UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2014
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.)
Pier 1, Bay 1, San Francisco, California
(415) 394-9000
(Registrants’ telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website; if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter periods that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Prologis, Inc.:
Prologis, L.P.:
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
The number of shares of Prologis, Inc.’s common stock outstanding as of May 1, 2014, was approximately 499,688,000.
EXPLANATORY NOTE
This report combines the quarterly reports on Form 10-Q for the period ended March 31, 2014, of Prologis, Inc. and Prologis, L.P. Unless stated otherwise or the context otherwise requires, references to “Prologis, Inc.” or the “REIT”, mean Prologis, Inc., and its consolidated subsidiaries; and references to “Prologis, L.P.” or the “Operating Partnership” mean Prologis, L.P., and its consolidated subsidiaries. The terms “the Company,” “Prologis,” “we,” “our” or “us” means the REIT and the Operating Partnership collectively.
Prologis, Inc. is a real estate investment trust and the general partner of the Operating Partnership. As of March 31, 2014, Prologis, Inc. owned an approximate 99.65% common general partnership interest in the Operating Partnership and 100% of the preferred units in the Operating Partnership. The remaining approximate 0.35% common limited partnership interests are owned by non-affiliated investors and certain current and former directors and officers of Prologis, Inc. As the sole general partner of the Operating Partnership, Prologis, Inc. has full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Operating Partnership.
We operate the REIT and the Operating Partnership as one enterprise. The management of the REIT consists of the same members as the management of the Operating Partnership. These members are officers of the REIT and employees of the Operating Partnership or one of its direct or indirect subsidiaries. As general partner with control of the Operating Partnership, the REIT consolidates the Operating Partnership for financial reporting purposes, and the REIT does not have significant assets other than its investment in the Operating Partnership. Therefore, the assets and liabilities of the REIT and the Operating Partnership are the same on their respective financial statements.
We believe combining the quarterly reports on Form 10-Q of the REIT and the Operating Partnership into this single report results in the following benefits:
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 entities. 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 entities 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 Information
Item 1. Financial Statements
Consolidated Balance Sheets – March 31, 2014 and December 31, 2013
Consolidated Statements of Operations – Three Months Ended March 31, 2014 and 2013
Consolidated Statements of Comprehensive Income (Loss) – Three Months Ended March 31, 2014 and 2013
Consolidated Statement of Equity – Three Months Ended March 31, 2014
Consolidated Statements of Cash Flows – Three Months Ended March 31, 2014 and 2013
Consolidated Statement of Capital – Three Months Ended March 31, 2014
Prologis, Inc. and Prologis, L.P.:
Notes to Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II.
Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
PROLOGIS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS
Investments in real estate properties
Less accumulated depreciation
Net investments in real estate properties
Investments in and advances to unconsolidated entities
Notes receivable backed by real estate and other
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
Total liabilities
Equity:
Prologis, Inc. stockholders’ equity:
Series Q preferred stock at stated liquidation preference of $50 per share; $0.01 par value; 2,000 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively
Common stock; $0.01 par value; 499,651 shares and 498,799 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively
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.
1
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
Revenues:
Rental income
Rental recoveries
Investment management income
Development management and other income
Total revenues
Expenses:
Rental expenses
Investment management expenses
General and administrative expenses
Depreciation and amortization
Other expenses
Total expenses
Operating income
Other income (expense):
Earnings from unconsolidated entities, net
Interest expense
Interest and other income, net
Gains on acquisitions and dispositions of investments in real estate, net
Foreign currency and derivative gains (losses), net
Gains (losses) on early extinguishment of debt, net
Total other income (expense)
Earnings before income taxes
Current income tax expense
Deferred income tax expense (benefit)
Total income tax expense
Earnings from continuing operations
Discontinued operations:
Income attributable to disposed properties and assets held for sale
Net gains on dispositions, including related impairment charges and taxes
Total discontinued operations
Consolidated net earnings
Net earnings attributable to noncontrolling interests
Net earnings attributable to controlling interests
Less preferred stock dividends
Loss on preferred stock redemption
Net earnings attributable to common stockholders
Weighted average common shares outstanding—Basic
Weighted average common shares outstanding—Diluted
Net earnings per share attributable to common stockholders—Basic:
Continuing operations
Discontinued operations
Net earnings per share attributable to common stockholders—Basic
Net earnings per share attributable to common stockholders—Diluted:
Net earnings per share attributable to common stockholders—Diluted
Dividends per common share
2
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss):
Foreign currency translation losses, net
Unrealized gains (losses) and amortization on derivative contracts, net
Comprehensive income
Other comprehensive loss (income) attributable to noncontrolling interest
Comprehensive income (loss) attributable to common stockholders
CONSOLIDATED STATEMENT OF EQUITY
Three Months Ended March 31, 2014
Balance as of January 1, 2014
Effect of common stock plans
Formation of Prologis U.S. Logistics Venture
Capital contributions
Settlement of noncontrolling interests
Foreign currency translation gains (losses), net
Unrealized losses and amortization on derivative contracts, net
Distributions and allocations
Balance as of March 31, 2014
3
CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating activities:
Adjustments to reconcile net earnings to net cash provided by operating activities:
Straight-lined rents
Stock-based compensation awards, net
Distributions and changes in operating receivables from unconsolidated entities
Amortization of debt and lease intangibles
Losses (gains) on early extinguishment of debt, net
Unrealized foreign currency and derivative losses (gains), net
Decrease (increase) in restricted cash, accounts receivable and other assets
Decrease in accounts payable and accrued expenses and other liabilities
Net cash provided by operating activities
Investing activities:
Real estate development activity
Real estate acquisitions
Tenant improvements on previously leased space and lease commissions
Non-development capital expenditures
Investments in and advances to unconsolidated entities, net
Return of investment from unconsolidated entities
Proceeds from dispositions and contributions of real estate properties
Net cash provided by (used in) investing activities
Financing activities:
Proceeds from issuance of common stock, net
Dividends paid on common and preferred stock
Noncontrolling interest contributions
Noncontrolling interest distributions
Debt and equity issuance costs paid
Net proceeds from credit facilities, net
Repurchase and payments of debt
Proceeds from issuance of 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 12 for information on non-cash investing and financing activities and other information.
4
PROLOGIS, L.P.
LIABILITIES AND CAPITAL
Capital:
Partners’ capital:
General partner—preferred
General partner—common
Limited partners
Total partners’ capital
Total capital
Total liabilities and capital
5
(In thousands, except per unit amounts)
Less preferred unit distributions
Loss on preferred unit redemption
Net earnings attributable to common unitholders
Weighted average common units outstanding—Basic
Weighted average common units outstanding—Diluted
Net earnings per unit attributable to common unitholders—Basic:
Net earnings per unit attributable to common unitholders—Basic
Net earnings per unit attributable to common unitholders—Diluted:
Net earnings per unit attributable to common unitholders—Diluted
Distributions per common unit
6
Other comprehensive loss (income) attributable to noncontrolling interests
Comprehensive income (loss) attributable to common unitholders
CONSOLIDATED STATEMENT OF CAPITAL
Effect of REIT’s common stock plans
7
Three Months Ended
March 31,
REIT stock-based compensation awards, net
Proceeds from issuance of common partnership units in exchange for contributions from the REIT, net
Distributions paid on common and preferred units
8
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 (“Internal Revenue Code”), 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 the controlling interest in the Operating Partnership, we are engaged in the ownership, acquisition, development and operation of industrial properties in global and regional markets throughout the Americas, Europe and Asia. Our current business strategy includes two reportable business segments: Real Estate Operations and Investment Management. Our Real Estate Operations segment represents the long-term ownership of industrial properties. Our Investment Management segment represents the long-term management of co-investment ventures. See Note 11 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.
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. As of March 31, 2014, the REIT owned an approximate 99.65% common general partnership interest in the Operating Partnership, and 100% of the preferred units. The remaining approximate 0.35% 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 direct or indirect subsidiaries. As general partner with control of the Operating Partnership, the REIT consolidates the Operating Partnership for financial reporting purposes. The REIT does not have significant assets other than its investment in the Operating Partnership and therefore, the assets and liabilities of the REIT and the Operating Partnership are the same on their respective financial statements.
