UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2011
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 November 1, 2011 was approximately 458,252,900.
EXPLANATORY NOTE
This report combines the quarterly reports on Form 10-Q for the period ended September 30, 2011 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 (“REIT”) and the general partner of the Operating Partnership. As of September 30, 2011, the REIT owned an approximate 99.55% common general partnership interest in the Operating Partnership and 100% of the preferred units in the Operating Partnership. The remaining approximate 0.45% common limited partnership interests are 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 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.
Financial Statements
Consolidated Statements of Operations – Three and Nine Months Ended September 30, 2011 and 2010
Consolidated Statement of Equity – Nine Months Ended September 30, 2011 September 30, 2011
Consolidated Statements of Comprehensive Income (Loss) – Nine Months Ended September 30, 2011 and 2010
Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2011 and 2010
Consolidated Balance Sheets – September 30, 2011 and December 31, 2010
Consolidated Statement of Capital – Nine Months Ended September 30, 2011 September 30, 2011
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
[Removed and Reserved]
Other Information
Exhibits
PART 1.
Item 1. Financial Statements
PROLOGIS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amount)
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; 459,058 shares issued and 458,254 shares outstanding at September 30, 2011 and 254,482 shares issued and outstanding at December 31, 2010
Additional paid-in capital
Accumulated other comprehensive loss
Distributions in excess of net earnings
Total Prologis, Inc. stockholders’ equity
Noncontrolling interests
Total equity
Total liabilities and equity
The accompanying notes are an integral part of these Consolidated Financial Statements.
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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
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
Loss on early extinguishment of debt, net
Total other income (expense)
Earnings (loss) before income taxes
Current income tax expense (benefit)
Deferred income tax expense (benefit)
Total income tax expense (benefit)
Earnings (loss) from continuing operations
Discontinued operations:
Income attributable to disposed properties and assets held for sale
Net gains on dispositions, net of related impairment charges and 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) attributable to common shares
Weighted average common shares outstanding - Basic
Weighted average common shares outstanding - Diluted
Net earnings (loss) per share attributable to common shares - Basic:
Continuing operations
Discontinued operations
Net earnings (loss) per share attributable to common shares - Basic
Net earnings (loss) per share attributable to common shares - Diluted:
Net earnings (loss) per share attributable to common shares - Diluted
Distributions per common share
2
CONSOLIDATED STATEMENT OF EQUITY
Nine Months Ended September 30, 2011
(In thousands)
Balance as of January 1, 2011
Merger and ProLogis European Properties (“PEPR”) acquisition
Issuances of stock in equity offering, net of issuance costs
Issuance (repurchase) of common stock under common stock plans, net of issuance costs
Acquisition of interest in consolidated entity
Distributions and allocations
Foreign currency translation gains (losses), net
Unrealized loss and amortization on derivative contracts, net
Balance as of September 30, 2011
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Nine Months Ended
September 30,
Net loss attributable to controlling interests
Other comprehensive income (loss):
Unrealized losses and amortization on derivative contracts, net
Comprehensive loss attributable to common stock
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating activities:
Consolidated net loss
Adjustments to reconcile net loss to net cash provided by operating activities:
Straight-lined rents
Cost of stock-based compensation awards, net
Earnings from unconsolidated investees
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 related impairment charges, included in discontinued operations
Gains recognized on property acquisitions and dispositions, net
Unrealized foreign currency and derivative gains, net
Decrease (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
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
Cash acquired in connection with AMB merger
Acquisition of PEPR, net of cash received
Net cash used in investing activities
Financing activities:
Issuance of common stock, net
Distributions paid on common stock
Dividends paid on preferred stock
Noncontrolling interest distributions, net
Debt and equity issuance costs paid
Net proceeds from (payments on) credit facilities
Repurchase of debt
Proceeds from issuance of debt
Payments on debt
Net cash provided by (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.
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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)
Less preferred unit dividends
Net earnings (loss) attributable to common unitholders
Weighted average common units outstanding - Basic
Weighted average common units outstanding - Diluted
Net earnings (loss) per unit attributable to common unitholders - Basic:
Net earnings (loss) per unit attributable to common unitholders - Basic
Net earnings (loss) per unit attributable to common unitholders - Diluted:
Net earnings (loss) per unit attributable to common unitholders - Diluted
Distributions per common unit
6
CONSOLIDATED STATEMENT OF CAPITAL
Merger and PEPR acquisition
Issuance of units in exchange for contributions of equity offering proceeds
Issuance (repurchase) of common units
Comprehensive loss attributable to common unitholders
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Proceeds from issuance of common partnership units in exchange for contributions
Distributions paid on common partnership units
Dividends paid on preferred units
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PROLOGIS, INC. AND PROLOGIS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Business. Prologis, Inc. (the “REIT”) 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: direct owned and private capital. Our direct owned segment represents the direct long-term ownership of industrial properties. Our private capital segment represents the long-term management of property funds and other unconsolidated investees, and the properties they own. 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 September 30, 2011, the REIT owned an approximate 99.55% general partnership interest in the Operating Partnership, and 100% of the preferred units. The remaining approximate 0.45% common limited partnership interests are 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. 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.
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 and its subsidiaries (the “Merger”). Following the Merger, AMB changed its name to Prologis, Inc. 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, ProLogis was the accounting acquirer. As such, in the Consolidated Financial Statements the historical results of ProLogis are included for the entire period presented and AMB’s results are included subsequent to the Merger. See Note 2 for further discussion on the Merger.
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, 2010 Consolidated Financial Statements of ProLogis and AMB, as previously filed with the SEC on Form 10-K and other public information.
Certain amounts included in the accompanying Consolidated Financial Statements for 2010 have been reclassified to conform to the 2011 financial statement presentation.
Recent Accounting Pronouncements. In September 2011, the Financial Accounting Standards Board (“FASB”) issued guidance to amend and simplify the rules related to testing goodwill for impairment. The revised guidance 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, but early adoption is permitted. Adoption of this guidance is not expected to have a material impact on our Consolidated Financial Statements.
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 do not expect the guidance to impact 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. The amendments will be effective for us on January 1, 2012 and we do not expect to have a material impact to our Consolidated Financial Statements.
In December 2010, the FASB updated the accounting standard related to business combinations that requires public entities to disclose certain pro forma information about revenues and earnings of the combined entity within the notes to the financial statements. As a result of the Merger
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and consolidation of ProLogis European Properties (“PEPR”) as described in Note 2, we are required to present pro forma information as if the business combinations occurred at the beginning of the prior annual reporting period for purposes of calculating both the current reporting period and the prior reporting period pro forma financial information. The disclosure requirements were effective for business combinations with effective dates beginning January 1, 2011. See Note 2 for our pro forma disclosures.
In July 2010, the FASB issued an accounting standard update that expands existing disclosures about the credit quality of financing receivables and the related allowance for credit losses. We adopted the expanded disclosure requirements for ending balances applicable to our Notes Receivable Backed by Real Estate as of December 31, 2010. Disclosures regarding activity that occurs during the reporting period were effective beginning January 1, 2011. See Note 5 for disclosure of this activity for the nine months ended September 30, 2011.
In January 2010, the FASB issued an accounting standard update that requires disclosures about purchases, sales, issuances and settlements in the reconciliation for Level 3 fair value measurements. The Level 3 disclosure requirements were effective for us on January 1, 2011. Since we do not have any significant financial assets or financial liabilities that are measured at fair value using Level 3 valuation techniques and inputs on a recurring basis, the adoption of this standard was not considered material.
Merger of AMB and ProLogis
As discussed above, 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 hold the largest portion of the voting rights in the merged entity and ProLogis appointees represent the majority of the Board of Directors. In our Consolidated Financial Statements, the historical results of ProLogis are included for the entire period presented and the results of AMB are included subsequent to the Merger.
As ProLogis was the accounting acquirer, the calculation of the purchase price for accounting purposes is based on the price of ProLogis common shares and common shares ProLogis would have had to issue to achieve a similar ownership split between AMB and ProLogis stockholders. We estimated the fair value of the pre-combination portion of AMB’s stock-based compensation awards based on market data and, in the case of the stock options, we used a Black-Scholes model to estimate the fair value of these awards as of the Merger date. An adjustment was made to equity for the vested portion while the unvested portion will be expensed over the remaining service period. The purchase price allocation reflects aggregate consideration of approximately $5.9 billion, as calculated below (in millions, except price per share):
ProLogis shares and limited partnership units outstanding at June 2, 2011 (60% of total shares of the combined company)
Total shares of the combined company (for accounting purposes)
Number of AMB shares to be issued (40% of total shares of the combined company)
Multiplied by price of ProLogis common share on June 2, 2011
Consideration associated with common shares issued
Add consideration associated with share based payment awards
Total consideration
The allocation of the purchase price requires a significant amount of judgment. While the current allocation of the purchase price is substantially complete, these allocations are subject to revision. We do not expect future revisions to have a significant impact on our financial position or results of operations. The allocation of the purchase price was as follows (in millions):
Cash, accounts receivable and other assets
Accounts payable, accrued expenses and other liabilities
Total purchase price
Acquisition of ProLogis European Properties
In April 2011, we purchased 11.1 million ordinary units of PEPR, increasing our ownership interest to approximately 39%, and launched a mandatory tender offer to acquire any or all of the outstanding ordinary units and convertible preferred units of PEPR that we did not own at that time. On May 25, 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 our June equity offering (“June 2011 Equity Offering”).
