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Prologis, Inc. 10-Q 2011 Documents found in this filing:Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2011
For the transition period from to Commission File Number: 001-13545 (Prologis, Inc.) 001-14245 (Prologis, L.P.)
Prologis, Inc. Prologis, L.P. (Exact name of registrant as specified in its charter)
(415) 394-9000 (Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website; if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter periods that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one): Prologis, Inc.:
Prologis, L.P.:
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
The number of shares of Prologis, Inc.’s common stock outstanding as of November 1, 2011 was approximately 458,252,900.
Table of ContentsEXPLANATORY NOTE This report combines the quarterly reports on Form 10-Q for the period ended September 30, 2011 of Prologis, Inc. and Prologis, L.P. Unless stated otherwise or the context otherwise requires, references to “Prologis, Inc.” or the “REIT”, mean Prologis, Inc., and its consolidated subsidiaries; and references to “Prologis, L.P.” or the “Operating Partnership” mean Prologis, L.P., and its consolidated subsidiaries. The terms “the Company”, “Prologis”, “we”, “our” or “us” means the REIT and the Operating Partnership collectively. Prologis, Inc is a real estate investment trust (“REIT”) and the general partner of the Operating Partnership. As of September 30, 2011, the REIT owned an approximate 99.55% common general partnership interest in the Operating Partnership and 100% of the preferred units in the Operating Partnership. The remaining approximate 0.45% common limited partnership interests are owned by non-affiliated investors and certain current and former directors and officers of the REIT. As the sole general partner of the Operating Partnership, the REIT has full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Operating Partnership. We operate the REIT and the Operating Partnership as one enterprise. The management of the REIT consists of the same members as the management of the Operating Partnership. These members are officers of the REIT and employees of the Operating Partnership or one of its subsidiaries. As general partner with control of the Operating Partnership, the REIT consolidates the Operating Partnership for financial reporting purposes, and the REIT does not have significant assets other than its investment in the Operating Partnership. Therefore, the assets and liabilities of the REIT and the Operating Partnership are the same on their respective financial statements. We believe combining the quarterly reports on Form 10-Q of the REIT and the Operating Partnership into this single report results in the following benefits:
We believe it is important to understand the few differences between the REIT and the Operating Partnership in the context of how we operate as an interrelated consolidated company. The REIT’s only material asset is its ownership of partnership interests in the Operating Partnership. As a result, the REIT does not conduct business itself, other than acting as the sole general partner of the Operating Partnership and issuing public equity from time to time. The REIT itself does not issue any indebtedness, but guarantees the unsecured debt of the Operating Partnership. The Operating Partnership holds substantially all the assets of the business, directly or indirectly, and holds the ownership interests in the Company’s investment in certain investees. The Operating Partnership conducts the operations of the business and is structured as a partnership with no publicly traded equity. Except for net proceeds from equity issuances by the REIT, which are contributed to the Operating Partnership in exchange for partnership units, the Operating Partnership generates the capital required by the business through the Operating Partnership’s operations, its incurrence of indebtedness, and the issuance of partnership units to third parties. Noncontrolling interests, stockholders’ equity and partners’ capital are the main areas of difference between the consolidated financial statements of the REIT and those of the Operating Partnership. The noncontrolling interests in the Operating Partnership’s financial statements include the interests in consolidated investees not owned by the Operating Partnership. The noncontrolling interests in the REIT’s financial statements include the same noncontrolling interests at the Operating Partnership level, as well as the common limited partnership interests in the Operating Partnership, which are accounted for as partners’ capital by the Operating Partnership. In order to highlight the differences between the REIT and the Operating Partnership, there are separate sections in this report, as applicable, that separately discuss the REIT and the Operating Partnership including separate financial statements, controls and procedures sections, and separate Exhibit 31 and 32 certifications. In the sections that combine disclosure of the REIT and the Operating Partnership, this report refers to actions or holdings as being actions or holdings of Prologis.
Table of ContentsINDEX
Table of ContentsItem 1. Financial Statements CONSOLIDATED BALANCE SHEETS (In thousands, except par value amount)
The accompanying notes are an integral part of these Consolidated Financial Statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share amounts)
The accompanying notes are an integral part of these Consolidated Financial Statements.
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Table of ContentsCONSOLIDATED STATEMENT OF EQUITY Nine Months Ended September 30, 2011 (Unaudited) (In thousands)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited) (In thousands)
The accompanying notes are an integral part of these Consolidated Financial Statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
See Note 16 for information on non-cash investing and financing activities and other information. The accompanying notes are an integral part of these Consolidated Financial Statements.
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Table of ContentsCONSOLIDATED BALANCE SHEETS (In thousands)
The accompanying notes are an integral part of these Consolidated Financial Statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per unit amounts)
The accompanying notes are an integral part of these Consolidated Financial Statements.
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Table of ContentsCONSOLIDATED STATEMENT OF CAPITAL Nine Months Ended September 30, 2011 (Unaudited) (In thousands)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited) (In thousands)
The accompanying notes are an integral part of these Consolidated Financial Statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
See Note 16 for information on non-cash investing and financing activities and other information. The accompanying notes are an integral part of these Consolidated Financial Statements.
