ITEM 1. Business
ProLogis
ProLogis (collectively with its consolidated subsidiaries and partnerships, “ProLogis”) is a real estate investment trust (“REIT”) that operates a global network of industrial distribution properties. ProLogis’ business strategy is designed to achieve long-term sustainable growth in cash flow and sustain its return on equity at a high level for its shareholders. ProLogis manages its business by utilizing the ProLogis Operating System®, an organizational structure and service delivery system that ProLogis built around its customers. When combined with ProLogis’ international network of distribution properties, the ProLogis Operating System enables ProLogis to meet its customers’ distribution space needs on a global basis. ProLogis believes that, by integrating international scope and expertise with a strong local presence in its markets, it has become an attractive choice for its targeted customer base, the largest global users of distribution space.
ProLogis is organized under Maryland law and has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). ProLogis’ world headquarters are located in Aurora, Colorado. ProLogis’ European headquarters are located in the Grand Duchy of Luxembourg while its European customer service headquarters are located in Amsterdam, The Netherlands. ProLogis has offices in Asia in Tokyo, Japan and Shanghai, China. ProLogis’ common shares of beneficial interest, par value $0.01 per share (“Common Shares”) were first listed on the New York Stock Exchange (“NYSE”) in March 1994.
This report on Form 10-K includes certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these expectations due to changes in global economic, business, competitive, market and regulatory factors. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors.”
A copy of this Annual Report on Form 10-K, as well as ProLogis’ Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports are available, free of charge, on the Internet in the Investor Relations section of ProLogis’ website (www.prologis.com). All required reports are made available on the website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (the “SEC”). Any references to ProLogis’ website address does not constitute incorporation by reference of the information contained in the website and such information should not be considered to be part of this document.
Business Strategy and Global Presence
ProLogis’ business strategy has evolved over time in response to changes in the environment in which it operates. Throughout this evolution, ProLogis’ focus has continued to be on its customers’ needs. ProLogis was formed in 1991 as an industrial distribution operating company in the United States with a primary objective of differentiating itself from its competition. To do this, ProLogis needed to be able to meet a corporate customer’s distribution space requirements on a national, regional and local basis while providing customers with consistent levels of service throughout the country. As such, ProLogis’ initial business strategy involved the acquisition and development of industrial distribution properties across the United States and the building of a management team that would operate throughout the United States. These operating properties represented one operating segment - the property operations segment - as ProLogis’ intent was, and continues to be, to hold certain investments on a long-term basis while generating income from leasing the properties to customers.
As ProLogis’ customers’ needs expanded to markets outside the United States, so did ProLogis’ portfolio and its management team. ProLogis expanded its operations to Mexico in 1996 and to Europe in 1997, and now has operations in 11 European countries. In 2001, ProLogis again expanded its operations, this time to Asia with the initiation of operations in Japan. ProLogis opened a representative office in China in 2003 and,
in 2004, acquired its first real estate assets in China. Further expansion in 2004 included ProLogis’ entry into Singapore, with the acquisition of an operating property, and Canada, with the acquisition of land for future development.
In 1995, ProLogis expanded its business to include the corporate distribution facilities services (“CDFS business”) operating segment. The CDFS business segment began utilizing ProLogis’ existing development capabilities, which had been primarily focused on the development of properties for direct, long-term investment, to develop properties for sale to third parties. As a REIT, ProLogis must distribute rather than reinvest substantial amounts of its internally generated capital. Accordingly, the CDFS business segment’s sales to third parties provided ProLogis with funds that it could use as an alternative to public capital (debt and equity markets).
The ability to recycle funds in the CDFS business segment became a more integral part of ProLogis’ business strategy in early 1999 when the public equity markets became an increasingly costly method of raising capital. As such, it was necessary for ProLogis to increase the volume of its CDFS business segment transactions so that it could self-fund its development activities. Therefore, ProLogis shifted the focus of its CDFS business segment from developing and selling properties to third parties to developing properties that would be contributed to property funds - property funds that would be formed by ProLogis with private equity capital sources, in which ProLogis would maintain an ownership position and that would each be managed by ProLogis. And, to supplement the private equity investments in each property fund, the property funds were positioned to obtain secured debt financing by using their properties as security. Today, the property funds’ leverage ratios typically range from 40% to 75%. As ProLogis’ property funds grew, ProLogis expanded its CDFS business segment activities to also include the acquisition of properties that would be rehabilitated and/or repositioned within the CDFS business segment prior to contribution to a property fund.
ProLogis’ property fund strategy:
•
Allows ProLogis to realize, for financial reporting purposes, a portion of the development profits from its CDFS business activities by contributing its stabilized development properties to property funds (profits are recognized to the extent of third party investment in the property fund);
•
Provides diversified sources of private capital to ProLogis thereby allowing ProLogis to have less overall capital invested;
•
Allows ProLogis to earn fees for providing services to the property funds;
•
Allows ProLogis to maintain a long-term ownership position in the properties; and
•
Allows ProLogis, as the manager of the property funds, to maintain the market presence and customer relationships that are the key drivers of the ProLogis Operating System (see “- ProLogis Management - ProLogis Operating System”).
ProLogis’ first property fund was formed in August 1999 primarily with operating properties from ProLogis’ property operations segment, however subsequent property funds formed by ProLogis have primarily included properties developed by ProLogis in the CDFS business segment. ProLogis’ fifteen property funds have been formed in several ways illustrating the flexibility that this business strategy affords ProLogis:
•
Five of ProLogis’ property funds, all in the United States, were formed with an initial amount of private capital that allowed the property fund to generally make one portfolio acquisition from ProLogis;
•
ProLogis European Properties Fund, ProLogis Japan Properties Fund and ProLogis North American Properties Fund V were all formed with partners who have provided capital commitments to acquire properties on a continuing basis after formation;
•
ProLogis and affiliates of four investment funds formed five property funds with the objective of acquiring properties from an established REIT in a business combination. These property funds also acquired properties from ProLogis; and
•
Interests in two established property funds were acquired by ProLogis as part of a business combination.
As ProLogis’ business strategy has evolved, the primary driver in this evolution has been ProLogis’ focus on its customers’ global needs for distribution space. After 13 years in operation, that focus has enabled ProLogis to become a leading global provider of distribution space operating on three continents.
ProLogis’ Operating Segments
ProLogis’ business is organized into two operating segments: property operations and the CDFS business.
Property Operations
Investments
The property operations segment represents the long-term ownership, management and leasing of industrial distribution properties. ProLogis’ property operations segment at December 31, 2004 (including assets owned by 15 property funds in which ProLogis has ownership interests) consisted of 1,936 operating properties aggregating 282.8 million square feet in North America (the United States and Mexico), 11 countries in Europe and in Asia (Japan and Singapore). Of the total operating properties, ProLogis directly owned 1,228 operating properties aggregating 133.6 million square feet and its property funds owned 708 properties aggregating 149.2 million square feet. ProLogis presents its investments in the property funds under the equity method. ProLogis’ ownership interests in its 15 property funds ranged from 11.5% to 50% at December 31, 2004. ProLogis’ investment strategy in the property operations segment focuses primarily on generic industrial distribution properties in key distribution markets.
ProLogis develops distribution properties in its other operating segment, the CDFS business segment, with the intent to contribute the properties to property funds or to sell the properties to third parties. ProLogis also acquires properties in the CDFS business segment, with the intent to contribute them to a property fund, generally after rehabilitation and/or repositioning activities have been completed. These CDFS business properties, along with their operations, are included in the property operations segment after they are completed or acquired through the date they are contributed or sold. The gains and losses realized from the contributions or sales of these properties are included in the CDFS business segment’s income because they were developed or acquired in that segment. At December 31, 2004, there were 90 CDFS business segment operating properties aggregating 18.0 million square feet at a total investment of $897.9 million that were included in the property operations segment’s investments pending contribution or sale.
Property operations segment investment activities in 2004 included:
•
Formation of five new United States property funds in which ProLogis has a 20% ownership interest (125 properties; 25.5 million square feet; $1.51 billion total investment).
•
Disposition of 14 properties that were direct, long-term investments in the property operations segment aggregating 1.1 million square feet generating aggregate net proceeds of $40.6 million.
•
In North America, ProLogis North American Properties Fund V acquired 32 properties aggregating 7.6 million square feet at a total investment of $313.8 million, including 25 properties aggregating 4.9 million square feet at a total investment of $215.0 million that were acquired from ProLogis.
•
In Europe, ProLogis European Properties Fund acquired 33 properties aggregating 7.4 million square feet at a total investment of $599.3 million, all of which were acquired from ProLogis except for one 0.2 million square foot property at a total investment of $9.5 million.
•
ProLogis Japan Properties Fund acquired eight properties aggregating 2.3 million square feet at a total investment of $359.1 million, including three properties aggregating 1.2 million square feet at a total investment of $220.2 million that were acquired from ProLogis.
•
Acquired 20% ownership interests in two property funds as part of the Keystone Transaction (26 properties; 7.7 million square feet; $496.4 million total investment).
•
Acquisition of nine properties aggregating 2.3 million square feet at a total investment of $126.6 million as part of the keystone Transaction with the intent to own these properties directly in the property operations segment rather than to contribute these properties to property funds.
See “Item 2.
ITEM 2. Properties
Industrial Distribution Properties
ProLogis has directly invested in real estate assets that are primarily generic industrial distribution properties. Due to the costs associated with retrofitting service center space for new customers, ProLogis has acquired properties containing service center space on a very limited basis. Generally, service center space has been acquired as part of portfolio acquisitions in which the majority of the properties being acquired were generic industrial distribution properties. In Japan, ProLogis’ distribution properties will generally be multi-level centers, which is common in Japan due to the high cost and limited availability of land. ProLogis’ properties are typically used for storage, packaging, assembly, distribution and light manufacturing of consumer and industrial products. Based on the square footage of operating properties directly owned by ProLogis at December 31, 2004, 86% of ProLogis’ properties are used for bulk distribution with the remaining properties used for light manufacturing and assembly (11%) and for other purposes, primarily service centers (3%).
Geographic Distribution
ProLogis has direct ownership of 1,286 distribution properties (operating and under development) in North America, Europe and Asia at December 31, 2004. In North America, properties that are owned directly by ProLogis are located in 39 markets in 22 states and the District of Columbia in the United States and in four markets in Mexico. In Europe, the properties that are owned directly by ProLogis are located in 17 markets in nine countries. In Asia, the properties that are owned directly by ProLogis are located in Japan (Tokyo and Osaka), in Shanghai, China and in Singapore.
ProLogis defines its markets based on the concentration of properties in a specific area. A market, as defined by ProLogis, can be a metropolitan area, a city, a subsection of a metropolitan area, a subsection of a city or a region of a state or country. Accordingly, the actual location of each market may not be easily identifiable by the name given to the market by ProLogis. Such markets are identified below along with the major metropolitan areas or cities located in that market to assist in understanding the information presented in the tables that follow in Item 2.
The table below illustrates the geographic distribution of ProLogis’ portfolio of directly owned operating properties and properties under development. The table excludes land held for future development. The table includes properties owned by ProLogis and its consolidated subsidiaries and partnerships, which may not be 100% owned by ProLogis (see “- Real Estate Partnerships”). The table does not include properties that are owned by the property funds or ProLogis’ other unconsolidated investees which are discussed under “- Unconsolidated Investees.”
(1)
Properties under development are reflected at their total expected cost at completion, rather than at the cost incurred as of the dates presented.
(2)
ProLogis California has the right of first offer with respect to properties that ProLogis develops, excluding properties developed under build to suit agreements, in certain counties included in ProLogis’ Los Angeles/ Orange County market, subject to the property meeting certain specified criteria, including leasing criteria.
(3)
ProLogis North American Properties Fund V has the right of first offer to all of ProLogis’ stabilized development properties that ProLogis desires to sell in North America (except those properties that are subject to an agreement with ProLogis California) through December 31, 2005. Properties subject to the
right of first offer must meet certain specified criteria, including leasing criteria. Rights under the agreement will terminate if ProLogis North American Properties Fund V does not acquire a property that meets the specified criteria.
(4)
Previously, ProLogis considered all of its properties in New Jersey to be in one market. For 2004, ProLogis reflects two New Jersey markets, I-95 Corridor and Central New Jersey. Also, for 2004, ProLogis has divided the properties previously presented in the San Francisco (East Bay) market between that market and the San Francisco (Central Valley) market.
(5)
For 2004, includes on property in the Brownsville, Texas market. For 2003, includes one property in each of the Birmingham, Alabama and Brownsville, Texas markets. Neither of these markets are considered to be target markets of ProLogis.
(6)
ProLogis is committed to offer to contribute all of its stabilized development properties in specific markets in Europe to ProLogis European Properties Fund through September 2019, and ProLogis European Properties Fund is committed to acquire such properties, subject to the property meeting certain specified criteria, including leasing criteria.
(7)
ProLogis is committed to offer to contribute all of its stabilized development properties in Japan to ProLogis Japan Properties Fund through June 2006, and ProLogis Japan Properties Fund is committed to acquire such properties, subject to the property meeting certain specified criteria, including leasing criteria.
(8)
Includes 58 properties under development at December 31, 2004 with a total expected cost at completion of $1.08 billion and 27 properties under development at December 31, 2003 with a total expected cost at completion of $678.5 million.
Properties
The information in the following tables is as of December 31, 2004 for the operating properties, properties under development and land directly owned by ProLogis and its consolidated subsidiaries and partnerships, which may not be 100% owned by ProLogis (see “- Real Estate Partnerships”). No individual property or group of properties operated as a single business unit amounted to 10% or more of ProLogis’ consolidated total assets at December 31, 2004 or generated income equal to 10% or more of ProLogis’ consolidated gross revenues or total income for the year ended December 31, 2004. The table does not include properties that are owned by property funds or by ProLogis’ other unconsolidated investees which are discussed under “- Unconsolidated Investees.”
n/a
Not Applicable
(1)
The percentage occupancy presented is the physical occupancy at December 31, 2004. Operating properties at December 31, 2004 include recently completed development properties that may be in the initial lease-up phase, including properties aggregating 5.1 million square feet that were completed in 2004. The inclusion of properties in the initial lease-up phase can reduce the overall occupancy percentage.
(2)
Investment represents ProLogis’ carrying value of the properties, before depreciation, at December 31, 2004.
(3)
Certain properties are pledged as security under ProLogis’ secured debt and assessment bonds at December 31, 2004. For purposes of this table, the total principal balance of a debt issuance that is secured by a pool of properties is allocated among the properties in the pool based on each property’s investment balance. See Schedule III - Real Estate and Accumulated Depreciation to ProLogis’ Consolidated Financial Statements in Item 8 for additional identification of the properties pledged.
(4)
All operating properties are included in the property operations segment. See “Item 1. Business - ProLogis’ Operating Segments - Property Operations.”
(5)
Includes 70 properties aggregating 12.7 million square feet at total investment of $404.7 million that were developed in the CDFS business segment that are pending contribution to a property fund or sale to a third party or that were acquired in the CDFS business segment that are pending contribution to a property fund. See “Item 1. Business - ProLogis’ Operating Segments - CDFS Business.”
(6)
Includes one property in Brownsville, Texas which is not considered to be a target market of ProLogis.
(7)
Includes 19 properties aggregating 3.9 million square feet at a total investment of $323.7 million that were developed in the CDFS business segment that are pending contribution to a property fund or sale to a third party. See “Item 1. Business - ProLogis’ Operating Segments - CDFS Business.”
(8)
Includes a 1.4 million square foot property at a total investment of $169.5 million that was developed in the CDFS business segment that is pending contribution to ProLogis Japan Properties Fund. See “Item 1. Business - ProLogis’ Operating Segments - CDFS Business.”
(9)
Represents the total expected cost at completion for properties under development, including the cost of land, fees, permits, payments to contractors, architectural and engineering fees and interest and property taxes to be capitalized during construction, rather than actual costs incurred to date.
(10)
All of the properties under development are included in the CDFS business segment. See “Item 1. Business - ProLogis’ Operating Segments - CDFS Business.”
(11)
Includes 16 properties aggregating 3.3 million square feet that are in the design and permit stage.
(12)
All of the land held for future development is included in the CDFS business segment. The land owned can be used for the development of approximately 52.0 million square feet of distribution properties. See “Item 1. Business - ProLogis’ Operating Segments - CDFS Business.” Does not include 1,167 acres of land controlled directly by ProLogis under option, letter of intent or contingent contract with the
capacity for the development of approximately 20.8 million square feet of distribution properties. Does not include 796 acres of land owned or controlled by unconsolidated investees of ProLogis with the capacity for the development of approximately 11.7 million square feet of distribution properties. See “- Unconsolidated Investees - CDFS Business.”
(13)
Other investments include: (i) earnest money deposits associated with potential acquisitions; (ii) costs incurred during the pre-acquisition due diligence process; and (iii) costs incurred during the pre-construction phase related to future development projects.
Real Estate Partnerships
At December 31, 2004, ProLogis held a majority ownership interest in and controlled five real estate partnerships (collectively, the “Partnerships”). For financial reporting purposes, the assets, liabilities, results of operations and cash flows of each of the Partnerships are included in ProLogis’ Consolidated Financial Statements and in the preceding real estate tables. The interests of the limited partners are reflected as minority interest in ProLogis’ Consolidated Balance Sheet.
Pursuant to the partnership agreements, ProLogis or a wholly owned subsidiary of ProLogis is the sole controlling general partner of each of the five real estate partnerships with all management powers over the business and affairs of the partnership. The limited partners of each of the partnerships generally do not have the authority to transact business for, or participate in the management decisions of, the partnerships. The general partner in each of the partnerships may not, without the written consent of all of the limited partners: (i) take any action that would prevent the partnership from conducting its business; (ii) possess the property of the partnership; (iii) admit an additional partner; or (iv) subject a limited partner to the liability of a general partner. In each partnership, ProLogis or a wholly owned subsidiary may not voluntarily withdraw from the partnership or transfer or assign its interests in the partnership without the consent of all of the limited partners. The limited partners may freely transfer their partnership units to their affiliates, provided that the transfer does not cause a termination of the partnership under the Code and does not cause ProLogis to cease to comply with the REIT requirements of the Code. The limited partners in each of the partnerships are entitled to redeem their partnership units for Common Shares.
See Note 8 to ProLogis’ Consolidated Financial Statements in Item 8.
The five real estate partnerships are as follows at December 31, 2004:
(1)
Real estate assets are presented before depreciation.
(2)
Irving F. Lyons, III, ProLogis’ Vice Chairman and former Chief Investment Officer, had an effective ownership in ProLogis Limited Partnership-I of 1.8% at December 31, 2004.
(3)
These properties cannot be sold, prior to the occurrence of certain events, without the consent of the limited partners, other than in tax-deferred exchanges. The applicable partnership agreement provides
that a minimum level of debt must be maintained within this partnership, which can include intercompany debt to ProLogis.
(4)
One operating property is located in the Tampa market; all other properties are located in San Francisco (the East Bay and South Bay markets).
(5)
Jeffrey H. Schwartz, ProLogis’ Chief Executive Officer, owned all of the minority interest outstanding at December 31, 2004 (4.82% of ProLogis Limited Partnership-III and 1.02% of ProLogis Limited Partnership-IV).
(6)
The operating properties are located in the Chicago, Orlando, San Antonio and Tampa markets. Real estate assets also include 16 acres of land held for future development located in the Tampa market with a book basis of $0.8 million.
(7)
ProLogis Limited Partnership-IV was formed through a cash contribution from a wholly owned subsidiary of ProLogis, ProLogis IV, Inc., and through the contribution of properties from the limited partner. ProLogis Limited Partnership-IV and ProLogis IV, Inc. are legal entities that are separate and distinct from ProLogis, its affiliates and each other, and each has separate assets, liabilities, business functions and operations. At December 31, 2004, the sole asset of ProLogis IV, Inc. was its interest in ProLogis Limited Partnership-IV. At December 31, 2004, ProLogis IV, Inc. had outstanding borrowings from ProLogis of $0.6 million.
(8)
The operating properties are located in the Cincinnati, Dallas/ Ft. Worth, Ft. Lauderdale/ Miami, I-95 Corridor (New Jersey), Northern Ohio, Orlando and Tampa markets. In addition, this partnership’s real estate assets include $11.0 million of cash held in escrow pending the completion of a deferred tax exchange transaction.
(9)
This partnership was formed by another REIT that was merged with and into ProLogis in 1999.
(10)
This property is located in the Los Angeles/ Orange County market
(11)
This limited partnership was formed on August 4, 2004 in connection with the Keystone Transaction to directly acquire certain net assets of Keystone. In addition to the real estate assets owned, this partnership owns interests in two property funds that own real estate assets (ProLogis North American Properties Funds XI and XII) and interests in two CDFS Joint Ventures (one that owns a recently completed 0.8 million square foot development property and one that has a 0.8 million square foot property under development). See “- Unconsolidated Investees - Property Operations” and “- Unconsolidated Investees - CDFS Business”. Also, see Note 3 to ProLogis’ Consolidated Financial Statements in Item 8.
(12)
Real estate assets of this partnership include nine operating properties located in the I-81 Corridor (Pennsylvania) and Indianapolis markets with an undepreciated cost of $126.6 million, a 0.8 million square foot property under development in the Central New Jersey market with a total expected cost at completion of $39.1 million, and land parcels and land option rights primarily in the Indianapolis market.
Unconsolidated Investees
At December 31, 2004, ProLogis’ investments in and advances to unconsolidated investees (entities that ProLogis presents under the equity method rather than on a consolidated basis) totaled $908.5 million. ProLogis’ investments in and advances to property funds discussed below under “- Property Operations” totaled $839.7 million at December 31, 2004. ProLogis’ investments in and advances to its entities operating in the CDFS business segment totaled $40.5 million at December 31, 2004 discussed below under “- CDFS Business”. ProLogis’ investment in and advances to a temperature-controlled distribution company was $5.1 million at December 31, 2004. ProLogis’ investments in and advances to other companies totaled $23.2 million at December 31, 2004. ProLogis’ unconsolidated investees are discussed in Note 5 to ProLogis’ Consolidated Financial Statements in Item 8. See also “Item 1. Business - ProLogis’ Operating Segments.”
The property fund component of ProLogis’ business strategy allows ProLogis to: (i) realize, for financial reporting purposes, a portion of the profits from its CDFS business activities upon contribution of a property to
a property fund; (ii) earn fees from the property funds; (iii) raise private capital to fund its future CDFS business activities; (iv) maintain an ownership interest in its developed properties; and (v) maintain relationships with its customers. See “Item 1. Business - ProLogis - Business Strategy and Global Presence.”
Property Operations
At December 31, 2004, ProLogis had ownership interests ranging from 11.5% to 50% in 15 property funds that are presented under the equity method. The property funds primarily own operating properties and ProLogis’ investments in the property funds are included in its property operations segment. The information provided in the table below is for the total entity in which ProLogis has an ownership interest, not ProLogis’ proportionate share of the entity. ProLogis acts as manager of each property fund. See “Item 1. Business - ProLogis’ Operating Segments - Property Operations” and Note 5 to ProLogis’ Consolidated Financial Statements in Item 8.
(1)
The percentage occupancy presented is the physical occupancy at December 31, 2004.
(2)
Investment represents 100% of the carrying value of the properties, before depreciation, of each entity at December 31, 2004, except with respect to ProLogis North American Properties Funds XI and XII. ProLogis acquired its ownership interest in these entities as part of the Keystone Transaction in August 2004. For this presentation, the investment represents 100% of the fair values of the operating properties owned by these entities that were determined as part of the associated purchase accounting adjustments,
not just ProLogis’ share of the fair values, as adjusted for subsequent activity. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Keystone Transaction”.
(3)
ProLogis had a 50% ownership interest in ProLogis California at December 31, 2004.
(4)
ProLogis had a 41.3% ownership interest in ProLogis North American Properties Fund I at December 31, 2004.
(5)
ProLogis had a 20% ownership interest in each of ProLogis North American Properties Fund II, ProLogis North American Properties Fund III, ProLogis North American Properties Fund IV and ProLogis Japan Properties Fund at December 31, 2004.
(6)
ProLogis had an effective ownership interest of 11.5% in ProLogis North American Properties Fund V at December 31, 2004.
(7)
ProLogis formed this property fund in 2004 as part of the Keystone Transaction (see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Keystone Transaction”). ProLogis’ ownership interest in each of ProLogis North American Properties Funds VI through X was 20% at December 31, 2004.
(8)
ProLogis acquired a 20% ownership interest in each of ProLogis North American Properties Fund XI and ProLogis North American Properties Fund XII as part of the Keystone Transaction (see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Keystone Transaction”).
(9)
ProLogis had a 21.8% ownership interest in ProLogis European Properties Fund at December 31, 2004.
CDFS Business
At December 31, 2004, ProLogis had ownership interests in six entities that perform CDFS business activities and are presented by ProLogis under the equity method. These entities are as follows at December 31, 2004:
•
United States: two entities in which ProLogis’ ownership interest is 50% in each; ownership interests were acquired as part of the Keystone Transaction (see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Keystone Transaction”); one entity recently completed a 0.8 million square foot property in Indianapolis with a total investment of $39.1 million and one entity that began development of another 0.8 million square foot property in Indianapolis with a total expected cost at completion of $22.7 million.
•
Europe: three entities in the United Kingdom in which ProLogis’ ownership interest is 50% in each, including one entity in which ProLogis no longer actively participates and two entities that own land parcels (10 acres, 0.2 million buildable square feet) and control land parcels through contract, option or letter of intent (396 acres, 7.5 million buildable square feet) but do not have any projects currently under development.
•
Asia: one entity in China that has two properties under development aggregating 0.2 million square feet at a total expected cost at completion of $7.8 million; both properties are in Shanghai. This entity also owns four operating properties in Shanghai aggregating 0.2 million square feet at a total acquisition cost of $7.3 million.
See “Item 1. Business - ProLogis’ Operating Segments - CDFS Business.”
ITEM 3.
ITEM 3.
Legal Proceedings
From time to time, ProLogis and its unconsolidated investees are parties to a variety of legal proceedings arising in the ordinary course of their businesses. ProLogis believes that, with respect to any such matters that it is currently a party to, the ultimate disposition of any such matters will not result in a material adverse effect on ProLogis’ business, financial position or results of operations.
ITEM 4.
ITEM 4.
Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
ITEM 5.
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information and Holders
ProLogis’ Common Shares are listed on the NYSE under the symbol “PLD”. The following table sets forth the high and low sale prices of the Common Shares, as reported in the NYSE Composite Tape, and distributions per Common Share, for the periods indicated.
On March 11, 2005, ProLogis had approximately 186,306,321 Common Shares outstanding, which were held of record by approximately 9,300 shareholders.
Distributions and Dividends
In order to comply with the REIT requirements of the Code, ProLogis is generally required to make Common Share distributions and Preferred Share dividends (other than capital gain distributions) to its shareholders in amounts that together at least equal to (i) the sum of (a) 90% of its “REIT taxable income” computed without regard to the dividends paid deduction and its net capital gains and (b) 90% of the net income (after tax), if any, from foreclosure property, minus (ii) certain excess noncash income. ProLogis’ Common Share distribution policy is to distribute a percentage of its cash flow that ensures that ProLogis will meet the distribution requirements of the Code and that allows ProLogis to maximize the cash retained to meet other cash needs, such as capital improvements and other investment activities.
ProLogis announces the following year’s projected annual Common Share distribution level after the Board performs its annual budget review and approves a Common Share distribution level, generally in December of each year. In December 2004, the Board announced an increase in the annual distribution level for 2005 from $1.46 to $1.48 per Common Share. The payment of Common Share distributions is subject to the discretion of the Board, is dependent on ProLogis’ financial condition and operating results and may be adjusted at the discretion of the Board during the year. A distribution of $0.37 per Common Share for the first quarter of 2005 was declared on February 1, 2005. This distribution was paid on February 28, 2005 to holders of Common Shares on February 15, 2005.
Common Share distributions to shareholders are characterized for federal income tax purposes as ordinary income, capital gains, non-taxable return of capital or a combination of the three. Common Share distributions that exceed ProLogis’ current and accumulated earnings and profits (calculated for tax purposes) constitute a return of capital rather than a dividend and generally reduce the shareholders’ basis in the Common Shares. To the extent that a distribution exceeds both current and accumulated earnings and profits and the shareholder’s basis in the Common Shares, it will generally be treated as a gain from the sale or exchange of that shareholder’s Common Shares. At the beginning of each year, ProLogis notifies its shareholders of the taxability of the Common Share distributions paid during the preceding year. The following table summarizes the taxability of Common Share distributions for the periods indicated (in U.S. dollars; taxability for 2004 is estimated):
In addition to Common Shares, ProLogis has issued cumulative redeemable preferred shares of beneficial interest (“Preferred Shares”). At December 31, 2004, ProLogis had three series of Preferred Shares outstanding (“Series C Preferred Shares”, “Series F Preferred Shares” and “Series G Preferred Shares”). Previously, ProLogis had three other series of Preferred Shares (“Series A Preferred Shares”, “Series D Preferred Shares” and “Series E Preferred Shares”) and one series of cumulative convertible redeemable preferred shares of beneficial interest (“Series B Convertible Preferred Shares”) outstanding, all of which have been redeemed. Holders of each series of Preferred Shares outstanding have, subject to certain conditions, limited voting rights, and are entitled to receive cumulative preferential dividends based upon each series’ respective liquidation preference. Such dividends are payable quarterly in arrears on the last day of March, June, September and December. Dividends on Preferred Shares are payable when, and if, they have been declared by the Board, out of funds legally available for payment of dividends. After the respective redemption dates, each series of Preferred Shares can be redeemed at ProLogis’ option. The cash redemption price (other than the portion consisting of accrued and unpaid dividends) with respect to Series C Preferred Shares is payable solely out of the cumulative sales proceeds of other capital shares of ProLogis, which may include shares of other series of Preferred Shares. With respect to the payment of dividends, each series of Preferred Shares ranks on parity with ProLogis’ other series of Preferred Shares. Annual per share dividends paid on each series of Preferred Shares were as follows for the periods indicated (in U.S. dollars):
(1)
For federal income tax purposes, $3.62 of the 2004 dividend, $4.11 of the 2003 dividend and $4.04 of the 2002 dividend are estimated to represent ordinary income to the holders with the remaining portions of each dividend estimated to represent capital gains.
(2)
For federal income tax purposes, of the $1.98 per share dividend paid in 2003 on shares that were not redeemed, $1.90 is estimated to represent ordinary income to the holders and of the total 2002 dividend,
$1.87 is estimated to represent ordinary income to the holders. The remaining portions in each year are estimated to represent capital gains.
(3)
ProLogis redeemed all of its 10,000,000 outstanding Series D Preferred Shares (5,000,000 shares on January 12, 2004 and 5,000,000 shares on December 1, 2003). No Series D Preferred Share dividends were declared and paid in 2004, although the total redemption value included accrued and unpaid dividends of $0.066 per share. For 2003, the total dividends paid on the 5,000,000 shares redeemed in that year were $1.82 per share, of which $1.48 was declared and paid prior to the redemption and $0.34 represented accrued and unpaid dividends that were included in the redemption value. Of the dividend declared and paid in 2003 of $1.48 per share, $1.26 is estimated to be ordinary income to the holders, $0.16 is estimated to be qualified dividends and $0.06 is estimated to represent capital gains
(4)
ProLogis redeemed all of its 2,000,000 outstanding Series E Preferred Shares on July 1, 2003. The total dividends paid on the redeemed shares in 2003 were $1.46 per share, of which $1.09 was declared and paid prior to the redemption and $0.37 represented accrued and unpaid dividends that were included in the redemption value. Of the dividend declared and paid in 2003 of $1.09 per share, $0.93 is estimated to represent ordinary income to the holders, $0.12 is estimated to be qualified dividends and $0.04 is estimated to represent capital gains.
(5)
The Series F Preferred Shares were issued on November 28, 2003. For federal income tax purposes, $1.43 of the 2004 dividend and $0.14 of the 2003 dividend are estimated to represent ordinary income to the holders with the remainder estimated to represent capital gains.
(6)
The Series G Preferred Shares were issued on December 30, 2003. For federal income tax purposes, $1.43 of the 2004 dividend is estimated to represent ordinary income to the holders with the remainder estimated to represent capital gains.
Pursuant to the terms of its Preferred Shares, ProLogis is restricted from declaring or paying any distribution with respect to its Common Shares unless and until all cumulative dividends with respect to the Preferred Shares have been paid and sufficient funds have been set aside for dividends that have been declared for the then-current dividend period with respect to the Preferred Shares.
ProLogis’ tax return for the year ended December 31, 2004 has not been filed. The taxability information presented for ProLogis’ distributions and dividends paid in 2004 is based upon the best available data. ProLogis’ tax returns for previous tax years have not been examined by the Internal Revenue Service. Consequently, the taxability of distributions and dividends is subject to change.
ProLogis’ earnings and profits are first allocated to the Preferred Shares, which increases the portion of the Common Share distribution that is characterized as return of capital. The portion of the Common Share distribution that is characterized as return of capital represents the excess of distributions over the earnings and profits, and primarily results because non-cash charges such as depreciation are not considered in determining distribution levels. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations.”
Securities Authorized for Issuance Under Equity Compensation Plans
For information regarding securities authorized for issuance under ProLogis’ equity compensation plans see Note 15 to ProLogis’ Consolidated Financial Statements in Item 8. The other information required by this Item 5 is incorporated herein by reference to the description under the caption “Equity Compensation Plan Information” in ProLogis’ definitive proxy statement for its 2005 annual meeting of shareholders (“2005 Proxy Statement”).
Other Shareholder Matters
Other Issuances of Common Shares
In 2004, ProLogis issued 16,000 Common Shares upon exchange of limited partnership units in two of ProLogis’ majority-owned and controlled real estate partnerships. See “Item 2. Properties - Real Estate
Partnerships” and Note 8 to ProLogis’ Consolidated Financial Statements in Item 8. These Common Shares were issued in transactions exempt from registration under Section 4(2) of the Securities Act of 1933.
On August 4, 2004, ProLogis issued 879,283 limited partnership units in a majority-owned and controlled real estate partnership. The units were issued, and the limited partnership was formed, as part of the Keystone Transaction. Each limited partnership unit is convertible into one Common Share and is entitled to receive quarterly distributions of available cash, as defined in the limited partnership agreement. See “Item 2. Properties - Real Estate Partnerships” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Keystone Transaction.” The Keystone Transaction was exempt from registration under Section 4(2) of the Securities Act of 1933.
Common Share Repurchase Program
ProLogis may repurchase up to $215.0 million of Common Shares under a Common Share repurchase program that began in January 2001. Through December 31, 2004, a total of 5,571,100 Common Shares have been repurchased at a total cost, including fees and commissions paid, of $130.9 million. ProLogis did not repurchase any Common Shares during 2004 and has not made any Common Share repurchases through March 11, 2005. The Common Shares that have been repurchased to date were purchased through open market and privately negotiated transactions, depending on market prices and other conditions. Future repurchases, if any, are expected to be through similar transactions.
