UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 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.)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
(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 October 31, 2014, was approximately 499,989,000.
EXPLANATORY NOTE
This report combines the quarterly reports on Form 10-Q for the period ended September 30, 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 September 30, 2014, Prologis, Inc. owned an approximate 99.63% common general partnership interest in the Operating Partnership and 100% of the preferred units in the Operating Partnership. The remaining approximate 0.37% 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’s only significant asset is 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
Consolidated Balance Sheets – September 30, 2014 and December 31, 2013
Consolidated Statements of Operations – Three and Nine Months Ended September 30, 2014 and 2013
Consolidated Statements of Comprehensive Income (Loss) – Three and Nine Months Ended September 30, 2014 and 2013
Consolidated Statement of Equity – Nine Months Ended September 30, 2014
Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2014 and 2013
Consolidated Statement of Capital – Nine Months Ended September 30, 2014
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.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
PROLOGIS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
ASSETS
Investments in real estate properties
Less accumulated depreciation
Net investments in real estate properties
Investments in and advances to unconsolidated entities
Notes receivable backed by real estate and other
Net investments in real estate
Cash and cash equivalents
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; 1,565 shares and 2,000 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively
Common stock; $0.01 par value; 499,953 shares and 498,799 shares issued and outstanding at September 30, 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)
Three Months Ended
September 30,
Nine Months Ended
Revenues:
Rental income
Rental recoveries
Strategic capital income
Development management and other income
Total revenues
Expenses:
Rental expenses
Strategic capital 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) and related amortization, net
Losses on early extinguishment of debt, net
Total other income (expense)
Earnings (loss) before income taxes
Current income tax expense
Deferred income tax expense (benefit)
Total income tax expense (benefit)
Earnings (loss) from continuing operations
Discontinued operations:
Income attributable to disposed properties and assets held for sale
Net gains on dispositions, including taxes
Total discontinued operations
Consolidated net earnings (loss)
Net loss (earnings) attributable to noncontrolling interests
Net earnings (loss) attributable to controlling interests
Less preferred stock dividends
Loss on preferred stock redemption
Net earnings (loss) attributable to common stockholders
Weighted average common shares outstanding - Basic
Weighted average common shares outstanding - Diluted
Net earnings (loss) per share attributable to common stockholders - Basic:
Continuing operations
Discontinued operations
Net earnings (loss) per share attributable to common stockholders - Basic
Net earnings (loss) per share attributable to common stockholders - Diluted:
Net earnings (loss) per share attributable to common stockholders - Diluted
Dividends per common share
2
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
Other comprehensive income (loss):
Foreign currency translation gains (losses), net
Unrealized gains (losses) and amortization on derivative contracts, net
Comprehensive income (loss)
Other comprehensive loss (income) attributable to noncontrolling interest
Comprehensive income (loss) attributable to common stockholders
CONSOLIDATED STATEMENT OF EQUITY
Nine Months Ended September 30, 2014
Balance as of January 1, 2014
Consolidated net earnings
Effect of common stock plans
Redemption of preferred stock
Formation of Prologis U.S. Logistics Venture
Capital contributions
Settlement of noncontrolling interests
Foreign currency translation losses, net
Unrealized losses and amortization on derivative contracts, net
Distributions and allocations
Balance as of September 30, 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 net changes in operating receivables from unconsolidated entities
Amortization of debt and lease intangibles
Gains on acquisitions and dispositions of investment in real estate, net
Unrealized foreign currency and derivative losses (gains) and related amortization, net
Deferred income tax benefit
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 and lease commissions on previously leased space
Non-development capital expenditures
Return of investment from unconsolidated entities
Proceeds from repayment of notes receivable backed by real estate
Proceeds from dispositions and contributions of real estate properties
Acquisition of unconsolidated co-investment ventures, net of cash received
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
Purchase of noncontrolling interest
Debt and equity issuance costs paid
Net proceeds from credit facilities
Repurchase and payments of debt
Proceeds from issuance of debt
Net cash used in financing activities
Effect of foreign currency exchange rate changes on cash
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
See Note 14 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 (loss) attributable to common unitholders
Weighted average common units outstanding - Basic
Weighted average common units outstanding - Diluted
Net earnings (loss) per unit attributable to common unitholders - Basic:
Net earnings (loss) per unit attributable to common unitholders - Basic
Net earnings (loss) per unit attributable to common unitholders - Diluted:
Net earnings (loss) per unit attributable to common unitholders - Diluted
Distributions per common unit
6
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
Redemption of preferred units
7
REIT stock-based compensation awards, net
Acquisition of unconsolidated co-investment venture, net of cash received
Proceeds from issuance of common partnership units in exchange for contributions from the REIT, net
Distributions paid on common and preferred units
Debt and capital issuance costs paid
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 Strategic Capital (formerly Investment Management). Our Real Estate Operations segment represents the long-term ownership of industrial properties. Our Strategic Capital segment represents the long-term management of co-investment ventures, both private and public. See Note 13 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 September 30, 2014, the REIT owned an approximate 99.63% common general partnership interest in the Operating Partnership, and 100% of the preferred units. The remaining approximate 0.37% 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. The REIT’s only significant asset is 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 May 2014, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update that will use a five step model to recognize revenue from customer contracts in an effort to increase consistency and comparability throughout global capital markets and across industries. Under the model, a company will identify the contract, identify any separate performance obligations in the contract, determine the transaction price, allocate the transaction price and recognize revenue when the performance obligation is satisfied. The new standard will replace most existing revenue recognition in GAAP when it becomes effective for us on January 1, 2017. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.