Basis of Presentation. The accompanying consolidated financial statements, presented in the U.S. dollar, are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the date of the financial statements and revenue and expenses during the reporting period. Our actual results could differ from those estimates and assumptions. All material intercompany transactions with consolidated entities have been eliminated.
The accompanying unaudited interim financial information has been prepared according to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with such rules and regulations. Our management believes that the disclosures presented in these financial statements are adequate to make the information presented not misleading. In our opinion, all adjustments and eliminations, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for both the REIT and the Operating Partnership for the reported periods have been included. The results of operations for such interim periods are not necessarily indicative of the results for the full year. The accompanying unaudited interim financial information should be read in conjunction with the December 31, 2013, Consolidated Financial Statements of Prologis, as previously filed with the SEC on Form 10-K and other public information.
Certain amounts included in the accompanying Consolidated Financial Statements for 2013, have been reclassified to conform to the 2014 financial statement presentation.
Recent Accounting Pronouncements. In April 2014, the FASB issued an accounting standard update that changed the criteria for classifying and reporting discontinued operations while enhancing disclosures. Under the new guidance, only disposals of a component of an entity, or a group of components of an entity, representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have, or will have, a major effect on the organization’s operations and financial results. Examples of disposals that may meet the new criteria include a disposal of a major geographic area, a major line of business, or a major equity method investment. In addition, the new guidance requires additional disclosures about discontinued operations and the disposal of an individually significant component of an entity that does not meet the criteria for discontinued operations. We early adopted this standard prospectively for all disposals subsequent to January 1, 2014. Prior to adoption, the results of operations for real estate properties sold or held for sale during the reported periods were shown under Discontinued Operations on the Consolidated Statements of Operations (see Note 4). Going forward, we expect the majority of our dispositions will not qualify as discontinued operations and the results will be presented in Income from Continuing Operations.
In March 2013, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update on the accounting for currency translation adjustment (“CTA”) when a parent sells or transfers part of its ownership interest in a foreign entity. When a company sells a subsidiary or group of assets that constitute a business while maintaining ownership of the foreign entity in which those assets or subsidiary reside, a complete or substantially complete liquidation of the foreign entity is required in order for a parent entity to release CTA to earnings. However, for a company that sells all or part of its ownership interest in a foreign entity, CTA is released upon the loss of a controlling financial interest in a consolidated foreign entity or partial sale of an equity method investment in a foreign entity. For step acquisitions, the CTA associated with the previous equity-method investment is fully released when control is obtained and consolidation occurs. We adopted this standard as of January 1, 2014, and it did not have, and we do not expect it to have, a material impact on the Consolidated Financial Statements.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Acquisitions of Unconsolidated Co-Investment Ventures
On August 6, 2013, we concluded the unconsolidated co-investment venture Prologis North American Industrial Fund III. The venture sold 73 properties to a third party and we subsequently acquired our partner’s 80% ownership interest in the venture. The allocation of net assets acquired was $519.2 million in real estate assets and $22.0 million of net other assets. While the current allocation of the purchase price is substantially complete, the valuation of the real estate properties is being finalized. We do not expect future revisions, if any, to have a significant impact on our financial position or results of operations.
On October 2, 2013, we acquired our partner’s 78.4% interest in the unconsolidated co-investment venture Prologis SGP Mexico and concluded the venture. The allocation of net assets acquired was $409.5 million in real estate assets and $4.0 million of net other assets and $158.4 million in debt. While the current allocation of the purchase price is substantially complete, the valuation of the real estate properties is being finalized. We do not expect future revisions, if any, to have a significant impact on our financial position or results of operations.
The impact of the results in 2013 for the properties acquired in these acquisitions was not significant.
Investments in real estate properties are presented at cost, and consisted of the following (square feet and dollars in thousands):
Industrial operating properties:
Improved land
Buildings and improvements
Development portfolio, including land costs:
Pre-stabilized
Properties under development
Land
Other real estate investments (2)
Total investments in real estate properties
At March 31, 2014, we owned real estate assets in the Americas (Canada, Mexico and the United States), Europe (Austria, Belgium, the Czech Republic, France, Germany, Hungary, Italy, the Netherlands, Poland, Romania, Slovakia, Spain, Sweden and the United Kingdom) and Asia (China, Japan and Singapore).
Dispositions
Real estate disposition activity for the three months ended March 31, was as follows (square feet and dollars in thousands):
Continuing Operations
Number of properties
Square feet
Net proceeds from contributions and dispositions
Net gains from contributions and dispositions
Discontinued Operations
Net proceeds from dispositions
Net gains from dispositions, including related impairment charges and taxes
The net gains included in continuing operations for the three months ended March 31, 2013, primarily represent the gain from the initial contribution of properties to our new unconsolidated co-investment venture in Japan, Nippon Prologis REIT (“NPR”).
10
Summary of Investments
We have investments in entities through a variety of ventures. We co-invest in entities that own multiple properties with strategic capital investors and provide asset and property management services to these entities. We refer to these entities as co-investment ventures. Our ownership interest in these entities range from 15-55%. These entities may be consolidated or unconsolidated, depending on the structure, our partner’s rights and participation and our level of control of the entity. This note details our investments in unconsolidated co-investment ventures, which are accounted for using the equity method of accounting. See Note 7 for more detail regarding our consolidated investments.
We also have other ventures, generally with one partner and that we do not manage. We refer to our investments in the entities accounted for on the equity method, both unconsolidated co-investment ventures and other ventures, collectively, as unconsolidated entities.
Our investments in and advances to our unconsolidated entities are summarized below (in thousands):
Unconsolidated co-investment ventures
Other ventures
Totals
Unconsolidated Co-Investment Ventures
As of March 31, 2014, we had investments in and managed unconsolidated co-investment ventures that own portfolios of operating industrial properties and may also develop properties. We account for our investments in these ventures under the equity method of accounting and, therefore, we record our share of each venture’s net earnings or loss as Earnings from Unconsolidated Entities, Netin the Consolidated Statements of Operations. We earn fees for the management services we provide to these ventures. These fees are recognized as earned and may include property and asset management fees or transactional fees for leasing, acquisition, construction, financing, legal and tax services. We may also earn incentive returns or promotes based on the third party investor returns over time. We report these fees and incentives as Investment Management Income in the Consolidated Statements of Operations. In addition, we may earn fees for services provided to develop a building within these ventures and those fees are reflected as Development Management and Other Income in the Consolidated Statements of Operations.
Summarized information regarding the amounts we recognize in the Consolidated Statements of Operations from our investments in the unconsolidated co-investment ventures is as follows (in thousands):
Earnings (loss) from unconsolidated co-investment ventures:
Americas (1)
Europe (2)
Asia (2)
Total earnings from unconsolidated co-investment ventures, net
Investment management and other income:
Americas
Total investment management income
Total investment management and other income
The amounts of Investment Management income and earnings we recognize depend on the size of co-investment ventures that we manage and in which we have an ownership interest. A summary of our outstanding unconsolidated co-investment ventures was as follows (square feet and total assets in thousands and represents 100% of the venture):
11
Americas:
Number of properties owned
Europe:
Asia:
Total:
The following is summarized financial information of the unconsolidated co-investment ventures and our investment (dollars in millions). The co-investment venture information represents the venture’s information (not our proportionate share) based on our U.S. GAAP basis in the entity.
2014 (1)
For the three months ended March 31, 2014:
Revenues
Net operating income
Net earnings
As of March 31, 2014:
Amounts due to us (2)
Third party debt (3)
Our weighted average ownership
Our investment balance
Deferred gains, net of amortization (4)
2013 (1)
For the three months ended March 31, 2013:
Net earnings (5)
As of December 31, 2013:
12
In April 2014, we acquired a partner’s 5.6% ownership interest in the Prologis North American Industrial Fund for $83.5 million and now own 28.7% of the venture.