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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). The fair value was based on the trading price and our acquisition price for the PEPR units previously outstanding and purchased during the tender offer period, respectively. As of September 30, 2011, we owned approximately 93.7% of the voting ordinary units of PEPR and 94.9% of the convertible preferred units.
We have allocated the aggregate purchase price, representing the share of PEPR we owned at the time of consolidation of €1.1 billion or ($1.6 billion) as set forth below. 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 and is subject to change. The primary areas of the purchase price allocation that are not yet completed relate to the valuation of the intangible lease assets associated with the real estate portfolio of PEPR of 232 industrial buildings in 11 countries in Europe aggregating approximately 53.0 million square feet. The allocation of the purchase price was as follows (in millions):
The allocations for the Merger and the PEPR acquisition were based on our assessment of the fair value of the acquired assets and liabilities, as summarized below.
Investments in Real Estate Properties- We estimated the fair value generally by applying an income approach methodology using a discounted cash flow analysis. Key assumptions included origination costs and discount and capitalization rates. Discount and capitalization rates were determined by market based on recent appraisals, transactions or other market data. The fair value also includes a portfolio premium that we estimate a third party would be willing to pay for the entire portfolio. Our valuations were based, in part, on a valuation prepared by an independent valuation firm.
Investments in Unconsolidated Investees- We estimated the fair value of the investee by using similar valuation methods as those used for consolidated real estate properties and debt and, based on our ownership interest in each entity, estimated the fair value our investment.
Intangible Assets- The fair value of in place leases was calculated based upon our estimate of the costs to obtain tenants, primarily leasing commissions, in each of the applicable markets. An asset or liability was recognized for acquired leases with favorable or unfavorable rents based on our estimate of current market rents in each of the applicable markets. The recognition of value of existing investment management agreements was calculated by discounting future expected cash flows under these agreements. Our valuations of the intangible assets were based, in part, on a valuation prepared by an independent valuation firm.
Debt- The fair value of debt was estimated based on contractual future cash flows discounted using borrowing spreads and market interest rates that would be available to us for the issuance of debt with similar terms and remaining maturities. In the case of publicly traded debt, the fair value was estimated based on available market data.
Noncontrolling Interest- We estimated the portion of the fair value of the net assets of our consolidated subsidiaries that was owned by third parties.
Pro forma Information
The following unaudited pro forma financial information presents our results as though the Merger and the acquisition of PEPR as well as the June 2011 Equity Offering that was 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 nine months ended September 30, 2011 included approximately four months of actual results for both the Merger and the PEPR acquisition and five months of pro forma adjustments. Actual results in 2011 included rental income and rental expenses of the acquired properties of $325.3 million and $86.7 million, respectively.
(amounts in thousands, except per share amounts)
Net loss attributable to common shares
Net loss per share attributable to common shares - basic
Net loss per share attributable to common shares - diluted
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These results include certain adjustments, primarily decreased revenues resulting from the amortization of the asset or liability from the acquired leases with favorable or unfavorable rents relative to estimated market rents and amortization of acquired management contracts, 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 decreased interest expense due to the accretion of the fair value adjustment of debt.
Investments in real estate properties are presented at cost, and consist of the following (in thousands):
Industrial portfolio (2):
Improved land
Buildings and improvements
Development portfolio, including cost of land (3)
Land (4)
Other real estate investments (5)
Total investments in real estate properties
Net investments in properties
At September 30, 2011, excluding our assets held for sale, we owned real estate properties 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 and nine months ended September 30, 2011, we recognized Gains on Acquisitions and Dispositions of Investments in Real Estate, Net in continuing operations of $8.4 million and $114.7 million, respectively. This includes gains principally recognized in the second quarter related to the recognition of an $85.9 million gain from the consolidation of PEPR (See Note 2), $13.5 million gain from the acquisition of a controlling interest in a joint venture in Japan and the contribution of properties to unconsolidated property funds.
When we contribute real estate properties to a property fund or joint venture in which we have an ownership interest, we defer a portion of the gain realized. If a loss is realized it is recognized when known. The amount of gain not recognized, based on our ownership interest in the entity acquiring the property, is deferred by recognizing a reduction to our investment in the applicable unconsolidated investee. Due to our continuing involvement through our ownership in the unconsolidated investee, these dispositions are not included in discontinued operations. See Note 7 for further discussion of properties we sold to third parties that are reported in discontinued operations.
During the nine months ended September 30, 2011, we recognized a $5.2 million charge for estimated repairs related primarily to one of our buildings in Japan that was damaged from the earthquake and related tsunami in March 2011. This charge was included in Interest and Other Income (Expense), Net on the Consolidated Statements of Operations.
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Summary of Investments
Our investments in and advances to unconsolidated investees, which we account for under the equity method, are summarized by type of investee as follows (in thousands):
Unconsolidated property funds
Other unconsolidated investees
Totals
Unconsolidated Property Funds
As of September 30, 2011 we had investments in 15 unconsolidated property funds that own portfolios of operating industrial properties and may also develop properties, and one property fund that has obtained commitments but does not own any properties. In addition to property and asset management fees, we may earn fees for acting as manager of the property funds and the properties they own. We may earn fees by providing other services including, but not limited to, leasing, construction, development and financing. We may also earn incentive performance returns based on the investors’ returns over a specified period.
Summarized information regarding our investments in the unconsolidated property funds is as follows (in thousands):
Earnings (loss) from unconsolidated property funds:
Americas
Europe
Asia
Total earnings from unconsolidated property funds, net
Private capital revenue:
Total private capital revenue
Development management and other income - Europe
Total
Private capital revenues include fees and incentives we earn for services provided to our unconsolidated property funds (shown above), as well as fees earned from other investees and third parties of $1.9 million and $8.9 million during the three and nine months ended September 30, 2011, respectively, and $1.1 million and $3.3 million for the three and nine months ended September 30, 2010, respectively.
Information about our investments in the unconsolidated property funds is as follows (dollars in thousands):
Unconsolidated property funds by region
Americas (2)
Europe (3)
Asia (4)
During the second quarter of 2011, we recorded impairment charges of $103.8 million primarily related to two of our investments in property funds. This included one investment in the U.S., Prologis North American Industrial Fund III, where our carrying value exceeded the estimated fair value of $31.5 million based on unobservable Level 3 inputs (see Note 14 for information on fair value measurements). The property fund has not had the same appreciation in value in its portfolio that we have experienced in our consolidated portfolio and in several of our other property funds. Based on the duration of time that the value of our investment has been less than carrying value and
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the lack of recovery as compared to our other real estate investments, we no longer believe the decline to be temporary. Also included was our investment in a property fund in South Korea that we sold to our fund partner in July 2011. We had previously recognized an impairment associated with this investment due to the decline in value that we believed to be other than temporary.
Equity Commitments Related to Certain Unconsolidated Property Funds
Certain unconsolidated property funds have equity commitments from us and our fund partners. We may fulfill our equity commitment through contributions of properties or cash. Our fund 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 these respective funds. These property funds are committed to acquire such properties, subject to certain exceptions, including that the properties meet certain specified leasing and other criteria, and that the property funds have available capital. We are not obligated to contribute properties at a loss. Depending on market conditions, the investment objectives of the property funds, our liquidity needs and other factors, we may make contributions of properties to these property funds through the remaining commitment period.
The following table is a summary of remaining equity commitments as of September 30, 2011(in millions):
Prologis Targeted U.S. Logistics Fund (1)
Prologis
Fund Partners
Prologis Brazil Logistics Partners Fund 1 (2)
Fund Partner
Prologis SGP Mexico (3)
Europe Logistics Venture 1 (4)
Prologis China Logistics Venture 1 (5)
In addition to the funds listed above, we also obtained additional equity commitments of €82 million (approximately $110.3 million) in October 2011 in an unconsolidated property fund, Prologis Targeted European Logistics Fund. Some of this equity was called in October 2011 to cover the contribution of two properties for total proceeds of €31.1 million (approximately $43 million). We also have a consolidated property fund in Mexico, Prologis Mexico Fondo Logistico, to which we have an equity commitment of $59.0 million and our fund partners have an equity commitment of $235.8 million. If we contribute a property to a consolidated property fund, 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.
