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PLD > SEC Filings for PLD > Form 10-Q on 8-May-2013All Recent SEC Filings

Show all filings for PROLOGIS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for PROLOGIS, INC.


8-May-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our Consolidated Financial Statements and the related notes included in Item 1 of this report and our 2012 Annual Report on Form 10-K.

Certain statements contained in this discussion or elsewhere in this report may be deemed "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Words and phrases such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," "designed to achieve," variations of such words and similar expressions are intended to identify such forward-looking statements, which generally are not historical in nature. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future - including statements relating to rent and occupancy growth, development activity and sales or contribution volume or profitability on such sales and contributions, economic and market conditions in the geographic areas where we operate and the availability of capital in existing or new co-investment ventures - are forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be attained and therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Many of the factors that may affect outcomes and results are beyond our ability to control. For further discussion of these factors see "Part II, Item 1A. Risk Factors" in our 2012 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 global owner, operator and developer of industrial real estate, focused on global and regional markets across the Americas, Europe and Asia. As of March 31, 2013, on an owned and managed basis, we had properties and development projects totaling 559 million square feet (51.9 million square meters) in 21 countries. These properties are leased to approximately 4,500 customers, including third-party logistics providers, manufacturers, retailers, transportation companies, and other enterprises.

Of the approximately 559 million square feet of our owned and managed portfolio as of March 31, 2013:

525 million square feet were in our operating portfolio with a gross book value of $39.6 billion that were 93.7% occupied;

24 million square feet were in our development portfolio with a total expected investment of $2.0 billion that were 51.7% leased;

10 million square feet consisted of properties in which we have an ownership interest but do not manage and other properties we own, including assets held for sale; and

the largest customer and 25 largest customers accounted for 2.0% and 17.7%, respectively, of our annualized base rent.

Prologis, Inc. is a self-administered and self-managed real estate investment trust ("REIT"), and is the sole general partner of Prologis, L.P. (the "Operating Partnership"). We operate Prologis, Inc. and the Operating Partnership as one enterprise, and, therefore, our discussion and analysis refers to Prologis, Inc. and its consolidated subsidiaries, including the Operating Partnership, collectively.

Our business strategy includes two operating segments: Real Estate Operations and Private Capital. We generate revenues, earnings, net operating income (calculated as rental income less rental expenses), funds from operations (as defined below) and cash flows through our segments primarily through three lines of business, as follows:

Real Estate Operations Segment

Rental Operations - This represents the primary source of our core revenue, earnings and FFO. We collect rent from our customers under operating leases, including reimbursements for the vast majority of our operating costs. We seek to generate long-term internal growth in rental income by maintaining a high occupancy rate at our properties, by controlling expenses and through contractual rent increases on existing space and renewals on rollover space, thus capitalizing on the economies of scale inherent in owning, operating and growing a large global portfolio. Our rental income is diversified due to both our global presence and our broad customer base. We expect to generate long-term internal growth in rents by increasing our occupancy rate and through rent increases on existing space and renewals on rollovers. We believe that our property management and leasing teams, regular maintenance programs, capital expenditure programs, energy management and sustainability programs create cost efficiencies, allowing us to leverage our global platform and provide flexible solutions for our customers as well as for us.

Capital Deployment Activities - Our development and re-development activities support our rental operations and are therefore included with that line of business for segment reporting. We develop and re-develop industrial properties primarily in global and regional markets to meet our customers' needs. Within this line of business, we provide additional value creation by utilizing:
(i) the land that we currently own in global and regional markets; (ii) the development expertise of our local personnel; (iii) our global customer relationships; and (iv) the demand for high quality distribution facilities in key markets. We seek to increase our rental income and the net asset value of the Company through the leasing of newly developed space, as well as through the acquisition of new properties. Depending on several factors, we may develop properties for long-term hold, for contribution into one of our co-investment ventures, or for sale to third parties. Properties that we choose to contribute or sell may result in the recognition of gains or losses. We develop directly as well as with our private capital partners in a variety of co-investment ventures.

