<PAGE>
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UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
---------------
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission File Number 01-12846
PROLOGIS TRUST
(Exact name of registrant as specified in its charter)
Maryland 74-2604728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14100 East 35th Place, Aurora, Colorado 80011
(Address or principal executive offices) (Zip Code)
(303) 375-9292
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing for the past 90 days. Yes X No _____
The number of shares outstanding of the Registrant's common stock as of
November 12, 1998 was 123,325,496.
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<PAGE>
PROLOGIS TRUST
INDEX
<TABLE>
<CAPTION>
Page
Number(s)
---------
<S> <C>
PART I. Financial Information
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets--September 30, 1998 and December 31, 1997............................ 3
Consolidated Statements of Income and Comprehensive Income--Three
and nine months ended September 30, 1998 and 1997........................................... 4
Consolidated Statements of Cash Flows--Nine months ended September 30, 1998
and 1997.................................................................................... 5
Notes to Consolidated Financial Statements...................................................... 6 - 16
Report of Independent Public Accountants........................................................ 17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................................... 18 - 32
Part II. Other Information
Item 4. Submission of Matters to a Vote of Securities Holders........................................... 33
Item 5. Other Information............................................................................... 33
Item 6. Exhibits and Reports on Form 8-K................................................................ 33
</TABLE>
<PAGE>
PROLOGIS TRUST
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
ASSETS
------
September 30, December 31,
1998 1997
(Unaudited) (Audited)
-------------- -------------
<S> <C> <C>
Real estate........................................................................... $ 3,483,817 $ 3,006,236
Less accumulated depreciation.................................................... 231,526 171,525
-------------- -------------
3,252,291 2,834,711
Investments in and advances to unconsolidated subsidiaries............................ 525,138 86,139
Cash and cash equivalents............................................................. 31,650 25,009
Accounts receivable................................................................... 18,266 12,554
Other assets.......................................................................... 96,783 75,540
-------------- -------------
Total assets........................................................ $ 3,924,128 $ 3,033,953
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Liabilities:
Lines of credit.................................................................. $ 159,500 $ --
Short-term borrowings............................................................ 150,000 --
Long-term debt................................................................... 958,586 724,052
Mortgage notes payable........................................................... 90,460 87,937
Securitized debt................................................................. 32,470 33,197
Assessment bonds payable......................................................... 11,604 11,894
Accounts payable and accrued expenses............................................ 103,492 62,850
Construction payable............................................................. 26,976 27,221
Due to affiliate................................................................. 1,546 1,138
Distributions payable............................................................ -- 33,449
Other liabilities................................................................ 23,884 22,174
-------------- -------------
Total liabilities................................................... 1,558,518 1,003,912
-------------- -------------
Commitments and contingencies
Minority interest..................................................................... 51,358 53,304
Shareholders' equity:
Series A preferred shares; $0.01 par value; 5,400,000 shares issued and
outstanding at September 30, 1998 and December 31, 1997; stated
liquidation preference of $25 per share...................................... 135,000 135,000
Series B Convertible preferred shares; $0.01 par value; 7,797,000 shares
issued and outstanding at September 30, 1998 and 8,000,300 shares
issued and outstanding at December 31, 1997; stated liquidation
preference of $25 per share.................................................. 194,925 200,008
Series C preferred shares; $0.01 par value; 2,000,000 shares issued and
outstanding at September 30, 1998 and December 31, 1997; stated
liquidation preference of $50 per share...................................... 100,000 100,000
Series D preferred shares; $0.01 par value; 10,000,000 shares issued
and outstanding at September 30, 1998; stated liquidation preference of
$25 per share................................................................ 250,000 --
Common shares of beneficial interest; $0.01 par value; 123,091,696
shares issued and outstanding at September 30, 1998 and 117,364,148
shares issued and outstanding at December 31, 1997........................... 1,231 1,174
Additional paid-in capital....................................................... 1,899,342 1,773,465
Employee share purchase notes.................................................... (25,660) (27,186)
Accumulated other comprehensive income........................................... 307 (63)
Distributions in excess of net earnings.......................................... (240,893) (205,661)
-------------- -------------
Total shareholders' equity.......................................... 2,314,252 1,976,737
-------------- -------------
Total liabilities and shareholders' equity.......................... $ 3,924,128 $ 3,033,953
============== =============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE>
PROLOGIS TRUST
CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME
(Unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Income:
Rental income...................................................... $ 88,687 $ 72,376 $ 251,605 $ 208,919
Other real estate income........................................... 3,538 3,756 10,542 9,446
Income (loss) from unconsolidated subsidiaries..................... (1,278) 711 1,930 2,257
Foreign exchange gains, net........................................ 3,273 -- 5,336 --
Interest income.................................................... 687 303 2,012 1,420
---------- ---------- ---------- ----------
Total income........................................... 94,907 77,146 271,425 222,042
---------- ---------- ---------- ----------
Expenses:
Rental expenses, net of recoveries of $14,459 and
$10,567 for the three-month periods in 1998 and 1997,
respectively, and $42,686 and $31,089 for the nine-month
periods in 1998 and 1997, respectively......................... 7,158 5,554 20,458 15,709
Property management fees paid to affiliate, net of recoveries of
$1,014 for the three-month period in 1997 and $3,870 for
the nine-month period in 1997.................................. -- 1,151 -- 3,821
General and administrative......................................... 5,168 1,560 14,060 2,247
Administrative services fee paid to affiliate...................... 545 288 1,566 288
REIT management fee paid to affiliate.............................. -- 4,957 -- 17,791
Depreciation and amortization...................................... 26,950 21,217 73,684 58,241
Interest rate hedge expense........................................ 27,652 -- 27,652 --
Interest........................................................... 18,448 14,630 52,455 39,188
Costs incurred in acquiring management companies from
affiliate...................................................... -- 75,376 -- 75,376
Other.............................................................. 2,579 776 4,096 2,237
---------- ---------- ---------- ----------
Total expenses......................................... 88,500 125,509 193,971 214,898
---------- ---------- ---------- ----------
Net earnings (loss) before minority interest and gain on disposition
of real estate..................................................... 6,407 (48,363) 77,454 7,144
Minority interest share in net earnings................................. 1,047 928 3,101 2,763
---------- ---------- ---------- ----------
Net earnings (loss) before gain on disposition of real estate........... 5,360 (49,291) 74,353 4,381
Gain on disposition of real estate...................................... -- 2,756 4,278 6,529
---------- ---------- ---------- ----------
Net earnings (loss)..................................................... 5,360 (46,535) 78,631 10,910
Less preferred share dividends.......................................... 13,669 8,829 35,543 26,488
---------- ---------- ---------- ----------
Net earnings (loss) attributable to Common Shares....................... (8,309) (55,364) 43,088 (15,578)
Other comprehensive income:
Foreign currency translation adjustments........................... 308 -- 370 --
---------- ---------- ---------- ----------
Comprehensive income.................................................... $ (8,001) $ (55,364) $ 43,458 $ (15,578)
========== ========== ========== ==========
Weighted-average Common Shares outstanding - basic...................... 123,045 100,033 121,183 97,948
========== ========== ========== ==========
Weighted-average Common Shares outstanding - diluted.................... 123,045 100,033 121,421 97,948
========== ========== ========== ==========
Per share net earnings (loss) attributable to Common Shares:
Basic.............................................................. $ (0.07) $ (0.55) $ 0.36 $ (0.16)
========= ========= ========== ==========
Diluted............................................................ $ (0.07) $ (0.55) $ 0.35 $ (0.16)
========= ========= ========== ==========
Distributions per Common Share.......................................... $ 0.3183 $ 0.2675 $ 0.9216 $ 0.8025
========= ========= ========== ==========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE>
PROLOGIS TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------------
1998 1997
-------------- -------------
<S> <C> <C>
Operating activities:
Net earnings..................................................................... $ 78,631 $ 10,910
Minority interest................................................................ 3,101 2,763
Adjustments to reconcile net earnings to net cash flow provided
by operating activities:
Depreciation and amortization................................................ 73,684 58,241
Gain on disposition of real estate........................................... (4,278) (6,529)
Costs incurred in acquiring management companies from affiliate.............. -- 75,376
Rent leveling................................................................ (4,170) (3,772)
Equity in earnings of unconsolidated subsidiaries............................ 7,293 --
Foreign exchange gain........................................................ (5,471) --
Amortization of deferred loan costs.......................................... 1,303 1,528
Interest rate hedge expense.................................................. 27,652 --
Increase in net amount due from affiliate........................................ -- (2,267)
Increase in accounts receivable and other assets................................. (24,909) (11,786)
Increase in accounts payable and accrued expenses................................ 19,366 15,720
Increase/(decrease) in other liabilities......................................... 1,710 (168)
Increase in amount due to affiliate.............................................. 408 --
-------------- -------------
Net cash flow provided by operating activities.......................... 174,320 140,016
-------------- -------------
Investing activities:
Real estate investments.......................................................... (520,611) (393,416)
Investments in and advances to unconsolidated subsidiaries....................... (446,292) (41,769)
Tenant improvements and lease commissions........................................ (8,905) (11,086)
Recurring capital expenditures................................................... (4,226) (3,659)
Proceeds from dispositions of real estate........................................ 64,222 111,838
-------------- -------------
Net cash flow used in investing activities.............................. (915,812) (338,092)
-------------- -------------
Financing activities:
Proceeds from sale of Common Shares, net of expenses............................. 130,460 205,843
Proceeds from sale of preferred shares, net of expenses.......................... 241,705 --
Proceeds from dividend reinvestment and share purchase plan...................... 399 304
Repurchase of Common Shares...................................................... (181) --
Proceeds from issuance of long-term debt......................................... 249,462 199,772
Debt issuance costs incurred..................................................... (2,689) (2,477)
Payments on long-term debt....................................................... (15,000) --
Proceeds from interest rate contracts............................................ -- 1,894
Loss on foreign currency hedge................................................... (4,322) --
Distributions paid on Common Shares.............................................. (111,769) (77,459)
Distributions paid to minority interest holders.................................. (4,764) (4,245)
Dividends paid on preferred shares............................................... (35,543) (26,488)
Proceeds from lines of credit and short-term borrowings.......................... 1,237,325 358,391
Payments on lines of credit and short-term borrowings............................ (927,825) (396,991)
Regularly scheduled principal payments on mortgage notes payable................. (3,714) (3,451)
Balloon principal payments made upon maturity.................................... (5,411) (14,804)
-------------- -------------
Net cash flow provided by financing activities.......................... 748,133 240,289
-------------- -------------
Net increase in cash and cash equivalents............................................. 6,641 42,213
Cash and cash equivalents, beginning of period........................................ 25,009 4,770
-------------- -------------
Cash and cash equivalents, end of period.............................................. $ 31,650 $ 46,983
============== =============
Noncash investing and financing activities:
In conjunction with real estate acquired:
Assumption of existing mortgage notes payable................................ $ 10,631 $ 12,591
Issuance of Common Shares.................................................... -- 1,000
In conjunction with the acquisition of management companies:
Issuance of Common Shares to affiliate....................................... -- 79,840
Tangible net assets acquired from affiliate.................................. -- (4,464)
Notes received for Common Shares issued under employee share purchase plan....... -- 27,345
Foreign currency translation adjustments......................................... 370 --
Conversion of limited partnership units into Common Shares....................... 302 --
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE>
PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(Unaudited)
1. General:
The consolidated financial statements of ProLogis Trust ("ProLogis"),
formerly Security Capital Industrial Trust, as of September 30, 1998 and for the
three and nine months ended September 30, 1998 and 1997 are unaudited, and
pursuant to the rules of the Securities and Exchange Commission, certain
information and footnote disclosures normally included in financial statements
have been omitted. While management of ProLogis believes that the disclosures
presented are adequate, these interim consolidated financial statements should
be read in conjunction with ProLogis' December 31, 1997 audited consolidated
financial statements contained in ProLogis' 1997 Annual Report on Form 10-K.