Summarized financial information of the unconsolidated property funds (for the entire entity, not our proportionate share) and our investment in such funds is presented below (dollars in millions):
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2011
For the three months ended September 30, 2011 (1):
Revenues
Net earnings (loss) (2)
For the nine months ended September 30, 2011 (1):
As of September 30, 2011:
Amounts due to us (3)
Third party debt (4)
Total liabilities and noncontrolling interest
Fund partners’ equity
Our weighted average ownership (5)
Our investment balance (6)
Deferred gains, net of amortization (7)
2010
For the three months ended September 30, 2010 (1):
Net earnings (loss) (8)
For the nine months ended September 30, 2010 (1):
As of December 31, 2010:
Amounts due to (from) us (3)
There were net losses of $6.3 million and $24.9 million for the three and nine months ended September 30, 2010, respectively, associated with interest rate contracts that no longer met the requirements for hedge accounting and, therefore, the change in fair value of these contracts was recognized within earnings, along with the gain or loss upon settlement. All derivatives were settled in 2010; therefore, there is no impact in 2011. Also included in net earnings (loss) in the Americas
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In connection with the Merger, we acquired several investments in joint ventures that own industrial and retail properties, perform development activity and hold a mortgage debt investment. We also had investments in entities that owned non-core properties, which were disposed of in late 2010 and in the first half of 2011.
Our investments in and advances to these entities was as follows (in thousands):
Asia (1)
Total investments in and advances to unconsolidated investees
The activity on the notes receivable backed by real estate for the nine months ended September 30, 2011 is as follows (in thousands):
Balance as of December 31, 2010
Investment
Principal payment received
Accrued interest, (interest payments received), net
Impact of changes in foreign currency exchange rates
Other assets consisted of the following, net of amortization and depreciation, if applicable, as of September 30, 2011 and December 31, 2010 (in thousands):
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Lease intangible assets
Straight-line rents assets
Investment management contracts
Prepaid assets
Value added tax and other tax receivables
Goodwill
Other
Other liabilities consisted of the following, net of amortization, if applicable, as of September 30, 2011 and December 31, 2010 (in thousands):
Deferred income taxes
Tenant security deposits
Value added tax and other tax liabilities
Unearned rent
Deferred income
Lease intangible liabilities
Included in certain balances of Other Assets and Other Liabilities as of September 30, 2011 are the purchase price allocations for the Merger and the PEPR acquisition. See Note 2.
Assets Held for Sale
As of September 30, 2011, we had two land parcels and five operating properties that met the criteria as held for sale. The amounts included inAssets Held for Sale include real estate investment balances and the related assets and liabilities for each property.
Discontinued Operations
During the nine months ended September 30, 2011, we disposed of 54 properties aggregating 4.8 million square feet to third parties, most of which were included in Assets Held for Sale at December 31, 2010, including one which was a development property. During all of 2010, we disposed of land subject to ground leases and 205 properties aggregating 25.4 million square feet to third parties, two of which were development properties.
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):
Net gains recognized on dispositions
Impairment charges
Income tax on dispositions
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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 related impairment charges and taxes
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. Generally, unsecured debt, including the credit facilities, senior notes, exchangeable senior notes, and unsecured term loans, is issued by the Operating Partnership or other wholly owned subsidiaries and guaranteed by the REIT. 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 (3)
Secured mortgage debt of consolidated investees (4)
Other debt of consolidated investees (5)
Other debt (6)
During the nine months ended September 30, 2010, we repurchased certain senior and exchangeable senior notes outstanding with maturities in 2012 and 2013. We utilized proceeds from borrowings under the credit facilities to repurchase the senior notes. In addition, in 2010 we repaid certain secured mortgage debt in connection with the sale of two properties in Japan. The activity is summarized as follows (in thousands):
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Original principal amount
Cash purchase / repayment price
Loss on early extinguishment of debt (1)
On June 3, 2011, we entered into a global senior credit facility (“Global Facility”), pursuant to which, the Operating Partnership and certain subsidiaries may obtain loans and/or procure the issuance of letters of credit in various currencies on a revolving basis in an aggregate amount not to exceed approximately $1.75 billion (subject to currency fluctuations). Funds may be drawn in U.S. dollar, euro, Japanese yen, British pound sterling and Canadian dollar. We may increase the Global Facility to $2.75 billion, subject to 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 of the Global Facility 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).
In addition, on June 3, 2011, we entered into a ¥36.5 billion (approximately $474.9 million at September 30, 2011) 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 $735.1 million at September 30, 2011) 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 September 30, 2011 were as follows (dollars in millions):
Aggregate - commitments
Less:
Borrowings outstanding
Outstanding letters of credit
Current availability
Senior Notes
In June 2011, we completed an exchange offer for $4.6 billion of ProLogis senior notes and convertible senior notes with approximately $4.4 billion, or 95%, of the aggregate principal amount being validly tendered for exchange. The senior unsecured notes were exchanged for notes issued by the Operating Partnership that are guaranteed by the REIT. As a result of the exchange offer, we have no separate remaining financial reporting obligations or financial covenants associated with the ProLogis senior notes. All other terms of the newly issued senior notes and exchangeable notes remain substantially the same.
Exchangeable Senior Notes
In connection with the Merger and the exchange offer discussed above, 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. The fair value of the derivative instrument was $62.5 million at the time of the Merger and was reclassified into Accounts Payable and Accrued Expenses from Debt in our Consolidated Balance Sheet. 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 was $11.2 million at September 30, 2011 and therefore, we have recognized an unrealized gain of $61.0 million and $51.3 million, for the three and nine months ended September 30, 2011, respectively.
Secured Mortgage Debt
TMK bonds are a financing vehicle in Japan for special purpose companies known as TMKs. We issued a ¥13.0 billion ($161.3 million) TMK bond on March 17, 2011 at 1.34% due March 2018 secured by one property with an undepreciated cost of $273.4 million at September 30,
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2011. In addition, we assumed ten secured mortgage notes and two additional TMK bonds with the Merger with an outstanding balance of $375.1 million and ¥13.5 billion ($176.0 million) at September 30, 2011, respectively, secured by 76 properties with an undepreciated cost of $934.4 million at September 30, 2011.
Other Debt
As of September 30, 2011, we had two outstanding term loans that we assumed in connection with the Merger, a Japanese Yen term loan with an outstanding balance of ¥12.5 billion ($165.4 million at September 30, 2011) that matures in October 2012 with a weighted average interest rate of 3.4%, and a €157.5 million ($211.8 million at September 30, 2011) senior unsecured term loan with a weighted average interest rate of 3.4% that matures in November 2015.
Long-Term Debt Maturities
Principal payments due on our debt, excluding the Credit Facilities, for the remainder of 2011 and for each of the years in the five-year period ending December 31, 2016 and thereafter are as follows (in thousands):
2011 (1)
2012 (1) (2)
2013 (2) (3)
2014
2015
2016
Thereafter
Total principal due
Premium, net
Net carrying balance
Debt Covenants
Our debt agreements contain various covenants, including maintenance of specified financial ratios. We believe the covenants are customary and we were in compliance with all covenants as of September 30, 2011.
Common Stock
In connection with the Merger, holders of ProLogis common shares received 0.4464 of a newly issued share of AMB common stock, ProLogis became a subsidiary of AMB and AMB changed its name to Prologis, Inc. Because ProLogis was the accounting acquirer (as discussed earlier), the historical ProLogis shares outstanding were adjusted by the Merger exchange ratio and restated to 254.5 million shares at January 1, 2011. As of the Merger date, 169.6 million shares were added to reflect the outstanding shares of common stock of AMB. In addition, in late June we issued 34.5 million shares of common stock generating net proceeds of $1.1 billion. As of September 30, 2011, we had 458.3 million shares of common stock outstanding.
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 own common limited partnership units that make up 0.45% of the common partnership units.
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Preferred Stock
Upon completion of the Merger, each outstanding Series C, F and G Cumulative Redeemable Preferred Share of beneficial interest in ProLogis was exchanged for a newly issued share of Cumulative Redeemable Preferred Stock, Series Q, R and S, respectively. 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;$0.01 par value; 2,000 shares
Series Q Preferred stock at stated liquidation preference of $50 per share;$0.01 par value; 2,000 shares
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;$0.01 par value; 5,000 shares
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. At September 30, 2011, there were no dividends in arrears. 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.
In connection with the Merger, we have incurred and expect to incur additional 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. The costs that were obligations of AMB and expensed pre-merger are not included in our Consolidated Financial Statements. At the time of the Merger, we terminated our existing credit facilities and wrote-off the remaining unamortized deferred loan costs associated with such facilities, which is included as a merger expense. 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 and nine months ended September 30, 2011 (in thousands):
Professional fees
Termination, severance and transitional employee costs
Office closure, travel and other costs
Write-off of deferred loan costs
Under its incentive plans, ProLogis had stock options and full value awards (restricted share units (“RSUs”) and performance share awards (“PSAs”)) outstanding as of the date the Merger was completed. Pursuant to the Merger, each outstanding stock award of ProLogis was converted into 0.4464 of a newly issued award of the REIT. Additionally, the exercise prices of stock options acquired and the grant date fair values of full value awards have been adjusted to reflect the conversion of the underlying award. Stock options, restricted stock and RSUs granted under AMB’s incentive plans were revalued pursuant to the Merger. The portion related to unvested awards will be amortized over the remaining service period.