Common Share Plans
ProLogis sells Common Shares under various Common Share plans as follows:
•
1999 Dividend Reinvestment and Share Purchase Plan, amended in November 2002 (the “1999 Common Share Plan”): Allows holders of Common Shares to automatically reinvest Common Share distributions and certain holders and persons who are not holders of Common Shares to purchase a limited number of additional Common Shares by making optional cash payments, without payment of any brokerage commission or service charge. Common Shares that are acquired under the 1999 Common Share Plan, either through reinvestment of distributions or through optional cash payments, are acquired at a price ranging from 98% to 100% of the market price of such Common Shares, as determined by ProLogis. ProLogis generated net proceeds of $35.2 million from the issuance of 1,021,000 Common Shares in 2004 under the 1999 Common Share Plan.
•
Continuous equity offering plan: Allows ProLogis to sell up to 7,400,000 Common Shares through two designated agents in at-the-market offerings who earn a fee of between 2.0% and 2.25% of the gross proceeds. In 2004, ProLogis sold 1,430,000 Common Shares under this plan generating net proceeds to ProLogis of $53.3 million.
•
ProLogis Trust Employee Share Purchase Plan (the “Employee Share Plan”): Employees of ProLogis and its participating entities may purchase Common Shares, through payroll deductions only, at a discounted price of 85% of the market price of the Common Shares. The aggregate fair value of Common Shares that an individual employee can acquire in a calendar year under the Employee Share Plan is $25,000. Subject to certain provisions, the aggregate number of Common Shares that may be issued under the Employee Share Plan may not exceed 5,000,000. ProLogis began issuing Common Shares under the Employee Share Plan in January 2002. In 2004, ProLogis generated net proceeds of $1.1 million from the sale of 43,000 Common shares under the Employee Share Plan.
Holders of Common Shares who do not participate in the 1999 Common Share Plan continue to receive Common Share distributions as declared and paid. The amount of Common Share distributions that can be reinvested is limited to those distributions earned on no more than 300,000 Common Shares per quarter. Purchases under the 1999 Common Share Plan can be made by holders of Common Shares that are registered on the share transfer books of ProLogis in the shareholder’s name, as well as persons who are not holders of Common Shares.
ITEM 6.
ITEM 6. Selected Financial Data
The following table sets forth selected financial data relating to the historical financial condition and results of operations of ProLogis for 2004 and the four preceding years. Certain amounts for the years prior to 2004 presented in the table below have been reclassified to conform to the 2004 financial statement presentation. The financial data in the tables is qualified in its entirety by, and should be read in conjunction with, “Item 7.
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with ProLogis’ Consolidated Financial Statements and the related notes included in Item 8 of this report.
Some statements contained in this discussion are not historical facts but are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements are based on current expectations, estimates and projections about the industry and markets in which ProLogis operates, management’s beliefs and assumptions made by management, they involve uncertainties that could significantly impact ProLogis’ financial results. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, variations of such words and similar expressions are intended to identify such forward-looking statements. Forward-looking statements include discussions of strategy, plans or intentions of management. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. The discussions concerning ProLogis’ expectations with respect to economic conditions in the geographic areas where it has operations
and its ability to raise private capital and generate income in the CDFS business segment (including the discussions with respect to ProLogis’ expectations as to the availability of capital in its existing property funds such that these property funds will be able to acquire ProLogis’ stabilized developed properties that are expected to be available for contribution in the future) contain forward-looking statements. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Factors that may affect outcomes and results include: (i) changes in general economic conditions in ProLogis’ markets that could adversely affect demand for ProLogis’ properties and the creditworthiness of ProLogis’ customers; (ii) changes in financial markets, interest rates and foreign currency exchange rates that could adversely affect ProLogis’ cost of capital, its ability to meet its financial needs and obligations and its results of operations; (iii) increased or unanticipated competition for distribution properties in ProLogis’ markets; (iv) the availability of private capital to ProLogis; (v) geopolitical concerns and uncertainties; and (vi) those additional factors discussed under “- Risk Factors.”
Overview
A summary of the discussions that follow in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” is presented below.
Results of Operations:
•
ProLogis’ net earnings attributable to Common Shares were $202.8 million in 2004 and $212.4 million in 2003.
•
Net operating income of ProLogis’ property operations segment increased by $17.6 million in 2004 over 2003; stabilized leased percentage at December 31, 2004 (92.3%) was higher than at December 31, 2003 (90.2%); rental rates on new leases of previously leased space decreased 4.7% in 2004; and same store net operating income, as defined, was 0.15% higher than in 2003.
•
ProLogis’ income from property funds increased by $22.2 million in 2004, including an increase in fees earned from property funds of $6.6 million. Five new property funds were formed in 2004 and ProLogis acquired interests in two additional property funds in 2004.
•
Operating income of ProLogis’ CDFS business segment was $49.5 million higher in 2004 than in 2003 due to higher transaction volume in Europe and Asia in 2004, while transaction volume in North America decreased slightly. Transaction volume in Europe in 2003 was lower than previous years as a result of slower leasing activity in the CDFS business segment’s properties.
•
ProLogis recognized an impairment loss of $50.6 million related to the French operations of its temperature-controlled company that are held for sale at December 31, 2004. In 2003, ProLogis recognized a net loss under the equity method (including an impairment loss recognized prior to the sale) of $10.7 million related to the United Kingdom operations of this same company that were sold in December 2003.
•
ProLogis recognized a gain of $3.3 million in 2004 from the partial disposition of its investment in ProLogis North American Properties Fund V. In 2003, ProLogis recognized a gain of $74.7 million on the partial redemption of its investment in ProLogis European Properties Fund, including a foreign currency exchange gain of $47.9 million resulting from the repatriation of the cash redemption proceeds to the United States.
•
ProLogis initiated operations in China in 2004 by acquiring properties (through an unconsolidated investee) and by beginning development activities (both direct starts and through an unconsolidated investee).
•
ProLogis acquired an operating property in Singapore and acquired land for future development in Canada in 2004.
Liquidity and Capital Resources:
•
Generated net cash flow from operating activities in 2004 of $481.3 million.
•
Used net cash in its investing activities of $612.5 million in 2004 (used $1.73 billion for real estate investments, used $333.5 million for the Keystone Transaction on a net basis and generated $1.41 billion from contributions and sales of properties and land parcels).
•
ProLogis issued 350.0 million euro of senior notes that are registered on the Luxembourg Stock Exchange (the currency equivalent of approximately $464.2 million at December 31, 2004). Cash proceeds to ProLogis were $420.6 million as of the issuance date in April 2004.
•
Sales and issuances of Common Shares under various Common Share plans generated net cash of $146.8 million.
•
Redeemed $125.0 million of Preferred Shares.
•
Distributed $1.46 per Common Share in 2004 for aggregate distributions paid of $266.1 million ; set the distribution level for 2005 at $1.48 per Common Share. ProLogis has increased its Common Share distribution level every year since its Common Shares became publicly traded in 1994.
•
Increased the total borrowing capacity under its lines of credit by 25.0 billion yen (approximately $241.1 million at December 31, 2003), total borrowing capacity was in excess of $1.8 billion at December 31, 2004.
Critical Accounting Policies
A critical accounting policy is one that is both important to the portrayal of an entity’s financial condition and results of operations and requires judgment on the part of management. Generally, the judgment requires management to make estimates about the effect of matters that are inherently uncertain. Of the accounting policies discussed in Note 2 to ProLogis’ Consolidated Financial Statements in Item 8, those presented below have been identified by ProLogis as critical accounting policies.
Consolidation
ProLogis’ consolidated financial statements include the accounts of ProLogis and all entities that ProLogis controls, either through ownership of a majority voting interest, as the primary beneficiary, or otherwise. Investments in entities in which ProLogis does not own a majority voting interest but over which ProLogis does have the ability to exercise significant influence over operating and financial policies are presented under the equity method. Investments in entities in which ProLogis does not own a majority voting interest and over which ProLogis does not have the ability to exercise significant influence are carried at the lower of cost or fair value, as appropriate. Management’s judgments with respect to its level of influence or control of an entity and whether it is the primary beneficiary of a variable interest entity involve consideration of various factors including the form of ProLogis’ ownership interest, its representation on the entity’s board of directors, the size of its investment (including loans) and ProLogis’ ability to participate in policy making decisions. Management’s ability to correctly assess its influence or control over an entity affects the presentation of these investments in ProLogis’ Consolidated Financial Statements and, consequently, its financial position and specific items in its results of operations that are used by its shareholders, potential investors, industry analysts and lenders in their evaluation of ProLogis.
Impairment of Long-Lived Assets
ProLogis and its unconsolidated investees assess the carrying values of their respective long-lived assets whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable and, with respect to goodwill, at least annually applying a fair-value-based test. The determination of the fair values of long-lived assets, including goodwill, involves significant judgment. This judgment is based on management’s analysis and estimates of the future operating results and resulting cash flows of each long-
lived asset. Management’s ability to accurately predict future operating results and cash flows impacts the determination of fair value.
If there is a decline in the fair value of a long-lived asset combined with a history of the asset generating operating losses, ProLogis or its unconsolidated investees will be required to determine whether the operating losses associated with the asset will continue. Management’s assessment as to the nature of a decline in fair value is primarily based on estimates of future operating results, the resulting cash flows and ProLogis’ intent to either hold or dispose of the long-lived asset. If an investment is considered impaired, a write-down is recognized based on these analyses.
Revenue Recognition
ProLogis recognizes gains and losses from the contributions and sales of real estate assets, generally at the time the title is transferred and ProLogis has no future involvement as a direct owner of the real estate asset contributed or sold. In many of its transactions, an entity in which ProLogis has an ownership interest will acquire a real estate asset from ProLogis. Management makes judgments based on the specific terms of each transaction as to the amount of the total profit from the transaction that ProLogis can recognize given its continuing ownership interest and its level of future involvement with the investee that acquires the assets. Management’s ability to accurately assess the provisions of each transaction under the accounting guidelines for profit recognition could impact ProLogis’ financial position and specific items in its results of operations that are used by shareholders, potential investors, industry analysts and lenders in their evaluation of ProLogis.
Depreciation and Useful Lives of Real Estate Assets
ProLogis estimates the depreciable portion of its real estate assets and their related useful lives in order to record depreciation expense. Management’s ability to accurately estimate the depreciable portions of its real estate assets and their useful lives is critical to the determination of the appropriate amount of depreciation expense recorded and the carrying values of the underlying assets. Any change to the estimated depreciable lives of these assets would have an impact on the depreciation expense recognized by ProLogis.
Keystone Transaction
On May 3, 2004, ProLogis and affiliates of four investment funds managed by Eaton Vance Management (the “Fund Affiliates”) established five property funds (the “Acquiring Property Funds” and also referred to by ProLogis as ProLogis North American Properties Funds VI, VII, VIII, IX and X - see Note 5 to ProLogis’ Consolidated Financial Statements in Item 8). ProLogis has a 20% ownership interest in each of the Acquiring Property Funds with the remainder owned by the Fund Affiliates. Also on May 3, 2004, ProLogis and the Acquiring Property Funds entered into an agreement to acquire the outstanding equity of Keystone Property Trust (“Keystone”), a publicly traded REIT, and the operating units of Keystone Operating Partnership, L.P., a subsidiary of Keystone (the “Keystone Transaction”). Keystone owned and leased industrial distribution properties located in New Jersey, Pennsylvania, Indiana, Florida, South Carolina and Ohio. The acquisition of Keystone by ProLogis and the Acquiring Property Funds was approved by Keystone’s shareholders on July 30, 2004 and was closed on August 4, 2004. Prior to the closing of the Keystone Transaction, ProLogis contributed 21 operating properties aggregating 3.0 million square feet to the Acquiring Property Funds. Total proceeds from these contributions, which were completed on June 30, 2004, were $127.4 million. See Note 5 to ProLogis’ Consolidated Financial Statements in Item 8.
At closing, ProLogis and the Acquiring Property Funds paid $23.80 per Keystone common share outstanding and retired approximately $567 million of Keystone’s outstanding debt. On September 3, 2004, ProLogis and the Acquiring Property Funds paid a cash liquidation distribution of approximately $125 million, including accrued dividends, to the holders of the outstanding preferred shares of Keystone and Keystone was liquidated. Including these payments, assumed liabilities (including the issuance of limited partnership units to certain of Keystone’s limited partners) and estimated transaction costs, the total consideration for the Keystone Transaction was approximately $1.7 billion. ProLogis’ share of the total consideration was approximately $579 million, including its investment in the Acquiring Property Funds of approximately
$279 million and its direct acquisition of certain assets and direct assumption of certain liabilities aggregating on a net basis approximately $300 million.
ProLogis’ direct acquisition, completed through a limited partnership in which limited partnership units were issued, included:
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nine operating properties aggregating 2.3 million square feet, one 0.8 million square foot property under development, 14 acres of land and land option rights that were valued on a combined basis at approximately $145 million;
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ownership interests in two unconsolidated property funds (20% interest in each) that own on a combined basis 7.7 million square feet of operating properties that were valued at approximately $102 million (including the proportionate assumption of approximately $26 million of secured debt of the property funds);
•
ownership interests in two unconsolidated CDFS business joint ventures (50% interest in each); one entity owns a recently completed 0.8 million square foot operating property and one entity in the planning stage for the development of a 0.8 million square foot property that were valued on a combined basis at approximately $15 million (including the proportionate assumption of approximately $6 million of secured debt);
•
a preferred equity interest in an unconsolidated entity that owns office properties that was valued at approximately $21 million; and
•
certain other assets, net of certain other liabilities that were valued at approximately $7 million.
In addition to the net assets acquired through the limited partnership, ProLogis, through its wholly owned subsidiary ProLogis Logistics Services Incorporated (“ProLogis Logistics”), directly acquired an interest in a management company owned by Keystone. The management company has the contractual rights to earn fees for providing property management and other services to the unconsolidated entities directly acquired by ProLogis through the limited partnership. These contractual rights were valued at approximately $13 million, of which approximately $10 million is attributable to ProLogis’ ownership interest. The management company is a variable interest entity. Accordingly, ProLogis, as the primary beneficiary, presents the management company on a consolidated basis in its financial statements. The total value of the contractual rights is reflected as a part of other assets and the Acquiring Property Funds’ portion of these rights, approximately $3 million, is reflected as a minority interest liability.
ProLogis’ share of the total consideration of approximately $579 million was funded through:
•
the issuance of approximately 879,000 limited partnership units that are redeemable for cash or, at ProLogis’ election, into one share of Common Shares; valued at approximately $30 million;
•
the direct assumption of secured debt, valued at approximately $13 million;
•
the indirect assumption of secured debt of unconsolidated investees, valued at approximately $32 million; and
•
cash of approximately $504 million, including approximately $177 million that was funded on a short-term basis at closing pending the completion of long-term, secured financing arrangements by the Acquiring Property Funds.
In addition, both ProLogis and the Fund Affiliates advanced cash to the Acquiring Property Funds to meet their initial working capital and liquidity requirements, of which ProLogis’ share was approximately $6 million.
The allocation of the total consideration to the net assets acquired in the Keystone Transaction is based on a preliminary assessment and is subject to change as additional information becomes available.
The Acquiring Property Funds completed secured financing arrangements in the fourth quarter of 2004. The total proceeds from these financing arrangements of approximately $892 million were returned to the
Fund Affiliates (approximately $715 million) and ProLogis (approximately $177 million). On a combined basis, the financing arrangements have an average term of eight years and provide for an average annual interest rate of 5.48%.
Results of Operations
ProLogis’ net earnings attributable to Common Shares were $202.8 million in 2004, $212.4 million in 2003 and $216.2 million in 2002. Basic and diluted net earnings attributable to Common Shares were $1.11 and $1.08 per share, respectively, in 2004, $1.18 and $1.16 per share, respectively, in 2003 and $1.22 and $1.20 per share, respectively, in 2002.
Property Operations
In addition to its directly owned operating properties, ProLogis includes its investments in property funds that are presented under the equity method in its property operations segment. See Note 5 to ProLogis’ Consolidated Financial Statements in Item 8. ProLogis owned operating properties directly or had ownership interests in operating properties through its investments in property funds as follows as of the dates indicated (square feet in thousands):
(1)
ProLogis’ ownership interests in the property funds ranged from 11.5% to 50% at December 31, 2004.
See “Item 2. Properties - Properties” and “Item 2. Properties - Unconsolidated Investees.”
The net operating income of ProLogis’ property operations segment consists of: (i) rental income and rental expenses from the operating properties that are directly owned by ProLogis; (ii) income recognized by ProLogis under the equity method from its investments in the property funds; (iii) fees and other income earned by ProLogis for services performed on behalf of the property funds, primarily property management and asset management services; and (iv) interest earned on advances to the property funds, if any. The net earnings or losses generated by operating properties that were developed or acquired in the CDFS business segment are included in the property operations segment during the interim period from the date of completion or acquisition through the date the properties are contributed or sold. See “Item 1. “Business - ProLogis’ Operating Segments - Property Operations”, “Item 1. Business - ProLogis’ Operating Segments - CDFS Business” and Note 12 to ProLogis’ Consolidated Financial Statements in Item 8.
The amounts recognized under the equity method represent ProLogis’ proportionate share of the net earnings or loss of each property fund based on its ownership interest in the property fund. The net earnings or losses of the property funds includes the following income and expense items of the property funds, in addition to rental income and rental expenses: (i) interest income and interest expense; (ii) depreciation and amortization expenses; (iii) general and administrative expenses; (iv) income taxes; and (v) foreign currency exchange gains and losses, with respect to ProLogis European Properties Fund. See Notes 5 and 12 to ProLogis’ Consolidated Financial Statements in Item 8. ProLogis’ net operating income from the property operations segment was as follows for the periods indicated (in thousands of U.S. dollars).
(1)
Amounts do not include rental income and rental expenses associated with 20 properties that are presented as discontinued operations in ProLogis’ Consolidated Statements of Earnings in Item 8. The amounts are:
•
Rental income of $2,949,000 in 2004; $3,224,000 in 2003 and $2,627,000 in 2002, including rental expense recoveries of $0.2 million in 2004, $0.4 million in 2003 and $0.3 million in 2002.
•
Rental expenses of $777,000 in 2004; $1,061,000 in 2003 and $687,000 in 2002.
(2)
The number and composition of operating properties that are directly owned by ProLogis throughout the periods presented impact rental income for each period. Rental income includes net termination and renegotiation fees of $2.4 million in 2004, $4.5 million in 2003 and $14.6 million in 2002. In certain leasing situations, ProLogis finds it advantageous to negotiate lease terminations with a customer,
particularly when the customer is experiencing financial difficulties or when ProLogis believes that it can re-lease the space at rates that, when combined with the termination fee, provides a total return to ProLogis in excess of what was being earned under the original lease terms. ProLogis cannot predict the level of such fees that will be earned in the future or whether ProLogis will be successful in re-leasing, in a timely manner, the vacant space associated with the lease terminations.
Rental expense recoveries from customers, a component of rental income, were $101.0 million in 2004, $99.0 million in 2003 and $92.4 million in 2002.
Rental income, excluding termination and renegotiation fees and rental expense recoveries and including discontinued operations, was $444.0 million in 2004, $442.1 million in 2003 and, $434.9 million in 2002. In 2004, the average occupancy levels were higher than in 2003. In 2003, the average occupancy levels were lower than 2002 levels; however, the increase in the number of properties in the directly owned portfolio in 2003 was sufficient to mitigate this effect.
(3)
The number and composition of operating properties that are directly owned by ProLogis throughout the periods presented impacts rental expenses for each period. Rental expenses, including discontinued operations were $143.1 million in 2004, $136.9 million in 2003 and $125.3 million in 2002. Rental expenses are presented before any recoveries from customers, which are a component of rental income. Also, ProLogis reports the costs of managing the properties owned by property funds as part of rental expenses. When a property is contributed to a property fund, ProLogis begins reporting its share of the earnings of the property under the equity method along with fee income earned for services provided to the property funds, and no longer reports the operations of the property as part of its rental income and rental expenses. However, the overhead costs to provide the management services to the property fund continues to be reported as part of rental expenses.
Rental expenses as a percentage of rental income, before rental expense recoveries and termination and renegotiation fees and including discontinued operations, were 32.2% in 2004, 31.0% in 2003 and 28.8% in 2002. Total rental expense recoveries were 71.0%, 72.9% and 74.2% of total rental expenses in 2004, 2003 and 2002, respectively. These trends are the result of lower average occupancy levels that have been experienced over this three-year period and due to the inclusion of the property management expenses associated with a higher number of managed properties in rental expenses. Lower occupancy levels will result in certain fixed costs being borne directly by ProLogis in instances where customers are not occupying the space to which the expenses relate. Additionally, ProLogis will absorb a higher percentage of common area costs when occupancy levels are lower because there are fewer customers available from whom these costs can be recovered.
(4)
The income from property funds includes fees earned by ProLogis for providing services to the property funds of $50.8 million in 2004, $44.2 million in 2003 and $34.5 million in 2002. As part of the Keystone Transaction (see “- Keystone Transaction”), ProLogis began earning fees from ProLogis North American Properties Funds VI through XII in 2004. These fees aggregated $3.6 million.
(5)
ProLogis’ ownership interest in the property fund was the same for all periods presented and each of the property funds was in operation with substantially the same portfolio of properties for all periods presented. ProLogis’ ownership interests are: ProLogis California (50%); ProLogis North American Properties Fund I (41.3%); ProLogis North American Properties Fund II (20%); ProLogis North American Properties Fund III (20%) and ProLogis North American Properties Fund IV (20%). With respect to each property fund, fluctuations between years in the amount that ProLogis recognizes under the equity method are generally due to occupancy levels and the amount of termination and renegotiation fees earned by the property fund. Additionally, fees earned by ProLogis for providing services to the property fund for other than property management and asset management services can fluctuate from year to year. ProLogis’ share of the net earnings of ProLogis California for 2004 includes $0.7 million of net gains from property dispositions.
(6)
ProLogis North American Properties Fund V has continued to acquire properties (generally from ProLogis) and increase its portfolio size since its inception on March 28, 2002. ProLogis’ ownership interest in ProLogis North American Properties Fund V was 11.5% at December 31, 2004, 14.0% at
December 31, 2003 and 16.1% at December 31, 2002. ProLogis earned fees other than for property management, asset management and leasing of $1.5 million in 2004, $3.9 million in 2003 and $5.2 million in 2002. Excluding these fees, ProLogis recognized income from ProLogis North American Properties Fund V of $11.5 million, $8.6 million and $2.3 million for 2004, 2003 and 2002, respectively. These amounts correspond with the growth in the portfolio over the three years (119 properties, 28.3 million square feet at December 31, 2004; 90 properties, 20.7 million square feet at December 31, 2003; 57 properties, 12.0 million square feet at December 31, 2002).
(7)
ProLogis North American Properties Funds VI through X began operations on June 20, 2004 when ProLogis contributed 21 properties aggregating 3.0 million square feet to the five property funds. Upon completion of the Keystone Transaction, ProLogis North American Properties Funds VI through X collectively acquired an additional 22.5 million square feet of properties. ProLogis has a 20% ownership interest in each property fund. (see “ - Keystone Transaction).
(8)
ProLogis North American Properties Funds XI and XII were formed by Keystone. ProLogis acquired Keystone’s 20% ownership interest in each of these property funds as part of the Keystone Transaction. These property funds own a combined 26 properties aggregating 7.7 million square feet (see “- Keystone Transaction”).
(9)
ProLogis European Properties Fund has continued to acquire properties, generally from ProLogis, and increase its portfolio size since it began operations in 1999. ProLogis’ ownership interest in ProLogis European Properties Fund was 21.8% at December 31, 2004, 21.9% at December 31, 2003 and 29.6% at December 31, 2002.
Amounts presented for ProLogis European Properties Fund include ProLogis’ proportionate share of net foreign currency exchange gains and losses. These amounts were net losses of $0.4 million in 2004, $13.4 million in 2003 and $4.5 million in 2002. Excluding these net foreign currency exchange losses, ProLogis’ proportionate share of the net earnings of ProLogis European Properties Fund was $38.3 million, $43.6 million and $28.7 million for 2004, 2003 and 2002, respectively. The fluctuations in the income recognized by ProLogis from its ownership in this property fund, excluding net foreign currency exchange losses, are the result of the following factors; (i) the size of the portfolio and occupancy levels in each period; (ii) increases in the fees earned by ProLogis for services provided to the property fund due to the increase in the number of properties managed by ProLogis; (iii) higher interest costs associated with the higher debt levels that primarily result from the use of debt to acquire the additional properties; (iv) decreases in ProLogis’ ownership interest in each year and (v) variances in the average foreign currency exchange rate at which ProLogis translates its share of the net earnings of the ProLogis European Properties Fund to U.S. dollars.
(10)
ProLogis Japan Properties Fund portfolio has grown to 13 properties aggregating 3.9 million square feet at December 31, 2004 from five properties aggregating 1.6 million square feet at December 31, 2003 and from one 0.2 million square foot property at December 31, 2002. ProLogis’ ownership interest in ProLogis Japan Properties Fund has been 20% since its inception on September 24, 2002. The increases in the amounts recognized by ProLogis under the equity method from its ownership in this property fund correspond with the growth in the portfolio over the three years.
The stabilized operating properties owned by ProLogis and the property funds were 92.3% leased at December 31, 2004, 90.2% leased at December 31, 2003 and 91.2% leased at December 31, 2002. A property enters the stabilized pool at the earlier of 12 months from acquisition or completion or when it becomes substantially leased, which is defined by ProLogis generally as 93%. Therefore, ProLogis’ stabilized properties are generally those properties where the capital improvements, repositioning efforts, new management and new marketing programs for acquisitions or the marketing programs in the case of newly developed properties, have been completed and in effect for a sufficient period of time.
Changes in economic conditions will generally impact customer leasing decisions and absorption of new distribution properties. Weakening economic conditions in the United States and certain Western European countries and certain geopolitical concerns and uncertainties, primarily in Europe, negatively impacted ProLogis’ stabilized occupancy levels in the last half of 2002 and in 2003. ProLogis observed improvements in North American absorption and occupancy levels beginning in the second quarter of 2004. At that same time,
ProLogis began to experience improvements in leasing activity in Europe, primarily with respect to its existing pipeline of CDFS business assets that were included in the property operations segment prior to being contributed or sold. With respect to Japan, ProLogis has not observed similar negative trends in economic conditions and continues to experience consistent demand for distribution space in its properties. ProLogis expects that the overall economic improvements experienced in 2004 will continue in 2005.
ProLogis believes that the positive trends in occupancies in North America and Europe will continue in 2005. However, ProLogis does not believe that occupancies will improve to the levels experienced in the 1999 to 2001 period, when occupancies were as high as 96.5%. ProLogis continues to believe that shifts in distribution patterns of its customers throughout the world and their needs to reduce their distribution costs have been, and will continue to be, key drivers of leasing decisions. ProLogis believes that the diversification of its global operating platform and the ProLogis Operating System have somewhat mitigated the effects of market occupancy decreases.
Rental rates in 2004 for both new and renewed leases for previously leased space (49.5 million square feet) for all properties, including those owned by the property funds, decreased by 4.7% as compared to a rental rate decrease of 4.8% in 2003 and rental rate growth of 2.0% in 2002 on similar transactions. ProLogis believes that the negative rental rate growth experienced in 2004 continues to be the result of economic conditions that have depressed current market rents such that they are generally below the rents that ProLogis was earning on expiring leases. ProLogis believes that this trend in rental rates will continue, although at a decreasing rate, through mid-2005.
ProLogis’ management evaluates the operating performance of its property operations segment, its management personnel and individual markets 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. ProLogis includes properties owned directly and properties owned by its property funds in the same store analysis. Accordingly, ProLogis defines its same store portfolio of operating properties for each quarter as those properties that have been in operation throughout the full quarter in both the current year and the prior year. When a property is disposed of to a third party it will be removed from the population for the current quarter and the corresponding quarter of the prior year only. ProLogis’ same store portfolio ranged from 207.2 million square feet to 206.3 million square feet (ProLogis adjusts its same-store portfolio for dispositions on a quarterly basis). Net operating income generated by the same store portfolio, defined for the same store analysis as rental income, excluding termination and renegotiation fees, less rental expenses, increased by 0.15% for 2004 from 2003. For 2003, the net operating income of the same store portfolio applicable to that period increased by 0.09% over 2002. The same store portfolio’s rental rates decreased in 2004 by 5.8%. ProLogis believes that the factors that result in decreases in net operating income and decreases in rental rates in the same store portfolio are the same as for its total portfolio. The percentage change presented is the weighted average of the measure computed separately for ProLogis and each of the property funds with the weighting based on each entity’s proportionate share of the combined component on which the change is computed. In order to derive an appropriate measure of period-to-period operating performance, the percentage change computation removes the effects of foreign currency exchange rate movements by computing each property’s components in that property’s functional currency.
Rental income computed under GAAP applicable to the properties included in the same store portfolio is adjusted to remove the net termination and renegotiation fees recognized in each period. Net termination and renegotiation fees excluded from rental income for the same store portfolio (including properties directly owned and properties owned by the property funds) were $3.7 million for 2004 and $5.6 million for 2003. Net termination and renegotiation fees represent the gross fee negotiated to allow a customer to terminate or renegotiate their lease, offset by that customer’s rent leveling asset that has been previously recognized under GAAP, if any. Removing the net termination fees from the same store calculation of rental income allows ProLogis’ management to evaluate the growth or decline in each property’s rental income without regard to items that are not indicative of the property’s recurring operating performance. Customer terminations are negotiated under specific circumstances and are not subject to specific provisions or rights allowed under the lease agreements.
In computing the percentage change in rental expenses, the rental expenses applicable to the properties in the same store portfolio include property management expenses for ProLogis’ directly owned properties. These expenses are based on the property management fee that is provided for in the individual agreements under which ProLogis’ wholly owned management company provides property management services to each property (generally the fee is based on a percentage of revenues). On consolidation, the management fee income earned by the management company and the management fee expense recognized by the properties are eliminated and the direct costs of providing property management services are recognized as part of ProLogis’ rental expenses reported under GAAP.
CDFS Business
Net operating income from ProLogis’ CDFS business segment consists primarily of: (i) gains and losses resulting from the contributions and sales of developed properties and from the contributions of properties that were acquired with the intent to contribute the properties to a property fund, including properties that have been rehabilitated and/or repositioned; (ii) gains and losses from the dispositions of land parcels; (iii) development management fees earned by ProLogis for services provided to third parties; and (iv) land holding costs and pursuit cost write-offs associated with CDFS business assets.
Income from the CDFS business segment is dependent on ProLogis’ ability to develop and timely lease properties, or to acquire properties that eventually can be contributed to property funds or sold to third parties, generating profits to ProLogis, and ProLogis’ success in raising private capital that can be used to acquire its properties, generally accomplished through the formation of property funds, but also from other sources. For 2004, ProLogis’ net operating income in this segment increased from 2003 by $49.5 million (an increase of $82.3 million when the gains from dispositions of CDFS business properties that are presented as discontinued operations are included). The net operating income in 2004 includes a net gain of $4.7 million as a result of recognizing net contingent proceeds related to a 2003 contribution.
The increase in the gains recognized in 2004 from 2003 reflects higher gross margins, particularly associated with the 2004 transactions in the United Kingdom and Japan, a higher volume of transactions (based on cost) in 2004, including more sales of land parcels in 2004, and increases in the foreign currency exchange rates that were used to translate gains recognized in Europe and Japan to U.S. dollars in 2004. ProLogis attributes the volume of transactions in 2004 to improved leasing activity for CDFS business properties, mostly in Europe, but also in Asia, and also to its ability to raise private capital. ProLogis believes that the increase in leasing activity results from improvements in economic conditions that have positively impacted its customers’ decision-making processes with respect to changes in their distribution networks. There can be no assurance that ProLogis will be able to maintain or increase the current level of net operating income in this segment. ProLogis cannot predict the effects that economic conditions or other uncertainties, including geopolitical concerns, will have on its ability to lease its properties. If ProLogis is unable to timely lease its completed developments and repositioned acquisitions, it will be unable to contribute these properties to property funds or otherwise dispose of the properties and would be unable to recognize profits from its CDFS business activities in the anticipated reporting period. See “Item 1. ProLogis - ProLogis’ Operating Segments - CDFS Business - Future Plans,” “- Risk Factors - General Real Estate Risks - Risks Associated with the Contribution and Sale of Properties” and “- Risk Factors - Financing and Capital Risks - Access to Capital.”
The CDFS business segment’s net operating income includes the following components for the periods indicated (in thousands of U.S. dollars):
(1)
ProLogis began presenting its investment in ProLogis UK Holdings S.A., formerly Kingspark Holding S.A., (collectively with its subsidiaries “Kingspark S.A.”), a Luxembourg company that performs CDFS business activities in the United Kingdom, and its investment in Kingspark LLC, a holding company that held the voting ownership interests of Kingspark S.A., on a consolidated basis on July 1, 2002. These investments were previously presented under the equity method. The changes in the reporting methods applicable to these entities occurred when ProLogis acquired (directly or indirectly) 100% of the ownership interests (voting and non-voting) of Kingspark S.A. To allow for comparability between periods, ProLogis also presents the components of the CDFS business segment’s net operating income on a proforma basis as if Kingspark S.A. and Kingspark LLC were presented on a consolidated basis for all of 2002.
(2)
The net proceeds and costs of assets disposed of related to transactions for the following assets (proceeds in 2003 include $35.9 million generated by the significant reduction of investment in a CDFS joint venture):
•
2004: 180 acres; 17.2 million square feet;
•
2003: 208 acres; 14.2 million square feet; and
•
2002: 45 acres; 16.9 million (68 acres, 18.1 million square feet on a proforma basis).
Also in 2003, ProLogis included charges of $6.3 million in its cost of assets disposed of that related to properties that were previously contributed to property funds. These charges were primarily associated
with the settlement of customer balances and additional costs associated with the transfers of certain properties in Mexico.
(3)
A contribution to ProLogis Japan Properties Fund in 2003 provided for an additional $5.9 million of proceeds, the receipt of which was contingent on the satisfactory performance of certain activities by ProLogis. These activities were completed in 2004. The receipt of these proceeds resulted in the recognition of an additional gain in 2004 of $4.7 million, after deferral.
(4)
When ProLogis contributes a property to a property fund in which it has an ownership interest, ProLogis does not recognize a portion of the proceeds in its computation of the gain resulting from the contribution. The amount of the proceeds that cannot be recognized is determined based on ProLogis’ continuing ownership interest in the contributed property that arises due to ProLogis’ ownership interest in the property fund that acquires the property. ProLogis defers this portion of the proceeds by recognizing a reduction to its investment in the respective property fund. ProLogis adjusts its proportionate share of the earnings or loss that it recognizes under the equity method from the property fund in later periods to reflect the property fund’s depreciation expense as if the depreciation expense was computed on ProLogis’ lower basis in the contributed property rather than on the property fund’s basis in the contributed property. If a loss results when a property is contributed to a property fund, the entire loss is recognized.