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments, consisting of normal recurring
adjustments, necessary for a fair presentation of ProLogis' consolidated
financial position and results of operations for the interim periods. The
consolidated results of operations for the three and nine months ended September
30, 1998 and 1997 are not necessarily indicative of the results to be expected
for the entire year.
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles ("GAAP") requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Name Change
The company changed its name to ProLogis Trust effective July 1, 1998.
The name change is intended to create stronger name recognition among its
customers as ProLogis expands globally. ProLogis has recognized $1.5 million of
expenses associated with the name change for the three and nine months ended
September 30, 1998.
Foreign Currency Gains and Losses
For foreign subsidiaries whose functional currency is not the U.S.
dollar, assets and liabilities are translated at the exchange rates in effect at
the end of the period and income statement accounts are translated at the
average exchange rates for the periods. Translation gains and losses are a
component of other comprehensive income and are recognized in shareholders'
equity.
6
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PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For foreign subsidiaries who have transactions denominated in
currencies other than their functional currency, nonmonetary assets and
liabilities at the end of the period are remeasured at historical rates,
monetary assets and liabilities at the end of the period are remeasured at the
exchange rates in effect at the end of the period and income statement accounts
are remeasured at average exchange rates for the period. The remeasurement gains
and losses of such foreign subsidiaries are included in the consolidated results
of operations as foreign exchange gains or losses. ProLogis recognized gains
from remeasurement of $3.4 million for both the three-month and the nine-month
periods ended September 30, 1998.
Transaction gains or losses occur when a transaction, denominated in a
currency other than the functional currency, is settled and the functional
currency cash flows realized are more or less than expected based upon the
exchange rate in effect when the transaction was initiated. ProLogis recognized
a foreign currency transaction loss of $0.1 million for both the three-month and
the nine-month periods ended September 30, 1998.
Comprehensive Income
On January 1, 1998, ProLogis adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income" which establishes
standards for the reporting and display of comprehensive income and its
components. The adoption of this standard did not have a significant impact on
the consolidated financial position, results of operations or financial
statement disclosures of ProLogis. Other comprehensive income in the
accompanying Consolidated Statements of Income and Comprehensive Income
represents a net unrealized gain on foreign currency translation adjustments.
This unrealized gain has been recognized as a component of shareholders' equity
with no impact to net earnings (loss).
Per Common Share Data
ProLogis adopted SFAS No. 128, "Earnings Per Share" in December 1997. SFAS
No. 128 replaces the presentation of primary and fully diluted earnings per
share with a presentation of basic and diluted earnings per share. The adoption
of SFAS No. 128 did not result in a restatement of previously reported earnings
per share data.
The weighted-average number of common shares of beneficial interest,
par value $0.01 per share ("Common Shares"), outstanding during the year is used
to calculate basic earnings per Common Share. Diluted earnings per Common Share
reflects the potential dilution that could occur if securities or other
contracts to issue Common Shares were exercised or converted into Common Shares
or resulted in the issuance of Common Shares that would then share in earnings.
See Note 8.
Accounting for Derivatives
SFAS No. 133, "Accounting for Derivative Instruments and for Hedging
Activities" was issued in June 1998. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999 and early adoption is allowed. 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 fair value. Management is evaluating the
effects, if any, this pronouncement will have on ProLogis' consolidated
financial position, results of operations and financial statement disclosures.
7
<PAGE>
PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Reclassifications
Certain 1997 amounts have been reclassified to conform to the 1998
presentation.
2. Real Estate:
Investments in Real Estate
ProLogis' investments in real estate, at cost, were as follows (in
thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Improved land...................................................... $ 476,491 $ 420,019
Buildings and improvements......................................... 2,593,464 2,233,585
Properties under development (including cost of land).............. 218,892 180,268
Land held for development.......................................... 171,250 159,645
Capitalized preacquisition costs................................... 23,720 12,719
------------ ------------
Total real estate 3,483,817 3,006,236
Less accumulated depreciation...................................... 231,526 171,525
------------ ------------
Net real estate........................................... $ 3,252,291 $ 2,834,711
============ ============
</TABLE>
Capitalized preacquisition costs include $4.8 million and $3.6 million
of funds on deposit with title companies as of September 30, 1998 and December
31, 1997, respectively, for property acquisitions.
In addition to the September 30, 1998 construction payable accrual of
$27.0 million, ProLogis has unfunded commitments on its contracts for
developments under construction totaling $210.8 million.
ProLogis Development Services
ProLogis Development Services Incorporated ("ProLogis Development
Services") develops corporate distribution facilities to meet customer
requirements or contracts on a fee basis to develop distribution facilities for
customers. ProLogis owns 100% of the preferred stock of ProLogis Development
Services and realizes substantially all economic benefits of its activities.
ProLogis advances mortgage loans to ProLogis Development Services to fund its
acquisition, development and construction activities. The activities of ProLogis
Development Services have been consolidated with ProLogis' activities and all
intercompany balances have been eliminated.
As of September 30, 1998, the outstanding balances of development and
mortgage loans made by ProLogis to ProLogis Development Services for the
purchase of distribution facilities and land for distribution facility
development aggregated $233.1 million. The gains recognized on disposition of
undepreciated property by ProLogis Development Services and the fees generated
by ProLogis Development Services are reflected as other real estate income by
ProLogis.
8
<PAGE>
PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Unconsolidated Subsidiaries:
Investments in and advances to unconsolidated subsidiaries were as
follows (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- -------------
<S> <C> <C>
Insight......................................................................... $ 1,513 $ 500
------------- -------------
ProLogis Logistics:
Investment.................................................................. 13,414 7,404
Note receivable............................................................. 125,642 75,207
Accrued interest and other receivables...................................... 5,988 3,028
------------- -------------
145,044 85,639
------------- -------------
Frigoscandia S.A.:
Investment.................................................................. 1,228 --
Note receivable from Frigoscandia S.A....................................... 80,000 --
Note receivable from Frigoscandia Holding AB................................ 101,919 --
Mortgage note receivable from Frigoscandia Limited UK....................... 30,000 --
Accrued interest and other receivables...................................... 6,168 --
------------- -------------
219,315 --
Kingspark S.A.:
Investment.................................................................. 14,174 --
Note receivable from Kingspark S.A.......................................... 118,893 --
Mortgage note receivable from ProLogis Kingspark............................ 19,524 --
Accrued interest and other receivables...................................... 6,675 --
------------- -------------
159,266 --
------------- -------------
Total.............................................................. $ 525,138 $ 86,139
============= =============
</TABLE>
Insight
ProLogis Development Services has a 23.1% ownership interest in
Insight, Inc. ("Insight"), a privately owned logistics optimization consulting
company. ProLogis Development Services is committed to investing an additional
$1,000,000 in Insight through July 1, 1999, which would bring its ownership
interest to 33.3%. This investment is accounted for on the equity method.
ProLogis recognized $13,000 of income from its investment in Insight for the
three and nine months ended September 30, 1998. Prior to July 1, 1998, this
investment was accounted for on the cost method.
ProLogis Logistics
ProLogis owns 100% of the preferred stock of ProLogis Logistics
Services Incorporated ("ProLogis Logistics"). ProLogis Logistics owns 100% of a
refrigerated distribution company, CS Integrated LLC ("CSI"). Prior to June 12,
1998, ProLogis Logistics owned, at various points in time, between 60.0% and
77.1% of CSI. At September 30, 1998, ProLogis had invested $20.1 million in the
preferred stock of ProLogis Logistics. At September 30, 1998, CSI owns or
operates refrigerated distribution facilities aggregating 96.0 million cubic
feet.
9
<PAGE>
PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The common stock of ProLogis Logistics is owned by an unrelated party.
ProLogis recognizes substantially all economic benefits of ProLogis Logistics
and its subsidiaries.
At September 30, 1998, ProLogis had a $125.6 million note receivable
from ProLogis Logistics. The note is unsecured, bears interest at 10% per annum
and matures on April 24, 2002. Interest payments on the note are due annually.
The interest rate on the note was reduced to 8% per annum effective November 1,
1998.
ProLogis accounts for its investment in ProLogis Logistics on the
equity method. ProLogis recognized income (including interest income on the
notes receivable and a management fee payable from CSI) from its investment in
ProLogis Logistics of $2.2 million and $0.7 million for the three months ended
September 30, 1998 and 1997, respectively, and $4.7 million and $2.3 million for
the nine months ended September 30, 1998 and 1997, respectively.
Frigoscandia S. A.
On January 16, 1998, ProLogis invested in 100% of the preferred stock
of Frigoscandia S.A., a Luxembourg company, which acquired a refrigerated
distribution company headquartered in Sweden for $400.3 million on the same
date. The acquired company, Frigoscandia AB, is 100% owned by Frigoscandia
Holding AB. Frigoscandia Holding AB is 100% owned by a wholly owned subsidiary
of Frigoscandia S.A. At September 30, 1998, Frigoscandia AB, which operates in
nine European countries, owns 192.1 million cubic feet of refrigerated
distribution facilities. At September 30, 1998, ProLogis had invested $20.0
million in the preferred stock of Frigoscandia S.A. Prior to September 30, 1998,
the common stock of Frigoscandia S.A. was owned by Security Capital Group
Incorporated ("Security Capital"), ProLogis' largest shareholder. On that date,
the common stock of Frigoscandia S.A. was sold to a limited liability company,
in which unrelated parties own 100% of the voting interests and Security Capital
owns 100% of the non-voting interests. ProLogis recognizes substantially all
economic benefits of the activities of Frigoscandia S. A. and its subsidiaries.