Summary of Activity
The activity for the nine months ended September 30, 2011, with respect to our stock options, was as follows:
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Balance at December 31, 2010
AMB awards
Settled
Exercised
Forfeited
Balance at September 30, 2011
The activity for the nine months ended September 30, 2011, with respect to unvested restricted stock grants, was as follows:
Granted
Vested
The activity for the nine months ended September 30, 2011, with respect to our full value awards, was as follows:
Distributed
In 2011, we granted 721,050 RSUs and 280,525 target PSAs. The PSAs were granted to certain employees of the company, vest over three years and may be earned based on the attainment of certain individual and company goals for 2011. The ultimate number of PSAs that may be earned and issued to each employee can be between 0 – 200% of their target award.
We report noncontrolling interest related to several entities we consolidate but do not own 100% of the common equity. These entities include three 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, generally at a rate of one share of common stock to one unit or into cash. The Limited Partnership units of two entities that were consolidated pre-merger are exchangeable at the Merger exchange ratio and have been reflected as such in our Consolidated Financial Statements.
In the aggregate as of September 30, 2011, for all our consolidated investees in which we own less than 100% of the equity, we have recorded approximately $6.3 billion of investments in real estate properties and $2.7 billion of debt. PEPR (in which we own 93.7% of the common equity) represents $4.2 billion of the real estate properties and $1.9 billion of the debt. See further discussion in Note 2 related to PEPR.
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 September 30, 2011, the REIT owned 99.55% of the common partnership units of the Operating Partnership.
The following is a summary of the noncontrolling interest (in thousands):
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Partnerships with exchangeable units
Prologis Institutional Alliance Fund II
PEPR
Prologis AMS
Other consolidated entities
Operating Partnership noncontrolling interest
Limited partners in the Operating Partnership
REIT noncontrolling interest
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 of common stock/units outstanding combined with the incremental weighted average effect from all outstanding potentially dilutive instruments.
The following tables set forth the computation of basic and diluted earnings per share/unit (in thousands, except per share/unit amounts):
Net earnings (loss) attributable to common share
Noncontrolling interest attributable to exchangeable limited partnership units
Adjusted net earnings (loss) attributable to common shares
Incremental weighted average effect of exchange of limited partnership units
Incremental weighted average effect of share awards
Weighted average common shares outstanding - Diluted (3)
Net earnings (loss) per share attributable to common shares - Basic and Diluted
Adjusted net earnings (loss) attributable to common unitholders
Weighted average common partnership units outstanding - Basic
Weighted average common partnership units outstanding - Diluted (3)
Net earnings (loss) per unit attributable to common unitholders - Basic and Diluted
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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.
Changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recorded in Accumulated Other Comprehensive Income (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 have entered into an interest rate cap agreement which allows us to receive variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an upfront premium. We had 44 interest rate swap contracts, including 34 contracts denominated in euro, three contracts denominated in British pound sterling and seven contracts denominated in Japanese yen, and one interest rate cap denominated in U.S. dollars, outstanding at September 30, 2011.
In connection with the Merger and the PEPR acquisition, we acquired interest rate swap contracts and an interest rate cap contract with combined notional amounts of $1.6 billion and $25.7 million, respectively, to fix the variable rate on certain indebtedness. We had $30.1 million and $1.4 million accrued in Accounts Payable and Accrued Expenses in our Consolidated Balance Sheets relating to these unsettled derivative contracts at September 30, 2011 and December 31, 2010, respectively.
There was no ineffectiveness recorded during the three and nine months ended September 30, 2011 and 2010. The amount reclassified to interest expense for the three and nine months ended September 30, 2011 and 2010, is not considered material.
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 Income (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 September 30, 2011, we estimate that an additional $8.2 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 nine months ended September 30:
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Notional amounts at January 1
Acquired contracts (1)
Matured or expired contracts
Notional amounts at September 30
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.
The fair value hierarchy consists of three broad levels, which are described below:
Level 1 – Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2 – Observable inputs, other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
Fair Value Measurements on a Recurring and Non-recurring Basis
At September 30, 2011, other than the derivatives discussed above and in Note 8, we do not have any significant financial assets or financial liabilities that are measured at fair value on a recurring or non-recurring basis in our consolidated financial statements.
Fair Value of Financial Instruments
At September 30, 2011 and December 31, 2010, 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 September 30, 2011 and December 31, 2010, 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 Scholes 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 September 30, 2011 and December 31, 2010, 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
Secured mortgage debt
Secured mortgage debt of consolidated investees
Other debt of consolidated investees
Other debt
Total debt
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Our business strategy currently includes two operating segments, as follows:
Direct Owned — 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 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 property funds and industrial joint ventures and the properties they own. We recognize our proportionate share of the earnings or losses from our investments in unconsolidated property funds and certain joint ventures operating in the Americas, Europe and Asia that are accounted for under the equity method. In addition, we recognize fees and incentives earned for services performed on behalf of the unconsolidated investees and certain third parties.
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 direct owned 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 property funds for certain expenses associated with managing these property funds.
Each investment in an unconsolidated property fund or joint venture 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).
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 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:
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Direct owned (1):
Total direct owned segment
Private capital (2):
Total private capital segment
Total segment revenue
Reconciling item (3)
Net operating income:
Direct owned (4):
Private capital (2)(5):
Total segment net operating income
Reconciling items:
Depreciation and amortization expense
Earnings from other unconsolidated investees, net
Impairment of real estate properties and other assets (6)
Total reconciling items
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Assets:
Direct owned:
Private Capital:
Total segment assets
Investments in and advances to other unconsolidated investees
Non-cash investing and financing activities for the nine months ended September 30, 2011 and 2010 are as follows:
We completed the Merger on June 3, 2011. See Note 2 for further information.
We capitalized portions of the total cost of our stock-based compensation awards of $6.0 million and $3.9 million in 2011 and 2010, respectively, to the investment basis of our real estate or other assets.
During 2011 and 2010, we received $1.2 million and $4.6 million, respectively, of ownership interests in certain unconsolidated investees as a portion of our proceeds from the contribution of properties to these property funds.
In April 2011, we assumed $61.7 million of debt upon the acquisition of the remaining interest in a joint venture that owned one property in Japan.
The amount of interest paid in cash, net of amounts capitalized, during the nine months ended September 30, 2011 and 2010 was $304.6 million and $254.2 million, respectively.
During the nine months ended September 30, 2011 and 2010, cash paid for income taxes, net of refunds, was $42.7 million and $25.9 million, respectively.
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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.
On October 14, 2011, a final order was entered in connection with the settlement of lawsuits filed in connection with the Merger. As part of the settlement, we agreed to pay the lawyers who filed the Maryland and Colorado actions attorneys’ fees and expenses in a cumulative amount of $600,000, which amount has been accrued.
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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”), formerly ProLogis and subsidiaries, as of September 30, 2011, the related consolidated statements of operations for the three-month and nine-month periods ended September 30, 2011 and 2010, the related consolidated statement of equity for the nine-month period ended September 30, 2011, the related consolidated statements of comprehensive income (loss) for the nine-month periods ended September 30, 2011 and 2010, and the related consolidated statements of cash flows for the nine-month periods ended September 30, 2011 and 2010. 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 and subsidiaries as of December 31, 2010, 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 25, 2011, 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, 2010, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
KPMG LLP
Denver, Colorado
November 8, 2011
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The Partners
We have reviewed the accompanying consolidated balance sheet of Prologis, L.P. and subsidiaries (the “Operating Partnership”), formerly ProLogis and subsidiaries, as of September 30, 2011, the related consolidated statements of operations for the three-month and nine-month periods ended September 30, 2011 and 2010, the related consolidated statement of capital for the nine-month period ended September 30, 2011, the related consolidated statements of comprehensive income (loss) for the nine-month periods ended September 30, 2011 and 2010, and the related consolidated statements of cash flows for the nine-month periods ended September 30, 2011 and 2010. These consolidated financial statements are the responsibility of the Operating Partnership’s management.
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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 2010 Annual Report on Form 10-K and the ProLogis 2010 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 property funds – 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 2010 Annual Report on Form 10-K and the ProLogis 2010 Annual Report on Form 10-K. References to “we”, “us” and “our” refer to ProLogis and its consolidated subsidiaries prior to the Merger and to Prologis, Inc. and its consolidated subsidiaries following the Merger.
Management’s Overview
Prologis, Inc (the “REIT”) is a self-administered and self-managed real estate investment trust that owns, operates and develops real estate properties, primarily industrial properties, in the Americas, Europe and Asia (directly and through our consolidated and unconsolidated investees). The REIT is the sole general partner of Prologis L.P. (the “Operating Partnership”). As of September 30, 2011, the REIT owned an approximate 99.55% general partnership interest in the Operating Partnership, and 100% of the preferred units. The remaining approximate 0.45% common limited partnership interests are 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. 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. Our business is primarily driven by requirements for modern, well-located inventory space in global, regional and other distribution locations. Our focus on our customers’ needs has enabled us to become a leading global provider of industrial distribution properties.