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Business. Prologis, Inc. (the “REIT”) commenced operations as a fully integrated real estate company in 1997, elected to be taxed as a real estate investment trust under the Internal Revenue Code of 1986, as amended, and believes the current organization and method of operation will enable the REIT to maintain its status as a real estate investment trust. The REIT is the general partner of Prologis, L.P. (the “Operating Partnership”). Through our controlling interest in the Operating Partnership, we are engaged in the ownership, acquisition, development and operation of industrial properties in global, regional and other distribution markets throughout the Americas, Europe and Asia. Our current business strategy includes two reportable business segments: direct owned and private capital. Our direct owned segment represents the direct long-term ownership of industrial properties. Our private capital segment represents the long-term management of property funds and other unconsolidated investees, and the properties they own. See Note 15 for further discussion of our business segments. Unless otherwise indicated, the notes to the Consolidated Financial Statements apply to both the REIT and the Operating Partnership. The terms “the Company”, “Prologis”, “we”, “our” or “us” means the REIT and Operating Partnership collectively. As of September 30, 2011, the REIT owned an approximate 99.55% general partnership interest in the Operating Partnership, and 100% of the preferred units. The remaining approximate 0.45% common limited partnership interests are owned by non-affiliated investors and certain current and former directors and officers of the REIT. As the sole general partner of the Operating Partnership, the REIT has full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Operating Partnership. We operate the REIT and the Operating Partnership as one enterprise. The management of the REIT consists of the same members as the management of the Operating Partnership. These members are officers of the REIT and employees of the Operating Partnership. As general partner with control of the Operating Partnership, the REIT consolidates the Operating Partnership for financial reporting purposes, and the REIT does not have significant assets other than its investment in the Operating Partnership. Therefore, the assets and liabilities of the REIT and the Operating Partnership are the same on their respective financial statements. On June 3, 2011, AMB Property Corporation (“AMB”) and AMB Property, LP completed the merger contemplated by the Agreement and Plan of Merger with ProLogis, a Maryland real estate investment trust and its subsidiaries (the “Merger”). Following the Merger, AMB changed its name to Prologis, Inc. As a result of the Merger, each outstanding common share of beneficial interest of ProLogis was converted into 0.4464 of a newly issued share of common stock of the REIT. As further discussed in Note 2, ProLogis was the accounting acquirer. As such, in the Consolidated Financial Statements the historical results of ProLogis are included for the entire period presented and AMB’s results are included subsequent to the Merger. See Note 2 for further discussion on the Merger. Basis of Presentation. The accompanying consolidated financial statements, presented in the U.S. dollar, are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the date of the financial statements and revenue and expenses during the reporting period. Our actual results could differ from those estimates and assumptions. All material intercompany transactions with consolidated entities have been eliminated. The accompanying unaudited interim financial information has been prepared according to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with such rules and regulations. Our management believes that the disclosures presented in these financial statements are adequate to make the information presented not misleading. In our opinion, all adjustments and eliminations, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for both the REIT and the Operating Partnership for the reported periods have been included. The results of operations for such interim periods are not necessarily indicative of the results for the full year. The accompanying unaudited interim financial information should be read in conjunction with the December 31, 2010 Consolidated Financial Statements of ProLogis and AMB, as previously filed with the SEC on Form 10-K and other public information. Certain amounts included in the accompanying Consolidated Financial Statements for 2010 have been reclassified to conform to the 2011 financial statement presentation. Recent Accounting Pronouncements. In September 2011, the Financial Accounting Standards Board (“FASB”) issued guidance to amend and simplify the rules related to testing goodwill for impairment. The revised guidance allows an entity to make an initial qualitative evaluation, based on the entity’s events and circumstances, to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The results of this qualitative assessment determine whether it is necessary to perform the currently required two-step impairment test. The new guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, but early adoption is permitted. Adoption of this guidance is not expected to have a material impact on our Consolidated Financial Statements. In June 2011, the FASB issued an accounting standard update that eliminates the option to present components of other comprehensive income as part of the changes in stockholders’ equity, and requires the presentation of components of net income and other comprehensive income either in a single continuous statement or in two separate but consecutive statements. This accounting standard update is effective, on a retrospective basis, for interim and annual periods beginning after December 15, 2011. We do not expect the guidance to impact our Consolidated Financial Statements. In May 2011, the FASB issued an accounting standard update to amend the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements in order to achieve further convergence with International Financial Reporting Standards. The amendments will be effective for us on January 1, 2012 and we do not expect to have a material impact to our Consolidated Financial Statements. In December 2010, the FASB updated the accounting standard related to business combinations that requires public entities to disclose certain pro forma information about revenues and earnings of the combined entity within the notes to the financial statements. As a result of the Merger
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
and consolidation of ProLogis European Properties (“PEPR”) as described in Note 2, we are required to present pro forma information as if the business combinations occurred at the beginning of the prior annual reporting period for purposes of calculating both the current reporting period and the prior reporting period pro forma financial information. The disclosure requirements were effective for business combinations with effective dates beginning January 1, 2011. See Note 2 for our pro forma disclosures. In July 2010, the FASB issued an accounting standard update that expands existing disclosures about the credit quality of financing receivables and the related allowance for credit losses. We adopted the expanded disclosure requirements for ending balances applicable to our Notes Receivable Backed by Real Estate as of December 31, 2010. Disclosures regarding activity that occurs during the reporting period were effective beginning January 1, 2011. See Note 5 for disclosure of this activity for the nine months ended September 30, 2011. In January 2010, the FASB issued an accounting standard update that requires disclosures about purchases, sales, issuances and settlements in the reconciliation for Level 3 fair value measurements. The Level 3 disclosure requirements were effective for us on January 1, 2011. Since we do not have any significant financial assets or financial liabilities that are measured at fair value using Level 3 valuation techniques and inputs on a recurring basis, the adoption of this standard was not considered material.