At September 30, 1998, ProLogis had a $101.9 million note receivable
from Frigoscandia Holding AB and an $80.0 million note receivable from
Frigoscandia S.A. These unsecured notes bear interest at 8% per annum and are
due on demand. The interest rate on these notes was reduced to the federal funds
rate effective November 1, 1998 (5.06% at November 12, 1998). Additionally, at
September 30, 1998, ProLogis had a $30.0 million mortgage note receivable from
Frigoscandia Limited UK, a subsidiary of Frigoscandia AB. The mortgage note
receivable, which provides for interest at 7% per annum and matures on March 20,
2018, is secured by refrigerated distribution properties.
ProLogis accounts for its investment in Frigoscandia S.A. on the equity
method. ProLogis recognized a loss of $4.7 million and $4.0 million for the
three and nine months periods ended September 30, 1998, respectively, (including
interest income on the mortgage note and note receivable) from its investment in
Frigoscandia S.A.
Frigoscandia AB has a multi-currency, three-year revolving credit
agreement through a consortium of 11 European banks in the currency equivalent
of approximately $200 million. The loan bears interest at each currency's LIBOR
rate plus 0.55%. ProLogis has entered into a guaranty agreement for 25% of the
loan balance.
10
<PAGE>
PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Kingspark S.A.
On August 14, 1998, ProLogis invested in 100% of the preferred stock of
Kingspark Holding S.A. ("Kingspark S.A."), a Luxembourg company, which acquired
an industrial real estate development company, Kingspark Group Holdings Limited
("ProLogis Kingspark"), operating in the United Kingdom, for $136.0 million. At
September 30, 1998, Kingspark had 0.3 million square feet of operating
properties, 0.2 million square feet of properties under development and 1.0
million square feet of properties being developed under construction management
agreements. Additionally, ProLogis Kingspark owns 391 acres and controls 1,703
acres of land through letter of intent or contingent contract for future
development of 36.6 million square feet of distribution facilities. At September
30, 1998, ProLogis had invested $14.3 in the preferred stock of Kingspark S.A.
The common stock of Kingspark S.A. is currently owned by Security Capital.
However, Security Capital has indicated that it plans to sell the common stock.
ProLogis recognizes substantially all economic benefits of the activities of
Kingspark S.A. and ProLogis Kingspark.
At September 30, 1998, ProLogis had a $118.9 million note receivable
from Kingspark S.A. The unsecured note bears interest at 8% per annum and is due
on demand. Also at September 30, 1998, ProLogis had a $19.5 million mortgage
note receivable from ProLogis Kingspark which bears interest at 8% per annum and
is secured by a land parcel.
ProLogis accounts for its investment in Kingspark S.A. on the equity
method. ProLogis recognized $1.2 million of income in the third quarter of 1998
(including interest income on the mortgage note and note receivable) from its
investment in Kingspark S.A.
4. Borrowings:
Lines of Credit
On August 11, 1998, ProLogis entered into an amended and restated
credit agreement with NationsBank, N.A. ("NationsBank") as agent for a bank
group that provides for a $350 million unsecured revolving line of credit. The
new agreement provides for interest, at ProLogis' option, at either (a) the
greater of the federal funds rate plus 0.5% and the prime rate, or (b) LIBOR
plus 0.75% based upon ProLogis' current senior debt ratings. In addition,
ProLogis pays certain annual fees. Under a competitive bid option contained in
the new line of credit agreement, ProLogis may be able to borrow at a lower
interest rate spread over LIBOR, depending on market conditions. This option is
available on up to $100 million of borrowings. The line of credit matures on May
1, 2000 and may be extended annually for an additional year with the approval of
NationsBank and the other participating lenders. All borrowings under the line
of credit are subject to certain covenants. At September 30, 1998, ProLogis was
in compliance with all covenants contained in the credit agreement. ProLogis had
$135.0 million of borrowings outstanding on the line of credit at September 30,
1998.
In addition, ProLogis has a $25 million short-term unsecured
discretionary line of credit with NationsBank that matures on January 1, 1999.
The rate of interest and the maturity date of each advance on this line of
credit are determined by agreement between ProLogis and NationsBank at the time
of each advance. At September 30, 1998, there were $24.5 million of borrowings
outstanding on this credit facility.
11
<PAGE>
PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Short-term Borrowings
ProLogis entered into a credit agreement with NationsBank on September
11, 1998. The agreement provides for a term loan of $150.0 million due November
30, 1998. Borrowings on the term loan bear interest at LIBOR plus 0.90% and are
subject to the covenants contained in the amended and restated credit agreement
with NationsBank. At September 30, 1998, ProLogis was in compliance with all
such covenants.
Long-term Debt Offerings
ProLogis completed two offerings of debt securities in 1998 (including one
offering subsequent to September 30, 1998) as follows:
o On July 20, 1998, $250 million of debt securities due July 15,
2006 (the "2006 Notes") with an interest rate of 7.05%. The 2006
Notes were sold at a discount resulting in a yield to maturity of
7.08%. Net proceeds of the offering were $247.6 million, net of
underwriters' commissions and other costs.
o On October 9, 1998, $125 million of debt securities due October 1,
2003 (the "2003 Notes") with an interest rate of 7.0%. The
securities were issued at par. Net proceeds of the offering were
approximately $124.0 million, net of underwriters' commissions and
other costs.
The securities issued as a result of these offerings are direct, senior
unsecured obligations of ProLogis and rank equally with all other unsecured and
unsubordinated indebtedness of ProLogis from time to time outstanding. Interest
is payable semiannually in arrears. The securities are redeemable at any time at
the option of ProLogis, in whole or in part, at a redemption price equal to the
principal amount of the securities being redeemed plus accrued interest thereon
to the redemption date plus a make-whole amount, if any. The securities are
governed by the terms and provisions of the indenture applicable to ProLogis'
other debt securities.
Interest Expense
For the nine months ended September 30, 1998 and 1997, interest expense
on all borrowings was $52.5 million and $39.2 million, respectively, which was
net of capitalized interest of $14.8 million and $12.9 million, respectively.
The total interest paid in cash was $67.6 million and $45.2 million for the nine
months ended September 30, 1998 and 1997, respectively.
5. Minority Interest:
Minority interest represents limited partners' interests in five real
estate partnerships controlled by ProLogis (Red Mountain Joint Venture, ProLogis
Limited Partnership-I, ProLogis Limited Partnership-II, ProLogis Limited
Partnership-III, and ProLogis Limited Partnership-IV). At September 30, 1998, a
total of 5,069,258 limited partnership units were held by minority interest
limited partners in the various real estate partnerships. Limited partners are
entitled to exchange each partnership unit for one Common Share and are entitled
to receive preferential cumulative quarterly distributions per unit equal to the
quarterly distribution in respect of Common Shares. For the nine months ended
September 30, 1998, distributions of $4.8 million were made to the minority
interest limited partners. For financial reporting purposes, the assets,
liabilities, results of operations and cash flows of these partnerships are
included in ProLogis' consolidated financial statements and the third party
investors' interests in the partnerships are reflected as minority interest.
12
<PAGE>
PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During the nine months ended September 30, 1998, ProLogis increased its
ownership in one partnership, ProLogis Limited Partnership-IV, from 96.36% to
97.66% by contributing additional funds to the partnership in conjunction with
tax deferred exchanges of real estate. The additional contribution aggregated
$4.2 million.
6. Distributions and Dividends:
Common Share Distributions
On March 5, 1998, the Board increased ProLogis' annual distribution to
$1.24 per Common Share from $1.14 per Common Share. ProLogis paid quarterly
distributions of $0.285 per Common Share on February 24, 1998 and $0.3183 per
Common Share on May 26, 1998 and August 25, 1998. On October 15, 1998, the Board
declared a quarterly distribution of $0.3183 per Common Share payable on
November 24, 1998 to shareholders of record on November 10, 1998.
Preferred Share Dividends
During 1998, ProLogis paid quarterly dividends of:
o $0.5875 per cumulative redeemable Series A preferred share on March 31,
1998, June 30, 1998 and September 30, 1998;
o $0.4375 per cumulative convertible Series B preferred share on March
31, 1998, June 30, 1998 and September 30, 1998;
o $1.0675 per cumulative redeemable Series C preferred share on March 31,
1998, June 30, 1998 and September 30, 1998; and,
o $0.43 per cumulative redeemable Series D preferred share on a
prorated basis for the period from April 13, 1998 (date of issuance)
to June 30, 1998 on June 30, 1998 and $0.495 per share on September 30,
1998.
7. Shareholders' Equity:
Authorized Shares
At the annual meeting on June 30, 1998, the shareholders of ProLogis
approved an amendment to the Declaration of Trust to increase the number of
authorized shares of beneficial interest to 230,000,000 shares from 180,000,000
shares.
Equity Offerings
ProLogis sold 4,000,000 Common Shares on March 18, 1998 and 1,493,878
Common Shares on April 29, 1998. The sales were made through underwritten public
offerings and generated proceeds, net of underwriting discounts and offering
costs, of $95.7 million and $34.7 million, respectively.
13
<PAGE>
PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
On April 13, 1998, ProLogis issued 10,000,000 shares of Series D
Cumulative Redeemable Preferred Stock, par value $0.01 per share with a stated
liquidation preference of $25.00 per share (the "Series D Preferred Shares").
Holders of the Series D Preferred Shares are entitled to receive cumulative
preferential cash distributions at a rate of 7.92% of the liquidation preference
per annum (equal to $1.98 per share). Such distributions are payable quarterly
in arrears, when, and if, declared by the ProLogis Board, out of funds legally
available for payment of distributions. Subject to certain conditions, the
holders of Series D Preferred Shares have limited voting rights. The Series D
Preferred Shares are redeemable on or after April 13, 2003 by ProLogis for cash
at the stated redemption price, plus accrued and unpaid distributions. The
redemption price (other than the portion thereof consisting of accrued and
unpaid distributions) is payable solely out of the sales proceeds of other
capital shares of ProLogis, which may include shares of other series of
preferred shares. The Series D Preferred Shares rank on parity with the other
series of preferred shares of ProLogis with respect to payment of distributions
and amounts upon liquidation. Net proceeds from the offering were $241.7
million, net of underwriting discount and offering costs.
Shelf Registration
On May 15, 1998, ProLogis filed an $800 million shelf registration
statement with the Securities and Exchange Commission, which was declared
effective on May 29, 1998. This shelf registration supplemented an existing
shelf registration with a balance of $183 million. As a result of this filing,
ProLogis can issue securities 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, subject to ProLogis' ability to effect offerings
on satisfactory terms. After giving effect to the July 1998 issuance of the 2006
Notes and the October 1998 issuance of the 2003 Notes discussed in Note 4,
ProLogis has $608 million of shelf-registered securities available for issuance.