On June 3, 2011, we completed a merger in which ProLogis shareholders received 0.4464 shares of AMB Property Corporation (“AMB”) common stock for each outstanding common share of beneficial interest in ProLogis (the “Merger”). In the Merger, AMB was the legal acquirer and ProLogis was the accounting acquirer. In addition in May 2011, we acquired a controlling interest in and began consolidating ProLogis European Properties (“PEPR acquisition”). Therefore, our results for 2011 reflect approximately four months of the impact of the Merger and the PEPR acquisition and are not comparable to 2010. We have recorded purchase price allocations in our September 30, 2011 Consolidated Balance Sheet. See Note 2 to the Consolidated Financial Statements in Item 1. As a result of the Merger and the PEPR acquisition, period to period comparisons may not provide as meaningful of information as if those transactions were reflected in both periods.
Our current business strategy includes two operating segments: Direct Owned and Private Capital. Our Direct Owned segment represents the direct long-term ownership of industrial properties. Our Private Capital segment represents the long-term management of property funds, other unconsolidated investees, and the properties they own.
We generate revenues; earnings; net operating income, as defined below; and cash flows through our segments primarily as follows:
Direct Owned Segment — Our investment strategy in this segment focuses primarily on the ownership and leasing of industrial properties in key global and regional markets. Within this segment, we also develop properties, so we include industrial properties that are currently under development, land available for development and/or disposition and land subject to ground leases.
We earn rent from our customers, including reimbursements of certain operating costs, generally under long-term operating leases. The revenue from this segment has increased in 2011 from 2010 due to the Merger and PEPR acquisition, as well as the lease up and increased occupancy levels of our operating portfolio, primarily from our developed properties. We anticipate additional increases in occupied square feet to come from leases that have been signed, but where the space will not be occupied until future quarters. Our direct owned operating portfolio was 90.1% and 87.6% leased and 89.4% and 85.9% occupied at September 30, 2011 and December 31, 2010, respectively.
Private Capital Segment — We recognize our proportionate share of the earnings or losses from our investments in unconsolidated property funds and certain joint ventures that are accounted for under the equity method. The property funds own primarily operating industrial properties and we also may develop properties on behalf of these entities. In addition, we recognize fees and incentives earned for services performed on behalf of these and other entities. We provide services to these entities, which may include property management, asset management, leasing, acquisition, financing and development services. We may also earn incentives from our property funds depending on the return provided to the fund partners over a specified period and we are reimbursed by the property funds for certain expenses associated with managing these property funds. The properties owned by the unconsolidated property funds in the operating portfolio were 93.2% and 93.4% leased and 92.7% and 92.8% occupied at September 30, 2011 and December 2010, respectively.
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Summary of 2011
We have established four strategic priorities:
first, to strengthen our financial position and to build one of the top three balance sheets in the REIT industry;
second, to better align our portfolio with our investment strategy while serving the needs of our customers;
third, to streamline our private capital business and to position it for substantial growth; and
fourth, to build the most effective and efficient organization in the REIT industry, and become the employer of choice among top professionals interested in real estate as a career.
We expect to accomplish these objectives by:
substantially reducing leverage, improving debt coverage ratios and maintaining a staggered debt maturity profile;
maintaining a large stable pool of wholly owned operating properties in global and regional markets, predominantly focused in the U.S;
generating proceeds to pay down debt and fund development through non-strategic property dispositions and contributions to our property funds;
developing new properties in global and regional markets for long term investment, contributions to property funds or sales to third parties, depending on a variety of factors and generally utilizing land we own today;
developing properties within the property fund structures in certain international markets to reduce our foreign currency exposure and limit our committed capital;
establishing new private capital funds or growing our existing funds through our contribution of suitable properties, acquisition from third parties or development of properties within the fund; and
evaluating our current property fund structures in order to reduce the number of investment vehicles and ensure an appropriate fee structure. This may result in an acquisition by us or sales by the property funds.
We have identified more than $90 million on an annualized basis of merger cost synergies as compared to the combined expenses of AMB and ProLogis on a pre-merger basis. These synergies include gross G&A savings, reduced facility fees on our Credit Facilities and lower amortization of non real estate assets. We expect to realize the total amount of these cost synergies by year-end 2012, if not sooner.
During the nine months ended September 30, 2011, we completed the following significant activities:
Closed on the Merger on June 3, 2011 and completed the PEPR acquisition in May 2011. See Note 2 to our Consolidated Financial Statements in Item 1 for additional information on these transactions.
During the third quarter, PEPR issued €97.5 million of equity ($139 million) (98% of which was purchased by us) and used the proceeds and cash on hand to repay €109 million ($150 million) of debt. In addition, we acquired €64.1 million ($86.1 million) of the PEPR public bonds with a maturity of 2014 in the open market. We also bought $135 million of our exchangeable debt with a maturity in 2012.
Issued 34.5 million shares of common stock in a public offering at a price of $33.50 per share, generating approximately $1.1 billion in net proceeds (“2011 Equity Offering”) in late June 2011. We utilized the proceeds to fully repay borrowings under the bridge facility that were used to fund a portion of our acquisition of PEPR. The remainder of the proceeds was used to repay borrowings under our credit facilities and for general corporate purposes.
Entered into a new $1.75 billion global senior credit agreement with a syndicate of 20 banks (“Global Facility”) and terminated our existing global line of credit. We also amended a ¥36.5 billion (approximately $474.9 million at September 30, 2011) revolving credit agreement with a syndicate of eight banks (“Revolver” and together “Credit Facilities”). See additional discussion below.
In June 2011, we completed an exchange offer for $4.6 billion of ProLogis senior notes and exchangeable senior notes, with approximately $4.4 billion, or 95 percent, of the aggregate principal amount being validly tendered for exchange.
Increased the leased percentage of our consolidated operating portfolio to 90.1% at September 30, 2011, as compared to 87.6% at December 31, 2010. This increase was due to the Merger and the PEPR Acquisition, as well as the additional leasing of 38.6 million square feet of space in 2011.
Commenced development on 12 properties aggregating 3.1 million square feet and utilizing land we owned and held for development. Six of these properties are in Europe, four properties are in the U.S. and two properties are in Asia. On average these properties were 47.7% leased at the start of development. In addition, we sold land parcels to third parties generating net proceeds of $113.9 million.
Generated aggregate proceeds of $729.7 million from the disposition of 54 properties to third parties, including the sale of the majority of our non-core assets for which we signed a definitive agreement in the fourth quarter of 2010, and the contribution of three development
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properties to ProLogis European Properties Fund II (“PEPF II”), and four development properties to ProLogis China Logistics Venture 1. We used these proceeds to help fund our development activities and pay down debt.
Sold our interest in the Korea property fund to our partner generating $13.5 million of proceeds.
Operational Outlook
Despite a recent slowdown in the global economic recovery, real estate fundamentals in the U.S. industrial markets were solid during the third quarter. Net absorption of U.S. industrial space measured 36 million square feet in the third quarter, the strongest quarter since the fourth quarter of 2007. Net absorption has been positive for the last five consecutive quarters, causing the availability rate to decline over the last year. We believe net effective rents are trending upward in several markets and, as a result, new development is beginning to occur in certain markets.
While economic growth may be slower than originally anticipated, we expect the rebuilding of inventories to normalized levels to be a powerful driver of demand for industrial real estate. Today the utilization rate at our facilities remains high and we see incremental demand for new space going forward. We now expect more than 125 million square feet of net absorption in 2011, with some of the previously expected growth pushed out an additional quarter or two. We expect net absorption as a percent of stock to surpass its pre-crisis peak level in 2012, though availability will be higher than it was at peak due to the delivery of new product in the early part of the downturn.
Within Europe and Japan, we believe significant supply chain reconfiguration, obsolescence and customers’ preference to lease, rather than own, facilities continue to drive increased demand for industrial space. Additionally, we see an increase in inquiries and leasing velocity in Japan as there has been an increased demand for quality Class-A distribution space as a result of the earthquake and tsunami, which has highlighted the need for modern facilities built to higher seismic standards. Demand in emerging markets where we have investments primarily through our property funds, such as Brazil, China, and Mexico remains strong.
In our total operating industrial portfolio, including properties managed by us and owned by our unconsolidated investees that are accounted for under the equity method and including properties that were part of the Merger, we leased 101.2 million square feet of space during the nine months ended September 30, 2011. Excluding the properties that were part of the Merger, we leased 119.4 million square feet of space during the year ended December 31, 2010. The effective rental rates on leases signed in our same store portfolio (as defined below) decreased by 8.6% in the third quarter, 6.1% in the second quarter and 8.9% in the first quarter when compared with the rental rates on the previous leases on that same space. The total operating portfolio was 91.0% occupied at September 30, 2011, up from 90.7% at June 30, 2011, 89.9% at March 31, 2011, 90.6% at December 31, 2010 and 89.3% at September 30, 2010. Our existing customers renewed their leases 73.4% of the time during the nine months ended September 30, 2011.