Equity Commitments Related to Certain Unconsolidated Co-Investment Ventures
Certain co-investment ventures have equity commitments from us and our venture partners. Our venture partners fulfill their equity commitment with cash. We may fulfill our equity commitment through contributions of properties or cash. The venture may obtain financing for the properties and therefore the acquisition price of additional investments that the venture could make may be more than the equity commitment. Depending on market conditions, the investment objectives of the ventures, our liquidity needs and other factors, we may make contributions of properties to these ventures through the remaining commitment period and we may make additional cash investments in these ventures.
The following table is a summary of remaining equity commitments as of March 31, 2014 (in millions):
Prologis Targeted U.S. Logistics Fund
Prologis Targeted Europe Logistics Fund (1)
Prologis European Properties Fund II (1)
Europe Logistics Venture 1 (1)
Prologis European Logistics Partners (2)
Prologis China Logistics Venture 1 and 2
Total
In April 2014, the FASB issued a standard updating the accounting and disclosure regarding discontinued operations. As discussed in Note 1, we have adopted this standard as of January 1, 2014. None of our property dispositions in 2014 met the new criteria to be classified as discontinued operations. The operations of the properties that were disposed of to third parties during 2013 that met the criteria for discontinued operations, including the aggregate net gains or losses recognized upon their disposition (See Note 3 for more detail on dispositions), are presented as discontinued operations in the Consolidated Statements of Operations. Income attributable to disposed properties and assets held for sale during the three months ended March 31, 2013, was as follows (in thousands):
Rental income and recoveries
All debt is held directly or indirectly by the Operating Partnership. The REIT itself does not have any indebtedness, but guarantees the unsecured debt of the Operating Partnership. We generally do not guarantee the debt issued by non-wholly owned subsidiaries.
13
Our debt consisted of the following (dollars in thousands):
Credit Facilities
Senior notes
Exchangeable senior notes
Secured mortgage debt
Secured mortgage debt of consolidated entities
Term loan
Other debt
We have a global senior credit facility (the “Global Facility”), in which funds may be drawn in U.S. dollar, euro, Japanese yen, British pound sterling and Canadian dollar on a revolving basis up to $2.0 billion (subject to currency fluctuations). We also have a ¥45.0 billion (approximately $435.7 million at March 31, 2014) Japanese yen revolver (the “Revolver”) with availability to ¥56.5 billion (approximately $547.0 million at March 31, 2014). We refer to the Global Facility and the Revolver, collectively, as our “Credit Facilities.”
Commitments and availability under our Credit Facilities as of March 31, 2014, were as follows (in millions):
Aggregate lender—commitments
Less:
Borrowings outstanding
Outstanding letters of credit
Current availability
Senior Notes
In February 2014, we issued €700 million ($959.4 million) of senior notes with an interest rate of 3.375%, maturing in 2024, at 98.9% of par value for an all-in rate of 3.52%. We used the net proceeds for general corporate purposes, including to repay borrowings under our multi-currency senior term loan (“Term Loan”) and our Global Facility.
Exchangeable Senior Notes
The fair value of the embedded derivative associated with our exchangeable notes was a liability of $63.8 million and $41.0 million at March 31, 2014 and December 31, 2013, respectively. In adjusting to fair value, we recognized unrealized losses of $22.8 million and $1.0 million for the three months ended March 31, 2014 and 2013, respectively.
Long-Term Debt Maturities
Principal payments due on our debt, for the remainder of 2014 and for each of the years in the ten-year period ending December 31, 2023, and thereafter are as follows (in millions):
14
Maturity
2015 (2)
2016
2017
2018
2019
2020
2021
2022
2023
Thereafter
Subtotal
Unamortized premiums (discounts), net
Debt Covenants
Our debt agreements contain various covenants, including maintenance of specified financial ratios. As of March 31, 2014, we were in compliance with all covenants.
We consolidate several entities in which we do not own 100% of the common equity. In certain partnerships, the units of the entity are exchangeable into our common stock.
If we contribute a property to a consolidated co-investment venture, the property is still reflected in the Consolidated Financial Statements, but due to our ownership of less than 100%, there is an increase in noncontrolling interest related to the contributed properties that represents the portion of the ownership attributable to our partners and the difference between cash received and historical cost is reflected as an adjustment to Additional Paid in Capital with no gain or loss recognized.
In January 2014, we closed on a U.S. co-investment venture, Prologis U.S. Logistics Venture (“USLV”), in which we hold a 55% equity ownership interest. The venture is consolidated for accounting purposes due to the structure and voting rights of the venture. At closing, the venture acquired from us a portfolio of 66 operating properties aggregating 12.8 million square feet for an aggregate purchase price of $1.0 billion.
The noncontrolling interests of the REIT include the noncontrolling interests presented for the Operating Partnership, as well as the common limited partnership units in the Operating Partnership that are not owned by the REIT. As of March 31, 2014, the REIT owned 99.65% common general partnership units in the Operating Partnership.
The following is a summary of the noncontrolling interests and the consolidated entity’s total investment in real estate and debt at March 31, 2014 and December 31, 2013 (dollars in thousands):
15
Partnerships with exchangeable units (1)
Mexico Fondo Logistico (AFORES)
Brazil Fund (2)
Prologis AMS
Prologis U.S. Logistics Venture (3)
Other consolidated entities
Operating Partnership noncontrolling interests
Limited partners in the Operating Partnership (4)
REIT noncontrolling interests
At March 31, 2014, Prologis had stock options and full value awards (restricted stock, performance share awards and restricted share units (“RSUs”)) under its incentive plan.
Summary of Activity
The activity for the three months ended March 31, 2014, with respect to our RSU and performance share awards, was as follows:
Balance at December 31, 2013
Granted
Vested and distributed
Forfeited
Balance at March 31, 2014
All awards granted in the period were in the form of RSUs which, generally vest over three years.
The activity for the three months ended March 31, 2014, with respect to our stock options, was as follows:
Exercised
Forfeited / Expired
16
Outperformance Plan
We grant awards in the form of points under our Outperformance Plan (“OPP”) corresponding to three-year performance periods. As of March 31, 2014, all awards were equity classified. At the end of the applicable performance period, if the performance criteria are met, the participants’ points will be paid in the form of common stock of the REIT or units of the Operating Partnership. The fair value of the awards are measured as of the grant date and amortized over the performance period.
We granted points on February 13, 2014, with a fair value of $23.1 million as of the date of the grant using a Monte Carlo valuation model that assumed a risk free interest rate of 0.67% and an expected volatility of 46% for Prologis and 30% for the index of selected peer companies. Such points related to a three-year performance period that began on January 1, 2014, and will end on December 31, 2016. We also granted points in 2012 (three-year performance period will end on December 31, 2014) and 2013 (three-year performance period will end on December 31, 2015).
We recognized $6.9 million and $7.8 million of compensation expense related to our outstanding OPP awards during the three months ended March 31, 2014 and 2013, respectively.
We determine basic earnings per share/unit based on the weighted average number of shares of common stock/units outstanding during the period. We compute diluted earnings per share/unit based on the weighted average number of shares outstanding combined with the incremental weighted average effect from all outstanding potentially dilutive instruments.
The following table sets forth the computation of our basic and diluted earnings per share/unit (in thousands, except per share/unit amounts):
REIT
Noncontrolling interest attributable to exchangeable limited partnership units
Interest expense on exchangeable debt assumed exchanged
Adjusted net earnings attributable to common stockholders
Weighted average common shares outstanding—Basic (1)
Incremental weighted average effect on exchange of limited partnership units (2)
Incremental weighted average effect of stock awards and warrants
Incremental weighted average effect on exchange of certain exchangeable debt
Weighted average common shares outstanding—Diluted (3)
Net earnings per share attributable to common stockholders -
Basic
Diluted
Operating Partnership
Adjusted net earnings attributable to common unitholders
Weighted average common partnership units outstanding—Basic (1)
Incremental weighted average effect on exchange of limited partnership units
Incremental weighted average effect of stock awards and warrants of the REIT
Weighted average common partnership units outstanding—Diluted (3)
Net earnings per unit attributable to common unitholders -
.
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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, such as foreign currency contracts to manage foreign currency exposure, and interest rate swaps to manage the effect of interest rate fluctuations. The majority of our derivative financial instruments are customized derivative transactions and are not exchange-traded. We only enter into transactions that we believe will be highly effective at offsetting the underlying risk. There have been no significant changes in our policy or strategy from what was previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December, 31, 2013.
