by borrowing in local currency where appropriate, and we might also enter into derivative contracts to swap U.S. dollar denominated debt into obligations denominated in euro and yen. We expect to also lower our currency exposure by holding assets we own outside the U.S. primarily in co-investment ventures in which we maintain an ownership interest and provide services generating private capital revenue. We will accomplish this through contributions and sales to our existing and newly formed co-investment ventures. In addition, we expect that new development projects, particularly in emerging markets such as Brazil, China and Mexico, will be done in conjunction with our private capital partners.
Streamline Private Capital Business
We are rationalizing our private capital business in conjunction with our private capital investors. Some of our legacy co-investment ventures have fee structures that do not adequately compensate us for the services we provide. Also, some ventures have governance or decision making processes in place that we would like to change. Therefore, we may terminate or restructure certain of these co-investment ventures. In other cases, we may combine some co-investment ventures to gain operational efficiencies. In every case, however, we will work very closely with our partners and venture investors who will be active participants in these decisions. We plan to grow our private capital business with the deployment of the private capital commitments we have already raised, formation of new co-investment ventures and raising incremental capital for our existing co-investment ventures.
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Improve the Utilization of Our Low Yielding Assets
We plan to increase the value of our low yielding assets by stabilizing our operating portfolio to 95% leased, completing the build-out and lease-up of our development projects as well as monetizing our land through development or sale to third parties.
Build the most effective and efficient organization in the real estate investment trust industry and become the employer of choice among top professionals interested in real estate as a career
We have identified more than $115 million of Merger cost synergies on an annualized basis, as compared to the combined expenses of AMB and ProLogis on a pre-Merger basis. These synergies include gross general and administrative savings, reduced global line of credit facility fees and lower amortization of non real estate assets. We believe we have realized substantially all of these synergies already and expect to realize the full amount by the end of 2012. In addition, we are in the process of implementing a new enterprise wide system that will include a property management/billing system (implemented in April 2012), a human resources system, a general ledger and accounting system and a data warehouse. In connection with this implementation, we are striving to utilize the most effective global business processes with the enhanced system functionality. As of January 1, 2012, we implemented two new compensation plans that we believe will better align employees’ compensation to our performance. We believe these efforts and others will help us with the attainment of this objective.
Summary of 2012
During the three months ended March 31, 2012, we completed the following activities in support of our strategic priorities:
We rationalized two of our unconsolidated co-investment ventures by purchasing our partner’s interest in Prologis North America Fund II (“ NAIF II”) and dissolving Prologis California and dividing the portfolio equally with our partner (collectively “Q1 Venture Acquisitions”). These two transactions increased our real estate by $2.1 billion and debt by $1.4 billion. See Note 2 to our Consolidated Financial Statements in Item 1 for more details.
We generated aggregate proceeds of $715.4 million from the disposition of land and 70 properties to third parties and the contribution of one property to one of our co-investment ventures and used the proceeds to reduce our outstanding debt.
We began three development projects in the first quarter of 2012 aggregating 1.5 million square feet with a total expected investment of $211.0 million, including two projects (or 93% of the total expected investment) that were 100% leased prior to development.
We entered into a multi-currency senior term loan agreement and used the proceeds to pay off two outstanding term loans with the remainder used to pay down our credit facilities.
As of March 31, 2012, our total owned and managed portfolio, including both consolidated and unconsolidated properties, was 92.3% occupied and 92.7% leased as compared to 92.2% occupied and 92.5% leased at December 31, 2011.
Operational Outlook
U.S. industrial net absorption measured 25.2 million square feet in the first quarter of 2012, down slightly from 27.7 million square feet in the fourth quarter of 2011. Typically, the first quarter has less absorption. Net absorption has been positive for the last seven consecutive quarters, reducing the availability rate by 120 basis points during that time. At 13.4%, availability is at its lowest level since the second quarter of 2009. Net effective rent has made modest improvements, and as a result, some speculative development is beginning in selected locations with lower relative vacancy levels, such as South Florida, Southern California, New Jersey and Houston.
Though economic growth remains relatively moderate, inventories continue to rise, and utilization rates have been on an overall upward trajectory since late 2010. In the U.S., net absorption totaled more than 117 million square feet in 2011, representing a remarkable improvement over the past few years, and we continue to expect net absorption of 150—175 million square feet in 2012.
Within Europe and Japan, we believe significant supply chain reconfiguration, obsolescence and strong tenant preference to rent rather than own will fuel additional demand for industrial space. Moreover, the undersupply of Class-A distribution space in Japan has and will continue to create demand for more modern, earthquake-resistant product, especially as Japan rebuilds from the March 2011 earthquake and tsunami, which temporarily interrupted its supply chain. Demand for logistics real estate in emerging markets where we have investments primarily through our co-investment ventures, such as Brazil, China, and Mexico, remains strong due to growing economies.
In our total owned and managed operating portfolio, which includes properties managed by us and owned by our unconsolidated co-investment ventures that are accounted for under the equity method, we leased 30.9 million square feet of space during the three months ended March 31, 2012. Excluding the properties that were part of the Merger, we leased 21.9 million square feet of space during the three months ended March 31, 2011. The effective rental rates on leases signed during the first quarter of 2012 in our same store portfolio (as defined below) decreased by 1.1% when compared with the rental rates on the previous leases on that same space. The total owned and managed portfolio was 92.3% occupied at March 31, 2012, up from 92.2% at December 31, 2011. Our existing customers with expiring leases renewed their leases 78.3% of the time during the three months of 2012 as compared with 65.9% in the first quarter of 2011.