Merger of AMB and ProLogis As discussed above, we completed the Merger on June 3, 2011. After consideration of all applicable factors pursuant to the business combination accounting rules, the Merger resulted in a reverse acquisition in which AMB was the “legal acquirer” because AMB issued its common stock to ProLogis shareholders and ProLogis was the “accounting acquirer” due to various factors, including the fact that ProLogis shareholders hold the largest portion of the voting rights in the merged entity and ProLogis appointees represent the majority of the Board of Directors. In our Consolidated Financial Statements, the historical results of ProLogis are included for the entire period presented and the results of AMB are included subsequent to the Merger. As ProLogis was the accounting acquirer, the calculation of the purchase price for accounting purposes is based on the price of ProLogis common shares and common shares ProLogis would have had to issue to achieve a similar ownership split between AMB and ProLogis stockholders. We estimated the fair value of the pre-combination portion of AMB’s stock-based compensation awards based on market data and, in the case of the stock options, we used a Black-Scholes model to estimate the fair value of these awards as of the Merger date. An adjustment was made to equity for the vested portion while the unvested portion will be expensed over the remaining service period. The purchase price allocation reflects aggregate consideration of approximately $5.9 billion, as calculated below (in millions, except price per share):
The allocation of the purchase price requires a significant amount of judgment. While the current allocation of the purchase price is substantially complete, these allocations are subject to revision. We do not expect future revisions to have a significant impact on our financial position or results of operations. The allocation of the purchase price was as follows (in millions):
Acquisition of ProLogis European Properties In April 2011, we purchased 11.1 million ordinary units of PEPR, increasing our ownership interest to approximately 39%, and launched a mandatory tender offer to acquire any or all of the outstanding ordinary units and convertible preferred units of PEPR that we did not own at that time. On May 25, 2011, we settled our mandatory tender offer that resulted in the acquisition of an additional 96.5 million ordinary units and 2.7 million convertible preferred units of PEPR. During all of the second quarter of 2011, we made aggregate cash purchases totaling €715.8 million ($1.0 billion). We funded the purchases through borrowings under our global line of credit and a new €500 million bridge facility, which was subsequently repaid with proceeds from our June equity offering (“June 2011 Equity Offering”).
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
Upon completion of the tender offer, we met the requirements to consolidate PEPR. In accordance with the accounting rules for business combinations, we marked our equity investment in PEPR from carrying value to fair value of approximately €486 million, which resulted in the recognition of a gain of €59.6 million ($85.9 million). The fair value was based on the trading price and our acquisition price for the PEPR units previously outstanding and purchased during the tender offer period, respectively. As of September 30, 2011, we owned approximately 93.7% of the voting ordinary units of PEPR and 94.9% of the convertible preferred units. We have allocated the aggregate purchase price, representing the share of PEPR we owned at the time of consolidation of €1.1 billion or ($1.6 billion) as set forth below. The allocation was based on our valuation, estimates and assumptions of the acquisition date fair value of the tangible and intangible assets and liabilities acquired and is subject to change. The primary areas of the purchase price allocation that are not yet completed relate to the valuation of the intangible lease assets associated with the real estate portfolio of PEPR of 232 industrial buildings in 11 countries in Europe aggregating approximately 53.0 million square feet. The allocation of the purchase price was as follows (in millions):
The allocations for the Merger and the PEPR acquisition were based on our assessment of the fair value of the acquired assets and liabilities, as summarized below. Investments in Real Estate Properties- We estimated the fair value generally by applying an income approach methodology using a discounted cash flow analysis. Key assumptions included origination costs and discount and capitalization rates. Discount and capitalization rates were determined by market based on recent appraisals, transactions or other market data. The fair value also includes a portfolio premium that we estimate a third party would be willing to pay for the entire portfolio. Our valuations were based, in part, on a valuation prepared by an independent valuation firm. Investments in Unconsolidated Investees- We estimated the fair value of the investee by using similar valuation methods as those used for consolidated real estate properties and debt and, based on our ownership interest in each entity, estimated the fair value our investment. Intangible Assets- The fair value of in place leases was calculated based upon our estimate of the costs to obtain tenants, primarily leasing commissions, in each of the applicable markets. An asset or liability was recognized for acquired leases with favorable or unfavorable rents based on our estimate of current market rents in each of the applicable markets. The recognition of value of existing investment management agreements was calculated by discounting future expected cash flows under these agreements. Our valuations of the intangible assets were based, in part, on a valuation prepared by an independent valuation firm. Debt- The fair value of debt was estimated based on contractual future cash flows discounted using borrowing spreads and market interest rates that would be available to us for the issuance of debt with similar terms and remaining maturities. In the case of publicly traded debt, the fair value was estimated based on available market data. Noncontrolling Interest- We estimated the portion of the fair value of the net assets of our consolidated subsidiaries that was owned by third parties. Pro forma Information The following unaudited pro forma financial information presents our results as though the Merger and the acquisition of PEPR as well as the June 2011 Equity Offering that was used to fund the PEPR acquisition had been consummated as of January 1, 2010. The pro forma information does not necessarily reflect the actual results of operations had the transactions been consummated at the beginning of the period indicated nor is it necessarily indicative of future operating results. The pro forma information does not give effect to any cost synergies or other operating efficiencies that could result from the Merger and also does not include any merger and integration expenses. The results for the nine months ended September 30, 2011 included approximately four months of actual results for both the Merger and the PEPR acquisition and five months of pro forma adjustments. Actual results in 2011 included rental income and rental expenses of the acquired properties of $325.3 million and $86.7 million, respectively.