8. Earnings Per Common Share:
The following is a reconciliation of the denominator used to calculate
basic earnings per Common Share to the denominator used to calculate diluted
earnings per Common Share under SFAS No. 128 for the periods indicated (in
thousands, except per Common Share amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
1998 1997 1998 1997
--------- -------- --------- ---------
<S> <C> <C> <C> <C>
Net earnings (loss) attributable to Common Shares........... $ (8,309) $(55,364) $ 43,088 $ (15,578)
========= ======== ========= =========
Weighted-average Common Shares outstanding - basic.......... 123,045 100,033 121,183 97,948
Incremental options and warrants (a)........................ -- -- 238 --
--------- -------- --------- ---------
Adjusted weighted-average Common Shares outstanding -
Diluted (b)............................................ 123,045 100,033 121,421 97,948
========= ======== ========= =========
Per share net earnings/(loss) attributable to Common Shares:
Basic.................................................. $ (0.07) $ (0.55) $ .36 $ (0.16)
========= ======== ======== =========
Diluted (b)............................................ $ (0.07) $ (0.55) $ .35 $ (0.16)
========= ======== ======== =========
<FN>
- ---------------
(a) The effect of outstanding options and warrants is antidilutive for the
three months ended September 30, 1998 and 1997 and the nine months ended
September 30, 1997.
</FN>
</TABLE>
14
<PAGE>
PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(b) For the three months ended September 30, 1998 and 1997, there were 10,052
and 10,320 weighted-average Series B preferred shares and 5,069 and 5,194
weighted-average limited partnership units outstanding on an as-converted
basis, respectively. For the nine months ended September 30, 1998 and 1997,
there were 10,156 and 10,320 weighted-average Series B preferred shares and
5,070 and 5,194 limited partnership units outstanding on an as-converted
basis, respectively. The Series B preferred shares and the limited
partnership units were not assumed to be converted into Common Shares for
purposes of calculating diluted earnings per Common Share as the effect was
antidilutive for each period presented. These securities may become
dilutive to earnings per Common Share in subsequent periods.
9. Derivative Financial Instruments:
ProLogis only enters into a limited number of derivative financial
instruments, all in connection with specific financing transactions. ProLogis
uses derivatives to manage well-defined risk associated with interest and
foreign currency rate fluctuations on existing obligations or anticipated
transactions and not for trading purposes.
The primary risks associated with derivative instruments are market
risk (price risk) and credit risk. Price risk is defined as the potential for
loss in the value of the derivative due to adverse changes in market prices
(interest or foreign currency rates). Through hedging, ProLogis can effectively
manage the risk of increases in interest rates and fluctuations in foreign
currency exchange rates.
Credit risk is the risk that the counterparty to a derivative contract
fails to perform or meet its 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, who have credit ratings
of AA+ or A+. ProLogis does not anticipate non-performance by any of the
counterparties to its derivative contracts. Should a counterparty fail to
perform, however, ProLogis would incur a financial loss to the extent of the
positive fair market value of the derivative instruments, if any.
In October 1997, in anticipation of debt offerings in 1998, ProLogis
entered into two interest rate protection agreements which have been renewed
past the original termination dates. These agreements were entered into by
ProLogis to fix the interest rate on expected financings. The intent was not to
speculate on interest rates, but to arrange acceptable financing terms prior to
the anticipated transaction. The agreements currently in effect are:
o a forward treasury lock agreement with a notional amount of $75
million that terminates on December 31, 1998 and effectively locks
in the 30-year treasury rate can be used to price a future
long-term debt issue at 6.394%; and,
o a swap agreement with a notional amount of $75 million that
terminates on December 31, 1998 and carries a fixed rate of
6.793%.
Due to changing market conditions in the third quarter of 1998, these
agreements no longer qualify for hedge accounting treatment under GAAP.
Accordingly, ProLogis marked these agreements to market at September 30, 1998
and recognized a non-cash expense of $27.7 million (the mark to market
adjustment as of November 12, 1998 was $21.4 million).
15
<PAGE>
PROLOGIS TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
On December 22, 1997, ProLogis entered into two separate contracts to
(i) exchange $373.8 million for 2.9 billion Swedish krona, and (ii) exchange
310.0 million German marks for $175.0 million in anticipation of the January
1998 acquisition and planned European currency denominated financing of
Frigoscandia AB by Frigoscandia S.A., ProLogis' unconsolidated subsidiary. The
contracts were marked to market at December 31, 1997 and ProLogis recognized a
net loss of $6.0 million in 1997. Both contracts were settled during the first
quarter of 1998 and ProLogis recognized a net gain of $2.0 million. This gain is
recognized in the caption "Foreign exchange gains, net" in the Consolidated
Statements of Income and Comprehensive Income. These foreign exchange hedges
were one-time, non-recurring contracts that fixed the exchange rate between the
U.S. dollar and the Swedish krona and German mark. ProLogis executed these
hedges after the execution of the purchase agreement to acquire Frigoscandia AB,
which required payment in Swedish krona. The contracts were executed exclusively
for the acquisition and financing of Frigoscandia AB and were not entered into
to hedge on-going income in foreign currencies.
10. 1997 Merger Transaction:
On September 8, 1997, ProLogis' shareholders voted to approve an
agreement with Security Capital to exchange Security Capital's REIT management
and property management companies for 3,692,023 Common Shares (the "Merger"). As
a result, ProLogis became an internally managed REIT on September 9, 1997 with
Security Capital remaining as ProLogis' largest shareholder. The $81.9 million
value of the management companies was approved by the independent members of the
Board and a fairness opinion was obtained from a third party investment bank.
The number of shares issued to Security Capital was based on the average market
price of the Common Shares ($22.175) over the five-day period prior to the
August 6, 1997 record date for determining the ProLogis shareholders entitled to
vote on the Merger. The market value of the Common Shares issued to Security
Capital on September 9, 1997 was $79.8 million of which $4.4 million was
allocated to the net tangible assets acquired and the $75.4 million difference
was accounted for as costs incurred in acquiring the management companies from
an affiliate. For accounting purposes the management companies were not
considered "businesses" for purposes of applying APB Opinion No. 16, "Business
Combinations", and therefore the market value of the Common Shares issued in
excess of the fair value of the net tangible assets acquired was charged to
operating income rather than capitalized as goodwill.
As a result of the Merger, ProLogis terminated its REIT management and
property management agreements. All employees of the REIT management and
property management companies became employees of ProLogis and ProLogis directly
incurs the personnel and other costs related to these functions. The costs
relating to property management are recorded as rental expenses whereas the
costs associated with managing the REIT are recorded as general and
administrative expenses. Direct and incremental costs related to successful
development and leasing activities are capitalized in accordance with GAAP.
Upon consummation of the Merger, ProLogis and Security Capital entered
into an administrative services agreement (the "ASA"), pursuant to which
Security Capital provides ProLogis with certain administrative and other
services with respect to certain aspects of ProLogis' business, as selected from
time to time by ProLogis at its option. Fees payable to Security Capital under
the ASA are equal to Security Capital's cost of providing such services, plus an
overhead factor of 20%, subject to a maximum amount of approximately $7.1
million during the initial term of the agreement, which expires on December 31,
1998. From September 8, 1997 through September 30, 1998, ProLogis' actual fees
under the ASA were $3.8 million.
16
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Trustees and Shareholders
of ProLogis Trust:
We have reviewed the accompanying consolidated balance sheet of
ProLogis Trust and subsidiaries as of September 30, 1998, and the related
consolidated statements of income and comprehensive income for the three and
nine months ended September 30, 1998 and 1997, and the consolidated statements
of cash flows for the nine months ended September 30, 1998 and 1997. These
financial statements are the responsibility of the Trust's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications
that should be made to the financial statements referred to above for them to be
in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted
auditing standards, the consolidated balance sheet of ProLogis Trust and
subsidiaries as of December 31, 1997, and in our report dated March 13, 1998, we
expressed an unqualified opinion on that statement. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 1997, is fairly stated in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
ARTHUR ANDERSEN LLP
Chicago, Illinois
November 3, 1998
17
<PAGE>
ITEM 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following information should be read in conjunction with
ProLogis' 1997 Annual Report on Form 10-K as well as the unaudited
consolidated financial statements and notes included in Item 1 of this report.
See ProLogis' 1997 Annual Report on Form 10-K for a discussion of various risk
factors associated with forward-looking statements made in these documents.
Overview
ProLogis' operating results depend primarily on the operating results
of its distribution properties, which are substantially influenced by (i) the
demand for and supply of distribution properties in ProLogis' target market
cities; (ii) the pace and economic returns at which ProLogis can acquire and
develop additional distribution properties; (iii) the extent to which ProLogis
can sustain improved market performance as measured by lease rates and occupancy
levels; and, (iv) the demand for the corporate distribution facilities services
that are provided by ProLogis Development Services and ProLogis Kingspark. In
addition, the operating performance of ProLogis' two unconsolidated subsidiaries
that are engaged in the refrigerated distribution business effect ProLogis'
operating results.
ProLogis' target market cities and submarkets have benefited
substantially in recent periods from demographic trends (including population
and job growth) which influence the demand for distribution properties. ProLogis
believes its ability to compete is significantly enhanced relative to other
companies due to its depth of management and ability to serve customers through
the ProLogis Operating System(TM), which includes acquisition, development,
property management personnel and presence in local markets.
At September 30, 1998, ProLogis' real estate investments included 100.0
million square feet of operating properties with a total expected investment of
$3.2 billion. During the nine months ended September 30, 1998, ProLogis acquired
4.0 million square feet of operating properties at a total expected investment
of $144.0 million, while disposing of properties from its operating portfolio
aggregating 2.0 million square feet. For the nine months ended September 30,
1998, ProLogis recognized $10.5 million of other real estate income related to
the activities of ProLogis Development Services, primarily from the disposition
of undepreciated property.
ProLogis had 10.6 million square feet of properties under development
at September 30, 1998 with a total expected investment at completion of $427.3
million. Development starts during the nine months ended September 30, 1998
aggregated 9.3 million square feet at a total expected investment of $374.2
million. Development completions during this period aggregated 6.1 million
square feet at a total expected investment of $243.0 million. At September 30,
1998, ProLogis had 1,687 acres of land in inventory for the future development
of approximately 29.7 million square feet of distribution facilities.
Additionally, ProLogis has 866 acres of land under option and controls 457 acres
of land through letter of intent or contingent contract for the future
development of 21.7 million square feet of distribution facilities.
Through ProLogis' third quarter 1998 investment in Kingspark S.A.,
ProLogis had an additional 0.2 million square feet of properties under
development and 1.0 million square feet of properties being developed under
construction management agreements in the United Kingdom at September 30, 1998.
Additionally, ProLogis Kingspark owns 391 acres of land and controls 1,703 acres
of land through letter of intent or contingent contract for future development
of 36.6 million square feet of distribution facilities.