Due to the lack of supply of class A facilities, coupled with the decreasing vacancy rates, we expect development volume to increase in our markets. Our development business consists of speculative development, build-to-suit development, value added conversions and redevelopment. We expect to develop directly and within the co-investment structures depending on location, market conditions, submarkets or building sites, and availability of capital. In response to this emerging demand, we are actively pursuing various development opportunities, as shown with the commencement of the development of three properties in the first quarter of 2012.
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Results of Operations
Three Months Ended March 31, 2012 and 2011
Summary
The following table illustrates the net operating income for each of our segments, along with the reconciling items to Earnings (Loss) from Continuing Operations on our Consolidated Statements of Operations in Item 1 for the three months ended March 31 (dollars in thousands):
Net operating income –Real Estate Operations segment
Net operating income – Private Capital segment
Other:
Income tax expense
See Note 15 to our Consolidated Financial Statements in Item 1 for additional information regarding our segments and a reconciliation of net operating income to Earnings (Loss) Before Income Taxes.
The net operating income of the Real Estate Operations segment consisted of rental income and rental expenses from industrial properties that we own and consolidate and is impacted by our capital deployment activities. The size and percentage of occupancy of our consolidated operating portfolio fluctuates due to the timing of acquisitions, development activity and contributions. Such fluctuations affect the net operating income we recognize in this segment in a particular period. Also included in this segment is revenue from land we own and lease to customers under ground leases and development management and other income, offset by acquisition costs and land holding costs. The net operating income from the Real Estate Operations segment for the three months ended March 31, excluding amounts presented as Discontinued Operations in our Consolidated Financial Statements in Item 1, was as follows (in thousands):
Rental and other income
Rental and other expenses
Total net operating income—Real Estate Operations segment
The increase in rental income and rental expense in 2012 from 2011 are due primarily to the impact of the Merger and the PEPR Acquisition in the second quarter of 2011, the Q1 Venture Acquisitions, increased occupancy in our consolidated operating portfolio (from 85.7% at March 31, 2011 to 91.9% at March 31, 2012) and the completion and stabilization of new development properties. The results for 2012 included rental income and expenses from properties acquired through the Merger and PEPR Acquisition of $225.3 million and $59.0 million, respectively.
In our consolidated portfolio, we leased 16.8 million square feet for the three months ended March 31, 2012 compared to 10.7 million square feet for the three months ended March 31, 2011. In our total owned and managed portfolio, we calculated the change in effective rental rates on leases signed during the quarter as compared to the previous rent on that same space in our same store portfolio (as defined below). During the first quarter of 2012 and 2011, the percentage decrease was 1.1% and 9.2%, respectively. A decline in rental rates is due to: (i) leases turning that were put in place when market rents were at or near peak; and (ii) decreased market rents. Under the terms of our lease agreements, we are able to recover the majority of our rental expenses from customers. Rental expense recoveries, included in both rental income and expenses, were $91.9 million and $43.0 million for the three months ended March 31, 2012 and 2011, respectively.
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Our consolidated operating properties are as follows (square feet in thousands):
March 31, 2012 (1)
December 31, 2011 (2)
March 31, 2011
Private Capital Segment
The net operating income of the Private Capital segment consisted of fees and incentives earned for services performed for our unconsolidated investees and certain third parties, reduced by our direct costs of managing these entities and the properties they own.
The direct costs associated with our Private Capital segment totaled $16.9 million and $10.6 million for the three months ended March 31, 2012 and 2011, respectively, and are included in the line item Private Capital Expenses in our Consolidated Statements of Operations in Item I. These expenses include the direct expenses associated with the asset management of the unconsolidated co-investment ventures provided by individuals who are assigned to our Private Capital segment. In addition, in order to achieve efficiencies and economies of scale, all of our property management functions are provided by a team of professionals who are assigned to our Real Estate Operations segment. These individuals perform the property-level management of the properties in our owned and managed portfolio including properties we consolidate and the properties we manage that are owned by the unconsolidated investees. We allocate the costs of our property management function to the properties we consolidate (reported in Rental Expenses) and the properties owned by the unconsolidated investees (included in Private Capital Expenses), by using the square feet owned by the respective portfolios. The increase in Private Capital Expenses in 2012 is due to the increased private capital platform and infrastructure that was part of the Merger, offset partially with a decline in the portion of our property management expenses that are allocated to this segment due to the consolidation of PEPR and the Q1 Venture Acquisitions.
The net operating income from the Private Capital segment, representing fees earned reduced by private capital expenses, for the three months ended March 31 was as follows (in thousands):
Americas (1)
Europe (2)
Asia (3)
Total net operating income—Private Capital segment
See Note 4 to our Consolidated Financial Statements in Item 1 for additional information on our unconsolidated investees.
Other Components of Income
General and Administrative (“G&A”) Expense
G&A expenses for the three months ended March 31 consisted of the following (in thousands):
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Gross G&A expense
Reported as rental expenses
Reported as private capital expenses
Capitalized amounts
Net G&A
The increase in G&A expenses and the various components is due primarily to the Merger, PEPR Acquisition and the larger infrastructure associated with the combined company.
Merger, Acquisition and Other Integration Expenses
In connection with the Merger and other related activities, we have incurred significant transaction, integration and transitional costs. These costs include investment banker advisory fees; legal, tax, accounting and valuation fees; termination and severance costs (both cash and stock based compensation awards) for terminated and transitional employees; system conversion costs; and other integration costs. These costs are expensed as incurred, which in some cases will be through the end of 2012. In 2011, the costs that were obligations of AMB and expensed pre-Merger are not included in our Consolidated Financial Statements. For the three months ended March 31, 2011, we have included reduction in workforce charges associated with dispositions made in 2011. The following is a breakdown of the costs incurred during the three months ended March 31 (in thousands):
During the three months ended March 31, 2012, we recorded an impairment charge of $16.1 million related to the land received in 2011 in exchange for a note receivable.