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 10). Going forward, we expect the majority of our property dispositions will not qualify as discontinued operations and the results will be presented inIncome from Continuing Operations. See Notes 3 and 4 for additional discussion.
In March 2013, the 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, nor do we 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. The adjustments to finalize the purchase price allocation during the measurement period were not considered to be material to our financial position or results of operations. These properties were contributed in January 2014 to a consolidated venture in which we own 55% of the equity as discussed in Note 8. When we acquire a controlling interest in an equity investment, we mark our equity investment to fair value and recognize a gain or loss. In the second quarter of 2013, we also concluded an unconsolidated co-investment in Japan. We recognized a net gain of $35.9 million from these transaction for the nine months ended September 30, 2013, in Gains on Acquisitions and Dispositions of Investments in Real Estate, Net in the Consolidated Statements of Operations. The results of operations for these properties were not significant in 2013.
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. The adjustments to finalize the purchase price allocation during the measurement period were not considered to be material to our financial position or results of operations. All properties acquired in this transaction were contributed in June 2014 to our new unconsolidated co-investment venture in Mexico, as discussed in Note 3. When we acquire a controlling interest in an equity investment, we mark our equity investment to fair value and recognize a gain or loss. We recognized a net loss of $1.1 million for this transaction during the fourth quarter of 2013. The results of operations for these properties were not significant in 2013.
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 September 30, 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).
Real estate acquisition activity for the nine months ended September 30, was as follows (square feet and dollars in thousands):
Acquisitions of properties from unconsolidated co-investment ventures
Number of properties
Square feet
Real estate acquisition value
Net gains
Building acquisitions from third parties
10
Dispositions
Real estate disposition activity for the nine months ended September 30, was as follows (square feet and dollars in thousands):
Continuing Operations
Contributions to co-investment ventures
Net proceeds
Net gains on contributions
Dispositions to third parties
Net proceeds (1)
Net gains on dispositions (1)
Discontinued Operations
Net proceeds from dispositions
Net gains from dispositions, including taxes
In June 2014, we launched the initial public offering for FIBRA Prologis (“FIBRA”), a Mexican real estate investment trust, on the Mexican Stock Exchange. In connection with the offering, FIBRA purchased 177 properties aggregating 29.7 million square feet (12.6 million square feet from our wholly-owned portfolio, 7.6 million square feet from our consolidated co-investment venture Mexico Fondo Logistico (“AFORES”) and 9.5 million square feet from our unconsolidated co-investment venture Prologis Mexico Industrial Fund). We received 287.3 million equity units of FIBRA (priced at Ps 27.00 ($2.09)) in exchange for our combined investments and have a 45% ownership interest that we account for under the equity method. The closing price of the equity units on the Mexican Stock Exchange was Ps 28.10 ($2.08) per unit on September 30, 2014. Based on this transaction, we recognized a gain on disposition of investments in real estate of $52.5 million; current tax expense of $32.4 million; deferred tax benefit of $55.5 million; and earnings attributable to noncontrolling interest of $61.0 million, which represented the third party investors’ portion of this transaction.
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. 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 8 for more detail regarding our consolidated investments.
We also have other ventures, generally with one partner and that we do not manage. At September 30, 2014, our investment in these other ventures totaled $173.5 million. 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.
Unconsolidated Co-Investment Ventures
As of September 30, 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, Net in the Consolidated Statements of Operations. We earn fees for the 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 promote fees based on the venture’s cumulative returns to the investors over time. We report these fees in Strategic Capital 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 in Development Management and Other Income in the Consolidated Statements of Operations.
In June 2014, we earned a promote fee from Prologis Targeted U.S. Logistics Fund of $42.1 million, which was based on the venture’s cumulative returns to the investors over the prior three-year period ended June 30, 2014. Of that amount, $31.3 million represented the third party investors’ portion and is reflected in Strategic Capital Income in the Consolidated Statements of Operations. We also recognized $4.2 million of expense which is reflected in Strategic Capital Expensesin the Consolidated Statements of Operations, representing the associated cash bonus paid pursuant to the terms of the Prologis Promote Plan.
11
During the nine months ended September 30, 2014, we increased our ownership of Prologis North American Industrial Fund (“NAIF”) to 63.3% by acquiring the equity units from several partners for $632.1 million. On October 20, 2014, we acquired an additional partner’s interest further increasing our ownership to 66.1% leaving one remaining limited partner, which resulted in us obtaining control over NAIF and required us to consolidate this entity in the fourth quarter of 2014.
In 2014, we also invested our proportionate ownership interest in certain other co-investment ventures for the acquisition of properties and repayment of debt, primarily in Europe.
As discussed in Note 3, we started a co-investment venture in Mexico in June 2014. During the first quarter of 2013, we started two co-investment ventures, one in Europe and one in Japan. We account for these ventures under the equity method and recognize strategic capital income from them.
The amounts recognized in Strategic Capital Income and Earnings from Unconsolidated Entities, Net in the Consolidated Statements of Operations depend on the size of co-investment ventures that we manage and in which we have an equity interest. Our ownership interest in these ventures also impacts the equity in earnings we recognize. A summary of our unconsolidated co-investment ventures was as follows and represents 100% of the venture (square feet and total assets in thousands):
Americas:
Number of properties owned
Europe:
Asia:
Total:
The following is summarized financial information of the unconsolidated co-investment ventures, the amount we recognized as our share of their earnings and our investment (dollars in millions). The co-investment venture information represents the venture’s information (not our proportionate share) based on our GAAP basis in the entity.