We believe that capital deployment opportunities are increasing and are currently evaluating multiple opportunities in our global and regional markets around the globe. Our development business consists of conventional development, build-to-suit development and redevelopment. We expect to develop directly and within the unconsolidated property fund structures, depending on market conditions, submarkets or building sites and availability of capital. We believe that developing, redeveloping and/or expanding of well-located, high-quality industrial properties provides higher rates of return than may be obtained from purchasing existing properties. However, development projects may require significant management attention and capital investment to maximize returns. During the nine months ended September 30, 2011, in response to this emerging demand, we (including AMB pre-Merger) commenced development of 33 properties totaling 8.5 million square feet with a total expected investment of $850.4 million. Of the total development start capital, Prologis’ share was $773.4 million, with $77 million being the responsibility of our fund partners.
As of September 30, 2011, we had 44 properties in our owned and managed development portfolio, including 36 properties that were under development and 38.4% leased. The properties that were under development had a total expected investment of $983.8 million, with a current investment of $441.1 million and an additional estimated $542.7 million of development and leasing costs remaining to be spent. Prologis’ share of the total expected investment, the current investment and the remaining costs to be spent was $828.4 million, $369.3 million, and $459.1 million, respectively.
Additionally, we had eight properties that were completed but had not yet reached stabilization. This portfolio had a total expected investment of $393.4 million, with a current investment of $364.7 million and $28.7 million of leasing costs remaining to be spent. Prologis’ share of the total expected investment, the current investment and the remaining costs to be spent was $378.8 million, $350.3 million, and $27.9 million, respectively.
Results of Operations
Nine Months Ended September 30, 2011 and 2010
Summary
The following table illustrates the net operating income for each of our segments, along with the reconciling items to Loss from Continuing Operations on our Consolidated Statements of Operations in Item 1 for the nine months ended September 30 (dollars in thousands):
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Net operating income – direct owned segment
Net operating income – private capital segment
Other:
Income tax benefit (expense)
Loss from continuing operations
As discussed above, these results are historical Prologis for the entire period and include the AMB results for approximately four months and the results of our investments in PEPR accounted for on the equity method for approximately five months and on a consolidated basis for approximately four months. See below and Notes 2 and 15 to our Consolidated Financial Statements in Item 1 for additional information regarding the impact of the Merger and the PEPR Acquisition and our segments and a reconciliation of net operating income to Loss Before Income Taxes.
Direct Owned Segment
The net operating income of the direct owned segment consists of rental income and rental expenses from industrial properties that we own and consolidate. The size and occupied percentage 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 land we own and lease to customers under ground leases, development management and other income, offset by acquisition costs and land holding costs. As discussed earlier, we have included the rental income and expenses from the properties acquired as part of the Merger and PEPR acquisition for approximately four months in 2011, including a full quarter for third quarter 2011. The results of properties that were sold to third parties are presented as Discontinued Operations in our Consolidated Financial Statements in Item 1 for all periods and therefore does not impact the segment results. The net operating income from the direct owned segment for the nine months ended September 30, was as follows (in thousands):
Rental and other income
Rental and other expenses
Total net operating income - direct owned segment
Our direct owned operating portfolio was as follows (square feet in thousands):
September 30, 2011 (1)
December 31, 2010 (2)
September 30, 2010
The increases in rental income and rental expense in 2011 from 2010 are due primarily to the impact of the Merger and the PEPR acquisition, increased occupancy in our operating portfolio and the completion and stabilization of new development properties. The results for 2011 include approximately four months of rental income and expenses of the acquired properties of $325.3 million and $86.7 million, respectively.
In our direct owned portfolio, we leased 38.6 million square feet for the nine months ended September 30, 2011 compared to 38.2 million square feet for the nine months ended September 30, 2010. As of September 30, 2011, our total direct owned industrial operating portfolio was 90.1% leased and 89.4% occupied, as compared with 87.6% leased and 85.9% occupied at December 31, 2010 and 86.0% leased and 84.6% occupied at September 30, 2010. The effective rental rates on leases signed in our same store portfolio (as defined below) decreased by 8.9%, 6.1% and 8.6% in the first, second, and third quarters of 2011, when compared with the rental rates on the previous leases on that same space. 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 $198.3 million and $123.9 million for the nine months ended September 30, 2011 and 2010, respectively.
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Private Capital Segment
The net operating income of the private capital segment consists of: (i) earnings or losses recognized under the equity method from our investments in unconsolidated property funds and certain joint ventures; (ii) fees and incentives earned for services performed for our unconsolidated investees and certain third parties; and (iii) dividends and interest earned on investments in preferred stock or debt securities of our unconsolidated investees; offset by (iv) our direct costs of managing these entities and the properties they own.
The net earnings or losses of the unconsolidated investees may include the following income and expense items, in addition to rental income and rental expenses: (i) interest income and interest expense; (ii) depreciation and amortization expenses; (iii) general and administrative expenses; (iv) income tax expense; (v) foreign currency exchange gains and losses; (vi) gains or losses on dispositions of properties or investments; and (vii) impairment charges. The fluctuations in income we recognize in any given period are generally the result of: (i) variances in the income and expense items of the unconsolidated investees; (ii) the size of the portfolio and occupancy levels; (iii) changes in our ownership interest; and (iv) fluctuations in foreign currency exchange rates at which we translate our share of net earnings to U.S. dollars, if applicable. In connection with the Merger, we recorded our investments in certain unconsolidated investees at fair value and will therefore have increased depreciation expense over what AMB recognized per-Merger.
The direct costs associated with our private capital segment totaled $39.2 million and $30.1 million for the nine months ended September 30, 2011 and 2010, respectively, and are included in the line item Private Capital Expenses in our Consolidated Statements of Operations in Item 1. These expenses 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 direct owned 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 and certain third parties. We allocate the costs of our property management function to the properties we own (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 is due to the increased private capital platform and infrastructure that was part of the Merger, offset with a decline in the portion of our property management expenses that are allocated to this segment due to the consolidation of PEPR.
The net operating income from the private capital segment for the nine months ended September 30 was as follows (in thousands):
Unconsolidated property funds:
Americas (1)
Europe (2)
Asia (3)
Other (4)
Total net operating income - private capital segment
As of September 30, 2011, we had investments in four property funds that we consolidate, including PEPR and three investments acquired through the Merger. As these entities are consolidated, their results are included in our direct owned 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”) Expenses
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G&A expenses for the nine months ended September 30 consisted of the following (in thousands):
Gross G&A expense
Reported as rental expense
Reported as private capital expense
Capitalized amounts
Net G&A
The increase in G&A expenses and the various components is due primarily to the Merger and the larger infrastructure associated with our larger company.
Merger, Acquisition and Other Integration Expenses
In connection with the Merger, we have incurred and expect to incur additional 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. The costs that were obligations of AMB and expensed pre-merger are not included in our Consolidated Financial Statements. At the time of the Merger, we terminated our existing credit facilities and wrote-off the remaining unamortized deferred loan costs associated with such facilities, which is included as a merger expense. 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 nine months ended September 30 (in thousands):
The majority of the costs incurred during the nine months ended September 30, 2011 were incurred during the second quarter when the Merger and the PEPR acquisition were completed.
Depreciation and Amortization
Depreciation and amortization expenses were $403.0 million and $235.9 million for the nine months ended September 30, 2011 and 2010, respectively. The increase is due to four months of depreciation and amortization expense on the additional properties acquired in the Merger and PEPR acquisition, as well as the leasing and stabilization of properties that we have developed, and the amortization of the management contracts valued in connection with the Merger.
Interest Expense
Interest expense for the nine months ended September 30 included the following components (in thousands):
Gross interest expense
Amortization of discount, net
Amortization of deferred loan costs
Interest expense before capitalization
Net interest expense
Gross interest expense increased in 2011 from 2010 due primarily to higher debt levels as a result of the Merger and PEPR acquisition for four months of 2011, offset partially by decreased interest rates.
In connection with the Merger and the PEPR acquisition, we increased our debt to $12.1 billion at September 30, 2011. The nine months ended September 30, 2011 include approximately four months of interest expense resulting from increased debt with the Merger and increased interest expense from the PEPR acquisition (both the interest incurred to fund the $1.0 billion acquisition of the PEPR units, as well as approximately four months of increased interest expense from the consolidation of PEPR). Our increased debt levels in 2011 was offset somewhat by our
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repayment and repurchase activities in 2010, which was funded with proceeds from asset sales and our November 2010 equity offering. We reduced our outstanding debt from $8.0 billion at December 31, 2009 to $6.5 billion at December 31, 2010.
The decrease in capitalized amounts in 2011 from 2010 was due to less development activity during this period and the stabilization of previously developed properties. Our weighted average effective interest rate (including amortization of deferred loan costs) was 5.60% and 6.40% for the nine month period ended September 30, 2011 and 2010, respectively. Our future interest expense, both gross and the portion capitalized, will vary depending on, among other things, the level of our development activities, which we expect will increase subsequent to the Merger. See Notes 2 and 8 to our Consolidated Financial Statements in Item 1 and Liquidity and Capital Resources for further discussion of our debt and borrowing costs.