When a property that ProLogis originally contributed to a property fund is disposed of to a third party by the property fund, ProLogis recognizes the net amount of the proceeds that it had previously deferred in results of operations in the period that the disposition to the third party occurs. Further, during periods when ProLogis’ ownership interest in a property fund decreases, ProLogis will recognize gains to the extent that previously deferred proceeds are recognized to coincide with ProLogis’ new ownership interest in the property fund. ProLogis’ ownership interests in ProLogis North American Properties Fund V and ProLogis European Properties Fund decreased from time to time. When this occurs, previously deferred proceeds are recognized as gains in the period the ownership decrease occurs. Of the total for 2004, $3.3 million related to an ownership decrease in ProLogis North American Properties Fund V from the partial disposition of ProLogis’ investment. Of the total for 2003, $25.9 million related to an ownership decrease in ProLogis European Properties Fund resulting from the partial redemption of ProLogis’ investment.
(5)
Represents the income that ProLogis recognizes under the equity method from the CDFS Joint Ventures. ProLogis’ ownership interest in each of the CDFS Joint Ventures is 50%. See Note 5 to ProLogis’ Consolidated Financial Statements in Item 8.
(6)
Includes land holding costs of $2.7 million, $2.9 million and $2.8 million in 2004, 2003 and 2002, respectively, and the write-off of previously capitalized pursuit costs related to potential CDFS business segment projects of $2.8 million, $1.9 million and $1.7 million in 2004, 2003 and 2002.
(7)
The income recognized by ProLogis under the equity method from its investments in Kingspark S.A. and Kingspark LLC for the six months in 2002 includes items that, when presented on a consolidated basis, would not be included in the CDFS business segment’s operating income. Such items include:
•
Net rental income of $1.7 million ;
•
General and administrative expenses of $1.6 million;
•
Interest income of $0.2 million;
•
Current income tax expense of $2.6 million;
•
Gross interest expense of $0.9 million and additional capitalized interest of $8.0 million;
•
Depreciation and amortization expense of $0.2 million; and
•
Net foreign currency exchange gains of $4.4 million.
(8)
Ten CDFS business properties aggregating 2.3 million square feet that were sold to third parties in 2004 met the criteria to be presented as discontinued operations in 2004. See Note 6 to ProLogis’ Consolidated Financial Statements in Item 8.
ProLogis continues to monitor leasing activity and general economic conditions as it pertains to its CDFS business segment. In the United States, ProLogis observed the early signs of economic recovery in 2004 and believes that continued improvement could provide increased CDFS business opportunities to ProLogis given its portfolio of properties available and under development. ProLogis acquired land for development in Toronto, Ontario and believes that this market along with its existing Mexico markets will provide opportunities within in the CDFS business segment in the future. In Europe, ProLogis believes that the continued demand for state-of-the-art distribution properties, improvement in economic conditions and lessening of geopolitical concerns resulted in its improved leasing activity in 2004. Such factors could continue to provide opportunities for ProLogis in the CDFS business segment. In Asia, as in Europe, ProLogis believes that demand for state-of-the-art distribution properties will continue to provide opportunities for ProLogis in the CDFS business segment. In Japan, the CDFS business opportunities available to ProLogis will be limited if ProLogis is unable to acquire adequate land parcels for development. In China, ProLogis is positioning itself to meet what it believes will be significant future demand for distribution space.
Other Components of Operating Income
General and Administrative Expenses
General and administrative expenses were $82.1 million in 2004, $65.9 million in 2003 and $53.9 million in 2002. Had ProLogis presented its investments in Kingspark S.A. and Kingspark LLC on a consolidated basis for all of 2002, ProLogis would have recognized total general and administrative expenses of $55.5 million for 2002. General and administrative expenses are primarily a function of the various business initiatives being undertaken in a given period. Increases in general administrative expenses in 2004 over 2003 and 2002 levels are the result of: (i) the international expansion of ProLogis’ operating platform; (ii) increases in share compensation expense (the value of share compensation awards is a function of the trading price of ProLogis’ Common Shares, which has increased from 2002 levels); and (iii) the average foreign currency exchange rate used to translate to U.S. dollars the general and administrative expenses recognized by ProLogis’ foreign subsidiaries prior to consolidation was significantly higher in 2004 as compared to 2003 and 2002.
For a discussion of the presentation of ProLogis’ investment in Kingspark S.A. and Kingspark LLC, see Notes 2 and 5 to ProLogis’ Consolidated Financial Statements in Item 8.
Relocation Expenses
ProLogis is relocating its information technology and corporate accounting functions from El Paso, Texas to Denver, Colorado and its Denver-based employees to a new corporate headquarters. The relocation from El Paso will be completed in the first quarter of 2005 and the relocation to the new corporate headquarters, which is located in Denver and is currently under development, is expected to be completed by the end of 2005.
For the year ended December 31, 2004, ProLogis recognized total relocation expenses of $6.8 million, including $2.6 million of employee termination benefits, $1.8 million of accelerated depreciation associated with non-real estate assets whose useful life has been shortened due to the relocation plans and $2.4 million of costs associated with the hiring and training of new personnel and other costs, including travel and temporary facility costs. ProLogis expects that the cost of its relocation activities to be expensed in 2005 will be between $6 million and $8 million.
Income (Losses) from Other Unconsolidated Investees, Net
ProLogis recognized its proportionate share of the net earnings or losses of each of its unconsolidated investees that are not included in one of its operating segments, including interest income, if any, as follows for the periods indicated (in thousands of U.S. dollars):
(1)
This investment is presented on a consolidated basis in 2004. CSI/ Frigo LLC is a limited liability company that owns 100% of the voting common stock of TCL Holding, representing 5% of its net earnings or losses. ProLogis owns 89% of the membership interests of this entity but recognizes 95% of its net earnings or losses through a participating note agreement. CSI/Frigo LLC and TCL Holding are presented on a consolidated basis in 2004. CSI/Frigo also had an ownership interest in ProLogis Logistics, representing 5% of its net earnings or losses. ProLogis acquired this interest on October 23, 2002. See Notes 2 and 5 to ProLogis’ Consolidated Financial Statements in Item 8.
(2)
This investment is presented on a consolidated basis in 2004. For 2003 and 2002, ProLogis’ effective ownership interest in TCL Holding was in excess of 99%, including its ownership in CSI/Frigo LLC. TCL Holding owns TCL Holding AB (formerly Frigoscandia Holding AB), a temperature-controlled distribution company that operates in Europe. During the years 2002 to 2003, TCL Holding and TCL Holding AB recognized net gains and losses from the dispositions of TCL Holding AB’s operations and operating assets in 10 countries. ProLogis’ proportionate share of the aggregate net gains from these asset dispositions was $0.5 million (a $5.2 million net gain in 2003 and a $4.7 million net loss in 2002). Also related to these dispositions, TCL Holding and TCL Holding AB recognized impairment charges associated with TCL Holdings’ investment in TCL Holding AB and the carrying value of TCL Holding AB’s property, plant and equipment. Through its investment in TCL Holding, ProLogis’ proportionate share of impairment charges recorded by TCL Holding and TCL Holding AB was $38.3 million in 2003 and $5.7 million in 2002. See Notes 2 and 5 to ProLogis’ Consolidated Financial Statements in Item 8.
(3)
TCL Holding has an investment in a temperature-controlled distribution company operating in Austria. While ProLogis’ investment in TCL Holding was presented under the equity method, this investment was not separately reported by ProLogis. See Note 5 to ProLogis’ Consolidated Financial Statements in Item 8.
(4)
ProLogis invested in ProLogis Logistics, which owns CS Integrated LLC (“CSI”), previously a temperature-controlled distribution company operating in the United States. Through October 2002, ProLogis effectively owned in excess of 99% of ProLogis Logistics. In October 2002, all of the operations and a significant portion of the assets of CSI were sold. ProLogis’ proportionate share of the aggregate net loss from this transaction was $88.2 million, consisting of cumulative impairment charges of $90.5 million recognized in 2002 ($37.2 million) and 2001 ($53.3 million) offset by a net gain of $2.3 million (a
$6.3 million net gain recognized upon closing the transaction in October 2002 and additional losses of $4.0 million recognized in 2004 and 2003 upon settlement of the prorations of CSI’s accounts as of the sale date). Subsequent to the October 2002 transaction, ProLogis’ ownership interests changed such that ProLogis owned 100% of ProLogis Logistics. Accordingly, ProLogis began consolidating its investment in ProLogis Logistics in October 2002. Certain assets that were retained by CSI after the sale (three operating properties and three tracts of land at December 31, 2004) are included with ProLogis’ real estate assets in its Consolidated Balance Sheet. See Notes 2 and 5 to ProLogis’ Consolidated Financial Statements in Item 8.
(5)
The assets of this investee were sold in 2002.
(6)
ProLogis had an indirect investment in a technology company that ceased operations in 2001. The amount recognized by ProLogis in 2002 represents ProLogis’ proportionate share of charges that this company recognized when it wrote down its remaining investments to zero.
Interest Expense
Interest expense is a function of the level of borrowings outstanding, interest rates charged on borrowings and the amount of interest capitalization that is calculated based on the volume of ProLogis’ development activities. Interest expense for the periods indicated includes the following components (in thousands of U.S. dollars):
(1)
Had ProLogis presented its investments in Kingspark S.A. and Kingspark LLC on a consolidated basis for all of 2002, ProLogis would have recognized interest expense before capitalization of $184.4 million for 2002. The change in gross interest expense in each year is primarily a function of ProLogis’ weighted average borrowings and weighted average interest rates, but is also impacted by the average foreign currency exchange rate used to translate to U.S. dollars the interest expense recognized by ProLogis’ foreign subsidiaries prior to consolidation.
(2)
Gross interest expense incurred on borrowings outstanding during the period is offset by the amount of interest that is capitalized based on ProLogis’ qualifying development expenditures. Had ProLogis presented its investments in Kingspark S.A. and Kingspark LLC on a consolidated basis for all of 2002, ProLogis’ capitalized interest would have been $38.5 million for 2002. Capitalized interest levels are reflective of ProLogis’ average cost of debt and the volume of development activities in each year.
(3)
Had ProLogis presented its investments in Kingspark S.A. and Kingspark LLC on a consolidated basis for all of 2002, ProLogis would have recognized net interest expense of $145.9 million for 2002.
For a discussion of the presentation of ProLogis’ investment in Kingspark S.A. and Kingspark LLC, see Notes 2 and 5 to ProLogis’ Consolidated Financial Statements in Item 8.
Gains Recognized on Dispositions of Non-CDFS Business Assets, Net
From time to time, ProLogis has contributed or sold properties that were held and used in the property operations segment. Certain sales to third parties will occur when a property is determined to have become non-strategic. Non-strategic properties are assets located in markets or submarkets that are no longer considered to be target markets or assets that were acquired as part of previous portfolio acquisitions that are
not consistent with ProLogis’ core portfolio based on the asset’s size or configuration. Also, ProLogis contributes properties to property funds that have been held for direct, long-term investment in the property operations segment to complement the portfolio of CDFS business properties that are contributed to the property funds. In 2004, such properties that were sold to third parties have been classified as discontinued operations. The net gains or losses recognized from contributions of properties that were held and used in the property operations segment to a property fund are included in income from continuing operations due to ProLogis’ continuing involvement with the properties. In 2003 and 2002, ProLogis did not classify any sales or contributions of properties that were held and used in the property operations segment as discontinued operations, as the effect of such reclassification would not have had a material effect on ProLogis’ consolidated financial statements. See “- Discontinued Operations.”
Contributions of long-term investment properties during 2004 and sales and contributions of long-term investment properties during the 2003 and 2002 were as follows:
•
2004: 0.4 million square feet of properties generating net proceeds of $17.5 million and an aggregate net gain of $6.1 million;
•
2003: 0.8 million square feet of properties generating net proceeds of $60.2 million and an aggregate net gain of $1.6 million; and
•
2002: 2.0 million square feet of properties generating net proceeds of $63.6 million of proceeds and an aggregate net gain of $6.6 million,
Included in the net gain recognized for 2003 is $1.1 million related to previous sales transactions. Adjustments to previously recognized gains or losses generally occur upon the settlement of contractual issues or due to changes in the original estimates of costs related to previous transactions.
Gains on Partial Dispositions of Investments in Property Funds
ProLogis recognized a gain of $3.3 million in the second quarter of 2004 resulting from its exchange of a portion of its investment in ProLogis-Macquarie Fund (referred to by ProLogis as ProLogis North American Properties Fund V) into units of MPR, the listed property trust in Australia that had an effective ownership interest in the ProLogis-Macquarie Fund of 86% at June 30, 2004. Upon receipt of the units in MPR, ProLogis sold them in the public market, generating net proceeds of $13.2 million.
In December 2003, ProLogis European Properties Fund disposed of 13 operating properties aggregating 2.1 million square feet in the United Kingdom to a third party. All of these properties were originally contributed to ProLogis European Properties Fund by ProLogis. Proceeds from these dispositions were used to redeem certain ownership interests in ProLogis European Properties Fund at the option of the unit holders. ProLogis redeemed 17.0 million units and recognized a gain on the partial redemption of its investment in ProLogis European Properties Fund of $74.7 million, including a foreign currency exchange gain of $47.9 million resulting from the repatriation of the cash redemption proceeds to the United States.
See Note 5 to ProLogis’ Consolidated Financial Statements in Item 8.
Foreign Currency Exchange Gains (Expenses/ Losses), Net
ProLogis recognized net foreign currency exchange gains of $14.7 million for 2004 and net foreign currency exchange expenses and losses of $10.6 million and $2.0 million for 2003 and 2002, respectively. Had ProLogis presented its investments in Kingspark S.A. and Kingspark LLC on a consolidated basis for all of 2002, ProLogis would have recognized a net foreign currency exchange gain of $2.4 million for 2002. For a discussion of the presentation of ProLogis’ investments in Kingspark S.A. and Kingspark LLC, see Notes 2 and 5 to ProLogis’ Consolidated Financial Statements in Item 8.
ProLogis and certain of its foreign consolidated subsidiaries have intercompany or third party debt that is not denominated in that entity’s functional currency. When the debt is remeasured against the functional currency of the entity, a gain or loss can result. To mitigate its foreign currency exchange exposure, ProLogis borrows in the functional currency of the borrowing entity when possible. Certain of ProLogis’ intercompany
debt are remeasured with the resulting adjustment recognized as a cumulative translation adjustment in accumulated other comprehensive income in shareholders’ equity. This treatment is applicable to intercompany debt that is deemed to be a permanent source of capital to the subsidiary or investee. Additionally, ProLogis utilizes derivative financial instruments to manage certain foreign currency exchange risks, primarily put option contracts with notional amounts corresponding to ProLogis’ projected net income from its operations in Europe and Japan. See Note 17 to ProLogis’ Consolidated Financial Statements in Item 8.
Generally, the amount of net foreign currency exchange gains or losses recognized in results of operations is a function of movements in exchange rates, the levels of intercompany and third party debt outstanding and the currency in which such debt is denominated as compared to the functional currency of the entities that are parties to the debt agreements. The net foreign currency exchange amounts recognized in ProLogis’ results of operations were as follows for the periods indicated (in thousands of U.S. dollars):
(1)
At the time certain debt balances are settled, remeasurement gains or losses that have been recognized in results of operations as unrealized are reversed and the cumulative foreign currency exchange gain or loss realized with respect to the settled balance is recognized in results of operations as a realized gain or loss in the period that the settlement occurs.
(2)
ProLogis enters into foreign currency put option contracts related to its operations in Europe and Japan. These put option contracts do not qualify for hedge accounting treatment. Accordingly, the cost of the contract is capitalized at the contract’s inception and is marked-to-market by ProLogis as of the end of each subsequent reporting period. Upon expiration of the contract, the mark-to-market adjustment is reversed, the total cost of the contract is expensed and any proceeds received are recognized as a gain. There were no outstanding contracts at December 31, 2004 although ProLogis did enter into new contracts in the first quarter of 2005. See Note 17 to ProLogis’ Consolidated Financial Statements in Item 8.
(3)
In 2003, ProLogis recognized a foreign currency exchange gain of $47.9 million as a result of the repatriation to the United States of the cash redemption proceeds that ProLogis received as a result of the partial redemption of its investment in ProLogis European Properties Fund. This gain is included with the total gains on partial dispositions of investments in property funds. See “- Gains on Partial Dispositions of Investments in Property Funds.”
Income Taxes
ProLogis has elected to be taxed as a REIT under the Code and is not generally required to pay federal income taxes if it meets the REIT requirements of the Code. ProLogis’ consolidated subsidiaries in the United States that are not qualified REIT subsidiaries for tax purposes are subject to federal income taxes, and ProLogis is taxed in certain states in which it operates. Also, the foreign countries where ProLogis has operations do not necessarily recognize REITs under their respective tax laws. Accordingly, ProLogis recognizes income taxes for these jurisdictions in accordance with GAAP, as necessary.
Current income tax expense was $24.9 million, $4.8 million and $10.5 million for 2004, 2003 and 2002, respectively. ProLogis recognized deferred income tax expense of $18.7 million, $10.6 million and $17.7 million for 2004, 2003 and 2002, respectively. Had ProLogis reported its investments in Kingspark S.A. and Kingspark LLC on a consolidated basis for all of 2002, current income tax expense would have been $13.1 million and deferred income tax expense would not have changed. For a discussion of the presentation of ProLogis’ investments in Kingspark S.A. and Kingspark LLC, see Notes 2 and 5 to ProLogis’ Consolidated Financial Statements in Item 8.
Current income tax expense is generally a function of the level of income recognized by ProLogis’ taxable subsidiaries operating in the CDFS business segment in addition to state income taxes and taxes incurred in foreign jurisdictions. During 2004, ProLogis disposed of a higher volume of properties to third parties that were located in the United Kingdom generating a higher level of net gains that are included in its taxable income in that country. The deferred income tax component of total income taxes is generally a function of the period’s temporary differences (items that are treated differently for tax purposes than for book purposes) and the utilization of tax net operating losses generated in prior years that had been previously recognized as deferred tax assets. Upon execution of certain indemnification agreements, ProLogis began recognizing deferred income tax liabilities associated with certain property contributions to ProLogis European Properties Fund (beginning in the third quarter of 2003) and ProLogis North American Properties Fund V (beginning in the second quarter of 2004). Under these indemnification agreements, ProLogis will continue to recognize deferred income tax liabilities related to its future contributions to ProLogis European Properties Fund and ProLogis North American Properties Fund V (contributions of properties located in Mexico only). Of the total deferred income tax expense recognized for 2004 and 2003, $15.0 million and $3.6 million, respectively, are related to the indemnification agreements. See Note 5 to ProLogis’ Consolidated Financial Statements in Item 8.
Discontinued Operations
Discontinued operations represent a component of an entity that has either been disposed of or is classified as held for sale if both the operations and cash flows of the component have been or will be eliminated from ongoing operations of the entity as a result of the disposal transaction and the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. The assets and liabilities of the component of the entity that has been classified as discontinued operations are presented separately in the balance sheet and the results of operations of the component of the entity that has been classified as discontinued operations are reported as discontinued operations in the statement of earnings. See Note 6 to ProLogis’ Consolidated Financial Statements in Item 8.
As of and for the year ended December 31, 2004, ProLogis has reported discontinued operations as follows:
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Assets held for sale: Certain of TCL Holding’s temperature-controlled distribution operations in France were classified as held for sale during 2003. However, because ProLogis’ investments in TCL Holding were presented under the equity method in 2003, ProLogis was not required to reflect the portion of the earnings of TCL Holding recognized under the equity method attributable to the French operations that are held for sale separately as discontinued operations. For 2004, TCL Holding is presented on a consolidated basis and all of its French operations are presented as discontinued operations. These operations generated a net loss of $36.7 million for 2004, including an impairment loss of $50.6 million.
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Assets disposed of in 2004: During 2004, ProLogis disposed of 20 properties to third parties that had not been developed under pre-sale agreements. ProLogis has reported the operations of these properties and the net gains or losses resulting from their dispositions as discontinued operations. Of the 20 properties, 10 were CDFS business properties whose dispositions generated an aggregate net gain of $32.7 million (see “- CDFS Business”) and 10 were properties held and used in the property operations segment whose dispositions generated an aggregate net gain of $3.5 million. The operations of these properties and the net gains from their dispositions have been presented as discontinued
operations in ProLogis’ Consolidated Statements of Earnings in Item 8 for 2004, 2003 and 2002. The net earnings attributable to these properties were $1.7 million, $1.5 million and $1.3 million for 2004, 2003 and 2002, respectively. A charge of $1.9 million representing an adjustment to the net gains previously recognized, primarily from the sale of TCL Holding’s operating assets in the United Kingdom in December 2003, is included in the net gain from dispositions of assets held and used in the property operations segment.
Excess of Redemption Values over Carrying Values of Preferred Shares Redeemed
ProLogis recognized charges to net earnings of $4.2 million in 2004 and $7.8 million in 2003, representing the excess of the redemption values over the carrying values of the remaining Series D Preferred Shares that were redeemed in January 2004 and in December 2003 and the Series E Preferred Shares that were redeemed in July 2003. After the 2004 redemption, all of ProLogis’ series of Preferred Shares that have met their optional redemption date have been redeemed. The next optional redemption date for a series of Preferred Shares is in 2008.
Environmental Matters
ProLogis has not been notified by any governmental authority of any non-compliance, liability or other claim in connection with any of the properties owned (directly or through investments in unconsolidated entities), or being acquired, as of December 31, 2004, and ProLogis is not aware of any environmental condition with respect to any of its properties that is likely to have material adverse effect on ProLogis’ business, financial condition or results of operations. See “- Risk Factors.”
Liquidity and Capital Resources
Overview
ProLogis considers its liquidity and its ability to generate cash from its operating activities, from the contributions and sales of properties and from its other available financing sources to be adequate and expects it to continue to be adequate to meet its anticipated future development, acquisition, operating and debt service needs, as well as its shareholder distribution requirements.
The Keystone Transaction was closed on August 4, 2004 (see “- Keystone Transaction”). ProLogis made a cash payment of approximately $510 million at closing, including ProLogis’ share of cash consideration and the funding of working capital and liquidity reserves of approximately $6 million. ProLogis’ lines of credit and a short-term borrowing agreement provided cash for this transaction. Of the total cash outlay, approximately $177 million was funded on a short-term basis which was returned to ProLogis as a result of the completion of approximately $892 million of long-term, secured financing arrangements by the Acquiring Property Funds in October and November 2004. Amounts returned to ProLogis were used to repay short-term borrowings and borrowings on ProLogis’ lines of credit.
ProLogis’ lines of credit provide liquidity and financial flexibility, thereby allowing ProLogis to efficiently respond to market opportunities and execute its business strategy. ProLogis anticipates that future repayments of its lines of credit borrowings will be funded primarily through the proceeds from future property contributions and sales and from the proceeds generated by future issuances of debt or equity securities, depending on market conditions. Such regular repayments of lines of credit borrowings are necessary to allow ProLogis to maintain adequate liquidity.
In addition to its Common Share distribution and Preferred Share dividend requirements, ProLogis expects that its primary cash needs will consist of the following for 2005 and future years:
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Acquisitions of land for future development;
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Development and acquisitions of properties in the CDFS business segment;
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Direct acquisitions of operating properties and/or portfolios of operating properties in key distribution markets for direct, long-term investment in the property operations segment; and
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Repayment of debt that is scheduled to mature.
While ProLogis has a Common Share repurchase program under which it may repurchase an additional $84.1 million of Common Shares at March 11, 2005, ProLogis did not repurchase any Common Shares in 2004 and does not currently expect that it will require cash for this program in 2005.
ProLogis expects to fund its cash needs for 2005 and future years primarily with cash from the following sources:
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Property operations;
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Proceeds from the disposition of the French operations of TCL Holding that are classified as held for sale;
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Proceeds from the contributions of properties to property funds (existing property funds and property funds that may be formed in the future);
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Proceeds from the sales of properties to third parties;
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Proceeds from the issuance of longer-term senior notes;
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Utilization of ProLogis’ lines of credit; and
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Proceeds from the sales of Common Shares, including sales of Common Shares under ProLogis’ various Common Share plans, and sales of Preferred Shares.
At March 11, 2005, ProLogis had $695.4 million of shelf-registered securities that can be issued in the form of senior notes, Preferred Shares, Common Shares, rights to purchase Common Shares and Preferred Share purchase rights on an as-needed basis, subject to ProLogis’ ability to affect an offering on satisfactory terms. ProLogis continues to evaluate the global public debt markets with the objective of reducing its shorter-term borrowings in favor of longer-term, fixed-rate debt, when it is deemed appropriate.
ProLogis is committed to offer to contribute all of its stabilized development properties available in specific markets in Europe to ProLogis European Properties Fund through September 2019 and all of its stabilized development properties available in Japan to ProLogis Japan Properties Fund through June 2006. These property funds are committed to acquire such properties, subject to the property fund meeting certain specified criteria, including leasing criteria, and having available capital. ProLogis believes that, while the current capital commitments and borrowing capacities of these property funds may be expended prior to the expiration dates of these commitments, each property fund does have sufficient capital to acquire the properties that ProLogis expects to have available during 2005.
ProLogis North American Properties Fund V has the right of first offer to all of ProLogis’ stabilized development properties that ProLogis desires to sell in North America (except those properties that are subject to an agreement with ProLogis California) through the end of 2005. Properties subject to the right of first offer must meet certain specified criteria, including leasing criteria. While ProLogis North American Properties Fund V’s majority owner is a listed property trust in Australia that is able to raise capital in the public market, there can be no assurance that ProLogis North American Properties Fund V will have the available capital to acquire additional properties from ProLogis in 2005 or, if capital is available, that ProLogis North American Properties Fund V will want to use its capital to acquire properties from ProLogis. Should ProLogis North American Properties Fund V choose not to acquire, or not have sufficient capital available to acquire, a property that meets the specified criteria, its rights under the agreement will terminate.
Should the property funds not have sufficient capital to acquire the properties that ProLogis has available or otherwise choose not to acquire properties from ProLogis, ProLogis is allowed to pursue other disposition opportunities. However, there can be no assurance that ProLogis can readily dispose of its CDFS business properties to third parties or that ProLogis could raise private capital through the formation of another property fund that would acquire the properties. Also, ProLogis could experience delays in completing
dispositions to third parties or to new property funds. Such delays could result in the recognition of the expected CDFS business income in a reporting period that is later than originally anticipated. See “- Risk Factors - General Real Estate Risks - Risks Associated with the Contribution and Sale of Properties”.
Cash Provided by Operating Activities
Net cash provided by operating activities was $481.3 million in 2004, $328.5 million in 2003 and $377.2 million in 2002. Operational items that impact net cash provided by operating activities are discussed in “- Results of Operations.” Additionally, cash provided by operating activities in 2004 is $152.8 million higher than in 2003, due in part to the change in working capital balances. Such changes are primarily a function of the timing of receipts and disbursements. Cash provided by operating activities exceeded the cash distributions paid on Common Shares in both periods.
Cash Investing and Cash Financing Activities
For 2004, 2003 and 2002, ProLogis’ investing activities used net cash of $612.5 million, $77.1 million and $94.6 million, respectively. The net cash used is summarized as follows:
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Investments in real estate (both acquisition and development expenditures), as well as recurring capital expenditures, tenant improvements and lease commissions on previously leased space required cash of $1.73 billion in 2004, $1.23 billion in 2003 and $1.16 billion in 2002.
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The Keystone Transaction during the third quarter of 2004 required a cash payment of $510.6 million, of which $177.1 million was returned to ProLogis after long-term debt arrangements were funded in the Acquiring Property Funds (see “- Keystone Transaction”).
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ProLogis’ unconsolidated investees generated net cash to ProLogis of $25.3 million, $73.3 million and $79.8 million for 2004, 2003 and 2002, respectively. Sales of operating assets in ProLogis’ temperature-controlled distribution companies were the primary source of the net cash provided by the unconsolidated investees in 2003 and 2002. The property funds make periodic cash distributions to ProLogis, generally on a monthly or quarterly basis.
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Net cash generated from contributions and sales of properties and land parcels were $1.41 billion, $835.2 million and $968.9 million in 2004, 2003 and 2002, respectively. In 2003, ProLogis received $35.9 million as the result of the discontinuation of its participation and significant reduction of its investment in one of the CDFS Joint Ventures.
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ProLogis also generated net proceeds of $13.2 million and $210.3 million from the partial dispositions of its investments in ProLogis North American Properties Fund V in 2004 and ProLogis European Properties Fund in 2003, respectively.
For 2004 and 2003, ProLogis’ financing activities provided net cash of $36.2 million. For 2003 and 2002, ProLogis’ financing activities used net cash of $30.8 million and $199.8 million. Excluding cash distributions on Common Shares and to minority interest holders and Preferred Share dividends paid in cash, ProLogis’ financing activities are summarized as follows:
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Generated net cash of $335.8 million in 2004 - Net borrowings on ProLogis’ lines of credit and short-term borrowing arrangements ($210.8 million), proceeds from the issuance of the Euro Notes ($420.6 million) and net proceeds from sales and issuances of Common Shares ($146.8 million) provided cash while the redemption of Preferred Shares ($125.0 million), principal payments on debt ($312.5 million), debt and equity issuance costs ($4.5 million) and purchases of derivative contracts ($0.4 million) used cash.
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Generated net cash of $268.0 million in 2003 - Proceeds from long-term debt issuances ($331.0 million), net proceeds from the sales of Preferred Shares ($241.8 million), net proceeds from sales and issuances of Common Shares ($42.3 million) and net proceeds on ProLogis’ lines of credit ($75.2 million) provided cash while repurchases of Common Shares ($9.7 million), the redemption of Preferred
Shares ($175.0 million), principal payments on debt ($224.8 million), debt and equity issuance costs ($10.4 million) and purchases of derivative contracts ($2.4 million) used cash.
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Generated net cash of $92.4 million in 2002 - Net proceeds from the sales and issuances of Common Shares ($146.7 million), net proceeds on ProLogis’ lines of credit ($97.0 million) and principal payments received on employee share purchase notes ($3.0 million) provided cash while repurchases of Common Shares ($95.5 million), principal payments on debt ($53.4 million), debt and equity issuance costs ($3.2 million) and purchases of derivative contracts, net of proceeds ($2.2 million) used cash.
Distributions paid to holders of Common Shares were $266.1 million, $258.2 million and $252.3 million for 2004, 2003 and 2002, respectively. Distributions paid to minority interest holders were $7.7 million, $9.3 million and $7.2 million for 2004, 2003 and 2002, respectively. Dividends paid on Preferred Shares were $25.7 million, $31.2 million and $32.7 million for 2004, 2003 and 2002, respectively.
Borrowing Capacities
ProLogis has over $1.8 billion of short-term borrowing capacity through six lines of credit under which ProLogis may borrow in four currencies. The lines of credit are summarized below for the periods indicated (dollar amounts in millions of U.S. dollars, as applicable):
(1)
Represents the weighted average interest rate on borrowings outstanding at December 31, 2004.
(2)
Borrowing capacity under the line of credit is fully committed.
(3)
The credit agreement may be extended for one year from this date at ProLogis’ option.
(4)
Borrowings can be denominated in U.S. dollar, euro, pound sterling and yen.
(5)
ProLogis’ maximum borrowing capacity at December 31, 2004 and March 11, 2005 is reduced by letters of credit outstanding of $7.2 million and $6.6 million, respectively.
(6)
Total committed borrowing capacity under the agreement is 450.0 million euro. At December 31, 2004, amounts outstanding represent the U.S. dollar equivalent of borrowings of 313.8 million euro and 50.5 million pound sterling. At March 11, 2005, amounts outstanding represent the U.S. dollar equivalent of borrowings of 332.5 million euro and 59.5 million pound sterling.
(7)
Borrowings are denominated in pound sterling with a maximum borrowing capacity of 25.0 million pound sterling. ProLogis’ maximum borrowing capacity at December 31, 2004 and March 11, 2005, is reduced by letters of credit outstanding of approximately $28.1 million (the currency equivalent of 14.5 million pound sterling at December 31, 2004) and approximately $28.0 million (the currency equivalent of 14.5 million pound sterling at March 11, 2005), respectively. Borrowings outstanding at March 11, 2005 bear interest at 6.47% per annum.
(8)
Borrowings are denominated in yen with a committed borrowing capacity of 65.0 billion yen (increased by 25.0 billion yen during 2004). At December 31, 2004 and March 11, 2005, amounts outstanding represent the U.S. dollar equivalent of borrowings of 41.3 billion yen and 51.7 billion yen, respectively.
In addition to the short-term borrowing capacity available through the six lines of credit, ProLogis had a short-term borrowing arrangement in the amount of 62.1 million Canadian dollars (the currency equivalent of approximately $51.3 million at December 31, 2004) through May 18, 2005. At December 31, 2004, ProLogis had borrowed 57.8 million Canadian dollars under the agreement (the currency equivalent of approximately $47.7 million at December 31, 2004) at an average annual interest rate of 3.27%.
Off-Balance Sheet Arrangements
Liquidity and Capital Resources of ProLogis’ Unconsolidated Investees
ProLogis had investments in and advances to unconsolidated investees of $908.5 million at December 31, 2004. Summarized financial information for certain of these unconsolidated investees at December 31, 2004 is presented below (in millions of U.S. dollars, as applicable). The information presented is for the entire entity, not ProLogis’ proportionate share of the entity.
(1)
Of the total third party debt, ProLogis has guaranteed $68.8 million of borrowings of ProLogis North American Properties Fund V, of which $29.4 million was repaid in February 2005. The remaining $39.4 million matures in April 2005. Also, see “- Contractual Obligations - Other Commitments.” ProLogis may in the future provide guarantees of short-term financing arrangements that property funds enter into associated with ProLogis’ contributions of properties to the property funds. ProLogis would provide these guarantees only with respect to short-term financing arrangements that the property funds enter into on an interim basis prior to finalizing long-term secured debt arrangements.
(2)
Third party debt of ProLogis California is due as follows:
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$17.3 million due May 2005, bearing interest at 8.67% per annum;
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$173.8 million due March 2009, bearing interest at 7.20% per annum;
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$91.3 million due August 2009, bearing interest at 7.63% per annum; and
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$52.0 million due August 2009, bearing interest at 4.64% per annum.
(3)
Third party debt of ProLogis North American Properties Fund I is due as follows:
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$130.5 million due December 2010, bearing interest at 7.65% per annum;
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$9.8 million due March 2011, bearing interest at 5.16% per annum; and
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$102.0 million due March 2011, bearing interest at 7.75% per annum.
(4)
Third party debt of ProLogis North American Properties Fund II is due in June 2007 and bears interest at 6.74% per annum.