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
These results include certain adjustments, primarily decreased revenues resulting from the amortization of the asset or liability from the acquired leases with favorable or unfavorable rents relative to estimated market rents and amortization of acquired management contracts, increased depreciation and amortization expense resulting from the adjustment of real estate assets to estimated fair value and recognition of intangible assets related to in-place leases and acquired management contracts, and decreased interest expense due to the accretion of the fair value adjustment of debt.
Investments in real estate properties are presented at cost, and consist of the following (in thousands):
At September 30, 2011, excluding our assets held for sale, we owned real estate properties in the Americas (Canada, Mexico and the United States), Europe (Austria, Belgium, the Czech Republic, France, Germany, Hungary, Italy, the Netherlands, Poland, Romania, Slovakia, Spain, Sweden and the United Kingdom) and Asia (China, Japan, and Singapore). During the three and nine months ended September 30, 2011, we recognized Gains on Acquisitions and Dispositions of Investments in Real Estate, Net in continuing operations of $8.4 million and $114.7 million, respectively. This includes gains principally recognized in the second quarter related to the recognition of an $85.9 million gain from the consolidation of PEPR (See Note 2), $13.5 million gain from the acquisition of a controlling interest in a joint venture in Japan and the contribution of properties to unconsolidated property funds. When we contribute real estate properties to a property fund or joint venture in which we have an ownership interest, we defer a portion of the gain realized. If a loss is realized it is recognized when known. The amount of gain not recognized, based on our ownership interest in the entity acquiring the property, is deferred by recognizing a reduction to our investment in the applicable unconsolidated investee. Due to our continuing involvement through our ownership in the unconsolidated investee, these dispositions are not included in discontinued operations. See Note 7 for further discussion of properties we sold to third parties that are reported in discontinued operations. During the nine months ended September 30, 2011, we recognized a $5.2 million charge for estimated repairs related primarily to one of our buildings in Japan that was damaged from the earthquake and related tsunami in March 2011. This charge was included in Interest and Other Income (Expense), Net on the Consolidated Statements of Operations.
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
Summary of Investments Our investments in and advances to unconsolidated investees, which we account for under the equity method, are summarized by type of investee as follows (in thousands):
Unconsolidated Property Funds As of September 30, 2011 we had investments in 15 unconsolidated property funds that own portfolios of operating industrial properties and may also develop properties, and one property fund that has obtained commitments but does not own any properties. In addition to property and asset management fees, we may earn fees for acting as manager of the property funds and the properties they own. We may earn fees by providing other services including, but not limited to, leasing, construction, development and financing. We may also earn incentive performance returns based on the investors’ returns over a specified period. Summarized information regarding our investments in the unconsolidated property funds is as follows (in thousands):
Private capital revenues include fees and incentives we earn for services provided to our unconsolidated property funds (shown above), as well as fees earned from other investees and third parties of $1.9 million and $8.9 million during the three and nine months ended September 30, 2011, respectively, and $1.1 million and $3.3 million for the three and nine months ended September 30, 2010, respectively. Information about our investments in the unconsolidated property funds is as follows (dollars in thousands):
During the second quarter of 2011, we recorded impairment charges of $103.8 million primarily related to two of our investments in property funds. This included one investment in the U.S., Prologis North American Industrial Fund III, where our carrying value exceeded the estimated fair value of $31.5 million based on unobservable Level 3 inputs (see Note 14 for information on fair value measurements). The property fund has not had the same appreciation in value in its portfolio that we have experienced in our consolidated portfolio and in several of our other property funds. Based on the duration of time that the value of our investment has been less than carrying value and
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
the lack of recovery as compared to our other real estate investments, we no longer believe the decline to be temporary. Also included was our investment in a property fund in South Korea that we sold to our fund partner in July 2011. We had previously recognized an impairment associated with this investment due to the decline in value that we believed to be other than temporary. Equity Commitments Related to Certain Unconsolidated Property Funds Certain unconsolidated property funds have equity commitments from us and our fund partners. We may fulfill our equity commitment through contributions of properties or cash. Our fund partners fulfill their equity commitment with cash. We are committed to offer to contribute certain properties that we develop and stabilize in select markets in Europe and Mexico to these respective funds. These property funds are committed to acquire such properties, subject to certain exceptions, including that the properties meet certain specified leasing and other criteria, and that the property funds have available capital. We are not obligated to contribute properties at a loss. Depending on market conditions, the investment objectives of the property funds, our liquidity needs and other factors, we may make contributions of properties to these property funds through the remaining commitment period. The following table is a summary of remaining equity commitments as of September 30, 2011(in millions):