Private Capital Segment -We co-invest in properties with private capital investors through a variety of co-investment ventures. We have direct and long-standing relationships with a significant number of institutional investors. We tailor industrial portfolios to investors' specific needs and deploy capital in both close-ended and open-ended venture structures and other joint ventures, while providing complete portfolio management and financial reporting services. We generally own 15-50% in these ventures. We believe our co-investment in each of our ventures provides a strong alignment of interests with our co-investment partners' interests. We generate revenues from our unconsolidated co-investment ventures


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by providing asset management and property management services. We may also earn revenues through additional services provided such as leasing, acquisition, construction, development, disposition, legal and tax services. Depending on the structure of the venture and the returns provided to our partners, we may also earn revenues through incentive returns or promotes. We believe our co-investment program with private capital investors will continue to serve as a source of capital for new investments and provide revenues for our stockholders, as well as mitigate risk associated with our foreign currency exposure. We expect to grow this business with the formation of new ventures, such as the two ventures formed in the first quarter of 2013 and discussed below, and through the growth in existing ventures with new third party capital and additional investments by us to be used for acquisitions.

At the time of our merger on June 3, 2011, we established our key strategic priorities to guide our path through the end of 2013. These priorities are:

to align our portfolio with our investment strategy while serving the needs of our customers;

to strengthen our financial position and build one of the top balance sheets in the REIT industry;

to streamline our private capital business and position it for substantial growth;

to improve the utilization of our low yielding assets; and

to build the most effective and efficient organization in the REIT industry and to become the employer of choice among top professionals interested in real estate as a career.

Align our Portfolio with our Investment Strategy

We have categorized our portfolio into three main market categories - global, regional and other markets. As of March 31, 2013, global markets represented approximately 84.9% of our overall owned and managed platform (based on gross book value) and regional markets represented approximately 11.5% of our total owned and managed platform. We intend to hold only the highest quality class-A product in our regional markets. We also own a small number of assets in other markets, which account for approximately 3.7% of our owned and managed platform and that we plan to exit from in an orderly fashion in the next few years. By segmenting our markets in this manner, we constructed a strategy to cull the portfolio of buildings and potentially submarkets that are no longer a strategic fit. We expect to use the proceeds from dispositions to pay off debt that is collateralized by the disposed asset, if any, to re-pay debt as it becomes due and to recycle capital into new development projects or strategic acquisitions.

Strengthen our Financial Position

We intend to further strengthen our financial position by lowering our financial risk and currency exposure and building one of the strongest balance sheets in the REIT industry. We expect to lower our financial risk by reducing leverage and maintaining staggered debt maturities, which will increase our financial flexibility and provide for continued access to capital markets. This financial flexibility will position us to capitalize on market opportunities across the entire business cycle as they arise. We also expect to reduce our exposure to foreign currency exchange fluctuations by borrowing in local currency where appropriate, and utilizing derivative contracts to hedge our foreign denominated equity and swap U.S. dollar-denominated debt into obligations denominated in foreign currencies. We expect to also lower our foreign currency risk by holding assets outside the United States primarily in co-investment ventures in which we maintain an ownership interest and provide services generating private capital revenue. We will accomplish this through contributions and sales to our existing and newly formed co-investment ventures, including the new ventures in Europe and Japan to which we contributed properties in the first quarter of 2013 as discussed below, significantly decreasing our outstanding debt and exposure to foreign currency fluctuations.

Streamline Private Capital Business

We are working with our private capital investors to rationalize certain of our co-investment ventures. Some of our legacy co-investment ventures have fee structures that do not adequately compensate us for the services we provide. Therefore, we have terminated or restructured certain of these co-investment ventures. In other cases, we may combine some co-investment ventures to gain operational efficiencies. In every case, however, we have worked and will continue to work very closely with our partners and venture investors who have been and will be active participants in these decisions. We expect to continue with these activities during 2013. We plan to grow our private capital business with the deployment of the private capital commitments we have already raised, formation of new co-investment ventures, including the new ventures in Europe and Japan, and raising incremental capital for our existing co-investment ventures.