Depreciation and Amortization
Depreciation and amortization expenses were $188.8 million and $80.0 million for the three months ended March 31, 2012 and 2011, respectively. The increase is primarily due to additional depreciation and amortization expenses associated with the assets (including intangible assets) acquired in the second quarter 2011, through the Merger and PEPR Acquisition, and the Q1 Venture Acquisitions, and completed and leased development properties.
Earnings from Unconsolidated Investees, Net
We recognized net earnings of $14.0 million and $13.6 million for the three months ended March 31, 2012 and 2011, respectively. These earnings relate to our investment in unconsolidated investees that are accounted for on the equity method. The primary reason for the increase in 2012 over 2011 is due to the investments we acquired through the Merger, partially offset by the consolidation of PEPR and the Q1 Venture Acquisitions. The earnings we recognize are impacted by: (i) variances in revenues and expenses of the entity; (ii) the size and occupancy rate of the portfolio of properties owned by the entity; (iii) our ownership interest in the entity; and (iv) fluctuations in foreign currency exchange rates used to translate our share of net earnings to U.S. dollar, if applicable. We manage the majority of the properties in which we have an ownership interest as part of our total owned and managed portfolio. See discussion of our portfolio results in the section, “Portfolio Information”. See also Note 4 to our Consolidated Financial Statements in Item I for further breakdown of our share of net earnings recognized.
Interest Expense
Interest expense from continuing operations for the three months ended March 31 included the following components (in thousands):
Gross interest expense
Amortization of discount (premium), net
Amortization of deferred loan costs
Interest expense before capitalization
Net interest expense
Gross interest expense and capitalized amounts increased in 2012 from 2011 primarily due to higher debt levels as a result of the Merger, the PEPR Acquisition and the Q1 Venture Acquisitions in the first quarter of 2012, partially offset by lower effective interest rates.
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Our weighted average effective interest rate (including amortization of deferred loan costs) was 4.90% and 6.20% for the three month period ended March 31, 2012 and 2011, respectively. Our future interest expense, both gross and the portion capitalized, will vary depending on, among other things, the level of our development activities. As a result of the Merger and PEPR Acquisition, we increased our debt from $6.4 billion at March 31, 2011 to $12.1 billion at June 30, 2011. We reduced our debt to $11.4 billion at December 31, 2011. As a result of the Q1 Venture Acquisitions, we increased debt to $12.4 billion as of March 31, 2012, which we expect to reduce with proceeds from property sales. See Notes 2 and 7 to our Consolidated Financial Statements in Item 1 and Liquidity and Capital Resources for further discussion of our debt and borrowing costs.
Interest and Other Income (Expense), Net
During the three months ended March 31, 2011, we recognized a $6.9 million charge related to one of our buildings in Japan that was damaged from the earthquake and related tsunami in March 2011.
Gains on Acquisitions and Dispositions of Investments in Real Estate, Net
We recognized net gains on acquisitions and dispositions of investments in real estate in continuing operations of $267.8 million during the three months ended March 31, 2012. This included a $273.0 million gain related to the Prologis California transaction. The gains represent the adjustment to fair value of our equity investments at the time we gained control and consolidated the entities. See Note 2 for more details on this transaction.
Foreign Currency Exchange and Derivative Gains (Losses), Net
In connection with the Merger and the exchange offer discussed in Note 7 to our Consolidated Financial Statements in Item 1, our convertible senior notes became exchangeable senior notes issued by the Operating Partnership that are exchangeable into common stock of the REIT. As a result, the accounting for the exchangeable senior notes changed, which required us to separate the fair value of the derivative instrument (exchange feature) from the debt instrument and account for it separately as a derivative. We adjust the derivative instrument at each reporting period to fair value with the resulting adjustment being recorded in earnings. We recognized an unrealized loss of $26.8 million for the three months ended March 31, 2012.
Gain on Early Extinguishment of Debt, Net
During the three months ended March 31, 2012, we extinguished some secured mortgage debt, unsecured credit facilities of PEPR and two term loans prior to maturity, which resulted in the recognition of $5.4 million in net gains. The gains or losses represent the difference between the recorded debt (net of premiums and discounts and including related debt issuance costs) and the consideration we paid to retire the debt, including fees.
Income Tax Expense
During the three months ended March 31, 2012 and 2011, our current income tax expense was $11.1 million and $5.5 million, respectively. We recognize current income tax expense for income taxes incurred by our taxable real estate investment trust subsidiaries and in certain foreign jurisdictions, as well as certain state taxes. We also include in current income tax expense the interest associated with our liability for uncertain tax positions. Our current income tax expense fluctuates from period to period based primarily on the timing of our taxable income and changes in tax and interest rates.
During the three months ended 2012 and 2011, we recognized a net deferred tax expense of $1.1 million and $0.9 million, respectively. Deferred income tax expense is generally a function of the period’s temporary differences and the utilization of net operating losses generated in prior years that had been previously recognized as deferred income tax assets in certain of our taxable subsidiaries operating in the U.S. or in foreign jurisdictions.
Discontinued operations represent a component of an entity that has either been disposed of or is classified as held for sale if both the operations and cash flows of the component have been or will be eliminated from ongoing operations of the entity as a result of the disposal transaction and the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. The results of operations of the component of the entity that has been classified as discontinued operations are reported separately in our Consolidated Financial Statements in Item 1.
During the three months ended March 31, 2012, we disposed of land subject to ground leases and 70 properties aggregating 7.9 million square feet to third parties, most of which was included in Assets Held for Sale at December 31, 2011. The net gains on disposition of these properties, net of taxes, are reflected in discontinued operations, along with the results of operations of these properties for all periods presented. During all of 2011, we disposed of land subject to ground leases and 94 properties aggregating 10.7 million square feet to third parties.