(5)
Third party debt of ProLogis North American Properties Fund III is due as follows:
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$150.0 million due September 2007, bearing interest at 7.03% per annum and
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$0.3 million (four assessment bond issues) due on various dates between October 2013 and March 2021, bearing interest at a weighted average interest rate of 6.35% per annum.
(6)
Third party debt of ProLogis North American Properties Fund IV is due as follows:
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$103.0 million due January 2008, bearing interest at 6.65% per annum and
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$0.2 million (two assessment bond issues) due March 2021, bearing interest at 5.32% per annum.
(7)
Third party debt of ProLogis North American Properties Fund V is due as follows:
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$29.4 million which was repaid in February 2005, bearing interest at 3.22% per annum; this debt was guaranteed by ProLogis and was repaid with proceeds from a secured debt financing that is not guaranteed by ProLogis;
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$39.4 million due April 2005, bearing interest at 2.94% per annum; this debt is guaranteed by ProLogis (expected to be repaid with proceeds from a secured debt financing that will not be guaranteed by ProLogis);
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$15.7 million due December 2005, bearing interest at 5.50%;
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$173.0 million due July 2007, bearing interest at 5.96% per annum;
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$102.0 million due June 2008, bearing interest at 4.28% per annum;
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$62.0 million due January 2009, bearing interest at 4.23% per annum;
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$35.7 million due August 2009, bearing interest at 4.66% per annum;
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$10.3 million due August 2009, bearing interest at 4.66% per annum;
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$74.8 million due September 2010, bearing interest at 4.51% per annum; and
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$64.0 million due January 2013, bearing interest at 5.43% per annum.
(8)
Third party debt of ProLogis North American Properties Fund VI is due October 2012, bearing interest at 5.44% per annum.
(9)
Third party debt of ProLogis North American Properties Fund VII is due as follows:
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$14.3 million due January 2013, bearing interest at 6.29% per annum and
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$215.0 million due November 2012, bearing interest at 5.40% per annum.
(10)
Third party debt of ProLogis North American Properties Fund VIII is due November 2012, bearing interest at 5.29% per annum.
(11)
Third party debt of ProLogis North American Properties Fund IX is due September 2012, bearing interest at 5.72% per annum.
(12)
Third party debt of ProLogis North American Properties Fund X is due November 2012, bearing interest at 5.67% per annum.
(13)
Balance sheet amounts presented are 100% of the fair values of the assets and liabilities that were determined a part of the purchase accounting adjustments associated with the Keystone Transaction. See “- Keystone Transaction”.
(14)
Third party debt of ProLogis North American Properties Fund XI is due as follows:
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$15.5 million due June 2009, bearing interest at 4.99% per annum;
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$30.7 million due September 2010, bearing interest at 4.96% per annum; and
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$5.0 million due July 2013, bearing interest at 5.32% per annum.
(15)
Third party debt of ProLogis North American Properties Fund XII is due as follows:
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$64.4 million due April 2007, bearing interest at 4.20% per annum; and
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$15.6 million due March 2009, bearing interest at 4.55% per annum.
(16)
Third party debt of ProLogis European Properties Fund is due as follows:
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$538.7 million due December 2005, bearing interest at 2.98% per annum;
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$145.5 million (four mortgage issues) due March 2009, bearing interest at a weighted average of 3.55% per annum;
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$283.5 million due April 2008, bearing interest at 5.75% per annum;
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$191.0 million due April 2009, bearing interest at 5.69% per annum;
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$472.2 million due July 2009, bearing interest at 5.72% per annum;
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$252.8 million due May 2010, bearing interest at 4.61% per annum; and
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$37.0 million (eight mortgage issues) maturing between January 2008 and December 2014, bearing interest at a weighted average of 5.48% per annum.
(17)
Third party debt of ProLogis Japan Properties Fund is due as follows:
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$29.9 million due June 2010, bearing interest at 1.04% per annum;
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$18.3 million due October 2010, bearing interest at 1.94% per annum;
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$46.3 million due December 2010, bearing interest at 1.63% per annum;
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$35.7 million due March 2011, bearing interest at 1.53% per annum;
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$27.0 million due March 2011, bearing interest at 1.59% per annum;
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$60.8 million due July 2011, bearing interest at 1.93% per annum;
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$15.4 million due September 2011, bearing interest at 1.50% per annum;
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$9.6 million due September 2011, bearing interest at 1.65% per annum;
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$7.7 million due September 2011, bearing interest at 1.84% per annum;
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$23.2 million due November 2011, bearing interest at 1.57% per annum;
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$15.4 million due January 2013, bearing interest at 1.75% per annum;
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$9.7 million due January 2013, bearing interest at 1.80% per annum; and
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$28.0 million due January 2014, bearing interest at 1.90% per annum.
Contractual Obligations
Long-Term Contractual Obligations
ProLogis had long-term contractual obligations at December 31, 2004 related to long-term debt (senior unsecured notes, secured debt and assessment bonds), unfunded commitments on development projects, an unfunded commitment to a property fund and amounts due on revolving lines of credit as follows (in millions of U.S. dollars):
(1)
ProLogis had properties under development at December 31, 2004 with a total expected cost at completion of $1.08 billion. ProLogis has entered into contracts for certain phases of the construction of these projects. However, these contracts do not generally cover all of the costs that are necessary to place the property into service, including the costs of tenant improvements and marketing and leasing costs. The unfunded commitments presented include all such costs, not only those costs that ProLogis is obligated to fund under construction contracts.
(2)
At December 31, 2004, ProLogis was committed to make additional equity contributions to ProLogis European Properties Fund of 135.4 million euro (the currency equivalent of approximately $179.6 million at December 31, 2004) through September 15, 2009. For purposes of this presentation, the total commitment is included in the earliest time period as there is no schedule for when the commitment will be funded.
(3)
For purposes of this presentation the expiration dates of the credit agreements that provide ProLogis with six lines of credit include extension periods that are at the option of ProLogis. See “- Borrowing Capacities.”
Distribution and Dividend Requirements
ProLogis’ Common Share distribution policy is to distribute a percentage of its cash flow that ensures that ProLogis will meet the distribution requirements of the Code and that allows ProLogis to maximize the cash retained to meet other cash needs such as capital improvements and other investment activities. Because depreciation is a non-cash expense, cash flow typically will be greater than operating income and net earnings.
Cash distributions per Common Share paid in 2004, 2003 and 2002 were $1.46, $1.44 and $1.42, respectively. The Board set a projected annual distribution rate for 2005 of $1.48 per Common Share. ProLogis paid a distribution for the first quarter of 2005 of $0.37 per Common Share on February 28, 2005 to holders of Common Shares at February 15, 2005. The payment of Common Share distributions is subject to the discretion of the Board, is dependent on ProLogis’ financial condition and operating results and may be adjusted at the discretion of the Board during the year. ProLogis has increased its Common Share distribution level every year since its Common Shares became publicly traded in 1994.
At December 31, 2004, ProLogis had three series of Preferred Shares outstanding. The annual dividend rates on ProLogis’ Preferred Shares are $4.27 per Series C Preferred Share, $1.69 per Series F Preferred Share and $1.69 per Series G Preferred Share.
Pursuant to the terms of its Preferred Shares, ProLogis is restricted from declaring or paying any distribution with respect to its Common Shares unless and until all cumulative dividends with respect to the Preferred Shares have been paid and sufficient funds have been set aside for dividends that have been declared for the then current dividend period with respect to the Preferred Shares.
Other Commitments
At December 31, 2004, ProLogis had letters of intent or contingent contracts, subject to ProLogis’ final due diligence, for the acquisition of properties aggregating 4.2 million square feet at an estimated total acquisition cost of $194.8 million. Through March 11, 2005, ProLogis completed the acquisition of one of these properties, a 0.4 million square foot property at a total acquisition cost of $12.3 million. The remaining transactions are subject to a number of conditions and ProLogis cannot predict with certainty that they will be consummated.
Under a Common Share repurchase program that began in January 2001, ProLogis may repurchase up to $215.0 million of Common Shares. The Common Shares that have been repurchased to date were purchased in the open market and in privately negotiated transactions, depending on market prices and other conditions. Future repurchases, if any, are expected to be through similar transactions. ProLogis has repurchased 5,571,100 Common Shares under this program at a total cost of $130.9 million, although no repurchases have occurred in 2004 or for the period from January 1, 2005 to March 11, 2005. ProLogis does not currently expect that it will make significant Common Share repurchases during the remainder of 2005.
ProLogis, from time to time, enters into Special Limited Contribution Agreements (“SLCA”) in connection with certain of its contributions of properties to certain of its property funds. Under the SLCAs, ProLogis is obligated to make an additional capital contribution to the respective property fund under certain circumstances, the occurrence of which ProLogis believes to be remote. Specifically, ProLogis would be required to make an additional capital contribution if the property fund’s third-party lender, whose loans to the property fund are generally secured by the property fund’s assets and are non-recourse, does not receive a specified minimum level of debt repayment. However, the proceeds received by the third-party lender from the exhaustion of all of the assets of the property fund combined with the debt repayments received directly from the property fund will reduce ProLogis’ obligations under the SLCA on a dollar-for-dollar basis. ProLogis’ potential obligations under the respective SLCAs, as a percentage of the assets in the property funds, range from 2% to 28%. Accordingly, the value of the assets of the respective property funds would have to decline by between 98% and 72% before ProLogis would be required to make an additional capital contribution. ProLogis believes that the likelihood of declines in the values of the assets that support the third-party loans of the magnitude necessary to require an additional capital contribution is remote, especially in light of the geographically diversified portfolios of properties owned by the property funds. Accordingly, these potential obligations have not been recognized as a liability by ProLogis at December 31, 2004 and ProLogis has assessed a nominal value to the guarantee undertaken through the SLCAs. The potential obligations under the SLCAs aggregate $407.4 million at December 31, 2004 and the combined book value of the assets in the property funds, before depreciation, that are subject to the provisions of the SLCAs was approximately $6.5 billion at December 31, 2004.
Derivative Financial Instruments
ProLogis uses derivative financial instruments as hedges to manage well-defined risk associated with interest and foreign currency exchange rate fluctuations on existing or anticipated obligations and transactions. ProLogis does not use derivative financial instruments for trading or speculative purposes.
The primary risks associated with derivative instruments are market risk and credit risk. Market risk is defined as the potential for loss in the value of the derivative due to adverse changes in market prices (interest rates or foreign currency exchange rates). The use of derivative financial instruments allows ProLogis to manage the risks of increases in interest rates and fluctuations in foreign currency exchange rates with respect to the effects these fluctuations would have on ProLogis’ income and cash flows.
Credit risk is the risk that one of the parties to a derivative contract fails to perform or meet their financial obligation under the contract. ProLogis does not obtain collateral to support financial instruments subject to credit risk but monitors the credit standing of counterparties, primarily global commercial banks. ProLogis does not anticipate non-performance by any of the counterparties to its derivative contracts. However, should a counterparty fail to perform, ProLogis would incur a financial loss to the extent there exists a positive fair market value attributable to ProLogis’ derivative positions.
At December 31, 2004, ProLogis had outstanding a forward-starting interest rate swap contract in the notional amount of $50.0 million related to an anticipated transaction. The contract, which is designated as a cash flow hedge, allows ProLogis to fix the interest rate associated with a portion of a debt instrument forecasted to be issued in 2005 for a four-year period. The interest rate swap contract qualifies for hedge accounting treatment. ProLogis recognized a mark-to-market adjustment representing a net decrease in the value of this contract of $1.1 million in other comprehensive income in shareholders’ equity at December 31, 2004.
Funds from Operations
Funds from operations is a financial measure that is commonly used in the real estate industry. Although NAREIT has published a definition of funds from operations, modifications to the NAREIT calculation of funds from operations are common among REITs, as companies seek to provide performance measures that meaningfully reflect their business. Funds from operations, as defined by ProLogis, is presented as a supplemental performance measure. Funds from operations is not used by ProLogis as, nor should it be considered to be, an alternative to net earnings computed under GAAP as an indicator of ProLogis’ operating performance or as an alternative to cash from operating activities computed under GAAP as an indicator of ProLogis’ ability to fund its cash needs.
Funds from operations is not meant to represent a comprehensive system of financial reporting and does not present, nor does ProLogis intend it to present, a complete picture of its financial condition and operating performance. ProLogis believes that net earnings computed under GAAP remains the primary measure of performance and that funds from operations is only meaningful when it is used in conjunction with net earnings. Further, ProLogis believes that its consolidated financial statements, prepared in accordance with GAAP, provide the most meaningful picture of its financial condition and its operating performance.
NAREIT’s funds from operations measure adjusts net earnings computed under GAAP to exclude historical cost depreciation and gains and losses from the sales of previously depreciated properties. ProLogis agrees that these two NAREIT adjustments are useful to investors for the following reasons:
(a) historical cost accounting for real estate assets in accordance with GAAP assumes, through depreciation charges, that the value of real estate assets diminishes predictably over time. NAREIT stated in its White Paper on Funds from Operations “since real estate asset values have historically risen or fallen with market conditions, many industry investors have considered presentations of operating results for real estate companies that use historical cost accounting to be insufficient by themselves.” Consequently, NAREIT’s definition of funds from operations reflects the fact that real estate, as an asset class, generally appreciates over time and depreciation charges required by GAAP do not reflect the underlying economic realities.
(b) REITs were created as a legal form of organization in order to encourage public ownership of real estate as an asset class through investment in firms that were in the business of long-term ownership and management of real estate. The exclusion, in NAREIT’s definition of funds from operations, of gains and losses from the sales of previously depreciated operating real estate assets allows investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT’s activity and assists in comparing those operating results between periods.
At the same time that NAREIT created and defined its funds from operations concept for the REIT 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.” ProLogis
believes that financial analysts, potential investors and shareholders who review its operating results are best served by a defined funds from operations measure that includes other adjustments to net earnings computed under GAAP in addition to those included in the NAREIT defined measure of funds from operations.
The ProLogis defined funds from operations measure excludes the following items from net earnings computed under GAAP that are not excluded in the NAREIT defined funds from operations measure: (i) deferred income tax benefits and deferred income tax expenses recognized by ProLogis’ taxable subsidiaries; (ii) certain foreign currency exchange gains and losses resulting from certain debt transactions between ProLogis and its foreign consolidated subsidiaries and its foreign unconsolidated investees; (iii) foreign currency exchange gains and losses from the remeasurement (based on current foreign currency exchange rates) of certain third party debt of ProLogis’ foreign consolidated subsidiaries and its foreign unconsolidated investees; and (iv) mark-to-market adjustments associated with derivative financial instruments utilized to manage ProLogis’ foreign currency risks. Funds from operations of ProLogis’ unconsolidated investees is calculated on the same basis as ProLogis.
The items that ProLogis excludes from net earnings, while not infrequent or unusual, are subject to significant fluctuations from period to period that cause both positive and negative effects on ProLogis’ results of operations, in inconsistent and unpredictable directions. Most importantly, the economics underlying the items that ProLogis excludes from net earnings are not the primary drivers in management’s decision-making process and capital investment decisions. Period to period fluctuations in these items can be driven by accounting for short-term factors that are not relevant to long-term investment decisions, long-term capital structures or to long-term tax planning and tax structuring decisions. Accordingly, ProLogis believes that investors are best served if the information that is made available to them allows them to align their analysis and evaluation of ProLogis’ operating results along the same lines that ProLogis’ management uses in planning and executing its business strategy.
Real estate is a capital-intensive business. Investors’ analyses of the performance of real estate companies tend to be centered on understanding the asset value created by real estate investment decisions and understanding current operating returns that are being generated by those same investment decisions. The adjustments to net earnings that are included in arriving at the ProLogis defined funds from operations measure are helpful to management in making real estate investment decisions and evaluating its current operating performance. ProLogis believes that these adjustments are also helpful to industry analysts, potential investors and shareholders in their understanding and evaluation of ProLogis’ performance on the key measures of net asset value and current operating returns generated on real estate investments.
Funds from operations attributable to Common Shares as defined by ProLogis was $400.4 million, $400.7 million and $393.0 million for the years ended December 31, 2004, 2003 and 2002, respectively. The reconciliations of funds from operations attributable to Common Shares as defined by ProLogis to net earnings attributable to Common Shares computed under GAAP are as follows for the periods indicated (in thousands of U.S. dollars):
Risk Factors
ProLogis’ operations involve various risks that could adversely affect ProLogis’ financial condition, results of operations, distributable cash flow and the value of ProLogis’ Common Shares. These risks include, among others:
General Real Estate Risks
General Economic Conditions
ProLogis is exposed to the general economic conditions and the local, regional, national and international economic conditions that affect the markets in which it owns properties. ProLogis’ operating performance is further impacted by the economic conditions of the specific markets in which it has concentrations of properties. ProLogis does not have in excess of 10% of its directly owned portfolio in any one market, nor does it have in excess of 10% of its total portfolio (including properties owned by the property funds) in any one market. However, ProLogis does have significant holdings in Atlanta, Chicago, Dallas/Ft. Worth, Houston, Los Angeles, New Jersey, Paris, San Francisco and certain other markets in France and the United Kingdom. ProLogis’ operating performance could be adversely affected if conditions in the markets with concentrations of properties, such as an oversupply of distribution space or a reduction in demand for distribution space, become less favorable. Any material oversupply of distribution space or material reduction of demand for distribution space could adversely affect ProLogis’ results of operations, distributable cash flow and the value of ProLogis’ Common Shares.
Risks Particular To Real Estate
Real property investments are subject to varying degrees of risk. While ProLogis seeks to minimize these risks through geographic diversification of its portfolio, market research and its property management capabilities, these risks cannot be eliminated. The factors that can affect real estate values include:
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changes in the general economic climate;
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local conditions, such as an oversupply of distribution space or a reduction in demand for distribution space in an area;
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the attractiveness of ProLogis’ properties to potential customers;
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competition from other available properties;
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ProLogis’ ability to provide adequate maintenance of, and insurance on, its properties;
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ProLogis’ ability to control variable operating costs;
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governmental regulations, including zoning, usage and tax laws and changes in these laws; and
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potential liability under, and changes in, environmental, zoning and other laws.
Risks Associated with Concentration of ProLogis’ Investments in the Industrial Sector
ProLogis’ investments in real estate assets are concentrated in the industrial distribution sector. This concentration may expose ProLogis to the risk of economic downturns in this sector to a greater extent than if ProLogis’ business activities included other types of real estate investments.
Risks Associated with ProLogis’ Development Activities
ProLogis has developed a significant number of distribution properties since its inception and intends to continue to pursue development activities as opportunities arise. Such development activities generally require
various government and other approvals and ProLogis may not receive such approvals. ProLogis will be subject to risks associated with such development activities including, but not limited to:
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the risk that development opportunities explored by ProLogis may be abandoned and that the related investment will be written off;
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the risk that construction costs of a property may exceed the original estimates or that construction may not be concluded on schedule could make the project less profitable than originally estimated; specific risks include, but are not limited to, the possibility of contract default, the effects of local weather conditions, the possibility of local or national strikes and the possibility of shortages in materials, building supplies or energy and fuel for equipment; and
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the risk that occupancy levels and the rents that can be charged for a completed project will not make the project as profitable as originally estimated.
Risks Associated with the Contribution and Sale of Properties
ProLogis has contributed to property funds, or sold to third parties a significant number of distribution properties in recent years. ProLogis intends to continue to contribute and sell properties as opportunities arise, particularly from its CDFS business segment. ProLogis’ ability to contribute or sell properties on advantageous terms is dependent upon several factors, some of which are beyond the control of ProLogis’ management, primarily competition from other owners of distribution properties that are trying to dispose of their properties. ProLogis’ ability to develop and timely lease properties will impact ProLogis’ ability to contribute or sell these properties. Continued access to private debt and equity capital by the property funds is necessary in order for ProLogis to continue its strategy of contributing properties to the property funds. Should ProLogis not have sufficient properties available that meet the investment criteria of current or future property funds, or should the property funds have limited or no access to capital on favorable terms, then these contributions could be delayed resulting in adverse effects on ProLogis’ liquidity and on its ability to meet projected earnings levels in a particular reporting period. Failure to meet its projected earnings levels in a particular reporting period could have an adverse effect on ProLogis’ results of operations, distributable cash flow and on the value of ProLogis’ Common Shares. Further, ProLogis’ inability to redeploy the proceeds from its divestitures in accordance with its investment strategy could have an adverse effect on ProLogis’ results of operations, distributable cash flow and the value of its Common Shares in subsequent periods.
Risks Associated with Acquisition of Properties
ProLogis acquires distribution properties from time to time. The acquisition of properties involves risks, including the risk that the acquired property will not perform as anticipated and the risk that any actual costs for rehabilitation, repositioning, renovation and improvements identified in the pre-acquisition due diligence process will exceed estimates. There is, and it is expected that there will continue to be, significant competition for investment opportunities that meet ProLogis’ investment criteria as well as risks associated with obtaining financing for acquisition activities, if necessary.
Tenant Default
ProLogis’ results of operations, distributable cash flow and the value of its Common Shares would be adversely affected if a significant number of ProLogis’ tenants are unable to meet their lease obligations to ProLogis. In the event of default by a significant number of tenants, ProLogis may experience delays and incur substantial costs in enforcing its rights as landlord.
Ability to Renew Leases or Re-lease Space as Leases Expire
ProLogis’ results of operations, distributable cash flow and the value of its Common Shares would be adversely affected if ProLogis is unable to lease, on economically favorable terms, a significant amount of space in its distribution properties. ProLogis had 6.1 million square feet of distribution space with leases that either expired on December 31, 2004 or were on a month-to-month basis at that date and ProLogis has
23.8 million square feet of distribution space (out of a total of 113.5 million occupied square feet of distribution space) with leases that expire in 2005 in its directly owned properties. The property funds had a combined 1.7 million square feet of distribution space with leases that either expired on December 31, 2004 or were on a month-to-month basis at that date and the property funds have a combined 15.4 million square feet of distribution space (out of a total of 140.5 million occupied square feet of distribution space) with leases that expire in 2005. The number of distribution properties in a market or submarket could adversely affect both ProLogis’ ability to re-lease distribution space and the rental rates that can be obtained in new leases. For the past two years, ProLogis’ rental rates on new or renewed leases of previously leased distribution space have declined.
Real Estate Investments Are Not As Liquid As Certain Other Types Of Assets
Real estate investments are not as liquid as other types of investments and this lack of liquidity may limit ProLogis’ ability to react promptly to changes in economic or other conditions. In addition, significant expenditures associated with real estate investments, such as mortgage payments, real estate taxes and maintenance costs, are generally not reduced when circumstances cause a reduction in income from the investments. Like other companies qualifying as REITs under the Code, ProLogis must comply with the safe harbor rules relating to the number of properties that can be disposed of in a year, the tax bases and the costs of improvements made to these properties, and meet other tests which enable a REIT to avoid punitive taxation on the sale of assets. Thus, ProLogis’ ability at any time to sell assets, or contribute assets to property funds or other entities in which ProLogis has an ownership interest may be restricted.
ProLogis’ Insurance Coverage Does Not Include All Potential Losses
ProLogis and its unconsolidated investees currently carry comprehensive insurance coverage including property, liability, fire, flood, earthquake, environmental, terrorism, extended coverage and rental loss as appropriate for the markets where each of their properties and their business operations are located. The insurance coverage contains policy specifications and insured limits customarily carried for similar properties, business activities and markets. ProLogis believes its properties and the properties of its unconsolidated investees are adequately insured. However, there are certain losses, including losses from floods, earthquakes, acts of war, acts of terrorism or riots, that are not generally insured against or that are not generally fully insured against because it is not deemed to be economically feasible or prudent to do so. If an uninsured loss or a loss in excess of insured limits occurs with respect to one or more of ProLogis’ properties, ProLogis could experience a significant loss of capital invested and potential revenues in these properties and could potentially remain obligated under any recourse debt associated with the property.
Potential Environmental Liability
Under various federal, state and local laws, ordinances and regulations, a current or previous owner, developer or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances at, on, under or in its property. The costs of removal or remediation of such substances could be substantial. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release or presence of such hazardous substances. ProLogis conducts Phase I environmental assessments as part of its due diligence activities. ProLogis has not been notified nor is ProLogis aware of any environmental condition with respect to its real estate assets that are likely to be material to ProLogis’ financial condition. However, ProLogis cannot give any assurance that such conditions do not exist or may not arise in the future. The presence of such substances on ProLogis’ real estate investments could adversely affect its ability to sell such investments or to borrow using such investments as collateral and may also have an adverse effect on ProLogis’ distributable cash flow.
Financing and Capital Risks
Access to Capital
ProLogis, as a REIT, is required to distribute at least 90% of its taxable income to its shareholders. Consequently, ProLogis is, as are all REITs, largely dependent on external capital to fund its development and acquisition activities. ProLogis has been accessing private debt and equity capital through the establishment of property funds that acquire properties from ProLogis. ProLogis’ ability to access private debt and equity capital through its property funds on favorable terms, or at all, is dependent upon a number of factors, including general market conditions and competition from other real estate companies. Further, ProLogis generates significant profits as a result of the contributions of properties to the property funds. To the extent that private capital is not available to the property funds to allow them to acquire properties from ProLogis, these profits may not be realized or their realization may be delayed which could result in an earnings stream that is less predictable than some of ProLogis’ competitors and result in ProLogis not meeting its projected earnings levels in a particular reporting period. Failure to meet its projected earnings levels in a particular reporting period could have an adverse effect on the value of Common Shares.
ProLogis is committed to offer to contribute all of its stabilized development properties available in specific markets in Europe to ProLogis European Properties Fund through September 2019 and all of its stabilized development properties available in Japan to ProLogis Japan Properties Fund through June 2006. These property funds are committed to acquire such properties, subject to the property meeting certain specified criteria, including leasing criteria, and having available capital. ProLogis believes that, while the current capital commitments and borrowing capacities of these property funds may be expended prior to the expiration dates of these commitments, each property fund does have sufficient capital to acquire the properties that ProLogis expects to have available during 2005.
ProLogis North American Properties Fund V has the right of first offer to all of ProLogis’ stabilized development properties that ProLogis desires to sell in North America (except those properties that are subject to an agreement with ProLogis California) through the end of 2005. Properties subject to the right of first offer must meet certain specified criteria, including leasing criteria. While ProLogis North American Properties Fund V’s majority owner is a listed property trust in Australia that is able to raise capital in the public market, there can be no assurance that ProLogis North American Properties Fund V will have the available capital to acquire additional properties from ProLogis in 2005 or, if capital is available, that ProLogis North American Properties Fund V will want to use its capital to acquire properties from ProLogis. Should ProLogis North American Properties Fund V choose not to acquire, or not have sufficient capital available to acquire, a property that meets the specified criteria, its rights under the agreement will terminate.
ProLogis’ ability to contribute or sell its development pipeline and recognize profits from its development activities will be jeopardized and ProLogis’ ability to meet its projected earnings levels and generate distributable cash flow would be adversely affected should the existing equity commitments not be available (due to investor default or otherwise) such that these property funds cannot acquire the properties that ProLogis expects to have available for contribution. This impact would occur in the short-term and would continue until ProLogis is able to sell the properties to third parties or until ProLogis could secure another source of private equity capital to form a new property fund.
Debt Financing
ProLogis is subject to risks normally associated with debt financing, including the risk that ProLogis’ cash flow will be insufficient to meet required payments of principal and interest. There can be no assurance that ProLogis will be able to refinance any maturing indebtedness, that such refinancing would be on terms as favorable as the terms of the maturing indebtedness, or otherwise obtain funds by selling assets or raising equity to make required payments on maturing indebtedness.
ProLogis utilizes the short-term borrowing capabilities (over $1.83 billion as of December 31, 2004) provided by six credit agreements that provide lines of credit to ProLogis in addition to operating cash flow and proceeds from dispositions to fund its development, acquisition and distribution requirements. ProLogis’ six
lines of credits expire through 2007 ($208 million of borrowing capacity expires during 2005, $997 million of borrowing capacity expires during 2006 and $627 million of borrowing capacity expires during 2007). These expiration dates are based on available extension periods if such extentions are at ProLogis’ option. ProLogis’ ability to refinance these credit agreements in a timely manner and at favorable terms is dependent on several factors including, but not limited to, general economic conditions, ProLogis’ credit ratings and interest rate levels. ProLogis’ short-term credit agreements bear interest at variable rates. Increases in interest rates would increase ProLogis’ interest expense under these agreements. If ProLogis is unable to refinance its indebtedness at maturity or meet its payment obligations, the amount of ProLogis’ distributable cash flow would be adversely affected.
Requirements of Credit Agreements
The terms of ProLogis’ various credit agreements and other indebtedness require ProLogis to comply with a number of customary financial and other covenants, such as maintaining debt service coverage and leverage ratios and maintaining insurance coverage. These covenants may limit ProLogis’ flexibility in its operations, and breaches of these covenants could result in defaults under the instruments governing the applicable indebtedness even if ProLogis has satisfied its payment obligations. If ProLogis is unable to refinance its indebtedness at maturity or meet its payment obligations, the amount of ProLogis’ distributable cash flow would be adversely affected.
Federal Income Tax Risks
Failure to Qualify as a REIT Could Adversely Affect Shareholders
ProLogis elected to be taxed as a REIT under the Code commencing with its taxable year ended December 31, 1993. To maintain REIT status, ProLogis must meet a number of highly technical requirements on a continuing basis. Those requirements seek to ensure, among other things, that the gross income and investments of a REIT are largely real estate related, that a REIT distributes substantially all its ordinary taxable income to shareholders on a current basis and that the REIT’s equity ownership is not overly concentrated. Due to the complex nature of these rules, the available guidance concerning interpretation of the rules, the importance of ongoing factual determinations and the possibility of adverse changes in the law, administrative interpretations of the law and changes in ProLogis’ business, no assurance can be given that ProLogis will qualify as a REIT for any particular year.
If ProLogis fails to qualify as a REIT, it will be taxed as a regular corporation, and distributions to shareholders will not be deductible in computing ProLogis’ taxable income. The resulting corporate income tax liabilities could materially reduce the distributable cash flow to ProLogis’ shareholders and funds available for reinvestment. Moreover, ProLogis might not be able to elect to be treated as a REIT for the four taxable years after the year during which ProLogis ceased to qualify as a REIT. In addition, if ProLogis later requalified as a REIT, it might be required to pay a full corporate-level tax on any unrealized gains in its assets as of the date of requalification and to make distributions to shareholders equal to any earnings accumulated during the period of non-REIT status. In the absence of REIT status, distributions to shareholders would no longer be required.
Potential Adverse Effect of REIT Distribution Requirements
To maintain its qualification as a REIT under the Code, ProLogis must annually distribute to its shareholders at least 90% of its REIT taxable income, excluding the dividends paid deduction and its net capital gains. This requirement limits ProLogis’ ability to accumulate capital. ProLogis may not have sufficient cash or other liquid assets to meet the distribution requirements. Difficulties in meeting the distribution requirements might arise due to competing demands for ProLogis’ funds or to timing differences between tax reporting and cash receipts and disbursements, because income may have to be reported before cash is received, because expenses may have to be paid before a deduction is allowed or because deductions may be disallowed or limited, or the Internal Revenue Service may make a determination that adjusts reported income. In those situations, ProLogis might be required to borrow funds or sell properties on adverse terms in
order to meet the distribution requirements and interest and penalties could apply. If ProLogis fails to make a required distribution, it would cease to be taxed as a REIT.
Prohibited Transaction Income Could Result From Certain Property Transfers
ProLogis contributes properties to property funds and sells properties to third parties, including contributions and sales of properties from ProLogis’ taxable subsidiaries. Under the Code, a disposition of a property from other than a taxable subsidiary could be deemed to be a prohibited transaction. In such case, a 100% penalty tax on the resulting gain could be assessed. The determination that a transaction constitutes a prohibited transaction is based on the facts and circumstances surrounding each transaction. The Internal Revenue Service could contend that certain contributions or sales of properties by ProLogis are prohibited transactions. While ProLogis’ management does not believe that the Internal Revenue Service would prevail in such a dispute, if the Internal Revenue Service successfully argued the matter, the 100% penalty tax could be assessed against the gains from these transactions. Additionally, any gain from a prohibited transaction may adversely affect ProLogis’ ability to satisfy the income tests for qualification as a REIT.
Other Risks
ProLogis is Dependent on Key Personnel
ProLogis’ executive officers and other senior officers have a significant role in ProLogis’ success. The ability of ProLogis to retain its management group or to attract suitable replacements should any members of the management group leave ProLogis is dependent on the competitive nature of the employment market. The loss of services from key members of the management group or a limitation in their availability could adversely impact ProLogis’ financial condition and cash flow. Further, such a loss could be negatively perceived in the capital markets.
Share Prices May Be Affected By Market Interest Rates
The annual distribution rate on Common Shares as a percentage of its market price may influence the trading price of such Common Shares. An increase in market interest rates may lead investors to demand a higher annual distribution rate than ProLogis has set, which could adversely affect the value of ProLogis’ Common Shares.
Foreign Currency Risk
ProLogis has pursued and intends to continue to pursue growth opportunities in international markets and often invests in countries where the U.S. dollar is not the national currency. As a result, ProLogis is subject to foreign currency risk due to potential fluctuations in exchange rates between foreign currencies and the U.S. dollar. For example, a significant depreciation in the value of the foreign currency of one or more countries where ProLogis has a significant investment may materially adversely affect ProLogis’ results of operations and the value of its Common Shares. ProLogis attempts to mitigate any such effects by borrowing under debt agreements denominated in foreign currencies and by entering into derivative contracts, although there can be no assurance that such attempts will be successful in neutralizing all foreign currency risks.
Government Regulations and Actions
There are many laws and governmental regulations that are applicable to ProLogis, its unconsolidated investees and their properties. Changes in these laws and governmental regulations, or their interpretation by agencies or the courts, could occur. Further, economic and political factors, including civil unrest, governmental changes and restrictions on the ability to transfer capital across borders in the United States, but primarily in the foreign countries in which ProLogis has invested, can have a major impact on a global company such as ProLogis.
ITEM 7A.
ITEM 7A.
Quantitative and Qualitative Disclosure About Market Risk
ProLogis is exposed to market risk from changes in interest rates and foreign currency exchange rates. ProLogis has used certain derivative financial instruments, primarily foreign currency put option contracts, to reduce its foreign currency market risk. To a lesser extent, ProLogis has used interest rate swap agreements to reduce its interest rate market risk. ProLogis does not use financial instruments for trading or speculative purposes and all financial instruments are entered into in accordance with polices that have been approved by the Board.
ProLogis has estimated its market risk exposures using a sensitivity analysis. ProLogis has defined its market risk exposure as: (i) the potential loss in future earnings and cash flows due to interest rate exposure and (ii) the future loss in future earnings with respect to foreign currency exchange exposure. ProLogis’ sensitivity analysis estimates the exposure to market risk sensitive instruments assuming a hypothetical 10% adverse change in year end interest rates and foreign currency exchange rates. The results of the sensitivity analysis are summarized below. The sensitivity analysis is of limited predictive value. As a result, ProLogis’ ultimate realized gains or losses with respect to interest rate and foreign currency exchange rate fluctuations will depend on the exposures that arise during a future period, hedging strategies at the time, and the prevailing interest and foreign currency exchange rates.