2014 (1)
For the three months ended September 30, 2014:
Revenues
Net operating income
Net earnings
Equity in earnings
For the nine months ended September 30, 2014:
Net earnings (2)
As of September 30, 2014:
Amounts due to us (3)
Third party debt (4)
Our weighted average ownership
Our investment balance
Deferred gains, net of amortization (5)
12
2013 (1)
For the three months ended September 30, 2013:
For the nine months ended September 30, 2013:
As of December 31, 2013:
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 September 30, 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 (3)
Total
13
At December 31, 2013, we had $188.0 million of notes backed by real estate that represented an investment in a preferred equity interest made in 2010 through the sale of a portfolio of industrial properties. We earned a preferred return at an annual rate of 7% for the first three years and 8% for the fourth year. In May 2014, the notes and all accrued interest were paid in full.
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.
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 loans
Other debt
Totals
Credit Facilities
We have a global senior credit facility (the “Global Facility”), in which funds may be drawn in U.S. dollars, euro, Japanese yen, British pounds sterling and Canadian dollars on a revolving basis. In June 2014, the Global Facility was amended to increase the availability from $2.0 billion to $2.5 billion (subject to currency fluctuations, approximately $2.43 billion at September 30, 2014). We also have a ¥45 billion ($410.0 million at September 30, 2014) Japanese yen revolver (the “Revolver”) with availability to increase to ¥56.5 billion ($514.8 million at September 30, 2014). 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, 2014, were as follows (in millions):
Aggregate lender - commitments
Less:
Borrowings outstanding
Outstanding letters of credit
Current availability
Senior Notes
During the nine months ended September 30, 2014, and through the date of this report, we issued the following senior notes (in thousands except for percentages):
February 2014 (2)
June 2014 (2)
October 2014 (3)
14
During 2014, we repurchased or repaid $1.3 billion of certain of our senior notes and other debt that was scheduled to mature during 2015 through 2018 in an effort to reduce our overall borrowing rate and extend our debt maturities. This resulted in a net loss from early extinguishment of $84.8 million and $163.4 million, respectively, for the three and nine months ended September 30, 2014.
Exchangeable Senior Notes
The fair value of the embedded derivative associated with our exchangeable notes was a liability of $19.9 million and $41.0 million at September 30, 2014 and December 31, 2013, respectively. In adjusting to fair value, we recognized unrealized gains of $27.6 million and $21.2 million for the three and nine months ended September 30, 2014, respectively, and we recognized unrealized gains of $6.5 million and unrealized losses of $6.6 million for the three and nine months ended September 30, 2013, respectively, in Foreign Currency and Derivative Gains (Losses) and Related Amortization, Net in the Consolidated Statements of Operations.
Term Loans
On June 19, 2014, we terminated our existing senior term loan agreement and entered into a new agreement (the “Euro Term Loan”) under which loans can be obtained in U.S. dollars, euro, Japanese yen, and British pounds sterling in an aggregate amount not to exceed €500 million ($629.2 million at September 30, 2014). We may pay down and re-borrow under the Euro Term Loan and increase the borrowings up to €1.0 billion ($1.3 billion at September 30, 2014), subject to obtaining additional lender commitments. The Euro Term Loan was fully drawn at September 30, 2014). The loan is scheduled to mature in June 2017; however, we may extend the maturity date twice, by one year each, subject to the satisfaction of certain conditions and payment of an extension fee.
In May 2014, we entered into a Japanese yen term loan (“Yen Term Loan”), under which we may obtain loans in an aggregate amount not to exceed ¥40.9 billion ($372.8 million at September 30, 2014). We may increase the borrowings to ¥51.1 billion ($465.6 million at September 30, 2014), subject to obtaining additional lender commitments. The Yen Term Loan is scheduled to mature in 2021, and the interest rate is yen LIBOR plus 120 basis points. The Yen Term Loan was fully drawn at September 30, 2014.
Long-Term Debt Maturities
Principal payments due on our debt, for the remainder of 2014 and for each of the years in the period ending December 31, 2023, and thereafter were as follows at September 30, 2014 (in millions):
2014(1)
2015(2)
2016
2017(3)
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 September 30, 2014, we were in compliance with all covenants.
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Preferred Stock of the REIT
We have one series of preferred stock outstanding, the series Q preferred stock, with a liquidation preference of $50 per share, a par value of $0.01 and a dividend rate of 8.54%, which will be redeemable at our option on and after November 13, 2026. During the second quarter of 2014, we repurchased approximately 435,300 shares and recognized a loss on preferred stock redemption of $6.5 million, which primarily represented the difference between redemption value and carrying value net of original issuance costs.
Partners’ Capital of the Operating Partnership
During the third quarter of 2014, we issued limited partnership units in the Operating Partnership in connection with our long-term compensation plans. See Note 9 for more information.
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. However, 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. The difference between cash received and historical cost is reflected as an adjustment to Additional Paid-in Capital in the Consolidated Balance Sheets with no gain or loss recognized.
In January 2014, we closed on a U.S. co-investment venture, Prologis U.S. Logistics Venture, 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 of 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, 2014, the REIT owned 99.63% 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 September 30, 2014 and December 31, 2013 (in thousands, except for percentages):
Partnerships with exchangeable units (1)
Mexico Fondo Logistico (AFORES) (2)
Brazil Fund (3)
Prologis AMS (4)
Prologis U.S. Logistics Venture (5)
Other consolidated entities
Operating Partnership noncontrolling interests
Limited partners in the Operating Partnership (6)
REIT noncontrolling interests
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At September 30, 2014, Prologis had stock options and full value awards (restricted stock, performance share awards and restricted stock units (“RSUs”) of Prologis and a special class of limited partnership units of the Operating Partnership (“LTIP Units”), as described below) outstanding under its incentive plans.