In addition to the funds listed above, we also obtained additional equity commitments of €82 million (approximately $110.3 million) in October 2011 in an unconsolidated property fund, Prologis Targeted European Logistics Fund. Some of this equity was called in October 2011 to cover the contribution of two properties for total proceeds of €31.1 million (approximately $43 million). We also have a consolidated property fund in Mexico, Prologis Mexico Fondo Logistico, to which we have an equity commitment of $59.0 million and our fund partners have an equity commitment of $235.8 million. If we contribute a property to a consolidated property fund, the property is still reflected in our Consolidated Financial Statements, but due to our ownership of less than 100%, there is an increase in noncontrolling interest related to the contributed properties. Summarized financial information of the unconsolidated property funds (for the entire entity, not our proportionate share) and our investment in such funds is presented below (dollars in millions):
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
Other unconsolidated investees In connection with the Merger, we acquired several investments in joint ventures that own industrial and retail properties, perform development activity and hold a mortgage debt investment. We also had investments in entities that owned non-core properties, which were disposed of in late 2010 and in the first half of 2011. Our investments in and advances to these entities was as follows (in thousands):
The activity on the notes receivable backed by real estate for the nine months ended September 30, 2011 is as follows (in thousands):
Other assets consisted of the following, net of amortization and depreciation, if applicable, as of September 30, 2011 and December 31, 2010 (in thousands):
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
Other liabilities consisted of the following, net of amortization, if applicable, as of September 30, 2011 and December 31, 2010 (in thousands):
Included in certain balances of Other Assets and Other Liabilities as of September 30, 2011 are the purchase price allocations for the Merger and the PEPR acquisition. See Note 2.
Assets Held for Sale As of September 30, 2011, we had two land parcels and five operating properties that met the criteria as held for sale. The amounts included in Assets Held for Sale include real estate investment balances and the related assets and liabilities for each property. Discontinued Operations During the nine months ended September 30, 2011, we disposed of 54 properties aggregating 4.8 million square feet to third parties, most of which were included in Assets Held for Sale at December 31, 2010, including one which was a development property. During all of 2010, we disposed of land subject to ground leases and 205 properties aggregating 25.4 million square feet to third parties, two of which were development properties. The operations of the properties held for sale or disposed of to third parties and the aggregate net gains recognized upon their disposition are presented as Discontinued Operations in our Consolidated Statements of Operations for all periods presented. Interest expense is included in discontinued operations only if it is directly attributable to these properties. Discontinued operations are summarized as follows (in thousands):
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
The following information relates to properties disposed of during the periods presented and recorded as discontinued operations, including adjustments to previous dispositions for actual versus estimated selling costs (dollars in thousands):
All debt is held directly or indirectly by the Operating Partnership. The REIT itself does not have any indebtedness, but guarantees the unsecured debt of the operating partnership. Generally, unsecured debt, including the credit facilities, senior notes, exchangeable senior notes, and unsecured term loans, is issued by the Operating Partnership or other wholly owned subsidiaries and guaranteed by the REIT. We generally do not guarantee the debt issued by consolidated subsidiaries in which we own less than 100%. Our debt consisted of the following (dollars in thousands):
During the nine months ended September 30, 2010, we repurchased certain senior and exchangeable senior notes outstanding with maturities in 2012 and 2013. We utilized proceeds from borrowings under the credit facilities to repurchase the senior notes. In addition, in 2010 we repaid certain secured mortgage debt in connection with the sale of two properties in Japan. The activity is summarized as follows (in thousands):
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
Credit Facilities On June 3, 2011, we entered into a global senior credit facility (“Global Facility”), pursuant to which, the Operating Partnership and certain subsidiaries may obtain loans and/or procure the issuance of letters of credit in various currencies on a revolving basis in an aggregate amount not to exceed approximately $1.75 billion (subject to currency fluctuations). Funds may be drawn in U.S. dollar, euro, Japanese yen, British pound sterling and Canadian dollar. We may increase the Global Facility to $2.75 billion, subject to obtaining additional lender commitments. The Global Facility is scheduled to mature on June 3, 2015, but the Operating Partnership may, at its option and subject to the satisfaction of certain conditions and payment of an extension fee, extend the maturity date of the Global Facility to June 3, 2016. Pricing under the Global Facility, including the spread over LIBOR, facility fees and letter of credit fees, varies based upon the public debt ratings of the Operating Partnership. The Global Facility contains customary representations, covenants and defaults (including a cross-acceleration to other recourse indebtedness of more than $50 million). In addition, on June 3, 2011, we entered into a ¥36.5 billion (approximately $474.9 million at September 30, 2011) yen revolver (the “Revolver”). The Revolver matures on March 1, 2014, but we may, at our option and subject to the satisfaction of customary conditions and payment of an extension fee, extend the maturity date to February 27, 2015. We may increase availability under the Revolver to an amount not exceeding ¥56.5 billion (approximately $735.1 million at September 30, 2011) subject to obtaining additional lender commitments. Pricing under the Revolver is consistent with the Global Facility pricing. The Revolver contains certain customary representations, covenants and defaults that are substantially the same as the corresponding provisions of the Global Facility. We refer to the Global Facility and the Revolver, collectively, as our “Credit Facilities”. Commitments and availability under our Credit Facilities as of September 30, 2011 were as follows (dollars in millions):