Interest Rate Risk
ProLogis’ interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows. To achieve this objective, ProLogis borrows on a fixed rate basis for longer-term debt issuances. In anticipation of a financing expected to occur in 2005, ProLogis has a forward-starting interest rate swap contract outstanding that is designated as a cash flow hedge to fix the interest rate on a portion of the expected financing. If the expected financing occurs in the projected time frame, any increase in interest rates would be offset by the positive value of the contract and any decrease in interest rates would be offset by the negative value of the contract, in each case for the hedged amount of the expected financing. If the expected financing did not occur and the contracts were unwound, based on the results of the sensitivity analysis, which assumed a 10% adverse change in interest rates, the estimated market risk exposure for the forward-starting interest rate swap contracts would be approximately $0.8 million for both future earnings and cash flows for the year ended December 31, 2004.
ProLogis’ primary interest rate risk is created by its variable rate lines of credit. During the year ended December 31, 2004, ProLogis had weighted average daily outstanding borrowings of $930.0 million on its variable rate lines of credit. Based on the results of the sensitivity analysis, which assumed a 10% adverse change in interest rates, the estimated market risk exposure for ProLogis’ variable rate lines of credit was approximately $1.9 million for both future earnings and cash flows for the year ended December 31, 2004. The sensitivity analysis was based on the weighted average outstanding variable rate borrowings for 2004 and assumed a flat yield curve for the year. Although ProLogis has no derivative contracts as hedges of its variable rate revolving lines of credit, ProLogis may in the future fix existing variable rate borrowings to manage its interest rate exposure.
Foreign Currency Risk
ProLogis incurs foreign currency exchange risk related to third-party and intercompany debt of its foreign consolidated subsidiaries and its foreign unconsolidated investees that are not denominated in the functional currency of the subsidiary or investee. The remeasurement of certain of this debt results in the recognition of foreign currency exchange gains or losses by ProLogis. ProLogis’ primary exposure to foreign currency exchange rates exists with the following currencies versus the U.S. dollar: euro, pound sterling and yen. Based on the results of a sensitivity analysis, which assumed a 10% adverse change in foreign currency exchange rates, the estimated market risk exposure to future earnings associated with this debt was $68.1 million at December 31, 2004.
ProLogis primarily uses foreign currency put option contracts to manage foreign currency exchange rate risk associated with the projected net operating income (operating income net of foreign denominated interest
expense) of its foreign consolidated subsidiaries and unconsolidated investees. However, at December 31, 2004, ProLogis did not have any foreign currency put option contracts outstanding.
ProLogis translates to U.S. dollars the income and expenses of its consolidated foreign subsidiaries and its proportionate share of the net earnings or losses of its unconsolidated investees recognized under the equity method. ProLogis hedges the foreign currency exchange risk associated with approximately 50% to 75% of the forecasted net operating income from its foreign consolidated subsidiaries and unconsolidated investees through foreign currency put option contracts. The effect of the change in foreign currency exchange rates on translated income and expenses of ProLogis’ foreign consolidated subsidiaries and unconsolidated investees has a high degree of inverse correlation with the derivative instruments used to hedge it, when rates go above the option strike rate (when rates are below or are expected to be below, there is no offset). Since ProLogis hedges approximately 50% to 75% of its projected net operating income from its foreign subsidiaries and investees for foreign currency rate fluctuations above the option strike rate, approximately 25% to 50% of the impact to the net earnings of its foreign subsidiaries and investees of an adverse movement in foreign exchange rates would not be offset by derivative instruments.
Fair Value of Financial Instruments
The following estimates of the fair value of financial instruments have been determined by ProLogis using available market information and valuation methodologies believed 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 ProLogis would realize upon disposition.
At December 31, 2004 and 2003, the carrying amounts of certain financial instruments employed by ProLogis, including cash and cash equivalents, accounts and notes receivable, accounts payable and accrued expenses and construction costs payable were representative of their fair values due to the short-term maturity of these instruments. Similarly, the carrying values of the lines of credit and short-term borrowings balances outstanding approximate their fair values as of those dates since the interest rates on the lines of credit and short-term borrowings are based on current market rates. At December 31, 2004 and 2003, the fair values of ProLogis’ senior notes, secured debt (including mortgage notes and securitized debt) and assessment bonds have been estimated based upon quoted market prices for the same or similar issues or by discounting the future cash flows using rates currently available for debt with similar terms and maturities. The differences in the fair values of ProLogis’ senior notes, secured debt and assessment bonds from the carrying values in the table below are the result of differences in the interest rates available to ProLogis at December 31, 2004 and 2003 from the interest rates that were in effect when the debt was issued. The senior notes and many of the secured debt issues contain pre- payment penalties or yield maintenance provisions that could make the cost of refinancing the debt at the lower rates exceed the benefit that would be derived from doing so.
At December 31, 2004 and 2003, the fair values of ProLogis’ derivative financial instruments are the amounts at which they could be settled, based on quoted market prices or estimates obtained from brokers or dealers. As ProLogis marks its derivative financial instruments to market, their fair values are the same as their carrying values. The carry value of the foreign currency forward contract is included as other liabilities and the carrying values of the foreign currency put option contracts and the interest rate swap contracts are included as other assets in ProLogis’ Consolidated Balance Sheet.
The following table reflects the carrying amounts and estimated fair values of ProLogis’ financial instruments as of the periods indicated (in thousands of U.S. dollars):
ITEM 8.
ITEM 8.
Financial Statements and Supplementary Data
ProLogis’ Consolidated Balance Sheets as of December 31, 2004 and 2003, its Consolidated Statements of Earnings, Shareholders’ Equity and Comprehensive Income and Cash Flows for each of the years in the three-year period ended December 31, 2004, Notes to Consolidated Financial Statements and Schedule III - Real Estate and Accumulated Depreciation, together with the reports of KPMG LLP, Independent Registered Public Accounting Firm, are included under Item 15 of this report and are incorporated herein by reference. Selected quarterly financial data is presented in Note 14 of the Notes to Consolidated Financial Statements.
ITEM 9.
ITEM 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
ITEM 9A.
ITEM 9A.
Controls and Procedures
An evaluation was carried out under the supervision and with the participation of ProLogis’ management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934). Based on this evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that ProLogis’ disclosure controls and procedures are effective as of December 31, 2004 to ensure that information required to be disclosed by ProLogis in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to December 31, 2004, there were no significant changes in ProLogis’ internal controls or in other factors that could significantly affect these controls, including any corrective actions with regard to significant deficiencies and material weaknesses.
Management’s Report on Internal Control over Financial Reporting
Management of ProLogis is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934.
Under the supervision and with the participation of ProLogis management, including ProLogis’ Chief Executive Officer and Chief Financial Officer, an evaluation of the effectiveness of ProLogis’ internal control over financial reporting was conducted as of December 31, 2004 based on the criteria described in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on this assessment, management determined that, as of December 31, 2004, ProLogis’ internal control over financial reporting was effective.
On August 4, 2004, ProLogis and certain equity method investees acquired Keystone Property Trust. Consistent with published guidance of the Securities and Exchange Commission, management excluded from its assessment of the effectiveness of ProLogis’ internal control over financial reporting as of December 31, 2004, Keystone’s internal control over financial reporting. Total assets and total revenues from the Keystone acquisition that are consolidated represent 3.8% and 0.5% respectively of the related consolidated financial statement amounts of ProLogis and subsidiaries as of and for the year ended December 31, 2004.
KPMG LLP, an independent registered public accounting firm, who audited and reported on the consolidated financial statements of ProLogis, has issued an attestation report on management’s assessment of internal control over financial reporting which is included in Item 8.
Limitations of the Effectiveness of Controls
Management’s assessment included an evaluation of the design of ProLogis’ internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. ProLogis’ internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
ITEM 9B.
ITEM 9B. Other Information
Not applicable.
PART III
ITEM 10.
ITEM 10.
Directors and Executive Officers of the Registrant
Trustees and Officers
For information regarding ProLogis’ Trustees and officers, see “Item 1. Business - ProLogis Management - Trustees” and “Item 1. Business - ProLogis Management - Senior Officers.” The other information required by this item is incorporated herein by reference to the description under the captions “Election of Trustees” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the 2005 Proxy Statement.
ITEM 11.
ITEM 11.
Executive Compensation
The information required by this item is incorporated herein by reference to the description under the captions “Executive Compensation,” “Compensation Committee Report on Executive Compensation,” “Trustee Compensation” and “Outside Trustee Plan” in the 2005 Proxy Statement.
ITEM 12.
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is incorporated herein by reference to the description under the caption “Information Relating to Trustees, Nominees and Executive Officers” in the 2005 Proxy Statement.
ITEM 13.
ITEM 13.
Certain Relationships and Related Transactions
The information required by this item is incorporated herein by reference to the description under the caption “Certain Relationships and Transactions” in the 2005 Proxy Statement.
ITEM 14.
ITEM 14.
Principal Accounting Fees and Services
The information required by this item is incorporated herein by reference to the description under the caption “Independent Registered Public Accounting Firm” in the 2005 Proxy Statement.
PART IV
ITEM 15.
ITEM 15.
Exhibits, Financial Statement Schedules
The following documents are filed as a part of this report:
(a) Financial Statements and Schedules:
1. Financial Statements:
See Index to Consolidated Financial Statements and Schedule III on page 90 of this report, which is incorporated herein by reference.
2. Financial Statement Schedules:
Schedule III - Real Estate and Accumulated Depreciation
All other schedules have been omitted since the required information is presented in the consolidated financial statements and the related notes or is not applicable.
(b) Exhibits: The Exhibits required by Item 601 of Regulation S-K are listed in the Index to Exhibits on pages 191 to 194 of this report, which is incorporated herein by reference.
(c) Financial Statements: See Index to Consolidated Financial Statements and Schedule III on page 90 of this report which is incorporated by reference.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE III
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Trustees and Shareholders
ProLogis:
We have audited the accompanying consolidated balance sheets of ProLogis and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of ProLogis’ management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ProLogis and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of ProLogis’ internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
KPMG LLP
Los Angeles, California
March 14, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Trustees and Shareholders
ProLogis:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that ProLogis maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). ProLogis’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of ProLogis’ internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that ProLogis maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, ProLogis maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
On August 4, 2004, ProLogis and certain equity method investees acquired Keystone Property Trust. Consistent with published guidance of the Securities and Exchange Commission, management excluded from its assessment of the effectiveness of ProLogis’ internal control over financial reporting as of December 31, 2004, Keystone’s internal control over financial reporting. Total assets and total revenues from the Keystone acquisition that are consolidated represent 3.8% and 0.5%, respectively, of the related consolidated financial statement amounts of ProLogis and subsidiaries as of and for the year ended December 31, 2004. Our audit of internal control over financial reporting of ProLogis also excluded an evaluation of the internal control over financial reporting of Keystone.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of ProLogis and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 14, 2005 expressed an unqualified opinion on those consolidated financial statements.
KPMG LLP
Los Angeles, California
March 14, 2005
PROLOGIS
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
PROLOGIS
CONSOLIDATED STATEMENTS OF EARNINGS
Years Ended December 31, 2004, 2003 and 2002
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
PROLOGIS
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
Years Ended December 31, 2004, 2003 and 2002
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
PROLOGIS
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2004, 2003 and 2002
(In thousands)
See Note 13 for information on non-cash investing and financing activities.
The accompanying notes are an integral part of these consolidated financial statements.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
1. Description of Business:
ProLogis (collectively with its consolidated subsidiaries and partnerships “ProLogis”) is a publicly held real estate investment trust (“REIT”) that owns (directly or through unconsolidated investees), operates and develops industrial distribution properties in North America, Europe and Asia. ProLogis’ business consists of two reportable business segments: property operations and the corporate distribution facilities services business (“CDFS business”). The property operations segment represents the long-term ownership, management and leasing of industrial distribution properties. The CDFS business segment primarily encompasses ProLogis’ development of industrial distribution properties that are either contributed to an unconsolidated property fund in which ProLogis has an ownership interest and acts as manager, or sold to third parties. Additionally, ProLogis will acquire industrial distribution properties that are generally rehabilitated and/or repositioned in the CDFS business segment prior to being contributed to a property fund. See Note 12.
2. Summary of Significant Accounting Policies:
Basis of Presentation and Consolidation
ProLogis and its subsidiaries are included in the accompanying consolidated financial statements and are presented in ProLogis’ functional currency, the U.S. dollar. All entities that ProLogis controls, either through ownership of a majority voting interest, as the primary beneficiary, or otherwise, are consolidated. All material intercompany transactions with consolidated entities have been eliminated.
ProLogis began presenting its investment in ProLogis UK Holdings S.A., formerly Kingspark Holding S.A., (collectively with its subsidiaries “Kingspark S.A.”), a Luxembourg company that performs CDFS business activities in the United Kingdom, and its investment in Kingspark LLC, a holding company that held the voting ownership interests of Kingspark S.A., on a consolidated basis on July 1, 2002. ProLogis began presenting its investment in ProLogis Logistics Services Incorporated (“ProLogis Logistics”), which owns CS Integrated LLC (“CSI”), on a consolidated basis on October 24, 2002. CSI previously operated as a temperature-controlled distribution company in the United States. These investments were previously presented under the equity method. The changes in the reporting methods applicable to these entities occurred when ProLogis acquired (directly or indirectly) 100% of the ownership interests (voting and non-voting) of Kingspark S.A. and ProLogis Logistics.
The Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities”, in January 2003 and revised it in December 2003. ProLogis adopted the revised Interpretation No. 46 (“FIN 46R”) as of January 1, 2004. FIN 46R clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, and requires that variable interest entities in which ProLogis is the primary beneficiary be presented on a consolidated basis in its financial statements. As a result of adopting FIN 46R on January 1, 2004, ProLogis began consolidating its investments in TCL Holding S.A. (“TCL Holding”), formerly Frigoscandia Holding S.A., and CSI/ Frigo LLC, a company that holds the voting ownership interest in TCL Holding. Through December 31, 2003, ProLogis presented its investments in TCL Holding and CSI/ Frigo LLC under the equity method. ProLogis’ combined effective ownership in these entities was 99.75% at December 31, 2004. The adoption of FIN 46R did not change the presentation of any of ProLogis’ other unconsolidated investments, as these investees are not variable interest entities and ProLogis will continue to present these investments under the equity method. See Note 5. However, an entity in which ProLogis acquired an ownership interest during 2004 is a variable interest entity of which ProLogis is the primary beneficiary. Based on the provisions of FIN 46R, ProLogis has presented this entity on a consolidated basis. See Notes 3 and 8.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Use of Estimates
The accompanying consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of income and expenses during the reporting period. Although these estimates and assumptions are based on current expectations, actual results could differ from those estimates and assumptions.
Reclassifications
Certain amounts included in ProLogis’ consolidated financial statements for prior years have been reclassified to conform to the 2004 financial statement presentation.
REIT Organization Status
ProLogis was formed as a Maryland business trust in January 1993 and has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). Under the Code, REITs are not generally required to pay federal income taxes if minimum distribution, income, asset and shareholder tests are met. For 2004, 2003 and 2002, ProLogis believes it was in compliance with the REIT requirements of the Code.
Long-Lived Assets
Real Estate Assets
Real estate assets are carried at cost, which is not in excess of estimated fair value. Costs incurred that are directly associated with the successful acquisition of real estate assets are capitalized as part of the investment basis of the real estate assets. Costs that are associated with unsuccessful acquisition efforts are expensed at the time the acquisition is abandoned. Costs incurred in developing, renovating and rehabilitating real estate assets are capitalized as part of the investment basis of the real estate assets. Costs incurred in making certain other improvements to the real estate assets are also capitalized. However, costs incurred in making repairs to and for maintaining real estate assets are expensed as incurred. Costs associated with in-place leases applicable to properties acquired for long-term investment are estimated and presented as a component of other assets. Further, as applicable, an additional allocation of the acquisition cost is made if the net present value of an acquired lease is favorable or unfavorable to relative market prices and to the extent customer relationships exist.
ProLogis capitalizes general and administrative costs, primarily payroll and payroll related costs, incurred prior to the acquisition of land parcels and associated with development, renovation, rehabilitation and leasing activities if such costs are incremental and identifiable to a specific activity. During the land development and construction periods of qualifying projects, interest costs and real estate taxes are capitalized. Capitalized costs are included in the investment basis of real estate assets except for the costs capitalized related to leasing activities, which are presented as a component of other assets.
The depreciable portions of real estate assets are charged to expense on a straight-line basis over their respective estimated useful lives. These useful lives are generally seven years for capital improvements, 10 years for standard tenant improvements, 30 years for acquired properties and 40 years for properties developed by ProLogis. Above standard tenant improvements are depreciated over the shorter of the lease term or the estimated useful life. Capitalized leasing costs are amortized over the respective lease term. ProLogis’ average lease term for all leases in effect at December 31, 2004 was between four and five years. ProLogis develops properties in its CDFS business segment with the intent to contribute the properties to
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
property funds in which ProLogis maintains an ownership interest and acts as manager, or to sell the properties to third parties. ProLogis may acquire properties in its CDFS business segment that it intends to rehabilitate and/or reposition prior to contributing the properties to a property fund. ProLogis does not depreciate properties during the period from the completion of the development, rehabilitation or repositioning activities through the date the properties are contributed or sold. See Note 12.
ProLogis acquired interests in certain real estate assets through the formation of partnerships wherein, in exchange for partnership interests, ProLogis, as the general partner, contributed cash and limited partners contributed real estate assets. In consolidating the partnerships’ assets, the investment bases of the real estate assets includes the estimated fair value attributable to the limited partners’ interests as of the formation dates. Real estate assets acquired as part of a business combination are recognized at their estimated fair value as of the date of the transaction.
Investments in Unconsolidated Investees
ProLogis’ investments in certain entities are presented under the equity method. The equity method is used when ProLogis has the ability to exercise significant influence over operating and financial policies of the investee but does not have control of the investee. Under the equity method, these investments (including advances to the investee) are initially recognized in the balance sheet at ProLogis’ cost and are subsequently adjusted to reflect ProLogis’ proportionate share of net earnings or losses of each of the investees, distributions received and certain other adjustments, as appropriate. See Note 5.
Goodwill
At December 31, 2004, the assets of each of ProLogis’ two reportable business segments included goodwill balances that have been recognized as a result of business combinations. Also, ProLogis’ investment in a temperature-controlled distribution entity includes a goodwill balance recognized when this investment was acquired.
On January 1, 2002, ProLogis adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 provides that goodwill is not subject to amortization over its estimated useful life but should be subject to at least an annual assessment for impairment by applying a fair-value-based test. Accordingly, as of January 1, 2002, ProLogis ceased recognizing amortization of recorded goodwill balances. The transitional rules related to the adoption of SFAS No. 142 required ProLogis and its unconsolidated investees to complete an initial assessment of goodwill balances recorded as of the date of adoption, January 1, 2002. No impairment adjustments were required as a result of the initial assessment.
Assets Held for Sale and Discontinued Operations
Discontinued operations represent a component of an entity that has either been disposed of or is classified as held for sale if both the operations and cash flows of the component have been or will be eliminated from ongoing operations of the entity as a result of the disposal transaction and the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, provides that the assets and liabilities of the component of the entity that has been classified as discontinued operations be presented separately in the entity’s balance sheet. The results of operations of the component of the entity that has been classified as discontinued operations are also reported as discontinued operations for all periods presented. A property is classified as held for sale when certain criteria, as outlined in SFAS No. 144, are met. At such time, depreciation is no longer recognized. Assets held for sale are reported at the lower of their carrying amount or their estimated fair value less the estimated costs to sell the assets. The results of operations of assets held for sale are reported as discontinued operations.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
At December 31, 2004, TCL Holding’s temperature-controlled distribution operations in France are classified as held for sale. During 2004, ProLogis recognized an impairment adjustment related to these assets of $50.6 million. See Note 6.
Properties disposed of to third parties are considered to be discontinued operations unless such properties were developed under a pre-sale agreement. However, properties contributed to property funds in which ProLogis maintains an ownership interest and acts as manager are not considered to be discontinued operations due to ProLogis’ continuing involvement with the properties. Discontinued operations recognized directly by ProLogis’ unconsolidated investees, if any, are not reflected separately from ProLogis’ investment balance or separately from the net earnings or losses of those equity investees.
In 2004, ProLogis disposed of 20 properties to third parties that were not developed under pre-sale agreements. Accordingly, these properties were classified as discontinued operations and ProLogis has reflected the results of operations of these properties and the net gain recognized upon their disposition as discontinued operations for the three years ended December 31, 2004, 2003 and 2002. In 2003 and 2002, ProLogis disposed of 15 and 13 such properties, respectively. However, the effect of reclassifying the results of operations of these properties to discontinued operations did not have a material effect on ProLogis’ Consolidated Statements of Earnings for either year and, accordingly, these properties were not classified as discontinued operations. See Note 6.
During the period prior to the contribution or sale of a CDFS business property, but after the completion of CDFS business segment activities (development, rehabilitation or repositioning), ProLogis includes these CDFS business properties in its operating portfolio and reports them as a part of the property operations segment. These assets do not meet the criteria to be classified as held for sale or as discontinued operations. See Note 12.
Impairment of Long-Lived Assets
In accordance with the provisions of SFAS No. 144, ProLogis and its unconsolidated investees assess the carrying values of their respective long-lived assets, other than goodwill, whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable. SFAS No. 142 requires that goodwill balances be assessed for impairment at least annually. ProLogis and its unconsolidated investees performed an assessment of the goodwill balance recorded in the CDFS business segment at June 30, 2004, of the goodwill balance recorded in the property operations segment at December 31, 2004 and of the goodwill balance related to its investment in a temperature-controlled distribution entity at December 31, 2004. The impairment recognized by ProLogis in 2004 associated with its temperature-controlled distribution net assets that are classified as held for sale reduced the goodwill balance associated with these assets to zero.
In management’s opinion, long-lived assets, including goodwill, of ProLogis and its unconsolidated investees are not carried at amounts in excess of their fair values at December 31, 2004. Other than the impairment adjustment recognized in 2004 associated with ProLogis’ assets held for sale, of which $18.0 million was associated with goodwill, ProLogis has not recognized any impairment adjustments directly. However, ProLogis did recognize its proportionate share of the total impairment adjustments recognized by its unconsolidated investees in 2003 (ProLogis’ share was $38.3 million) and 2002 (ProLogis’ share was $42.9 million). See Notes 5 and 6.
Cash and Cash Equivalents
ProLogis considers all cash on hand, demand deposits with financial institutions and short-term, highly liquid investments with original maturities of three months or less to be cash equivalents.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
ProLogis’ cash and cash equivalents are financial instruments that are exposed to concentrations of credit risk. ProLogis invests its cash with high-credit quality institutions that are federally or governmentally insured, as applicable. Cash balances with any one institution may be in excess of insured limits or may be invested in money market accounts that are not insured. ProLogis has not realized any losses in such cash investments or accounts and believes that it is not exposed to any significant credit risk.
Minority Interest
ProLogis recognizes the minority interests in real estate partnerships in which it has a controlling interest at each minority holder’s respective share of the estimated fair value of the real estate as of the date of formation. Minority interest liabilities that have been created or assumed as a part of business combinations are recognized at their estimated fair value as of the date of the transaction. Minority interest liabilities are subsequently adjusted for additional contributions, distributions to minority holders and the minority holders’ proportionate share of the net earnings or losses of each respective entity.
Certain limited partnership interests issued by ProLogis in connection with the formation of a real estate partnership and as consideration in a business combination are exchangeable into ProLogis’ common shares of beneficial interest (“Common Shares”). Common Shares issued upon exchange of a holder’s minority interest are accounted for at ProLogis’ carrying value of the surrendered minority interest. See Note 8.
Guarantees
ProLogis applies the provisions of Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others as an interpretation to SFAS Nos. 5, 57 and 107 and a rescission of Interpretation No. 34”, which provides that the entity that issues a guarantee must recognize an initial liability for the fair value, or market value, of the obligation that it assumes under the guarantees. The initial recognition and measurement provisions of Interpretation No. 45 were applicable to guarantees issued or modified after December 31, 2002. Interpretation No. 45 also provides disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit.
From time to time, ProLogis enters into Special Limited Contribution Agreements (“SLCA”) in connection with certain of its contributions of properties to certain of its property funds. Under the SLCAs, ProLogis is obligated to make an additional capital contribution to the respective property fund under certain circumstances, the occurrence of which ProLogis believes to be remote. Specifically, ProLogis would be required to make an additional capital contribution if the property fund’s third-party lender, whose loans to the property fund are generally secured by the property fund’s assets and are non-recourse, does not receive a specified minimum level of debt repayment. However, the proceeds received by the third-party lender from the exhaustion of all of the assets of the property fund combined with the debt repayments received directly from the property fund will reduce ProLogis’ obligations under the SLCA on a dollar-for-dollar basis. ProLogis’ potential obligations under the respective SLCAs, as a percentage of the assets in the property funds, range from 2% to 28%. Accordingly, the value of the assets of the respective property funds would have to decline by between 98% and 72% before ProLogis would be required to make an additional capital contribution. ProLogis believes that the likelihood of declines in the values of the assets that support the third-party loans of the magnitude necessary to require an additional capital contribution is remote, especially in light of the geographically diversified portfolios of properties owned by the property funds. Accordingly, these potential obligations have not been recognized as a liability by ProLogis at December 31, 2004 and ProLogis has assessed a nominal value to the guarantee undertaken through the SLCAs. The potential obligations under the SLCAs aggregate $407.4 million at December 31, 2004 and the combined book value of the assets in the property funds, before depreciation, that are subject to the provisions of the SLCAs was approximately $6.5 billion at December 31, 2004.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Common Share Repurchases
ProLogis recognizes the gross cost of the Common Shares it reacquires in a contra equity account in shareholders’ equity, or treasury stock account. The equity accounts that were credited for the original issuance remain intact. Under Maryland law, shares reacquired must be classified as retired shares that cannot be reissued. Accordingly, ProLogis does not separately reflect a treasury stock account in shareholders’ equity. Rather, the contra equity account is included in the additional paid-in capital balance.
Preferred Share Redemptions
ProLogis recognizes the excess of the redemption value of cumulative redeemable preferred shares of beneficial interest (“Preferred Shares”) redeemed over their carrying value as a charge to earnings in accordance with FASB - Emerging Issues Task Force (“EITF”) Topic D-42, “The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock” and the clarification issued in July 2003 by the Securities and Exchange Commission (“SEC”) staff.
Costs of Raising Capital
Costs incurred in connection with the issuance of both Common Shares and Preferred Shares are treated as a reduction to shareholders’ equity. Costs incurred in connection with the issuance or renewal of debt are capitalized in other assets, and amortized over the remaining term of the related debt.
Financial Instruments
ProLogis accounts for derivative financial instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and for Hedging Activities,” as amended. SFAS No. 133 provides comprehensive guidelines for the recognition and measurement of derivatives and hedging activities and, specifically, requires all derivatives to be recorded on the balance sheet at their fair value, either as an asset or liability, with an offset to results of operations, or if the derivative instrument qualifies for hedge accounting treatment, to accumulated other comprehensive income,
In the normal course of business, ProLogis uses certain types of derivative financial instruments for the purpose of foreign currency exchange rate and interest rate risk management. To qualify for hedge accounting treatment, the derivative instruments used for risk management purposes must effectively reduce the risk exposure that they are designed to hedge. For instruments associated with the hedge of anticipated transactions, hedge effectiveness criteria also require that the occurrence of the underlying transactions be probable. Instruments meeting these hedging criteria are formally designated as hedges at the inception of the contract. Those risk management instruments not meeting these criteria are accounted for at fair value with changes in fair value recognized immediately as a component of results of operations.
In assessing the fair values of its financial instruments, both derivative and non-derivative, ProLogis uses a variety of methods and assumptions that are based on market conditions and risks existing at each balance sheet date. Primarily, ProLogis uses quoted market prices or quotes from brokers or dealers for the same or similar instruments. These values represent a general approximation of possible value and may never actually be realized.
ProLogis’ financial instruments, including derivative instruments, are further discussed in Note 17.
Foreign Operations
The U.S. dollar is the functional currency for ProLogis’ consolidated subsidiaries and unconsolidated investees operating in the United States and Mexico and for certain of ProLogis’ consolidated subsidiaries that operate as holding companies for foreign investments. The functional currency for ProLogis’ consolidated
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
subsidiaries and unconsolidated investees operating in countries other than the United States and Mexico is the principal currency in which the entity’s assets, liabilities, income and expenses are denominated, which may be different from the local currency of the country of incorporation or the country where the entity conducts its operations. The functional currencies of ProLogis’ consolidated subsidiaries and unconsolidated investees include the euro, the Swedish krona, British pound sterling, Hungarian forint, Czech Republic koruna, Polish zloty, Japanese yen, Canadian dollar, Chinese renminbi and Singapore dollar.
ProLogis’ consolidated subsidiaries whose functional currency is not the U.S. dollar translate their financial statements into U.S. dollars prior to the consolidation of those subsidiaries’ financial statements into ProLogis’ financial statements. Assets and liabilities are translated at the exchange rate in effect as of the financial statement date. Income statement accounts are translated using the average exchange rate for the period. Income statement accounts that represent significant nonrecurring transactions are translated at the rate in effect as of the date of the transaction. Gains and losses resulting from the translation are included in accumulated other comprehensive income as a separate component of shareholders’ equity. ProLogis translates its share of the net earnings or losses of its unconsolidated investees whose functional currency is not the U.S. dollar at the average exchange rate for the period.
ProLogis and its consolidated subsidiaries and unconsolidated investees may have transactions, including investments and advances, denominated in currencies other than their functional currency. In these instances, nonmonetary assets and liabilities are reflected at the historical exchange rate, monetary assets and liabilities are remeasured at the exchange rate in effect at the end of the period and income statement accounts are remeasured at the average exchange rate for the period. Gains and losses from remeasurement are generally included in ProLogis’ results of operations. Investment balances and certain intercompany advances are remeasured with the resulting adjustment recognized as a cumulative translation adjustment in accumulated other comprehensive income in shareholders’ equity. This treatment is applicable to intercompany advances that are deemed to be a permanent source of capital to the subsidiary or investee. Upon the partial or complete sale of the foreign investment or upon complete or substantially complete liquidation of the foreign investment, the gain or loss on the sale or redemption transaction will include a portion of the cumulative translation adjustments that have been previously recorded in other comprehensive income. The amount included in the gain or loss is the portion of the cumulative translation adjustments that is attributable to that particular investment or intercompany advance that has become realized as a result of the transaction, generally when funds are repatriated to the United States. See Note 5.
Gains or losses are also included in results of operations when transactions with a third party, denominated in a currency other than the entity’s functional currency, are settled and the functional currency cash flows realized are more or less than expected based upon the exchange rate in effect when the transactions were initiated.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The components of the net foreign currency exchange gains (expenses/losses) recognized in ProLogis’ results of operations were as follows for the years indicated (in thousands of U.S. dollars):
(1)
At the time certain debt balances are settled, remeasurement gains or losses that have been recognized in results of operations as unrealized are reversed and the cumulative foreign currency exchange gain or loss realized with respect to the settled balance is recognized in results of operations as a realized gain or loss in the period that the settlement occurs.
(2)
ProLogis enters into foreign currency put option contracts related to its operations in Europe and Japan. These put option contracts do not qualify for hedge accounting treatment. Accordingly, the cost of the contract is capitalized at the contract’s inception and is marked-to-market by ProLogis as of the end of each subsequent reporting period. Upon expiration of the contract, the mark-to-market adjustment is reversed, the total cost of the contract is expensed and any proceeds received are recognized as a gain. See Note 17.
(3)
In 2003, ProLogis recognized a foreign currency exchange gain of $47.9 million as a result of the repatriation to the United States of the cash redemption proceeds that ProLogis received as a result of the partial redemption of its investment in ProLogis European Properties Fund. This gain is included with the total gains on partial dispositions of investments in property funds in ProLogis’ Consolidated Statement of Earnings as allowed under SFAS No. 52 “Foreign Currency Translation.”
Revenue Recognition
ProLogis leases its operating properties to customers under agreements that are classified as operating leases and recognizes the total minimum lease payments provided for under the leases on a straight-line basis over the lease term in accordance with SFAS No. 13, “Accounting for Leases.” A provision for possible loss is made if the collection of a receivable balance is considered to be doubtful.
Under the terms of the respective leases, some or all of ProLogis’ rental expenses are recovered from its customers. ProLogis reflects amounts recovered from customers as a component of rental income.
Gains or losses on the dispositions of real estate assets are recorded when the recognition criteria set forth in SFAS No. 66, “Accounting for Sales of Real Estate” have been met, generally at the time title is transferred and ProLogis does not have substantial continuing involvement with the real estate asset sold.
When ProLogis contributes a property to a property fund in which it has an ownership interest, ProLogis does not recognize a portion of the proceeds in its computation of the gain resulting from the contribution. The amount of the proceeds that cannot be recognized is based on ProLogis’ continuing ownership interest in the
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contributed property that arises due to ProLogis’ ownership interest in the property fund acquiring the property. ProLogis defers this portion of the proceeds by recognizing a reduction to its investment in the applicable property fund. ProLogis adjusts its proportionate share of the net earnings or losses that it recognizes under the equity method from the property funds in future periods to reflect the property fund’s recorded depreciation expense as if it were computed on ProLogis’ lower basis in the contributed properties rather than on the property fund’s basis. If a loss is computed when a property is contributed to a property fund, the entire loss is recognized.
When a property that ProLogis originally contributed to a property fund is sold to a third party, ProLogis recognizes as income the amount of the gain that it had previously deferred at the time the third party sale occurs. Further, during periods when ProLogis’ ownership interest in a property fund decreases, ProLogis will recognize a portion of the gains that were previously deferred to coincide with its new ownership interest in the property fund. If ProLogis receives non-monetary consideration, other than an ownership interest in the acquiring entity, as part of the proceeds from a property disposition, ProLogis does not recognize that portion of the proceeds.
Rental Expenses
Rental expenses primarily include the cost of on-site and property management personnel, utilities, repairs and maintenance, property insurance and real estate taxes.
Relocation Expenses
ProLogis is relocating its information technology and corporate accounting functions from El Paso, Texas to Denver, Colorado and its Denver-based employees to a new corporate headquarters. The relocation from El Paso will be completed in the first quarter of 2005 and the relocation to the new corporate headquarters, which is located in Denver and is currently under development, is expected to be completed by the end of 2005.