As of March 31, 2012, we had land and nine operating properties that met the criteria to be recorded as held for sale, including the real estate investment balances and the related assets and liabilities of each property.
See Note 6 to our Consolidated Financial Statements in Item 1.
Other Comprehensive Income (Loss)—Foreign Currency Translation (Losses), Net
For our consolidated subsidiaries whose functional currency is not the U.S. dollar, we translate their financial statements into U.S. dollar at the time we consolidate those subsidiaries’ financial statements. Generally, assets and liabilities are translated at the exchange rate in effect as of the balance sheet date. The resulting translation adjustments, due to the fluctuations in exchange rates from the beginning of the period to the end of the period, are included in Other Comprehensive Income (Loss).
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During the three months ended March 31, 2012 and 2011, we recorded unrealized losses in Other Comprehensive Income (Loss) of $41.2 million and gains of $203.9 million, respectively, related to foreign currency translations of our foreign subsidiaries into U.S. dollar upon consolidation. In 2012, we recorded net unrealized losses due to the weakening of yen to the U.S. dollar, from the beginning to the end of the period. In 2011, the unrealized gains are mainly the result of the strengthening of the euro and pound sterling to the U.S. dollar, from the beginning to the end of the period.
Portfolio Information
Our total owned and managed portfolio of properties includes operating industrial properties and does not include properties under development, properties held for sale or non-industrial properties and was as follows (square feet in thousands):
Consolidated
Unconsolidated
Same Store Analysis
We evaluate the performance of the operating properties we own and manage using a “same store” analysis because the population of properties in this analysis is consistent from period to period, thereby eliminating the effects of changes in the composition of the portfolio on performance measures. We include properties owned by us, and properties owned by the unconsolidated investees (accounted for on the equity method) that are managed by us (referred to as “unconsolidated investees”), including those owned and managed by AMB prior to the Merger, in our same store analysis. We have defined the same store portfolio, for the three months ended March 31, 2012, as those properties that were in operation at January 1, 2011, and have been in operation throughout the three-month periods in both 2012 and 2011. We have removed all properties that were disposed of to a third party or were classified as held for sale from the population for both periods. We believe the factors that impact rental income, rental expenses and net operating income in the same store portfolio are generally the same as for the total portfolio. In order to derive an appropriate measure of period-to-period operating performance, we remove the effects of foreign currency exchange rate movements by using the current exchange rate to translate from local currency into U.S. dollar, for both periods. The same store portfolio, for the three months ended March 31, 2012, included 522.6 million of aggregated square feet.
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Rental Income (1)(2)
Consolidated:
Rental income per our Consolidated Statements of Operations
Adjustments to derive same store results:
Rental income of properties not in the same store portfolio—properties developed and acquired during the period and land subject to ground leases
Effect of changes in foreign currency exchange rates and other
Unconsolidated investees:
Rental income of properties managed by us and owned by our unconsolidated investees
Rental income of AMB properties pre-Merger
Same store portfolio—rental income (2)(3)
Rental Expenses (1)(4)
Rental expenses per our Consolidated Statements of Operations
Rental expenses of properties not in the same store portfolio—properties developed and acquired during the period and land subject to ground leases
Rental expenses of properties managed by us and owned by our unconsolidated investees
Rental expense of AMB properties pre-Merger
Same store portfolio—rental expenses (3)(4)
Net Operating Income (1)
Net operating income per our Consolidated Statements of Operations
Net operating income of properties not in the same store portfolio—properties developed and acquired during the period and land subject to ground leases
Net operating income of properties managed by us and owned by our unconsolidated investees
Net operating income of AMB properties pre-Merger
Same store portfolio—net operating income (3)
Rental expenses in the same store portfolio include the direct operating expenses of the property such as property taxes, insurance, utilities, etc. In addition, we include an allocation of the property management expenses for our direct-owned properties based on the property management fee that is provided for in the individual management agreements under which our wholly owned management companies provide property management services to each property (generally, the fee is based on a percentage of revenues). On consolidation, the management fee income earned by the management company and the management fee expense recognized by the properties are eliminated
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Environmental Matters
A majority of the properties acquired by us were subjected to environmental reviews either by us or the previous owners. While some of these assessments have led to further investigation and sampling, none of the environmental assessments have revealed an environmental liability that we believe would have a material adverse effect on our business, financial condition or results of operations.
We record a liability for the estimated costs of environmental remediation to be incurred in connection with certain operating properties we acquire, as well as certain land parcels we acquire in connection with the planned development of the land. The liability is established to cover the environmental remediation costs, including cleanup costs, consulting fees for studies and investigations, monitoring costs and legal costs relating to cleanup, litigation defense, and the pursuit of responsible third parties. We purchase various environmental insurance policies to mitigate our exposure to environmental liabilities. We are not aware of any environmental liability that we believe would have a material adverse effect on our business, financial condition or results of operations.
Liquidity and Capital Resources
Overview
We consider our ability to generate cash from operating activities, dispositions of properties and from available financing sources to be adequate to meet our anticipated future development, acquisition, operating, debt service, dividend and distribution requirements.
Near-Term Principal Cash Sources and Uses
In addition to dividends to the common and preferred stockholders of the REIT and distributions to the limited partnership units of the Operating Partnership, we expect our primary cash needs will consist of the following:
completion of the development and leasing of the properties in our consolidated development portfolio (a);
investments in current or future unconsolidated investees, as discussed below, primarily for the development and/or acquisition of properties depending on market and other conditions;
development of new properties for long-term investment;
repayment of debt, including payments on our credit facilities and repurchases of senior notes and/or exchangeable senior notes;
scheduled consolidated debt principal payments in the remainder of 2012 of $668.8 million, which includes $113.4 million of our consolidated but not wholly-owned entities;
capital expenditures and leasing costs on properties;
depending on market and other conditions, acquisition of operating properties and/or portfolios of operating properties in global or regional markets for direct, long-term investment (this might include acquisitions from our co-investment ventures); and
Merger integration and transition expenses.