Improve the Utilization of Our Low Yielding Assets

We expect to increase the value of our low yielding assets by stabilizing our operating portfolio to 95% leased, completing the build-out and lease-up of our development projects, as well as monetizing our land through development or sale to third parties. We also expect rental rate increases throughout the portfolio as leases turn, as we experienced in the first quarter of 2013 after 17 consecutive quarters of decreases.

Build the most effective and efficient organization in the REIT industry and become the employer of choice among top professionals interested in real estate as a career

We realized more than $115 million of cost synergies on an annualized basis, compared to the combined expenses of AMB Property Corporation and ProLogis on a pre-merger basis. These synergies included gross general and administrative savings, reduced global line of credit facility fees and lower amortization of non real estate assets. In addition, we implemented a new enterprise wide system that includes a property management/billing system (implemented in April 2012), a human resources system (implemented in July 2012), a general ledger and accounting


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system and a data warehouse (implemented in January 2013). In connection with this implementation, we are striving to utilize the most effective global business processes with the enhanced system functionality, and have also implemented several analytical tools to further empower and assist our regional and local teams. In early 2012, we implemented two new compensation plans that we believe will better align employees' compensation to our company performance. We believe these efforts and others will help us with the attainment of this objective. We will continue to look for additional efficiencies and savings opportunities.

Summary of 2013

During the three months ended March 31, 2013 and through the date of this report, we completed the following activities in support of our strategic priorities:

In the first quarter of 2013, we formed two new ventures, one in Japan and one in Europe:

In early 2013, we launched the initial public offering for Nippon Prologis REIT, Inc. ("NPR"). NPR will serve as the long-term investment vehicle for our stabilized properties in Japan. On February 14, 2013, NPR was listed on the Japan Stock Exchange and commenced trading. At that time, NPR acquired a portfolio of 12 properties from us for an aggregate purchase price of 173 billion ($1.9 billion). This resulted in 158 billion ($1.7 billion) in net cash proceeds and a gain of 31.5 billion ($337.9 million) after the deferral of 15%, which represents our ongoing ownership interest in NPR. We account for our ownership interest in NPR using the equity method of accounting.

On March 19, 2013, we closed on a euro-denominated co-investment venture, Prologis European Logistics Partners Sarl ("PELP"). PELP is structured as a 50/50 joint venture and has an initial term of 15 years, which may be extended for an additional 15-year period. At closing, the venture acquired a portfolio of 195 properties from us for an aggregate purchase price of 2.3 billion ($3.0 billion). This resulted in 1.0 billion ($1.3 billion) in net cash proceeds and a gain of 1.4 million ($1.8 million) after the deferral of 50%, which represents our ongoing ownership interest in PELP. In the fourth quarter of 2012, we recognized an impairment charge of $135.3 million to adjust the carrying value of the portfolio of assets to the expected proceeds upon contribution. We account for our ownership interest in PELP using the equity method of accounting.

Excluding the NPR and PELP transactions discussed above, we generated aggregate proceeds of $127.4 million from the disposition of land and seven operating buildings to third parties and the contribution of two operating buildings to one unconsolidated co-investment venture. We recognized a net loss of $0.9 million in continuing operations and a net gain of $5.8 million in discontinued operations as a result of these transactions.

As a result and in combination with our significant contribution and disposition activity, we decreased our total debt to $9.1 billion at March 31, 2013 from $11.8 billion at December 31, 2012 and we increased our U.S. dollar net equity to 66%. Through this activity:

We significantly reduced debt with the proceeds received from the contributions to the new co-investment ventures. We: (i) repaid $969.2 million of secured mortgage debt in Japan, (ii) repaid $310.1 million of secured mortgage debt in Europe, (iii) paid off a $112.5 million senior note, (iv) made payments on our global senior credit facility, and (v) transferred $353.2 million of secured mortgage debt to PELP.

As of March 31, 2013, we had remaining unrestricted cash balances of $785.4 million, of which $482.5 million was used to redeem our preferred stock in April 2013.