For the year ended December 31, 2004, ProLogis recognized total relocation expenses of $6.8 million, including $2.6 million of employee termination benefits recognized in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”, $1.8 million of accelerated depreciation associated with non-real estate assets whose useful life has been shortened due to the relocation plans and $2.4 million of costs associated with the hiring and training of new personnel and other costs, including travel and temporary facility costs. ProLogis expects that the cost of its relocation activities to be expensed in 2005 will be between $6 million and $8 million.
Income Taxes
ProLogis is a REIT for federal income tax purposes and is not generally required to pay federal income taxes if it meets the REIT requirements of the Code. Also, ProLogis’ subsidiaries that meet the requirements of the Code to be qualified REIT subsidiaries are generally not required to pay federal income taxes. However, ProLogis must recognize income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” for its subsidiaries that are not qualified REIT subsidiaries and in certain states in which ProLogis operates. Also, the foreign countries where ProLogis has operations do not necessarily recognize REITs under their respective tax laws. Accordingly, ProLogis recognizes income taxes, as necessary.
SFAS No. 109 requires that interperiod income tax allocation be based on the asset and liability method. Accordingly, ProLogis has recognized the tax effects of temporary differences between its tax and financial reporting bases of assets and liabilities that will result in taxable or deductible amounts in future periods. At December 31, 2004 and 2003, ProLogis recognized net deferred income tax liabilities of $29.9 million and $10.0 million, respectively, including $19.7 million at December 31, 2004 and $3.6 million at December 31,
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2003 that have been recognized pursuant to indemnification agreements with two of ProLogis’ property funds. See Note 5.
Share-Based Compensation
ProLogis recognizes the costs of its share-based compensation plans under the provision of SFAS No. 123, “Accounting for Stock-Based Compensation,” that allows ProLogis to continue to account for these plans using Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Under APB No. 25, if the exercise price of the share option granted equals or exceeds the market price of the underlying share on the date of grant, no compensation expense is recognized. SFAS No. 123 requires that the fair value of the share options granted be recognized as compensation expense, regardless of the relationship of the exercise price to the market price. ProLogis grants share options to employees and members of its Board of Trustees (the “Board”) that have an exercise price that is equal to the average of the high and low market prices on the day the options are granted. Therefore, no compensation expense is recognized. ProLogis does recognize compensation expense if the terms of the share options or other instruments awarded are changed in such a manner that the variable accounting rules as provided in APB No. 25 become applicable.
Had compensation expense been recognized by ProLogis for the years ended December 31, 2004, 2003 and 2002 using an option valuation model as provided in SFAS No. 123, ProLogis’ net earnings attributable to Common Shares and net earnings attributable to Common Shares per share for these years would have changed as follows (in thousands of U.S. dollars, except per share amounts):
Since share options vest over several years and additional grants are likely to be made in future years, the pro forma compensation expense presented above may not be representative of compensation cost to be expected in future years.
The pro forma amounts above were calculated using the Black-Scholes model to value the option grants with the following assumptions:
On December 16, 2004, the FASB issued SFAS No. 123R, “Share Based Payment” which requires ProLogis and other public companies to measure the cost of employee services received in exchange for an award of an equity instrument based on the award’s fair value on the grant date. The cost of these awards will
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
be recognized over the period during which an employee is required to provide service in exchange for the award, generally the vesting period. In addition, a public company will measure the cost of employee services received in exchange for an award of liability instruments at its initial fair value, which will subsequently be remeasured at each reporting period. Changes in fair value during the service period will be recognized as compensation expense over that period. SFAS No. 123R is effective for ProLogis beginning in the third quarter of 2005, however, early adoption is allowed. ProLogis is currently evaluating the impact the adoption of SFAS No. 123R will have on its financial position and its results of operations.
3.
Keystone Transaction:
On May 3, 2004, ProLogis and affiliates of four investment funds managed by Eaton Vance Management (the “Fund Affiliates”) established five property funds (the “Acquiring Property Funds” and also referred to by ProLogis as ProLogis North American Properties Funds VI, VII, VIII, IX and X - see Note 5). ProLogis has a 20% ownership interest in each of the Acquiring Property Funds with the remainder owned by the Fund Affiliates. Also on May 3, 2004, ProLogis and the Acquiring Property Funds entered into an agreement to acquire the outstanding equity of Keystone Property Trust (“Keystone”), a publicly traded REIT, and the operating units of Keystone Operating Partnership, L.P., a subsidiary of Keystone (the “Keystone Transaction”). Keystone owned and leased industrial distribution properties located in New Jersey, Pennsylvania, Indiana, Florida, South Carolina and Ohio. The acquisition of Keystone by ProLogis and the Acquiring Property Funds was approved by Keystone’s shareholders on July 30, 2004 and was closed on August 4, 2004. Prior to the closing of the Keystone Transaction, ProLogis contributed 21 operating properties aggregating 3.0 million square feet to the Acquiring Property Funds. Total proceeds from these contributions, which were completed on June 30, 2004, were $127.4 million. See Note 5.
At closing, ProLogis and the Acquiring Property Funds paid $23.80 per Keystone common share outstanding and retired approximately $567 million of Keystone’s outstanding debt. On September 3, 2004, ProLogis and the Acquiring Property Funds paid a cash liquidation distribution of approximately $125 million, including accrued dividends, to the holders of the outstanding preferred shares of Keystone, and Keystone was liquidated. Including these payments, assumed liabilities (including the issuance of limited partnership units to certain of Keystone’s limited partners) and estimated transaction costs, the total consideration for the Keystone Transaction was approximately $1.7 billion. ProLogis’ share of the total consideration was approximately $579 million, including its investment in the Acquiring Property Funds of approximately $279 million and its direct acquisition of certain assets and its direct assumption of certain liabilities aggregating on a net basis approximately $300 million.
ProLogis’ direct acquisition, completed through a limited partnership in which limited partnership units were issued, included:
•
nine operating properties aggregating 2.3 million square feet, one 0.8 million square foot property under development, 14 acres of land and land option rights, valued on a combined basis at approximately $145 million;
•
ownership interests in two unconsolidated property funds (20% interest in each) that own on a combined basis 7.7 million square feet of operating properties that were valued at approximately $102 million (including the proportionate assumption of approximately $26 million of secured debt of the property funds);
•
ownership interests in two unconsolidated CDFS business joint ventures (50% interest in each); one entity owns a recently completed 0.8 million square foot operating property and one entity in the planning stage for the development of a 0.8 million square foot property that were valued on a combined basis at approximately $15 million (including the proportionate assumption of approximately $6 million of secured debt);
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
•
a preferred equity interest in an unconsolidated entity that owns office properties that was valued at approximately $21 million; and
•
certain other assets, net of certain other liabilities that were valued at approximately $7 million.
In addition to the net assets acquired through the limited partnership, ProLogis, through its wholly owned subsidiary ProLogis Logistics, directly acquired an interest in a management company owned by Keystone. The management company has the contractual rights to earn fees for providing property management and other services to the unconsolidated entities directly acquired by ProLogis through the limited partnership. These contractual rights were valued at approximately $13 million, of which approximately $10 million is attributable to ProLogis’ ownership interest. The management company is a variable interest entity, as defined in FIN 46R. Accordingly, ProLogis, as the primary beneficiary, presents the management company on a consolidated basis in its financial statements. The total value of the contractual rights is reflected as a part of other assets and the Acquiring Property Funds’ portion of these rights, approximately $3 million, is reflected as a minority interest liability. See Note 8.
ProLogis’ share of the total consideration of approximately $579 million was funded through:
•
the issuance of approximately 879,000 limited partnership units that are redeemable for cash or, at ProLogis’ election, into one share of Common Shares; valued at approximately $30 million;
•
the direct assumption of secured debt, valued at approximately $13 million;
•
the indirect assumption of secured debt of unconsolidated investees, valued at approximately $32 million; and
•
cash of approximately $504 million, including approximately $177 million that was funded on a short-term basis at closing pending the completion of long-term, secured financing arrangements by the Acquiring Property Funds.
In addition, both ProLogis and the Fund Affiliates advanced cash to the Acquiring Property Funds to meet their initial working capital and liquidity requirements, of which ProLogis’ share was approximately $6 million.
The allocation of the total consideration to the net assets acquired in the Keystone Transaction is based on a preliminary assessment and is subject to change as additional information becomes available.
The Acquiring Property Funds completed secured financing arrangements in the fourth quarter of 2004. The total proceeds from these financing arrangements of approximately $892 million were returned to the Fund Affiliates (approximately $715 million) and ProLogis (approximately $177 million). On a combined basis, the financing arrangements have an average term of eight years and provide for an average annual interest rate of 5.48%. The Acquiring Property Funds entered into interest rate swap agreements to hedge a portion of the future interest payments associated with these financing arrangements. These interest rate swap agreements qualified for hedge accounting treatment. Certain of the interest rate swap agreements were subject to an indemnification agreement between the Acquiring Property Funds and ProLogis that obligated ProLogis to make any settlement payments that became due and, alternatively, entitled ProLogis to receive any settlement proceeds that were paid. The indemnification agreement relates to interest swap agreements with an aggregate notional amount of $185.2 million, originally estimated to be the amount of the financing arrangements to be incurred by the Acquiring Property Funds attributable to ProLogis’ 20% ownership interest. Upon settlement of the swap agreements in June and July 2004, ProLogis’ proportionate share of the net payment was $1.2 million, which ProLogis paid to the counterparties under the indemnification agreement. The portion of this payment attributable to each of the Acquiring Property Funds has been included in ProLogis’ investment basis and will be amortized to ProLogis’ share of the earnings or losses of the respective property fund over the term of the associated debt.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4.
Real Estate:
Real Estate Assets
Real estate assets directly owned by ProLogis consist of income producing industrial distribution properties, industrial distribution properties under development and land held for future development of industrial distribution properties. ProLogis’ real estate assets, presented at cost, include the following as of the dates indicated (in thousands of U.S. dollars):
(1)
At December 31, 2004 and 2003, ProLogis had 1,228 and 1,252 operating properties, respectively, consisting of 133.6 million and 133.1 million square feet, respectively.
(2)
Properties under development consist of 58 buildings aggregating 15.1 million square feet at December 31, 2004 and 27 buildings aggregating 9.8 million square feet at December 31, 2003.
(3)
In addition to the construction costs payable balance of $63.5 million at December 31, 2004, ProLogis had aggregate unfunded commitments on its contracts for properties under development of $508.9 million at December 31, 2004.
(4)
Land held for future development consisted of 2,991 acres at December 31, 2004 and 2,706 acres at December 31, 2003.
(5)
Other investments include: (i) earnest money deposits associated with potential acquisitions; (ii) costs incurred during the pre-acquisition due diligence process; and (iii) costs incurred during the pre-construction phase related to future development projects.
ProLogis’ directly owned real estate assets are located in North America (United States, Mexico and Canada), Europe (France, United Kingdom, Poland, Netherlands, Italy, Germany, Spain, Czech Republic, Sweden, Hungary and Belgium) and in Asia (Japan, China and Singapore). No individual market in any country, as defined by ProLogis and presented in Item 2 of its 2004 Annual Report on Form 10-K, represents more than 10% of ProLogis’ total real estate assets, before depreciation.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Operating Lease Agreements
ProLogis leases its operating properties to customers under agreements that are generally classified as operating leases. At December 31, 2004, minimum lease payments on leases with lease periods greater than one year for space in ProLogis’ directly owned properties during each of the years in the five-year period ending December 31, 2009 and thereafter are as follows (in thousands of U.S. dollars):
For ProLogis’ directly owned properties, the largest customer and the 25 largest customers accounted for 1.35% and 15.6%, respectively, of ProLogis’ annualized collected base rents at December 31, 2004.
5.
Unconsolidated Investees:
Summary of Investments and Income
Since 1997, ProLogis has invested in various entities in which its ownership interest is less than 100% and in which it does not have control as defined under GAAP. Accordingly, these investments are presented under the equity method in ProLogis’ Consolidated Financial Statements. Certain of these investments were originally structured such that ProLogis’ ownership interest would allow ProLogis to continue to comply with the requirements of the Code to qualify as a REIT. However, with respect to ProLogis’ investments in property funds, having an ownership interest of 50% or less is part of ProLogis’ business strategy. This property fund strategy allows ProLogis to realize, for financial reporting purposes, a portion of the profits from its development activities, raise private equity capital or issue private debt instruments, generate fee income, provide liquidity to fund its future development activities, all the while allowing ProLogis to maintain a long-term ownership interest in its developed properties.
ProLogis’ investments in entities that were accounted for under the equity method are summarized by type of investee as follows as of the dates indicated (in thousands of U.S. dollars):
(1)
As of January 1, 2004, ProLogis began presenting its investments in TCL Holding and CSI/ Frigo LLC on a consolidated basis as a result of adopting FIN 46R. See Note 2.
ProLogis recognizes income or losses from its investments in its unconsolidated investees consisting of its proportionate share of the net earnings or losses of these investees recognized under the equity method and interest income on advances made to these investees, if any. Further, ProLogis earns fees for providing services
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
to the property funds. The amounts recognized by ProLogis from its investments in unconsolidated investees are summarized as follows for the periods indicated (in thousands of U.S. dollars):
(1)
As of January 1, 2004, ProLogis began presenting its investments in TCL Holding and CSI/ Frigo LLC on a consolidated basis as a result of adopting FIN 46R. See Note 2.
Property Funds
Contributions of developed properties to a property fund allow ProLogis to realize, for financial reporting purposes, a portion of the profits from its development activities while at the same time allowing ProLogis to maintain a long-term ownership interest in its developed properties. This business strategy also provides liquidity to fund ProLogis’ future development activities and generates fee income to ProLogis. ProLogis has investments in 15 property funds (13 of which were formed by ProLogis). ProLogis’ ownership interests in these property funds ranged from 11.5 to 50.0% at December 31, 2004. The property funds formed by ProLogis own operating properties that have generally been contributed to them by ProLogis, although certain of the property funds have also acquired properties from third parties, including properties acquired as part of the Keystone Transaction. Interests in two property funds were acquired by ProLogis as part of the Keystone Transaction (See Note 3 for a discussion of the Keystone Transaction). In most cases, ProLogis receives ownership interests in the property funds as part of the proceeds generated by the contributions of properties to the property funds. ProLogis recognizes its proportionate share of the earnings or losses of each property fund under the equity method. ProLogis earns fees for acting as the manager of each of the property funds and may earn additional fees by providing other services to certain of the property funds including, but not limited to, acquisition, development and leasing activities performed on their behalf.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
ProLogis’ investments in the 15 property funds, presented under the equity method, were as follows as of the dates indicated (in thousands of U.S. dollars):
ProLogis’ investments in the property funds at December 31, 2004 consisted of the following components (in millions of U.S. dollars):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
ProLogis’ proportionate share of the net earnings or losses of each of the property funds recognized under the equity method, interest income on advances to the property funds, if any, and fees earned for services provided to the property funds were as follows for the periods indicated (in thousands of U.S. dollars):
(1)
ProLogis California I LLC (“ProLogis California”):
•
Began operations on August 26, 1999;
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
•
Members are ProLogis (50%) and New York State Common Retirement Fund (50%);
•
Owned 81 properties aggregating 14.2 million square feet at December 31, 2004;
•
Acquired four properties aggregating 1.5 million square feet (two properties aggregating 1.2 million square feet were acquired from ProLogis) and disposed of two properties aggregating 0.3 million square feet during the year ended December 31, 2004;
•
All but three of the properties owned were contributed by ProLogis or were developed by ProLogis on behalf of the property fund;
•
Properties are located in the Los Angeles/ Orange County market;
•
ProLogis California has the right of first offer with respect to properties that ProLogis develops, excluding properties developed under build to suit lease agreements, in certain counties included in ProLogis’ Los Angeles/ Orange County market; and
•
Property management, asset management, leasing and other fees recognized by ProLogis were $3.4 million, $3.3 million and $3.1 million for the years ended December 31, 2004, 2003 and 2002, respectively.
(2) ProLogis North American Properties Fund I LLC (“ProLogis North American Properties Fund I”):
•
Began operations on June 30, 2000;
•
Members are ProLogis (41.3%) and State Teachers’ Retirement Board of Ohio (58.7%);
•
Owned 36 properties aggregating 9.4 million square feet at December 31, 2004;
•
All properties were contributed by ProLogis;
•
Properties are located in 17 markets in the United States;
•
ProLogis’ ownership interest has been 41.3% since January 15, 2001; and
•
Property management, asset management, leasing and other fees recognized by ProLogis were $2.3 million $2.2 million and $2.7 million for the years ended December 31, 2004, 2003 and 2002, respectively.
(3) ProLogis First U.S. Properties LP (“ProLogis North American Properties Fund II”):
•
Began operations on June 30, 2000;
•
Partners are ProLogis (20%) and an affiliate of First Islamic Investment Bank E.C. (“First Islamic Bank”) (80%);
•
Owned 27 properties aggregating 4.5 million square feet at December 31, 2004;
•
All properties were contributed by ProLogis;
•
Properties are located in 13 markets in the United States; and
•
Property management, asset management, leasing and other fees recognized by ProLogis were $2.3 million, $1.9 million and $2.1 million for the years ended December 31, 2004, 2003 and 2002, respectively.
(4) ProLogis Second U.S. Properties LP (“ProLogis North American Properties Fund III”):
•
Began operations on June 15, 2001;
•
Partners are ProLogis (20%) and an affiliate of First Islamic Bank (80%);
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
•
Owned 34 properties aggregating 4.4 million square feet at December 31, 2004;
•
All properties were contributed by ProLogis;
•
Properties are located in 15 markets in the United States; and
•
Property management, asset management, leasing and other fees recognized by ProLogis were $2.2 million, $2.1 million and $2.0 million for the years ended December 31, 2004, 2003 and 2002, respectively.
(5) ProLogis Third U.S. Properties LP (“ProLogis North American Properties Fund IV”):
•
Began operations on September 21, 2001;
•
Partners are ProLogis (20%) and an affiliate of First Islamic Bank (80%);
•
Owned 17 properties aggregating 3.5 million square feet at December 31, 2004;
•
All properties were contributed by ProLogis;
•
Properties are located in 10 markets in the United States; and
•
Property management, asset management, leasing and other fees recognized by ProLogis were $1.2 million, $1.4 million and $1.2 million for the years ended December 31, 2004, 2003 and 2002, respectively.
(6) ProLogis North American Properties Fund V:
•
Began operations on March 28, 2002;
•
Ownership interests (direct and indirect) of the ProLogis-Macquarie Fund at December 31, 2004 are held directly or indirectly by ProLogis, Macquarie ProLogis Trust (“MPR”), a listed property trust in Australia, and Macquarie Bank Limited (“Macquarie Bank”);
•
MPR’s effective ownership interest in the ProLogis-Macquarie Fund was 85.8% at December 31, 2004 through its 96.3% weighted ownership interest in two entities that collectively owned 89.1% of the ProLogis-Macquarie Fund. MPR’s effective ownership interest in the ProLogis-Macquarie Fund was 83.1% at December 31, 2003 and 79.7% at December 31, 2002;
•
ProLogis’ effective ownership interest in the ProLogis-Macquarie Fund was 11.5% at December 31, 2004 based on its 10.9% direct ownership interest in the ProLogis-Macquarie Fund and its 0.7% ownership interest in two entities that collectively own 89.1% of the ProLogis-Macquarie Fund. ProLogis’ effective ownership interest in the ProLogis-Macquarie Fund was 14.0% at December 31, 2003 and 16.1% at December 31, 2002;
•
Macquarie Bank’s effective ownership interest in the ProLogis-Macquarie Fund was 2.7% at December 31, 2004 based on its 3.0% ownership interest in two entities that collectively own 89.1% of the ProLogis-Macquarie Fund. Macquarie Bank’s effective ownership interest was 2.9% at December 31, 2003 and 4.2% at December 31, 2002;
•
ProLogis and a United States subsidiary of Macquarie Bank each have a 50% ownership interest in a company that was formed to act as manager of the ProLogis-Macquarie Fund;
•
ProLogis refers to the combined entities in which it has ownership interests (ProLogis-Macquarie Fund and the management company) as one property fund named ProLogis North American Properties Fund V. ProLogis’ combined ownership interest in this property fund has ranged from 11.4% to 16.9% since the property fund’s inception;
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
•
ProLogis reduced its ownership interest in the ProLogis-Macquarie Fund in June 2004 by exchanging a portion of its investment into units of MPR as allowed under certain formation agreements. Upon receipt of the units of MPR, ProLogis sold them in the public market. The sale generated net proceeds of $13.2 million. ProLogis recognized a net gain on the disposition of the investment of $3.3 million;
•
Owned 119 properties aggregating 28.3 million square feet at December 31, 2004 (including 25 properties aggregating 4.9 million square feet that have been contributed by ProLogis during 2004);
•
Acquired seven properties aggregating 2.7 million square feet from third parties during 2004;
•
All but seven of the properties owned were contributed by ProLogis;
•
Properties are located in 24 markets in the United States and four markets in Mexico;
•
At December 31, 2004, ProLogis had guaranteed $68.8 million of borrowings of ProLogis North American Properties Fund V. ProLogis provided this guarantee on short-term borrowings of the property fund associated with the acquisition of properties from ProLogis. In February 2005, ProLogis North American Properties Fund V repaid $29.4 million of the guaranteed borrowings with proceeds from a secured debt financing that is not guaranteed by ProLogis. The remaining $39.4 million of guaranteed borrowings mature in April 2005 and ProLogis expects that these borrowings will be repaid with the proceeds from a secured debt financing that will not be guaranteed by ProLogis;
•
ProLogis North American Properties Fund V has the right of first offer to all of ProLogis’ stabilized development properties that ProLogis desires to sell in North America (except those properties that are subject to an agreement with ProLogis California) through the end of 2005. Properties subject to the right of first offer must meet certain specified criteria, including leasing criteria. ProLogis cannot predict the extent to which ProLogis North American Properties Fund V will have funds available to continue to acquire properties from ProLogis during 2005. Should ProLogis North American Properties Fund V choose not to acquire, or not have sufficient capital available to acquire, a property that meets the specified criteria, its rights under the agreement will terminate; and
•
Fees and other income recognized by ProLogis were (in millions of U.S. dollars):
(a)
Consists of income earned based on certain performance criteria of the property fund.
(7)
These property funds, originally formed on May 3, 2004 to acquire properties as part of the Keystone Transaction described in Note 3, each began operations on June 30, 2004 when ProLogis contributed properties to each property fund. The remainder of the properties were acquired as part of the Keystone Transaction (see Note 3). The ownership interests in each property fund are held by ProLogis (20%) and an affiliate of an investment fund managed by Eaton Vance Management (80%). ProLogis earns
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
fees for providing property management, asset management, leasing and certain other services to the property funds. Other information about these property funds is as follows:
(a)
Includes five properties aggregating 1.1 million square feet contributed by ProLogis on June 30, 2004.
(b)
Includes four properties aggregating 0.6 million square feet contributed by ProLogis on June 30, 2004.
(c)
Includes four properties aggregating 0.4 million square feet contributed by ProLogis on June 30, 2004.
(d)
Includes three properties aggregating 0.3 million square feet contributed by ProLogis on June 30, 2004.
(e)
Includes five properties aggregating 0.6 million square feet contributed by ProLogis on June 30, 2004.
(8)
ProLogis North American Properties Fund XI:
•
Ownership interest in existing property fund acquired by ProLogis on August 4, 2004 as part of the Keystone Transaction (see Note 3);
•
Partners are ProLogis (20%) and AFL-CIO Building Investment Trust (80%);
•
Owned 14 properties aggregating 4.3 million square feet at December 31, 2004;
•
Properties are located in three markets in the United States; and
•
Property management fees recognized by ProLogis were $0.4 million for the period ended December 31, 2004.
(9)
ProLogis North American Properties Fund XII:
•
Ownership interest in existing property fund acquired by ProLogis on August 4, 2004 as part of the Keystone Transaction (see Note 3);
•
Partners are ProLogis (20%) and CalEast Industrial Investors, LLC (80%);
•
Owned 12 properties aggregating 3.4 million square feet at December 31, 2004;
•
Properties are located in two New Jersey markets; and
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
•
Property management fees recognized by ProLogis were $0.4 million for the period ended December 31, 2004.
(10)
ProLogis European Properties Fund:
•
Began operations on September 23, 1999;
•
ProLogis and 21 third parties, primarily institutional investors, own units in the property fund. ProLogis European Properties Fund has equity commitments from nine investors through subscription agreements aggregating 636.6 million euro (the currency equivalent of approximately $844.4 million at December 31, 2004) of which 373.3 million euro (the currency equivalent of approximately $495.1 million at December 31, 2004) was unfunded at December 31, 2004. The subscription agreements expire on August 29, 2006;
•
At December 31, 2004, ProLogis was committed to make additional equity contributions to ProLogis European Properties Fund of 135.4 million euro (the currency equivalent of approximately $179.6 million as of December 31, 2004) through September 15, 2009;
•
Owned 230 properties aggregating 47.9 million square feet at December 31, 2004 (including 32 properties aggregating 7.2 million square feet that were contributed by ProLogis during 2004);
•
Acquired a 0.2 million square foot property from a third party during 2004;
•
Properties owned at December 31, 2004 have been contributed by ProLogis (184 properties, 36.7 million square feet) and acquired from third parties (46 properties, 11.2 million square feet);
•
Properties are located in 26 markets in 11 countries in Europe;
•
ProLogis is committed to offer to contribute all of its stabilized development properties in specified markets in Europe through September 2019 to ProLogis European Properties Fund. ProLogis European Properties Fund is committed to acquire such properties, subject to the property meeting certain specified criteria, including leasing criteria, and having available capital;
•
ProLogis’ ownership interest was 21.8%, 21.9% and 29.6% at December 31, 2004, 2003 and 2002, respectively; and
•
Property management, asset management and other fees recognized by ProLogis were $25.3 million, $23.8 million and $16.5 million for the years ended December 31, 2004, 2003 and 2002, respectively.
(11)
PLD/RECO Japan TMK Property Trust (“ProLogis Japan Properties Fund”):
•
Began operations on September 24, 2002;
•
Partners are ProLogis (20%) and a real estate investment subsidiary of the Government of Singapore Investment Corporation (“GIC”) (80%);
•
The total capital commitment by the real estate investment subsidiary of GIC to the property fund is $300.0 million, of which $135.6 million was unfunded at December 31, 2004;
•
Owned 13 properties aggregating 3.9 million square feet at December 31, 2004 (including three properties aggregating 1.2 million square feet that were contributed by ProLogis during 2004);
•
Acquired five properties aggregating 1.1 million square feet from third parties during 2004;
•
Seven of the 13 properties owned by the property fund were contributed by ProLogis;
•
Properties are located in three markets in Japan;
•
ProLogis is committed to offer to contribute all of its stabilized development properties in Japan through June 2006 to ProLogis Japan Properties Fund. ProLogis Japan Properties Fund is committed
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
to acquire such properties, subject to the property meeting certain specified criteria, including leasing criteria, and having available capital; and
•
Property management and asset management fees recognized by ProLogis were $2.9 million, $0.8 million and $0.1 million for the years ended December 31, 2004, 2003 and 2002, respectively.
(12)
Under GAAP, a portion of the proceeds resulting from ProLogis’ contribution of a property to a property fund is deferred due to ProLogis’ continuing ownership in the property fund that acquires the property. The amount of the proceeds that ProLogis is unable to recognize in computing the gain on the contribution is recorded as a reduction to ProLogis’ balance sheet investment in the property fund that acquires the property. The proceeds that have not been recognized are eventually recognized when ProLogis adjusts its proportionate share of the earnings or loss of the property fund, recognized under the equity method, to reflect lower depreciation expense within the property fund. The lower depreciation expense is the result of ProLogis’ reduced investment in the property fund and, accordingly, its lower basis in the contributed property. The proceeds not recognized are eventually recognized in results of operations by ProLogis if the property fund disposes of a property to a third party that was originally contributed to the property fund by ProLogis. ProLogis also recognizes gains associated with the previously deferred proceeds in amounts proportionate to reductions in its ownership interest in the property fund after the contribution is made. If a loss results when a property is contributed to a property fund, the entire loss is recognized.
(13)
Includes costs associated with ProLogis’ investment in the property fund, ProLogis’ proportionate share of the accumulated other comprehensive income or loss recognized by ProLogis European Properties Fund (cumulative translation adjustments and hedge accounting adjustments) and ProLogis Japan Properties Fund (cumulative translation adjustments) and settlement amounts either paid or received associated with the interest rate swap agreements and a related indemnification agreement between ProLogis and ProLogis North American Properties Funds VI through X (see Note 3).
In August 2003, ProLogis entered into an indemnification agreement with ProLogis European Properties Fund whereby ProLogis would indemnify ProLogis European Properties Fund for certain future capital gains tax liabilities that could be incurred by ProLogis European Properties Fund. The indemnification agreement applies to properties that ProLogis contributed to ProLogis European Properties Fund after March 31, 2003. ProLogis’ contributions to ProLogis European Properties Fund are primarily structured as contributions of the shares of companies that own the real estate assets. Accordingly, the capital gains tax liability associated with the step up in the value of the underlying real estate assets is deferred and transferred to ProLogis European Properties Fund at contribution. ProLogis has indemnified ProLogis European Properties Fund to the extent that ProLogis European Properties Fund: (i) incurs capital gains tax as a result of a direct sale of the real estate asset, as opposed to a transaction in which the shares of the company owning the real estate asset are transferred or sold or (ii) is required to grant a discount to the buyer of shares under a share transfer transaction as a result of ProLogis European Properties Fund transferring the embedded capital gain tax liability to the buyer of the shares in the transaction. Further, if an initial public offering of units in ProLogis European Properties Fund is undertaken, ProLogis has indemnified the unit holders of ProLogis European Properties Fund in the event the unit holders are required to accept a discount to the value of their units because the capital gain tax liability is being transferred to the holders of units in the new public entity. The agreement limits the amount that is subject to ProLogis’ indemnification to 100% of the actual capital gains tax liability that is deferred and transferred by ProLogis to ProLogis European Properties Fund at the time of the initial contribution. Pursuant to the indemnification agreements, ProLogis has recognized a deferred income tax liability of $15.7 million associated with the contributions of 46 properties to ProLogis European Properties Fund during the period from April 1, 2003 to December 31, 2004.
In June 2004, ProLogis entered into an indemnification agreement with ProLogis North American Properties Fund V whereby ProLogis would indemnify ProLogis North American Properties Fund V for
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
certain future capital gains tax liabilities that could be incurred by ProLogis North American Properties Fund V associated with the contribution of assets located in Mexico. ProLogis’ contributions of properties located in Mexico to ProLogis North American Properties Fund V are structured as contributions of the shares of companies that own the real estate assets. Accordingly, the capital gains tax liability in Mexico associated with the step up in the value, if any, of the underlying real estate assets is deferred and transferred to ProLogis North American Properties Fund V at contribution. ProLogis has indemnified ProLogis North American Properties Fund V to the extent that ProLogis North American Properties Fund V incurs capital gains tax in Mexico as a result of a sale of the real estate asset or an interest in the real estate asset. The agreement limits the amount that is subject to ProLogis’ indemnification with respect to each property located in Mexico to the lesser of (1) the actual capital gains tax paid in Mexico upon the sale of the real estate assets or (2) 100% of the capital gains tax liability in Mexico that is deferred and transferred by ProLogis to ProLogis North American Properties Fund V at the time of the initial contribution. Pursuant to the indemnification agreement, ProLogis has recognized a deferred income tax liability of $4.0 million associated with the contributions of 20 properties located in Mexico to ProLogis North American Properties Fund V during the period from March 28, 2002 to December 31, 2004.
Summarized financial information of the property funds as of and for the year ended December 31, 2004 is presented below (in millions of U.S. dollars). The information presented is for the entire entity, not ProLogis’ proportionate share of the entity.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(1)
ProLogis North American Properties Funds VI through X began operations on June 30, 2004 and acquired additional properties on August 4, 2004 with the closing of the Keystone Transaction. See Note 3.
(2)
ProLogis acquired its interests in ProLogis North American Properties Funds XI and XII on August 4, 2004 as part of the Keystone Transaction. Balance sheet amounts presented are 100% of the fair values of the assets and liabilities that were determined as part of the purchase accounting adjustments associated with the Keystone Transaction. See Note 3.
(3)
ProLogis recognizes its proportionate share of the earnings or losses of each the property funds under the equity method, fees that it earns from services it provides to the property funds and interest income on advances made to the property funds, if any. The net earnings of the property funds include interest expense on amounts due to ProLogis, if any. The net earnings of ProLogis European Properties Fund include a net foreign currency exchange loss of $2.0 million.
(4)
Represents the actual ownership interest at December 31, 2004 for each property fund and the weighted average of the ownership interests in all property funds at December 31, 2004 based on each entity’s contribution to total assets, before depreciation, net of other liabilities.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other Investees
At December 31, 2004, ProLogis had investments in: (i) six entities that perform CDFS business activities (the “CDFS Joint Ventures”); (ii) in a temperature-controlled distribution company; and (iii) certain other companies that are not included in either of ProLogis’ two reportable business segments. Generally these investments were structured to allow ProLogis to continue to meet the REIT requirements of the Code. ProLogis’ investments in these companies were as follows as of the dates indicated (in thousands of U.S. dollars):
(1)
ProLogis acquired investments in two entities as part of the Keystone Transaction in August 2004 (see Note 3). ProLogis has a 50% ownership interest in each entity (one entity owns a recently developed operating property with 0.8 million square feet in Indianapolis and one entity has a 0.8 million square foot property under development in Indianapolis).
(2)
ProLogis has active investments in two joint ventures and an investment in one joint venture in which ProLogis discontinued its participation and significantly reduced its investment in November 2003. ProLogis’ ownership interest in each joint venture is 50%. At December 31, 2004, on a combined basis the two joint ventures in which ProLogis actively participates owned land for future development (10 acres) or controlled land positions (396 acres). During 2004, ProLogis acquired the third party interest in one CDFS Joint Venture bringing its ownership to 100%. Therefore, this investment is presented on a consolidated basis at December 31, 2004.
(3)
This joint venture was formed in 2004 with the acquisition of four operating properties aggregating 0.2 million square feet in the Shanghai, China market. Also in 2004, the joint venture began development on two operating properties aggregating 0.2 million square feet in the Shanghai, China market. ProLogis has a 50% ownership interest in the joint venture. This joint venture’s activities are expected to include both the acquisition of properties that will be rehabilitated and/or repositioned as well as development of properties.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(4)
CSI/ Frigo LLC is a limited liability company that owns 100% of the voting common stock of TCL Holding, representing 5% of its net earnings or losses. ProLogis owns 89% of the membership interests (all non-voting) of CSI/ Frigo LLC and K. Dane Brooksher, ProLogis’ Chairman of the Board and former Chief Executive Officer, owns the remaining 11% of the membership interests (all voting) and is the managing member of CSI/ Frigo LLC. Through a participating note agreement between ProLogis and CSI/ Frigo LLC, ProLogis can recognize 95% of the net earnings or losses of CSI/ Frigo LLC.