Senior Notes In June 2011, we completed an exchange offer for $4.6 billion of ProLogis senior notes and convertible senior notes with approximately $4.4 billion, or 95%, of the aggregate principal amount being validly tendered for exchange. The senior unsecured notes were exchanged for notes issued by the Operating Partnership that are guaranteed by the REIT. As a result of the exchange offer, we have no separate remaining financial reporting obligations or financial covenants associated with the ProLogis senior notes. All other terms of the newly issued senior notes and exchangeable notes remain substantially the same. Exchangeable Senior Notes In connection with the Merger and the exchange offer discussed above, our convertible senior notes became exchangeable senior notes issued by the Operating Partnership that are exchangeable into common stock of the REIT. As a result, the accounting for the exchangeable senior notes now requires us to separate the fair value of the derivative instrument (exchange feature) from the debt instrument and account for it separately as a derivative. The fair value of the derivative instrument was $62.5 million at the time of the Merger and was reclassified into Accounts Payable and Accrued Expenses from Debt in our Consolidated Balance Sheet. At each reporting period, we adjust the derivative instrument to fair value with the resulting adjustment being recorded in earnings as Foreign Currency Exchange and Derivative Gains (Losses), Net. The fair value of the derivative was $11.2 million at September 30, 2011 and therefore, we have recognized an unrealized gain of $61.0 million and $51.3 million, for the three and nine months ended September 30, 2011, respectively. Secured Mortgage Debt TMK bonds are a financing vehicle in Japan for special purpose companies known as TMKs. We issued a ¥13.0 billion ($161.3 million) TMK bond on March 17, 2011 at 1.34% due March 2018 secured by one property with an undepreciated cost of $273.4 million at September 30,
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
2011. In addition, we assumed ten secured mortgage notes and two additional TMK bonds with the Merger with an outstanding balance of $375.1 million and ¥13.5 billion ($176.0 million) at September 30, 2011, respectively, secured by 76 properties with an undepreciated cost of $934.4 million at September 30, 2011. Other Debt As of September 30, 2011, we had two outstanding term loans that we assumed in connection with the Merger, a Japanese Yen term loan with an outstanding balance of ¥12.5 billion ($165.4 million at September 30, 2011) that matures in October 2012 with a weighted average interest rate of 3.4%, and a €157.5 million ($211.8 million at September 30, 2011) senior unsecured term loan with a weighted average interest rate of 3.4% that matures in November 2015. Long-Term Debt Maturities Principal payments due on our debt, excluding the Credit Facilities, for the remainder of 2011 and for each of the years in the five-year period ending December 31, 2016 and thereafter are as follows (in thousands):
Debt Covenants Our debt agreements contain various covenants, including maintenance of specified financial ratios. We believe the covenants are customary and we were in compliance with all covenants as of September 30, 2011.
Common Stock In connection with the Merger, holders of ProLogis common shares received 0.4464 of a newly issued share of AMB common stock, ProLogis became a subsidiary of AMB and AMB changed its name to Prologis, Inc. Because ProLogis was the accounting acquirer (as discussed earlier), the historical ProLogis shares outstanding were adjusted by the Merger exchange ratio and restated to 254.5 million shares at January 1, 2011. As of the Merger date, 169.6 million shares were added to reflect the outstanding shares of common stock of AMB. In addition, in late June we issued 34.5 million shares of common stock generating net proceeds of $1.1 billion. As of September 30, 2011, we had 458.3 million shares of common stock outstanding. Operating Partnership For each share of common stock or preferred stock the REIT issues, the Operating Partnership issues a corresponding common or preferred partnership unit, as applicable, to the REIT in exchange for the contribution of the proceeds from the stock issuance. In addition, other third parties own common limited partnership units that make up 0.45% of the common partnership units.
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
Preferred Stock Upon completion of the Merger, each outstanding Series C, F and G Cumulative Redeemable Preferred Share of beneficial interest in ProLogis was exchanged for a newly issued share of Cumulative Redeemable Preferred Stock, Series Q, R and S, respectively. We had the following preferred stock issued and outstanding (in thousands, except per share and par value data):
The holders of the preferred stock have preference rights with respect to distributions and liquidation over the common stock and certain rights in the case of arrearage. Holders of the preferred stock are not entitled to vote on any matters, except under certain limited circumstances. At September 30, 2011, there were no dividends in arrears. The series L, M, O, P, R and S preferred stock are redeemable solely at our option, in whole or in part. The series Q preferred stock will be redeemable at our option on and after November 13, 2026.