Summary of Activity
The activity for the nine months ended September 30, 2014, with respect to our RSU and performance share awards, was as follows (number of shares in thousands):
Balance at December 31, 2013
Granted (1)
Vested and distributed
Forfeited
Balance at September 30, 2014
The activity for the nine months ended September 30, 2014, with respect to our stock options, was as follows (number of options in thousands):
Exercised
Forfeited / Expired
Outperformance Plan
We grant awards in the form of points under our Outperformance Plan (“OPP”) corresponding to three-year performance periods. As of September 30, 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. 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 relate to a three-year performance period that began on January 1, 2014, and will end on December 31, 2016. We also granted points in 2013 (three-year performance period will end on December 31, 2015) and 2012 (three-year performance period will end on December 31, 2014).
We recognized $6.9 million and $20.8 million of compensation expense related to our outstanding OPP awards during the three and nine months ended September 30, 2014, respectively, and $5.0 million and $18.0 million during the three and nine months ended September 30, 2013, respectively.
Prologis Promote Plan
The Prologis Promote Plan (“PPP”) was modified in the third quarter of 2014 to allow certain participants the option to receive LTIP Units in lieu of RSUs. Under the PPP, the awards may be settled in cash or RSUs (or LTIP Units if elected), which vest over a specified period of time. Each LTIP Unit represents a partnership interest in the Operating Partnership and, after vesting, may be convertible into a common unit in the Operating Partnership after the satisfaction of certain conditions. This modification did not trigger additional compensation expense. A compensation pool was funded in August 2014 associated with an incentive fee earned from one of our co-investment ventures. The total value of the awards in the third quarter 2014 from this compensation pool was $11.3 million, of which $4.2 million was paid in cash, approximately 57,000 RSUs were issued with a grant date fair value of $2.4 million and approximately 113,000 LTIP Units were issued with a grant date fair value of $4.7 million. The RSUs and LTIP Units vest over three years.
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In April 2014, the FASB issued a standard updating the accounting and disclosure regarding discontinued operations. As discussed in Note 1, we 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 was as follows (in thousands):
Rental income and recoveries
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):
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REIT
Noncontrolling interest attributable to exchangeable limited partnership units
Gains, net of expenses, associated with exchangeable debt assumed exchanged
Adjusted net earnings (loss) 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 exchangeable debt
Weighted average common shares outstanding - Diluted (3)
Net earnings (loss) per share attributable to common stockholders -
Basic
Diluted
Operating Partnership
Adjusted net earnings (loss) 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 (loss) per unit attributable to common unitholders -
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.
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Foreign Currency
We may use foreign currency option contracts, including puts, calls and collars to mitigate foreign currency exchange rate risk associated with the projected net operating income of our international subsidiaries, primarily in Europe. Foreign currency collars mitigate foreign currency exchange rate risk associated with the projected net operating income of our international subsidiaries. This strategy includes the purchase of a foreign currency put option, combined with the sale of a foreign currency call option such that there is no cash outlay at execution. The put option contracts provide us with the option to exchange euros for U.S. dollars at a fixed exchange rate if the euro were to depreciate against the U.S. dollar, such that, if the euro were to depreciate against the U.S. dollar to predetermined levels as set by the contracts, we could exercise our options and mitigate our foreign currency exchange losses. The call option would create an obligation to exchange euros for U.S. dollars at a fixed exchange rate if the euro were to appreciate against the U.S. dollar, such that, if the euro were to appreciate against the U.S. dollar to predetermined levels as set by the contracts we would be obligated to pay out under the contract and offset our foreign currency exchange gains. This strategy effectively locks in a range around the rate at which net operating earnings of our international subsidiaries will be translated into U.S. dollars.
Foreign currency option contracts are not designated as hedges as they do not meet hedge accounting requirements. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in earnings within the line item Foreign Currency and Derivative Gains (Losses) and Related Amortization, Net in the Consolidated Statements of Operations.
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 at the time the ineffectiveness occurred.
We primarily manage our foreign currency exposure by borrowing in the currencies in which we invest. 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. Ineffectiveness, if any, is recognized in Interest Expense at the time the ineffectiveness occurred.
The following table summarizes the activity in our derivative instruments (in millions):
2014
Notional amounts at January 1
New contracts
Matured or expired contracts
Notional amounts at September 30
Weighted Average Forward Rate at September 30
Active contracts at September 30
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2013
As discussed in Note 6, we issued €1.2 billion ($1.6 billion) of debt during the nine months ended September 30, 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 September 30, 2014 and December 31, 2013, we had €1.9 billion ($2.4 billion) and €700 million ($1.0 billion) of debt, respectively, designated as non-derivative financial instrument hedges on our net investment in international subsidiaries. Amounts included in AOCI in the Consolidated Balance Sheets for our non-derivative financial instrument hedges at September 30, 2014 and December 31, 2013, were gains of $214.6 million and losses of $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. As discussed above, 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
Net investment hedges - pounds sterling denominated
Foreign currency options - euro denominated (1)
Interest rate swap hedges
Our share of derivatives from un consolidated co-investment ventures (2)
Total fair value of derivatives
During the three and nine months ended September 30, 2014, we did not record any ineffectiveness on our derivative contracts. During the three and nine months ended September 30, 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 all periods presented, and is not expected to be significant for the next 12 months.