Foreign Currency
We hedge the net assets of certain international subsidiaries using foreign currency derivative contracts (net investment hedges) to offset the translation and economic exposures related to our investments in these subsidiaries by locking in a forward exchange rate at the inception of the hedge. We measure the effectiveness of our net investment hedges by using the changes in forward exchange rates because this method reflects our risk management strategies, the economics of those strategies in the financial statements and better manages interest rate differentials between different countries. Under this method, all changes in fair value of the forward currency derivative contracts designated as net investment hedges are reported in equity in the foreign currency translation component of Accumulated Other Comprehensive Income (Loss) in the Consolidated Balance Sheets (“AOCI”) and offsets translation adjustments on the underlying net assets of our foreign investments, which are also recorded in AOCI. Ineffectiveness, if any, is recognized in earnings.
In certain circumstances, we may also borrow debt in a currency that is not the same functional currency of the borrowing entity to offset the translation and economic exposures related to our net investment in international subsidiaries. To mitigate the impact to our earnings from the fluctuations in the exchange rate, we may designate the debt as a non-derivative financial instrument hedge. We measure our effectiveness in the same manner as our net investment hedges described above. As a result, the change in the value of this debt upon translation is recorded in the foreign currency translation component of AOCI to offset the foreign currency fluctuations related to the net investment in our subsidiaries with the same functional currency as the debt.
Interest Rate
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. We may enter into interest rate swap agreements that allow us to receive variable-rate amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreement. The effective portion of the gain or loss on the derivative is reported as a component of AOCI in the Consolidated Balance Sheets, and reclassified to Interest Expense in the Consolidated Statements of Operations over the corresponding period of the hedged item. Losses on a derivative representing hedge ineffectiveness, if any, are recognized in Interest Expense at the time the ineffectiveness occurred.
The following table summarizes the activity in our derivative instruments for the three months ended March 31, (in millions):
Notional amounts at January 1,
New contracts
Matured or expired contracts
Notional amounts at March 31,
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As discussed in Note 6, we issued €700 million ($959.4 million) of debt in February 2014. This debt was issued by the Operating Partnership, which is a U.S. dollar functional entity, and designated as a non-derivative financial instrument hedge. As of March 31, 2014 and December 31, 2013, we had €1.4 billion ($1.9 billion) and €700 million ($1.0 billion) of debt designated as non-derivative financial instrument hedges on our net investment in international subsidiaries, respectively. Amounts included in AOCI in the Consolidated Balance Sheets at March 31, 2014 and December 31, 2013, were losses of $20.4 million and $14.9 million, respectively.
All derivatives are recognized at fair value in the Consolidated Balance Sheets and are within the line items Other Assets or Accounts Payable and Accrued Expenses, as applicable. Changes in the fair value of derivatives that are designated and qualify as cash flow hedges and hedges of net investments in foreign operations are recorded as accumulated gains (losses) in AOCI in the Consolidated Balance Sheets. The following table presents the fair value of our derivative instruments (in thousands):
Net investment hedges—euro denominated
Net investment hedges—yen denominated
Interest rate swap hedges
Total derivatives
During the three months ended March 31, 2014, we did not record any ineffectiveness on our derivative contracts. During the three months ended March 31, 2013, we had no significant hedge ineffectiveness. In addition, the effective portion of the gain or loss on the interest rate swaps reclassified to interest expense was not considered significant for the first quarter of 2014, and is not expected to be significant for the next 12 months. In the first quarter 2013, the effective portion reclassified to interest expense was $2.3 million.
The following table presents gains (losses) from the change in fair value for the effective portion of our derivative and non-derivative instruments included in Other Comprehensive Income (Loss) in the Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, (in thousands):
Derivative net investment hedges (1)
Non-derivative net investment hedges
Fair Value Measurements
We have estimated the fair value of our financial instruments using available market information and valuation methodologies we believe to be appropriate for these purposes. Considerable judgment and a high degree of subjectivity are involved in developing these estimates and, accordingly, they are not necessarily indicative of amounts that we would realize upon disposition.
Fair Value Measurements on a Recurring Basis
At March 31, 2014 and December 31, 2013, other than the derivatives discussed above and in Note 6, we do not have any significant financial assets or financial liabilities that are measured at fair value on a recurring basis in the Consolidated Financial Statements. The fair value of our derivative instruments were determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves, foreign exchange rates, and implied volatilities. The fair values of our interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts or payments and the discounted expected variable cash payments. The variable cash payments are based on an expectation of future interest rates, or forward curves, derived from observable market interest rate curves. The fair values of our net investment hedges are based upon the change in the spot rate at the end of the period as compared to the strike price at inception.
We incorporate credit valuation adjustments to appropriately reflect both our nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
We have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy. Although the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties, we assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives. As a result, all of our derivatives held as of March 31, 2014 and December 31, 2013, were classified as Level 2 of the fair value hierarchy.
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Fair Value Measurements on Non-Recurring Basis
Assets measured at fair value on a non-recurring basis in the Consolidated Financial Statements consist of real estate assets and investments in and advances to unconsolidated entities that were subject to impairment charges. There were no assets that met these criteria at March 31, 2014 and December 31, 2013.
Fair Value of Financial Instruments
At March 31, 2014 and December 31, 2013, our carrying amounts of certain financial instruments, including cash and cash equivalents, restricted cash, accounts and notes receivable, accounts payable and accrued expenses were representative of their fair values due to the short-term nature of these instruments.
At March 31, 2014 and December 31, 2013, 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 differences in the fair value of our debt from the carrying value in the table below are the result of differences in interest rates and/or borrowing spreads that were available to us at March 31, 2014 and December 31, 2013, 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):
Term loan and other debt
Total debt
Our current business strategy includes two operating segments: Real Estate Operations and Investment Management. We generate revenues, earnings, net operating income and cash flows through our segments, as follows:
Reconciliations are presented below for: (i) each reportable business segment’s revenue from external customers to Total Revenues in the Consolidated Statements of Operations; (ii) each reportable business segment’s net operating income from external customers to Earnings before Income Taxes in the Consolidated Statements of Operations; and (iii) each reportable business segment’s assets to Total Assets in the Consolidated Balance Sheets. 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 Total Revenues, Earnings 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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Real estate operations:
Europe
Asia
Total Real Estate Operations segment
Investment management:
Total Investment Management segment
Net operating income:
Total segment net operating income
Reconciling items:
Total reconciling items
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Assets:
Investment management (1):
Total segment assets
As partial consideration for properties we contributed to PELP during the first quarter of 2013, we received ownership interests of $1.3 billion, representing a 50% ownership interest, and PELP assumed $353.2 million of secured debt.
The amount of interest paid in cash, net of amounts capitalized, for the three months ended March 31, 2014 and 2013, was $75.1 million and $110.6 million, respectively.
During the three months ended March 31, 2014 and 2013, cash paid for income taxes, net of refunds, was $23.6 million and $4.9 million, respectively.
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
We have reviewed the accompanying consolidated balance sheet of Prologis, Inc. and subsidiaries (the “Company”) as of March 31, 2014, the related consolidated statements of operations, comprehensive income (loss) and cash flows for the three-month periods ended March 31, 2014 and 2013, and the related consolidated statement of equity for the three-month period ended March 31, 2014. These consolidated financial statements are the responsibility of the Company’s management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Prologis, Inc. and subsidiaries as of December 31, 2013, 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 26, 2014, 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, 2013, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for discontinued operations as of January 1, 2014, on a prospective basis, due to the adoption of Accounting Standards Update 2014-08.
KPMG LLP
Denver, Colorado
May 6, 2014
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The Partners
We have reviewed the accompanying consolidated balance sheet of Prologis, L.P. and subsidiaries (the “Operating Partnership”) as of March 31, 2014, the related consolidated statements of operations, comprehensive income (loss) and cash flows for the three-month periods ended March 31, 2014 and 2013, and the related consolidated statement of capital for the three-month period ended March 31, 2014. These consolidated financial statements are the responsibility of the Operating Partnership’s management.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Prologis, L.P. and subsidiaries as of December 31, 2013, and the related consolidated statements of operations, comprehensive income (loss), capital, and cash flows for the year then ended (not presented herein); and in our report dated February 26, 2014, 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, 2013, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
As discussed in Note 1 to the financial statements, the Operating Partnership has changed its method of accounting for discontinued operations as of January 1, 2014, on a prospective basis, due to the adoption of Accounting Standards Update 2014-08.