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 $114.7 million during the nine months ended September 30, 2011. This included gains recognized in the second quarter related to the PEPR acquisition ($85.9 million) and the acquisition of our partner’s interest in a joint venture in Japan ($13.5 million). The gains represent the adjustment to fair value of our equity investments at the time we gained control and consolidated the entities. This also includes the contribution of properties to unconsolidated property funds.
Foreign Currency Exchange and Derivative Gains (Losses), net
In connection with the Merger and the exchange offer discussed in Note 8 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 has changed and, we are now required 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 gain of $61.0 million and $51.3 million for the three and nine months ended September 30, 2011, respectively.
Impairment of Other Assets
During the nine months ended September 30, 2011, we recorded impairment charges of $103.8 million primarily related to two of our investments in unconsolidated property funds. This included one investment in the U.S.,(Prologis North American Industrial Fund III) where our carrying value exceeded the estimated fair value. The property fund has not had the same appreciation in value in its portfolio that we have experienced in our consolidated portfolio and in several of our other property funds. Based on the duration of time that the value of our investment has been less than carrying value and the lack of recovery as compared to our other real estate investments, we no longer believe the decline to be temporary. Also, included was our investment in a property fund in South Korea that we sold to our fund partner in July 2011.
Interest and Other Income (Expense), Net
During the nine months ended September 30, 2011, we recognized a $5.2 million charge related to one of our buildings in Japan that was damaged from the earthquake and related tsunami in March 2011.
Loss on Early Extinguishment of Debt, Net
During the nine months ended September 30, 2011 and 2010, in connection with our initiatives to reduce debt and smooth debt maturities, we purchased portions of several series of senior notes, senior exchangeable notes and eurobonds outstanding and extinguished some secured mortgage debt prior to maturity, which resulted in the recognition of losses of $0.3 million and $48.4 million, respectively, with the most significant losses in the first quarter of 2010. The gains or losses represent the losses of difference between the recorded debt (net of premiums and discounts and including related deferred loan costs) and the consideration we paid to retire the debt, including fees. See Note 8 to our Consolidated Financial Statements in Item 1 for more information regarding our debt repurchases.
Income Tax Expense (Benefit)
During the nine months ended September 30, 2011 and 2010, our current income tax expense was $7.2 million and $15.9 million, respectively. We recognize current income tax expense for income taxes incurred by our taxable REIT 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 third quarter of 2011, we recognized a current tax benefit of $4.6 million, which included credits due to certain expiring statutes.
During the nine months ended September 30, 2011 and 2010, we recognized a net deferred tax expense of $2.8 million and a net deferred tax benefit of $40.4 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. The benefit recognized in 2010 related to the conversion of two of our European management companies to taxable entities. This conversion created an asset for tax purposes that will be utilized against future taxable income as it is amortized.
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
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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.
In 2011, we disposed of land subject to ground leases and 54 non-development properties aggregating 4.8 million square feet to third parties, most of which was included in Assets Held for Sale at December 31, 2010. 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 2010, we disposed of land subject to ground leases and 205 properties aggregating 25.4 million square feet to third parties.
As of September 30, 2011, we had two land parcels and five operating properties that met the criteria to be reflected as held for sale, including the real estate investment balances and the related assets and liabilities.
See Note 7 to our Consolidated Financial Statements in Item 1.
Net Earnings Attributable to Noncontrolling Interests
For all periods presented, this amount represents the amount of earnings or loss that is attributable to the third party ownership interest in the consolidated entities for which we do not own 100% of the equity. In the Consolidated Statements of Operations for the Operating Partnership, this represents only our partners’ share of the consolidated property funds and joint ventures. In the Consolidated Financial Statements for the REIT, this also includes the limited partnership units in the Operating Partnership not owned by the REIT.
Other Comprehensive Income (Loss) – Foreign Currency Translation (Losses), Net
For our subsidiaries whose functional currency is not the U.S. dollar, we translate their financial statements into U.S. dollars 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).
During the nine months ended September 30, 2011, we recorded unrealized losses in Other Comprehensive Income (Loss)of $94.1 million and substantially zero in 2010 that related to foreign currency translations of our foreign subsidiaries into U.S. dollars upon consolidation. The euro and pound sterling remained relatively flat from December 31, 2010 to September 2011, but both weakened to the U.S. dollar from Merger and PEPR acquisition date to September 2011. These losses were offset slightly by the strengthening of the yen to the U.S. dollar during 2011.
Weighted Average Shares/Units Outstanding
For purposes of computing weighted average shares/units, the historical weighted average shares/units outstanding of ProLogis were adjusted by the Merger exchange ratio of 0.4464 for all period presented. As of the date of the Merger, the calculation for weighted average shares/units includes the 169.6 million shares/units, which represents the outstanding common stock of AMB (for the REIT) or the outstanding general partner common units (for the Operating Partnership). The weighted average units for the Operating Partnership also includes 2.1 million common units of the limited partners not owned by the REIT.
Three Months Ended September 30, 2011 and 2010
Our results for the three months ended September 30, 2011 include a full quarter of results related to the Merger and PEPR acquisition while the results for the nine months ended September 30, 2011 include four months of results for the Merger and PEPR acquisition. Other than that, the changes in net earnings attributable to common shares and its components for the three months ended September 30, 2011, as compared to the three months ended September 30, 2010, are similar to the changes for the nine months periods ended in the same dates, except as separately discussed above.
Portfolio Information
Our total operating portfolio of properties includes industrial properties owned by us and the unconsolidated property funds and joint ventures we manage and account for on the equity method. The operating portfolio reflects the Merger and PEPR acquisition (movement from private capital segment to direct owned segment) and does not include properties under development, properties held for sale or non-industrial properties owned by unconsolidated investees or properties we manage in which we do not have an ownership interest, and was as follows (square feet in thousands):
Reportable Business Segment
Direct Owned
Private Capital
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
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store analysis. We have defined the same store portfolio, for the three months ended September 30, 2011, as those properties that were in operation at January 1, 2010, and have been in operation throughout the three-month periods in both 2011 and 2010. 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. dollars, for both periods. The same store portfolio, for the three months ended September 30, 2011, included 547.4 million of aggregated square feet.
The following is a reconciliation of our consolidated rental income, rental expenses and net operating income (calculated as rental income less rental expenses) for the three months ended September 30, 2011 and 2010, as included in our Consolidated Statements of Operations in Item 1, to the respective amounts in our same store portfolio analysis.
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 premerger
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 expenses of AMB properties premerger
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 premerger
Same store portfolio — net operating income (3)
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Environmental Matters
A majority of the properties we own 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 and stockholder distribution requirements.
Near-Term Principal Cash Sources and Uses
In addition to distributions to the common stockholders of the REIT, the limited partnership units of the Operating Partnership and the preferred stockholders, 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, primarily for the development and/or acquisition of properties depending on market and other conditions (b);
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 debt principal payments in the remainder of 2011 of $89 million and 2012 of $1.5 billion, of which approximately $310 million was repaid in October 2011;
capital expenditures and leasing costs on properties;
depending on market and other conditions, direct acquisition of operating properties and/or portfolios of operating properties in global or regional markets for direct, long-term investment; and
merger integration and transition expenses.
We expect to fund our cash needs principally from the following sources, all subject to market conditions:
available cash balances ($217 million at September 30, 2011);
property operations;
fees and incentives earned for services performed on behalf of the property funds and distributions received from the property funds;
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proceeds from the disposition of properties, land parcels or other investments to third parties;
proceeds from the contributions of properties to property funds or other unconsolidated investees (subsequent to September 30, 2011, we received proceeds of $453 million from the contribution of properties to unconsolidated property funds);
borrowing capacity under our Credit Facilities ($0.8 billion available as of September 30, 2011), other facilities or borrowing arrangements;
proceeds from the issuance of equity securities; and
proceeds from the issuance of debt securities, including secured mortgage debt.
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 June 3, 2011, we entered into the Global Facility, pursuant to which the Operating Partnership and certain subsidiaries and affiliates may obtain loans and/or procure the issuance of letters of credit in various currencies on a revolving basis in an aggregate amount not exceeding approximately $1.75 billion (subject to currency fluctuations). An accordion feature will allow us to increase the Global Facility to $2.75 billion, subject to obtaining additional lender commitments.
In addition, on June 3, 2011, we entered into the Revolver, which has a total borrowing capacity of ¥ 36.5 billion (approximately $474.9 million at September 30, 2011). 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 $735.1 million at September 30, 2011) 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.
Information related to our Credit Facilities as of September 30, 2011 is as follows (dollars in millions):
Aggregate lender - commitments
In connection with the Merger and PEPR acquisition, we recorded $5.9 billion in additional debt. This debt was recorded at estimated fair value as of the Merger/acquisition dates. The interest expense that is reflected in our Consolidated Financial Statements in Item 1 is based on the effective interest rate recorded as part of the fair value allocated to the debt. Included in the total debt recorded, was $2.2 billion that is an obligation of PEPR that we consolidate but do not own 100% and do not guarantee. PEPR may repay the debt with borrowings under its credit facilities or other borrowings. During the third quarter, PEPR issued €97.5 million of equity (98% of which was purchased by us) and used the proceeds to repay €109 million ($150 million) of debt. In addition, we acquired €61.1 million ($86.1 million) of the PEPR public bonds with a maturity of 2014 in the open market reducing debt on a consolidated basis. We also bought $135 million of our exchangeable debt with a maturity in 2012 through open market purchases.