We expect to fund our cash needs principally from the following sources, all subject to market conditions:
available unrestricted cash balances ($343.7 million at March 31, 2012);
property operations;
fees and incentives earned for services performed on behalf of the co-investment ventures and distributions received from the co-investment ventures;
proceeds from the disposition of properties, land parcels or other investments to third parties;
proceeds from the contributions or sales of properties to co-investment ventures;
borrowing capacity under our current credit facility arrangements discussed below ($1.2 billion available as of March 31, 2012), other facilities or borrowing arrangements;
proceeds from the issuance of equity securities; and
proceeds from the issuance of debt securities, including secured mortgage debt.
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We may repurchase our outstanding debt securities through cash purchases, in open market purchases, privately negotiated transactions, tender offers or otherwise. Such repurchases will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.
On February 2, 2012, we entered into a senior term loan agreement where we may obtain loans in an aggregate amount not to exceed €487.5 million ($641.9 million at March 31, 2012). The loans can be obtained in U.S. dollar, euro, Japanese yen, and British pound sterling. We may increase the borrowings to approximately €987.5 million ($1.3 billion at March 31, 2012), subject to obtaining additional lender commitments. The loan agreement is scheduled to mature on February 2, 2014, but we may extend the maturity date three times at our option, in each case up to one year, subject to satisfaction of certain conditions and payment of an extension fee. We used the proceeds from this senior term loan to pay off the two outstanding term loans assumed in connection with the Merger and the remainder to pay down borrowings on our credit facilities.
In the first quarter of 2012 in connection with the Q1 Venture Acquisitions, we have assumed additional debt of approximately $1.0 billion. See Note 2 to our Consolidated Financial Statements in Item 1 for more details on these transactions.
As of March 31, 2012, we were in compliance with all of our debt covenants. These covenants include customary financial covenants for total debt ratios, encumbered debt ratios and fixed charge coverage ratios.
See Note 7 to our Consolidated Financial Statements in Item 1 for further discussion on our debt.
Equity Commitments Related to Certain Co-Investment Ventures
Certain co-investment ventures have equity commitments from us and our venture partners. We may fulfill our equity commitment through contributions of properties or cash. Our venture partners fulfill their equity commitment with cash. We are committed to offer to contribute certain properties that we develop and stabilize in select markets in Europe and Mexico to certain co-investment ventures. These ventures are committed to acquire such properties, subject to certain exceptions, including that the properties meet certain specified leasing and other criteria, and that the ventures have available capital. Generally the venture obtains financing for the properties and therefore the equity commitment is less than the acquisition price of the real estate. We are not obligated to contribute properties at a loss. Depending on market conditions, the investment objectives of the ventures, our liquidity needs and other factors, we may make contributions of properties to these ventures through the remaining commitment period.
Prologis Targeted U.S. LogisticsFund (1)
Total Unconsolidated
Prologis Brazil Logistics Partners Fund
Total Consolidated
Grand Total
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For more information on our investments in unconsolidated co-investment ventures, see Note 4 to our Consolidated Financial Statements in Item 1.
Cash Provided by Operating Activities
For the three months ended March 31, 2012 and 2011, operating activities provided net cash of $71.4 million and $2.6 million, respectively. In the first three months of 2012 and 2011, cash provided by operating activities was less than the cash distributions paid on common and preferred shares and distributions to noncontrolling interest by $80.7 million and $67.9 million, respectively. We used cash flows from operating activities and proceeds from the disposition of real estate properties ($713.0 million in 2012 and $394.5 million in 2011) to fund dividends on common and preferred shares and distributions to noncontrolling interests.
Cash Investing and Cash Financing Activities
For the three months ended March 31, 2012 and 2011, investing activities provided net cash of $176.6 million and $178.3 million, respectively. The following are the significant activities for both periods presented:
We generated cash from contributions and dispositions of properties and land parcels of $713.0 million and $394.5 million during 2012 and 2011, respectively. In 2012, we disposed of land, land subject to ground leases and 71 properties. In 2011, we disposed of land, land subject to ground leases and 34 properties that included the majority of our non-industrial assets.
We invested $221.9 million in real estate during 2012 and $217.7 million for the same period in 2011, including costs for current and future development projects and recurring capital expenditures and tenant improvements on existing operating properties. In 2012, we acquired one property with an aggregate purchase price of $10.4 million.
In 2012, we invested cash of $31.7 million in unconsolidated investees. In 2011, we received advances, net of repayments, from unconsolidated investees of $11.3 million.
In connection with the acquisition of NAIF II in 2012, we repaid the loan from NAIF II to our partner for a total of $336.1 million. The loan repayment was reduced by the cash acquired in the consolidation of NAIF II.
We received distributions from unconsolidated investees as a return of investment of $34.6 million and $38.7 million during 2012 and 2011, respectively.
We generated net cash proceeds from payments on notes receivable of $6.5 million in 2011.
In 2011, we invested $55.0 million in a preferred equity interest in a subsidiary of the buyer of a portfolio of non-industrial assets.
For the three months ended March 31, 2012 and 2011, financing activities used net cash of $80.2 million and $195.2 million, respectively. The following are the significant activities for both periods presented:
In 2012, we incurred $1.0 billion in secured mortgage and senior term loan debt. In 2011, we incurred $164.5 million in secured mortgage debt.
We had net payments on our credit facilities of $51.5 million and $269.8 million during 2012 and 2011, respectively.
We made net payments of $927.9 million and $16.4 million on debt during 2012 and 2011, respectively.