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The following discussion should be read in conjunction with the Consolidated Financial Statements and the related notes included in Item 1 of this report and our 2013 Annual Report on Form 10-K.
Certain statements contained in this discussion or elsewhere in this report may be deemed “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Words and phrases such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “designed to achieve,” variations of such words and similar expressions are intended to identify such forward-looking statements, which generally are not historical in nature. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future – including statements relating to rent and occupancy growth, development activity and sales or contribution volume or profitability on such sales and contributions, economic and market conditions in the geographic areas where we operate and the availability of capital in existing or new co-investment ventures – are forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be attained and therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Many of the factors that may affect outcomes and results are beyond our ability to control. For further discussion of these factors see Part I, Item 1A. Risk Factors in our 2013 Annual Report on Form 10-K. References to “we,” “us” and “our” refer to Prologis, Inc. and its consolidated subsidiaries.
Management’s Overview
We are the leading owner, operator and developer of industrial real estate, focused on global and regional markets across the Americas, Europe and Asia. As of March 31, 2014, we owned and managed operating properties and development projects totaling 574 million square feet (53.3 million square meters) in 21 countries. These properties were leased to more than 4,700 customers, including third-party logistics providers, transportation companies, retailers and manufacturers.
Prologis, Inc. (the “REIT”) is a self-administered and self-managed real estate investment trust, and is the sole general partner of Prologis, L.P. (the “Operating Partnership”). We operate the REIT and the Operating Partnership as one enterprise, and, therefore, our discussion and analysis refers to the REIT and its consolidated subsidiaries, including the Operating Partnership, collectively.
Our business is comprised of two operating segments: Real Estate Operations and Investment Management.
Real Estate Operations Segment
Rental Operations – This represents the primary source of our revenue, earnings and funds from operations (“FFO”). We collect rent from our customers under operating leases, including reimbursements for the vast majority of our operating costs. We expect to generate long-term internal growth in rental income by maintaining a high occupancy rate, controlling expenses and through rent increases. Our rental income is diversified due to our global presence and broad customer base. We believe that our property management, leasing and maintenance teams, together with our capital expenditure, energy management and risk management programs create cost efficiencies, and allow us to capitalize on the economies of scale inherent in owning, operating and growing a large global portfolio.
Capital Deployment - Capital deployment includes development, re-development and acquisition of industrial properties that lead to rental operations and are therefore included with that line of business for segment reporting. We deploy capital primarily in global and regional markets to meet our customers’ needs. Within this line of business, we capitalize on: (i) our land bank; (ii) the development expertise of our local personnel; (iii) our global customer relationships; and (iv) the demand for high-quality distribution facilities. We seek to increase our rental income and the net asset value of the Company through the leasing of newly developed space, as well as through the acquisition of operating properties. We also develop properties for long-term hold, for contribution into our co-investment ventures, or occasionally for sale to third parties.
Investment Management Segment - We invest with partners and investors through our ventures, both private and public. We tailor industrial portfolios to investors’ specific needs and deploy capital with a focus on larger, long duration ventures and open ended funds with leading global institutions. We also access alternative sources of public equity through publicly traded vehicles such as Nippon Prologis REIT, Inc. (“NPR”). These private and public vehicles provide capital for distinct geographies across our global platform. We hold a significant ownership interest in these ventures ranging between 15-55%, which we believe provides a strong alignment of interests with our partners. We generate investment management revenues from our unconsolidated ventures by providing asset management and property management services. We may earn additional revenues from leasing, acquisition, construction, development, disposition, legal and tax services. Depending on the structure of the venture and the returns provided to our partners, we may also earn revenues through incentive returns or promotes during the life of a venture or upon liquidation. We believe our co-investment ventures will continue to serve as a source of capital for investments, provide incremental revenues and mitigate risk associated with our foreign currency exposure. We plan to grow this business through the formation of new ventures and growth in existing ventures.
Growth Strategies
We believe the scale and quality of our operating platform, the skills of our team and the strength of our balance sheet provide us with unique competitive advantages. We have a plan to grow revenue, earnings, net operating income (“NOI”), Core FFO (see definition below) and dividends that is based on the following three key elements:
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Summary of 2014
During the three months ended March 31, 2014, we completed the following activities:
Operational Outlook
The global logistics real estate market improved in the first quarter of 2014. Operating fundamentals are strengthening and we believe this trend will continue as the leading indicators of industrial real estate are positive. Global trade is expected to grow 4.3% in 2014 and 5.3% in 2015 (a). Based on our internal analysis, activity levels and space utilization in our facilities continues to trend higher, which means our customers have limited capacity to handle their current needs and potential future growth.
Market conditions in the U.S. are favorable and an ongoing supply and demand imbalance exists. Net absorption continues to exceed new supply, albeit at a more modest pace than in 2013. During the quarter, net absorption totaled 43 million square feet and completions were 23 million square feet (b). These conditions have driven U.S. market vacancy to 7.0%, which is the lowest since 2000(b). As customer demand remains active and supply pipelines are below historical norms, we expect vacancy to continue to decline and rental rates to increase further.
Operating conditions in our Latin American markets are positive. In Mexico, GDP growth is expected to be 3.0% in 2014, up from just 1.1% last year (a). Demand has continued to recover and the market occupancy rate across the six largest logistics markets (Mexico City, Monterrey, Guadalajara, Juarez, Reynosa and Tijuana) was 91.6% at March 31, 2014, an increase of 0.7% from the prior year, based on internally generated data. Brazil is an underserved logistics market. Consequently, while economic growth has been uneven, demand for modern logistics facilities remains strong as companies serve the growing consumer market.
In Europe, operating conditions are improving although at an uneven pace. Economic momentum turned positive in 2013 and, in our view, brighter macroeconomic prospects are generating demand for logistics facilities. Customer sentiment is also strengthening. The pan-European market occupancy was 91.3% (c) as of December 31, 2013, higher than the level achieved in 2007 as near-record low development activity has tightened the market. The occupancy rate rose 1.0% in 2013 and we expect further gains in 2014 due to prospects for stronger demand and still-low development levels. We expect net effective rents will increase and the recovery will broaden. We believe improving occupancy and rent growth, combined with a rapid decline in capitalization rates will lead to an increase in European logistics real estate values.
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Market expansion is evident in our Asian markets and our business is a direct beneficiary. In Japan, vacancy rates remain below 5% (b).The availability of Class-A distribution space remains constrained and net effective rents are rising; in part due to upward pressure on construction costs, especially in Tokyo and Osaka. Increasing development costs, driven by higher land and construction pricing, are expected to keep new supply in balance. Demand in China is accelerating and we see new requirements from retailers and e-commerce customers. In our view, low vacancy rates will lead to significant rental rate growth. Barriers to supply continue to drive rents ahead of inflation, and we believe that we are well positioned with our development platform to meet this accelerating demand.
We believe elevated occupancy rates across our markets, coupled with the still-gradual pickup in new construction starts, are leading to notable increases in effective rents. We expect to use our land bank to support increased development activity in this environment. Our development business comprises speculative, build-to-suit, value-added conversions and redevelopment activities. We will develop directly and within our co-investment ventures, depending on location, market conditions, submarkets or building sites and availability of capital.
Results of Operations
Three Months Ended March 31, 2014 and 2013
Included this segment is rental income and rental expense recognized from our consolidated operating properties. We had significant real estate activity during 2013 that impacted the size of our portfolio. In addition, the operating fundamentals in our markets have been improving, which has impacted both the occupancy and rental rates we have experienced, and has fueled development activity. Also included in this segment is revenue from land we own and lease to customers and development management and other income, offset by acquisition, disposition and land holding costs.
We adopted a new accounting standard as of January 1, 2014, which changed the criteria for classifying and reporting discontinued operations. As a result, none of our property dispositions in 2014 met the criteria to be classified as discontinued operations, while the results of properties sold to third parties during 2013 were reclassified to Discontinued Operations under the previous standard.