We commenced construction of 10 projects on an owned and managed basis aggregating 4.3 million square feet with a total expected investment of $313.2 million (our share was $218.0 million), including five projects (35% of the total expected investment) that were 100% leased prior to the start of development. We used $58.1 million of land we already owned for these projects. We expect these developments to be completed by February 2014 or earlier.

We leased a total of 35.8 million square feet in our owned and managed portfolio and incurred average turnover costs (tenant improvements and leasing costs) of $1.38 per square foot. This compares to the first quarter of 2012 when we leased 30.9 million square feet in our owned and managed portfolio with turnover costs of $1.14 per square foot. As of March 31, 2013, our total owned and managed operating portfolio was 93.7% occupied and 94.2% leased as compared to 94.0% occupied and 94.5% leased at December 31, 2012 and 92.3% occupied and 92.7% leased at March 31, 2012.

The effective rental rates increased 2.0% over in place rents on leases signed for our owned and managed portfolio during the first quarter of 2013, following 17 quarters of negative rent change on rollovers. Rent change is continuing its upward trend in our portfolio and we expect positive rollover for the full year 2013. Tenant retention in the first quarter was 78.0%.

On April 30, 2013, we closed on a public offering of 35.65 million common shares at a price of $41.60 per share, which included an overallotment option of 4.65 million shares that was exercised by the underwriters prior to the closing (the "Equity Offering"). We received net proceeds, after underwriters' fees, of $1.4 billion. We intend to use the net proceeds for general corporate purposes, including our investment in co-investment ventures, debt repayment and potential incremental acquisitions and development. In the short term, we expect to use a portion of the net proceeds to repay approximately $470.9 million in outstanding borrowings under our global senior credit facility, repurchase approximately $202.3 million of our senior notes due in June 2013 and repurchase all of the approximately $341.0 million outstanding principal amount of our 2.625% exchangeable notes due May 15, 2038, which are redeemable at our option beginning May 2013.


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Operational Outlook

The recovery in industrial real estate markets continues around the world. Signals continue to point to a positive outlook for our sector, in our view. Consumption is rising globally driven by e-commerce, which is growing by roughly 15% in development markets and 25% or more, in emerging markets where we operate. Tenant utilization rates remain near record levels based on our own internal surveys, which suggests customers have less shadow space than normal. Global trade growth is forecasted to be 3.6% during 2013 and over 5% for 2014 according to the International Monetary Fund. Inventories continue to rebuild as well; in the United States, real inventories have been rising for the past three years, and are almost back to their pre-crisis levels according to the United States Bureau of Economic Analysis. We expect further rebuilding of inventories this year to levels that will surpass the previous peak.

Total United States net absorption during the first quarter was approximately 63 million square feet according to CBRE, Inc., a strong result in what is usually a seasonally light quarter (and the strongest first quarter since 2000). The vacancy rate continues to fall (7.8% at March 31, 2013) and supply remains near historically low levels. Further, as the recovery broadens throughout the United States, demand should increase across more of the major tenant business sectors, further reducing vacancy spaces smaller than 100,000 square feet. This segment is closely tied to the recovery in the housing market and we expect demand to increase in the future. Thus, overall conditions in the United States industrial market should continue to improve and as such we are forecasting 150 million square feet of net absorption in 2013.

In Europe, net absorption continues to be positive, and has been, since we began collecting the data series, in the first quarter of 2011. In both Japan and China, the availability of class-A distribution space remains constrained. We expect the supply chain reconfiguration in Japan and growing consumption in China to continue to drive demand for our product in the long-term. Brazil continues to be an underserved logistics market as growing gross domestic product and increasing consumption is driving high levels of new requirements into the market. Demand momentum has been similarly positive in Mexico, benefitting from the economic recovery in the United States and increasingly frequent instances of 'near-shoring' of production activities. Net absorption has been positive for several years and market occupancy rates increased 60 basis points during the prior four quarters through March 31, 2013 across the six largest markets.