18
<PAGE>
In 1997, ProLogis began expanding its distribution facilities operations
into Europe and Mexico. This expansion was necessary to meet the needs of its
targeted national and international customers as they expand and reconfigure
their distribution facility requirements globally. With over 20 target market
cities identified in Europe and four target market cities identified in Mexico,
ProLogis believes significant growth opportunities exist internationally to
enable ProLogis to meet its objective of achieving long-term sustainable growth
in cash flow. At September 30, 1998 (excluding its investment in ProLogis
Kingspark), ProLogis owned 2.0 million square feet of operating properties with
a total expected investment of $104.8 million in Europe and 1.1 million square
feet of operating properties with a total expected investment of $41.0 million
in Mexico. Additionally, at September 30, 1998, ProLogis had 590,000 square feet
of properties under development in Europe with a total expected investment of
approximately $50.6 million and 1.0 million square feet of properties under
development in Mexico with a total expected investment of $42.2 million. To the
extent ProLogis' business activities outside the United States conducted are in
a currency other than the U.S. dollar, ProLogis is exposed to foreign currency
exchange rate fluctuations. However, all of ProLogis' business activities in
Mexico and Poland are transacted in the U.S. dollar.
At September 30, 1998, ProLogis' had approximately 288.1 million cubic
feet of refrigerated distribution facilities in operation (192.1 million cubic
feet located in Europe) through its investment in two unconsolidated
subsidiaries. At September 30, 1997, ProLogis had approximately 58.0 million
cubic feet of refrigerated distribution facilities in operation, all in the
United States.
No assurance can be given that the current cost of funds available to
ProLogis will be available in the future or that ProLogis will continue to be
able to obtain unsecured debt or equity financing in the public markets on
favorable terms. In recent months the real estate industry has experienced a
general tightening of the equity and credit markets. Additionally, no assurance
can be given that the expected trends in leasing rates and economic returns on
acquired and developed properties will be realized. There are risks associated
with ProLogis' development and acquisition activities which include future
factors such as development and acquisition opportunities explored by ProLogis
may be abandoned; construction costs of a project may exceed original estimates
due to increased materials, labor or other expenses; and construction and
lease-up may not be completed on schedule, resulting in increased debt service
expense and construction costs. Acquisition activities entail risks that
investments will fail to perform in accordance with expectations and that
analysis with respect to the cost of improvement to bring an acquired project up
to standards will prove inaccurate, as well as general investment risks
associated with any new real estate investment. Although ProLogis undertakes a
thorough evaluation of the physical condition of each proposed investment before
it is acquired, certain defects or necessary repairs may not be detected until
after it is acquired, which could increase ProLogis' total acquisition cost.
There are also risks associated with the hedging strategies used to manage
interest rate fluctuations on anticipated transactions. If these anticipated
transactions do not occur as planned, ProLogis could incur costs. Risks include
the occurrence of any of the events described above that could adversely affect
ProLogis' ability to achieve its projected returns on acquisitions and projects
under development and could hinder ProLogis' ability to make expected
distributions to equity holders.
Results of Operations
Nine Months Ended September 30, 1998 and 1997
Net earnings (loss) attributable to Common Shares increased by $58.7
million to $43.1 million for the first nine months of 1998 from a loss of $15.6
million for the same period in 1997. For a comparison of the three months ended
September 30, 1998 to the same period in 1997, see "--Three Months Ended
September 30, 1998 and 1997." The increase of $58.7 million resulted primarily
from:
19
<PAGE>
o an increase in net operating income from property operations
(after deductions for depreciation), primarily the result of the
increased number of distribution properties in operation in 1998
as compared to 1997;
o an increase in other real estate income, primarily gains on
dispositions of undepreciated properties and fees generated by
ProLogis Development Services;
o a one-time charge of $75.4 million incurred in September 1997 as a
result of the acquisition of the management companies from
Security Capital and the resulting reduction of expenses; and,
o a net foreign exchange gain recognized during 1998.
These increases in net earnings (loss) were partially offset by:
o a net decrease in income generated by ProLogis' unconsolidated
subsidiaries in 1998 from 1997, primarily due to the recognition
of a net foreign currency exchange loss by Frigoscandia S.A.; and,
o the recognition of a $27.7 million expense in the third quarter of
1998 as a result of mark to market adjustments related to two
interest rate protection agreements.
Interest expense, preferred share dividends and weighted-average Common
Shares outstanding all increased for the first nine months of 1998 as compared
to the first nine months of 1997, as additional debt and equity were used by
ProLogis to finance its increased acquisition and development activities.
Property Operations
At September 30, 1998 ProLogis had 1,074 operating properties totaling
100.0 million of rentable square feet, an increase of 12.7 million square feet
over September 30, 1997. This increase in operating properties resulted in an
increase in property-level net operating income of $41.8 million as follows (in
thousands):
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------
1998 1997
---------- -----------
<S> <C> <C>
Rental income............................................ $ 251,605 $ 208,919
Property operating expenses:
Rental expenses, net of recoveries....................... 20,458 15,709
Property management fees paid to affiliate............... -- 3,821
---------- -----------
Net operating income..................................... $ 231,147 $ 189,389
========== ===========
</TABLE>
Rental income increased by $42.7 million for the first nine months of
1998 as compared to the same period in 1997. This increase is comprised from the
following components:
o properties acquired or developed during the first nine months of
1998 contributed $2.2 million and $6.3 million of additional
rental revenues, respectively;
o properties acquired or developed during 1997 contributed $11.1
million and $16.9 million of additional rental revenues,
respectively;
o properties owned and operated at January 1, 1997 contributed $15.1
million of additional rental revenues; and,
20
<PAGE>
o properties that were in operation during the first nine months of
1997 but have subsequently been disposed of reduced rental
revenues for the first nine months of 1998 by $8.9 million. Of the
properties acquired or developed in 1997 and 1998, three have been
disposed of as of September 30, 1998.
Rental expenses, including property management fees paid to affiliate
in 1997, net of recoveries from tenants, increased $928,000 for the first nine
months of 1998 over the same period in 1997. Rental expenses, before the
deduction of amounts recovered from tenants, were 25% of rental income for the
nine-month period ended September 30, 1998 and 26% of rental income for the
nine-month period ended September 30, 1997.
As a result of the Merger discussed in Note 10 to the Consolidated
Financial Statements in Item 1, ProLogis no longer pays a property management
fee. However, ProLogis has recognized the actual personnel and other operating
costs associated with the property management function in rental expenses in
1998. See "--1997 Merger Transaction".
ProLogis frequently acquires properties that are underleased and
develops properties which are not fully leased at the start of construction,
which reduces ProLogis' overall occupancy rate below its stabilized level but
provides opportunities to increase revenues. The term "stabilized" means that
capital improvements, repositioning, new management and new marketing programs
(or development and marketing, in the case of newly developed properties) have
been completed and in effect for a sufficient period of time (but in no case
longer than 12 months for properties acquired by ProLogis and 12 months after
shell completion for properties developed by ProLogis) to achieve stabilized
occupancy (typically 93%). ProLogis has been successful in increasing
occupancies on acquired and developed properties during their initial months of
operation resulting in an occupancy rate of 94.98% and a leased rate of 95.86%
for stabilized properties owned at September 30, 1998. The average increase in
rental rates for new and renewed leases on previously leased space (25.0 million
square feet) during the first nine months of 1998 was 14.8%. As leases are
renewed or new leases are acquired, ProLogis expects most lease rates on
renewals or new leases to increase in the remainder of 1998.
Other Real Estate Income
Other real estate income consists primarily of gains on the disposition
of undepreciated properties and fees and other income received from corporate
distribution facilities customers. Other real estate income is generated
primarily by ProLogis Development Services. ProLogis Development Services
develops corporate distribution facilities to meet specific customer
requirements or contracts on a fee basis to develop distribution facilities for
customers. Through its preferred stock ownership of ProLogis Development
Services, ProLogis realizes substantially all economic benefits of these
activities. ProLogis advances mortgage loans to ProLogis Development Services to
fund its acquisition, development and construction activities. The activities of
ProLogis Development Services are consolidated with ProLogis' activities and all
intercompany balances are eliminated. Due to the timing of the completion of
these development projects and the related dispositions, other real estate
income recognized by ProLogis will vary on a quarterly basis.
Income (Loss) from Unconsolidated Subsidiaries
Income (loss) from unconsolidated subsidiaries relates primarily to
ProLogis' investments in 100% of the preferred stock of two companies, whose
primary source of income is their respective investments in refrigerated
distribution businesses, and in Kingspark S.A., which owns an industrial real
estate development company. These investments, discussed in Note 3 to the
Consolidated Financial Statements in Item 1, generated income as follows (in
thousands):
21
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Insight............................................................. $ 13 $ --
----------- -----------
ProLogis Logistics (a):
Equity in earnings (loss)...................................... (4,223) (1,091)
Management fee from CSI........................................ 1,011 422
Interest income on note receivable............................. 7,933 2,926
----------- -----------
4,721 2,257
----------- -----------
Frigoscandia S.A. (b):
Equity in earnings (loss) (c).................................. (18,735) --
Interest income on mortgage notes and notes receivable......... 14,753 --
----------- -----------
(3,982) --
----------- -----------
Kingspark S.A. (d):
Equity in earnings (loss)...................................... (76) --
Interest income on mortgage note and note receivable........... 1,254 --
----------- -----------
1,178 --
----------- -----------
Total .................................................. $ 1,930 $ 2,257
=========== ===========
- -----------------
<FN>
(a) ProLogis Logistics was acquired on April 24, 1997.
(b) Frigoscandia S.A. was acquired on January 16, 1998.
(c) Frigoscandia S.A.'s loss for the nine months ended September 30, 1998
includes $8.0 million of net losses on the remeasurement of intercompany
and other debt based on the foreign exchange rates as of September 30,
1998.
(d) Kingspark S.A. was acquired on August 14, 1998.
</FN>
</TABLE>
Foreign Exchange Gain
The foreign exchange gain for the nine months ended September 30, 1998
consists of a gain of $2.0 million associated with forward exchange contracts, a
gain of $3.4 million related to remeasurement adjustments and a transaction loss
of $0.1 million.