The change in Other Comprehensive Income (Loss) in the Consolidated Statements of Comprehensive Income (Loss) during the periods presented is due to the translation upon consolidation of the financial statements into U.S. dollars of our consolidated subsidiaries whose functional currency is not the U.S. dollar and the change in fair value for the effective portion of our derivative and non-derivative instruments. The following table presents the gains and losses associated with the change in fair value for the effective portion of our derivative and non-derivative instruments included in Other Comprehensive Income (Loss) (in thousands):
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Derivative net investment hedges (1)
Our share of derivatives from unconsolidated co-investment ventures
Total gain (loss) on derivative instruments
Non-derivative net investment hedges
Total gain (loss) on derivative and non-derivative instruments
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 September 30, 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 September 30, 2014 and December 31, 2013, were classified as Level 2 of the fair value hierarchy.
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 September 30, 2014 or December 31, 2013.
Fair Value of Financial Instruments
At September 30, 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 September 30, 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 September 30, 2014 and December 31, 2013, as compared with those in effect when the debt was issued or acquired, including reduced borrowing spreads due to our improved credit ratings. 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.
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The following table reflects the carrying amounts and estimated fair values of our debt (in thousands):
Term loans and other debt
Total debt
Our current business strategy includes two operating segments: Real Estate Operations and Strategic Capital (formerly 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 (Loss) 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 (Loss) before Income Taxes and Total Assets are allocated to each reportable business segment’s revenues, net operating income and assets. Items that are not directly assignable to a segment, such as certain corporate income and expenses, are reflected as reconciling items. The following reconciliations are presented in thousands:
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Real estate operations:
Americas
Europe
Asia
Total Real Estate Operations segment
Strategic capital:
Total Strategic Capital segment
Net operating income:
Total segment net operating income
Reconciling items:
Total reconciling items
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Assets:
Strategic capital (1):
Total segment assets
25
Significant non-cash investing and financing activities for the nine months ended September 30, 2014 and 2013 are discussed below.
The amount of interest paid in cash, net of amounts capitalized, for the nine months ended September 30, 2014 and 2013, was $222.1 million and $308.9 million, respectively.
During the nine months ended September 30, 2014 and 2013, cash paid for income taxes, net of refunds, was $93.9 million and $80.3 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 September 30, 2014, the related consolidated statements of operations, and consolidated statements of comprehensive income (loss) for the three-month and nine-month periods ended September 30, 2014 and 2013, the related consolidated statement of equity for the nine-month period ended September 30, 2014 and the related consolidated statements of cash flows for the nine-month periods ended September 30, 2014 and 2013. 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
November 4, 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 September 30, 2014, the related consolidated statements of operations, and consolidated statements of comprehensive income (loss) for the three-month and nine-month periods ended September 30, 2014 and 2013, the related consolidated statement of capital for the nine-month period ended September 30, 2014 and the related consolidated statements of cash flows for the nine-month periods ended September 30, 2014 and 2013. 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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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 September 30, 2014, we owned and managed operating properties and development projects totaling 585 million square feet (54 million square meters) in 21 countries. These properties were leased to more than 4,700 customers, including manufacturers, retailers, transportation companies and third-party logistics providers.
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 Strategic Capital (formerly Investment Management).
Real Estate Operations Segment
Rental Operations. This represents the primary source of our revenues, 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 develop properties for long-term hold, for contribution into our co-investment ventures, or occasionally for sale to third parties.
Strategic Capital 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”) and FIBRA Prologis (“FIBRA”). NPR began trading on the Tokyo stock exchange in early 2013 and FIBRA began trading on the Mexican stock exchange in June 2014. These private and public vehicles provide capital for distinct geographies across our global platform. We hold a significant ownership interest in these ventures, which we believe provides a strong alignment of interests with our partners. We generate strategic capital revenues from our unconsolidated ventures by providing asset management and property management services. We 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 also earn revenues through promote fees 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 generally through 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:
Rising Rents. Market rents are growing across the majority of our markets at a pace ahead of our prior forecast. We believe this trend will continue, as market rents are still below replacement-cost-justified rents. We believe demand for logistics facilities is strong across the
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globe and will support increases in net effective rents as many of our in-place leases were originated during low rent periods. As we are able to recover the majority of our operating expenses from customers, the increase in rent translates into increased net operating income, earnings and cash flow. We had positive rent change on rollover (when comparing the net effective rent of the new lease to the prior lease for the same space) during each quarter of 2014, ranging between 6.6% and 9.7%, and the third quarter was our seventh consecutive quarter to have rent increases.
Summary of 2014
During the nine months ended September 30, 2014, we completed the following activities as further described in the Consolidated Financial Statements:
Results of Operations
Nine Months Ended September 30, 2014 and 2013
Included in this segment is rental income and rental expense recognized from our consolidated operating properties. We had significant real estate activity during 2014 and 2013 that impacted the size of our consolidated 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.