As of September 30, 2011, we were in compliance with all of our debt covenants.
See Note 8 to our Consolidated Financial Statements in Item 1 for further discussion of our debt.
Cash Provided by Operating Activities
For the nine months ended September 30, 2011 and 2010, operating activities provided net cash of $104.9 million and $224.6 million, respectively. In the first nine months of 2011 and 2010, cash provided by operating activities was less than the cash distributions paid on common stock and dividends paid on preferred stock by $175.8 million and $10.4 million, respectively. In 2011, the decrease in cash provided by operating activities was largely due to the Merger and integration cash expenses of $103.9 million recognized in 2011 and timing of certain payments, offset somewhat with higher earnings and cash flows from operations as a result of the Merger and PEPR acquisition.
Cash Investing and Cash Financing Activities
For the nine months ended September 30, 2011 and 2010, investing activities used net cash of $798.5 million and $88.5 million, respectively. The following are the significant activities for both periods presented:
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We generated cash from dispositions of $812.2 million and $603.5 million during 2011 and 2010, respectively. In 2011, we disposed of land, land subject to ground leases and 61 properties that included the majority of our non-core assets. In 2010, we disposed of land and 22 properties.
We invested $875.7 million in real estate during 2011 and $436.5 million for the same period in 2010; including costs for current and future development projects, property acquisitions and recurring capital expenditures and tenant improvements on existing operating properties.
In connection with the Merger, we acquired $234.0 million in cash in 2011.
During the second quarter 2011, we used $1.0 billion of cash to purchase units in PEPR (see Note 2 to the Consolidated Financial Statements in Item I). The acquisition was funded with borrowings on a new €500 million bridge facility (“PEPR Bridge Facility”) that was put in place for the acquisition and borrowings under our other credit facilities. The borrowings on the PEPR Bridge Facility were repaid with proceeds from the 2011 Equity Offering.
We received distributions from unconsolidated investees as a return of investment of $114.4 million and $77.0 million during 2011 and 2010, respectively.
In the first quarter of 2011, we invested $55.0 million in a preferred equity interest in a subsidiary of the buyer of a portfolio of non-core assets. In the third quarter of 2010, we purchased a $81.0 million loan to an unconsolidated investee from the lender which is secured by buildings in the property fund.
We generated net cash proceeds from payments on notes receivables of $6.5 million and $13.6 million in 2011 and 2010, respectively.
In 2011, we invested $9.7 million in unconsolidated investees, net of repayment of advances by the investees. In 2010, we invested cash of $265.1 million in unconsolidated investees including investments in connection with a property contribution we made, net of repayment of advances by the investees.
For the nine months ended September 30, 2011 and 2010, financing activities provided net cash of $874.0 million and used $151.8 million, respectively. The following are the significant activities for both periods presented:
In June 2011, we completed the 2011 Equity Offering and issued 34.5 million shares of common stock and received net proceeds of approximately $1.2 billion. The proceeds were used to repay the PEPR Bridge Facility completely and the remainder were used to repay a portion of the borrowings outstanding under our Credit Facilities.
In 2011, we incurred $164.8 million in secured mortgage debt and borrowed $721.0 million on the PEPR Bridge Facility. In March 2010, we issued $1.1 billion of senior notes due 2017 and 2020 and $460.0 million of exchangeable senior notes due 2015 and incurred $293.4 million in secured mortgage debt.
We had net proceeds on our Credit Facilities of $377.8 million and net payments of $305.4 million during 2011 and 2010, respectively. In connection with the Merger, we repaid the outstanding balance under our existing global line of credit and entered into new credit facilities as discussed below.
In 2011, we used $711.8 million in proceeds from the 2011 Equity Offering to repay the amounts borrowed under the PEPR Bridge Facility. In addition, we made net payments of $226.5 million and $54.4 million on regularly scheduled debt principal and maturity payments during 2011 and 2010, respectively. This includes the repayment of €101.3 million ($146.8 million) of the euro notes that matured in April 2011.
In 2011 and 2010, we purchased and extinguished $243.3 million and $1.4 billion, respectively, for approximately the original principal amount of our senior and exchangeable senior notes and secured mortgage debt.
We paid distributions of $257.8 million and $215.9 million to our common stockholders during 2011 and 2010, respectively. We paid dividends on our preferred stock of $23.0 million and $19.1 million during both 2011 and 2010, respectively.
In 2011, we distributed $11.1 million to noncontrolling interests.
We generated proceeds from the sale and issuance of common stock under our various common stock plans of $29.9 million in 2010, primarily from our at-the-market equity issuance program. We had no activity in 2011. In connection with the Merger, this program was terminated.
Off-Balance Sheet Arrangements
Unconsolidated Property Fund Debt
We had investments in and advances to the property funds at September 30, 2011 of $2.5 billion. The property funds had total third party debt of $9.1 billion (for the entire entity, not our proportionate share) at September 30, 2011 that matures as follows (in millions):
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Total unconsolidated property funds
We have notes receivable from certain property funds: (i) a loan that bears interest at 8%, matures in May 2015 is secured by 12 buildings in the property fund with an outstanding balance as of September 30, 2011 of $78.3 million, and (ii) a loan with an outstanding balance of $21.4 million. In addition, we have pledged properties we own directly, valued at approximately $276.0 million, to serve as additional collateral on a loan payable to an affiliate of our fund partner that is due in 2014.
Contractual Obligations
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 of 1986, as amended, relative to maintaining our REIT status, while still allowing us to maximize the cash retained to meet other cash needs such as capital improvements and other investment activities.
Prior to the Merger, ProLogis paid a cash distribution of $0.252 (adjusted by Merger exchange ratio) per common share for the first quarter on February 28, 2011 and for the second quarter on May 25, 2011. Also prior to the Merger, AMB paid a dividend of $0.28 per common share on February 28, 2011 for the first quarter and on May 25, 2011 for the second quarter. Neither AMB dividend has been reflected in the Consolidated Financial Statements in Item 1 since ProLogis is considered the accounting acquirer, as discussed earlier. We paid a cash distribution of $0.28 per common share for the third quarter on September 30, 2011. Our future common stock dividends may vary and will be determined by our Board of Directors (“Board”) upon the circumstances prevailing at the time, including our financial condition, operating results and real estate investment trust distribution requirements, and may be adjusted at the discretion of the Board during the year.
At September 30, 2011, 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 distributions on those shares have been reflected in the Consolidated Financial Statements in Item 1 through September 30, 2011. The dividends on preferred stock are payable quarterly in arrears.
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.
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.
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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. At September 30, 2011, we have ¥54.2 billion ($705.6 million) in TMK bond agreements and a ¥12.5 billion ($162.5 million) term loan with variable interest rates. We have entered into interest rate swap agreements to fix the interest rate on ¥35.5 billion ($461.8 million as of September 30, 2011) of the TMK bonds and the entire term loan for the term of the agreements. At September 30, 2011, we have also entered into interest rate swap agreements to fix the interest rate on €784.5 million ($1.1 billion) of secured debt, of which €753.8 million ($1.0 billion) relates to PEPR, with variable interest rates.
Our primary interest rate risk is created by the variable rate Credit Facilities. During the nine months ended September 30, 2011, we had weighted average daily outstanding borrowings of $753.1 million 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 $1.5 million of cash flow for the nine months ended September 30, 2011.
We also have $472.7 million of variable interest rate debt which has a market risk of increased rates. Based on a sensitivity analysis with a 10% adverse change in interest rates our estimated market risk exposure for this issuance is approximately $0.7 million on our cash flow for the nine months ended September 30, 2011.
Foreign Currency Risk
Foreign currency risk is the possibility that our financial results of operations and financial position 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, our financial results of operations and financial position of our foreign subsidiaries into U.S. dollars, 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 September 30, 2011, 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 September 30, 2011, 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 September 30, 2011. 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 September 30, 2011. 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
On October 14, 2011, a final order was entered in connection with the settlement of lawsuits filed in connection with the Merger. As part of the settlement, we agreed, among other things, to pay the lawyers who filed the Maryland and Colorado actions attorneys’ fees and expenses in a cumulative amount of $600,000, which amount has been accrued.
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Item 1A. Risk Factors
As of September 30, 2011, no material changes had occurred in our risk factors as discussed in Item 1A of our 2010 Annual Report on Form 10-K, and the 2010 Annual Report on Form 10-K of ProLogis.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Item 4. [Removed and Reserved]
Item 5. Other Information
Item 6. Exhibits
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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.
/s/ William E. Sullivan
/s/ Lori A. Palazzolo
Date: November 8, 2011
Index to Exhibits