On December 22, 1997, ProLogis entered into two separate contracts to
(i) exchange $373.8 million for 2.9 billion Swedish krona, and (ii) exchange
310.0 million German marks for $175.0 million in anticipation of the January
1998 acquisition and planned European currency denominated financing of
Frigoscandia AB by Frigoscandia S.A., ProLogis' unconsolidated subsidiary. The
contracts were marked to market at December 31, 1997 and ProLogis recognized a
net loss of $6.0 million in 1997. Both contracts were settled during the first
quarter of 1998 and ProLogis recognized a net gain of $2.0 million. This gain is
recognized in the caption "Foreign exchange gains net" in the Consolidated
Statements of Income and Comprehensive Income. These foreign exchange hedges
were one-time, non-recurring contracts that fixed the exchange rate between the
U.S. dollar and the Swedish krona and German mark. ProLogis executed these
hedges after the execution of the purchase agreement to acquire Frigoscandia AB,
which required payment in Swedish krona. The contracts were executed exclusively
for the acquisition and financing of Frigoscandia AB and were not entered into
to hedge on-going income in foreign currencies.
22
<PAGE>
Interest Income
Interest income for the first nine months of 1998 increased $592,000
from the same period in 1997. The increase in interest income was primarily a
result of higher average cash balances in the first nine months of 1998 compared
to the same period in 1997.
Depreciation and Amortization
The increase in depreciation and amortization expense of $15.4 million
for the nine months ended September 30, 1998 as compared to the same period in
1997 results primarily from the increase in operating properties in 1998. See
"--Property Operations".
Interest Rate Hedge Expense
See "--Liquidity and Capital Resources--Derivative Financial
Instruments" for a discussion of this expense.
Interest Expense
Interest expense is summarized as follows (in thousands):
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Line of credit.......................................... $ 10,709 $ 3,163
Long-term debt.......................................... 48,602 40,759
Mortgage notes payable.................................. 4,058 4,061
Securitized debt........................................ 2,154 2,285
Assessment bonds payable................................ 1,746 1,783
Capitalized interest.................................... (14,814) (12,863)
----------- -----------
$ 52,455 $ 39,188
=========== ===========
</TABLE>
Interest expense on line of credit borrowings increased $7.5 million
for the first nine months of 1998 over the same period in 1997 due primarily to
a higher average outstanding balance ($208.6 million in 1998 compared to $54.7
million in 1997) partially offset by a lower weighted-average daily interest
rate (6.56% in 1998 compared to 6.74% in 1997). Of the interest expense incurred
in 1998, $2.7 million related to $200 million of short-term borrowings
associated with the Frigoscandia AB acquisition in the first quarter of 1998,
which was repaid on March 31, 1998. See "--Liquidity and Capital Resources
- --Investing and Financing Activities".
Long-term debt interest increased by $7.8 million for the nine months
ended September 30, 1998 as compared to the nine months ended September 30, 1997
due primarily to interest incurred in 1998 on the $100 million long-term debt
issuance in July 1997 and the $250 million long-term debt issuance in July 1998.
Interest expense recognized on borrowings is offset by interest
capitalized with respect to ProLogis' development activities. Capitalized
interest increased by $2.0 million in the first nine months of 1998 over the
first nine months of 1997. Capitalized interest levels are reflective of
ProLogis' cost of funds and the level of development activity. The increase in
capitalized interest is due to increased development activity during the first
nine months of 1998.
23
<PAGE>
Other Expense
Other expenses, which increased by $1.9 million for the nine months
ended September 30, 1998 over the nine months ended September 30, 1997, consist
of land holding costs, the write-off of previously capitalized pursuit costs and
costs associated with name change to ProLogis. Land holding costs were $1.7
million for the first nine months of 1998 compared to $1.5 million for the same
period in 1997. Pursuit cost write-offs were $0.9 million for the first nine
months of 1998 as compared to $0.7 million for the same period in 1997.
Non-recurring costs associated with the name change in 1998 were $1.5 million.
Preferred Share Dividends
The increase in preferred share dividends of $9.1 million for the nine
months ended September 30, 1998 over the same period in 1997 is primarily
attributable to the issuance of Series D Preferred Shares in April 1998. See
"--Liquidity and Capital Resources--Investing and Financing Activities".
1997 Merger Transaction
As a result of the Merger discussed in Note 10 to the Consolidated
Financial Statements in Item 1, ProLogis terminated its REIT management and
property management agreements. All employees of the REIT management and
property management companies became employees of ProLogis and ProLogis directly
incurs the personnel and other costs related to these functions. The costs
relating to property management are recorded as rental expenses whereas the
costs associated with managing the REIT are recorded as general and
administrative expenses. During the period from September 8, 1997 to March 30,
1998, direct and incremental costs related to successful acquisition,
development and leasing activities were capitalized in accordance with GAAP.
Effective April 1, 1998, ProLogis no longer capitalizes any costs associated
with acquisition activities.
Upon consummation of the Merger, ProLogis and Security Capital entered
into an administrative services agreement (the "ASA"), pursuant to which
Security Capital provides ProLogis with certain administrative and other
services with respect to certain aspects of ProLogis' business, as selected from
time to time by ProLogis at its option. Fees payable to Security Capital under
the ASA are equal to Security Capital's cost of providing such services, plus an
overhead factor of 20%, subject to a maximum amount of approximately $7.1
million during the initial term of the agreement, which expires on December 31,
1998. From September 8, 1997 through September 30, 1998, ProLogis actual fees
under the ASA were $3.8 million. Total ASA fees for the nine months ended
September 30, 1998 aggregated $2.7 million, including $682,000 that has been
recognized as rental expenses. Of the total ASA fees, $459,000 have been
capitalized. The ASA, which expires on December 31, 1998, provides for automatic
renewals of consecutive one-year terms, subject to approval by a majority of the
independent members of the Board.
In connection with this transaction, ProLogis recognized a one-time
expense of $75.4 million, representing the excess of the purchase price over the
net tangible assets acquired.
24
<PAGE>
Three Months Ended September 30, 1998 and 1997
ProLogis had a net loss attributable to Common Shares for the three
months ended September 30, 1998 of $8.3 million as compared to a loss of $55.4
million for the same period in 1997. The losses recognized were primarily
attributable to large, non-operating expenses recognized in both three-month
periods, which are discussed are above. The components of the Net Loss
Attributable to Common Shares for the three months ended September 30, 1998
compared to three months ended September 30, 1997 reflect changes similar to
those discussed in the preceding paragraphs for comparison of the nine months
ended on the same dates. The changes for the three-month periods are
substantially attributable to the same reasons discussed in the preceding
paragraphs.
Liquidity and Capital Resources
Overview
ProLogis considers its liquidity and ability to generate cash from
operations and financing to be adequate and expects it to continue to be
adequate to meet its anticipated development, acquisition, operating and debt
service needs as well as its shareholder distribution requirements.
ProLogis expects to finance future activities with cash on hand,
redeployment of proceeds from the disposition of selected properties, borrowings
on its credit facilities, issuance of limited partnership units, the assumption
of existing mortgage debt, when applicable, entering into securitized debt
agreements, secured and unsecured debt issuances and sales of Common Shares and
preferred shares. ProLogis is also considering the feasibility of entering into
certain joint venture agreements where the joint venture would pursue
securitized debt financing arrangements. The credit facilities provide ProLogis
with the ability to efficiently respond to market opportunities while minimizing
the amount of cash invested in short-term investments at lower yields. At
September 30, 1998 ProLogis had $215.5 million available for borrowing under its
credit facilities ($238.4 million available at November 12, 1998). Another
source of future liquidity and financial flexibility is ProLogis'
shelf-registered securities ($608 million available at November 12, 1998) which
can be issued 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, subject to ProLogis' ability to effect an offering on
satisfactory terms.
Operating Activities
Cash provided by operating activities increased by $34.3 million during
the first nine months of 1998 as compared to the first nine months of 1997
($174.3 million in 1998 and $140.0 million in 1997). This increase is primarily
the result of the increased number of operating properties in 1998 over 1997.
See "--Results of Operations--Property Operations".
Investing and Financing Activities
ProLogis funds its current investment needs primarily with line of
credit borrowings, which are subsequently repaid with proceeds from sales of
debt and equity securities. ProLogis' investment activities used approximately
$915.8 million and $338.1 million of cash during the first nine months of 1998
and 1997, respectively. ProLogis' financing activities provided net cash flow of
$748.1 million and $240.3 million during the first nine months of 1998 and 1997,
respectively. Cash distributions paid on Common Shares were $111.8 million and
$77.5 million for the nine months ended September 30, 1998 and 1997,
respectively, which have been substantially funded by cash generated from
operating activities.
25
<PAGE>
Investments in real estate, net of proceeds from dispositions, used
cash of $469.5 million during the first nine months of 1998 and $296.3 million
during the first nine months of 1997. ProLogis' cash investment in ProLogis
Logistics and related subsidiaries was $60.7 million during the first nine
months of 1998 and $41.3 million during the first nine months of 1997. During
1998, ProLogis' net cash investment in Frigoscandia S. A. and its related
subsidiaries and Kingspark S.A. and its related subsidiaries aggregated $231.9
million and $152.7 million, respectively. Additionally, ProLogis Development
Services invested $1.0 million and $0.5 million in cash in Insight during the
nine months ended September 30, 1998 and 1997, respectively.
ProLogis' primary financing activities in the first nine months of 1998
were: (i) the sale of Series D Preferred Shares generating net proceeds of
$241.7 million; (ii) sales of Common Shares (net of repurchases of Common Shares
under the employee share purchase plan) generating net proceeds of $130.7
million; (iii) net borrowings on ProLogis' credit facilities of $309.5 million;
(iv) proceeds from a short-term loan from NationsBank of $200 million (used
primarily to finance the acquisition of Frigoscandia AB), which was repaid on
March 31, 1998 after Frigoscandia Holding AB obtained third-party financing;
and, (v) the issuance of long-term debt securities generating net proceeds of
$247.6 million.
ProLogis' primary financing activities during the first nine months of
1997 were: (i) the issuance of long-term debt generating net proceeds of $199.5
million; (ii) sales of Common Shares (net of repurchases of Common Shares under
the employee share purchase plan) generating net proceeds of $206.1 million;
and, (iii) net repayments on ProLogis' credit facilities of $38.6 million.
On July 20, 1998, ProLogis completed a $250 million offering of debt
securities due July 15, 2006 with an interest rate of 7.05%. The securities were
issued at a discount resulting in a yield to maturity of 7.08%. Net proceeds
from the offering were approximately $247.6 million, net of underwriters'
commissions and other costs. The proceeds were used to repay borrowings on
ProLogis' credit facilities.
On October 9, 1998, ProLogis issued $125 million of debt securities due
October 1, 2003 with an interest rate of 7.0%. The securities were issued at par
value. Net proceeds from the offering were approximately $124.0 million, net of
underwriters' commissions and other costs. The proceeds were used to repay
borrowings on ProLogis' credit facilities.