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NOI from the Real Estate Operations segment for the nine months ended September 30 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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The NOI from the Strategic Capital segment represents fees earned for services performed reduced by strategic capital expenses (direct costs of managing these entities and the properties they own). The following table details this information by geographic location for the nine months ended September 30 (dollars in thousands):
NOI - Strategic Capital segment:
Asset management and other fees
Leasing commissions, acquisition and other transaction fees
Promote fees
Subtotal Americas
Subtotal Europe
Subtotal Asia
NOI - Strategic Capital segment
We had the following assets under management held through our unconsolidated co-investment ventures (in thousands):
Strategic Capital income fluctuates due to the size of the co-investment ventures that are under management and the transactional activity in the venture. We formed a co-investment venture in Mexico in June 2014 and formed two co-investment ventures in 2013 (one in Europe and one in Japan), as well as made contributions to several co-investment ventures during 2014 and 2013. We earned a promote fee in June 2014 from our co-investment venture Prologis Targeted U.S. Logistics Fund of $42.1 million, which was based on the venture’s cumulative returns to the investors over the last three years. Of that amount, $31.3 million represented the third party investors’ portion and is reflected in Strategic Capital Income in the Consolidated Statements of Operations.
Direct costs associated with our Strategic Capital segment totaled $74.4 million and $66.9 million for the nine months ended September 30, 2014 and 2013, respectively, and are included in Strategic Capital Expenses in the Consolidated Statements of Operations. The increase in expenses is primarily due to the increased size of our co-investment ventures and $4.2 million of expense that represents the associated cash bonus earned pursuant to the terms of the Prologis Promote Plan.
See Note 4 to the Consolidated Financial Statements for additional information on our unconsolidated co-investment ventures.
Our Owned and Managed Portfolio
We manage our business on an owned and managed basis without regard to whether a particular property is wholly owned by us or owned by one of our co-investment ventures. We believe this allows us to make business decisions based on the property operations and not based on our ownership. As further discussed below, we believe that the operating fundamentals of our owned and managed portfolio are consistent with that of our consolidated portfolio. This activity impacts our Real Estate Operations segment through the consolidated properties we own, our Strategic Capital segment in the fees we recognize and the net earnings we recognize from our unconsolidated co-investment ventures.
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Operating Activity
During 2014, we leased a total of 97.5 million square feet in our operating portfolio and incurred average turnover costs (tenant improvements and leasing costs) of $1.44 per square foot, compared to $1.42 per square foot for the same period in 2013. We had positive rent change on rollover (when comparing the net effective rent of the new lease to the prior lease for the same space) during each quarter of 2014, ranging between 6.6% and 9.7%, and the third quarter was our seventh consecutive quarter to have rent increases. We retained 84% of customers whose leases were expiring.
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
Development Activity
Since the beginning of 2014, we commenced construction of 51 development projects on an owned and managed basis, aggregating 16.7 million square feet with a total expected investment of $1.3 billion (our share was $1.2 billion), including 13 projects (23.5% of our share of the total expected investment) that were 100% leased prior to the start of development. These projects have an estimated weighted average yield at stabilization of 7.2%, which we estimate will result in these development properties being valued at 19.4% above the cost of development (which we refer to as development margin). We expect these developments to be completed on or before December 2015. We may continue to hold these properties long-term or in certain cases we will contribute to existing co-investment ventures.
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 September 30, 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 September 30, 2014, included 490.6 million of aggregated square feet.
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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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Other Components of Income (Expense)
General and Administrative (“G&A”) Expenses
G&A expenses for the nine months ended September 30 consisted of the following (in thousands):
Gross overhead
Allocated to rental expenses
Allocated to strategic capital expenses
Capitalized amounts
G&A expenses
Gross overhead includes all costs related to our business, including the Real Estate Operations and Strategic Capital segments. We allocate a portion of our G&A expenses that relate to property management functions to both segments based on the size of the respective portfolios. Costs directly associated to our Strategic Capital segment are also allocated to that segment. The increase in gross overhead was principally due to increased compensation; including amounts related to the Prologis Promote Plan, as described above.
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 nine months ended September 30, were as follows (in thousands):
Development activities
Leasing activities
Costs related to internally developed software
Total capitalized G&A expenses
For the nine months ended September 30, 2014 and 2013, the capitalized salaries and related costs represented 23.8% 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 $471.1 million and $483.2 million for the nine months ended September 30, 2014 and 2013, respectively. The decrease was principally a result of the disposition and contribution of properties, offset slightly by additional depreciation and amortization from completed development, acquired 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 $79.4 million and $59.6 million for the nine months ended September 30, 2014 and 2013, respectively. The increase in 2014 is due primarily to the two co-investment ventures formed in the first quarter of 2013 and FIBRA formed in June 2014, as well as increased ownership in several of the co-investment ventures. The earnings we recognize are impacted by: (i) variances in revenues and expenses of each venture; (ii) the size and occupancy rate of the portfolio of properties owned by each venture; (iii) our ownership interest in each venture; 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 Strategic Capital segment discussion and in Note 4 to the Consolidated Financial Statements for further breakdown of our share of net earnings recognized.
Interest Expense
Interest expense for the nine months ended September 30 included the following components (in thousands):
Gross interest expense
Amortization of 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 during the period and a decrease in interest rates. Although our debt levels were consistent at period-end ($8.8 billion at September 30, 2014 compared to $9.1 billion at September 30, 2013), we had higher debt outstanding during the first quarter of 2013. We decreased our debt by $2.7 billion near the end of the first quarter of 2013, primarily from the proceeds received from the contributions made to our unconsolidated co-investment ventures. Our weighted average effective interest rate was 4.3% and 4.8% for the nine months ended September 30, 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 nine months ended September 30, 2014, we recognized gains on dispositions of investments in real estate of $337.7 million. This includes $156.7 million of gains recognized in connection with the contribution of properties to co-investment ventures, net of the deferral due to our ongoing investments in the ventures, and $180.9 million of gains recognized primarily from the disposition of properties and land to third parties, principally in the United States.