NOI from the Real Estate Operations segment for the three months ended March 31 was as follows (dollars in thousands):
Rental and other income
Rental and other expenses
NOI - Real Estate Operations segment
Operating margin
Average occupancy
Detail of our consolidated operating properties was as follows (square feet in thousands):
Square Feet
Occupied %
Below are the key drivers that have influenced the NOI of this segment:
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Investment Management Segment
The NOI from the Investment Management segment represents fees and incentives earned for services performed reduced by investment management expenses (direct costs of managing these entities and the properties they own). The following table details this information by geographic location for the three months ended March 31 (dollars in thousands):
NOI - Investment Management Segment:
Asset management and other fees
Leasing commissions, acquisition and other transaction fees
Subtotal Americas
Subtotal Europe
Subtotal Asia
NOI - Investment Management segment
Operating Margin
We had the following assets under management held through our unconsolidated co-investment ventures (in thousands):
Gross book value
Investment management income fluctuates due to the size of co-investment ventures that are under management. Investment management expenses, which include direct costs associated with asset and property management, totaled $24.2 million and $19.9 million for the three months ended March 31, 2014 and 2013, respectively. The increase in NOI in 2014 was due to the new ventures that were formed in Europe and Asia during first quarter 2013.
See Note 4 to the Consolidated Financial Statements in Item 1 for additional information on our unconsolidated entities.
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Other Components of Income
General and Administrative (“G&A”) Expenses
G&A expenses for the three months ended March 31 consisted of the following (in thousands):
Gross overhead
Reclass to rental expenses
Reclass to investment management expenses
Capitalized amounts
G&A expenses
The increase in gross overhead was principally due to timing differences and we expect future quarters to be lower than the first three months of 2014. We allocate a portion of our G&A expenses that relate to property management functions to our Real Estate Operations and Investment Management segments.
We capitalize certain costs directly related to our development and leasing activities. Capitalized G&A expenses include salaries and related costs, as well as other general and administrative costs. The capitalized G&A for the three months ended March 31, were as follows (in thousands):
Development activities
Leasing activities
Costs related to internally developed software
Total capitalized G&A expenses
For the three months ended March 31, 2014 and 2013, the capitalized salaries and related costs represented 23.0% and 24.8%, respectively, of our total salaries and related costs. Salaries and related costs are comprised primarily of wages, other compensation and employee-related expenses.
Depreciation and Amortization
Depreciation and amortization expenses were $160.3 million and $172.1 million for the three months ended March 31, 2014 and 2013, respectively. The decrease was principally a result of disposition and contribution of properties, offset slightly by additional depreciation and amortization from completed development properties and increased leasing activity.
Earnings from Unconsolidated Entities, Net
We recognized earnings related to our investments in unconsolidated entities that are accounted for under the equity method of $29.7 million and $24.8 million for the three months ended March 31, 2014 and 2013, respectively. The earnings we recognize are impacted by: (i) variances in revenues and expenses of the entity; (ii) the size and occupancy rate of the portfolio of properties owned by the entity; (iii) our ownership interest in the entity; and (iv) fluctuations in foreign currency exchange rates used to translate our share of net earnings to U.S. dollars, if applicable. We manage the majority of the properties in which we have an ownership interest as part of our owned and managed portfolio. See the discussion of our co-investment ventures above in the Investment Management segment discussion and in Note 4 to the Consolidated Financial Statements in Item 1 for further breakdown of our share of net earnings recognized.
Interest Expense
Interest expense for the three months ended March 31 included the following components (in thousands):
Gross interest expense
Amortization of discount (premium), net
Amortization of deferred loan costs
Interest expense before capitalization
Net interest expense
Gross interest expense decreased in 2014 compared to 2013 due to lower debt levels, offset slightly by an increase in interest rates. As of March 31, 2014, we decreased our debt by $0.2 billion from March 31, 2013. Near the end of the first quarter of 2013, we decreased our debt by $2.7 billion, primarily from the proceeds received with the contributions made to our two new unconsolidated co-investment ventures. Our weighted average effective interest rate was 4.7% and 4.6% for the three month period ended March 31, 2014 and 2013, respectively.
See Note 6 to the Consolidated Financial Statements in Item 1 and Liquidity and Capital Resources for further discussion of our debt and borrowing costs.
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Gains on Acquisitions and Dispositions of Investments in Real Estate, Net
During the three months ended March 31, 2014, we recognized gains on acquisitions and dispositions of investments in real estate of $17.1 million, primarily related to the disposition of properties and land in the United States and Europe. During the three months ended March 31, 2013, we recognized net gains on dispositions of investments in real estate in continuing operations of $338.8 million, primarily related to the contribution of properties to NPR.
Foreign Currency and Derivative Gains (Losses), Net
We recognized unrealized losses of $27.0 million and $1.0 million for the three months ended March 31, 2014 and 2013, respectively, on the derivative instrument (exchange feature) related to our exchangeable senior notes. In 2014, this amount included $4.2 million related to the amortization of a discount associated with the derivative instrument.
Gains (Losses) on Early Extinguishment of Debt, Net
During the three months ended March 31, 2013, we extinguished certain secured mortgage debt and several series of senior notes prior to maturity, which resulted in the recognition of losses of $17.4 million.
Income Tax (Benefit) Expense
During the three months ended March 31, 2014 and 2013, our current income tax expense was $5.8 million and $55.5 million, respectively. We recognize current income tax expense for income taxes incurred by our taxable real estate investment trust subsidiaries and in certain foreign jurisdictions, as well as certain state taxes. Our current income tax expense fluctuates from period to period based primarily on the timing of our taxable income. The majority of the current income tax expense for both periods relates to asset sales and contributions of properties that were held in foreign subsidiaries or taxable real estate investment trust subsidiaries.
During the three months ended March 31, 2014 and 2013, we recognized a net deferred tax expense of $1.0 million and benefit of $3.6 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 taxable subsidiaries operating in the United States or in foreign jurisdictions.
As discussed above, we adopted a new accounting standard regarding discontinued operations effective January 1, 2014, and none of our property dispositions in 2014 met the criteria to be classified as discontinued operations. Earnings from discontinued operations were $7.6 million for the three months ended March 31, 2013. Discontinued operations represent the results of operations of properties that were sold to third parties along with the related gain or loss on sale. The result of operations that have been classified as discontinued operations are reported separately in the Consolidated Financial Statements in Item 1.
See Note 5 to the Consolidated Financial Statements in Item 1 for additional information on our discontinued operations.
Net Earnings Attributable to Noncontrolling Interests
During the three months ended March 31, 2014 and 2013, the net earnings attributable to noncontrolling interest for the REIT was $5.2 million and $12.1 million, respectively. The decrease from 2013 was due to the reduction of earnings in one of our consolidated co-investment ventures following the sale of a majority of its portfolio in the fourth quarter of 2013 and the gain on sale of properties recognized in the first quarter of 2013. This was offset slightly by the increase in earnings from the establishment of USLV in the first quarter of 2014.
Other Comprehensive Income (Loss) – Foreign Currency Translation Gains (Losses), Net
For our consolidated 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 Foreign Currency Translation Gains (Losses), Net in the Consolidated Statements of Comprehensive Income (Loss) in Item 1.
During the three months ended March 31, 2014 and 2013, we recorded unrealized losses of $4.7 million and $286.3 million, respectively, related to foreign currency translations of our foreign subsidiaries into U.S. dollars upon consolidation. In 2013, this included approximately $190 million of foreign currency translation losses on the properties contributed to Prologis European Logistics Partners Sàrl (“PELP”) and NPR due to the weakening of the euro and Japanese yen, respectively, to the U.S. dollar from December 31, 2012, through the date of the contributions.