We paid distributions of $129.5 million and $64.0 million to our common stockholders during 2012 and 2011, respectively. We paid dividends on our preferred stock of $16.7 million and $6.4 million during 2012 and 2011, respectively.
We generated proceeds from the sale and issuance of common stock under our stock option plan of $18.6 million in 2012.
In 2012, noncontrolling interest partners made contributions of $12.8 million and we distributed $6.0 million to noncontrolling interests.
Off-Balance Sheet Arrangements
Unconsolidated Co-Investment Ventures Debt
We had investments in and advances to certain unconsolidated co-investment ventures at March 31, 2012 of $2.1 billion. These unconsolidated ventures had total third party debt of $7.2 billion (in the aggregate, not our proportionate share) at March 31, 2012 that matures as follows (in millions):
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Prologis North American Properties Fund I
Prologis North American Properties Fund XI
Prologis North American Industrial Fund
Prologis North American Industrial Fund III
Prologis Targeted U.S. Logistics Fund
Prologis Mexico Industrial Fund
Prologis SGP Mexico
Prologis European Properties Fund II
Prologis Targeted Europe Logistics Fund
Prologis Japan Fund 1
Total co-investment ventures
Contractual Obligations
Distribution and Dividend Requirements
Our dividend policy on our common stock is to distribute a percentage of our cash flow to ensure we will meet the dividend requirements of the Internal Revenue Code, relative to maintaining our real estate investment trust status, while still allowing us to retain cash to meet other needs such as capital improvements and other investment activities.
We paid a cash distribution of $0.28 per common share for the first quarter on March 30, 2012. On May 3, 2012, our Board of Directors (“Board”) declared the second quarter distribution of $0.28 per common share that will be payable on June 29, 2012 to shareholders of record on June 11, 2012. Our future common share distributions may vary and will be determined by our Board upon the circumstances prevailing at the time, including our financial condition, operating results and REIT distribution requirements, and may be adjusted at the discretion of the Board during the year.
At March 31, 2012, we had seven series of preferred stock outstanding. The annual dividend rates on preferred stock are 6.5% per Series L, 6.75% per Series M, 7.0% per Series O, 6.85% per Series P, 8.54% per Series Q, 6.75% per Series R and 6.75% per Series S. The Series Q, R and S were preferred shares of ProLogis prior to the Merger and dividends on those shares have been reflected in the Consolidated Financial Statements in Item 1 for both periods ended March 31, 2012 and 2011. The dividends on the Series L, M, O and P preferred stock have been included in the Consolidated Financial Statements since the Merger, and thus, reflected in the three-month period ended March 31, 2012 only. The dividends on preferred stock are payable quarterly in arrears.
Pursuant to the terms of our preferred stock, we are restricted from declaring or paying any dividend with respect to our common stock unless and until all cumulative dividends with respect to the preferred stock has been paid and sufficient funds have been set aside for dividends that have been declared for the relevant dividend period with respect to the preferred stock.
Other Commitments
On a continuing basis, we are engaged in various stages of negotiations for the acquisition and/or disposition of individual properties or portfolios of properties.
New Accounting Pronouncements
See Note 1 to our Consolidated Financial Statements in Item 1.
Funds from Operations (“FFO”)
FFO is a non-GAAP measure that is commonly used in the real estate industry. The most directly comparable GAAP measure to FFO is net earnings. Although the National Association of Real Estate Investment Trusts (“NAREIT”) has published a definition of FFO, modifications to the NAREIT calculation of FFO are common among REITs, as companies seek to provide financial measures that meaningfully reflect their business.
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FFO is not meant to represent a comprehensive system of financial reporting and does not present, nor do we intend it to present, a complete picture of our financial condition and operating performance. We believe net earnings computed under GAAP remains the primary measure of performance and that FFO is only meaningful when it is used in conjunction with net earnings computed under GAAP. Further, we believe our consolidated financial statements, prepared in accordance with GAAP, provide the most meaningful picture of our financial condition and our operating performance.
NAREIT’s FFO measure adjusts net earnings computed under GAAP to exclude historical cost depreciation and gains and losses from the sales and impairment charges of previously depreciated properties. We agree that these two NAREIT adjustments are useful to investors for the following reasons:
Our FFO Measures
At the same time that NAREIT created and defined its FFO measure for the REIT industry, it also recognized that “management of each of its member companies has the responsibility and authority to publish financial information that it regards as useful to the financial community.” We believe stockholders, potential investors and financial analysts who review our operating results are best served by a defined FFO measure that includes other adjustments to net earnings computed under GAAP in addition to those included in the NAREIT defined measure of FFO. Our FFO measures are used by management in analyzing our business and the performance of our properties and we believe that it is important that stockholders, potential investors and financial analysts understand the measures management uses.
We use these FFO measures, including by segment and region, to: (i) evaluate our performance and the performance of our properties in comparison to expected results and results of previous periods, relative to resource allocation decisions; (ii) evaluate the performance of our management; (iii) budget and forecast future results to assist in the allocation of resources; (iv) assess our performance as compared to similar real estate companies and the industry in general; and (v) evaluate how a specific potential investment will impact our future results. Because we make decisions with regard to our performance with a long-term outlook, we believe it is appropriate to remove the effects of short-term items that we do not expect to affect the underlying long-term performance of the properties. The long-term performance of our properties is principally driven by rental income. While not infrequent or unusual, these additional items we exclude in calculating FFO, as defined by Prologis, are subject to significant fluctuations from period to period that cause both positive and negative short-term effects on our results of operations in inconsistent and unpredictable directions that are not relevant to our long-term outlook.
We use our FFO measures as supplemental financial measures of operating performance. We do not use our FFO measures as, nor should they be considered to be, alternatives to net earnings computed under GAAP, as indicators of our operating performance, as alternatives to cash from operating activities computed under GAAP or as indicators of our ability to fund our cash needs.