During the nine months ended September 30, 2013, we recognized net gains on dispositions of investments in real estate in continuing operations of $446.0 million; primarily related to contributions of properties to our new co-investment ventures in Japan and Europe and the acquisition of a controlling interest in a co-investment venture as a result of the adjustment to fair value of our equity investment at the time we gained control and consolidated the entity.
Foreign Currency and Derivative Gains (Losses) and Related Amortization, Net
Foreign currency and derivative gains (losses) and related amortization, net, were $2.7 million for the nine months ended September 30, 2014. The gains were principally driven by gains of $8.8 million on the embedded derivative instrument (exchange feature), net of related amortization, related to our exchangeable senior notes that are marked to fair value at each reporting period, offset by foreign currency transactional losses.
Losses on Early Extinguishment of Debt, Net
During the nine months ended September 30, 2014, we purchased $1.3 billion in principal amount of our senior notes scheduled to mature in 2015 through 2018 and recognized a $163.4 million loss from early extinguishment. During the nine months ended September 30, 2013, we extinguished certain secured mortgage debt and several series of senior notes prior to maturity, which resulted in the recognition of losses of $164.2 million. See further discussion in Liquidity and Capital Resources for the information on our debt.
Income Tax Expense (Benefit)
During the nine months ended September 30, 2014 and 2013, our current income tax expense was $59.3 million and $91.4 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 and therefore triggered a tax on the built-in-gain.
During the nine months ended September 30, 2014 and 2013, we recognized deferred tax benefits of $84.6 million and $6.8 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. During 2014, we recognized a benefit of $63.7 million due to the reversal of deferred tax liabilities that had been provided for in Mexico, primarily related to the FIBRA transaction, of which $30.4 million was offset by current taxes, and a benefit of $27.3 million due to the expiration of the holding period on properties previously acquired with existing built-in-gains.
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. For the nine months ended September 30, 2013, earnings from discontinued operations were $64.7 million. Discontinued operations under the previous standard represent the results of operations of properties that were sold to third parties along with the related gain or loss on sale.
Net Earnings Attributable to Noncontrolling Interests
This amount represents the third party investors’ share of the earnings generated in consolidated ventures in which we do not own 100%, as well as the limited partners’ interests in the Operating Partnership. In June 2014, we recognized net earnings attributable to noncontrolling interests in Mexico Fondo Logistico (“AFORES”) of $61.0 million due to the FIBRA transaction, primarily related to the third party investors’ share of the gain on disposition and the net deferred income tax benefit.
In June 2013, we earned a promote fee of approximately $18.8 million from the cumulative returns of the investors of our consolidated co-investment venture, Prologis Institutional Alliance Fund II. Of that amount, $13.5 million represents the third party investors’ portion and is reflected as a component of noncontrolling interest.
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).
During the nine months ended September 30, 2014 and 2013, we recorded unrealized losses of $72.0 million and $250.3 million, respectively, related to foreign currency translations of our foreign subsidiaries into U.S. dollars upon consolidation. In 2014, we recorded unrealized losses principally due to the weakening of the Japanese yen, euro and British pounds sterling to the U.S. dollar, from the beginning of the period to the end of the period. In 2013, our unrealized losses 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. In addition, we recorded net unrealized losses in 2013 due to the weakening of the Japanese yen and euro to the U.S. dollar, from the beginning of the period to the end of the period.
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Three Months Ended September 30, 2014 and 2013
Except as separately discussed above including the contribution activity, the changes in net earnings attributable to common shares and its components for the three months ended September 30, 2014, as compared to the three months ended September 30, 2013, are similar to the changes for the nine month periods ended on the same dates.
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 September 30, 2014, we had $8.8 billion of debt with a weighted average interest rate of 3.6% and a weighted average maturity of 73 months. As of 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.
During 2014, we issued €1.8 billion ($2.4 billion) of senior notes, including €600 million ($756.4 million) in early October. These notes have interest rates ranging from 1.375% to 3.375% and mature in 2020, 2024 and 2026. The proceeds were used to repay $1.3 billion of outstanding senior notes scheduled to mature in 2015 through 2018, the acquisition and development of European properties, additional investments in our co-investment ventures and general corporate purposes.
In June 2014, we terminated our existing senior term loan agreement and entered into a new agreement under which loans can be obtained in U.S. dollars, euro, Japanese yen and British pounds sterling in an aggregate amount not to exceed €500 million ($629.2 million at September 30, 2014). We may pay down and re-borrow under this arrangement. We also entered into a Japanese yen term loan under which we may obtain loans in an aggregate amount not to exceed ¥40.9 billion ($372.8 million at September 30, 2014).
As of September 30, 2014, we had credit facilities with an aggregate borrowing capacity of $2.8 billion, of which $2.1 billion was available.
As of September 30, 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 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
Prologis China Logistics Venture
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.
Cash Provided by Operating Activities
For the nine months ended September 30, 2014 and 2013, operating activities provided net cash of $450.8 million and $332.2 million, respectively. In the first nine months of 2014 and 2013, cash provided by operating activities was less than cash dividends paid on common and preferred stock by $51.5 million and $98.8 million, respectively. We used proceeds from dispositions and contributions of real estate properties to consolidated and unconsolidated entities ($1.7 billion in 2014 and $3.9 billion in 2013) to fund dividends not covered by cash flows from operating activities.