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Portfolio Information
Our total owned and managed portfolio of properties, which includes operating industrial properties and does not include properties under development, properties held for sale or non-industrial properties, was as follows (square feet in thousands):
Consolidated
Unconsolidated
Same Store Analysis
We evaluate the performance of the operating properties we own and manage using a “same store” analysis because the population of properties in this analysis is consistent from period to period, thereby eliminating the effects of changes in the composition of the portfolio on performance measures. We include properties from our consolidated portfolio, and properties owned by the co-investment ventures (accounted for on the equity method) that are managed by us (referred to as “co-investment ventures”), in our same store analysis. We have defined the same store portfolio, for the three months ended March 31, 2014, as those properties that were in operation at January 1, 2013, and have been in operation throughout the three-month periods in both 2014 and 2013. 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 March 31, 2014, included 505.6 million of aggregated square feet.
Rental Income (1) (2)
Rental income per the Consolidated Statements of Operations
Rental recoveries per the Consolidated Statements of Operations
Consolidated adjustments to derive same store results:
Rental income and recoveries 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 co-investment ventures — rental income
Same store portfolio — rental income (2) (3)
Rental Expenses (1) (4)
Rental expenses per the 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
Unconsolidated co-investment ventures — rental expenses
Same store portfolio — rental expenses (3) (4)
Net Operating Income (1)
Net operating income per the 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
Unconsolidated co-investment ventures — Net operating income
Same store portfolio — net operating income (3)
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Liquidity and Capital Resources
Overview
We consider our ability to generate cash from operating activities, dispositions of properties and from available financing sources to be adequate to meet our anticipated future development, acquisition, operating, debt service, dividend and distribution requirements.
Near-Term Principal Cash Sources and Uses
In addition to dividends to the common and preferred stockholders of Prologis and distributions to the holders of limited partnership units of the Operating Partnership and other partnerships, we expect our primary cash needs will consist of the following:
We expect to fund our cash needs principally from the following sources, all subject to market conditions:
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As of March 31, 2014, we had $8.9 billion of debt with a weighted average interest rate of 4.4% and a weighted average maturity of 66 months. At December 31, 2013, we had $9.0 billion of debt with a weighted average interest rate of 4.2% and a weighted average maturity of 58 months. Our debt levels remained relatively consistent, but we lengthened the maturities by issuing longer-term debt (such as €700 million of 3.375% senior notes maturing 2024) and repaying borrowings under our credit facilities, which results in a higher average interest rate.
As of March 31, 2014, we had credit facilities with an aggregate borrowing capacity of $2.5 billion, of which $2.3 billion was available.
As of March 31, 2014, we were in compliance with all of our debt covenants. These covenants include customary financial covenants for total debt, encumbered debt and fixed charge coverage ratios.
See Note 6 to the Consolidated Financial Statements in Item 1 for further discussion on our debt.
Equity Commitments Related to Certain Co-Investment Ventures
Prologis Targeted Europe Logistics Fund
Prologis European Properties Fund II
Europe Logistics Venture 1
Prologis European Logistics Partners
Total Unconsolidated
Brazil Fund
Total Consolidated
Grand Total
For more information on our unconsolidated co-investment ventures, see Note 4 to the Consolidated Financial Statements in Item 1.
Cash Provided by Operating Activities
For the three months ended March 31, 2014 and 2013, operating activities provided net cash of $72.2 million and $129.1 million, respectively. In the first three months of 2014 and 2013, cash provided by operating activities was less than the cash dividends paid on common and preferred stock by $96.0 million and $11.4 million, respectively. We used proceeds from the dispositions and contribution of real estate properties to consolidated and unconsolidated entities ($0.5 billion in 2014 and $3.3 billion in 2013) to fund dividends not covered by cash flows from operating activities.
Cash Investing and Cash Financing Activities
For the three months ended March 31, 2014 and 2013, investing activities used net cash of $517.1 million and provided net cash of $2.8 billion, respectively. The following are the significant activities for both periods presented:
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For the three months ended March 31, 2014 and 2013, financing activities provided net cash of $132.2 million and used net cash of $2.3 billion, respectively. The following are the significant activities for both periods presented:
Off-Balance Sheet Arrangements
Unconsolidated Co-Investment Venture Debt
We had investments in and advances to unconsolidated co-investment ventures at March 31, 2014, of $4.5 billion. These unconsolidated ventures had total third party debt of $7.4 billion (in the aggregate, not our proportionate share) at March 31, 2014. This debt is primarily secured or collateralized by properties within the venture and is non-recourse to Prologis and the other investors in the co-investment ventures and matures as follows (dollars in millions):
Prologis North American Industrial Fund
Prologis Mexico Industrial Fund
Prologis European Properties Fund II (2)
Nippon Prologis REIT
Prologis China Logistics Venture 1 & 2 (3)
Total co-investment ventures
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Contractual Obligations
Distribution and Dividend Requirements
Our dividend policy on our common stock is to distribute a percentage of our cash flow to ensure we will meet the dividend requirements of the Internal Revenue Code, relative to maintaining our real estate investment trust status, while still allowing us to retain cash to meet other needs such as capital improvements and other investment activities.
We paid a cash dividend of $0.33 per common share for the first quarter on March 31, 2014. Our future common stock dividends may vary and will be determined by our board of directors 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 of directors during the year.
At March 31, 2014, we had one series of preferred stock outstanding, the series Q. The annual dividend rate is 8.54% per share and dividends are payable quarterly in arrears.
Pursuant to the terms of our preferred stock, we are restricted from declaring or paying any dividend with respect to our common stock unless and until all cumulative dividends with respect to the preferred stock have been paid and sufficient funds have been set aside for dividends that have been declared for the relevant dividend period with respect to the preferred stock.
Other Commitments
On a continuing basis, we are engaged in various stages of negotiations for the acquisition and/or disposition of individual properties or portfolios of properties.
New Accounting Pronouncements
See Note 1 to the Consolidated Financial Statements in Item 1.
Funds from Operations (“FFO”)
FFO is a non-GAAP measure that is commonly used in the real estate industry. The most directly comparable GAAP measure to FFO is net earnings. Although the National Association of Real Estate Investment Trusts (“NAREIT”) has published a definition of FFO, modifications to the NAREIT calculation of FFO are common among real estate investment trusts, as companies seek to provide financial measures that meaningfully reflect their business.
FFO is not meant to represent a comprehensive system of financial reporting and does not present, nor do we intend it to present, a complete picture of our financial condition and operating performance. We believe net earnings computed under GAAP remains the primary measure of performance and that FFO is only meaningful when it is used in conjunction with net earnings computed under GAAP. Further, we believe our consolidated financial statements, prepared in accordance with GAAP, provide the most meaningful picture of our financial condition and our operating performance.
NAREIT’s FFO measure adjusts net earnings computed under GAAP to exclude historical cost depreciation and gains and losses from the sales, along with impairment charges, of previously depreciated properties. We agree that these NAREIT adjustments are useful to investors for the following reasons:
Our FFO Measures
At the same time that NAREIT created and defined its FFO measure for the real estate investment trust industry, it also recognized that “management of each of its member companies has the responsibility and authority to publish financial information that it regards as useful to the financial community.” We believe stockholders, potential investors and financial analysts who review our operating results are best served by a defined FFO measure that includes other adjustments to net earnings computed under GAAP in addition to those included in the NAREIT defined measure of FFO. Our FFO measures are used by management in analyzing our business and the performance of our properties and we believe that it is important that stockholders, potential investors and financial analysts understand the measures management uses.
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We use these FFO measures, including by segment and region, to: (i) evaluate our performance and the performance of our properties in comparison to expected results and results of previous periods, relative to resource allocation decisions; (ii) evaluate the performance of our management; (iii) budget and forecast future results to assist in the allocation of resources; (iv) assess our performance as compared to similar real estate companies and the industry in general; and (v) evaluate how a specific potential investment will impact our future results. Because we make decisions with regard to our performance with a long-term outlook, we believe it is appropriate to remove the effects of short-term items that we do not expect to affect the underlying long-term performance of the properties. The long-term performance of our properties is principally driven by rental income. While not infrequent or unusual, these additional items we exclude in calculating FFO, as defined by Prologis, are subject to significant fluctuations from period to period that cause both positive and negative short-term effects on our results of operations in inconsistent and unpredictable directions that are not relevant to our long-term outlook.
We use our FFO measures as supplemental financial measures of operating performance. We do not use our FFO measures as, nor should they be considered to be, alternatives to net earnings computed under GAAP, as indicators of our operating performance, as alternatives to cash from operating activities computed under GAAP or as indicators of our ability to fund our cash needs.