Short-term Borrowings
On August 11, 1998, ProLogis entered into an amended and restated
credit agreement with NationsBank that provides for a $350 million unsecured
revolving line of credit. The new agreement, which replaced the credit agreement
in effect at June 30, 1998, provides for interest at ProLogis' option, at either
(a) the greater of the federal funds rate plus 0.5% and the prime rate, or (b)
LIBOR plus 0.75% based upon ProLogis' current senior debt ratings. In addition,
ProLogis pays certain annual fees. Under a competitive bid option contained in
the new line of credit agreement, ProLogis may be able to borrow at a lower
interest rate spread over LIBOR, depending on market conditions. This option is
available on up to $100 million of borrowings. The line of credit matures on May
1, 2000 and may be extended annually for an additional year with the approval of
NationsBank and the other participating lenders. All borrowings on the line of
credit are subject to certain covenants similar to those contained in the
previous line of credit agreement.
In addition, ProLogis has a $25 million short-term, unsecured
discretionary line of credit with NationsBank that provides for additional
flexibility through same day borrowings and more efficient cash management.
26
<PAGE>
ProLogis entered into a credit agreement with NationsBank on September
11, 1998. The agreement provides for a term loan of $150.0 million due November
30, 1998. Borrowings on the term loan bear interest at LIBOR plus 0.90% and are
subject to the covenants contained in the amended and restated credit agreement
with NationsBank. At September 30, 1998, ProLogis was in compliance with all
such covenants.
Derivative Financial Instruments
ProLogis only enters into a limited number of derivative instruments,
all in connection with specific financing transactions. ProLogis utilizes
derivative financial instruments to manage well-defined interest rate risk and
not for trading purposes. Through hedging, ProLogis can effectively manage the
risk of increases in interest rates on future debt issuances. In October 1997,
in anticipation of debt offerings in 1998, ProLogis entered into two interest
rate protection agreements which have been renewed past the original termination
dates. These agreements were entered into by ProLogis to fix the interest rate
on expected financings. The intent was not to speculate on interest rates, but
to arrange acceptable financing terms prior to the anticipated transaction.
The agreements currently in effect are:
o a forward treasury lock agreement with a notional amount of $75
million that terminates on December 31, 1998 and effectively locks
in the 30-year treasury rate that can be used to price a future
long-term debt issue at 6.394%; and,
o a swap agreement with a notional amount of $75 million that
terminates on December 31, 1998 and carries a fixed rate of
6.793%.
Due to changing markets conditions in third quarter of 1998, these
agreements no longer qualify for hedge accounting treatment under GAAP.
Accordingly, ProLogis marked these agreements to market at September 30, 1998
and recognized a non-cash expense of $27.7 million (the mark to market
adjustment as of November 12, 1998 was $21.4 million). For purposes of
calculating funds from operations, ProLogis intends to defer this expense and
amortize it as a component of interest expense over the term of a future debt
offering. See "--Funds from Operations".
ProLogis intends to also utilize derivative instruments in order to
manage currency risk exposure associated with foreign currency denominated
purchase contracts, and is analyzing the benefits of utilizing derivatives
financial instruments in order to manage currency risk exposure associated with
foreign currency denominated income in excess of foreign currency denominated
interest expense.
ProLogis had no open foreign currency contracts as of September 30,
1998.
Commitments
At September 30, 1998, ProLogis had letters of intent or contingent
contracts, subject to ProLogis' final due diligence, for the acquisition of 10.8
million square feet in various target markets with an acquisition cost of $532.1
million. Through October 31, 1998, ProLogis had completed the acquisition of
171,000 square feet at an acquisition cost of $7.7 million of properties subject
to these contingent contracts. The foregoing transactions are subject to a
number of conditions, and ProLogis cannot predict with certainty that any of
them will be consummated. In addition, at September 30, 1998, ProLogis had
$429.4 million of budgeted development cost for developments in process, of
which $210.8 million was unfunded.
27
<PAGE>
Frigoscandia AB has a multi-currency, three-year revolving credit
agreement through a consortium of 11 European banks in the currency equivalent
of approximately $200 million. The loan bears interest at each currency's LIBOR
rate plus 0.55%. ProLogis has entered into a guaranty agreement for 25% of the
loan balance.
ProLogis' current distribution policy is to pay quarterly distributions
to shareholders based upon what it considers to be a reasonable percentage of
cash flow and at the level that will allow ProLogis to continue to qualify as a
REIT for tax purposes. Because depreciation is a non-cash expense, cash flow
typically will be greater than earnings from operations and net earnings.
Therefore, quarterly distributions are expected to be consistently higher than
quarterly earnings.
Pursuant to the terms of the Series A Preferred Shares, the Series B
Preferred Shares, the Series C Preferred Shares and the Series D Preferred
Shares (the "Preferred Shares"), ProLogis is restricted from declaring or paying
any distribution with respect to the Common Shares unless all cumulative
distributions with respect to the Preferred Shares have been paid and sufficient
funds have been set aside for distributions that have been declared for the then
current distribution period with respect to the Preferred Shares.
Conversion to the Euro
Effective January 1, 1999, eleven of the fifteen member countries of
the European Monetary Union will launch the new monetary unit, the euro, as the
single currency for the European community. During the period from January 1,
1999 to January 1, 2002 a transition period will be in effect during which time
the euro will be available for non-cash transactions. However, transactions can
continue to be denominated in the old national currencies. After January 1,
2002, all transactions must be denominated in the euro. The targeted exchange
rates of the old national currencies to the euro were determined in May 1998.
Management is not aware of any effects of the conversion to the euro that will
have a material impact on its business operations or results of operations.
Funds from Operations
Funds from operations attributable to Common Shares increased $55.6
million to $171.1 million for the first nine months of 1998 from $115.5 million
for the same period in 1997.
Funds from operations represent ProLogis' net earnings (computed in
accordance with GAAP) before minority interest, before gains or losses from debt
restructuring, before gains or losses on disposition of depreciated real estate,
before gains or losses from mark to market adjustments resulting from the the
remeasurement (based on current foreign currency exchange rates) of intercompany
and other debt of ProLogis' foreign subsidiaries, before deferred tax benefits
and deferred tax expenses of ProLogis' taxable subsidiaries, before significant
non-recurring items that materially distort the comparative measurement of
company performance over time, plus real estate depreciation and amortization
(exclusive of amortization of loan costs), and after adjustments for
unconsolidated subsidiaries calculated to compute their funds from operations on
the same basis as ProLogis. ProLogis believes that funds from operations is
helpful to a reader as a measure of the performance of an equity REIT because,
along with cash flow from operating activities, financing activities and
investing activities, it provides a reader with an indication of the ability of
ProLogis to incur and service debt, to make capital expenditures and to fund
other cash needs. The funds from operations measure presented by ProLogis, while
consistent with the National Association of Real Estate Investment Trusts'
definition, will not be comparable to similarly titled measure of other REITs
which do not compute funds from operations in a manner
28
<PAGE>
consistent with ProLogis. Funds from operations is not intended to represent
cash made available to shareholders. Funds from operations should not be
considered as an alternative to net earnings or any other GAAP measurement of
performance as an indicator of ProLogis' operating performance, or as an
alternative to cash flows from operating, investing or financing activities as a
measure of liquidity. Funds from operations were as follows (in thousands):
<TABLE>
<CAPTION>
Nine Months Ended,
September 30,
-------------------------------
1998 1997
------------- -------------
<S> <C> <C>
Net earnings (loss) attributable to Common Shares........................ $ 43,088 $ (15,578)
Add (Deduct):
Real estate depreciation and amortization....................... 72,902 58,184
Minority interest .............................................. 3,101 2,763
Gain on disposition of depreciated real estate.................. (4,278) (6,529)
Non-recurring foreign currency exchange gain (a)................ (2,054) --
Interest rate hedge expense (b)................................. 27,652 --
Net foreign exchange gain on remeasurement of
intercompany debt (a)...................................... (3,417) --
Non-recurring costs (c)......................................... 1,452 75,376
ProLogis' share of reconciling items of unconsolidated subsidiaries:
Real estate depreciation and amortization.................. 26,668 1,263
Net foreign currency exchange loss on
remeasurement of intercompany and other debt........... 8,046 --
Deferred income tax benefit................................ (2,759) --
Other...................................................... 747 --
------------- -------------
Funds from operations attributable to Common Shares...................... $ 171,148 $ 115,479
============= =============
<FN>
- ---------------
(a) See "--Results of Operations - Foreign Currency Gain".
(b) See "--Derivative Financial Instruments".
(c) See "--Results of Operations - Other Expense" with respect to the 1998
amount and "--Results of Operations - 1997 Merger Transaction" with respect
to the 1997 amount.
</FN>
</TABLE>
Year 2000
Overview
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Certain
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar business activities.
29
<PAGE>
ProLogis has undertaken a review of all of its computer systems and
applications to determine if these programs are Year 2000 compliant and if not,
the efforts that will be necessary to bring the programs into compliance.
ProLogis has not identified any computer system or applications that, upon
failure to be Year 2000 compliant, would have a material adverse impact on its
business or results of operations.
Information Technology Systems
ProLogis' information technology ("IT") environment is primarily a
Microsoft Windows-based personal computer network (NT or Novell) utilizing
desktop applications, primarily data base and spreadsheet applications.
Additionally, ProLogis utilizes third-party developed software, including
accounting and property management systems. ProLogis' critical computer
hardware, operating systems and key general accounting, property management and
financial reporting applications are Year 2000 compliant, as verified by the
various vendors. ProLogis has identified one accounting application that is not
Year 2000 compliant.
Because ProLogis has undertaken to replace its core financial systems
with computer software that will better serve its future needs (such software is
Year 2000 compliant), it is not expected that the non-compliant accounting
application will continue to be used by ProLogis after mid-1999. Should the
enterprise-wide implementation of the new computer software not be accomplished
in a timely manner and the non-compliant accounting application is still in use
at the end of 1999, ProLogis has two contingency plans. The first option is to
install a Year 2000 compliant version of the current software that the vendor
has indicated will be available in 1999. Secondly, ProLogis can, with minimal
efforts, convert this application to the Year 2000 compliant software currently
in use for all other accounting applications.
Non-IT Systems
Many of ProLogis' operating properties have microchips embedded in the
building operating systems. ProLogis, as owner and lessor of these buildings,
has assessed its exposure with respect to Year 2000 related failures in these
operating systems. These building operating systems include programmable
thermostats, security systems, communications systems, utility monitoring
systems and timed locks.
Under the terms of substantially all of ProLogis' building leases, the
tenant has responsibility for the operating systems within their leased space,
including the responsibility for addressing the Year 2000 compliance of those
systems. However, ProLogis is responsible for the operating systems that control
the common exterior areas of the buildings, including parking lot lighting and
sprinkler systems. Generally, these systems are programmed on daily or weekly
cycles (as opposed to calendar-based programming). Consequently, the risk of a
Year 2000 related malfunction is extremely low and any such malfunction would
not have a material impact on ProLogis' operations. ProLogis is also responsible
for the fire and life safety monitoring systems in its buildings. ProLogis
contracts with a third party to monitor these systems. These systems are not
calendar-based, because reportable events are identified as they occur.