Cash Investing and Cash Financing Activities
For the nine months ended September 30, 2014 and 2013, investing activities used net cash of $603.5 million and provided net cash of $1.7 billion, respectively. The following are the significant activities for both periods presented:
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For the nine months ended September 30, 2014 and 2013, financing activities used net cash of $23.1 million and $1.9 billion, respectively. The following are the significant activities for both periods presented:
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Off-Balance Sheet Arrangements
Unconsolidated Co-Investment Venture Debt
We had investments in and advances to unconsolidated co-investment ventures at September 30, 2014, of $5.6 billion. These ventures had total third party debt of $7.9 billion (in the aggregate, not our proportionate share) at September 30, 2014. This debt is primarily secured or collateralized by properties within the venture and is non-recourse to Prologis and the other investors and matures as follows (dollars in millions):
Prologis Targeted U.S. Logistics Fund (2)
Prologis North American Industrial Fund (2)
FIBRA Prologis
Prologis European Properties Fund II (2)
Nippon Prologis REIT (2)
Prologis China Logistics Venture (2)
Total co-investment ventures
Contractual Obligations
Distribution and Dividend Requirements
Our dividend policy on our common stock is to distribute a percentage of our cash flow to ensure we will meet the dividend requirements of the Internal Revenue Code, relative to maintaining our real estate investment trust status, while still allowing us to retain cash to meet other needs such as capital improvements and other investment activities.
We paid a cash dividend of $0.33 per common share for the first three quarters of 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.
As of September 30, 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.
Funds from Operations (“FFO”)
FFO is a non-U.S. generally accepted accounting principles (“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.
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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.
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.
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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 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 strategic capital business, net of operating, administrative and financing expenses. This income stream is not directly impacted by fluctuations in the market value of our investments in real estate or debt securities. Although the adjustments we make to arrive at Core FFO have had a material impact on our operations and are reflected in our financial statements, the removal of the effects of these items allows us to better understand the core operating performance of our properties over the long-term.
We use Core FFO, including by segment and region, to: (i) evaluate our performance and the performance of our properties in comparison to expected results and results of previous periods, relative to resource allocation decisions; (ii) evaluate the performance of our management; (iii) budget and forecast future results to assist in the allocation of resources; (iv) provide guidance to the financial markets to understand our expected operating performance; (v) assess our operating performance as compared to similar real estate companies and the industry in general; and (vi) evaluate how a specific potential investment will impact our future results. Because we make decisions with regard to our performance with a long-term outlook, we believe it is appropriate to remove the effects of items that we do not expect to affect the underlying long-term performance of the properties we own. As noted above, we believe the long-term performance of our properties is principally driven by rental income. We believe investors are best served if the information that is made available to them allows them to align their analysis and evaluation of our operating results along the same lines that our management uses in planning and executing our business strategy.
Limitations on Use of our FFO Measures
While we believe our defined FFO measures are important supplemental measures, neither NAREIT’s nor our measures of FFO should be used alone because they exclude significant economic components of net earnings computed under GAAP and are, therefore, limited as an analytical tool. Accordingly, these are only a few of the many measures we use when analyzing our business. Some of these limitations are:
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We compensate for these limitations by using our FFO measures only in conjunction with net earnings computed under GAAP when making our decisions. 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.
FFO:
Reconciliation of net earnings to FFO measures:
Net earnings attributable to common stockholders
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:
Deferred income tax benefit, net
Adjustments to arrive at Core FFO:
Net gains on acquisitions and dispositions of investments in real estate, net of expenses
Losses on early extinguishment of debt and redemption of preferred stock, net
Our share of reconciling items included in earnings from unconsolidated entities less third party share of consolidated entities
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Risk
We are exposed to 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 September 30, 2014, we had derivative contracts with an aggregate notional amount of €600.0 million ($800 million using the weighted average forward rate of 1.33) to hedge a portion of our investment in Europe at a fixed euro rate in U.S. dollars, and we had derivative contracts with an aggregate notional amount of £238.0 million ($400.0 million using the weighted average forward rate of 1.68) to hedge a portion of our investment in the United Kingdom at a fixed British pounds sterling rate in U.S. dollars. We also had derivative contracts with an aggregate notional amount of ¥24.1 billion ($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, a strengthening or weakening of the U.S. dollar against the euro, British pound sterling and Japanese yen by 10% would result in a $145 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 September 30, 2014, we had €1.9 billion ($2.4 billion) of debt denominated in euro. This debt was issued 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 carrying 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 net investment in Europe.
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As of September 30, 2014, taking into account the derivative and the non-derivative hedges of our net investment, approximately 89% 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 September 30, 2014, we had $1.8 billion of variable rate debt outstanding, of which $741.6 million was outstanding on our credit facilities, $1.0 billion was outstanding under term loans and $71.0 million was outstanding secured mortgage debt. As of September 30, 2014, we entered into interest rate swap agreements to fix $372.8 million of our Japanese yen term loan and $71.0 million of our variable rate secured mortgage debt. During the nine months ended September 30, 2014, we had weighted average daily outstanding borrowings of $842.7 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 nine 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.
Item 4. Controls and Procedures
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 September 30, 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.
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 September 30, 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
Item 1. Legal Proceedings
From time to time, we and our unconsolidated investees are party to a variety of legal proceedings arising in the ordinary course of business. We believe that, with respect to any such matters that we are currently a party to, the ultimate disposition of any such matters will not result in a material adverse effect on our business, financial position or results of operations.
Item 1A. Risk Factors
As of September 30, 2014, no material changes had occurred in our risk factors as discussed in Item 1A in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Not Applicable.
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Item 5. Other Information
Item 6. Exhibits
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: November 4, 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.