FFO, as defined by Prologis
To arrive at FFO, as defined by Prologis, we adjust the NAREIT defined FFO measure to exclude:
We calculate FFO, as defined by Prologis for our unconsolidated entities on the same basis as we calculate our FFO, as defined by Prologis.
We believe investors are best served if the information that is made available to them allows them to align their analysis and evaluation of our operating results along the same lines that our management uses in planning and executing our business strategy.
Core FFO
In addition to FFO, as defined by Prologis, we also use Core FFO. To arrive at Core FFO, we adjust FFO, as defined by Prologis, to exclude the following recurring and non-recurring items that we recognized directly or our share of these items recognized by our unconsolidated entities to the extent they are included in FFO, as defined by Prologis:
We believe it is appropriate to further adjust our FFO, as defined by Prologis for certain recurring items as they were driven by transactional activity and factors relating to the financial and real estate markets, rather than factors specific to the on-going operating performance of our properties or investments. The impairment charges we have recognized were primarily based on valuations of real estate, which had declined due to market conditions, that we no longer expected to hold for long-term investment. Over the last few years, we made it a priority to strengthen our financial position by reducing our debt, our investment in certain low yielding assets and our exposure to foreign currency exchange fluctuations. As a result, we changed our intent to sell or contribute certain of our real estate properties and recorded impairment charges when we did not expect to recover the costs of our investment. Also, we have purchased portions of our debt securities when we believed it was advantageous to do so, which was based on market conditions, and in an effort to lower our borrowing costs and extend our debt maturities. As a result, we have recognized net gains or losses on the early extinguishment of certain debt due to the financial market conditions at that time. In addition, we and our co-investment ventures make acquisitions of real estate and we believe the costs associated with these transactions are transaction based and not part of our core operations.
We analyze our operating performance primarily by the rental income of our real estate and the revenue driven by our investment management business, net of operating, administrative and financing expenses. This income stream is not directly impacted by fluctuations in the market value of our investments in real estate or debt securities. As a result, although these items have had a material impact on our operations and are reflected in our financial statements, the removal of the effects of these items allows us to better understand the core operating performance of our properties over the long-term.
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We use Core FFO, including by segment and region, to: (i) evaluate our performance and the performance of our properties in comparison to expected results and results of previous periods, relative to resource allocation decisions; (ii) evaluate the performance of our management; (iii) budget and forecast future results to assist in the allocation of resources; (iv) provide guidance to the financial markets to understand our expected operating performance; (v) assess our operating performance as compared to similar real estate companies and the industry in general; and (vi) evaluate how a specific potential investment will impact our future results. Because we make decisions with regard to our performance with a long-term outlook, we believe it is appropriate to remove the effects of items that we do not expect to affect the underlying long-term performance of the properties we own. As noted above, we believe the long-term performance of our properties is principally driven by rental income. We believe investors are best served if the information that is made available to them allows them to align their analysis and evaluation of our operating results along the same lines that our management uses in planning and executing our business strategy.
Limitations on Use of our FFO Measures
While we believe our defined FFO measures are important supplemental measures, neither NAREIT’s nor our measures of FFO should be used alone because they exclude significant economic components of net earnings computed under GAAP and are, therefore, limited as an analytical tool. Accordingly, these are only a few of the many measures we use when analyzing our business. Some of these limitations are:
We compensate for these limitations by using our FFO measures only in conjunction with net earnings computed under GAAP when making our decisions. This information should be read with our complete consolidated financial statements prepared under GAAP. To assist investors in compensating for these limitations, we reconcile our defined FFO measures to our net earnings computed under GAAP.
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FFO:
Reconciliation of net earnings to FFO measures:
Add (deduct) NAREIT defined adjustments:
Real estate related depreciation and amortization
Net gains on non-FFO dispositions and acquisitions
Reconciling items related to noncontrolling interests
Our share of reconciling items included in earnings from unconsolidated entities
Subtotal-NAREIT defined FFO
Add (deduct) our defined adjustments:
Unrealized foreign currency and derivative losses (gains) and related amortization, net
Deferred income tax expense
Adjustments to arrive at Core FFO, including our share of unconsolidated entities:
Net gains on acquisitions and dispositions of investments in real estate, net of expenses
Losses (gains) on early extinguishment of debt and redemption of preferred stock, net
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Risk
We are exposed to the impact of interest rate changes and foreign-exchange related variability and earnings volatility on our foreign investments. Foreign currency market risk is the possibility that our financial results or financial position could be better or worse than planned because of changes in foreign currency exchange rates. In order to reduce our exposure to foreign currency risk, we borrow in the currencies in which we are invested, when we deem appropriate. We have also used certain derivative financial instruments, primarily foreign currency forward contracts, and non-derivative financial instruments to further reduce our foreign currency market risk, as we deem appropriate. 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.
As of March 31, 2014, we had derivative contracts with an aggregate notional amount of €1.0 billion ($1.4 billion using the weighted average forward rate of 1.35) to hedge a portion of our investment in Europe at a fixed euro rate in U.S. dollars. We also had derivative contracts with an aggregate notional amount of ¥24.1billion ($250.0 million using the weighted average forward rate of 96.54) to hedge a portion of our investment in Japan at a fixed yen rate in U.S. dollars. Based on a sensitivity analysis, strengthening or weakening of the U.S. dollar against the euro and Japanese yen by 10% would result in a $162 million positive or negative change, respectively, in our cash flows upon settlement of the forward contracts. These derivatives were designated and qualify as hedging instruments and therefore the changes in fair value of these derivatives are recorded in the foreign currency translation component of Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets in Item 1.
At March 31, 2014, we had €1.4 billion ($1.9 billion) of debt denominated in euro, including €700 million ($959.4 million) of debt issued in February 2014, by the Operating Partnership, which is a U.S. dollar functional entity. To mitigate the risk of fluctuations in the exchange rate of the euro, we designated this debt as non-derivative financial instrument hedges, and as a result, the change in the value of this debt upon translation into dollars is recorded in the foreign currency translation component of Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets to offset the foreign currency fluctuations related to our investment in Europe.
As of March 31, 2014, taking into account the derivative and the non-derivative hedges of our net investment, approximately 82% of our net equity was denominated in U.S. dollars.
Interest Rate Risk
We are also exposed to the impact of interest rate changes. Our interest rate risk 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, but we may use interest rate swap agreements to reduce our risk interest rate risk. As of March 31, 2014, we had a total of $298.4 million of variable rate debt outstanding, of which $71.0 million was fixed using an interest rate swap agreement. During the three months ended March 31, 2014, we had weighted average daily outstanding borrowings of $168.3 million on our variable rate debt not subject to interest rate swap agreements. An adverse change in interest rates is not expected to have a material impact on results of operations or cash flows.
There were no other significant changes to our quantitative and qualitative disclosures about market risk during the first three months of 2014. Please refer to Item 7A. Quantitative and Qualitative Disclosures about Market Risk in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 for a more complete discussion of the market risks we encounter.
Controls and Procedures (The REIT)
The REIT carried out an evaluation under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the disclosure controls and procedures (as defined in Rule 13a-14(c)) under the Securities and Exchange Act of 1934 (the “Exchange Act”) as of March 31, 2014. Based on this evaluation, the Chief Executive Officer 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.
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Controls and Procedures (The Operating Partnership)
The Operating Partnership carried out an evaluation under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the disclosure controls and procedures (as defined in Rule 13a-14(c)) under the Exchange Act as of March 31, 2014. Based on this evaluation, the Chief Executive Officer 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
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.
As of March 31, 2014, no material changes had occurred in our risk factors as discussed in Item 1A of our Form 10-K.
None.
Not Applicable.
The exhibits required by this item are set forth on the Exhibit Index attached hereto.
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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/ Thomas S. Olinger
/s/ Lori A. Palazzolo
Date: May 6, 2014
Index to Exhibits
Certain of the following documents are filed herewith. Certain other of the following documents that have been previously filed with the Securities and Exchange Commission and, pursuant to Rule 12-b-32, are incorporated herein by reference.