FFO, as defined by Prologis:
To arrive at FFO, as defined by Prologis, we adjust the NAREIT defined FFO measure to exclude:
We calculate FFO, as defined by Prologis for our unconsolidated investees on the same basis as we calculate our FFO, as defined by Prologis.
We believe investors are best served if the information that is made available to them allows them to align their analysis and evaluation of our operating results along the same lines that our management uses in planning and executing our business strategy.
Core FFO
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In addition to FFO, as defined by Prologis, we also use Core FFO. To arrive at Core FFO, we adjust FFO, as defined by Prologis, to exclude the following recurring and non-recurring items that we recognized directly or our share recognized by our unconsolidated investees to the extent they are included inFFO, as defined by Prologis:
gains or losses from acquisition, contribution or sale of land or development properties;
income tax expense related to the sale of investments in real estate;
impairment charges recognized related to our investments in real estate (either directly or through our investments in unconsolidated investees) generally as a result of our change in intent to contribute or sell these properties;
impairment charges of goodwill and other assets;
gains or losses from the early extinguishment of debt;
merger, acquisition and other integration expenses; and
expenses related to natural disasters
We believe it is appropriate to further adjust our FFO, as defined by Prologis for certain recurring items as they were driven by transactional activity and factors relating to the financial and real estate markets, rather than factors specific to the on-going operating performance of our properties or investments. The impairment charges we recognized were primarily based on valuations of real estate, which had declined due to market conditions, that we no longer expected to hold for long-term investment. We currently have and have had over the past several years a stated priority to strengthen our financial position. We expect to accomplish this by reducing our debt, our investment in certain low yielding assets, such as land that we decide not to develop and our exposure to foreign currency exchange fluctuations. As a result, we have sold to third parties or contributed to unconsolidated investees real estate properties that, depending on market conditions, might result in a gain or loss. The impairment charges related to goodwill and other assets that we have recognized were similarly caused by the decline in the real estate markets. Also in connection with our stated priority to reduce debt and extend debt maturities, we have purchased portions of our debt securities. As a result, we recognized net gains or losses on the early extinguishment of certain debt due to the financial market conditions at that time.
We have also adjusted for some non-recurring items. The merger, acquisition and other integration expenses include costs we incurred in 2011 and that we expect to incur in 2012 associated with the Merger and PEPR Acquisition and the integration of our systems and processes. We have not adjusted for the acquisition costs that we have incurred as a result of routine acquisitions but only the costs associated with significant business combinations that we would expect to be infrequent in nature. Similarly, the expenses related to the natural disaster in Japan that we recognized in 2011 are a rare occurrence but we may incur similar expenses again in the future.
We analyze our operating performance primarily by the rental income of our real estate and the revenue driven by our private capital business, net of operating, administrative and financing expenses. This income stream is not directly impacted by fluctuations in the market value of our investments in real estate or debt securities. As a result, although these items have had a material impact on our operations and are reflected in our financial statements, the removal of the effects of these items allows us to better understand the core operating performance of our properties over the long-term.
We use Core FFO, including by segment and region, to: (i) evaluate our performance and the performance of our properties in comparison to expected results and results of previous periods, relative to resource allocation decisions; (ii) evaluate the performance of our management; (iii) budget and forecast future results to assist in the allocation of resources; (iv) provide guidance to the financial markets to understand our expected operating performance; (v) assess our operating performance as compared to similar real estate companies and the industry in general; and (vi) evaluate how a specific potential investment will impact our future results. Because we make decisions with regard to our performance with a long-term outlook, we believe it is appropriate to remove the effects of items that we do not expect to affect the underlying long-term performance of the properties we own. As noted above, we believe the long-term performance of our properties is principally driven by rental income. We believe investors are best served if the information that is made available to them allows them to align their analysis and evaluation of our operating results along the same lines that our management uses in planning and executing our business strategy.
Limitations on Use of our FFO Measures
While we believe our defined FFO measures are important supplemental measures, neither NAREIT’s nor our measures of FFO should be used alone because they exclude significant economic components of net earnings computed under GAAP and are, therefore, limited as an analytical tool. Accordingly, they are two of many measures we use when analyzing our business. Some of these limitations are:
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We compensate for these limitations by using our FFO measures only in conjunction with net earnings computed under GAAP when making our decisions. To assist investors in compensating for these limitations, we reconcile our defined FFO measures to our net earnings computed under GAAP. This information should be read with our complete financial statements prepared under GAAP.
FFO:
Reconciliation of net earnings (loss) to FFO measures:
Add (deduct) NAREIT defined adjustments:
Real estate related depreciation and amortization
Net gains on non-FFO dispositions
Reconciling items related to noncontrolling interests
Our share of reconciling items from unconsolidated investees
Subtotal-NAREIT defined FFO
Add (deduct) our defined adjustments:
Deferred income benefit
FFO, as defined by Prologis
Impairment charges
Japan disaster expenses
Our share of gains on acquisitions and dispositions of investments in real estate, net
Our share of gains on early extinguishment of debt, net
Income tax expense on dispositions
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to the impact of interest rate changes and foreign-exchange related variability and earnings volatility on our foreign investments. We have used certain derivative financial instruments, primarily foreign currency put option and forward contracts, to reduce our foreign currency market risk, as we deem appropriate. We have also used interest rate swap agreements to reduce our interest rate market risk. We do not use financial instruments for trading or speculative purposes and all financial instruments are entered into in accordance with established policies and procedures.