In connection with the Merger, we have incurred and expect to incur additional significant transaction, integration, and transitional costs. These costs include investment banker advisory fees; legal, tax, accounting and valuation fees; termination and severance costs (both cash and stock based compensation awards) for terminated and transitional employees; system conversion costs; and other integration costs. These costs are expensed as incurred, which in some cases will be through the end of 2012. The costs that were obligations of AMB and expensed pre-merger are not included in our Consolidated Financial Statements. At the time of the Merger, we terminated our existing credit facilities and wrote-off the remaining unamortized deferred loan costs associated with such facilities, which is included as a merger expense. In addition, we have included costs associated with the acquisition of a controlling interest in PEPR and the reduction in workforce charges associated with dispositions made in 2011. The following is a breakdown of the costs incurred during the three and nine months ended September 30, 2011 (in thousands):
Under its incentive plans, ProLogis had stock options and full value awards (restricted share units (“RSUs”) and performance share awards (“PSAs”)) outstanding as of the date the Merger was completed. Pursuant to the Merger, each outstanding stock award of ProLogis was converted into 0.4464 of a newly issued award of the REIT. Additionally, the exercise prices of stock options acquired and the grant date fair values of full value awards have been adjusted to reflect the conversion of the underlying award. Stock options, restricted stock and RSUs granted under AMB’s incentive plans were revalued pursuant to the Merger. The portion related to unvested awards will be amortized over the remaining service period. Summary of Activity The activity for the nine months ended September 30, 2011, with respect to our stock options, was as follows:
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
The activity for the nine months ended September 30, 2011, with respect to unvested restricted stock grants, was as follows:
The activity for the nine months ended September 30, 2011, with respect to our full value awards, was as follows:
In 2011, we granted 721,050 RSUs and 280,525 target PSAs. The PSAs were granted to certain employees of the company, vest over three years and may be earned based on the attainment of certain individual and company goals for 2011. The ultimate number of PSAs that may be earned and issued to each employee can be between 0 – 200% of their target award.
Operating Partnership We report noncontrolling interest related to several entities we consolidate but do not own 100% of the common equity. These entities include three real estate partnerships that have issued limited partnership units to third parties. Depending on the specific partnership agreements, these limited partnership units are exchangeable into shares of our common stock, generally at a rate of one share of common stock to one unit or into cash. The Limited Partnership units of two entities that were consolidated pre-merger are exchangeable at the Merger exchange ratio and have been reflected as such in our Consolidated Financial Statements. In the aggregate as of September 30, 2011, for all our consolidated investees in which we own less than 100% of the equity, we have recorded approximately $6.3 billion of investments in real estate properties and $2.7 billion of debt. PEPR (in which we own 93.7% of the common equity) represents $4.2 billion of the real estate properties and $1.9 billion of the debt. See further discussion in Note 2 related to PEPR. REIT The noncontrolling interest of the REIT includes the noncontrolling interests presented in the Operating Partnership, as well as the common limited partnership units in the Operating Partnership that are not owned by the REIT. As of September 30, 2011, the REIT owned 99.55% of the common partnership units of the Operating Partnership. The following is a summary of the noncontrolling interest (in thousands):
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
We determine basic earnings per share/unit based on the weighted average number of shares of common stock/units outstanding during the period. We compute diluted earnings per share/unit based on the weighted average number of shares of common stock/units outstanding combined with the incremental weighted average effect from all outstanding potentially dilutive instruments. The following tables set forth the computation of basic and diluted earnings per share/unit (in thousands, except per share/unit amounts):
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
Derivative Financial Instruments In the normal course of business, our operations are exposed to global market risks, including the effect of changes in foreign currency exchange rates and interest rates. To manage these risks, we may enter into various derivative contracts. We may use foreign currency contracts, including forwards and options, to manage foreign currency exposure. We may use interest rate swaps or caps to manage the effect of interest rate fluctuations. We do not use derivative financial instruments for trading purposes. The majority of our derivative financial instruments are customized derivative transactions and are not exchange-traded. Management reviews our hedging program, derivative positions, and overall risk management strategy on a regular basis. We only enter into transactions that we believe will be effective at offsetting the underlying risk. Our use of derivatives does involve the risk that counterparties may default on a derivative contract. We establish exposure limits for each counterparty to minimize this risk and provide counterparty diversification. Substantially all of our derivative exposures are with counterparties that have long-term credit ratings of single-A or better. We enter into master agreements with counterparties that generally allow for netting of certain exposures; therefore, the actual loss we would recognize if all counterparties failed to perform as contracted would be significantly lower. To mitigate pre-settlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. All derivatives are recognized at fair value in our Consolidated Balance Sheets within the line items Other Assets or Accounts Payable and Accrued Expenses, as applicable. We do not net our derivative position by counterparty for purposes of balance sheet presentation and disclosure. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives are designated as, and qualify as, hedging instruments. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. Changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recorded in Accumulated Other Comprehensive Income (Loss) in our Consolidated Balance Sheets. We reclassify changes in the fair value of derivatives into the applicable line item in our Consolidated Statements of Operations in which the hedged items are recorded in the same period that the underlying hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures hedged, fluctuations in the value of the derivative instruments will generally be offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized in earnings. For derivatives that will be accounted for as hedging instruments in accordance with the accounting standards, we formally designate and document, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, we formally assess both at inception and at least quarterly thereafter, whether the derivatives used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. Any ineffective portion of a derivative financial instrument’s change in fair value is immediately recognized in earnings. Derivatives not designated as hedges are not speculative and are used to manage our exposure to foreign currency fluctuations but do not meet the strict hedge accounting requirements. Our interest rate risk management strategy is to limit the impact of future interest rate changes on earnings and cash flows as well as to stabilize interest expense and manage our exposure to interest rate movements. To achieve this objective, we have entered into interest rate swap and cap agreements, which allow us to borrow on a fixed rate basis for longer-term debt issuances. The maximum length of time that we hedge our exposure to future cash flows is typically less than 10 years. We use cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in interest rates. We also have entered into interest rate swap agreements which allow us to receive variable-rate amounts from a counterparty in exchange for us making fixed-rate payments over the life of our agreements without the exchange of the underlying notional amount. We have entered into an interest rate cap agreement which allows us to receive variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an upfront premium. We had 44 interest rate swap contracts, including 34 contracts denominated in euro, three contracts denominated in British pound sterling and seven contracts denominated in Japanese yen, and one interest rate cap denominated in U.S. dollars, outstanding at September 30, 2011. In connection with the Merger and the PEPR acquisition, we acquired interest rate swap contracts and an interest rate cap contract with combined notional amounts of $1.6 billion and $25.7 million, respectively, to fix the variable rate on certain indebtedness. We had $30.1 million and $1.4 million accrued in Accounts Payable and Accrued Expenses in our Consolidated Balance Sheets relating to these unsettled derivative contracts at September 30, 2011 and December 31, 2010, respectively. There was no ineffectiveness recorded during the three and nine months ended September 30, 2011 and 2010. The amount reclassified to interest expense for the three and nine months ended September 30, 2011 and 2010, is not considered material. We typically designate our interest rate swap and interest rate cap agreements as cash flow hedges as these derivative instruments may be used to manage the interest rate risk on potential future debt issuances or to fix the interest rate on a variable rate debt issuance. The effective portion of the gain or loss on the derivative is reported as a component of Accumulated Other Comprehensive Income (Loss) (“AOCI”) in our Consolidated Balance Sheets, and reclassified to Interest Expense in the Consolidated Statements of Operations over the corresponding period of the hedged item. For the next twelve months from September 30, 2011, we estimate that an additional $8.2 million will be reclassified as interest expense. Losses on the derivative representing hedge ineffectiveness are recognized in Interest Expense at the time the ineffectiveness occurred. The following table summarizes the activity in our derivative instruments (in millions) for the nine months ended September 30:
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Table of ContentsPROLOGIS, INC. AND PROLOGIS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited)
Fair Value Measurements We have estimated the fair value of our financial instruments using available market information and valuation methodologies we believe to be appropriate for these purposes. Considerable judgment and a high degree of subjectivity are involved in developing these estimates and, accordingly, they are not necessarily indicative of amounts that we would realize upon disposition. The fair value hierarchy consists of three broad levels, which are described below:
Fair Value Measurements on a Recurring and Non-recurring Basis At September 30, 2011, other than the derivatives discussed above and in Note 8, we do not have any significant financial assets or financial liabilities that are measured at fair value on a recurring or non-recurring basis in our consolidated financial statements. Fair Value of Financial Instruments At September 30, 2011 and December 31, 2010, the carrying amounts of certain of our financial instruments, including cash and cash equivalents, accounts and notes receivable and accounts payable and accrued expenses were representative of their fair values due to the short-term nature of these instruments and the recent acquisition of these items. At September 30, 2011 and December 31, 2010, the fair value of our senior notes and exchangeable senior notes, has been estimated based upon quoted market prices for the same (Level 1) or similar (Level 2) issues when current quoted market prices are available, the fair value of our Credit Facilities has been estimated by discounting the future cash flows using rates and borrowing spreads currently available to us (Level 3), and the fair value of our secured mortgage debt and assessment bonds that do not have current quoted market prices available has been estimated by discounting the future cash flows using rates currently available to us for debt with similar terms and maturities (Level 3). The fair value of our derivative financial instruments is determined through widely accepted valuation techniques, such as a discounted cash flow analysis on the expected cash flows and a Black Scholes option pricing model (Level 2). The differences in the fair value of our debt from the carrying value in the table below are the result of differences in interest rates and/or borrowing spreads that were available to us at September 30, 2011 and December 31, 2010, as compared with those in effect when the debt was issued or acquired. The senior notes and many of the issues of secured mortgage debt contain pre-payment penalties or yield maintenance provisions that could make the cost of refinancing the debt at lower rates exceed the benefit that would be derived from doing so. The following table reflects the carrying amounts and estimated fair values of our debt (in thousands):
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