Consequently, the risk of a Year 2000 related failure is low.
ProLogis is currently conducting a review of all operating systems that
fall within its responsibility. Preliminary results have indicated that
ProLogis' primary vendor for monitoring of fire and life safety systems has
verified that their system is Year 2000 compliant. ProLogis is continuing its
review of other systems and performing testing and verification as deemed
appropriate. This process is expected to be completed during the first quarter
of 1999. Based upon the results of this review, ProLogis will formulate a
contingency plan to address risk areas identified, if any.
30
<PAGE>
Third Parties
Management believes that its planning efforts are adequate to address
the Year 2000 issue and that its risk factors are primarily those that it cannot
directly control, including the readiness of financial institutions and utility
providers. Failure on the part of these entities to become Year 2000 compliant
could result in disruptions in certain business operations of ProLogis.
Costs
ProLogis' activities with respect to its assessment of Year 2000
compliance and its remediation efforts are being performed by existing
personnel. ProLogis has not obtained a cost estimate for upgrading the
accounting application referred to above, as the need for this contingency plan
is not considered probable at this time. ProLogis' historical costs for
addressing the Year 2000 issue are not material and management does not
anticipate that its future costs associated with the Year 2000 issue will be
material. Third-party costs and interim software solutions for Year 2000 issues
have been less than $40,000 and are not expected to exceed $250,000. ProLogis
does not separately track the internal costs incurred for Year 2000 compliance
issues. Such costs are principally the related payroll costs of its information
technology group. Although the cost of replacing ProLogis' key IT systems is
substantial, the replacements have been and are being made to improve
operational efficiency and were not accelerated due to the Year 2000 issue.
ProLogis has not delayed any material projects as a result of the Year 2000
issue. Funds expended to address Year 2000 issues have been made from operating
cash flow.
Unconsolidated Subsidiaries
As part of its compliance program, management of ProLogis has received
ongoing reports from CSI, Frigoscandia AB and ProLogis Kingspark on the impact
of the Year 2000 problems on their operations and financial results.
CSI has completed testing on all IT and embedded operating systems. No
critical IT or embedded operating systems have been identified that have not
already been remediated or are not Year 2000 compliant, with the exception of
CSI's payroll processing applications. Management of CSI intends to use the
payroll services offered by Security Capital through an administrative services
agreement to solve this problem. Security Capital's payroll processing systems
are Year 2000 compliant. CSI also has retained an outside consulting firm to
confirm their internal testing results. The consultants review is expected to be
completed during the first quarter of 1999. CSI estimates that the total cost
incurred to date and estimated cost to be incurred for Year 2000 remediation is
less than $200,000.
Frigoscandia AB has substantially completed all testing of its IT and
embedded operating systems. No critical IT or embedded operating systems have
been identified that have not already been remediated, with the exception of the
financial reporting application for its French operations and certain components
of an inventory management system. A new financial reporting system for the
French operations is being implemented and is expected to be fully operational
by February 1999. Modifications to the components of the inventory management
system will be completed in the first quarter of 1999.
Frigoscandia AB has retained an outside consulting firm to confirm
their internal testing results. The consultants' review is expected to be
completed during the first quarter of 1999. Frigoscandia AB estimates that the
total cost incurred to date and estimated to be incurred for Year 2000
remediation is between $2 million and $4 million.
31
<PAGE>
Pursuant to the due diligence analysis performed during ProLogis'
acquisition of ProLogis Kingspark, ProLogis determined that the primary
accounting applications of ProLogis Kingspark are not Year 2000 compliant. To
remediate this problem, ProLogis Kingspark plans to install a Year 2000
compliant version of non-customized accounting software that is available for
immediate implementation. The maximum time period for installation of this
product is estimated to be three months.
ProLogis Kingspark has virtually no risk associated with embedded
operating systems because substantially all of ProLogis Kingspark activities are
related to development of properties for third parties and not for its own
long-term ownership. ProLogis Kingspark estimates that the total cost incurred
to date and estimated cost to be incurred for the Year 2000 remediation is less
than $250,000.
There can be no assurances that Year 2000 remediation efforts by
ProLogis, its unconsolidated subsidiaries or third parties will be properly and
timely completed, and failure to do so could have a material adverse effect on
ProLogis, its business and its financial condition. ProLogis cannot predict the
actual effects to it of the Year 2000 problem, which depends on numerous
uncertainties such as: (i) whether significant third parties properly and timely
address the Year 2000 issue; and, (ii) whether broad-based or systemic economic
failures may occur. Due to the general uncertainty inherent in the Year 2000,
ProLogis is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on its operations. ProLogis' Year
2000 compliance program is expected to significantly reduce the level of
uncertainty about the Year 2000 impact in areas that are within its direct
control and management of ProLogis believes that the possibility of
significant interruptions of normal operations will be reduced.
32
<PAGE>
PART II--OTHER INFORMATION
Item 4. Submission of Matters to Vote of Securities Holders
Not applicable.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
12.1 Computation of Ratio of Earnings to Fixed Charges
12.2 Computation of Ratio of Earnings to Combined Fixed
Charges and Preferred Share Dividends
15.2 Letter from Arthur Andersen LLP regarding unaudited
financial information dated November 3, 1998
27 Financial Data Schedule
(b) Reports on Form 8-K:
None.
33
<PAGE>
SIGNATURES
Pursuant to the requirements 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 TRUST
------------------------------
/s/ M. GORDON KEISER
M. Gordon Keiser
Senior Vice President
(Principal Financial Officer)
------------------------------
/s/ EDWARD F. LONG
Edward F. Long
Vice President and Controller
-------------------------------
/s/ SHARI J. JONES
Shari J. Jones
Vice President
(Principal Accounting Officer)
Date: November 13, 1998
34
<PAGE>
EXHIBIT 12.1
PROLOGIS TRUST
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, Year Ended December 31,
------------------ -----------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- ------- -------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Earnings from Operations $ 74,353 $ 4,381 $32,371 $ 79,384 $47,660 $25,066 $4,412
Add:
Interest Expense 52,455 39,188 52,704 38,819 32,005 7,568 321
-------- ------- ------- -------- ------- ------- ------
Earnings as Adjusted $126,808 $43,569 $85,075 $118,203 $79,665 $32,634 $4,733
======== ======= ======= ======== ======= ======= ======
Fixed Charges:
Interest Expense $ 52,455 $39,188 $52,704 $ 38,819 $32,005 $7,568 $ 321
Capitalized Interest 14,814 12,863 18,365 16,138 8,599 2,208 98
-------- ------- ------- -------- ------- ------ ------
Total Fixed Charges $ 67,269 $52,051 $71,069 $ 54,957 $40,604 $9,776 $ 419
======== ======= ======= ======== ======= ====== ======
Ratio of Earnings to Fixed Charges 1.9 (a) 1.2 2.2 2.0 3.3 11.3
======== ======= ======= ======== ======= ====== ======
<FN>
(a) Due to a one-time charge related to the costs of $75.4 million incurred
upon acquiring the management companies from a relted party, earnings were
insufficient to cover fixed charges for the nine months ended September 30,
1997 by $8.5 million.
</FN>
</TABLE>
<PAGE>
EXHIBIT 12.2
PROLOGIS TRUST
COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED
CHARGES AND PREFERRED SHARE DIVIDENDS
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, Year Ended December 31,
------------------ ------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- -------- -------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Earnings from Operations $ 74,353 $ 4,381 $ 32,371 $ 79,384 $47,660 $25,066 $4,412
Add:
Interest Expense 52,455 39,188 52,704 38,819 32,005 7,568 321
-------- ------- -------- -------- ------- ------- ------
Earnings as Adjusted $126,808 $43,569 $ 85,075 $118,203 $79,665 $32,634 $4,733
======== ======= ======== ======== ======= ======= ======
Combined Fixed Charges and
Preferred Share Dividends:
Interest Expense $ 52,455 $39,188 $ 52,704 $ 38,819 $32,005 $7,568 $ 321
Capitalized Interest 14,814 12,863 18,365 16,138 8,599 2,208 98
-------- ------- -------- -------- ------- ------ ------
Total Fixed Charges $ 67,269 $52,051 $ 71,069 $ 54,957 $40,604 $9,776 $ 419
Preferred Share Dividends (a) 35,543 26,488 35,318 25,895 6,698 - -
-------- ------- -------- -------- ------- ------ ------
Combined Fixed Charges and
Preferred Share Dividends $102,812 $78,539 $106,387 $ 80,852 $47,302 $9,776 $ 419
======== ======= ======== ======== ======= ====== ======
Ratio of Earnings to Combined
Fixed Charges and Preferred
Share Dividends 1.2 (b) (b) 1.5 1.7 3.3 11.3
======== ======= ======== ======== ======= ====== ======
<FN>
(a) ProLogis had no preferred shares prior to 1995.
(b) Due to a one-time, charge of $75.4 million relating to the costs incurred
in acquiring the management companies from a related party, earnings
were insufficient to cover combined fixed charges and preferred
dividends for the nine months ended September 30, 1997 by $35.0 milllion
and for the year ended December 31, 1997 by $21.3 million.
</FN>
</TABLE>
<PAGE>
EXHIBIT 15.2
November 3, 1998
Board of Trustees and Shareholders
of ProLogis Trust:
We are aware that ProLogis Trust has incorporated by reference in its
Registration Statement Nos. 33-91366, 33-92490, 333-4961, 333-31421, 333-39797,
333-38515, 333-52867 and 333-26597 its Form 10-Q for the quarter ended September
30, 1998, which includes our report dated November 3, 1998 covering the
unaudited interim financial information contained therein. Pursuant to
Regulation C of the Securities Act of 1933 (the "Act"), that report is not
considered a part of the registration statements prepared or certified by our
firm or a report prepared or certified by our firm within the meaning of
Sections 7 and 11 of the Act.
Very truly yours,
ARTHUR ANDERSEN LLP
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 31,650
<SECURITIES> 0
<RECEIVABLES> 543,404
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 3,483,817
<DEPRECIATION> 231,526
<TOTAL-ASSETS> 3,924,128
<CURRENT-LIABILITIES> 0
<BONDS> 1,093,120
0
679,925
<COMMON> 1,231
<OTHER-SE> 1,633,096
<TOTAL-LIABILITY-AND-EQUITY> 3,924,128
<SALES> 251,605
<TOTAL-REVENUES> 271,560
<CGS> 0
<TOTAL-COSTS> 20,458
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 52,590
<INCOME-PRETAX> 43,088
<INCOME-TAX> 0
<INCOME-CONTINUING> 43,088
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 43,088
<EPS-PRIMARY> 0.36
<EPS-DILUTED> 0.35
</TABLE>