(5)
TCL Holding, through a wholly owned subsidiary, owns and operates a temperature-controlled distribution network in Europe, primarily in France. ProLogis directly owns 100% of the non-voting preferred stock of TCL Holding, representing a 95% interest in its net earnings or losses. ProLogis’ ownership interests in TCL Holding and CSI/ Frigo LLC, a holding company that has an ownership interest in TCL Holding, did not result in ProLogis having ownership of or control of the voting common stock or the voting membership interests of these entities. Therefore, these entities were not consolidated in ProLogis’ financial statements in 2003. However, upon adopting FIN 46R, ProLogis began consolidating these investments as of January 1, 2004. See Notes 2 and 6.
(6)
TCL Holding has an investment in a temperature-controlled distribution company operating in Austria. While ProLogis’ investment in TCL Holding was presented under the equity method, this investment was not separately reported by ProLogis. See Note 2.
(7)
ProLogis acquired a preferred equity interest in a real estate company as part of the Keystone Transaction. The preferred interest entitles ProLogis to an annual return of approximately $3 million. However, prior to the closing of the Keystone Transaction in August 2004, Nocha LLC advised Keystone and ProLogis that it was experiencing cash flow constraints and that the payment of monthly cash distributions would be impacted. While ProLogis is entitled to receive its full return on the investment, no income was recognized for the year ended December 31, 2004. ProLogis considered this situation in determining the fair value of this investment as part of its purchase accounting adjustments. See Note 3.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
ProLogis recognized its proportionate shares of the net earnings or losses of its other unconsolidated investees including interest income, if any, as follows for the periods indicated (in thousands of U.S. dollars):
(1)
ProLogis acquired its 50% ownership interests in these joint ventures as part of the Keystone Transaction in August 2004. See Note 3.
(2)
For 2004, ProLogis had active investments in two joint ventures that primarily hold land for future development. In addition to these two joint ventures, ProLogis actively participated in a third joint venture until November 2003 when it discontinued its participation in and significantly reduced its investment in a joint venture that owned 11 operating properties. These joint ventures were owned by Kingspark S.A. While ProLogis presented its investments in Kingspark S.A. and Kingspark LLC under the equity method (through June 30, 2002), these investments were not separately presented in ProLogis’ balance sheet. ProLogis’ ownership interest in each joint venture is 50%.
(3)
Through June 30, 2002, ProLogis accounted for its investments in Kingspark LLC and Kingspark S.A. under the equity method and recognized income of $29.5 million for the period from January 1, 2002 through June 30, 2002. All of ProLogis’ CDFS business activities in the United Kingdom were performed through these entities. ProLogis had an effective ownership interest in these entities of 99.75% for the period from January 1, 2002 through June 30, 2002.
(4)
ProLogis has a 50% ownership interest in this joint venture which was formed in 2004.
(5)
CSI/ Frigo LLC recognized its 5% share of the earnings or losses of TCL Holding under the equity method through its ownership of 100% of TCL Holdings’ voting common stock. ProLogis’ non-voting membership interest in CSI/ Frigo entitles it to recognize 89% of the earnings or losses of CSI/ Frigo LLC. However, ProLogis and CSI/ Frigo LLC entered into a note agreement that allows ProLogis to participate in up to 95% of CSI/ Frigo LLC’s net earnings or losses. This investment is presented on a consolidated basis in 2004.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(6)
ProLogis’ shares of the losses of CSI/ Frigo LLC and TCL Holding for the year ended December 31, 2003 includes its proportionate share of an impairment loss recognized by TCL Holding associated with its operations in the United Kingdom that were disposed of in December 2003.
(7)
ProLogis directly owns 100% of the non-voting preferred stock of TCL Holding, representing a 95% interest in the earnings or losses of TCL Holding. On a combined basis through its direct and indirect ownership interests, ProLogis recognized 99.75% of the earnings of TCL Holding under the equity method during year ended December 31, 2003. This investment is presented on a consolidated basis in 2004.
(8)
ProLogis, through TCL Holding, has a 50% ownership interest in an operating company and recognizes its proportionate share of the earnings or losses of this entity under the equity method. While ProLogis’ investments in TCL Holding were presented under the equity method, this income was not separately reported by ProLogis.
(9)
Represents adjustments to the operating expenses of CS Integrated LLC (“CSI”) incurred prior to October 2002 and additional losses associated with CSI’s disposition of a significant portion of its operating assets in October 2002. CSI is owned by ProLogis Logistics Services Incorporated (“ProLogis Logistics”). Prior to the disposition transaction in October 2002, ProLogis recognized 99.23% of the earnings or losses of ProLogis Logistics under the equity method through its direct and indirect ownership interests in CSI.
(10)
Represents ProLogis’ proportionate share of the loss recognized by a company in which ProLogis held a non-voting preferred interest. The loss was generated when this company wrote off its remaining investment in a technology company in which it had invested. See Note 16.
6. Discontinued Operations:
Assets Held For Sale
The net assets of TCL Holding’s temperature-controlled distribution operations in France that are classified as held for sale consisted of the following at December 31, 2004 (in thousands of U.S. dollars):
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
TCL Holding’s operations in France that are classified as held for sale generated a loss of $36.7 million for the year ended December 31, 2004, including an impairment loss of $50.6 million recognized in the fourth quarter of 2004 to reflect the carrying value of the net assets held for sale at their estimated fair value less costs to sell based on current negotiations. These assets were first classified as held for sale in December 2003. While the sale of these assets was not completed within one year of this classification due to unforeseen circumstances, ProLogis does expect to complete the disposal transaction before the end of the second quarter of 2005.
Assets Disposed of in 2004
ProLogis recognized net gains of $36.2 million as discontinued operations for the year ended December 31, 2004. Of the 20 properties disposed of during 2004 that met the criteria to be presented as discontinued operations, 10 properties were CDFS business assets. These properties generated an aggregate net gain of $32.7 million from aggregate net disposition proceeds of $241.0 million. The remaining 10 properties disposed of in 2004 were held and used in ProLogis’ property operations segment. The dispositions of these properties generated an aggregate net gain of $3.5 million from aggregate net disposition proceeds of $23.1 million. Also, included in the net gain recognized related to properties held and used in the property operations segment for 2004 was a charge of $1.9 million, representing an adjustment to the net gains previously recognized, primarily from the sale of TCL Holding’s operating assets in the United Kingdom in December 2003.
The rental income, rental expenses and depreciation expense attributable to the 20 properties that are presented as discontinued operations (other than the amounts recognized upon disposition) are as follows for the periods indicated (in thousands of U.S. dollars):
(1)
Includes rental expenses recovered from customers of $0.2 million, $0.4 million and $0.3 million for the years ended December 31, 2004, 2003 and 2002, respectively.
7.
Borrowings:
Lines of Credit
The following credit agreements provide ProLogis with revolving lines of credit:
•
$400.0 million revolving line of credit; borrowings generally bear interest at the applicable London Interbank Offered Rate (“LIBOR”) for U.S. dollar denominated borrowings plus 0.65% per annum; facility fee of 0.15% per annum; maturity date of November 8, 2005 that may be extended for one year at ProLogis’ option; Bank of America N.A. acts as administrative agent for a syndicate of 15 banks; no borrowings were outstanding at December 31, 2004.
•
$100.0 million multi-currency (U.S. dollar, euro, pound sterling and yen) revolving line of credit; borrowings generally bear interest at LIBOR for the relevant currency borrowed plus 0.675% per annum; facility fee of 0.125% per annum; maturity date of November 4, 2005; Bank of America N.A. acts as administrative agent for a syndicate of six banks; no borrowings were outstanding at December 31, 2004.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
•
$60.0 million multi-currency (U.S. dollar, euro, pound sterling and yen) discretionary line of credit; borrowings, by agreement, bear interest at a rate determined at the time the advance is made; maturity date of November 8, 2005; Bank of America N.A. is the lending bank; no borrowings were outstanding at December 31, 2004; total available borrowing capacity at December 31, 2004 was reduced by $7.2 million, representing ProLogis’ outstanding letters of credit with Bank of America N.A. at December 31, 2004.
•
450.0 million euro (the currency equivalent of approximately $596.9 million at December 31, 2004) multi-currency (U.S. dollar, euro, pound sterling and yen) revolving line of credit; borrowings generally bear interest at the Euro Interbank Offered Rate of the Banking Federation of the European Union (“EURIBOR”) for euro denominated borrowings or LIBOR for the relevant currency borrowed (U.S. dollar, pound sterling and yen) plus 0.80% per annum; unused commitment fee of 0.32% per annum; maturity date of August 8, 2006; ABN AMRO Bank N.V. acts as agent for a syndicate of 23 banks; 313.8 million euro and 50.5 million pound sterling (the currency equivalent of approximately $513.9 million) were outstanding at December 31, 2004 at an average annual interest rate of 3.48%.
•
25.0 million pound sterling (the currency equivalent of approximately $48.3 million at December 31, 2004) revolving line of credit; borrowings bear interest at the Royal Bank of Scotland plc’s base rate plus 1.0% per annum, generally ranging from 4.75% to 5.75% per annum; maturity date of July 31, 2005; Royal Bank of Scotland plc is the lending bank; no borrowings were outstanding at December 31, 2004; total available borrowing capacity at December 31, 2004 was reduced by 14.5 million pound sterling (the currency equivalent of approximately $28.1 million at December 31, 2004), representing ProLogis’ outstanding letters of credit with the Royal Bank of Scotland plc at December 31, 2004.
•
65.0 billion yen (the currency equivalent of approximately $627.0 million at December 31, 2004) revolving line of credit (increased from 40.0 billion yen during 2004); borrowings bear interest at the Tokyo Interbank Offered Rate (“TIBOR”) plus 0.90% per annum; unused commitment fee of 0.25% per annum; maturity date of August 5, 2006 that may be extended for one year at ProLogis’ option; Sumitomo Mitsui Banking Corporation acts as agent for a syndicate of 20 banks; 41.3 billion yen (the currency equivalent of approximately $398.4 million at December 31, 2004) was outstanding at December 31, 2004 at an average annual interest rate of 0.98%.
At December 31, 2004, ProLogis was in compliance with all covenants contained in each of its credit agreements.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
ProLogis’ lines of credit borrowings are summarized below for the periods indicated (in thousands of U.S. dollars as applicable).
(1)
In 2002, ProLogis replaced a $500.0 million line of credit with the two separate facilities currently in place (the $400.0 million facility and the $100.0 million multi-currency facility).
(2)
The aggregate borrowing capacity of the discretionary line of credit has been reduced by an amount representing ProLogis’ outstanding letters of credit with Bank of America N.A. as of December 31st of each year presented ($7.2 million for 2004, $10.4 million for 2003 and $9.2 million for 2002). The aggregate borrowing capacity of the Royal Bank of Scotland plc revolving line of credit has been reduced by an amount representing ProLogis’ outstanding letters of credit with that bank as of December 31st of each year presented ($28.1 million for 2004, $8.8 million for 2003 and $9.9 million for 2002, representing the U.S. dollar equivalent of pound sterling denominated letters of credit outstanding).
Short-Term Borrowing
On November 18, 2004, ProLogis entered into a credit agreement with Bank of America N.A. providing for a short-term borrowing arrangement in the amount of 62.1 million Canadian dollars (the currency equivalent of approximately $51.3 million at December 31, 2004). Borrowings under this credit agreement, which expires on May 18, 2005, generally bear interest at the Canadian Prime Rate plus 0.65% per annum. The agreement also provides for the payment of a facility fee of 0.15% per annum. At December 31, 2004, 57.8 million Canadian dollars were outstanding under this agreement (the currency equivalent of approximately $47.7 million at December 31, 2004) at an average annual interest rate of 3.27%.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Senior Notes
ProLogis has issued senior notes denominated in U.S. dollars that bear interest at fixed rates to be paid on a semi-annual basis. At December 31, 2004, ProLogis had $1.34 billion of publicly traded senior notes (the “Public Notes”) and $160.0 million of senior notes issued pursuant to a private placement (the “Private Placement Notes”) (collectively the “Notes”) outstanding. On April 13, 2004, ProLogis issued 350.0 million euro of senior notes (the currency equivalent of approximately $464.2 million as of December 31, 2004) that are registered on the Luxembourg Stock Exchange (the “Euro Notes”). The Notes require semi-annual interest payments and the Euro Notes require annual interest payments beginning in April 2005. The senior notes outstanding at December 31, 2004 are summarized as follows (in thousands of U.S. dollars as applicable):
(1)
Amounts are net of applicable unamortized original issue discount.
(2)
Principal due at maturity.
(3)
Beginning on May 15, 2005, and through May 15, 2008, requires annual principal payments of $25.0 million.
(4)
Annual principal payments of $18.75 million began on March 1, 2003 and are due on March 1st of each year through 2009.
(5)
Annual principal payments of $9.375 million began on May 15, 2004 and are due on May 15th of each year through 2009.
(6)
Beginning on February 1, 2010, and through February 1, 2015, requires annual principal payments ranging from $10.0 million to $20.0 million.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(7)
Beginning on March 1, 2010, and through March 1, 2015, requires annual principal payments ranging from $5.0 million to $12.5 million.
(8)
Beginning on May 15, 2010, and through May 15, 2016, requires annual principal payments ranging from $5.0 million to $12.5 million.
(9)
The proceeds from the issuance of the Euro Notes were 347.8 million euro (approximately $420.6 million on the date of issuance). A portion of the proceeds were used to repay 76.8 million euro of borrowings under ProLogis’ revolving lines of credit. The remaining cash was repatriated to the United States. The effective annual interest rate is 4.414%.
The holders of the Euro Notes and the Notes, together with various creditors of ProLogis, share in the benefits of the pledge of intercompany debt obligations by certain subsidiaries of ProLogis. However, the Euro Notes and the Notes are effectively subordinated in certain respects to: (i) any debt of ProLogis secured by a lien on its real property, to the extent of the value of such real property; (ii) debt of certain subsidiaries of ProLogis (that by law are not permitted to guarantee debt of ProLogis) that are allowed to borrow under ProLogis’ 65.0 billion yen revolving line of credit agented by Sumitomo Mitsui Banking Corporation; (iii) borrowings under ProLogis’ 25.0 million pound sterling revolving line of credit provided by Royal Bank of Scotland plc; and (iv) debt of certain other non-U.S. subsidiaries of ProLogis that due to restrictions under applicable law or due to tax considerations, or by agreement, are not required to pledge assets to secure debt of ProLogis. In addition, as a result of the termination of a guaranty by certain subsidiaries of ProLogis that was temporarily in place with respect to the Public Notes, the Public Notes are effectively subordinated in certain respects to any debt of ProLogis that has the benefit of a guaranty by one or more subsidiaries of ProLogis.
The Notes and the Euro Notes are redeemable at any time at ProLogis’ option. Such redemption and other terms are governed by the provisions of an indenture agreement for the Public Notes, various note purchase agreements for the Private Placement Notes and a trust deed for the Euro Notes. Under the terms of these agreements, ProLogis must meet certain financial covenants. ProLogis was in compliance with all such covenants as of December 31, 2004.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Secured Debt and Assessment Bonds
Secured debt and assessment bonds outstanding at December 31, 2004 consisted of the following (in thousands of U.S. dollars as applicable):
(1)
The weighted average annual interest rates for the mortgage notes and assessment bonds were 7.14% and 7.08%, respectively, at December 31, 2004. The combined weighted average annual interest rate for all of these borrowings at December 31, 2004 was 7.14%.
(2)
The mortgage notes are secured by various real estate assets with an aggregate undepreciated cost of $944.1 million at December 31, 2004. The property name is used to denote the real estate assets that secure the mortgage note, except for mortgage notes that are secured by a pool of properties, in which case the lender is noted.
(3)
Mortgage note was assumed by ProLogis in connection with a merger transaction in 1999. Under purchase accounting, the mortgage note was recorded at its fair value and a premium or discount was recognized, as applicable.
(4)
Principal balance includes premium. Terms are interest only with the stated principal amount of $47.9 million due at maturity.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(5)
Monthly amortization with a balloon payment due at maturity.
(6)
Fully amortizing.
(7)
Mortgage note was assumed by ProLogis in connection with the Keystone Transaction in 2004. Under purchase accounting, the mortgage note was recorded at its fair value and a premium or discount was recognized, as applicable. See Note 3.
(8)
Interest only with the stated principal amount due at maturity.
(9)
Monthly interest payments are due through May 2005; monthly principal and interest payments are due during the period from June 2005 to April 2024 with a balloon payment due at maturity.
(10)
The assessment bonds are issued by municipalities as a means of financing infrastructure and are secured by assessments (similar to property taxes) on various underlying real estate assets with an aggregate undepreciated cost of $229.2 million at December 31, 2004.
(11)
Includes 13 issues of assessment bonds with four municipalities. Interest rates range from 5.50% per annum to 8.75% per annum. Maturity dates range from April 2005 to March 2021.
Long-Term Debt Maturities
The approximate principal payments due on the senior notes, secured debt (mortgage notes and securitized debt) and assessment bonds during each of the years in the five-year period ending December 31, 2009 and thereafter are as follows (in thousands of U.S. dollars):
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Interest Expense
Interest expense for the periods indicated includes the following components (in thousands of U.S. dollars):
(1)
Includes the stated interest on the debt instrument plus applicable fees.
(2)
The amount of interest paid in cash for the years ended December 31, 2004, 2003 and 2002 was $173.6 million, $184.3 million and $178.1 million, respectively.
8. Minority Interest:
The minority interest liability at December 31, 2004 consists of:
•
a $63.9 million liability representing the limited partners’ interests in five partnerships controlled by ProLogis;
•
a $2.9 million liability representing the Acquiring Property Funds combined interest in the management company acquired by ProLogis as part of the Keystone Transaction (see Note 3); and
•
offset by $0.5 million representing the minority interest holder’s share of the cumulative losses of TCL Holding S.A. (see Notes 2 and 6).
Pursuant to certain partnership agreements, ProLogis or a wholly owned subsidiary of ProLogis is the sole controlling general partner of each of five real estate partnerships with all management powers over the business and affairs of the partnership. The limited partners of each of the partnerships generally do not have the authority to transact business for, or participate in the management decisions of, the partnerships. The general partner in each of the partnerships may not, without the written consent of all of the limited partners: (i) take any action that would prevent the partnership from conducting its business; (ii) possess the property of the partnership; (iii) admit an additional partner; or (iv) subject a limited partner to the liability of a general partner. In each partnership, ProLogis or a wholly owned subsidiary, may not voluntarily withdraw from the partnership or transfer or assign its interests in the partnership without the consent of all of the limited partners. The limited partners may freely transfer their partnership units to their affiliates, provided that the transfer does not cause a termination of the partnership under the Code and does not cause ProLogis to cease to comply with the REIT requirements of the Code.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The five partnerships in which ProLogis is the general partner are as follows at December 31, 2004 (in millions of U.S. dollars as applicable):
(1)
During 2004, all of the outstanding limited partnership units in ProLogis Limited Partnership-II were converted into Common Shares bringing ProLogis’ ownership in this partnership to 100%.
(2)
Each outstanding limited partnership unit is entitled to receive cumulative preferential quarterly cash distributions equal to the quarterly distributions paid on Common Shares.
(3)
These properties cannot be sold, prior to the occurrence of certain events, without the consent of the limited partners, other than in tax-deferred exchanges. The Partnership Agreement provides that a minimum level of debt must be maintained within the Partnership, which can include intercompany debt to ProLogis.
(4)
Each limited partnership unit is convertible into one Common Share.
(5)
Entities in which Irving F. Lyons, III, ProLogis’ Vice Chairman and former Chief Investment Officer, has ownership interests owned 2,459,183 of the outstanding limited partnership units in ProLogis Limited Partnership-I at December 31, 2004 or 17.1% of ProLogis Limited Partnership-I’s total units outstanding at December 31, 2004. Mr. Lyons’ effective ownership in ProLogis Limited Partnership-I was 1.8% at December 31, 2004. See Note 16.
(6)
All of the outstanding limited partnership units in ProLogis Limited Partnership-III are owned by Jeffrey H. Schwartz, ProLogis’ Chief Executive Officer. See Note 16.
(7)
ProLogis Limited Partnership-IV was formed through a cash contribution from a wholly owned subsidiary of ProLogis, ProLogis IV, Inc. and through the contribution of properties from the limited partner. ProLogis Limited Partnership-IV and ProLogis IV, Inc. are legal entities that are separate and distinct from ProLogis, its affiliates and each other, and each has separate assets, liabilities, business functions and operations. At December 31, 2004, the sole asset of ProLogis IV, Inc. was its interest in ProLogis Limited Partnership-IV. At December 31, 2004, ProLogis IV, Inc. had outstanding borrowings from ProLogis of $0.6 million.
(8)
During 2004, 4,919 limited partnership units in ProLogis Limited Partnership-IV were converted into Common Shares. After this conversion, all of the outstanding limited partnership units of ProLogis Limited Partnership-IV are owned by Jeffrey H. Schwartz, ProLogis’ Chief Executive Officer. See Note 16.
(9)
This partnership was formed by another REIT that was merged with and into ProLogis in 1999.
(10)
Each limited partnership unit is convertible into 1.1 Common Shares, plus $2.00.
(11)
Each of the outstanding limited partnership units in this partnership are entitled to receive quarterly cash distributions based on available cash, as defined in the partnership agreement. See Note 3.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(12)
This limited partnership was formed on August 4, 2004 in connection with the Keystone Transaction to directly acquire certain net assets of Keystone, including but not limited to real estate assets and interests in property funds that own real estate assets, valued at approximately $245 million as of August 4, 2004. The limited partnership units were valued at $29.7 million. See Note 3.
9. Shareholders’ Equity:
Shares Authorized
At December 31, 2004, 275,000,000 shares were authorized. The Board may increase the number of authorized shares and may classify or reclassify any unissued shares of ProLogis stock from time to time by setting or changing the preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications and terms or conditions of redemption of such shares.
Common Shares
ProLogis had 185,788,783 and 180,182,615 Common Shares outstanding at December 31, 2004 and 2003, respectively. Common Shares have a par value of $0.01 per share.
ProLogis sells and/or issues Common Shares under various Common Share plans, including share-based compensation plans as follows:
•
1999 Dividend Reinvestment and Share Purchase Plan, amended in November 2002 (the “1999 Common Share Plan”): Allows holders of Common Shares to automatically reinvest Common Share distributions and certain holders and persons who are not holders of Common Shares to purchase a limited number of additional Common Shares by making optional cash payments, without payment of any brokerage commission or service charge. Common Shares that are acquired under the 1999 Common Share Plan, either through reinvestment of distributions or through optional cash payments, are acquired at a price ranging from 98% to 100% of the market price of such Common Shares, as determined by ProLogis. ProLogis generated net proceeds of $35.2 million from the issuance of 1,021,000 Common Shares in 2004, $26.2 million from the issuance of 991,000 Common Shares in 2003 and $125.6 million from the issuance of 5,295,000 Common Shares in 2002 under the 1999 Common Share Plan.
•
Continuous equity offering plan: Allows ProLogis to sell up to 7,400,000 Common Shares through two designated agents who earn a fee of between 2.0% and 2.25% of the gross proceeds. In 2004, ProLogis sold 1,430,000 Common Shares under this plan generating net proceeds to ProLogis of $53.3 million.
•
Long-term incentive plan (the “Incentive Plan”) and Share Option Plan for Outside Trustees (the “Outside Trustees Plan”): Certain employees and members of the Board participate in these share-based compensation plans that provide compensation, generally in the form of Common Shares. There are an aggregate of 22,600,000 Common Shares (190,000 of which are allocated to the ProLogis 401(k) Plan and Trust) that have been made available for award under the Incentive Plan, of which 4,090,000 Common Shares were available for future awards at December 31, 2004 (3,900,000 under the Incentive Plan and 190,000 that are allocated to the 401(k) Plan and Trust). Of the 3,900,000 available for future awards, 3,083,000 Common Shares can only be awarded in the form of share options and 817,000 Common Shares can only be awarded in other forms as allowed under the Incentive Plan, excluding share options. There are an aggregate of 500,000 Common Shares that have been made available under the Outside Trustees Plan of which 282,000 Common Shares are available for future awards at December 31, 2004. Under the Incentive Plan and the Outside Trustees Plan, the exercise of share options and other share awards generated net proceeds to ProLogis of $61.0 million from the issuance of 3,096,000 Common Shares in 2004, $21.4 million from the issuance of 1,296,000 Common Shares in 2003 and $18.7 million from the issuance of 1,073,000 Common Shares in 2002.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Also, in 2004, 2003 and 2002, certain employees who earned share awards under the Incentive Plan received cash payments of $2.6 million, $4.3 million and $0.1 million, respectively in lieu of Common Shares. See Note 15.
•
ProLogis Trust Employee Share Purchase Plan (the “Employee Share Plan”): Employees of ProLogis and its participating entities may purchase Common Shares, through payroll deductions only, at a discounted price of 85% of the market price of the Common Shares. The aggregate fair value of Common Shares that an individual employee can acquire in a calendar year under the Employee Share Plan is $25,000. Subject to certain provisions, the aggregate number of Common Shares that may be issued under the Employee Share Plan may not exceed 5,000,000. ProLogis began issuing Common Shares under the Employee Share Plan in January 2002. In 2004, 2003 and 2002, 43,000, 34,000 and 22,000 Common Shares were purchased under the Employee Share Plan, respectively, generating net proceeds to ProLogis of $1.1 million, $0.7 million and $0.4 million, respectively.
Limited partnership units were redeemed into 16,000 Common Shares in 2004, 104,000 Common Shares in 2003 and 272,000 Common Shares in 2002 (see Note 8).
ProLogis may repurchase up to $215.0 million of Common Shares under a Common Share repurchase program that began in January 2001. Through December 31, 2004, a total of 5,571,100 Common Shares have been repurchased at a total cost, including fees and commissions paid, of $130.9 million. ProLogis did not repurchase any Common Shares during 2004 and has not made any Common Share repurchases through March 11, 2005. The Common Shares that have been repurchased to date were purchased through open market and privately negotiated transactions, depending on market prices and other conditions. Included in these repurchases are 393,600 Common Shares that were repurchased from employees to retire $9.7 million of outstanding loans related to employee share purchases in 1997.
Preferred Shares
At December 31, 2004, ProLogis had three series of Preferred Shares outstanding (“Series C Preferred Shares”, “Series F Preferred Shares”, and “Series G Preferred Shares”). Holders of each series of Preferred Shares outstanding have, subject to certain conditions, limited voting rights and all holders are entitled to receive cumulative preferential dividends based upon each series’ respective liquidation preference. Such dividends are payable quarterly in arrears on the last day of March, June, September and December. Dividends on Preferred Shares are payable when, and if, they have been declared by the Board, out of funds legally available for the payment of dividends. After the respective redemption dates, each series of Preferred Shares can be redeemed at ProLogis’ option. The cash redemption price (other than the portion consisting of accrued and unpaid dividends) with respect to Series C Preferred Shares is payable solely out of the cumulative sales proceeds of other capital shares of ProLogis, which may include shares of other series of Preferred Shares. With respect to the payment of dividends, each series of Preferred Shares ranks on parity with ProLogis’ other series of preferred shares.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
ProLogis’ Preferred Shares outstanding at December 31, 2004 are summarized as follows (amounts in U.S. dollars as applicable):
The following preferred share redemptions occurred during the years ended December 31, 2004, 2003 and 2002:
•
All of the 10,000,000 Series D Preferred Shares were redeemed (5,000,000 on December 1, 2003 and 5,000,000 on January 12, 2004). The 2003 redemption was at the price of $25.00 per share, plus $0.3355 in accrued and unpaid dividends for a total redemption value (including accrued dividends) of $126.7 million. The 2004 redemption was at the price of $25.00 per share, plus $0.066 in accrued and unpaid dividends for a total redemption value (including accrued dividends) of $125.3 million. ProLogis recognized a charge of $4.2 million in both 2004 and 2003 representing the excess of the redemption values over the carrying values of the Series D Preferred Shares redeemed in each period.
•
All of the 2,000,000 outstanding Series E Preferred Shares were redeemed on July 1, 2003 at the price of $25.00 per share, plus $0.3685 in accrued and unpaid dividends. The total redemption value (including accrued dividends) was $50.7 million. ProLogis recognized a charge of $3.6 million representing the excess of the redemption value over the carrying value of the Series E Preferred Shares redeemed. The carrying value of the Series E Preferred Shares included a purchase accounting adjustment that was recognized when these shares were issued as part of a 1999 merger transaction.
Shelf Registration
ProLogis has a shelf registration statement on file with the SEC that allows it to issue securities in the United States in the form of debt securities, Preferred Shares, Common Shares, rights to purchase Common Shares and Preferred Share purchase rights on an as-needed basis. At December 31, 2004, $695.4 million of shelf-registered securities were available for issuance, subject to ProLogis’ ability to affect an offering on satisfactory terms.
Ownership Restrictions
For ProLogis to qualify as a REIT under the Code, five or fewer individuals may own not more than 50% of the value of its outstanding shares of beneficial interest at any time during the last half of ProLogis’ taxable year. Therefore, ProLogis’ Declaration of Trust restricts beneficial ownership (or ownership generally attributed to a person under the REIT tax rules) of ProLogis’ outstanding shares of beneficial interest by a single person, or persons acting as a group, to 9.8% of ProLogis’ outstanding shares. This provision assists ProLogis in protecting and preserving its REIT status and protects the interests of shareholders in takeover transactions by preventing the acquisition of a substantial block of outstanding shares.
Shares of beneficial interest owned by a person or group of persons in excess of these limits are subject to redemption by ProLogis. The provision does not apply where a majority of the Board, in its sole and absolute discretion, waives such limit after determining that the status of ProLogis as a REIT for federal income tax
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
purposes will not be jeopardized or the disqualification of ProLogis as a REIT is advantageous to the shareholders.
10.
Distributions and Dividends:
Common Share Distributions
In order to comply with the REIT requirements of the Code, ProLogis is generally required to make Common Share distributions (other than capital gain distributions) to its shareholders in amounts at least equal to (i) the sum of (a) 90% of its “REIT taxable income” computed without regard to the dividends paid deduction and its net capital gains and (b) 90% of the net income (after tax), if any, from foreclosure property, minus (ii) certain excess noncash income. ProLogis’ Common Share distribution policy is to distribute a percentage of its cash flow that ensures that ProLogis will meet the distribution requirements of the Code and that allows ProLogis to maximize the cash retained to meet other cash needs, such as capital improvements and other investment activities.
In December 2004, the Board announced an increase in the annual distribution level for 2005 from $1.46 to $1.48 per Common Share. The payment of Common Share distributions is subject to the discretion of the Board, is dependent upon ProLogis’ financial condition and operating results, and may be adjusted at the discretion of the Board during the year. A distribution of $0.37 per Common Share for the first quarter of 2005 was declared on February 1, 2005. This distribution was paid on February 28, 2005 to holders of Common Shares on February 15, 2005.
Common Share distributions to shareholders are characterized for federal income tax purposes as ordinary income, capital gains, non-taxable return of capital or a combination of the three. Common Share distributions that exceed ProLogis’ current and accumulated earnings and profits (calculated for tax purposes) constitute a return of capital rather than a dividend and generally reduce the shareholder’s basis in the Common Shares. To the extent that a distribution exceeds both current and accumulated earnings and profits and the shareholder’s basis in the Common Shares, it will generally be treated as a gain from the sale or exchange of that shareholder’s Common Shares. At the beginning of each year, ProLogis notifies its shareholders of the taxability of the Common Share distributions paid during the preceding year. The following summarizes the taxability of Common Share distributions for the periods indicated (in U.S. dollars; taxability for 2004 is estimated):
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Preferred Share Dividends
Annual per share dividends paid on each series of Preferred Shares were as follows for the periods indicated (in U.S. dollars):
(1)
For federal income tax purposes, $3.62 of the 2004 dividend, $4.11 of the 2003 dividend and $4.04 of the 2002 dividend are estimated to represent ordinary income to the holders with the remaining portions of each dividend estimated to represent capital gains.
(2)
For federal income tax purposes, of the $1.98 per share dividend paid in 2003 on shares that were not redeemed, $1.90 is estimated to represent ordinary income to the holders and of the total 2002 dividend, $1.87 is estimated to represent ordinary income to the holders. The remaining portions in each year are estimated to represent capital gains.
(3)
ProLogis redeemed all of its 10,000,000 outstanding Series D Preferred Shares (5,000,000 shares on January 12, 2004 and 5,000,000 shares on December 1, 2003). No Series D Preferred Share dividends were declared and paid in 2004, although the total redemption value included accrued and unpaid dividends of $0.066 per share. For 2003, the total dividends paid on the 5,000,000 shares redeemed in that year were $1.82 per share, of which $1.48 was declared and paid prior to the redemption and $0.34 represented accrued and unpaid dividends that were included in the redemption value. Of the dividend declared and paid in 2003 of $1.48 per share, $1.26 is estimated to be ordinary income to the holders, $0.16 is estimated to be qualified dividends and $0.06 is estimated to represent capital gains
(4)
ProLogis redeemed all of its 2,000,000 outstanding Series E Preferred Shares on July 1, 2003. The total dividends paid on the redeemed shares in 2003 were $1.46 per share, of which $1.09 was declared and paid prior to the redemption and $0.37 represented accrued and unpaid dividends that were included in the redemption value. Of the dividend declared and paid in 2003 of $1.09 per share, $0.93 is estimated to represent ordinary income to the holders, $0.12 is estimated to be qualified dividends and $0.04 is estimated to represent capital gains.
(5)
The Series F Preferred Shares were issued on November 28, 2003. For federal income tax purposes, $1.43 of the 2004 dividend and $0.14 of the 2003 dividend are estimated to represent ordinary income to the holders with the remainder estimated to represent capital gains.
(6)
The Series G Preferred Shares were issued on December 30, 2003. For federal income tax purposes, $1.43 of the 2004 dividend is estimated to represent ordinary income to the holders with the remainder estimated to represent capital gains.
Pursuant to the terms of its Preferred Shares, ProLogis is restricted from declaring or paying any distribution with respect to its Common Shares unless and until all cumulative dividends with respect to the Preferred Shares have been paid and sufficient funds have been set aside for dividends that have been declared for the then-current dividend period with respect to the Preferred Shares.
ProLogis’ tax return for the year ended December 31, 2004 has not been filed. The taxability information presented for ProLogis’ distributions and dividends paid in 2004 is based upon the best available data.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
ProLogis’ tax returns for previous tax years have not been examined by the Internal Revenue Service. Consequently, the taxability of distributions and dividends is subject to change.
11.
Earnings Per Common Share:
Reconciliations of the numerator and denominator used to calculate basic net earnings attributable to Common Shares per share to the numerator and denominator used to calculate diluted net earnings attributable to Common Shares per share for the periods indicated are as follows (in thousands of U.S. dollars, except per share amounts):
(1)
Total weighted average potentially dilutive instruments outstanding were 11,356,000, 10,937,000 and 10,866,000 for 2004, 2003 and 2002, respectively. Of the total potentially dilutive instruments, 553,000, 503,000 and 2,101,000 were antidilutive for 2004, 2003 and 2002, respectively.