Due to the lack of supply of class-A facilities, high space utilization rates and decreasing vacancy rates, we expect development volume to increase in our markets. Our development business comprises speculative development, build-to-suit development, value-added conversions and redevelopment. We expect to develop directly and within our co-investment structures depending on location, market conditions, submarkets or building sites and availability of capital.

Results of Operations

Three Months Ended March 31, 2013 and 2012

Summary

The following table illustrates the net operating income for each of our
segments, along with the reconciling items to Earnings from Continuing
Operations on our Consolidated Statements of Operations in Item 1 for the three
months ended March 31 (dollars in thousands):



                                                              2013               2012
Net operating income - Real Estate Operations segment      $  318,709         $  324,007
Net operating income - Private Capital segment                 13,726             15,476
Other:
General and administrative expenses                           (56,197 )          (60,159 )
Depreciation and amortization                                (177,266 )         (180,280 )
Merger, acquisition and other integration expenses                 -             (10,728 )
Impairment of real estate properties                               -              (3,185 )
Earnings from unconsolidated entities, net                     24,768             13,995
Interest expense                                             (115,028 )         (133,056 )
Interest and other income, net                                 11,627              5,101
Gains on acquisitions and dispositions of investments
in real estate, net                                           338,845            267,771
Foreign currency and derivative gains (losses), net               884            (26,775 )
Gains (losses) on early extinguishment of debt, net           (17,351 )            5,419
Impairment of other assets                                         -             (16,135 )
Income tax expense                                            (51,866 )          (12,124 )

Earnings from continuing operations                        $  290,851         $  189,327

See Note 13 to our Consolidated Financial Statements in Item 1 for additional information regarding our segments and a reconciliation of net operating income to Earnings Before Income Taxes.


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Real Estate Operations Segment

The net operating income of the Real Estate Operations segment consisted of rental income and rental expenses from industrial properties that we own and consolidate and is impacted by our capital deployment activities. The size and percentage of occupancy of our consolidated operating portfolio fluctuates due to the timing of acquisitions, development activity and contributions. Such fluctuations affect the net operating income we recognize in this segment in a particular period. Also included in this segment is revenue from land we own and lease to customers under ground leases and development management and other income, offset by acquisition costs and land holding costs. The net operating income from the Real Estate Operations segment for the three months ended March 31, excluding amounts presented as Discontinued Operations in our Consolidated Financial Statements in Item 1, was as follows (in thousands):

                                                                  2013               2012
Rental and other income                                         $ 456,981             $ 447,073
Rental and other expenses                                         138,272               123,066

Total net operating income - Real Estate Operations segment     $ 318,709             $ 324,007

The increases in rental income and rental expenses in 2013 from 2012 are due primarily to the impact of the acquisitions of three unconsolidated co-investment ventures in 2012, increased occupancy in our consolidated operating properties (from 91.8% at March 31, 2012 to 93.1% at March 31, 2013) and the completion and stabilization of new development properties. This was offset by the decrease in rental income and expenses from the properties contributed to NPR on February 14, 2013 and to PELP on March 19, 2013. These decreases were offset in the Private Capital segment with higher equity in earnings and Private Capital revenues.

In our consolidated portfolio, we leased 21.1 million square feet for the three months ended March 31, 2013 compared to 16.8 million square feet for the three months ended March 31, 2012. We calculate the change in effective rental rates on leases signed during the quarter as compared to the previous rent on that same space in our total owned and managed portfolio. During the first quarter of 2013 and 2012, the percentage change was an increase of 2.0% and a decrease of 1.1%, respectively. This was the first quarter in 17 quarters that the change was positive. A decrease in rental rates in previous periods was due to:
(i) leases turning that were put in place when market rents were at or near peak; and (ii) decreased market rents. Under the terms of our lease agreements, we are able to recover the majority of our rental expenses from customers. Rental expense recoveries, included in both rental income and expenses, were 74.0% and 73.2% of total rental expenses for the three months ended March 31, 2013 and 2012, respectively.

Our consolidated operating properties are as follows (square feet in thousands):

. . .

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