We monitor our market risk exposures using a sensitivity analysis. Our sensitivity analysis estimates the exposure to market risk sensitive instruments assuming a hypothetical 10% adverse change in interest rates. The results of the sensitivity analysis are summarized below. The sensitivity analysis is of limited predictive value. As a result, our ultimate realized gains or losses with respect to interest rate and foreign currency exchange rate fluctuations will depend on the exposures that arise during a future period, hedging strategies at the time and the prevailing interest and foreign currency exchange rates.
Interest Rate Risk
Our interest rate risk management objective is to limit the impact of future interest rate changes on earnings and cash flows. To achieve this objective, we primarily borrow on a fixed rate basis for longer-term debt issuances. As of March 31, 2012, we had $642 million outstanding under multi-currency senior term loan with variable interest rates. As of March 31, 2012, we had ¥44.9 billion ($547.1 million) in TMK bond agreements with variable interest rates. We have entered into interest rate swap agreements to fix the interest rate on ¥43.1 billion ($524.9 million) of the TMK bonds. As of March 31, 2012, we had €711.0 million ($936.2 million) in secured debt with variable interest rates. We have entered into interest rate swap agreements to fix the interest rate on €682.8 million ($899.0 million) of secured debt, of which €665.3 million ($875.9 million) is related to PEPR. As of March 31, 2012, we have entered into an interest swap agreement to fix the interest rate on $71.0 million of variable rate secured mortgage debt assumed in connection with NAIF II acquisition.
Our primary interest rate risk is created by the variable rate credit facilities. During the three months ended March 31, 2012, we had weighted average daily outstanding borrowings of $1.1 billion on our variable rate credit facilities. Based on the results of the sensitivity analysis, which assumed a 10% adverse change in interest rates, the estimated market risk exposure for the variable rate lines of credit was approximately $0.5 million of cash flow for the three months ended March 31, 2012.
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Foreign Currency Risk
Foreign currency risk is the possibility that our financial results could be better or worse than planned because of changes in foreign currency exchange rates.
Our primary exposure to foreign currency exchange rates relates to the translation of the net income of our foreign subsidiaries into U.S. dollar, principally euro, British pound sterling and yen. To mitigate our foreign currency exchange exposure, we borrow in the functional currency of the borrowing entity, when appropriate. We also may use foreign currency put option contracts to manage foreign currency exchange rate risk associated with the projected net operating income of our foreign consolidated subsidiaries and unconsolidated investees. At March 31, 2012, we had no put option contracts outstanding and, therefore, we may experience fluctuations in our earnings as a result of changes in foreign currency exchange rates.
We also have some exposure to movements in exchange rates related to certain intercompany loans we issue from time to time and we may use foreign currency forward contracts to manage these risks. At March 31, 2012, we had no forward contracts outstanding and, therefore, we may experience fluctuations in our earnings from the remeasurement of these intercompany loans due to changes in foreign currency exchange rates.
Item 4. Controls and Procedures
Controls and Procedures (Prologis, Inc.)
Prologis, Inc. carried out an evaluation under the supervision and with the participation of management, including the Co-Chief Executive Officers and Chief Financial Officer, of the effectiveness of the disclosure controls and procedures (as defined in Rule 13a-14(c)) under the Securities and Exchange Act of 1934 (the “Exchange Act”) as of March 31, 2012. Based on this evaluation, the Co-Chief Executive Officers and the Chief Financial Officer have concluded that the disclosure controls and procedures are effective to ensure the information required to be disclosed in reports that are filed or submitted under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.
There have been no changes in the internal controls over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.
Controls and Procedures (Prologis, L.P.)
Prologis, L.P. carried out an evaluation under the supervision and with the participation of management, including the Co-Chief Executive Officers and Chief Financial Officer, of the effectiveness of the disclosure controls and procedures (as defined in Rule 13a-14(c)) under the Exchange Act as of March 31, 2012. Based on this evaluation, the Co-Chief Executive Officers and the Chief Financial Officer have concluded that the disclosure controls and procedures are effective to ensure the information required to be disclosed in reports that are filed or submitted under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.
PART II
Item 1. Legal Proceedings
From time to time, we and our unconsolidated investees are party to a variety of legal proceedings arising in the ordinary course of business. We believe that, with respect to any such matters that we are currently a party to, the ultimate disposition of any such matters will not result in a material adverse effect on our business, financial position or results of operations.
In December 2011, arbitration hearings began in connection with a dispute related to a real estate development project known as Pacific Commons. The plaintiff, Cisco Technology, Inc. (“Cisco”), is seeking rescission of a 2007 Restructuring and Settlement Agreement (the “Contract”) and other agreements, and declaratory relief, and damages for breach of the Contract. Specifically, Cisco seeks (1) declaratory relief that Prologis owes certain Community Facilities District taxes that have been assessed against Cisco’s land, following Cisco’s purchase of the land from Prologis through the exercise of option agreements; (2) declaratory relief that Prologis’ partial transfers of rights and obligations under the Contract to third parties are void; and (3) damages for alleged breaches of the Contract relating to the plans to build a baseball stadium at Pacific Commons. Although the total damages alleged by Cisco are approximately $200 million, we believe these claims are without merit and are defending these matters vigorously. Based on the facts and circumstances surrounding this dispute, we believe the low end of our range of loss is zero and therefore, in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”), we have not recorded any liability with respect to this matter as of March 31, 2012.
Item 1A. Risk Factors
As of March 31, 2012, no material changes had occurred in our risk factors as discussed in Item 1A of our Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
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Item 4. Mine Safety Disclosures
Not Applicable.
Item 5. Other Information
Item 6. Exhibits
10.1
12.1
12.2
12.3
12.4
15.1
15.2
31.1
31.2
31.3
31.4
32.1
32.2
101.INS**
101.SCH**
101.CAL**
101.DEF**
101.LAB**
101.PRE**
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrants have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized.
Date: May 7, 2012
Index to Exhibits