12.
Business Segments:
ProLogis has two reportable business segments:
•
Property operations - representing the long-term ownership, management and leasing of industrial distribution properties, either directly or through investments in unconsolidated property funds in which ProLogis has an ownership interest and acts as manager. Each operating property and each investment in a property fund is considered to be an individual operating segment having similar economic characteristics that are combined within the reportable segment based upon geographic location. ProLogis’ operations in the property operations business segment are in North America (the United States and Mexico), Europe (primarily through its investment in ProLogis European Properties Fund which operates in 11 countries, primarily France and the United Kingdom), and Asia (Japan, primarily through its investment in ProLogis Japan Properties Fund, and Singapore).
•
CDFS business - representing the development, acquisition and rehabilitation and/or acquisition and repositioning of industrial distribution properties with the intent to contribute the properties to unconsolidated property funds in which ProLogis has an ownership interest and acts as manager or to sell the developed properties to third parties. Additionally, ProLogis includes the fees earned for
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
development activities on behalf of customers or third parties. Dispositions of land parcels when ProLogis’ development plans no longer include the development of the parcels are also included in this reportable segment. The separate activities in this segment are considered to be individual operating segments having similar economic characteristics that are combined within the reportable segment based upon geographic location. ProLogis’ CDFS business segment operations are in North America (the United States, Mexico and Canada), in 11 countries in Europe (France, United Kingdom, Poland, Netherlands, Italy, Germany, Spain, Czech Republic, Sweden, Hungary and Belgium) and in Asia (Japan, China and Singapore).
The assets of the CDFS business segment generally include properties under development and land held for development. During the period between the completion of development, rehabilitation or repositioning of a property and the date the property is contributed to a property fund or sold to a third party, the property and its associated rental income and rental expenses are included in the property operations segment because the primary activity associated with the property during that period is leasing. Upon contribution or sale, the resulting gain or loss is part of the income of the CDFS business segment.
Through December 31, 2002, ProLogis’ investments in companies that operated temperature-controlled distribution networks met the criteria of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”, to be presented as a reportable business segment. Beginning in 2003, these investments no longer met the requirements to be separately reported. Consequently, ProLogis’ investments in temperature-controlled distribution operating companies are no longer separately presented and amounts for periods previously presented have been reclassified. Certain sales to third parties are presented as discontinued operations. See Note 6.
Reconciliations are presented below for: (i) each reportable business segment’s income from external customers to ProLogis’ total revenues; (ii) each reportable business segment’s net operating income from external customers to ProLogis’ earnings before minority interest; and (iii) each reportable business segment’s assets to ProLogis’ total assets. ProLogis’ 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 ProLogis’ revenues, earnings before minority interest and assets are allocated to each reportable business segment’s income, net operating income and assets. Items that are not directly assignable to a segment are reflected as reconciling items. The following reconciliations are presented in thousands of U.S. dollars:
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(1)
Although certain properties owned by ProLogis North American Properties Fund V in 2004, 2003 and 2002 are located in Mexico (19 properties at December 31, 2004, 15 properties at December 31, 2003 and 13 properties at December 31, 2002), ProLogis classifies its entire investment in ProLogis North American Properties Fund V and the associated income recognized under the equity method from its investment in this property fund as part of its United States income, operating income and assets in the property operations segment.
(2)
Excludes rental income of $2,949,000 ($2,060,000 for the United States and $889,000 for Europe), $3,224,000 (all for the United States) and $2,627,000 (all for the United States) for the years ended December 31, 2004, 2003 and 2002, respectively, associated with properties sold to third parties during 2004. These amounts are presented as discontinued operations by ProLogis. See Note 6.
(3)
All amounts relate to properties and operations in Mexico.
(4)
Amounts for each year were generated by operations in Japan with the exception of $44,000 in 2004 which relates to operations in Singapore.
(5)
Amounts include the operations of ProLogis that are reported on a consolidated basis, including the fees earned by ProLogis for providing services to its unconsolidated property funds and ProLogis’ proportionate shares of the earnings or losses of its unconsolidated property funds recognized under the equity method. See Note 5.
(6)
Excludes rental expenses of $777,000 ($474,000 for the United States and $303,000 for Europe), $1,061,000 ($877,000 for the United States and $184,000 for Europe) and $687,000 (all for the United States) for the years ended December 31, 2004, 2003 and 2002, respectively, associated with properties sold to third parties in 2004. These amounts are presented as discontinued operations by ProLogis. See Note 6.
(7)
Amounts recognized under the equity method from an unconsolidated property fund operating in Europe include net foreign currency exchange losses of $0.4 million, $13.4 million and $4.5 million in 2004, 2003 and 2002, respectively. See Note 5.
(8)
Amounts for each year were generated by operations in Japan with the exception of $42,000 in 2004 which relates to operations in Singapore.
(9)
Net proceeds from dispositions of CDFS business assets were as follows:
•
United States: $376.1 million, $357.6 million and $400.4 million for the years ended December 31, 2004, 2003 and 2002, respectively;
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
•
Other North America (all in Mexico): $21.2 million, $24.0 million and $86.8 million for the years ended December 31, 2004, 2003 and 2002, respectively;
•
Europe: $674.1 million, $363.8 million and $392.6 million for the years ended December 31, 2004, 2003 and 2002, respectively; and
•
Asia (all in Japan): $217.3 million, $155.6 million and $61.2 million for the years ended December 31, 2004, 2003 and 2002, respectively.
(10)
Excludes net proceeds from dispositions of $241.0 million and net gains from dispositions of $32.7 million the year ended December 31, 2004 associated with properties sold to third parties during 2004. These amounts are presented as discontinued operations by ProLogis. See Note 6.
(11)
Includes amounts recognized under the equity method. See Note 5.
(12)
Other than $77,000 recognized in 2004 from ProLogis’ investment in a CDFS Joint Venture operating in China, all amounts are related to the contributions of properties to ProLogis Japan Properties Fund.
(13)
These amounts relate to unconsolidated investees that do not operate in one of ProLogis’ two reportable business segments. See Note 5.
(14)
Includes properties that were developed or acquired in the CDFS business segment that have not yet been contributed or sold as follows:
•
United States: $335.6 million, $388.2 million and $326.8 million at December 31, 2004, 2003 and 2002, respectively;
•
Other North America (all in Mexico): $69.1 million, $59.8 million and $45.3 million at December 31, 2004, 2003 and 2002, respectively;
•
Europe: $323.7 million, $480.3 million and $290.9 million at December 31, 2004, 2003 and 2002, respectively; and
•
Asia (all in Japan): $169.5 million at December 31, 2004.
(15)
Amounts include investments presented under the equity method. See Note 5.
(16)
At December 31, 2004, includes assets in Japan of $245.0 million and assets in Singapore of $11.6 million. At December 31, 2003 and 2002, all assets are in Japan.
(17)
At December 31, 2004, includes assets in Mexico of $31.6 million and assets in Canada of $51.3 million. At December 31, 2003 and 2002, all assets are in Mexico.
(18)
At December 31, 2004, includes assets in Japan of $223.0 million, in China of $28.4 million and assets in Singapore of $1.9 million. At December 31, 2003 and 2002, all assets are in Japan.
13.
Supplemental Cash Flow Information:
Non-cash investing and financing activities for the years ended December 31, 2004, 2003 and 2002 are as follows:
•
ProLogis received $115.5 million, $55.8 million and $67.3 million of equity interests in property funds from the contribution of properties to these property funds during 2004, 2003 and 200, respectively.
•
Net foreign currency translation adjustments of $63.3 million $101.2 million and $111.0 million were recognized in 2004, 2003 and 2002, respectively.
•
Limited partnership units aggregating $0.9 million, $0.4 million and $1.5 million were converted into Common Shares in 2004, 2003 and 2002, respectively.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
•
During 2004, 2003, and 2002, ProLogis capitalized portions of the total cost of its share-based compensation awards of $4.7 million, $5.0 million and $4.1 million, respectively, to the investment basis of its real estate assets.
•
As partial consideration for certain property contributions, ProLogis received: (i) $23.4 million and $24.9 million in the form of notes receivable from ProLogis North American Properties Fund V in 2004 and 2003, respectively, ($20.2 million outstanding at December 31, 2004); (ii) a $21.4 million note receivable from ProLogis Japan Properties Fund in December 2003, which was repaid in January 2004; (iii) a $50.9 million note from a third party (all of which was outstanding at December 31, 2004); and (iv) the assumption of an outstanding mortgage note in the amount of $14.5 million by ProLogis North American Properties Fund VII.
•
On October 23, 2002, ProLogis acquired the voting common stock of ProLogis Logistics and began presenting its investment in ProLogis Logistics on a consolidated basis. Prior to this change in reporting method, ProLogis’ investment in ProLogis Logistics was presented under the equity method. See Notes 2 and 5. At October 23, 2002, ProLogis’ investment in ProLogis Logistics was $85.5 million. ProLogis Logistics had total assets of $117.3 million, liabilities to third parties of $17.7 million, minority interest liability to ProLogis of $99.6 million and net equity of ($31,000) at October 23, 2002.
•
On July 1, 2002, ProLogis acquired the voting membership interests in Kingspark LLC. Kingspark LLC owned the voting common stock of Kingspark S.A. Consequently, ProLogis began presenting its investments in both Kingspark S.A. and Kingspark LLC on a consolidated basis. Prior to this change in reporting method, ProLogis’ investments in Kingspark LLC and Kingspark S.A. were presented under the equity method. See Notes 2 and 5. At June 30, 2002, ProLogis’ combined investments in Kingspark LLC and Kingspark S.A. were $510.1 million (net of amounts deferred related to the portion of gains that do not qualify for current income recognition of $19.5 million - see Note 5). Kingspark S.A. and Kingspark LLC had combined total assets of $644.0 million; combined liabilities to third parties of $114.1 million (including $31.4 million of line of credit borrowings); combined minority interest liability to ProLogis of $529.6 million (including loans of $429.7 million) and net equity of $0.3 million at July 1, 2002.
•
ProLogis assumed $37.2 million of secured debt in connection with the acquisition of properties in 2002.
See also the discussion of the Keystone Transaction in Note 3.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14.
Selected Quarterly Financial Data (Unaudited):
Selected quarterly financial data (in thousands of U.S. dollars, except for per share amounts) for 2004 and 2003 is as follows:
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
ProLogis disposed of 20 properties in 2004 that met the criteria to be presented as discontinued operations. Rental income, rental expenses and depreciation expense attributable to these properties for the three-month periods ended March 31, 2004, June 30, 2004 and September 30, 2004 as reported in ProLogis’ Quarterly Reports on Form 10-Q for those quarterly periods and for the three-month periods in 2003 as reported in ProLogis’ 2003 Annual Report on Form 10-K have been restated to reflect the classification of these properties as discontinued operations for all applicable periods.
In order to conform to the presentation adopted in the fourth quarter of 2003 to reflect rental expense recoveries from customers as a part of rental income rather than as a reduction to rental expenses, rental income amounts for the three-month periods ended March 31, 2003, June 30, 2003, September 30, 2003 as
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
reported in ProLogis’ Quarterly Reports on Form 10-Q for those quarterly periods are presented after reclassification. This adjustment has no effect on ProLogis’ net earnings attributable to Common Shares for these periods.
15.
Long-Term Compensation:
Incentive Plan and Outside Trustees Plan
The Incentive Plan includes a share option plan, a restricted share unit plan and a performance share plan. No more than 22,410,000 Common Shares in the aggregate may be awarded under the Incentive Plan and no individual may be granted awards with respect to more than 500,000 Common Shares in any one-year period. Common Shares may be awarded under the Incentive Plan through 2007. Additionally, ProLogis has 500,000 Common Shares authorized for issuance under the Outside Trustees Plan. At December 31, 2004, 3,900,000 Common Shares remain to be issued under the Incentive Plan and 282,000 Common Shares remain to be issued under the Outside Trustees Plan. Of the total available for future awards under the Incentive Plan, 3,083,000 Common Shares can only be awarded in the form of share options and 817,000 Common Shares can only be awarded in other forms as allowed under the Incentive Plan, excluding share options.
Share Options
ProLogis has granted various share options under the Incentive Plan and the Outside Trustees Plan. Share options issued under the Incentive Plan and the Outside Trustees Plan provide for graded vesting at various rates over periods from one to 10 years, subject to certain conditions. Each share option is exercisable into one Common Share. Share options outstanding at December 31, 2004 were as follows:
(1)
The exercise price is equal to the average of the high and low market prices on the date of grant for each issuance.
(2)
Share options granted generally vest over a four-year period.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(3)
The holders of share options granted before 2001 earn dividend equivalent units (“DEU”) each year until the earlier of the date the underlying share option is exercised or the expiration date of the underlying share option. The holders of share options granted in 2001 earn DEUs only through the vesting period of the underlying share option and the holders of share options granted in 2002 and later do not earn DEUs.
(4)
Share options granted in 1997 vested over a five-year period while other share options granted generally vest over a four-year period.
(5)
The holders of these share options earn DEUs each year until the earlier of the date the underlying share option is exercised or the end of the year prior to the expiration date of the underlying share option.
(6)
The holders of these share options earn DEUs each year until the earlier of the date the underlying share option is exercised or the end of the vesting period of the underlying share option.
(7)
The holders of these share options do not earn DEUs.
(8)
In September 1997, certain employees of ProLogis purchased Common Shares at a price of $21.21875 per share. ProLogis financed 95% of the total price ($27.3 million) of the 1,356,834 Common Shares purchased through ten-year, recourse notes to the participants. For each Common Share purchased, participants were granted two options each to purchase one Common Share for $21.21875. In November 2002, ProLogis repurchased the 393,602 Common Shares that were outstanding from the 1997 employee purchases for $24.643 per share. The employees who sold their Common Shares to ProLogis used the $9.7 million of proceeds that they received from the sales of their Common Shares to repay all of the outstanding amounts due on their notes. As incentive to allow ProLogis to repurchase these Common Shares, ProLogis issued 587,793 share options, each to purchase one Common Share for $24.643 to the employees.
The weighted average fair value of the share options granted under the Incentive Plan to ProLogis’ employees and granted under the Outside Trustees Plan during 2004 was $5.10 per option. The activity with respect to ProLogis’ share options is presented below for the periods indicated.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Restricted Share Units
Restricted share units (“RSU”) in the form of Common Shares are granted at a rate of one Common Share per RSU from time to time to employees of ProLogis. The RSUs are valued on the grant date based upon the market price of a Common Share on that date. ProLogis recognizes the value of the RSUs granted over the applicable vesting period as compensation expense.
Additional information with respect to ProLogis’ RSUs includes:
•
There were 706,325 RSUs outstanding at December 31, 2004 with a total value of $17.7 million. Of the RSUs outstanding, 361,875 RSUs were vested with the remaining 344,450 RSUs scheduled to vest through December 31, 2008 (100,858 in each of 2005, 2006 and 2007 with the remainder in 2008).
•
Of the total value of the RSUs outstanding, ProLogis had recognized $9.2 million as compensation expense through December 31, 2004 with the remainder scheduled to be recognized as compensation expense through December 31, 2008 ($2.6 million in each of 2005, 2006 and 2007 with the remainder in 2008).
•
Activity in 2004 included new RSU grants (4,450 at a total value of $0.2 million) and RSU exercises (1,875).
Performance Share Plan
Under the performance share plan, certain employees are granted performance share awards (“PSA”). The grants are based on performance criteria established in advance for each employee eligible for the grant. If, based on the performance criteria, a PSA is earned, the recipient must continue to be employed by ProLogis for two years before any portion of the grant is vested. The PSAs carry no voting rights during this two-year waiting period but do earn DEUs, which are vested at the end of the two-year waiting period. The PSAs are valued on the grant date, generally December 31st, based upon the market price of a Common Share on that date. ProLogis recognizes the value of the PSAs granted over the two-year vesting period as compensation expense. For the PSAs that were earned on December 31, 2003 and 2002, ProLogis gave certain employees the option to receive their award in the form of Common Shares or in cash. When cash is paid in settlement of vested PSAs, ProLogis recognizes any excess of the total amount of cash paid over the original value of the award as additional expense at the time the payment is made.
Additional information with respect to ProLogis’ PSAs includes:
•
There were 811,000 PSAs outstanding at December 31, 2004 with an original value of $27.8 million. Of the PSAs outstanding, 242,050 PSAs with a total value of $6.1 million were fully vested at December 31, 2004 and were distributed in the form of Common Shares to employees in January 2005.
•
Of the PSAs outstanding at December 31, 2004 that had not vested, 260,500 PSAs with a total value of $8.3 million are scheduled to vest on December 31, 2005. The remaining 308,450 PSAs outstanding at December 31, 2004 with an original value of $13.4 million were granted on that date and are scheduled to vest on December 31, 2006.
•
The total value of the vested PSAs at December 31, 2004 had been recognized as compensation expense by ProLogis as of that date. Through December 31, 2004, ProLogis had recognized compensation expense with respect to $4.2 million of the $8.3 million original value of the PSAs scheduled to vest at December 31, 2005. The remaining $4.1 million of value is scheduled to be recognized as compensation expense in 2005.
•
The PSAs granted in 2004 will be expensed in 2005 and 2006 ($6.7 million in each year).
Dividend Equivalent Units
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DEUs in the form of Common Shares are earned at a rate of one Common Share per DEU for certain share options, RSUs and PSAs. The DEUs are valued on the grant date, generally December 31st, based on the market price of the Common Shares on that date. ProLogis recognizes the value as compensation expense over the vesting period of the underlying share award. Beginning in 2002, share options granted do not earn DEUs. Of the total RSUs outstanding, 167,500 RSUs do not earn DEUs, but do receive cash dividends at ProLogis’ current Common Share annual distribution rate. All PSAs earn DEUs.
ProLogis had 1,128,000 DEUs with a total value of $32.5 million outstanding at December 31, 2004. Of the total DEUs outstanding, 1,080,000 were vested with the remaining 48,000 DEUs scheduled to vest in 2005. Of the total value of DEUs outstanding, $30.8 million had been recognized as compensation expense through December 31, 2004. The remaining $1.7 million of compensation expense is scheduled to be recognized in 2005.
Other Plans
ProLogis has a 401(k) Savings Plan and Trust (“401(k) Plan”), that provides for matching employer contributions in Common Shares of 50 cents for every dollar contributed by an employee, up to 6% of the employees’ annual compensation (within the statutory compensation limit). A total of 190,000 Common Shares have been authorized for issuance under the 401(k) Plan. The vesting of contributed Common Shares is based on the employees’ years of service, with 20% vesting each year of service, over a five-year period. Through December 31, 2004, no Common Shares have been issued under the 401(k) Plan. All of ProLogis’ matching contributions have been made with Common Shares purchased by ProLogis in the open market.
ProLogis has a Nonqualified Savings Plan to provide benefits for certain employees. The purpose of this plan is to allow highly compensated employees the opportunity to defer the receipt and income taxation of a certain portion of their compensation in excess of the amount permitted under the 401(k) Plan. ProLogis will match the lesser of (a) 50% of the sum of deferrals under both the 401(k) Plan and this plan, and (b) 3% of total compensation up to certain levels. The matching account will vest in the same manner as the 401(k) Plan. For both the 401(k) Plan and the Nonqualified Savings Plan, ProLogis’ expense under the matching provisions was $0.5 million, $0.6 million and $0.5 million for 2004, 2003 and 2002, respectively.
16.
Related Party Transactions:
Transactions with Related Parties
ProLogis paid a fee of $4.1 million to an affiliate of Macquarie Bank related to capital raised by ProLogis European Properties Fund in 2003. Macquarie Bank has an ownership interest in the manager of ProLogis-Macquarie Fund. See Note 5.
Transactions with Chairman
Investments
ProLogis invested in the non-voting preferred stock of certain entities that have ownership interests in companies that produce income that is not REIT qualifying income (i.e., rental income and mortgage interest income) under the Code. Third parties, including entities in which ProLogis’ former shareholder held non-voting ownership interests, held the voting ownership common stock of these companies. The Code was amended in 2001 to allow ProLogis to have a voting ownership interest in these types of entities. ProLogis began negotiations to acquire the voting ownership interests in these entities in 2000. Before the acquisitions were completed it was determined that some state income tax laws governing REITs would not be changed to coincide with the amendments to the Code. Therefore, CSI/Frigo LLC and Kingspark LLC, limited liability companies in which K. Dane Brooksher, ProLogis’ Chairman of the Board and former Chief Executive
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Officer, owned the voting membership interests, acquired the voting ownership interests in TCL Holding, ProLogis Logistics and Kingspark S.A. from the third parties.
Prior to December 31, 2004, ProLogis directly or indirectly acquired Mr. Brooksher’s ownership interests in ProLogis Logistics and Kingspark S.A. Therefore, Mr. Brooksher’s only remaining ownership interest at December 31, 2004 is in TCL Holding S.A., through his membership interest in CSI/Frigo LLC. See Notes 2 and 5.
CSI/Frigo LLC is a limited liability company that owns 100% of the voting common stock of TCL Holding, representing 5% of its net earnings or losses. ProLogis owns 89% of the membership interests (all non-voting) of CSI/Frigo LLC and Mr. Brooksher owns the remaining 11% of the membership interests (all voting) and is the managing member of CSI/Frigo LLC. Through a participating note agreement between ProLogis and CSI/Frigo LLC, ProLogis can recognize 95% of the net earnings or losses of CSI/Frigo LLC. Mr. Brooksher’s membership interest in CSI/Frigo LLC entitles him to an effective interest in the earnings or losses of TCL Holding of 0.25%. Mr. Brooksher may transfer his membership interests, subject to certain conditions, including the approval of ProLogis. There are no provisions that give ProLogis the right to acquire Mr. Brooksher’s membership interests. Mr. Brooksher does not receive compensation in connection with being the managing member.
Mr. Brooksher also owns the voting common stock of two technology entities in which ProLogis owns the non-voting common stock. Through this ownership, Mr. Brooksher was entitled to receive dividends equal to 2% of the net cash flow of each entity as defined, if any, and a 2% interest in the net earnings or losses of each entity. Mr. Brooksher contributed non-recourse promissory notes to these entities in the aggregate amount of $1.2 million in exchange for his ownership interest. The notes are payable in July 2005 ($1.1 million), in September 2005 ($71,429) and January 2006 ($51,020) and bear interest at 8% per annum. Neither entity ever made any distributions to either Mr. Brooksher or ProLogis and both entities have ceased operations. ProLogis wrote its investments in each entity to zero in 2001 and 2002. See Note 5.
Loans
During 2002, Mr. Brooksher’s outstanding loan associated with the purchase of Common Shares in 1997 under a loan plan that ProLogis offered to certain of its employees was fully repaid through a $1.0 million cash payment and the repurchase of 33,253 Common Shares from Mr. Brooksher. See Note 9.
Transactions with Other Senior Officers
Entities in which Irving F. Lyons, III, ProLogis’ Vice Chairman and former Chief Investment Officer, has ownership interests, owned 2,459,183 of the outstanding limited partnership units in ProLogis Limited Partnership-I at December 31, 2004 or 17.1% of ProLogis Limited Partnership-I’s total units outstanding at December 31, 2004. Mr. Lyons’ effective ownership in ProLogis Limited Partnership-I was 1.8% at December 31, 2004. See Note 8.
At December 31, 2004, Jeffrey H. Schwartz, ProLogis’ Chief Executive Officer owned all of the limited partnership units in ProLogis Limited Partnership-III and in ProLogis Limited Partnership-IV (4.82% of ProLogis Limited Partnership-III’s total units outstanding at December 31, 2004 and 1.02% of ProLogis Limited Partnership-IV’s total units outstanding at December 31, 2004). See Note 8.
17. Financial Instruments:
Fair Value of Financial Instruments
The following estimates of the fair value of financial instruments have been determined by ProLogis using available market information and valuation methodologies believed to be appropriate for these purposes.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Considerable judgment and a high degree of subjectivity are involved in developing these estimates and, accordingly, they are not necessarily indicative of amounts that ProLogis would realize upon disposition.
At December 31, 2004 and 2003, the carrying amounts of certain financial instruments employed by ProLogis, including cash and cash equivalents, accounts and notes receivable, accounts payable and accrued expenses and construction costs payable were representative of their fair values due to the short-term maturity of these instruments. Similarly, the carrying values of the lines of credit and short-term borrowings balances outstanding approximate their fair values as of those dates since the interest rates on the lines of credit and short-term borrowings are based on current market rates. At December 31, 2004 and 2003, the fair values of ProLogis’ senior notes, secured debt (including mortgage notes and securitized debt) and assessment bonds have been estimated based upon quoted market prices for the same or similar issues or by discounting the future cash flows using rates currently available for debt with similar terms and maturities. The differences in the fair values of ProLogis’ senior notes, secured debt and assessment bonds from the carrying values in the table below are the result of differences in the interest rates that were available to ProLogis at December 31, 2004 and 2003 from the interest rates that were in effect when the debt was issued. The senior notes and many of the secured debt issues contain pre-payment penalties or yield maintenance provisions that could make the cost of refinancing the debt at the lower rates exceed the benefit that would be derived from doing so.
At December 31, 2004 and 2003, the fair values of ProLogis’ derivative financial instruments are the amounts at which they could be settled, based on quoted market prices or estimates obtained from brokers or dealers. As ProLogis marks its derivative financial instruments to market, their fair values are the same as their carrying values. At December 31, 2004, the carrying value of the interest rate swap contract (the only outstanding derivative contract) is reflected as a component of other liabilities. At December 31, 2003, the carrying values of the foreign currency put option contracts and the interest rate swap contracts are reflected as a component of other assets and the carrying value of the foreign currency forward contract is reflected as a component of other liabilities.
The following table reflects the carrying amounts and estimated fair values of ProLogis’ financial instruments as of the periods indicated (in thousands of U.S. dollars):
Derivative Financial Instruments
ProLogis uses derivative financial instruments as hedges to manage well-defined risk associated with interest and foreign currency exchange rate fluctuations on existing or anticipated obligations and transactions. ProLogis does not use derivative financial instruments for trading purposes.
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The primary risks associated with derivative instruments are market risk and credit risk. Market risk is defined as the potential for loss in the value of the derivative due to adverse changes in market prices (interest rates or foreign currency exchange rates). The use of derivative financial instruments allows ProLogis to manage the risks of increases in interest rates and fluctuations in foreign currency exchange rates with respect to the effects these fluctuations would have on ProLogis’ income and cash flows.
Credit risk is the risk that one of the parties to a derivative contract fails to perform or meet their financial obligation under the contract. ProLogis does not obtain collateral to support financial instruments subject to credit risk but monitors the credit standing of counterparties, primarily global commercial banks. ProLogis does not anticipate non-performance by any of the counterparties to its derivative contracts. However, should a counterparty fail to perform, ProLogis would incur a financial loss to the extent of the positive fair market value of the derivative contracts, if any.
The following table summarizes the activity in ProLogis’ derivative contracts for the years ended December 31, 2004, 2003 and 2002 (in millions of U.S. dollars):
(1)
The foreign currency put option contracts are paid in full at execution and are related to ProLogis’ operations in Europe and Japan. The put option contracts provide ProLogis with the option to exchange euro, pound sterling and yen for U.S. dollars at a fixed exchange rate such that, if the euro, pound sterling or yen were to depreciate against the U.S. dollar to predetermined levels as set by the contracts, ProLogis could exercise its options and mitigate its foreign currency exchange losses. The notional amounts of the put option contracts represent the U.S. dollar equivalent of put option contracts with notional amounts of 28.4 million euro, 7.7 million pound sterling and 874.4 million yen at December 31, 2003 and with notional amounts of 38.7 million euro and 9.6 million pound sterling at December 31, 2002.
These contracts generally do not qualify for hedge accounting treatment and are marked-to-market through results of operations at the end of each period. Upon expiration of the contract, the mark-to-market adjustment is reversed, the total cost of the contract is expensed and any proceeds are recognized as a gain. ProLogis recognized aggregate expense of $0.6 million, $2.7 million and $4.4 million in 2004, 2003 and 2002, respectively, on various put option contracts. The amounts recognized include mark-to-market gains of $1.5 million in 2004 and $0.2 million in 2003 and mark-to-market losses of $1.4 million in 2002. See Note 2.
(2)
The foreign currency forward swap contracts were designated as a net investment hedge of certain of ProLogis’ investments in Europe and allowed ProLogis to sell euro at a fixed exchange rate to the U.S. dollar. The aggregate notional amount of these contracts was 97.5 million euro (the currency equivalent
PROLOGIS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
of approximately $119.2 million at settlement in April 2004). These contracts qualified for hedge accounting treatment and ProLogis recognized the total increase in value of the contracts of $1.7 million in other comprehensive income in shareholders’ equity in April 2004 and settled the contracts.
(3)
In 2003 and 2004, ProLogis entered into forward-starting interest rate swap contracts with an aggregate notional amount of $185.6 million related to the anticipated issuance of the Euro Notes (see Note 7). The contracts, designated as cash flow hedges, allowed ProLogis to fix a portion of the interest rate associated with the seven-year Euro Notes that were issued in April 2004. These contracts qualified for hedge accounting treatment and ProLogis recognized a total decrease in value of $5.6 million in other comprehensive income in shareholders’ equity upon settlement of the contracts. The amount reported in other comprehensive income related to these contracts is being reclassified to interest expense as interest payments are made on the Euro Notes. Through December 31, 2004, $0.5 million of expense had been reclassified.
In July 2004, ProLogis entered into two forward-starting interest rate swap contracts, each with a notional amount of $50.0 million, related to an anticipated transaction. The contracts were designated as cash flow hedges. The contracts, which qualified for hedge accounting treatment, allowed ProLogis to fix a portion of the interest rate associated with a debt instrument forecasted to be issued for a five-year period. As of December 31, 2004, the anticipated transaction had not been completed. One contract was terminated in August 2004 and ProLogis recognized $0.3 million of expense upon termination. ProLogis recognized a mark-to-market adjustment of $1.1 million in other comprehensive income in shareholders’ equity at December 31, 2004 representing the decrease in value of the outstanding contract. This amount will be reclassified to interest expense as interest payments are made on the forecasted debt instrument. ProLogis will reclassify a total of $0.9 million from other comprehensive income to interest expense in 2005 associated with this interest rate swap contract and four other contracts that have received hedge accounting treatment. ProLogis is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of four months.
18.
Commitments and Contingencies:
Environmental Matters
All of the properties acquired by ProLogis were subjected to environmental reviews by either ProLogis or the predecessor owners. While some of these assessments have led to further investigation and sampling, none of the environmental assessments have revealed an environmental liability (including any asbestos related liability) that ProLogis believes would have a material adverse effect on ProLogis’ business, financial condition or results of operations. Further, ProLogis is not currently aware of any environmental liability (including any asbestos related liability) that ProLogis believes would have a material adverse effect on ProLogis’ business, financial condition or results of operations.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Trustees and Shareholders
ProLogis:
Under date of March 14, 2005, we reported on the consolidated balance sheets of ProLogis and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule, Schedule III - Real Estate and Accumulated Depreciation (Schedule III). Schedule III is the responsibility of ProLogis’ management. Our responsibility is to express an opinion on Schedule III based on our audits.
In our opinion, Schedule III - Real Estate and Accumulated Depreciation, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Los Angeles, California
March 14, 2005
PROLOGIS
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2004
(In thousands of U.S. dollars, as applicable)
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(a)
Reconciliation of real estate assets per Schedule III to ProLogis’ Consolidated Balance Sheet as of December 31, 2004 (in thousands of U.S. dollars):
(b)
The aggregate cost of ProLogis’ real estate assets for federal income tax purposes was approximately $6,134,078,660.
(c)
Real estate assets (excluding land balances) are depreciated over their useful lives. These useful lives are generally seven years for capital improvements, 10 years for standard tenant improvements, 30 years for acquired properties and 40 years for properties under development. Above standard tenant improvements are depreciated over the shorter of the lease term or the estimated useful life. ProLogis does not depreciate properties that have been developed or acquired in the CDFS business segment with the intent to sell the property to a third party or contribute the property to a property fund.
(d)
Total operating properties include 90 properties developed or acquired in the CDFS business segment aggregating 18.0 million square feet at an aggregate investment of $897.9 million. See “Item 1 - Business - ProLogis’ Operating Segments - CDFS Business Segment.”
(e)
Properties with an aggregate undepreciated cost of $364,842,000 secure $200,000,000 of mortgage notes. See Note 7.
(f)
Properties with an aggregate undepreciated cost of $227,296,000 secure $139,548,000 of mortgage notes. See Note 7.
(g)
Properties with an aggregate undepreciated cost of $351,981,000 secure $145,344,000 of mortgage notes. See Note 7.
(h)
With respect to one building, ProLogis owns only 32,000 square feet or 39% of the building. The remaining portion is owned by ProLogis North American Properties Fund V.
(i)
With respect to one building, ProLogis owns only 159,000 square feet or 50% of the building. The remaining portion is owned by ProLogis North American Properties Fund V.
(j)
With respect to one building, ProLogis owns only 64,000 square feet or 42% of the building. The remaining portion is owned by ProLogis North American Properties Fund V.
(k)
With respect to one building, ProLogis owns only 115,000 square feet or 32% of the building. The remaining portion is owned by ProLogis North American Properties Fund V.
(l)
With respect to one building, ProLogis owns only 32,000 square feet or 28% of the building. The remaining portion is owned by ProLogis North American Properties Fund V.
(m)
Properties with an aggregate undepreciated cost of $229,158,000 secure $6,751,000 of assessment bonds. See Note 7.
(n)
With respect to one building, ProLogis owns only 11,000 square feet or 15% of the building. The remaining portion is owned by ProLogis North American Properties Fund V.
(o)
All properties under development are included in the CDFS business segment. See “Item 1 - Business - ProLogis’ Operating Segments - CDFS Business Segment.”
(p)
All of the land held for future development is included in the CDFS business segment. See “Item 1 - Business - ProLogis’ Operating Segments - CDFS Business Segment.”
PROLOGIS
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION - (Continued)
(q)
Other investments include: (i) earnest money deposits associated with potential acquisitions; (ii) costs incurred during the pre-acquisition due diligence process; and (iii) costs incurred during the pre-construction phase related to future development projects.
(r)
A summary of activity for ProLogis’ real estate assets and accumulated depreciation for the three years ended December 31, 2004, 2003 and 2001 is as follows (in thousands of U.S. dollars):
See accompanying report of independent registered public accounting firm.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PROLOGIS
By:
/s/ JEFFREY H. SCHWARTZ
Jeffrey H. Schwartz
Chief Executive Officer
Date: March 15, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS
Certain of the following documents are filed herewith. Certain other of the following documents have been previously filed with the Securities and Exchange Commission and, pursuant to Rule 12b-32, are incorporated herein by reference.
* Management Contract or Compensatory Plan or Arrangement